Form 10QSB for TIMBERLINE RESOURCES CORP
14-Aug-2008
Quarterly Report
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
You should read the following discussion and analysis of our financial condition and results of operations together with our financial statements and related notes appearing elsewhere in this quarterly report. This discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of many factors, including, but not limited to, those set forth under "Risk Factors and Uncertainties" in our Annual Report on Form 10-KSB, filed with the SEC on January 14, 2008.
Overview
We commenced our exploration stage in January 2004 with the change in the management of the Company. From January 2004 until March 2006, we were strictly a mineral exploration company. Beginning with the management appointments of John Swallow and Paul Dircksen and our acquisition of a drilling services company, Kettle Drilling, Inc. ("Kettle"), in March 2006, we have advanced a new, aggressive business plan. Prior to our new business model, the addition of new management, and the purchase of Kettle, the Company had no reported revenues and accumulated losses.
Timberline Resources Corporation has taken the complementary businesses of mine development, contract mining, drilling and mineral exploration and combined them into a unique, forward-thinking investment vehicle. The Timberline business model provides investors exposure to both the "picks and shovels" and "blue sky" aspects of the mining industry. The "picks and shovels" aspect of our business includes the mining services provided by Kettle and the services which SMD will provide if the proposed acquisition is approved. We use the term "blue sky" to mean the potential of our exploration properties. Because of the nature of exploration for precious metals, a property's exploration potential is not known until a significant amount of geologic information has been generated. As the work progresses, the potential of the property becomes more and more clear. If the exploration results are favorable, the value of the property may increase significantly, and the term "blue sky" refers to the upside potential of that value. Our business model offers the opportunity to participate both the "picks and shovels" and "blue sky" aspects of the business-we can participate in the surging markets for precious and base metal mining without the degree of risk inherent to mine operation and/or sole reliance on speculative early-stage drill-plays. Following the closing of its proposed acquisition of SMD, we believe Timberline will be poised to become North America's premier vertically-integrated emerging resource company.
As we have announced previously, the Company's shares began trading on the American Stock Exchange (AMEX) during the quarter ended June 30. In addition to commencing trading on the AMEX, the Company was also added to the Russell Microcap Index during the quarter. We believe the Russell indexes are widely used by investment managers and institutional investors for index funds and as benchmarks for both passive and active investment strategies. These two events are significant milestones for the Company, as they both improve our access to capital markets and further validate our business model as a vehicle providing mainstream investors with exposure to the resource sector.
Kettle and its subsidiary, World Wide Exploration S.A. de C.V. ("WWE"), provide both surface and underground drilling services but specialize in underground, hard rock core drilling. Their clients include both mining and exploration companies in the United States and Mexico. For the second consecutive year, total revenues, both for the quarter and for the first nine months of 2008, increased approximately 100 percent compared to the prior year. Compared to the same quarter in the previous year, WWE showed an almost five-fold increase in net income before income taxes to $682,164 and an over 300 percent increase in net income before taxes to $1,451,322 for the nine months ended June 30, 2008.
Once again, we are pleased with our performance in Mexico and expect profitability to continue.
During the quarter we implemented our previously announced management transition at Kettle, which included severance payments to the previous management that resulted in a one-time charge of $1,880,590. As a part of this management transition, the Company undertook a detailed materials and supplies inventory analysis and determined that a charge to net income of $535,658 was appropriate to reflect the net realizable value of the materials and supplies inventory.
For the three months ended June 30, 2008, Kettle reported a net loss of $1,745,974. Without the one-time severance payments and adjustment to inventory, Kettle would have reported a net income before taxes of $670,274 for the quarter ended June 30, 2008 in addition to the net income before taxes of $682,164 realized by WWE in the quarter. In addition, we obtained a loan to repurchase and retire the majority of the outstanding Series A Preferred shares held by the previous owners of Kettle Drilling.
As a part of this transition, we have a new and more focused corporate culture at Kettle with an emphasis on improving the performance of the U.S. operations. During the quarter we hired Martin Lanphere as President of Kettle. Mr. Lanphere brings a hands-on management and banking background to the Company. In addition to Mr. Lanphere and a number of other personnel changes at Kettle, subsequent to quarter end we hired Reggie Montgomery as General Manager in charge of all drilling
operations. Mr. Montgomery was most recently with Newmont Mining and was Manager of Drilling Services. Newmont is a current customer of Kettle and our drilling teams worked directly with Mr. Montgomery in Nevada.
We believe that our new management team and ongoing focus from rapid growth to profitability will continue to improve our operating results. As previously announced, and based on the revenues reported by our drilling operations for the first three quarters, we are confident that, barring unforeseen events, we will achieve our 2008 drilling revenue objective of $30-million.
Subsequent to the end of the quarter, we announced the filing of our Definitive Proxy and Annual Meeting. The Proxy includes, among other items, our proposal to acquire Small Mine Development, LLC ("SMD"), one of the largest underground mine contractors in the United States. We believe that if we receive shareholder approval and complete the acquisition of SMD, this will provide us with the foundation to be a significant player in the North American mining services industry. We believe that our pursuit of SMD demonstrates our belief that a strong presence in both mining services and exploration is likely to provide excellent returns to our shareholders over the long term.
In our Exploration Division, during the quarter, as in previous quarters, we continued our exploration, permitting, and drilling activities. Our increased expenditures are representative of our commitment to ramp up exploration activity during 2008 on several of our properties. Subsequent to the end of the quarter, as announced, we mobilized a drill rig to the Butte Highlands property and drilling is currently underway on this project. Furthermore, we are moving forward with the permitting and planning necessary for additional drilling and exploration at Butte Highlands.
Also, as previously announced we received approval from Inyo County to proceed with exploration at Conglomerate Mesa and are awaiting final approval from the Bureau of Land Management for our planned road building and drill program. In preparation for our upcoming drill program, we conducted extensive mapping and sampling at this property, and we continue to build upon previous work performed by Newmont and BHP-Billiton as we explore and define this district-scale gold exploration prospect.
Results of Operations for the Three Month and Nine Month Periods ended June 30, 2008 and 2007
Combined Results - Timberline Corporate, Timberline Exploration, Kettle Drilling and WWE
For the three months ended June 30, 2008, we reported $9,703,813 in revenue compared to $4,798,748 in the same period of 2007. For the nine months ended June 30, 2008 we reported revenues of $24,525,265 versus revenues of $11,840,469 in the same period of 2007. Our revenues are derived entirely from our drilling subsidiaries and are comprised of $7,318,802 from Kettle Drilling and $2,385,011 from WWE for the three months ended June 30, 2008. For the nine months ended June 30, 2008, Kettle Drilling and WWE reported revenues of $17,983,223 and $6,542,042, respectively. Our revenue increase was primarily due to the growth in the number of drill rigs operating this year versus last year. Gross profit from Kettle and WWE was $1,271,632 and $784,544, respectively, for the three months ended June 30, 2008, and $3,664,286 and $1,929,783, respectively, for the nine months ended June 30, 2008.
Our overall after tax net loss for the three months ended June 30, 2008 was $2,615,278 compared to an overall net loss of $918,897 for the three months ended June 30, 2007. For the nine months ended June 30, 2008, our overall net loss was $5,096,026 compared to $2,279,947 for the same period in 2007. Our net loss for the three months ended June 30, 2008 is comprised of $1,325,486 for Timberline Corporate and Exploration and $1,745,974 for Kettle Drilling, offset by income of $456,182 at WWE. Our net loss for the nine months ended June 30, 2008 is comprised of $4,060,370 for Timberline Corporate and Exploration and $1,935,476 for Kettle Drilling offset by a gain of $899,820 at WWE. Kettle Drilling's net loss for the three months and nine months ended June 30, 2008 includes one-time severance benefits of $1,880,590 to former managers of the company.
Timberline Corporate and Exploration Division
The after tax net loss of $1,325,486 for the combined Timberline Corporate and the Exploration division during the three months ended June 30, 2008 is comprised of non-cash charges of $493,289, exploration expenditures of $167,098, and other general and administrative costs of $670,130, less other income of $5,031. A significant portion of other general and administrative costs during the quarter were related to legal and accounting costs associated with our proposed acquisition of SMD and our definitive proxy that was filed with the SEC subsequent to quarter end. Included in the non-cash charges are expenses related to stock options that vested during the quarter. Also included in the non-cash charges is $12,734 in Depreciation and Amortization.
The after tax net loss of $4,060,370 for the combined Timberline Corporate and the Exploration division during the nine months ended June 30, 2008 is comprised of non-cash charges of $1,332,222, exploration expenditures of $1,166,818, and other general and administrative costs of $1,661,188, less other income of $99,858. A significant portion of other general and administrative costs for the year to date were related to legal and accounting costs associated with our proposed acquisition of SMD and our definitive proxy that was filed with the SEC subsequent to quarter end. Included in the non-cash charges are expenses related to common stock issuances for consulting services, stock based compensation, and for stock options that vested during the year to date. Also included in the non-cash charges is $139,724 in Depreciation and Amortization.
Kettle Drilling and WWE
For the three months ended June 30, 2008, Kettle Drilling had revenues of $7,318,802 as compared to $3,855,351 for the three months ended June 30, 2007.
WWE had revenues of $2,385,011 for the three months ended June 30, 2008 as compared to $943,397 for the three months ended June 30, 2007. The increase in revenues is attributable to the growth in the number of operating drill rigs at each company.
For the three months ended June 30, 2008, net loss before taxes from Kettle was $1,745,974 while net income before taxes at WWE was $682,164 as compared to a net loss of $395,071 for Kettle and net income of $135,005 for WWE for the three months ended June 30, 2007. At Kettle, the current quarter loss is attributable to one-time severance expenses incurred as part of our management transition at the Company, while the net income at WWE grew substantially compared to the corresponding quarter in 2007 due to the increased activity and number of drill rigs in Mexico.
For the nine months ended June 30, 2008, Kettle Drilling had revenues of $17,983,223 as compared to $9,351,425 for the nine months ended June 30, 2007.
WWE had revenues of $6,542,042 for the nine months ended June 30, 2008 as compared to $2,489,044 for the nine months ended June 30, 2007. The considerable increase in revenues is attributable to the growth in the number of operating drill rigs at each company.
For the nine months ended June 30, 2008, net loss before taxes from Kettle was $1,935,476 while net income before taxes at WWE was $1,451,322, as compared to a net loss of $1,044,406 for Kettle and net income before taxes of $415,526 for WWE for the nine months ended June 30, 2007. At Kettle, the increased loss from last year is attributable to one time severance expenses incurred as part of our management transition at the Company, while the net income at WWE grew substantially due to the increased activity and number of drill rigs in Mexico.
Financial Condition and Liquidity
At June 30, 2008, we had assets of $23,722,439 consisting of cash in the amount of $2,922,345; accounts receivable, net of allowance for doubtful accounts, in the amount of $4,594,657; inventories valued at $2,048,350; property, mineral rights and equipment, net of depreciation of $9,785,525; and other assets of $4,371,562. The Company believes that its cash and cash flow from continuing operations will be sufficient to fund our operations for the next twelve months.
Off-Balance Sheet Arrangements
We do not have any off balance sheet arrangements that are reasonably likely to have a current or future effect on our financial condition, revenues, results of operations, liquidity or capital expenditures.
Critical Accounting Policies and Estimates
See Note 2 to the financial statements contained elsewhere in this Quarterly Report for a complete summary of the significant accounting policies used in the presentation of our financial statements. The summary is presented to assist the reader in understanding the financial statements. The accounting policies used conform to accounting principles generally accepted in the United States of America and have been consistently applied in the preparation of the financial statements.
Our critical accounting policies are as follows:
Exploration Expenditures
All exploration expenditures are expensed as incurred. Significant property acquisition payments for active exploration properties are capitalized. If no mineable ore body is discovered, previously capitalized costs are expensed in the period the property is abandoned.
Revenue Recognition
Generally, the Company recognizes drilling service revenues as the drilling services are provided to the customer based on the actual amount drilled for each contract. In some cases, the customer is responsible for mobilization and "stand by" costs when the Company deploys its personnel and equipment to a specific drilling site, but for reasons beyond the Company's control, drilling activities are not able to take place. Usually, the specific terms of each drilling job are agreed to by the customer and the Company prior to the commencement of drilling.
Intangible Assets
Intangible assets from the acquisition of Kettle Drilling, including employment contracts, and customer drilling contracts, are stated at the estimated value at the date of acquisition. Amortization of employment contracts is calculated on a straight-line basis over a useful life of three years. Amortization of the drilling contracts is calculated on a straight-line basis over the life of the contracts (typically one year or less). The value of employment and customer drilling contracts will be periodically tested for impairment. Any impairment loss revealed by this test would be reported in earnings for the period during which the loss occurred.
Inventories
The Company values its inventories at the lower of average cost or market, using the first-in-first-out (FIFO) method. Allowances are recorded for inventory considered to be in excess or obsolete. Inventories consist primarily of parts, operating supplies, drill rods and drill bits. The value of inventory previously used in drilling and still considered useable, is valued at 25-90% of cost depending on remaining life expectancy.
Review of Carrying Value of Property and Equipment for Impairment
The Company reviews the carrying value of property and equipment for impairment whenever events and circumstances indicate that the carrying value of an asset may not be recoverable from the estimated future cash flows expected to result from its use and eventual disposition. In cases where undiscounted expected future cash flows are less than the carrying value, an impairment loss is recognized equal to an amount by which the carrying value exceeds the fair value of the asset. The factors considered by management in performing this assessment include current operating results, trends and prospects, the manner in which the property is used, and the effects of obsolescence, demand, competition, and other economic factors.
Goodwill
Goodwill relates to the acquisition of Kettle Drilling. In accordance with Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets," at least annually goodwill is tested for impairment by applying a fair value based test. In assessing the value of goodwill, assets and liabilities are assigned to the reporting units and a discounted cash flow analysis is used to determine fair value. There was no impairment loss revealed by this test as of September 30, 2007.
Derivative Financial Instruments
The Company does not use derivative instruments to hedge exposures to cash flow, market, or foreign currency risks. Derivative financial instruments are initially measured at their fair value. For derivative financial instruments that are accounted for as liabilities, the derivative instrument is initially recorded at its fair value, with changes in the fair value reported as charges or credits to income. For option-based derivative financial instruments, we use the Black-Scholes option pricing model to value the derivative instruments.
Certain information contained in this "Management Discussion and Analysis" constitutes forward looking information and actual results could differ from estimates, expectations or beliefs contained in such statements.
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