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MEIL > SEC Filings for MEIL > Form 10-Q on 15-Jul-2013All Recent SEC Filings

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Form 10-Q for METHES ENERGIES INTERNATIONAL LTD


15-Jul-2013

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion of our financial condition and results of operations should be read in conjunction with the condensed consolidated financial statements and related notes included elsewhere in this report. Some of the statements in this discussion and elsewhere in this report constitute forward-looking statements within the meaning of Section 21E of the Securities and Exchange Act of 1934. See "Cautionary Statement Regarding Forward-Looking Information" following the Table of Contents of this report. Because this discussion involves risk and uncertainties, our actual results may differ materially from those anticipated in these forward-looking statements.

Overview

We are a renewable energy company that offers an array of products and services to a network of biodiesel fuel producers. We also market and sell in the U.S. and Canada biodiesel fuel produced at our small-scale production and demonstration facility in Mississauga, Ontario, Canada, and have recently commissioned and are scaling-up biodiesel production at our new facility in Sombra, Ontario, Canada.

Among other services, we sell feedstock to our network of biodiesel producers, sell their output in the U.S. and Canada, provide them with proprietary software used to operate and control their processors, remotely monitor the quality and characteristics of their output, upgrade and repair their processors, and advise them on adjusting their processes to use varying feedstock and improve their output. Through the accumulation of production data from our network, we are equipped to provide consulting services to network members and other producers for operating their facilities, maintaining optimum production and solving production problems. For our network services and the license of our operating and communications software, we receive a royalty from network members based on the gallons of biodiesel produced.

Our revenue sources include the sale of biodiesel produced at our own facility, the sale of biodiesel that we purchase from network members and other third-party producers, the sale of biodiesel equipment, the sale of feedstock to network members and other third-party biodiesel producers, Canadian government incentive payments, royalties from our network members, and revenue from other services we provide related to the production of biodiesel.

As at May 31, 2013, due in large part to the funds spent to develop, build and commission our Sombra facility as well as reduced sales of biodiesel which we believed were primarily due to invalid RINs (defined below) generated and sold by some U.S. producers in late 2011 and early 2012, we had a working capital deficiency of $4,434,647. During the six months ended May 31, 2013, we incurred a loss of $2,883,143 and had negative cash flow from operations of $2,136,667.

In October 2012, our Sombra facility was approved by the U.S. Environmental Protection Agency ("EPA") as a Foreign Renewable Fuel Producer and as a result the biodiesel produced at this facility became eligible for export to the United States. Obtaining this approval from the EPA enables us to sell our biodiesel into the U.S., and provides our U.S. importers the ability to generate Renewable Identification Numbers ("RINs"). RINs are used in the U.S. by obligated parties to comply with certain obligations under the Renewable Fuel Standard 2 ("RFS2").

On October 12, 2012, our registration statement on Form S-1 (File No. 333-182302) for our initial public offering ("IPO") was declared effective by the U.S. Securities and Exchange Commission ("SEC"). On October 30, 2012, we consummated our IPO pursuant to which we sold 560,000 units (each a "Unit") at a price $5.00 per Unit and raised net proceeds of approximately $1.8 million, after deducting the underwriting fees and offering expenses. Each Unit consists of (i) one share of Common Stock, (ii) one Class A warrant, to purchase one share of Common Stock at an exercise price of $7.50, and (iii) one Class B warrant, to purchase one share of Common Stock at an exercise price of $10.00.

On February 19, 2013, we completed a private placement under which we sold 425,000 Units at a price of $4.00 per Unit and raised net proceeds of approximately $1.4 million, after deducting the sales commission and fees. Each Unit consists of (i) one share of common stock, $.001 par value ("Common Stock"), (ii) one Class A Warrant, to purchase one share of Common Stock at an exercise price of $7.50, and (iii) one Class B Warrant, to purchase one share of Common Stock at an exercise price of $10.00 (the "February 2013 Private Placement").

The consolidated financial statements include our accounts and the accounts of our wholly-owned subsidiaries Methes Energies Canada Inc. ("Methes Canada") and Methes Energies USA Ltd. ("Methes USA"). All significant inter-company transactions and balances have been eliminated.


Factors Influencing Our Results of Operations

The principal factors affecting our results of operations are as follows:

Biodiesel and feedstock price fluctuations

Biodiesel is a low carbon, renewable alternative to petroleum-based diesel fuel and is primarily sold to the end user after it has been blended with petroleum-based diesel fuel. Biodiesel prices have historically been correlated to petroleum-based diesel fuel prices. Accordingly, biodiesel prices have generally been affected by the same factors that affect petroleum prices, such as worldwide economic conditions, wars and other political events, OPEC production quotas, changes in refining capacity and natural disasters. Recently enacted government requirements and incentive programs, such as RFS2 and the blenders' tax credit, which expires on December 31, 2013, have reduced this correlation, although it remains a significant factor in the market price of our product.

Our operating results also generally reflect the relationship between the price of biodiesel and the price of the feedstock used to produce biodiesel. Spot market prices for virgin vegetable oil or used vegetable oil or rendered animal fat may increase, which would adversely affect our gross margins. The price of vegetable oil, as with most other products made from crops, is affected by weather, disease, changes in government incentives, demand and other factors. A significant reduction in the supply of vegetable oil because of weather or disease, or increases in the demand for vegetable oil, could result in higher feedstock prices. The price of vegetable oil and other feedstock has fluctuated significantly in the past and may fluctuate significantly in the future.

Government programs related to biodiesel production and use

Biodiesel has been more expensive to produce than petroleum-based diesel fuel and as a result the industry depends on Canadian and U.S. federal and, to a lesser extent, provincial and state usage requirements and tax incentives.

On July 1, 2010, RFS2 was implemented, stipulating volume requirements for the amount of biomass-based diesel that must be utilized in the United States each year. Under RFS2, obligated parties, including petroleum refiners and fuel importers, must show compliance with these standards. The RFS2 program required the domestic use of 800 million gallons of biodiesel in 2011 and one billion gallons in 2012. The EPA recently mandated a requirement for domestic use of biodiesel by obligated parties of 1.28 billion gallons in 2013.

Renewable Identification Numbers ("RINs")

RINs are used to track compliance with RFS2 and are generated when a gallon of biodiesel is produced or imported into the U.S. In late 2011 and early 2012 the EPA announced that some U.S. producers had generated and sold invalid RINs. The loss of integrity and confidence in the RINs market affected the demand as well as the price of biodiesel. This problem has now been corrected by the EPA with the introduction of Quality Assurance Programs ("QAPs").

In February 2013, the EPA introduced two new QAPs that would allow buyers of RINs to verify their validity. The QAPs provide a clear path and system for independent third parties, approved by the EPA, to audit and monitor, on an ongoing basis, the production of biodiesel and verify that RINs have been correctly generated. The QAPs, once fully in place, will be retroactive to January 1, 2013.


Seasonal fluctuations

Our operating results are influenced by seasonal fluctuations in the price of biodiesel. Our sales tend to decrease during the winter season due to perceptions that biodiesel will not perform adequately in colder weather. Colder seasonal temperatures can cause the higher cloud point biodiesel we make from inedible animal fats to become cloudy and eventually gel at a higher temperature than petroleum-based diesel or lower cloud point biodiesel made from soybean, canola or inedible corn oil. Reduced demand in the winter for our higher cloud point biodiesel may result in excess supply of such higher cloud point biodiesel or lower prices for such higher cloud point biodiesel. In addition, our production facilities are located in Canada and our costs of shipping biodiesel to warmer climates generally increase in cold weather months.

Dependence on significant customers

A large part of our revenue is generated from a few large customers. The sales to these customers are made at spot market prices, and we have no binding purchase agreements for our biodiesel, which could affect the consistency of our revenues. Potential customers for biodiesel regularly bid for biodiesel in the spot market at prices that are quoted on a daily basis. As a matter of convenience, we prefer to deal with customers with whom we have had a past relationship, although the specific customers to whom we sell have varied over time. The loss of one or more customers who have been among our largest customers historically would not have a material adverse effect on our business because we believe that a customer or customers could be replaced by one or more new customers regularly bidding for biodiesel, and we believe this will continue to be the case. For example, in the six months ended May 31, 2013, one new major customer accounted for 24% of our total revenue and our largest customer improved to 60% of total revenue in the six-month period ended May 31, 2013 from 54% of total revenue in same period in fiscal 2012.

Lengthy sales cycle

The sale of one of our Denami processors in a particular financial period has a significant effect on our quarter-to-quarter and year-to-year results. The purchase of our Denami processors involves a significant commitment of capital by customers, with the attendant delays frequently associated with large capital expenditures. For these and other reasons, the sales cycle associated with our Denami processors is typically lengthy, varying from 6 to 18 months. The lengthy sales cycles of our equipment sales, as well as the size and timing of orders, make it difficult to forecast our future results of operations.


Results of Operations

Three and six months ended May 31, 2012 and 2013

Set forth below is a summary of certain financial information for the periods
indicated:

                                           Three Months     Three Months
                                              Ended             Ended          Six Months Ended       Six Months Ended
                                             May 31,           May 31,             May 31,                May 31,
                                               2012             2013                 2012                   2013

Revenue
Biodiesel sales
  Resales                                  $    705,218     $     415,782     $        2,528,798     $         463,9460
  Internal production                         1,058,879         1,664,522              1,786,190              1,747,244
Feedstock sales                                  49,213            40,802                283,961                 84,988
Glycerin sales                                   21,098            22,635                 49,767                 36,441
Government incentives                           150,440           170,124                244,456                179,004
Equipment sales                                   7,592             2,657                 16,500                  2,657
Royalties                                         9,597             2,793                 44,279                  6,775
Others                                           80,186             9,039                110,448                 17,860
                                              2,082,223         2,328,354              5,064,400              2,538,465
Cost of goods sold                            1,681,147         2,221,184              4,438,052              2,410,713
Gross profit                                    401,076           107,170                626,348                127,752

Operating expenses

Selling, general and administrative
 expenses                                       957,510         1,476,838              1,807,435              2,767,926
Loss before interest and taxes                 (556,434 )      (1,369,668 )           (1,181,087 )           (2,640,174 )

Other expenses
Interest expense                                (22,261 )        (122,143 )              (31,448 )             (242,969 )
Loss before income taxes                       (578,695 )      (1,491,811 )           (1,212,535 )           (2,883,143 )

Income taxes                                          -                 -                      -                      -

Net loss for the period                    $   (578,695 )   $  (1,491,811 )   $       (1,212,535 )   $       (2,883,143 )


Three and six months ended May 31, 2012 compared to three and six months ended May 31, 2013

Revenue. Our total revenues for the three months ended May 31, 2012 and 2013 were $2.08 million and $2.33 million, respectively, representing an increase of $246,131, or 12%. Our total revenues for the six months ended May 31, 2012 and 2013 were $5.06 million and $2.54 million, respectively, representing a decrease of $2.52 million, or 50%. The reasons for these changes are outlined below.

Biodiesel. Biodiesel sales for the three months ended May 31, 2012, excluding government incentives, were $1.76 million and increased by $320,000, or 18%, to $2.08 million in the three months ended May 31, 2013. For the three months ended May 31, 2012 and 2013, our resales of biodiesel purchased from third party producers were $705,000 and $416,000, respectively, a decrease of approximately $289,000, or 41%. Revenue from our internal production, excluding government incentives, for the three months ended May 31, 2012 and 2013 was $1.06 million and $1.66 million, respectively, an increase of $600,000, or 57%. For the three months ended May 31, 2012 and 2013, our average sales price per gallon for 100 percent biodiesel ("B100") was $4.44 and $4.11, respectively, a decrease of $0.33 per gallon, or 7%. The decrease in our average sales price per gallon in the three months ended May 31, 2013 was due to some fixed price contracts that we entered into in early 2013. Gallons sold for the three months ended May 31, 2012 and 2013 were 397,000 and 506,000 gallons, respectively, an increase of 109,000 gallons, or 22%.

Biodiesel sales for the six months ended May 31, 2012, excluding government incentives, were $4.31 million and decreased by $2.1 million, or 49%, to $2.21 million in the six months ended May 31, 2013. For the six months ended May 31, 2012 and 2013, our resales of biodiesel purchased from third party producers were $2.53 million and $463,000, respectively, a decrease of approximately $2.07 million, or 82%. Revenue from our internal production, excluding government incentives, for the six months ended May 31, 2012 and 2013 was $1.79 million and $1.75 million, respectively, a decrease of $40,000, or 2%. For the six months ended May 31, 2012 and 2013, our average sales price per gallon for 100 percent biodiesel ("B100") was $4.49 and $4.13, respectively, a decrease of $0.36 per gallon, or 8%. The decrease in our average sales price per gallon in the six months ended May 31, 2013 was due to some fixed price contracts that we entered into in early 2013.Gallons sold for the six months ended May 31, 2012 and 2013 were 961,377 and 535,447 gallons, respectively, a decrease of 425,930 gallons, or 44%.

The decrease in revenue from the sales of our biodiesel and the resales of biodiesel purchased from others was primarily due to a much lower demand for biodiesel which we believe was caused by the remaining uncertainty about the integrity of RINs market in the United States caused by invalid RINs sold by some U.S. producers in late 2011 and early 2012. As a small and medium size producer, we and our existing customers have been directly affected by this situation. Another factor contributing to the lower sales of our biodiesel during the current quarter was the production and start-up issues that we faced at our Sombra facility which resulted in delays in shipments to customers and lower production. These issues have now been resolved.

In early February 2013, the EPA introduced QAPs that would allow buyers of RINs to verify their validity. The QAPs provide a clear path and system for independent third parties, approved by the EPA, to audit and monitor, on an ongoing basis, the production of biodiesel and verify that RINs have been correctly generated. We believe that the QAP's coupled with the EPA's mandate that 1.28 billion gallons of biodiesel be produced for domestic use in 2013 will greatly reduce the uncertainty about the integrity of RINs and increase the demand for biodiesel from us in the remaining periods of this year. At this time, we are evaluating two third party providers of QAPs which have been approved by the EPA and expect to be selecting one during this quarter.

Feedstock. For the three months ended May 31, 2012 and 2013, feedstock sales were $49,000 and $41,000, respectively, a decrease of $8,000, an immaterial amount. For the six months ended May 31, 2012 and 2013, feedstock sales were $284,000 and $85,000, respectively, a decrease of $199,000, or 70%. Feedstock sales were down due to lower demand for biodiesel that affected other small biodiesel producers and also due to their direct purchase from other suppliers.

Glycerin. For the three months ended May 31, 2012 and 2013, Glycerin sales were $21,000 and $23,000, respectively, an increase of $2,000, an immaterial amount. For the six months ended May 31, 2012 and 2013, Glycerin sales were $50,000 and $36,000, respectively, a decrease of $14,000 or 28%. For the three months ended May 31, 2012 and 2013, the increase was a result of new production of glycerin at our Sombra facility, which is a byproduct of our biodiesel production. For the six months ended May 31, 2012 and 2013, Glycerin sales decreased because of lower biodiesel production.

Government incentives. For the three months ended May 31, 2012 and 2013, we received $150,000 and $170,000, respectively, of government incentives. This increase of $20,000 or 13%, was due to the increase in production of biodiesel at our Sombra facility. For the six months ended May 31, 2012 and 2013, we received $244,000 and $179,000, respectively, of government incentives. This decrease of $65,000, or 27%, was due to no production at our Mississauga facility and a slower than anticipated ramp-up in production at our Sombra facility.

Equipment sales. For the three months ended May 31, 2012 and 2013, we generated $7,600 and $2,700, respectively, from equipment sales. For the six months ended May 31, 2012 and 2013, we generated $17,000 and $2,700, respectively, from equipment sales. Equipment sales during the three and six months consisted of small lab and shop supplies.


Royalties. We received royalties of $9,600 during the three months ended May 31, 2012, from two network members that purchased our Denami 600 processors late in fiscal 2010. Royalties for the three months ended May 31, 2013 were $2,800, a decrease of $6,800. We received royalties of $44,000 during the six months ended May 31, 2012 from two network members that purchased our Denami 600 processors late in fiscal 2010. Royalties for the six months ended May 31, 2013 were $6,700, a decrease of $37,300. Our customers own the Denami 600 processors, but license the software and monitoring system from us in exchange for an ongoing royalty payment of $0.11 per gallon of biodiesel produced by their Denami 600 processors. The lower demands for biodiesel during the six months ended May 31, 2013 lowered the amounts of royalties received.

Other. Other revenue includes revenue from consulting services, delivery charges, laboratory and shop supplies, storage and rental income. Other revenue for the three months ended May 31, 2012 and 2013, was $ 80,000 and $9,000, respectively, a decrease of $71,000, or 89%, primarily due to decrease in sales of these services. For the six months ended May 31, 2012 and 2013, other revenue was $110,000 and $18,000, respectively, a decrease of $92,000 or 84%, mainly due to a one time revenue item of a fire insurance claim and a one time large storage container sale that occurred in 2012.

Cost of goods sold. Our cost of goods sold for the three months ended May 31, 2012 and 2013 were $1.68 million and $2.22 million, respectively, an increase of $540,000, or 32%. This increase was primarily due to increases in biodiesel sales and freight costs during the three months ended May 31, 2013. Our cost of goods sold for the six months ended May 31, 2012 and May 31, 2013 were $4.44 million and $2.41 million, respectively, a decrease of $2.03 million, or 46%. The decrease was mainly due to lower biodiesel sales as a result of lower production at both of our facilities during the six months ended May 31, 2013.

Biodiesel cost of goods sold increased 24% from the three months ended May 31, 2012 compared to the same period in fiscal 2013, or from $1.60 million for the three months ended May 31, 2012 to $1.98 million for the three months ended May 31, 2013. If the average feedstock price and the price paid for biodiesel purchased from other biodiesel producers in Canada remained constant from the three months ended May 31, 2012 to the end of the same period in 2013, the increase in gallons of biodiesel sold would have resulted in a 28%, or $457,000, increase in the related biodiesel cost of goods sold. The decrease in average feedstock prices for the three months ended May 31, 2012 compared the same three month period in 2013 resulted in a decrease in biodiesel cost of goods sold of $72,000 of which $2,000 was attributable to the lower price paid for biodiesel purchased from others.

Biodiesel cost of goods sold increased 50% from the six months ended May 31, 2012 compared to the same period in fiscal 2013, or from $4.13 million for the six months ended May 31, 2012 to $2.05 million for the six months ended May 31, 2013. If the average feedstock price and the price paid for biodiesel purchased from other biodiesel producers in Canada remained constant from the six months ended May 31, 2012 to the end of the same period in 2013, the decrease in gallons of biodiesel sold would have resulted in a 44%, or $1.84 million, decrease in the related biodiesel cost of goods sold. The decrease in average feedstock prices for the six months ended May 31, 2012 compared to the same period in 2013 resulted in a decrease in biodiesel cost of goods sold of $187,000 of which $53,000 was attributable to the lower price paid for biodiesel purchased from others.

All other costs of goods sold, excluding biodiesel cost of goods sold, for the three months ended May 31, 2012 and 2013, were $84,000 and $241,000, respectively. The increase was mainly due to including freight costs in other cost of goods sold. For the six months ended May 31, 2012 and 2013, all other costs of goods sold, were $309,000 and $363,000, respectively.

Selling, general and administrative expenses. Our selling, general and administrative expenses for the three months ended May 31, 2012 and 2013 were $ 958,000 and $1.48 million, respectively, an increase of $522,000, or 54%. The increase in the more recent period was mainly related to an increase in salaries and wages of $270,000, an increase in utilities of $61,000 and an increase in professional fees of $89,000. For the six months ended May 31, 2012 and 2013, selling, general and administrative expenses were $1.81 million and $2.77 million, respectively, an increase of $960,000, or 53%. The increase in six months ended May 31, 2013 was mainly related to an increase in salaries and wages of $483,000, an increase in utilities of $336,000 and an increase in depreciation expense of $135,000. The increases in salaries and wages, and utilities were necessary to support the higher level of operations at our Sombra facility.

Other expenses. For the three months ended May 31, 2012 and 2013, we incurred interest expenses of $22,000 and $122,000, respectively. For the six months ended May 31, 2012 and 2013, we incurred interest expenses of $32,000 and $243,000, respectively. The increase in interest expense in 2013 was due to the interest expense on the CDN$1.5 million term loan described below entered into in June 2012 (the "June 2012 Term Loan Facility").

Income taxes. No income tax expense or benefit was recorded during the three and six months ended May 31, 2012 and 2013 due to ongoing taxable losses. As of May 31, 2013, we were not subject to any uncertain tax exposures.

Net loss. Our net loss for the three months ended May 31, 2012 was $579,000 and increased by $911,000 to $1.49 million for the three months ended May 31, 2013 due primarily to the $540,000 increase in cost of goods sold and resultant $294,000 decrease in gross profit, and $522,000 increase in selling, general and administrative expenses to support our higher level of operations, which included development of, and the higher level of operations at, our Sombra facility and higher financing costs.


Liquidity and Capital Resources

Sources of liquidity. Since inception, a significant portion of our operations has been financed through the sale of our capital stock. At November 30, 2012 and May 31, 2013, we had cash and cash equivalents of $402,724 and $188,486, respectively.

During the six months ended May 31, 2013, we raised net cash proceeds of approximately $1.4 million from the February 2013 Private Placement. Additionally, on January 26, 2013, we borrowed a total of $397,400 (CDN$400,000) from a third party. The loan is unsecured, payable on demand and carries interest at 8% per annum.

On June 20, 2012, Methes Canada entered into the June 2012 Term Loan Facility with a lender that allows Methes Canada to borrow up to CDN$1.5 million. The term loan, which was drawn down in late June 2012, is repayable in 12 months and bears interest at 23% per annum. The loan is repayable by Methes Canada after six months upon payment of a penalty equal to one-month's interest. The facility is guaranteed by us and collateralized by a general security agreement from Methes Canada and a first collateral mortgage on certain assets located at our Sombra facility. The facility prohibits payment of debt in excess of $550,000 owed by us to certain of our stockholders and directors during the life of the facility and contains other customary debt covenants. The facility also provides that, beginning October 1, 2012, any additional operating losses incurred by Methes Canada must be financed by stockholders or new equity funding.

On July 12, 2013, Methes Canada entered into a Term Loan Facility Agreement with 1730636 Ontario Limited (the "Agreement") pursuant to which Methes Canada may . . .

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