ITEM 1. BUSINESS - -----------------
GENERAL - -------
Ag-Bag International Limited (the "Company" or "Ag-Bag") was incorporated as a New York corporation in 1989. The primary operating company, Ag-Bag Corporation, a Nebraska corporation, was incorporated in 1978. The Company changed its name in 1990 from AB Holding Group, Inc. to Ag-Bag International Limited. In 1994, in an effort to streamline and save administrative expenses, two of the Company's operating subsidiaries, A.B. Rental, Inc. and Ag-Bag Corporation were merged into the Delaware subsidiary, ABVIN Merging Corp. On January 1, 1995, the Company was merged into its Delaware subsidiary resulting in the reincorporation of the Company in Delaware and a change in its name to Ag-Bag International Limited.
The Company has pioneered an alternate method of storing feed for livestock. Traditional methods of storing feed have included placing it in bunkers, pits, and silos or baling and stacking it. The Company's method is to store the feed in huge plastic bags of up to 500 feet in length and up to 14 feet in diameter by tightly stuffing the feed into the bag. The Company assembles the machines for stuffing the feed into the bags. It has the bags manufactured to its specifications and then folds and distributes the bags through its dealer network and directly in an area where a dealer is not present. The benefits of bagging the feed include reduced cost, additional flexibility in harvesting and storing the feed, enhanced feed quality, and relatively small capital requirements. The Company also sells ancillary products that complement the Company's main line of bagging machines and bags.
The following table identifies the revenue from each product line that accounted for more than 15% of total revenue over the last three years:
Product 2001 2002 2003 ------- ----------- ---------- ----------- Bags 48% 48% 49% Machines 43% 44% 40% Other 9% 8% 11% ----------- ---------- ----------- Net Sales 100% 100% 100%
The Company expects the use of bagging as a means of silage storage to continue to play a major role in the future because the quality of stored feed is better than other known competitive methods, allowing farmers to be more efficient and to produce dairy, beef, sheep and pork products at a lower price. The Company believes the concept of bagging is one way in which farmers can be more profitable by reducing, or completely eliminating, the purchase of feed and grain from outside sources. Bagging enables the farmer to produce and store the feed on the farm and provides easier access to the silage, thereby allowing the farmer to choose the quality of silage to feed at any given time. The bagged feed has shown high quality, allowing for higher production.
In 1994, the Company shipped its first orders to dealers in Japan, Latin America and Germany. The Company continues to sell worldwide in Asia, Australia, New Zealand, and Western and Central Europe. Export sales from the Company's United States operations were 6.2% of net sales for the year ended December 31, 2003.
In 1997, the Company formed a German joint venture in which the Company owns a 50% interest and its German dealer owns the remaining 50%. The joint venture folds and distributes silage bags to the Company's German and European dealers.
The Company is developing other uses for its bagging technology. In 1993, the Company adapted its bagging machines to permit bagging of compostable organic matter in the Company's recyclable Tri-Dura(R) plastic bags. The Company also has developed mobile and stationary plastic recovery units which enable the Company to bail and pick up the recyclable Tri-Dura(R) plastic bags as a service to its customers.
SEASONAL NATURE OF BUSINESS - ---------------------------
The core business of the Company is historically seasonal due to the harvest seasons in North America and Europe. The Company's 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. The Company took steps to counteract some of this seasonality by generating sales in Latin America beginning in 1994 and in Australia and New Zealand in 1996. In September 2002, the Company took additional 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 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.
FARM EQUIPMENT AND PRODUCTS - ---------------------------
Introduction. Silage is made using the Ag-Bag(R) system by storing forage crops, such as corn, sorghum, or alfalfa, under anaerobic (without oxygen) conditions in sealed Ag-Bag Tri-Dura(R) storage bags. The traditional methods for making silage involve storing it in bunkers, pits or silos. Using traditional methods, there is a nutrient loss resulting from a reduction in the moisture content of the forage before storage. The moisture content must be reduced to compensate for the high oxygen content of the forage, which results from the inability to pack the forage tightly enough. When the forage is not packed sufficiently, the silage fermentation process produces too much heat resulting in an even greater loss of nutrient value than would occur if the moisture content were not reduced. The loss of nutrient value results in the need for additional food supplements or an increased volume of feed.
The Ag-Bag(R) system is an alternative to bunkers, pits and silos. The Ag-Bag(R) bagging machines push the forage into huge recyclable plastic film Tri-Dura(R) bags with sufficient compaction to minimize the amount of oxygen in the bag, which is then sealed tightly when filled. As a result, the forage can be stored with significantly higher moisture content. The ability to store the forage in this manner also reduces the time required to cut, prepare and store the forage thus reducing the loss of nutrients and providing higher quality feed for production within the farmers' herds.
Ag-Bag(R) Farm Equipment. The Company's principal line of farm equipment is marketed under the trade name "Ag-Bagger(R)." The Ag-Bagger(R) is available in three versions with a number of optional features. Wide ranges of optional features are offered by the Company on its bagging machines in order to meet the budget needs of the farmer.
The smallest version consists of machines used to load forage into Ag-Bag Tri-Dura(R) storage bags ranging in size from 8 to 10 feet in diameter and 100 to 250 feet in length. The Company first introduced this version in 1987. Dairymen use it primarily in smaller dairy and cattle feeding operations with herds averaging about 50 head and by cattlemen feeding up to about 300 head of feeder cattle. Most of these machines are powered by the power take-off unit of a farm tractor and moved by a tractor or other farm vehicle. In late 2002, the Company introduced its most basic model of its smaller bagging machine, the "Personal Bagger". The retail price for these machines range from approximately $19,900 to $53,000.
In 1992, the Company introduced a medium-sized machine that can be operated by the power take-off unit of a farm tractor or operated independently with an optional diesel engine made by Caterpillar or Deere & Company. This machine allows farmers to load forage into Ag-Bag Tri-Dura(R) storage bags ranging in size from 9 to 10 feet in diameter and 100 to 250 feet in length. This machine is primarily suitable for use by dairymen with herds ranging from 150 to 300 head and by cattlemen feeding between 300 and 800 head of feeder cattle. The retail price for this machine ranges from approximately $80,000 to $228,500.
The largest version consists of machines that can be used to load Ag-Bag Tri-Dura(R) storage bags ranging in size from 9 to 14 feet in diameter and 150 to 500 feet in length. These machines are primarily used by dairymen with herds ranging from 300 to 2,000 head, by cattlemen with herds ranging from 800 to 15,000 head, and by custom operators. A super 12-foot Ag-Bagger(R) was developed in 1989 and enhanced in 1995. In 2002, the Company introduced its 14-foot version of the Ag-Bagger(R) for use by very large dairy and custom operators and by cattle feeding operations with herds ranging from 15,000 to 25,000 head of cattle. The larger machines are available with optional diesel engines made by Caterpillar. The retail price for the larger machines range from approximately $155,000 to $325,000.
In response to a competitor's introduction of a cable-less machine in early 1995, the Company began research and development on its own cable-less machine in early 1996. The Company began production of its own cable-less machine in 1997. In 1998, the Company introduced its own cable-less bagging machine called the HFC (Hydraulic Finger Controlled) Silage Bagger. The introduction of this machine was in response to what the Company felt was a change in direction of the industry towards the cable-less machine design and the latest in bagging technology. In 1999, the Company continued to develop and improve its cable-less bagging machine by developing the Powered Anchor Control (PAC) system, and in 2000 introduced its latest version of the cable-less bagging machine, the HYPAC(R) (Hydraulic Powered Anchor Control) system. The Company offers the HYPAC(R) model in small, medium-sized and large-sized bagging machines. The retail price for the HYPAC(R) machines range from approximately $53,000 to $325,000.
The Company assembles and sells a separate line of related equipment called the Ag-Bag Flex-a-Tuber(R) with a retail price ranging from $11,500 to $18,000. The Flex-a-Tuber(R) permits farmers to store round-baled alfalfa, sorghum, and other forage in Ag-Bag Tri-Dura(R) storage bags. The round bale Flex-a-Tubers(R) are made in two sizes to permit the bagging of 4 and 5 foot bales. The bales can be stored in Ag-Bag Tri-Dura(R) storage bags up to 200 feet in length. In 2002, the Company began manufacturing this line of equipment on a made-to-order basis.
The Company assembles and sells a separate line of related equipment called the Square Bale Bagger, which retails for approximately $23,500 to $31,000. The Square Bale Bagger permits farmers to store square bales of alfalfa, sorghum and other forage, two bales high in Ag-Bag Tri-Dura(R) flex storage bags. The Square Bale Bagger permits the bagging of the bales in Ag-Bag Tri-Dura(R) flex storage bags of 7 to 10 feet in diameter and up to 200 feet in length. Beginning in 2002, the Company began manufacturing this line of equipment on a made-to-order basis.
The Company assembles and sells the Ag-Bag(R) Pro-Grain Bagger, which retails for approximately $33,500. This machine is similar in design to the smallest Ag-Bagger(R) machines but has been adapted to permit the storage of grains, such as corn, rice, wheat and soybeans, as well as other products, in Ag-Bag Tri-Dura(R) storage bags. The machine permits the grain to be bagged without damaging the kernel. After the grain is bagged and sealed, it will retain the necessary quality for human consumption.
The Company also assembles and sells the Mighty Bite(R) front-end load bucket. This revolutionary bucket replaces the conventional bucket. Hydraulically operated, the Mighty Bite(R) closes tightly around material, thus eliminating spillage and increasing load capacity due to compaction. The Company manufactures the
Mighty Bite(R) in sizes ranging from one-half cubic yard to two cubic yards with a retail price ranging from $3,300 to $4,900.
The Company adapted its Ag-Bag(R) bagging machines for use in large-scale "in-vessel" composting of organic matter. The bagging machine is used in conjunction with a shredder that shreds the organic material, which is then fed into the bagging machine that bags the compostable matter into Ag-Bag Tri-Dura(R) storage bags. An air blower is attached to the bag and circulates air through the bag during the composting process. The Ag-Bag(R) compost bagging machines retail for between $52,500 to $137,000.
Ag-Bag Tri-Dura(R) Storage Bags. The Ag-Bag Tri-Dura(R) disposable storage bags range in size from 8 to 14 feet in diameter and 100 to 500 feet in length and are made of extruded plastic. Rolls of plastic are manufactured to the Company's specifications. The plastic contains special stabilizers to protect the bags from deterioration due to exposure to weather and the sun's ultraviolet rays. Once a Tri-Dura(R) bag is used, it may be recycled or disposed of in another manner, but may not be reused.
The Company contracts for the manufacture of, and sells Tri-Dura(R) three-ply bags with a white exterior and black interior intended for storage of silage up to 24 months. The retail price of the bags ranges from approximately $136 to $2,150. The manufactured plastic rolls are shipped to the Company's plant in Blair, Nebraska, where they are folded and packed for sale using proprietary folding techniques. The proprietary bag folding techniques reduce bag folding time and allow the bags to uniformly unfold when being filled, which thereby reduces operational delays. Ag-Bag(R) Inoculant. The Company markets a liquid inoculant and a dry powder inoculant under the trade name Ag-Bag Plus!(R). The inoculant is added to the forage or the round or square bales during bagging. It enhances the fermentation process for making silage in bags, bunkers, pits and silos by substantially shortening the time necessary for the creation of the silage. A liquid inoculant was developed in 1989 by a Company supplier and introduced into the market in 1990. The dry inoculant is produced from a proprietary formula owned by the Company and developed by Larry R. Inman and Walter L. Jay. See "Executive Officers of the Registrant." The Company also markets an inoculant designed specifically for composting.
MARKET SIZE - -----------
The market for Ag-Bag(R) machinery and Ag-Bag Tri-Dura(R) recyclable storage bags is primarily in the dairy and beef cattle industries. Silage is used most often as dairy and beef animal feed. It is also used by farmers to a lesser extent to feed hogs and sheep. In 2002, over 250 million tons of corn, alfalfa, sorghum, silage, and hay were harvested by United States farmers according to the AG IQ Handbook XX published in 2003 by Agricom, Inc. (the "AG Handbook"). Based on 2000 United States Department of Agriculture (USDA) statistics, the Company estimates that there are approximately 105,000 dairies, and 150,000 beef, hog, and sheep farms in the United States that are potential customers for Ag-Bag(R) farm equipment and Tri-Dura(R) storage bags; and that only about 8-12% of this group are actually using storage bags made by the Company or its competitors. It further estimates that about 50-55% of the bagging industry customers purchase silage storage bags from the Company. In addition to the U.S., the Company believes there is a large population of such farms in Canada, Latin America, Western and Central Europe, Australia, New Zealand, and Asia, where the Company currently sells and distributes its products, and there is a large potential market in other countries into which the Company may expand.
The Company also markets a system for "in-vessel" composting which is designed to eliminate odors and control leachate inherent with composting. Composting is an alternative for disposing of or eliminating the large number of organics from landfills. The Company's primary focus is currently directed towards municipalities, private composters, military bases, zoos and the Company's dairy and beef customers. The Company currently estimates the size of the compost market within North America to be over $2 billion a year.
Until further marketing efforts are made outside North America, the Company cannot estimate with any certainty the foreign market size. However, the Company believes that there is a large potential market in other countries into which it may expand. No assurance can be given that the "in-vessel" composting system will be accepted in either the domestic or foreign marketplace.
MARKETING - ---------
The Company markets its Ag-Bag(R) farm equipment, Tri-Dura(R) storage bags, Ag-Bag Plus!(R) and other inoculants primarily through a network of United States, Canadian, and international dealers. As of December 31, 2003, there were 62 dealers serviced by a combined total of 16 regional and territorial Company-employed managers and sales support coordinators. Most of the dealers market the entire Ag-Bag(R) line of farm equipment and products; however, some dealers sell only the farm equipment and others sell only the Ag-Bag(R) inoculants. The Company also sells farm equipment, Tri-Dura(R) storage bags, and inoculant directly to large customers in states where there are no nearby Ag-Bag(R) dealers. Beginning in 2002, the Company began focusing its marketing efforts more on dealer development and expanding its dealer network rather than a focus towards direct selling. In September 2002, the Company introduced its new pre-season ordering program for its products, whereby the Company's dealers place their next year's annual product requirements order in advance. As a result of this program's success, the Company continued the Pre-Season Order Program for its 2003-04 season with minor modifications.
The Company offers customers the opportunity to finance the purchase of Ag-Bag(R) farm equipment through unaffiliated third parties who offer lease-purchase and wholesale financing.
The Company also rents used Ag-Bag(R) bagging machines to farmers in various areas of the United States. The rental charge is based on the number of bags purchased and filled with forage.
Prior to December 31, 1997, the Company offered a custom bagging service through its subsidiary Ag-Bag Europe PLC in the United Kingdom. The Company sold its subsidiary that had not been performing at a profitable level due to the BSE (Mad Cow) problem within the British farming industry on December 31, 1997.
In late 2003, BSE (Mad Cow) was discovered in the United States. Based upon the quick response of the USDA and their findings to date, the Company does not feel that BSE (Mad Cow) will impact its operations as its customer base is largely focused on dairy farming rather than the beef industry.
The Company markets its composting system through a sublicense that allows the end user to use the Ag-Bag(R) compost technology. The Company plans to establish a composting dealer network and develop a regional and territorial sales force that will have expertise in composting. The timing for these plans will depend on the pace of market acceptance of the Company's composting system.
The Company is not dependent on any single customer or a few customers. The loss of any single customer would not have a material adverse effect on the Company's financial condition or results of operations.
WEBSITE - -------
The Company maintains a website for use by its customers, containing information about the Company, its products, and educational materials regarding their use. The website address for Ag-Bag is http://www.ag-bag.com
ASSEMBLY AND MANUFACTURING - --------------------------
Ag-Bag(R) Farm Equipment. The Company buys some of its components for its bagging machines from various manufacturers, manufactures the remaining components, and assembles the machines itself. The medium and large sized machines, composting machines, HYPAC(R) (cable-less) machines, Square Bale Baggers, and Flex-a-Tubers(R) are all assembled at the Company's headquarters facility in Warrenton, Oregon. The smaller machines are assembled at the Company's Blair, Nebraska plant. In 1999, the Company licensed its German dealer to manufacture bagging machines for distribution within Europe.
The Company assembles all of its machines in order to better control the quality of the farm equipment. This method also permits the Company to offer customized assembly for the end user of its equipment. The Company can acquire and install name brand manufactured components specified by the customer in lieu of those ordinarily installed by the Company.
Ag-Bag Tri-Dura(R) Storage Bags. All of the three-ply Tri-Dura(R) storage bags are manufactured for the Company by a single manufacturer. The bags are manufactured to the Company's specifications using a stabilizer that protects the plastic from becoming brittle due to exposure to weather and the sun's ultraviolet light rays. The Tri-Dura(R) plastic bags are made in various diameters based on bag orders received by the Company. The bags are shipped in roll form to the Company's plant in Blair, Nebraska, where they are folded and packaged for shipment.
Ag-Bag(R) Inoculants. The Company purchases on the open market the liquid and compost inoculant. The Company believes that the liquid and compost inoculant will be reasonably available for purchase on the open market for the foreseeable future. The dry inoculant is produced by the Company at the Blair, Nebraska plant pursuant to a proprietary formula owned by the Company and developed by Larry R. Inman and Walter L. Jay. See "Executive Officers of the Registrant."
PRINCIPAL SUPPLIERS AND MANUFACTURERS - -------------------------------------
The Company purchases its Tri-Dura(R) rolls from a company partially owned by Steven G. Ross ("Supplier") pursuant to a supply agreement. Steven G. Ross is a 14.9% stockholder in the Company and owner of a company which competes with the Company's Tri-Dura(R) bags. The supply agreement provides that the Company purchase all of its plastic rolls, with certain exceptions, from Supplier through at least December 31, 2007. Thereafter, either the Company or Supplier may terminate the Supply Agreement upon two years' prior written notice. The Company may purchase plastic rolls from other suppliers to the extent Supplier is unable to supply plastic rolls under the Supply Agreement. The Company has a good relationship with Supplier, and there are alternative suppliers available in the event Supplier is unable to provide rolls.
Several manufacturing companies manufacture the structural components of the Company's farm and composting equipment in Oregon, Nebraska and Iowa. The Company believes that alternative sources of supply are readily available at competitive prices if the present sources of supply should become unavailable. The Company is not aware of any raw materials shortages or problems with these suppliers that would adversely affect the Company's operations.
The Company mixes the dry inoculant at its Blair, Nebraska facility. It purchases the ingredients for the dry inoculant from a variety of suppliers. The Company purchases the liquid and compost inoculant from a supplier, who mixes the inoculants to the Company's specifications. The Company believes there are various other alternative sources of supply.
COMPETITION - -----------
As the Company's corporate slogan, the "Complete 1(R)," indicates, the Company believes it is the industry leader in the manufacture and sale of complete sealed feed farm bagging systems. Ag-Bag is the only company that manufactures the full line of equipment, bags, and other accessories for sealed feed farm management. There are three competitors within the United States that manufacture similar silage bagging machines. There are also a number of competitors that manufacture bale wrapping machines, which compete with the Company's Flex-a-Tuber(R). The Company distinguishes itself in the market place from other manufacturers by providing a top quality product, better warranty protection, and customer service.
The bag market is highly competitive. The Company competes in the bag market by providing what the Company believes to be a superior product and better warranty protection at a competitive price. The Company is also offering, through central pickup and fixed locations in selected geographic areas of the U.S., a recycling service for used Ag-Bag Tri-Dura(R) bags.
The Company also competes with companies constructing bunkers and pits and, to a lesser extent, silos. These competitors are mostly smaller companies that build the bunkers and pits for the farmer, which the farmer then fills with forage using available or rented farm equipment otherwise used in the farming operation. While these methods do not require bags or special equipment to fill the bags, the use of these alternatives involves a significant loss of flexibility in storing and harvesting the feed and an overall loss of feed quality. Flexibility is lost since structures must be permanently placed and significant capital requirements are necessary to expand them. The feed quality is inferior because of the amount of oxygen remaining after the forage is placed in the pits or bunkers.
The Company competes primarily with windrow turner manufacturers in composting. Windrow turners compost by turning and watering static piles weekly and require containment of odor and leachate. These turners are comparable in price to the Company's compost machines. However, the Company's composting systems offer the advantage of being self-contained, thus reducing odor and requiring no turning or watering. There are approximately 50 manufacturers of turners. In addition to the windrow turner manufacturers, the Company competes with several companies that manufacture "in-vessel" systems, such as burners and incinerators for large projects, which generally cost from $1.1 to $15 million.
In addition to the current competition, national competitors may emerge if the bagging equipment and storage bag markets continue to grow. These potential competitors include large farm equipment manufacturers, large farm co-operatives, and large chemical companies who might decide to manufacture and sell the storage bags.
The Company competes in its product markets primarily on the basis of product quality, warranty protection, and customer service. Some of its competitors are larger and have greater financial, marketing, technical, and other resources than the Company.
BACKLOG - -------
The dollar amount of backlog orders of the Company that are believed to be firm as of March 1, 2004, was approximately $9,300,000, compared to $12,400,000 on March 1, 2003, a 25 % decrease. Backlog for 2004 is lower than 2003 as a result of the depressed U.S. milk prices. Under the Company's pre-season order program, the Company's dealers place their next year's annual product requirements order in advance by each October 31st. Due to the depressed U.S. milk prices during 2003, dealers did not sell out of all their 2002 pre-season ordered product and consequently were conservative with their 2003-04 pre-season orders. The Company introduced this new program in September 2002 for the 2002-03-ordering season and continued the program for the 2003-04 ordering season as well. (See "Seasonal Nature of Business") Backlog, however, may not be a meaningful indicator of future sales. This backlog is seasonal and is reasonably expected to be filled within the current fiscal year.
RESEARCH AND DEVELOPMENT - ------------------------
During 2003, the Company focused research and development expenditures on testing a newer design of its larger-sized silage-bagging machine, in addition to further compost machine modification and development. The Company also completed research on various projects undertaken regarding new silage and nutritional studies of bagged feed and their effects on animal production during the year. The Company also continues with ongoing research and testing in this area as well.
ENVIRONMENTAL MATTERS - ---------------------
Compliance with federal, state and local laws and regulations regulating the discharge of materials into the environment, or otherwise relating to the protection of the environment, had no material effect upon capital expenditures, earnings, or competitive positions of the Company during the year ended December 31, 2003.
PATENTS AND TRADEMARKS - ----------------------
The Company has basic and improvement patents in the U.S., as well as a number of patents pending, that encompass machines, bags and systems for silage bagging, grain bagging, and hay/straw bale bagging. Corresponding applications have or will be filed in selected foreign countries. In addition, proprietary rights in the bagging of compost have been and are being developed in the U.S and in selected foreign countries.
The Company's patents on its basic bagging machine have been found to be valid and have been successfully defended in prior litigation. The Company believes that it has developed its position in the industry partially as a result of protection provided by these patents. The Company also owns the proprietary formula for making the dry inoculant marketed under the trade name Ag-Bag Plus!(R), which was developed by Larry R. Inman and Walter L. Jay. (See "Executive Officers of the Registrant")
The names Ag-Bag(R), Ag-Bag Plus!(R), Bale-Bag(R), Flex-a-Tuber(R), Flex-a-Tube(R), ABCTI System(R), Mighty Bite(R), Tri-Dura(R), and the symbol "AB"(R) are all registered as trademarks with the United States Patent and Trademark Office.
The Company believes that its color scheme and trademarks are well known in the industry, are an important part of its business, and give the Company a competitive advantage.
EMPLOYEES - ---------
On December 31, 2003, the Company had 84 full-time employees. The Company employs approximately 110 people during its busy season. None of the Company's employees are represented by a union, and the Company believes that its employee relations are good.
FINANCIAL INFORMATION RELATING TO FOREIGN AND DOMESTIC OPERATIONS AND EXPORT SALES - --------------------------------------------------------------------------------
(In thousands) Year Ended December 31 ----------------------
2001 2002 2003 ---- ---- ----
Sales to unaffiliated customers: United States $26,888 $25,445 $20,165 Canada 1,030 1,148 861 Germany 445 275 273 Latin America/Mexico 89 113 31 Other foreign countries 248 202 168 --------- ---------- ---------- $28,700 $27,183 $21,498
Sales to affiliated customers: Officers and Directors 8 6 5 --------- ---------- ---------- Total $28,708 $27,189 $21,503 ========= ========== ==========
Substantially all the Company's assets are located in the United States. Reference is also made to the Selected Financial Data at Item 6.
ITEM 2.
ITEM 2. PROPERTIES - -------------------
In early 1990, the Company began occupying its 30,000 square foot facility located in Warrenton, Oregon. This facility serves as a warehouse and houses the major portion of its silage bagging equipment manufacturing. The Company's administrative offices are also located there. Management estimates that the manufacturing at the Warrenton plant is currently at approximately 65% of capacity. The Company occupies the land pursuant to a lease that expires in 2015.
The Company owns facilities in Blair, Nebraska, where the Company: folds and packages its Tri-Dura(R) feed storage bags; prepares and packages its proprietary inoculant; and, assembles its smaller bagging machines and warehouses products. The Blair, Nebraska facility consists of three buildings comprising approximately 70,000 square feet. Management estimates that manufacturing at the Blair facility is currently at approximately 65-70% of capacity.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS - --------------------------
The Company is a defendant in alleged patent infringement lawsuits, Versa Corporation v. Ag-Bag International Ltd., filed October 30, 2000 and March 19, 2003 in the United States District Court for the District of Oregon. The claim alleges patent infringement upon Versa's U.S. Patent Nos. 5,799,472; 5,894,713; 5,345,744; 5,426,910; RE38020 and 5,452,562 relating to a bag pan, density control and adjustable anchor wing patent for an agricultural feed bagging machine and composting method patents. Plaintiff seeks monetary damages. On February 6, 2004, the bag pan, density control and composting method patent matters were settled and the cases dismissed in their entirety, thereby concluding these three matters. On January 28, 2004, the court ruled, in the remaining adjustable anchor wing patent matter, that the Company does not infringe upon Versa's RE38020 patent. The Company previously filed for summary judgment for non-infringement of Versa's patent and filed a motion for summary judgment for Versa's patent invalidity of the RE38020 patent. This matter is currently pending before the court. The Company believes that the outcome of the litigation will not have a material adverse impact on its financial condition or results of operations.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS - ------------------------------------------------------------
During the fourth quarter of 2003, no matters were submitted to a vote of security holders.
EXECUTIVE OFFICERS OF THE REGISTRANT - ------------------------------------
The executive officers of the Company, their respective ages as of March 1, 2004, business experience, and the period for which they have served are set forth below. The Board of Directors at the first meeting following the start of the new calendar year elects the executive officers annually. Officers serve at the discretion of the Board of Directors. Beginning in 2003, the Board of Directors voted to separate the position of Chief Executive Officer and Chairman of the Board. As a result, Michael J. Schoville was promoted to Chief Executive Officer from his former position of Chief Operating Officer.
PART II -------
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS - ------------------------------------------------------------------------------
The Company's Common Stock began trading publicly on January 17, 1990, and was approved for quotation on Nasdaq on April 24, 1990, under the symbol "AGBG." 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.
As of March 1, 2004, there were approximately 331 holders of record of the Company's Common Stock. The Company estimates there are approximately 1,300 beneficial holders of the Company's Common Stock. The following table sets forth the range of high and low bid prices of the Company's Common Stock for the quarters indicated through the fourth quarter of 2003 as reported on the OTC Bulletin Board:
Calendar Year High Bid Low Bid - ------------- -------- ------- 2002: - -----
First quarter $.33 $.17 Second quarter $.58 $.30 Third quarter $.51 $.32 Fourth quarter $.32 $.18
2003: - -----
First quarter $.29 $.20 Second quarter $.35 $.20 Third quarter $.42 $.26 Fourth quarter $.50 $.30
- ---------------------------
The quotations reflect inter-dealer prices, without retail markups, markdowns, or commissions and do not necessarily represent actual transactions.
DIVIDENDS - ---------
The Company has not paid any dividends on its Common Stock since its inception, and the Board of Directors does not anticipate declaring any cash dividends on its Common Stock in the foreseeable future. The Company currently intends to utilize any earnings in its business. The Company may not pay dividends on Common Stock pursuant to certain loan agreements, or while it is in arrears in dividends on its preferred stock.
UNREGISTERED SECURITIES - -----------------------
The Company has issued the following unregistered securities during the year ended December 31, 2003:
The above-unregistered securities were granted in reliance on an exemption from the registration requirements of the Securities Act of 1933, as amended ("Act") under Section 4(2) of the Act and/or under the "bonus stock/no sale" interpretive position of the Securities and Exchange Commission.
- ------------------------- (1) Granted under Non-employee Director Stock Option Plan. Options vest according to terms of plan
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA - --------------------------------
The following table sets forth financial data derived from the audited financial statements of the Company for the years ended December 31, 1999, 2000, 2001, 2002 and 2003. This selected financial data should be read in conjunction with the audited financial statements of the Company and the related notes thereto and with "Management's Discussion and Analysis of Financial Condition and Results of Operation" included elsewhere in this report on Form 10-K.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION - --------------------------------------------------------------------------------
CRITICAL ACCOUNTING POLICIES - ----------------------------
The Company's significant accounting policies are described in Note 1 to the financial statements included in Item 15 of this form 10-K. 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 $1,021,322 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 $204,081 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 $10,000, 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.
- ----------------------- (1) Includes deferred taxes. (2) Includes loans from shareholders and deferred taxes. (3) Includes $696 of preferred stock.
The $74,453 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 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 $73,266 under this program at December 31, 2003.
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. At December 31, 2003, the balance of assigned accounts with recourse was $3,155,990. The Company has determined, that at December 31, 2003, 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 $1,577,772 valuation allowance against its tax assets as of December 31, 2003.
RESULTS OF OPERATIONS - ---------------------
The following table sets forth for the periods indicated certain items reflected in the Company's statements of operations as a percentage of revenue:
Percentage of Total Revenue --------------------------- Year Ended December 31, -----------------------
1999 2000 2001 2002 2003 ---- ---- ---- ---- ----
Net Sales 100% 100% 100% 100% 100%
Costs and Expenses: Cost of Sales 77% 79% 80% 81% 85% Selling and Administration 19% 19% 21% 23% 24% Research and Development 1% - - 1% 1% ------ ----- ----- ----- -----
Income (Loss) From Operations 3% 2% (1)% (5%) (10%) ====== ===== ===== ===== =====
YEARS ENDED DECEMBER 31, 2003 AND 2002 - --------------------------------------
For the year ended December 31, 2003, net sales decreased 20.91% to $21,502,654 compared to $27,189,140 for the year ended December 31, 2002. Sales were down for the year as a result of the slow U.S. farm economy which resulted from the lowest U.S. milk prices seen since 2000. Milk prices were at record lows for the first half of the year and saw some improvement in the third quarter of 2003, but began to fall off again during the fourth quarter of 2003. The outlook for 2004 indicates that milk prices will remain above the record low levels seen during early 2003 of $9.11 and are anticipated to reach the $14-$15 range over the summer of 2004. Farmers began seeing increases in their monthly milk checks during the third quarter of 2003, but continued to remain cautious, despite continued low interest rates, on increasing their capital expenditures. Management believes that once sustained, prolonged upward movement in U.S. milk prices are seen, farmers will be able to repay their existing obligations which mounted from the persistently low milk prices over the last year. Also contributing to the decline was continued tightening in agricultural credit availability, as a result of the depressed U.S. milk prices, coupled with rising supplemental grain feed costs brought on by the summer drought conditions in the U.S.. In addition, increased volume discounts from the implementation of the Company's pre-season order program coupled with continued strong competition in the silage bag market, as farmers look for the most economically priced bag, without considering quality and customer service, contributed to the decline.
[GRAPHIC OMITTED - TABULAR DATA SET FORTH BELOW]
Source: USDA Basic Formula Price (BFP)
PAGE BREAK REQUIRED DUE TO EDGAR PAGE SIZE.
Machine sale revenue for the year declined 23.55% and bag sale revenue declined 17.15% compared to 2002. Machine sale revenue for the year declined as a result of the U.S. milk price and farm economic conditions previously discussed. As a percentage of total revenue for the year 2003, machine revenue declined 3% and bag revenue increased 1%. (See "Item 1. Business - General.") The following table identifies the number of machines sold by size by the Company in 2003 compared to 2002:
Units Sold Units Sold Machine Size 2003 2002 ------------ ---- ----
Small 134 158 Medium 5 6 Large 25 36 ---------------- ------------------
Total 164 200 ================ ==================
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.
For the year ended December 31, 2003, the Company sold two composting systems in addition to compost bag sales, generating approximately $524,000 in revenue, compared to four systems sold and compost bag sales for the year ended December 31, 2002, generating approximately $592,000 in revenue. Compost sales were down for the year as a result of current economic conditions and tight budgetary constraints for the Company's potential end users in the U.S.
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 make up between 30-35% 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. The Company anticipates its sales mix to begin to favor more dealer sales in the future as a result of its change of sales focus during the later half of 2002. (See "Item 1. Business - Marketing.")
International sales for the Company in 2003 were down in comparison to 2002 as a result of drought weather conditions in international dairy areas where the Company has a large portion of its international customer base, coupled with continued economic uncertainty affecting the international farm economy, resulting largely from BSE (mad cow) concerns. International sales to Germany remained constant compared to the prior year. In 1999, the Company's German dealer began manufacturing mid-sized bagging machines in Germany under a license from the Company. Therefore, the Company no longer sells mid-sized machines directly to its German dealer. Instead, the Company receives a royalty fee for each mid-sized machine sold by its German dealer, which is recorded as other income. In 1997, the Company formed a German joint venture in which the Company owns a 50% interest and its German dealer owns the remaining 50%. The joint venture distributes bags to the Company's German and European dealers. The Company's earnings from the joint venture are reported as other income and are accounted for using the equity method. Approximately $4.7 million in bag sales and service were distributed through the venture during 2003, an increase of 27%, compared to approximately $3.7 million in bag sales and service for 2002.
Gross profit as a percentage of sales decreased 21.51% for the year ended December 31, 2003 compared to 2002. The decrease for the year was the result of lower sales volumes to cover fixed operating overheads, coupled with lower margins on the Company's used equipment sold during the year and increases incurred in the Company's inventory reserves. The decrease was partially offset by improved margins on the Company's "core" smaller bagging machines from production improvements made during 2002, in addition to lower warranty costs as a result of the Company passing on more of its warranty costs to its suppliers, coupled with lower freight costs for the year resulting largely from the Company streamlining its warehouse locations during 2002 to help in improving overall margins. (See "Item 1. Business - Farm Equipment and Products.") Also contributing to the decline for the year was an increase in volume discounts (which are recorded as a reduction in net sales) from the Company's implementation of its pre-season order program, as 2003 was the first full year for this program and the related discount.
Selling expenses for the year ended December 31, 2003 decreased 24.82% to $2,628,971 compared to $3,496,672 for the year ended December 31, 2002. The decrease in selling expenses for the year was the result of lower commissions and third party financing fees from lower sales volumes, lower overall advertising costs, coupled with lower personnel, benefit, and travel costs associated with sales personnel reductions made in late 2002 in connection with the shift more towards selling through the Company's dealer network, partially offset by increased dealer incentive costs.
Administrative expenses for the year ended December 31, 2003 increased 2.59% to $2,810,904 compared to $2,739,811 for the year ended December 31, 2002. The increase for the year was the result of increased insurance expense and higher professional fees related to public company compliance with the Sarbanes-Oxley Act of 2002, in addition to slightly higher patent costs, which were partially offset by lower bad debt, general office and administrative personnel expenses.
During the year ended December 31, 2003, the Company recorded a gain from the sale of assets of $185,358. The gain largely resulted from depreciated folding equipment that was sold to its German joint venture during the second quarter of 2003, in addition to the sale of fully depreciated miscellaneous manufacturing equipment and vehicles which occurred during the third quarter of 2003. During the second quarter of 2003, the Company recorded a gain from the sale of assets of $345,837. However, under the equity method of accounting with the Company's 50% ownership in the German joint venture, the Company's share of the gain of $172,918 was deferred and will be recognized as the German joint venture depreciates the folding equipment over its useful life. During the year ended December 31, 2003, $86,454 of the deferred gain was recognized as joint venture income.
Research and development expenses for the year ended December 31, 2003 decreased 36.74% to $139,160 compared to $219,980 for the year ended December 31, 2002. The decrease in research and development expenses for the year was the result of completed research on various projects undertaken
regarding new silage and nutritional studies of bagged feed and their effects on animal production, offset by continued research and testing in this area as well. Additionally, the Company continued testing on the newer design of the Company's larger-sized silage-bagging machines, and compost machine modification and development.
Interest expense for the year ended December 31, 2003 decreased 21.78% to $245,656 compared to $314,068 for the year ended December 31, 2002. The decrease for the year was the result of the Company utilizing a smaller credit facility as a result of the Company changing its collection methods during the fourth quarter of 2002 whereby the Company's customers no longer have open account terms, which was partially offset by increased interest rates on the facility during the year. 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.
Joint venture equity and royalty income for the year ended December 31, 2003 increased 34.23% to $423,074 compared to $315,196 for the year ended December 31, 2002. The increase for the year was the result of increased income from the joint venture as a result of the recognition of deferred folder sale gain (see discussion of gain from sale of assets above), coupled with a special one-time folding royalty received from the Company's joint venture upon the sale of the folding equipment to the joint venture which occurred during the second quarter of 2003. (See "Item 8. Financial Statements and Supplementary Data.")
The Company's effective tax rate for the year ended December 31, 2003 was 41%. The effective tax rate was an expense during the year due to the fact the Company established a $1,577,772 valuation allowance against its deferred tax assets in respect to the Company's ability to utilize its Net Operating Loss carryforwards and research tax credits, which was offset by the fact the Company's income from its German joint venture is not taxable in the United States, and the extraterritorial income exclusion provisions of the current United States tax code.
Net loss for the year ended December 31, 2003 was $2,753,715 compared to a net loss of $663,988 for the year ended December 31, 2002. The net loss for the year was the result of lower sales and gross margins, lower miscellaneous income, increased administrative expenses, and the establishment of a deferred tax valuation allowance on its deferred tax assets, partially offset by decreased selling, research and development, and interest expenses and increased joint venture equity and royalty income and gain from the sale of assets.
YEARS ENDED DECEMBER 31, 2002 AND 2001 - --------------------------------------
For the year ended December 31, 2002, net sales decreased 5.29% to $27,189,140 compared to $28,708,233 for the year ended December 31, 2001. Sales were down for the year as a result of drought weather conditions experienced in much of the Midwest and upper-Midwestern United States that greatly reduced the summer alfalfa harvest for 2002. Additionally, milk prices continued their steep decline, which began during the second quarter of 2002, to record low levels, causing farmers to become cautious on purchasing capital equipment. Also contributing to the decline was continued tightening in agricultural credit availability, as a result of the depressed U.S. milk prices, coupled with rising supplemental grain feed costs during the third quarter of 2002 brought on by the drought conditions in the U.S.
This is a shift from the positive trends that could be seen moving into the first quarter of 2002. These positive trends included stabilizing milk prices, continued optimism that milk prices in the U.S. would remain above the record low levels of the year 2000 throughout 2002 and continued easing of credit by financial institutions for the farming sector that, coupled with the interest rate reductions of 2001, allowed farmers to be more optimistic and resume capital expenditures. Sales were down for the year which began eroding during the second quarter and continued throughout the remainder of 2002. Supplemental grain feed costs remained low during the first two quarters of 2002, which
tended to improve the availability of farm operating funds. However, this trend reversed during the third quarter as discussed above. Throughout 2002, strong competition in the silage bag market continued, as farmers look for the most economical bag, with lesser consideration to overall quality, customer service and recycling of the used plastic silage bags offered by the Company.
Machine sale revenue for the year declined 3.61% and bag sale revenue declined 5.54% compared to 2001. Machine sale revenue for the year declined as a result of a decrease in the Company's smaller unit bagging machine sales during the second and third quarters of 2002 compared to 2001, resulting from the drought and milk price conditions previously discussed. As a percentage of total revenue for the year 2002, machine and bag revenue was unchanged. (See "Item 1. Business - General.") 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.
For the year ended December 31, 2002, the Company sold four composting systems in addition to compost bag sales, generating approximately $592,000 in revenue, compared to ten systems sold and compost bag sales for the year ended December 31, 2001, generating approximately $1.3 million in revenue. Compost sales were down for the year as a result of current economic conditions and tight budgetary constraints for the Company's potential end users in the U.S.
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 make up between 33-38% 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. The Company anticipates its sales mix to begin to favor more dealer sales in the future as a result of its change of sales focus during the later half of 2002. (See "Item 1. Business - Marketing.")
The Company continued evaluating selling its bagging machines via e-commerce and concluded that e-commerce is not currently a viable distribution avenue for its machinery. This is due to the complexity and required understanding of the end user's needs and farming operation, which requires discussion in an individual setting with a Company sales representative. The Company however, will continue to evaluate whether to offer some of its other products via e-commerce at some point in the future.
International sales for the Company in 2002 were down in comparison to 2001 due to continued economic uncertainty affecting the international farm economy. International sales to Canada and Latin America saw a slight increase in 2002, while sales to Germany saw a decline for the year. In 1999, the Company's German dealer began manufacturing mid-sized bagging machines in Germany under a license from the Company. Therefore, the Company no longer sells mid-sized machines directly to its German dealer. Instead, the Company receives a royalty fee for each mid-sized machine sold by its German dealer, which is recorded as other income. In 1997, the Company formed a German joint venture in which the Company owns a 50% interest and its German dealer owns the remaining 50%. The joint venture distributes bags to the Company's German and European dealers. The Company's earnings from the joint venture are reported as other income and are accounted for using the equity method. Approximately $3.7 million in bag sales were distributed through the venture during 2002, an increase of 12%, compared to approximately $3.3 million in bag sales for 2001.
Gross profit as a percentage of sales decreased 1.43% for the year ended December 31, 2002 compared to 2001. The decrease for the year was the result of 1) lower sales volumes to cover fixed operating overheads, 2)
higher machine warranty costs (related largely to the Company's large-sized bagging machines), 3) lower margins on the Company's used equipment sold during the year, and, 4) lower margins on bags in certain highly competitive, high volume geographic areas. The decrease was partially offset by improved margins on the Company's "core" smaller bagging machines from production improvements made during 2002. Also contributing to the decline for the year was the mix of machine models sold during the year, which saw a 16% increase in unit sales of the Company's larger-sized bagging machines. Larger-sized bagging machines generate a lower overall margin for the Company than its "core" small sized bagging machine. (See "Item 1. Business - Farm Equipment and Products.")
Selling expenses for the year ended December 31, 2002 increased 1.61% to $3,496,672 compared to $3,441,197 for the year ended December 31, 2001. The increase for the year was the result of increased advertising, promotion, meeting, and dealer incentive costs, partially offset by lower personnel, benefit, and travel costs associated with sales personnel reductions made in 2002 in connection with the shift more towards selling through the Company's dealer network (See "Item 1. Business - Marketing."), coupled with lower commissions from lower sales volumes for the year.
Administrative expenses for the year ended December 31, 2002 increased 4.32% to $2,739,811 compared to $2,626,268 for the year ended December 31, 2001. The increase for the year was the result of higher professional fees related to ongoing patent litigation and increases in administrative salary, general office, annual meeting and insurance expense, partially offset by lower bad debt, employee benefit, and director fee expenses.
Research and development expenses for the year ended December 31, 2002 increased 2.91% to $219,980 compared to $213,757 for the year ended December 31, 2001. The increase for the year was the result of new research and development on testing a newer design of the Company's larger-sized silage-bagging machine, in addition to further compost machine modification and development. The Company also completed research on various projects undertaken regarding new silage and nutritional studies of bagged feed and their effects on animal production during the year, and is continuing research and testing in this area as well.
Interest expense for the year ended December 31, 2002 decreased 11.70% to $314,068 compared to $355,686 for the year ended December 31, 2001. The decrease for the year was the result of lower interest rates on the Company's credit line, partially offset by the Company utilizing a larger portion of its credit facilities through the third quarter of 2002.
Joint venture equity and royalty income for the year ended December 31, 2002 increased 5.39% to $315,196 compared to $299,065 for the year ended December 31, 2001. The increase for the year was the result of increased sales from the joint venture during the year (see the international sales discussion above) coupled with a slight increase in folding royalties, as plastic tonnage folded in 2002 by the German joint venture increased approximately 12% from 2001 tonnage folded. (See "Item 8. Financial Statements and Supplementary Data".)
The Company's effective tax rate for the year ended December 31, 2002 was (45%). This was due to 1) the fact the Company incurred a net loss for the year, 2) the recognition of research and development credits associated with its 2002 activities, 3) the fact the Company's income from its German joint venture is not taxable in the United States, and 4) the extraterritorial income exclusion provisions of the current United States tax code. In 2002, the Company generated net general business tax credit benefits of approximately $9,000.
Net loss for the year ended December 31, 2002 was $663,988 compared to a net loss of $164,150 for the year ended December 31, 2001. The decline for the year was the result of lower sales, lower gross profit resulting from competition and mix of bagging machinery sold during the year, coupled with increased selling,
administrative, and research expense, partially offset by higher income from the Company's German joint venture and lower interest costs.
RECENT ACCOUNTING PRONOUNCEMENTS - --------------------------------
In June 2003, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standard ("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. Management does not expect that the application of the provisions of this statement will have a material impact on the Company's financial statements.
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." Management does not expect that the application of the provisions of this statement will 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 is associated with a potential variable interest entity through their investment in BAW as described in Note 12 to the Financial Statements. Management determined that BAW is a variable interest entity, but concluded that the Company is not the primary beneficiary. Management does not expect that the application of the provisions of this interpretation will have a material impact on the Company's financial statements.
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.
As a result of the Company incurring net losses during the previous three years and its negative cash flows from operations for the current year, 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 has a direct impact on the disposable income of its dairy farm customers, who account for 75% of the Company's business. The Company further believes that dairy farmers have been delaying or eliminating capital expenditures due to their uncertainties regarding milk prices and their disposable income. Early predictions for 2004 show milk prices significantly higher than the historically low levels seen for many of the previous years and the Company expects operating results to improve as dairy farmers begin to see increases in their disposable income through stabilizing milk prices. The Company's management also feels that dealers have been conservative on their pre-season orders for 2003-04 as a result of the prolonged, depressed milk price situation. It is management's feeling that some dealers will have the need to re-order additional product during the year as a result of the forecasted improving milk price, which should help the Company's dealers sell out of their remaining inventories. If this happens, there is a potential for higher gross margins for the Company, as the dealers would be re-ordering outside of the pre-season order program terms which provide for a lower volume discount on their re-orders. (See "Results of Operation" discussion.)
To help provide positive cash flow for the Company, management has implemented an expense reduction plan. Specifically, management has implemented staff reductions and reduced salaries of senior management. Nonessential capital expenditures, travel and other expenses have either been eliminated or postponed. Management has also been 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, including selling the Company's 50% interest in its joint venture, or take out a policy loan against the life insurance policies currently in force in which the Company is the beneficiary. However, no assurance can be given that the Company will be successful in accomplishing these objectives.
Accounts receivable increased 5.82% at December 31, 2003 to $1,226,390 compared to $1,158,927 at December 31, 2002. The increase for the year was a result of several large machine sales occurring during December where the Company did not receive funding from its third party financing sources prior to the end of December. The Company received payment during the first quarter of 2004. (See "Item 8. Financial Statements and Supplementary Data.") As a result of the Company changing its collection methods during the fourth quarter of 2002, whereby the Company's customers no longer have open account terms, the Company generally receives funding from its third party financing sources within 10 days of invoice processing. For new purchases, the Company's customers 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 has established adequate reserves ($204,081 at December 31, 2003 compared to $203,595 at December 31, 2002) against accounts 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 for their 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 obtain payment for their purchases 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.
Inventory decreased 4.47% at December 31, 2003 to $5,781,345 compared to $6,051,720 at December 31, 2002. The decrease in inventory resulted from the Company's continued efforts to streamline its inventory and more closely match its production with planned inventory requirements. Contributing to these efforts was the implementation of the Company's pre-season ordering program introduced in September 2002 for the 2002-03 season which the Company continued in October 2003 for the 2003-04 season. (See Item 1. "Business - Marketing.")
Prepaid expenses and other current assets increased 26.61% at December 31, 2003 to $251,808 compared to $198,877 at December 31, 2002. The increase was the result of an increase in trade show deposits and prepaid insurance expense.
Deferred income taxes decreased to $-0- at December 31, 2003 compared to $1,013,000 at December 31, 2002. The decrease was the result of the Company establishing a valuation allowance of $1,577,772 against its deferred tax assets during 2003.
Intangible assets at December 31, 2003 increased to $15,066 compared to $11,511 at December 31, 2002. The increase was the result of new patents developed on the Company's bagging machine technology, offset by normal amortization expense.
The BAW joint venture asset decreased to $376,974 at December 31, 2003 compared to $397,938 at December 31, 2002. The decrease was the result of the deferred gain under the equity method of 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, which was offset by the Company's share of income for the year. During the year ended December 31, 2003, $86,454 of deferred gain was recognized.
Other assets were flat at December 31, 2003 at $491,513 compared to $490,628 on December 31, 2002.
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 December 31, 2003, $2,090,448 had been drawn 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 not in compliance with the net worth and earnings covenants at December 31, 2003 and has received a waiver for these violations. The Company's covenants have been reset for 2004 to provide the Company with the ability to operate under its financial plan submitted to its primary lender. Management believes that funds generated from operations, management's implemented expense reduction plan and other changes being considered to the Company's business model (as discussed above and in Note 2 to the Company's Financial Statements), 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.
On December 18, 2000, the Company entered into an agreement with Dresdner Bank to guarantee up to 511,292 Euro ($535,987 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 ($312,500 US). There
was -0- Euro outstanding and guaranteed by the Company under this additional cash credit facility at December 31, 2003.
Accounts payable increased 3.72% at December 31, 2003 to $936,953 compared to $903,309 at December 31, 2002. The increase for the year was the result of the Company continuing its manufacturing process during the fourth quarter (resulting from the Company's pre-season order program whereby the Company is trying to level out its production process), coupled with some extended term payment arrangements provided by some of the Company's principal suppliers. (See "trade credit" discussion above.)
Accrued expenses and other current liabilities in total decreased 15.31% at December 31, 2003 to $961,731 compared to $1,135,608 at December 31, 2002. The decrease in total accrued expenses and other current liabilities for the year was the result of decreased payroll & benefit accruals from personnel reductions during the year, coupled with decreased dealer deposits from the Company's change in its customer payment options implemented in late 2002, in addition to lower accrued warranty expenses resulting from the Company passing on more warranty costs to its principal suppliers. This was offset by increases in volume discounts from the Company's pre-season order program, coupled with increased general and pre-season order flooring interest accruals.
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:
OFF-BALANCE SHEET ARRANGEMENTS - ------------------------------
As of December 31, 2003, we did not have any significant off-balance sheet arrangements, as defined in Item 303(a)(4)(ii) of SEC Regulation S-K.
FACTORS AFFECTING FORWARD-LOOKING STATEMENTS - --------------------------------------------
You should carefully consider the following factors regarding forward-looking statements and other information included in this Annual Report. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties not currently known to us or that we currently deem immaterial also may impair our business operations. If any of the following risks actually occur, our business, financial condition and operating results could be materially adversely affected.
o We are dependent on the Dairy Industry
More than 75% of our revenues come from the dairy industry.
o A downturn in the dairy industry could cause a reduction in our revenues.
Our sales are highly correlated with the price of milk products and revenues of the dairy industry. When dairy farmers make money, they buy our products. When dairy farmers are not making money, our sales decline.
o A sharp decline in the health and government subsidies of the farming sector of the U.S. economy could cause a reduction in our revenue.
If a reduction in availability of credit or government subsidies in the farming sector occurs, or, interest rates begin to rise, our sales may decline as farmers will find it more difficult to purchase capital equipment and may become more cautious on incurring additional farm debt.
o Our revenues are historically seasonal and dependent on weather conditions.
Our core business is dependent on weather conditions during the harvest seasons in North America and Europe. Adverse weather conditions affect farmers' crops and reduce demand for our products. Approximately 53%-70% of our revenue is historically generated in the second and third quarters. In September 2002 however, the Company took steps to begin to counteract some of this seasonality with the introduction of its pre-season order program which it continued for the 2003-04 season with some modifications.
o We may not continue to gain market acceptance of our pre-season order program.
The Company introduced a new pre-season order program in September 2002, which was modified in October 2003, for use by the Company's dealers in placing their entire anticipated next year's product order. This is the first time the Company has introduced such a comprehensive program and no assurance can be given that it will be fully accepted in the marketplace.
o We may lose our third-party financing sources.
The Company is dependent upon its relationships with its independent third-party financing sources and dealers' local banks, which provide both wholesale and retail financing to the Company's dealers and end users. If the Company's independent third-party financing sources, or dealers' local banks, were unable to offer their current programs or provide the level of credit to the Company's dealers, alternative sources would have to be found. This may cause a delay in the Company's ability to ship product under the terms of its pre-season order program.
o Our intellectual property protection may not be adequate.
We have patents on our basic bagging machines and patents pending for additional machines, bags and systems for silage bagging, grain bagging and hay/straw bale bagging. We may not obtain these patents and our patents may not withstand litigation challenges. If our patents do not withstand litigation challenges, our rights in bag and machine technology could be diminished or eliminated. Moreover, the issuance of patents covering any of our products may be insufficient to prevent competitors from duplicating our products. The patent laws of other countries may differ from those of the United States as to the patent ability of our products and processes, and the degree of protection afforded by foreign patents may be different from that in the United States.
o We rely on one principal supplier for our bags.
We purchase nearly all of our bags from one supplier under a long-term requirements contract. Any disruption of the manufacturing process could affect that company's ability to supply our needs, and could adversely affect our sales.
o Our bag pricing is dependent on the price of resin.
The prices that we pay for bags, which account for approximately half of our annual sales, are fixed annually in advance and are tied directly to the price of resin. Resin prices have historically been subject to significant price volatility. Increases in the price of bags could adversely affect our profit margins if we are unable to pass along the price increase, and would likely affect our revenues if alternatives to our product become more attractive because of the price increases.
o Our stock is quoted on the OTC Bulletin Board, which may make the stock more difficult to sell.
We no longer satisfy the criteria for continued quotation on The Nasdaq SmallCap Market. Our stock is, instead, quoted on the OTC Bulletin Board. As a result, our shareholders may find it more difficult to dispose of, or to obtain accurate quotations as to the market value of, our common stock, and the market price for our common stock may decline. Trading in our common stock is subject to the requirements of Rule 15g-9 promulgated under the Securities Exchange Act of 1934. Under this rule, broker/dealers who recommend low-priced securities to persons other than established customers and accredited investors must satisfy special sales practice requirements, including a requirement that they make an individualized written suitability determination for the purchaser and receive the purchaser's written consent prior to the transaction. The Securities Enforcement Remedies and Penny Stock Reform Act of 1990 also requires additional disclosure in connection with any trades involving a stock defined as a penny stock (generally any equity security not traded on an exchange or quoted on Nasdaq that has a market price of less than $5.00 per share, subject to certain exceptions), including the delivery, prior to any penny stock transaction, of a disclosure schedule explaining the penny stock market and the risks associated with the penny stock market. These requirements could severely limit the market liquidity of our common stock and the ability of our shareholders to dispose of their shares, particularly in a declining market.
ITEM 7A.
ITEM 7A. 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 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - ----------------------------------------------------
Reference is made to the financial statements and related notes and supplemental data under Item 15 filed with this report.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE - --------------------------------------------------------------------------------
None.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES - ---------------------------------
As of December 31, 2003, 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 III --------
ITEMS 10 AND 11. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT AND EXECUTIVE COMPENSATION - --------------------------------------------------------------------------------
A definitive proxy statement for the 2004 Annual Meeting of Stockholders of Ag-Bag International Limited to be held on June 7, 2004 will be filed with the Securities and Exchange Commission not later than 120 days after the end of the Company's fiscal year ("Proxy Statement"). The information set forth in the Proxy Statement under "Election of Directors," "Executive Compensation," and "Section 16(a) Beneficial Ownership Reporting Compliance" is incorporated herein by reference. Executive officers of Ag-Bag International Limited are listed under the heading "Executive Officers of the Registrant" in this Form 10-K.
The Company has not adopted a Code of Ethics, within the meaning of applicable SEC rules, relating to the conduct of its officers and directors. The Company has identified the need for a Code of Ethics but has been unable to adopt one yet because of other management focus and time constraints. The Company's board of directors is currently reviewing this requirement and intends to develop a Code of Ethics during 2004.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS - --------------------------------------------------------------------------------
Part of the information required is set forth under the caption "Security Ownership of Beneficial Owners" in the Proxy Statement and is incorporated herein by reference.
EQUITY COMPENSATION PLAN INFORMATION
The Company has an Employee Stock Plan, Incentive Stock Plan and Non-employee Director Stock Option Plan, which have not been approved by security holders. Information on the plans are contained in Note 10 to the Company's Financial Statements. These plans have previously been filed as exhibits to the Company's public filings. (See "Exhibit Index")
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - --------------------------------------------------------
Information required is set forth under the caption "Certain Relationships and Related Transactions" in the Proxy Statement and is incorporated herein by reference.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES - ------------------------------------------------
Information required is set forth under the caption "Audit Committee Report" in the Proxy Statement and is incorporated herein by reference.
PART IV -------
ITEM 15.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) The following documents are filed as part of this report:
(b) No reports on Form 8-K were required to be filed during the last quarter of the period covered by this report.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
AG-BAG INTERNATIONAL LIMITED, a Delaware corporation
Date: March 29, 2004 By: \s\ MICHAEL J. SCHOVILLE --------------------------------------------- Michael J. Schoville, Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Company and in the capacities and on the dates indicated.
Date: March 29, 2004 By: \s\ LARRY R. INMAN -------------------------------------------- Larry R. Inman, Chairman, Board of Directors and President
Date: March 29, 2004 By: \s\ MICHAEL J. SCHOVILLE -------------------------------------------- Michael J. Schoville, Chief Executive Officer (Principal Executive Officer)
Date: March 29, 2004 By: \s\ MICHAEL R. WALLIS -------------------------------------------- Michael R. Wallis, Chief Financial Officer and Vice President, Finance (Principal Financial and Accounting Officer)
Date: March 29, 2004 By: \s\ LEMUEL E. CUNNINGHAM -------------------------------------------- Lemuel E. Cunningham, Director
Date: March 29, 2004 By: \s\ MICHAEL W. FOSTER -------------------------------------------- Michael W. Foster, Director
Date: March 29, 2004 By: \s\ JIM DEMATTEO -------------------------------------------- Jim DeMatteo, Director
Date: March 29, 2004 By: \s\ ARTHUR P. SCHUETTE -------------------------------------------- Arthur P. Schuette, Director
Date: March 29, 2004 By: \s\ UDO WEBER -------------------------------------------- Udo Weber, Director
Page ---- AG-BAG INTERNATIONAL LIMITED - ----------------------------
Independent Auditor's Report
Financial Information
Balance Sheets
Statements of Operations and Comprehensive Loss
Statements of changes in Shareholders' Equity
Statements of Cash Flows
Notes to Financial Statements
Supplemental Information
Independent Auditor's Report on Supplemental Information
Valuation and Qualifying Accounts
BAW - ---
Independent Auditor's Report
Balance Sheets
Statements of Income and Comprehensive Income
Statement of Shareholders' Equity
Statements of Cash Flows
Notes to Financial Statements
Reconciliation of German GAAP to U.S. GAAP
Exhibit I - Composition and development of tangible assets
Exhibit 2 - Euro exchange rate table
CONTENTS - --------------------------------------------------------------------------------
PAGE
INDEPENDENT AUDITOR'S REPORT
FINANCIAL STATEMENTS
Balance sheets -
Statements of operations and comprehensive loss
Statements of changes in shareholders' equity
Statements of cash flows
Notes to financial statements -
SUPPLEMENTAL INFORMATION
Independent auditor's report on supplemental information
Valuation and qualifying accounts
- --------------------------------------------------------------------------------
INDEPENDENT AUDITOR'S REPORT
To the Board of Directors and Shareholders Ag-Bag International Limited
We have audited the accompanying balance sheets of Ag-Bag International Limited as of December 31, 2003 and 2002, and the related statements of operations and comprehensive loss, changes in shareholders' equity, and cash flows for each of the years in the three-year period ended December 31, 2003. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States of America. These standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Ag-Bag International Limited as of December 31, 2003 and 2002, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2003, in conformity with accounting principles generally accepted in the United States of America.
The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 2 to the financial statements, the Company has suffered recurring losses from operations, has a retained deficit, negative cash flows from operations and is out of compliance with its bank covenants, which raise substantial doubt about its ability to continue as a going concern. Management's plans regarding those matters also are described in Note 2. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.
Medford, Oregon February 20, 2004
AG-BAG INTERNATIONAL LIMITED BALANCE SHEETS - --------------------------------------------------------------------------------
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AG-BAG INTERNATIONAL LIMITED BALANCE SHEETS - --------------------------------------------------------------------------------
LIABILITIES AND SHAREHOLDERS' EQUITY
See accompanying notes. - --------------------------------------------------------------------------------
AG-BAG INTERNATIONAL LIMITED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS - --------------------------------------------------------------------------------
See accompanying notes. - --------------------------------------------------------------------------------
AG-BAG INTERNATIONAL LIMITED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY - --------------------------------------------------------------------------------
See accompanying notes. - --------------------------------------------------------------------------------
AG-BAG INTERNATIONAL LIMITED STATEMENTS OF CASH FLOWS - --------------------------------------------------------------------------------
See accompanying notes - --------------------------------------------------------------------------------
AG-BAG INTERNATIONAL LIMITED NOTES TO FINANCIAL STATEMENTS - --------------------------------------------------------------------------------
NOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION - Ag-Bag International Limited (the Company) is a Delaware corporation. The Company's primary operations include the manufacturing and sale of machines and related bags used in the agriculture industry to store feed for livestock, grain, and other products. The Company also manufactures machines and bags for composting. The Company's primary market is North America; however, it sells products worldwide.
The Company's common stock began trading publicly on January 17, 1990, and is traded on the OTC Bulletin Board under the symbol "AGBG."
STATEMENTS OF CASH FLOWS - For purposes of the statements of cash flows, the Company considers all highly-liquid investments with original maturities of three months or less to be cash equivalents.
The Company transferred $135,490 in 2003 from rental equipment to inventory held-for-sale. In 2003, 2002, and 2001 the Company transferred $183,911, $331,726, and $697,849, respectively, from inventory held-for-sale to rental equipment.
ACCOUNTS RECEIVABLE - Accounts receivable are from distributors and customers of the Company's products. The Company performs periodic credit evaluations of its customers and maintains allowances for potential credit losses. Also, to reduce the risk of credit loss, the Company requires letters of credit from foreign customers with which no credit history has been established.
Receivables are presented at the aggregate unpaid principle balance amounts, net of an allowance for doubtful accounts. The allowance for doubtful accounts is established through a provision for bad debts expense. Receivables are charged against the allowance for bad debt when management believes the collectibility of an account is unlikely. The allowance is an amount that management believes will be adequate to absorb future losses on existing receivables that may become uncollectible based upon overall receivable quality, review of specific problem accounts, current economic conditions, and prior charge-off experience. The uncollectible portion of a customer's unpaid principle balance is charged-off after the Company initiates the collection process, investigates the circumstances of the past-due balance, and determines an amount to be uncollectible. Generally, the Company considers receivables from import shipments past due after 15 days; export and air freight shipments past due after 30 days; and shipments utilizing a foreign agent past due after 60 days. The Company accrues interest on past-due accounts and continues to accrue interest until the Company considers the receivable uncollectible.
INVENTORIES - 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. The Company's estimates of market value incorporate projections of future sales volume by product class. In estimating the market value of parts inventory, 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.
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AG-BAG INTERNATIONAL LIMITED NOTES TO FINANCIAL STATEMENTS - --------------------------------------------------------------------------------
NOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - (continued)
PROPERTY, PLANT, AND EQUIPMENT - Property, plant, and equipment are stated at cost and are depreciated on the straight-line method over their estimated useful lives which range from 5 to 7 years for equipment, and 20 to 30 years for buildings.
Expenditures for additions and major improvements are capitalized. Expenditures for repairs and maintenance are charged to expense as incurred.
INTANGIBLE ASSETS - Intangible assets consist of licenses and patents. The cost of the licenses and patents are amortized over the lesser of the terms of the related agreement or the estimated useful lives of the respective asset, ranging from 7 to 12 years.
THIRD-PARTY FINANCING ARRANGEMENTS - The Company assigns some of its trade accounts receivable to various third-party financing sources with discount rates ranging from .75% to 1.5% at December 31, 2003. The accounts can be assigned with or without recourse depending on the specific account being assigned. At December 31, 2003, the balance of assigned accounts with recourse was $3,155,990. Management has reviewed the accounts with recourse at December 31, 2003, and determined that no accrual is necessary for potential future recourse obligations.
PRE-SEASON ORDER FLOORING - During 2002, the Company implemented a Pre-Season Order Program under which the Company pays the flooring interest for dealers who make purchases from the Company under specific provisions of the Pre-Season Order Program. The Company estimates their future obligations under this program at the time of sale, reduces sales revenues, and accrues a liability for the estimated future interest obligation. Total dealer flooring interest was $344,870 and $113,534 for the years ended December 31, 2003 and 2002, respectively.
VOLUME DISCOUNTS - Under the same Pre-Season Order Program, the Company pays volume discounts to dealers based upon a sliding scale for the volume of orders placed by dealers. The Company estimates their future obligations under this program at the time of sale, reduces sales revenues, and accrues a liability for the estimated future volume discount obligation. Total volume discounts were $732,458, $182,765 and $71,635 for years ended December 31, 2003, 2002 and 2001, respectively.
REVENUE RECOGNITION - Revenue is recognized when the customer has placed an order for the product, the product is delivered or shipped to the customer, the sale's price has been determined, and collection is reasonably assured. The Company includes revenues earned on shipping costs billed to customers in "Net Sales," and costs to ship products are included in "Cost of Sales."
ADVERTISING COSTS - The Company expenses advertising costs as they are incurred. Advertising expenses for the years ended December 31, 2003, 2002, and 2001 were $412,047, $504,060, and $573,945, respectively.
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AG-BAG INTERNATIONAL LIMITED NOTES TO FINANCIAL STATEMENTS - --------------------------------------------------------------------------------
NOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - (continued)
WARRANTY RESERVE - 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. Warranty activity for the years ended December 31, 2003 and 2002 was as follows:
2003 2002 -------------- --------------
Balance, beginning of year $ 177,384 $ 124,482 Charged to expense 93,330 328,041 Warranty costs incurred during the year (195,961) (275,139) -------------- --------------
Balance, end of year $ 74,753 $ 177,384 ============== ==============
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 the Financial Accounting Standards Board's (FASB) Statement of Financial Accounting Standards (SFAS) No. 123, "Accounting for Stock-Based Compensation," additional compensation expense would have been recognized.
The Company has computed, for pro forma disclosure purposes, the value of all options granted during 2003, 2002, and 2001 using the Black-Scholes pricing model as prescribed under SFAS No. 123. The following assumptions were made for grants in 2003, 2002, and 2001: risk-free interest rate of 2.94%, 4.41%, and 4.41%, respectively, expected life of seven years, and dividend rates of 0%. For 2003, 2002, and 2001 the expected volatility over the expected lives of the grants was assumed to be 102.52%, 77.04%, and 77.92%, respectively. The weighted-average fair value of the options granted was estimated to be $.34 in 2003, $.20 in 2002, and $.34 in 2001.
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AG-BAG INTERNATIONAL LIMITED NOTES TO FINANCIAL STATEMENTS - --------------------------------------------------------------------------------
NOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - (continued)
If the Company had accounted for the value of the options granted during 2003, 2002, and 2001, in accordance with SFAS No. 123, the Company's net loss would have been increased to the pro forma amounts indicated below:
2003 2002 2001 ---------------- -------------- ---------------
Net loss: As reported $ (2,753,715) $(663,988) $(164,150) Pro forma $ (2,766,083) $(673,278) $(178,023)
Net loss per share: As reported $ (0.24) $ (0.06) $ (0.02) Pro forma $ (0.24) $ (0.06) $ (0.02)
The resulting pro forma compensation costs may not be representative of that expected in future years.
INCOME TAXES - 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 recorded a deferred tax asset of $1,577,772 and $1,013,000 as of December 31, 2003 and 2002, respectively. Management has established a valuation allowance of $1,577,772 against these deferred tax assets.
NET INCOME PER COMMON SHARE - Basic net income per share is calculated using the weighted-average number of common shares outstanding during each year. Preferred stock dividends were considered in the computation. The calculation of diluted net income per share excludes the effect of potentially dilutive common stock equivalents because their impact, when calculated using the treasury stock method, is antidilutive.
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AG-BAG INTERNATIONAL LIMITED NOTES TO FINANCIAL STATEMENTS - --------------------------------------------------------------------------------
NOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - (continued)
SEGMENT INFORMATION -the FASB issued SFAS No. 131, "Disclosure about Segments of an Enterprise and Related Information," which establishes annual and interim reporting standards for an enterprise's operating segments and related disclosures about its products, services, geographic areas, and major customers. The Company has analyzed the reporting requirements of the standard and has determined that its operations are within a single operating segment.
DISCLOSURE OF FAIR VALUE OF FINANCIAL INSTRUMENTS - The carrying amounts of financial instruments including cash and cash equivalents, accounts receivable, and accounts payable approximated fair value as of December 31, 2003 and 2002, because of the relatively short maturity of these instruments. The carrying value of notes payable approximated fair value as of December 31, 2003 and 2002, based upon interest rates and terms available for the same or similar loans.
MANAGEMENT ESTIMATES - The preparation of financial statements, in conformity with generally accepted accounting principles, requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Accordingly, actual results could differ from those estimates. Significant estimates used in preparing these financial statements include allowances for doubtful accounts receivable, inventory obsolescence reserves, depreciation methods for property, plant and equipment, valuation allowances for deferred tax assets and reserves for recourse obligations, warranty obligations, and Pre-Season Order flooring interest obligations.
RECENTLY ISSUED ACCOUNTING STANDARDS - In June 2003, the 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 assets 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. Management does not expect that the application of the provisions of this statement will have a material impact on the Company's financial statements.
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AG-BAG INTERNATIONAL LIMITED NOTES TO FINANCIAL STATEMENTS - --------------------------------------------------------------------------------
NOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - (continued)
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." Management does not expect that the application of the provisions of this statement will 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 is associated with a potential variable-interest entity through their investment in BAW as described in Note 12. Management determined that BAW is a variable-interest entity but concluded that the Company is not the primary beneficiary. Management does not expect that the application of the provisions of this interpretation will have a material impact on the Company's financial statements.
RECLASSIFICATIONS - Certain reclassifications have been made to the 2002 financial statements to conform with the 2003 presentation.
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AG-BAG INTERNATIONAL LIMITED NOTES TO FINANCIAL STATEMENTS - --------------------------------------------------------------------------------
NOTE 2 - GOING CONCERN
As shown in the accompanying financial statements, the Company incurred net losses of $2,753,715, $663,988, and $164,150 during the previous three years and has an accumulated deficit of $3,696,569 at December 31, 2003. The Company also had negative cash flows from operations of $1,341,605 for the current period. The Company is out of compliance with its net worth and earnings covenants under their line of credit agreement with its primary lender, Wells Fargo Business Credit.
Management believes their recent weak operating results have been primarily due to depressed milk prices in the agricultural sector, which has a direct impact on the disposable income of their dairy farmer customers. Management estimates that over 75% of their end users are dairy farmers. Management believes that dairy farmers have been delaying or eliminating capital expenditures due to their uncertainties regarding milk prices and their disposable income. Management further believes that early predictions for 2004 show milk prices significantly higher than the historically low levels seen for much of the previous years and expects operating results to improve as dairy farmers begin to see increases in their disposable income through stabilizing milk prices. Management also feels that its dealers have been conservative on their pre-season orders for 2003-04 as a result of the prolonged, depressed milk price situation. It is managements feeling that some of its dealers will have the need to re-order additional product during the year as a result of the forecasted improving milk price, which should help them sell out of their remaining inventories currently in their dealer stock. If this happens, there is a potential for higher gross margins for the Company, as the dealer would be re-ordering outside of the pre-season order program terms which provide for a lower volume discount on their re-orders. In addition, management has implemented an expense reduction plan. Specifically, management has implemented staff reductions and reduced salaries of senior management. Nonessential capital expenditures, travel and other expenses have either been eliminated or postponed. Management has also been considering other changes to their business model such as opportunities to sell the business, refinance its 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, including selling the Company's 50% interest in its joint venture, or take out a policy loan against the life insurance policies currently in force in which the Company is the beneficiary, to provide positive cash flows to the Company.
Because it is unclear whether the Company will be successful in accomplishing 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.
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AG-BAG INTERNATIONAL LIMITED NOTES TO FINANCIAL STATEMENTS - --------------------------------------------------------------------------------
NOTE 3 - INVENTORIES
Inventories consist of the following:
2003 2002 -------------- --------------
Parts and subassembly $ 1,878,102 $ 2,314,476 Work-in-process and raw materials 934,986 1,221,388 Machines 2,249,183 1,690,710 Bags and other finished goods 719,074 825,146 -------------- --------------
$ 5,781,345 $ 6,051,720 ============== ==============
NOTE 4 - INTANGIBLE ASSETS, NET
Intangible assets, net, consist of the following:
2003 2002 -------------- --------------
License and patent costs $ 629,645 $ 617,113 Less accumulated amortization (614,579) (605,602) -------------- --------------
$ 15,066 $ 11,511 ============== ==============
Intangible assets are being amortized over their estimated useful lives ranging from 7 to 12 years. Amortization expense for the years ended December 31, 2003, 2002, and 2001, was $8,977, $7,382, and $6,880, respectively.
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AG-BAG INTERNATIONAL LIMITED NOTES TO FINANCIAL STATEMENTS - --------------------------------------------------------------------------------
NOTE 5 - PROPERTY, PLANT, AND EQUIPMENT
Property, plant, and equipment consist of the following:
2003 2002 -------------- --------------
Land $ 160,826 $ 160,826 Buildings 2,858,539 2,853,400 Vehicles 319,133 369,931 Office furniture, fixtures, and equipment 2,336,346 2,317,425 Plant equipment 3,324,125 3,580,758 Rental equipment 857,238 841,948 Leasehold improvements 80,399 80,399 -------------- --------------
Total property, plant, and equipment 9,936,606 10,204,687 Less accumulated depreciation and amortization (6,702,933) (6,246,214) -------------- --------------
Property, plant, and equipment, net $ 3,233,673 $ 3,958,473 ============== ==============
Certain property, plant, and equipment serve as collateral for short- and long-term debt obligations. The Company leases certain assets under capital lease agreements. At December 31, 2003 and 2002, the gross amount of equipment under lease was $84,622. Accumulated depreciation related to those capital leases was $84,622 at December 31, 2003 and 2002, respectively.
Depreciation expense for the years ended December 31, 2003, 2002, and 2001 was $767,003, $808,880, and $755,510, respectively.
NOTE 6 - LINE OF CREDIT
The Company has an operating line of credit with a bank for up to $3,000,000 at December 31, 2003, and up to $5,000,000 at December 31, 2002. The line of credit is secured by accounts receivable, inventories, fixed-asset blanket and general intangibles, and bears interest at the bank's prime rate plus 4-3/4 % at December 31, 2003, and prime plus 1/4% December 31, 2002 (8.75% at December 31, 2003 and 4.5% at December 31, 2002). As of December 31, 2003 and 2002, $2,090,448 and $384,725 were outstanding under the operating line of credit. The line of credit is subject to certain net worth and income covenants, and an annual capital expenditure limit. The Company was not in compliance with the net worth and income covenants at December 31, 2003. The Company has received a waiver for these covenant violations at December 31, 2003. In addition, the line is subject to borrowing base restrictions. The borrowing base is equal to the lessor of the maximum line amount or the sum of 70% of eligible accounts receivable plus the lessor of 40% of eligible inventory or $2,000,000. The line is subject to renewal on May 14, 2006.
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AG-BAG INTERNATIONAL LIMITED NOTES TO FINANCIAL STATEMENTS - --------------------------------------------------------------------------------
NOTE 7 - LONG-TERM DEBT AND CAPITAL LEASE OBLIGATIONS
Long-term debt is comprised of the following:
2003 2002 ------------ ------------
Note payable in monthly installments of $2,436, including interest at 8.32%, through July 2005, secured by certain equipment, office furniture and fixtures, and personal guarantees of certain shareholders, sub- ordinate to building loan and certain equip- ment loans $ 48,544 $ 68,765
Note payable, monthly payments of $6,724, including interest at 6.84% through August 2014, secured by real property 607,836 644,939
Note payable in monthly installments of $4,969, including interest at 6.62% through November 2017, secured by real property 503,566 525,041
Note payable in monthly principal install- ments of $5,833, plus interest at prime plus .75% (5.0% at December 31, 2002) through April 2003, secured by fixed-asset blanket - 23,333
Note payable in monthly installments of $8,333, plus interest at 8.38% through January 2006, secured by certain equipment. This note was repaid in May 2003 - 308,333
Note payable with the City of Blair, Nebraska, with monthly installments of $6,607, including interest at 3% through September 2004, secured by Blair plant and equipment 58,723 134,996
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AG-BAG INTERNATIONAL LIMITED NOTES TO FINANCIAL STATEMENTS - --------------------------------------------------------------------------------
NOTE 7 - LONG-TERM DEBT AND CAPITAL LEASE OBLIGATIONS - (continued)
Future maturities of long-term debt and capital lease obligations are summarized as follows:
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AG-BAG INTERNATIONAL LIMITED NOTES TO FINANCIAL STATEMENTS - --------------------------------------------------------------------------------
NOTE 8 - INCOME TAXES
The provision (benefit) for income taxes consists of the following:
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AG-BAG INTERNATIONAL LIMITED NOTES TO FINANCIAL STATEMENTS - --------------------------------------------------------------------------------
NOTE 8 - INCOME TAXES - (continued)
Deferred tax assets and liabilities consist of the following:
2003 2002 ------------- -------------
State net operating loss carryforward $ 214,000 $ 138,000 Federal net operating loss carryforward 1,016,000 660,000 General business credit carryforward 436,000 252,000 Alternative minimum tax credit carryforward - 21,000 Other expenses not currently deductible 41,772 92,000 ------------- -------------
Gross deferred tax asset 1,707,772 1,163,000 Valuation allowance (1,577,772) - ------------- -------------
Net deferred tax assets 130,000 1,163,000 Gross deferred tax liability, primarily due to differences in depreciation (130,000) (150,000) ------------- -------------
Net deferred tax assets $ - $ 1,013,000 ============= =============
At December 31, 2003, the Company had a federal net operating loss of approximately $2,990,000 available to offset future federal taxable income through 2022. At December 31, 2003, the Company had state net operating loss of approximately $3,045,000 available to offset future state taxable income through 2012. The Company has established a valuation allowance of $1,577,772 against its deferred tax assets at December 31, 2003.
At December 31, 2003, the Company has research tax credit carryforwards for federal income tax purposes of approximately $436,000 that are available to offset future federal income. These credits can be carried forward through 2022. The Company had a capital loss carryforward of $886,431, which expired unused in 2002. The $135,632 deferred tax asset and the $135,632 valuation allowance have been eliminated upon the expiration of this capital loss carryforward in 2002.
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AG-BAG INTERNATIONAL LIMITED NOTES TO FINANCIAL STATEMENTS - --------------------------------------------------------------------------------
NOTE 8 - INCOME TAXES - (continued)
The provision for income taxes differs from the amount of income tax determined by applying the applicable U.S. statutory federal income tax rate to pretax income as a result of the following differences:
NOTE 9 - SUPPLEMENTAL DISCLOSURES REGARDING CASH FLOWS
Supplemental disclosure of cash flow information:
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AG-BAG INTERNATIONAL LIMITED NOTES TO FINANCIAL STATEMENTS - --------------------------------------------------------------------------------
NOTE 10 - SHAREHOLDERS' EQUITY
TREASURY STOCK - During 2001, the Company repurchased 105,000 shares of its common stock from a retiring director for $31,500.
PREFERRED STOCK - The preferred stock is redeemable solely at the option of the Company. The Company maintains life insurance on the owner of the preferred stock and, in the event of the stockholder's death, currently intends to use the proceeds of that insurance to redeem all outstanding shares of the preferred stock.
STOCK AWARDS - The Company has a 1991 Employee Stock Plan (the Plan) and has reserved 133,575 shares of common stock for issuance under the Plan. Under terms of the Plan, stock is awarded to employees at the sole discretion of the Board of Directors. No awards were granted under the Plan for 2003, 2002, and 2001. At December 31, 2003, there were 125,335 shares available for grant under the Employee Stock Plan.
COMMON STOCK OPTIONS - The Company has an Incentive Stock Option Plan (the Incentive Plan) and has reserved 185,000 shares of common stock for issuance under the Incentive Plan. Options under the Incentive Plan are issuable to officers and employees of the Company and all option grants will be at the market value of the stock at the date of grant. Vesting of stock options is determined for each grant by the Board of Directors. During 2003, there were no options granted by the Company. At December 31, 2003, there were 135,000 shares available for grant under the Incentive Stock Option Plan.
During 1996, the Company adopted a Non-Employee Director Stock Option Plan (the Director Plan) and has reserved 1,000,000 shares of common stock for issuance under the Director Plan. The Director Plan grants 50,000 options to each member of the Board of Directors who is not an employee of the Company. Forty percent of the 50,000 options vest and become exercisable six months after the grant date, another 40% of the options vest and become exercisable two years after the grant date, and the remaining portion of the options vest and become exercisable three years after the grant date. Beginning with the annual meeting in 2000, those directors who have served a three-year period, receive an annual grant of 10,000 options which become exercisable six months after the grant date. During 2003, the Company granted 40,000 options under the annual grant. Additionally, the Company had 190,000 options expire during 2003. At December 31, 2003, there were 700,000 shares available for grant under the Non-Employee Director Stock Option Plan.
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AG-BAG INTERNATIONAL LIMITED NOTES TO FINANCIAL STATEMENTS - --------------------------------------------------------------------------------
NOTE 10 - SHAREHOLDERS' EQUITY - (continued)
Transactions and other information relating to the Company's stock option plans for the three years ended December 31, 2003, are summarized as follows:
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AG-BAG INTERNATIONAL LIMITED NOTES TO FINANCIAL STATEMENTS - --------------------------------------------------------------------------------
NOTE 10 - SHAREHOLDERS' EQUITY - (continued)
At December 31, 2003, the Company had outstanding options for the purchase of 350,000 shares of common stock as follows:
NOTE 11 - FOREIGN SALES ACTIVITY
Export sales from the Company's operations are as follows:
2003 2002 2001 -------------- --------------- ---------------
Latin America/Mexico $ 30,540 $ 112,956 $ 88,864 Canada 861,195 1,147,872 1,030,174 Germany 273,303 275,415 444,767 Other 168,481 202,008 248,183 -------------- --------------- ---------------
$1,333,519 $ 1,738,251 $ 1,811,988 ============== =============== ===============
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AG-BAG INTERNATIONAL LIMITED NOTES TO FINANCIAL STATEMENTS - --------------------------------------------------------------------------------
NOTE 12 - BAW JOINT VENTURE
On February 27, 1997, the Company entered into a Joint Venture Agreement (Joint Venture) with Budissa Agroservice Gesellschaft and formed Budissa Agrodienstleistungen und Warenhandels (BAW). The Company has a 50% interest in BAW which is accounted for under the equity method. BAW folds and distributes silage bags throughout Europe. The Company's accumulated deficit has been reduced by undistributed equity earnings from BAW of $441,229 as of December 31, 2003.
2003 2002 ------------- -------------
Initial investment $ 22,209 $ 22,209 Accumulated earnings, beginning of year 375,729 250,729 Deferred folder sale gain (86,464) - Share of income for the year 65,500 125,000 ------------- -------------
Investment, end of year $ 376,974 $ 397,938 ============= =============
On February 27, 1997, BAW also entered into a lease agreement with Ag-Bag International Limited for the use of a folding machine. Royalties are earned by the Company based upon the poundage folded by BAW. In 2003, 2002, and 2001, income from this agreement was $200,000, $190,000 and $168,000, respectively. On June 30, 2003, the Company sold the depreciated folding machine to the Joint Venture for $400,000, which terminated this folding lease agreement. The sale resulted in a gain of $345,836, of which $172,918 was deferred. The deferred gain is being recognized over the estimated useful life of the asset on BAW's books. At December 31, 2003, the remaining deferred gain is $86,464.
On December 18, 2000, Ag-Bag International Limited entered into an agreement with Dresdner Bank to guarantee up to 511,292 Euro ($535,987 USD) as security for an additional cash credit facility of BAW. On August 5, 2003, the guarantee was reduced by Dresdner Bank to 250,000 Euro ($312,500 USD). There was no Euro outstanding under this additional cash credit facility at December 31, 2003 and 2002, respectively. Upon modification of the agreement during 2003, management estimated the fair value of the guarantee to be $15,000. The Company has recorded an accrued a liability of $15,000 at December 31, 2003.
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AG-BAG INTERNATIONAL LIMITED NOTES TO FINANCIAL STATEMENTS - --------------------------------------------------------------------------------
NOTE 12 - BAW JOINT VENTURE - (continued)
Condensed financial statements for the Company's Joint Venture in Germany are as follows:
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AG-BAG INTERNATIONAL LIMITED NOTES TO FINANCIAL STATEMENTS - --------------------------------------------------------------------------------
NOTE 12 - BAW JOINT VENTURE - (continued)
The condensed balance sheets have been translated from the Euro to the U.S. Dollar at the exchange rate in effect at December 31, 2003 and 2002, and from the German Mark to the U.S. Dollar at the exchange rates in effect at December 31, 2001. The exchange rates used at December 31, 2003, 2002, and 2001, for the balance sheets were $1.25, $1.05, and $.45, respectively. The condensed income statements have been translated from the Euro to the U.S. Dollar at the average exchange rate in effect at December 31, 2003 and 2002, and from the German Mark to the U.S. Dollar at the average exchange rates in effect at December 31, 2001. The average exchange rates used at December 31, 2003, 2002, and 2001, for the income statements were $1.13, $.95, and $.47, respectively.
NOTE 13 - COMMITMENTS AND CONTINGENCIES
PURCHASE COMMITMENTS - The Company purchases its Tri-Dura(R) rolls from a company owned by Steven G. Ross (Supplier) pursuant to a supply agreement. Steven G. Ross is a 14.9% stockholder in the Company and owner of a company which competes with the Company's Tri-Dura(R) bags. The supply agreement provides that the Company purchase all of its plastic rolls, with certain exceptions, from Supplier through at least December 31, 2007. Thereafter, either the Company or Supplier may terminate the supply agreement upon two years' prior written notice. The Company may purchase plastic rolls from other suppliers to the extent Supplier is unable to supply plastic rolls under the supply agreement. The Company believes there are adequate alternative suppliers available in the event Supplier is unable to provide rolls. Total purchases from Steven G. Ross for the years ended December 31, 2003, 2002, and 2001, were in excess of $7 million annually.
LEASE COMMITMENTS - The Company leases land under a noncancellable operating lease. This lease requires monthly payments with terms that expire through 2014. Total rent expense under all operating leases for the years ended December 31, 2003, 2002, and 2001, totaled $60,036, $66,361 and $59,418, respectively.
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AG-BAG INTERNATIONAL LIMITED NOTES TO FINANCIAL STATEMENTS - --------------------------------------------------------------------------------
NOTE 13 - COMMITMENTS AND CONTINGENCIES - (continued)
Future minimum lease payments under noncancellable operating leases are as follows:
Years ending December 31, 2004 $ 18,264 2005 21,914 2006 21,917 2007 21,917 2008 21,917 Thereafter 153,417 -----------------
$ 259,346 =================
CONTINGENCIES - The Company is involved in litigation matters that are in the normal course of business. Management is of the opinion that these matters will not have a material effect on the accompanying financial statements. Accordingly, no provision for these matters is included in the financial statements for the year ended December 31, 2003.
NOTE 14 - CONCENTRATION OF CREDIT RISK
Financial instruments which potentially subject the Company to credit risk consist of cash and receivables. The Company's cash balances are with federally insured banks and periodically exceed insured limits. The Company has outstanding accounts receivable balances with four customers totaling approximately $760,217 at December 31, 2003. These four balances represent 54% of the accounts receivable balance at December 31, 2003.
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AG-BAG INTERNATIONAL LIMITED NOTES TO FINANCIAL STATEMENTS - --------------------------------------------------------------------------------
NOTE 15 - 401(K) PROFIT SHARING PLAN
The Company has a qualified 401(k) profit sharing plan covering all full-time personnel with at least one year of continuous service. Employer contributions to the plan are at the discretion of the Company's management. No contributions were made by the Company to the 401(k) profit sharing plan in 2003 or 2002. The Company's eligible employees made contributions to the plan of $196,292 and $230,652 for the years ended December 31, 2003 and 2002, respectively.
NOTE 16 - QUARTERLY FINANCIAL DATA - (UNAUDITED)
Volume discounts offered to dealers under the Company's Pre-Season Order Program were previously reported as selling expenses for quarterly financial reporting purposes. The rebates have been reclassified as a reduction of net sales for annual financial reporting purposes at December 31, 2003. The effect on net sales and gross profits from operations as reported previously is reflected above.
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SUPPLEMENTAL INFORMATION - --------------------------------------------------------------------------------
INDEPENDENT AUDITOR'S REPORT ON SUPPLEMENTAL INFORMATION
To the Board of Directors and Shareholders Ag-Bag International Limited
Under date of February 20, 2004, we reported on the balance sheets of Ag-Bag International Limited as of December 31, 2003 and 2002, and the related statements of income, changes in shareholders' equity, and cash flows for the years ended December 31, 2003, 2002, and 2001, as contained in the annual report on Form 10-K for the year 2003. In connection with our audits of the aforementioned financial statements, we also audited the related schedule of Valuation and Qualifying Accounts. This schedule is the responsibility of the Company's management. Our responsibility is to express an opinion on the financial statement schedule based on our audits.
In our opinion, the schedule of Valuation and Qualifying Accounts, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
Medford, Oregon February 20, 2004
AG-BAG INTERNATIONAL LIMITED VALUATION AND QUALIFYING ACCOUNTS - --------------------------------------------------------------------------------
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INDEPENDENT AUDITORS REPORT -------------------------------
We have audited the accompanying balance sheets of BAW group as of December 31, 2003, 2002 and 2001 and the related statements of operating results and cash flows, for the years then ended, which, as described in Note 1 to the financial statements have been prepared on the basis of accounting principles generally accepted in Germany. These financial statements are the responsibility of the company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America and in Germany. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of BAW group as of December 31, 2003, 2002 and 2001, and the results of its operations and its cash flows for the years ended December 31, 2003, 2002 and 2001, in conformity with accounting principles generally accepted in Germany.
02625 Bautzen, January 23, 2004
Treuhand-Gesellschaft Dr. Steinebach & Partner GmbH Wirtschaftsprufungsgesellschaft
/s/ MARTIN STEINEBACH --------------------- Dipl.Ing. Martin Steinebach Auditor
BAW GROUP BALANCE SHEETS
December 31, -------------------------------- 2003 2002 2001 EUR ThEUR ThEUR A. FIXED ASSETS ------------- -------- ---------
II. TANGIBLE ASSETS 1. Land and buildings 714,733.95 570.4 494.3 2. Technical equipment and machines 309,160.89 209.2 288.4 3. Other systems, equipment and devices 14,684.43 21.8 21.3 4. Buildings under construction 2,597.42 0.0 0.0 ------------- -------- --------- 1,041,176.69 801.4 804.0 ============= ======== ========= B. REVOLVING ASSETS I. STOCKS AND INVENTORIES
1. Raw materials and supplies 10,157.-- 11.1 4.1 2. Unfinished products and goods 77,740.84 0.0 0.0 3. Finished products and goods 442,855.85 205.9 245.1 4. Advance payments made -.- 1.0 0.1 ------------- -------- --------- 530,753.69 218.0 249.3 ------------- -------- ---------
II. ACCOUNTS RECEIVABLE AND OTHER ASSETS 1. Accounts receivable for goods and services 382,745.29 347.3 446.8 3. Accounts receivable from shareholders -.- 0.0 51.1 4. Other assets 72,837.13 18.4 14.1 ------------- -------- --------- 455,582.42 365.7 512.0 ------------- -------- --------- IV. CHEQUES, CASH IN HAND, BALANCES AT BUNDESBANK AND POSTBANK, BALANCES AT FINANCIAL INSTITUTIONS 163,720.99 621.3 336.9 ------------- -------- --------- Total revolving assets 1,150,057.10 1,205.0 1,098.2 ============= ======== ========= C. TRANSITORY ITEMS 13,902.67 3.4 9.0 ============= ======== ========= D. DEFERRED TAXES 8,765.30 4.1 11.2 ============= ======== ========= TOTAL ASSETS 2,213,901.76 2,013.9 1,922.4 ============= ======== =========
BAW GROUP BALANCE SHEETS
December 31, -------------------------------- 2003 2002 2001 EUR ThEUR ThEUR -------------- --------- --------- A. CAPITAL
I. CAPITAL STOCK 75,000.-- 75.0 75.0 III. OTHER PROFIT RESERVES 431,510.88 223.8 80.5 IV. PROFIT BROUGHT FORWARD 332,312.20 254.7 116.3 V. ANNUAL SURPLUS 85,847.57 287.2 284.3 -------------- --------- --------- Subtotal 924,670.65 840.7 556.1 VI. CURRENCY CONVERSION ./. 64,556.27 ./. 12.8 24.7 VII. SHARES OF OTHER SHAREHOLDERS 74,612.65 68.4 53.0 -------------- --------- --------- Total capital 934,727.03 896.3 633.8 ============== ========= =========
B. SPECIAL ITEM INCLUDING RESERVES 172,353.92 141.7 134.1 ============== ========= ========= C. RESERVES
1. Deferred taxes -.- 59.8 61.4 2. Tax reserves 44,372.89 91.3 166.6 4. Other reserves 49,342.84 46.3 47.7 -------------- --------- --------- Total reserves 93,715.73 197.4 275.7 ============== ========= ========= D. ACCOUNTS PAYABLE
2. Accounts payable to financial institutions 558,468.04 433.2 466.6 3. Advance payments received -,- 9.5 0.0 4. Accounts payable for goods and services 8,507.74 21.4 29.7 6. Accounts payable to shareholders 431,533.78 294.2 344.5 8. Other accounts payable 14,595.52 14.2 16.0 of which from taxes EUR 2,085.54 of which for social insurance EUR 5,470.61 -------------- --------- --------- Total accounts payable 1,013,105.08 772.5 856.8 ============== ========= =========
E. TRANSITORY ITEMS -.- 6.0 22.0 ============== ========= =========
TOTAL LIABILITIES AND EQUITY 2,213,901.76 2,013.9 1,922.4 ============== ========= =========
BAW GROUP STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
BAW GROUP STATEMENT OF SHAREHOLDERS' EQUITY DECEMBER 31, 2003
01.01.2003 addition deduction 12.31.2003 EUR EUR EUR EUR ---------- ----------- ----------- ------------
Capital stock 75,000.-- -.- -.- 75,000.-- Profit reserves 223,819.86 207,691.02 U -.- 431,510.88 Profit carry forward 254,685.66 287,233.54 U 207,691.02 U 1,915.98 2) 332,312.20 Annual surplus 287,233.54 85,847.57 1) 287,233.54 U 85,847.57 ---------- ----------- ----------- ------------ Subtotal 840,739.06 85,847.57 1,915.98 924,670.65 Shares of other shareholders 68,434.39 6,657.26 1) 479.-- 2) 74,612.65* Difference from conversion of currency ./. 12,835.89 -.- 51,720.38 ./. 64,556.27 ---------- ----------- ----------- ------------ Total equity 896,337.56 92,504.83 54,115.36 934,727.03 ========== =========== =========== ============
U = transfer 1) Annual surplus EUR 92,504.83 = EUR 85,847.57 + EUR 6,657.26 2) Capital adjustment due to government tax audit in Poland
* Breakdown and development equity of other shareholder
BAW GROUP STATEMENT OF SHAREHOLDERS' EQUITY DECEMBER 31, 2003
EQUITY OF OTHER SHAREHOLDERS' - -----------------------------
CONSOLIDATED 01.01.2003 (deductions) 12.31.2003 U=transfers EUR EUR EUR --- --- ---
Subscribed capital 7,719.52 -.- 7,719.52
Profit carry forward 45,228.92 15,485.95 U (479.--) 2) 60,235.87
Annual surplus 15,485.95 (15,485.95) U 6,657.26 6,657.26 ----------- ----------- ----------- 68,434.39 6,657.26 (479.--) 74,612.65 =========== =========== ===========
01.01.2003 additions deductions 12.31.2003 EUR EUR EUR EUR ----------- ----------- ----------- -----------
"AG BAG POLSKA" SP.ZO.O. Subscribed capital 4,820.60 -.- -.- 4,820.60 Profit carry forward 44,959.76 13,416.17 U (479.--) 2) 57,896.93 Annual surplus 13,416.17 5,897.77 13,416.17 U 5,897.77 ----------- ----------- ----------- ----------- 63,196.53 5,897.77 (479.--) 68,615.30 ----------- ----------- ----------- ----------- AG-BAG HUNGARIA KFT Subscribed capital 2,898.92 -.- -.- 2,898.92 Profit carry forward + 269.16 2,069.78 U -.- + 2,338.94 Annual surplus 2,069.78 759.49 2,069.78 U 759.49 ----------- ----------- ----------- ----------- 5,237.86 759.49 -.- 5,997.35 ----------- ----------- ----------- ----------- Total 68,434.39 6,657.26 (479.--) 74,612.65 =========== =========== =========== ===========
2) capital adjustment from investigation by tax authorities
BAW GROUP STATEMENTS OF CASH FLOWS
Years ended December 31, ---------------------------------- 2003 2002 2001 ThEUR ThEUR ThEUR ---------- --------- --------- I. OPERATING RESULTS Turnover 4,175.0 3,894.0 3,411.6 Changes in stocks and Inventories + 314.7 ./. 39.2 + 136.2 Other operational earnings 112.3 100.8 263.1 Material expenditure ./. 3,401.9 ./. 2,727.7 ./. 2,708.3 ---------- --------- --------- Gross profit 1,200.1 1,227.9 1,102.6
less Personnel expenditure 227.1 196.7 169.9 Depreciation (without special depr.) 299.5 144.8 151.5 Other expenditure 473,5 381.5 320.0 Other taxes 3.5 3.2 2.0 ---------- --------- --------- Operating results + 196.5 + 501.7 + 459.2 ========== ========= ========= II. FINANCIAL RESULTS Interest income 4.9 + 8.4 + 6.0 Interest expense ./. 27.4 ./. 35.4 ./. 39.5 ---------- --------- --------- ./. 22.5 ./. 27.0 ./. 33.5 ========== ========= ========= III. TAXES ON INCOME AND EARNINGS ./. 81.5 ./. 172.0 ./. 107.7 ========== ========= =========
IV. SUMMARY OF THE YEAR-END RESULT Operating result + 196.5 + 501.7 + 459.2 Financial result ./. 22.5 ./. 27.0 ./. 33.5 Taxes on income and earnings ./. 81.5 ./. 172.0 ./. 107.7 ---------- --------- --------- Results for the year + 92.5* + 302.7**+ 318.0*** ========== ========= =========
* Of which for other shareholders 6.7 ThEUR. ** Of which for other shareholders 15.5 ThEUR. *** Of which for other shareholders 33.7 ThEUR.
B) DYNAMIC LIQUIDITY ANALYSIS BY CASH FLOW PRESENTATION
Years ended December 31, ---------------------------------- 2003 2002 2001 ThEUR ThEUR ThEUR ---------- --------- --------- Annual surplus + 92.5 + 302.7 + 318.0 Depreciation + 299.5 + 144.8 + 151.5 ---------- --------- --------- Cash flow (after tax) + 392.0 + 447.5 + 469.5 Plus taxes + 81.5 + 172.0 + 107.7 ---------- --------- --------- Cash flow (before tax) + 473.5 + 619.5 + 577.2 ========== ========= =========
BAW GROUP NOTES TO FINANCIAL STATEMENTS
NOTE 1 - DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: - --------------------------------------------------
LEGAL STRUCTURE OF THE GROUP
The legal structure of the group complies with ss. 290 sub-p. 1 HGB. The parent company of the group is BAW Budissa Agrodienstleistungen und Warenhandels GmbH having its registered office at Malschwitz, Ortsteil Kleinbautzen. The subsidiaries of BAW Budissa Agrodienst-leistungen und Warenhandels GmbH - AG-BAG HUNGARIA KFT and "AG BAG Polska" Sp.zo.o. - are affiliated companies pursuant to ss. 271 sub-p. 2 HGB or, respectively, to ss. 290 sub-p. 2 HGB.
AG-BAG HUNGARIA KFT was incorporated February 11, 1999 in Gyor (Hungary) by cash subscription. BAW Budissa Agrodienstleistungen und Warenhandels GmbH holds 90 % of the shares of the corporation with a paid initial contribution of 6,300,000.--Forint. Mr. Csaba Szocs holds 10 % of the shares of the corporation with a paid initial contribution of 700,000.--Forint. In 2001 the capital was increased from 3,000,000.-- Forint by 4,000,000.-- Forint to 7,000,000.-- Forint.
"AG BAG Polska" Sp.zo.o. was incorporated on 08.19.1999 in Szelejewo Drugie (Republic of Poland) by cash subscription. BAW Budissa Agrodienstleistungen und Warenhandels GmbH holds 80 % of the shares of the corporation with a paid initial contribution of 80,000.-- Zloty. Mr. Karol Benedykt Glapiak and Ms Marta Kashyna paid an initial contribution of 10,000.-- Zloty each, and each of them holds 10 % of the shares of the corporation.
Both subsidiaries are registered in the respective Commercial Register. The average number of the employers during the business years was 13 people (p.y. 10).
PRINCIPLES OF CONSOLIDATION
a) Voluntary group accounts
Pursuant to the resolution adopted by the shareholders January 29, 2003 the corporation prepared the group accounts voluntarily as per December 31, 2003. The limits of ss. 293 HGB are not exceeded. The group accounts were prepared on the basis of the provisions of the commercial law. These are group accounts according to the commercial law only. Tax options were not used.
b) Cut-off Date and deferred valuation of the consolidated companies
BAW Budissa Agrodienstleistungen und Warenhandels GmbH as the parent company and the subsidiaries AG-BAG HUNGARIA KFT and "AG BAG Polska" Sp.zo.o. were included in the group accounts. The group accounts date is December 31, 2003. Both the parent company and the included subsidiaries prepared proper annual financial statements as of this cut-off date.
c) Breakdown of the group accounts and valuation principles
The group accounts and the group profit and loss account are shown and classified pursuant to the provisions of the commercial law regarding corporations. The requirements of ss.ss. 297 ff HGB were complied with.
Since the corporation is a joint venture, uniform valuation regulations had to be agreed for the group accounts.
Since the parent company has its registered office and its management in Germany, they agreed to use German valuation regulations for the present group accounts without considering tax privileges according to the German, Polish or Hungarian tax laws.
The balancing and valuation options were executed pursuant to ss. 300 sub-p. 2 HGB such that they meet the accounting standards of the USA (US GAAP).
As a result, pursuant to ss. 300 sub-p. 2 HGB a commercial balance sheet II had to be drawn up for the individual financial statements to be included (see Tz. 26 to ss. 300 HGB in Beck'scher Bilanzkommentar, 4. edition). In this commercial balance sheet II tax privileges were eliminated and uniform valuation principles were used. The currencies of the foreign individual financial statements were converted according to the concept of the functional currency. Pursuant to this concept the balance sheet had to be converted at the exchange rate date - except the equity which was valued at the historical rate - and the profit and loss account at the average rate.
Poland Hungary
Current rate 1 PLZ = 0.21228 EUR 1 HUF = 0.003831 EUR Average rate 1 PLZ = 0.23034 EUR 1 HUF = 0.004035 EUR
Fixed assets were valued on the basis of the initial costs less a linear pro rata temporis or degressive depreciation, respectively.
Stocks and inventories are valued at group manufacturing costs or cost prices considering the lowest value principle.
Accounts receivable and other assets are valued at their nominal value minus potential allowances for losses on individual bank loan accounts or retirements of accounts receivable.
Transitory items were shown pursuant to ss. 250 HGB.
The special item including reserves (allowances) was shown pursuant to the recommendations of the HFA-Stellungnahme 1/1984 of the Institut der Wirtschaftsprufer in Deutschland e.V.
Reserves take into account all risks apparent at the time. Accounts payable are shown at their repayment value.
d) Consolidation of Funds
For the capital consolidation the book-value method (ss. 301 sub-p. 1 no. 1 HGB) was applied, that is the valuation of the shares in the subsidiaries were set off against the equity of the subsidiaries, allocated to these shares, that corresponds to the book value of the assets and debts to be included in the group accounts. The difference amounting to EUR 4,072.28 was not capitalized as goodwill - different from what is required by ss. 301 sub-p. 3 HGB - but was deducted from the group capital (profit carry forward), since it includes only the costs for incorporation. The shares of other shareholders shown pursuant to ss. 307 HGB were taken into account.
e) Consolidation of Debts
According to the standard theory the mutual accounts receivable and accounts payable existing between the companies included in the group accounts were set off pursuant to ss. 303 sub-p. 1 HGB. The total amount of the mutual accounts receivable and accounts payable that were set off amounts to 164.6 ThEUR. 11.0 ThEUR was shown as money being transferred (from Hungary to Germany).
f) Interim result elimination
In the financial year 2003, like in the previous years, interim results were eliminated, see ss. 304 sub-p. 1 HGB. A total of EUR 21,913.25 was debited as expenditure. This was necessary for the readjustment of the valuation of the finished products and goods to group-uniform manufacturing costs.
g) Expenditure and Income Consolidation
The expenditure and earnings from the mutual supply and service transactions were set off against one another amounting to 736.5 ThEUR.
h) Deferred taxation
Deferred taxation was made according to ss. 274 HGB and ss. 306 HGB as follows:
a) In the commercial balance sheet II of BAW Budissa Agrodienstleistungen und Warenhandels GmbH the tax option was eliminated pursuant to ss. 7 g EStG (ss. 300 sub-p. 2 HGB).
b) The item of deferred taxes in the group accounts was currently adjusted in the year under review starting from 01.01.2003.
c) National differences in the tax rates were kept.
LISTING OF THE SUBSIDIARIES OF THE GROUP
The following subsidiaries were included in the group accounts:
Name and reg.office Share Capital Results for the financial year of Stock parent in national company trade balance II in % in EUR currency in EUR
AG-BAG HUNGARIA KFT registered office at Mosonmagyarovar (Hungary) 90 *28,989.23 + 1,881,095.45 HUF + 7,594.92
"AG BAG Polska" Sp.zo.o. registered office at Szelejewo Drugie (Republic of Poland) 80 *24,102.-- + 128,023.07 zl. + 29,488.84
* historical exchange rate
The subsidiaries have not acquired shares in the parent company in the year under report.
NOTE 2 - COMMITMENTS AND CONTINGENCIES - --------------------------------------
Contingent Liabilities and other Financial Obligations:
There are no contingent liabilities or other financial obligations.
NOTE 3 - BREAKDOWN AND EXPLANATION OF THE ITEMS OF THE BALANCE SHEET - --------------------------------------------------------------------
1. FIXED ASSETS - EUR 1,041,176.69 - ----------------------------------
The composition and development of fixed assets are listed in Exhibit 1.
2. RAW MATERIALS, AUXILIARIES AND MEDIA - EUR 10,157. - ----------------------------------------------------
Classification:
Company Valuation EUR p.y.ThEUR
BAW Budissa Agrodienst- leistungen und Waren- packaging material handels GmbH and small parts 10,157.-- 11.1 =========== ===========
An interim profit elimination was not necessary since no intra- group deliveries are included.
3. UNFINISHED PRODUCTS AND GOODS - EUR 77,740.84 - ------------------------------------------------
Classification: EUR p.y.ThEUR
BAW Budissa Agrodienstleistungen und Warenhandels GmbH 77,740.84 0.0 =========== ===========
Unfinished products were valued at manufacturing costs. An interim result elimination was not necessary.
4. FINISHED PRODUCTS AND GOODS - EUR 442,855.85 - -----------------------------------------------
Classification: EUR p.y.ThEUR
BAW Budissa Agrodienstleistungen und Warenhandels GmbH -.- 41.2 "AG BAG Polska" Sp.zo.o. 353,958.73 154.6 AG-BAG HUNGARIA KFT 88,897.12 10.1 ---------- ----- 442,855.85 205.9 ========== =====
For stocks and inventories an interim result elimination of a total of EUR 21,913.25 was made, of which EUR 5,657.-- include stocks and inventories in Hungary and EUR 16,256.25 in Poland.
5. ACCOUNTS RECEIVABLE FROM GOODS AND SERVICES - EUR 382,745.29 - --------------------------------------------------------------
Classification: EUR p.y.ThEUR
BAW Budissa Agrodienstleistungen und Warenhandels GmbH 81,944.85 22.4 "AG BAG Polska" Sp.zo.o. 253,537.58 230.0 AG-BAG HUNGARIA KFT 47,262.86 94.9 ---------- ----- 382,745.29 347.3 ========== =====
The reserve from last year ThEUR 31.0 was utilized during the current year.
6. OTHER ASSETS - EUR 72,837.13 - -------------------------------
Classification: EUR p.y.ThEUR BAW Budissa Agrodienstleistungen und Warenhandels GmbH 8,779.72 3.1 "AG BAG Polska" Sp.zo.o. 59,234.84 15.3 AG-BAG HUNGARIA KFT 4,822.57 0.0 --------- ---- 72,837.13 18.4 ========= ====
Specified as follows: EUR Repayment of turnover tax (D) 7,920.76 Repayment of turnover tax (P) 51,556.80 Repayment of corporate tax(P) 6,838.39 Repayment of turnover tax (H) 3,246.26 Repayment of corporate tax (H) 1,183.79 Repayment of trade tax(H) 392.52 --------- Total repayments 71,138.52 Interest limitation premium (D) 858.96 Insurance fund (P) 839.65 --------- Total 72,837.13 =========
7. CHEQUES, CASH IN HAND, BALANCES AT BUNDESBANK AND POSTBANK, BALANCES AT FINANCIAL INSTITUTIONS - EUR 163,720.99 - ----------------------------------------------------
Classification: BAW Budissa Agro- "AG BAG AG-BAG group dienstleistungen Polska" HUNGARIA und Warenhandels sp.zo.o. KFT GmbH in EUR EUR EUR EUR p.y.ThEUR Cash in bank 125,735.56 8,262.64 14,849.52 148,847.72 604.4 Cash on hand 821.15 2,548.74 503.38 3,873.27 3.9 Transfers within the group -.- -.- 11,000.-- 11,000.-- 13.0 ---------- --------- --------- ---------- ----- 126,556.71 10,811.38 26,352.90 163,720.99 621.3 ========== ========= ========= ========== =====
8. DEFERRED ITEMS - EUR 13,902.67 - ---------------------------------
Classification: EUR p.y.ThEUR BAW Budissa Agrodienstleistungen und Warenhandels GmbH 12,904.25 2.0 "AG BAG Polska" Sp.zo.o. 772.46 0.7 AG-BAG HUNGARIA KFT 225.96 0.7 --------- --- 13,902.67 3.4 ========= ===
For all companies these items include advance financial expenditures for technical equipment and vehicles as well as loan fees.
9. SPECIAL ITEM INCLUDING RESERVES - EUR 172,353.92 - ---------------------------------------------------
Classification and development: as per allocation as per 12.31.2002 (reversal) 12.31.2003 EUR EUR EUR
Investment grant 141,711.75 54,000.-- (23,357.83) 172,353.92 ========== ========= ==========
These are subsidies provided by Sachsische Aufbaubank (GA-Fordermittel) paid out to BAW Budissa Agrodienstleistungen und Warenhandels GmbH.
10. DEFERRED TAXES - EUR ZERO - -----------------------------
Development: EUR As of 12.31.2002 59,755.05 Minus: Transfer in tax reserves ./. 59,755.05 --------- -.- =====
In the previous year the deferred taxation corresponded to 40 % of the tax-free reserves pursuant to ss. 7g EStG at BAW GmbH. The formation of this item was made in HB II. In the current year the reserve was completely reversed. For this reason the deferred taxes were reversed.
11. TAX RESERVES - EUR 44,372.89 - --------------------------------
Classification and development: as per allocation as of 12.31.2002 (consumption) 12.31.2003 (release)* Trade income tax EUR EUR EUR
2001 44,936.42 (44,936.42) -.- 2002 19,032.-- -.- 19,032.-- 2003 -.- 2,746.-- 2,746.-- Corporate tax
2001 3,825.49 (4,373.09) U 547.60 -.- 2002 21,569.92 (4,375.--) 17,194.92 2003 -.- 4,221.88 4,221.88 Reunification charge
2001 788.37 (240.55) U (547.60) (0.22)* -.- 2002 1,186.43 (240.62) 945.81 2003 -.- 232.28 232.28 --------- --------- --------- 91,338.63 7,200.16 (54,165.68) (0.22)* 44,372.89 ========= ========= =========
For the group accounts as per 12.31.2003 the respective national tax rates were used. The tax reserve applies only to BAW GmbH.
12. OTHER RESERVES - EUR 49,342.84 - ----------------------------------
The other reserves include expenses for guaranties/warranties, drawing up and auditing of the annual statement of accounts, fees to IHK and trade associations as well as backlog of vacation. These reserves cover all discernable risks and obligations.
13. LIABILITIES - EUR 1,013,105.08 - ----------------------------------
Accounts payable Total Breakdown according to periods ------------------------------ amount up to 1 y. up to 5 y. 5 y.+ more EUR EUR EUR EUR
to credit institutions 558,468.04 144,386.26 325,335.45 88,746.33
for goods and services 8,507.74 8,507.74 -.- -.-
to shareholders 431,533.78 176,425.03 255,108.75 -.-
Other* 14,595.52 14,595.52 -.- -.- ------------ ---------- ---------- --------- Total 1,013,105.08 343,914.55 580,444.20 88,746.33 ============ ========== ========== =========
* of which from taxes EUR 2,085.54 of which for social insurance EUR 5,470.61
NOTE 4 - BREAKDOWN AND EXPLANATION OF THE INCOME STATEMENT ITEMS - ---------------------------------------------------------------
1. TURNOVER - EUR 4,175,003.54 (P.Y. 3.894.0 THEUR) - -------------------------------------------------------
Classification:
BAW Budissa Agro- "AG BAG AG-BAG dienstleistungen Polska" HUNGARIA und Warenhandels Sp.zo.o. KFT group GmbH in EUR EUR EUR EUR
Proceeds from sale of goods 1,910,268.32 1,434,235.50 378,580.87 3,723,084.69 Proceeds from Services -.- 437,457.19 13,485.26 450,942.45 Other turnover 976.40 -.- -.- 976.40 ------------ ------------ ---------- ------------ 1,911,244.72 1,871,692.69 392,066.13 4,175,003.54 ============ ============ ========== ============
2. OTHER OPERATIONAL EARNINGS - EUR 112,289.09 - ----------------------------------------------
Classification: BAW Budissa Agro- "AG BAG AG-BAG dienstleistungen Polska" HUNGARIA und Warenhandels Sp.zo.o. KFT group GmbH in EUR EUR EUR EUR
77,534.92 28,134.33 6,619.84 112,289.09 ========= ========= ======== ==========
3. EXPENDITURE ON RAW MATERIALS, AUXILIARIES AND MEDIA - EUR 2,955,079.19 - ---------------------------------------------------------
Classification: BAW Budissa Agro- "AG BAG AG-BAG dienstleistungen Polska" HUNGARIA und Warenhandels Sp.zo.o. KFT group GmbH in EUR EUR EUR EUR
1,713,451.72 1,047,946.30 193,681.17 2,955,079.19 ============ ============ ========== ============
4. EXPENDITURE ON OUTSOURCED SERVICES - EUR 446,825.71 - -----------------------------------------------------
Classification: BAW Budissa Agro- "AG BAG AG-BAG dienstleistungen Polska" HUNGARIA und Warenhandels Sp.zo.o. KFT group GmbH in EUR EUR EUR EUR
270,102.05 168,280.62 8,443.04 446,825.71 ========== ========== ======== ==========
5. PERSONNEL EXPENDITURE - EUR 227,191.38 - -----------------------------------------
Classification: EUR p.y.ThEUR a) Wages and salaries BAW Budissa Agrodienstleistungen und Warenhandels GmbH 98,427.91 82.7 "AG BAG Polska" Sp.zo.o. 61,626.59 56.0 AG-BAG HUNGARIA KFT 23,263.70 21.9 ---------- ----- Subtotal wages and salaries 183,318.20 160.6 ---------- -----
5. PERSONNEL EXPENDITURE - EUR 227,191.38 (CONTINUED) - -----------------------------------------------------
EUR p.y.ThEUR b) Social security contributions
BAW Budissa Agrodienstleistungen und Warenhandels GmbH 22,974.44 17.9
"AG BAG Polska" Sp.zo.o. 12,944.26 10.9
AG-BAG HUNGARIA KFT 7,954.48 7.3 --------- ---- Subtotal Social security contributions 43,873.18 36.1 --------- ---- Total personnel expenditure 227,191.38 196.7 ========== =====
6. DEPRECIATION ON TANGIBLE ASSETS - EUR 299,462.17 - --------------------------------------------------
Classification: EUR p.y.ThEUR
BAW Budissa Agrodienstleistungen und Warenhandels GmbH 272,531.89 111.6
"AG BAG Polska" Sp.zo.o. 12,433.75 18.2
AG-BAG HUNGARIA KFT 14,496.53 15.0 ---------- ----- 299,462.17 144.8 ========== =====
An exact specification is shown in Exhibit 1, List of Fixed Assets.
7. OTHER OPERATIONAL EXPENDITURE - EUR 473,488.92 - -------------------------------------------------
Classification:
BAW Budissa Agro- "AG BAG AG-BAG dienstleistungen Polska" HUNGARIA und Warenhandels Sp.zo.o. KFT group GmbH in EUR EUR EUR EUR
244,518.84 186,026.30 42,943.78 473,488.92 ========== ========== ========= ==========
8. OTHER INTEREST AND SIMILAR EARNINGS - EUR 4,915.44 - ----------------------------------------------------
Classification: EUR p.y.ThEUR BAW Budissa Agrodienstleistungen und Warenhandels GmbH 4,177.09 2.8
"AG BAG Polska" Sp.zo.o. 629.03 4.1
AG-BAG HUNGARIA KFT 109.32 1.5 -------- --- 4,915.44 8.4 ======== ===
These are interest earnings from time deposit accounts, current accounts and other interest.
9. INTEREST AND SIMILAR EXPENDITURE - EUR 27,387.48 - ---------------------------------------------------
Classification: EUR p.y.ThEUR
BAW Budissa Agrodienstleistungen und Warenhandels GmbH 27,262.11 28.1
"AG BAG Polska" Sp.zo.o. 125.37 3.8
AG-BAG HUNGARIA KFT -.- 3.5 --------- ---- 27,387.48 35.4 ========= ====
10. TAX ON INCOME AND EARNINGS - EUR 81,461.99 - ----------------------------------------------
Classification: EUR p.y.ThEUR
BAW Budissa Agrodienstleistungen und Warenhandels GmbH 112,758.52 130.5
"AG BAG Polska" Sp.zo.o. 30,221.30 29.3
AG-BAG HUNGARIA KFT 2,858.55 6.8 ---------- ----- Subtotal national taxes 145,838.37 166.6
less: Retirement of deferred taxes BAW-GmbH for reversal of savings reserve (p.y. for tax reductions) in CBS II ./. 59,755.05 ./. 1.6
less: New formation of deferred taxes ./. 4,621.33 + 7.0 --------- ----- 81,461.99 172.0 ========= =====
11. OTHER TAXES - EUR 3,471.29 - ------------------------------
Classification: EUR p.y.ThEUR
BAW Budissa Agrodienstleistungen und Warenhandels GmbH 1,596.03 1.6
"AG BAG Polska" Sp.zo.o. 1,864.67 1.5
AG-BAG HUNGARIA KFT 10.59 0.0 -------- --- 3,471.29 3.1 ======== ===
This item includes property and motor vehicle tax.
RECONCILIATION OF GERMAN GAAP TO U.S. GAAP - ------------------------------------------
The primary difference between the generally accepted accounting principles (GAAP) of Germany and the United States is that German GAAP allows for the special reserve for a company's economic development plans. This reserve, and related tax impact, would not be recognized under U.S. GAAP. The following is a reconciliation of affected balance sheet and profits and loss accounts for the differences between German GAAP and U.S. GAAP:
BAW GROUP
EXHIBIT 1 LIST OF FIXED ASSSETS
BAW GROUP EXHIBIT 2 EURO EXCHANGE RATE
High Low Rate at During During Average Year December, 31, Year Year Rate - ---- ------------- ------ ------ ------- 2003 1.2552 1.2562 1.0333 1.1321 2002 1.0481 1.0497 0.8560 0.9459 2001 0.8858 0.9597 0.8344 0.9138 2000 0.9416 1.0419 0.8226 0.9728 1999 1.0040 1.1960 0.9986 1.0667 1998 1.1669 1.2324 1.0532 1.1135
EXHIBIT INDEX ------------- EXHIBIT NUMBER DESCRIPTION OF EXHIBIT - ------- ----------------------
3.1 Restated Certificate of Incorporation(2)
3.2 Bylaws of the Company(2)
4.1 Form of Common Stock Certificate(1)
4.3 Warrant dated February 13, 1995, to Norwood Venture Corp.(2)
10.1 Employment Contract of Larry R. Inman(1)*
10.2 Form of Change of Control Agreement between the Company and each of its executive officers and key employees(4)*
10.3 1991 Employee Stock Plan, as amended effective November 1, 1996(3)*
10.4 Incentive Stock Option Plan, as amended effective November 1, 1996(3)*
10.5 Non-employee Director Stock Option Plan(3)*
10.6 Credit and Security Agreement with Wells Fargo Credit, Inc. effective May 13, 2003
10.7 First Amendment to Credit and Security Agreement
10.8 Second Amendment to Credit and Security Agreement
11 Statement re computation of earnings per share
12 Statement re computation of ratios
21 Subsidiaries of Registrant
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
* Management contract or compensatory plan (1) Filed as exhibit to the Form S-1 Registration No. 33-46115 (2) Filed as exhibit to the Form 10-K for the fiscal year ended December 31, (3) Filed as exhibit to the Form 10-K for the fiscal year ended December 31, (4) Filed as exhibit to the Form 10-K for the fiscal year ended December 31,