UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the quarterly period ended: September 30, 2004
Commission file Number: 0-18259
AG-BAG INTERNATIONAL LIMITED
(Exact name of registrant as specified in its charter)
Delaware 93-1143627
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
2320 SE Ag-Bag Lane, Warrenton OR 97146
(Address of principal executive offices) (Zip Code)
(503)861-1644
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
YES [ X ] NO [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2)
YES [ ] NO [ X ]
The registrant has one class of Common Stock with 11,956,991 shares
outstanding as of October 13, 2004.
PART 1 - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
AG-BAG INTERNATIONAL LIMITED
CONDENSED BALANCE SHEETS
ASSETS
September 30 December 31
(Unaudited)
2004 2003 2003
---------- ---------- ----------
Current assets:
Cash and cash equivalents $ 89,102 $ 344,629 $ 167,528
Accounts receivable 1,435,236 2,638,828 1,226,390
Inventories 6,384,617 6,634,189 5,781,345
Other current assets 305,537 298,273 251,808
Deferred income tax - 312,000 -
---------- ---------- ----------
Total current assets 8,214,492 10,227,919 7,427,071
Deferred income tax - 927,000 -
Intangible assets, less
accumulated amortization 7,637 17,543 15,066
Property, plant and equipment
less accumulated depreciation 2,228,033 3,410,617 3,233,673
BAW Joint-venture - 359,747 376,974
Other assets 125,763 481,417 491,513
--------- ---------- ----------
Total assets $10,575,925 $15,424,243 $11,544,297
========== ========== ==========
(Continued)
2
AG-BAG INTERNATIONAL LIMITED
CONDENSED BALANCE SHEETS
LIABILITIES AND SHAREHOLDERS' EQUITY
September 30 December 31
(Unaudited)
2004 2003 2003
---------- ---------- ----------
Current liabilities:
Notes payable to bank $ 1,630,483 $ 2,942,818 $ 2,090,448
Current portion of long term
debt and capital lease
obligations 97,638 190,988 182,706
Accounts payable 1,036,526 1,200,892 936,953
Accrued expenses and other
current liabilities 1,834,435 1,311,735 961,731
Income tax payable 2,210 2,210 2,210
----------- ----------- -----------
Total current liabilities 4,601,292 5,648,643 4,174,048
Long-term debt and capital
lease obligation, less
current portion 1,005,825 1,108,662 1,071,488
--------- ---------- ----------
Total liabilities 5,607,117 6,757,305 5,245,536
--------- ---------- ----------
Commitments
Shareholders' equity:
Preferred stock, $4LV 8 1/2%
nonvoting - 696,000 696,000
Common stock, $.01 par value 120,619 120,619 120,619
Additional paid-in capital 9,542,578 9,210,211 9,210,211
Treasury stock ( 31,500) (31,500) ( 31,500)
Accumulated deficit (4,662,889) (1,328,392) (3,696,569)
--------- --------- ----------
Total shareholders' equity 4,968,808 8,666,938 6,298,761
--------- --------- ----------
Total liabilities and
shareholders' equity $10,575,925 $15,424,243 $11,544,297
========== ========== ==========
See Notes to Condensed Financial Information
3
AG-BAG INTERNATIONAL LIMITED
CONDENSED STATEMENT OF SHAREHOLDERS' EQUITY
(Unaudited)
Preferred Stock Common Stock Treasury Stock Paid-In Accumulated
Shares Amount Shares Amount Shares Amount Capital Deficit Total
------- -------- ---------- -------- -------- -------- ---------- ----------- ----------
Balance December 31, 2003 174,000 $696,000 12,061,991 $120,619 105,000 ($31,500) $9,210,211 $(3,696,569) $6,298,761
Net loss (408,948) (408,948)
------- -------- ---------- -------- -------- -------- ---------- ----------- ----------
Balance March 31, 2004 174,000 $696,000 12,061,991 $120,619 105,000 ($31,500) $9,210,211 $(4,105,517) $5,889,813
Preferred stock dividends (29,580) (29,580)
Net loss (172,150) (172,150)
------- -------- ---------- -------- -------- -------- ---------- ----------- ----------
Balance June 30, 2004 174,000 $696,000 12,061,991 $120,619 105,000 ($31,500) $9,210,211 $(4,307,247) $5,688,083
Redemption of preferred stock (174,000) (696,000) 332,367 (363,633)
Preferred stock dividends forgiven 29,580 29,580
Net loss (385,222) (385,222)
------- -------- ---------- -------- -------- -------- ---------- ----------- ----------
Balance September 30, 2004 - $ - 12,061,991 $120,619 105,000 ($31,500) $9,542,578 $(4,662,889) $4,968,808
======= ======== ========== ======== ======== ======== ========== =========== ==========
See Notes to Condensed Financial Information
4
AG-BAG INTERNATIONAL LIMITED
CONDENSED STATEMENTS OF OPERATIONS
Three Months
Ended September 30
(Unaudited)
----------------------
2004 2003
Net sales $ 4,557,829 $ 5,692,292
Cost of sales 3,772,109 4,860,689
--------- ---------
Gross profit from operations 785,720 831,603
Selling expenses 475,800 668,313
Administrative expenses 643,080 655,244
Gain on sale of assets ( 2,005) ( 12,439)
Research and development expenses 31,445 17,319
--------- ---------
Loss from operations (362,600) (496,834)
Other income (expense):
Interest income 1,850 -
Interest expense ( 63,933) ( 63,219)
Miscellaneous 39,461 113,498
--------- ---------
Loss before provision for income taxes (385,222) (446,555)
Benefit for income taxes - (130,000)
--------- ---------
Net loss and comprehensive loss $ (385,222) $ (316,555)
========= =========
Basic and diluted net loss
per common share $ (.03) $ (.03)
========= =========
Basic and diluted weighted average
number of common shares outstanding 11,956,991 11,963,657
========== ==========
See Notes to Condensed Financial Information
5
AG-BAG INTERNATIONAL LIMITED
CONDENSED STATEMENTS OF OPERATIONS
Nine Months
Ended September 30
(Unaudited)
----------------------
2004 2003
---- ----
Net sales $14,370,916 $18,341,101
Cost of sales 11,877,176 15,257,275
---------- ----------
Gross profit from operations 2,493,740 3,083,826
Selling expenses 1,526,655 2,023,238
Administrative expenses 1,985,579 2,085,512
Gain on sale of assets ( 82,926) (185,358)
Research and development expenses 116,921 107,437
--------- ---------
Loss from operations (1,052,489) (947,003)
Other income (expense):
Interest income 1,850 -
Interest expense (204,412) (174,673)
Miscellaneous 288,731 495,348
--------- ---------
Loss before provision for income taxes (966,320) (626,328)
Benefit for income taxes - (226,000)
--------- ---------
Net loss and comprehensive loss $ (966,320) $ (400,328)
========= =========
Basic and diluted net loss
per common share $ (.08) $ (.04)
========= =========
Basic and diluted weighted average
number of common shares outstanding 11,956,991 11,962,508
========== ==========
See Notes to Condensed Financial Information
6
AG-BAG INTERNATIONAL LIMITED
CONDENSED STATEMENTS OF CASH FLOWS
Nine Months
Ended September 30
(Unaudited)
-----------
2004 2003
Cash flows from operating activities: ---- ----
Net loss $ (966,320) $ (400,328)
Adjustments to reconcile net loss
to net cash used in operating activities:
Depreciation and amortization 441,000 593,847
Inventory obsolescence reserves (205,000) 165,000
Deferred income taxes - (226,000)
(Gain) on sale of assets ( 82,926) (185,358)
Changes in assets and liabilities:
Accounts receivable ( 208,846) (1,479,901)
Inventories 70,413 (795,890)
Other current assets ( 53,729) ( 99,396)
Accounts payable 99,573 297,585
Accrued expenses and other current
liabilities 872,704 176,127
Other assets (84,347) (125,516)
---------- ----------
Net cash used in operating
activities (117,478) (2,079,830)
---------- -----------
Cash flows from investing activities:
Capital expenditures ( 2,369) ( 47,035)
Intangible assets - ( 12,532)
Proceeds from sale of assets 652,116 414,239
--------- ---------
Net cash provided by investing
activities 649,747 354,672
--------- ---------
Cash flows from financing activities:
Net proceeds/(repayments on)
line of credit (459,965) 2,558,093
Principal payments on debt (150,730) (511,462)
Payment of preferred dividends - (44,370)
---------- ---------
Net cash provided by/(used in) financing
activities ( 610,695) 2,002,261
---------- ----------
Net increase/(decrease) in cash (78,426) 277,103
Cash and cash equivalents at beginning
of period 167,528 67,526
--------- ---------
Cash and cash equivalents at end of period $ 89,102 $ 344,629
========= ==========
See Notes to Condensed Financial Information
7
AG-BAG INTERNATIONAL LIMITED
Notes to Condensed Financial Information
(Unaudited)
Note 1 - Description of Business and Summary of Significant
Accounting Policies
- --------------------------------------------------------------------------------
The accompanying unaudited condensed financial statements have been prepared in
accordance with the instructions to Form 10-Q. They do not include all
information and footnotes necessary for a fair presentation of financial
position and results of operations and cash flows in conformity with accounting
principles generally accepted in the United States of America. These condensed
financial statements should be read in conjunction with the financial statements
and related notes contained in the Company's Annual Report on Form 10-K for the
year ended December 31, 2003. In the opinion of management, all adjustments of a
normal recurring nature that are considered necessary for a fair presentation
have been included in the interim period. Operating results for the period ended
September 30, 2004 are not necessarily indicative of the results that may be
expected for the year ending December 31, 2004.
Going Concern
- -------------
As a result of the Company incurring net losses during the previous three
years and during the first nine-months of 2004, and its negative cash flows from
operations for the prior year and nine months ended September 30, 2004, there is
uncertainty about the Company's ability to continue as a going concern. The
Company's management believes the Company's weak operating results have been
primarily due to the depressed milk prices in the agriculture sector, which have
a direct impact on the disposable income of its dairy farm customers, who
account for approximately 75% of the Company's business. The Company further
believes that dairy farmers have been delaying or eliminating capital
expenditures due to uncertainties regarding milk prices and their disposable
income. Additionally, dealers' are uncertain about Ag-Bag's future and the
pending asset sale to Miller St. Nazianz Inc., as dealers are waiting to see the
transition plans of Miller St. Nazianz Inc. relative to their dealer operations
and programs for sales of the Company's products. Predictions for the remainder
of 2004 and into 2005 continue to show milk prices declining from earlier highs
of over $20 in May 2004, but remaining higher than the historically low levels
seen for many of the previous years and the Company expects operating results to
improve slowly as dairy farmers continue to see increases in their disposable
income through stabilizing milk prices. As dealer's inventories become depleted,
they will need to increase the size of their next pre-season order (2004-05) to
take full advantage of the various sales incentives and to maximize their volume
discounts.
8
To help provide positive cash flow for the Company, management implemented
an expense reduction plan in late 2003. Specifically, management implemented
staff reductions and reduced salaries of senior management. Nonessential capital
expenditures, travel and other expenses have either been eliminated or
postponed. Management also continues considering other changes to the Company's
business model such as opportunities to sell the business, refinance the
Warrenton, Oregon facility (which has only a small economic development loan
outstanding against this collateral), consolidate or dispose of manufacturing
facilities or other tangible or intangible assets, or take a policy loan against
the life insurance policies currently in force in which the Company is the
beneficiary. On August 13, 2004, the Company entered into an Asset Purchase
Agreement to sell substantially all of the Company's operating assets to Miller
St. Nazianz, Inc., a Wisconsin corporation who will integrate the operations of
Ag-Bag into their current farm equipment manufacturing business operations. The
transaction, which has been approved by the Company's Board of Directors, is
subject to stockholder approval and other customary closing conditions, and is
anticipated to close within the next ninety days. However, no assurance can be
given that the Company will be successful in accomplishing any of these
objectives.
Because it is unclear whether the Company will be successful in
accomplishing any of these objectives, there is uncertainty about the Company's
ability to continue as a going concern. The financial statements do not include
any adjustments that might be necessary should the Company be unable to continue
as a going concern.
9
Sale to Miller St. Nazianz Inc.
- ------------------------------
On August 13, 2004, the Company entered into an Asset Purchase Agreement to sell
substantially all of the Company's operating assets to Miller St. Nazianz, Inc.,
a Wisconsin corporation who will integrate the operations of Ag-Bag into their
current farm equipment manufacturing business operations. The Company estimates
this transaction (based upon the September 30, 2004 Balance Sheet) to be valued
at approximately $7-8 million in cash, subject to adjustments for assets and
inventory actually acquired at closing under the agreement. The transaction,
which has been approved by the Company's Board of Directors, is subject to
stockholder approval and other customary closing conditions, and is anticipated
to close within the next ninety days.
As a result of the pending sale to Miller St. Nazianz Inc., the Company will
terminate most employees and be required to pay termination benefits and make
payments pursuant to change of control agreements. The following table outlines
these anticipated expenses:
Amount incurred Amount incurred
during three-month for the nine-month
Amount expected period ended period ended
to be incurred Sept. 30, 2004 Sept. 30, 2004
-------------- -------------- --------------
One-time termination benefits $ 130,500 $ - $ -
Change of control agreement payments $ 1,200,000 $ - $ -
Payment of unused sick/vacation benefits $ 46,000 $ - $ -
Contract termination costs $ 10,500 $ - $ -
Other costs $ 60,000 $ - $ -
------------ ------------ ------------
Total $ 1,447,000 $ - $ -
============ ============ ============
The Company anticipates that it will terminate most of its remaining employees
that will not be hired by Miller St. Nazianz Inc., during the fourth quarter of
2004. The Company currently estimates that only 3 employees will remain to run
the limited operations of the Company and that those employees will be
terminated upon the final distribution and liquidation of the Company. The total
number of employees anticipated to be terminated is 45, which consist of office,
customer service and manufacturing personnel. There have been no employees
terminated pursuant to the pending sale to Miller St. Nazianz Inc., as of
September 30, 2004.
The Company has prepaid transactional costs on the pending sale to Miller St.
Nazianz Inc., as of September 30, 2004 of $38,568 which are included in other
current assets.
10
Inventories
- -----------
Inventories consist of the following:
September 30 December 31
(Unaudited)
2004 2003 2003
---------- ---------- ----------
Finished goods $5,733,473 $5,432,231 $4,846,358
Work in process $ 454,694 $ 945,463 $ 880,687
Raw materials $ 196,450 $ 256,495 $ 54,300
---------- ---------- ----------
Total $6,384,617 $6,634,189 $5,781,345
========== ========== ==========
Inventories are stated at the lower of cost or market (net realizable value).
The Company determines cost on the first-in, first-out (FIFO) basis.
Seasonal Fluctuations
The core business of the Company is historically seasonal due to the harvest
seasons in North America and Europe. The seasonal nature of the Company's
operations results in between 53-70% of the Company's revenue being generated
during the spring and summer (2nd and 3rd Quarters). In September 2002, the
Company took additional steps to counteract seasonality by developing and
introducing a pre-season ordering program, whereby the Company's dealer's place
their next year's annual product requirements order in advance. This allows the
Company to know in advance its production mix which in turn allows leveling of
production and flexibility in customer shipments. During 2003, the Company
expanded this program by allowing dealers to finance through their local bank,
rather than requiring them to utilize one of the Company's third party financing
programs. This however, has brought seasonality back into play for the Company,
as shipments under the dealer bank program are at the timing of the dealer
rather than the Company under the terms of the program. The nine-month results
may not be indicative of the estimated results for a full fiscal year.
11
BAW Joint Venture
- -----------------
On April 27, 2004, the Company sold its investment in the BAW Joint Venture
(Budissa Agrodienstleistungen Und Warenhandels) to its German dealer, BAG
(Budissa Agroservice) for $500,000 in cash, payable 30 days from closing, to
provide the Company with working capital. The Company received the $500,000 on
May 26, 2004. The Company recognized $36,562 of gain from this sale. Prior to
this date, the Company had a 50% interest in the BAW Joint Venture which was
accounted for under the equity method of accounting. The condensed income
statement for the Company's former BAW Joint Venture in Germany was as follows:
(Dollars in 000's)
Nine Months
Ended September 30
(Unaudited)
---------------------------
2004 2003
---- ----
Net sales $ - $ 2,406
Cost of goods sold - (1,881)
---------------------------
Gross profit - 525
Selling & administrative expenses - (219)
Other income - 120
Income tax expense - (171)
---------------------------
Net income* $ - $ 255
===========================
* Attributed to other shareholders $ - $ 13
The condensed income statement has been translated from the Euro to the U.S.
dollar at average exchange rates in effect for the period ended September 30,
2003. The average exchange rate used at September 30, 2003 was $1.10.
Income Taxes
- ------------
Income taxes are lower than the expected statutory rates due to the Company's
recognition of the tax benefits of the research and development tax credit and
the non-taxability of income from the Company's investment in its BAW Joint
Venture and international royalties and the extraterritorial income exclusion.
In addition, management has established a valuation allowance of $1,988,772 to
fully reserve against its deferred tax assets at September 30, 2004.
12
Warranty
- --------
At the time of sale, the Company accrues a liability for the estimated future
costs to be incurred under the provisions of its warranty agreements. The
Company reviews its historical warranty expense and current sales trends in
products covered under warranty, and adjusts its warranty reserves accordingly.
The activity in that account for the quarters ended was as follows:
September 30, September 30,
2004 2003
---------------------------------
Balance, beginning of the year
$ 74,753 $177,384
Charged to expense 80,987 130,716
Warranty costs incurred during the period (79,453) (150,998)
---------------------------------
Balance, end of period $ 76,287 $157,102
=================================
Stock option plan
The Company applies Accounting Principles Board (APB) Opinion No. 25,
"Accounting for Stock Issued to Employees," and related interpretations in
accounting for its stock option plan. Accordingly, compensation expense related
to grants to employees would be recorded on the date of grant only if the
current market price of the underlying stock exceeded the exercise price. Had
compensation cost for the Company's stock option plan been determined based upon
the fair value at grant date for awards under the plan consistent with the
methodology prescribed under Statement of Financial Accounting Standards
("SFAS") No. 123, "Accounting for Stock-Based Compensation," additional
compensation expense would have been recognized.
The Company has computed the value of all options granted during the nine-month
periods ended September 30, 2004 and 2003 using the Black-Scholes pricing model
as prescribed under SFAS No. 123. The pro-forma effect on net loss of options
granted is as follows:
September 30, September 30,
2004 2003
---------------- --------------
Net income (loss):
As reported $(966,320) $(400,328)
Pro forma $(968,734) $(409,604)
Net income (loss)per share:
As reported (.08) (.04)
Pro forma (.08) (.04)
13
Supplemental Disclosures Regarding Cash Flows
- ---------------------------------------------
Supplemental disclosure of cash flow information:
2004 2003
---- ----
Cash paid during the nine-month period
ended September 30:
Interest $ 204,412 $ 174,673
Income taxes $ 11,305 $ 4,085
The Company transferred $468,685 and $135,490 from rental equipment to inventory
held-for-sale for the nine months ending September 30, 2004 and 2003,
respectively. The Company transferred $183,911 from inventory held-for-sale to
rental equipment for the nine months ending September 30, 2003.
Supplemental schedule of non-cash investing and financing activities:
2004 2003
---- ----
Preferred stock redeemed through
exchange of life insurance Policy $ 363,633 $ -
Recently Issued Accounting Standards
- ------------------------------------
In June 2003, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics
of Both Liabilities and Equity." This statement establishes standards regarding
classification and measurement of certain financial instruments with
characteristics of both liabilities and equity. It requires financial
instruments within the scope of this statement to be classified as liabilities
(or an asset in some circumstances). Many of these financial instruments were
previously classified as equity. This statement is effective for financial
instruments entered into or modified after May 31, 2003, and was otherwise
effective at the beginning of the first interim period beginning after June 15,
2003. For financial instruments created before the issuance date of this
statement and still existing at the beginning of the interim period of adoption,
transition is achieved by reporting the cumulative effect of a change in an
accounting principle by initially measuring the financial instruments at fair
value. The implementation of this statement did not have a material impact on
the Company's financial statements.
14
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133
on Derivative Instruments and Hedging Activities." This statement amends and
clarifies financial accounting and reporting for derivative instruments,
including certain derivative instruments embedded in other contracts and for
hedging activities under SFAS No. 133, "Accounting for Derivative Instruments
and Hedging Activities." The implementation of this statement did not have a
material impact on the Company's financial statements.
In January 2003, the FASB issued Interpretation No. 46 (FIN 46),
"Consolidation of Variable Interest Entities." This interpretation clarifies the
application of Accounting Research Bulletin No. 51, "Consolidated Financial
Statements," and requires existing unconsolidated variable interest entities to
be consolidated by their primary beneficiaries if the entities do not
effectively disperse risks among parties involved. This interpretation explains
how to identify variable interest entities and how an enterprise assesses its
interests in a variable interest entity to decide whether to consolidate that
entity. In December 2003, FASB made revisions and delayed implementation of
certain provisions of FIN 46. As a public entity that is not a "Small Business
Issuer," the Company is now required to apply FIN 46 to all unconsolidated
variable interest entities no later than March 31, 2004, with the exception of
unconsolidated special-purpose entities, which had an implementation deadline of
December 31, 2003. Special-purpose entities for this provision are expected to
include entities whose activities are primarily related to securitizations or
other forms of asset-backed financings or single-lessee leasing arrangements.
The Company was associated with a potential variable interest entity through its
investment in BAW, prior to its sale in April 2004. Management determined that
BAW was a variable interest entity, but concluded that the Company was not the
primary beneficiary.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS.
General
- -------
Reference is made to Item 7, "Management's Discussion and Analysis of
Financial Condition and Results of Operations", included in the Company's Annual
Report on Form 10-K for the year ended December 31, 2003, on file with the
Securities and Exchange Commission ("SEC"). The following discussion and
analysis pertains to the Company's results of operations for the three-month
period ended September 30, 2004, compared to the results of operations for the
three-month period ended September 30, 2003, and to the results of operations
for the nine-month period ended September 30, 2004, compared to the results of
operations for the nine-month period
15
ended September 30, 2003, and to changes in the Company's financial condition
from December 31, 2003 to September 30, 2004.
Critical Accounting Policies
- ----------------------------
The Company's significant accounting policies are described in Note 1 to
the financial statements included in Item 15 of the Annual Report on Form 10-K,
filed with the SEC for the year ended December 31, 2003. The Company believes
its most critical accounting policies include inventory obsolescence reserves,
allowance for doubtful accounts, accounting for warranty reserves, accounting
for pre-season order flooring interest, recourse obligation reserves and
accounting for income taxes.
The $816,321 estimate for inventory obsolescence reserves was developed
using inventory-aging reports for finished goods, combined with historical
usage, and forecasted usage and inventory shelf life. The Company's estimates of
market value incorporate projections of future sales volume by product class. In
estimating the market value of parts inventory items, the Company reviews
current inventory levels in relation to sales forecasts and adjusts the
valuation reserve accordingly. For the remaining categories of inventory, the
Company establishes a reserve balance based on the aging of the specific
inventory items. As trends in these variables change, the percentages applied to
the inventory aging categories are updated.
The $202,903 estimate of allowance for doubtful accounts is comprised of a
specific account analysis which addresses accounts over 90 days past due and a
general reserve of $5,000, which is deemed appropriate for the level of
receivables carried by the Company. Accounts where specific information
indicates a potential loss may exist are reviewed and a specific reserve against
amounts due is recorded. As additional information becomes available such
specific account reserves are updated. Additionally, a general reserve is
applied based upon historical collection and write-off experience. As trends in
historical collection and write-offs change, the general reserve is updated.
The $76,287 estimate for warranty reserve is developed based upon the
estimated future costs to be incurred under the provisions of the Company's
warranty agreements on its bags and machines. The Company reviews its historical
warranty expense and current sales trends in specific products covered under
warranty and reserves are updated as trends in these variables change.
The Company estimates the future interest that will be incurred by the
Company associated with current sales under its dealer pre-season order program.
At the time of sale, the Company reduces sales revenue and accrues a liability
for the estimated future interest obligation. The Company estimates its future
interest obligation pursuant to the terms of its pre-season order
16
program and the shipping periods defined therein. The Company estimates that
machinery shipped between October and May of each year, will be sold at the
dealer level by the end of May and accrues an estimated future interest
liability accordingly (ranging from 30 to 210 days). For machinery shipped after
May, the Company estimates (since bagging season is in full swing) that it will
incur interest for approximately 30 days, and accrues an estimated liability
accordingly. For all other products, the company accrues an estimated future
interest liability (ranging from 30 to 180 days) under the assumptions that the
product will be sold at the dealer level by the end of the respective shipping
periods as defined in the pre-season order program. For additional products
ordered and shipped outside the defined shipping periods, the Company accrues an
estimated future interest liability of approximately 30 days, which according to
the pre-season order program, the Company pays interest through the end of the
month of shipment. The Company had accrued an estimated liability of $11,679
under this program at September 30, 2004, as the Company's interest obligations
under the 2003-04 pre-season order program end on September 30, 2004.
The Company periodically assigns some of its trade accounts receivable to
various third-party financing sources. These accounts can be assigned with or
without recourse depending on the specific accounts assigned. The Company
reviews on a monthly basis, those accounts assigned with recourse to determine
their payment history with the third-party financing source and estimates if any
accrual is necessary for potential future recourse obligations. The Company has
determined, that at September 30, 2004, no accrual was necessary for potential
future recourse obligations with its third-party financing sources.
The Company accounts for income taxes under the asset and liability
method. Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases. Deferred tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled. Valuation allowances are
established to reduce potential deferred tax assets when it is more likely than
not that all or some portion of potential deferred tax assets will not be
realized. The Company has established a $1,988,772 valuation allowance against
its deferred tax assets as of September 30, 2004.
Forward-Looking Statements
- --------------------------
Certain statements in this Form 10-Q contain "forward-looking"
information that involves risks and uncertainties that may cause actual results
to differ materially from those predicted in the forward-looking statements.
Forward-looking statements can be
17
identified by their use of such verbs as expects, anticipates, believes or
similar verbs or conjugations of such verbs. If any of the Company's assumptions
on which the forward-looking statements are based prove incorrect or should
unanticipated circumstances arise, the Company's actual results could differ
materially from those anticipated by such forward-looking statements. The
differences could be caused by a number of factors or combination of factors
including, but not limited to, the factors listed below and the risks detailed
in the Company's Securities and Exchange Commission filings, including the
Company's Form 10-K for the fiscal year ended December 31, 2003.
Forward-looking statements contained in this Form 10-Q relate to the
Company's plans and expectations as to: timing of demand for bagging machines
and bags; reductions in U.S. milk prices; optimism for increased milk prices
within the U.S. farm economy throughout the remainder 2004 and into 2005 above
record lows in 2000; availability of credit in the farming sector and rising
interest rates; potential purchases of the Company's bagging machines, bags and
composting systems; anticipated inventory production; the availability of trade
credit and working capital; the availability of third party financing sources;
the Company's implementation of its plan, which began September 30, 2004, to
accept charges for only preferred customers using the John Deere Credit Farmplan
program as a third party financing source and discontinue accepting merchant
authorized charges; the availability of the Company's line of credit; consumer
sentiment and health of the U.S. and global economy; the Company's dependence on
the dairy industry; the outcome of the pending asset sale to Miller St. Nazianz,
Inc.; and the outcome of pending litigation against the Company.
The following factors, among others, could cause actual results to
differ from those indicated in the forward-looking statements: a downturn in the
dairy industry; a sharp decline in U.S. milk prices; a reduction in availability
of credit in the farming sector or the Company's third party financing sources;
an inability of customers'/dealers' to qualify for or maintain preferred status
using the John Deere Farmplan third party financing program; an increase in
interest rates; adverse weather conditions; a sharp decline in the health of the
farming sector of the U.S. economy; a sharp decline in government subsidies to
the farming sector; disruption of the manufacturing process of our sole bag
manufacturer; increases in the price of bags and raw material costs; rejection
by the Company's shareholders' of the pending asset sale to Miller St. Nazianz,
Inc.; and an adverse outcome in any of the pending litigation against the
Company.
Overview
- --------
The core business of the Company is historically seasonal due to the
harvest seasons in North America and Europe. The Company's
18
machinery tends to be purchased in anticipation of the next harvest season, so
most of the sales of machinery occur in the spring and summer. This requires the
Company to carry significant amounts of inventory to meet rapid delivery
requirements of customers. Bag sales tend to occur as the harvest season
approaches in the summer, and during the harvest season in the fall. In
September 2002, the Company took steps to counteract seasonality by developing
and introducing a pre-season ordering program, whereby the Company's dealers
place their next year's annual product requirements order in advance and utilize
one of the Company's third party financing sources. The pre-season program has
allowed the Company to know in advance its production mix which in turn has
provided the Company with the ability to level its production and flexibility in
customer shipments. During 2003, the Company expanded this program by allowing
dealers to finance through their local bank, rather than requiring them to
utilize one of the Company's third party financing programs. This however, has
brought seasonality back into play for the Company, as shipments under the
dealer bank program are at the timing of the dealer rather than the Company
under the terms of the program. The Company's trade-off with shipment
flexibility however, is lower overall financing costs under the dealer bank
program. Approximately 50% of the Company's dealers use the local dealer bank
financing program option. The pre-season order program is a program under which
the Company pays the flooring interest for dealers and pays volume discounts to
dealers based upon a sliding scale for the volume of orders placed by the dealer
under the program.
Approximately 95% of the Company's business is concentrated in the Northern
Hemisphere resulting in between 53-70% of the Company's revenue being generated
during the spring and summer (2nd and 3rd Quarters). The following table
outlines the percentage of revenue over the past three years by quarter:
Quarter 2001 2002 2003
-------
----------- ---------- -----------
First 15% 18% 32%
Second 35% 37% 27%
Third 35% 32% 26%
Fourth 15% 13% 15%
As a result of the introduction in September 2002 and modification in 2003 of
the Company's pre-season order program, these historical revenue percentages may
not be indicative of future revenue percentage by quarter.
The following chart outlines historical yearly average milk prices as
published by the USDA.
19
Average Annual Milk Prices
Year Average Year Average Year Average
Price Price Price
1980 $ 11.88 1988 $ 11.03 1996 $ 13.39
1981 $ 12.57 1989 $ 12.37 1997 $ 12.05
1982 $ 12.49 1990 $ 12.21 1998 $ 14.20
1983 $ 12.49 1991 $ 11.05 1999 $ 12.43
1984 $ 12.29 1992 $ 11.88 2000 $ 9.74
1985 $ 11.48 1993 $ 11.80 2001 $ 13.10
1986 $ 11.30 1994 $ 12.00 2002 $ 10.42
1987 $ 11.23 1995 $ 11.83 2003 $ 11.42
2004 $ 15.50
Source: USDA Basic Formula Price (BFP) annualized average
The outlook for the remainder of 2004 and into 2005 still indicates
that milk prices will remain above the record low levels seen during early 2003
of $9.11, and are forecast to settle above $12. The following chart outlines the
historical monthly milk prices from January 2003 through September 2004 as
published by the U.S. Department of Agriculture (USDA).
2003 2004
------ ------
Jan 9.78 11.61
Feb 9.66 11.89
Mar 9.11 14.49
Apr 9.41 19.66
May 9.71 20.58
Jun 9.75 17.68
Jul 11.78 14.85
Aug 13.80 14.04
Sep 14.30 14.72
Oct 14.39
Nov 13.47
Dec 11.87
Source: USDA Basic Formula Price (BFP) monthly
20
Dairy farmers began seeing increases in their monthly milk checks during the
first quarter of 2004, but continued to remain cautious, despite continued low
interest rates, on increasing their capital expenditures, as milk prices have
fallen off the highs seen earlier in 2004 and are settling back down to a
forecasted level for the balance of 2004 between $12-$13. Management believes
that once sustained, prolonged upward movement in U.S. milk prices and breakeven
yearly milk price averages of above $12 are seen, farmers will be able to repay
their existing, older obligations which have mounted from the persistently low
milk prices over the last several years and purchase the Company's products.
However, recently the milk prices have begun falling off their highs of May
2004, and end users seem to believe that milk prices will settle back to below
breakeven levels for them, despite recent forecasts indicating milk prices
averaging over $12 for 2004 and into 2005. As a result, farmers seem to have
become over cautious again on their capital expenditures and are conserving
their operating cash.
Results of Operations
- ---------------------
Net sales for the quarter ended September 30, 2004 decreased 19.93% to
$4,557,829 compared to $5,692,292 for the quarter ended September 30, 2003. Net
sales for the nine-month period ended September 30, 2004 decreased 21.65% to
$14,370,916 compared to $18,341,101 for the nine-month period ended September
30, 2003. Net sales were down for the quarter as a result of continued, guarded
customer buying attitudes in the near term from the prolonged, depressed U.S.
milk price situation in the dairy industry. Additionally, the Company's dealers
were conservative when placing orders under the pre-season order program for
2003-04 resulting from carryover of inventory at the dealer level from the prior
year. Some of the Company's dealers had to re-order machinery during the
quarter, outside of the pre-season order program, which helped to partially
offset some of the sales decline and helped to improve gross margins for the
quarter.
Net sales for the nine-month period were down as a result of the above
mentioned factors. Additionally with the expansion of the Company's pre-season
order program to the dealers' local bank level in late 2003, seasonality began
to enter the Company's operations again, as shipment of product is at the
discretion of the dealer instead of the Company.
Also contributing to the decline in sales for the quarter and
nine-month period was increased volume discounts from the Company's pre-season
order program and other incentive programs offered to increase market share
during the second and third quarters of 2004, coupled with continued strong
competition in the silage bag market, as farmers look for the most economically
priced bag, with lesser consideration for quality and customer service.
21
The following table identifies revenue from each product line that
accounted for more that 15% of total revenue for the quarter and nine-month
period as compared to the same quarter and nine-month period in the prior year:
Nine Months Nine Months
3rd Quarter 3rd Quarter Ended Ended
Product 2004 2003 Sept. 30, 2004 Sept. 30, 2003
------------ ----------- ----------- -------------- --------------
Machines 29% 28% 39% 40%
Bags 62% 61% 51% 48%
Other 9% 11% 10% 12%
----------- ----------- -------------- --------------
Net Sales 100% 100% 100% 100%
Net machine sale revenue for the quarter decreased 18.76% and bag sale
revenue declined 19.08% compared to the same period of 2003. Net machine sale
revenue for the nine-month period declined 26.71% and bag sale revenue declined
19.50% compared to the same period of 2003. Net machine and bag sale revenue
declined for the quarter as a result of dealers being cautious on new capital
expenditures with the milk prices beginning to fall during the quarter, coupled
with dealer uncertainty about Ag-Bag's future with the pending asset sale
announcement of its operating assets to Miller St. Nazianz Inc. on August 16,
2004. Dealers appear to be waiting to see the transition plans of Miller St.
Nazianz Inc. relative to their dealer operations and programs for sales of the
Company's products. This decline was slightly offset by dealers ordering
additional machines outside of the pre-season order program from their
conservative orders placed a year ago under the 2003-04 pre-season order
program. Net machine and bag sale revenue for the nine-month period declined as
a result of the sales factors previously discussed, partially offset by the fact
the Company had a large international machine sale that occurred during the
second quarter of 2004.
The following table identifies the number of machines sold by size by
the Company for the third quarter and nine-month period of 2004 compared to
2003:
Units Sold Units Sold Units Sold Units Sold
3rd Quarter 3rd Quarter Nine Months Ended Nine Months Ended
Product 2004 2003 Sept. 30, 2004 Sept. 30, 2003
---------- ----------- ----------- ----------------- -----------------
Small 31 30 97 105
Medium 2 1 6 5
Large - 3 6 21
----------- ----------- ----------------- -----------------
Total 33 34 109 131
22
Machine sales are directly tied to farmers' income and therefore their
ability to purchase new equipment. The total number of bagging machines that are
in the marketplace drives the Company's bag and parts sales. However, there is
not a perfect correlation between the Company's bag sales and machine sales, as
the Company's and competitors' bags are interchangeable on all bagging machinery
in the industry. The Company cannot estimate with any certainty the total number
of machines or bags used in the industry.
The Company sold two composting systems in addition to compost bag
sales during the quarter ended September 30, 2004, generating approximately
$219,000 in revenue, compared to the quarter ended September 30, 2003 where one
composting system in addition to compost bags were sold, generating
approximately $247,000 in revenue. For the nine-month period ended September 30,
2004, the Company sold five composting systems in addition to compost bag sales,
generating approximately $597,000 in revenue, compared to the nine-month period
ended September 30, 2003 where one composting system in addition to compost bags
were sold, generating approximately $379,000 in revenue.
Although the Company sells its products primarily through a worldwide
dealer network, certain sales are made directly to large volume customers when a
dealer is not present in the customer's geographic market. For each of the last
three years, the Company estimates that direct sales made up between 10-15% of
total sales. The gross margin realized on the Company's direct sales are
typically within 1-3% of those sales realized through the Company's dealer
network. However, various economic, volume and market factors in the geographic
area impact the ultimate margin. Beginning in late 2002, the Company began
focusing its marketing efforts more on dealer development and expanding its
dealer network rather than a focus towards direct selling. As a result of this
shift, the Company anticipates its sales mix to begin to favor more dealer
sales.
Gross profit as a percentage of sales increased 18.00% for the quarter
ended September 30, 2004 compared to the same period in 2003. Gross profit as a
percentage of sales increased 3.21% for the nine-month period ended September
30, 2004 compared to the same period in 2003. The increase for the quarter was
the result of dealers ordering additional product outside of their 2003-04
pre-season order which yields the Company higher margins as a result of reduced
discounts. In addition the Company realized improved margins on sales of its
used equipment sold during the quarter. The above increases were partially
offset by a slowdown in factory utilization at the Company's production
facilities where manufacturing costs were not fully absorbed, as a result of
dealer uncertainty and placing machine orders as a result of the pending sale to
Miller St. Nazianz Inc. as previously discussed. As a result, the Company's
facilities were running only at approximately
23
55%-60% capacity for the quarter. The increase for the nine-month period was the
result of the above mentioned factors, coupled with stable margins on the
Company's "core" smaller-sized bagging machines, in addition to cost reductions
implemented during late 2003 which continued during the nine-month period to
lower the Company's fixed manufacturing overheads.
Selling expenses for the quarter ended September 30, 2004 decreased 28.81%
to $475,800 compared to $668,313 for the quarter ended September 30, 2003.
Selling expenses for the nine-month period ended September 30, 2004 decreased
24.54% to $1,526,655 compared to $2,023,238 for the nine-month period ended
September 30, 2003. The decrease for the quarter and nine-month period was the
result of lower commissions and third party financing fees caused by lower sales
volumes, lower overall advertising costs, and lower personnel, benefit, and
travel costs associated with cost reductions implemented late in 2003 which were
fully in place during the first nine-months of 2004.
Administrative expenses for the quarter ended September 30, 2004 decreased
1.86% to $643,080 compared to $655,244 for the quarter ended September 30, 2003.
Administrative expenses for the nine-month period ended September 30, 2004
decreased 4.79% to $1,985,579 compared to $2,085,512 for the nine-month period
ended September 30, 2003. The decrease for the quarter was the result of
decreases in administrative salaries and general office expenses, partially
offset by increased insurance, professional, and bad debt expense and patent
development costs. The decrease for the nine-month period was the result of the
above mentioned factors, except that the Company had lower professional fees
during the second quarter of 2004 as a result of the ongoing patent litigation
coming to a conclusion during the first quarter of 2004.
During the third quarter of 2004, the Company recorded a gain from the
sale of assets of $2,005. The gain resulted from the sale of fully depreciated
miscellaneous manufacturing equipment. For the nine-month period ended September
30, 2004, the Company recorded a gain from the sale of assets of $82,926. The
gain was the result of the above mentioned factor, coupled with the sale of a
parcel of vacant land owned by the Company in addition to the Company
recognizing a gain from the sale of its entire investment in the Company's
German joint venture during the second quarter of 2004. During the third quarter
of 2003, the Company recorded a gain from the sale of assets of $12,439, which
resulted from the sale of fully depreciated miscellaneous manufacturing
equipment and vehicles. For the nine-month period ended September 30, 2003, the
Company recorded a gain from the sale of assets of $358,276. The gain largely
resulted from depreciated folding equipment that was sold to its German joint
venture during the second quarter of 2003. Under the equity method of accounting
with the Company's 50% ownership in the German joint venture, the Company's
share of the
24
gain of $172,918 was deferred and recognized as the German joint venture
depreciated the folding equipment over its useful life.
Research and development expenses for the quarter ended September 30, 2004
increased 81.62% to $31,445 compared to $17,319 for the quarter ended September
30, 2003. Research and development expenses for the nine-month period ended
September 30, 2004 increased 8.83% to $116,921 compared to $107,437 for the
nine-month period ended September 30, 2003. The increase for the quarter and
nine-month period was the result of ongoing research and continued development
and testing of the newer design of the Company's larger-sized silage bagging
machine and compost machine modifications and recycling development, in addition
to continuing ongoing research regarding new silage and nutritional studies of
bagged feed and their effects on animal production.
Interest expense for the quarter ended September 30, 2004 increased 1.13%
to $63,933 compared to $63,219 for the quarter ended September 30, 2003.
Interest expense for the nine-month period ended September 30, 2004 increased
17.03% to $204,412 compared to $174,673 for the nine-month period ended
September 30, 2003. The increase for the quarter and nine-month period was the
result of the Company utilizing a larger portion of its credit line, coupled
with an increase in the interest rate on its line of credit as a result of an
amendment to the Company's credit agreement during the first quarter of 2004 and
implementation by Wells Fargo Business Credit of an additional interest rate
premium of 2 1/4% during the third quarter of 2004 as a result of a default by
the Company of two of its financial covenants.
Miscellaneous income for the quarter ended September 30, 2004 decreased
65.23% to $39,461 compared to $113,498 for the quarter ended September 30, 2003.
Miscellaneous income for the nine-month period ended September 30, 2004
decreased 41.71% to $288,731 compared to $495,348 for the nine-month period
ended September 30, 2003. The decrease for the quarter was the result of lower
joint venture income as a result of the sale of the Company's investment in its
German joint venture and the reduction in folding fees paid by the joint venture
upon the sale of the folding equipment during the second quarter of 2003. The
decrease for the nine-month period was the result of the above mentioned factors
coupled with lower general miscellaneous income, partially offset by increased
machine royalty income and total deferred gain on the sale of the folding
equipment recognized of $86,464 during the first half of 2004. Additionally,
during the second quarter of 2003, the Company received a special one-time
folding royalty from the sale of the folding equipment which it did not have in
2004.
The Company's effective income tax rate for the quarter ended September
30, 2004 was zero compared to (29.11%) for the quarter ended September 30, 2003.
The Company's effective income tax rate for the nine-month period ended
September 30, 2004 was zero
25
compared to (36.08%) for the nine-month period ended September 30, 2003. The
effective tax rate was zero during the quarter and nine-month period due to the
fact the Company established an additional $121,000 valuation allowance during
the third quarter, and a total of an additional $411,000 valuation allowance for
the nine-month period against its deferred tax assets. The valuation allowance
was established because of the Company's expected inability to utilize its net
operating loss carryforwards and research tax credits, which was partially
offset by the fact the Company's income from its international royalties are not
taxable in the United States, and the extraterritorial income exclusion
provisions of the current United States tax code.
Net loss for the quarter ended September 30, 2004 was $385,222 compared to
$316,555 for the quarter ended September 30, 2003. Net loss for the nine-month
period ended September 30, 2004 was $966,320 compared to $400,328 for the
nine-month period ended September 30, 2003. The decrease for the quarter and
nine-month period was the result of lower sales, increased research and interest
expense, lower miscellaneous income, and reduced gain on sale of assets, and no
tax benefit being realized from the losses due to establishment of a valuation
allowance against the deferred tax assets generated during the quarter and
nine-month period, partially offset by improved gross profit, and decreases in
selling and administrative expenses.
Liquidity and Capital Resources
- -------------------------------
The seasonal nature of the northern hemisphere farming industry, the
production time for equipment and the time required to prepare bags for use
requires the Company to manufacture and carry high inventories to meet rapid
delivery requirements. In particular, the Company must maintain a significant
level of bags during the spring and summer to meet the sales demands during the
harvest season. The Company uses working capital and trade credit to increase
its inventory so that it has sufficient inventory levels available to meet its
sales demands. Although the Company's pre-season ordering program provides it
with some flexibility in production, the Company must maintain adequate
inventory levels for those customers, both old and new, who order or re-order
product outside of this program throughout the year.
The Company relies on its suppliers to provide trade credit to enable the
Company to build its inventory. The Company's suppliers have provided sufficient
trade credit to meet the demand to date and have been flexible with their
payment terms (including extended payment arrangements) provided to the Company
and management believes this will continue. However, no assurance can be given
that suppliers will continue to provide sufficient trade credit in the future.
26
As a result of the Company incurring net losses during the previous three
years and during the first nine-months of 2004, and its negative cash flows from
operations for the prior year and nine months ended September 30, 2004, there is
uncertainty about the Company's ability to continue as a going concern. The
Company's management believes the Company's weak operating results have been
primarily due to the depressed milk prices in the agriculture sector, which have
a direct impact on the disposable income of its dairy farm customers, who
account for approximately 75% of the Company's business. The Company further
believes that dairy farmers have been delaying or eliminating capital
expenditures due to uncertainties regarding milk prices and their disposable
income. Predictions for the remainder of 2004 and into 2005 continue to show
milk prices declining from earlier highs of over $20 in May 2004, but remaining
higher than the historically low levels seen for many of the previous years and
the Company expects operating results to improve slowly as dairy farmers
continue to see increases in their disposable income through stabilizing milk
prices. As dealer's inventories become depleted, they will need to increase the
size of their next pre-season order (2004-05) to take full advantage of the
various sales incentives and to maximize their volume discounts.
To help provide positive cash flow for the Company, management implemented
an expense reduction plan in late 2003. Specifically, management implemented
staff reductions and reduced salaries of senior management. Nonessential capital
expenditures, travel and other expenses have either been eliminated or
postponed. Management also continues considering other changes to the Company's
business model such as opportunities to sell the business, refinance the
Warrenton, Oregon facility (which has only a small economic development loan
outstanding against this collateral), consolidate or dispose of manufacturing
facilities or other tangible or intangible assets, or a policy loan against the
life insurance policies currently in force in which the Company is the
beneficiary. See Part II, Item 5 regarding the Company's plans to sell
substantially all of its operating assets. However, no assurance can be given
that the Company will be successful in accomplishing any of these objectives. In
April of 2004, the Company was successful in selling its German joint venture to
generate operating cash in the amount of $500,000.
Accounts receivable decreased 45.61% at September 30, 2004 to $1,435,236
compared to $2,638,828 at September 30, 2003. The decrease was the result of
lower sales for the quarter. At September 30, 2004, the Company still had some
receivables outstanding under its previous collection method of providing terms
for its customers. For new purchases, the Company's customers now have the
option to pay in advance for their order, utilize their own established credit,
or utilize one of the Company's third-party financing sources or programs
offered for their purchases. The Company generally receives funding from its
third party financing sources within 10 days of invoice processing. The Company
has established adequate reserves ($202,903 at September 30, 2004 compared to
$172,293 at September 30, 2003) against accounts
27
receivable in the event that some of the remaining accounts become
uncollectible.
The Company relies on its third-party financing sources and the dealers'
own established credit with their local banks, to provide funding for the
Company's dealers' and retail customers' purchases under the pre-season order
program. The Company's third party financing sources and dealers' local banks
have provided sufficient credit to the Company's dealers to date for the Company
to receive payment and management believes this will continue. However, no
assurance can be given that the Company's third-party financing sources and
dealers' local banks will continue to provide the Company with dealer and end
user financing programs designed for the Company. As of September 30, 2004, the
Company began processing charges for its customers/dealers who use John Deere
Credit's Farmplan program on a preferred customer basis only and no longer
accepts charges for those who are merchant authorized. Farmplan preferred is
more advantageous to the customer/dealer as they receive better interest rates
and payment options than under the merchant program. Additionally, this reduces
the Company's potential recourse liability in the event the customer/dealer
fails to pay their account under the Farmplan program terms. (See critical
accounting policies.)
Inventory decreased 3.76% at September 30, 2004 to $6,384,617 compared to
$6,634,189 at September 30, 2003. The decrease in inventory was the result of
the Company's continued efforts to streamline its inventory and more closely
match its production with planned inventory requirements and market conditions.
However, as a result of the Company's pre-season order program being expanded to
include a dealers' local bank financing component, the Company's dealers control
more of the timing of their product shipments and usually take their product
closer to their time of need, which has brought a seasonality component back
into the Company's business.
Other current assets increased 2.44% at September 30, 2004 to $305,537
compared to $298,273 at September 30, 2003. The increase was the result of an
increase in deposits and other prepaid expenses.
Deferred income taxes decreased to $-0- at September 30, 2004 compared to
$1,239,000 at September 30, 2003. The decrease was the result of the Company
establishing a valuation allowance of $1,988,772 against its deferred tax assets
at September 30, 2004.
Intangible assets at September 30, 2004 decreased 56.47% to $7,637
compared to $17,543 at September 30, 2003. The decrease was the result of normal
amortization expense.
The BAW joint venture asset decreased to $-0- at September 30, 2004
compared to $359,747 at September 30, 2003. The decrease was the result of the
sale of the Company's investment in its joint venture during the second quarter
of 2004 and recognizing the balance of the deferred gain, under the equity
method of
28
accounting, of the Company's share of gain from the sale of folding equipment
sold to the German joint venture in the second quarter of 2003. The balance of
deferred gain from the folding equipment recognized for the nine-month period
ended September 30, 2004 was $86,464, which occurred prior to the end of the
second quarter.
Other assets decreased 73.88% at September 30, 2004 to $125,763 compared
to $481,417 at September 30, 2003. The decrease was the result of a decrease in
the cash surrender value of insurance on policies maintained by the Company, in
which the Company was the beneficiary, by redeeming the Company's outstanding
preferred stock with the life insurance policy the Company maintained on the
owner of the preferred stock.
The Company has a revolving operating line of credit with a limit of
$3,000,000, secured by accounts receivable, inventory, fixed asset blanket and
general intangibles, and bears interest at the bank's prime rate plus 4 3/4%. As
of September 30, 2004, $1,630,483 was outstanding under the credit line. The
line of credit will fluctuate based upon production needs and the timing of
collection of receivable balances. Additionally, the Company's borrowing base
fluctuates as receivables and inventory change. The borrowing base is equal to
(1) the lesser of the maximum line amount or (2) the sum of 70% of eligible
accounts receivable plus the lesser of 40% of eligible inventory or $2 million.
The line of credit is subject to certain net worth and earnings covenants, and
an annual capital expenditure limit. The Company was in default at September 30,
2004 with the net worth and earnings covenants and continues working with its
primary lender to cure the default and reset covenants. Management believes that
funds generated from operations, management's implemented expense reduction plan
and other changes being considered to the Company's business model, including
the sale of substantially all of the Company's operating assets to Miller St.
Nazianz Inc., and the Company's operating line of credit, will be sufficient to
meet the Company's cash requirements through 2004. The Company's line of credit
is subject to renewal in May 2006. The Company currently anticipates paying off
its credit line with the proceeds from the sale of assets to Miller St. Nazianz
Inc., and anticipates incurring an early termination fee of $60,000 from Wells
Fargo Business Credit as a result.
On December 18, 2000, the Company entered into an agreement with Dresdner
Bank to guarantee up to 511,292 Euro ($630,167 US) as security for an additional
cash credit facility of the Company's German joint venture. In August 2003, the
guarantee was reduced by Dresdner Bank to 250,000 Euro ($308,125 US). On April
27, 2004, upon the sale of the Company's German joint venture, the Company was
relieved of its bank guarantee with Dresdner Bank and has no further guarantees
or obligations outstanding with Dresdner Bank.
Accounts payable decreased 13.69% at September 30, 2004 to $1,036,526
compared to $1,200,892 at September 30, 2003. The
29
decrease was the result of the Company slowing its manufacturing process during
the period (resulting from dealer uncertainty for equipment orders from the
pending sale to Miller St. Nazianz Inc. of the Company's operating assets and
market conditions stemming from declines in milk prices), partially offset with
extended term payment arrangements provided by some of the Company's principal
suppliers.
Accrued expenses and other current liabilities increased 39.85% at
September 30, 2004 to $1,834,435 compared to $1,311,735 at September 30, 2003.
The increase was the result of increases in volume discounts from the Company's
pre-season order program and other short-term customer incentive accruals
offered during seasonal demand periods, and from deposits received from Miller
St. Nazianz Inc. for the prepayment of some assets being acquired. These
increases were partially offset by decreased payroll, commission and benefit
accruals from personnel reductions, and lower accrued warranty expenses
resulting from the Company passing on more warranty costs to its principal
suppliers.
In 1997, the Nasdaq listing requirements were substantially expanded. The
Company does not currently qualify under the more stringent requirements because
the price at which its Common Stock is trading is below the $1 per share
minimum. The Company was formally notified on January 13, 1999, that its Common
Stock was delisted from quotation on The Nasdaq SmallCap Market for failure to
meet the new listing requirements. The Company's Common Stock is now quoted on
the OTC Bulletin Board. The removal from quotation on the Nasdaq SmallCap Market
could have a material adverse effect on the Company's ability to raise
additional equity capital in a public stock offering should that become
necessary.
The following table outlines the Company's future contractual obligations
by type:
Payments due by period
-------------------------------------------------------
Contractual Less than More than
Obligations Total 1 year 1-3 years 3-5 years 5 years
-------------------------------------------------------
Long-term debt $1,103,463 $ 97,638 $142,585 $159,265 $703,975
Operating leases 246,209 21,558 43,834 43,834 136,983
Purchase obligations - - - - -
-------------------------------------------------------
Total $1,349,672 $119,196 $186,419 $203,099 $840,958
=======================================================
Off-Balance Sheet Arrangements
- ------------------------------
As of September 30, 2004, we did not have any significant off-balance sheet
arrangements, as defined in Item 303(a)(4)(ii) of SEC Regulation S-K.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Market risk is the exposure to loss resulting from changes in interest
rates, foreign currency exchange rates, commodity prices and equity prices. The
primary market risk to which the Company is exposed is interest rates.
The Company's exposure to changes in interest rates is minimal.
Primarily all of the Company's long-term debt is fixed rate. The Company's line
of credit is based on the prime rate plus 4 3/4%.
ITEM 4. CONTROLS AND PROCEDURES.
As of September 30, 2004, the Company carried out an evaluation, under
the supervision and with the participation of the Company's management,
including the Company's Chief Executive Officer and the Company's Chief
Financial Officer, of the effectiveness of the design and operation of the
Company's disclosure controls and procedures. Based on the evaluation, the
Company's Chief Executive Officer and Chief Financial Officer have concluded
that the Company's disclosure controls and procedures are effective to ensure
that information required to be disclosed by the Company in the reports it files
or submits under the Securities Exchange Act of 1934 is recorded, processed,
summarized and reported within the time periods specified in Securities and
Exchange Commission rules and forms. There were no significant changes in the
Company's internal controls or in other factors that could significantly affect
these controls including any corrective actions with regard to significant
deficiencies and material weaknesses subsequent to the date the Company
completed its evaluation.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
The Company is a defendant in an alleged breach of contract lawsuit,
UpNorth Plastics, Inc., vs Ag-Bag International Ltd., filed September 8, 2004 in
the United States District Court Northern District of Texas. The claim alleges
breach of the "no-shop" provision of the letter of intent dated February 27,
2004 between the parties. The Company denies the allegations and is vigorously
defending itself against the lawsuit. On October 12, 2004, the Company filed a
motion to dismiss the complaint for failure to state a claim upon which relief
can be granted. UpNorth Plastics, Inc., president, Steven G. Ross, is a 15.05%
shareholder of the Company.
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The Company is a defendant in an alleged lawsuit, Case Credit Ltd, v.
Artomda Farms Ltd, Tom's Custom Services Ltd.; Thomas Stoker, and Ag-Bag
International Ltd, filed September 24, 2003 in the Court of Queen's Bench of
Alberta Judicial District of Calgary. The claim alleges improper assignment of a
retail installment contract for a bagging machine sold by the Company to Thomas
Stoker. Plaintiff seeks monetary damages. The Company denies all allegations of
this claim and is vigorously defending itself against this claim. Depositions
continue and discovery is ongoing in this matter.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
The Company was in default at September 30, 2004 with two of its
financial covenants under its revolving operating line of credit with its
primary lender, Wells Fargo Business Credit, and the default has not been cured
as of the date of filing of this report. The Company was not in compliance with
the net worth and earnings before taxes covenant, and continues working with
Wells Fargo Business Credit to cure the default and amend its financial
covenants for the balance of the year. The amount outstanding under the
revolving line of credit was $1,630,483 at September 30, 2004.
ITEM 5. OTHER INFORMATION.
On August 13, 2004, the Company entered into an Asset Purchase
Agreement to sell substantially all of the Company's operating assets to Miller
St. Nazianz, Inc., a Wisconsin corporation who will integrate the operations of
Ag-Bag into their current farm equipment manufacturing business operations. The
Company estimates this transaction to be valued at approximately $7-8 million in
cash, subject to adjustments for assets and inventory actually acquired at
closing under the agreement. The transaction, which has been approved by the
Company's Board of Directors, is subject to stockholder approval and other
customary closing conditions, and is anticipated to close within the next ninety
days. In addition, the Company is actively looking to sell its real estate and
other assets not being sold to Miller St. Nazianz, Inc.
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ITEM 6. EXHIBITS.
31.1 Rule 13a-14(a)/15d-14(a) Certification of Chief
Executive Officer
31.2 Rule 13a-14(a)/15d-14(a) Certification of Chief
Financial Officer
32.1 Section 1350 Certification of Chief Executive Officer
32.2 Section 1350 Certification of Chief Financial Officer
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
AG-BAG INTERNATIONAL LIMITED,
a Delaware corporation
(Registrant)
Date: October 22, 2004 By: /s/ MICHAEL R. WALLIS
---------------------------
Michael R. Wallis
Chief Financial Officer and
Vice President of Finance
(duly authorized and principal
financial officer)
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EXHIBIT INDEX
Exhibit
Number Description of Exhibit
- ------ ----------------------
31.1 Rule 13a-14(a)/15d-14(a) Certification of Chief
Executive Officer
31.2 Rule 13a-14(a)/15d-14(a) Certification of Chief
Financial Officer
32.1 Section 1350 Certification of Chief Executive Officer
32.2 Section 1350 Certification of Chief Financial Officer
35