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cvfcorp.com
April 8, 2005
CVF Technologies Corp (CNV) Annual Report (SEC form 10KSB)
ITEM 6 MANAGEMENT'S DISCUSSION AND ANALYSIS
Plan of Operation
Subject to the limitations of its financial position as discussed above, CVF plans to build on the successes and advances achieved by its investee companies in 2004. It will continue its efforts to assist all of its investee companies to realize their full potential. The ability of certain of the investee companies (excluding Biorem which has been profitable for the past three fiscal years), which currently are not profitable, to meet the goals included in the plan of operation may be limited by CVF's ability to fund its investees as described in "Factors That May Affect Future Results".
The four Consolidated Entities which are active technology businesses, namely Ecoval, SRE, Biorem, and Gemprint, each made progress in 2004 and each are positioned to expand in 2005.
BIOREM's 2004 sales revenues were at a record $7,665,754 and net income of $750,167. For the twelve months ended December 31, 2004, sales bookings were $8,720,000 which is a 252% increase over last year's comparable figure of $2,475,000. The bookings for the year have resulted in a backlog of $3,781,000 at December 31, 2004. Backlog includes firm orders and acknowledgement of contract awards through a Letter of Intent. The 36% increase in backlog compared to December 31, 2003 continues to support management's expectations for the continued growth of the business. Large orders in any particular period make it difficult to compare periodic revenue and bookings results. Order bookings and the completion schedule of orders will continue to fluctuate quarter to quarter.
Ecoval expanded its product line with the addition of a moss cleaner. Patents have also been granted in North America on an improved herbicidal composition and insecticidal composition. Ecoval also developed an insecticide formulation that is exempt from U.S. registration because it is composed of ingredients that the EPA has determined pose minimal risk to the public. In 2005, Ecoval will continue to generate sales revenues by establishing key distributor relationships in North America, establishing potential licensees to generate royalty income and by working to expand sales to its current customer base, as it has done with Scotts Canada which is a subsidiary of Scotts Miracle-Gro Company, the largest retail horticultural supply company in the world.
Gemprint's strategy of targeting all links in the diamond supply chain bore fruit in 1999 with the completion of the Canadian Northwest Territories Agreements and the commencement of Gemprinting of cut diamonds sourced in the new Canadian diamond fields. Leveraging on this success, Gemprint is working to increase sales to wholesalers, major retailers, laboratories and manufacturers in North America, Europe and the Far East. Over the past few years international concern over the issue of `conflict diamonds' has heightened. "Clean Diamonds" legislation has recently been enacted by the U.S. Congress and demonstrates public interest in the certification of the origin of diamonds imported into the U.S. Gemprint's technology has already provided the basis for diamond tracking systems in Canada and may well find wider application as such systems proliferate.
SRE extended the number of OEM customers served in 2004 and expanded its dealer network. Also, SRE is continuing to develop working relationships with certain electric vehicle manufacturers to supply electrical subsystems to expand its product offering in the marketplace. During 2004 SRE expanded marketing activities and expanded engineering staff, all intended to increase sales revenue, quality, new technology and customer appeal. These activities are expected to have a positive impact on future financial results.
On March 11, 2005, a secured creditor of SRE Controls Inc. called a $550,000 cdn secured demand note and appointed a receiver to administer the Company. The assets of SRE are estimated by the receiver at $902,000 cdn while the total due creditors (secured and unsecured) is estimated at $1,600,000 cdn. On March 31, 2005 a bankruptcy filing was filed in the office of the Superintendent of Bankruptcy Canada. The first meeting of creditors has been set for April 15, 2005.
CVF's Equity Investee, Petrozyme, advanced in 2004 with a Saudia Arabia consulting contract to study the feasibility of using Petrozymes technology for its refineries and is positioned to make further progress in 2005.
CVF, when possible, will continue to work to provide equity investment and/or debt financing, based on the progress made by the investee companies as it assesses their
needs. CVF will accomplish this within the limits of its own funds or by assisting its investee companies in completing private placements or public offerings for themselves, as and when appropriate.
Individual investee companies are expected to continue approximately the same level of research and development that they have performed in the past two years. There are no expectations for significant increases in plant or equipment or in the number of employees for these companies over the next 12 months.
Comparison of Consolidated Results 2004 and 2003
Consolidated sales of CVF for the fiscal year amounted to $7,957,675, representing a decrease of $746,394 (9%) compared to sales of $8,704,069 for 2003. CVF, on a stand-alone basis, has no sales from operations. Sales and gross profit reflect the operations of CVF's consolidated subsidiaries only. These subsidiaries include Ecoval, Gemprint, Biorem (effective November 24, 2004, Biorem's results are no longer included in CVF's consolidated results as CVF's ownership in Biorem as a result of Biorem issuing additional stock during its going public transaction as well as the exercising of all stock options and conversion of all debt, as well as CVF selling a portion of its Biorem shares, has now decreased to 33%), and SRE (results consolidated through March 24, 2004 only, the date CVF had its majority interest in SRE diluted to 37%).
CVF records profit and loss using the equity method for companies in which CVF holds 20% to 50% ownership. These companies are not included in the consolidation. These companies are Petrozyme and SRE (subsequent to March 24, 2004 when CVF's ownership position in SRE declined to 37%).
Biorem's sales that were consolidated in 2004 period were $6,691,686 (excludes the period November 24, 2004 to December 31, 2004 when CVF's ownership position fell below 50%), compared to $6,189,488 (for the full year) in 2003 period or an increase of $502,198 (8%). This increase was due to numerous modular system installations in Canada and the United States. SRE's sales that were consolidated in 2004 were $411,357 (from the first quarter only), compared to $1,518,323 (from the full year 2003) or a decrease of $1,106,966 (73%). Effective March 25, 2004, SRE's results are no longer included in CVF's consolidated results as CVF's ownership in SRE decreased to 37%. Gemprint's sales decreased by $89,863 or 13% compared to 2003 due to lower diamond registrations and lower system sales. Also the weaker US dollar in the 2004 period contributed to the decrease. Ecoval's sales decreased by $51,763 (18%) since fertilizer orders were no longer being actively pursued as the company focuses on its pesticide division.
CVF's gross margin of $3,735,220 for 2004 represents an increase of $160,961 (5%) compared to gross margin of $3,574,259 for 2003. Gross margin as a percentage of sales increased to 46.9% for 2004 compared to 41.1% in 2003. This increase is mainly due to Biorem which had $403,491 higher gross margin in the 2004 period due to higher margin business (46.2 % in 2004 versus 43.5 % in 2003). Biorem's gross margin increased as a result of improved cost efficiencies achieved through increased volumes, purchasing negotiations and improved manufacturing efficiencies. Ecoval's gross margin increased by $88,846 due to generally improved margin percentages on its business. Gemprint had a gross margin decrease of $102,755 (19%) due to weaker sales. SRE had $228,621 lower gross margin in 2004 as effective March 25, 2004 SRE's sales are no longer consolidated in CVF's results.
Selling, general and administrative expenses, on a consolidated basis, amounted to $4,840,615 for 2004 representing a decrease of $380,042 or 7% compared to $5,220,657 for 2003. This decrease is mainly due to $782,161 lower expenses at SRE due to CVF no longer consolidating that company, $156,746 lower amortization expense as the Ecoval intangible asset was fully amortized as of mid 2004, $112,650 due to one of the Company's subsidiaries settling a claim with a former officer during 2003, $100,560 (54%) lower accounting fees due to the Company changing its independent accountants during 2003, and consulting fees $92,021(17%) lower in 2004. These decreases are off set somewhat by higher expenses at Biorem due to the high sales activity and to $512,498 of expense in 2004 at CVF related to CVF officers and/or directors exercising stock options. Management continues to undertake a concerted effort to effect an overall reduction in administrative costs. Over the past 4 years CVF has undertaken many initiatives to lower the Company's expenses. (See further discussion in the Liquidity and Capital Resources section).
Repriced stock options expense for 2004 amounted to $121,247, representing a decrease of $374,203 (76%) compared to expense of $495,450 for 2003. The majority of this decrease is the CVF repriced options as all the CVF officers and/or directors exercised the repriced stock options in 2004 offset somewhat by an increase ($276,644) in the value of the repriced Biorem stock options from $0.80 cdn per share at the end of 2003 to $2.00 cdn per share at the end of 2004.
Research and development expenses for 2004 amounted to $359,233 compared to $504,613 for 2003 (a 29% decrease). This decrease in R & D spending was attributable to a decrease in spending for such activity at Ecoval offset somewhat by an increase in spending at Biorem.
Loss from continuing operations decreased to $1,585,875 in 2004 from $2,646,461 in 2003, a decrease of $1,060,586 (or 40%). $742,558 of this decrease can be attributed to SRE as that company is no longer consolidated (as of March 25, 2004).
Net interest expense for 2004 increased to $334,364 from $246,371 in 2003. This increase is due to an increase in loans outstanding in 2004.
Loss on sale of holdings was $2,067 in 2004 from a loss of $1,621 in 2003. In 2004 the Company sold additional holdings in TurboSonic and in 2003 some holdings in RDM. The remaining holdings are relatively small and are not expected to contribute significant gains to the Company.
Other expense of $29,829 in 2004 represents other expense representing mainly foreign exchange loss. Other expense in 2003 of $89,825 represented foreign exchange loss of $196,924 offset somewhat by other income mainly at Biorem totaling $107,099.
Income of CVF from equity holdings (entities in which CVF has a 50% or less ownership) represented $178,885 in 2004 which was CVF's share of Biorem's income from November 24, 2004 to December 31, 2004.
Gain on sale of equity in subsidiary totaling $742,568 in 2004 representing a third party investment which resulted in a restructuring of SRE whereby CVF's equity position decreased from 75% to 37%.
CVF's gain on sale of some Biorem shares totaled $829,287 in 2004.
CVF's realized translation loss totaled $1,662,505 in 2004 due to the disposition of many Canadian assets during 2004 with the decrease in CVF's position at SRE and Biorem.
Income tax expense amounted to $78,637 in 2004 compared to a recovery of $526,386 in 2003 due to tax loss carry forwards recorded at Biorem.
Minority interest portion of the loss decreased to $79,251 in 2004 from $171,286 in 2003. This amount in 2004 relates only to Gemprint while the 2003 loss relates to Gemprint and SRE. SRE's minority interest balance is now zero since its results are no longer consolidated with the Company.
As a result of the operations described above, CVF recorded a net loss of $1,863,286 in 2004 as compared to a net loss of $2,286,606 incurred in 2003.
LIQUIDITY AND CAPITAL RESOURCES
Total Stockholders' equity as of December 31, 2004 was in a deficit position of $2,096,492 compared to a deficit of $3,732,580 as of December 31, 2003. This net decrease in the deficit of $1,636,088 is primarily attributable to the restructuring of the Series B Preferred Stock, common shares sold by Biorem totaling $681,000 and offset somewhat by a net loss of $200,781 which was recognized in 2004.
The current ratio of CVF as at December 31, 2004 is .09 to 1, which has decreased from .58 to 1 as at December 31, 2003. This decrease is mainly due to no longer consolidating Biorem.
CVF management anticipates that over the next twelve month period CVF should have sufficient cash from various sources to sustain itself. Between cash on hand, value of the Biorem stock that became listed on a public market in January 2005 (and is valued as of March 28, 2005, at $9.5 million), the issuance of new securities, and the sales of a portion of its holdings in certain investee companies, the Company expects to have enough cash to fund itself and certain of its investee companies that are currently not profitable. Additionally, CVF has limited outside debt and a line of credit could be sought.
Over the past three and a half years CVF has undertaken many initiatives to lower the parent company's expenses. These initiatives have included lowering the head count of its office staff as well as the elimination of two executive positions. The use of consultants has been significantly reduced except those consultants who have been satisfied to receive their fee in CVF common shares. Travel and entertainment has been significantly reduced over the last year and will continue at the reduced level going forward. CVF management has adopted a very aggressive cost and expenditure controls and monitoring policy. During 2004 CVF and the holder of CVF's Series B Convertible Preferred Stock entered into a transaction whereby the holder exchanged its Series B Convertible Preferred Stock with a stated value of $3,385,000 and accrued dividends of approximately $673,600 for 1,000,000 shares of CVF's common stock and a new Series C 6% Convertible Preferred Stock with a stated value of $1,000,000, convertible into common stock at $1 per share. The Series C Preferred and all accrued dividends thereon will be subject to mandatory redemption on February 27, 2006; however, CVF's obligation to redeem will be limited to cash available to it at that time in excess of one year's prospective working capital. The Company also issued to the former Series B holder a three-year warrant to purchase 100,000 shares of CVF's common stock at an exercise price of $0.35 per share.
As at December 31, 2004, CVF's cash balance was $112,648 which is a decrease of $112,887 compared to December 31, 2003. The primary source of cash for the Company is expected to be from sale of a portion of its investments in its public holding, Biorem Inc. (which had a value to CVF as of March 28, 2005 of approximately $9.5 million) or from CVF issuing additional securities. During 2004 CVF obtained $1,704,000 cdn from Biorem through sale of 923,296 common shares, sale of preferred shares, dividend receipts and interest income. The Company also raised $200,000 through the sale of # 606,061 CVF common shares to an outside investor. The company is pursuing opportunities to raise funds from potential investors in CVF. The Company will also continue to assist its investee companies in their efforts to obtain outside financing in order to fund their growth and development of their business plans. Certain of the Company's financial obligations included in current liabilities related to items that will not be paid in the near term. The Company will carefully manage its cash payments on such obligations.
Critical Accounting Policies
An understanding of CVF's accounting policies is necessary for a complete analysis of our results, financial position, liquidity and trends. We focus your attention on the following accounting policies of the Company:
Going concern - These consolidated financial statements have been prepared on a going concern basis, which presumes that assets will be realized and liabilities discharged in the normal course of business over the foreseeable future. The consolidated Company's current liabilities exceed its current assets. The consolidated Company has incurred losses over the year, although substantially lower than previous years and for the past six years, which have reduced the Company's cash reserves, and depleted stockholders' equity. Further, the Company has a contingent liability described in item 6.
These conditions raise substantial doubt about the consolidated Company's ability to continue in the normal course of business as a going concern, in relation to its ability to support its investee companies.
The Company's primary need for cash is to maintain its ability to support the operations and ultimately the carrying values of certain of its individual investee companies. The Company plans to sell some of its shares in publicly traded Biorem, borrow against CVF's assets, or issue additional securities as a method of generating cash, as well as reducing its cash flow needs. The Company will continue to assist its investee companies in their efforts to obtain outside financing in order to fund the growth and development of their respective businesses and has taken steps to reduce the operating cash requirements of the parent company and its investees. The Company is also seeking outside investment. There is no assurance that these initiatives will be successful that certain of its investees will continue to have adequate cash resources and capital to be able to continue as going concerns.
The Company's ability to continue to realize assets and discharge liabilities in the normal course is uncertain and dependent on these and other initiatives. These financial statements do not include any of the adjustments to the amounts or classification of assets and liabilities that might be necessary should the Company be unable to continue its business in the normal course.
During 2004 one of its investee companies, Biorem, had operating profitability and also had positive cash flow. Biorem is currently operating on a positive cash flow basis and does not currently require any cash support from CVF. The Company will continue to assist its other investee companies in their efforts to obtain outside financing in order to fund the growth and development of their respective businesses, as a means of augmenting CVF's needs to finance them.
Revenue recognition - Revenue from the sale of manufactured products is recognized when the goods are shipped and accepted by the customer. The Company recognizes revenue on long-term contracts on the percentage of completion basis, based on costs incurred relative to the estimated total contract costs. Losses on such contracts are accrued when the estimate of total costs indicates that a loss will be realized. Contract billings in excess of costs and accrued profit margins are included as deferred revenue, which is part of current liabilities. Service revenue is recognized when the services are performed.
Inventory - Finished goods are stated at the lower of cost or market using the first-in, first-out method of costing. Raw materials are stated at the lower of cost or replacement value, using the first-in, first-out method.
Goodwill - In June 2001, the FASB issued SFAS No. 141, "Business Combinations" and SFAS No. 142, "Goodwill and Other Intangible Assets". SFAS No. 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001. SFAS No. 141 also specifies criteria which intangible assets acquired in purchase method business combinations after June 30, 2001 must meet to be recognized and reported apart from goodwill. SFAS No. 142 addresses the initial recognition and measurement of intangible assets acquired outside of a business combination and the accounting for goodwill and other intangible assets subsequent to their acquisition. SFAS No. 142 requires that intangible assets with finite useful lives be amortized, and that goodwill and intangible assets with indefinite lives no longer be amortized, but instead be tested for impairment at least annually.
The Company adopted the provisions of SFAS No. 141 on July 1, 2001. Such adoption had no effect on the Company's financial position or results of operations. The Company adopted the provisions of SFAS No. 142 effective January 1, 2002, at which time the amortization of the Company's existing goodwill ceased. The new standard also required that the Company test the goodwill for impairment before June 30, 2002. Any impairment, arising from the test, is charged to income. The Company's goodwill has been tested and the Company has calculated that no impairment exists as at December 31, 2004.
As of December 31, 2004 the carrying value of the intangible assets associated with its subsidiary, Ecoval has been reduced through normal amortization to zero. Although Ecoval has successfully developed natural pesticide, herbicide and fertilizer products, and patented certain technologies related to these products, sales of these products and related cashflows are still being developed, as the Company works to expand its licensing and marketing partnerships. In addition, the Company's resources available to support the expansion of Ecoval are currently lim
Contingencies - The Company is currently under an audit by the Internal Revenue Service ("IRS"). As part of the routine audit, the IRS indicated that they reviewed the treatment of capital losses claimed in the prior year and refunds of $2,532,000 received in 2001. A proposed deficiency in federal income tax was issued by the IRS on December 1, 2003 totaling $2,969,123. On February 5, 2004 CVF issued a formal protest to the proposed deficiency and its protest has now gone before appeals at the IRS. If it is not resolved at the appeals level of the IRS, CVF intends to challenge the IRS ruling in federal tax court, as CVF and its legal counsel strongly believes its original deductions were correctly taken. This process could take up to 2 more years to be resolved.
The Company is involved from time to time in litigation, which arises in the normal course of business. In respect of these claims the Company believes it has valid defenses and/or appropriate insurance coverage in place. In management's judgment, no material exposure exists on the eventual settlement of such litigation, and accordingly, no provision has been made in the accompanying financial statements.
Stock Options/Warrants - The Compensation Committee of the Board of Directors approved an adjustment to the exercise price for all options held by our employees, including executive officers, as well as certain consultants. The revised exercise price was established by reference to the closing bid price of the Company's common stock on April 16, 2002, which was $0.16. Options to purchase approximately 1,405,000 shares of common stock were repriced, resulting in the "variable" method for determining compensation expense being enacted under FASB interpretation #44 of APB 25. Under this method, expense is recorded for the quoted market price of the stock issued or, in the case of options, for the difference between the stock's quoted market price on the date of grant and the option exercise price. Increases and decreases (but not below the exercise price) in the quoted market price of the stock between the date of grant and the measurement date result in a change in the measure of compensation for the award. As the Company's stock as at December 31, 2004 was $0.48 ($0.41 at December 31, 2003), and 1,260,000 shares of the repriced options as well as 200,000 of the options granted in 2003 were exercised during 2004 additional compensation expense of $211,474 ($351,250 in 2003) was recorded.
The Company also issued warrants which were priced at $0.16 on April 16, 2002. The warrants are fully vested and subject to fair value accounting in accordance with SFAS 123. The charge to income for the warrants issued was $111,094 during 2002.
Special Note Regarding Forward-Looking Statements
Certain statements in this Annual Report on Form 10-KSB, under the captions "The Corporations," "Financial Considerations" and elsewhere, constitute "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995 (the "Reform Act"). Such forward-looking statements involve unknown and uncertain risks, uncertainties and other factors which may cause the actual results, performance or achievements of CVF, or industry results, to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. Given these uncertainties, prospective investors are cautioned not to place undo reliance on such forward-looking statements.
Factors That May Affect Future Results
CVF's current financial condition raises substantial doubt about the ability of some of its subsidiaries and equity holdings to continue in the normal course of business as a going concern as CVF may not wish to support the operations and ultimately the carrying values, of certain of its individual investee companies.
The Company's cash resources have been significantly depleted by operating losses. As at December 31, 2004 the cash reserve and other liquid resources was $112,648. The Company has operating cash requirements in the range of $105,000 monthly, though the Company is working to reduce this expense. The primary source of cash for the Company in 2005 is expected to be from sale of a portion of its investments in Biorem (which had a value to CVF as of March 28, 2005 of approximately $9.5 million), through borrowing against CVF's assets, or from CVF issuing additional securities. The Company will also continue to assist its investee companies in their efforts to obtain outside financing in order to fund their growth and development of their business plans. Certain of the Company's financial obligations included in current liabilities relate to items that will not be paid in the near term. The Company will carefully manage its cash payments on such obligations. There is no assurance that all or any of these initiatives will be successful, and that certain of its investees may not have sufficient cash resources or capital resources to continue as going concerns.
The investees ability to continue to realize assets and discharge liabilities in the normal course is uncertain and dependent on these and other initiatives. The Company's financial statements do not include any of the adjustments to the amounts or classification of assets and liabilities that might be necessary should its investees be unable to continue its business in the normal course. Other factors that may affect CVF's future results include:
foreign currency fluctuations, particularly involving Canadian dollars;
the Company's ability to find additional suitable investments and the ability of those investments to generate an acceptable return on invested capital;
the uncertainties and risks involved in investing in early-stage development companies which can arise because of the lack of a customer base, lack of name recognition and credibility, the need to bring in experienced management and the need to develop and refine the business and its operations, among other reasons;
the Company's ability to obtain capital to fund its operations and those of its investees
The Company will not update any forward-looking statements to reflect actual results or changes in the factors affecting the forward-looking statements.
FINANCIAL CONSIDERATIONS
Early Stage Development Companies. Each of the Corporations is an early stage development company with a limited relevant operating history upon which an evaluation of its prospects can be made. As such, there can be no assurance of the future success of any of the Corporations.
Quarterly Fluctuations. CVF's financial results have historically been, and will continue to be, subject to quarterly and annual fluctuations due to a variety of factors, primarily resulting from the nature of the technology companies in which it invests. Any shortfall in revenues in a given quarter may impact CVF's results of operations due to an inability to adjust expenses during the quarter to match the level of revenues for the quarter. There can be no assurance that...
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