ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This discussion and analysis contains statements of a forward-looking nature relating to future events or our future financial performance or financial condition. Such statements are only predictions and the actual events or results may differ materially from the results discussed in or implied by the forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in “Part I. Item 1A. Risk Factors” as well as those discussed elsewhere in this report. The historical results set forth in this discussion and analyses are not necessarily indicative of trends with respect to any actual or projected future financial performance. This discussion and analysis should be read in conjunction with the financial statements and the related notes thereto included elsewhere in this report.
Overview
Amerityre engages in the research and development, manufacturing and sale of polyurethane tires. We believe that we have developed unique polyurethane formulations that allow us to make products with superior performance characteristics, including high abrasion resistance, increased energy efficiency, and higher load-bearing capabilities, when compared to conventional rubber tires. We also believe that our manufacturing processes are more energy efficient than the traditional rubber tire manufacturing processes, in part because our polyurethane compounds do not require the multiple processing steps, extreme heat, and high pressure that are necessary to cure rubber. Using our polyurethane technologies, we believe tires can be produced which last longer, are less susceptible to failure and are friendly to the environment.
We concentrate on three segments of the flat free tire market: light duty polyurethane foam tires, polyurethane elastomer industrial tires and agricultural tires. Our focus continues to be applications and markets where our advantages in product technology and tire performance give us an opportunity to obtain premium pricing. Our most recent activities in these areas are set forth below:
Light Duty Polyurethane Foam Tires
– The sale of polyurethane foam tires to original equipment manufacturers, distributors and dealers accounts for the majority of our revenue. We have the ability to produce a broad range of products for the light duty tire market. Our efforts in product development and marketing allow us to build customer relationships and expand sales with original equipment manufacturers and tire distributors. We continue our focus on creating unique product solutions for customers with specific tire performance requirements. During fiscal year 2017 we have seen increased demand for our golf cart and baggage cart tires, and we expect this trend to continue in the future. In general our international sales over the past year have been adversely affected by the strong US dollar, but recent weakening of the US dollar indicates that this headwind may be subsiding.
Polyurethane Elastomer Industrial Tires
– During the fourth quarter of fiscal year 2016 we relaunched the forklift tire product line with select customers. The slow acceptance of our forklift tires in the marketplace continued during the recent quarter. Our scissor lift tire also continues to experience limited interest as OEMs have to date not approved the use of the tire as a replacement for their current offering. In our opinion the issue is not related to tire performance but the lack of financial incentive for the OEM. The financial benefits of our tire accrues to the tire replacement market, and the suppliers of replacement tires will see less revenue if our less expensive tire alternative is adopted. These products contributed negligible revenue during the quarter. We intend to continue to promote these products in our target markets and believe that eventually the marketplace will recognize their unique benefits compared to other current offerings in the market. We continue to utilize our research and development resources to develop new elastomers that may offer specific advantages in certain tire applications.
Agricultural Tires
– Sales of agricultural tires during the quarter continue to be negatively impacted by low farm commodity prices, which have reduced farm income levels and funds available for the purchase of farm equipment. Recent projections of farm commodity pricing indicate that the market may continue to remain depressed over the next year. Therefore, we are expecting continued difficult conditions for agricultural tire sales until we see substantial evidence of a turnaround in commodity market prices. We will manage our business accordingly, but we intend to continue our efforts to educate the agricultural market on our product benefits while investing in research and development to develop new products for this market segment.
Due to the Company’s limited resources, tire projects which are contingent on additional significant development have been put on hold. However, we believe investment in R&D for new and improved products is important to the continued turnaround in our overall business, and we will selectively invest in promising opportunities that fit in our current budget. These efforts are targeted on enhanced polyurethane formula enhancements for specific targeted tire applications.
As described above, our product line covers diverse market segments which are unrelated in terms of customer base, product, distribution, market demands and competition. Our sales team is comprised of our in-house sales department supplemented by three independent manufacturer representatives. The Company’s emphasis on proper product pricing and new marketing campaigns continues to drive more sales, as shown by our increase in sales revenue in Q1 fiscal year 2018 versus the same quarter in fiscal year 2017. Our upgraded website continues to educate the marketplace about our products as well as generate some online sales. We have a solid backlog for orders to be delivered over the next 12 months However, we continue to pursue relationships with large distributors in key market segments. These relationships will bring additional exposure for Amerityre products in the marketplace and we expect this to lead to increased sales. Our future marketing activities will also be more targeted to these higher growth market segments.
During the recent quarter our gross margins were negatively impacted by higher raw material costs. These increases were driven by a strengthening economy increasing demand while available supply was reduced due to hurricane damage to manufacturing facilities in Texas. While manufacturing facilities have come back online, we expect elevated raw material costs to continue to affect gross margins going forward. We are looking to mitigate these cost pressures by qualifying alternative supply sources, which will enable us to establish a more competitive supplier situation, as well as looking to develop new formulations that utilize less expensive raw materials while providing the same level of superior performance that defines Amerityre products.
Factors Affecting Results of Operations
Our operating expenses consisted primarily of the following:
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•
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Cost of sales, which consists primarily of raw materials, components and production of our products, including applied labor costs and benefits expenses, maintenance, facilities and other operating costs associated with the production of our products;
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•
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Selling, general and administrative expenses, which consist primarily of salaries, commissions and related benefits paid to our employees and related selling and administrative costs including professional fees;
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•
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Research and development expenses, which consist primarily of direct labor conducting research and development, equipment and materials used in new product development and product improvement using our technologies;
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•
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Consulting expenses, which consist primarily of amounts paid to third-parties for outside services;
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•
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Depreciation and amortization expenses which result from the depreciation of our property and equipment, including amortization of our intangible assets; and
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•
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Stock based compensation expense related to stock and stock option awards issued to employees and consultants for services performed for the Company.
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Critical Accounting Policies
Our discussion and analysis of our financial condition and results of operations are based upon our financial statements, which have been prepared in accordance with United States generally accepted accounting principles. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. On an ongoing basis, we evaluate our estimates, including those related to uncollectible receivables, inventory valuation, deferred compensation and contingencies. We base our estimates on historical performance and on various other assumptions that we believe to be reasonable under the circumstances. These estimates allow us to make judgments about the carrying values of assets and liabilities that are not readily apparent from other sources.
We believe the following accounting policies are our critical accounting policies because they are important to the portrayal of our financial condition and results of operations and they require critical management judgments and estimates about matters that may be uncertain. If actual results or events differ materially from those contemplated by us in making these estimates, our reported financial condition and results of operations for future periods could be materially affected.
Revenue Recognition
The majority of our revenue is derived from short-term sales contracts. We account for revenue in accordance with Accounting Standards Codification (“ASC”) Topic 606, “Revenue from Contracts with Customers”, which we adopted on July 1, 2017, using the modified retrospective method.
Revenue for our products is recognized at the time in which our performance obligation is satisfied which we have defined as “control” of the product by the customer. “Control” is defined as a customer having “rights/obligations of physical control over the product or has the rights and intention to control the product.” Based on the terms of our contracts, a customer’s “control” is based on analysis of the following; (i) when a customer arranges their own shipping, and once the product has left our dock, Amerityre recognizes revenue for the product. In effect by arranging their own shipping the customer is “taking control” of the product when it leaves our warehouse; or (ii) when a customer does not arrange their own shipping we cannot recognize revenue until it is delivered and the customer takes “control” of the product.
This establishes a “deferred revenue” event until such time as delivery of the product has been completed and we have proof from the shipper of the delivery (and change in control).
We invoice the customer at shipping, starting the accounts receivable process. Our Company collection policies on products does not change (this includes any prepayment and credit establishment processes). Nor do our refund and return policies change where credit is provided on account for the next purchase as no refunds are given.
The result of this accounting change is $9,637 of deferred revenue, inclusive of $1,532 of shipping and handling revenue (see below), as of September 30, 2017. The related deferred cost of sales, included within our inventory accounts was $1,664 as of September 30, 2017.
Shipping and Handling
Shipping and Handling Fees require that freight costs charged to customers be classified as revenues. Freight expenses are included in costs of sales and are recognized as incurred. However, due to our adoption of ASC 606 as discussed above, we defer the revenues of shipping and handling until the related revenue is also recognized.
The result of this accounting change is a deferral of $1,532 as of September 30, 2017.
Valuation of Intangible Assets and Goodwill
Patent and trademark costs have been capitalized at September 30, 2017, totaling $487,633 with accumulated amortization of $337,882 for a net book value of $149,751. Patent and trademark costs capitalized at September 30, 2016, totaled $479,633 with accumulated amortization of $311,078 for a net book value of $168,555.
The patents which have been granted are being amortized over a period of 20 years. Patents which are pending or are being developed are not amortized. Amortization begins once the patents have been issued. As of September 30, 2017 and 2016, respectively, there were no pending patents. Annually, pending or expired patents are inventoried and analyzed, which resulted in the recognition of a loss on abandonment, expiration or retirement of patents and trademarks of $-0- for each of the periods ended September 30, 2017 and 2016, respectively.
Amortization expense for the years ended September 30, 2017 and 2016 was $6,201 and $6,824 respectively. The Company evaluates the recoverability of intangibles and reviews the amortization period on a continual basis utilizing the guidance of Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 350,
Intangibles – Goodwill and Other
. We consider the following indicators, among others, when determining whether or not our patents are impaired:
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•
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any changes in the market relating to the patents that would decrease the life of the asset;
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•
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any adverse change in the extent or manner in which the patents are being used;
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•
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any significant adverse change in legal factors relating to the use of the patents;
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•
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current period operating or cash flow loss combined with our history of operating or cash flow losses;
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•
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future cash flow values based on the expectation of commercialization through licensing; and
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•
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current expectations that, more likely than not, the patents will be sold or otherwise disposed of significantly before the end of its previously estimated useful life.
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Inventory
Inventory is stated at the lower of cost (computed on a first-in, first-out basis) or market. The cost of finished goods includes the cost of raw material, direct and indirect labor, and other indirect manufacturing costs. The inventory consists of chemicals, finished goods produced in the Company’s plant and products purchased for resale.
Stock-Based Compensation
We account for stock-based compensation under the provisions of FASB ASC 718,
Compensation – Stock Compensation
. Our financial statements as of and for the fiscal years ended September 30, 2017 and 2016 reflect the impact of FASB ASC 718. Stock-based compensation expense recognized under FASB ASC 718 for the fiscal years ended September 30, 2017 and 2016 was $7,168 and $8,068, respectively, related to employee stock options and employee stock grants.
FASB ASC 718 requires companies to estimate the fair value of share-based payment awards on the date of grant using an option-pricing model. The value of the portion of the award that is ultimately expected to vest is recognized as expense over the requisite service periods in our Statement of Operations. Stock-based compensation expense recognized in our Statements of Operations for fiscal years ended September 30, 2017 and 2016 assume all awards will vest; therefore no reduction has been made for estimated forfeitures.
Results of Operations
Our management reviews and analyzes several key performance indicators in order to manage our business and assess the quality and potential variability of our sales and cash flows. These key performance indicators include:
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Revenues, net of returns and trade discounts, which consists of product sales and services and is an indicator of our overall business growth and the success of our sales and marketing efforts;
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Gross profit, which is an indicator of both competitive pricing pressures and the cost of goods sold of our products and the mix of product and license fees, if any;
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Growth in our customer base, which is an indicator of the success of our sales efforts; and
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Distribution of sales across our products offered.
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The following summary table presents a comparison of our results of operations for the fiscal quarters ended September 30, 2017 and 2016 with respect to certain key financial measures. The comparisons illustrated in the table are discussed in greater detail below.
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Three Month Period Ended September 30,
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Percent Change
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(in 000’s)
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2017
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2016
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2017 vs. 2016
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Net revenues
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$
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926
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$
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836
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10.8
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%
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Cost of revenues
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(652
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)
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(555
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)
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17.5
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%
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Gross profit
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274
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281
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(2.1
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)%
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Research and development expenses
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(58
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)
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(53
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)
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9.4
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%
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Sales and marketing expense
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(66
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)
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(67
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)
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(1.5
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)%
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General and administrative expense
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(195
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)
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(192
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)
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2.1
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%
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Loss on asset abandonment
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(17
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)
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-
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0.0
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%
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Other income (expense)
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(3
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)
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(3
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)
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0.0
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%
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Net loss
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(64
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)
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(34
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)
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93.9
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%
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Preferred stock dividend
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(25
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)
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(25
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)
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0.0
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%
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Net loss attributable to common shareholders
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$
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(89
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)
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$
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(59
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)
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53.4
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%
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Quarter Ended September 30, 2017 Compared to September 30, 2016
As disclosed in our June 30, 2017 Annual Report on Form 10-K, the first quarter of each of our fiscal years has traditionally been our weakest quarter. However, during Q1 of fiscal year 2018, we experienced a 10.8% increase in net revenues. A 75% increase in golf cart and baggage cart tire sales, as well as a 11% increase in mobility tire sales accounted for this increase in total revenues, despite a decrease in sales of lawn and garden tires during the year over year period. Our large polyurethane foam tires continue to gain acceptance in the market, and future marketing efforts will target new market applications for these products.
Net Sales.
Net sales of $925,716 for the quarter ended September 30, 2017, represents a 10.8% increase over net sales of $836,153 for the same period in 2016. These results were better than expected as gains in our large closed cell tires offset declines in our lawn and garden market segment. Sales of pivot tires, while better than the Q1 fiscal year 2017 period, were still hindered by low farm incomes caused by low crop prices. We continue to have a positive response to our marketing and pricing plans for our polyurethane foam tires, which has helped to maintain our sales backlog levels. Our forecast for the remainder of Fiscal 2018 anticipates continued depressed agricultural tire sales, due to the continuation of lower than normal farm income. We expect our polyurethane foam products to constitute the majority of our sales during the upcoming fiscal year.
Cost of Revenues.
Cost of revenues for the quarter ended September 30, 2017 was $651,816 or 70.4% of sales compared to $555,452 or 66.4% of sales for the same period in 2016. Cost of revenues were higher in the period due to increased raw material prices, driven by an improved market demand for chemicals as well as impacts from Hurricane Irma on production facilities in Texas. The Company continues to maintain sufficient production capacity to meet anticipated customer demand without incurring a proportionate increase in overall production costs.
Gross Profit.
Gross profit for the quarter ended September 30, 2017 was $273,900 compared to $280,701 for the same period in 2016. Gross profit for the quarter ended September 30, 2017 decreased by $6,801 or 2.5% over the same period in 2016 due to the increase in cost of revenue outlined in the discussion above. The September 30, 2017 gross profit reflects a 29.6% gross margin for product sales compared to a gross margin on product sales of 33.6% in 2016.
Research & Development Expenses (R&D).
Research and development expenses for the quarter ended September 30, 2017 were $58,141 compared to $52,859 for the same period in 2016. We continue to focus on investment in product formulation research and new product development. The Company plans to continue this level of expenditure as R&D is a key component of our new product and business improvement initiatives.
Sales & Marketing Expenses.
Sales and marketing expenses for the quarter ended September 30, 2017 were $65,735 as compared to $67,230 for the same period in 2016.
General & Administrative Expenses
. General and administrative expenses for the quarter ended September 30, 2017 were $194,951 compared to $192,306 for the same period in 2016. We continue to look for ways to control costs and find more efficient ways to run our business activities.
Other Expense.
Other expense for the quarter ended September 30, 2017 was $18,728 compared to $3,132 for the same period in 2016. Other expense consists of loss on the abandonment of fixed assets in relation to a failed CRM implementation and interest expense which increased due to our bank debt facilities.
Net Loss
. Net loss for the quarter ended September 30, 2017 of $63,655 compared to a net loss of $34,826 for the same period in 2016, an increase of $28,829. Without the one-time expense items our net loss would have been $46,303 compared to the same period in 2016, an increase of $11,477.
Liquidity and Capital Resources
Our principal sources of liquidity consist of cash and payments received from our customers. We do not have any significant revolving credit arrangements. Historically, our expenses have exceeded our sales, resulting in operating losses. From time to time, we have obtained additional liquidity to fund our operations through the sale of shares of our common stock and the placement of short-term debt instruments. At the end of 2016, we were able to obtain term bank debt financing to finance critical manufacturing equipment and operating enhancements, the majority of which was placed in service in fiscal year 2017. Management continues to evaluate financing options but is choosing to delay financing at terms that subject the Company to high costs of debt and we are reluctant to raise money through stock sales at what we believe are highly dilutive share prices. Additionally, management has notified our preferred shareholder that we are suspending future payments of their preferred cash dividend payments, so the Company can increase its working capital levels.
We have historically not succeeded in establishing favorable revolving short term financing such as lines of credit. In the quarter ended March 31, 2015, we entered into a short term receivable factoring agreement with a third party to sell our receivable invoices. This agreement enables us to sell individual customer invoices for faster cash flow to the Company as we deem needed. As of September 30, 2017, we have not needed to activate this financing option due to increased focus on adherence to established collection policies and proactive communication with repeat customers, including adjusting credit limits to allow for increased sales volume where warranted.
Cash Flows
The following table sets forth our cash flows for the quarters ended September 30, 2017 and 2016.
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Periods ended Sept. 30,
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(in 000’s)
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2017
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2016
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Net cash used by operating activities
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$
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(32
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)
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$
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(58
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)
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Net cash used in investing activities
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-
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|
(5
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)
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|
Net cash used by financing activities
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|
(6
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)
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|
|
(3
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)
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Net decrease in cash during the period
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$
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(38
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)
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$
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(66
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)
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Net Cash Used by Operating Activities.
Our primary sources of operating cash during the quarter ended September 30, 2017 came from collections from customers, however, our period end receivables balance increased as we waited for several large customers to remit payment in early October 2017. Our primary use of operating cash was an increase in prepaid and other current assets, specifically related to renewal of insurance policies. Net cash used by operating activities was $31,700 for the quarter ended September 30, 2017 compared to net cash used by operating activities of $57,843 for the same period in 2016.
Non-cash items include depreciation and amortization and stock based compensation. Our net loss was $63,655 for the quarter ended September 30, 2017 compared to a net loss of $34,826 for the same period in 2016. The net loss for the quarter ended September 30, 2017 included non-cash expenses for depreciation and amortization of $23,559 and stock-based compensation of $7,168. As of September 30, 2016, depreciation and amortization was $26,000 and stock-based compensation (both stock issued and options) totaled $8,068.
Net Cash Used by Investing Activities.
Net cash used by investing activities was $0 for the quarter ended September 30, 2017 and $5,048 for the same period in 2016. In 2016 we purchased critical facility equipment of which $5,048 was paid in cash the remainder financed through bank financing.
Net Cash Used by Financing Activities
. Net cash used by financing activities was $6,088 for the quarter ended September 30, 2017 and $2,941 for the same period in 2016. The primary use of cash for the quarter ended September 30, 2017 was payment toward the capital lease of $1,772 and payment of notes payable of $4,316.
Contractual Obligations and Commitments
The following table summarizes our contractual cash obligations and other commercial commitments at September 30, 2017.
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Payments due by period
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Total
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Less than
1 year
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1 to 3 years
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3 to 5 years
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After
5 years
|
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|
|
|
|
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|
Facility lease (1)
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|
$
|
379,500
|
|
|
$
|
138,000
|
|
|
$
|
241,500
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
Capital lease (2)
|
|
|
6,621
|
|
|
|
6,621
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
Bank debt (3)
|
|
|
74,669
|
|
|
|
17,626
|
|
|
|
57,043
|
|
|
|
-
|
|
|
|
-
|
|
|
Total contractual cash obligations
|
|
$
|
460,790
|
|
|
$
|
162,247
|
|
|
$
|
298,543
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
(1)
|
In May 2015, we negotiated a five (5) year extension of the lease on our executive office and manufacturing facility located at 1501 Industrial Road, Boulder City, Nevada. The property consists of a 49,200 square foot building. We currently occupy all 49,200, inclusive of approximately 5,500 square feet of office space, situated on approximately 4.15 acres. All other terms and conditions of the building lease remain in effect.
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(2)
|
In July 2015 we entered into a capital lease for research and development equipment for $19,337.
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(3)
|
In June and July 2016, in two separate bank promissory notes, we financed critical manufacturing and facility equipment and operating enhancements, the majority of which was placed in service in fiscal year 2017.
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Cash Position, Outstanding Indebtedness and Future Capital Requirements
At November 6, 2017, our total cash balance was $177,407, none of which is restricted; accounts receivables was $255,919; and inventory, net of reserves for slow moving or obsolete inventory, and other current assets was $719,840. Our total indebtedness was $525,870 and includes $339,781in accounts payable and accrued expenses, $16,755 in current portion of long-term debt, $6,009 in capital lease liability and $119,222 in long-term debt.
We have been working during the past year to improve our liquidity and access to capital resources. In order to fully execute the annual strategic business plan discussed during our shareholder meeting in November 2016, we required more capital resources. However, management decided that an equity financing at the market conditions at the time would be too dilutive and not in the best interests of our shareholders. We will continue to pursue potential opportunities to secure short-term loans, long-term bank financing, revolving lines of credit with banking institutions and equity based transactions with interested financial firms and strategic industry partners in our effort to improve the Company’s financial position and enhance shareholder value.
The Company currently does not have an existing revolving credit facility but we were able to obtain term bank debt financing at the end of 2016 to finance critical manufacturing equipment and operating enhancements the majority of which was placed in service in fiscal year 2017. We continue to work with our vendors to obtain extended credit terms and increase credit lines where needed. Additionally, we continue to focus on adherence to established collection policies and proactive communication with repeat customers, including adjusting credit limits to allow for increased sales volume where warranted.
We are intent on focusing on the sale and distribution of profitable product lines. Management continues to look for further financing facilities at affordable terms that will allow the Company to maintain sufficient raw material and finished goods inventory to capitalize on sales growth opportunities. We are limiting our capital expenditures to that required to maintain current manufacturing capability or support key business initiatives identified in our strategic sales plan. We continue to work to reduce our overall costs wherever possible.
To help address our cash resources which at times may be limited, we have held discussions with banks and other lenders regarding establishing a line of credit for short term cash needs, however at this time we have not succeeded in establishing such a line of credit. Lastly, we have entered into a short term receivable factoring agreement with a third party to sell our receivable invoices. This agreement enables us to sell individual customer invoices for faster cash flow to the Company as we deem needed. During fiscal year 2018 we have not had the need to utilize any factoring of our invoices.
Management continues to execute its strategic plan focusing on “Profitability as a Mindset”. The Company’s emphasis on proper product pricing and new marketing campaigns has driven more profitable sales. While the recently ended quarter was adversely impacted by increased raw material pricing, our continued emphasis on cost control and sales at a profitable price level will enable the Company to be successful in this competitive market environment. The Company achieved full year profitability in fiscal year 2017 and can be attributed to our “Profitability as a Mindset” initiative.
In assessing our liquidity, management reviews and analyzes our current cash, accounts receivable, accounts payable, capital expenditure commitments and other obligations. In connection with the preparation of our financial statements for the period ended September 30, 2017, we have analyzed our cash needs for the next twelve months. We have concluded that our available cash and accounts receivables are sufficient to meet our current minimum working capital, capital expenditure and other cash requirements for this period. However, to expand manufacturing and sales operations beyond the current level, additional capital may be required.
The Company has, on occasion, instituted initiatives to incentivize sales of slower moving inventory through promotional pricing. These programs will continue to be selectively utilized in the upcoming quarters to monetize inventory, promote individual product lines, and improve our cash flow.
As of November 8, 2017, the Company has approximately 3,881,132 shares authorized and available for issuance. Although we are reluctant to raise money through stock sales at what we believe are dilutive share prices, these authorized but unissued and unreserved shares of our common stock can be utilized if necessary to fund the expansion of our manufacturing operations or to obtain additional working capital.
Off-Balance Sheet Arrangements
We do not currently have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. In addition, we do not engage in trading activities involving non-exchange traded contracts.