Amended 10K for Fiscal year 2003...
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion contains forward-looking statements that involve known and unknown risks and uncertainties which may cause actual results in future periods to differ materially from those indicated herein as a result of a number of factors, including, but not limited to, those set forth under "Factors That May Affect Future Results," Notes to the Consolidated Financial Statements, Part I, Item 3., Legal Proceedings, and the discussion below. When the Company uses words like "may," "believes," "expects," "anticipates," "should," "estimate," "project," "plan," their opposites and similar expressions, the Company is making forward-looking statements. These expressions are most often used in statements relating to business plans, strategies, anticipated benefits or projections about the anticipated revenues, earnings or other aspects of our operating results. We make these statements in an effort to keep stockholders and the public informed about our business and have based them on our current expectations about future events. Such
statements should be viewed with caution. These statements are not guarantees of future performance or events. As noted elsewhere in this report, all phases of our business are subject to uncertainties, risks and other influences, many of which the Company has no control over. Additionally, any of these factors, either alone or taken together, could have a material adverse effect on the Company and could change whether any forward-looking statement ultimately turns out to be true. The Company undertakes no obligation to publicly release updates or revisions to these statements. The following discussion should be read in conjunction with audited consolidated financial statements and the notes thereto for the year ending June 30, 2003, included elsewhere in this Form 10-KSB.
2003 FINANCIAL RESULTS COMPARED TO 2002
The Company's 2003 operating revenue was $2,463,795 compared to $2,268,940 last year, with a gross profit of $465,488 compared to $486,106 last year. Revenue and direct costs increased in 2003 as a result of the Company having a full year of engineering contracts completed compared to only having completed engineering contracts in the fourth quarter of 2002 as a result of the merger occurring on March 25, 2002.
STRATEGY
The Company plans to increase sales and expand its engineering and scientific services base via new customer contracts. Revenue generated will be used to meet cash flow requirements, dissolve remaining accumulated merger costs, and any excess will be used to support and develop the Company's biofuels production initiatives.
In the area of biofuels, the Company intends to not just focus on providing traditional engineering services for individual renewable and alternative energy components or business elements, but to apply a holistic approach to developing biofuels projects. This means integrating several complementary, and contiguous, activities into a synergistic "complex", whereby the Company will provide the overall technical and integrating management for planning, coordinating, developing, operating and implementing such projects.
Studies have shown that individual "stand-alone" projects often operate on such narrow margins that even slight fluctuations in critical items such as feedstock or utility prices can have a magnified effect on returns. However, with careful selection and integration of technologies and various revenue generating activities, it is possible to dampen the effects of outside influences. The Company's focus involves the combining of dairy operations, grain processing and ethanol and biogas production at a single "closed-loop" complex. The objective is to ensure consistent and reliable feed supplies; a guaranteed local market for byproducts; and a ready, renewable, predictable source of process energy in short, providing a "hedge" against those variables that have such impact on operating margins.
The emphasis is on ownership of several geographically dispersed complexes in the Southern Idaho region. From there the Company intends to expand production and ownership to other locations within Idaho and the Western United States.
Pilot Project
The south-central region of Idaho known as the "Magic Valley" presents a unique opportunity for the Company to implement its vision of biofuels - specifically ethanol - production in the Western United States. A plant in this region is 1000 miles closer to the west coast fuel markets than the nearest mid-west ethanol facility, and would be located in the midst of several large diaries.
The fact that tremendous amounts of corn are already being railed in from the Midwest to meet the feed demands of the existing dairies makes the use of corn as a feedstock for the ethanol facility a natural fit. Because of the volume of corn required to feed this size of a facility, the Company will be able to purchase corn in unit train (100 car) lots, substantially lowering the per bushel cost. Besides helping to improve operating margins for the plant, this also provides additional opportunity to be competitive in the supply of rolled and flaked corn for direct sale from our complex to the area cattlemen.
A further economic advantage and benefit derives from the distillers grains produced in the ethanol plant. These grains are the residue left after the extraction of the starch from the corn kernel and are exceptionally high in protein - making
them a very desirable feed source for dairy cattle. As with the raw corn, large quantities of distiller grains are currently being railed into Idaho every day and are being sold to the local dairymen for prices up to 50% higher than their mid-west points of origin. Sufficient dairy herds exist within 20 miles of the plant site to consume all of the distillers grains produced and at a much more attractive price to the dairy owners - while still maintaining a good profit margin.
A unique, and very significant element of this project involves the processing of the animal residue (manure) generated by the cows into natural gas (methane) through anaerobic digestion and then using this gas as the fuel to fire the boilers that provide process steam for the ethanol plant. This has huge and lasting economic benefit because it insulates the operation from fluctuating energy prices for both natural gas and electricity because those essential requirements are generated internally and onsite - making the entire process "energy independent". Next to corn, natural gas is the largest single operating cost for an ethanol plant. The digesters will also produce compost and liquid fertilizers, both of which have significant demand in Idaho and Utah.
The Magic Valley Energy Company, LLC, has been formed to be the legal entity under which the integrated operations will be managed. A one-third partner in the venture, the Magic Valley Energy Coalition, LLC, was sought to ensure the concerns and needs of the community were addressed throughout all phases of the project, minimizing the possibility of unforeseen resistance to progress.
Other Projects Under Consideration
The Company has explored several other potential sites in Southern Idaho that hold promise for application of the Magic Valley Model discussed above. These include two sites located in Southeastern Idaho that are convenient to existing cattle feeding and dairy operations and have easy access to heavy rail and other necessary support infrastructure. A third ideal site located on Native American lands is being discussed with tribal leaders with the intent of developing a complex that will produce stable revenue, jobs and provide a sustainable, renewable energy supply for tribal members. It also appears that the dairy industry in Magic Valley is sufficiently robust that a second complex could be located in the valley.
Cellulose-to-Ethanol Conversion
The feedstock of choice for ethanol production in the United States is currently corn, which is mostly grown in the Midwestern United States. If quotas for ethanol production are established, as is currently being considered by the US Congress, corn as a feedstock may lose its appeal because of competition as a food source and potential escalation in price for corn. An attractive alternative to corn might be cellulose, which is derived from materials such as wheat and barley straw, corn stover, or wood. Idaho is host to large amounts of wheat and barley straw and wood materials. The Company is currently working with a group of organizations to establish the economic viability of using such materials for producing ethanol and the potential of converting an existing small Idaho ethanol plant to a commercial scale cellulose-to-ethanol demonstration/test facility where various feedstocks and technologies can be explored and the economies determined. The Company's role will be to manage the overall project and to operate the demonstration plant. Involvement in this type of project would give the Company a leading position in the utilization of cellulose for economical production of ethanol for the future.
Hydrogen Production
Using hydrogen as a means of providing energy for transportation systems and production of electrical energy will become an important part of the future energy portfolio for this country. The Bush Administration is promoting the use of hydrogen fuel cells for powering transportation systems and there are bills before Congress to establish quotas for vehicles that will use these cells during the next decade. The question remains how to most effectively produce hydrogen in sufficient quantities to make it cost competitive. The Company is investigating the potential of using ethanol and or biogas, both of which are rich in hydrogen atoms as precursor fuels for fuel cell systems.
Mining
Given that mining and minerals are not compatible with Company goals, strengths or objectives, the Company has entered into discussions, subject to shareholder approval, to divest its two main mining rights, which include development, mining and marketing rights to a large diatomaceous earth deposit in south central Idaho and precious
metals properties in Montana in return for settlement of various obligations, the assignment of future royalties back to the Company, a note receivable, and the return of shares of the Company common stock to the Company treasury. It is anticipated that this agreement will be finalized during the second quarter of fiscal 2004.
At the present time the Company does not anticipate paying dividends, cash or otherwise, on it's Common Stock in the foreseeable future. Future dividends will depend on earnings, if any, of the Company, its financial requirements and other factors.
RESULTS OF OPERATIONS
The Company generated engineering service revenue in 2003 and 2002, compared to only interest income in 2001. The success of the Company in increasing sales over the previous year provides reasonable assurance that the Company will be able to continue to increase its customer base and accomplish longer-term commitments for projects in both the engineering services and biofuels production areas.
The following table shows each element of the statement of operations as a percentage of revenue:
Year Ended Year Ended
June 30, 2003 June 30, 2002
----------------------------------- -----------------------------------
Whole $ % Whole $ %
----------------------------------- -----------------------------------
Revenue 2,463,795 2,268,940
Direct operating costs 1,998,307 81.1% 1,782,834 78.6%
--------- ---------
Gross profit 465,488 18.9% 486,106 21.4%
Write down of assets -- 0.0% -- 0.0%
Selling, general and administrative 557,844 22.6% 844,426 37.2%
--------- ---------
Income from operations (92,356) -3.8% (358,320) -15.8%
Interest income -- 0.0% -- 0.0%
Interest expense (32,905) -1.3% (20,775) .9%
--------- ---------
Net loss before income taxes (125,261) -5.1% (379,095) -16.7%
Income tax expense (benefit) (49,543) -2.0% (336,000) -14.8%
--------- ---------
Net loss (75,718) -3.1% (43,095) -1.9%
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REVENUE
Revenue for 2003, increased to $2,463,795 compared to $2,268,940 for 2002. The Company's 2003 operating revenue increased 9% from the prior year showing a continuous improvement upon which the Company intends to expand and further develop along with the alternative energy and resource work.
DIRECT OPERATING COSTS
For the year ending June 30, 2003, the Company had direct operating costs of $1,998,307 or 81.1% of revenue in support of the engineering services compared to $1,782,834 or 78.6% of revenue for the year ended June 30, 2002. For the year ended June 30, 2002 direct operating costs were adjusted by an increase of $1,177,683 as a result of the merger showing 12 months of operation rather than only the fourth quarter as originally reported. These increases in direct
operating costs are the result of the Company's engineering revenue increasing, in that direct operating costs are relatively constant in relation to revenue.
GROSS PROFIT
Gross profit decreased to $465,488 in fiscal year 2003 compared to $486,106 in fiscal year 2002. This decrease is a direct reflection of the increased direct operating costs, but is relatively constant in relation to revenue for the two years at 18.9% and 21.4% respectively.
GENERAL SELLING AND ADMINISTRATIVE EXPENSES
General selling and administrative expenses were 22.6% of revenue or $557,844 at June 30, 2003 compared to 37.2% of revenue or $844,426 at June 30, 2002. This large reduction of general selling and administrative expenses is the result of the Company having resolved and paid most of the large costs associated with the merger with Iron Mask Mining Company. The Company had been encumbered with a large amount of general selling and administrative expenses for certain consulting, legal fees, and surveys and assessments associated with the merger. The greater majority of these merger costs have now been paid and settled and the Company expects the future general selling and administrative expenses to be related to current business.
INTEREST REVENUE
The Company had no interest revenue for the year ended June 30, 2003 or 2002.
INTEREST EXPENSE
Interest expense for the year ended June 30, 2003 increased to $32,905 compared to $20,775 for the same period ending June 30, 2002. The interest expense was increased by $14,965 as a result of the merger reflecting 12 months of operation rather than the 3 months originally reported. The total interest expense increased in 2003, as a result of higher debt balances owed to shareholders and officers.
INCOME TAXES
The effective tax rate equals or is close to statutory tax rate as a result of the fact that NOL carry forwards amount of losses are not deductible and the change in valuation allowance taken against the deferred tax asset. The net operating loss carry forward of approximately $1,800,000 at June 30, 2003, begins to expire in the year 2019. The provision increased as the Company had a total net loss for the year. The Company has calculated the total deferred tax asset of approximately $826,000, which is offset by an allowance of approximately $441,000. The Company has shown net income for the past three quarters and believes that more likely than not enough net income will be generated from anticipated projects, over the next several years, that the deferred tax asset, net of valuation allowance will be used. In the current year the provision amount relates to current operations. The amount of net operating loss carry forward expires $66,000 in 2008, $21,000 in 2018, $7,000 in 2019, $89,000 in 2020, $77,000 in 2021 and $1,371,000 in 2022 and $169,000 in 2023.
NET LOSS
At June 30, 2003 the Company realized a net loss of $75,718 compared to a loss of $43,095 for the year ended June 30, 2002. The net loss is also adjusted in total as a result of the restated merger reflecting 12 months of operation in 2002 rather than the 3 months that was originally reported.
OTHER INFORMATION
CUSTOMERS
In 2003, the Company managed several engineering services agreements with Idaho National Engineering and Environmental Laboratory ("INEEL") at Idaho Falls, Idaho, which constituted the majority of the Company's revenue. In 2002, the Company's primary customers were: INEEL, Fluor Federal Services, Inc., Duratek, Argonne National Laboratory West, the Bureau of Land Management and the state of Idaho. In 2003 and 2002, INEEL provided revenue in the amount of $2,128,099 and $1,257,364 respectively while Fluor Federal Services, Inc., provided $36,214 and $72,704 for each year respectively. Of these two companies, only the INEEL provided more than ten percent of the total revenue recognized by the Company in either year. In the future, the Company cannot be certain that it will derive the same percentages of federal contracted revenue due to a recently announced mission change and intent to rebid the primary Site Maintenance & Operations (M&O) contract at the INEEL, along with a decision by the incumbent M&O contractor to give preference to local minority and disadvantaged business rather than openly compete contracts. The Company is continuously seeking additional revenue sources from engineering and alternative energy work for other private, commercial and government customers.
COMPLIANCE WITH APPLICABLE LAWS AND REGULATIONS - The Company is in compliance with all current laws and regulations.
CHANGES IN LAWS AND REGULATIONS - None Applicable
EXPOSURE TO LITIGATION - None
NEW TECHNOLOGIES - None
ACCESS TO CAPITAL - The Company will make reasonable efforts to meet cash flow demands from ongoing operations however, the Company believes that it will be necessary to supplement the cash flow from operations with the use of outside resources such as additional loans and possibly investment capital by issuance of debenture notes or preferred stock
LOSS OF MAJOR CONTRACTS - None
NEW BUSINESS - The Magic Valley Energy Company, LLC, has been formed to be the legal entity under which the development of the Magic Valley Ethanol/Methane Biogas Production Complex integrated operations will be managed. A one-third partner in the venture, the Magic Valley Energy Coalition, LLC, was sought to ensure the concerns and needs of the community were addressed throughout all phases of the project, minimizing the possibility of unforeseen resistance to progress.
MATERIAL COMMITMENTS FOR CAPITAL EXPENDITURES - The Company has no outstanding commitments at this time, though anticipates purchase of engineering design hardware and software, additional computers, and office furniture to expand its operations. The Company also anticipates significant capital outlays related to the Magic Valley ethanol/methane project once investor support has been secured. Funding for office-related expenses will come from ongoing operations generated by engineering services, whereas the source of funding for the Magic Valley project will be outside capital resources.
CAPITAL RESOURCES AND LIQUIDITY
The Company will make reasonable efforts to meet cash flow demands from ongoing operations; however, it believes that it will be necessary to supplement the cash flow from operations with the use of outside resources such as additional loans and possibly investment capital by issuance of debenture notes and preferred stock. As of June 30, 2003, the Company had a working capital deficit of $438,285 compared to a deficit of $434,838 for the previous year ending June 30, 2002. The current ratio at June 30, 2003 was .51:1 and also .51:1 at June 30, 2002. The Company believes that with new contracts and its current efforts for borrowing that it will be able to meet obligations as they
become due. The Company is also taking active measures to speed up the collection of its current accounts receivable, while no receivables appear to be uncollectible.
The Company had available for borrowing a line of credit of $200,000 as of June 30, 2003 and of which $199,779 was outstanding at June 30, 2003. The line of credit bore interest at the prime rate plus two percent. The Company has converted this line of credit to a term loan with the same interest rate (prime plus two percent) and which will expire March 15, 2004. The credit is secured by all business assets and personally guaranteed by the principals of the Company. As of June 30, 2003, the line of credit was in good standing, and as of the date of this amended filing the term loan is also in good standing. The Company also has shareholder notes payable from certain officers, employees or directors. The notes are unsecured demand notes. It is not anticipated by the Company that the notes will be called in the next year. The following are shareholder creditors to the company: The loans from Mr. Kenoyer of $21,222 and Mr. Dustin of $42,488 accrue interest at an annual rate of 10 percent payable on demand.
In September 2002, the Company entered into an agreement with a capital investment company that has encouraged outside investors to invest in the Company through the issuance of debenture notes. These notes are to be in $10,000 denomination and have certain conversion rights for common stock of the Company if the Company has not fulfilled the repayment obligation by November 2003. The funds derived from the debenture notes are to be used for repayment of some current obligations, but will mainly be used for the start-up of new capital intensive projects like that of biogas production. At the date of this filing there has been one issuance of the debenture note.
SEASONAL CHANGES
The Company's operating revenue is generally not affected by seasonal changes.
SENIOR MANAGEMENT
The Board of Directors and Officers of the Company as presently constituted were duly elected by the shareholders during the 2003 Annual Shareholder Meeting held December 6, 2002, and no further changes were made during the year.
AI
