10-Q 1 d17701e10vq.txt FORM 10-Q SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2003 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM __________ TO ___________ COMMISSION FILE NUMBER: 0-26096 THE UNIMARK GROUP, INC. ----------------------- UNIMARK HOUSE 124 MCMAKIN ROAD BARTONVILLE, TEXAS 76226 REGISTRANT'S TELEPHONE NUMBER: (817) 491-2992 STATE OF INCORPORATION IRS EMPLOYER IDENTIFICATION NO. ---------------------- ------------------------------- TEXAS 75-2436543 INDICATE BY CHECK MARK WHETHER THE REGISTRANT (1) HAS FILED ALL REPORTS REQUIRED TO BE FILED BY SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 DURING THE PRECEDING 12 MONTHS (OR FOR SUCH SHORTER PERIOD THAT THE REGISTRANT WAS REQUIRED TO FILE SUCH REPORTS), AND (2) HAS BEEN SUBJECT TO SUCH FILING REQUIREMENTS FOR THE PAST 90 DAYS. YES [ ] NO [X] INDICATE BY CHECK MARK WHETHER THE REGISTRANT IS AN ACCELERATED FILER (AS DEFINED IN EXCHANGE ACT RULE 12b-2). YES [ ] NO [X] AS OF AUGUST 12, 2004, THERE WERE 21,044,828 SHARES OF COMMON STOCK, PAR VALUE $0.01 PER SHARE, OUTSTANDING. 1 INDEX
PAGE PART I FINANCIAL INFORMATION Item 1. Financial Statements (Unaudited) Condensed Consolidated Balance Sheets - December 31, 2002 and September 30, 2003............................................... 3 Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2002 and 2003........................ 4 Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2002 and 2003.................................. 5 Notes to Condensed Consolidated Financial Statements - September 30, 2003................ 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.......................................................... 19 Item 3. Quantitative and Qualitative Disclosures About Market Risks.............................. 35 Item 4. Controls and Procedures................................................................. 35 PART II OTHER INFORMATION Item 1. Legal Proceedings........................................................................ 36 Item 2. Changes in Securities and Use of Proceeds................................................ 37 Item 3. Defaults Upon Senior Securities.......................................................... 37 Item 4. Submission of Matters to a Vote of Security Holders...................................... 37 Item 5. Other Information........................................................................ 37 Item 6. Exhibits and Reports on Form 8-K......................................................... 38 SIGNATURES......................................................................................... 39 EXHIBIT INDEX...................................................................................... 40
2 PART I FINANCIAL INFORMATION ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) THE UNIMARK GROUP, INC. CONDENSED CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT FOR SHARE AND PER SHARE AMOUNTS)
DECEMBER 31, SEPTEMBER 30, 2002 2003 ------------ ------------- (NOTE 1) (UNAUDITED) ASSETS Current assets: Cash and cash equivalents ........................................... $ 406 $ 7,628 Accounts receivable - trade, net of allowance of $1,118 in 2002 and $571 in 2003 ............................................ 736 609 Accounts receivable - other ......................................... 246 428 Notes receivable .................................................... 310 470 Income and value added taxes receivable ............................. 909 949 Inventories ......................................................... 5,221 4,296 Prepaid expenses .................................................... 199 179 -------- -------- Total current assets .......................................... 8,027 14,559 Property, plant and equipment, net ..................................... 32,486 17,051 Deposit on plant facility .............................................. 2,044 1,821 Note receivable, less current portion .................................. -- 320 Other assets ........................................................... 218 121 -------- -------- Total assets .................................................. $ 42,775 $ 33,872 ======== ======== LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Short-term borrowings ............................................... $ 100 $ -- Short-term and long-term debt in default ............................ 8,529 6,310 Current portion of long-term debt ................................... 28 19 Accounts payable - trade ............................................ 4,401 3,020 Accrued liabilities ................................................. 4,621 5,049 -------- -------- Total current liabilities ..................................... 17,679 14,398 Long-term debt, less current portion ................................... 4,622 4,356 Deferred Mexican statutory profit sharing .............................. 1,443 411 Other long-term liability .............................................. 1,434 1,704 -------- -------- Total liabilities ............................................. 25,178 20,869 -------- -------- Commitments and contingencies Shareholders' equity: Common stock, $0.01 par value: Authorized shares - 40,000,000 Issued and outstanding shares - 21,044,828 in 2002 and 2003 ................................................... 210 210 Additional paid-in capital .......................................... 68,671 68,671 Accumulated deficit ................................................. (51,284) (55,878) -------- -------- Total shareholders' equity .................................... 17,597 13,003 -------- -------- Total liabilities and shareholders' equity .................... $ 42,775 $ 33,872 ======== ========
See accompanying notes. 3 THE UNIMARK GROUP, INC. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, -------------------------- --------------------------- 2002 2003 2002 2003 --------- --------- --------- --------- (In thousands, except for per share amounts) Net sales .................................... $ 5,435 $ 6,088 $ 20,197 $ 21,399 Cost of products sold ........................ 6,536 6,405 21,062 20,985 -------- -------- -------- -------- Gross profit (loss) .......................... (1,101) (317) (865) 414 Selling, general and administrative expenses.. 846 1,123 2,884 2,334 Impairment of long-lived assets .............. -- -- -- 232 -------- -------- -------- -------- Loss from operations ......................... (1,947) (1,440) (3,749) (2,152) Other income (expense): Interest expense .......................... (130) (600) (329) (815) Other income (expense), net ............... 51 (178) 242 (218) Foreign currency translation gain (loss) .. (104) (368) 304 (920) -------- -------- -------- -------- (183) (1,146) 217 (1,953) -------- -------- -------- -------- Loss before income taxes ..................... (2,130) (2,586) (3,532) (4,105) Income tax expense ........................... 169 163 786 489 -------- -------- -------- -------- Net loss ..................................... $ (2,299) $ (2,749) $ (4,318) $ (4,594) ======== ======== ======== ======== Basic and diluted net loss per share ......... $ (0.11) $ (0.13) $ (0.21) $ (0.22) ======== ======== ======== ========
See accompanying notes. 4 THE UNIMARK GROUP, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
NINE MONTHS ENDED SEPTEMBER 30, ----------------------- 2002 2003 --------- --------- (IN THOUSANDS) OPERATING ACTIVITIES Net loss ............................................................. $ (4,318) $ (4,594) Adjustments to reconcile net loss to net cash provided by (used in) Operating activities: Depreciation ..................................................... 1,251 1,650 Deferred Mexican statutory profit sharing ........................ (151) (1,032) Impairment of long-lived assets .................................. -- 232 Loss on disposal of property and equipment ....................... -- 474 Cash provided by (used in) operating working capital: Receivables .................................................. 1,564 (575) Inventories .................................................. 3,178 925 Prepaid expenses ............................................. 121 20 Accounts payable and accrued liabilities ..................... 155 (783) Other long-term liability .................................... 30 270 -------- -------- Net cash provided by (used in) operating activities .................. 1,830 (3,413) -------- -------- INVESTING ACTIVITIES Purchases of property and equipment .................................. (1,632) (626) Proceeds from the rescission of all contract rights relating to the growing and processing of Italian lemons .......................... -- 12,500 Proceeds from sale of the Poza Rica property, plant and equipment .... -- 1,035 Decrease in deposit on plant facility ................................ 205 223 Decrease (increase) in other assets .................................. (31) 97 -------- -------- Net cash (used in) provided by investing activities .................. (1,485) 13,229 -------- -------- FINANCING ACTIVITIES Proceeds from short-term promissory notes ............................ -- 560 Payment of short-term promissory notes ............................... -- (660) Net reductions of short-term debt, short and long-term debt in default and current portion of long-term debt ............................ (999) (2,228) Change in long-term debt ............................................. (21) (266) -------- -------- Net cash used in financing activities ................................ (1,020) (2,594) -------- -------- Net increase (decrease) in cash and cash equivalents ................. (648) 7,222 Cash and cash equivalents at beginning of period ..................... 1,135 406 -------- -------- Cash and cash equivalents at end of period ........................... $ 487 $ 7,628 ======== ========
See accompanying notes. 5 THE UNIMARK GROUP, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 2003 NOTE 1 - SIGNIFICANT ACCOUNTING POLICIES Description of Business: The UniMark Group, Inc., a Texas corporation, ("we," "us," "our" and the "company") is a citrus and tropical fruit growing and processing company with substantially all of its operations in Mexico. The company was organized in 1992 to combine the packaged fruit operations of a Mexican citrus and tropical fruit processor, which commenced operations in 1974, with UniMark Foods, Inc. ("UniMark Foods") a company that marketed and distributed products in the United States. We conduct substantially all of our operations through our operating subsidiaries. In Mexico, our operating subsidiaries include: Industrias Citricolas de Montemorelos, S.A. de C.V. ("ICMOSA") and Grupo Industrial Santa Engracia, S.A. de C.V. ("GISE"). In the United States, our subsidiary is UniMark Foods. Historically, we have, for operating and financial reporting purposes, classified our business into two distinct business segments: packaged fruit and juice and oil. Due to the continued unfavorable and volatile worldwide market prices of frozen concentrate orange juice ("FCOJ") that existed over the past several years and negative long-term prospects for the FCOJ market, we explored various strategic alternatives for our juice and oil business segment and decided to discontinue our FCOJ line of business and sell all of its production assets. Upon the divestiture of our juice and oil division's remaining assets, our business segments for operating and financial reporting purposes will consist of two distinct business segments: packaged fruit and agricultural operations. Within our packaged fruit business segment, we focus on niche citrus and tropical fruit products including chilled, frozen and canned cut fruits and other specialty food ingredients. The packaged fruit business segment processes and packages our products at three processing plants in Mexico. Our Mexican plants are located in major fruit growing regions. We utilize independent food brokers to sell our foodservice and industrial products in the United States. Sales to our Japanese customers are facilitated through Japanese trading companies. On August 31, 2000, we sold to Del Monte Foods Company ("Del Monte") all of our interests in our worldwide rights to the Sunfresh(R), Fruits of Four Seasons(R) and Flavor Fresh(TM) brands, our McAllen, Texas distribution facility, including certain inventory associated with our retail and wholesale club business and other property and equipment. Separately, we entered into a 5-year supply agreement with Del Monte under which we have been contracted to produce chilled and canned citrus products for Del Monte's retail and wholesale club markets. Under the terms of the agreement, Del Monte has agreed to purchase minimum quantities of our citrus products at agreed upon prices for sale in the United States. We retained the rights to our foodservice, industrial and Japanese business. Also, we were granted by Del Monte a 5-year license for the rights to the Sunfresh(R), Fruits of Four Seasons(R) and Flavor Fresh(TM) brands for specific areas, including Europe, Asia, the Pacific Rim and Mexico. In March 2003, we received formal offers from The Coca-Cola Export Corporation, Mexico Branch ("Coca-Cola") to purchase our Victoria juice and oil plant and rescind certain contract rights for the growing and processing of Italian lemons for aggregate cash payments by Coca-Cola of $16.0 million. In April 2003, we consummated the portion of the transaction with Coca-Cola pertaining to the rescission of all contract rights and obligations for the growing and processing of Italian lemons for an aggregate cash payment of $12.5 million, plus value added taxes. In this regard, we retained the approximately 7,100 acres of land, of which 4,800 acres are currently planted with lemon trees. We also retained all of the irrigation systems and related agricultural property and equipment. As part of the sale agreement we are contractually restricted from industrially processing our lemons and are limited in marketing our lemons solely as fresh fruit until July 30, 2007. The proceeds from the rescission of the contract rights were offset against our capitalized orchard development costs during the second quarter of 2003, which were classified in property, plant and equipment in our condensed consolidated balance sheet at December 31, 2002. 6 In June 2003, we sold our Poza Rica juice plant to an unaffiliated third party for $1.0 million, plus value added taxes of $120,000. Through May 31, 2004, total payments received amounted to $585,000 with the remaining balance of $570,000 payable in three remaining installments in 2004 under a promissory note. On June 30, 2004, we received payment of $541,500 in full satisfaction of this obligation. Effective November 17, 2003, we closed the sale of our Victoria juice and oil plant to Coca-Cola, for a cash payment of $3.5 million, plus value added taxes. Through May 31, 2004, of the $16.0 million proceeds, net of value added taxes, from the Coca-Cola transactions, approximately $5.3 million have been used to pay past due accounts payable, current operating expenses of our lemon groves, operating expenses of our juice and oil processing plants prior to sale, severance payments to former plant and administrative employees of the juice division, corporate expense charges, repay the Cooperative Centrale Raiffeisen-Boerenleenbank B.A. ("Rabobank Nederland") loan of $1.5 million, repay the Banco Nacional de Mexico, S.A., ("Banamex") loans of $558,000 and repayment of bridge loans to our largest shareholder, M&M Nominee, LLC ("M&M Nominee") of $368,000. The remaining cash of approximately $8.2 million is anticipated to be used to pay operating expenses of the lemon groves, repay Fondo de Capitalizacion e Inversion del Sector Rural ("FOCIR"), provide working capital for our continuing operations and/or distributed to our shareholders upon a potential liquidation of the company (See below - Decision to Explore Strategic Alternatives.) Cash disbursements for purposes other than those associated with GISE's juice division and agricultural operations were subject to the 9-year term financing agreement (the "FOCIR Agreement") with FOCIR, a public Trust of the Mexican Federal Government that invests in agricultural projects with long-term viability and required their prior approval for disbursement. On August 4, 2004, the company and FOCIR entered into a new agreement that restructured its debt into a $47.0 million Mexico peso (approximately U.S. $4.1 million) secured term loan. Under the terms of the restructured agreement, FOCIR agreed to forgive all accreted interest (approximately $2.0 million) and changed the repayment terms to a seven year note payable in increasing amounts with the first annual principal payment due in October 2005 with interest payable quarterly at the rate of 2.5% plus Certificados de la Testorenia de la Federation (CETES), the Mexican Treasury Bill rate which is currently around 6.7%. The FOCIR debt is secured by a first lien on our El Cielo lemon grove. Decision to Explore Strategic Alternatives: With the completion of the sale of our Victoria juice and oil plant and related processing equipment, our juice and oil business segment consists exclusively of our Italian lemon groves. Given the increased costs associated with being a public company, the lack of liquidity for our common stock, the liquidity problems at ICMOSA (see discussion in Note 2 - "Recent Developments Impacting Liquidity and Capital Resources") and the operational challenges facing the company, to maximize shareholder value, we are exploring available strategic alternatives, including the sale of all or a part of the company, its productive assets and strategic partnering relationships for the growing, distribution and marketing of fresh lemons. Our Board of Directors has engaged ComStock Valuation Advisors to assist the Board in reviewing the terms of a non-binding proposal received for the purchase of our packaged fruit business segment. No assurances can be given that our efforts will be successful. Interim Financial Statements: The condensed consolidated financial statements at September 30, 2003, and for the three and nine month periods then ended are unaudited and reflect all adjustments (consisting only of normal recurring adjustments) which are, in the opinion of management, necessary for a fair presentation of the financial position and operating results for the interim period. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto, together with Management's Discussion and Analysis of Financial Condition and Results of Operations, contained in our Annual Report on Form 10-K for the year ended December 31, 2002 filed with the Securities and Exchange Commission ("SEC"). The results of operations for the three and nine months ended September 30, 2003 are not necessarily indicative of future financial results. Year End Balance Sheet: The condensed consolidated balance sheet at December 31, 2002 has been derived from the audited consolidated financial statements at that date but does not include all of the 7 information and footnotes required by generally accepted accounting principles for complete financial statements. Risk Factors: Our operations are subject to risk factors that could impact our business. These factors include risks relating to our financial condition, our Mexican operations, general business risks and our common stock. Risks relating to our financial condition include the fact that one of our Mexican banks has recently exercised its legal rights and remedies and we may be forced to seek protection under applicable provisions of the Mexican bankruptcy code; we are experiencing significant liquidity problems at one of our Mexican subsidiaries; that we may continue to sustain losses and accumulated deficits in the future; that we are dependent upon a limited number of customers, particularly Del Monte; that we may lose our net operating loss carryforwards, which could prevent us from offsetting future taxable income in the United States; that we have been unable to file our annual Form 10-K and periodic report for our fiscal year ended December 31, 2003 and our Form 10-Q report for our first quarter of 2004 with the SEC; that if the conditions or assumptions differ from the judgments, assumptions or estimates used in our critical accounting policies, the accuracy of our financial statements and related disclosures could be affected; and that we are subject to risks associated in implementation of our business strategy. Risks relating to our Mexican operations include the fact that we are subject to the risk of fluctuating foreign currency exchange rates and inflation; that we are dependent upon fruit growing conditions, access and availability of water and the price of fresh fruit; that we are subject to governmental laws that relate to ownership of rural lands in Mexico; that labor shortages and union activity could affect our ability to hire and we are dependent on the Mexican labor market; that we are subject to statutory employee profit sharing in Mexico; that we are subject to volatile interest rates in Mexico which could increase our capital costs; and that trade disputes between the United States, Mexico, Japan and Europe could result in tariffs, quotas and bans on imports, including our products, which could impair our financial condition. General business risk include the fact that we may be subject to product liability and product recall; that we are subject to governmental and environmental regulations; that we are dependent upon our management team; that we have a seasonal business; that we face strong competition; that we have a significant shareholder that has substantial control over our company and can affect virtually all decisions made by our shareholders and directors; and we are subject to recent legislative actions and potential new accounting pronouncements. Risks relating to our common stock include the delisting from the Over-the-Counter Bulletin Board has further reduced the liquidity and marketability of our common stock and may further depress the market price of our common stock; that "Penny Stock" regulations may impose restrictions on marketability of our stock; that our common stock price has been and may continue to be highly volatile; and that we have never paid a dividend. For a discussion of additional factors that may affect actual results, investors should refer to our filings with the SEC and those factors listed under "Risk Factors" starting on page 27 of this Form 10-Q. Recently Adopted Accounting Pronouncements: In August 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 143, "Accounting for Asset Retirement Obligations," which establishes the accounting standards for the recognition and measurement of obligations associated with the retirement of tangible long-lived assets. Under SFAS No. 143, legal obligations associated with the retirement of long-lived assets will be recorded as a liability when the retirement obligation arises, and the cost capitalized as part of the related long-lived assets and amortized over the life of the assets. SFAS No. 143 is effective for fiscal years beginning after June 15, 2002. The adoption of SFAS No. 143 on January 1, 2003 did not have any impact on our condensed consolidated financial position or results of operations. In April 2002, the FASB issued SFAS No. 145, "Rescission of SFAS Nos. 4, 44 and 64, Amendment of SFAS No. 13, and Technical Corrections." This pronouncement, among other things, requires certain gains and losses on the extinguishment of debt previously treated as extraordinary items to be classified as income or loss from continuing operations. SFAS No. 145 is effective for fiscal years beginning after May 15, 2002. We elected to adopt SFAS No. 145 in 2002 related to a previously reported gain from the settlement of certain debt with a Mexican bank, and reclassified the amount previously reported as an extraordinary amount to other income. 8 In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities." This pronouncement addresses the financial accounting and reporting costs associated with an exit activity (including restructuring) or with a disposal of long-lived assets. SFAS No. 146 requires an entity to record a liability for costs associated with an exit or disposal activity when that liability is incurred and can be measured at fair value, and to subsequently adjust the recorded liability for changes in estimated cash flows. SFAS No. 146 is effective for exit or disposal activities initiated after December 31, 2002. The initial adoption of SFAS No. 146 on January 1, 2003 did not have any impact on our condensed consolidated results of operations or financial position. In November 2002, the FASB issued Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, including Indirect Guarantees of Indebtedness of Others." Interpretation No. 45 supersedes Interpretation No. 34, "Disclosure of Indirect Guarantees of Indebtedness of Others," and provides guidance to guarantors on the recognition and disclosure concerning obligations under certain guarantees in interim and annual financial statements. The initial recognition and measurement provisions of Interpretation No. 45 are effective for guarantees issued or modified after December 31, 2002, and are to be applied prospectively. The disclosure requirements were effective for financial statements for interim or annual periods ending after December 15, 2002. The initial adoption of Interpretation No. 45 on January 1, 2003 did not have any impact on our condensed consolidated results of operations or financial position. In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure." SFAS No. 148 amends SFAS No. 123, "Accounting for Stock-Based Compensation," and provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. This Statement also amends the disclosure requirements of SFAS No. 123 to require prominent disclosure in annual and interim financial statements about the effects of stock-based compensation. The transition guidance and annual disclosure provisions of SFAS No. 148 are effective for financial statements issued for fiscal years ending after December 15, 2002. The interim disclosure provisions of this Statement are effective for financial reports containing financial statements for interim periods beginning after December 15, 2002. The adoption of SFAS No. 148 during the first quarter of 2003 did not have any impact on our condensed consolidated financial position or results of operations. New Accounting Pronouncements: In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement No. 133 on Derivative Instruments and Hedging Activities." SFAS No. 149 amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities under FASB No. 133, "Accounting for Derivative Instruments and Hedging Activities." SFAS No. 149 is generally effective for contracts entered into or modified after June 30, 2003, and for hedging relationships designated after June 30, 2003. We do not expect adoption of this statement to have any significant impact on our financial accounting and reporting as a result of implementation of SFAS No 149. In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity." SFAS No. 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It required that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances). SFAS No. 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. Through September 30, 2003 we have not issued financial instruments with characteristics of both liabilities and equity. Reclassifications: Certain prior period items have been reclassified to conform to the current period presentations in our condensed consolidated financial statements. 9 NOTE 2 - LIQUIDITY AND CAPITAL RESOURCES Financial Position: At September 30, 2003, our cash and cash equivalents totaled $7.6 million, an increase of $7.2 million from year-end 2002. During the first nine months of 2003, our operating activities used cash of $3.4 million principally from our net loss of $4.6 million, net changes in our working capital components aggregating $100,000 and a reduction in our deferred Mexican statutory profit sharing liability of $1.0 million, offset by non-cash charges associated with depreciation expense, impairment of long-lived assets and disposal of property and equipment aggregating $2.4 million. Investing activities provided $13.2 million, primarily from the proceeds from the rescission of all contract rights and obligations for the growing and processing of Italian lemons and the sale of our Poza Rica juice plant. Net cash used in financing activities was $2.6 million, which was the result of net debt repayment of $2.3 million. Working capital at September 30, 2003 amounted to $161,000 as compared to our December 31, 2002 deficit of $9.7 million. Recent Transactions: In April 2003, we consummated the portion of the transaction with Coca-Cola pertaining to the rescission of all contract rights and obligations for the growing and processing of Italian lemons for an aggregate cash payment of $12.5 million, plus value added taxes. In June 2003, we sold our Poza Rica juice plant to an unaffiliated third party for $1.0 million, plus value added taxes of $120,000. Through May 31, 2004, total payments received amounted to $585,000 with the remaining balance of $570,000 payable in three remaining installments in 2004 under a promissory note. On June 30, 2004, we received payment of $541,500 in full satisfaction of this obligation. Effective November 17, 2003, we closed the sale of our Victoria juice and oil plant to Coca-Cola, for a cash payment of $3.5 million, plus value added taxes. Through May 31, 2004, of the $16.0 million proceeds, net of value added taxes, from the Coca-Cola transactions, approximately $5.3 million have been used to pay past due accounts payable, current operating expenses of our lemon groves, operating expenses of our juice and oil processing plants prior to sale, severance payments to former plant and administrative employees of the juice division, corporate expense charges, repay the Rabobank Nederland loan of $1.5 million, repay the Banamex loans of $558,000 and repayment of bridge loans to our largest shareholder, M&M Nominee of $368,000. The remaining cash of approximately $8.2 million is anticipated to be used to pay operating expenses of the lemon groves, repay FOCIR, provide working capital for our continuing operations and/or distributed to our shareholders upon a potential liquidation of the company (See Note 1 - Description of Business -Decision to Explore Strategic Alternatives.) Cash disbursements for purposes other than those associated with GISE's juice division and agricultural operations were subject to the FOCIR Agreement and required their prior approval for disbursement. Substantially all the proceeds are invested in short-term, interest bearing investment grade securities. As of September 30, 2003, principal of $4.4 million and accrued accretion of $1.7 million was owed to FOCIR. On August 4, 2004, the company and FOCIR entered into a new agreement that restructured its debt into a $47.0 million Mexico peso (approximately U.S. $4.1 million) secured term loan. Under the terms of the restructured agreement, FOCIR agreed to forgive all accreted interest (approximately $2.0 million) and changed the repayment terms to a seven year note payable in increasing amounts with the first annual principal payment due in October 2005 with interest payable quarterly at the rate of 2.5% plus Certificados de la Testorenia de la Federation (CETES), the Mexican Treasury Bill rate which is currently around 6.7%. The FOCIR debt is secured by a first lien on our El Cielo lemon grove. 10 Recent Developments Impacting Liquidity and Capital Resources: We are experiencing significant operational and financial challenges in the near term at our ICMOSA subsidiary as a result of its working capital deficits. Our working capital deficits at ICMOSA are approximately $4.8 million, we have been recently served with a lawsuit by one of its banks and had another of its banks exercise one of their legal remedies under its loan agreement by charging a past due installment and accrued interest against one of ICMOSA's bank accounts (see discussion in Note 3 below.) In addition, we are actively evaluating ICMOSA's business strategy and operational model. The complexity of this evaluation is further aggravated by the significant immediate liquidity issues that must be addressed in parallel with any contemplated strategic and operational changes. In connection with this evaluation, the company has determined that ICMOSA's long-lived assets have been significantly impaired by its liquidity and business model issues and that an impairment analysis under SFAS No. 144 needs to be performed in its fourth quarter of 2003. Based on ICMOSA's projected continuing negative undiscounted operating cash flows for the foreseeable future, with no opportunities for additional debt or capital, along with limited interest by any third parties in acquiring ICMOSA for any more than the assumption of liabilities, an impairment charge of approximately $5.0 million is projected to be recorded in the company's fourth quarter of 2003. We have received a non-binding proposal for the purchase of our packaged fruit business segment and have engaged valuation advisors to assist in reviewing the terms of this proposal. No assurances can be given that our efforts will be successful. Although our current cash balances as of June 30, 2004 at our GISE subsidiary is approximately $8.2 million, this cash was restricted by the FOCIR Agreement and required FOCIR's prior approval before such cash could be used to fund working capital deficits at our ICMOSA subsidiary or our general corporate overhead. On August 4, 2004, the company and FOCIR entered into a new agreement that restructured its debt into a $47.0 million Mexico peso (approximately U.S. $4.1 million) secured term loan. Under the terms of the restructured agreement, FOCIR agreed to forgive all accreted interest (approximately $2.0 million) and changed the repayment terms to a seven year note payable in increasing amounts with the first annual principal payment due in October 2005 with interest payable quarterly at the rate of 2.5% plus Certificados de la Testorenia de la Federation (CETES), the Mexican Treasury Bill rate which is currently around 6.7%. The FOCIR debt is secured by a first lien on our El Cielo lemon grove. Given the increased costs associated with being a public company, the lack of liquidity for our common stock, the liquidity problems at ICMOSA and the operational challenges facing the company, to maximize shareholder value, we are exploring available strategic alternatives, including the sale of all or a part of the company, its productive assets and strategic partnering relationships for the growing, distribution and marketing of fresh lemons. We have received a non-binding proposal for the purchase of our packaged fruit business segment and have engaged valuation advisors to assist in reviewing the terms of this proposal. No assurances can be given that our efforts will be successful. NOTE 3 - SHORT AND LONG-TERM DEBT Short-term debt: As of December 31, 2002, we owed $1.5 million to Rabobank Nederland under a loan agreement that was due and payable on January 2, 2002. This loan, which was in default at December 31, 2002, was repaid in May 2003. As of December 31, 2002 and September 30, 2003, our Mexican subsidiary, ICMOSA, owed $3.5 million under a secured pre-export financing loan agreement with Banco Nacional de Comercio Exterior, S.N.C. ("Bancomext.") The outstanding balance, which consists of six separate notes that became due in various amounts and dates during 2002, have not been renewed by Bancomext, and are in default. As of September 30, 2003, unpaid interest under these notes, computed at the default interest rate, is approximately $524,000. On February 12, 2004, an action styled Banco Nacional de Comercio Exterior, S.N.C. vs. Industrias Citricolas de Montemorelos, S.A. de C.V. and Rafael Vaquero Bazan was filed in the Federal District 11 (Mexico City), Mexico. The action seeks recovery of $ 3.5 million in bank debt, past due interest, interest accruing during the proceedings and expenses and fees resulting from the action. In addition, in the suit Bancomext seeks to foreclose on ICMOSA's accounts receivable and seize its bank accounts. Should Bancomext be successful in obtaining the remedies sought, this lawsuit would have a material adverse effect on our consolidated financial condition and prospects and would significantly impact ICMOSA's ability to continue as a going concern. In such event, ICMOSA may be forced to seek protection under the applicable provisions of the Mexico bankruptcy code. See Item 2, "Management's Discussion and Analysis of Results of Operations and Financial Condition - Legal Proceedings and Loss Contingencies" and "Risk Factor - Risks Relating to Our Financial Condition - One of our Mexican banks has exercised its legal rights and remedies and we may be forced to seek protection under applicable provisions of the Mexican bankruptcy code." The Rabobank Nederland and Bancomext outstanding balances are included under the caption "Short and long-term debt in default" in our condensed consolidated balance sheet at December 31, 2002. At September 30, 2003, the Bancomext debt is included in this caption. Long-term debt: During 2002, ICMOSA entered into a restructured loan agreement with Grupo Financiero Banorte ("Banorte") that amortized the outstanding principal balance over a period of five and one-half years. The loan repayment schedule requires quarterly payments of principal and interest (Libor plus 3.50%) through December 31, 2007, with $300,000 due over the next twelve months. As of December 31, 2002 and September 30, 2003, $3.0 million and $2.8 million, respectively, were outstanding under the restructured loan agreement. The restructured loan agreement is secured by certain assets of ICMOSA, corporate guarantees by the company and certain covenants that, amongst others, restrict future borrowings and contain a cross-default provision. As a result of the default of the Bancomext loan, we are currently in default of the Banorte loan agreement and the entire loan balance has been included under the caption "Short and long-term debt in default" in our condensed consolidated balance sheets at December 31, 2002 and September 30, 2003. Although we are currently discussing loan restructuring options with Banorte, on March 17, 2004 they exercised one of their legal remedies available under the loan agreement by charging one of ICMOSA's bank accounts for a past due installment payment of $75,000 plus accrued interest of approximately $33,000. As of December 31, 2002, notes payable to a Mexican bank by GISE, in the amounts of $450,000 and $96,000, were in default of their scheduled payments and have been included under the caption "Short and long-term debt in default" in our condensed consolidated balance sheet at December 31, 2002. These loans were repaid in July 2003. On February 21, 2000, we entered into a $48.0 million Mexican pesos (U.S. $5.1 million at the exchange rate in effect at that time), 9-year term financing agreement with FOCIR. Under the terms of the FOCIR Agreement, FOCIR agreed to provide up to $48.0 million Mexican pesos to fund additional lemon grove costs, which included land preparation, planting, equipment, irrigation systems and grove maintenance. This financing represents the purchase of an equity interest in GISE of approximately 17.6%. Amounts advanced under the FOCIR Agreement are classified outside equity due to a mandatory redemption provision. As of December 31, 2002 and September 30, 2003, advances under the FOCIR Agreement were $4.9 million and $4.4 million ($47.0 million Mexican pesos), respectively. The terms of the FOCIR Agreement provided for the calculation and accrual of annual accretion using one of two alternative methods. The first method determined accretion by multiplying the year's Mexican inflation index rate plus 4.2% by the FOCIR balance. The second method determined annual accretion by multiplying GISE's shareholders equity; using Mexican generally accepted accounting principles, by factors of 1.126 for 2002, and 1.168 for 2003, and then multiplying by the FOCIR equity interest percentage. The calculation that resulted in the greater amount would be the annual accretion amount. Accretion accumulated annually over the 9-year period of the prior FOCIR Agreement and would be paid only upon expiration or early termination of the FOCIR Agreement. As of December 31, 2002 and September 30, 2003, accreted interest under the FOCIR Agreement amounted to $1.4 million and $1.7 12 million, respectively, which is classified as a long-term liability in our condensed consolidated balance sheets as of December 31, 2002 and September 30, 2003. As of September 30, 2003, the weighted average accretion rate for all advances under the FOCIR Agreement was approximately 10.6%. The FOCIR Agreement also contained, among other things, certain provisions relating to GISE's future financial performance, the establishment of an irrevocable trust guaranteeing the FOCIR debt, which included transferring to the trust GISE common shares that represented 33.4% of GISE's outstanding shares and the governance of GISE. As of December 31, 2002 and September 30, 2003, we were not in compliance with certain of the FOCIR Agreement covenants, and accordingly, we were in default of the agreement. On August 4, 2004, the company and FOCIR entered into a new agreement that restructured its debt into a $47.0 million Mexico peso (approximately U.S. $4.1 million) secured term loan. Under the terms of the restructured agreement, FOCIR agreed to forgive all accreted interest (approximately $2.0 million) and changed the repayment terms to a seven year note payable in increasing amounts with the first annual principal payment due in October 2005 with interest payable quarterly at the rate of 2.5% plus Certificados de la Testorenia de la Federation (CETES), the Mexican Treasury Bill rate which is currently around 6.7%. The FOCIR debt is secured by a first lien on our El Cielo lemon grove. Certain of our Mexico loan contracts establish restrictions and obligations with respect to the application of funds and require maintenance of insurance on the assets and timely presentation of financial information. In addition, after considering the repayment of the Rabobank Nederland and Banamex loans during 2003, approximately $7.0 million of net property, plant and equipment and certain receivables are pledged as collateral under short and long-term debt agreements. NOTE 4 - RELATED PARTY TRANSACTIONS Effective September 1, 2000, we entered into an agreement with Promecap, S.C. ("Promecap") for the services of Emilio Castillo Olea to become our President and Chief Executive Officer at the annual rate of $150,000. As of September 30, 2003, the company owed Promecap $362,500 in connection with this agreement. Mr. Castillo was also a Director of Promecap, a financial advisory services firm to Mexico Strategic Investment Fund Ltd. ("MSIF"), which owned 80% of M&M Nominee. M&M Nominee is our largest shareholder (see discussion below). On January 31, 2003, Mr. Castillo resigned his officer positions with our company, and on May 30, 2003, resigned as a Director. The company has agreed to commence making monthly payments due Promecap under the agreement starting in August 2004. On January 10, 2003, January 24, 2003, February 11, 2003 and March 6, 2003, respectively, we received $125,000, $200,000, $110,000 and $125,000 under the terms of short-term promissory notes, interest at 10%, from our largest shareholder. These notes, including an additional note under which we received $100,000 on December 18, 2002, were repaid in April 2003, including accrued interest of approximately $16,000. On May 20, 2004, the company's board of directors appointed its chairman, Jakes Jordaan, to serve as its President and Chief Executive Officer. Mr. Jordaan is a member of the firm Jordaan & Riley, PLLC, which serves as the company's legal counsel. Fees paid to Mr. Jordaan's firm for legal services rendered were $38,000 and $69,000, for the nine months ended September 30, 2002 and 2003, respectively. On July 7, 2004, we announced that Cardinal UniMark Investors, L.P. ("Cardinal") purchased 10,519,419 shares of UniMark common stock in a private transaction from MSIF for $0.40 per share. MSIF was a member of UniMark's controlling shareholder, M & M Nominee, which owned 13,149,274 shares of the company's common stock. Madera LLC ("Madera"), the other partner in M & M Nominee, retained its 2,629,855 shares of common stock. NOTE 5 - LEMON GROVES In March 2003, we received formal offers from Coca-Cola to purchase our Victoria juice and oil plant and rescind certain contract rights for the growing and processing of Italian lemons for aggregate cash payments by Coca-Cola of $16.0 million. In April 2003, we consummated the portion of the transaction 13 with Coca-Cola pertaining to the rescission of all contract rights and obligations for the growing and processing of Italian lemons for an aggregate cash payment of $12.5 million, plus value added taxes. In this regard, we retained the approximately 7,100 acres of land, of which 4,800 acres are currently planted with lemon trees. We also retained all of the irrigation systems and related agricultural property and equipment. As part of the sale agreement we are contractually restricted from industrially processing our lemons and are limited to marketing our lemons solely as fresh fruit until July 30, 2007. The proceeds from the rescission of the contract rights were offset against our capitalized orchard development costs during the second quarter of 2003, which were classified in property, plant and equipment in our condensed consolidated balance sheet at December 31, 2002. As of September 30, 2003, our lemon groves consisted of 2,871 hectares (approximately 7,100 acres). This land, which is situated in the northern states of Tamaulipas and San Luis Potosi, consists of two separate groves with different maturity profiles. These groves were initially planted with approximately 800,000 lemon trees. Pursuant to the terms of the now cancelled long-term supply contract, Coca-Cola provided us, free of charge, 765,000 lemon tree seedlings that were used for planting approximately 6,023 acres. We also operate our own nursery where young seedlings are prepared for planting, which provided us with the remaining 35,000 trees, as well as acting as a source of replanting for damaged trees. In connection with the transaction with Coca-Cola pertaining to the rescission of all contract rights and obligations for the growing and processing of Italian lemons for an aggregate cash payment of $12.5 million, we elected to cease active cultivation of recently planted lemon tree seedlings and used some for replanting of damaged trees. As such, we presently have approximately 560,000 lemon trees under active cultivation on approximately 4,800 acres. As part of the sale agreement we are contractually restricted from industrially processing our lemons and are limited to marketing our lemons solely as fresh fruit until July 30, 2007. All costs incurred to plant and maintain our lemon orchards were capitalized and deferred through March 31, 2003. As a result of the rescission of all contract rights and obligation for the growing of Italian lemons in April 2003, these deferred and capitalized orchard development costs were reduced by the $12.5 million sale proceeds, and all remaining costs are being amortized over their estimated useful lives commencing in the second quarter of 2003. In prior periods, it was determined that these deferred costs would be amortized based on the projected year's yield to total estimated yield over the life of the rescinded supply contract. As of September 30, 2003, our lemon groves consisted of the following:
PROPERTY NAME LOCATION HECTARES ACREAGE CROP INTEREST ------------------------- --------------------- -------- ------- -------------- -------- Gomez Farias, (A) El Cielo Grove .......... Tamaulipas, Mexico 725 1,791 Italian lemons Owned Cd. Valles, San Luis Potosi, Flor de Maria Grove...... Mexico 2,146 5,301 Italian lemons Leased ----- ----- Total 2,871 7,092 ===== =====
(A) One hectare equals approximately 2.47 acres. Included in our lemon groves is a long-term lease associated with 2,100 hectares (approximately 5,200 acres) of rural land used for the growing of Italian lemons, comprising substantially all the land of our Flor de Maria grove. This lease, which was prepaid at the land purchase price of $1.9 million, was entered into in 1999 with a group of local Mexican land owners, which acquired the land under the "Ejido" system of land ownership. We are currently in the process of negotiating a transition of the lease into land ownership. No assurances can be given that such efforts will be successful. In connection with transfer of this land, we have received a request from the "Ejido" for the payment of an additional $1.2 million ($12.6 14 million Mexican pesos). The company has been advised by Mexican counsel that it has no legal obligation to make such payment. NOTE 6 - NET LOSS PER SHARE The following table sets forth the computation of basic and diluted net loss per share:
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ------------------------- ----------------------- 2002 2003 2002 2003 ----------- ----------- ----------- --------- (IN THOUSANDS, EXCEPT FOR PER SHARE AMOUNTS) NUMERATOR Net loss .......................................... $ (2,299) $ (2,749) $ (4,318) $ (4,594) ========== ========== ========== ======== DENOMINATOR Denominator for basic net loss per share - weighted average shares outstanding ...................... 21,045 21,045 21,045 21,045 ========== ========== ========== ======== Basic and diluted net loss per share .............. $ (0.11) $ (0.13) $ (0.21) $ (0.22) ========== ========== ========== ========
We had stock options outstanding of 132,500 and 95,000 at September 30, 2002 and September 30, 2003, respectively, that were not included in their respective periods per share calculations because their effect would have been anti-dilutive. NOTE 7 - INVENTORIES Inventories consist of the following:
DECEMBER 31, SEPTEMBER 30, 2002 2003 ------------ ------------- (IN THOUSANDS) Finished Goods - Cut fruit.................... $ 2,939 $ 2,262 Raw materials and supplies.................... 1,825 1,543 Advances to suppliers......................... 457 491 ------- -------- Total $ 5,221 $ 4,296 ======= ========
NOTE 8 - SEGMENT INFORMATION For operating and financial reporting purposes, we have historically classified our business into two fundamental areas: packaged fruit and juice and oil. Our packaged fruit divisions consists of three operating plants that hand-process and sell tropical and citrus fruit products directly to our largest customer, Del Monte, to foodservice providers and distributors and to industrial food and beverage processors. This division also operated our pineapple orchards. Our juice and oil business segment has consisted of our juice division, which produced FCOJ and other citrus juices, which were sold directly to juice bottlers and the extraction of essential oils from citrus fruits, which were sold directly to commercial users, and our agricultural operation, which is developing our Italian lemon orchards. With the completion of the sale of our Victoria juice and oil plant and related processing equipment, our juice and oil business segment consists exclusively of our Italian lemon groves. We evaluate our segment performance and allocate resources based on profit or loss from operations before income taxes and commenced allocating a portion of our corporate general and administrative expenses during our third quarter of 2003. Inter-segment sales and transfers are insignificant. Our reportable segments are each managed separately because they process and distribute distinct products with different production processes. Information pertaining to the operations of our two business segments is set forth below. 15
PACKAGED JUICE FRUIT AND OIL TOTAL ---------- ---------- ---------- THREE MONTHS ENDED SEPTEMBER 30, 2002 Net sales to external customers............ $ 5,036 $ 399 $ 5,435 Segment loss .............................. (1,716) (152) (1,868) THREE MONTHS ENDED SEPTEMBER 30, 2003 Net sales to external customers............ $ 5,474 $ 614 $ 6,088 Segment loss............................... (1,367) (1,033) (2,400) NINE MONTHS ENDED SEPTEMBER 30, 2002 Net sales to external customers............ $ 19,183 $ 1,014 $ 20,197 Segment loss............................... (2,003) (738) (2,741) NINE MONTHS ENDED SEPTEMBER 30, 2003 Net sales to external customers............ $ 20,008 $ 1,391 $ 21,399 Segment loss............................... (1,429) (1,799) (3,228) Segment assets............................. 29,394 17,543 46,937
The following are reconciliations of reportable segment profit or loss to our consolidated totals.
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, -------------------------- ----------------------- 2002 2003 2002 2003 ----------- --------- --------- -------- Total loss for reportable segments......... $ (1,868) $ (2,400) $ (2,741) $(3,228) Unallocated corporate expenses - General and administrative............ (262) (186) (791) (877) ---------- -------- -------- ------- Loss before income taxes................... $ (2,130) $ (2,586) $ (3,532) $(4,105) ========== ======== ======== =======
The following are reconciliations of reportable segment assets to our consolidated totals.
SEPTEMBER 30, DECEMBER 31, 2002 2003 ----------------- ------------- ASSETS Total assets for reportable segments .............. $ 58,683 $ 46,937 Other assets ...................................... 59,165 59,165 Elimination of intercompany profits in inventory .. (48) (48) Elimination of intercompany receivables ........... (24,807) (25,859) Allocation of acquisition costs of subsidiaries recorded in consolidation ....................... (44,585) (44,585) Reclassification of deferred tax assets recorded in consolidation ................................... (5,633) (1,740) -------- -------- Total consolidated assets ... $ 42,775 $ 33,872 ======== ========
NOTE 9 - COMMITMENTS AND CONTINGENCIES On February 12, 2004, an action styled Banco Nacional de Comercio Exterior, S.N.C. vs. Industrias Citricolas de Montemorelos, S.A. de C.V. and Rafael Vaquero Bazan was filed in the Federal District (Mexico City), Mexico. The action seeks recovery of $3.5 million in bank debt, past due interest, interest 16 accruing during the proceedings and expenses and fees resulting from the action. In addition, in the suit Bancomext seeks to foreclose on ICMOSA's accounts receivable and seize its bank accounts. Should Bancomext be successful in obtaining the remedies sought, this lawsuit would have a material adverse effect on our consolidated financial condition and prospects and would significantly impact ICMOSA's ability to continue as a going concern. In such event, ICMOSA may be forced to seek protection under the applicable provisions of the Mexico bankruptcy code. Effective January 1, 1995, we entered into a long-term operating agreement with Industrias Horticolas de Montemorelos, S.A. de C.V. ("IHMSA") to operate a freezing plant located in Montemorelos, Nuevo Leon, Mexico. Pursuant to the terms of the operating agreement, our company was obligated to pay IHMSA an operating fee sufficient to cover the interest payments on IHMSA's $3.4 million of outstanding debt with a Mexican bank. During the term of the operating agreement, we have the option to buy the IHMSA facility. During the third quarter of 2001, we successfully negotiated revisions to the operating agreement with IHMSA's management, extending the agreement's expiration date from January 1, 2002 to January 1, 2021, and reducing the purchase option price from $4.5 million to $3.5 million. The revised purchase option also includes the assumption of approximately $1.0 million of IHMSA's debt ($11.0 million Mexican pesos). During 1997, we elected to advance $1.7 million to IHMSA to retire certain of its then outstanding debt and during the fourth quarter of 2001, we advanced IHMSA an additional $636,000, $300,000 of which was used to retire its $3.4 million of bank debt, both of which will be applied to the purchase price. As a result of remeasuring Mexican pesos into U.S. dollars, the total advance of $2.3 million has been reduced to $1.8 million, or by approximately $500,000. This reduction has been included as a component of translation loss in our statements of operations over the past several years. All amounts previously paid to IHMSA, along with the assumption of the $1.0 million of debt comprise the final purchase price. At September 30, 2003, all amounts advanced to IHMSA of $1.8 million, which is net of any unpaid operating fees, are included under the caption "Deposit on plant facility" in our condensed consolidated balance sheet at September 30, 2003. Until we formally exercise our purchase option, which is subject to approval of the IHMSA debt assumption by a Mexican lending institution and ICMOSA's current banks, we will continue to operate the IHMSA facility under the long-term operating agreement. We are currently in the process of negotiating a transition of our Flor de Maria lease into land ownership. No assurances can be given that such efforts will be successful. In connection with transfer of this land, we have received a request from the "Ejido" for the payment of an additional $1.2 million ($12.6 million Mexican pesos). The company has been advised by Mexican legal counsel that it has no legal obligation to make such payment. Several legal proceedings arising in the normal course of business are pending against us, including certain of our Mexican subsidiaries. On September 18, 2002, an action captioned "Complaint for Avoidance of Preferential Transfers and Turnover of Property of the Estate styled Golden Gem Growers, Inc., a Reorganized Debtor and Daniel E. Dempsey, CPA, Disbursing Agent for The Estate of Golden Gem Growers, Inc., Plaintiff vs. The UniMark Group, Inc., Gisalamo S.A. de C.V., and Grupo Industrial Santa Engracia S.A. de C.V., Defendants", was filed in the United States Bankruptcy Court, Middle District of Florida, Orlando Division, Adversary Proceeding No. 02-258. The compliant seeks recovery of $200,000 of payments made by Golden Gem prior to its filing for bankruptcy protection in September 2001. In March 2004 we entered into a settlement agreement with the Disbursing Agent on this matter for $5,000, which was approved by the Bankruptcy court. As a result of the decline in the worldwide market prices of FCOJ, during 2000 we decided to discontinue operating a juice processing facility in Mexico that had been leased from Frutalamo S.A. de C.V. ("Frutalamo") under the terms of deposit, operating and stock purchase agreements entered into in 17 December 1996. As we were unsuccessful in negotiating a settlement with Frutalamo to terminate such agreements, we wrote off a previously recorded non-refundable deposit of $1.5 million and recorded a cancellation fee of $1.0 million, both of which were non-cash charges. Subsequent to December 31, 2000, Frutalamo and certain of its shareholders (collectively, the "Frutalamo Plaintiffs") initiated legal proceedings in Mexico naming as defendants certain of our Mexican subsidiaries, certain current and former employees, officers and directors of our company and a former contractor. In September 2002, we settled these claims for $125,000 in cash. We have learned that, notwithstanding such settlement, certain claims asserted against us by the Frutalamo Plaintiffs, prior to September 2002, continue to be under review before the Mexican courts. Management denies any wrongdoing in this matter and intends to vigorously contest these claims. The resolution of this matter is not expected to have a material adverse effect on our condensed consolidated financial condition or results of operations. On October 10, 2003, an action styled "James R. Scott, Plaintiff vs. UniMark Group, Inc, Defendant," was filed in the County Court, Denton, Texas, Cause Number TI-2003-01345. The compliant seeks recovery of approximately $90,000 of unpaid rent and injunctive relief. In addition to the actions described above, from time to time our company is engaged in various other legal proceedings in the normal course of business. The ultimate liability, if any, for the aggregate amounts claimed cannot be determined at this time. However, our company, based on the consultation with legal counsel, is of the opinion that there are no matters pending or threatening, except for Bancomext, which could have a material adverse effect on our consolidated financial position or results of operations. NOTE 10 - SUBSEQUENT EVENTS Effective November 17, 2003, we closed the sale of our Victoria juice and oil plant to Coca-Cola, for a cash payment of $3.5 million, plus value added taxes. With the completion of the sale of our Victoria juice and oil plant and related processing equipment, our juice and oil business segment consists exclusively of our Italian lemon groves. Given the increased costs associated with being a public company, the lack of liquidity for our common stock, the liquidity problems at ICMOSA (see discussions in Note 2 - "Recent Developments Impacting Liquidity and Capital Resources") and the operational challenges facing the company, to maximize shareholder value, we are exploring available strategic alternatives, including the sale of all or a part of the company, its productive assets and strategic partnering relationships for the growing, distribution and marketing of fresh lemons. No assurances can be given that our efforts will be successful. On May 20, 2004 the company's board of directors appointed Jakes Jordaan to serve as President and Chief Executive Officer succeeding R. Arturo Herrera Barre who became Chief Operating Officer. On May 26, 2004, the company notified Mr. Herrera that his employment agreement would not be renewed. On July 7, 2004, we announced that Cardinal purchased 10,519,419 shares of UniMark common stock in a private transaction from MSIF for $0.40 per share. MSIF was a member of UniMark's controlling shareholder, M & M Nominee, which owned 13,149,274 shares of the company's common stock. Madera, the other partner in M & M Nominee, retained its 2,629,855 shares of common stock. Subsequent to September 30, 2003, the company determined that the carrying amounts of the long-lived assets to be held and used at its ICMOSA subsidiary have been impaired and that an impairment analysis under SFAS No. 144 needs to be performed in the fourth quarter of 2003. Based upon ICMOSA's projected continuing negative undiscounted operating cash flows for the foreseeable future with no opportunities for additional debt or capital, along with limited interest by any third parties in acquiring ICMOSA for assumption of its liabilities, an impairment charge of approximately $5.0 million is projected to be recorded in the company's fourth quarter of 2003. 18 On August 4, 2004, the company and FOCIR entered into a new agreement that restructured its debt into a $47.0 million Mexico peso (approximately U.S. $4.1 million) secured term loan. Under the terms of the restructured agreement, FOCIR agreed to forgive all accreted interest (approximately $2.0 million) and changed the repayment terms to a seven year note payable in increasing amounts with the first annual principal payment due in October 2005 with interest payable quarterly at the rate of 2.5% plus Certificados de la Testorenia de la Federation (CETES), the Mexican Treasury Bill rate which is currently around 6.7%. The FOCIR debt is secured by a first lien on our El Cielo lemon grove. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RECENT DEVELOPMENTS Due to the continued unfavorable and volatile worldwide market prices of FCOJ that existed over the past several years and negative long-term prospects for the FCOJ market, we explored various strategic alternatives for our juice and oil business segment and decided to discontinue our FCOJ line of business and sell all of its production assets. In March 2003, we received formal offers from Coca-Cola to purchase our Victoria juice and oil plant and rescind certain contract rights for the growing and processing of Italian lemons for aggregate cash payments by Coca-Cola of $16.0 million. In April 2003, we consummated the portion of the transaction with Coca-Cola pertaining to the rescission of all contract rights and obligations for the growing and processing of Italian lemons for an aggregate cash payment of $12.5 million, plus value added taxes. In this regard, we retained the approximately 7,100 acres of land, of which 4,800 acres are currently planted with lemon trees. We also retained all of the irrigation systems and related agricultural property and equipment. As part of the sale agreement we are contractually restricted from industrially processing our lemons and are limited in marketing our lemons solely as fresh fruit until July 30, 2007. The proceeds from the rescission of the contract rights were offset against our capitalized orchard development costs during the second quarter of 2003, which were classified in property plant and equipment in our condensed consolidated balance sheet at December 31, 2002. In June 2003, we sold our Poza Rica juice plant to an unaffiliated third party for $1.0 million, plus value added taxes of $120,000. Through May 31, 2004, total cash payments received amounted to $565,000 with the remaining balance payable in four remaining installments under a promissory note. The remaining payments, which aggregate $570,000 in 2004, are secured by personal guarantees of the purchaser's shareholders and a related company and a pledge agreement. On June 30, 2004, we received payment of $541,500 in full satisfaction of this obligation. Effective November 17, 2003, we closed the sale of our Victoria juice and oil plant to Coca-Cola, for a cash payment of $3.5 million, plus value added taxes. With the completion of the sale of our Victoria juice and oil plant and related processing equipment, our juice and oil business segment consists exclusively of our Italian lemon groves. Given the increased costs associated with being a public company, the lack of liquidity for our common stock, the liquidity problems at ICMOSA (see discussions in Note 2 - "Recent Developments Impacting Liquidity and Capital Resources") and the operational challenges facing the company, to maximize shareholder value, we are exploring available strategic alternatives, including the sale of all or a part of the company, its productive assets and strategic partnering relationships for the growing, distribution and marketing of fresh lemons. No assurances can be given that our efforts will be successful. On February 12, 2004, an action styled Banco Nacional de Comercio Exterior, S.N.C. vs. Industrias Citricolas de Montemorelos, S.A. de C.V. and Rafael Vaquero Bazan was filed in the Federal District (Mexico City), Mexico. The action seeks recovery of $ 3.5 million in bank debt, past due interest, interest accruing during the proceedings and expenses and fees resulting from the action. In addition, in the suit Bancomext seeks to foreclose on ICMOSA's accounts receivable and seize its bank accounts. Should Bancomext be successful in obtaining the remedies sought, this lawsuit would have a material adverse effect on our consolidated financial condition and prospects and would significantly impact ICMOSA's 19 ability to continue as a going concern. In such event, ICMOSA may be forced to seek protection under the applicable provisions of the Mexico bankruptcy code. CONVERSION TO U.S. GAAP We conduct substantially all of our operations through our operating Mexican subsidiaries. ICMOSA is a Mexican corporation whose principal activities consist of operating citrus processing plants and various citrus groves throughout Mexico. GISE is a Mexican corporation whose principal activities were the operation of two citrus juice and oil processing plants, as well as currently managing our Italian lemon groves. ICMOSA and GISE maintain their accounting records in Mexican pesos and in accordance with Mexican generally accepted accounting principles and are subject to Mexican income tax laws. Our Mexican subsidiaries financial statements have been converted to United States generally accepted accounting principles ("U.S. GAAP") and U.S. dollars. Unless otherwise indicated, all dollar amounts included herein are set forth in U.S. dollars. The functional currency of the company and its subsidiaries is the U.S. dollar. CRITICAL ACCOUNTING POLICIES The preparation of our consolidated financial statements in conformity with accounting principals generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported revenues and expenses during the reporting periods. We base our estimates and judgments on historical experience and various other factors that we believe to be reasonable under the circumstances, which results in forming the basis for making judgments about the carrying values of our assets and liabilities. Actual results may differ from these estimates under different assumptions or conditions. The critical accounting policies described herein are those that are most important to the depiction of our condensed consolidated financial condition and results of operations and their application requires management's most subjective judgment in making estimates about the effect of matters that are inherently uncertain. We believe that the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our condensed consolidated financial statements. ALLOWANCE FOR DOUBTFUL ACCOUNTS In the normal course of business, we extend credit to our customers on a short-term basis. Although credit risks associated with our customers is considered minimal, we routinely review our accounts receivable balances and make provisions for probable doubtful accounts. In circumstances where management is aware of a specific customer's inability to meet their financial obligations to us, a specific reserve is provided to reduce the receivable to the amount expected to be collected. Historically we do not provide a general reserve. IMPAIRMENT OF LONG-LIVED ASSETS Effective January 1, 2002, we adopted SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" ("FAS No. 144"), which requires our management to review for impairment its long-lived assets whenever events or changes in circumstances indicate that the carrying amount of an asset might not be recoverable. When such an event occurs, management determines whether there has been impairment by comparing the anticipated undiscounted future net cash flows to the related asset's carrying value. If an asset is considered impaired, the asset is written down to fair value, which is determined based either on discounted cash flows or appraised value, depending on the nature of the asset. Prior to January 1, 2002, management determined whether any long-lived assets had been impaired based on the criteria established in Statement of Financial Accounting Standards No. 121 (SFAS 121), "Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets to be disposed of." The carrying amount of a long-lived asset was considered impaired when the estimated undiscounted cash flow from each asset was 20 less than its carrying amount. In that event, we recorded a loss equal to the amount by which the carrying amount exceeds the fair value of the long-lived asset. Changes in our projected cash flows as well as differences in the discount rate used in the calculation could have a material effect on the condensed consolidated financial statements. INCOME TAXES Income taxes are accounted for using the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to the differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carry forwards. Deferred tax assets and liabilities are measured using enacted rates. The effect on deferred tax assets and liabilities of a change in tax rates is recognized as income in the period that includes the enactment date. In assessing the realization of deferred income tax assets, management considers whether it is more likely than not that some portion or all of the deferred income tax assets will be realized. The ultimate realization of deferred income tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Due to our historical operating results, management is unable to conclude on a more likely than not basis that all deferred income tax assets generated through operating losses through September 30, 2003 will be realized. Accordingly, we have recognized a valuation allowance equal to the difference between deferred income tax assets and the deferred income tax liabilities. LEGAL PROCEEDINGS AND LOSS CONTINGENCIES Our company is involved in routine legal and administrative matters that arise from the normal conduct of business. Some of these matters are not within our control and are difficult to predict and often are resolved over long periods of time. We maintain insurance, including directors' and officers' and corporate liability insurance, with third parties to mitigate any loss that is related to certain claims. Loss contingencies are recorded as liabilities in the financial statements when it is determined that we have incurred a loss that is probable and the amount of the loss is reasonably estimable, in accordance with SFAS No. 5, "Accounting for Contingencies." On February 12, 2004, an action styled Banco Nacional de Comercio Exterior, S.N.C. vs. Industrias Citricolas de Montemorelos, S.A. de C.V. and Rafael Vaquero Bazan was filed in the Federal District (Mexico City), Mexico. The action seeks recovery of $ 3.5 million in bank debt, past due interest, interest accruing during the proceedings and expenses and fees resulting from the action. In addition, in the suit Bancomext seeks to foreclose on ICMOSA's accounts receivables and seize its bank accounts. Should Bancomext be successful, this lawsuit would have a material adverse effect on our consolidated financial condition and prospects and would significantly impact ICMOSA's ability to continue as a going concern. In such event, ICMOSA may be forced to seek protection under the applicable provisions of the Mexico bankruptcy code. See Item 2, "Management's Discussion and Analysis of Results of Operations and Financial Condition - Legal Proceedings and Loss Contingencies" and "Risk Factor - Risks Relating to Our Financial Condition - One of our Mexican banks has exercised its legal rights and remedies and we may be forced to seek protection under applicable provisions of the Mexican bankruptcy code." CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS The discussion in this Quarterly Report on Form 10-Q contains forward-looking statements that involve risks and uncertainties. The actual results could differ significantly from those discussed herein. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in "Management's Discussion and Analysis of Financial Condition and Results of Operations" as well as those discussed elsewhere in this report. Statements contained in this report that are not historical facts are forward-looking statements that are subject to the safe harbor created by the Private Securities Litigation Reform Act of 1995. A number of important factors could cause the actual results for 2003 and beyond to differ materially from those expressed in any forward-looking statements made by us, or on our behalf. These factors include risks relating to our financial condition, our Mexican operations, general business risks and risks relating to our common stock. For a discussion of these factors that may affect actual 21 results, investors should refer to our filings with the SEC and those factors listed under "Risk Factors" starting on page 27 of this Form 10-Q. RESULTS OF OPERATIONS The following table sets forth certain condensed consolidated financial data, expressed as a percentage of net sales for the periods indicated:
THREE MONTHS NINE MONTHS ENDED SEPTEMBER 30, ENDED SEPTEMBER 30, -------------------- ------------------- 2002 2003 2002 2003 ---- ---- ----- ---- Net sales .................................. 100.0% 100.0% 100.0% 100.0% Cost of products sold ...................... 120.3 105.2 104.3 98.1 ----- ----- ----- ----- Gross profit (loss) ........................ (20.3) (5.2) (4.3) 1.9 Selling, general and administrative expenses 15.5 18.5 14.3 10.9 Impairment of long-lived assets ............ -- -- -- 1.1 ----- ----- ----- ----- Loss from operations ....................... (35.8) (23.7) (18.6) (10.1) Other income (expense): Interest expense ....................... (2.4) (9.9) (1.6) (3.8) Other income (expense), net ............ 0.9 (2.9) 1.2 (1.0) Foreign currency translation gain (loss) (1.9) (6.0) 1.5 (4.3) ----- ----- ----- ----- (3.4) (18.8) 1.1 (9.1) ----- ----- ----- ----- Loss before income taxes ................... (39.2) (42.5) (17.5) (19.2) Income tax expense ......................... 3.1 2.7 3.9 2.3 ----- ----- ----- ----- Net loss ................................... (42.3)% (45.2)% (21.4)% (21.5)% ===== ===== ===== =====
Three Months Ended September 30, 2003 and 2002 Net sales consist of packaged fruit and citrus juice and oil. Packaged fruit sales increased $500,000 from $5.0 million in 2002 to $5.5 million in 2003, or 10.0%. This sales increase was primarily caused by increases in our retail sales of $700,000 from $3.6 million in 2002 to $4.3 million in 2003, or 19.4%, offset by decreases in our foodservice, industrial and miscellaneous sales of $300,000 from $900,000 in 2002 to $600,000 in 2003, or 33.3%. Sales to Japan remained constant between periods at $600,000. Retail sales consist primarily of sales to Del Monte, which includes both retail and wholesale club products. The increase in retail sales was primarily due to the timing of our production schedule for our citrus products sold to Del Monte and the recent introduction of their new 8 ounce cup of fresh red grapefruit, which is sold under their Fruit Naturals(R) trade name. Foodservice and industrial sales were impacted by our focus on higher margin customers, which resulted in lower sales volume. Citrus juice and oil sales increased $215,000 from $398,000 in 2002 to $613,000 in 2003, or 54.0%. Sales in both periods consisted primarily from the processing of Italian lemons for Coca-Cola under the now rescinded processing agreement. Due to the continued unfavorable and volatile worldwide market prices for FCOJ that has existed over the past several years and negative long-term prospects for the FCOJ market, in early 2002, our board of directors decided to pursue strategic alternatives available for our juice division and suspended our juice division's FCOJ operations. In April 2003, we consummated a transaction with Coca-Cola pertaining to the rescission of all contract rights and obligations for the growing and processing of Italian lemons. In June 2003, we sold our Poza Rica juice plant to an unaffiliated third party and in November 2003, we closed the sale of our Victoria juice and oil plant to Coca-Cola. As a result of these plant sales, our juice and oil business segment consists exclusively of our Italian lemon groves. As a result of the foregoing, net sales increased from $5.4 million in 2002 to $6.1 million in 2003, or 13.0% primarily due to increased sales in our packaged fruit business segment. Gross profit, as a percentage of net sales, in our packaged fruit segment, improved from a loss of 15.5% in the 2002 period to a loss of 2.9% in the 2003. The 2002 period was negatively impacted by a non-cash 22 inventory write-down of $567,000 associated with our pineapple growing operations, which reduced gross margin by 11.3%, as a result of competitive conditions and our decision to discontinue these growing operations. Citrus juice and oil gross profit improved from a loss of 79.9% in 2002 on sales of $398,000 to a loss of 25.4% in 2003 on sales of $613,000. This gross margin improvement was due to the increased margin generated from the sales increase, offset by the expensing of all lemon grove operating costs commencing in our second quarter of 2003. Prior to April 1, 2003, all expenses relating to the development of our lemon groves were capitalized as deferred orchard costs. Effective April 1, 2003, with the Coca-Cola transaction discussed above, we discontinued the deferral of these costs and are now expensing these costs as incurred. For the 2003 period these costs were approximately $424,000. Gross profit overall increased as a percent of net sales from a loss of 20.3% in 2002 to a loss of 5.2% in 2003 due to the factors discussed above. Selling, general and administrative expenses increased from $846,000 in 2002 to $1.1 million in 2003, or 30.0%. This increase consisted primarily of costs associated with preparing our Victoria juice and oil plant for sale to Coca-Cola. Interest expense increased from $130,000 in 2002 to $600,000 in 2003 due to recognizing in the current period interest expense on the Bancomext debt at the default rate, which is payable at twice the stated rate associated with the unpaid notes and expensing the accreted interest on the FOCIR debt which had previously been deferred as part of the costs relating to the development of our lemon groves. Other income (expense), net decreased from net income of $51,000 in 2002 to net expense of $178,000 in 2003. The 2002 amount consisted primarily of short-term rental income from a lease associated with one of our juice division plants which was nonrecurring in the 2003 period. The 2003 amount consisted primarily from the write-off of machinery and equipment at one of our Mexican subsidiaries. Foreign currency translation gain (loss) decreased from a net gain of $104,000 in 2002 to a net loss of $368,000 in 2003 and result primarily from the re-measurement of our foreign subsidiaries financial statements to U.S. dollars. This increased loss is the result of a stronger Mexican peso in the current period as compared to the U.S. dollar. Income tax expense decreased slightly from $169,000 in 2002 to $162,000 in 2003 and consists entirely of asset tax expense. Asset tax is an alternative minimum tax in Mexico and is calculated at 1.8% of assets less certain liabilities. As a result of the foregoing, we reported net losses of $2.3 million in 2002 and $2.7 million in 2003. Nine Months Ended September 30, 2003 and 2002 Net sales consist of packaged fruit and citrus juice and oil. Packaged fruit sales increased by $800,000 from $19.2 million in 2002 to $20.0 million in 2003, or 4.2%. This sales increase was caused by an increase in our retail sales of $3.2 million from $12.5 million in 2002 to $15.7 million in 2003, or 25.6%, offset by decreases in our Japan sales of $2.0 million from $4.4 million in 2002 to $2.4 million in 2003, or 45.5%, and in our foodservice, industrial and miscellaneous sales of $400,000 from $2.3 million in 2002 to $1.9 million in 2003. Retail sales consist primarily of sales to Del Monte, which includes both retail and wholesale club products. This retail sales increase was attributable to the timing of our production schedule for our citrus products sold to Del Monte and the introduction in early 2003 of their new 8 ounce cup of fresh red grapefruit, which is sold under their Fruit Naturals(R) trade name. The decrease in our Japan sales during the 2003 period was caused by timing differences in shipments compared to the prior year period and reduced demand for our citrus products. Foodservice and industrial sales were impacted by our focus on higher margin customers, which resulted in lower sales volume. 23 Citrus juice and oil sales increased from $1.0 million in 2002 to $1.4 million in 2003. Sales in both periods were primarily from the processing of Italian lemons for Coca-Cola under the now rescinded processing agreement. Due to the continued unfavorable and volatile worldwide market prices for FCOJ that has existed over the past several years and negative long-term prospects for the FCOJ market, in early 2002, our board of directors decided to pursue strategic alternatives available for our juice division and suspended our juice division's FCOJ operations. In April 2003, we consummated a transaction with Coca-Cola pertaining to the rescission of all contract rights and obligations for the growing and processing of Italian lemons. In June 2003, we sold our Poza Rica juice plant to an unaffiliated third party and in November 2003, we closed the sale of our Victoria juice and oil plant to Coca-Cola. As a result of these plant sales, our juice and oil business segment consists exclusively of our Italian lemon groves. As a result of the foregoing, net sales increased $1.2 million from $20.2 million in 2002 to $21.4 million in 2003, or 5.9% due primarily to increased sales in our packaged fruit segment. Gross profit, as a percentage of net sales, in our packaged fruit segment improved from a loss of 1.1% in 2002 to a gross profit of 6.9% in 2003. The 2002 period was negatively impacted by inventory write-downs of $1.1 million associated with our pineapple growing operations, which reduced gross margin by 5.7%, as a result of competitive conditions and our decision to discontinue these growing operations. Citrus juice and oil gross profit decreased from a loss of 64.6% in 2002 on sales of $1.0 million to a loss of 69.3% in 2003 on sales of $1.4 million. This gross margin decrease was caused by the expensing of all lemon grove operating costs commencing in our second quarter of 2003, offset by gross margin increases associated with the increase in sales. Prior to April 1, 2003, all expenses relating to the development of our Italian lemon groves were capitalized as deferred orchard costs. Effective April 1, 2003, with the Coca-Cola transaction discussed above, we discontinued the deferral of these costs and are now expensing these costs as incurred. For the 2003 period these costs were approximately $845,000. Gross profit overall increased as a percent of net sales from a loss of 10.8% in 2002 to a gross profit of 1.9% in 2003 due to the factors discussed above. Selling, general and administrative expenses decreased $600,000 from $2.9 million in 2002 to $2.3 million in 2003, or 20.7%. This reduction consisted primarily of a costs associated with preparing our Victoria juice and oil plant for sale to Coca-Cola offset by a gain of approximately $1.0 million recognized from the reversal of previously recorded Mexican deferred profit sharing expenses, as required under generally accepted accounting principles. This reversal was caused primarily by the calculation method of determining the deferred profit sharing liability, which allowed the $12.5 million proceeds from the Coca-Cola transaction to be offset against prior net operating losses at GISE. Impairment of long-lived assets of $232,000 in the 2003 period represents a non-cash charge that resulted from the decision to discontinue our pineapple growing operations and write-down certain long-lived assets associated with these operations to estimated fair value. Interest expense increased from $329,000 in 2002 to $815,000 in 2003 due to interest expense on the Bancomext debt recognized at the default rate, which is payable at twice the stated rate associated with the unpaid notes and expensing the accreted interest on the FOCIR debt which had previously been deferred as part of the costs relating to the development of our lemon groves. Other income (expense), net decreased from net income of $242,000 in 2002 to net expense of $218,000 in 2003. The 2002 amount consisted primarily of short-term rental income from a lease associated with one of our juice division plants which was nonrecurring in the 2003 period. The 2003 amount consisted primarily from the write-off of machinery and equipment at one of our Mexican subsidiaries. Foreign currency translation gain (loss) decreased from a net gain of $304,000 in 2002 to a net loss of $920,000 in 2003 and result primarily from the re-measurement of our foreign subsidiaries financial statements to U.S. dollars. This increased loss is the result of a stronger Mexican peso in the current period as compared to the U.S. dollar. 24 Income tax expense decreased from $786,000 in 2002 to $488,000 in 2003. The 2002 amount included $512,000 of asset tax expense and $436,000 of deferred taxes which increased our valuation allowances associated with financial and tax reporting differences in Mexico, which is required in accordance with U.S. GAAP. Offset against the 2002 asset tax expense is a Mexican jobs tax credit of $162,000 associated with the increased employment at one of our Mexican subsidiaries in prior years. The 2003 period income tax expense of $488,000 consisted entirely of asset tax expense. Asset tax is an alternative minimum tax in Mexico and is calculated at 1.8% of assets less certain liabilities. As a result of the foregoing, we reported net losses of $4.3 million and $4.6 million in our 2002 and 2003 periods, respectively. LIQUIDITY AND CAPITAL RESOURCES Financial Position: At September 30, 2003, our cash and cash equivalents totaled $7.6 million, an increase of $7.2 million from year-end 2002. During the first nine months of 2003, our operating activities used cash of $3.4 million principally from our net loss of $4.6 million, net changes in our working capital components aggregating $100,000 and a reduction in our deferred Mexican statutory profit sharing liability of $1.0 million, offset by non-cash charges associated with depreciation expense, impairment of long-lived assets and disposal of property and equipment aggregating $2.4 million. Investing activities provided $13.2 million, primarily from the proceeds from the rescission of all contract rights and obligations for the growing and processing of Italian lemons and the sale of our Poza Rica juice plant. Net cash used in financing activities was $2.6 million, which was the result of net debt repayment of $2.3 million. Working capital at September 30, 2003 amounted to $61,000 as compared to our December 31, 2002 deficit of $9.7 million. Recent Transactions: In April 2003, we consummated the portion of the transaction with Coca-Cola pertaining to the rescission of all contract rights and obligations for the growing and processing of Italian lemons for an aggregate cash payment of $12.5 million, plus value added taxes. In June 2003, we sold our Poza Rica juice plant to an unaffiliated third party for $1.0 million, plus value added taxes of $120,000. Through May 31, 2004, total payments received amounted to $585,000 with the remaining balance of $570,000 payable in three remaining installments in 2004 under a promissory note. On June 30, 2004, we received payment of $541,500 in full satisfaction of this obligation. Effective November 17, 2003, we closed the sale of our Victoria juice and oil plant to Coca-Cola, for a cash payment of $3.5 million, plus value added taxes. Through May 31, 2004, of the $16.0 million proceeds, net of value added taxes, from the Coca-Cola transactions, approximately $5.3 million have been used to pay past due accounts payable, current operating expenses of our lemon groves, operating expenses of our juice and oil processing plants prior to sale, severance payments to former plant and administrative employees of the juice division, corporate expense charges, repay the Rabobank Nederland loan of $1.5 million, repay the Banamex loans of $558,000 and repayment of bridge loans to our largest shareholder, M&M Nominee of $368,000. The remaining cash of approximately $8.2 million is anticipated to be used to pay operating expenses of the lemon groves, repay FOCIR, provide working capital for our continuing operations and/or distributed to our shareholders upon a potential liquidation of the company (See Note 1 - Description of Business - Decision to Explore Strategic Alternatives.) Cash disbursements for purposes other than those associated with GISE's juice division and agricultural operations were subject to the FOCIR Agreement and required their prior approval for disbursement. Substantially all the proceeds are invested in short-term, interest bearing investment grade securities. As of September 30, 2003, principal of $4.4 million and accrued accretion of $1.7 million was owed to FOCIR. On August 4, 2004, the company and FOCIR entered into a new agreement that restructured its debt into a $47.0 million Mexico peso (approximately U.S. $4.1 million) secured term loan. Under the terms of the restructured agreement, FOCIR agreed to forgive all 25 accreted interest (approximately $2.0 million) and changed the repayment terms to a seven year note payable in increasing amounts with the first annual principal payment due in October 2005 with interest payable quarterly at the rate of 2.5% plus Certificados de la Testorenia de la Federation (CETES), the Mexican Treasury Bill rate which is currently around 6.7%. The FOCIR debt is secured by a first lien on our El Cielo lemon grove. Recent Developments Impacting Liquidity and Capital Resources: We are experiencing significant operational and financial challenges in the near term at our ICMOSA subsidiary as a result of our working capital deficits. Our working capital deficits at September 30, 2003 at ICMOSA are approximately $4.8 million and we have been recently served with a lawsuit by one of its banks. See Item 2, "Management's Discussion and Analysis of Results of Operations and Financial Condition - Legal Proceedings and Loss Contingencies" and "Risk Factor - Risks Relating to Our Financial Condition - One of our Mexican banks has exercised its legal rights and remedies and we may be forced to seek protection under applicable provisions of the Mexican bankruptcy code." On March 17, 2004 another one of ICMOSA's lenders exercised one of their legal remedies available under its loan agreement by charging one of ICMOSA's bank accounts for a past due installment payment of $75,000 plus accrued interest of approximately $33,000. In addition, we are actively evaluating ICMOSA's business strategy and operational model. The complexity of this evaluation is further aggravated by the significant immediate liquidity issues that must be addressed in parallel with any contemplated strategic and operational changes. In connection with this evaluation, the company has determined that ICMOSA's long-lived assets have been significantly impaired by its liquidity and business model issues and that an impairment analysis under SFAS No. 144 needs to be performed in its fourth quarter of 2003. Based on ICMOSA's projected continuing negative undiscounted operating cash flows for the foreseeable future, with no opportunities for additional debt or capital, along with limited interest by any third parties in acquiring ICMOSA for any more than the assumption of liabilities, an impairment charge of approximately $5.0 million is projected to be recorded in the company's fourth quarter of 2003. Although our current cash balances as of May 31, 2004 at our GISE subsidiary are approximately $8.2 million, this cash was restricted by the FOCIR Agreement and required FOCIR's prior approval before such cash could be used to fund working capital deficits at our ICMOSA subsidiary or our general corporate overhead. ficits and corporate overhead. On August 4, 2004, the company and FOCIR entered into a new agreement that restructured its debt into a $47.0 million Mexico peso (approximately U.S. $4.1 million) secured term loan. Under the terms of the restructured agreement, FOCIR agreed to forgive all accreted interest (approximately $2.0 million) and changed the repayment terms to a seven year note payable in increasing amounts with the first annual principal payment due in October 2005 with interest payable quarterly at the rate of 2.5% plus Certificados de la Testorenia de la Federation (CETES), the Mexican Treasury Bill rate which is currently around 6.7%. The FOCIR debt is secured by a first lien on our El Cielo lemon grove. Given the increased costs associated with being a public company, the lack of liquidity for our common stock, the liquidity problems at ICMOSA (see discussion in Item 1. Note 2 - "Recent Developments Impacting Liquidity and Capital Resources") and the operational challenges facing the company, to maximize shareholder value, we are exploring available strategic alternatives, including the sale of all or a part of the company, its productive assets and strategic partnering relationships for the growing, distribution and marketing of fresh lemons. No assurances can be given that our efforts will be successful. NEW ACCOUNTING PRONOUNCEMENTS In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement No. 133 on Derivative Instruments and Hedging Activities." SFAS No. 149 amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities under FASB No. 133, "Accounting for Derivative Instruments and Hedging Activities." SFAS No. 149 is generally effective for contracts entered into or modified after June 30, 2003, and for hedging relationships designated after June 30, 2003. Adoption of this statement has not had any 26 significant impact on our financial accounting and reporting as a result of implementation of SFAS No. 149. In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity." SFAS No. 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It required that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances). SFAS No. 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. Through September 30, 2003, we have not issued financial instruments with characteristics of both liabilities and equity. RISK FACTORS If any of the following risks actually occur, our business, financial condition or operating results could be materially adversely affected. In such case, the trading price of our underlying common stock could decline and you may lose part or all of your investment. Additional risks and uncertainties not presently known to us or that we currently deem immaterial may also impair our business operations. As a result, we cannot predict every risk factor, nor can we assess the impact of all of the risk factors on our businesses or to the extent to which any factor, or combination of factors, may impact our financial condition and results of operation. Additional risks and uncertainties not presently known to us or that we currently deem immaterial may also impair our business operations. RISKS RELATING TO OUR FINANCIAL CONDITION ONE OF OUR MEXICAN BANKS HAS RECENTLY EXERCISED ITS LEGAL RIGHTS AND REMEDIES AND WE MAY BE FORCED TO SEEK PROTECTION UNDER APPLICABLE PROVISIONS OF THE MEXICAN BANKRUPTCY CODE. As of September 30, 2003, our Mexican subsidiary, ICMOSA, owed $3.5 million and $2.8 million, respectively, under secured financing agreements with Bancomext and Banorte. The loan agreement with Bancomext has not been renewed and is in default. As of September 30, 2003, accrued interest of approximately $524,000 is still outstanding. As a result of the default of the Bancomext loan, we are currently in default of the Banorte loan agreement. On February 12, 2004, an action styled Banco Nacional de Comercio Exterior, S.N.C. vs. Industrias Citricolas de Montemorelos, S.A. de C.V. and Rafael Vaquero Bazan was filed in the Federal District (Mexico City), Mexico. The action seeks recovery of $ 3.5 million in bank debt, past due interest, interest accruing during the proceedings and expenses and fees resulting from the action. In addition, in the suit Bancomext seeks to foreclose on ICMOSA's accounts receivable and seize its bank accounts. Should Bancomext be successful in the remedies sought, this lawsuit would have a material adverse effect on our consolidated financial condition and prospects and would significantly impact ICMOSA's ability to continue as a going concern. In such event, ICMOSA may be forced to seek protection under the applicable provisions of the Mexico bankruptcy code. Although we are currently discussing loan restructuring options with Banorte, on March 17, 2004 they exercised one of their legal remedies available under the loan agreement by charging one of ICMOSA's bank accounts for a past due installment payment of $75,000 plus accrued interest of approximately $33,000. WE ARE EXPERIENCING SIGNIFICANT LIQUIDITY PROBLEMS AT ONE OF OUR MEXICAN SUBSIDIARIES. We have sustained net losses in each of the last six fiscal years and in the first nine months of 2003. As of September 30, 2003, our accumulated deficit was $55.9 million, we are unable to repay two of our Mexican subsidiary's loans with principal and accrued interest totaling approximately $6.6 million under loan agreements that are in default (see above for a discussion of the lawsuit that has been recently served by one of these banks) and we are generating insufficient gross margins. 27 Although our current cash balances as of May 31, 2004 at our GISE subsidiary are approximately $8.2 million, this cash was restricted by the FOCIR Agreement and required FOCIR's prior approval before such cash could be used to fund working capital deficits at our ICMOSA subsidiary or our general corporate overhead. On August 4, 2004, the company and FOCIR entered into a new agreement that restructured its debt into a $47.0 million Mexico peso (approximately U.S. $4.1 million) secured term loan. Under the terms of the restructured agreement, FOCIR agreed to forgive all accreted interest (approximately $2.0 million) and changed the repayment terms to a seven year note payable in increasing amounts with the first annual principal payment due in October 2005 with interest payable quarterly at the rate of 2.5% plus Certificados de la Testorenia de la Federation (CETES), the Mexican Treasury Bill rate which is currently around 6.7%. The FOCIR debt is secured by a first lien on our El Cielo lemon grove. Given the increased costs associated with being a public company, the lack of liquidity for our common stock, the liquidity problems at ICMOSA (see discussion in Item 1. Note 2 - "Recent Developments Impacting Liquidity and Capital Resources") and the operational challenges facing the company, to maximize shareholder value, we are exploring available strategic alternatives, including the sale of all or a part of the company, its productive assets and strategic partnering relationships for the growing, distribution and marketing of fresh lemons. No assurances can be given that our efforts will be successful. WE MAY CONTINUE TO SUSTAIN LOSSES AND ACCUMULATED DEFICITS IN THE FUTURE. We have sustained net losses in each of the last six fiscal years and in the first nine months of 2003. As of September 30, 2003 our accumulated deficit was $55.9 million. Our ability to achieve profitability in the future will depend on many factors, including our ability to produce and market commercially acceptable products into foreign countries while reducing operating costs. Because we were not profitable in each of the last six years and during the first nine months of 2003, there can be no assurance that we will achieve a profitable level of operations in remainder of fiscal 2003 and beyond, or, if profitability is achieved that it can be sustained. Given the increased costs associated with being a public company, the lack of liquidity for our common stock, the liquidity problems at ICMOSA and the operational challenges facing the company, to maximize shareholder value, we are exploring available strategic alternatives, including the sale of all or a part of the company, its productive assets and strategic partnering relationships for the growing, distribution and marketing of fresh lemons. No assurances can be given that our efforts will be successful. WE ARE DEPENDENT UPON A LIMITED NUMBER OF CUSTOMERS. We have a limited number of customers. As a result of the sale of our Sunfresh(R) brand to Del Monte during 2000 and entering into a 5-year agreement to supply a minimum quantity of chilled and canned citrus products for distribution by Del Monte under the Sunfresh(R) brand into the United States retail and wholesale club markets, sales to them represented 61.4%, 59.8%, 69.4% and 72.8%, respectively, of our three and nine months ended September 30, 2002 and 2003 consolidated net sales. In addition, we expect that more than half of our foreseeable future net sales will be dependent on Del Monte. We believe that our future success depends upon the future operating results of Del Monte with respect to the Sunfresh(R) brand and their ability to broaden the customer base of the Sunfresh(R) brand products. Although the 5-year supply agreement requires Del Monte to purchase minimum quantities of product, there can be no assurances that Del Monte will not reduce, delay or eliminate purchases from us, which could have a material adverse effect on our results of operations and financial condition. In addition, Del Monte has significant leverage and could attempt to change the terms, including pricing and volume, upon which Del Monte and we do business, thereby adversely affecting our consolidated results of operations and financial condition. 28 WE MAY LOSE OUR NET OPERATING LOSS CARRYFORWARDS, WHICH COULD PREVENT US FROM OFFSETTING FUTURE TAXABLE INCOME IN THE UNITED STATES. In June 2001, we completed a rights offering wherein M&M Nominee, our largest shareholder, purchased an additional 6,849,315 shares of our common stock increasing their ownership from 45.2% to 62.48%. Accordingly, we experienced an ownership change as defined by Section 382 of the Internal Revenue Code of 1986, as amended, which limits the use of net operating loss carryforwards where changes occur in the stock ownership of a company. As a result, this limitation will allow us to use only a portion of our pre-change net operating loss carryforwards, which amounted to $17.7 million at December 31, 2002, to reduce subsequent taxable income in the United States, if any for federal income tax purposes. Based upon the limitations of Section 382, we may only be allowed to use approximately $425,000 of such losses each year to reduce taxable income, if any, until such unused losses expire. On July 7, 2004, we announced that Cardinal UniMark Investors, L.P. purchased 10,519,419 shares of UniMark common stock in a private transaction from MSIF. MSIF was a member of UniMark's controlling shareholder, M & M Nominee, which owned 13,149,274 shares of the company's common stock. Madera, the other partner in M & M Nominee, retained its 2,629,855 shares of common stock. As a result of this transaction, additional Section 382 limitations will further reduce the amount of our net operating losses available each year to reduce taxable income. WE ARE SUBJECT TO RISKS ASSOCIATED IN IMPLEMENTATION OF OUR BUSINESS STRATEGY. We are subject to our ability to implement our business strategy and improve our operating results, which will depend in part on our ability to realize significant cost savings associated with our supply agreement with Del Monte through operating efficiencies, achieve additional sales penetration for products sold into foreign markets and develop new products and customers in our packaged fruit business segment. No assurance can be given that we will be able to achieve such goals or that, in implementing cost saving measures, it will not impair our ability to respond rapidly or efficiently to changes in the competitive environment. In such circumstances, our consolidated results of operations and financial condition could be materially adversely affected. WE HAVE BEEN UNABLE TO FILE OUR FORM 10-K ANNUAL REPORT FOR OUR FISCAL YEAR ENDED DECEMBER 31, 2003 AND OUR FORM 10-Q QUARTERLY REPORT FOR OUR FIRST QUARTER OF 2004 WITH THE SEC, AND MATERIAL INFORMATION CONCERNING OUR CURRENT OPERATING RESULTS AND FINANCIAL CONDITION IS THEREFORE UNAVAILABLE. We have been unable to file our annual and periodic report with the SEC for our fiscal year ended December 31, 2003 and our quarter ended March 31, 2004, and the information to be contained therein is unavailable at this time. We cannot predict how soon complete financial and operational information relating to our annual and quarterly report will become available. When it is, it may reflect changes or trends that are material to our business. IF CONDITIONS OR ASSUMPTIONS DIFFER FROM THE JUDGMENTS, ASSUMPTIONS OR ESTIMATES USED IN OUR CRITICAL ACCOUNTING POLICIES, THE ACCURACY OF OUR FINANCIAL STATEMENTS AND RELATED DISCLOSURES COULD BE AFFECTED. The preparation of financial statements and related disclosures in conformity with accounting principles generally accepted in the United States of America requires management to make judgments, assumptions, and estimates that affect the amounts reported in our consolidated financial statements and accompanying notes. Our critical accounting policies, which are set forth above, describe the significant accounting policies and methods used in the preparation of our consolidated financial statements. These accounting policies are considered "critical" because they require judgments, assumptions and estimates that materially impact our consolidated financial statements and related disclosures. As a result, if future events differ significantly from the judgments, assumptions, and estimates in our critical accounting policies or different assumptions are used in the future, such events or assumptions could have a material impact on our consolidated financial statements and related disclosures. 29 RISKS RELATING TO OUR MEXICAN OPERATIONS WE ARE SUBJECT TO THE RISK OF FLUCTUATING FOREIGN CURRENCY EXCHANGE RATES AND INFLATION. We are subject to market risk associated with adverse changes in foreign currency exchange rates and inflation in our operations in Mexico. Our consolidated results of operations are affected by changes in the valuation of the Mexican peso to the extent that our Mexican subsidiaries have peso denominated net monetary assets or net monetary liabilities. In periods where the peso has been devalued in relation to the U.S. dollar, a gain will be recognized to the extent there are peso denominated net monetary liabilities while a loss will be recognized to the extent there are peso denominated net monetary assets. In periods where the peso has gained value, the converse would be recognized. Our consolidated results of operations are also subject to fluctuations in the value of the peso as they affect the translation to U.S. dollars of our Mexican subsidiaries financial statements. Since the assets and liabilities therein are peso denominated, a falling peso results in a translation loss to the extent there are net peso assets or a translation gain to the extent there are net peso liabilities. Pricing associated with the 5-year supply agreement entered into with Del Monte is in U.S. dollars. Our exposure to foreign currency exchange rate risk is difficult to estimate due to factors such as balance sheet accounts, and the existing economic uncertainty and future economic conditions in the Mexican marketplace. Significant fluctuations in the exchange rate of the Mexican peso compared to the U.S. dollar, as well as the Mexican inflation rate, could significantly impact our ability to fulfill our contractual obligations under the Del Monte supply agreement in a profitable manner, which could result in a material adverse effect upon our consolidated results of operations and financial conditions. WE ARE DEPENDENT UPON FRUIT GROWING CONDITIONS, ACCESS AND AVAILABILITY OF WATER AND THE PRICE OF FRESH FRUIT. We grow grapefruit, which is used in our packaged fruit operations, and Italian lemons. Severe weather conditions, lack of water and natural disasters, such as floods, droughts, frosts, earthquakes or pestilence, may affect the supply of one or more of our products and could significantly impact the yields of our Italian lemon groves. Substantially all of our growing operations are irrigated and a lack of water has not had a materially adverse effect on our growing operations. There can be no assurances that future weather conditions and lack of irrigation water will not have a material adverse effect on the results of our operations and our financial conditions. In addition, we also source a substantial amount of our raw materials from third-party suppliers throughout various growing regions in Mexico and Texas. A crop reduction or failure in any of these fruit growing regions resulting from factors such as weather, pestilence, disease or other natural disasters could increase the cost of our raw materials or otherwise adversely affect our operations. Competitors may be affected differently depending upon their ability to obtain adequate supplies from sources in other geographic areas. If we are unable to pass along the increased raw material costs, our consolidated financial condition and results of operations could be materially adversely affected. WE ARE SUBJECT TO GOVERNMENTAL LAWS THAT RELATE TO OWNERSHIP OF RURAL LANDS IN MEXICO. We own or lease, on a long-term basis, approximately 7,100 acres of rural land in Mexico, which are used primarily for growing our Italian lemons. Historically, the ownership of rural land in Mexico has been subject to legal limitations and claims by residents of rural communities. Although we have not experienced any legal disputes with respect to our land ownership, we are transitioning, pursuant to the terms of an existing agreement with an "Ejido" system of land ownership, approximately 5,200 acres of land from a 30-year lease to a land purchase. In connection with transfer of this land, we have received a request from the "Ejido" for the payment of an additional $1.2 million ($12.6 million Mexican pesos). The company has been advised by Mexican counsel that it has no legal obligation to make such payment. If we were unsuccessful in our efforts to transition the lease, such event could adversely affect the potential strategic alternative to divest our lemon groves. 30 LABOR SHORTAGES AND UNION ACTIVITY COULD AFFECT OUR ABILITY TO HIRE AND WE ARE DEPENDENT ON THE MEXICAN LABOR MARKET. We are heavily dependent upon the availability of a large labor force to produce our products and work our lemon groves. The turnover rate among the labor force is high due to competitive labor conditions in the area that our plants are located. If it becomes necessary to pay more to attract labor, our labor costs will increase. Our Mexican work force, whether seasonal or permanent, are generally affiliated with labor unions that are generally affiliated with a national confederation. If the unions attempt to disrupt production and are successful on a large scale, labor costs will likely increase and work stoppages may be encountered, which could be particularly damaging in our industry where the harvesting season for citrus crops occur at peak times and getting the fruit processed and packed on a timely basis is critical. WE ARE SUBJECT TO STATUTORY EMPLOYEE PROFIT SHARING IN MEXICO. All Mexican companies, including ours, are required to pay their employees, in addition to their agreed compensation benefits, profit sharing in an aggregate amount equal to 10% of taxable income, as adjusted to eliminate most of the effects of Mexican inflation, calculated for employee profit sharing purposes, of the individual corporation employing such employees. As a result of losses for income tax purposes at our Mexican subsidiaries over the past several years, we have not been required to pay any profit sharing. Statutory employee profit sharing expense, when paid, is reflected in our cost of goods sold and selling, general and administrative expenses, depending upon the function of the employees to whom profit sharing payments are made. Our net losses as shown in our consolidated statements of operations are not always a meaningful indication of taxable income of our subsidiaries for profit sharing purposes or of the amount of employee profit sharing. WE ARE SUBJECT TO VOLATILE INTEREST RATES IN MEXICO, WHICH COULD INCREASE OUR CAPITAL COSTS. We are subject to volatile interest rates in Mexico. Historically, interest rates in Mexico have been volatile, particularly in times of economic unrest and uncertainty. High interest rates restrict the availability and raise the cost of capital for our Mexican subsidiaries and for growers and other Mexican parties with whom we do business, both for borrowings denominated in pesos and for borrowings denominated in U.S. dollars. As a result, costs of operations for our Mexican subsidiaries could be higher. TRADE DISPUTES BETWEEN THE UNITED STATES, MEXICO, JAPAN AND EUROPE COULD RESULT IN TARIFFS, QUOTAS AND BANS ON IMPORTS, INCLUDING OUR PRODUCTS, WHICH COULD IMPAIR OUR FINANCIAL CONDITION. We are subject to trade agreements between the United States, Mexico, Japan and Europe. Despite the enactment of the North American Free Trade Agreement, Mexico and the United States from time to time are involved in trade disputes. The United States has, on occasion, imposed tariffs, quotas, and importation limitations on products produced in Mexico. Because all of our products are currently produced by our subsidiaries in Mexico, which we sell in the United States, Japan and Europe, such actions, if taken, could adversely affect our business. GENERAL BUSINESS RISKS WE MAY BE SUBJECT TO PRODUCT LIABILITY AND PRODUCT RECALL. We produce a consumer product that is subject to product recall. The testing, marketing, distribution and sale of food and beverage products entail an inherent risk of product liability and product recall. There can be no assurance that product liability claims will not be asserted against us or that we will not be obligated to recall our products. Although we maintain product liability insurance coverage in the amount of $11.0 million per occurrence, there can be no assurance that this level of coverage is adequate. A product recall or a partially or completely uninsured judgment against us could have a material adverse effect on our consolidated results of operations and financial condition. 31 WE ARE SUBJECT TO GOVERNMENTAL AND ENVIRONMENTAL REGULATIONS. We are subject to numerous domestic and foreign governmental and environmental laws and regulations as a result of our agricultural, food and juice processing activities. The Food and Drug Administration ("FDA"), the United States Department of Agriculture ("USDA"), the Environmental Protection Agency and other federal and state regulatory agencies in the United States extensively regulate our activities in the United States. The manufacturing, processing, packing, storage, distribution and labeling of food and juice products are subject to extensive regulations enforced by, among others, the FDA and to inspection by the USDA and other federal, state, local agencies. Applicable statutes and regulations governing food products include "standards of identity" for the content of specific types of foods, nutritional labeling and serving size requirements and under "Good Manufacturing Practices" with respect to production processes. We believe that our products satisfy, and any new products will satisfy all applicable regulations and that all of the ingredients used in our products are "Generally Recognized as Safe" by the FDA for the intended purposes for which they will be used. Failure to comply with applicable laws and regulations could subject us to civil remedies, including fines, injunctions, recalls or seizures, as well as potential criminal sanctions, which could have a material adverse effect on our consolidated results of operations and financial condition. The Secretaria de Agricultura, Ganaderia, Desarrollo Rural, Pesca y Alimentacion ("SAGARPA"), the Secretaria de Medio Ambiente y Recursos Naturales ("SEMARNAT"), the Secretaria de Salud ("SS"), and other federal and state regulatory agencies in Mexico extensively regulate our Mexican operations. Many of these laws and regulations are becoming increasingly stringent and compliance with them is becoming increasingly expensive. On a daily basis, we test our products in our internal laboratories and, periodically, submit samples of our products to independent laboratories for analysis. Failure to comply with applicable laws and regulations could subject us to civil remedies, including fines, injunctions, recalls or seizures, as well as potential criminal sanctions, which could have a material adverse effect on results of operations and financial condition. Although we believe that our facilities are currently in compliance with all applicable environmental laws, failure to comply with any such laws could have a material adverse effect on our consolidated results of operations and financial condition. WE ARE DEPENDENT UPON OUR SENIOR MANAGEMENT TEAM. We rely on the business, technical expertise and experience of our senior management and certain other key employees. The loss of services of any of these individuals could have a material adverse effect on our results of operations and financial condition. We believe that our future success is also dependent upon our ability to continue to attract and retain qualified personnel in all areas of our business. No senior members of our management team are bound by non-compete agreements, and if such members were to depart and subsequently compete with us, such competition could have a material adverse effect on our consolidated results of operations and financial condition. WE HAVE A SEASONAL BUSINESS. We are a seasonal business and, as with any agribusiness, demand for our citrus and tropical fruit products is strongest during the fall, winter and spring when many seasonal fresh products are not readily available for sale in supermarkets in North America. In addition, a substantial portion of our exports to Japan are processed and shipped during the first and fourth quarters of each year. Our management believes that our quarterly consolidated net sales will continue to be impacted by this pattern of seasonality. WE FACE STRONG COMPETITION. We operate in a highly competitive market. The food industry, including the markets in which we compete, is highly competitive with respect to price and quality, including taste, texture, healthfulness and nutritional value. We face direct competition from citrus processors with respect to our existing product lines and face potential competition from numerous, well established competitors possessing substantially greater financial, marketing, personnel and other resources than we do. In recent years, numerous 32 companies have introduced products positioned to capitalize on growing consumer preference for fresh fruit products. It can be expected that we will be subject to increasing competition from companies whose products or marketing strategies address these consumer preferences. WE HAVE A SHAREHOLDER THAT HAS SUBSTANTIAL CONTROL OVER OUR COMPANY AND CAN AFFECT VIRTUALLY ALL DECISIONS MADE BY OUR SHAREHOLDERS AND DIRECTORS. M&M Nominee owned 13,149,274 shares of our common stock accounting for 62.48% of all issued and outstanding shares. On July 7, 2004, we announced that Cardinal purchased 10,519,419 shares of UniMark common stock in a private transaction from MSIF for $0.40 per share. MSIF was a member of UniMark's controlling shareholder, M & M Nominee, which owned 13,149,274 shares of the company's common stock. Madera, the other partner in M & M Nominee, retained its 2,629,855 shares of common stock. Cardinal has the contractual right to vote Madera's shares. As a result, Cardinal has the requisite voting power to significantly affect virtually all decisions made by our company and its shareholders, including the power to elect all directors and to block corporate actions such as amendments to most provisions of our articles of incorporation. This ownership and management structure could inhibit initiatives taken by our company that are not acceptable to Cardinal. WE ARE SUBJECT TO RECENT LEGISLATIVE ACTIONS AND POTENTIAL NEW ACCOUNTING PRONOUNCEMENTS. In order to comply with the newly adopted Sarbanes-Oxley Act of 2002 and proposed accounting changes by the SEC, we may be required to increase or modify our internal controls, hire additional personnel and additional outside legal, accounting and advisory services, all of which could cause our general and administrative costs to increase. Proposed changes in accounting rules, including legislative and other proposals to account for employee stock options as compensation expense among others, could potentially increase the expenses we report under United States Generally Accepted Accounting Practices and could adversely affect our operating results. RISKS RELATING TO OUR COMMON STOCK THE DELISTING FROM THE OVER-THE-COUNTER BULLETIN BOARD HAS FURTHER REDUCED THE LIQUIDITY AND MARKETABILITY OF OUR COMMON STOCK AND MAY FURTHER DEPRESS THE MARKET PRICE OF OUR COMMON STOCK. On March 15, 2001, Nasdaq delisted our common stock from The Nasdaq National Market and moved our common stock to the Over-the-Counter Electronic Bulletin Board ("OTC Bulletin Board") under the symbol "UNMG.OB." On May 29, 2003, our common stock ceased to be quoted for trading on the OTC Bulletin Board, and is presently listed on the "Pink Sheets." Prices for securities traded solely on the Pink Sheets may be difficult to obtain. As such, our stock has very limited liquidity and marketability. This very limited liquidity, marketability, the reduced public access to quotations for our common stock and lack of a regular trading market for our stock have depressed the market price of our stock. Although we intend to take actions necessary to have our stock included in the OTC Bulletin Board, there can be no assurance that we will be successful. Further, the OTC Bulletin Board is an unorganized, inter-dealer, over-the-counter market with significantly less liquidity than other recognized markets such as The Nasdaq Stock Market. "PENNY STOCK" REGULATIONS MAY IMPOSE RESTRICTIONS ON MARKETABILITY OF OUR COMMON STOCK. The SEC has adopted regulations which generally define "penny stock" to be any equity security that is not traded on a national securities exchange or Nasdaq and that has a market price of less than $5.00 per share or an exercise price of less than $5.00 per share, subject to certain exceptions. Since our securities that are currently included on the OTC Bulletin Board are trading at less than $5.00 per share at any time, our common stock may become subject to rules that impose additional sales practice requirements on broker-dealers who sell such securities to persons other than established customers and accredited investors. Accredited investors generally include investors that have assets in excess of $1.0 million or an individual annual income exceeding $200,000, or, together with the investor's spouse, a joint income of $300,000. For transactions covered by these rules, the broker-dealer must make a special suitability 33 determination for the purchase of such securities and have received the purchaser's written consent to the transaction prior to the purchase. Additionally, for any transaction involving a penny stock, unless exempt, the rules require, among other things, the delivery, prior to the transaction, of a risk disclosure document mandated by the SEC relating to the penny stock market and the risks associated therewith. The broker-dealer must also disclose the commission payable to both the broker-dealer and the registered representative, current quotations for the securities and, if the broker-dealer is the sole market-maker, the broker-dealer must disclose this fact and the broker-dealer's presumed control over the market. Finally, monthly statements must be sent disclosing recent price information for the penny stock held in the account and information on the limited market in penny stocks. Consequently, the penny stock rules may restrict the ability of broker-dealers to sell our securities and may affect the ability of stockholders to sell our securities in the secondary market. OUR COMMON STOCK PRICE HAS BEEN AND MAY CONTINUE TO BE HIGHLY VOLATILE. The price of our common stock has been particularly volatile and will likely continue to fluctuate in the future. Announcements of chronological innovations, regulatory matters or new commercial products by us or our competitors, developments or disputes concerning patent or proprietary rights, publicity regarding actual or potential product results relating to products under development by us or our competitors, regulatory developments in both the United States and foreign countries, public concern as to the safety of pharmaceutical or dietary supplement products, and economic and other external factors, as well as period-to-period fluctuations in financial results, may have a significant impact on the market price of our common stock. In addition, from time to time, the stock market experiences significant price and volume fluctuations that may be unrelated to the operating performance of particular companies or industries. The market price of our common stock, like the stock prices of many publicly traded smaller companies, has been and may continue to be highly volatile. WE HAVE NEVER PAID A DIVIDEND. We have never paid cash dividends on our common stock or any other securities. We anticipate that we will retain any future earnings for use in the expansion and operation of our business, and do not anticipate paying cash dividends in the foreseeable future. 34 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK INTEREST RATE RISK Our interest expense is most sensitive to changes in the general level of U.S. interest rates and London interbank offered rates. In this regard, changes in these interest rates affect the interest paid on our debt. The following table presents principal cash flows and related weighted-average interest rates by expected maturity dates for our debt obligations. INTEREST RATE SENSITIVITY Principal Amount by Expected Maturity Average Interest Rate (In thousands, except interest rates)
Estimated There- Fair Value 2003 2004 2005 2006 2007 after Total 9/30/03 ---- ---- ---- ---- ---- ----- ----- ------- Long-term debt, including current portion Fixed rate $ 19 $ -- $ -- $ -- $ -- $ -- $ 19 $ 19 Average interest rate 6.9% Variable rate $150 $ 300 $400 $ 700 $1,260 $ 4,356 $7,166 $7,166 Average interest rate 4.8% 4.8% 4.8% 4.8% 4.8% 10.6%
The scheduled maturities of long-term debt above are based on the original loan agreement maturities before reclassifications arising from defaults. At September 30, 2003, U.S. dollar denominated long-term debt amounted to $2.8 million as compared to Mexican peso denominated long-term debt of $4.4 million. ITEM 4. CONTROLS AND PROCEDURES (a) Evaluation of Disclosure Controls and Procedures Our company maintains a system of disclosure controls and procedures. The term "disclosure controls and procedures", as defined by regulations of the SEC, means controls and other procedures that are designed to ensure that information required to be disclosed in the reports that our company files or submits to the SEC under the Securities Exchange Act of 1934, as amended (the "Act"), is recorded, processed, summarized and reported, within the time period specified in the SEC's rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by our company in the reports that it files or submits to the SEC under the Act is accumulated and communicated to our company's management, including its principal executive officer and its principal financial officer, as appropriate to allow timely decisions to be made regarding required disclosure. Our company's Chief Executive Officer and our Chief Financial Officer have evaluated our company's disclosure controls and procedures as of a date within 90 days of the filing date of this quarterly report on Form 10-Q and have concluded that our company's disclosure controls and procedures need improvement. (See Item 4. (b) below.) With the filing of this quarterly report on Form 10-Q for the quarterly period ended September 30, 2003, we will be filing approximately eight months past our extension request to November 14, 2003. This filing delay has been caused by several factors, which are as follows - - The annual audit of our consolidated financial statements for our fiscal year ending December 31, 2002, by our independent public accountants was finalized on July 25, 2003 and we filed our annual report on Form 10-K for our fiscal year ended December 31, 2002 on August 12, 2003. Their quarterly review under SAS 100 of our first quarter 2003 did not 35 commence until shortly after the completion of their audit. Filing of our Form 10-Q for our quarterly period ended June 30, 2003 was made on March 8, 2004. - As a result of the finalization of a transaction with Coca-Cola for the rescission of certain contract rights for the growing and processing of Italian lemons in Mexico, which was completed in April 2003, a detailed analysis of the impact of this transaction on our December 31, 2002 deferred orchard costs was required to assess impairment of these long-lived assets under current accounting literature, which included an expert third party appraisal of the assets which we obtained in June 2003. - As part of our company's decision to discontinue the juice division of our juice and oil business segment, we entered into contracts to sell our juice processing plants and related equipment located in Mexico. As a result, additional analysis was required in assessing the impairment of these long-lived assets under current accounting literature. - The review of certain internal control deficiencies by our company's Audit Committee and independent accountants. - The replacement of several members of our company's Audit Committee with independent directors. - The resignation of certain personnel and their impact on financial statement preparation. (b) Changes in Internal Controls Our company also maintains a system of internal controls. The term "internal controls", as defined by the American Institute of Certified Public Accountants' Codification of Statement on Auditing Standards, AU Section 319, means controls and other procedures designed to provide reasonable assurance regarding the achievement of objectives in the reliability of our company's financial reporting, the effectiveness and efficiency of our company's operations and our company's compliance with applicable laws and regulations. In connection with the preparation of this quarterly report on Form 10-Q, our management identified certain deficiencies in the company's internal control procedures, none of which would be deemed to be a material weakness under standards established by the American Institute of Certified Public Accountants. These internal control deficiencies, which were investigated by our Audit Committee and independent accountants, did not result in a material misstatement of our condensed consolidated financial statements. Management and our Audit Committee have adopted corrective measures, and will be adopting others, to address and eliminate these deficiencies, which should improve our internal and disclosure controls. These measures include the hiring of an external accounting firm to assist in the preparation of timely monthly, quarterly and annual financial statements in accordance with U.S. GAAP and improved controls relating to the payment of certain expenses at one of our Mexican subsidiaries and a closer monitoring of the company's financial results by its Audit Committee. PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS Several legal proceedings arising in the normal course of business are pending against us, including certain of our Mexican subsidiaries. On February 12, 2004, an action styled Banco Nacional de Comercio Exterior, S.N.C. vs. Industrias Citricolas de Montemorelos, S.A. de C.V. and Rafael Vaquero Bazan was filed in the Federal District (Mexico City), Mexico. The action seeks recovery of $ 3.5 million in bank debt, past due interest, interest accruing during the proceedings and expenses and fees resulting from the action. In addition, in the suit Bancomext seeks to foreclose on ICMOSA's accounts receivable and seize its bank accounts. Should Bancomext be successful in obtaining the remedies sought, this lawsuit would have a material adverse effect on our consolidated financial condition and prospects and would significantly impact ICMOSA's ability to continue as a going concern. In such event, ICMOSA may be forced to seek protection under the applicable provisions of the Mexico bankruptcy code. 36 On September 18, 2002, an action captioned "Complaint for Avoidance of Preferential Transfers and Turnover of Property of the Estate styled Golden Gem Growers, Inc., a Reorganized Debtor and Daniel E. Dempsey, CPA, Disbursing Agent for The Estate of Golden Gem Growers, Inc., Plaintiff vs. The UniMark Group, Inc., Gisalamo S.A. de C.V., and Grupo Industrial Santa Engracia S.A. de C.V., Defendants", was filed in the United States Bankruptcy Court, Middle District of Florida, Orlando Division, Adversary Proceeding No. 02-258. The compliant seeks recovery of $200,000 of payments made by Golden Gem prior to its filing for bankruptcy protection in September 2001. Although the ultimate resolution of this matter cannot be determined at this time, any unfavorable outcome would not have a material adverse effect on our consolidated financial condition. In March 2004 we entered into a settlement agreement with the Disbursing Agent on this matter for $5,000, which was approved by the Bankruptcy court. As a result of the decline in the worldwide market prices of FCOJ, during 2000 we decided to discontinue operating a juice processing facility in Mexico that had been leased from Frutalamo under the terms of deposit, operating and stock purchase agreements entered into in December 1996. As we were unsuccessful in negotiating a settlement with Frutalamo to terminate such agreements, we wrote off a previously recorded non-refundable deposit of $1.5 million and recorded a cancellation fee of $1.0 million, both of which were non-cash charges. Subsequent to December 31, 2000, Frutalamo and certain of its shareholders initiated legal proceedings in Mexico naming as defendants certain of our Mexican subsidiaries, certain current and former employees, officers and directors of our company and a former contractor. In September 2002, we settled these claims for $125,000 in cash. We have learned that, notwithstanding such settlement, certain claims asserted against us by the Frutalamo Plaintiffs, prior to September 2002, continue to be under review before the Mexican courts. Management denies any wrongdoing in this matter and intends to vigorously contest these claims. The resolution of this matter is not expected to have a material adverse effect on our consolidated financial condition or results of operations. On October 10, 2003, an action styled "James R. Scott, Plaintiff vs. UniMark Group, Inc, Defendant," was filed in the County Court, Denton, Texas, Cause Number TI-2003-01345. The compliant seeks recovery of approximately $90,000 of unpaid rent and injunctive relief. In addition to the actions described above, from time to time our company is engaged in various other legal proceedings in the normal course of business. The ultimate liability, if any, for the aggregate amounts claimed cannot be determined at this time. However, our company, based on the consultation with legal counsel, is of the opinion that there are no matters pending or threatening, except for Bancomext, which could have a material adverse effect on our consolidated financial position or results of operations. ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS None ITEM 3. DEFAULTS UPON SENIOR SECURITIES See Note 3 to our condensed consolidated financial statements for a discussion of our noncompliance with our loan agreements with Bancomext, Banorte and FOCIR. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None ITEM 5. OTHER INFORMATION None 37 ITEM 6. EXHIBITS AND REPORTS ON FORM 8 -K (a) Exhibits See "Exhibit Index" immediately following the signature page. (b) Reports on Form 8-K - On May 28, 2004, we filed a Current Report on Form 8-K with the Securities and Exchange Commission announcing management changes. On July 7, 2004, we filed a Current Report on Form 8-K with the Securities and Exchange Commission announcing a change in its significant shareholder and the resignation of a director. 38 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. THE UNIMARK GROUP, INC. ----------------------- Registrant Date: August 13, 2004 /s/ Jakes Jordaan ------------------- Jakes Jordaan, President (Principal Executive Officer) Date: August 13, 2004 /s/ R. Arturo Herrera Barre ---------------------------- R. Arturo Herrera Barre (Principal Executive Officer during the Reporting Period) Date: August 13, 2004 /s/David E. Ziegler --------------------- David E. Ziegler, Chief Financial Officer (Principal Accounting Officer) 39 EXHIBIT INDEX
Exhibit Number ------ 10.64 Employment Agreement by and among The UniMark Group, Inc. and Ricardo Arturo Herrera Barre dated as of August 28, 2003 31.1 Certification of Chief Executive Officer Pursuant to Pursuant to Section 302 of the Sarbanes- Oxley Act of 2002 31.2 Certification of Chief Executive Officer During Reporting Period Pursuant to Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 31.3 Certification of Chief Financial Officer Pursuant to Pursuant to Section 302 of the Sarbanes- Oxley Act of 2002 32 Certification of Chief Executive Officer, Chief Executive Officer During Reporting Period and Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
40