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19-Sep-2008
Quarterly Report
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
THE FOLLOWING DISCUSSION AND ANALYSIS PROVIDES INFORMATION WHICH OUR MANAGEMENT BELIEVES IS RELEVANT TO AN ASSESSMENT AND UNDERSTANDING OF OUR RESULTS OF OPERATIONS AND FINANCIAL CONDITION. THIS DISCUSSION SHOULD BE READ TOGETHER WITH OUR CONSOLIDATED FINANCIAL STATEMENTS AND THE NOTES TO OUR CONSOLIDATED FINANCIAL STATEMENTS WHICH ARE INCLUDED IN THIS REPORT, AND WITH OUR ANNUAL REPORT ON FORM 10-KSB FILED ON MARCH 31, 2008 AS AMENDED BY FORM 10-KSB/A FILED ON APRIL 30, 2008.
As used in this report, the terms "we," "us," and "our," mean Kreido Biofuels, Inc. and our subsidiaries, unless otherwise indicated.
We took our current form on January 12, 2007, when our wholly-owned subsidiary, Kreido Acquisition Corp., or Acquisition Sub, and Kreido Laboratories, or Kreido Labs, executed a Merger Agreement and Plan of Reorganization, or the Merger Agreement. On January 12, 2007, Acquisition Sub merged with and into Kreido Labs, with Kreido Labs remaining as the surviving corporation and as our wholly-owned subsidiary, or the Merger. Also contemporaneously with the closing of the Merger, we split-off another wholly-owned subsidiary, Gemwood Leaseco, Inc., a Nevada corporation, through the sale of all of the outstanding capital stock of Gemwood Leaseco, Inc., or the Split-Off. As a consequence of the sale of Gemwood Leaseco, Inc., we discontinued all of our business operations which we conducted prior to the closing of the Merger, and spun off all material liabilities existing prior to that date in any way related to our pre-closing business operations. Our primary operations are now those operated by Kreido Labs.
The Merger was treated as a recapitalization of our company for accounting purposes. Our historical financial statements before the Merger were replaced with the historical financial statements of Kreido Labs in all filings with the SEC subsequent to January 12, 2007.
Kreido Labs is a corporation founded to develop proprietary technology for building micro-composite materials for electronic applications. In 1995, Kreido Labs began to develop the technology used in the design and assembly of our STT� Reactor. Kreido Labs thereafter sought to develop the technology to improve the speed, completeness and efficiency of certain chemical reactions, including esterifications and transesterifications, in the pharmaceutical and chemical industries. We designed and developed the STT� Reactor which incorporates our proprietary and patented "spinning tube-in-tube" design configuration to improve the speed and yield of chemical reactions. One of the Environmental Protection Agency's largest laboratories has been using our STT�Reactor-based technology since 2004 to develop and evaluate new chemical processes and develop and optimize protocols for use of the STT� Reactor by public and private entities. Beginning in the last quarter of 2005, Kreido Labs began to evaluate the advantages of the STT� Reactor specifically for the production of biodiesel. In the first quarter of 2006, Kreido Labs elected to focus almost exclusively on the biodiesel industry and began to prepare and execute our current business plan. On January 12, 2007, as a result of the Merger, Kreido Labs became a wholly-owned subsidiary of Kreido Biofuels, Inc.
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Plan of Operations
On June 20, 2008, we announced that we were suspending our plan to commercialize our proprietary equipment system for biodiesel production on an industrial scale and to become one of the leading providers of biodiesel in the United States and elsewhere. We expected to execute our business plan by generating revenues from multiple sources: 1) by building and operating our own STT�biodiesel Production Units; 2) licensing our STT� Reactor-based technology to others which may require one of our production units to be in operation, and 3) in the longer term, by providing technology and investing in businesses that will develop or use our STT� Reactor-based technology for production of biofuels and other products. We are now pursuing a limited action plan to realize the value of our assets and our STT� technology.
Since June 20, 2008, we have wound down our plant development activities, and begun monetizing and physically consolidating selected assets. We have focused our attention on identifying, and engaging in discussions with, other companies that have the capacity to acquire some or all of our assets and continue our business while also addressing supplier-creditor matters. We have reduced our operating costs through curtailing our manufacturing operations, site development and other operating activities as well as reducing our staff from 19 to 7 executive and key technical and accounting personnel who we believe are instrumental in pursuing the Company's limited action plan and marketing its technology. The Company has incurred, and will continue to incur, costs associated with carrying out its limited action plan. The amount of these costs, which are being expensed as incurred, are expected to have a significant adverse affect on the results of operations and on the Company's cash position. Additionally, there can be no assurances that any of the interested parties will ultimately purchase any or all of the assets or intellectual property of the Company or that all supplier-creditor matters will be addressed and settled. The goal of this limited action plan is to effect an orderly disposition of our tangible and intangible assets, satisfy the Company's liabilities, and ultimately share the remaining assets, if any, among our shareholders. Our ability to successfully carry out the limited action plan and accomplish this goal will be affected by the business conditions in the alternative fuels industry, general economic conditions, and other matters, many of which are beyond our control. Taking into account these factors and various disposition assumptions, some of which may not materialize, we have made impairment adjustments of approximately $13.4 million to the value of our assets at June 30, 2008. Our ability to effectively complete our limited action plan is inherently uncertain. In addition, unanticipated and uncertain events and circumstances occurring subsequent to the date of this Quarterly Report may affect the actual value of our assets, the related impairment adjustments and the results of our plan both favorably or unfavorably.
Consolidated Results of Operations for the six months ended June 30, 2008 and 2007
Operating Expenses
Operating expenses of $17.9 million for the six months ended June 30, 2008 increased by $15.7 million compared to $2.2 million for the same period in 2007. Research and development expense for the six months ended June 30, 2008 were $809,000 compared to $298,000 for the same period in 2007, an increase of $511,000. Research and development expenses increased for the first half of 2008 compared to the same period in 2007 due to the hiring of a chief technology officer and a scientist in the second quarter of 2007 whose costs were not reflected in the earlier months of 2007 and also to the patent valuation write down of $639,000 in 2008. We expect research and development expenses to be at a minimum in the future. General and administrative costs increased to $3.7 million for the six months ended June 30, 2008 from $1.9 million for the same period in 2007. The increase was related primarily to the rental of tanks from Vopak and the write off of capitalized site specific costs related to the proposed full scale plant site, the costs associated with being a public company, an increase in stock compensation expense from the issuance and repricing of stock options to employees and an increase in payroll related costs from the hiring of additional personnel. Also during 2008, we expensed $13.4 million of costs attributed to plant assets and costs associated with building extra reactors and acquiring spare parts as an impairment reserve. We expect general and administrative costs to decrease compared to the first six months of the year as we complete the winding down of our operations and pursue our limited action plan to realize the value of our assets and business. Additionally, we will continue to incur costs associated with operating as a public reporting entity.
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Other Income (Expense)
Other income (expense) for the six months ended June 30, 2008 declined to $53,000 from $421,000 for the same period in 2007. Other income for the six months ended June 30, 2008 and 2007 consisted of interest income. The interest income decrease reflects the changes in the available cash balances. Net Loss
Net loss for the six months ended June 30, 2008 was $17,808,000, or about 908% increase compared to the net loss of $1,766,000 for the same six month period for 2007. There were no net sales or gross profit for the six months ended June 30, 2008 and 2007. We expect to incur net losses for the foreseeable future as we continue to pursue our limited action plan.
Consolidated Results of Operations for the three months ended June 30, 2008 and 2007
Operating Expenses
Operating expenses of $15.3 million for the three months ended June 30, 2008 increased by $13.8 million compared to $1.5 million for the same period in 2007. Research and development expense for the three months ended June 30, 2008 were $582,000 compared to $278,000 for the same period in 2007, an increase of $304,000. The increase in research and development expenses was due primarily to the patent valuation write down of $398,000 in the second quarter of 2008. General and administrative costs increased to $2.1 million for the three months ended June 30, 2008 from $1.2 million for the same period in 2007. The increase was related primarily to the write off of $891,000 of capitalized site specific costs related to the proposed full scale plant site. Development of the full scale plant site was suspended on June 20, 2008. Also during 2008, we expensed $13.4 million of costs attributed to plant assets and costs associated with building extra reactors and acquiring spare parts as an impairment reserve. We expect general and administrative costs to decrease compared to the prior three months of 2008 as we complete the winding down of our operations and pursue our limited action plan to realize the value of our assets and business. Additionally, we will continue to incur costs associated with operating as a public reporting entity.
Other Income (Expense)
Other income (expense) for the three months ended June 30, 2008 declined to $12,000 from $229,000 for the same period in 2007. Other income for the three months ended June 30, 2008 and 2007 consisted of interest income. The interest income decrease reflects the changes in the available cash balances. Net Loss
Net loss for the three months ended June 30, 2008 was $15,303,000 compared to the net loss of $1,233,000 for the same three month period for 2007. There were no net sales or gross profit for the three months ended June 30, 2008 and 2007. We expect to incur net losses for the foreseeable future as we continue to pursue our limited action plan.
Liquidity and Capital Resources
A summary of our sources and use of cash for the six months ended June 30, 2008, is as follows:
� Source of cash consisted of interest income of $52,000.
� Uses of cash consisted of plant development costs including purchases of fixed assets and construction of plant components and reactors of $4.1 million, operating expenses of $2.1 million (net of non-cash expenses such as loss on impairment of property and equipment, stock compensation, and depreciation and amortization), repayment of capital leases of $19,000 and investments in patents of $68,000 for a total use of cash of approximately $6.3 million.
� The decrease in cash balance to $1.4 million results from net sources of $52,000 less uses of cash of $6.3 million plus an increase in the amounts due to vendors of $1.2 million which will be paid in future periods.
The details of the cash flow activities for the six months ended June 30, 2008 are discussed below.
Net cash used by operating activities for the six months ended June 30, 2008 was $941,000 as compared to net cash provided by operating activities of $680,000 for the same period in 2007. Net cash used by operations in 2008 is primarily related to operating costs and an increase in accounts payable which consisted of certain large payments due to vendors associated with the construction of our biodiesel production plant. In addition, we supplemented our net operating loss with a $13.4 million reserve for the possible impairment of our fixed assets. We also incurred an increase in stock compensation costs compared to the prior period.
Net cash used by investing activities for six months ended June 30, 2008 was approximately $4.1 million which was a decrease from $6.1 million used by investing activities for the same period in 2007. The cash used in 2008 and 2007 consisted primarily of the purchase and construction of equipment and facilities associated with our Wilmington Plant. Costs of the plant consist of: (1) site selection, leasing, permitting and other legal compliance; (2) architectural, design and engineering; (3) labor, overhead and materials to build in-house the STT� Reactors; (4) designing, engineering and manufacturing of the plant production unit which includes components such as centrifuges, tanks, control panels and other equipment being built by third parties for delivery to the plant site; and (5) the general contractor fees, engineering and construction of the buildings and physical improvements including tanks, piping, boilers and various lab and other equipment and machinery comprising the plant. In addition, approximately $2.3 million has been recorded as outstanding payables for services, equipment and construction work incurred through June 30, 2008 provided by sub-contractors and equipment vendors. We also invested $68,000 in patents for six months ended June 30, 2008.
Net cash used by financing activities for six months ended June 30, 2008 was $19,000 which is due to repayment of capital lease obligations. For the same period in 2007, $22.7 million was provided by financing activities consisting primarily of the private placement sale of our common stock netting proceeds to us of approximately $23 million. This was offset by the repayment of outstanding notes and the payment of capital leases of $151,000.
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In furtherance of our limited action plan, in July, 2008, we received $400,000 in full settlement of a claim we had against a former professional advisor, which settlement included a release of all of the Company's claims against the former professional advisor.
Summary of Significant Accounting Policies Basis of Presentation
The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America.
Research and Development
Research and development costs related to the design, development, demonstration, and testing of reactor technology are charged to operations as incurred.
Cash and Cash Equivalents
We consider all highly liquid investments with a maturity date of three months or less when purchased to be cash equivalents. Use of Estimates
Preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and reported amounts of revenues and expenses during the reporting periods covered by the consolidated financial statements and accompanying notes. Actual results could differ from those estimates.
Depreciation and Amortization
The provision for depreciation of property and equipment is calculated when put into service on the straight-line method over the estimated useful lives of the related assets, generally ranging from five to seven years. Leasehold improvements are amortized over the shorter of the useful life of the related asset or the lease term.
Patents
Capitalized patent costs consist of direct costs associated with obtaining patents such as legal expenses and filing fees. Patent costs are amortized on a straight-line basis over 15 years, which is the expected life, beginning in the month that the patent is issued. Patent costs are capitalized beginning with the filing of the patent application. The patents are tested for impairment annually, or more frequently if events or conditions indicate the asset might be impaired and the carrying value may not be recoverable. These conditions may include an economic downturn, new and or competitive technology, new industry regulations and a change in our operations or business direction. The impairment tests include a comparison of estimated undiscounted cash flows associated with the asset's carrying amount. If the assessment determines that the fair value is less than the carrying amount of the patent, an impairment charge is recorded to reduce the amount of the patent.
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Impairment of Long-Lived Assets
We continually evaluate whether events and circumstances have occurred that indicate the remaining estimated useful life of long-lived assets may warrant revision or that the remaining balance of long-lived assets may not be recoverable in accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. When factors indicate that long-lived assets should be evaluated for possible impairment, we use an estimate of the related undiscounted future cash flows over the remaining life of the long-lived assets in measuring whether they are recoverable. If the estimated undiscounted future cash flows are less than the carrying amount of the asset, a loss is recorded as the excess of the asset's carrying amount over its fair value. Management has performed an assessment of the fixed assets of the Company which includes assessments of the future realizable value of the assets through discussion with potential buyers and our current manufactures and vendors though a formal appraisal was not obtained due to its cost. Based on this analysis, we have reserved a significant portion of the amount of our assets for future plants, spare parts and other fixed assets though there can be no assurance that additional reserves or write offs may be required nor that a reduction in the current reserve may be recorded when the actual realized value of the fixed assets are determined through sale or exchange. Stock-Based Compensation
Effective January 1, 2006, we adopted SFAS 123(R) "Share Based Payment" using the modified prospective approach and accordingly prior periods have not been restated to reflect the impact of SFAS 123(R). Under SFAS 123(R), stock-based awards granted prior to January 1, 2006 will be charged to expense over the remaining portion of their vesting period. These awards will be charged to expense under the straight-line method using the same fair value measurements which were used in calculating pro forma stock-based compensation expense under SFAS 123. For stock-based awards granted on or after January 1, 2006, we determined stock-based compensation based on the fair value method specified in SFAS 123(R), and we will amortize stock-based compensation expense on the straight-line basis over the requisite service period.
For periods prior to January 1, 2006, SFAS 123(R) requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from initial estimates. Fair Value of Financial Instruments
The carrying values reflected in the balance sheets for cash and cash equivalents, accounts receivable, accounts payable and accrued expenses approximate their fair values due to the short maturity of these instruments. The carrying value of convertible notes payable and capital leases approximates their fair value based upon current market borrowing rates with similar terms and maturities.
Comprehensive Loss
Except for net loss, we have no material components of comprehensive loss, and accordingly, the comprehensive loss is the same as the net loss for all periods presented.
Recent Accounting Pronouncements
In March 2008, the FASB issued SFAS No. 161, "Disclosures about Derivative Instruments and Hedging Activities" ("SFAS No. 161"). SFAS 161 requires companies with derivative instruments to disclose information that should enable financial-statement users to understand how and why a company uses derivative instruments, how derivative instruments and related hedged items are accounted for under FASB Statement No. 133 "Accounting for Derivative Instruments and Hedging Activities" and how derivative instruments and related hedged items affect a company's financial position, financial performance and cash flows. SFAS 161 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008. We will review the effect of the adoption of this statement, and if it applies, it is likely to have a material effect on our future financial position or results of operations.
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In December 2007, the Financial Accounting Standards Board (FASB) issued Statement No. 141 (revised 2007), "Business Combinations." The new standard requires the acquiring entity in a business combination to recognize all (and only) the assets acquired and liabilities assumed in the transaction; establishes the acquisition-date fair value as the measurement objective for all assets acquired and liabilities assumed; and requires the acquirer to disclose to investors and other users all of the information they need to evaluate and understand the nature and financial effect of the business combination. This Statement is effective for us starting January 1, 2009 and we currently believe it will have no financial impact on us.
In December, 2007, the FASB issued Statement No. 160, "Noncontrolling Interests in Consolidated Financial Statements-an amendment of ARB No. 51." This statement establishes accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. This statement is effective prospectively, except for certain retrospective disclosure requirements, for fiscal years beginning after December 15, 2008. We currently believe this Statement will have no financial impact on us.
In February 2007, the Financial Accounting Board (FASB) issued SFAS No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities" ("SFAS 159") which permits entities to choose to measure many financial instruments and certain other items at fair value that are not currently required to be measured at fair value. SFAS 159 is effective for us on January 1, 2008. We evaluated the impact of the adoption and determined that it does not have any impact on our current financial condition or results of operations.
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements ("SFAS 157"). SFAS 157 defines fair value, establishes a framework for measuring fair value and expands disclosure of fair value measurements. SFAS 157 applies under other accounting pronouncements that require or permit fair value measurements and, accordingly, does not require any new fair value measurements. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007. We evaluated the impact of the adoption and determined that it does not have any impact on our current financial condition or results of operations.
Off-Balance Sheet Arrangements
We do not have any off-balance sheet arrangements as defined in Item 303(c) of Regulation S-B, promulgated by the SEC.
