ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis contain forward-looking statements 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 the Risk Factors contained in our 2019 Annual Report as well as those discussed elsewhere in this report. The historical results set forth in this discussion and analysis 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 solid polyurethane foam tires. We have developed unique polyurethane formulations that allow us to make products with superior performance characteristics in the areas of abrasion resistance, energy efficiency and 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. We believe tires produced with our proprietary polyurethane formulations last longer, are less susceptible to failure and are friendlier to the environment when compared to competitor offerings.
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, tire performance, and customer service 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 produce a broad range of products for the light duty tire market. Our product development and marketing efforts are focused on building customer relationships and expanding sales with original equipment manufacturers and tire distributors. Our competitive advantage is creating unique product solutions for customers who have challenging tire performance requirements that cannot be met by competitor offerings.
We continued to experience strong demand for our polyurethane foam tires in the fiscal 2020 second quarter, exceeding our expectations. Higher sales were driven by stability in the overall economy as well as seasonal factors that have traditionally boosted sales this time of year. While the tariff dispute with China continues to provide a headwind to our imported wheel rim costs and the overall US economy. For the majority of our products we continue to manage these costs with minimal price increases to our customers. We reluctantly implemented a small price increase on our industrial wheel assemblies to partially offset price increases on purchased 12 inch rims during the first quarter of fiscal year 2020.
Polyurethane Elastomer Industrial Tires – We had negligible sales of elastomer forklift and elastomer industrial tires during the fiscal 2020 second quarter. During the recent quarter we produced additional elastomer samples for new customer projects currently under evaluation. Once the testing of these samples is complete we expect to be able to evaluate whether this development will lead to new business in the coming quarters.
The Company continued to see increasing sales of tires produced with its new elastomer formulation ElastothaneTM 500. Sales to date are mainly small orders from customers conducting tire evaluations. We remain optimistic that this new formulation represents a significant business opportunity as product adoption increases.
Agricultural Tires – Agricultural tires sales continue to remain under pressure due to international trade issues and low farm incomes. The lifting of Chinese tariffs on US-grown soybeans and certain other agricultural products should remove some of the drag on commodity pricing domestically and on overseas demand. We have ongoing discussions with original equipment manufacturers (OEMs) and distributors to identify new opportunities for our elastomer products. The introduction of our ElastothaneTM 500 formulation has generated new interest in our tire offerings for agricultural applications, which we believe will present new business opportunities once the farmers have money to invest in new equipment.
Due to the Company’s limited resources, business development projects which require significant investment have been put on hold. We believe investment in new and improved products is important to the continued growth of our business, and we will continue to selectively invest in promising opportunities that fit our current financial plan. We have several ongoing product evaluation programs that have the potential to develop into significant business in the coming quarters.
As described above, our product line covers a wide range of diverse market segments which are unrelated in terms of customer base, product distribution, market demands and competition. Our external sales team is comprised of independent manufacturer representatives with strong tire industry experience. The Company’s strategy of targeted marketing campaigns and proper product pricing continue to drive more profitable sales. Our website is a valuable educational tool for the marketplace, and it continues to generate some online sales. During the recent quarter we also launched our Amazon store for online sale of golf cart and industrial tire assemblies.
Our strategy continues to be based on focusing resources on the development of market segments where we have identified technological and product performance advantages. Costs for raw materials remained stable during the fiscal second quarter of 2020, versus the fiscal first quarter of 2020, as the trade dispute and tariffs between China and the US did not escalate during the period, although tariff relief on our wheel rims imported from China has not yet been obtained. Improving top line sales revenue growth remains our primary goal, and sales for the second quarter of fiscal 2020 were 35.9% higher than the second quarter of fiscal 2019. Our ability to broaden our customer base has enabled us to overcome challenging business conditions in key segments, and we are optimistic that these new customers will develop into larger revenue opportunities as applications for our tires continues to grow. Continued strength in the US economy remains a key factor in our future revenue growth expectations, and weakness in the overall economy remains a risk factor in the latter half of fiscal year 2020.
Factors Affecting Results of Operations
Our operating expenses consisted primarily of the following:
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Cost of sales, which consists primarily of raw materials, components and production costs 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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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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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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Consulting expenses, which consist primarily of amounts paid to third-parties for outside services;
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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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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.
Valuation of Intangible Assets and Goodwill
Patent and trademark costs have been capitalized at December 31, 2019, totaling $487,633 with accumulated amortization of $385,880 for a net book value of $101,753. Patent and trademark costs capitalized at December 31, 2018, totaled $487,633 with accumulated amortization of $366,457 for a net book value of $121,176.
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 December 31, 2019, and 2018, 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 three and six month periods ended December 31, 2019 and 2018, respectively.
Amortization expense for the years ended December 31, 2019 and 2018 was $8,849 and $11,429 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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any changes in the market relating to the patents that would decrease the life of the asset;
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any adverse change in the extent or manner in which the patents are being used;
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any significant adverse change in legal factors relating to the use of the patents;
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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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future cash flow values based on the expectation of commercialization through licensing; and
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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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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 December 31, 2019 and 2018 with respect to certain key financial measures. The comparisons illustrated in the table are discussed in greater detail below.
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For the Three Months Ended
December 31,
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For the Six Months Ended
December 31
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(in 000’s)
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Change
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(in 000’s)
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Change
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2019
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2018
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2019 vs. 2018
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2019
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2018
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2019 vs. 2018
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Net revenues
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$
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1,067
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$
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785
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35.9
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%
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$
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2,047
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$
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1,612
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27.0
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%
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Cost of revenues
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(768
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)
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(637
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)
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20.6
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%
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(1,460
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)
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(1,198
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)
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21.9
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%
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Gross profit
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299
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148
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102.0
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%
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587
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414
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41.8
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%
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Research & Development
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(36
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(25
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)
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44.0
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%
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(62
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)
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(48
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)
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29.2
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%
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Sales and Marketing
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(51
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)
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(53
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)
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(3.8
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%)
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(95
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)
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(104
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)
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(8.7
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%)
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General and Administrative
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(174
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)
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(164
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)
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6.1
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%
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(366
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)
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(353
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)
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3.4
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%
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Other income (expense)
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-
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(1
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)
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(100.
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%)
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3
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1
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200.0
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%
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Net income (loss)
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38
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(95
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)
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(140.0
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%)
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67
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(90
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)
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(174.4
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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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0.00
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%
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(50
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)
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(50
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)
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0.0
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%
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Net income (loss) attributable to common shareholders
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$
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13
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$
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(120
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)
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(110.8
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%)
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$
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17
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$
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(140
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)
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(112.1
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%)
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Quarter Ended December 31, 2019 Compared to December 31, 2018
Net Revenues. Net revenues of $1,067,440 for the quarter ended December 31, 2019, represents a 35.9% increase over net revenues of $785,105 for the same period in 2018. These results exceeded our expectations. The improved results were driven by higher than expected polyurethane foam tires from current customers as well as purchases from new customers. We expect our polyurethane foam products to continue to account for the majority of our sales during the upcoming fiscal year.
Cost of Revenues. Cost of revenues for the quarter ended December 31, 2019 was $768,758 or 72.0% of sales compared to $637,265 or 81.2% of sales for the same period in 2018. This increase in Gross Margin was due to sales of higher margin products in the recent quarter compared to the year earlier period. There was also a stabilization in the costs associated with chemical raw material and steel wheels. We anticipate that raw material costs volatility will remain stable for the rest of fiscal year 2020, with no additional costs associated with trade tariffs.
Gross Profit. Gross profit for the quarter ended December 31, 2019 was $298,682 compared to $147,840 for the same period in 2018. Gross profit for the quarter ended December 31, 2019 increased by $150,842 or 102.0% over the same period in 2018 due to greater sales of higher margin products. The December 31, 2019 gross profit reflects a 28.0% gross margin for product sales compared to a gross margin on product sales of 18.8% in 2018.
Research & Development Expenses (R&D). Research and development expenses for the quarter ended December 31, 2019 were $35,897 compared to $24,717 for the same period in 2018. The difference between periods is due to the funding during the quarter of a new program to test and evaluate Amerityre bike tires.
Sales & Marketing Expenses. Sales and marketing expenses for the quarter ended December 31, 2019 were $51,309 compared to $53,325 for the same period in 2018.
General & Administrative Expenses. General and administrative expenses for the quarter ended December 31, 2019 were $172,936 compared to $163,895 for the same period in 2018. The difference between periods was due to planned higher legal costs related to the engagement of new SEC counsel, offset by lower warranty expense in the current period compared to the year earlier period.
Other Expense, net. Other expense, net, for the quarter ended December 31, 2019 was $145 compared to $647 for the same period in 2018. The primary driver of this variance is lower interest expense due to the payoff of debt.
Net Income (Loss). Net income for the quarter ended December 31, 2019 of $38,395 compared to net loss of $94,744 for the same period in 2018, a positive increase in net income of $133,139.
Six Months Ended December 31, 2019 Compared to December 31, 2018
Net Revenues. Net revenues of $2,046,737 for the six-month period ended December 31, 2019, represents a 27.0% increase over net sales of $1,612,349 for the same period in 2018. These results were above our expectations and driven by increased demand for polyurethane foam tires from current customers as well as sales to new customers. We expect farm income to remain low for the remainder of fiscal year 2020 resulting in continued depressed agricultural tire sales. However, we believe the strength in the polyurethane foam tire market segment will continue for the remainder of fiscal year 2020.
Cost of Revenues. Cost of revenues for the six-month period ended December 31, 2019 was $1,459,357 or 71.3% of sales compared to $1,198,277 or 74.3% of sales for the same period in 2018. This increase in Gross Margin was due to sales of higher margin products as well as stabilized raw material costs. The prospects for tariff relief for our steel wheels purchased from China are uncertain, but we do not expect tariffs to increase further in the coming year.
Gross Profit. Gross profit for the six-month period ended December 31, 2019 was $587,380 compared to $414,072 for the same period in 2018, an increase of $173,308 or 41.8% over the same period in 2018. The December 31, 2019 gross profit reflects a 28.7% gross margin for product sales compared to a gross margin on product sales of 25.7% in 2018.
Research & Development Expenses (R&D). Research and development expenses for the six-month period ended December 31, 2019 were $61,913 compared to $47,790 for the same period in 2018. The higher expenses in the fiscal year 2020 period are due to costs associated with our new bike tire evaluation and test program. The Company plans to continue to invest in R&D as a key component of our new product and business improvement initiatives.
Sales & Marketing Expenses. Sales and marketing expenses for the six-month period ended December 31, 2019 were $94,780 compared to $104,249 for the same period in 2018. The difference between periods relates to lower commissions paid as a percentage of sales during the current period, offset by higher trade show expenses, when compared to the same six-month period in 2018.
General & Administrative Expenses. General and administrative expenses for the six-month period ended December 31, 2019 were $366,366 compared to $353,443 for the same period in 2018. The difference between periods related to higher anticipated legal costs related to the engagement of new SEC counsel.
Other Income, net. Other income for the quarter ended December 31, 2019 was $2,977 compared to $983 for the same period in 2018. The primary driver in this variance is lower interest expense due to the payoff of debt.
Net Income (Loss). Net income for the six-month period ended December 31, 2019 of $67,298 compared to a net loss of $90,427 for the same period in 2018, an increase in positive net income of $157,725.
Liquidity and Capital Resources
Cash Flows
The following table sets forth a summary of our cash flows for the periods below.
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Six Months ended Dec. 31,
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(in 000’s)
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2019
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2018
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Net cash (used) provided by operating activities
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$
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(162
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)
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$
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169
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Net cash used in investing activities
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|
(30
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)
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|
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(78
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)
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Net cash used in financing activities
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(25
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)
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|
|
(9
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)
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Net (decrease) increase in cash during the period
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$
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(217
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)
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$
|
82
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|
Net Cash Used by Operating Activities. In 2019, the Company decided to use a portion of its available cash to make a lump sum payment for annual insurance premiums rather than finance these expenditures over the course of the year. As a result, our prepaid assets increased in the period. During the fiscal 2020 second quarter we also saw a rise in finished product inventories in advance of our Christmas holiday shutdown, in order to be prepared for customer product shipments in early January. Net cash used in operating activities was $161,525 for the period ended December 31, 2019 compared to net cash provided by operating activities of $169,214 for the same period in 2018.
Non-cash items include depreciation and amortization and stock-based compensation. Amortization includes the amortization of our right to use asset, our facility rent. Our net income was $67,298 for the period ended December 31, 2019 compared to a net loss of $90,427 for the same period in 2018. The net income for the period ended December 31, 2019 included non-cash expenses for depreciation and amortization of $120,762 and stock-based compensation of $19,654. As of December 31, 2018, depreciation and amortization was $41,221 and stock-based compensation totaled $17,778.
Net Cash Used by Investing Activities. Net cash used by investing activities was $30,318 for the period ended December 31, 2019 and $78,302 for the same period in 2018. In fiscal year 2019, we invested in various manufacturing equipment items and upgraded our in-house computer infrastructure and server.
Net Cash Used by Financing Activities. In line with the Company’s initiative to pay off high interest term debt with available cash, a total of $25,121 was used in financing activities for the period ended December 31, 2019 and $9,335 for the same period in 2018. The use of cash for the period ended December 31, 2019 was used to retire all of our term debt early.
Our principal sources of liquidity consist of cash and payments received from our customers. As of the date of this filing, the Company is negotiating with a local bank to secure a $50,000 line of credit to provide financial flexibility. Historically, management has been reluctant to pursue financing at terms that subject the Company to the high costs of debt, or raise money through the sale of equity at prices we believe do not reflect the true value of the Company.
As part of its effort to maintain adequate working capital levels, Amerityre has not declared dividends on its preferred stock since June 2016. These unpaid dividends have accrued in the amount of $25,000 per quarter since that time.
We continue to have access to 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 of December 31, 2019, we have not needed to activate this financing option due to increased focus on enforcement of established collection policies and proactive communication with customers.
Cash Position, Outstanding Indebtedness and Future Capital Requirements
At February 7, 2020, our total cash balance was $414,787, none of which is restricted; accounts receivables was $343,953; and inventory, net of reserves for slow moving or obsolete inventory, and other current assets was $947,271. Our total indebtedness, specifically which management reviews for cash management, was $1,289,141 and includes $1,225,235 in accounts payable, accrued expenses and operating lease liability; $2,000 in current portion of long-term debt and $61,906 in long-term debt. As of December 31, 2019 none of our debt is term debt and is payable in association with the sales of forklift tires as described in our financial statements in this filing.
We continue to take actions to improve our liquidity and access to capital resources. To fully execute the annual strategic business plan discussed during our shareholder meeting in December 2019, we require more capital resources. However, management continues to maintain that an equity financing in the current market environment would be too dilutive and not in the best interests of our shareholders. We will pursue potential opportunities to secure short-term loans, long-term bank financing, revolving lines of credit with banking institutions and equity-based transactions with strategic financial firms and industry partners in our effort to improve the Company’s financial and market positions and enhance shareholder value.
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. We believe that the Company’s emphasis on proper product pricing and new marketing campaigns has driven more profitable sales.
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 December 31, 2019, 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 February 12, 2020, the Company has approximately 707,000 shares of common stock authorized and available for issuance. At our 2019 Annual Shareholders Meeting, we received approval from shareholders to increase the number of authorized shares of common stock to 100 million shares. We requested this approval for an increase in authorized shares to provide management the flexibility to raise capital if required. However, we have yet to receive approval from our preferred shareholder to increase the level of the authorized shares, which is required by our current preferred stock agreement.
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.
Cautionary Note Regarding Forward Looking Statements
This report contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, including statements regarding economic conditions in general and in the agricultural market, in particular, tariffs imposed by China and the US arising from the current geo-political tension between those jurisdictions, our ability to increase our authorized capital and pursue future financings, our sales prospects in light of new products, increased sales and resulting profits, continued strength of our current polyurethane foam tire market segment and liquidity. All statements other than statements of historical facts contained in this report, including statements regarding our future financial position, liquidity, business strategy and plans and objectives of management for future operations, are forward-looking statements. The words “believe,” “may,” “estimate,” “continue,” “anticipate,” “intend,” “should,” “plan,” “could,” “target,” “potential,” “is likely,” “will,” “expect” and similar expressions, as they relate to us, are intended to identify forward-looking statements. We have based these forward-looking statements largely on our current expectations and projections about future events and financial trends that we believe may affect our financial condition, results of operations, business strategy and financial needs.
These forward-looking statements are subject to a number of risks, uncertainties and assumptions, including those described in our 2019 Annual Report. New risk factors emerge from time-to-time and it is not possible for us to predict all such risk factors, nor can we assess the impact of all such risk factors on our business or the extent to which any risk factor, or combination of risk factors, may cause actual results to differ materially from those contained in any forward-looking statements. Except as otherwise required by applicable laws, we undertake no obligation to publicly update or revise any forward-looking statements described in this report, whether as a result of new information, future events, changed circumstances or any other reason after the date this report is filed.