MANAGEMENT’S DISCUSSION & ANALYSIS REVENUE PRODUCT SALES EXPENSES COST OF GOODS SOLD AND GROSS MARGIN Cost of goods sold is comprised of the direct raw materials required for the specific formulation of products, as well as direct labour, quality assurance and control, packaging, transportation costs, plant costs, and amortization on plant and equipment assets. Aside from labour, rent, quality control related expenses, overhead, and property plant and equipment amortization, the majority of costs are variable in relation to the volume of product produced or shipped. During the year ended December 31, 2012, the cost of goods sold increased by $178,000 or 7%, from $2,538,000 in 2011 to $2,716,000 in 2012. The gross margin in 2012 is lower by 25% mostly due to higher cost of goods sold and lower sales. The gross margin percentage decreased by 9% from 56% in 2011 to 47% in 2012. The main reasons for the decreases were lower quality of avenanthramide feed stocks and labor force retention challenges due to the robust Alberta economy. During the fourth quarter of 2012, the cost of goods sold rose by $135,000 or 21%, from $634,000 in 2011 to $769,000 in 2012. The gross margin in the fourth quarter of 2012 is lower by 53% due to lower revenue and higher cost of goods sold of certain higher margin products. The gross margin percentage decreased by 23% from 59% in the fourth quarter of 2011 to 36% in the same period of 2012. The same factors for the year end results were applicable in the fourth quarter. Additionally in the fourth quarter, certain products had to be written off and re-manufactured due to technical issues; these write-offs represent $98,634. 14 CEAPRO Annual Report 2012 Total sales in the year ended December 31, 2012 decreased by $621,000 or 11% primarily as a result of lower sales volumes of beta glucan and veterinary shampoo premix that were rescheduled to 2013. The sales in the fourth quarter of 2012 decreased $350,000 or 23% primarily as a result of lower sales volumes of avenanthramides and veterinary shampoo premix that were rescheduled to 2013. Year Ended Quarter Ended December 31 December 31 $000S 2012 2011 CHANGE 2012 2011 CHANGE Total revenues 5,165 5,786 GLYPH<H11502> 11% 1,202 1,552 GLYPH<H11502> 23% Year Ended Quarter Ended December 31 December 31 $000S 2012 2011 CHANGE 2012 2011 CHANGE Sales 5,165 5,786 GLYPH<H11502> 11% 1,202 1,552 GLYPH<H11502> 23% Cost of goods sold 2,716 2,538 7% 769 634 21% Gross margin 2,449 3,248 GLYPH<H11502> 25% 433 918 GLYPH<H11502> 53% Gross margin % 47% 56% 36% 59%