HONG YUAN HOLDING GROUP - Quarter Report: 2011 June (Form 10-Q)

 

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934

Commission File Number 001-34689

CEREPLAST, INC.

(Exact name of registrant as specified in its charter)

Nevada (State or Other Jurisdiction of Incorporation or Organization)		91-2154289 (I.R.S. Employer Identification No.)
300 N. Continental Boulevard, Suite 100
El Segundo, California		90245
(Address of Principal Executive Office)		(Zip Code)

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 þ No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 or Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes þ No o

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer o		Accelerated filer o		Non-accelerated filer o		Smaller reporting company þ
		(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ

The number of shares of common stock outstanding as of August 12, 2011 is 15,757,305.

 

 

CEREPLAST, INC.
FORM 10-Q
TABLE OF CONTENTS

		Page
PART I—FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
Consolidated Balance Sheets at June 30, 2011 and December 31, 2010			3
Consolidated Statements of Operations and Other Comprehensive Income for the Three months and six months ended June 30, 2011 and 2010			4
Consolidated Statements of Cash Flows for the Six months ended June 30, 2011 and 2010			5
Notes to the Consolidated Financial Statements			6
Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS			15
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK			23
Item 4T CONTROLS AND PROCEDURES			23
PART II—OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS			24
Item 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS			24
Item 3. DEFAULTS UPON SENIOR SECURITIES			24
Item 4. RESERVED			24
Item 5. OTHER INFORMATION			24
Item 6. EXHIBITS			25
SIGNATURES			26
EX-10.1
EX-31.1
EX-31.2
EX-32.1
EX-32.2
EX-101 INSTANCE DOCUMENT
EX-101 SCHEMA DOCUMENT
EX-101 CALCULATION LINKBASE DOCUMENT
EX-101 LABELS LINKBASE DOCUMENT
EX-101 PRESENTATION LINKBASE DOCUMENT
EX-101 DEFINITION LINKBASE DOCUMENT

Unless otherwise indicated or unless the context requires otherwise, all references in this report to “we,” “us,” “our,” “Cereplast” or the “Company” shall refer to Cereplast, Inc.

PART I — FINANCIAL INFORMATION

ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS

CEREPLAST, INC.

CONSOLIDATED BALANCE SHEETS
(in thousands, except shares data)

		June 30, 2011				December 31, 2010
		(Unaudited)
ASSETS
Current Assets
Cash		$	13,136			$	2,391
Accounts Receivable, Net			15,838				5,289
Inventory, Net			1,936				1,392
Prepaid Expenses and Other Current Assets			1,447				65
Total Current Assets			32,357				9,137
Property and Equipment
Property and Equipment			6,151				5,564
Accumulated Depreciation and Amortization			(2,652	)			(2,213	)
Property and Equipment, Net			3,499				3,351
Other Assets
Restricted Cash			43				43
Deferred Loan Costs			1,424				266
Intangible Assets, Net			151				173
Deposits			49				14
Total Other Assets			1,667				496
Total Assets		$	37,523			$	12,984
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current Liabilities
Accounts Payable		$	2,907			$	2,567
Accrued Expenses			2,422				1,251
Capital Leases, Current Portion			18				9
Loan Payable, Current Portion			1,038				149
Total Current Liabilities			6,385				3,976
Long-Term Liabilities
Loan Payable			3,767				2,119
Convertible Subordinated Notes			12,500				—
Capital Leases, Long-Term			22				—
Total Long-Term Liabilities			16,289				2,119
Total Liabilities			22,674				6,095
Equity
Shareholders’ Equity
Preferred Stock, $0.001 par value; 5,000,0000 shares authorized and none outstanding			—				—
Common Stock, $0.001 par value; 495,000,000 shares authorized; 15,757,305 and 12,992,195 shares issued and outstanding at June 30, 2011 and December 31, 2010, respectively			16				13
Additional Paid in Capital			61,866				49,737
Accumulated Deficit			(47,070	)			(42,933	)
Accumulated Other Comprehensive Income			33				72
Total Shareholders’ Equity			14,845				6,889
Noncontrolling Interests			4				—
Total Equity			14,849				6,889
Total Liabilities and Shareholders’ Equity		$	37,523			$	12,984

See accompanying notes to unaudited consolidated financial statements.

CEREPLAST, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS AND OTHER COMPREHENSIVE INCOME
(unaudited, in thousands, except per share data)

		Three months ended								Six months ended
		June 30, 2011				June 30, 2010				June 30, 2011				June 30, 2010
GROSS SALES		$	8,149			$	684			$	15,435			$	1,003
Sales Discounts, Returns and Allowances			(538	)			(38	)			(583	)			(67	)
NET SALES			7,611				646				14,852				936
COST OF SALES			6,688				447				13,226				645
GROSS PROFIT			923				199				1,626				291
Research and Development			259				119				509				196
Selling, General and Administrative			2,724				1,718				4,768				3,199
LOSS FROM OPERATIONS BEFORE OTHER EXPENSES			(2,060	)			(1,638	)			(3,651	)			(3,104	)
OTHER EXPENSES
Restructuring Costs			—				93				—				311
Interest Expense, Net			327				—				486				1
TOTAL OTHER EXPENSE, NET			327				93				486				312
NET LOSS BEFORE PROVISION FOR INCOME TAXES			(2,387	)			(1,731	)			(4,137	)			(3,416	)
Provision for Income Taxes			—				—				—				—
NET LOSS			(2,387	)			(1,731	)			(4,137	)			(3,416	)
OTHER COMPREHENSIVE INCOME
Gain (Loss) on Foreign Currency Translation			8				(19	)			(39	)			(1	)
TOTAL COMPREHENSIVE LOSS		$	(2,379	)		$	(1,750	)		$	(4,176	)		$	(3,417	)
BASIC AND DILUTED LOSS PER SHARE		$	(0.15	)		$	(0.15	)		$	(0.27	)		$	(0.32	)
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING, BASIC AND DILUTED			15,750				11,264				15,314				10,570

See accompanying notes to unaudited consolidated financial statements.

CEREPLAST, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited, in thousands, except shares data)

		Six Months Ended
		June 30, 2011				June 30, 2010
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Loss		$	(4,137	)		$	(3,416	)
Adjustment to Reconcile Net Loss to Net Cash Used in Operating Activities
Depreciation and Amortization			449				370
Allowance for Doubtful Accounts			97				(7	)
Common Stock Issued for Services, Salaries and Wages			747				872
Amortization of Loan Discount			38				—
Loss on Disposal of Leasehold Improvements			—				12
Impairment of Intangible Assets			64				—
Changes in Operating Assets and Liabilities
Accounts Receivable			(10,646	)			(217	)
Deferred Loan Costs			98				—
Inventory			(544	)			(101	)
Deposits			(35	)			30
Prepaid Expenses			(1,381	)			(237	)
Restricted Cash			—				(43	)
Intangibles			—				(1	)
Accounts Payable			341				(355	)
Accrued Expenses			1,192				(129	)
NET CASH USED IN OPERATING ACTIVITIES			(13,717	)			(3,222	)
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of Property and Equipment, and Intangibles			(638	)			(87	)
NET CASH USED IN INVESTING ACTIVITIES			(638	)			(87	)
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments on Capital Leases			(4	)			(13	)
Proceeds from Capital Leases			32				—
Noncontrolling Interest Activities			4				—
Payments made on Notes Payable			—				(54	)
Proceeds from Loan Payable, Net of Loan Costs			2,500				21
Proceeds from Convertible Subordinated Notes, Net of Issuance Costs			11,243				—
Proceeds from Issuance of Common Stock and Subscriptions, Net of Issuance Costs			11,364				7,916
NET CASH PROVIDED BY FINANCING ACTIVITIES			25,139				7,870
FOREIGN CURRENCY TRANSLATION			(39	)			(1	)
NET INCREASE IN CASH			10,745				4,560
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD			2,391				1,306
CASH AND CASH EQUIVALENTS, END OF PERIOD		$	13,136			$	5,866
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash Paid During the Year For:
Interest		$	269			$	1
Income Taxes		$	—			$	—

During the six months ended June 30, 2011, the Company issued 2,596,500 shares in exchange for net proceeds of $11,218 under a private placement. During the six months ended June 30, 2010, the Company issued 2,842,642 shares in exchange for net proceeds of $8,025 under a private placement.

SUPPLEMENTAL DISCLOSURE OF NON-CASH TRANSACTIONS

During the six months ended June 30, 2011, the Company issued 117,548 shares valued at $554 for services to directors and employees, 35,000 shares valued at $155 for exercise of common stock warrants, 12,000 shares valued at $59 for prepaid services and 4,062 shares valued at $20 for a settlement agreement. The Company also recognized $134 of expense related to vesting of employee stock options for the same period. During the six months ended June 30, 2010, the Company issued 31,250 shares valued at $125 for fees associated with an early lease termination, 12,500 shares valued at $50 for board member services, 112,552 shares valued at $569 for prepaid services and rent and 22,804 shares valued at $116 for employee services.

See accompanying notes to unaudited consolidated financial statements.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

1. ORGANIZATION AND LINE OF BUSINESS

Organization

We were incorporated on September 29, 2001 in the State of Nevada under the name Biocorp North America Inc. On March 18, 2005, we filed an amendment to our certificate of incorporation to change our name to Cereplast, Inc.

Line of Business

We have developed and are commercializing proprietary bio-based resins through two complementary product families: (1) Cereplast Compostables^® resins which are renewable, ecologically sound substitutes for petroleum-based plastics and (2) Cereplast Sustainables™ resins, which replace up to 90% of the petroleum-based content of traditional plastics with materials from renewable resources. Our resins aim to be competitively priced compared to fully petroleum-based plastic resins and can be converted into finished products using conventional manufacturing equipment without significant additional capital investment by downstream converters.

The demand for non-petroleum based, clean and renewable sources for materials, such as bioplastics, and the demand for compostable/biodegradable products are being driven globally by a variety of factors, including environmental concerns, new stringent regulations on compostable material, fossil fuel price volatility, and energy security. These factors have led to increased spending on clean and sustainable products by corporations and individuals as well as legislative initiatives at the local and state level.

We are a full-service resin solution provider uniquely positioned to capitalize on the rapidly increasing demand for sustainable and environmentally friendly alternatives to traditional plastic products.

We primarily conduct our operations through two product families:

•

Cereplast Compostables® resins are compostable and bio-based, ecologically-sound substitutes for petroleum-based plastics targeting primarily single-use disposables and packaging applications. We offer 12 commercial grades of Compostables resins in this product line. These resins are compatible with existing manufacturing processes and equipment making them a ready substitute for traditional petroleum-based resins. We commercially introduced our Compostables line in November 2006.

•

Cereplast Sustainables™ resins are partially or fully bio-based, ecologically-sound substitutes for fully petroleum-based plastics targeting primarily single-use disposables and packaging applications. We offer eight commercial grades of Sustainables resins in this product line. These resins are compatible with existing manufacturing processes and equipment, making them a ready substitute for traditional petroleum-based resins. We commercially introduced our Sustainables line in late 2007 under the name “Cereplast Hybrid Resins®”.

•

Cereplast Hybrid Resins® replace up to 50% of the petroleum content in conventional plastics with bio-based materials such as industrial starches sourced from plants. The Hybrid resins line is designed to offer similar properties to traditional polyolefins such as impact strength and heat deflection temperature, and is compatible with existing converter processes and equipment. Cereplast Hybrid Resins® provide a viable alternative for brand owners and converters looking to partially replace petroleum-based resins in durable goods applications. Hybrid resins address this need in a wide range of markets, including automotive, consumer goods, consumer electronics, medical, packaging, and construction. We commercially introduced our first grade of Hybrid resin, Hybrid 150, at the end of 2007. We currently offer three commercial grades in this product line.

•

Cereplast Algae Plastic® resins. In October 2009 we announced that we have been developing a new technology to transform algae into bioplastics and intend to launch a new resin family containing algae-based materials that will complement the company’s existing line of resins. The first commercial product with Cereplast Algae Plastic® resin is now being produced and sold as part of our Sustainables resin family.

We believe that it is important to enhance research on non-food crops as we expect a surge in demand in bioplastics in future years, thus potentially creating pressure on food crops. Algae is the first non-food crop project the company will introduce and our R&D department is contemplating the development of additional non-food crop based materials in future years.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation and Consolidation

The accompanying consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States (“GAAP”). The unaudited consolidated financial statements include the financial condition and results of operations of our wholly-owned subsidiary, Cereplast International, S.A., a Luxembourg company organized during the year ended December 31, 2008, for the purpose of conducting sales operations in Europe. Intercompany balances and transactions have been eliminated in consolidation. The results of operations for interim periods are not necessarily indicative of the results that may be expected for a full year. These financial statements should be read in conjunction with the consolidated financial statements and the notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2010.

Use of Estimates

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the accompanying financial statements. Significant estimates made in preparing these financial statements include the estimate of useful lives of property and equipment, the deferred tax valuation allowance and the fair value of stock options. Actual results could differ from those estimates.

Cash and Cash Equivalents

The Company considers all highly liquid investments with an original maturity of three months or less to be cash equivalents. At various times throughout the year, the Company may have exceeded federally insured limits. At June 30, 2011 and December 31, 2010, balances in our cash accounts exceeded federally insured limits of $0.25 million by approximately, $13.0 million and $2.3 million, respectively. We have not experienced any losses in such accounts and we do not believe we are exposed to any significant credit risk on cash and cash equivalents.

Concentration of Credit Risk

We had unrestricted cash, cash equivalents, and short-term investment, totaling $13.1 million and $2.4 million at June 30, 2011 and December 31, 2010, respectively. The unrestricted cash and cash equivalents are held for working capital purposes. We do not enter into investments for trading or speculative purposes. Some of the securities in which we invest, however, may be subject to market risk. This means that a change in prevailing interest rates may cause the principal amount of the investment to fluctuate. To minimize this risk, we intend to maintain our portfolio of cash equivalents and short-term investments in a variety of securities, including commercial paper, money market funds, debt securities and certificates of deposit. Due to the short-term nature of these investments, we believe that we do not have any material exposure to changes in the fair value of our investment portfolio as a result of changes in interest rates. We actively monitor changes in interest rates.

Concentration of credit risk with respect to accounts receivable is limited to certain European customers to whom we make substantial sales. As at June 30, 2011 we had one large European customer that accounted for 45% of our accounts receivable balance. To reduce risk, we routinely assess the financial strength of our most significant customers, using standard credit risk evaluation methods with reference to publicly available and customer supplied information, and monitor the amounts owed to us, taking appropriate action when necessary. As a result, we believe that accounts receivable credit risk exposure is limited. We maintain an allowance for doubtful accounts, but historically have not experienced any significant losses related to an individual customer or group of customers in any particular geographic area.

Other Concentration

During the six months ended months ended June 30, 2011, we had three significant suppliers that accounted for 31.1%, 23.8% and 10.4% of total cost of goods sold. During the same period in the prior year, we had two significant suppliers that accounted for 25.7% and 24.7% of total cost of goods sold. No other suppliers accounted for more than 10% of cost of sales during these periods.

Restricted Cash

We had restricted cash in the amount of approximately $43,000 on June 30, 2011 and December 31, 2010. The restricted cash amount consists of a “Certificate of Deposit” which supports a “Letter of Credit” for a leased facility.

Fair Value of Financial Instruments

The carrying amounts of our financial instruments as of June 30, 2011, which include cash equivalents, accounts receivable, accounts payable, accrued expenses, loans payable and convertible subordinated notes approximate their fair values due to the short-term nature of these instruments.

Accounts Receivable

We maintain an allowance for doubtful accounts for estimated losses that may arise if any of our customers are unable to make required payments. Management performs a review of the receivables past due from customers on a monthly basis and reserves against uncollectible items for each customer after all reasonable means of collection have been exhausted and the potential for recovery is considered remote. The allowance for doubtful accounts was approximately $164,000 and $66,000 as of June 30, 2011 and December 31, 2010, respectively.

Inventory

Inventories are stated at the lower of cost (first-in, first-out basis) or market and consist primarily of raw materials used in the manufacturing of bioplastic resins, finished bioplastic resins and finished goods. Inventories are reviewed for excess and obsolescence and a reserve is established accordingly. As of June 30, 2011 and December 31, 2010, inventories consisted of the following (in thousands):

		June 30, 2011				December 31, 2010
		(Unaudited)
Raw Materials		$	1,526			$	936
Bioplastic Resins			387				318
Finished Goods			43				44
Packaging Materials			64				53
WIP			—				41
Obsolescence Reserve			(84	)			—
Inventory, Net		$	1,936			$	1,392

Property and Equipment

Property and equipment are stated at cost and depreciation is computed on the straight-line method over the estimated useful lives of the assets. The estimated useful lives of the assets are between five and seven years. Repairs and maintenance expenditures are charged to expense as incurred. Property and Equipment consist of the following (in thousands):

		June 30, 2011				December 31, 2010
		(Unaudited)
Equipment		$	5,388			$	5,074
Construction in Progress			217				135
Furniture & Fixtures			293				279
Automobile			25				25
Leasehold Improvements			228				51
			6,151				5,564
Less Accumulated Depreciation			(2,652	)			(2,213	)
Property and Equipment, Net		$	3,499			$	3,351

Intangible Assets

Intangible assets are stated at cost and consist primarily of patents and trademarks. Amortization is computed on the straight-line method over the estimated life of these assets, estimated to be between five and fifteen years. Intangible assets consist of the following (in thousands):

		June 30, 2011				December 31, 2010
		(Unaudited)
Intangible Assets		$	185			$	206
Less Accumulated Amortization			(34	)			(33	)
Intangible Assets, Net		$	151			$	173

Deferred Income Taxes

Deferred income taxes are provided using the liability method whereby deferred tax assets are recognized for deductible temporary differences and operating loss and tax credit carry forwards and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax bases. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects of the changes in tax laws and rates of the date of enactment.

The benefit of a tax position is recognized in the financial statements in the period during which, based on all available evidence, management believes it is more likely than not that the position will be sustained upon examination, including the resolution of appeals or litigation processes, if any. Tax positions taken are not offset or aggregated with other positions. Tax positions that meet the more-likely-than-not recognition threshold are measured as the largest amount of tax benefit that is more than 50 percent likely of being realized upon settlement with the applicable taxing authority. The portion of the benefits associated with tax positions taken that exceeds the amount measured as described above is reflected as a liability for unrecognized tax benefits in the accompanying balance sheet along with any associated interest and penalties that would be payable to the taxing authorities upon examination.

Interest and penalties associated with unrecognized tax benefits are classified as additional income taxes in the statement of income.

Revenue Recognition

We recognize revenue at the time of shipment of products, when the following fundamental criteria are met: (i) persuasive evidence of an arrangement exists; (ii) delivery has occurred; (iii) the price to the customer is fixed or determinable; and (iv) collection of the sales price is probable.

Marketing and Advertising

We expense marketing and advertising costs as incurred. Marketing and advertising costs for the three months ended June 30, 2011 and 2010 were approximately $0.1 million and $0.2 million, respectively. Marketing and advertising costs for the six months ended June 30, 2011 and 2010 were approximately $0.2 million and $0.4 million, respectively.

Stock-Based Compensation

Compensation cost for all stock-based awards is measured at fair value on the date of grant and recognized over the service period for awards expected to vest. The fair value of stock options is determined using the Black-Scholes valuation model. Such value is recognized as expense over the service period, net of estimated forfeitures, using the straight-line method. Adjustments to this expense are made periodically to recognize actual rates of forfeiture which vary significantly from estimates.

Loss Per Share Calculations

Basic loss per share is computed by dividing net loss available to common shareholders by the weighted-average number of common shares available. Diluted loss per share is computed similar to basic loss per share except that the denominator is increased to include the number of additional common shares that would have been outstanding if the potential common shares had been issued and if the additional common shares were dilutive. Our diluted loss per share is the same as the basic loss per share for the three months and six months ended June 30, 2011 and 2010 as inclusion of any potential shares would have had and anti-dilutive effect due to us generating a loss.

Legal Proceedings

From time to time, we may become involved in various lawsuits and legal proceedings, which arise in the ordinary course of business. However, litigation is subject to inherent uncertainties, and an adverse result in these or other matters may arise from time to time that may harm our business. We are currently not aware of any such legal proceedings or claims that we believe will have, individually or in the aggregate, a material adverse effect on our business, financial condition or operating results.

Comparative Figures

Certain of the prior year figures have been reclassified to conform to the presentation adopted in the current year.

3. CAPITAL STOCK

Reverse Stock Split

On March 15, 2010, we implemented a reverse split of our common stock in ratio of one-for-forty. The reverse split was effective at 6:00 a.m. on March 15, 2010. All historical and per share amounts have been adjusted to reflect the reverse stock split.

Capital Stock Issued

During the six months ended June 30, 2011, we issued shares of common stock as follows:

•

We issued 2,596,500 shares of common stock and 649,128 warrants with an exercise price of $6.35 for gross proceeds of $12.3 million pursuant to a Securities Purchase Agreement dated January 26, 2011 between the Company and each of the signatories thereto. The Company incurred stock issuance costs of $1.1 million.

•

We issued 35,000 shares of common stock pursuant to a warrant exercise for gross proceeds of $0.2 million.

•

We issued 129,548 shares of common stock valued at $0.7 million to various employees, directors, and third parties for services rendered during the period.

•

We issued 4,062 shares of common stock valued at $20,000 pursuant to a settlement agreement.

Valuation Assumptions for Stock Options

During the six months ended June 30, 2011, total stock options granted to employees were 300,000 with estimated total grant-date fair values of $0.7 million. We estimate that stock-based compensation for awards not expected to be exercised is $0.2 million. During the three and six months ended June 30, 2011, we recorded stock-based compensation related to stock options of $23,000 and $0.1 million, respectively. The grant date fair value was estimated at the date of grant using the Black-Scholes option pricing model, assuming no dividends and the following assumptions:

		January 14, 2011
Average risk-free interest rate			2.29	%
Average expected life (in years)			6.0
Volatility			41.9	%

•

Expected Volatility: The fair values of stock based payments were valued using a volatility factor based on our historical stock prices.

•

Expected Term: We elected to use the “simplified method” as discussed in SAB No. 107 to develop the estimate of the expected term.

•

Expected Dividend: We have not paid any dividends and do not anticipate paying dividends in the foreseeable future.

•

Risk-Free Interest Rate: We base the risk-free interest rate used on the implied yield currently available on U.S. Treasury zero-coupon issues with remaining term equivalent to the expected term of the options.

Stock Option Activity

Under the 2004 Employee Stock Option Plan adopted by our Board of Directors, the Board of Directors may issue incentive and non-qualified stock options to our employees. Options granted under the Plan generally expire at the end of five or ten years and vest in accordance with a vesting schedule determined by our Board of Directors, usually over three years from the grant date. As of June 30, 2011, 34,375 shares are available for future grants under our 2004 Employee Stock Option Plan. We settle stock option exercises with newly issued common shares. The following is a summary of stock option activity (in thousands, except per share data):

		2011								2010
						Weighted								Weighted
						Average								Average
		Shares				Exercise Price				Shares				Exercise Price
Outstanding—January 1			73			$	22.40				73			$	22.40
Granted at fair value			300				5.31				—				—
Exercised			—				—				—				—
Canceled/forfeited			—				—				—				—
Outstanding—June 30			373				8.65				73				22.40
Options exercisable at June 30			133			$	14.69				73			$	22.40

The following table summarizes information about stock options as of June 30, 2011 (in thousands, except per share data):

		Options Outstanding																Options Exercisable
										Weighted																Weighted
						Weighted				Average												Weighted				Average
						Average				Remaining				Aggregate								Average				Remaining				Aggregate
						Exercise				Contract				Intrinsic								Exercise				Contract				Intrinsic
Range of Exercise Prices		Shares				Price				Life				Value				Shares				Price				Life				Value
$0.0 - $5.31			300			$	5.31				9.68			$	—				60			$	5.31				9.68			$	—
$5.32 - $22.40			73			$	22.40				3.42			$	—				73			$	22.40				3.42			$	—

The aggregate intrinsic value in the table above represents the total pretax intrinsic value, based on our closing stock price of $4.44 at June 30, 2011 which would have been received by the option holders had all option holders exercised their options as of that date.

Common Stock Warrants

In connection with the issue of 2,596,500 shares of common stock to accredited investors pursuant to the Securities Purchase Agreement entered into on January 26, 2011, we issued warrants to purchase 649,128 shares of the Company’s common stock. The warrants have an exercise price of $6.35 per share and are exercisable for a period of five years commencing August 1, 2011.

A summary of warrant activity is as follows (in thousands except per share data):

		2011								2010
						Weighted								Weighted
		Number of				Average				Number of				Average
		Warrants				Exercise Price				Warrants				Exercise Price
Outstanding— January 1			1,273			$	4.44				—			$	—
Issued			649				6.35				1,133				4.44
Exercised			(35	)			4.44				—				—
Outstanding—June 30			1,887			$	5.09				1,133				4.44
Warrants exercisable at end of period			1,887			$	5.09				1,133			$	4.44

4. LOANS PAYABLE AND CONVERTIBLE SUBORDINATED NOTES

Venture Loan Payable

On December 21, 2010, we entered into a Venture Loan and Security Agreement (the “Loan Agreement”) with Compass Horizon Funding Company, LLC (the “Lender” or “Horizon”). The Loan Agreement provides for a total loan commitment of $5.0 million comprising of Loan A and Loan B, each in the amount of $2.5 million. Loan A was funded at closing on December 21, 2010 and matures 39 months after the date of advance. Loan B was funded on February 17, 2011 and also matures 39 months after the date of advance. We are obligated to pay interest per annum equal to the greater of (a) 12% or (b) 12% plus the difference between (i) the one month LIBOR Rate, on the date which is five business days before the funding of such loan and (ii) .30%. We are required to make interest only payments for the first nine months of each loan and equal payments of principal over the final thirty months of each loan. We granted a security interest to the Lender in all of our property.

In connection with loan, we issued a seven year warrant to the Lender to purchase 140,000 shares of common stock of the Company at an exercise price of $4.40. The relative fair value of the warrants was $0.2 million and will be recorded as interest expense over the term of the loan. We estimated the fair value of the warrants using the Black-Scholes option pricing model using the following assumptions:

		December 22,
Assumptions:		2010
Expected Life		7 years
Expected volatility			39.9	%
Dividends		None
Risk-free interest rate			2.74	%

Also in connection with the Loan Agreement, we incurred $0.3 million of debt issue costs which were deferred and are being amortized to interest expense over the term of the loan.

Promissory Note

We signed a promissory note in the amount of $20,359 related to the purchase of an automobile in fiscal year 2010. The note bears interest at 7.69% per annum and is to be repaid over a period of 60 months.

Convertible Subordinated Notes

On May 24, 2011, we issued $12.5 million in aggregate principal amount of 7% Senior Subordinated Convertible Notes due June 1, 2016 (the “Notes”). The Notes were issued pursuant to an indenture (the “Indenture”), entered into between us and Wells Fargo Bank, National Association, as trustee, on May 24, 2011. In connection with the issuance of the Notes, we entered into a Waiver to our Venture Loan and Security Agreement with Horizon, dated May 18, 2011 pursuant to which Horizon provided its consent to the offering and waived any restriction in the Loan Agreement.

The Notes are senior subordinated unsecured obligations which will rank subordinate in right to payment to all of our existing and future senior secured indebtedness and bear interest at a rate of 7% per annum payable semi-annually in arrears on June 1 and December 1 of each year, commencing on December 1, 2011. The Notes mature on June 1, 2016, with an early repurchase date of June 15, 2014 at the option of the purchaser. The Notes are convertible into shares (the “Shares”) of common stock, $0.001 par value per share, of the Company, in accordance with the terms of the Notes and the Indenture, at the initial conversion rate of 172.4138 Shares per $1,000 principal amount of Notes, equivalent to a conversion price of approximately $5.80 per Share, subject to adjustment. If the Notes are converted into Shares prior to June 2, 2014, an interest make-whole payment will be due based on the conversion date up until June 2, 2014. Upon a non-stock change in control, additional shares may need to be issued upon conversion with a maximum additional shares of 25.606 per $1,000 principal Note for a total maximum of 198.0198 shares per $1,000 Note. Certain customary anti-dilution clauses are incorporated that could adjust the conversion rate. At June 30, 2011, the Notes are convertible into 2,155,173 Shares.

The conversion feature within the Notes is not considered to be a beneficial conversion feature within the meaning of Accounting Standards Codification (“ASC”) 470, Debt, and therefore all of the gross proceeds from the Notes have been classified as long term debt. In connection with the issue of the Notes, we incurred approximately $1.2 million of debt issue costs which were deferred and are being amortized to interest expense over the term to the early repurchase date of June 15, 2014.

Also in connection with the issuance of the Notes, we entered into a Securities Purchase Agreement dated May 18, 2011 pursuant to which we agreed to prepare and file a registration statement with the Securities and Exchange Commission (“SEC”) registering the resale of the Notes and the shares of common stock underlying the Notes. If we do not file the registration statement within 30 days after the initial issuance of the Notes, such registration statement is not declared effective within 90 days, or 150 days if reviewed by the SEC, after the initial issuance of the Notes, or the prospectus is suspended for more than 30 days in any three-month period or more than 90 days in any 12-month period, additional interest will accrue equal to 0.25% per annum for the first 90 days from and including the date on which such registration default has occurred and increase to 0.50% per annum from and after the 91st day after such registration default to but excluding the date on which the registration default has been cured. We filed the registration statement with the SEC on June 16, 2011.

5. LEASES

We currently operate out of three locations in El Segundo, California, Seymour, Indiana and Bönen, Germany. The leases underlying these three facilities are summarized below:

California Facility — The El Segundo facility consists of approximately 5,475 square feet of corporate office space. The lease commenced on March 1, 2010 and has a term of five years. The lease was subsequently amended on April 1, 2011 to add additional office space (“expansion space”). The lease term relating to the expansion space expires on May 31, 2013. Our current monthly rent is $13,124, with 3% annual escalation.

Indiana Facility — The Seymour facility consists of approximately 105,000 square feet used as a manufacturing and distribution facility for our products. The lease commenced in January 2008, with a ten year term expiring in January 2018. Our current monthly rent is $25,000.

Bönen Facility— The Bönen facility consists of approximately 1,000 square feet of corporate office space. The facility is subject to a lease with monthly rents of approximately $2,000 expiring in December 2018.

6. MAJOR CUSTOMERS AND FOREIGN SALES

The following customers accounted for 10% or more of gross revenue in the periods presented:

		Three Months Ended June 30,								Six Months Ended June 30,
		2011				2010				2011				2010
Customer A			44.7	%			—				26.0	%			—
Customer B			24.0	%			—				12.6	%			—
Customer C			13.9	%			—				7.3	%			—
Customer D			9.9	%			—				35.5	%			—

Our gross sales were made up of sales to customers in the following geographic regions (in thousands):

		Three Months Ended June 30,
		2011								2010
North America		$	430				5.3	%		$	480				70.2	%
International
Italy			5,585				68.5	%			—				—	%
Malta			1,131				13.9	%			—				—	%
Other			1,003				12.3	%			204				29.8	%
Gross sales		$	8,149				100.0	%		$	684				100.0	%

		Six Months Ended June 30,
		2011								2010
North America		$	668				4.3	%		$	746				74.3	%
International
Italy			7,208				46.7	%			—				—	%
Germany			5,491				35.6	%			210				21.0	%
Other			2,068				13.4	%			47				4.7	%
Gross sales		$	15,435				100.0	%		$	1,003				100.0	%

7. INCOME TAX

We are subject to U.S. and California income tax. Subject to limited statutory exceptions, we are no longer subject to federal, state and local or non-U.S. income tax examinations by tax authorities for years before 2006. We are not presently liable for any income taxes nor are we undergoing any tax examinations by the Internal Revenue Service. No Deferred Tax Assets or Deferred Tax Liabilities are included in our balance sheets at June 30, 2011 or December 31, 2010.

Our policy is to recognize interest accrued related to unrecognized tax benefits in interest expense and penalties in operating expenses.

8. SUBSEQUENT EVENTS

The company has evaluated subsequent events pursuant to ASC 855, Subsequent Events, and has determined that there are no events that require disclosure.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

CAUTIONARY STATEMENTS

This Form 10-Q may contain forward-looking statements, as that term is used in federal securities laws, about our financial condition, results of operations and business. These statements include, among others, statements concerning the potential benefits that we may experience from our business activities and certain transactions we contemplate or have completed; and statements of our expectations, beliefs, future plans and strategies, anticipated developments and other matters that are not historical facts. These statements may be made expressly in this Form 10-Q. You can find many of these statements by looking for words such as believes, expects, anticipates, estimates, opines, or similar expressions used in this Form 10-Q. These forward-looking statements are subject to numerous assumptions, risks and uncertainties that may cause our actual results to be materially different from any future results expressed or implied by us in those statements. The most important facts that could prevent us from achieving our stated goals include, but are not limited to, the following:

•

inability to raise sufficient additional capital to finance operations;

•

potential fluctuation in quarterly results;

•

failure to earn profits;

•

inadequate capital to expand our business, inability to raise additional capital or financing to implement our business plans;

	•		decline in demand for our products and services;
	•		inability to source raw materials in sufficient quantities to support growth in customer demand;

•

rapid and significant changes in markets and other factors, including national, state and local legislation, that encourage use of bioplastics;

•

failure to commercialize new grades of resin being pursued in our technical / market development “pipeline;”

•

competitor actions that curtail our market share, negatively affect pricing or limit sales growth;

•

litigation with or legal claims and allegations by outside parties;

•

insufficient revenues to cover operating costs;

There is no assurance that we will be profitable. We may not be able to successfully manage or market our products, attract or retain qualified executives and technology personnel or obtain additional customers for our products. Our products may become obsolete, government regulation may hinder our business, additional dilution in outstanding stock ownership may be incurred due to the issuance of more shares, warrants and stock options, or the exercise of outstanding warrants and stock options and other risks inherent in our business.

Because forward-looking statements are subject to risks and uncertainties, actual results may differ materially from those expressed or implied by the forward-looking statements. We caution you not to place undue reliance on these statements, which speak only as of the date of this Form 10-Q. The cautionary statements contained or referred to in this section should be considered in connection with any subsequent written or oral forward-looking statements that our company or persons acting on our behalf may issue. We do not undertake any obligation to review or confirm analysts’ expectations or estimates or to release publicly any revisions to any forward-looking statements to reflect events or circumstances after the date of this Form 10-Q, or to reflect the occurrence of unanticipated events.

OVERVIEW

General

We have developed and are commercializing proprietary bio-based resins through two complementary product families: (1) Cereplast Compostables^® resins, which are compostable and bio-based, ecologically sound substitutes for petroleum-based plastics, and (2) Cereplast Sustainables™ resins, which replace up to 90% of the petroleum-based content of traditional plastics with materials from renewable resources. Our resins aim to be competitively priced compared to fully petroleum-based plastic resins and can be converted into finished products using conventional manufacturing equipment without significant additional capital investment by downstream converters.

The demand for non-petroleum based, clean and renewable sources for materials, such as bioplastics, and the demand for compostable/biodegradable products are being driven globally by a variety of factors, including environmental concerns, new stringent regulations on compostable material, fossil fuel price volatility and energy security. These factors have led to increased spending on clean and sustainable products by corporations and individuals as well as legislative initiatives at the local and state level.

We are a full-service resin solution provider uniquely positioned to capitalize on the rapidly increasing demand for sustainable and environmentally friendly alternatives to traditional plastic products.

We primarily conduct our operations through two product families:

•

Cereplast Compostables® resins are compostable and bio-based, ecologically-sound substitutes for petroleum-based plastics targeting primarily single-use disposables and packaging applications. We offer 12 commercial grades of Compostables resins in this product line. These resins are compatible with existing manufacturing processes and equipment making them a ready substitute for traditional petroleum-based resins. We commercially introduced our Compostables line in November 2006.

•

Cereplast Sustainables™ resins are partially or fully bio-based, ecologically-sound substitutes for fully petroleum-based plastics targeting primarily single-use disposables and packaging applications. We offer eight commercial grades of Sustainables resins in this product line. These resins are compatible with existing manufacturing processes and equipment, making them a ready substitute for traditional petroleum-based resins. We commercially introduced our Sustainables line in late 2007 under the name “Cereplast Hybrid Resins®.”

•

Cereplast Hybrid Resins® replace up to 50% of the petroleum content in conventional plastics with bio-based materials such as industrial starches sourced from plants. The Hybrid resins line is designed to offer similar properties to traditional polyolefins such as impact strength and heat deflection temperature, and is compatible with existing converter processes and equipment. Cereplast Hybrid Resins® provide a viable alternative for brand owners and converters looking to partially replace petroleum-based resins in durable goods applications. Hybrid resins address this need in a wide range of markets, including automotive, consumer goods, consumer electronics, medical, packaging and construction. We commercially introduced our first grade of Hybrid resin, Hybrid 150, at the end of 2007. We currently offer three commercial grades in this product line.

Cereplast Algae Plastic® resin. In October 2009 we announced that we have been developing a new technology to transform algae into bioplastics and intend to launch a new resin family containing algae-based materials that will complement the Company’s existing line of Compostables and Sustainables resins. The first commercial product with Cereplast Algae Plastic® resin is now being produced and sold as part of our Sustainables resin family. We believe that it is important to enhance research on non-food crops as we expect a surge in demand in bioplastics in future years, thus potentially creating pressure on food crops. Algae is the first non-food crop project the Company has introduced and our R&D department is contemplating the development of additional non-food crop based materials in future years.

Recent Strategic Events

Italian Expansion. On May 2, 2011 we announced our intention to establish a bioplastics manufacturing plant in Cannara, Italy to meet the growing demand for bioplastic resin in Europe while improving efficiencies, reducing transportation costs and minimizing logistics related risks. The plant will be located on a 125,000 square foot former industrial plant site, enabling us to benefit from existing infrastructure. Current plans for the plant include a total capacity of approximately 220 million pounds, which will be built in phases; the first phase of 50,000 tons is expected to start operations in late 2012. Additional capacity will be added coincidental with market demand.

We expect that the expansion will be financed entirely through local and regional debt facilities with Italian financial institutions as well as subsidies from various Italian state and local agencies. We are in advanced stages of negotiations with these various parties and expect to conclude the financing arrangements late in the third quarter of 2011. While the acquisition has not yet been completed, we have been granted access to the site to begin preliminary work. Capital expenditures to complete Phase I of the expansion are estimated at between €10 million and €12 million, or $14 million to $17 million.

New Distribution Agreements. During 2011, we announced the signing of six new distribution agreements in Italy, Romania, Poland, Croatia, Slovenia and Turkey with multiple companies. These contracts reflect our rapid growth and expansion across the Pan-European marketplace.

European Office. On January 4, 2011 we announced the opening of our European headquarters in Bönen, Germany to support the rapid expansion of our European operations and provide European-based customer with regional support and provide us with an effective platform to support the growth of bioplastics outside of the U.S.

Private Placement. In February, 2011 we raised $12.3 million through a private placement offering pursuant to which we issued 2,596,500 shares of common stock and 649,128 warrants with an exercise price of $6.35. Proceeds of the financing are being allocated to fund working capital needed to meet the rapidly growing demand for our products, particularly in the European market.

Venture Loan. In February, 2011 we received additional $2.5 million in growth capital from Horizon Technology Finance Corporation pursuant to a Venture Loan and Security Agreement entered into in December, 2010. Proceeds from the loan are being allocated to fund working capital needed to meet the robust demand for our resin.

Convertible Subordinated Notes. In May, 2011, we issued $12.5 million in aggregate principal amount of 7% Senior Subordinated Convertible Notes due June 1, 2016 (the “Notes”). Proceeds from the Notes are being allocated to fund working capital needed to meet the rapidly growing demand for our products, particularly in the European market.

Trends and Uncertainties that May Impact Future Results of Operations

Global Market and Economic Conditions. Recent global market and economic conditions have been unprecedented and challenging with tighter credit conditions and slower growth. These conditions, combined with volatile oil prices, declining business and consumer confidence and increased unemployment have contributed to continued volatility of unprecedented levels.

As a result of these market conditions, the cost and availability of credit has been, and may continue to be, adversely affected by illiquid credit markets and wider credit spreads. Concern about the stability of the markets generally, and the strength of counterparties specifically, has led many lenders and institutional investors to reduce, and in some cases, cease to provide funding to borrowers and to developing companies, such as ours. Continued turbulence in the U.S. and international markets and economies may adversely affect our liquidity and financial condition and the liquidity and financial condition of our customers. If these market conditions continue, they may limit our ability, and the ability of our customers, to timely replace maturing liabilities and access the capital markets to meet liquidity needs, resulting in an adverse effect on our financial condition and results of operations.

Sales. We record sales at the time that we ship our products, provided that evidence of an arrangement exists, title and risk of loss have passed to the customer, fees are fixed or determinable and collection of the related receivable is reasonably assured. We record sales net of sales discounts and allowances. In 2011, we provided price incentives to several customers that entered into a significant supply contract for their initial purchase commitments to assist in commercial launch activities. In the future, we may offer these incentives on a selective basis as we continue to grow our customer base. The amount of these incentives in future periods will be a function of the growth of our customer base and the particular commercialization.

Operating Expenses. Operating expenses consist principally of salaries (both cash and non-cash equity-based compensation), professional fees (including legal, accounting, patent-related, government compliance), marketing, sales commissions, rent and research and development. Salaries include all cash and non-cash compensation and related costs for all principal selling, general and administrative functions. During recent periods we have made grants of equity awards, including shares of restricted stock and stock options, to attract directors and members of senior management, which have resulted in non-cash compensation expense for the periods reported. We expect that non-cash compensation expense attributed to equity-based awards may increase in future periods as the result of future equity-based incentive compensation awards granted to attract and retain talented employees as we continue to grow our business. In addition, we expect to experience increases in our research and development expenses as we continue to develop new products and formulations, as well as increases in marketing and promotional expenses as we seek to increase our customer base.

CRITICAL ACCOUNTING POLICIES AND USE OF ESTIMATES

Our discussion and analysis of our financial condition and results of operations are based upon our unaudited financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. We monitor our estimates on an ongoing basis for changes in facts and circumstances, and material changes in these estimates could occur in the future. Changes in estimates are recorded in the period in which they become known. We base our estimates on historical experience and other assumptions that we believe to be reasonable under the circumstances. Actual results may differ from our estimates if past experience or other assumptions do not turn out to be substantially accurate.

Revenue Recognition

We recognize revenue at the time of shipment of products, provided that evidence of an arrangement exists, title and risk of loss have passed to the customer, fees are fixed or determinable, and collection of the related receivable is reasonably assured.

Research and Development Costs

Research and development costs are charged to expense as incurred. These costs consist primarily of research with respect to new grades of bioplastic resins, testing of both the bioplastic resins as well as testing of finished products made from the bio-based resins.

Stock-Based Compensation

Compensation cost for all stock-based awards is measured at fair value on the date of grant and recognized over the service period for awards expected to vest. The fair value of stock options is determined using the Black-Scholes valuation model. Such value is recognized as expense over the service period, net of estimated forfeitures, using the straight-line method. Adjustments to this expense are made periodically to recognize actual rates of forfeiture which vary significantly from estimates.

Accounts Receivable

We maintain an allowance for doubtful accounts for estimated losses that may arise if any of our customers are unable to make required payments. Management performs a review of the receivables past due from customers on a monthly basis and reserves against uncollectible items for each customer after all reasonable means of collection have been exhausted, and the potential for recovery is considered remote.

Inventories

Inventories are stated at the lower of cost (first-in, first-out basis) or market, and consist primarily of raw materials used in the manufacturing of bioplastic resins, finished bioplastic resins and finished goods. Inventories are reviewed for excess and obsolescence and a reserve is established accordingly.

Intangibles

Intangibles are stated at cost and consist primarily of patents and trademarks. Amortization is computed on the straight-line method over the estimated life of these assets, estimated to be between five and fifteen years.

Property and Equipment

Property and equipment are stated at cost, and depreciation is computed on the straight-line method over the estimated useful lives of the assets. The estimated useful lives of the assets are between five and seven years. Repairs and maintenance expenditures are charged to expense as incurred.

Deferred Income Taxes

Deferred income taxes are provided using the liability method whereby deferred tax assets are recognized for deductible temporary differences and operating loss and tax credit carry forwards and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax bases. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects of the changes in tax laws and rates of the date of enactment.

The benefit of a tax position is recognized in the financial statements in the period during which, based on all available evidence, management believes it is more likely than not that the position will be sustained upon examination, including the resolution of appeals or litigation processes, if any. Tax positions taken are not offset or aggregated with other positions. Tax positions that meet the more-likely-than-not recognition threshold are measured as the largest amount of tax benefit that is more than 50 percent likely of being realized upon settlement with the applicable taxing authority. The portion of the benefits associated with tax positions taken that exceeds the amount measured as described above is reflected as a liability for unrecognized tax benefits in the accompanying balance sheet along with any associated interest and penalties that would be payable to the taxing authorities upon examination.

RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED JUNE 30, 2011 COMPARED TO THE THREE MONTHS ENDED JUNE 30, 2010

Sales

Net sales for the three months ended June 30, 2011 were $7.6 million, an increase of $7.0 million, compared to the same period in 2010. The sales increase for the period is attributable to volume increases associated with both existing customer contracts and new contracts with European customers. Environmental legislation, such as that banning the use of plastic bags in Italy that took effect on January 1, 2011, as well as the increased volatility in oil prices, were key drivers of demand for our bioplastic resins in the current year.

Cost of Sales

Cost of sales includes both fixed and variable costs, including materials and supplies, labor, facilities and other overhead costs associated with our product revenues. Cost of sales for the three months ended June 30, 2011 was $6.7 million, or 87.9% of net sales, compared to $0.4 million, or 69.2% of net sales, for the same period in 2010. The increase in cost of sales over the same period in the prior year is attributable to two main factors: (1) Cost of sales in the prior year period cannot be considered representative of normal sales or operations as we were in the process of relocating our production operations from California to Indiana and therefore had minimal production during this period in 2010, and (2) Cost of sales in the current period reflect the tremendous growth in sales volume from the prior year.

Gross Profit

Gross profit for the three months ended June 30, 2011 was $0.9 million, or 12.1% of net sales, compared to $0.2 million, or 30.8% of net sales, for the same period in 2010. The decrease in gross profit margin reflects the unusually high margins on very low volume sales in the prior year period combined with our sales strategy to gain critical market share by offering low introductory pricing to some key customers to support their programs to bring new bioplastic products to market. This strategy has proven effective in contributing to strong sales growth and growing market share. We were successful in improving margins by 24.7% in the three month period ended June 30, 2011 compared to the three month period ended March 31, 2011, in line with expectations that margins will improve gradually through 2011 as we capitalize on demand growth to diversify our customer base, implement strategic price increases, and continue to gain operational efficiencies.

Research and Development Expenses

Research and development expenses for the three months ended June 30, 2011 were $0.3 million, or 3.4% of net sales, compared to approximately $0.1 million, or 18.4% of net sales, for the same period in 2010. Although research and development expenses decreased as a percentage of net sales, we incurred higher expenses in 2011 related to additional headcount, including the appointment of a new Chief Technology Officer and increased manufacturing supplies used for new product development.

Selling, General and Administrative Expenses

Selling, general and administrative expenses for the three months ended June 30, 2011 were $2.7 million, or 35.8% of net sales, compared to $1.7 million, or 265.9% of net sales, for the same period in 2010. Although selling, general and administrative expenses decreased as a percentage of net sales, we incurred incremental expenses in 2011 across all areas of the business, including compensation associated with increased headcount, performance related compensation, marketing, sales commissions, professional fees (including legal and accounting fees) to support the rapid growth of the business, including the expansion of European operations, specifically in Italy.

Other Expense, Net

Other expense, net for the three months ended June 30, 2011 was $0.3 million, as compared to $0.1 million in the same period in 2010. Other expense in 2011 consists of interest expense related to both our Loan Agreement as well as our convertible senior subordinated notes. There was no interest expense reported for the same period in the prior year. Other expense in 2010 consisted of restructuring charges which were not incurred in the current year period.

Net Loss

Net loss for the three months ended June 30, 2011 was $2.4 million, as compared to $1.7 million in the same period in 2010. As discussed above, our results were favorably impacted by increases in net sales and gross profit, offset by higher research and development, and selling, general and administrative expenses incurred to support the growth of the business.

RESULTS OF OPERATIONS FOR THE SIX MONTHS ENDED JUNE 30, 2011 COMPARED TO THE SIX MONTHS ENDED JUNE 30, 2010

Sales

Net sales for the six months ended June 30, 2011 were $14.9 million, an increase of $13.9 million, compared to the same period in 2010. The sales increase for the period is attributable to volume increases associated with both existing customer contracts and new contracts with European customers. Environmental legislation, such as that banning the use of plastic bags in Italy that took effect on January 1, 2011, as well as the increased volatility in oil prices, were key drivers of demand for our bioplastic resins in the current quarter.

Cost of Sales

Cost of sales includes both fixed and variable costs, including materials and supplies, labor, facilities and other overhead costs associated with our product revenues. Cost of sales for the six months ended June 30, 2011 was $13.2 million, or 89.1% of net sales, compared to $0.6 million, or 68.9% of net sales, for the same period in 2010. The increase in cost of sales over the same period in the prior year is attributable to two main factors: (1) Cost of sales in the prior year period cannot be considered representative of normal sales or operations as we were in the process of relocating our production operations from California to Indiana and therefore had minimal production during this period in 2010, and (2) Cost of sales in the current period reflect the tremendous growth in sales volume from the prior year.

Gross Profit

Gross profit for the six months ended June 30, 2011 was $1.6 million, or 10.9% of net sales, compared to $0.3 million, or 31.1% of net sales, for the same period in 2010. The decrease in gross profit reflects the unusually high margins on very low volume sales in the prior year period combined our sales strategy to gain critical market share by offering low introductory pricing to some key customers to support their programs to bring new bioplastic products to market. This strategy has proven effective in contributing to strong sales growth and growing market share. We expect that margins will improve gradually through 2011 as we capitalize on demand growth to diversify our customer base, implement strategic price increases, and continue to gain operational efficiencies.

Research and Development Expenses

Research and development expenses for the six months ended June 30, 2011 were $0.5 million, or 3.4% of net sales, compared to approximately $0.2 million, or 20.9% of net sales, for the same period in 2010. Although research and development expenses decreased as a percentage of net sales, we incurred higher expenses in 2011 related to additional headcount, including the appointment of a new Chief Technology Officer, increased manufacturing supplies used for new product development and impairment charges on intangible assets.

Selling, General and Administrative Expenses

Selling, general and administrative expenses for the six months ended June 30, 2011 were $4.8 million, or 32.1% of net sales, compared to $3.2 million, or 341.8% of net sales, for the same period in 2010. Although selling, general and administrative expenses decreased as a percentage of net sales, we incurred incremental expenses in 2011 across all areas of the business, including compensation associated with increased headcount, performance related compensation, marketing, sales commissions, professional fees (including legal and accounting fees) to support the rapid growth of the business, including the expansion of European operations, specifically in Italy.

Other Expense, Net

Other expense, net for the six months ended June 30, 2011 was $0.5 million, as compared to $0.3 million in the same period in 2010. Other expense in 2011 consists of interest expense related to both our Loan Agreement as well as our convertible senior subordinated notes. There was no interest expense related to these items reported for the same period in the prior year. Other expense in 2010 consisted of restructuring charges which were not incurred in the current year period.

Net Loss

Net loss for the six months ended June 30, 2011 was $4.1 million, as compared to $3.4 million in the same period in 2010. As discussed above, our results were favorably impacted by increases in net sales and gross profit, offset by higher research and development, and selling, general and administrative expenses incurred to support the growth of the business.

LIQUIDITY AND CAPITAL RESOURCES

We require working capital to fund our operations, including payments to finance our research and development and expand sales and marketing, to purchase equipment, service indebtedness, satisfy lease obligations and execute on our business plan and growth strategy.

We had net unrestricted cash of $13.1 million at June 30, 2011 as compared to $2.4 million at December 31, 2010. The net increase in unrestricted cash is attributable principally to funds received through equity sold through a private placement and proceeds received from our venture loan and convertible senior subordinated notes, offset by cash used in operations.

Our working capital increased from $5.2 million at December 31, 2010, to $26.0 million at June 30, 2011. The increase in working capital is due primarily to net proceeds received from our private placement offering, convertible senior subordinated notes and venture loan, combined with increases in accounts receivable associated with higher revenue.

Cash used in operating activities during the six months ended June 30, 2011 was $13.7 million, compared to $3.2 million during the same period in the 2010. The increase in the use of cash for operating activities was primarily a result of an increase in working capital, including an increase in accounts receivable, which reflect the significant sales growth in the 2011 compared to 2010.

Cash used in investing activities during the six months ended June 30, 2011 was $0.6 million compared to cash used in investing activities of approximately $0.1 million during the same period in 2010. Investing activities during 2011 consist primarily of purchase of capital equipment to improve operational efficiency and capacity at our Seymour manufacturing facility.

Cash provided by financing activities during the six months ended June 30, 2011 was $25.1 million compared to $7.9 million provided by financing activities during the same period in 2010. The increase is attributable to an increase in funds received through a private placement offering consummated on February 1, 2011, proceeds from our issuance of convertible senior subordinated notes and proceeds from a venture loan from Compass Horizon Technology.

OFF-BALANCE SHEET ARRANGEMENTS

We do not have any relationships with unconsolidated entities or financial partnerships such as entities often referred to as structured finance or special purpose entities that would have been established for the purpose of facilitating off-balance-sheet arrangements or for other contractually narrow or limited purposes. As such, we are not exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in such relationships.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We are exposed to a number of market risks in the ordinary course of business. These risks, which include interest rate risk, foreign currency exchange risk and commodity price risk, arise in the normal course of business rather than from trading. We have examined our exposures to these risks and concluded that none of our exposures in these areas is material to fair values, cash flows or earnings. We regularly review these risks to determine if we should enter into active strategies, such as hedging, to help manage the risks. At the present time, we do not have any hedging programs in place and we are not trading in any financial or derivative instruments.

We currently do not have any material debt, so we do not have interest rate risk from a liability perspective. We do have a significant amount of cash and short-term investments with maturities less than three months. This cash portfolio exposes us to interest rate risk as short-term investment rates can be volatile. Given the short-term maturity structure of our investment portfolio, and the high-grade investment quality of our portfolio, we believe that we are not subject to principal fluctuations and the effective interest rate of our portfolio tracks closely to various short-term money market interest rate benchmarks.

ITEM 4. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

As of the end of the period covered by this report, we conducted an evaluation, under the supervision and with the participation of our chief executive officer and chief financial officer of our disclosure controls and procedures (as defined in Rule 13a-15(e) and Rule 15d-15(e) of the Exchange Act). Based upon this evaluation, our chief executive officer and chief financial officer concluded that our disclosure controls and procedures are effective to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is: (i) recorded, processed, summarized and reported, within the time periods specified in the Commission’s rules and forms, and (ii) accumulated and communicated to our management, including our chief executive officer and chief financial officer, or persons performing similar functions as appropriate to allow timely decisions regarding required disclosure.

Changes in Internal Control Over Financial Reporting

There were no changes in our internal control over financial reporting, as defined in Rule 13a-15(f) and 15d-15(f) under the Exchange Act, during the fiscal quarter ended June 30, 2011 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II — OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

From time to time, we may become involved in various lawsuits and legal proceedings that arise in the ordinary course of business. However, litigation is subject to inherent uncertainties, and an adverse result in matters that may harm our business may arise from time to time. We are currently not aware of nor have any knowledge of any such legal proceedings or claims that we believe will have, individually or in the aggregate, a material adverse effect on our business, financial condition or operating results.

ITEM 1A. RISK FACTORS

There are no material changes from the risk factors previously disclosed in the Registrant’s Form 10-K filed on March 31, 2011.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

We issued the following unregistered securities during the three months ended June 30, 2011:

•

On April 4, 2011, we issued 35,000 shares of common stock valued $0.2 million pursuant to a warrant exercise.

•

On April 15, 2011, we issued 33,671 shares of common stock valued at $0.1 million to various employees for services rendered.

All of the offerings and sales above were deemed to be exempt under rule 506 of Regulation D and/or Section 4(2) of the Securities Act, No advertising or general solicitation was employed in offering the securities. The offerings and sales were made to a limited number of persons, all of whom were accredited investors, our business associates or our executive officers, and transfers of the securities were restricted by us in accordance with the requirements of the Securities Act. In addition to representations by the above-referenced persons, we have made independent determinations that all of the above-referenced persons were accredited or sophisticated investors, were capable of analyzing the merits and risks of their investment, and understood the speculative nature of their investment. Furthermore, all of the above-referenced persons were provided with access to our SEC filings.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

Not applicable.

ITEM 4. RESERVED

ITEM 5. OTHER INFORMATION

On August 12, 2011, with the prior approval of the Company’s Board of Directors and its Compensation Committee, the Company entered into the Amended and Restated Employment Agreement, effective as of August 1, 2011, by and between the Company and Frederic Scheer, the Company’s President and Chief Executive Officer (the “Scheer Employment Agreement”). Key provisions of the Scheer Employment Agreement include: (i) an annual base salary of $565,000, (ii) a performance based bonus of up to 50% of annual base salary, (iii) the opportunity to participate in equity incentive programs to the same extent as other senior executives of the Company, and (iv) other benefits including long term disability benefits and a car allowance. If Mr. Scheer’s employment is terminated by the Company for reasons other than cause, or by Mr. Scheer for good reason, or in the event of death or disability, Mr. Scheer will be entitled to receive severance pay equal to 1.5 times his base salary then in effect, together with an amount equal to the average of his previous two years’ bonus payments and the continuation of coverage under the Consolidated Omnibus Budget Reconciliation Act (“COBRA”), for the maximum time period permitted under COBRA.

ITEM 6. EXHIBITS

Exhibit
Number		Description
10.1		Employment agreement between Frederic Scheer and Cereplast, Inc. dated August 12, 2011. (filed herewith)
31.1		Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2		Certification of the Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1		Certification of the Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. ***
32.2		Certification of the Principal Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002***
101		XBRL (Extensible Business Reporting Language) The following materials from Cereplast Inc.’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2011, formatted in Extensive Business Reporting Language (XBRL), (i) consolidated balance sheets, (ii) consolidated statements of operations and other comprehensive loss, (iii) consolidated statements of cash flows, and (iv) the notes to the consolidated financial statements.

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.