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| CERP > SEC Filings for CERP > Form 10-K on 16-Apr-2012 | All Recent SEC Filings |
16-Apr-2012
Annual Report
OVERVIEW
General
We have developed and are commercializing proprietary bio-based resins through two complementary product families: (1) Cereplast Compostables® resins, which are compostable and bio-based, ecologically sound substitutes for traditional petroleum-based non-compostable plastics, and (2) Cereplast Sustainables™ resins, which replace up to 90% of the petroleum-based content of traditional plastics with materials from renewable resources. Our resins aim to be competitively priced compared to fully petroleum-based plastic resins and can be converted into finished products using conventional manufacturing equipment without significant additional capital investment by downstream converters.
The demand for non-petroleum based, clean and renewable sources for materials, such as bioplastics, and the demand for compostable/biodegradable products, is each being driven globally by a variety of factors, including environmental concerns, new stringent regulations on compostable material, fossil fuel price volatility and energy security. These factors have led to increased spending on clean and sustainable products by corporations and individuals as well as legislative initiatives at the local and state level.
We are a full-service resin solution provider uniquely positioned to capitalize on the rapidly increasing demand for sustainable and environmentally friendly alternatives to traditional plastic products.
We primarily conduct our operations through two product families:
• Cereplast Compostables® resins are compostable and bio-based, ecologically sound substitutes for petroleum-based plastics targeting primarily compostable bags, single-use food service products and packaging applications. We offer 13 commercial grades of Compostable resins in this product line. These resins are compatible with existing manufacturing processes and equipment making them a ready substitute for traditional petroleum-based resins. We commercially introduced our Compostable line in November 2006.
• Cereplast Sustainables™ resins are partially or fully bio-based, ecologically sound substitutes for fully petroleum-based plastics targeting primarily durable goods, packaging applications. We offer six commercial grades of Sustainable resins in this product line. These resins are compatible with existing manufacturing processes and equipment, making them a ready substitute for traditional petroleum-based resins. We commercially introduced our Sustainable line in late 2007 under the name "Cereplast Hybrid Resins®."
• Cereplast Hybrid Resins® products replace up to 55% of the petroleum content in conventional plastics with bio-based materials such as industrial starches sourced from plants. The Hybrid resins line is designed to offer similar properties to traditional polyolefins such as impact strength and heat deflection temperature, and is compatible with existing converter processes and equipment. The Cereplast Hybrid Resins® line provides a viable alternative for brand owners and converters looking to partially replace petroleum-based resins in durable goods applications. Hybrid resins address this need in a wide range of markets, including automotive, consumer goods, consumer electronics, medical, packaging, and construction. We commercially introduced our first grade of Hybrid resin, Hybrid 150, at the end of 2007. We currently offer four commercial grades in this product line.
• Cereplast Algae Plastic® resins. In October of 2009 we announced that we have been developing a new technology to transform algae into bioplastics and intend to launch a new resin family containing algae-based materials that will complement our existing line of resins. The first commercial product with Cereplast Algae Plastic ® resin is now being produced and sold as part of our Sustainables resin family. We believe that it is important to enhance research on non-food crops as we expect a surge in demand in bioplastics in future years, thus potentially creating pressure on food crops. Algae are the first non-food crop project that we have introduced and our R&D department is contemplating the development of additional non-food crop based materials in future years.
Our patent portfolio is currently comprised of six patents in the United States ("U.S."), one Mexican patent, and eight pending patent applications in the U.S. and abroad. Our trademark portfolio is currently comprised of approximately 45 registered marks and 21 pending applications in the U.S. and abroad.
Recent Strategic Events
Italian Expansion.
On October 24, 2011 we completed the purchase of a manufacturing plant in Cannara, Italy that will serve as the hub for our European bioplastics production. We believe that this purchase will enable us to meet the growing demand for bioplastic resin in Europe while improving efficiencies, reducing transportation costs and minimizing logistics related risks. The plant is located on a 125,000 square foot former industrial plant site, enabling us to benefit from existing infrastructure. Current plans for the plant include a total annum capacity of approximately 220 million pounds, which will be built in phases; the first phase of 50,000 tons. Additional capacity will be added coincidental with market demand.
The aggregate purchase price of €4.6 million ($6.5 million) was financed with loan and credit facilities established by Cereplast Italia SpA, our wholly owned subsidiary, and local Italian banking institutions. Additional capital expenditures to complete Phase I of the expansion are estimated at between €6 million and €8 million, or between $8 million and $11 million. We expect that these costs will also be financed entirely through local debt facilities and subsidies from government agencies.
While we had initially anticipate to start operations in late 2012, however due to a combination of the financial crisis in Europe and other factors, including large accounts receivables balances with some of our European customers, we have determined to delay the commencement of operations until a later time.
New Distribution Agreements.
During 2011, we announced the signing of eight new distribution agreements in Italy, Romania, Poland, Croatia, Slovenia, Turkey, Sweden, Norway and Denmark with multiple companies. These contracts reflect our growth and expansion across the Pan-European marketplace.
Private Placement.
In February, 2011 we raised $12.3 million through a private placement offering pursuant to which we issued 2,596,500 shares of common stock and 649,128 warrants with an exercise price of $6.35 per share. Proceeds of the financing are being allocated to fund working capital needed to meet the growing demand for our products, particularly in the European market.
Venture Loan.
In February, 2011 we received additional $2.5 million in growth capital from Horizon Technology Finance Corporation pursuant to a Venture Loan and Security Agreement entered into in December, 2010. Proceeds from the loan are being allocated to fund working capital needed to meet the demand for our resin.
Convertible Subordinated Notes.
In May, 2011 we issued $12.5 million in aggregate principal amount of 7% Senior Subordinated Convertible Notes due June 1, 2016 (the "Notes"). Proceeds from the Notes are being allocated to fund working capital needed to meet the growing demand for our products, particularly in the European market.
Registered Direct Offering.
In November, 2011 we entered into subscription agreements for the sale of up to an aggregate of 3,125,000 units in a registered direct offering for gross proceeds of approximately $5.0 million before deducting the placement agents' fees and estimated offering expenses payable by us. Each unit consists of one share of common stock, par value $0.001 per share, and one warrant to purchase 0.75 of a share of common stock.
Trends and Uncertainties that May Impact Future Results of Operations
Global Market and Economic Conditions. Recent global market and economic conditions, particularly in Europe, have been unprecedented and challenging with tighter credit conditions and slower growth. These conditions, combined with volatile oil prices, declining business and consumer confidence and increased unemployment have contributed to continued volatility of unprecedented levels.
As a result of these market conditions, the cost and availability of credit has been, and may continue to be, adversely affected by illiquid credit markets and wider credit spreads. Concern about the stability of the markets generally, and the strength of counterparties specifically, has led many lenders and institutional investors to reduce, and in some case cease, to provide funding to borrowers and to developing companies, such as our company. Continued turbulence in the U.S. and international markets and economies may adversely affect our liquidity and financial condition and the liquidity and financial condition of our customers. If these market conditions continue, they may limit our ability, and the ability of our customers, to timely replace maturing liabilities and access the capital markets to meet liquidity needs, resulting in an adverse effect on our financial condition and results of operations.
Sales. We record sales at the time that we ship our products, provided that evidence of an arrangement exists, title and risk of loss have passed to the customer, fees are fixed or determinable, and collection of the related receivable is reasonably assured. We record sales net of sales discounts and allowances. For the year ended December 31, 2011 we provided price incentives to several customers that entered into multi-year supply contracts for their initial purchase commitments to assist in testing, sample production and commercial launch activities. In the future, we may offer these incentives on a selected basis as we continue to grow our customer base. The amount of these incentives in the future periods will be a function of the growth of our customer base and the particular commercialization.
Operating Expenses. Operating expenses consist principally of salaries (both cash and non-cash equity-based compensation), professional fees (including legal, accounting, patent-related, government compliance), marketing, rent and research and development. Salaries include all cash and non-cash compensation and related costs for all principal functions including executive, finance, accounting, production, and human resources. During recent periods we have made grants of equity awards, including shares of restricted stock and stock options, to attract directors and members of senior management, which have resulted in non-cash compensation expense for the periods reported. We expect that non-cash compensation expense attributed to equity-based awards may increase in future periods as the result of future equity-based incentive compensation awards granted to attract and retain talented employees as we continue to grow our business. In addition, we expect to experience increases in our research and development expenses as we continue to develop new products and formulations, as well as increases in marketing and promotional expenses as we seek to increase our customer base.
CRITICAL ACCOUNTING POLICIES AND USE OF ESTIMATES
Our discussion and analysis of our financial condition and results of operations are based upon our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. We monitor our estimates on an on-going basis for changes in facts and circumstances, and material changes in these estimates could occur in the future. Changes in estimates are recorded in the period in which they become known. We base our estimates on historical experience and other assumptions that we believe to be reasonable under the circumstances. Actual results may differ from our estimates if past experience or other assumptions do not turn out to be substantially accurate.
Revenue Recognition
We recognize revenue at the time of shipment of products, when the following
fundamental criteria are met: (i) persuasive evidence of an arrangement exists;
(ii) delivery has occurred; (iii) the price to the customer is fixed or
determinable; and (iv) collection of the sales price is probable.
Certain of our product sales are made to distributors under agreements with generally the same terms of sale and credit as all other customer agreements. Revenue from product sales to our customers, including our customers who are distributors, is recognized upon shipment provided the above noted fundamental criteria of revenue recognition are met. The sale of products to our customers who are distributors is not contingent upon the distributor selling the product to the end-user, and our current agreements with distributors do not have any rights of return.
Stock-Based Compensation
Compensation cost for all stock-based awards is measured at fair value on the date of grant and recognized over the service period for awards expected to vest. The fair value of stock options is determined using the Black-Scholes valuation model. Such value is recognized as expense over the service period, net of estimated forfeitures, using the straight-line method. Adjustments to this expense are made periodically to recognize actual rates of forfeiture which vary significantly from estimates.
Accounts Receivable
We maintain an allowance for doubtful accounts for estimated losses that may arise if any of our customers are unable to make required payments. Management performs a quantitative and qualitative review of the receivables past due from customers on a monthly basis. Quantitative factors include customer's past due balance, prior payment history, recent sales activity and days sales outstanding. Qualitative factors include macroeconomic environment, current product demand, estimated inventory levels and customer's financial position. In certain cases, we may have access to repossess unsold products held at customer locations as recourse for payment defaults. The fair market value of these products are considered as potential recovery in estimating net losses from uncollectible accounts. We record an allowance against uncollectible items for each customer after all reasonable means of collection have been exhausted, and the potential for recovery is considered remote.
Inventories
Inventories are stated at the lower of cost (first-in, first-out basis) or market, and consist primarily of raw materials used in the manufacturing of bioplastic resins, finished bioplastic resins and finished goods. Inventories are reviewed for excess and obsolescence and a reserve is established accordingly.
Intangibles
Intangibles are stated at cost and consist primarily of patents and trademarks. Amortization is computed on the straight-line method over the estimated life of these assets, estimated to be between five and fifteen years.
Property and Equipment
Property and equipment are stated at cost, and depreciation is computed on the straight-line method over the estimated useful lives of the assets. The estimated useful lives of the assets are between three and seven years. Repairs and maintenance expenditures are charged to expense as incurred. Assets under construction are not depreciated until placed into service.
Deferred Income Taxes
Deferred income taxes are provided using the liability method whereby deferred tax assets are recognized for deductible temporary differences and operating loss and tax credit carry forwards 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.
The benefit of a tax position is recognized in the financial statements in the period during which, based on all available evidence, management believes it is more likely than not that the position will be sustained upon examination, including the resolution of appeals or litigation processes, if any. Tax positions taken are not offset or aggregated with other positions. Tax positions that meet the more-likely-than-not recognition threshold are measured as the largest amount of tax benefit that is more than 50 percent likely of being realized upon settlement with the applicable taxing authority. The portion of the benefits associated with tax positions taken that exceeds the amount measured as described above is reflected as a liability for unrecognized tax benefits in the accompanying balance sheet along with any associated interest and penalties that would be payable to the taxing authorities upon examination.
RESULTS OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 2011 COMPARED TO THE YEAR ENDED DECEMBER 31, 2010
Net Sales
Net sales increased by $13.9 million or 219.3%, to $20.3 million for the year ended December 31, 2011 compared to $6.3 million for the year ended December 31, 2010. The sales increase for the period is attributable to volume increases associated with both existing customer contracts and new contracts with European customers. Environmental legislation, such as that banning the use of plastic bags in Italy that took effect on January 1, 2011, as well as the increased volatility in oil prices, were key drivers of demand for our bioplastic resins in the current year.
Cost of Sales
Cost of sales includes both fixed and variable costs, including materials and
supplies, labor, facilities and other overhead costs associated with our product
revenues. Cost of sales for the year ended December 31, 2011 was $18.2 million,
or 90.0% of net sales, compared to $5.2 million, or 82.7% of net sales for the
same period in 2010. The increase in cost of sales over the same period in the
prior year is attributable to two main factors: (1) cost of sales in the prior
year period cannot be considered representative of normal sales or operations as
we were in the process of relocating our production operations from California
to Indiana and therefore had minimal production during this period in 2010, and
(2) cost of sales in the current period reflects the tremendous growth in sales
volume from the prior year.
Gross Profit
Gross profit for the year ended December 31, 2011 was $2.0 million, or 10.0% of net sales, compared to $1.1 million, or 17.3% of net sales for the same period in 2010. The decrease in gross profit percentage reflects the unusually high margins on very low volume sales in the prior year period combined with our sales strategy to gain critical market share in 2011 by offering low introductory pricing to some key customers to support their programs to bring new bioplastic products to market. This strategy has proven effective in contributing to strong sales growth and growing market share. We expect that margins will improve gradually in future periods as we capitalize on demand growth to diversify our customer base, implement strategic price increases and continue to gain operational efficiencies.
Research and Development Expenses
Research and development expenses for the year ended December 31, 2011 were $1.0 million, or 5.2% of net sales, compared to approximately $0.5 million, or 7.3% of net sales, for the same period in 2010. Although research and development expenses decreased as a percentage of net sales, we incurred higher expenses in 2011 related to additional headcount, including the appointment of a new Chief Technology Officer and increased manufacturing supplies used for new product development.
Selling, General and Administrative Expenses
Selling, general and administrative expenses for the year ended December 31, 2011 were $13.4 million, or 66.1% of net sales, compared to $7.5 million, or 118.5% of net sales, for the same period in 2010. The increase is primarily attributable to the $5.3 million increase in our allowance for doubtful accounts during the year ended December 31, 2011. In addition, we incurred incremental expenses in 2011 across all areas of the business, including compensation associated with increased headcount, performance related compensation, marketing, sales commissions, professional fees (including legal and accounting fees) to support the rapid growth of the business, including the expansion of European operations, specifically with our new industrial plant in Italy.
Other Expense, Net
Other expenses, net for year ended December 31, 2011 were $1.6 million, as compared to $0.6 million in the same period in 2010. Other expense in 2011 consists of interest expense related to our Loan Agreement and our convertible senior subordinated notes. Other expense in 2010 consisted of restructuring charges which were not incurred in the current year period.
Net Loss
Net loss for the year ended December 31, 2011 was $14.0 million, as compared to $7.5 million in the same period in 2010. As discussed above, our results were favorably impacted by increases in net sales and gross profit, offset by higher operating expenses and interest expense incurred to support the growth of the business.
LIQUIDITY AND CAPITAL RESOURCES
We require working capital to fund our operations, including payments to finance our research and development and expand sales and marketing, to purchase equipment, service indebtedness, satisfy lease obligations and execute on our business plan and growth strategy.
We had net unrestricted cash of $3.9 million at December 31, 2011 as compared to $2.4 million at December 31, 2010. The net increase in unrestricted cash is attributable principally to funds received through equity sold through a private placement and proceeds received from our venture loan and convertible senior subordinated notes, offset by cash used in operations.
Our working capital increased from $5.2 million at December 31, 2010, to $17.6 million at December 31, 2011. The increase in working capital is primarily due to increases in accounts receivable and inventory associated with higher revenue volumes and increased product demand.
Cash used in operating activities for the year ended December 31, 2011 was $24.8 million, compared to $8.6 million during the same period in the 2010. The increase in the use of cash for operating activities was primarily a result of an increase in working capital, including increases in accounts receivable and inventory, which reflect the significant sales growth and increased product demand in the 2011 compared to 2010.
Cash used in investing activities for the year ended December 31, 2011 was $7.9 million compared to cash used in investing activities of approximately $0.3 million during the same period in 2010. The increase in cash used in investing activities during 2011 was primarily attributed to purchase of our industrial plant in Italy and capital equipment purchases to increase production capacity and improve operational efficiency at our Seymour manufacturing facility.
Cash provided by financing activities for the year ended December 31, 2011 was $34.2 million compared to $9.9 million provided by financing activities during the same period in 2010. The increase is attributable to an increase in funds received through issuance of common stock in a private placement and a registered direct offering, proceeds from our issuance of convertible senior subordinated notes and proceeds from a venture loan from Compass Horizon Technology.
We have incurred a net loss of $14.0 million for the year ended December 31, 2011, and $7.5 million for the year ended December 31, 2010, and have an accumulated deficit of $56.9 million as of December 31, 2011. Based on our operating plan, our existing working capital will not be sufficient to meet the cash requirements to fund our planned operating expenses, capital expenditures and working capital requirements through December 31, 2012 without additional sources of cash.
Our plan to address the shortfall of working capital is to generate additional financing through a combination of refinancing existing credit facilities, incremental product sales and collection of outstanding receivables. We are confident that we will be able to deliver on our plans, however, there are no assurances that we will be able to obtain any sources of financing on acceptable terms, or at all.
If we cannot obtain sufficient additional financing in the short-term, we may be forced to curtail or cease operations or file for bankruptcy. The consolidated financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or amounts and classification of liabilities that might be necessary should we be forced to take such actions.
Loans Payable and Long Term Debt
Venture Loan Payable
On December 21, 2010, we entered into a Venture Loan and Security Agreement (the "Loan Agreement") with Compass Horizon Funding Company, LLC (the "Lender" or "Horizon"). The Loan Agreement provides for a total loan commitment of $5.0 million comprising of Loan A and Loan B, each in the amount of $2.5 million. Loan A was funded at closing on December 21, 2010 and matures 39 months after the date of advance. Loan B was funded on February 17, 2011 and also matures 39 months after the date of advance. We are obligated to pay interest per annum equal to the greater of (a) 12% or (b) 12% plus the difference between (i) the one month LIBOR Rate in effect on the date preceding the funding of such loan by five business days and (ii) .30%. We are required to make interest only payments for the first nine months of each loan and equal payments of principal over the final thirty months of each loan. In connection with the loan, we issued a seven year warrant to the Lender to purchase 140,000 shares of our common stock at an exercise price of $4.40. We granted a security interest in all of our assets to the Lender.
Auto Loan Payable
We signed a promissory note in the amount of $20,359 related to the purchase of an automobile in fiscal year 2010. The note bears interest at 7.7% per annum and is to be repaid over a period of 60 months. We repaid this promissory note in full during the first quarter of 2012.
Convertible Subordinated Notes
On May 24, 2011, we issued $12.5 million in aggregate principal amount of 7% Senior Subordinated Convertible Notes due June 1, 2016 (the "Notes"). The Notes were issued pursuant to an indenture (the "Indenture"), entered into between us and Wells Fargo Bank, National Association, as trustee, on May 24, 2011. In connection with the issuance of the Notes, we entered into a Waiver to our Venture Loan and Security Agreement with Horizon, dated May 18, 2011 pursuant to which Horizon provided its consent to the offering of the Notes and waived any restrictions in the Loan Agreement.
The Notes are senior subordinated unsecured obligations which will rank subordinate in right to payment to all of our existing and future senior secured . . .
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