Cereplast had a $1.8 million net loss or $0.12 per share in Q1 2011 as compared to a $1.7 million net loss in Q1 2010 or $0.17 per share. Cereplast's CFO, Heather Sheehan, said that gross margins will gradually improve throughout the year and the company expects it to be over 20% by the end of the year 2011.
Management has said that in order to break even, Cereplast would have to have annual revenues of between $30 - $35 million. Its guidance for 2011 is between $28-$34 million. By my calculations, if Cereplast hits its guidance, it will still have a loss for the year.
For example, let's say that Cereplast's revenue for 2011 totals $34 million, the top of its range. That's another $27 million for the year. Now let's estimate its gross margin for the rest of the year averages 15%, then that makes a gross profit of $4 million for the last three quarters. Then we can assume SG&A and R&D expenses are conservatively about $2 million per quarter, so $4M - ($2M*3) equals a loss of $2 million for the remaining three quarters, for a total loss of $3.8 million for the year, and that doesn't even include interest expense.
The company just took on a large amount of convertible debt. At a 7% interest rate, it will cost Cereplast $12.5M x .07 = $875,000 for the next year.
Furthermore, I don't believe Cereplast will even reach its predicted revenues of $28-$34 million this year. I have spoken with Cereplast's investor relations and they give no specifics of how the company came to its guidance of $28-$34 million. They just said it is from "scenario probabilities." They don't say what percentage will be compostables and what will be sustainables. When I tried to get down to specifics, they didn't give me much. They ended up basically saying that people who invest in Cereplast don't do it because of specifics, they invest because they see the value and potential of bio-based plastics, and Cereplast is a pure play on this. So therefore, it's a good investment. I have witnessed this attitude in Cereplast's conference calls as well. Management keeps things simple for investors and dances around inquisitive questions. You get the impression that Cereplast's management have a lot of knowledge behind the scenes that they don't want to talk about for some reason. I guess it's because they don't want to confuse people.
Some 85% of Cereplast's revenues come from the EU. Right now, the so-called PIIGS (Portugal, Italy, Ireland, Greece, and Spain) are at risk of going bankrupt. Paying off debt is much more important to those countries at the moment than doing what's best for the environment. A country like Italy, which is burdened with debt, can't afford to give Cereplast too many subsidies and tax breaks to fund its plant. This is not good because Cereplast expects government support for its plant. Even the EU countries doing well like Germany and France aren't going to want to spend too much tax dollars on environmental products because their economies are also affected by the PIIGS contagion. All those EU countries will have to make spending cuts, and usually "green" spending is among the first that gets cut.
In my opinion, the convertible loan terms are a bad deal for Cereplast shareholders, but a great deal for the lenders. The deal was $12.5 million in 7% senior convertible notes due June 1, 2016. The notes are convertible into common stock at 172 shares per $1000 of notes, which comes out to about $5.80 per share. If the company does well, and all the notes are converted, that would dilute the shares by 2.15 million shares, or 13.6% of the outstanding shares. Since the notes are senior, all the bondholders have to worry about is if Cereplast goes bankrupt, which probably won't happen because it will be able to issue more common stock. So basically the bondholders have no risk and are getting a nice 7% return. But if Cereplast manages to knock it out of the park, they don't get left out. The fact that the terms are so favorable to the bondholders means bankruptcy must be a material risk for the company. In general, bond purchasers are allowed access to more information than shareholders are. I can guarantee that they know a lot more about the interworkings of the company than shareholders are privy to.
There is also a good chance that Cereplast will do another share dilution in the next year or two, because it will need more funds for the Italy plant. If the company issues more debt, it will probably have to do so at too high of a rate, definitely above 7%. That's because the debt would be junior to this recent debt offering. Therefore, it would be more prudent to do a share offering.
Mr. Scheer said:
There seems to be a new era developing in India. As of April 2011, India has placed a ban on the sale and storage of plastic bags. The market for bioplastic in India has the potential to be five times that of Italy.
What does all this mean for the stock? It's hard to tell because we don't know how much competition Cereplast has in places like Italy, other countries in the EU, and India.
