This quarterly report on Form 10-Q and other reports filed by Cardinal Resources, Inc. (the “Company”) from time to time with the SEC (collectively, the “Filings”) contain or may contain forward-looking statements and information that are based upon beliefs of, and information currently available to, the Company’s management as well as estimates and assumptions made by Company’s management. Readers are cautioned not to place undue reliance on these forward-looking statements, which are only predictions and speak only as of the date hereof. When used in the Filings, the words “anticipate,” “believe,” “estimate,” “expect,” “future,” “intend,” “plan,” or the negative of these terms and similar expressions as they relate to the Company or the Company’s management identify forward-looking statements. Such statements reflect the current view of the Company with respect to future events and are subject to risks, uncertainties, assumptions, and other factors, including the risks relating to the Company’s business, industry, and the Company’s operations and results of operations. Should one or more of these risks or uncertainties materialize, or should the underlying assumptions prove incorrect, actual results may differ significantly from those anticipated, believed, estimated, expected, intended, or planned.
Although the Company believes that the expectations reflected in the forward-looking statements are reasonable, the Company cannot guarantee future results, levels of activity, performance, or achievements. Except as required by applicable law, including the securities laws of the United States, the Company does not intend to update any of the forward-looking statements to conform these statements to actual results.
Our financial statements are prepared in accordance with accounting principles generally accepted in the United States (“GAAP”). These accounting principles require us to make certain estimates, judgments and assumptions. We believe that the estimates, judgments and assumptions upon which we rely are reasonable based upon information available to us at the time that these estimates, judgments and assumptions are made. These estimates, judgments and assumptions can affect the reported amounts of assets and liabilities as of the date of the financial statements as well as the reported amounts of revenues and expenses during the periods presented. Our financial statements would be affected to the extent there are material differences between these estimates and actual results. In many cases, the accounting treatment of a particular transaction is specifically dictated by GAAP and does not require management’s judgment in its application. There are also areas in which management’s judgment in selecting any available alternative would not produce a materially different result. The following discussion should be read in conjunction with our financial statements and notes thereto appearing elsewhere in this report.
Basis of Presentation
The following management’s discussion and analysis is intended to provide additional information regarding the significant changes and trends which influenced our financial performance for the quarters ending March 31, 2014, and 2013. This discussion should be read in conjunction with the unaudited financial statements and notes as set forth in this Report.
Overview
Cardinal Resources began operations in 2004, providing environmental engineering services, remediation, water and waste water treatment to US companies on a global basis. In 2005, we began development of proprietary technologies to create sustainable water and waste water systems to be produced by Cardinal Resources and operated globally. The prototype filters were deployed in 2007, first full prototype was built in 2008 and the first full system was built in 2009. We were issued our first patents for our technologies and applications in 2009 with subsequent patents issued in 2012.
During the time period when the Company was in the development of the Red Bird System and other sustainable technologies we continued to provide environmental services to our clients. As a result Cardinal Resources worked in over 20 countries including multimillion dollar projects in Australia, Brazil, Japan and China. As a result of our work we received recognition by U.S. Commercial Services as the Exporter of the Year in 2011 for Environmental and Congressional Export Achievement Awards. In 2013 Cardinal Resources was presented the Presidential E Award for Export Promotion.
In 2011, the Company made the decision to begin focusing on the transition to the systems based business. While we have continued to serve existing customers in our services area, we are projecting that the systems business will be dominant going forward.
Plan of Operations
Our Plan of Operations is focused on becoming the global preferred provider of sustainable water treatment systems using a distributed architecture. To meet this goal our plans call for the Company to expand our financial management, technical implementation staff, and market development. Part of our plan is to continue to expand our technologies, and approaches as well beginning with distributed waste water treatment. In terms of expansion our plan is to first have implementation well underway for our three large contracts in Cameroon, Nigeria, and Senegal. We can then move aggressively to close on other opportunities in our pipeline and expand into our next targets of India, Panama, and Southeast Asia. We are planning to continue to outsource our manufacturing within the US. Depending on growth within a specific region, we may in the future, outsource a portion of the assembly overseas while retaining US manufacturing for key components, technology protection and producing the majority of the systems sold.
Contracts
In 2013 Cardinal Resources signed over $30.0 million in commercial contracts to provide the Red Bird System and associated services in Cameroon, Nigeria and Senegal. These contracts, which are back by a combination of bank guarantees, sovereign guarantees, and export bank financing, are scheduled for completion in early 2015. Over $200.0 million in contract expansions are planned by the customers based on successful execution of the initial phases of each contract.
Revenues
We generate our net sales from the sale of the patented Red Bird System and environmental services. Historically the majority of the sales have been tied to services but beginning in 2012 and 2013 the majority of our sales are trending to the Red Bird System.
Cost of Sales
Our cost of sales includes internal labor, supply chain management, logistics and the purchase of components that are part of the Red Bird System.
Other items contributing to our cost of sales are the direct assembly labor and manufactured overhead from our component suppliers.
Gross Profit
Gross profit is affected by numerous factors, including our average selling prices, scheduling and our manufacturing costs. Another factor impacting gross profits is the ramp up of production going forward. As a result of the above, gross profits may vary from quarter to quarter and year to year.
Research and Development.
Research and development expense consists primarily of salaries and personnel-related costs in addition to the cost of products, materials and outside services used in our process and product research and development activities.
Selling, General and Administrative
Selling, general and administrative expense consists primarily of salaries and other personnel-related costs, professional fees, insurance costs, travel expense, other selling expenses as well as share based compensation expense relating to stock options. We expect these expenses to increase in the near term, both in absolute dollars and as a percentage of net sales, to support the growth of our business as we expand our sales and marketing efforts, particularly international travel, improve our information processes and systems and implement the financial reporting, compliance and other infrastructure required by a public company. Over time, we expect selling, general and administrative expense to decline as a percentage of net sales as our net sales increase.
Use of Estimates
The discussion and analysis of our financial condition and results of operations are based upon audited consolidated financial statements, which have been prepared in accordance with U.S. GAAP. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amount of assets, liabilities, net sales and expenses and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates, including those related to inventories, intangible assets, income taxes, warranty obligations, marketable securities valuation, derivative financial instrument valuation, end-of-life collection and recycling, contingencies and litigation and share based compensation. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources.
Recent Developments
In July 2013 the Company signed a contract and received the down payment for a contract with the State of Bayelsa Nigeria for $6.2 million to provide 10 Red Bird Systems and ancillary services. The contract is backed by a Bank Guarantee/Letter of Credit in the company’s favor. In November 2013, the company signed a Commercial Export Contract with the Cameroon Water Corporation with a value of $28.0 million to provide 35 systems, mobile laboratories, and ancillary products and services. Based on this contract the government of Cameroon is applying for credit through the U.S. Export Import Bank. This application is pending. In December 2013 the Company signed a contract for $4.3 million with the Republic of Senegal to provide a solar powered waste water treatment system for the city of Touba.
Results of Operations for the Three Months Ended March 31, 2014 and 2013:
|
|
Three Months Ended
|
|
|
|
March 31, 2014
|
|
|
March 31, 2013
|
|
Sales
|
|
$
|
295,420
|
|
|
$
|
140,842
|
|
Gross Profit (Loss)
|
|
$
|
143,895
|
|
|
$
|
60,824
|
|
Research and Development Expenses
|
|
$
|
---
|
|
|
$
|
--
|
|
General and Administrative Expenses
|
|
$
|
281,017
|
|
|
$
|
173,949
|
|
Operating Expenses
|
|
$
|
444,378
|
|
|
$
|
267,819
|
|
Other Income (Expense)
|
|
$
|
(39,071
|
)
|
|
$
|
(7,734
|
)
|
Net Loss
|
|
$
|
(188,029
|
)
|
|
$
|
(134,711
|
)
|
For the three months ended March 31, 2014 and 2013, the Company reported a net loss of $188,029 and $134,711, respectively. The change in net loss between the three months ended March 31, 2014 and 2013 was primarily attributable to the ramp up costs associated with increased manufacturing activities, and we continued to reduce outstanding accounts payable from historic operations..
Sales -
Net sales for the three months ended March 31, 2014, were $295,420, compared to $140,842 for the three months ended March 31, 2013. The increase in sales reflects the shift to the systems business and the continued work on the Bayelsa project.
Gross Profit/(Loss) -
During the three months ended March 31, 2014, our gross loss as a percentage of sales was 48.7%, compared to a gross profit as a percentage of sales of 43.2 % for the three months ended March 31, 2013. This increase in gross profit percentage is primarily attributable to the shift from services to systems and improved supply chain management during the ramp up to meet contracted orders.
Operating Expenses
–
Research and Development
- Research and Development for the three months ended March 31, 2014, and for the three months ended March 31, 2013 were insignificant. The lack of research and development is short term and is primarily attributable to the focus on implementation of existing contracts and opportunities..
General and Administrative Expenses
– General and Administrative for the three months ended March 31, 2014, were $281,017, as compared to $173,949 for the three months ended March 31, 2013. The change is primarily attributable to the expenses associated with the Company’s various public security filings, increased payroll costs, higher travel and entertainment expenses associated with obtaining new customers.
Total Operating expenses for the three months ended March 31, 2014 were $444,378, as compared to $267,819 for the three months ended March 31, 2013.
We anticipate that as our operations increase our research and development expenses may increase because we believe that maintaining state of the art products is a key to our continued success, however, we believe that such expenses will constitute a lower percentage of our operating budget. We expect to achieve economies of scale in our general and administrative expenses as our operations increase as much of our administrative expenses are fixed costs, such as salaries of key personnel and rent. As a result, while we may need to hire additional personnel as operations increase, we believe that the increases in general and administrative expenses will be at a lower rate than the increase in revenues.
Other Income (Expense) -
Other income (expense) for the three months ended March 31, 2014 was ($39,071), as compared to $(7,734) for the three months ended March 31, 2013. The increase is primarily attributable to amortization of the discount from our notes payable charged to interest expense.
Liquidity and Capital Resources
The following table summarizes total current assets, liabilities and working capital at March 31, 2014 compared to December 31, 2013:
|
|
March 31, 2014
|
|
|
December 31, 2013
|
|
|
Increase/(Decrease)
|
|
Current Assets
|
|
$
|
1,002,095
|
|
|
$
|
1,178,246
|
|
|
$
|
(176,151)
|
|
Current Liabilities
|
|
$
|
2,685,020
|
|
|
$
|
2,684,978
|
|
|
$
|
42
|
|
Working Capital
|
|
$
|
(1,682,925
|
)
|
|
$
|
(1,506,732
|
)
|
|
$
|
(176,193
|
)
|
As of March 31, 2014, we had negative working capital of $1,682,925 which was an improvement period to period as compared to negative working capital of $1,506,732 as of December 31, 2013. The improvement was due primarily to improved cash flow from operations and increased sources of financing.
Net cash used in operating activities for the three months ended March 31, 2014 and 2013 was $(469,621) and $12,723 respectively. The increase in cash used in operating activities was primarily related to the increased marketing, increased manufacturing, and increases in related working capital.
Net cash in all investing activities for the three months ended March 31, 2014 and 2013 was $0 and $(23,806) respectively due to the repayment of notes payable in place of salaries.
The estimated working capital requirement for the next 12 months is $1,800,000 with an estimated burn rate of $150,000 per month. As reflected in the accompanying financial statements, the Company had cash of $76,093 at March 31, 2014.
The ability of the Company to continue its operations is dependent on Management’s plans, which include the contract specific financing, raising of capital through debt and/or equity markets with some additional funding from other traditional financing sources, including term notes, until such time that funds provided by operations are sufficient to fund working capital requirements. The Company may need to incur additional liabilities with certain related parties to sustain the Company’s existence.
The Company will require additional funding to finance the growth of its current and expected future operations as well as to achieve its strategic objectives. The Company believes its current available cash along with anticipated
revenue may be insufficient to meet its cash needs for the near future if it does not receive the anticipated additional funding. There can be no assurance that financing will be available in amounts or terms acceptable to the Company, if at all. In that event, the Company would be required to change its growth strategy and seek funding on that basis, if at all.
The accompanying financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. These financial statements do not include any adjustments relating to the recovery of the recorded assets or the classification of the liabilities that might be necessary should the Company be unable to continue as a going concern.
Recent Accounting Pronouncements
There are no recent accounting pronouncements that are expected to have an effect on the Company’s financial statements.
Critical Accounting Policies
Our financial statements and related public financial information are based on the application of accounting principles generally accepted in the United States (“GAAP”). GAAP requires the use of estimates; assumptions, judgments and subjective interpretations of accounting principles that have an impact on the assets, liabilities, revenues and expense amounts reported. These estimates can also affect supplemental information contained in our external disclosures including information regarding contingencies, risk and financial condition. We believe our use of estimates and underlying accounting assumptions adhere to GAAP and are consistently and conservatively applied. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. Actual results may differ materially from these estimates under different assumptions or conditions. We continue to monitor significant estimates made during the preparation of our financial statements.
Our significant accounting policies are summarized in Note 2 of our financial statements. While all these significant accounting policies impact our financial condition and results of operations, we view certain of these policies as critical. Policies determined to be critical are those policies that have the most significant impact on our financial statements and require management to use a greater degree of judgment and estimates. Actual results may differ from those estimates. Our management believes that given current facts and circumstances, it is unlikely that applying any other reasonable judgments or estimate methodologies would cause effect on our consolidated results of operations, financial position or liquidity for the periods presented in this report.
We believe the following critical accounting policies and procedures, among others, affect our more significant judgments and estimates used in the preparation of our consolidated financial statements:
Use of Estimates - The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Such estimates and assumptions impact, among others, the following: allowance for bad debt, inventory obsolescence, the fair value of share-based payments.
Making estimates requires management to exercise significant judgment. It is at least reasonably possible that the estimate of the effect of a condition, situation or set of circumstances that existed at the date of the financial statements, which management considered in formulating its estimate could change in the near term due to one or more future confirming events. Accordingly, the actual results could differ significantly from our estimates.
Revenues and Cost of Revenues
Revenues from fixed-price and cost-plus contracts are recognized on the percentage of completion method, whereby revenues on long-term contracts are recorded on the basis of the Company’s estimates of the percentage of completion of contracts based on the ratio of actual cost incurred to total estimated costs. This cost-to-cost method is used because management considers it to be the best available measure of progress on these contacts. Revenues from cost-plus-fee contracts are recognized on the basis of costs incurred during the period plus the fee earned, measured on the cost-to-cost method.
Revenues from time-and-material and rate chart contracts are recognized currently as work is performed.
Revenues from maintenance service contracts are recognized on a straight-line basis over the life of the contract once the Company has an agreement, service has begun, the price is fixed or determinable and collectability is reasonably assumed.
Cost of revenues include all direct material, sub-contractor, labor and certain other direct costs, as well as those indirect costs related to contract performance, such as indirect labor and fringe benefits. Selling, general, and administrative costs are charged to expense as incurred. Provisions for estimated losses on uncompleted contracts are made in the period in which such losses are determined. Changes in job performance, job conditions and estimated profitability may result in revisions to cost and income, which are recognized in the period in which the revisions are determined. Changes in estimated job profitability resulting from job performance, job conditions, contract penalty provisions, claims, change orders, and settlements, are accounted for as changes in estimates in the current period. Claims for additional contract revenue are recognized when realization of the claim is probable and the amount can be reasonably determined.
The asset, “cost and estimated earnings in excess of billings on uncompleted contract” represents revenues recognized in excess of amounts billed. The liability, “billings in excess of costs and estimated earnings on uncompleted contracts,” represents billings in excess of revenues recognized.
Off Balance Sheet Arrangements:
We do not have any off-balance sheet arrangements, financings, or other relationships with unconsolidated entities or other persons, also known as “special purpose entities” (SPEs).