10QSB: ARETE INDUSTRIES INC
11/19/2002 5:49:34 PM
(EDGAR Online via COMTEX) -- Item 2 - Management's Discussion and Analysis
Critical accounting policies:
The Company has identified the accounting policies described below as critical to its business operations and the understanding of the Company's results of operations. The impact and any associated risks related to these policies on the Company's business operations is discussed throughout this section where such policies affect the Company's reported and expected financial results. The preparation of this Quarterly Report requires the Company to make estimates and assumptions that affect the reported amount of assets and liabilities of the Company, revenues and expenses of the Company during the reporting period and contingent assets and liabilities as of the date of the Company's financial statements. There can be no assurance that the actual results will not differ from those estimates.
Stock issuances:
The Company has relied upon the issuance of shares of its common stock, options to purchase its common stock and preferred stock to fund much of the Company's operations. The following describes the methods used to record various stock related transactions.
Stock issued for services is valued at the market price of the Company's stock at the date of grant.
Compensation related to the issuance of stock options to employees and directors is recorded at the intrinsic value of the options, which is the market price of the Company's common stock less the exercise price of the option at the measurement date. The Company's common stock issued to consultants is recorded at the market price of the Company's common stock at the measurement date. The measurement date is generally the date the options are fully vested.
Revenue recognition:
The Company has provided management services to companies in the process of developing new products with no operations. These management fees have not been recorded as revenue at this time since collectibility is not reasonably assured.
Research and development:
The Company has also advanced funds to these start-up companies. As the start-up companies have used these advances for research and development, these amounts have been recorded as research and development expense in the Company's financial statements.
Overview.
During the quarter ended September 30, 2002, the Company filed a current report on Form 8-K reporting events commencing May 31, 2002 including material transactions through August 7, 2002 which disclosure is incorporated herein by reference, and which information is briefly summarized below, but which is qualified in its entirety by the more detailed disclosure contained in such Current Report.
During the Quarter ended September 30, 2002, we held our shareholders meeting and completed a recapitalization that included a 20 to 1 reverse stock split, installed a new board of directors and brought two new members to our executive management team. New management jointly agreed to accept compensation for the balance of the fiscal year in the form of common stock grants and options, and to accept future cash and/or stock compensation after the end of the current fiscal year, based on achieving successful, positive business results that add value to the Company.
Eagle Capital Funding Corp., an affiliate of the Company ("Eagle Capital"), continued to advance funds to cover the Company's expenses, totaling approximately $12,448 during the third quarter 2002. Subsequently, Eagle Capital advanced an additional $14,817 through the date of this report. In total, Eagle has advanced $73,951, in cash of which $50,115 has been converted into 5,012 shares of Series 2 Convertible Preferred Stock, which has conversion rights to convert into 5,011,519 shares of common stock of the Company. As previously disclosed in the Company's Periodic Report on Form 8-K described above, an additional 10,000 shares of the Series 2 Convertible Preferred Stock has been issued to Eagle Capital Fund-I, LLC, an affiliate of Eagle Capital (the "Eagle Fund") in payment of two $50,000 promissory notes of the Company. As part of agreements pertaining to this transaction, 500,000 restricted shares of the Company's common stock originally pledged by the Company as collateral for the two notes and deemed unissued for accounting purposes, was deemed issued and recorded as additional interest expense of $10,000.
We continue in our efforts to resolve our outstanding employment tax liabilities by pursuing an offer in compromise with the Internal Revenue Services. As previously disclosed, during the second Quarter, 2002, we settled or converted certain debts owed to the CEO and the former CFO in the amount of $344,000. We continue to pursue settlements or conversion of debt including payables and accrued salaries and bonuses owed to former management employees in the approximate amount of $300,000.
With the aid of these transactions, we are nearing completion of our plan to change our capital and corporate structure. With the continuing development of Eagle Capital's business plan, we have become confident enough to move forward on several business initiatives that we believe will set the groundwork for attracting more valuable acquisition and investment opportunities to the Company in the future.
In November, 2002, we became engaged by Celexx Corporation, a publicly held holding company, to provide certain investment banking consulting services including arranging or providing directly a short term loan to Celexx, assisting it in its efforts to recapitalize and restructure itself, including resolving a dispute with its preferred shareholder, and are consulting with the company to structure and arrange for permanent debt and/or equity financing for its wholly owned subsidiary, Pinneast.com to expand its operations and make certain contemplated acquisitions. We have presented our recommendations to Celexx for a structure and plan, and the client is evaluating our proposal, at which time the relationship will either proceed or be terminated. The Company may receive compensation including equity participation, Celexx common shares, professional and consulting fees and origination fees for successful completion of permanent debt and/or equity financing, and acquisitions.
We have recently retained our affiliate, Eagle Capital, operated by Mr. Gerald Brandimarte, who is an officer and director of the Company, to assist us in implementing a proprietary Variable Rate Bond Note program (the "Note Program"). The initial plan is for the Company to sell Variable Rate Bond Notes in the approximate amount of from $10 Million to $20 Million. The Note Program is designed to provide the Company with funds for operations and acquisitions of from $4.5 Million to $9 Million, with the balance invested in rated instruments and pledged against the bond notes to cover debt service. This is a unique and innovative structure that has recently been developed by Mr. Brandimarte and launched by Eagle Capital. Eagle Capital is currently drafting a prospectus and is in the process of obtaining necessary confirmations to set up this Note Program for a current client, and we intend to employ the Note Program, customized for our use as a principal feature among other financing alternatives for our potential investment banking consulting projects, future acquisitions and portfolio investments.
Since obtaining our shareholders' permission to change the Company's state of domicile to Nevada, we have deferred our decision to effect the change while we evaluate corporate governance and other requirements for listing on the new BBX exchange being proposed by NASDAQ, and until we can determine whether the benefits we hoped to obtain from redomestication would be eliminated by requirements of Business Development Companies under the Investment Company Act of 1940 (the "'40 Act").
During the period ended September 30, 2002, the Company's operations continued to be funded principally by cash infusions from insiders including Eagle Capital, by management deferring its salaries, and issuances of common stock for services. Management anticipates that ongoing expenses for the short term will be covered by proceeds of its current private placement to Eagle Capital and by exercise of stock options, to be replaced by revenues from operations as it executes its business plan as a Business Development Company.
Financial Condition
As of September 30, 2002, the Company had $232,957 in total assets and $1,342,714 in total liabilities, as compared to $252,087 and $1,837,518 at the end of fiscal year ended December 31, 2001, respectively. Accounts payable and accrued expenses at September 30, 2002 were $1,288,571 as compared to $1,553,300 at December 31, 2001. The decrease in accounts payable and accrued expenses from December 31, 2001 of $264,729 is attributable to increases in accrued salaries of $60,000 and settlement of other outstanding accrued salaries to insiders of $344,000 off set by accrued and unpaid legal, accounting, transfer agent fees, and increases in general payables. Additional reduction in total liabilities of $230,075 from December 31, 2001 through the end of the third Quarter, 2002 was achieved by payment of $100,000 in notes payable to third parties with issuance of Series 2 Convertible Preferred Stock, payment of a note payable to an affiliate of the CEO of $160,014 with Series 1 Convertible Preferred Stock, and an increase in notes payable-related parties by $29,939 including $21,804 advanced to the Company by the CEO and a company owned by the CEO. Losses were partially funded through increased accounts payable by accruing or deferring salaries, and advances from officers and affiliates and issuance of Preferred Stock.
The Company's subsidiary, Global Direct Marketing Services, Inc., which is now inactive, has left an obligation of trade payables of $87,625 and unpaid 1999 payroll taxes of $46,897 remaining from its printing and direct mail advertising business. The Company owes approximately $79,000 in unpaid Federal payroll taxes for calendar years 1995 through 1997 including penalties and interest. The Company owes approximately $65,858 in 2000 and $97,373 in 2001, respectively, in accrued payroll taxes, including penalties and interest.
During the nine months ended September 30, 2002, the Company continued to rely upon infusions of cash from loans and cash advances by executives and affiliates of the Company. The proceeds were used for overhead, expenses associated with the shareholders meeting payment of corporate obligations and business development activities. Also during the nine-month period ended September 30, 2002, of a total of $99,000 in director and executive salaries, $78,000 was paid in common stock ($39,000 to be expensed in the next quarter) and $60,000 was accrued; plus cash advances by directors and executives of $21,804 have been accrued; a total of $24,400 in compensation was paid in cash and common stock to employees and consultants; and salaries and bonuses of $477,232, which were accrued as of December 31, 2001, remain unpaid.
Results of operations
The company's operations during the third quarter of 2002 have been confined to business development activities of its officers, directors and consultants, and administrative bookkeeping tasks related to creditor and investor relations and Securities Act compliance. The Company did not engage in venture management or advisory activities and therefore was not generating revenue from executive and management services.
For the quarter ended September 30, 2002, the Company incurred $135,309 in total operating expenses. This included $39,000 of executive compensation to its officers and directors in the form of registered common stock, $37,747 to consultants in the form of stock options, rent of $8,327 other operating
associated with the annual shareholder's meeting. During the first quarter, the Company was successful in reducing its rental expense by negotiating out of its larger space and moving to a smaller suite in the same building, reducing its monthly rental to $1,968 for office. The Company continues to rent storage space for its files, inventory and excess office equipment. We envision operating the Company as a holding company in the future for other going concerns and revenue generating businesses, which will require minimal staff for accounting and administrative matters. Our future expectation is that monthly operating expenses will remain as low as possible until new opportunities are initiated, of which there can be no assurance, in which event, the operating costs of the Company may increase relative to the need for administrative and executive staff and overhead to provide support for these new business entities.
Total other income (expense) of ($13,083) included $3,277 in interest and miscellaneous income, and an interest expense of $16,360 including $10,000 in additional interest booked on payment of $100,000 in notes payable-third parties with Series 2 Convertible Preferred Stock resulting in a net loss from operations of $148,392.
Liquidity and Capital Resources
The Company has a working capital deficit as of September 30, 2002 of $1,252,173. This compares to a working capital deficit of $1,757,367 as of December 31, 2001. The $505,194 decrease in working capital deficit for the quarter ended September 30, 2002 is primarily attributable to a decrease of $273,581 in accrued expense from $852,323 for the fiscal year ended December 31, 2001, a decrease of $230,075 in notes payable from $265,568 at December 31, 2001 and payment of $100,000 in notes payable - third parties. During the quarter ended September 30, 2002, 7,800,000 shares of common stock were issued for services, and the Company issued 1,117 shares of Series 2 Convertible Preferred stock valued at face value of $11,170.
The Company had a stockholder's deficit at September 30, 2002 of $1,109,757. This is compared to stockholder's deficit at December 31, 2001 of $1,585,431. The stockholder's deficit decreased due to the Company's operating at a loss plus payment of compensation with common stock, offset by the issuance of preferred stock for cash, for conversion of certain notes payable and accrued compensation to related parties.
The Company has recently reduced the number of outstanding common shares to allow it to raise equity capital and to effect conversion and exercise of outstanding common stock options and conversion rights of preferred stock which has been reserved for issuance to insiders in exchange for their accrued cash advances, and for issuance in a private placement of up to $200,000 in Series 2 Convertible Preferred stock, which the Company is currently conducting to an affiliated entity. As of September 30, 2002, the Company had raised $50,115 in gross proceeds of this private placement and issued 5,012 outstanding shares of Series 2 Convertible Preferred Stock. Also, the Company paid off two notes payable of $50,000 each with issuance of 10,000 shares of Series 2 Convertible Preferred Stock. In addition, the Company has $23,836 in note payable - related parties for cash advances from Eagle Capital through November 15, 2002. It is expected that these cash advances will be exchanged for issuance of additional shares of Series 2 Convertible Preferred stock under the private placement.
Due to its recent liquidity issues, the Company has defaulted on several short term obligations including for its operating overhead, trade payables, and state and federal employment taxes, resulting in tax liens being imposed on the Company's assets, which will have to be resolved with an infusion of new capital, of which no assurances can be made.
At September 30, 2002, the Company had no material commitments for capital expenditures.
The Company finds itself in a highly illiquid situation with few assets and no revenue to fund ongoing operations. The Company has relied on loans from insiders and deferral of salary and compensation by its employees, as well as issuance of Common Stock and Convertible Preferred Stock to affiliates. The Company's current business plan will require minimal funds for overhead and for maintaining its financial reporting obligations. Due to the illiquidity in the Company's public trading market and the investment environment in general, the Company's ability to raise additional capital publicly or privately to launch its current business plan in the near term is severely limited. Due to such conditions the Company may continue to be required to issue further stock to pay executives, consultants and other employees, which may have a continuing dilutive effect on other shareholders of the Company. Failure of the Company to acquire additional capital in the form of either debt or equity capital will most likely impair the ability of the company to meet its obligations in the near term. The Company continues because its principal officers and affiliates continue to support the Company on a deferred compensation basis.
Subsidiaries/Employees:
Arete Industries, Inc. has one full time employee, and two part-time Corporate Officers, and its subsidiary, Aggression Sports, Inc. presently has no employees other than its acting president, the Company's current CEO. In December, 2001, Eagle Capital became independent of Arete's ownership and has been operated principally by Mr. Brandimarte, with Mr. Raabe and Mr. Stewart on its board of directors. Eagle Capital has since become a major controlling shareholder of the Company. The CEO remains on a deferred salary basis for the first two quarters of 2002 and has accepted a 2,000,000 share stock grant and an Incentive stock option to purchase 2,000,000 shares of common stock at $0.02 per share in lieu of salary for the balance of 2002, as have Mr. Stewart and Mr. Brandimarte.
Although the Aggression Sports, Inc. subsidiary is inactive, we are continuing to seek revenue generating activities including finding manufacturing and/or marketing partners for our developed products, and are hoping to recruit a new management team and investors focused on growing this company through acquisition of young outdoor sports companies, neither of which is currently in place nor can be assured with any degree of certainty. |
