Alto Ingredients - 10-Q quarterly report FY

 

 

(Mark One)

 

 

 

For the transition period from _______ to _______

 

 

 

(Exact name of registrant as specified in its charter)

 

(Address of principal executive offices)

(Registrant’s telephone number, including Area Code)

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

 

 

 

As of August 8, 2007, there were 40,580,478 shares of Pacific Ethanol, Inc. common stock, $.001 par value per share, outstanding.

 

 

 

 

 

 

 

See accompanying notes to consolidated financial statements.

 

 

 

See accompanying notes to consolidated financial statements.

 

 

 

 

 

 

The Company is engaged in the business of marketing and producing ethanol and its co-products, including wet distillers grain (“WDG”).

 

 

Activity occurring during the three and six months ended June 30, 2006 and reflected in the consolidated statements of operations, consolidated statements of comprehensive income and consolidated statements of cash flows does not include the operations or transactions of Front Range, the Company’s variable interest entity, as the Company did not obtain a variable interest in Front Range until October 17, 2006.

 

Reclassifications of prior year’s data have been made to conform to 2007 classifications.

 

 

 

 

 

 

 

 

The cost, gross unrealized gains (losses) and fair value of available-for-sale securities by security type were as follows (in thousands):

 

 

 

Inventories consist primarily of bulk ethanol, unleaded fuel and corn, and are valued at the lower-of-cost-or-market, with cost determined on a first-in, first-out basis. Inventory balances consisted of the following (in thousands):

 

 

 

 

 

The following table summarizes the Company’s long term borrowings and capital lease obligations (in thousands):

 

 

 

 

 

 

Loans and letters of credit under the Debt Financing are subject to conditions precedent, including, among others, the absence of a material adverse effect; the absence of defaults or events of defaults; the accuracy of certain representations and warranties; the maintenance of a debt-to-equity ratio that is not in excess of 65:35; the contribution of all required equity by the Company to the Borrowers, which is expected to be approximately $218,800,000 in the aggregate; and the attainment of at least a 1.5-to-1.0 debt service coverage ratio. Also, the Borrowers may not be able to fully utilize the Debt Financing if the completed ethanol plants fail to meet certain minimum performance standards. Loans made under the construction and term loan facilities may not be re-borrowed once repaid or re-borrowed once prepaid. Finally, loan amounts under the construction and term loan facilities are limited to a percentage of project costs of the corresponding plant but are not to exceed approximately $1.15 per gallon of annual production capacity of the plant.

 

The Borrowers have the option to select from multiple interest rates that float with common interest rate indices, such as the LIBOR, with reset periods of differing durations. Depending upon the floating interest rate selected, the type of loan and whether the loan is made under a construction loan facility, a term loan facility or the working capital and letter of credit facility, loans under the Debt Financing bear interest at rates ranging from 2.25% to 4.35% over the selected interest rate index.

 

In addition to scheduled principal payments, starting after the Conversion Date, the term loan facilities require mandatory repayments of principal in amounts based on the Borrowers’ free cash flow. The percentage of the Borrowers’ free cash flow to be applied to principal repayments is to vary from 50% in the first two years following the Conversion Date to 75-100% in succeeding years, based upon repayment amounts measured against targeted balances.

 

Borrowings and the Borrowers’ obligations under the Debt Financing are secured by a first-priority security interest in all of the equity interests in the Borrowers and substantially all the assets of the Borrowers. The security interests granted by the Borrowers under the Debt Financing restrict the assets and revenues of the Borrowers and therefore may inhibit the Company’s ability to obtain other debt financing. The Borrowers are subject to certain financial and other covenants, with which the Company believes they are in compliance as of June 30, 2007.

 

In connection with the Debt Financing, the Company also entered into a Sponsor Support Agreement under which the Company is to provide limited contingent equity support in connection with the development, construction, installation, engineering, procurement, design, testing, start-up and maintenance of the five ethanol production facilities. In particular, the Company has agreed to contribute to the Borrowers up to an aggregate of approximately $42,400,000 (the “Sponsor Funding Cap”) of contingent equity in the event the Borrowers have insufficient funds to either pay their project costs as they become due and payable or, by delay in payment, cause the ethanol production facilities to fail to be completed by the Conversion Date. The Company has agreed to provide a warranty with respect to all ethanol plants other than its Madera facility, which is under standard warranty through the contractor. The warranty obligations of the Company with respect to the other four facilities extend one year beyond final completion of each facility. The warranty obligation will cease one year from the date the fifth ethanol plant achieves final completion. The Company’s obligations under the warranty are capped at the Sponsor Funding Cap. Until the Company’s contingent equity obligations have been fully performed or the warranty period has expired, the Company may not incur any secured indebtedness for borrowed money, grant liens on its assets or provide any secured credit enhancements in an aggregate amount in excess of $10,000,000 unless the Company provides the lenders under the Debt Financing with the same liens or credit support.

 

The Company incurred $10,699,000 of costs associated with the completion of the Debt Financing arrangement and has capitalized these costs in other assets, except the portion amortizing during the next 12 months, which is classified in other current assets. These costs are being amortized over a six year life.

 

 

 

The Company has three equity incentive compensation plans: an Amended 1995 Incentive Stock Plan, a 2004 Stock Option Plan and a 2006 Stock Incentive Plan.

 

 

 

The Company’s accounting for income taxes is based on an asset and liability approach. The Company recognizes the amount of taxes payable or refundable for the current year, and deferred tax assets and liabilities for the future tax consequences that have been recognized in its financial statements or tax returns. The measurement of tax assets and liabilities is based on the provisions of enacted tax laws.

 

 

The Company adopted the provisions of FIN 48 on January 1, 2007. As of the date of adoption, the Company had no unrecognized income tax benefits. Accordingly, the annual effective tax rate was not affected by the adoption of FIN 48. Unrecognized tax benefits are not expected to increase or decrease within the next 12 months as a result of the anticipated lapse of an applicable statute of limitations. Interest and penalties related to unrecognized income tax benefits will be accrued in interest expense and operating expense, respectively. The Company has not accrued interest or penalties as of the date of adoption because they are not applicable.

 

The Company may be audited by applicable federal and state taxing authorities in the following income tax jurisdictions in which the Company previously filed or expects to file income tax returns for the years indicated:

 

 

However, because the Company had net operating losses and credits carried forward in several of the jurisdictions including federal and California, certain items attributable to closed tax years are still subject to adjustment by applicable taxing authorities through an adjustment to tax attributes carried forward to open years.

 

 

The following table computes basic and diluted earnings per share (in thousands, except per share data):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

On February 9, 2007, Mr. Spiegel filed an amended complaint which purports to state the following five counts: (i) breach of fiduciary duty, (ii) fraudulent inducement, (iii) violation of Florida’s Securities and Investor Protection Act, (iv) fraudulent concealment, and (v) breach of fiduciary duty of disclosure. The amended complaint includes the Company as a defendant. The breach of fiduciary duty counts are alleged solely against the Individual Defendants and not the Company. On June 19, 2007, the Company filed a motion to dismiss the amended complaint. The Court denied the motion to dismiss the amended complaint by order dated July 31, 2007, and the Company must file an answer. Defendants have scheduled Mr. Spiegel’s deposition for September 10, 2007. The Company intends to vigorously defend the amended complaint.

 

 

 

 

 

 

The Company marked its derivative instruments to fair value at each period end, except for those derivative contracts that qualified for the normal purchase and sale exemption under SFAS No. 133. According to the Company’s designation of the derivatives, changes in the fair value of derivatives are reflected in earnings or accumulated other comprehensive income.

 

 

 

The estimated fair values of the Company’s derivatives as of June 30, 2007 and December 31, 2006 were as follows (in thousands):

 

 

During 2006, the Company signed a sales contract at market terms with an entity which at the time was owned by a member of the Company’s Board of Directors. The contracts were in effect after the beginning of the year and expired on March 31, 2007. The Company recorded sales of $0 and $6,039,000 for the three and six months ended June 30, 2007 and $2,723,000 and $8,585,000 for the three and six months ended June 30, 2006, respectively, related to these contracts.

 

In 2006, the Company entered into an agreement with a construction company to build an ethanol production facility in Madera County, California. An officer of the construction company is a former member of the board of directors of PEI California. The Company had outstanding liabilities to the construction company in the amount of $4,107,000 as of June 30, 2007.

 

In April 2007, the Company commenced business with an entity owned by a member of the Board of Directors. The Company recorded sales of $67,000 and had accounts receivable of $62,000 at June 30, 2007.

 

 

 

The following discussion and analysis should be read in conjunction with our consolidated financial statements and notes to consolidated financial statements included elsewhere in this report. This report and our consolidated financial statements and notes to consolidated financial statements contain forward-looking statements, which generally include the plans and objectives of management for future operations, including plans and objectives relating to our future economic performance and our current beliefs regarding revenues we might generate and profits we might earn if we are successful in implementing our business and growth strategies. The forward-looking statements and associated risks may include, relate to or be qualified by other important factors, including, without limitation:

 

We do not undertake to update, revise or correct any forward-looking statements.

 

Any of the factors described above or in the “Risk Factors” section of our Annual Report on Form 10-K for the year ended December 31, 2006, could cause our financial results, including our net income or loss or growth in net income or loss to differ materially from prior results, which in turn could, among other things, cause the price of our common stock to fluctuate substantially.

 

 

Our primary goal is to become the leading marketer and producer of renewable fuels in the Western United States.

 

We produce and sell ethanol and its co-products and provide transportation, storage and delivery of ethanol through third-party service providers in the Western United States, primarily in California, Nevada, Arizona, Oregon and Colorado. We have extensive customer relationships throughout the Western United States and extensive supplier relationships throughout the Western and Midwestern United States.

 

Our customers are integrated oil companies and gasoline marketers who blend ethanol into gasoline. We supply ethanol to our customers either from our own ethanol production facilities located within the regions we serve, or with ethanol procured in bulk from other producers. In some cases, we have marketing agreements with other ethanol producers to market all of the output of their facilities. Additionally, we have customers who purchase our co-products for animal feed.

 

In October 2006, we achieved commercial operations of an ethanol production facility with a nameplate annual production capacity of 35 million gallons located in Madera, California. Currently this facility is producing ethanol at a rate in excess of 40 million gallons per year. In October 2006, we also acquired approximately 42% of the outstanding membership interests of Front Range Energy, LLC, or Front Range, which owns and operates an ethanol production facility with nameplate annual production capacity of 40 million gallons located in Windsor, Colorado. The Front Range facility is currently producing ethanol at a rate in excess of 40 million gallons per year. In addition, we have one ethanol plant in start-up and three additional facilities under construction. We also intend to construct or otherwise acquire additional ethanol production facilities as financial resources and business prospects make the construction or acquisition of these facilities advisable.

 

In 2006, total annual gasoline consumption in the United States was approximately 140 billion gallons. Total annual ethanol consumption currently represents less than 4% of annual gasoline consumption, or approximately 5.6 billion gallons of ethanol. We believe that the domestic ethanol industry has substantial potential for growth to reach what we estimate is an achievable level of at least 10% of the total annual gasoline consumption in the United States, or approximately 14 billion gallons of ethanol. In California alone, an increase in the consumption of ethanol from California’s current level of 5.7%, or approximately 1.0 billion gallons of ethanol per year, to at least 10% of total annual gasoline consumption would result in consumption of approximately 700 million additional gallons of ethanol, representing an increase in annual ethanol consumption in California alone of approximately 75% and an increase in annual ethanol consumption in the entire United States of approximately 13%.

 

We intend to achieve our goal of becoming the leading marketer and producer of renewable fuels in the Western United States in part by expanding our relationships with customers and third-party ethanol producers to market higher volumes of ethanol throughout the Western United States, by expanding our relationships with animal feed distributors and end users to build local markets for wet distillers grains, or WDG, the primary co-product of our ethanol production, and by expanding the market for ethanol by continuing to work with state governments to encourage the adoption of policies and standards that promote ethanol as a fuel additive and ultimately as a primary transportation fuel. In addition, we intend to achieve this goal in part by expanding our production capacity to 220 million gallons of annual production capacity by mid 2008 and 420 million gallons of annual production capacity by the end of 2010. We also intend to expand our distribution infrastructure by expanding our ability to provide transportation, storage and related logistical services to our customers throughout the Western United States.

 

 

The preparation of our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America, requires us to make judgments and estimates that may have a significant impact upon the portrayal of our financial condition and results of operations. We believe that of our significant accounting policies, the following require estimates and assumptions that require complex, subjective judgments by management that can materially impact the portrayal of our financial condition and results of operations: revenue recognition; consolidation of variable interest entities; impairment of intangible and long-lived assets; stock-based compensation; derivative instruments and hedging activities; allowance for doubtful accounts; and costs of start-up activities. These significant accounting principles are more fully described in “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Policies” in our Annual Report on Form 10-K for the year ended December 31, 2006.

 

 

The tables below, which compare our results of operations between or among periods, present the results for each period, the change in those results from one period to another in both dollars and percentage change, and the results for each period as a percentage of net sales.

 

 

The following table presents our net sales, cost of goods sold and gross profit in dollars and gross profit as a percentage of net sales (in thousands, except percentages):

 

 

The increase in our net sales for the three months ended June 30, 2007 as compared to the three months ended June 30, 2006 was predominantly due to increased sales volume. For the three months ended June 30, 2007, total volume of ethanol sold as a principal and as an agent increased by 24.1 million gallons, or 122%, to 43.9 million gallons as compared to 19.8 million gallons for the three months ended June 30, 2006. For the three months ended June 30, 2007, our average sales price of ethanol increased by $0.04 per gallon, or 2%, to $2.32 per gallon for all gallons sold as a principal and an agent as compared to $2.28 per gallon for the three months ended June 30, 2006. The substantial increase in sales volume is primarily due to additional supply provided under our ethanol marketing agreement and the commencement of ethanol production. In the fourth quarter of 2006, we began producing ethanol and its co-products at our Madera facility and, based on our ownership interest in Front Range, began recording its net sales. The production and sale of ethanol and its co-products at our Madera facility and through Front Range contributed an aggregate of $50,219,000 in sales for the three months ended June 30, 2007, whereas there were no such sales during the three months ended June 30, 2006.

 

The increase in our gross profit for the three months ended June 30, 2007 as compared to the three months ended June 30, 2006, both in dollars and as a percentage of net sales, is primarily due to the commencement of ethanol production at our Madera facility and the gross profit generated from Front Range. This increase in gross profit was partially offset by a loss of $2,601,000 related to derivative instruments, of which $1,725,000 was from the change in fair value of non-designated derivative instruments that will settle in future periods.

 

The increase in our net sales for the six months ended June 30, 2007 as compared to the six months ended June 30, 2006 was predominantly due to increased sales volume. For the six months ended June 30, 2007, total volume of ethanol sold as a principal and as an agent increased by 43.1 million gallons, or 109%, to 82.8 million gallons as compared to 39.7 million gallons for the six months ended June 30, 2006. For the six months ended June 30, 2007, our average sales price of ethanol increased by $0.19 per gallon, or 9%, to $2.29 per gallon for all gallons sold as a principal and an agent as compared to $2.10 per gallon for the six months ended June 30, 2006. The substantial increase in sales volume is primarily due to additional supply provided under our ethanol marketing agreement and the commencement of ethanol production. In the fourth quarter of 2006, we began producing ethanol and its co-products at our Madera facility and, based on our ownership interest in Front Range, began recording its net sales. The production and sale of ethanol and its co-products at our Madera facility and through Front Range contributed an aggregate of $97,796,000 in sales for the six months ended June 30, 2007, whereas there were no such sales during the six months ended June 30, 2006.

 

The increase in our gross profit for the six months ended June 30, 2007 as compared to the six months ended June 30, 2006, both in dollars and as a percentage of net sales, is primarily due to the commencement of ethanol production at our Madera facility and the gross profit generated from Front Range. Manufacturing margins have been more advantageous than those when we were exclusively a marketer. This increase in gross profit was partially offset by a loss of $2,843,000 related to derivative instruments, of which $1,587,000 was from the change in fair value of non-designated derivative instruments that will settle in future periods.

 

Future gross profit margins will vary based upon, among other things, the size and timing of our net long or short positions during our various contract periods and the volatility of the market price of ethanol.

 

 

The following table presents our selling, general and administrative expenses in dollars and as a percentage of net sales (in thousands, except percentages):

 

 

The increase in selling, general and administrative expenses during the three months ended June 30, 2007 as compared to the three months ended June 30, 2006 was largely due to an increase of $1,512,000 of amortization of intangible assets associated with our acquisition of the 42% interest in Front Range, and an increase of $1,474,000 in employee wages and salaries related to the hiring of additional staff positions. These increases are offset slightly by a $543,000 decrease in legal expenses.

 

The increase in selling, general and administrative expenses during the six months ended June 30, 2007 as compared to the six months ended June 30, 2006 was primarily due to an increase of $3,025,000 of amortization of intangible assets associated with our acquisition of the 42% interest in Front Range, an increase of $2,775,000 in employee wages and salaries related to the hiring of additional staff positions, and an increase of $1,658,000 in consulting expense. These increases are offset slightly by a $629,000 decrease in legal expenses.

 

Our cost-control efforts are ongoing and we expect that over the near-term, our selling, general and administrative expenses will decrease as a percentage of net sales as we continue to expand our marketing and production operations.

 

 

The following table presents our other income in dollars and our other income as a percentage of net sales (in thousands, except percentages):

 

Other income, net decreased during the three months ended June 30, 2007 as compared to the three months ended June 30, 2006, largely due to an increase of $1,014,000 in interest-related expenses net of capitalized interest, which was partially offset by a decrease in interest expense ineffectiveness of $602,000 and an increase of $374,000 in interest income due to higher average interest-earning cash balances.

 

Other income, net decreased during the six months ended June 30, 2007 as compared to the six months ended June 30, 2006, largely due to an increase of $2,835,000 in interest-related expenses net of capitalized interest, which was partially offset by a decrease in interest expense ineffectiveness of $624,000 and an increase of $2,117,000 in interest income due to higher average interest-earning cash balances.

 

 

The following table presents the proportionate share of the non-controlling interest in Front Range, a variable interest entity, and this charge as a percentage of net sales (in thousands, except percentages):

 

 

The charge related to the non-controlling interest in variable interest entity relates to the consolidated treatment of Front Range, a variable interest entity, and represents the non-controlling interests in the earnings of Front Range.

 

 

The following table presents our net income (loss) in dollars and our net income (loss) as a percentage of net sales (in thousands, except percentages):

 

 

 

 

 

The following table presents the preferred stock dividends in dollars for our Series A Cumulative Redeemable Convertible Preferred Stock, or Series A Preferred Stock, these preferred stock dividends as a percentage of net sales, and our income (loss) available to common stockholders in dollars and our income (loss) available to common stockholders as a percentage of net sales (in thousands, except percentages):

 

 

For the three months ended June 30, 2007 and 2006, we declared cash dividends on shares of our Series A Preferred Stock in the aggregate amount of $1,050,000 and $898,000, respectively. For the six months ended June 30, 2007 and 2006, we declared cash dividends on shares of our Series A Preferred Stock in the aggregate amount of $2,100,000 and $898,000, respectively. Shares of our Series A Preferred Stock are entitled to quarterly cumulative dividends payable in arrears in cash in an amount equal to 5% per annum of the purchase price per share of the Series A Preferred Stock, or, at our option, these dividends may be paid in additional shares of Series A Preferred Stock based on the value of the purchase price per share of the Series A Preferred Stock.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

The Debt Financing includes:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

We use derivative instruments to protect cash flows from fluctuations caused by volatility in commodity prices for periods of up to twelve months to protect gross profit margins to reduce the potentially adverse effects of market volatility. For the three months ended June 30, 2007 and 2006, gains from ineffectiveness in the amount of $17,000 and $22,000, respectively, were recorded in cost of goods sold and an ineffective gain in the amount of $369,000 and an effective loss of $10,000, respectively, were recorded in cost of goods sold. For the six months ended June 30, 2007 and 2006, gains from ineffectiveness in the amount of $159,000 and $22,000, respectively, were recorded in cost of goods sold and an effective gain in the amount of $244,000 and an effective loss of $10,000, respectively, were recorded in cost of goods sold. Amounts remaining in accumulated other comprehensive income (loss) will be reclassified to earnings upon the recognition of the related purchase or sale. Accumulative other comprehensive loss in the amount of $742,000 associated with commodity cash flow hedges is expected to be recognized in income over the next twelve months. The fair value notional balances remaining on these derivatives as of June 30, 2007 and December 31, 2006 were $14,429,000 and $11,588,000, respectively.

 

 

 

We marked all of our derivative instruments to fair value at each period end, except for those derivative contracts which qualified for the normal purchase and sale exemption pursuant to SFAS No. 133. According to our designation of the derivatives, changes in the fair value of derivatives are reflected in net income or other comprehensive income.

 

 

 

 

The estimated fair values of our derivatives as of June 30, 2007 and December 31, 2006 were as follows (in thousands):

 

 

The disclosures with respect to the above noted risks do not take into account the underlying commitments or anticipated transactions. If the underlying items were included in the analysis, the gains or losses on the futures contracts may be offset. Actual results will be determined by a number of factors that are not generally under our control and could vary significantly from those factors disclosed.

 

We are exposed to credit losses in the event of nonperformance by counterparties on the above instruments, as well as credit or performance risk with respect to our hedged customers’ commitments. Although nonperformance is possible, we do not anticipate nonperformance by any of these parties.

 

 

 

 

 

Management concluded as of December 31, 2006 in our Annual Report on Form 10-K, or Annual Report, for the year then ended, that our internal control over financial reporting was not effective. You should refer to management’s discussion under “Item 9A—Controls and Procedures” in our Annual Report for a complete description of the criteria applied by management and the factors based upon which management concluded that our internal control over financial reporting was not then effective.

 

In our Annual Report, management identified seven material weaknesses in our internal control over financial reporting. During the quarter ended June 30, 2007, we implemented a variety of changes to our internal control over financial reporting, in addition to those implemented during the quarter ended March 31, 2007, intended to remediate these material weaknesses.

 

Based on management’s evaluation of the effectiveness of the design and operation of our disclosure controls and procedures, our Chief Executive Officer and Acting Chief Financial Officer concluded that, as of June 30, 2007, all seven of the material weaknesses identified in our Annual Report had been fully remediated.

 

Management’s evaluation and conclusions set forth above have not been audited by our independent registered public accounting firm. Because of the possibility of changed circumstances between now and year-end, and because the testing of our internal control over financial reporting that will be required under Section 404 of the Sarbanes-Oxley Act of 2002 in connection with our annual audit is more comprehensive and rigorous than the evaluation we have just performed, we cannot assure you that management and our independent registered public accounting firm will not identify material weaknesses in our internal control over financial reporting and conclude that our disclosure controls and procedures were not effective at a reasonable assurance level and that we did not maintain effective internal control over financial reporting as of December 31, 2007.

 

Following is a summary description of the changes in our internal control over financial reporting implemented during the quarter ended June 30, 2007, and in some cases subsequent to June 30, 2007, organized based on the seven material weaknesses described below to which they relate:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

The changes noted above are the only changes during our most recently completed fiscal quarter that have materially affected or are reasonably likely to materially affect, our internal control over financial reporting, as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act.

 

 

Management does not expect that our disclosure controls and procedures or our internal control over financial reporting will prevent or detect all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control systems are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in a cost-effective control system, no evaluation of internal control over financial reporting can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, have been or will be detected.

 

These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of a simple error or mistake. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Projections of any evaluation of controls effectiveness to future periods are subject to risks. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures.

 

 

 

 

We are subject to legal proceedings, claims and litigation arising in the ordinary course of business. While the amounts claimed may be substantial, the ultimate liability cannot presently be determined because of considerable uncertainties that exist. Therefore, it is possible that the outcome of those legal proceedings, claims and litigation could adversely affect our quarterly or annual operating results or cash flows when resolved in a future period. However, based on facts currently available, management believes such matters will not adversely affect our financial position, results of operations or cash flows.

 

 

 

 

 

 

 

In 2003, we filed a lawsuit seeking damages in excess of $100,000,000 against: (i) Presidion Corporation, f/k/a MediaBus Networks, Inc., the parent corporation of Presidion Solutions, Inc., or Presidion, (ii) Presidion’s investment bankers, Mercator Group, LLC, or Mercator, and various related and affiliated parties and (iii) Taurus Global LLC, or Taurus, (collectively referred to as the “Mercator Action”), alleging that these parties committed a number of wrongful acts, including, but not limited to tortiously interfering in a transaction between us and Presidion. In 2004, we dismissed this lawsuit without prejudice, which was filed in Florida state court. In January 2005, we refiled this action in the State of California, for a similar amount, as we believe that to be the proper jurisdiction. On August 18, 2005, the court stayed the action and ordered the parties to arbitration. The parties agreed to mediate the matter. Mediation took place on December 9, 2005 and was not successful. On December 5, 2005, we filed a Demand for Arbitration with the American Arbitration Association. On April 6, 2006, a single arbitrator was appointed. Arbitration hearings have been scheduled to commence in July 2007. In April 2007, the arbitration proceedings were suspended due to non-payment of arbitration fees by Presidion and Taurus. As a result of non-payment of arbitration fees, a default order was entered against Taurus by the Los Angeles Superior Court. In July, 2007, we entered into a confidential settlement agreement with Presidion and its former officers. On July 23, 2007, we dismissed Presidion from the arbitration. We intend to continue to prosecute the arbitration proceedings against Mercator. The share exchange agreement relating to the Share Exchange Transaction provides that following full and final settlement or other final resolution of the Mercator Action, after deduction of all fees and expenses incurred by the law firm representing us in this action and payment of the 25% contingency fee to the law firm, shareholders of record of Accessity on the date immediately preceding the closing date of the Share Exchange Transaction will receive two-thirds and we will retain the remaining one-third of the net proceeds from any Mercator Action recovery.

 

 

In addition to the other information set forth in this report, you should carefully consider the factors discussed under “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2006, which could materially affect our business, financial condition and results of operations. The risks described in our Annual Report on Form 10-K for the year ended December 31, 2006 are not the only risks we face. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and results of operations.

 

 

 

Not applicable.

 

 

For the three and six months ended June 30, 2007, we declared $1,050,000 and $2,100,000 in dividends on our Series A Preferred Stock, respectively. We have never declared or paid cash dividends on our common stock and do not currently intend to pay cash dividends on our common stock in the foreseeable future. We currently anticipate that we will retain any earnings for use in the continued development of our business.

 

 

None.

 

 

 

 

 

 

 

 

None.

 

____________________

 

 

In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.