e424b4
Filed pursuant to Rule 424(b)(4)
Registration Nos. 333-161917 and 333-162488
$15,900,000
15,000,000 Units
We are selling 15,000,000 units, each unit consisting of one
share of our common stock and one Class H warrant. Each
Class H warrant entitles the holder to purchase one share
of our common stock at a price of $1.30, and will expire on
October 14, 2014. The Class H warrants will be
exercisable 60 days after issuance, or on December 14,
2009.
Our common stock and Class B warrants are quoted on the
NASDAQ Capital Market under the symbols COIN and
COINZ, respectively. The last sale prices of our
common stock and Class B warrants on October 1, 2009
were $1.15 per share and $0.37 per warrant,
respectively.
There is presently no public market for our units or
Class H warrants. The units will be listed on the NASDAQ
Capital Market under the symbol COINU, on or
promptly after the date of this prospectus. Each of the common
stock and the Class H warrants may begin trading separately
on the 45th day after the date of this prospectus, unless
the representative of the underwriters determines that an
earlier date is acceptable. Once the securities comprising the
units begin separate trading, the common stock and the
Class H warrants will be traded on the NASDAQ Capital
Market under the symbols COIN and COINW,
respectively. We cannot assure you, however, that our securities
will continue to be listed on the NASDAQ Capital Market.
These are speculative securities. Investing in our securities
involves significant risks. You should purchase these securities
only if you can afford a complete loss of your investment. See
Risk Factors beginning on page 7.
Neither the Securities and Exchange Commission nor any state
securities commission has approved or disapproved of these
securities or passed upon the adequacy or accuracy of this
prospectus. Any representation to the contrary is a criminal
offense.
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Underwriting
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Proceeds to
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Price to
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Discounts and
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Converted
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Public
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Commissions(1)
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Organics
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Per Unit
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$
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1.06
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$
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0.0636
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$
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0.9964
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Total
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$
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15,900,000
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$
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954,000
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$
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14,946,000
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(1) |
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This amount does not include a non-accountable expense allowance
in the amount of 2.5% of the gross proceeds, or $397,500
($0.0265 per unit) payable to Chardan Capital Markets, LLC. |
Delivery of the units will be made on or about October 20,
2009. We have granted the underwriters a
45-day
option to purchase up to 2,250,000 additional units solely to
cover over-allotments, if any.
In connection with this offering, we have also agreed to sell to
Chardan Capital Markets, LLC an option to purchase up to 2% of
the units sold for $100. If the representative of the
underwriters exercises this option, each unit may be purchased
for $1.749 per unit (165% of the price of the units sold in the
offering).
Chardan
Capital Markets, LLC
The
date of this prospectus is October 14, 2009
TABLE OF
CONTENTS
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Page
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1
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7
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17
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18
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19
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20
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21
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22
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35
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47
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50
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52
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53
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54
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56
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63
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63
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63
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64
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You should rely only on the information contained in this
document or to which we have referred you. We have not
authorized anyone to provide you with information that is
different. This document may only be used where it is legal to
sell these securities. The information contained in this
document may only be accurate on the date of this document.
PROSPECTUS
SUMMARY
The following summary highlights selected information
contained in this prospectus. This summary does not contain all
the information that may be important to you. You should read
the more detailed information contained in this prospectus,
including but not limited to, the risk factors beginning on
page 7. Reference to we, us,
our, Converted Organics or the
Company means Converted Organics Inc. and its
subsidiaries.
Our
Company
We use food and other food processing waste as a raw material to
manufacture, sell and distribute all-natural soil amendment and
fertilizer products combining disease suppression and
nutritional characteristics.
Our revenue comes from two sources: tip fees and
product sales. Waste haulers pay the tip fees to us for
accepting food waste generated by food distributors such as
grocery stores, produce docks, fish markets and food processors,
and by hospitality venues such as hotels, restaurants,
convention centers and airports. Revenue also comes from the
customers who purchase our products. Our products possess a
combination of nutritional, disease suppression and soil
amendment characteristics. The products are sold in both dry and
liquid form and are stable with an extended shelf life compared
to other organic fertilizers. Among other uses, the liquid
product is expected to be used to mitigate powdery mildew, a
leaf fungus that restricts the flow of water and nutrients to
plants. These products can be used either on a stand-alone basis
or in combination with more traditional petrochemical-based
fertilizers and crop protection products. Based on growth trial
performance, increased environmental awareness, trends in
consumer food preferences and company-sponsored research, we
believe there will be a demand for our products in the
agribusiness, turf management and retail markets. We also expect
to benefit from increased regulatory focus on organic waste
processing and on environmentally friendly growing practices.
We operate two manufacturing facilities, one in Woodbridge, New
Jersey and the other in Gonzales, California, where we use both
owned and licensed proprietary technology to produce our
products.
We are positioning ourselves to take advantage of the growing
market for organic products. We believe there are two primary
business drivers influencing commercial agriculture. First,
commercial farmers are focused on improving the economic yield
of their land: maximizing the value derived from crop output
(quantity and quality). Second, commercial farmers are focused
on reducing the use of chemical products, while also meeting the
demand for cost-effective, environmentally responsible
alternatives. We believe this change in focus is the result of:
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Consumer demand for safer, higher quality food;
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The restriction on use of registered chemical products. Several
U.S. governmental authorities, including the Environmental
Protection Agency, the Food and Drug Administration, and the
U.S. Department of Agriculture, or USDA, regulate the use
of fertilizers;
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Environmental concerns and the demand for sustainable
technologies;
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Demand for more food for the growing world population; and
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The cost effectiveness and efficacy of non-chemical-based
products to growers.
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In connection with the foregoing, according to the Organic Trade
Association, sales of organic food and beverages in the United
States have grown from $1 billion in 1990 to approximately
$20 billion in 2007 and are expected to continue to grow at
an average of 18% per year through 2010. Furthermore, the
Organic Trade Association reports that organic foods represented
approximately 2.8% of total food and beverage sales in 2006,
growing 20.9% in 2006, one of the fastest growing categories.
According to the Nutrition Business Journal, consumer demand is
driving organic sector expansion, particularly for fruit,
vegetables and dairy products. This demand, in turn, is driving
commercial farmers to shift more of their acreage from
conventional practices, which predominantly use synthetic
fertilizers, to organic practices, which require the use of
certified organic fertilizers or other natural organic materials
to facilitate crop growth. The USDAs Economic Research
1
Service reports that the number of certified organic farm acres
has grown from 0.9 million in 1992 to 4.1 million in
2005, a compound annual growth rate of 12% per year.
We believe farmers are facing pressures to change from
conventional production practices to more environmentally
friendly practices. U.S. agricultural producers are turning
to certified organic farming methods as a potential way to lower
production costs, decrease reliance on nonrenewable resources
such as chemical fertilizers, increase market share with an
organically grown label and capture premium prices,
thereby boosting farm income.
Our long-term strategic plan calls for the development and
construction of facilities in addition to our Gonzales and
Woodbridge facilities. In connection with this plan, we have
already done preliminary work aimed at establishing facilities
in Rhode Island and Massachusetts. Any future expansion is
dependent on our ability to raise additional financing beyond
the proceeds we may receive from the offering contemplated by
this prospectus. We may also seek to expand by licensing third
parties to use our technology or by building less
capital-intensive, smaller facilities, if they are commercially
feasible.
Opening additional facilities should allow us to achieve
economies of scale in marketing and selling our fertilizer
products as the cost of these activities would be spread over a
larger volume of product. If our overall volume of production
increases, we also believe we may be able to more effectively
approach larger agribusiness customers requiring larger
quantities of fertilizer to efficiently utilize their
distribution systems.
We were incorporated under the laws of the state of Delaware in
January 2006, and we transitioned from a development stage
company to an operating company in the second quarter of 2008 as
operations commenced. We generated approximately
$1.5 million in revenue for the year ended
December 31, 2008.
In February 2006, we merged with our predecessor organizations,
Mining Organics Management, LLC and Mining Organics Harlem River
Rail Yard, LLC, in transactions accounted for as a
recapitalization. These predecessor organizations provided
initial technical and organizational research that led to the
foundation of the current business plan.
On February 16, 2007, we completed an initial public
offering of stock and also completed a bond offering with the
New Jersey Economic Development Authority. The net proceeds of
the stock offering of $8.9 million, together with the net
proceeds of the bond offering of $16.5 million, were used
to develop and construct the Woodbridge facility, fund our
marketing and administrative expenses during the construction
period and fund specific principal and interest reserves as
specified in the bond offering. Of the total net proceeds of the
stock and bond offerings of $25.4 million,
$14.6 million was used towards the construction of the
Woodbridge facility and the remaining $10.8 million was
used for items detailed above.
On January 24, 2008, we acquired the assets, including the
intellectual property, of Waste Recovery Industries, LLC, or
WRI. This acquisition made us the exclusive owner of the
proprietary technology and process known as the High Temperature
Liquid Composting or HTLC system, which processes various
biodegradable waste products into liquid and solid organic-based
fertilizer and feed products.
Also on January 24, 2008, we acquired the net assets of
United Organic Products, LLC, which was under common ownership
with WRI. With this acquisition, we acquired a leading liquid
fertilizer product line, as well as the operations of the
Gonzales facility.
Our principal business office is located at 7A Commercial Wharf
West, Boston, Massachusetts 02110, and our telephone number is
(617) 624-0111.
Our website address is www.convertedorganics.com.
Information contained on our website or any other website does
not constitute part of this prospectus.
2
THE
OFFERING
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Securities offered: |
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15,000,000 units, at $1.06 per unit (plus
2,250,000 additional units if the underwriters exercise the
over-allotment option), each unit consisting of: |
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one share of common stock; and
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one Class H warrant.
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The units are expected to begin trading on or promptly after the
date of this prospectus. Each of the common stock and
Class H warrants may trade separately on the 45th day
after the date of this prospectus, unless the representative of
the underwriters determines that an earlier date is acceptable. |
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Units: |
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Number outstanding before this
offering
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None. |
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Number to be outstanding after this
offering
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15,000,000 |
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Common Stock: |
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Number outstanding before this
offering
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20,494,532 shares |
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Number to be outstanding after this
offering
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35,494,532 shares (without giving effect to exercise of the
Class H warrants, or any of our other outstanding options,
warrants or convertible notes) |
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Class H Warrants: |
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Number outstanding before this
offering
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None. |
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Number to be outstanding after this
offering
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15,000,000 |
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Exercise price
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$1.30 |
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Securities issuable on exercise of Class H
warrants
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Each Class H warrant is exercisable for one share of common
stock. |
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Exercise period
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The Class H warrants will be exercisable 60 days after
issuance, or on December 14, 2009. The Class H
warrants will expire at 5:00 p.m., New York City time, on
October 14, 2014. |
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NASDAQ Capital Market symbols for our:
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Common stock
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COIN |
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Class B warrants
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COINZ |
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Units
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COINU |
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Class H Warrants
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COINW |
3
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Risk Factors
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You should carefully consider all of the risks set forth in the
section entitled Risk Factors beginning on
page 7 of this prospectus. |
The number of shares to be outstanding after this offering
excludes:
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1,248,895 shares of common stock issuable upon the exercise
of outstanding options issued pursuant to our current stock
option plans;
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274,772 shares of common stock issuable upon the exercise
of options available for future grant under our stock option
plans;
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517,003 shares of common stock issuable upon the exercise
of 131,219 underwriter units issued in connection with our
initial public offering;
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1,000,000 shares of common stock issuable upon conversion
of a $1,540,000 convertible note issued in September 2009;
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shares underlying a convertible note that is convertible into
our common stock at the option of the holder at a price equal to
the average closing price of our common stock on the NASDAQ
Capital Market for the five days preceding conversion (as of
October 1, 2009, the note had a remaining principal balance
of approximately $373,000);
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2,516,810 Class B warrants to purchase a total of 3,699,711
shares of common stock at $7.48 per share (we refer to these as
the Class B warrants), and 2,284,409 Class B warrants,
which were issued at a later date, to purchase a total of
2,284,409 shares of common stock at $11.00 per share (we refer
to these as the Class B-1 warrants);
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885,000 shares of common stock reserved for issuance under our
Class C warrants exercisable at $1.00 per share;
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415,000 shares of common stock reserved for issuance under our
Class D warrants exercisable at $1.02 per share;
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1,500,000 shares of common stock reserved for issuance under our
Class E warrants exercisable at $1.63 per share;
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585,000 shares of common stock reserved for issuance under our
Class F warrants exercisable at $1.25 per share; and
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2,500,000 shares of common stock reserved for issuance under our
Class G warrants exercisable at $1.25 per share.
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Except where we state otherwise, the information we present in
this prospectus assumes:
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no exercise of our outstanding options;
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no exercise of our outstanding warrants;
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no conversion of our outstanding convertible notes;
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no exercise of the underwriters unit purchase
option; and
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no exercise of the underwriters over-allotment option.
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4
SUMMARY
CONSOLIDATED AND OTHER FINANCIAL DATA
The following tables summarize our consolidated financial and
other data. The consolidated statements of operations data for
the years ended December 31, 2008 and 2007 and the
consolidated balance sheet data as of December 31, 2008 and
2007 have been derived from our audited consolidated financial
statements included elsewhere in this prospectus. The
consolidated statement of operations data for the six months
ended June 30, 2009 and 2008, and the consolidated balance
sheet data as of June 30, 2009, have been derived from our
unaudited consolidated financial statements included elsewhere
in this prospectus. The unaudited consolidated financial
statements have been prepared on a basis consistent with our
audited financial statements and include, in the opinion of
management, all adjustments that management considers necessary
for the fair statement of the financial information set forth in
those financial statements. The following financial data should
be read in conjunction with, and is qualified by reference to,
our consolidated financial statements and related notes and
schedules included elsewhere in this prospectus and the
information under Managements Discussion and
Analysis of Financial Condition and Results of Operations
below. Our historical results are not necessarily indicative of
the results to be expected in any future period.
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Years Ended December 31,
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2008
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2007
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Selected Operating Data:
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Revenues
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$
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1,547,981
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$
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Cost of good sold
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1,981,084
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Gross (loss)
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(433,103
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)
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Loss from operations
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(10,381,733
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)
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(3,674,842
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)
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Other (expenses), net
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(5,797,365
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)
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(409,170
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Loss before provision for income taxes
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(16,179,098
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)
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(4,084,012
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Net loss
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(16,179,098
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)
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(4,084,012
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Net loss per share, basic and diluted
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(2.70
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(0.87
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)
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Weighted average common shares outstanding
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5,985,017
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4,716,378
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As of December 31,
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2008
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2007
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Selected Balance Sheet Data:
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Cash and cash equivalents
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$
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3,357,940
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$
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287,867
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Property, plant and equipment
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19,725,146
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Other assets
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9,534,922
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21,888,860
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Total assets
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32,618,008
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22,176,727
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Working capital (deficit)
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(2,243,941
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)
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663,050
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Total liabilities
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27,571,076
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20,090,372
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Total owners equity
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5,046,932
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2,086,355
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5
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Six Months Ended June 30,
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2009
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2008
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Selected Operating Data:
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Revenues
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$
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1,484,023
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$
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752,907
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Cost of good sold
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3,757,264
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624,548
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Gross (loss) profit
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(2,273,061
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128,359
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Loss from operations
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(7,443,230
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(5,617,669
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Other income/(expenses)
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516,828
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(2,920,705
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Loss before provision for income taxes
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(6,926,402
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)
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(8,538,374
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Net loss
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(6,926,402
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(8,538,374
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Net loss per share, basic and diluted
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(0.58
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(1.49
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Weighted average common shares outstanding
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11,985,904
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5,747,616
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As of June 30,
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2009
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2008
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Selected Balance Sheet Data:
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Cash and cash equivalents
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$
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1,808,156
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$
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5,202,718
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Property, plant and equipment
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22,825,134
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7,648,088
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Other assets
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6,330,777
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18,710,416
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Total assets
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30,964,067
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31,561,222
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Working capital (deficit)
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(3,782,563
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)
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1,247,785
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Total liabilities
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26,006,202
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24,481,359
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Total shareholders equity
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4,957,865
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7,079,863
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6
RISK
FACTORS
If you purchase our securities, you will assume a high degree
of risk. In deciding whether to invest, you should carefully
consider the following risk factors, as well as the other
information contained elsewhere in this prospectus. Any of the
following risks, as well as other risks and uncertainties
discussed in this prospectus, could have a material adverse
effect on our business, financial condition, results of
operations or prospects and cause the value of our securities to
decline, which could cause you to lose all or part of your
investment.
Risks
Relating to Our Business
We
received a modified report from our independent registered
public accounting firm with an emphasis of matter paragraph for
our year ended December 31, 2008 with respect to our
ability to continue as a going concern. The existence of such a
report may adversely affect our stock price and our ability to
raise capital, and even if we are successfully able to complete
this offering, there is no assurance that we will not receive a
similar emphasis of matter paragraph in their opinion for our
year ending December 31, 2009.
We believe there exists substantial doubt regarding our ability
to continue as a going concern unless this offering or a similar
financing is consummated. Our independent registered public
accounting firm has modified and included in their report for
our year ended December 31, 2008 an emphasis of matter
paragraph with respect to our ability to continue as a going
concern. Even if we are able to complete this offering, there is
no assurance that our independent registered public accounting
firm will not again so emphasis this matter in their report for
our year ending December 31, 2009. Our consolidated
financial statements have been prepared on the basis of a going
concern, which contemplates the realization of assets and the
satisfaction of liabilities in the normal course of business. If
we became unable to continue as a going concern, we would have
to liquidate our assets and we might receive significantly less
than the values at which they are carried on our consolidated
financial statements. The inclusion of a going concern
modification in our independent registered public accounting
firms audit opinion for the year ended December 31,
2008 may materially and adversely affect our stock price
and our ability to raise new capital, as well as adversely
affect our business. In addition, if our independent registered
public accounting firms report for our year ending
December 31, 2009 again has an emphasis of this matter, it
may adversely affect our stock price and our ability to raise
new capital in the future, as well as adversely affect our
business.
We
need to raise additional capital to fund our operations through
the near term, and we do not have any commitments for that
capital.
For the year ended December 31, 2008, we incurred a net
loss of approximately $16.2 million, and had an accumulated
deficit of $26.6 million. For the six months ended
June 30, 2009, we had a net loss of $6.9 million, an
accumulated deficit of approximately $35.7 million,
negative working capital of approximately $3.7 million, and
we continue to incur such losses. We need additional capital to
execute our business strategy, and if we are unsuccessful in
raising additional capital either through this offering or
otherwise, we will be unable to fully execute our business
strategy on a timely basis, if at all. If we complete this
offering, we expect the funds received will be sufficient to
operate our current business until we are cash flow positive,
which we expect to occur by the end of the third quarter of
2010, assuming that our sales levels do not decrease and
assuming that we do not encounter any unforeseen costs or
expenses. If our sales levels decrease or if we encounter
unforeseen costs or expenses, we will require additional
financing prior to such date for which we have no commitments.
The proceeds from this offering are intended to fund our current
business operations, and will not permit us to finance
additional facilities. If we are unable to complete this
offering, we will need additional financing immediately, for
which we have no commitments. We do not know whether any
financing, if obtained, will be adequate to meet our capital
needs and to support our growth. If adequate capital cannot be
obtained on satisfactory terms, we may curtail or delay the
implementation of updates to our facilities or delay the
expansion of our sales and marketing capabilities, any of which
could cause our business to fail.
7
If we raise additional capital through the issuance of equity
securities, such issuances will likely cause dilution to our
stockholders, particularly if we are required to do so during
periods when our common stock is trading at historically low
price levels. If we raise additional capital through the
issuance of debt securities, the debt securities may be secured
and any interest payments would reduce the amount of cash
available to operate and grow our business.
We
will need to obtain additional debt and equity financing to
complete subsequent stages of our business plan.
Even if this offering is consummated, we will require
significant additional financing to increase the capacity of our
Woodbridge facility to its permitted 500 tons per day capacity
from the current full processing capacity of 250 tons per day
and to invest in the construction of new facilities. Our
long-term business strategy contemplates the expansion of our
Woodbridge facility and the construction of new facilities, and
we do not have any commitments for the financing required to
complete such projects. Any new facility will likely be
individually financed and require considerable debt. While we
believe state government-sponsored debt programs may be
available to finance our requirements, public or private debt
may not be available at all or on terms acceptable to us for the
development of future facilities. We do not intend to utilize
the proceeds from this offering to finance any new manufacturing
facilities or to expand our Woodbridge facility.
To meet our future capital requirements, we may issue additional
securities in the future with rights, terms and preferences
designated by our Board of Directors, without a vote of
stockholders, which could adversely affect stockholder rights.
Additional financing will likely cause dilution to our
stockholders and could involve the issuance of securities with
rights senior to our currently outstanding shares. There is no
assurance that such financing will be sufficient, that the
financing will be available on terms acceptable to us and at
such times as required, or that we will be able to obtain the
additional financing required, if any, for the continued
operation and growth of our business. Any inability to raise
necessary capital will have a material adverse effect on our
ability to implement our business strategy and will have a
material adverse effect on our revenues and net income.
Constructing
and equipping our Woodbridge facility has taken longer and has
cost more than we expected, which has resulted in significant
amounts being owed to construction vendors that we do not have
the cash resources to satisfy.
Our Woodbridge facility became operational in June 2008. We
incurred approximately $5.7 million in construction costs
and design change overruns on an initial budget of
$19.6 million. These design changes and upgrades are
substantially complete, but we can offer no assurance that we
will not experience additional overruns and delays before total
completion.
Of the $5.7 million in upgrades, design changes and
construction costs discussed above, we currently estimate that
we will be able to fund approximately $500,000 in costs. In
order to finance the additional $5.2 million in upgrades,
design changes and construction costs, we have entered into
agreements with all but one of the various construction vendors
regarding payment plans, which generally provide that we pay
interest only for six months with the remaining principal
balance and interest thereon to be repaid in 18 monthly
installments. We owe approximately $2.4 million to one
construction vendor with whom we are presently negotiating. Such
vendor has commenced a lawsuit against us. These negotiations
and legal actions could result in interruptions to the
operations of our Woodbridge facility, which would adversely
effect our business.
We
have limited operating history, and our prospects are difficult
to evaluate.
We have not operated any facility other than our Gonzales
facility, which we purchased in January 2008, and our Woodbridge
facility, which became operational in June 2008. Our activities
to date have been primarily limited to developing our business,
and consequently there is limited historical financial
information related to operations available upon which you may
base your evaluation of our business and prospects. The revenue
and income potential of our business is unproven. If we are
unable to develop our business, we will
8
not achieve our goals and could suffer economic loss or
collapse, which would have a material negative effect on our
financial performance.
We
expect to incur significant losses for some time, and we may
never operate profitably.
From inception through June 30, 2009, we incurred an
accumulated net loss of approximately $35.7 million. The
revenues that we began generating from our Gonzales facility in
February 2008 and from our Woodbridge facility during the first
half of 2009 have not yet resulted in our earning of a profit,
and we will continue to incur significant losses for at least
the near future. There is no assurance that our operations will
ever become profitable.
If we
are unable to manage our transition to an operating company
effectively, our operating results will be adversely
affected.
Failure to effectively manage our transition to an operating
company will harm our business. To date, substantially all of
our activities and resources have been directed at developing
our business plan, arranging financing, licensing technology,
obtaining permits and approvals, securing a lease for our
Woodbridge facility and options for additional facilities,
purchasing our Gonzales facility and beginning to operate our
facilities. The transition to a converter of waste and
manufacturer and vendor of fertilizer products requires
effective planning and management. In addition, future expansion
will be expensive and will likely strain our management and
other resources. We may not be able to easily transfer our
skills to operating a facility or otherwise effectively manage
our transition to an operating company.
We are
dependent on a small number of major customers for our revenues
and the loss of any of these major customers would adversely
affect our results of operations.
Our Gonzales and Woodbridge facilities rely on a few major
customers for a majority of their revenues. From January 1,
2009 until August 31, 2009, approximately 71% of the
revenues generated by the Gonzales facility were from a total of
three customers. From January 1, 2009 until August 31,
2009, approximately 48% of the revenues generated by the
Woodbridge facility, excluding tip fees, were from a
total of two customers. We do not have any long-term agreements
with any of our customers. The loss of any of our major
customers could adversely effect our results of operations.
We are
exposed to risks from legislation requiring companies to
evaluate internal control over financial
reporting.
Section 404 of the Sarbanes-Oxley Act of 2002
(Section 404) required our management to begin
to report on the operating effectiveness of our internal control
over financial reporting for the year ended December 31,
2008. CCR LLP, our independent registered public accounting
firm, will be required to opine on the effectiveness of our
internal control over financial reporting beginning with the
year ending December 31, 2009. We must continue an ongoing
program to perform the system and process evaluation and testing
necessary to comply with these requirements. We expect that this
program will require us to incur significant expenses and to
devote resources to Section 404 compliance on an ongoing
annual basis.
It is difficult for us to predict how long it will take to
complete managements assessment of the effectiveness of
our internal control over financial reporting each year and to
remediate any deficiencies in our internal control over
financial reporting, if any. We are currently completing
internal assessments in anticipation of our independent
registered public accounting firm opining on the effectiveness
of our internal control over financial reporting for the current
year. Due to financial constraints, we have not yet retained any
outside consultants to assist us, although we intend to hire
such consultants if we are able to successfully complete this
offering. As a result, we may not be able to complete the
assessment process on a timely basis each year. In the event
that our Chief Executive Officer, Chief Financial Officer or
independent registered public accounting firm determines that
our internal control over financial reporting is not effective
as defined under Section 404, we cannot predict how
regulators will react or how the market prices of our securities
will be affected.
9
Our
future success is dependent on our existing key employees, and
hiring and assimilating new key employees, and our inability to
attract or retain key personnel in the future would materially
harm our business and results of operations.
Our success depends on the continuing efforts and abilities of
our current management team. In addition, our future success
will depend, in part, on our ability to attract and retain
highly skilled employees, including management, technical and
sales personnel. We may be unable to identify and attract highly
qualified employees in the future. In addition, we may not be
able to successfully assimilate these employees or hire
qualified personnel to replace them if they leave the Company.
The loss of services of any of our key personnel, the inability
to attract or retain key personnel in the future, or delays in
hiring required personnel could materially harm our business and
results of operations.
We
have little or no experience in the food waste conversion or
fertilizer industries, which increases the risk of our inability
to build our facilities and operate our business.
We are currently, and are likely for some time to continue to
be, dependent upon our present management team. Most of these
individuals are experienced in business generally, and in
governing and operating public companies. However, our present
management team does not have experience in organizing the
construction, equipping and start up of a food waste conversion
facility. In addition, none of our directors has any experience
in the food waste conversion or fertilizer products industries.
As a result, we may not develop our business successfully.
We
license certain technology from a third party, and our failure
to perform under the terms of the license could result in
material adverse consequences to our business.
We use certain licensed technology and patented pieces of
process equipment in our Woodbridge facility that have been
licensed to us by International Bio-Recovery Corporation, or
IBRC. The license contains various criteria, such as the payment
of royalties, the branding on packaging and the requirement to
conduct our processing within certain parameters. If we fail to
perform under the terms of the license, the license may be
terminated by the licensor, and we will have to modify our
process and employ other equipment. We currently own and employ
an alternative process to that of IBRC, which is utilized at our
Gonzales facility. If the license agreement is terminated or
held invalid for any reason, or if it is determined that IBRC
has improperly licensed its process to us, our Woodbridge
operations and revenues could be adversely affected.
The
EATAD technology we will use to operate our Woodbridge facility
is unproven at the scale on which we intend to
operate.
While IBRC has operated a facility in British Columbia using the
Enhanced Autothermal Thermophilic Aerobic Digestion, or EATAD,
process, its plant there is smaller than our Woodbridge
facility. IBRC developed the initial drawings for our Woodbridge
facility, but neither IBRC nor we have operated a plant of the
proposed size. There is no assurance that we will be able to
scale-up the
Woodbridge facility successfully.
Our
Woodbridge and Gonzales facility sites, as well as future
facility sites, may have unknown environmental problems that
could be expensive and time-consuming to correct.
There can be no assurance that we will not encounter hazardous
environmental conditions at the Woodbridge and Gonzales facility
sites or at any additional future facility sites that may delay
the construction of our food waste conversion facilities or
require us to incur significant
clean-up or
correction costs. Upon encountering a hazardous environmental
condition, our contractor may suspend work in the affected area.
If we receive notice of a hazardous environmental condition, we
may be required to correct the condition prior to continuing
construction. The presence of a hazardous environmental
condition will likely delay construction of the particular
facility and may require significant expenditures to correct the
environmental condition. If we encounter any hazardous
environmental conditions during construction that require time
or money to correct, such event could delay our ability to
generate revenue.
10
We
have recently commenced operations and may not be able to
successfully operate our Woodbridge or Gonzales
facility.
We believe our Woodbridge facility is the first commercial
facility of its kind in the United States to recycle food waste
into fertilizer, and it therefore may not function as
anticipated. We have produced our products at our Gonzales
facility since February 2008 and have had limited production
from our Woodbridge facility since June 2008. As such, we have
limited operating experience, and may be unable to successfully
operate these facilities. In addition, the control of the
manufacturing process will require operators with extensive
training and experience that may be difficult to attain.
Our
lack of business diversification may have a material negative
effect on our financial performance.
We have two products to sell to customers to generate revenue:
dry and liquid soil fertilizer products. We do not expect to
have any other products. Although we also expect to receive
tip fees from food waste haulers, our lack of
business diversification could have a material adverse effect on
our operations.
We may
not be able to produce products from our facilities in
commercial quantities or sell them at competitive
prices.
We have produced our products at our Gonzales facility since
February 2008 and have had limited production from our
Woodbridge facility since June 2008. Accordingly, our ability to
produce our products in commercial quantities at a competitive
cost is unproven. We may not be able to produce products from
our facilities in commercial quantities or sell them at prices
competitive with other similar products.
We may
be unable to establish marketing and sales capabilities
necessary to commercialize and gain market acceptance for our
products.
We currently have limited resources with which to expand our
sales and marketing capabilities. We will need to either hire
sales personnel with expertise in the markets that we intend to
address or contract with others to provide sales support.
Co-promotion or other marketing arrangements to commercialize
our planned products could significantly limit the revenues we
derive from our products, and the parties with whom we would
enter into such agreements may fail to commercialize our
products successfully. Our products address different markets
and can be offered through multiple sales channels. Addressing
each market effectively will require sales and marketing
resources tailored to the particular market and to the sales
channels that we choose to employ, and we may not be able to
develop such specialized marketing resources.
Pressure
by our customers to reduce prices and agree to long-term supply
arrangements may adversely affect our net sales and profit
margins.
Our current and potential customers, especially large
agricultural companies, are often under budgetary pressure and
are very price sensitive. Our customers may negotiate supply
arrangements with us well in advance of delivery dates, thereby
requiring us to commit to product prices before we can
accurately determine our final costs. If this happens, we may
have to reduce our conversion costs and obtain higher volume
orders to offset lower average sales prices. If we are unable to
offset lower sales prices by reducing our costs, our gross
profit margins will decline, which could have a material
negative effect on our financial performance.
The
fertilizer industry is highly competitive, which may adversely
affect our ability to generate and grow sales.
Chemical fertilizers are manufactured by many companies and are
plentiful and relatively inexpensive. In addition, there are
approximately 1,700 crop products registered as
organic with the Organic Materials Review Institute,
a number that has more than doubled since 2002. If we fail to
keep up with changes affecting the markets that we intend to
serve, we will become less competitive, thereby adversely
affecting our financial performance.
11
Defects
in our products or failures in quality control could impair our
ability to sell our products or could result in product
liability claims, litigation and other significant events with
substantial additional costs.
Detection of any significant defects in our products or failure
in our quality control procedures may result in, among other
things, delay in
time-to-market,
loss of sales and market acceptance of our products, diversion
of development resources, and injury to our reputation. The
costs we may incur in correcting any product defects may be
substantial. Additionally, errors, defects or other performance
problems could result in financial or other damages to our
customers, which could result in litigation. Product liability
litigation, even if we prevail, would be time consuming and
costly to defend, and if we do not prevail, could result in the
imposition of a damages award. We presently maintain product
liability insurance; however, it may not be adequate to cover
any claims.
Energy
and fuel cost variations could adversely affect operating
results and expenses.
Energy costs, particularly electricity and natural gas,
constitute a substantial portion of our operating expenses. The
price and supply of energy and natural gas are unpredictable and
fluctuate based on events outside our control, including demand
for oil and gas, weather, actions by OPEC and other oil and gas
producers, and conflict in oil-producing countries. Price
escalations in the cost of electricity or reductions in the
supply of natural gas could increase operating expenses and
negatively affect our results of operations. We may not be able
to pass through all or part of the increased energy and fuel
costs to our customers.
We may
not be able to obtain sufficient material to produce our
products, and we are dependent on a small number of waste
haulers to provide the food waste we use to produce our
products.
Our revenue comes from two sources: tip fees and
product sales. We are dependent on a stable supply of food waste
in order to produce our products and to utilize our available
capacity. Waste haulers pay the tip fees to us for accepting
food waste generated by food distributors such as grocery
stores, produce docks, fish markets and food processors, and by
hospitality venues such as hotels, restaurants, convention
centers and airports. Insufficient food waste feedstock will
adversely affect our efficiency and may cause us to increase our
tip fee discount from prevailing rates, which is the discount we
pay to haulers that provide larger quantities of food waste,
likely resulting in reduced revenues and net income. Competing
disposal outlets for food waste and increased demand for
applications such as biofuels may develop and adversely affect
our business. In addition, if alternate uses for food waste are
developed in the future, these alternate uses could increase the
competition for food waste.
Our
license agreement with IBRC restricts the territory into which
we may sell our products and grants a cooperative a right of
first refusal to purchase our products.
We have entered into a license agreement with IBRC that, among
other terms, contains a restriction on our right to sell our
planned products outside a territory defined generally as the
Eastern Seaboard of the United States. The license agreement
also grants a proposed cooperative, which to our knowledge has
not yet been formed and of which IBRC will be a member when
formed, a right of first refusal to purchase the products sold
from our Woodbridge facility under certain circumstances. While
we believe that the territory specified in the license agreement
is broad enough to absorb the amount of product that we plan to
produce and that the right of first refusal will not impair our
ability to sell our products, these restrictions may have a
material adverse effect on the volume and price of our product
sales. In addition, we may become completely dependent on a
third party for the sale of our products.
Successful
infringement claims by third parties could result in substantial
damages, lost product sales and the loss of important
proprietary rights.
We may have to defend ourselves against patent and other
infringement claims asserted by third parties regarding the
technology we have licensed, resulting in diversion of
management focus and additional expenses for the defense of
claims. In addition, if a patent infringement suit was brought,
we might be forced to stop or delay the development, manufacture
or sales of potential products that were claimed to infringe a
patent covering a third partys intellectual property
unless that party granted us rights to use its intellectual
12
property. We may be unable to obtain these rights on terms
acceptable to us, if at all. If we cannot obtain all necessary
licenses or other such rights on commercially reasonable terms,
we may be unable to continue selling such products. Even if we
are able to obtain certain rights to a third partys
patented intellectual property, these rights may be
non-exclusive, and therefore our competitors may obtain access
to the same intellectual property. Ultimately, we may be unable
to commercialize our potential products or may have to cease
some or all of our business operations as a result of patent
infringement claims, which could severely harm our business.
Our
EATAD license agreement with IBRC imposes obligations on us
related to infringement actions that may become burdensome or
result in the termination of our license
agreement.
If our use of the licensed EATAD technology is alleged to
infringe the intellectual property of a third party, we may
become obligated to defend such infringement action. If the
licensed EATAD technology is found by a court to be infringing,
IBRC could terminate the license agreement, which may prevent us
from continuing to operate our Woodbridge facility. In such an
event, we may become obligated to find alternative technology or
to pay a royalty to a party other than IBRC in order to continue
to operate.
If a third party is allegedly infringing on any of the licensed
technology, then either we or IBRC may attempt to enforce the
IBRC intellectual property rights. In general, our possession of
rights to use the know-how related to the licensed technology
will not be sufficient to prevent others from employing similar
technology that we believe is infringing. Any such enforcement
action against alleged infringers, whether by us or by IBRC, may
be required to be maintained at our expense under the terms of
the license agreement. The costs of such an enforcement action
may be prohibitive, reduce our net income, if any, or prevent us
from continuing operations.
Our
HTLC technology imposes obligations on us related to
infringement actions that may become burdensome.
If the use of our HTLC technology is alleged to infringe the
intellectual property of a third party, we may become obligated
to defend such infringement action. In such an event, we may
become obligated to find alternative technology or to pay a
royalty to a third party in order to continue to operate.
If a third party is allegedly infringing any of our HTLC
technology, then we may attempt to enforce our intellectual
property rights. In general, our possession of rights to use the
know-how related to our HTLC technology will not be sufficient
to prevent others from employing similar technology that we
believe is infringing. Any such enforcement action against
alleged infringers may be required at our expense. The costs of
such an enforcement action may be prohibitive, reduce our net
income, if any, or prevent us from continuing operations.
We
have provided a bond guaranty to the holders of the bonds issued
in connection with our Woodbridge facility, and the terms of the
guaranty may hinder our ability to operate our business by
imposing restrictive covenants, which may prohibit us from
taking actions to manage or expand our business.
The terms of the bond guaranty executed by us on behalf of
Converted Organics of Woodbridge LLC prohibit us from repaying
debt and other obligations that funded our working capital until
certain ratios of EBITDA to debt service are met. Specifically,
commencing in 2009, we are required to achieve a debt service
ratio coverage of 2.0 to 1. We do not currently expect that we
will meet the required debt service ratio coverage in 2009,
which means that our bond guaranty will remain outstanding, and
we will continue to be prohibited from repaying debt and other
obligations that funded our working capital.
Mandatory
redemption of our bonds issued in connection with our Woodbridge
facility could have a material adverse effect on our liquidity
and cash resources.
The bonds issued to construct our Woodbridge facility are
subject to mandatory redemption by us if the Woodbridge facility
is condemned, we cease to operate the facility, the bonds become
taxable, a change in control occurs or under certain other
circumstances. Depending upon the circumstances, such an event
could
13
require a payment to our bondholders ranging between 100% and
110% of the principal amount of the bonds outstanding, plus
interest. If we are required to redeem our bonds, such
redemption will have a material adverse effect on our liquidity
and cash resources, and may impair our ability to continue to
operate.
The
communities where our facilities may be located may be averse to
hosting waste handling and manufacturing
facilities.
Local residents and authorities in communities where our
facilities may be located may be concerned about odor, vermin,
noise, increased truck traffic, air pollution, decreased
property values, and public health risks associated with
operating a manufacturing facility in their area. These
constituencies may oppose our permitting applications or raise
other issues regarding our proposed facilities or bring legal
challenges to prevent us from constructing or operating
facilities.
During the
start-up
phase at the Woodbridge facility, we experienced odor-related
issues. As a result of these issues, we have been assessed fines
from the Health Department of Middlesex County, New Jersey, and
have been named as a party in a lawsuit by a neighboring
business. With respect to the fines assessed by the Health
Department, we are currently contesting or attempting to
negotiate the extent of the fines. With respect to the
litigation, the plaintiff has alleged various causes of action
connected to the odors emanating from the facility, and in
addition to monetary damages is seeking enjoinment of any and
all operations which in any way cause or contribute to the
alleged pollution. If we are unsuccessful in defending the above
litigation or any new litigation, we may be subject to judgments
or fines, or our operations may be interrupted or terminated.
Our
facilities will require certain permits to operate, which we may
not be able to obtain at all or obtain on a timely
basis.
For our Woodbridge facility and Gonzales facility, we have
obtained the permits and approvals required to operate the
facilities. We may not be able to secure all the necessary
permits for future facilities on a timely basis or at all, which
may prevent us from operating such facilities according to our
business plan.
For our facilities, we may need certain permits to operate solid
waste or recycling facilities, as well as permits for our sewage
connection, water supply, land use, air emission, and wastewater
discharge. The specific permit and approval requirements are set
by the state and the various local jurisdictions, including but
not limited to city, town, county, township and state agencies
having control over the specific properties. Permits once given
may be withdrawn. Inability to obtain or maintain permits to
construct, operate or maintain our facilities will severely and
adversely affect our business.
Changes
in environmental regulations or violations of such regulations
could result in increased expense and could have a material
negative effect on our financial performance.
We are subject to extensive air, water and other environmental
regulations and need to maintain the environmental permits we
have received to operate our Woodbridge and Gonzales facilities,
and need to obtain a number of environmental permits to
construct and operate our planned facilities. If for any reason
any of these permits are not maintained or granted, construction
costs for our food waste conversion facilities may increase, or
the facilities may not be constructed at all. Additionally, any
changes in environmental laws and regulations, both at the
federal and state level, could require us to invest or spend
considerable resources in order to comply with future
environmental regulations. We have been fined for alleged
environmental violations in connection with the operation of our
Woodbridge facility, and are currently contesting certain
alleged environmental violations. Our failure to comply with
environmental regulations could cause us to lose our required
permits, which could cause the interruption or cessation of our
operations. Furthermore, the expense of compliance could be
significant enough to reduce our net income and have a material
negative effect on our financial performance.
14
Risks
Related to Investment in Our Securities
We
have a significant number of warrants outstanding, and while
these warrants are outstanding, it may be more difficult to
raise additional equity capital. Additionally, certain of these
warrants contain anti-dilution provisions that may result in the
reduction of their exercise prices due to the completion of this
offering.
In addition to the Class H warrants being issued in this
offering, we have outstanding:
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2,516,810 Class B warrants to purchase a total of 3,699,711
shares of common stock at $7.48 per share, and 2,284,409
Class B-1
warrants to purchase a total of 2,284,409 shares of common stock
at $11.00 per share;
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885,000 Class C warrants exercisable at $1.00 per share;
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415,000 Class D warrants exercisable at $1.02 per share;
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1,500,000 Class E warrants exercisable at $1.63 per share;
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585,000 Class F warrants exercisable at $1.25 per
share; and
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2,500,000 Class G warrants exercisable at $1.25 per share.
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The holders of those warrants are given the opportunity to
profit from a rise in the market price of our common stock. In
addition, the Class B, C, D and H warrants are not
redeemable by us. We may find it more difficult to raise
additional equity capital while these warrants are outstanding.
At any time during which these public warrants are likely to be
exercised, we may be able to obtain additional equity capital on
more favorable terms from other sources.
Furthermore, the Class C, D and G warrants contain
anti-dilution provisions under which, if we issue securities at
a price lower than the exercise price of such warrants, the
exercise price of the warrants will be reduced, with certain
exceptions, to the lower price; provided that the Class G
warrants have a minimum exercise price of $1.08 per share,
unless we receive stockholder approval for a lower price.
If we
issue shares of preferred stock, your investment could be
diluted or subordinated to the rights of the holders of
preferred stock.
Our Board of Directors is authorized by our Certificate of
Incorporation to establish classes or series of preferred stock
and fix the designation, powers, preferences and rights of the
shares of each such class or series without any further vote or
action by our stockholders. Any shares of preferred stock so
issued could have priority over our common stock with respect to
dividend or liquidation rights. The issuance of shares of
preferred stock, or the issuance of rights to purchase such
shares, could be used to discourage an unsolicited acquisition
proposal. For instance, the issuance of a series of preferred
stock might impede a business combination by including class
voting rights that would enable a holder to block such a
transaction. In addition, under certain circumstances, the
issuance of preferred stock could adversely affect the voting
power of holders of our common stock. Although our Board of
Directors is required to make any determination to issue
preferred stock based on its judgment as to the best interests
of our stockholders, our Board could act in a manner that would
discourage an acquisition attempt or other transaction that
some, or a majority, of our stockholders might believe to be in
their best interests or in which such stockholders might receive
a premium for their stock over the then-market price of such
stock. Presently, our Board of Directors does not intend to seek
stockholder approval prior to the issuance of currently
authorized preferred stock, unless otherwise required by law or
applicable stock exchange rules. Although we have no plans to
issue any shares of preferred stock or to adopt any new series,
preferences or other classification of preferred stock, any such
action by our Board of Directors or issuance of preferred stock
by us could dilute your investment in our common stock and
warrants or subordinate your holdings to such shares of
preferred stock.
15
You
will experience immediate dilution in the book value per share
of the common stock you purchase as part of the
units.
Because the price per share of the common stock included in the
units being offered is substantially higher than the book value
per share of our common stock, you will suffer substantial
dilution in the net tangible book value of the common stock that
you purchase in this offering. See the section entitled
Dilution below for a more detailed discussion of the
dilution you will incur if you purchase the units.
Future
issuances or sales, or the potential for future issuances or
sales, of shares of our common stock, the exercise of warrants
to purchase our common stock, or the conversion of convertible
notes into our common stock, may cause the trading price of our
securities to decline and could impair our ability to raise
capital through subsequent equity offerings.
During 2009, we have issued a significant number of shares of
our common stock, warrants to acquire shares of our common
stock, and convertible notes that may be converted into our
common stock in connection with various financings and the
repayment of debt, and we anticipate that we will continue to do
so in the future. The additional shares of our common stock
issued and to be issued in the future upon the exercise of
warrants or options or the conversion of debt could cause the
market price of our common stock to decline, and could have an
adverse effect on our earnings per share if and when we become
profitable. In addition, future sales of a substantial number of
shares of our common stock or other securities in the public
markets, or the perception that these sales may occur, could
cause the market price of our common stock and our Class H
warrants to decline, and could materially impair our ability to
raise capital through the sale of additional securities.
If we
do not maintain an effective registration statement or comply
with applicable state securities laws, you may not be able to
exercise the Class H warrants.
For you to be able to exercise the Class H warrants, the
shares of our common stock to be issued to you upon exercise of
the Class H warrants must be covered by an effective and
current registration statement and be qualified or exempt under
the securities laws of the state or other jurisdiction in which
you reside. We cannot assure you that we will continue to
maintain a current registration statement relating to the shares
of our common stock underlying the Class H warrants. As
such, you may encounter circumstances in which you will be
unable to exercise the Class H warrants. Consequently,
there is a possibility that you will never be able to exercise
the Class H warrants, and that you will never receive
shares or payment of cash in settlement of the warrants. This
potential inability to exercise the Class H warrants may
have an adverse effect on demand for such warrants and the
prices that can be obtained from reselling them.
16
SPECIAL
NOTE REGARDING FORWARD-LOOKING STATEMENTS
The SEC encourages companies to disclose forward-looking
information so that investors can better understand a
companys future prospects and make informed investment
decisions. This prospectus contains such forward-looking
statements within the meaning of the Private Securities
Litigation Reform Act of 1995.
Words such as may, potential,
anticipate, could, estimate,
expects, projects, intends,
plans, believes and words and terms of
similar substance used in connection with any discussion of
future operating or financial performance identify
forward-looking statements. All forward-looking statements are
managements present expectations of future events and are
subject to a number of risks and uncertainties that could cause
actual results to differ materially from those described in the
forward-looking statements. Some of the factors which could
cause our results to differ materially from our expectations
include the following:
|
|
|
|
|
consumer demand for our products;
|
|
|
|
the availability of an adequate supply of food waste stream
feedstock and the competition for such supply;
|
|
|
|
the unpredictable cost of compliance with environmental and
other government regulation;
|
|
|
|
the time and cost of obtaining USDA, state or other product
labeling designations;
|
|
|
|
our ability to manage expenses;
|
|
|
|
the demand for organic fertilizer and the resulting prices that
customers are willing to pay;
|
|
|
|
supply of organic fertilizer products from the use of competing
or newly developed technologies;
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|
|
|
our ability to attract and retain key personnel;
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|
|
|
adoption of new accounting regulations and standards;
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|
|
|
adverse changes in the securities markets;
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|
|
|
our ability to comply with continued listing requirements of the
NASDAQ Capital Market; and
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|
|
|
the availability of and costs associated with sources of
liquidity, including our ability to obtain bond financing for
future facilities.
|
Please also see the discussion of risks and uncertainties under
the heading Risk Factors above.
In light of these assumptions, risks and uncertainties, the
results and events discussed in the forward-looking statements
contained in this prospectus might not occur. Investors are
cautioned not to place undue reliance on the forward-looking
statements, which speak only as of the date of this prospectus.
We are not under any obligation, and we expressly disclaim any
obligation, to update or alter any forward-looking statements,
whether as a result of new information, future events or
otherwise.
17
USE OF
PROCEEDS
We estimate that the net proceeds from the sale of the units by
us in the offering (assuming no exercise of the Class H
warrants or the underwriters over-allotment option), after
deducting estimated underwriting discounts and commissions and
estimated offering expenses payable by us, will be
$14.2 million, at a public offering price of $1.06 per unit.
We anticipate that we will use the net proceeds of this offering
for:
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|
|
|
|
the further development and execution of our sales, marketing
and distribution plan;
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|
|
|
further expansion at our Gonzales facility;
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|
|
|
continued development of our smaller capacity operating unit
line of business (including patent and intellectual property
development);
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|
|
|
potential investment and development in new facilities,
additional alliances and acquisitions;
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|
|
|
continued development of our licensing program; and
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|
|
|
to repay the six-month note we issued in September 2009 in
principal amount of $1,540,000, which was issued at an original
issue discount of 10%, or the September 2009 Note. The
funds from the September 2009 Note are being utilized for
working capital.
|
Other than the repayment of the September 2009 Note, we have no
definitive agreements or commitments with respect to any of the
above activities. Our management may decide to change the use of
the net proceeds from this offering if opportunities or needs
arise. Such opportunities and needs could include payment of
certain contractual obligations, the need to make increased
capital or operating expenditures if we change our business
plan, or payment of an unexpected liability. The actual use of
the proceeds may vary significantly and will depend on a number
of factors, including our future revenue and cash generated by
operations and the other factors described in the section
entitled Risk Factors appearing elsewhere in this
prospectus. Accordingly, our management will have broad
discretion in applying the net proceeds of this offering.
18
PRICE
RANGE OF COMMON STOCK
Market
Information
Our common stock has been listed on the NASDAQ Capital Market
under the symbol COIN since March 16, 2007.
Prior to March 16, 2007, there was no public market for our
common stock. The following table sets forth the range of high
and low sales prices per share as reported on NASDAQ for the
periods indicated.
|
|
|
|
|
|
|
|
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2009
|
|
High
|
|
|
Low
|
|
|
Fourth Quarter (through October 14, 2009)
|
|
$
|
1.34
|
|
|
$
|
1.14
|
|
Third Quarter
|
|
$
|
1.59
|
|
|
$
|
0.92
|
|
Second Quarter
|
|
$
|
2.62
|
|
|
$
|
0.72
|
|
First Quarter
|
|
$
|
4.16
|
|
|
$
|
0.66
|
|
|
|
|
|
|
|
|
|
|
2008
|
|
High
|
|
|
Low
|
|
|
Fourth Quarter
|
|
$
|
6.46
|
|
|
$
|
2.00
|
|
Third Quarter
|
|
$
|
7.83
|
|
|
$
|
2.99
|
|
Second Quarter
|
|
$
|
10.37
|
|
|
$
|
4.50
|
|
First Quarter
|
|
$
|
14.17
|
|
|
$
|
3.93
|
|
|
|
|
|
|
|
|
|
|
2007
|
|
High
|
|
|
Low
|
|
|
Fourth Quarter
|
|
$
|
4.39
|
|
|
$
|
2.05
|
|
Third Quarter
|
|
$
|
2.83
|
|
|
$
|
1.86
|
|
Second Quarter
|
|
$
|
2.72
|
|
|
$
|
2.02
|
|
First Quarter (from March 16, 2007)
|
|
$
|
2.86
|
|
|
$
|
2.31
|
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Dividends
We have not declared or paid any cash dividends and do not
intend to pay any cash dividends in the foreseeable future. We
intend to retain any future earnings for use in the operation
and expansion of our business. Any future decision to pay cash
dividends on our common stock will be at the discretion of our
Board of Directors and will depend upon our financial condition,
results of operation, capital requirements and other factors our
Board of Directors may deem relevant.
19
CAPITALIZATION
The following table is derived from our unaudited financial
statements as of June 30, 2009 and sets forth:
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our actual capitalization as of June 30, 2009; and
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our capitalization on a pro forma as adjusted basis to reflect:
(a) the sale of the units offered by us at a public
offering price of $1.06 per unit; (b) the sale of
1,961,000 shares of our common stock issued in our July
2009 offering at a price of $1.02 per share; and (c) the
repayment of the $1,540,000 note issued in September 2009.
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|
|
|
|
|
|
|
|
|
|
June 30, 2009
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|
|
|
|
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Pro Forma
|
|
|
|
Actual
|
|
|
as Adjusted
|
|
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DEBT
|
|
|
|
|
|
|
|
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Term notes payable
|
|
$
|
2,269,183
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|
|
$
|
2,269,183
|
|
Convertible note payable
|
|
|
541,450
|
|
|
|
541,450
|
|
Bonds payable
|
|
|
17,500,000
|
|
|
|
17,500,000
|
|
|
|
|
|
|
|
|
|
|
Total debt
|
|
$
|
20,310,633
|
|
|
$
|
20,310,633
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|
|
|
|
|
|
|
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OWNERS EQUITY
|
|
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Preferred stock, $.0001 par value, authorized
10,000,000 shares; no shares issued and outstanding
|
|
$
|
|
|
|
$
|
|
|
Common stock, $.0001 par value, authorized
75,000,000 shares; 18,353,608 shares outstanding at
June 30, 2009 actual; shares issued and outstanding pro
forma as adjusted
|
|
|
1,835
|
|
|
|
3,531
|
|
Additional paid-in capital
|
|
|
40,668,709
|
|
|
|
57,575,649
|
|
Deficit accumulated during the development stage
|
|
|
(35,712,679
|
)
|
|
|
(36,507,044
|
)
|
|
|
|
|
|
|
|
|
|
Total owners equity
|
|
$
|
4,957,865
|
|
|
$
|
21,072,136
|
|
|
|
|
|
|
|
|
|
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This table assumes no exercise by the underwriters of their
option to purchase up to an additional 2,250,000 units from us
to cover over-allotments.
This table should be considered in conjunction with the sections
of this prospectus captioned Use of Proceeds and
Managements Discussion and Analysis of Financial
Condition and Results of Operations, as well as the
financial statements and related notes included elsewhere in
this prospectus.
20
DILUTION
Our unaudited net tangible book value on June 30, 2009 was
approximately $791,044, or approximately $0.04 per share of
common stock. Net tangible book value per share is equal to the
amount of our total tangible assets, less total liabilities,
divided by the aggregate number of shares of common stock
outstanding. Dilution per share represents the difference
between the amount per unit paid by purchasers of units in this
offering of $1.06 per unit and the net tangible book value per
share of our common stock immediately after this offering. After
giving effect to the sale of 15,000,000 units in this
offering at a price of $1.06 per unit (and assuming no exercise
of the Class H warrants) and the sale of
1,961,000 shares of common stock in our July 2009 offering
at a price of $1.02 per share, and after deducting $1,540,000
for repayment of the note issued in September 2009 and estimated
offering expenses of $1,664,000, our net tangible book value as
of June 30, 2009 would have been approximately $
15,365,312, or approximately $0.44 per share. This represents an
immediate dilution of $0.62 per share to new investors
purchasing units in this offering. The following table
illustrates this dilution:
|
|
|
|
|
|
|
|
|
Public offering price per unit
|
|
|
|
|
|
$
|
1.06
|
|
|
|
|
|
|
|
|
|
|
Net tangible book value per share as of June 30, 2009
|
|
$
|
0.04
|
|
|
|
|
|
Increase per unit attributable to July 2009 offering and the
current offering (assumes repayment of September 2009 note)
|
|
$
|
0.40
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net tangible book value per share as of June 30, 2009 after
giving effect to the July 2009 offering and the sale of the
shares in this offering (assumes repayment of September 2009
note)
|
|
$
|
0.44
|
|
|
|
0.44
|
|
|
|
|
|
|
|
|
|
|
Dilution per unit to new investors
|
|
|
|
|
|
$
|
0.62
|
|
|
|
|
|
|
|
|
|
|
21
MANAGEMENTS
DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the
consolidated financial statements and related notes to the
consolidated financial statements included elsewhere in this
prospectus. This discussion contains forward-looking statements
that relate to future events or our future financial
performance. These statements involve known and unknown risks,
uncertainties and other factors that may cause our actual
results, levels of activity, performance or achievements to be
materially different from any future results, levels of
activity, performance or achievements expressed or implied by
these forward-looking statements. These forward-looking
statements are based largely on our current expectations and are
subject to a number of uncertainties and risks including those
set forth in the Risk Factors section above. Actual
results could differ materially from these forward-looking
statements.
Introduction
Our operating structure is composed of our parent company,
Converted Organics Inc., two wholly-owned operating subsidiaries
and a 92.5% owned non-operating subsidiary. The first operating
subsidiary is Converted Organics of Woodbridge, LLC, which
includes the operation of our Woodbridge, New Jersey facility.
The second operating subsidiary is Converted Organics of
California, LLC, which includes the operation of our Gonzales,
California facility. The 92.5% owned subsidiary is Converted
Organics of Rhode Island, LLC, which currently has no operating
activity. We construct and operate processing facilities that
use food waste as raw material to manufacture all-natural soil
amendment and fertilizer products combining nutritional and
disease suppression characteristics. In addition to our current
sales in the agribusiness and retail markets, we plan to sell
and distribute our products in the turf management market. We
have hired experienced sales and marketing personnel in these
markets and have begun to introduce the product to the
marketplace. We plan to hire additional experienced sales
personnel during 2009. We also hope to achieve additional
revenue by licensing the use of our technology to others.
Woodbridge
Facility
We obtained a long-term lease expiring June 2026 for a site in a
portion of an industrial building in Woodbridge, New Jersey that
the landlord has modified and that we have equipped as our first
internally-constructed food waste conversion facility. We are
currently producing both liquid and dry product at that
facility. In the first half of 2009, we began to record tip fee
and product sales revenue; nevertheless, we are currently
operating at less than full capacity at that facility. Full
capacity is 250 tons per day. As we have transitioned to an
operating company, we have experienced operating inefficiencies.
We have also experienced odor-related issues that have caused
interruptions in our production. At full capacity, the
Woodbridge facility is expected to process approximately 78,000
tons of food waste and produce approximately 9,900 tons of dry
product and approximately 10,000 tons of liquid product
annually. We have substantially completed upgrades to the
Woodbridge facility, and we are presently bringing equipment
on-line to fulfill our commitment to overcome operational
difficulties that hampered the efficiency of the plant at
opening. We believe these upgrades will allow us to achieve
capacity at the facility of approximately 70% of full capacity.
During the first half of 2009, we generated revenue from this
facility in the form of tip fees of approximately $75,000 and
product sales of approximately $277,000. In order for this
facility to be cash flow positive, we estimate that total
revenues from the facility would need to be in a range of
$450,000 to $550,000 per month. We estimate that our products,
both liquid and dry, can be sold for a price in the range of
$400 to $700 per ton based on the market to which it is sold.
Therefore, the potential monthly sales from this facility at 70%
capacity ranges from approximately $700,000 to $1,100,000. Based
on the above, we would have to produce and sell approximately
45-55% of
the capacity of the Woodbridge facility to be cash flow positive
at that facility, and, until our sales and production volume
reach that level, we will not be cash flow positive and may
therefore require additional funding to subsidize operations at
that facility. Cash flow generated by exceeding that
sales/production number would be used to fund operations at the
corporate level and to pay down approximately $2.4 million
of the payables related to construction activity at this
facility.
22
UOP
Acquisition; Gonzales Facility
On January 24, 2008, we acquired the net assets of United
Organic Products, LLC, or UOP, which was under common ownership
with Waste Recovery Industries, LLC, or WRI. With this
transaction, we acquired a leading liquid fertilizer product
line, as well as the Gonzales facility, which is a
state-of-the-art
production facility that services a strong West Coast
agribusiness customer base through established distribution
channels. This facility is operational and began to generate
revenues for us in February 2008. The purchase price of
$2,500,000 was paid in cash of $1,500,000 and notes payable of
$1,000,000. The note matures on January 1, 2011, has an
interest rate of 7% per annum, is payable monthly in arrears,
and is convertible into our common stock at the option of the
holder at a price equal to the average closing price of our
common stock on the NASDAQ Capital Market for the five days
preceding conversion. As of October 1, 2009, the note
payable had a remaining principal balance of approximately
$373,000 and the holder had converted approximately $138,000 in
principal and interest on the note into 102,500 shares of
our common stock.
The Gonzales facility generated revenue during the first half of
2009 of approximately $1,079,000 with a negative operating
margin of approximately $77,000 (based on no allocation of
corporate overhead). In the three months ended June 30,
2009, the facility generated approximately $809,000 in sales,
with a positive operating margin of approximately $68,000. We
plan to continue to improve this operating margin by channeling
sales into the turf and retail markets, which we believe to be
more profitable, by generating tip fees from receiving
additional quantities of food processing waste and by reducing
the amount of raw material and freight costs currently
associated with the production process. In addition, we have
plans to add capacity to the Gonzales plant, whereby the plant
will be able to produce approximately three times its current
production and will be capable of producing both liquid and
solid products. We have completed certain aspects of the planned
upgrades which allow us to receive solid food waste for
processing but have delayed the upgrades which would allow us to
produce dry product. The remaining upgrades have been delayed
due to cash flow constraints. We intend to use the proceeds from
this offering to complete the upgrades.
In order for the Gonzales facility to begin to generate cash
flow from operations, we estimate it would need to generate
sales levels of approximately $200,000 per month for 2009. We
estimate that the plant in its current configuration, and based
on current market prices, has the capacity to generate monthly
sales in the range of $350,000 to $400,000. If sales increase
above the $200,000 per month level, we expect the additional
cash flow from the Gonzales facility will be used to offset
operating expenses at the corporate level. Based on sales in the
latter months of the second quarter of 2009, we believe we have
achieved breakeven sales levels at the Gonzales facility.
On January 24, 2008, we entered into a
10-year
lease for land in Gonzales, California, where our Gonzales
facility is located. The land is leased from Valley Land
Holdings, LLC, or VLH, a California limited liability company
whose sole member is a former officer and director. The lease
provides for an initial monthly rent of $9,000 for 2008, after
which the lease payments increase by 3% per year during the term
of the lease. The lease is also renewable for three five-year
terms after the expiration of the initial
10-year
term. In addition, we own the Gonzales facility and the
operating equipment used in the facility.
WRI
Acquisition
On January 24, 2008, we also acquired the net assets,
including the intellectual property, of WRI. This acquisition
makes us the exclusive owner of the proprietary technology and
process known as the High Temperature Liquid Composting, or
HTLC, system, which processes various biodegradable waste
products into liquid and solid food waste-based fertilizer and
feed products. The purchase price of $500,000 was paid with a 7%
short-term note that matured and was paid on May 1, 2008.
In addition, the purchase price provides for a technology fee
payment of $5,500 per ton of waste-processing capacity that is
added to plants that were not planned at the time of this
acquisition and that use this new technology. The per ton fee is
not payable on the Woodbridge facility, the facility that is
being planned in Rhode Island, or the Gonzales facility acquired
in the acquisition or the currently planned addition thereto,
except to the extent that capacity (in excess of the currently
planned addition) is added to those facilities in the future.
The purchase agreement also provides for a 50% profit share with
WRIs sellers on any portable facilities. The purchase
agreement provides further that if we decide to
23
exercise our right, obtained in the WRI acquisition, to enter
into a joint venture with Pacific Seafoods Inc. for the
development of a fish waste-processing product, we will pay 50%
of our profits, which is less the 50% of the profits paid to
Pacific Seafoods Inc., earned from this product to the seller of
WRI. Combined payments of both the $5,500 per ton technology fee
and the profits paid from the fish waste-processing product, if
any, is capped at $7.0 million with no minimum payment
required. In April 2008, we entered into an agreement with
Pacific Seafoods Inc. whereby we will pay Pacific Seafoods Inc.
50% of the profits from the fish waste-processing product. To
date, no profits have been earned from the fish waste-processing
product. It is our intention to expense the payments, if any,
that are paid on either the profits from the fish
waste-processing product or the $5,500 per-ton technology fee.
Pro Forma
Financial Information
The unaudited supplemental pro forma information discloses the
condensed results of operations for the year ended
December 31, 2008 and for the current fiscal year up to the
date of the most recent interim period presented, which is the
six months ended June 30, 2009 (and for the corresponding
period in the preceding year) as though the business combination
had been completed as of January 1, 2008. In addition, the
unaudited supplemental pro forma information discloses the
condensed balance sheet as of December 31, 2008 as though
the business combination had been completed as of
January 1, 2008.
The pro forma condensed consolidated financial information is
based upon available information and certain assumptions that we
believe are reasonable. The unaudited supplemental pro forma
information does not purport to represent what our financial
condition or results of operations would actually have been had
these transactions in fact occurred as of the dates indicated
above or to project our results of operations for the period
indicated or for any other period.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Twelve Months Ended December 31, 2008
|
|
|
|
Historical Converted
|
|
|
|
|
|
|
|
|
|
|
|
|
Organics and
|
|
|
Pro forma
|
|
|
|
|
|
Pro forma
|
|
|
|
Subsidiaries
|
|
|
Adjustments
|
|
|
Reference
|
|
|
Consolidated
|
|
|
Revenues (in thousands)
|
|
$
|
1,548
|
|
|
$
|
|
|
|
|
(1
|
)
|
|
$
|
1,548
|
|
Cost of goods sold
|
|
|
1,981
|
|
|
|
20
|
|
|
|
(2
|
)
|
|
|
2,001
|
|
General & administrative expenses
|
|
|
9,310
|
|
|
|
33
|
|
|
|
(3
|
)
|
|
|
9,343
|
|
Net loss (in thousands)
|
|
|
(16,179
|
)
|
|
|
(53
|
)
|
|
|
|
|
|
|
(16,232
|
)
|
Net loss per share basic and diluted
|
|
|
(2.70
|
)
|
|
|
|
|
|
|
|
|
|
|
(2.71
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended June 30, 2009
|
|
|
Historical Converted
|
|
|
|
|
|
|
|
|
Organics and
|
|
Pro forma
|
|
|
|
Pro forma
|
|
|
Subsidiaries
|
|
Adjustments
|
|
Reference
|
|
Consolidated
|
|
Revenues (in thousands)
|
|
$
|
1,484
|
|
|
$
|
|
|
|
|
|
|
|
$
|
1,484
|
|
Cost of goods sold
|
|
|
3,757
|
|
|
|
|
|
|
|
|
|
|
|
3,757
|
|
General & administrative expenses
|
|
|
4,176
|
|
|
|
|
|
|
|
|
|
|
|
4,176
|
|
Net loss (in thousands)
|
|
|
(6,926
|
)
|
|
|
|
|
|
|
|
|
|
|
(6,926
|
)
|
Net loss per share basic and diluted
|
|
|
(0.58
|
)
|
|
|
|
|
|
|
|
|
|
|
(0.58
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended June 30, 2008
|
|
|
Historical Converted
|
|
|
|
|
|
|
|
|
Organics and
|
|
Pro forma
|
|
|
|
Pro forma
|
|
|
Subsidiaries
|
|
Adjustments
|
|
Reference
|
|
Consolidated
|
|
Revenues (in thousands)
|
|
$
|
753
|
|
|
$
|
|
|
|
|
(1
|
)
|
|
$
|
753
|
|
Cost of goods sold
|
|
|
625
|
|
|
|
20
|
|
|
|
(2
|
)
|
|
|
645
|
|
General & administrative expenses
|
|
|
5,346
|
|
|
|
33
|
|
|
|
(3
|
)
|
|
|
5,379
|
|
Net loss (in thousands)
|
|
|
(8,538
|
)
|
|
|
(53
|
)
|
|
|
|
|
|
|
(8,591
|
)
|
Net loss per share basic and diluted
|
|
|
(1.49
|
)
|
|
|
|
|
|
|
|
|
|
|
(1.49
|
)
|
|
|
|
(1) |
|
No revenues are recognized in the pro forma presentation. |
24
|
|
|
(2) |
|
The acquired company incurred Cost of Goods Sold during the
pre-acquisition period of approximately $20,000. |
|
(3) |
|
The acquired company incurred General & administrative
expenses of approximately $33,000 during the pre-acquisition
period. |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of December 31, 2008
|
|
|
Historical Converted
|
|
|
|
|
|
|
|
|
Organics and
|
|
Pro forma
|
|
|
|
Pro forma
|
|
|
Subsidiaries
|
|
Adjustments
|
|
Reference
|
|
Consolidated
|
|
Current assets
|
|
$
|
7,230
|
|
|
|
|
|
|
|
(1
|
)
|
|
$
|
7,230
|
|
Total assets
|
|
|
32,618
|
|
|
|
|
|
|
|
|
|
|
|
32,618
|
|
Current liabilities
|
|
|
9,474
|
|
|
|
|
|
|
|
|
|
|
|
9,474
|
|
Total liabilities
|
|
|
27,571
|
|
|
|
|
|
|
|
|
|
|
|
27,571
|
|
Owners equity
|
|
|
5,047
|
|
|
|
|
|
|
|
|
|
|
|
5,047
|
|
|
|
|
(1) |
|
No pro forma adjustments are made since the balances of the
acquired entity are included in the balances as of
December 31, 2008. |
Rhode
Island Facility
The Rhode Island Industrial Facilities Corporation provided
initial approval to our Revenue Bond Financing Application for
up to $15.0 million for the construction of a new facility
in Rhode Island. In addition, the Rhode Island Resource Recovery
Corporation, or RIRRC, gave us final approval to lease nine
acres of land in the newly created Lakeside Commerce Industrial
Park in Johnston, Rhode Island. We previously filed an
application with the Rhode Island Department of Environmental
Management for the operation of a Putrescible Waste Recycling
Center at that site. On September 1, 2008, we entered into
a twenty-year ground lease with the RIRRC under which we are
obligated to pay $9,167 per month, plus $8 per ton of fertilizer
(liquid or solid) sold from the facility.
Recent
Financing Activities January 2008, March 2009, May
2009 and July 2009 Financings
On January 24, 2008, we entered into private financing with
three investors, in which we received $4,050,000 in proceeds,
referred to herein as the 2008 Financing. We used the proceeds
to fund the acquisition of the assets described above, to fund
further development activities and to provide working capital.
The 2008 Financing was offered at an original issue discount of
10%. The investors were issued convertible debentures in the
principal amount of $4,500,000, with interest accruing at 10%
per annum and with the principal balance to be paid by
January 24, 2009, which deadline was extended to
July 24, 2009. In addition, we initially issued to the
investors an aggregate of 750,000 Class A warrants and
750,000 Class B warrants exercisable at $8.25 and $11.00
per warrant share, respectively. Of these warrants, 50% were
returned to us when we obtained shareholder approval for the
2008 Financing, in compliance with the rules of the NASDAQ Stock
Market. A placement fee of $225,000 was paid out of the proceeds
of this loan to Chardan Capital Markets, LLC. The investors had
the option, at any time on or before the extended maturity date
of July 24, 2009 to convert the outstanding principal of
the convertible debentures into shares of our common stock at
the rate per share equal to 70% of the average of the three
lowest closing prices of common stock during the
20-day
trading period immediately prior to a notice of conversion. As
of June 30, 2009, the investors converted the entirety of
the debentures into 7,366,310 shares, reducing the
principal amount of the debt to $0. In addition, the investors
received 131,834 shares of common stock as interest on the
debentures during the pay-off period.
On March 6, 2009, we entered into an agreement with the
holders of our $17.5 million New Jersey Economic
Development Authority bonds to release $2.0 million for
capital expenditures on our Woodbridge facility and to defer
interest payments on the bonds through July 30, 2009. These
funds had been held in a reserve for bond principal and interest
payments along with a reserve for lease payments. As
consideration for the release of the reserve funds, we issued
the bond holders 2,284,409 Class B warrants. The
Class B warrants are exercisable at $11.00 per warrant.
These warrants are not registered and cannot be traded.
25
On May 7, 2009, we entered into a formal agreement with an
institutional investor, wherein we agreed to sell to the
investor, for the sum of $1,182,500, six-month nonconvertible
original issue discount notes with an aggregate principal amount
of $1,330,313. The agreement provided that if we raised over
$1,330,313 while the notes were outstanding, the first
$1,330,313 must be used to repay the notes. Additionally, in
connection with the notes issued pursuant to the agreement, the
investor received five-year Class C warrants to purchase
750,000 shares and five-year Class D warrants to
purchase 350,000 shares of common stock, with exercise
prices of $1.00 per share and $1.02 per share, respectively,
subject to certain anti-dilution rights for issuances below the
exercise prices. These warrants are not registered and there is
no public market for them. The expense associated with the
issuance of these warrants was calculated using a Black-Scholes
model with the following assumptions: risk-free interest rate of
2.05%; no dividend yield; volatility factor of 96.7%; and a term
of five years. We determined that the warrants issued have a
fair value of $1,557,953. We recorded the relative fair value of
the warrants to the underlying notes of $1,330,313 as
additional-paid-in capital and established a discount on the
debt. The discount was fully amortized at repayment of the note
(12 days later) and at such time the entire amortization
totaled approximately $637,850 for the three months ended
June 30, 2009. Also pursuant to this agreement, Chardan
Capital Markets, LLC, representative of the underwriters, was
issued five-year Class C warrants to purchase
135,000 shares of common stock and Class D warrants to
purchase 65,000 shares of common stock with exercise prices
of $1.00 per share and $1.02 per share, respectively.
The expense associated with these warrants was calculated in the
same manner as described above. The expense of $285,000 is
included in general and administrative expense on the
consolidated statements of operations for the three and six
month periods ended June 30, 2009 and 2008.
On May 19, 2009, we entered into an agreement with four
institutional investors whereby the investors agreed to purchase
1,500,000 shares of our common stock for $1.40 per share,
providing $2.2 million before fees and expenses. The
May 7, 2009 nonconvertible short-term note described above
was immediately repaid with the proceeds of the May 19,
2009 offering as required under such an instrument. In addition,
and as an inducement to enter into this transaction, we issued
the investors 1,500,000 warrants, with a strike price of $1.40
per share and a
90-day term.
We made the offering and sale of these shares and the shares
underlying the warrants pursuant to a shelf registration
statement.
On May 26, 2009, we entered into an amended agreement with
the same four institutional investors, discussed in the prior
paragraph, pursuant to which the warrants exercisable at $1.40
per share were exercised in full for aggregate proceeds of
$2.1 million. Pursuant to such amended agreement, we agreed
to issue to these investors in the aggregate Class E
warrants to purchase an additional 1,500,000 shares of our
common stock at an exercise price of $1.63 per share. We may
redeem these warrants for $.001 per warrant share at any time
after our common stock has closed at or above $2.42 for five
consecutive trading days. The Class E warrants are
exercisable six months after their date of issuance and expire
on May 27, 2014. We made the offering and sale of these
warrants and the shares underlying the warrants pursuant to a
shelf registration statement.
On July 16, 2009, we sold 1,961,000 shares of common
stock at $1.02 per share under our shelf registration statement
for an aggregate of $2,000,220. In addition, we issued 585,000
Class F warrants with an exercise price of $1.25 per share.
The Class F warrants have a five-year life from the date of
issuance and cannot be exercised until six months from the date
of issuance.
On September 14, 2009, we entered into an agreement with an
institutional investor, wherein we agreed to sell to the
investor, for the sum of $1,400,000, a six-month convertible
original issue discount note with a principal amount of
$1,540,000. The agreement provided that if we raised any debt or
equity financing while the note was outstanding, the first
monies raised must be used to repay the note. The principal
amount of the note is convertible into shares of our common
stock at $1.54 per share. Additionally, in connection with the
note issued, the investor received a five-year Class G
warrant to purchase 2,500,000 shares of common stock, with
an exercise price of $1.25 per share, subject to certain
anti-dilution rights for issuances below the exercise price.
26
Construction
and Start-up
Period
We commenced plant operations at our Woodbridge facility in June
2008, where we are processing both liquid and solid waste and
producing both liquid and solid fertilizer and soil enhancement
products. Construction has been substantially completed on all
aspects of the facility, and we are generating both tip fee and
product sales revenue. Although the plant is operating at less
than full capacity, we have substantially completed all plant
upgrades, which we expect will allow us to operate at 70%
capacity. We had budgeted approximately $14.6 million for
the design, building, and testing of our facility, including
related non-recurring engineering costs. The capital outlay of
$14.6 million came from the $25.4 million raised by
our initial public offering of stock and the issuance of New
Jersey Economic Development Bonds, both of which closed on
February 16, 2007, and does not include $4.6 million
of capital improvements provided by the landlord of the
Woodbridge facility, which are being financed over the term of
the lease by increased lease payments at an imported interest
rate of 4%.
The total cost of the plant exceeded the estimate of
$14.6 million by approximately $2.2 million (which did
not include $4.6 million of lease financing discussed
above). Also, we purchased additional equipment, which will
allow us to produce additional dry product, which is in high
demand by the retail market. The cost of this additional
equipment was approximately $1.5 million. We decided to
incorporate the HTLC technology acquired from WRI into the
Woodbridge facility. These costs were approximately
$2.0 million, bringing the total plant cost to
$20.3 million, not including lease financing. Installation
of the HTLC technology and additional equipment was dependent on
our ability to raise additional capital and negotiate extended
payment terms with our construction vendors. We have negotiated
revised payment terms with all but one of our construction
vendors. This vendor has placed a lien on the property in New
Jersey and commenced a lawsuit against us, which are further
discussed in the Liquidity and Capital Resources
section. A party that leases equipment to us has a lien on the
equipment to secure payment of the approximately $44,000 to be
paid over the remaining life of the lease. The purpose of adding
the HTLC technology to the Woodbridge facility is two-fold:
first, we believe it will significantly lower operating costs,
most notably utility costs, as the need to evaporate significant
amounts of liquid byproduct would no longer be necessary, and
second, the non-evaporated liquid can be used in the production
process and sold as additional product.
During the start up phase at the Woodbridge facility, we
experienced emissions violations related to odor issues. We were
fined by the Middlesex County Health Department for these
violations and we subsequently hired additional consultants to
assist with the correction process. In late July 2009, we began
implementing operational procedures at the plant which were
recommended by the odor control consultants and since then we
have not experienced significant odor issues; however, we have
not obtained release from the Middlesex County Health Department
concerning this issue and there is no assurance that we can
obtain such a release. As of September 3, 2009, the total
amount of fines levied by the Middlesex County Health Department
total $356,250, of which we have paid $87,750, and we are either
contesting or negotiating the unpaid balance of $268,500, based
on the date of violation. The financial statements at
June 30, 2009 include an accrued liability of $75,000
related to the unpaid balance.
Full-scale
Operations
Full capacity at the Woodbridge facility would provide
processing capacity of approximately 250 tons per day. As
discussed above, we have completed the necessary upgrades to the
Woodbridge facility, which are expected to allow us to increase
capacity at the facility to approximately 70% of full capacity.
We have two revenue streams: (1) tip fees that in our
potential markets range from $40 to $80 per ton, and
(2) product sales. Tip fees are paid to us to receive the
food waste stream from waste haulers; the hauler pays us,
instead of a landfill, to take the waste. If the haulers source,
separate and pay in advance, they are charged tip fees that are
up to 20% below market.
Operations at the Gonzales facility began in February 2008 with
the production of approximately 25 tons per day of liquid
fertilizer. This output is presently being sold into the
California agricultural market. We have completed certain
upgrades to the plant that allow us to accept solid food waste
for processing. We have not
27
completed the upgrades that would allow us to produce a solid
fertilizer product, as we have delayed those enhancements due to
cash flow restrictions.
Critical
Accounting Policies and Estimates
Our plan of operation is based in part upon our consolidated
financial statements, which have been prepared in accordance
with accounting principles generally accepted in the United
States of America (GAAP). The preparation of financial
statements in accordance with GAAP requires management to make
estimates and assumptions that affect the reported amounts of
assets and liabilities, including the recoverability of tangible
and intangible assets, disclosure of contingent assets and
liabilities as of the date of the financial statements, and the
reported amounts of expenses during the periods covered. A
summary of accounting policies that have been applied to the
historical financial statements can be found in the notes to the
consolidated financial statements.
We evaluate our estimates on an on-going basis. The most
significant estimates relate to intangible assets, deferred
financing and issuance costs, and the fair value of financial
instruments. We base our estimates on our historical and
industry experience and on various other assumptions that we
believe to be reasonable under the circumstances, the results of
which form the basis for making judgments about the carrying
values of assets and liabilities that are not readily apparent
from other sources. Actual results may differ materially from
those estimates.
The following is a brief discussion of our critical accounting
policies and methods, and the judgments and estimates used by us
in their application:
Revenue
Recognition
Revenue is recognized when each of the following criteria is met:
|
|
|
|
|
persuasive evidence of a sales arrangement exists;
|
|
|
|
delivery of the product has occurred;
|
|
|
|
the sales price is fixed or determinable; and
|
|
|
|
collectability is reasonably assured.
|
In those cases where all four criteria are not met, we defer
recognition of revenue until the period where these criteria are
satisfied. Revenue is generally recognized upon shipment.
Share-Based
Compensation
Share-based compensation issued to employees is measured at the
grant date, based on the fair value of the award, and is
recognized as an expense over the requisite service period
(generally the vesting period of the grant). Share-based
compensation issued to non-employees is measured at grant date,
based on the fair value of the consideration received or the
fair value of the equity instruments issued, whichever is more
readily measurable, and is recognized as an expense over the
requisite service period. Stock options granted in 2008 were
calculated at the date of grant using a Black-Scholes pricing
model with the following assumptions: risk-free interest rate of
3.52%; no dividend yield; expected volatility factor of 52.3%;
and an expected term of five years. The fair value for the
10,000 immediately vesting stock options granted in 2007 was
estimated at the date of grant using a Black-Scholes pricing
model with the following assumptions: risk-free interest rate of
4.9%; no dividend yield; expected volatility factor of 16.9%;
and an expected term of five years. Estimates and judgments used
in the preparation of our financial statements are, by their
nature, uncertain and unpredictable, and depend upon, among
other things, many factors outside of our control, such as the
results of our operations and other economic conditions.
Accordingly, our estimates and judgments may prove to be
incorrect and actual results may differ, perhaps significantly,
from these estimates under different estimates, assumptions or
conditions.
28
Other
Long-Lived Assets
Long-lived assets and certain intangible assets are reviewed for
impairment whenever events or changes in circumstances indicate
that the carrying amount may not be recoverable, such as
technological changes or significantly increased competition. If
undiscounted expected future cash flows are less than the
carrying value of the assets, an impairment loss is to be
recognized based on the fair value of the assets, calculated
using a discounted cash flow model. There is inherent
subjectivity and judgment involved in cash flow analyses such as
estimating revenue and cost growth rates, residual or terminal
values and discount rates, which can have a significant impact
on the amount of any impairment.
Other long-lived assets, such as identifiable intangible assets,
are amortized over their estimated useful lives. These assets
are reviewed for impairment whenever events or circumstances
provide evidence that suggests that the carrying amount of the
assets may not be recoverable, with impairment being based upon
an evaluation of the identifiable undiscounted cash flows. If
impaired, the resulting charge reflects the excess of the
assets carrying cost over its fair value. As described
above, there is inherent subjectivity involved in estimating
future cash flows, which can have a significant impact on the
amount of any impairment. Also, if market conditions become less
favorable, future cash flows (the key variable in assessing the
impairment of these assets) may decrease and as a result we may
be required to recognize impairment charges in the future.
Estimates and judgments used in the preparation of our financial
statements are, by their nature, uncertain and unpredictable,
and depend upon, among other things, many factors outside of our
control, such as the results of our operations and other
economic conditions. Accordingly, our estimates and judgments
may prove to be incorrect and actual results may differ, perhaps
significantly, from these estimates under different estimates,
assumptions or conditions.
Capitalization
of Interest Costs
We have capitalized interest costs, net of certain interest
income, related to our New Jersey Economic Development Authority
bonds in the amount of $1,077,689 and $403,573 as of
December 31, 2008 and December 31, 2007, respectively.
Capitalized interest costs during the construction phase of the
Woodbridge facility are included in
construction-in-progress
on the consolidated balance sheets.
Construction-in-Progress
Construction-in-progress
includes amounts incurred for construction costs, equipment
purchases and capitalized interest costs for items still under
construction related to the construction of the Woodbridge
facility.
Restricted
Cash
As of December 31, 2008, we had remaining approximately
$2,608,000 of restricted cash as required by our bond agreement.
This cash was raised by us in our initial public offering and
bond financing, both of which closed on February 16, 2007,
and is set aside in three separate accounts consisting of
$34,000 for the construction of the Woodbridge facility, $8,000
for the working capital requirements of the Woodbridge
subsidiary while the facility is under construction, and
$2,028,000 in reserve for bond principal and interest payments
along with a reserve for lease payments. In March 2009, the
bondholder released $2,000,000 of these restricted funds for us
to use and therefore we have classified cash as a current asset
on our balance sheet as of December 31, 2008. We have
classified this restricted cash as non-current to the extent
that such funds are to be used to acquire non-current assets or
are to be used to service non-current liabilities. Third-party
trustee approval is required for disbursement of all restricted
funds.
Consolidation
Our consolidated financial statements include the transactions
and balances of Converted Organics Inc. and its subsidiaries,
Converted Organics of California, LLC, Converted Organics of
Woodbridge, LLC and Converted Organics of Rhode Island, LLC. The
transactions and balances of Valley Land Holdings, LLC, a
29
variable interest entity of Converted Organics of California,
LLC, were also consolidated therein until April 1, 2009.
All intercompany transactions and balances have been eliminated
in consolidation.
The consolidated financial statements included Valley Land
Holdings, LLC, or VLH, as VLH had been deemed to be our variable
interest entity as it was the primary beneficiary of that
variable interest entity following the acquisition of the net
assets of United Organic Products, LLC. VLHs assets and
liabilities consist primarily of cash, land and a mortgage note
payable on the land on which the California facility is located.
Its operations consist of rental income on the land from us and
related operating expenses. In 2009, the sole member of VLH
contributed cash and property to VLH in a recapitalization. VLH
has henceforth been sufficiently capitalized and is no longer
considered to be a variable interest entity of us. We have
deconsolidated VLH as a variable interest entity as of
April 1, 2009 in our financial statements.
Fair
Value Measurements
We have partially implemented SFAS No. 157, Fair
Value Measurements (SFAS No. 157)
for assets and liabilities. SFAS No. 157 defines fair
value, establishes a framework for measuring fair value, and
expands disclosure about fair value. This standard only applies
when other standards require or permit the fair value
measurement of assets and liabilities. It does not increase the
use of fair value measurement. The standard is effective for
fiscal years beginning after November 15, 2008. The major
categories of assets and liabilities that have not been measured
and disclosed using SFAS No. 157 fair value guidance
are property and equipment and goodwill.
Earnings
(Loss) Per Share
Basic earnings (loss) per share, or EPS, is computed by dividing
the net income (loss) attributable to the common stockholders
(the numerator) by the weighted average number of shares of
common stock outstanding (the denominator) during the reporting
periods. Diluted income (loss) per share is computed by
increasing the denominator by the weighted average number of
additional shares that could have been outstanding from
securities convertible into common stock, such as stock options
and warrants (using the treasury stock method), and
convertible preferred stock and debt (using the
if-converted method), unless their effect on net
income (loss) per share is antidilutive. Under the
if-converted method, convertible instruments are
assumed to have been converted as of the beginning of the period
or when issued, if later. The effect of computing the diluted
income (loss) per share is antidilutive and, as such, basic and
diluted earnings (loss) per share are the same for the three and
six month periods ended June 30, 2009 and 2008.
Results
of Operations for the Six Months Ended June 30, 2009 and
2008
During the six months ended June 30, 2009, we had sales of
approximately $1,484,000, compared to $753,000 for the same
period in 2008. During 2009, we had cost of goods sold of
approximately $3,757,000, leaving a negative gross margin of
approximately $2,273,000, compared to $625,000 cost of goods
sold and $128,000 gross margin for the same period in 2008.
The negative gross margins in 2009 were generated due to high
production costs (salaries, rents, depreciation, supplies, etc.)
at both our Woodbridge and Gonzales facilities and low sales and
production volume. We expect gross margin to improve in the
future as we increase production and expand our sales efforts
into the more profitable retail and agricultural markets. Of the
$2,273,000 negative gross margin in the six months ended
June 30, 2009, approximately $77,000 was generated at our
Gonzales facility due to sales volumes not yet being high enough
to cover all fixed production costs, higher than anticipated
production and transportation costs, and approximately
$2,215,000 in negative gross margin was generated at our
Woodbridge facility due to low sales volume and fixed costs
associated with the facility.
During the three months ended June 30, 2009, we had sales
of approximately $992,000, compared to $493,000 for the same
period in 2008. During 2009, we had cost of goods sold of
approximately $2,113,000, leaving a negative gross margin of
approximately $1,120,000, compared to $403,000 cost of goods
sold and $90,000 gross margin for the same period in 2008.
Of the $1,120,000 negative gross margin in the three
30
months ended June 30, 2009, approximately $68,000 positive
gross margin was generated at our Gonzales facility, and the
Woodbridge facility generated $1,180,000 of negative gross
margin.
We incurred general and administrative expenses of approximately
$4,175,000 and $5,346,000 for the
six-month
periods ended June 30, 2009 and 2008, respectively. The
principal components of the approximately $1,171,000 decrease in
general and administrative expenses is due to allocation of
rent, production salaries and utilities to cost of sales in
2009, along with a decrease in compensation expense associated
with the issuance of stock options of $2,140,000. This was
offset by an increase in professional fees associated with
financing activities and general costs of growing the business.
We incurred general and administrative expenses of approximately
$2,503,000 and $3,759,000 for the three-month periods ended
June 30, 2009 and 2008, respectively. The principal
components of the approximately $1,256,000 decrease in general
and administrative expenses are similar in nature to the
components of the decrease in the six-month activity described
above.
We incurred depreciation expense of approximately $626,000 and
$7,000 for the six months ended June 30, 2009 and 2008,
respectively, and $306,000 and $3,000 for the three months ended
June 30, 2009 and 2008, respectively. The increase in
depreciation expense is due to assets placed in service and
depreciated, particularly at the Woodbridge facility.
We recognized derivative accounting gains of $3,565,000 and $0
in the six-month periods ended June 30, 2009 and 2008,
respectively, and derivative gains of $2,153,000 and $0 in the
three months ended June 30, 2009 and 2008, respectively.
These gains are non-cash in nature.
Interest expense for the six months ended June 30, 2009 and
2008 was $3,110,000 and $3,127,000, respectively. The components
of interest expense for the period ended June 30, 2009 are:
(i) recognition of $562,000 of interest expense associated
with the extension of the convertible debentures issued in
January 2008, which became due in January 2009 and which were
extended until July 2009 (200,000 shares of common stock
were issued in connection with such extension),
(ii) recognition of approximately $660,000 of interest
expense associated with the issuance of warrants in connection
with the March 6, 2009 financing arrangement with the
holders of our bonds, and approximately $920,000 of interest
expense associated with the issuances of warrants related to
short-term non-convertible notes issued in the quarter, and
(iii) recognition of $700,000 in interest expense on our
New Jersey Economic Development Authority bonds, and
approximately $268,000 on our other various borrowings during
the six months ending June 30, 2009.
Interest expense for the six months ended June 30, 2008 was
comprised of (i) $176,000 of interest expense on various
short-term notes; (ii) recognition of approximately
$2,093,000 in connection with borrowing transactions, primarily
non-cash items; (iii) $700,000 on our NJ EDA bonds; and
(iv) approximately $158,000 in penalties associated with
convertible debt.
As a result of the variances described above, for the six months
ended June 30, 2009, net loss was $6.9 million,
compared to $8.5 million for the same period in 2008. For
the three months ended June 30, 2009, the net loss was
$3.0 million versus $6.1 million for the same period
in 2008.
As of June 30, 2009, we had current assets of approximately
$3.5 million, compared to $7.2 million as of
December 31, 2008. Our total assets were approximately
$30.9 million as of June 30, 2009, compared to
approximately $32.6 million as of December 31, 2008.
The majority of the decrease in current assets from
December 31, 2008 to June 30, 2009 is due to the use
of cash for working capital requirements.
As of June 30, 2009, we had current liabilities of
approximately $7.3 million, compared to $9.5 million
at December 31, 2008. This decrease is due largely to the
conversion of debt into shares of our common stock, and the
negotiation of term notes with our construction vendors, which
moved some of that liability from current to non-current. In
addition, we had long-term liabilities of approximately
$18.8 million as of June 30, 2009 as compared to
$18.1 million at December 31, 2008. The increase is
due to the reclassification of amounts owed to construction
vendors to long-term liabilities.
For the six months ended June 30, 2009, we had negative
cash flow from operating activity of approximately
$4.1 million, comprised primarily of loss from operations
offset by certain non-cash items such
31
as depreciation, non-cash interest expense associated with the
issuance of warrants, amortization of deferred financing fees
and amortization of discounts on private financing, and an
increase in accounts payable and accrued expenses. We also had
negative cash flow from investing activities of $985,000,
primarily related to construction at the Woodbridge facility,
offset by the release of restricted cash set aside for that
purpose. The negative cash flow from both operating and
investing activities was offset by approximately
$3.6 million in positive cash flow from financing
activities, comprised of proceeds from our various equity
transactions.
Results
of Operations for the Years Ended December 31, 2008 and
2007
For the period from inception (May 3, 2003) until
December 31, 2007, we were a development stage company with
no revenues. We began to earn revenues from our Gonzales and
Woodbridge facilities during 2008, and therefore we are no
longer reporting as a development stage company.
During the year ended December 2008, we had sales of
approximately $1.5 million, compared to $0 for the same
period in 2007. During 2008, we had cost of goods sold of
approximately $2.0 million, leaving a negative gross margin
of approximately $433,000, compared to $0 cost of goods sold and
$0 gross margin for the same period in 2007. The sales and
negative gross margins were derived primarily from both our
Gonzales and Woodbridge facilities. The negative gross margin
was generated in the third and fourth quarters and is further
explained below. Of the $433,000 negative gross margin in the
year ended December 31, 2008, approximately $275,000 was
generated at our Gonzales facility due to lower than expected
sales volume and higher than anticipated production and
transportation costs, and approximately $158,000 in negative
gross margin was generated at our Woodbridge facility due to low
sales volume and the start up nature of the facility.
We incurred operating expenses of approximately
$10.3 million and $3.7 million for the years ended
December 31, 2008 and 2007, respectively. The principal
components of the $6.6 million increase in operating
expenses is an increase in general and administrative expenses
of $6.3 million (due mainly to an increase in general and
administrative expenses of $1.4 million for additional
personnel and other costs associated with the start up of the
Woodbridge facility, $829,000 in additional expenses associated
with the Gonzales facility, $500,000 in additional personnel at
the corporate offices, $290,000 in expense related to the
issuance of stock for remuneration for services rendered,
$200,000 in professional fees relating to private placement
financing, $160,000 relating to recognition of liquidated
damages associated with the private placement financing, an
additional $200,000 in amortization of intangible assets
acquired from UOP and WRI, and $2.3 million recognized as
compensation expense upon the issuance of employee stock options
as calculated using the Black-Scholes pricing model), offset by
a $350,000 reduction in research and development costs.
Interest expense for the years ended December 31, 2008 and
2007 was $5.8 million and $1.2 million, respectively.
The increase is due to the interest payments on the convertible
debentures issued in the 2008 Financing described above;
amortization of the original issue discount on the convertible
debentures issued in the 2008 Financing; and amortization of the
discount related to the beneficial conversion feature of the
convertible debentures issued in the 2008 Financing and other
convertible debt. Interest income was $290,000 in the year ended
December 31, 2008 and $824,000 for the same period in 2007.
The decrease is due to our declining balances in restricted cash.
Amortization of other intangible assets expense was $399,000 for
the year ended December 31, 2008 and $62,000 during the
same period in 2007. The increase is due to amortization of
costs associated with the convertible debentures issued in the
2008 Financing, which are being amortized over the life of the
loan.
For the year ended December 31, 2008, net loss was
$16.2 million, compared to $4.1 million for the same
period in 2007. The increase in net loss primarily represents
the effects of the increase in our operating costs and interest
expense, as discussed above.
As of December 31, 2008, we had current assets of
approximately $7.2 million, compared to $3.2 million
as of December 31, 2007. Our total assets were
approximately $32.6 million as of December 31, 2008
compared to approximately $22.2 million as of
December 31, 2007. The majority of the increase in both
current and total assets from December 31, 2007 to
December 31, 2008 is due to receipt of approximately
32
$11.3 million in cash from the voluntary exercise of our
Class A warrants and $3.0 million in net assets
acquired with our acquisitions of UOP and WRI.
As of December 31, 2008, we had current liabilities of
approximately $9.5 million, compared to $2.5 million
at December 31, 2007. This significant increase is due
largely to the convertible debentures issued in the 2008
Financing, net of discounts of $230,000 and debt matured in
association with our acquisitions of UOP and WRI, and an
increase in accounts payable to construction-related vendors. In
addition, we had long-term liabilities of approximately
$18.1 million as of December 31, 2008, as compared to
$17.6 million at December 31, 2007. This increase is
primarily due to the issuance of long-term notes payable in
association with our acquisition of UOP and WRI.
For the twelve months ended December 31, 2008, we had
negative cash flow from operating activity of approximately
$7.3 million, comprised primarily of loss from operations
offset by certain non-cash items such as depreciation,
amortization of deferred financing fees and amortization of
discounts on private financing, $2.3 million in expense
associated with the grant of stock options and an increase in
accounts payable and accrued expenses. We also had negative cash
flow from investing activities of $4.7 million, primarily
related to the purchase of UOP assets and construction at the
Woodbridge facility, offset by the release of restricted cash
set aside for that purpose. The negative cash flow from both
operating and investing activities was offset by approximately
$15.0 million in positive cash flow from financing
activities, comprised of approximately $11.3 million from
the exercise of warrants, and $3.7 million from the
proceeds of the January 24, 2008 private financing.
Liquidity
and Capital Resources
At June 30, 2009, we had total current assets of
approximately $3.5 million consisting primarily of cash,
accounts receivable, inventories and prepaid assets, and had
current liabilities of approximately $7.3 million,
consisting primarily of accounts payable, accrued expenses and
notes payable, leaving us with negative working capital of
approximately $3.8 million. Non-current assets totaled
$27.4 million and consisted primarily of property and
equipment, intangible assets and construction in process.
Non-current liabilities of $18.7 million consist primarily
of bonds payable of $17.5 million and the long-term portion
of our term notes payable of $1.2 million at June 30,
2009. We have an accumulated deficit at June 30, 2009 of
approximately $35.7 million. Owners equity at
June 30, 2009 was approximately $5.0 million. For the
first half of 2009, we generated revenues from operations of
approximately $1,484,000.
At June 30, 2009, our current liabilities are greater than
our current assets by approximately $3.8 million. We have
trade accounts payable of approximately $4.3 million, of
which approximately $2.4 million relates to construction at
the Woodbridge facility. We have come to agreement with three of
our four construction vendors for extended payment terms with
interest. Those vendors have agreed to release their liens upon
receipt of final payment. We continue to negotiate with the
fourth vendor, who has filed a lien against our assets and has
commenced a lawsuit for breach of contract. The funds from the
debt and equity offerings we recently completed have not been
used towards payment of the construction vendor amounts and we
are currently negotiating with the vendor to issue a note for
the outstanding amounts owed.
Our independent registered public accountants have issued a
going-concern opinion on our financial statements as of
December 31, 2008. We had incurred a net loss of
approximately $16.2 million during the year ended
December 31, 2008, had a working capital deficiency as of
December 31, 2008, and an accumulated deficit of
approximately $26.6 million. As of June 30, 2009, we
continued to have a working capital deficiency, and for the six
months ended June 30, 2009, we had a net loss of
$6.9 million and an accumulated deficit of approximately
$35.7 million.
Our plan to become cash flow positive and to work through our
current working capital deficit is as follows:
We currently have manufacturing capabilities in our Woodbridge
and Gonzales facilities as a means to generate revenues and
cash. Our cash requirements on a monthly basis are approximately
$275,000 at the corporate level, $500,000 for Woodbridge and
$200,000 for Gonzales. Currently, only the Gonzales facility is
33
generating enough cash flow to cover its cash requirements,
leaving us with a cash shortfall of approximately $775,000 per
month. We estimate that at the current production capacity we
could provide enough product to achieve additional revenues of
$1,000,000 to $1,500,000 per month, which at those levels would
provide sufficient cash flow to cover our cash requirements,
including additional variable costs associated with increased
production. Until such sales levels are achieved and we are cash
flow positive, we will have to seek additional means of
financing in order to cover the shortfall. During the first half
of 2009, we reduced the entire $4.5 million convertible
debenture balance from our January 24, 2008 financing by
converting the balance into shares of our common stock. In
addition, during the first quarter of 2009, the holders of the
New Jersey Economic Development Authority bonds released
$2.0 million of escrowed funds for us to use and we
obtained $1.3 million of secured debt financing. We raised
another $4.2 million in capital through the issuance of
common stock and the exercise of warrants. In September 2009, we
raised $1.4 million by the issuance of a convertible note
in principal amount of $1.54 million, which included an
original issue discount of 10%, and the issuance of warrants to
purchase 2,500,000 shares of common stock at an exercise
price of $1.25 per share. In addition, we have a shelf
registration statement which would allow us to sell shares into
the market to raise additional financing of up to
$2.0 million, provided that pursuant to SEC rules we may
not access the $2.0 million available under the shelf
registration statement until our stock price is at or above
$1.86. We are using the proceeds from the debt and equity
offerings we completed during the year to fund working capital
requirements and to add additional sales and marketing personnel
in order to achieve increased sales levels during the remainder
of 2009. Specifically, we are seeking sales personnel to assist
with sales of liquid product into the agricultural market. Also,
we continue to expand our sales efforts into the retail market
by increasing the number of sales presentations to the retail
channel for orders to be placed for early 2010 delivery.
We need additional capital to execute our business strategy, and
if we are unsuccessful in either raising additional capital
through this offering or otherwise, we will be unable to fully
execute our business strategy on a timely basis, if at all. If
we complete this offering, we expect the funds received will be
sufficient to operate our current business until we are cash
flow positive, which we expect to occur by the end of the third
quarter of 2010, assuming our sales levels do not decrease and
assuming we do not encounter any unforeseen costs or expenses.
If our sales levels decrease or if we encounter unforeseen costs
or expenses, we will require additional financing prior to such
date for which we have no commitments. The proceeds from this
offering are intended to fund our current business operations,
and will not permit us to finance additional facilities. If are
unable to complete this offering, we will need additional
financing in the short-term for which we have no commitments. We
do not know whether any financing, if obtained, will be adequate
to meet our capital needs and to support our growth. If adequate
capital cannot be obtained on satisfactory terms, we may curtail
or delay the implementation of updates to our facilities or
delay the expansion of our sales and marketing capabilities, any
of which could cause our business to fail.
During this period of limited cash availability, we have lowered
costs in the administrative areas of the company and
concentrated on production in both Woodbridge and Gonzales. In
addition, we have and will continue to be required to curtail
certain production and sales costs until sales orders begin to
increase to the desired levels, and most notably we will have to
limit the production of product to two variations of liquid and
dry product and the desired sales level will have to be derived
from those products.
We do not have any commitments for additional equity or debt
funding, and there is no assurance that capital in any form
would be available to us, and if available, on terms and
conditions that are acceptable. Moreover, we are not permitted
to borrow any future funds unless we obtain the consent of the
holders of the New Jersey Economic Development Authority bonds.
We have obtained such consent for prior financing, but there is
no guarantee that we can obtain such consent in the future.
Off-Balance
Sheet Transactions
We do not engage in material off-balance sheet transactions.
34
BUSINESS
Overview
During 2008, we transitioned from a development stage company
(our first reported revenues were in February 2008) to a
fully operational company that operates processing facilities
that use food waste as raw material to manufacture all-natural
soil amendment and fertilizer products combining nutritional and
disease suppression characteristics. In addition to our sales in
the agribusiness market, we sell and distribute our products in
the turf management and retail markets. We currently operate two
facilities:
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Woodbridge facility. A facility in Woodbridge,
New Jersey that we have equipped as our first
internally-constructed food waste conversion facility, referred
to herein as the Woodbridge facility. Operations at the
Woodbridge facility began in late June of 2008, and include
processing solid waste and producing both liquid and dry
fertilizer and soil enhancement products.
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Gonzales facility. A facility in Gonzales,
California, referred to herein as the Gonzales facility, that we
acquired in January 2008. The Gonzales facility is operational
and began to generate revenue for us in February 2008.
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We were incorporated under the laws of the state of Delaware in
January 2006. In February 2006, we merged with our predecessor
organizations, Mining Organics Management, LLC, or MOM, and
Mining Organics Harlem River Rail Yard, LLC, or HRRY, in
transactions accounted for as a recapitalization. These
predecessor organizations provided initial technical and
organizational research that led to the foundation of the
current business plan.
On February 16, 2007, we successfully completed an initial
public offering of stock and successfully completed a bond
offering with the New Jersey Economic Development Authority. The
net proceeds of the stock offering of $8.9 million,
together with the net proceeds of the bond offering of
$16.5 million, were used to develop and construct the
Woodbridge facility, fund our marketing and administrative
expenses during the construction period and fund specific
principal and interest reserves as specified in the bond
offering. Of the total net proceeds of the stock and bond
offerings of $25.4 million, $14.6 million was used
towards the construction of the Woodbridge facility and the
remaining $10.8 million was used for items detailed above.
On January 24, 2008, we acquired the assets, including the
intellectual property, of Waste Recovery Industries, LLC, or
WRI. This acquisition makes us the exclusive owner of the
proprietary technology and process known as the High Temperature
Liquid Composting, or HTLC, system, which processes various
biodegradable waste products into liquid and solid organic-based
fertilizer and feed products.
Also on January 24, 2008, we acquired the net assets of
United Organic Products, LLC, or UOP, which was under common
ownership with WRI. With this acquisition, we acquired a leading
liquid fertilizer product line, as well as the Gonzales
facility, which is a production facility that services a West
Coast agribusiness customer base through established
distribution channels.
Our
Revenue Sources
Our revenue comes from two sources: tip fees and
product sales. Waste haulers pay tip fees to us for accepting
food waste generated by food distributors such as grocery
stores, produce docks, fish markets and food processors, and by
hospitality venues such as hotels, restaurants, convention
centers and airports. Revenue also comes from the customers who
purchase our products. Our products possess a combination of
nutritional, disease suppression and soil amendment
characteristics. The products are sold in both dry and liquid
form and are stable with an extended shelf life compared to
other organic fertilizers. Among other uses, the liquid product
is expected to be used to mitigate powdery mildew, a leaf fungus
that restricts the flow of water and nutrients to plants. Our
products can be used either on a stand-alone basis or in
combination with more traditional petrochemical-based
fertilizers and crop protection products. Based on growth trials
we have conducted with local farmers, company-sponsored
research, increased environmental awareness and trends in
consumer food preferences, we believe our products will have
demand in the agribusiness, turf management
35
and retail markets. We also expect to benefit from increased
regulatory focus on food waste processing and on environmentally
friendly growing practices.
Our
Woodbridge Facility
We obtained a long-term lease expiring June 2026 for a site in a
portion of an industrial building in Woodbridge, New Jersey that
the landlord has modified and that we have equipped as our first
internally-constructed food waste conversion facility. We are
currently producing both liquid and dry product at that
facility. In the first half of 2009, we began to record tip fee
and product sales revenue; nevertheless, we are currently
operating at less than full capacity at that facility, or 250
tons per day. As we have transitioned to an operating company,
we have experienced operating inefficiencies. We have also
experienced odor-related issues that have caused interruptions
in our production. At full capacity, the Woodbridge facility is
expected to process approximately 78,000 tons of food waste and
produce approximately 9,900 tons of dry product and
approximately 10,000 tons of liquid product annually. We have
substantially completed upgrades to the Woodbridge facility, and
we are presently bringing equipment on-line to fulfill our
commitment to overcome operational difficulties that hampered
the efficiency of the plant at opening. We believe these
upgrades will allow us to achieve capacity at the facility of
approximately 70% of full capacity. During the first half of
2009, we generated revenue from this facility in the form of tip
fees of approximately $75,000 and product sales of approximately
$277,000. In order for this facility to be cash flow positive,
we estimate that total revenues from the facility would need to
be in a range of $450,000 to $550,000 per month. We estimate
that our products, both liquid and dry, can be sold for a price
in the range of $400 to $700 per ton based on the market to
which it is sold. Therefore, the potential monthly sales from
this facility at 70% capacity ranges from approximately $700,000
to $1,100,000. Based on the above, we would have to produce and
sell approximately
45-55% of
the capacity of the Woodbridge facility to be cash flow positive
at that facility, and, until our sales and production volume
reach that level, we will not be cash flow positive and may
therefore require additional funding to subsidize operations at
that facility. Cash flow generated by exceeding that
sales/production number would be used to fund operations at the
corporate level and to pay down approximately $2.4 million
of the payables related to construction activity at this
facility.
As of June 30, 2009, we have outstanding amounts due to our
New Jersey construction vendors of approximately
$4.2 million. With the exception of one contractor, we have
negotiated with our remaining contractors to issue notes or
otherwise repay approximately $1.8 million of the
outstanding amounts owed. We have not been able to negotiate
payment terms with one contractor owed approximately
$2.4 million who has placed a lien on the Woodbridge
facility and has commenced a lawsuit in the matter.
We have agreements with 11 waste-hauling companies to provide
food waste to the Woodbridge facility. Based on our current
processing capacity, we are primarily utilizing three haulers
that provide almost all of the food waste we need for our
facility. We believe that we have an adequate supply of raw
material to operate the plant at full processing capacity.
Our Woodbridge facility receives raw material from the New
York-Northern New Jersey metropolitan area. It is located near
the confluence of two major highways in northern New Jersey,
providing efficient access for the delivery of feedstock from
throughout this geographic area.
Our conversion process has been approved for inclusion in the
Middlesex County and New Jersey State Solid Waste Management
Plan. We have been granted our Class C recycling permit,
which is the primary environmental permit for this project. The
remaining required permits are primarily those associated with
the construction and operation of any manufacturing business,
which we have also obtained.
Our
Gonzales Facility
On January 24, 2008, we acquired the net assets of UOP,
which was under common ownership with WRI. With this
transaction, we acquired a leading liquid fertilizer product
line, and ownership of the Gonzales facility, a
state-of-the-art
production facility located in Gonzales, California that
services a strong West Coast agribusiness customer base through
established distribution channels. This facility is operational
and began to generate revenues for us in February 2008. The
purchase price of $2,500,000 was paid in cash of $1,500,000
36
and a note payable of $1,000,000. The note matures on
January 1, 2011, has an interest rate of 7% per annum, is
payable monthly in arrears, and is convertible into our common
stock at the option of the holder for a price equal to the
average closing price of the stock on the NASDAQ Capital Market
for the five days preceding conversion. As of October 1,
2009, the note payable had a remaining principal balance of
approximately $373,000.
The Gonzales facility generated revenue during the first half of
2009 of approximately $1,079,000, with a negative operating
margin of approximately $77,000 (based on no allocation of
corporate overhead). In the three months ended June 30,
2009, the facility generated approximately $809,000 in sales,
with a positive operating margin of approximately $68,000. We
plan to continue to improve this operating margin by channeling
sales into the turf and retail markets, which we believe to be
more profitable, by generating tip fees from receiving
additional quantities of food waste and by reducing the amount
of raw material and freight costs currently associated with the
production process. In addition, we have plans to triple the
actual production capacity of our Gonzales facility, and to make
the facility capable of producing both liquid and dry products.
We have completed certain aspects of the planned upgrades that
allow us to receive solid food waste for processing but have
delayed the upgrades that would allow us to produce dry product.
The remaining upgrades have been delayed due to cash flow
constraints. We intend to use the proceeds from this offering to
complete the upgrades.
In order for the Gonzales facility to begin to generate positive
cash flow from operations, we estimate it would need to generate
sales levels of approximately $200,000 per month for 2009. We
estimate that in its current configuration the plant has the
capacity, based on current market prices, to generate monthly
sales in the range of $350,000 to $400,000. If sales increase
above the $200,000 per month level, we expect the additional
cash flow from the Gonzales facility will be used to offset
operating expenses at the corporate level. Based on sales in the
latter months of the second quarter of 2009, we believe we have
achieved facility breakeven sales levels at the Gonzales
facility.
On January 24, 2008, we entered into a
10-year
lease for land in Gonzales, California, where our Gonzales
facility is located. The land is leased from Valley Land
Holdings, LLC, or VLH, a California limited liability company
whose sole member is a former officer and director of ours. The
lease provided for a monthly rent of $9,000 for 2008, after
which the lease payments were to increase 3% per year during the
term of the lease. The lease is also renewable for three
five-year terms after the expiration of the initial
10-year
term. In addition, we own the Gonzales facility and the
operating equipment used in the facility.
Future
Expansion of Business
In addition to our Gonzales and Woodbridge facilities, our
strategic plan calls for the development and construction of
facilities in Rhode Island and Massachusetts. We currently are
planning to operate these new facilities using the technology
that we acquired in our acquisition of WRI. We anticipate that
we will be able to use much of the engineering and design work
used in our Gonzales facility. Any plans to further expand our
Gonzales facility, or to construct any future facilities, is
dependent on our ability to raise additional financing in
addition to the funds from the offering contemplated by this
prospectus.
In each of our contemplated locations, we have:
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Engaged a local businessperson well-acquainted with the
community to assist us in the permitting process and development
of support from community groups;
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Participated in numerous meetings with state, county and local
regulatory bodies as well as environmental and economic
development authorities; and
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Identified potential facility sites.
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If we are able to build new facilities, we anticipate we will
achieve economies of scale in marketing and selling our
fertilizer products as the cost of these activities is spread
over a larger volume of product. If our overall volume of
production increases, we also believe we may be able to more
effectively approach larger agribusiness customers who may
require larger quantities of fertilizer to efficiently utilize
their distribution systems.
37
To date, we have undertaken the following activities in the
following markets to prepare to develop additional facilities:
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The Rhode Island Industrial Facilities Corporation gave initial
approval to our Revenue Bond Financing Application for up to
$15.0 million for the construction of our proposed Rhode
Island facility. In addition, the Rhode Island Resource Recovery
Corporation gave us final approval to lease nine acres of land
in the newly created Lakeside Commerce Industrial Park in
Johnston, Rhode Island. We previously filed an application with
the Rhode Island Department of Environmental Management for the
operation of a Putrescible Waste Recycling Center at that site.
As part of our efforts to establish a Rhode Island facility, we
have established Converted Organics of Rhode Island, LLC, of
which we are 92.5% owners. The minority share is owned by a
local businessman who has assisted us with the process of
developing a Rhode Island facility.
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In Massachusetts, we have performed initial development work in
connection with construction of three manufacturing facilities
to serve the eastern Massachusetts market. Our proposals to
develop these facilities are currently under review by the
property owners. The Massachusetts Strategic Envirotechnology
Partnership Program has completed a review of our technology.
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We are actively pursuing the development of a licensing program
and the production of a smaller capacity operating unit to be
used by us or sold to third parties. We have begun the
development of smaller capacity operating units, namely the
Scalable Modular AeRobic Technology (SMART) units that are
suitable for processing 5 to 50 tons of waste per day, depending
on owner/user preference. The semi-portable units will be
capable of operating indoors or outdoors, depending on certain
criteria, and may be as sophisticated or as basic in design and
function as the owner/user requires. The SMART system will be
delivered to each jobsite in a number of pre-assembled,
pre-tested components, and will include a license to use the
HTLC technology. Our target market is users who seek to address
waste problems on a smaller scale than would be addressed by a
large processing facility. Our plan contemplates that purchasers
of the SMART units would receive tip fees for accepting waste
and would sell fertilizer and soil amendment products in the
markets where their units operate. We plan to market and sell
the SMART units in both the United States and abroad.
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Conversion
Process
We use two processes in our Woodbridge facility to convert food
waste into our solid and liquid fertilizer products. The first
is based on technology called Enhanced Autothermal Thermophilic
Aerobic Digestion, or EATAD. The EATAD process was developed by
International Bio-Recovery Corporation, or IBRC, a British
Columbia company that possesses technology in the form of
know-how integral to the process and that has licensed to us
their technology for food waste conversion in the metropolitan
New York and Northern New Jersey areas. In addition, we use our
own HTLC technology. We acquired the proprietary rights to the
HTLC technology when we purchased UOP in 2008 and began to
incorporate it into the operations at our Woodbridge facility.
In simplified terms, both technologies work in a similar fashion
in that once the prepared foodstock is heated to a certain
temperature, it self-generates additional heat (autothermal),
rising to very high, pathogen-destroying temperature levels
(thermophilic). Bacteria added to the feedstock use vast amounts
of oxygen (aerobic) to convert the food waste (digestion) to a
rich blend of nutrients and single cell proteins. Foodstock
preparation, digestion temperature, rate of oxygen addition,
acidity and inoculation of the microbial regime are carefully
controlled to produce products that are highly consistent from
batch to batch.
We use only the HTLC process at our Gonzales facility.
The products we manufacture are as follows:
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A solid base product with plant nutrition, disease suppression
and soil enhancement (amendment) benefits. The solid base
product can then be used by us to produce a variety of products
with various nitrogen (N), phosphorous (P), and potassium
(K) compositions. In describing the composition of
fertilizer, the nitrogen (N), phosphorus (P), and potassium
(K) composition is identified. Presently, we
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produce both an 8-1-4 and a 4-1-8 solid granular product. These
figures refer to the ratio of nitrogen (N), phosphorus (P), and
potassium (K), respectively, in the products.
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A liquid base product with plant nutrition, disease suppression
and soil enhancement (amendment) benefits. The liquid base
product can then be used to produce a variety of products with
various nitrogen, phosphorous and potassium compositions (NPK).
Presently, we produce both a 1-1-1 and
6-0-0 liquid
product.
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We produce a variety of liquid products including: Converted
Organics 521, Converted Organics GP, Converted Organics XP,
Converted Organics XK, Converted Organics LC, Converted Organics
NC, SoilStart 7-1-1, and Aqueous Potash 0-0-10.
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The efficacy of our products has been demonstrated both in
university laboratories and multi-year growth trials funded by
us and by IBRC. These field trials have been conducted on more
than a dozen crops including potatoes, tomatoes, squash,
blueberries, grapes, cotton and turf grass. While these studies
have not been published, peer-reviewed or otherwise subject to
third-party scrutiny, we believe the trials and other data show
our solid and liquid products produced using the EATAD process
have several valuable attributes:
Plant nutrition. Historically, growers have
focused on the nitrogen (N), phosphorous (P) and potassium
(K) content of fertilizers. As agronomists have gained a
better understanding of the importance of soil culture, they
have turned their attention to humic and fulvic acids,
phytohormones and other micronutrients and growth regulators not
present in petrochemical-based fertilizers.
Disease suppression. Based on field trials
using product produced by the licensed technology, we believe
our products combine nutrition with disease suppression
characteristics to eliminate or significantly reduce the need
for fungicides and other crop protection products. The
products disease suppression properties have been observed
under controlled laboratory conditions and in documented field
trials. We also have other field reports that have shown the
liquid concentrate to be effective in reducing the severity of
powdery mildew on grapes, reducing verticillium pressure on
tomatoes and reducing scab in potatoes.
Soil amendment. As a result of its
slow-release nature, our dry fertilizer product increases the
organic content of soil, improving granularity and water
retention and thus reducing NPK leaching and run-off.
Pathogen-free. Due to high processing
temperatures, our products are virtually pathogen-free and have
extended shelf life.
We plan to apply to the U.S. Department of Agriculture, or
the USDA, and various state agencies to have our products
produced by the EATAD process labeled as an organic fertilizer
or separately as an organic fungicide. We expect organic
labeling, if obtained, to have a significant positive impact on
pricing. We believe our products are positioned for the
commercial market as a fertilizer supplement or as a material to
be blended into traditional nutrition and disease suppression
applications.
We use the HTLC system at our Gonzales facility to process food
waste into liquid organic-based fertilizer and feed products.
The HTLC technology used in our Gonzales facility can be used in
all of our future operating plants. We have adopted the HTLC
technology for certain aspects at the Woodbridge facility even
though that facility and any future facility in the New York
City metropolitan area is licensed to use the EATAD technology,
and accordingly, we will be required to pay royalties on sales
from those facilities to the owners of the EATAD technology. As
exclusive owner of the HTLC technology, we expect to achieve the
same or better operating results as we would with the licensed
EATAD technology at a lower operating cost. Pursuant to the
terms of the acquisition of the assets of WRI, we pay a fee for
each ton of additional capacity added to our current or planned
expansion. We anticipate that over time this fee will be less
than the royalty expense paid for use of the licensed EATAD
technology. In addition, we believe the product produced by the
HTLC technology will be equal to or better in terms of quality
than products made through the use of the EATAD technology.
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IBRC
License
Pursuant to a know-how license agreement dated July 15,
2003, as amended, IBRC granted us an exclusive license for a
term of 40 years to use its proprietary EATAD technology
for the design, construction and operation of facilities within
a 31.25 mile radius from City Hall in New York City for the
conversion of food waste into solid and liquid organic material.
The license permits us to use the technology at our Woodbridge
facility site; restricts the ability of IBRC and an affiliated
company, Shearator Corporation, to grant another know-how or
patent license related to the EATAD technology within the
exclusive area; and restricts our ability to advertise or
contract for a supply of food waste originating outside the same
exclusive area. The licensed know-how relates to machinery and
apparatus used in the EATAD process.
We are obligated to pay IBRC an aggregate royalty equal to 9% of
the gross revenues from the sale of product produced by the
Woodbridge facility using EATAD technology. We began paying
royalties in the first half of 2009, as product shipments from
Woodbridge commenced at that time. We are also obligated to
purchase IBRCs patented macerators and shearators, as
specified by or supplied by IBRC or Shearator Corporation for
use at the Woodbridge facility.
In addition, we paid a non-refundable deposit of $139,978 to
IBRC in 2007 on a second plant licensing agreement. To date, we
have not used the second licensing agreement to develop a new
facility. We have also paid IBRC for market research, growth
trails and other services.
Also, pursuant to the license agreement, we have granted a
proposed cooperative called Genica, which has yet to be formed
and of which IBRC will be a member, a right of first refusal to
market all of our products in accordance with the terms and upon
payment to us of the price listed on our then current price
list. If we propose to sell end products to a third party for a
price lower or otherwise on terms more favorable than such
published price and terms, Genica also has a right of first
refusal to market such products on the terms and upon payment to
us of the price proposed to the third party. The license
agreement does not specify the duration of such rights.
Marketing
and Sales
Target
Markets
According to the U.S. Fertilizer Institute, as of June
2007, U.S. fertilizer demand equaled approximately
58 million tons per year, with agribusiness consuming the
majority of product and the professional turf and retail
segments consuming the remainder. The concern of farmers,
gardeners and landscapers about nutrient runoffs, soil health
and other long-term effects of conventional chemical fertilizers
has increased demand for organic fertilizer. We have identified
three target markets for our products:
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Agribusiness: conventional farms, organic
farms, horticulture, hydroponics and aquaculture;
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Turf management: professional lawn care and
landscaping, golf courses, sod farms, commercial, government and
institutional facilities; and
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Retail sales: home improvement outlets, garden
supply stores, nurseries, Internet sales and shopping networks.
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Agribusiness: We believe there are two primary
business drivers influencing commercial agriculture. First,
commercial farmers are focused on improving the economic yield
of their land: maximizing the value derived from crop output
(quantity and quality). Second, commercial farmers are focused
on reducing the use of chemical products, while also meeting the
demand for cost-effective, environmentally responsible
alternatives. We believe this change in focus is the result of:
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Consumer demand for safer, higher quality food;
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The restriction on use of registered chemical products. Several
U.S. government authorities, including the Environmental
Protection Agency, the Food and Drug Administration, and the
USDA regulate the use of fertilizers;
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Environmental concerns and the demand for sustainable
technologies;
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Demand for more food for the growing world population; and
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The cost effectiveness and efficacy of non-chemical based
products to growers.
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Consumer demand for organic food products increased throughout
the 1990s to date at approximately 20% or more per annum. In the
wake of USDAs implementation of national organic standards
in October 2002, the organic food industry has continued to
grow. According to the Organic Trade Association,
United States sales of organic food and beverages
have grown from $1 billion in 1990 to approximately
$20 billion in 2007 and are expected to grow at an average
of 18% per year through 2010. Furthermore, the Organic Trade
Association reports that organic foods represented approximately
2.8% of total food and beverage sales in 2006, growing 20.9% in
2006, one of the fastest growing categories. According to the
Nutrition Business Journal, consumer demand is driving organic
sector expansion, particularly for fruit, vegetables and dairy
products. This demand, in turn, is driving commercial farmers to
shift more of their acreage from conventional practices, which
predominantly use synthetic fertilizers, to organic practices,
which require the use of certified organic fertilizers or other
natural organic materials to facilitate crop growth. The
USDAs Economic Research Service reports that the number of
certified organic farm acres has grown from 0.9 million in
1992 to 4.1 million in 2005, a compound annual growth rate
of 12% per year.
We believe farmers are facing pressures to change from
conventional production practices to more environmentally
friendly practices. U.S. agricultural producers are turning
to certified organic farming methods as a potential way to lower
production costs, decrease reliance on nonrenewable resources
such as chemical fertilizers, increase market share with an
organically grown label and capture premium prices,
thereby boosting farm income.
Turf management: We believe that the more than
16,000 golf courses in the U.S. will continue to reduce
their use of chemicals and chemical-based fertilizers to limit
potentially harmful effects, such as chemical fertilizer runoff.
The United States Golf Association, or USGA, provides guidelines
for effective environmental course management. These guidelines
include using nutrient products and practices that reduce the
potential for contamination of ground and surface water.
Strategies include using slow-release fertilizers and selected
organic products and the application of nutrients through
irrigation systems. Further, the USGA advises that the selection
of chemical control strategies should be utilized only when
other strategies are inadequate. We believe that our
all-natural, slow-release fertilizer products will be well
received in this market.
Retail sales: The Freedonia Groups
report on Lawn & Garden Consumables indicates that the
U.S. market for packaged lawn and garden consumables is
$7.5 billion and is expected to grow 4.5% per year to
$9.3 billion in 2012. Fertilizers are the largest product
category, generating $2.85 billion, or 38%, of total lawn
and garden consumables sales. Fertilizers, mulch and growing
media will lead gains, especially rubber mulch, colored mulch
and premium soils. Organic formulations are expected to
experience more favorable growth than conventional formulations
across all product segments, due to increased consumer concern
with regard to how synthetic chemical fertilizers and pesticides
on lawns and gardens may affect human/pet health and the
environment. Further, in 2009, The National Gardening
Association reported that 40% of the nations
100 million households with a yard say they are likely to
use all-natural methods in the future due largely to
environmental and health concerns.
Product
Sales and Distribution
Our license with IBRC restricts the sale of products from our
Woodbridge facility to the Eastern Seaboard states, including
Maine, New Hampshire, Vermont, Massachusetts, Rhode Island,
Connecticut, New York, New Jersey, Pennsylvania, Delaware,
Maryland, Virginia, District of Columbia, North Carolina, South
Carolina, Georgia and Florida. Our Gonzales facility and future
plants will not be subject to these territory restraints as they
will operate using the HTLC technology that we acquired from WRI.
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We sell and distribute our products through our sales
organization, comprised of six employees and three to four
independent contractors, which targets large purchasers of
fertilizer products for distribution in our target geographic
and product markets. Key activities of the sales organization
include introduction of our products and the development of
relationships with targeted clients and us. In addition, we have
signed distribution agreements with six distributors to sell our
products to numerous outlets in all of our target markets. Due
to our small size, we believe the most efficient method for
distribution of our products is through regional distributors.
This method of distribution currently accounts for the majority
of our sales. To the extent we make sales directly to customers,
we generally require our customers to handle delivery of the
product. We have also had preliminary discussions with
manufacturers representatives to explore sales of our
products in appropriate retail outlets. In order to develop a
consistent sales and distribution strategy, we have hired a
seasoned professional to serve as Vice President of Marketing
and have hired five in-house salespeople to assist with product
pull-through into all of our targeted markets. In addition, with
our acquisition of UOP, we have retained the services of former
UOP employees who are currently selling product into the
agribusiness market.
Environmental
Impact of Our Business Model
Food waste, the raw material of our manufacturing process, comes
from a variety of sources. Prior to preparation, food must be
grown or raised, harvested, packaged, shipped, unpacked, sorted,
selected and repackaged before it finds its way into markets,
restaurants or home kitchens. Currently, this process creates a
large amount of food waste, particularly in densely populated
metropolitan areas such as New York City, Northern New Jersey,
and Eastern Massachusetts. Traditionally, the majority of food
waste is disposed of in either landfills or incinerators that do
not produce a product from this recyclable resource. We use a
demonstrated technology that is environmentally benign to
convert waste into valuable all-natural soil amendment and
fertilizer products.
According to the Environmental Protection Agency Food waste
comprises 18% of the nations waste stream. Disposing of or
recycling food waste should be simple, since organic materials
grow and decompose readily in nature. However, the large volumes
of food wastes generated in urban areas combined with a lack of
available land for traditional recycling methods, such as
composting, make disposal of food wastes increasingly expensive
and difficult. Landfill capacity is a significant concern,
particularly in densely populated areas. In addition, landfills
may create negative environmental effects including liquid
wastes migrating into groundwater, landfill gas, consumption of
open space, and air pollution associated with trucking waste to
more remote sites. The alternative of incineration may produce
toxic air pollutants and climate-changing gases, as well as ash
containing heavy metals. Incineration also fails to recover the
useful materials from organic wastes that can be recycled.
Traditional composting is a slow process that uses large tracts
of land, may generate offensive odors, and may attract vermin.
In addition, composting usually creates an inconsistent product
with lower economic value than the fertilizer products we will
produce.
Our process occurs in enclosed digesters housed
within a building that uses effective emissions control
equipment, which results in minimal amounts of dust and noise.
By turning food waste into a fertilizer product using an
environmentally benign process, we are able to reduce the total
amount of solid waste that goes to landfills and incinerators,
which in turn reduces the release of greenhouse gases such as
methane and carbon dioxide.
During the
start-up
phase at our Woodbridge facility, we experienced odor-related
issues. As a result of these issues, we have been assessed fines
from the Health Department of Middlesex County, New Jersey, and
have been named a party in a lawsuit by a neighboring business.
Based on a change in operational procedures and working with two
outside odor-control consultants, we believe we have
significantly reduced the odor issues. However, if we are
unsuccessful in controlling odor-related issues, we may be
subject to further fines or litigation, and our operations may
be interrupted or terminated.
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The following table summarizes some of the advantages of our
process compared with currently available methods employed to
dispose of food waste:
Comparison
of Methods for Managing Food Waste
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Environmental
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Method
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Impacts
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Products
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Landfilling
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Loss of land
Groundwater threat
Methane gas
Air pollution from trucks
Useful materials not recycled
Undesirable land use
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Landfill gas (minimal energy generation at some landfills)
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Incineration
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Air pollution
Toxic emissions
Useful materials not recycled
Disposal of ash still required
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Electricity (only at some facilities)
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Composting
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Groundwater threat
Odor
Vermin
Substantial land required
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Low value compost
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Converted Organics
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No solid waste
Odor
No harmful by-products
Removal of waste from waste stream
Consumption of electricity and natural gas
Discharge of treated wastewater into sewage system
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Natural fertilizer
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Environmental regulators and other governmental authorities in
our target markets have also focused more recently on the
potential benefits of recycling increased amounts of food waste.
For example, the New Jersey Department of Environmental
Protection, or the NJDEP, estimates nearly 1.5 million
tons, or approximately 7.4% of the states total waste
stream, is food waste, but in 2003, only 221,000 tons were
recycled, which represented just over 15% of the recycled waste.
The 2006 NJDEP Statewide Solid Waste Management Plan focused
particularly on the food waste recycling stream as
one of the most effective ways to create significant increases
in recycling tonnages and rates. In New York, state and local
environmental agencies are taking measures to encourage the
diversion of organic materials from landfills and are actively
seeking processes consistent with health and safety codes. The
goal is to further reduce the amount of waste going to landfills
and other traditional disposal facilities, particularly waste
that is hauled great distances, especially in densely populated
areas in the Northeast. In 2005, the Rhode Island Resource
Recovery Corporation, or the RIRRC, began an examination of the
bulk food waste processing technology of our technology licensor
to determine whether using our licensed technology would be
economically feasible, cost-effective, practicable, and an
appropriate application in Rhode Island. The RIRRC completed its
review and included the technology in its 2006 Solid Waster
Master Plan. In Massachusetts, the 2006 State Solid Waste Master
Plan has also identified a need for increased
organics-processing capacity within the state and has called for
a streamlined regulatory approval path.
Competition
We operate in a very competitive environment in our
businesss three dimensions organic waste
stream feedstock, technology and end products each
of which is quickly evolving. We believe we will be able to
compete effectively because of the abundance of the supply of
food waste in our geographic markets, the pricing of our tip
fees and the quality of our products and technology.
Organic Waste Stream Feedstock. Competition
for the organic waste stream feedstock includes landfills,
incinerators, animal feed, land application and traditional
composting operations. Organic waste streams are generally
categorized as pre- and post-consumer food waste, lawn and
garden waste (sometimes called green
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waste), and bio-solids, including sewage sludge or the
by-product of wastewater treatment. Some states, including New
Jersey, have begun to regulate the manner in which food waste
may be composted. New Jersey has created specific requirements
for treatment in tanks or in-vessel, and we believe our
Woodbridge facility is the first approved in-vessel processing
facility in the state. In Massachusetts, state regulators are
considering a ban on the disposal of organic materials at
landfills and incinerators once sufficient organic processing
capacity exists within the state, which, if adopted, would
provide a competitive advantage for organic processes such as
our process.
Technology. There are a variety of
technologies used to treat organic wastes including composting,
digestion, hydrolysis and thermal processing. Companies using
these technologies may compete with us for organic material.
Composting is a natural process of decomposition that can be
enhanced by mounding the waste into windrows to retain heat,
thereby accelerating decomposition. Large-scale compost
facilities require significant amounts of land for operations
that may not be readily available or that may be only available
at significant cost in major metropolitan areas. Given the
difficulties in controlling the process or the consistent
ability to achieve germ-killing temperatures, the resulting
compost is often inconsistent and generally would command a
lower market price than our product.
Digestion may be either aerobic, like the HTLC or EATAD
processes, or anaerobic. Anaerobic digestion is, in simple
terms, mechanized in-vessel composting. In addition to compost,
most anaerobic digestion systems are designed to capture the
methane generated. While methane has value as a source of
energy, it is generally limited to
on-site use,
as it is not readily transported.
Hydrolysis is an energy-intensive chemical process that produces
a by-product, most commonly ethanol. Thermal technologies
extract the British thermal unit, or BTU, content of the waste
to generate electricity. Food waste, which is typically 75%-90%
water, is generally not a preferred feedstock. Absent
technological breakthroughs, neither hydrolysis nor thermal
technologies are expected to be accepted for food waste
processing on a large-scale in the near term.
End Products. The organic fertilizer business
is relatively new, highly fragmented, under-capitalized and
growing rapidly. We are not aware of any dominant producers or
products currently in the market. There are a number of single
input, protein-based products, such as fish, bone and cottonseed
meal, that can be used alone or mixed with chemical additives to
create highly formulated fertilizer blends that target specific
soil and crop needs. In this sense they are similar to our
products, and provide additional competition in the organic
fertilizer market. In the future, large producers of non-organic
fertilizer may also increase their presence in the organic
fertilizer market. These companies are generally better
capitalized than us and have greater financial and marketing
resources than us.
Most of the 58 million tons of fertilizer consumed annually
in North America is mined or derived from natural gas or
petroleum. These petroleum-based products generally have higher
nutrient content (NPK) and cost less than organic fertilizers.
Traditional petrochemical fertilizers are highly soluble and
readily leach from the soil. Slow release products that are
coated or specially processed command a premium. However, the
economic value offered by petrochemicals, especially for field
crops including corn, wheat, hay and soybeans, will not be
supplanted in the foreseeable future. We compete with large
producers of non-organics fertilizers, many of which are
significantly larger and better capitalized than us. In
addition, we compete with numerous smaller producers of
fertilizer.
Despite a large number of new products in the end market, we
believe that our products have a unique set of characteristics.
We believe positioning and branding the combination of nutrition
and disease suppression characteristics will differentiate our
products from other organic fertilizer products to develop
market demand, while maintaining or increasing pricing. In view
of the barriers to entry created by the supply of food waste,
regulatory controls and the cost of constructing facilities, we
do not foresee a dominant manufacturer or product emerging in
the near-term.
Major
Customers
Our Gonzales and Woodbridge facilities rely on a few major
customers for a majority of their revenues. From January 1,
2009 until August 31, 2009, approximately 71% of the
revenues generated by the Gonzales
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facility were from three customers. From January 1, 2009
until August 31, 2009, approximately 48% of the revenues
generated by the Woodbridge facility, excluding tip fees, were
from two customers. We do not have any long-term agreements with
any of our customers. The loss of any of our major customers
could adversely effect our results of operations.
Government
Regulation
Certain of our fertilizer end products are regulated or
controlled by state, county and local governments as well as
various agencies of the federal government, including the Food
and Drug Administration and the USDA.
In addition to the regulations governing the sale of our end
products, our facilities are subject to extensive regulation. We
need certain permits to operate solid waste or recycling
facilities as well as permits for our sewage connection, water
supply, land use, air emission, and wastewater discharge. The
specific permit and approval requirements are set by the state
and the various local jurisdictions, including but not limited
to city, town, county, and township and state agencies having
control over the specific properties. We have obtained the
permits and approvals required to operate our Woodbridge
facility and Gonzales facility.
Environmental regulations also govern the operation of our
facilities. Our future facilities will most likely be located in
urban industrial areas where contamination may be present.
Regulatory agencies may require us to remediate environmental
conditions at our locations.
We have contracted with a company to explore our ability to
create carbon credits as a result of our manufacturing process
and our diverting food waste from landfills. We have not
determined the value, if any, of the potential carbon credits
associated with our business.
Legal
Proceedings
On December 11, 2008, we received notice that a complaint
had been filed in a putative class action lawsuit on behalf of
59 persons or entities that purchased units pursuant to a
financing terms agreement, or FTA, dated April 11, 2006,
captioned Gerald S. Leeseberg, et al. v. Converted
Organics, Inc., filed in the U.S. District Court for the
District of Delaware. The lawsuit alleges breach of contract,
conversion, unjust enrichment, and breach of the implied
covenant of good faith in connection with the alleged failure to
register certain securities issued in the FTA, and the
redemption of our Class A warrants in November 2008. The
lawsuit seeks damages related to the failure to register certain
securities, including alleged late fee payments, of
approximately $5.25 million, and unspecified damages
related to the redemption of the Class A warrants. In
February 2009, we filed a Motion for Partial Dismissal of
Complaint. On October 7, 2009, the Court concluded that
Leeseberg has properly stated a claim for actual damages
resulting from our alleged breach of contract, but that
Leeseberg has failed to state claims for conversion, unjust
enrichment and breach of the implied covenant of good faith, and
the Court dismissed such claims. We plan to vigorously defend
this matter and are unable to estimate any contingent losses
that may or may not be incurred as a result of this litigation
and its eventual disposition. Accordingly, no contingent loss
has been recorded related to this matter.
On May 19, 2009, we received notice that a complaint had
been filed in the Middlesex County Superior Court of New Jersey,
captioned Lefcourt Associates, Ltd., et al. v. Converted
Organics of Woodbridge, et al. The lawsuit alleges private and
public nuisances, negligence, continuing trespasses and consumer
common-law fraud in connection with the odors emanating from our
Woodbridge facility and our alleged, intentional failure to
disclose to adjacent property owners the possibility of our
facility causing pollution and was later amended to allege
adverse possession, acquiescence and easement. The lawsuit seeks
enjoinment of any and all operations which in any way cause or
contribute to the alleged pollution, compensatory and punitive
damages, counsel fees and costs of suit and any and all other
relief the Court deems equitable and just. In response to these
allegations, we have filed opposition papers with the Court and
have complied with the plaintiffs requests for
information. We have also paid to the Middlesex County Health
Department penalties in the amount of $86,000 relating to odor
emissions. We plan to vigorously defend this matter and are
unable to estimate any contingent losses that may or may not be
incurred as a result of this litigation and its eventual
disposition. Accordingly, no contingent loss has been recorded
related to this matter.
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On May 28, 2009, we received notice that a Lien Claim
Foreclosure Complaint had been filed in the Middlesex County
Superior Court of New Jersey, captioned Armistead Mechanical,
Inc. v. Converted Organics Inc., et al. Armistead filed
this Lien Claim Foreclosure Complaint in order to perfect its
previously filed lien claim. The Complaint also alleges breach
of contract, reasonable value, demand for payment, unjust
enrichment, and breach of the implied covenant of good faith and
fair dealing, and seeks compensatory, consequential and
incidental damages, attorneys fees, costs, interest, and other
fair and equitable relief. In connection with the Complaint,
Armistead also filed a Demand for Arbitration in order to
preserve its status quo and right to submit a contract dispute
claim to binding arbitration. Armistead has indicated to us that
it wishes to continue settlement discussions and has offered to
cooperate with our efforts to secure financing for a mutually
agreeable settlement. We intend to continue working towards an
agreeable settlement with Armistead. On July 10, 2009, we
received an Amended Lien Claim Foreclosure Complaint from
Armistead Mechanical. The amended complaint did not make any
substantial changes to the suit. On August 4, 2009, we
filed a response to the complaint whereby we denied certain
claims and at this time we are unable to estimate any contingent
losses. On August 28, 2009, the court entered an order
staying the litigation pending the outcome of arbitration.
The Middlesex County Health Department (MCHD) issued us a number
of notices of violation, or NOV, following the commencement of
our operations at our Woodbridge facility in February 2009, for
alleged violations of New Jersey State Air Pollution Control
Act, which prohibits certain off-site odors. The NOV alleged
that odors emanating from our Woodbridge facility had impacted
surrounding businesses and those odors were of sufficient
intensity and duration to constitute air pollution under the
act. As of September 3, 2009, the total amount of fines
levied by the Middlesex County Health Department equaled
$356,250, of which we have paid $87,750 (of which $86,000 were
related to odor emissions), and we are either contesting or
negotiating the unpaid balance of $268,500, based on the date of
violation. We recorded a liability of $75,000 in our financial
statements as of June 30, 2009 relating to the unpaid
potion of the penalties. In addition, based on a change in
operational procedures and working with two outside odor-control
consultants, we believe we have significantly rectified the odor
issues.
The NJDEP Bureau of Air Compliance and Enforcement issued us an
Administrative Order in June 2009 for alleged violations of the
air permit issued to us pursuant to the Air Pollution Control
Act. The Administrative Order alleged that we were not operating
in compliance with our air permit and that we had violated the
New Jersey Administrative Code for various pre-constructions
without permits. No penalties were assessed in the
Administrative Order. However, the Administrative Order remains
an open matter because, as the NJDEP stated in the
Administrative Order, the provisions of the order remain in
effect during pendency of the hearing request. Additionally,
while we have taken corrective actions, such actions do not
preclude the State from initiating a future enforcement action
or seeking penalties with respect the violations listed in the
Administrative Order.
The NJDEP Bureau of Solid Waste Compliance and Enforcement
issued us a NOV for alleged violations of the New Jersey State
Solid Waste Management Act in June 2009. The NOV alleged that
our Woodbridge facility was not operating in accordance with the
terms of the General Class C Permit Approval. No penalties
were assessed by the NOV. However, the NOV constituted
notification that the facility is allegedly out of compliance
with certain provisions of the General Class C Permit
and/or the
NJDEP Solid Waste regulations. The NOV remains an open matter
because, as NJDEP stated in the NOV, while we have taken
corrective actions, such actions do not preclude the State from
initiating a future enforcement action with respect the
violations listed in the NOV.
Employees
As of October 1, 2009, we had 31 full-time employees,
13 of whom are in sales, management and administration, seven of
whom work in our Gonzales facility and 11 of whom work in our
Woodbridge facility. Once the Woodbridge facility reaches its
initial design capacity of 250 tons per day, we expect to have
another seven full-time employees at that location, working in
the areas of general plant management, equipment operation,
quality control, maintenance, laborers, and administrative
support. We are also planning for additional employees in the
sales, marketing, finance, technology and administrative areas
of the Company.
46
MANAGEMENT
Executive
Officers and Directors
The following table sets forth information about our executive
officers and members of our board of directors as of
October 1, 2009:
|
|
|
|
|
|
|
Name
|
|
Age
|
|
Position
|
|
Edward J. Gildea
|
|
|
57
|
|
|
President, Chief Executive Officer and Chairman of the Board
|
David R. Allen
|
|
|
54
|
|
|
Chief Financial Officer and Executive Vice-President of
Administration
|
Robert E. Cell(1)(2)(3)
|
|
|
40
|
|
|
Director
|
John P. DeVillars(1)(2)(3)
|
|
|
60
|
|
|
Director
|
Edward A. Stoltenberg(1)(2)(3)
|
|
|
70
|
|
|
Director
|
|
|
|
(1) |
|
Member of the audit committee. |
|
(2) |
|
Member of the compensation committee. |
|
(3) |
|
Member of the nominating committee. |
The following is a brief description of the principal occupation
and recent business experience of each of our directors and
executive officers:
Edward J. Gildea has been our Chairman, President and
Chief Executive Officer since January 2006. From 2001 to 2005,
he held several executive positions including Chief Operating
Officer, Executive Vice President, Strategy and Business
Development, and General Counsel of QualityMetric Incorporated,
a private health status measurement business. During that
period, Mr. Gildea was also engaged in the private practice
of law representing business clients and held management
positions in our predecessor companies. He holds an A.B. degree
from the College of the Holy Cross and a J.D. degree from
Suffolk University Law School. Mr. Gildea is the brother of
William A. Gildea, a former affiliate of the company.
David R. Allen has been our Chief Financial Officer since
March 2007. He was previously a director from June 2006 to March
2007. Until 2004, he was the Chief Executive Officer and the
Chief Financial Officer of Millbrook Press Inc., a publicly held
publisher of childrens books. Millbrook Press Inc. filed
for bankruptcy in the District of Connecticut in February 2004
in a liquidation proceeding in which all creditors were paid in
full. Since 2004, Mr. Allen has acted as a management
consultant and advisor to small public companies. Mr. Allen
holds a B.S. degree and an M.S. degree from Bentley College in
Waltham, Massachusetts. Mr. Allen is a Certified Public
Accountant.
Robert E. Cell has been a director since June 2006. In
2006, he became the President and Chief Executive Officer of
MyBuys.com, a preference-based marketing company. From 2004 to
2005, he was the Chief Executive Officer of Cool Sign Media
Inc., a provider of digital advertising and signage. From 2000
to 2004, he held several executive positions, including Chief
Operating Officer and Chief Financial Officer, at Blue Martini
Software, Inc., a publicly held provider of client relationship
management software applications. Mr. Cell has acted as a
consultant to several public and private companies.
Mr. Cell holds a B.S. degree and an M.B.A. from the
University of Michigan.
John P. DeVillars has been a director since June 2006. He
is a founder and managing partner of BlueWave Strategies LLC, an
environmental and renewable energy consulting firm established
in 2003, and is a managing partner of its affiliated investment
group, BlueWave Capital. He is a director of Clean Harbors Inc.,
a hazardous waste management company. Until 2003,
Mr. DeVillars held the position of Lecturer in
Environmental Policy in the Department of Urban Studies and
Planning at the Massachusetts Institute of Technology.
Mr. DeVillars continues to lecture at MIT, the Harvard
Graduate School of Design and the Kennedy School of Government.
Mr. DeVillars holds a B.A. degree from the University of
Pennsylvania and an M.P.A. from Harvard University.
47
Edward A. Stoltenberg has been a director since March
2007. He is a Managing Director of Phoenix Financial Services,
an investment banking firm which provides financial services to
middle market public and private companies. He has been with
Phoenix since 1999. Mr. Stoltenberg is a Certified Public
Accountant and holds a B.A from Ohio Wesleyan University and an
M.B.A from the University of Michigan.
There are no family relationships among our officers and
directors.
Board
Classifications; Independence
Our Board of Directors is comprised of four members divided into
three classes as nearly equal in number as possible. Currently,
Messrs. Stoltenberg and Cell serve as
Class 1 directors, whose terms expire in 2010,
Mr. DeVillars serves as a Class 2 director, whose
term expires in 2011, and Mr. Edward Gildea serves as a
Class 3 director, whose term expires in 2012.
Our Board of Directors is subject to the independence
requirements of the NASDAQ Stock Market. In March 2009, our
Board of Directors undertook its annual review of director
independence. During this review, the Board considered
transactions and relationships between each director or any
member of his or her immediate family and the company and its
subsidiaries and affiliates. The purpose of this review was to
determine whether any such relationships or transactions existed
that were inconsistent with a determination that the director is
independent. Of the four members of the Board,
Messrs. Cell, DeVillars and Stoltenberg were determined to
be independent directors as defined by the NASDAQ Stock Market.
Our Board of Directors has three standing committees: an Audit
Committee, a Compensation Committee and a Nominating and
Governance Committee.
Audit Committee. Our Audit Committee oversees
our accounting and financial reporting processes, internal
systems of accounting and financial controls, relationships with
independent auditors, and audits of financial statements.
Specific responsibilities include the following:
|
|
|
|
|
appointing, evaluating and terminating our independent auditors;
|
|
|
|
evaluating the qualifications, independence and performance of
our independent auditors;
|
|
|
|
approving the audit and any non-audit services to be performed
by the independent auditors;
|
|
|
|
reviewing the design, implementation, adequacy and effectiveness
of our internal controls and critical accounting policies;
|
|
|
|
overseeing and monitoring the integrity of our financial
statements and our compliance with legal and regulatory
requirements as they relate to financial statements or
accounting matters;
|
|
|
|
with management and our independent auditors, reviewing any
earnings announcements and other public announcements regarding
our results of operations; and
|
|
|
|
|
|
preparing the report that the Securities and Exchange Commission
requires in our annual proxy statement.
|
Our Audit Committee is comprised of Messrs. Stoltenberg,
DeVillars and Cell. Mr. Stoltenberg serves as Chairman of
the Audit Committee. The Board has determined that all members
of the Audit Committee are independent under the rules of the
Securities and Exchange Commission and the NASDAQ Stock Market.
The Board has determined that Mr. Stoltenberg qualifies as
an audit committee financial expert, as defined by
the rules of the Securities and Exchange Commission.
Compensation Committee. Our Compensation
Committee assists our Board of Directors in determining the
development plans and compensation of our officers, directors
and employees. Specific responsibilities include the following:
|
|
|
|
|
approving the compensation and benefits of our executive
officers;
|
|
|
|
reviewing the performance objectives and actual performance of
our officers; and
|
|
|
|
administering our stock option and other equity compensation
plans.
|
48
Our Compensation Committee is comprised of Messrs. Cell,
DeVillars and Stoltenberg. Mr. Cell serves as Chairman of
the Compensation Committee. The Board has determined that all
members of the Compensation Committee are independent under the
rules of the NASDAQ Stock Market.
Nominating and Governance Committee. Our
Nominating and Governance Committee assists the Board by
identifying and recommending individuals qualified to become
members of our Board of Directors, reviewing correspondence from
our stockholders, and establishing, evaluating and overseeing
our corporate governance guidelines. Specific responsibilities
include the following:
|
|
|
|
|
evaluating the composition, size and governance of our Board of
Directors and its committees and making recommendations
regarding future planning and the appointment of directors to
our committees;
|
|
|
|
determining procedures for selection of the CEO and other senior
management; and
|
|
|
|
evaluating and recommending candidates for election to our Board
of Directors.
|
Our Nominating and Governance Committee is comprised of
Messrs. DeVillars, Cell and Stoltenberg. Mr. DeVillars
serves as Chairman of our Nominating and Governance Committee.
The Board has determined that all members of the Nominating and
Governance Committee are independent under the rules of the
NASDAQ Stock Market.
Compensation
Committee Interlocks and Insider Participation
None of the members of our Compensation Committee is an officer
or employee of ours. None of our executive officers currently
serves, or in the past year has served, as a member of the board
of directors or compensation committee of any entity that has
one or more executive officers serving on our Board of Directors
or Compensation Committee.
Director
Compensation
In 2008, our independent directors received options to purchase
an aggregate of 44,000 shares and an aggregate of $69,000
in fees for their service on the Board of Directors, which
included meeting fees of $1,000 per meeting per director.
Directors who are also our employees do not receive compensation
for their services as directors.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fees Earned or
|
|
|
Option
|
|
|
|
|
Name
|
|
Paid in Cash
|
|
|
Awards(1)
|
|
|
Total
|
|
|
Edward A. Stoltenberg(1)
|
|
$
|
25,000
|
|
|
$
|
139,040
|
|
|
$
|
164,040
|
|
Robert Cell
|
|
$
|
20,000
|
|
|
$
|
139,040
|
|
|
$
|
159,040
|
|
John DeVillars
|
|
$
|
24,000
|
|
|
$
|
139,040
|
|
|
$
|
163,040
|
|
|
|
|
(1) |
|
Represents the compensation expense incurred by us in the
respective fiscal year in connection with grants of stock
options. The fair value for the stock options was estimated at
the date of grant using a
Black-Scholes
pricing model with the following assumptions: risk-free interest
rate of 3.52%; no dividend yield; volatility factor of 52.3%;
and an expiration period of five years. The price resulting from
the valuation was $3.16 per share. |
49
EXECUTIVE
COMPENSATION
Summary
Compensation Table
The following table sets forth certain information concerning
total compensation received by our Chief Executive Officer and
Chief Financial Officer (named executive officers)
during 2008 and 2007 for services rendered to us in all
capacities for the last two fiscal years.
Summary
Compensation Table
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Option
|
|
|
|
|
|
|
|
|
|
Salary
|
|
|
Awards
|
|
|
Total
|
|
Name and Principal Position
|
|
Year
|
|
|
($)
|
|
|
($)
|
|
|
($)
|
|
|
Edward J. Gildea,
|
|
|
2008
|
|
|
|
215,260
|
(1)
|
|
|
395,000
|
|
|
|
610,260
|
|
President and Chief Executive Officer
|
|
|
2007
|
|
|
|
208,923
|
(2)
|
|
|
|
|
|
|
208,923
|
|
David Allen,
|
|
|
2008
|
|
|
|
139,523
|
(3)
|
|
|
224,976
|
|
|
|
364,499
|
|
Chief Financial Officer and Executive Vice-President of
Administration
|
|
|
2007
|
|
|
|
72,930
|
(4)
|
|
|
|
|
|
|
72,930
|
|
|
|
|
(1) |
|
Includes $22,000 of unpaid salary from 2007 that was paid in
2008. |
|
(2) |
|
Includes paid salary of $186,923 and unpaid salary of $22,000.
The unpaid salary was paid in January and February 2008. |
|
(3) |
|
Includes $8,580 of unpaid salary from 2007 that was paid in 2008. |
|
|
|
(4) |
|
Includes paid salary of $64,350 and unpaid salary of $8,580. The
unpaid salary was paid in January 2008 and February 2008. |
Outstanding
Equity Awards at Fiscal Year End
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Number of Securities
|
|
|
|
|
|
|
|
|
|
Underlying Unexercised
|
|
|
|
|
|
|
|
|
|
Options
|
|
|
Option Exercise
|
|
|
Option
|
|
Name
|
|
Exercisable
|
|
|
Unexercisable
|
|
|
Price ($ per share)
|
|
|
Expiration Date
|
|
|
Edward J. Gildea
|
|
|
100,000
|
|
|
|
0
|
|
|
$
|
3.75
|
|
|
|
June 15, 2011
|
|
|
|
|
125,000
|
|
|
|
0
|
|
|
$
|
5.02
|
|
|
|
June 27, 2018
|
|
David R. Allen
|
|
|
10,000
|
|
|
|
0
|
|
|
$
|
3.75
|
|
|
|
June 15, 2011
|
|
|
|
|
71,195
|
|
|
|
0
|
|
|
$
|
5.02
|
|
|
|
June 27, 2018
|
|
2006
Stock Option Plan
In June 2006, our Board of Directors and stockholders approved
the 2006 Stock Option Plan, or Option Plan. The Option Plan
authorizes the grant and issuance of options and other equity
compensation to employees, officers and consultants. A total of
1,666,667 shares of common stock are reserved for issuance
under the Option Plan.
The Option Plan is administered by our Compensation Committee.
Subject to the provisions of the Option Plan, the Compensation
Committee determines who will receive the options, the number of
options granted, the manner of exercise and the exercise price
of the options. The term of incentive stock options granted
under the Option Plan may not exceed ten years, or five years
for options granted to an optionee owning more than 10% of our
voting stock. The exercise price of an incentive stock option
granted under the Option Plan must be equal to or greater than
the fair market value of our common stock on the date the option
is granted. The exercise price of a non-qualified option granted
under the Option Plan must be equal to or greater than 85% of
the fair market value of our stock on the date the option is
granted. An incentive stock option granted to an optionee owning
more than 10% of our voting stock must have an exercise price
equal to or greater than 110% of the fair market value of our
common stock on the date the option is granted. Stock options
issued under the option plan vest immediately upon date of grant.
50
At a Special Meeting of Shareholders on April 3, 2008, our
shareholders approved an amendment to the Option Plan to include
an evergreen provision pursuant to which on
January 1st of each year, commencing in 2009, the
number of shares authorized for issuance under the Option Plan
shall automatically be increased to an amount equal to 20% of
our outstanding shares of common stock on the last day of the
prior fiscal year.
Employment
Agreements
Effective as of February 16, 2007, we entered into an
employment agreement with Mr. Gildea to ensure the
continuity of executive leadership, to clarify his roles and
responsibilities, and to make explicit the terms and conditions
of executive employment. Provisions concerning a change of
control, and terms of compensation in that event, are included
in the employment agreement consistent with what our
Compensation Committee believes to be best industry practices.
The change of control provisions in the employment agreement are
designed to ensure that Mr. Gildea devotes his full energy
and attention to the best long-term interests of the
shareholders in the event that business conditions or external
factors make consideration of a change of control appropriate.
Change of Control is defined in the employment
agreement to include: (i) the acquisition of any person or
group (as defined by the Securities Exchange Act of
1934, as amended) of beneficial ownership of 20% of the total
shares or more than 35% of the then-outstanding shares of common
stock, except for acquisitions of stock from us, by us or by
employee benefit plans maintained by us or any of our
affiliates; (ii) individuals who constitute our Board of
Directors cease for any reason to constitute at least a majority
of the Board unless the new members of the Board were nominated
by the existing Board members for other than an election
contest; (iii) consummation of a reorganization, merger,
consolidation or sale or other disposition of all or
substantially all of our assets, unless the transaction merger,
consolidation or sale was initiated or approved by the Board of
Directors; or (iv) approval by our stockholders of a
complete liquidation or dissolution.
The employment agreement with Mr. Gildea for his service as
President and Chief Executive Officer provides for a base salary
of $220,000, which may be increased at the discretion of the
Board. The employment agreement also provides for participation
in the various benefit programs provided by us, including group
life insurance, sick leave and disability, retirement plans and
medical and dental insurance programs to the extent they are
offered by us and to the extent that Mr. Gildea is eligible
to participate in such plans under the terms of such plans.
In the event that Mr. Gildeas employment is
terminated or in the event that Mr. Gildea resigns for
good reason following a Change of Control,
Mr. Gildea is entitled to a lump sum of three years base
salary plus three times his incentive compensation paid in the
preceding 12 months or the incentive compensation
plans target, if any, whichever is greater, plus continued
participation in the insurance benefits for a three-year period.
All stock options granted to Mr. Gildea would immediately
vest and remain exercisable for three months following the date
of termination.
Resignation for good reason under the employment
agreement, means, among other things, the resignation of
Mr. Gildea as a result of (i) without the express
written consent of Mr. Gildea, our materially breach of the
employment agreement which breach is not cured within
30 days following written notice by Mr. Gildea;
(ii) the Board of Directors, without cause, substantially
changing Mr. Gildeas core duties or removing his
responsibility for those core duties, so as to effectively cause
him to no longer be performing the duties of President and CEO;
(iii) the Board of Directors, without cause, placing
another executive above Mr. Gildea or one of the named
officers in the company or requiring Mr. Gildea to be based
in an office that is more than 100 miles from
Mr. Gildeas principal place of employment; or
(iv) a Change of Control. The estimated expense to us of
Mr. Gildeas termination in the event of a Change of
Control as of December 31, 2008 was $660,000. The estimated
expense to us of Mr. Gildeas resignation for good
reason or termination without cause in the absence of a change
in control as of December 31, 2008 was $220,000.
51
PRINCIPAL
STOCKHOLDERS
The following table sets forth information regarding the
beneficial ownership of our outstanding common stock as of
October 1, 2009, and as adjusted to reflect the sale of the
shares of common stock offered by us in this offering (assuming
no exercise of the warrants included in the units), for:
|
|
|
|
|
each person or group of affiliated persons known by us to
beneficially own more than 5% of our common stock;
|
|
|
|
each of our directors;
|
|
|
|
each of our named executive officers; and
|
|
|
|
all of our directors and executive officers as a group.
|
Beneficial ownership is determined in accordance with the rules
of the SEC. In computing the number of shares beneficially owned
by a person and the percentage ownership of that person, shares
of common stock subject to options or warrants held by that
person that are currently exercisable or exercisable within
60 days of October 1, 2009 are deemed outstanding, but
are not deemed outstanding for computing the percentage
ownership of any other person. These rules generally attribute
beneficial ownership of securities to persons who possess sole
or shared voting power or investment power with respect to such
securities. The percentage of ownership is based on
20,494,532 shares of common stock outstanding as of
October 1, 2009.
Except as otherwise indicated below, the persons named in the
table have sole voting and investment power with respect to all
shares of common stock held by them, subject to applicable
community property laws. Unless otherwise indicated, the address
of each stockholder is
c/o Converted
Organics Inc., 7A Commercial Wharf West, Boston, Massachusetts
02110.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Shares Beneficially Owned
|
|
|
Shares Beneficially Owned
|
|
|
|
Prior to this Offering
|
|
|
After this Offering
|
|
Name of Beneficial Owner
|
|
Number
|
|
|
Percent
|
|
|
Number
|
|
|
Percent
|
|
|
Edward J. Gildea
|
|
|
324,911
|
(1)
|
|
|
1.6
|
%
|
|
|
324,911
|
(1)
|
|
|
*
|
|
David R. Allen
|
|
|
85,141
|
(2)
|
|
|
*
|
|
|
|
85,141
|
(2)
|
|
|
*
|
|
Robert E. Cell
|
|
|
54,000
|
(3)
|
|
|
*
|
|
|
|
54,000
|
(3)
|
|
|
*
|
|
John P. DeVillars
|
|
|
54,000
|
(3)
|
|
|
*
|
|
|
|
54,000
|
(3)
|
|
|
*
|
|
Edward A. Stoltenberg
|
|
|
63,269
|
(4)
|
|
|
*
|
|
|
|
63,269
|
(4)
|
|
|
*
|
|
All directors and officers as a group (five persons)
|
|
|
581,321
|
|
|
|
2.8
|
%
|
|
|
581,321
|
|
|
|
1.7
|
%
|
5% Stockholders
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Oppenheimer Funds, Inc.(5)
|
|
|
2,284,409
|
|
|
|
10.0
|
%
|
|
|
2,284,409
|
|
|
|
6.5
|
%
|
Oppenheimer Rochester National Municipals(5)
|
|
|
1,631,721
|
|
|
|
7.4
|
%
|
|
|
1,631,721
|
|
|
|
4.7
|
%
|
|
|
|
* |
|
Less than 1%. |
|
(1) |
|
Includes 1,400 Class B Warrants and options to purchase
225,000 shares. |
|
(2) |
|
Includes options to purchase 81,195 shares. |
|
(3) |
|
Consists of options to purchase shares of our common stock. |
|
(4) |
|
Includes options to purchase 44,000 shares. Includes
2,966 shares beneficially owned and held in trust. |
|
(5) |
|
The following information is based on the Schedule 13G/A
filed May 4, 2009. Oppenheimer Funds, Inc. is an investment
adviser in accordance with
Rule 13d-1(b)(1)(ii)(E)
of the Securities Exchange Act of 1934, as amended, or the
Exchange Act. Oppenheimer Rochester National Municipals is an
investment company registered under section 8 of the
Investment Company Act of 1940. All beneficial ownership is
disclaimed pursuant to
Rule 13d-4
of the Exchange Act). All positions reported reflect the
exercise of warrants for shares of common stock. The principal
address of Oppenheimer Funds, Inc. is Two World Financial
Center, 225 Liberty Street, New York, NY 10289. The principal
address of Oppenheimer Rochester National Municipals is
6803 S. Tucson Way, Centennial, CO 80112. Oppenheimer
Funds, Inc.s amount of beneficial ownership includes the
ownership reported Oppenheimer Rochester National Municipals. |
52
RELATED
PARTY TRANSACTIONS
As payment for compensation accrued and not paid since
April 1, 2006 and expenses incurred but not reimbursed
since April 1, 2006, we intend to pay in the future, out of
available cash, a total of $250,000 to the following current and
former executive officers, directors and consultants, each of
whom will receive $50,000: Edward J. Gildea, Thomas R. Buchanan,
John A. Walsdorf, William A. Gildea and John E. Tucker.
We paid Mr. William A. Gildea, who was a 5% stockholder
during 2007 and 2008 and is the brother of our President and
CEO, for his services in connection with development efforts in
New Jersey, New York and Rhode Island as well as his services in
connection with the sale of our common stock. Mr. Gildea
was paid $155,000 in 2007 and $180,000 in 2008.
We paid Mr. John E. Tucker, who was a 5% stockholder during
2007 and 2008, and his company, BioVentures LLC, for its
services in connection with the design and development work for
our manufacturing facility in Woodbridge, New Jersey.
BioVentures LLC was paid $76,669 in 2007 and $60,000 in 2008.
We have a term note payable to our CEO, Mr. Edward J.
Gildea. The unsecured term note for $89,170 is dated
April 30, 2007 with an original maturity of April 30,
2009, and accrues interest at 12% per annum. The note has been
extended for one year until April 30, 2010. We paid accrued
interest of $21,400 upon extension of the notes due date.
This note is subordinate to the New Jersey Economic Development
Authority Bonds.
We believe the transactions described above were made on terms
at least as favorable as those generally available from
unaffiliated third parties. The transactions have been ratified
by a majority of the members of our Board of Directors who are
independent directors. Future transactions with our officers,
directors or greater than five percent stockholders will be on
terms no less favorable to us than could be obtained from
unaffiliated third parties, and all such transactions will be
reviewed and subject to approval by our Audit Committee, which
will have access, at our expense, to our or independent legal
counsel.
53
UNDERWRITING
We and the underwriters named below have entered into an
underwriting agreement with respect to the units being offered.
Subject to certain conditions, each underwriter is severally
committed to purchase all of the units offered hereby in the
respective amounts indicated in the following table, other than
those units covered by the over-allotment option described
below. Chardan Capital Markets, LLC is the representative of the
underwriters.
|
|
|
|
|
Number of
|
Underwriters
|
|
Units
|
|
Chardan Capital Markets, LLC
|
|
13,500,000
|
Paulson Investment Company, Inc.
|
|
1,500,000
|
Units sold by the underwriters to the public will initially be
offered at the public offering price set forth on the cover of
this prospectus. Any units sold by the underwriters to
securities dealers may be sold at a discount of up to $0.0636
per unit from the public offering price. If all the units are
not sold at the public offering price, the underwriters may
change the offering price and the other selling terms.
We have granted to the underwriters an over-allotment option to
purchase up to 2,250,000 additional units from us at the
same price to the public, less underwriting discounts. The
underwriters may exercise this option any time during the
45-day
period after the date of this prospectus, but only to cover
over-allotments, if any. We have also agreed to pay the
underwriters a non-accountable expense allowance equal to 2.5%
of the gross proceeds of this offering (not including proceeds
from the over-allotment option exercise), which shall include
payment for fees and expenses of underwriters counsel.
We have agreed to sell to the representative of the
underwriters, for $100, an option to purchase up to a total of
300,000 units (2% of the units sold). The units issuable upon
exercise of this option are identical to those offered by this
prospectus. This option is exercisable at $1.749 per unit (165%
of the price of the units sold in the offering), commencing on a
date which is one year from the effective date of the
registration statement and expiring five years from the
effective date of the registration statement. Further, in
accordance with the Financial Industry Regulatory Authority,
Inc. (FINRA) Rule 5110(g)(l), the option will
not be sold during this offering, nor will the representative of
the underwriters be able to sell, transfer or assign the option
for a period of one year immediately following the
effective date of the registration statement.
We estimate that the total fees and expenses payable by us,
excluding underwriting discounts and commissions, will be
approximately $312,400. The following table shows the
underwriting fees to be paid to the underwriters by us in
connection with this offering. These amounts are shown assuming
both no exercise and full exercise of the underwriters
over-allotment option.
|
|
|
|
|
|
|
No Exercise
|
|
Full Exercise
|
|
Per share paid by us
|
|
$0.0636
|
|
$0.0636
|
Total
|
|
$954,000
|
|
$1,097,100
|
We have agreed to indemnify the underwriters against certain
liabilities, including civil liabilities under the Securities
Act, or to contribute to payments that the underwriters may be
required to make in respect of those liabilities.
We and each of our directors and executive officers have agreed
to certain restrictions on the ability to sell additional shares
of our common stock for a period ending 180 days after the
date of this prospectus, subject to extension as described
below. We and they have agreed not to directly or indirectly
offer for sale, sell, contract to sell, grant any option for the
sale of, or otherwise issue or dispose of, any shares of common
stock, options or warrants to acquire shares of common stock, or
any related security or instrument, without the prior written
consent of Chardan Capital Markets, LLC on behalf of the
underwriters, subject to certain exceptions.
The lock-up
period described in the preceding paragraph will be extended if
(1) during the last 17 days of the
lock-up
period we issue an earnings release or material news or a
material event relating to us occurs or (2) prior to the
expiration of the lock-up period we announce that we will
release earnings results during the
54
16-day period beginning on the last day of the lock-up period,
in which case the
lock-up
period will be extended until the expiration of the
18-day
period beginning on the date of issuance of the earnings release
or the occurrence of the material news or material event.
To facilitate the offering, the underwriters may engage in
transactions that stabilize, maintain or otherwise affect the
price of our common stock during and after the offering.
Specifically, the underwriters may over-allot or otherwise
create a short position in the common stock for their own
account by selling more shares of common stock than have been
sold to them by us. Short sales involve the sale by the
underwriters of a greater number of shares than they are
required to purchase in this offering. Covered short
sales are sales made in an amount not greater than the
underwriters over-allotment option to purchase additional
shares in this offering. The underwriters may close out any
covered short position by either exercising their option to
purchase additional shares or purchasing shares in the open
market. In determining the source of shares to close out the
covered short position, the underwriters will consider, among
other things, the price of shares available for purchase in the
open market as compared to the price at which they may purchase
shares through the over-allotment option. Naked
short sales are sales in excess of this option. The underwriters
must close out any naked short position by purchasing shares in
the open market. A naked short position is more likely to be
created if the underwriters are concerned that there may be
downward pressure on the price of the common stock in the open
market after pricing that could adversely affect investors who
purchase in this offering.
In addition, the underwriters may stabilize or maintain the
price of the common stock by bidding for or purchasing shares of
common stock in the open market and may impose penalty bids. If
penalty bids are imposed, selling concessions allowed to
syndicate members or other broker dealers participating in the
offering are reclaimed if shares of common stock previously
distributed in the offering are repurchased, whether in
connection with stabilization transactions or otherwise. The
effect of these transactions may be to stabilize or maintain the
market price of the common stock at a level above that which
might otherwise prevail in the open market. The imposition of a
penalty bid may also effect the price of the common stock to the
extent that it discourages resales of the common stock. The
magnitude or effect of any stabilization or other transactions
is uncertain. These transactions may be effected on The NASDAQ
Capital Market or otherwise and, if commenced, may be
discontinued at any time.
As placement agent for our May 7, 2009 issuance and sale of
notes in the aggregate principal amount of $1,330,313 and an
aggregate of 1,100,000 warrants to certain investors, the
representative of the underwriters received warrants to purchase
135,000 shares of our common stock, exercisable at $1.00 per
share, and warrants to purchase 65,000 shares of our common
stock, initially exercisable at $1.50 per share and
currently exercisable at $1.02 per share. Such
underwriters warrants could not be exercised for 180 days
from issuance, and the warrants to purchase 110,000 shares of
our common stock currently held by the underwriters are locked
up for an additional 180 days from the effective date of this
offering. During such lock-up period, the underwriters
warrants cannot be exercised, transferred, sold, assigned,
pledged or hypothecated, or be the subject of any hedging, short
sale, derivative, put, or call transaction that would result in
the effective economic disposition of such warrants by any
registered holder thereof, all in accordance with FINRA Rule
5110(g)(1).
From time to time in the ordinary course of their respective
business, certain of the underwriters and their affiliates may
also in the future engage in commercial banking or investment
banking transactions with us and our affiliates.
55
DESCRIPTION
OF CAPITAL STOCK
The following information describes our capital stock as well
as certain provisions of our certificate of incorporation and
bylaws. This description is only a summary. You should also
refer to our certificate of incorporation and bylaws, which have
been filed as exhibits to the registration statement of which
this prospectus is a part.
Our authorized capital stock consists of 75,000,000 shares
of common stock, $0.0001 par value per share, and
10,000,000 shares of preferred stock, $0.0001 par
value per share. As of October 1, 2009, we had
20,494,532 shares of common stock and no shares of
preferred stock outstanding.
Units
Each unit consists of one share of common stock and one
Class H warrant. Each Class H warrant entitles the
holder to purchase one share of common stock at an exercise
price of $1.30 per share. The common stock and the Class H
warrants underlying the units may begin to trade separately on
the 45th day after the date of this prospectus, unless the
representative of the underwriters informs us of its decision to
allow earlier separate trading.
Common
Stock
Each outstanding share of common stock has one vote on all
matters requiring a vote of the stockholders. There is no right
to cumulative voting; thus, the holders of 50% or more of the
shares outstanding can, if they choose to do so, elect all of
the directors. In the event of a voluntary or involuntary
liquidation, all stockholders are entitled to a pro rata
distribution after payment of liabilities and after
provision has been made for each class of stock, if any, having
preference over the common stock. The holders of the common
stock have no preemptive rights with respect to future offerings
of shares of common stock.
Dividend
Policy
We have not declared or paid any cash dividends and do not
intend to pay any cash dividends in the foreseeable future. We
intend to retain any future earnings for use in the operation
and expansion of our business. Any future decision to pay cash
dividends on common stock will be at the discretion of our board
of directors and will depend upon our financial condition,
results of operation, capital requirements and other factors our
board of directors may deem relevant. Holders of common stock
are entitled to dividends if, as and when declared by the Board
out of the funds legally available therefor. It is our present
intention to retain earnings, if any, for use in our business.
The payment of cash dividends on the common stock included in
the units is unlikely in the foreseeable future.
Class H
Warrants
Each Class H warrant entitles the holder to purchase one
share of our common stock at a price of
$1.30 per share, subject to adjustment as discussed
below, at any time commencing 60 days after issuance, or on
December 14, 2009. The Class H warrants will expire on
October 14, 2014 at 5:00 p.m., New York City time. The
Class H warrants are not redeemable.
The Class H warrants will be issued in registered form
under a warrant agreement between Computershare Trust Company,
N.A., as warrant agent, and us. You should review a copy of the
warrant agreement, which has been filed as an exhibit to the
registration statement of which this prospectus is a part, for a
complete description of the terms and conditions applicable to
the Class H warrants.
The exercise price and number of shares of common stock issuable
on exercise of the Class H warrants may be adjusted in
certain circumstances including in the event of a stock
dividend, or our recapitalization, reorganization, merger or
consolidation. However, the Class H warrants will not be
adjusted for issuances of common stock, preferred stock or other
securities at a price below their respective exercise prices.
56
The Class H warrants may be exercised upon surrender of the
warrant certificate on or prior to the expiration date at the
offices of the warrant agent, with the exercise form on the
reverse side of the warrant certificate completed and executed
as indicated, accompanied by full payment of the exercise price,
by certified check payable to us, for the number of Class H
warrants being exercised. The Class H warrantholders do not
have the rights or privileges of holders of common stock and any
voting rights until they exercise their Class H warrants
and receive shares of common stock. After the issuance of shares
of common stock upon exercise of the Class H warrants, each
holder will be entitled to one vote for each share held of
record on all matters to be voted on by stockholders.
No Class H warrants will be exercisable unless at the time
of exercise a prospectus relating to common stock issuable upon
exercise of the Class H warrants is current and the common
stock has been registered or qualified or deemed to be exempt
under the securities laws of the state of residence of the
holder of the Class H warrants. We will use our reasonable
efforts to maintain a current prospectus relating to common
stock issuable upon exercise of the Class H warrants until
the expiration of the Class H warrants. However, we cannot
assure you that we will be able to do so. The Class H
warrants may be deprived of any value and the market for the
Class H warrants may be limited if the prospectus relating
to the common stock issuable upon the exercise of the
Class H warrants is not current or if the common stock is
not qualified or exempt from qualification in the jurisdictions
in which the holders of the Class H warrants reside.
No fractional shares will be issued upon exercise of the
Class H warrants. Whenever any fraction of a share of
common stock would otherwise be required to be issued or
distributed upon exercise of the Class H warrants, the
actual issuance or distribution made shall reflect a rounding of
such fraction to the nearest whole share (up or down), with
fractions of half of a share or less being rounded down and
fractions in excess of half of a share being rounded up.
Purchase
Option
We have agreed to sell to the representative of the underwriters
an option to purchase up to a total of 300,000 units at a
per-unit
price of $1.749. For a more complete description of the purchase
option, including the terms of the units underlying the option,
see the section of this prospectus entitled
Underwriting.
Other
Warrants
Class B
Warrants
General. We have 4,932,438 Class B
warrants outstanding. The Class B warrants may be exercised
until the expiration date, which is February 13, 2012. Each
Class B warrant entitles the holder to purchase one share
of common stock at an exercise price of $11.00 per share.
Accordingly, holders of the Class B warrants may currently
purchase 1.276 shares of common stock for each warrant
exercised, except for approximately 2.2 million
Class B warrants that are owned by our bond holders, who
may purchase one share of common stock for each warrant
exercised. Accordingly, in the aggregate, holders of the
Class B warrants may currently purchase a total of
6,177,012 shares of our common stock. The warrant exercise
price will be adjusted if specific events, summarized below,
occur. A holder of warrants will not be deemed a holder of the
underlying stock for any purpose until the warrant is exercised.
If at their expiration date the Class B warrants are not
currently exercisable, the expiration date will be extended for
30 days following notice to the holders of the warrants
that the warrants are again exercisable. If we cannot honor the
exercise of Class B warrants and the securities underlying
the warrants are listed on a securities exchange or if there are
three independent market makers for the underlying securities,
we may, but are not required to, settle the warrants for a price
equal to the difference between the closing price of the
underlying securities and the exercise price of the warrants.
Because we are not required to settle the warrants by payment of
cash, and because there is a possibility that warrant holders
will not be able to exercise the warrants when they are
in-the-money
or otherwise, there is a risk that the warrants will never be
settled in shares or payment of cash.
No Redemption. The Class B warrants are
non-redeemable.
57
Exercise. The holders of the Class B
warrants may exercise them only if an appropriate registration
statement is then in effect. To exercise a warrant, the holder
must deliver to our transfer agent the warrant certificate on or
before the expiration date or the redemption date, as
applicable, with the form on the reverse side of the certificate
executed as indicated, accompanied by payment of the full
exercise price for the number of warrants being exercised.
Fractional shares of common stock will not be issued upon
exercise of the warrants.
Class C
Warrants and Class D Warrants
General: In connection with our financing
completed in May 2009, we issued Class C warrants to
purchase an aggregate of 885,000 shares of common stock and
Class D warrants to purchase an aggregate of
415,000 shares of common stock. The Class C warrants
and Class D warrants both expire in May 2014. The initial
exercise prices of the Class C warrants and Class D
warrants were $1.00 per share and $1.50 per share, respectively.
The warrants are subject to anti-dilution rights, which provide
that the exercise price of the warrants shall be reduced if we
make new issuances of our securities, with certain exceptions,
below the warrants exercise prices to the price of such lower
priced issuances. Pursuant to such provision, the exercise price
of the Class D warrants has been reduced to and is
currently at $1.02 per share. The Class C warrants and
Class D warrants are non-redeemable. The warrant holders
are entitled to a cashless exercise option if, at
any time of exercise, there is no effective registration
statement registering, or no current prospectus available for,
the resale of the shares of common stock underlying the
warrants. This option entitles the warrant holders to elect to
receive fewer shares of common stock without paying the cash
exercise price. The number of shares to be issued would be
determined by a formula based on the total number of shares with
respect to which the warrant is being exercised, the volume
weighted average price per share of our common stock on the
trading date immediately prior to the date of exercise and the
applicable exercise price of the warrants.
Fundamental Transactions: If, at any time
while the warrants are outstanding, we (1) effect any
merger or consolidation, (2) effect any sale of all or
substantially all of our assets, (3) are subject to or
complete a tender offer or exchange offer, (4) effect any
reclassification of our common stock or any compulsory share
exchange pursuant to which our common stock is converted into or
exchanged for other securities, cash or property, or
(5) engage in one or more transactions with another party
that results in that party acquiring more than 50% of our
outstanding shares of common stock, each, a Fundamental
Transaction, then the holder shall have the right
thereafter to receive, upon exercise of the warrant, the same
amount and kind of securities, cash or property as it would have
been entitled to receive upon the occurrence of such Fundamental
Transaction if it had been, immediately prior to such
Fundamental Transaction, the holder of the number of shares then
issuable upon exercise of the warrant, and any additional
consideration payable as part of the Fundamental Transaction.
Any successor to us or surviving entity shall assume the
obligations under the warrant.
Class E
Warrants and Class F Warrants
General: In connection with our financings
completed in May 2009 and July 2009, we issued Class E
warrants to purchase an aggregate of 1,500,000 shares of
our common stock and Class F warrants to purchase
585,000 shares of our common stock. The Class E
warrants and Class F warrants expire in May 2014 and July
2014, respectively.
The warrant holders are entitled to a cashless
exercise option if, at any time of exercise, there is no
effective registration statement registering, or no current
prospectus available for, the issuance or resale of the shares
of common stock underlying the warrants. This option entitles
the warrant holders to elect to receive fewer shares of common
stock without paying the cash exercise price. The number of
shares to be issued would be determined by a formula based on
the total number of shares with respect to which the warrant is
being exercised, the volume weighted average price per share of
our common stock on the trading date immediately prior to the
date of exercise and the applicable exercise price of the
warrants.
58
Call Provision: Subject to certain exceptions,
if the volume weighted average price per share of our common
stock for each of five consecutive trading days exceeds $2.10
(subject to adjustment for forward and reverse stock splits,
recapitalizations, stock dividends and the like), then we may,
within one trading day of the end of such period, call for
cancellation of all or any portion of the unexercised warrants
for consideration equal to $.001 per share.
Fundamental Transaction: If, at any time while
the warrants are outstanding, we (1) consolidate or merge
with or into another corporation, (2) sell all or
substantially all of our assets or (3) are subject to or
complete a tender or exchange offer pursuant to which holders of
our common stock are permitted to tender or exchange their
shares for other securities, cash or property, (4) effect
any reclassification of our common stock or any compulsory share
exchange pursuant to which our common stock is converted into or
exchanged for other securities, cash or property, or
(5) engage in one or more transactions with another party
that results in that party acquiring more than 50% of our
outstanding shares of common stock, each, a Fundamental
Transaction, then the holder shall have the right
thereafter to receive, upon exercise of the warrant, the same
amount and kind of securities, cash or property as it would have
been entitled to receive upon the occurrence of such Fundamental
Transaction if it had been, immediately prior to such
Fundamental Transaction, the holder of the number of warrant
shares then issuable upon exercise of the warrant, and any
additional consideration payable as part of the Fundamental
Transaction. Any successor to us or surviving entity shall
assume the obligations under the warrant.
Class G
Warrants
General: In connection with our financing
completed in September 2009, we issued Class G warrants to
purchase an aggregate of 2,500,000 shares of common stock.
The Class G warrants expire in September 2014. The initial
exercise price of the Class G warrants is $1.25 per share.
The warrants are subject to anti-dilution rights, which provide
that the exercise price of the warrants be reduced if we make
new issuances of our securities, with certain exceptions, below
the warrant exercise price to the price of the lower priced
securities; provided that without stockholder approval, the
exercise price may not be reduced below $1.08 per share. The
Class G warrants are non-redeemable. The warrant holders
are entitled to a cashless exercise option if, at
any time of exercise, there is no effective registration
statement registering, or no current prospectus available for,
the resale of the shares of common stock underlying the
warrants. This option entitles the warrant holders to elect to
receive fewer shares of common stock without paying the cash
exercise price. The number of shares to be issued would be
determined by a formula based on the total number of shares with
respect to which the warrant is being exercised, the volume
weighted average price per share of our common stock on the
trading date immediately prior to the date of exercise and the
applicable exercise price of the warrants.
Fundamental Transactions: If, at any time
while the warrants are outstanding, we (1) effect any
merger or consolidation, (2) effect any sale of all or
substantially all of our assets, (3) are subject to or
complete a tender offer or exchange offer, (4) effect any
reclassification of our common stock or any compulsory share
exchange pursuant to which our common stock is converted into or
exchanged for other securities, cash or property, or
(5) engage in one or more transactions with another party
that results in that party acquiring more than 50% of our
outstanding shares of common stock, each, a Fundamental
Transaction, then the holder shall have the right
thereafter to receive, upon exercise of the warrant, the same
amount and kind of securities, cash or property as it would have
been entitled to receive upon the occurrence of such Fundamental
Transaction if it had been, immediately prior to such
Fundamental Transaction, the holder of the number of shares then
issuable upon exercise of the warrant, and any additional
consideration payable as part of the Fundamental Transaction.
Any successor to us or surviving entity shall assume the
obligations under the warrant.
IPO
Underwriters Warrants
In connection with our initial public offering, we issued to the
representative of the underwriters warrants to purchase
131,219 units, consisting of 131,219 shares of our
common stock, 131,219 Class A warrants and 131,219
Class B warrants. The underwriters warrants are
exercisable for units until February 13, 2012. However,
neither the underwriters warrants nor the underlying
securities may be sold, transferred, assigned,
59
pledged or hypothecated, or be the subject of any hedging, short
sale, derivative, put or call transaction that would result in
the effective economic disposition of the securities by any
person, except to any member participating in the offering and
the officers or partners thereof, and only if all securities so
transferred remain subject to the one-year
lock-up
restriction for the remainder of the
lock-up
period. We are obligated to cause a registration statement to
remain effective until the earlier of February 13, 2012 and
the time that all the underwriters warrants have been
exercised, or will file a new registration statement covering
the exercise and resale of these securities. If we cannot honor
the exercise of the underwriters warrants and the
securities underlying the warrants are listed on a securities
exchange or if there are three independent market makers for the
underlying securities, we may, but are not required to, settle
the underwriters warrants for a price equal to the
difference between the closing price of the underlying
securities and the exercise price of the warrants. Because we
are not required to settle the underwriters warrants by
payment of cash, it is possible that the underwriters
warrants will never be settled in shares or payment of cash. The
common stock and public warrants issued to the underwriter upon
exercise of these underwriters warrants will be freely
tradable.
Convertible
Notes
On January 24, 2008, in connection with our acquisition of
the Gonzales facility, we issued a convertible note with a
principal amount of $1,000,000. The note matures on
January 1, 2011, has an interest rate of 7% per annum, is
payable monthly in arrears, and is convertible into our common
stock at the option of the holder at a price equal to the
average closing price of our common stock on the NASDAQ Capital
Market for the five days preceding conversion. As of
October 1, 2009, the note payable had a remaining principal
balance of approximately $373,000.
On September 14, 2009, we entered into a formal agreement
with an institutional investor, wherein we agreed to sell to the
investor, for the sum of $1,400,000, a six-month convertible
original issue discount note with a principal amount of
$1,540,000. The agreement provided that if we raised any debt or
equity financing while the note was outstanding, the first
monies raised must be used to repay the note. The principal
amount of the note is convertible into shares of our common
stock at $1.54 per share. Additionally, in connection with the
note issued, the investor received Class G warrants to
purchase 2,500,000 shares of common stock.
Preferred
Stock
Our Board of Directors is authorized by our Certificate of
Incorporation to establish classes or series of preferred stock
and fix the designation, powers, preferences and rights of the
shares of each such class or series and the qualifications,
limitations or restrictions thereof without any further vote or
action by our stockholders. Any shares of preferred stock so
issued would have priority over our common stock with respect to
dividend or liquidation rights. Any future issuance of preferred
stock may have the effect of delaying, deferring or preventing a
change in our control without further action by our stockholders
and may adversely affect the voting and other rights of the
holders of our common stock. At present we have no plans to
issue any additional shares of preferred stock or to adopt any
new series, preferences or other classification of preferred
stock.
The issuance of shares of preferred stock, or the issuance of
rights to purchase such shares, could be used to discourage an
unsolicited acquisition proposal. For instance, the issuance of
a series of preferred stock might impede a business combination
by including class voting rights that would enable a holder to
block such a transaction. In addition, under certain
circumstances, the issuance of preferred stock could adversely
affect the voting power of holders of our common stock. Although
our Board of Directors is required to make any determination to
issue preferred stock based on its judgment as to the best
interests of our stockholders, our Board could act in a manner
that would discourage an acquisition attempt or other
transaction that some, or a majority, of our stockholders might
believe to be in their best interests or in which such
stockholders might receive a premium for their stock over the
then market price of such stock. Our Board presently does not
intend to seek stockholder approval prior to the issuance of
currently authorized stock, unless otherwise required by law or
applicable stock exchange rules.
60
2006
Stock Option Plan
Our 2006 Stock Option Plan, or the Plan, currently authorizes
the grant of up to 1,666,667 shares, and the Plan provides
an evergreen provision pursuant to which the number
of shares issuable under the Plan will be automatically
increased on January 1 of each year to an amount equal to 20% of
the number of shares of our common stock outstanding on the last
day of the prior fiscal year. Under the Plan, we may issue
restricted stock awards, incentive stock option grants and
non-qualified stock option grants. Employees and, in the case of
nonqualified stock options, directors, consultants or any
affiliate are eligible to receive grants under our Plan. As of
September 4, 2009, there were outstanding options to
purchase 1,248,895 shares under our Plan.
Anti-Takeover
Effects of Certain Provisions of Delaware Law and Our
Certificate of Incorporation and Bylaws
Our Certificate of Incorporation and Bylaws contain a number of
provisions that could make our acquisition by means of a tender
or exchange offer, a proxy contest or otherwise more difficult.
These provisions are summarized below.
Staggered Board. Staggered terms tend to
protect against sudden changes in management and may have the
effect of delaying, deferring or preventing a change in our
control without further action by our stockholders. Our Board of
Directors is divided into three classes, with one class of
directors elected at each years annual stockholder meeting.
Special Meetings. Our Bylaws provide that
special meetings of stockholders can be called by the President,
at the request of a majority of the Board of Directors or at the
written request of holders of at least 50% of the shares
outstanding and entitled to vote.
Undesignated Preferred Stock. The ability to
authorize the issuance of our undesignated preferred stock makes
it possible for our Board of Directors to issue preferred stock
with voting or other rights or preferences that could impede the
success of any attempt to acquire us. The ability to issue
preferred stock may have the effect of deferring hostile
takeovers or delaying changes in our control or management.
Delaware Anti-Takeover Statute. We are subject
to the provisions of Section 203 of the Delaware General
Corporation Law regulating corporate takeovers. In general,
Section 203 prohibits a publicly-held Delaware corporation
from engaging under certain circumstances in a business
combination with an interested stockholder for a period of three
years following the date the person became an interested
stockholder unless:
|
|
|
|
|
Prior to the date of the transaction, the board of directors of
the corporation approved either the business combination or the
transaction which resulted in the stockholder becoming an
interested stockholder.
|
|
|
|
Upon completion of the transaction that resulted in the
stockholder becoming an interested stockholder, the stockholder
owned at least 85% of the voting stock of the corporation
outstanding at the time the transaction commenced, excluding for
purposes of determining the number of shares outstanding
(1) shares owned by persons who are directors and also
officers and (2) shares owned by employee stock plans in
which employee participants do not have the right to determine
confidentially whether shares held subject to the plan will be
tendered in a tender or exchange offer.
|
|
|
|
On or subsequent to the date of the transaction, the business
combination is approved by the board and authorized at an annual
or special meeting of stockholders, and not by written consent,
by the affirmative vote of at least
662/3%
of the outstanding voting stock which is not owned by the
interested stockholder.
|
Generally, a business combination includes a merger, asset or
stock sale, or other transaction resulting in a financial
benefit to the interested stockholder. An interested stockholder
is a person who, together with affiliates and associates, owns
or, within three years prior to the determination of interested
stockholder status, did own 15% or more of a corporations
outstanding voting securities. We expect the existence of this
provision to have an anti-takeover effect with respect to
transactions our Board of Directors does not approve
61
in advance. We also anticipate that Section 203 may also
discourage attempted acquisitions that might result in a premium
over the market price for the shares of common stock held by
stockholders.
The provisions of Delaware law, our Certificate of Incorporation
and our Bylaws could have the effect of discouraging others from
attempting hostile takeovers and, as a consequence, they may
also inhibit temporary fluctuations in the market price of our
common stock that often result from actual or rumored hostile
takeover attempts. These provisions may also have the effect of
preventing changes in our management. It is possible that these
provisions could make it more difficult to accomplish
transactions that stockholders may otherwise deem to be in their
best interests.
Limitation
of Officer and Director Liability
The Delaware General Corporation Law authorizes corporations to
limit or eliminate the personal liability of officers and
directors to corporations and their stockholders for monetary
damages for breach of the officers and directors
fiduciary duty of care. Although the law does not change the
officers and directors duty of care, it enables
corporations to limit available relief in most cases to
equitable remedies such as an injunction. Our certificate of
incorporation limits the liability of officers and directors to
us or our stockholders to the fullest extent permitted by
applicable law. Specifically, our officers and directors will
not be personally liable to us or our stockholders for monetary
damages for breach of an officers or a directors
fiduciary duty as an officer or a director, as applicable,
except for liability:
|
|
|
|
|
for any breach of the officers or directors duty of
loyalty to us or our stockholders;
|
|
|
|
for acts or omissions not in good faith or which involve
intentional misconduct or a knowing violation of law;
|
|
|
|
for unlawful payments of dividends or unlawful stock repurchases
or redemptions as provided in Section 174 of the
DGCL; or
|
|
|
|
for any transaction from which the officer or director derived
an improper personal benefit.
|
Indemnification
To the maximum extent permitted by law, our bylaws provide for
mandatory indemnification of directors and permit
indemnification of our employees and agents against all expense,
liability and loss to which they may become subject or which
they may incur as a result of being or having been our director,
officer, employee or agent. In addition, we must advance or
reimburse directors and officers, and may advance or reimburse
employees and agents, for expenses incurred by them as a result
of indemnifiable claims.
Transfer
Agent, Warrant Agent and Registrar
The transfer agent and registrar for our common stock and
warrant agent for our public warrants is Computershare
Shareholder Services, Inc., and its wholly owned subsidiary,
Computershare Trust Company, N.A., 250 Royall Street,
Canton, Massachusetts 02021.
Listing
Our common stock and Class B warrants are listed on the
NASDAQ Capital Market under the trading symbols COIN
and COINZ, respectively. Our units and Class H
warrants are listed on the NASDAQ Capital Market under the
trading symbols COINU and COINW,
respectively.
62
LEGAL
MATTERS
The validity of the securities offered in this prospectus is
being passed upon for us by Cozen OConnor. Mintz, Levin,
Cohn, Ferris, Glovsky and Popeo, P.C. is acting as counsel
for the underwriters in this offering.
EXPERTS
The consolidated financial statements as of December 31,
2008 and 2007 and for each of the two years then ended, included
in this prospectus have been audited by CCR LLP, an independent
registered public accounting firm, to the extent set forth in
their report appearing herein. Such consolidated financial
statements have been included in the prospectus and elsewhere in
the registration statement in reliance upon the report of CCR
LLP given upon their authority as experts in accounting and
auditing.
WHERE YOU
CAN FIND MORE INFORMATION
We have filed a registration statement on
Form S-1
with the SEC with respect to the units, common stock and
Class H warrants we are offering by this prospectus. This
prospectus does not include all of the information contained in
the registration statement. You should refer to the registration
statement and its exhibits for additional information. Whenever
we make reference in this prospectus to any of our contracts,
agreements or other documents, the references are not
necessarily complete and you should refer to the exhibits
attached to the registration statement for copies of the actual
contract, agreement or other document. We are subject to the
information reporting requirements of the Securities Exchange
Act of 1934, and accordingly we are required to file annual,
quarterly and special reports, proxy statements and other
information with the SEC.
You can read our SEC filings, including the registration
statement, on the Internet at the SECs website at
www.sec.gov. You can also read and copy any document we
file with the SEC at its public reference room at
100 F Street, N.E., Washington, D.C. 20549. You
can also obtain copies of the documents at prescribed rates by
writing to the Public Reference Section of the SEC at
100 F Street, N.E., Washington, D.C. 20549.
Please call the SEC at
1-800-SEC-0330
for further information on the operation of the public reference
room.
63
REPORT OF
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Stockholders and Board of Directors of Converted Organics
Inc.
We have audited the accompanying consolidated balance sheets of
Converted Organics Inc. (the Company) as of
December 31, 2008 and 2007, and the related consolidated
statements of operations, changes in owners equity
(deficit) and cash flows for the years then ended. These
consolidated financial statements are the responsibility of the
Companys management. Our responsibility is to express an
opinion on these consolidated financial statements based on our
audits.
We conducted our audits in accordance with the standards of the
Public Company Accounting Oversight Board (United States). Those
standards require that we plan and perform the audits to obtain
reasonable assurance about whether the consolidated financial
statements are free of material misstatement. The Company is not
required to have, nor were we engaged to perform, an audit of
its internal control over financial reporting. Our audits
included consideration of internal control over financial
reporting as a basis for designing audit procedures that are
appropriate in the circumstances, but not for the purpose of
expressing an opinion on the effectiveness of the Companys
internal control over financial reporting. Accordingly, we
express no such opinion. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the
consolidated financial statements, assessing the accounting
principles used and significant estimates made by management, as
well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the consolidated financial statements referred
to above present fairly, in all material respects, the financial
position of Converted Organics Inc. as of December 31, 2008
and 2007, and the results of their operations and their cash
flows for the years then ended, in conformity with accounting
principles generally accepted in the United States of America.
The accompanying consolidated financial statements have been
prepared assuming that the Company will continue as a going
concern. As shown in the accompanying consolidated financial
statements, the Company has incurred a net loss of approximately
$16.2 million during the year ended December 31, 2008,
has a working capital deficiency as of December 31, 2008
and an accumulated deficit of approximately $26.6 million.
These factors raise substantial doubt about the Companys
ability to continue as a going concern. Managements plans
in regards to these matters are described in Note 2. These
consolidated financial statements do not include any adjustments
that might result from the outcome of this uncertainty.
Glastonbury, Connecticut
March 27, 2009, except for Note 2, as to which the
date is October 14, 2009
F-1
CONVERTED
ORGANICS INC.
|
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
|
December 31,
|
|
|
|
2008
|
|
|
2007
|
|
|
ASSETS
|
CURRENT ASSETS
|
|
|
|
|
|
|
|
|
Cash and cash equivalents
|
|
$
|
3,357,940
|
|
|
$
|
287,867
|
|
Restricted cash
|
|
|
2,547,557
|
|
|
|
2,590,053
|
|
Accounts receivable, net
|
|
|
313,650
|
|
|
|
|
|
Inventories
|
|
|
289,730
|
|
|
|
|
|
Prepaid rent
|
|
|
389,930
|
|
|
|
190,600
|
|
Other prepaid expenses
|
|
|
73,937
|
|
|
|
40,282
|
|
Deposits
|
|
|
141,423
|
|
|
|
|
|
Other receivables
|
|
|
94,250
|
|
|
|
55,450
|
|
Deferred financing and issuance costs, net
|
|
|
22,042
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total current assets
|
|
|
7,230,459
|
|
|
|
3,164,252
|
|
|
|
|
|
|
|
|
|
|
Deposits
|
|
|
912,054
|
|
|
|
554,978
|
|
Restricted cash
|
|
|
60,563
|
|
|
|
12,006,359
|
|
Property and equipment, net
|
|
|
19,725,146
|
|
|
|
|
|
Construction-in-progress
|
|
|
974,900
|
|
|
|
4,947,067
|
|
Capitalized bond costs, net
|
|
|
862,010
|
|
|
|
909,679
|
|
Intangible assets, net
|
|
|
2,852,876
|
|
|
|
585,750
|
|
Deferred financing and issuance costs, net
|
|
|
|
|
|
|
8,642
|
|
|
|
|
|
|
|
|
|
|
Total assets
|
|
$
|
32,618,008
|
|
|
$
|
22,176,727
|
|
|
|
|
|
|
|
|
|
|
|
LIABILITIES AND OWNERS EQUITY (DEFICIT)
|
CURRENT LIABILITIES
|
|
|
|
|
|
|
|
|
Term notes payable current
|
|
$
|
89,170
|
|
|
$
|
375,000
|
|
Accounts payable
|
|
|
3,583,030
|
|
|
|
898,270
|
|
Accrued compensation officers, directors and
consultants
|
|
|
430,748
|
|
|
|
397,781
|
|
Accrued legal and other expenses
|
|
|
164,620
|
|
|
|
199,261
|
|
Accrued interest
|
|
|
601,166
|
|
|
|
630,890
|
|
Convertible notes payable, net of unamortized discount
|
|
|
4,602,660
|
|
|
|
|
|
Mortgage payable, current
|
|
|
3,006
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total current liabilities
|
|
|
9,474,400
|
|
|
|
2,501,202
|
|
|
|
|
|
|
|
|
|
|
Term note payable, net of current portion
|
|
|
|
|
|
|
89,170
|
|
Mortgage payable, net of current portion
|
|
|
245,160
|
|
|
|
|
|
Convertible note payable, net of current portion
|
|
|
351,516
|
|
|
|
|
|
Bonds payable
|
|
|
17,500,000
|
|
|
|
17,500,000
|
|
|
|
|
|
|
|
|
|
|
Total liabilities
|
|
|
27,571,076
|
|
|
|
20,090,372
|
|
|
|
|
|
|
|
|
|
|
COMMITMENTS AND CONTINGENCIES
|
|
|
|
|
|
|
|
|
OWNERS EQUITY (DEFICIT)
|
|
|
|
|
|
|
|
|
Preferred stock, $.0001 par value, authorized
10,000,000 shares; no shares issued and outstanding
|
|
|
|
|
|
|
|
|
Common stock, $.0001 par value, authorized
40,000,000 shares; 7,431,436 and 4,229,898 shares
issued and outstanding at December 31, 2008 and
December 31, 2007
|
|
|
743
|
|
|
|
423
|
|
Additional paid-in capital
|
|
|
31,031,647
|
|
|
|
12,460,357
|
|
Members equity
|
|
|
619,657
|
|
|
|
|
|
Accumulated deficit
|
|
|
(26,605,115
|
)
|
|
|
(10,374,425
|
)
|
|
|
|
|
|
|
|
|
|
Total owners equity
|
|
|
5,046,932
|
|
|
|
2,086,355
|
|
|
|
|
|
|
|
|
|
|
Total liabilities and owners equity
|
|
$
|
32,618,008
|
|
|
$
|
22,176,727
|
|
|
|
|
|
|
|
|
|
|
The accompanying notes are an integral part of these
consolidated financial statements.
F-2
CONVERTED
ORGANICS INC.
|
|
|
|
|
|
|
|
|
|
|
Year Ended
|
|
|
|
December 31,
|
|
|
December 31,
|
|
|
|
2008
|
|
|
2007
|
|
|
Revenues
|
|
$
|
1,547,981
|
|
|
$
|
|
|
Cost of goods sold
|
|
|
1,981,084
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross loss
|
|
|
(433,103
|
)
|
|
|
|
|
Operating expenses
|
|
|
|
|
|
|
|
|
General and administrative expenses
|
|
|
9,309,976
|
|
|
|
3,009,678
|
|
Research and development
|
|
|
375,267
|
|
|
|
648,664
|
|
Amortization of license and intangible assets
|
|
|
263,387
|
|
|
|
16,500
|
|
|
|
|
|
|
|
|
|
|
Loss from operations
|
|
|
(10,381,733
|
)
|
|
|
(3,674,842
|
)
|
|
|
|
|
|
|
|
|
|
Other income/(expenses)
|
|
|
|
|
|
|
|
|
Interest income
|
|
|
290,125
|
|
|
|
824,466
|
|
Other income
|
|
|
146,677
|
|
|
|
|
|
Amortization of capitalized costs
|
|
|
(399,269
|
)
|
|
|
(62,429
|
)
|
Interest expense
|
|
|
(5,834,898
|
)
|
|
|
(1,171,207
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
(5,797,365
|
)
|
|
|
(409,170
|
)
|
|
|
|
|
|
|
|
|
|
Loss before provision for income taxes
|
|
|
(16,179,098
|
)
|
|
|
(4,084,012
|
)
|
Provision for income taxes
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss
|
|
|
(16,179,098
|
)
|
|
|
(4,084,012
|
)
|
|
|
|
|
|
|
|
|
|
Net loss per share, basic and diluted
|
|
$
|
(2.70
|
)
|
|
|
(0.87
|
)
|
|
|
|
|
|
|
|
|
|
Weighted average common shares outstanding
|
|
|
5,985,017
|
|
|
|
4,716,378
|
|
|
|
|
|
|
|
|
|
|
The accompanying notes are an integral part of these
consolidated financial statements.
F-3
CONVERTED
ORGANICS INC.
Years
Ended December 31, 2008 and 2007
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Common Stock
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
|
Shares Issued
|
|
|
|
|
|
Additional
|
|
|
|
|
|
|
|
|
Owners
|
|
|
|
and
|
|
|
|
|
|
Paid-in
|
|
|
Members
|
|
|
Accumulated
|
|
|
Equity
|
|
|
|
Outstanding
|
|
|
Amount
|
|
|
Capital
|
|
|
Equity
|
|
|
Deficit
|
|
|
(Deficit)
|
|
|
Balance, December 31, 2006
|
|
|
1,333,333
|
|
|
$
|
133
|
|
|
$
|
4,113,385
|
|
|
$
|
|
|
|
$
|
(6,290,413
|
)
|
|
$
|
(2,176,895
|
)
|
Issuance of common stock and warrants in connection with the
Companys initial public offering, net of issuance costs of
$1,736,715
|
|
|
1,800,000
|
|
|
|
180
|
|
|
|
8,163,105
|
|
|
|
|
|
|
|
|
|
|
|
8,163,285
|
|
Common stock and warrants issued in connection with bridge units
|
|
|
293,629
|
|
|
|
29
|
|
|
|
(29
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
Common stock issued in connection with extension of bridge
financing
|
|
|
55,640
|
|
|
|
6
|
|
|
|
178,042
|
|
|
|
|
|
|
|
|
|
|
|
178,048
|
|
Issuance of stock options
|
|
|
|
|
|
|
|
|
|
|
5,929
|
|
|
|
|
|
|
|
|
|
|
|
5,929
|
|
Stock dividends
|
|
|
747,296
|
|
|
|
75
|
|
|
|
(75
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(4,084,012
|
)
|
|
|
(4,084,012
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, December 31, 2007
|
|
|
4,229,898
|
|
|
|
423
|
|
|
|
12,460,357
|
|
|
|
|
|
|
|
(10,374,425
|
)
|
|
|
2,086,355
|
|
Consolidation of variable interest entity
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
23,965
|
|
|
|
|
|
|
|
23,965
|
|
Common stock issued upon exercise of warrants
|
|
|
1,780,506
|
|
|
|
178
|
|
|
|
11,435,476
|
|
|
|
|
|
|
|
|
|
|
|
11,435,654
|
|
Common stock issued upon exercise of options
|
|
|
143,000
|
|
|
|
14
|
|
|
|
536,236
|
|
|
|
|
|
|
|
|
|
|
|
536,250
|
|
Common stock issued for services rendered
|
|
|
45,480
|
|
|
|
5
|
|
|
|
212,614
|
|
|
|
|
|
|
|
|
|
|
|
212,619
|
|
Warrants issued in connection with financings, net of
cancellations
|
|
|
|
|
|
|
|
|
|
|
1,113,750
|
|
|
|
|
|
|
|
|
|
|
|
1,113,750
|
|
Beneficial conversion features on convertible notes
|
|
|
|
|
|
|
|
|
|
|
2,943,386
|
|
|
|
|
|
|
|
|
|
|
|
2,943,386
|
|
Stock dividends
|
|
|
1,232,552
|
|
|
|
123
|
|
|
|
(123
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
Issuance of stock options
|
|
|
|
|
|
|
|
|
|
|
2,329,951
|
|
|
|
|
|
|
|
|
|
|
|
2,329,951
|
|
Members contributions
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
544,100
|
|
|
|
|
|
|
|
544,100
|
|
Net income (loss)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
51,592
|
|
|
|
(16,230,690
|
)
|
|
|
(16,179,098
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, December 31, 2008
|
|
|
7,431,436
|
|
|
$
|
743
|
|
|
$
|
31,031,647
|
|
|
$
|
619,657
|
|
|
$
|
(26,605,115
|
)
|
|
$
|
5,046,932
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The accompanying notes are an integral part of these
consolidated financial statements.
F-4
CONVERTED
ORGANICS INC.
|
|
|
|
|
|
|
|
|
|
|
Years Ended
|
|
|
|
December 31,
|
|
|
December 31,
|
|
|
|
2008
|
|
|
2007
|
|
|
CASH FLOWS FROM OPERATING ACTIVITIES:
|
|
|
|
|
|
|
|
|
Net loss
|
|
$
|
(16,179,098
|
)
|
|
$
|
(4,084,012
|
)
|
Adjustments to reconcile net loss to net cash used in operating
activities:
|
|
|
|
|
|
|
|
|
Consolidation of variable interest entity
|
|
|
6,164
|
|
|
|
|
|
Amortization of intangible asset license
|
|
|
16,500
|
|
|
|
16,500
|
|
Amortization of other intangible assets
|
|
|
246,887
|
|
|
|
|
|
Amortization of capitalized bond costs
|
|
|
47,669
|
|
|
|
43,696
|
|
Amortization of deferred financing fees
|
|
|
331,600
|
|
|
|
18,733
|
|
Depreciation and amortization of property and equipment
|
|
|
411,843
|
|
|
|
|
|
Amortization of beneficial conversion features
|
|
|
2,712,009
|
|
|
|
|
|
Amortization of discounts on private financing
|
|
|
1,563,750
|
|
|
|
|
|
Stock option compensation expense
|
|
|
2,329,951
|
|
|
|
5,929
|
|
Stock issued for services rendered
|
|
|
212,619
|
|
|
|
|
|
Forgiveness of debt and accrued interest
|
|
|
(146,677
|
)
|
|
|
|
|
Loss on sale of fixed asset
|
|
|
176
|
|
|
|
|
|
Stock issued for extension of bridge financing
|
|
|
|
|
|
|
178,048
|
|
Changes in operating assets and liabilities:
|
|
|
|
|
|
|
|
|
(Increase) decrease in:
|
|
|
|
|
|
|
|
|
Accounts receivable
|
|
|
(284,948
|
)
|
|
|
|
|
Inventories
|
|
|
(278,616
|
)
|
|
|
|
|
Prepaid expenses and other current assets
|
|
|
(242,983
|
)
|
|
|
(144,329
|
)
|
Other assets
|
|
|
(38,800
|
)
|
|
|
|
|
Deposits
|
|
|
(507,500
|
)
|
|
|
(350,000
|
)
|
Increase (decrease) in:
|
|
|
|
|
|
|
|
|
Accounts payable and other accrued expenses
|
|
|
2,425,206
|
|
|
|
71,191
|
|
Accrued compensation officers, directors and
consultants
|
|
|
32,967
|
|
|
|
97,781
|
|
Accrued interest
|
|
|
(8,048
|
)
|
|
|
488,271
|
|
Other
|
|
|
25,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash used in operating activities
|
|
|
(7,324,329
|
)
|
|
|
(3,658,192
|
)
|
|
|
|
|
|
|
|
|
|
CASH FLOWS FROM INVESTING ACTIVITIES
|
|
|
|
|
|
|
|
|
Release of restricted cash
|
|
|
11,988,292
|
|
|
|
6,050,199
|
|
Cash paid for acquisitions
|
|
|
(1,500,000
|
)
|
|
|
|
|
Purchase of property and equipment
|
|
|
(14,233,823
|
)
|
|
|
|
|
Proceeds from sale of fixed assets
|
|
|
24,000
|
|
|
|
|
|
Capitalized interest
|
|
|
(72,438
|
)
|
|
|
(403,572
|
)
|
Construction costs
|
|
|
(902,462
|
)
|
|
|
(4,543,495
|
)
|
Restrictions of cash
|
|
|
|
|
|
|
(20,646,611
|
)
|
Deposit on license
|
|
|
|
|
|
|
(139,978
|
)
|
|
|
|
|
|
|
|
|
|
Net cash used in investing activities
|
|
|
(4,696,431
|
)
|
|
|
(19,683,457
|
)
|
|
|
|
|
|
|
|
|
|
CASH FLOWS FROM FINANCING ACTIVITIES
|
|
|
|
|
|
|
|
|
Net proceeds from exercise of warrants
|
|
|
11,435,654
|
|
|
|
|
|
Proceeds from private financing, net of original issue discount
|
|
|
3,715,000
|
|
|
|
|
|
Net proceeds from exercise of options
|
|
|
536,250
|
|
|
|
|
|
Members contributions
|
|
|
544,100
|
|
|
|
|
|
Payments made for deferred issuance costs
|
|
|
|
|
|
|
(42,916
|
)
|
Payments made on mortgage payable
|
|
|
(6,124
|
)
|
|
|
|
|
Repayment of term notes issued for acquisition
|
|
|
(814,447
|
)
|
|
|
|
|
Net proceeds from bond financing
|
|
|
|
|
|
|
16,546,625
|
|
Net proceeds from initial public offering of stock
|
|
|
|
|
|
|
8,859,784
|
|
Proceeds from term notes
|
|
|
|
|
|
|
89,170
|
|
Repayment of term notes
|
|
|
(250,000
|
)
|
|
|
(125,000
|
)
|
Repayment of demand notes
|
|
|
(69,600
|
)
|
|
|
(250,000
|
)
|
Repayment of bridge loan
|
|
|
|
|
|
|
(1,515,000
|
)
|
|
|
|
|
|
|
|
|
|
Net cash provided by financing activities
|
|
|
15,090,833
|
|
|
|
23,562,663
|
|
|
|
|
|
|
|
|
|
|
NET INCREASE IN CASH
|
|
|
3,070,073
|
|
|
|
221,014
|
|
CASH AND CASH EQUIVALENTS, beginning of period
|
|
|
287,867
|
|
|
|
66,853
|
|
|
|
|
|
|
|
|
|
|
CASH AND CASH EQUIVALENTS, end of period
|
|
$
|
3,357,940
|
|
|
$
|
287,867
|
|
|
|
|
|
|
|
|
|
|
Supplemental cash flow information:
|
|
|
|
|
|
|
|
|
Cash paid during the period for:
|
|
|
|
|
|
|
|
|
Interest
|
|
$
|
5,864,622
|
|
|
$
|
908,456
|
|
Non-cash financing activities:
|
|
|
|
|
|
|
|
|
Financing costs paid from proceeds of private financing
|
|
$
|
335,000
|
|
|
$
|
|
|
Issuance costs paid from proceeds of initial public offering
|
|
|
|
|
|
|
1,040,216
|
|
Issuance costs paid from proceeds of bond financing
|
|
|
|
|
|
|
953,375
|
|
Beneficial conversion discount on convertible notes
|
|
|
2,943,386
|
|
|
|
|
|
Warrants issued in connection with financing
|
|
|
1,113,750
|
|
|
|
|
|
The accompanying notes are an integral part of these
consolidated financial statements.
F-5
CONVERTED
ORGANICS INC.
|
|
NOTE 1
|
NATURE
OF OPERATIONS
|
Converted Organics Inc. (the Company) uses food and
other waste as a raw material to manufacture, sell and
distribute all-natural soil amendment products combining disease
suppression and nutrition characteristics. The Company
transitioned from a development stage company to an operating
company in the second quarter of 2008 as operations commenced
and the Company has approximately $1.5 million in revenue
for the year ended December 31, 2008. The Companys
revenues come from two sources: tip fees and product sales.
Waste haulers pay the Company tip fees for accepting
food waste generated by food distributors such as grocery
stores, produce docks and fish markets, food processors, and
hospitality venues such as hotels, restaurants, convention
centers and airports. Revenue also comes from the sale of the
Companys fertilizer products. The Companys products
possess a combination of nutritional, disease suppression and
soil amendment characteristics.
Converted Organics of California, LLC, (California)
a California limited liability company and
wholly-owned
subsidiary of the Company, was formed when the Company acquired
the assets of United Organics Products, LLC. The California
plant is located in Gonzales, California, in the Salinas Valley.
California produces approximately 25 tons of organic fertilizer
per day, and sells primarily to the California agricultural
market. The California facility employs a proprietary method
called High Temperature Liquid Composting (HTLC).
The facility is currently being upgraded to expand its capacity
and to enable it to accept larger amounts of food waste from
waste haulers, thereby increasing tip fee revenue.
The Companys second facility, located in Woodbridge, New
Jersey (Woodbridge), is designed to service the New
York-Northern New Jersey metropolitan area. The Company
constructed this facility and it became partially operational in
the second quarter of 2008. Converted Organics of Woodbridge,
LLC, a New Jersey limited liability company and wholly
owned subsidiary of the Company, was formed for the purpose of
owning, constructing and operating the Woodbridge, New Jersey
facility.
Converted Organics of Rhode Island, LLC (Rhode Island), a
Rhode Island limited liability company and subsidiary of the
Company, was formed for the purpose of developing a facility at
the Rhode Island central landfill.
|
|
NOTE 2
|
MANAGEMENTS
PLAN OF OPERATION
|
The Company currently has manufacturing capabilities in its
Woodbridge and Gonzales facilities as a means to generate
revenues and cash, although neither facility is currently
generating positive cash flow from operations. If the remaining
$3.6 million of convertible debentures from the
Companys 2008 Financing is converted into shares of common
stock, the Company believes the release of $2.0 million of
escrowed funds by the holders of the NJEDA bonds (Note 18),
along with the cash from estimated sales from the Woodbridge and
Gonzales facilities will provide enough working capital until
the upgrades to the Woodbridge facility are complete and until
the Company holds a shareholder vote to allow an investor
(Note 18) to purchase $1,500,000 of convertible term
notes assuming they receive such approval and achieve the
$750,000 sales level by May 31, 2009; and provided that the
Company is able to come to agreements with its construction
vendors allowing them to delay payments to such vendors. If the
Company obtains shareholder approval for the purchase of the
convertible term notes but does not achieve positive cash flow
from Woodbridge and Gonzales, the Company will need to seek
additional sources of working capital. If shareholder approval
is received for the issuance of the convertible notes the
Company would have to achieve breakeven sales levels by
July 31, 2009 or the proceeds of the notes would not
provide sufficient working capital for operations and if
shareholder approval is not obtained and breakeven sales levels
are not achieved, the Company will not have sufficient working
capital to operate past May 31, 2009. Based on 2009 sales
as of the date of this report, the Company will need to increase
sales volumes to achieve such break even sales levels, and there
is no assurance that such efforts will be successful.
F-6
CONVERTED
ORGANICS INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
During this period of limited cash availability the company
plans to lower costs in the administrative areas and to
concentrate on production in both Woodbridge and Gonzales. In
addition they will also have to curtail certain production and
sales costs until sales orders begin to increase to the desired
levels; most notably, the Company will have to limit the
production of product to two variations of liquid and dry
product and the desired sales level will have to be derived from
those products.
The Company does not have any commitments for additional equity
or debt funding and there is no assurance that capital in any
form would be available and, if available, on terms and
conditions that are acceptable. Moreover, the Company is not
permitted to borrow any future funds unless they obtain the
consent of the bondholders of the New Jersey Economic
Development Bond. The Company has obtained such consent for
prior financing, but there is no guarantee that they can obtain
such consent in the future.
|
|
NOTE 3
|
SIGNIFICANT
ACCOUNTING POLICIES
|
CONSOLIDATION
The accompanying consolidated financial statements include the
transactions and balances of Converted Organics Inc. and its
subsidiaries, Converted Organics of Woodbridge, LLC, Converted
Organics of California, LLC, and Converted Organics of Rhode
Island, LLC. The transactions and balances of Valley Land
Holdings, LLC, a variable interest entity, have also been
consolidated therein. All intercompany transactions and balances
have been eliminated in consolidation.
DEVELOPMENT
STAGE COMPANY
Until the second quarter of 2008, the Company was a development
stage company as defined by Statement of Financial Accounting
Standards (SFAS) No. 7, Accounting and Reporting
by Development Stage Enterprises, as it had no
principal operations or significant revenue. During the second
quarter of 2008, the Companys California facility was
operating near capacity and recognized revenue from the sale of
its product. Also during the second quarter of 2008, the tip
floor of the New Jersey facility commenced operations and began
to accept food waste on a limited basis. During the second half
of 2008, operations have increased at both facilities, and the
Company is no longer a development stage company.
VARIABLE
INTEREST ENTITY
The consolidated financial statements include Valley Land
Holdings, LLC (VLH), as VLH has been deemed to be a
variable interest entity of the Company as it is the primary
beneficiary of that variable interest entity following the
acquisition of the net assets of United Organic Products, LLC
(Note 4). VLHs assets and liabilities consist
primarily of cash, land and a mortgage note payable on the land
on which the California facility is located. Its operations
consist of rental income on the land from the Company and
related operating expenses. VLHs activities support the
operations of the California facility and do not have sufficient
equity at risk to remain viable without the support of the
Company.
USE OF
ESTIMATES
The preparation of consolidated financial statements in
conformity with accounting principles generally accepted in the
United States of America requires management to make estimates
and assumptions that affect the reported amounts and disclosures
in the consolidated financial statements. Actual results could
differ from those estimates.
CASH
AND CASH EQUIVALENTS
The Company considers financial instruments with an original
maturity date of three months or less from the date of purchase
to be cash equivalents. The Company had cash equivalents of
$534,800 and $0 at
F-7
CONVERTED
ORGANICS INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
December 31, 2008 and December 31, 2007, respectively,
consisting of certificates of deposit. These certificates of
deposit are held by VLH.
RESTRICTED
CASH
As of December 31, 2008 and 2007, the Company had remaining
approximately $2,608,000 and $14,596,000, respectively, of cash
which is restricted under its bond agreement (Note 11).
This cash was raised by the Company in its initial public
offering and bond financing on February 16, 2007 and is set
aside in three separate accounts at December 31, 2008 and
2007, consisting of $34,000 and $10,032,000, respectively, for
the construction of the Woodbridge operating facility; $8,000
and $1,541,000, respectively, for the working capital
requirements of the Woodbridge subsidiary while the facility is
under construction; and $2,566,000 and $3,023,000, respectively,
in reserve for bond principal and interest payments along with a
reserve for lease payments. The Company has classified this
restricted cash as non-current to the extent that such funds are
to be used to acquire non-current assets or are to be used to
service non-current liabilities. Third party trustee approval is
required for disbursement of all restricted funds. Subsequent to
December 31, 2008, $2,000,000 of the restricted cash was
made available to the Company for use other than its restricted
purpose (Note 18).
ACCOUNTS
RECEIVABLE
Accounts receivable represents balances due from customers, net
of applicable reserves for doubtful accounts. In determining the
need for an allowance, objective evidence that a single
receivable is uncollectible, as well as historical collection
patterns for accounts receivable are considered at each balance
sheet date. At December 31, 2008, an allowance for doubtful
accounts of $16,000 has been established against certain
receivables that management has identified as uncollectible. A
charge of $16,000 is reflected in the consolidated statements of
operations for the year ended December 31, 2008. There was
no allowance for doubtful accounts deemed necessary at
December 31, 2007.
INVENTORIES
Inventories are valued at the lower of cost or market, with cost
determined by the first in, first out method. Inventory consists
primarily of raw materials, packaging materials and finished
goods, which consist of soil amendment products. Inventory
balances are presented net of applicable reserves. There were no
inventory reserves at December 31, 2008 and
December 31, 2007.
PREPAID
RENT
The Company has recorded prepaid rent on its consolidated
balance sheets which represents the difference between actual
lease rental payments made as of December 31, 2008 and 2007
and the straight line rent expense recorded in the
Companys consolidated statements of operations for the
years then ended relating to the Companys facilities in
Woodbridge, New Jersey and Gonzales, California.
DEPOSITS
The Company has made deposits totaling $415,000 for its
Woodbridge facility in accordance with the terms of that lease
and has made a deposit of $139,986 for a license at its planned
Rhode Island facility. The Gonzales facility has deposits on
equipment of $346,668. The Company has various security deposits
relating to operating leases of $10,400. These amounts are
recorded as noncurrent assets on the Companys consolidated
balance sheets. The Company also has made deposits on packaging
materials ordered for product to be manufactured in its New
Jersey facility of $141,423, which is recorded as a current
asset on the Companys consolidated balance sheets.
F-8
CONVERTED
ORGANICS INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
CONSTRUCTION-IN-PROGRESS
Construction-in-progress
on the consolidated balance sheets includes amounts incurred for
construction costs, equipment purchases and capitalized interest
costs related to the construction of the Companys
Woodbridge, New Jersey facility, and expansion of its Gonzales,
California plant that have not yet been placed in service.
INTANGIBLE
ASSETS LICENSE AND OTHER INTANGIBLES
The Company accounts for its intangible assets in accordance
with SFAS No. 142, Goodwill and Other
Intangible Assets. SFAS No. 142 requires
that intangible assets with finite lives, such as the
Companys license, be capitalized and amortized over their
respective estimated lives and reviewed for impairment whenever
events or other changes in circumstances indicate that the
carrying amount may not be recoverable.
LONG-LIVED
ASSETS
In accordance with SFAS No. 144, Accounting
for the Impairment or Disposal of Long-Lived Assets,
long-lived assets are reviewed for impairment whenever
events or changes in circumstances indicate that the carrying
amount of an asset may not be recoverable. Such reviews are
based on a comparison of the assets undiscounted cash
flows to the recorded carrying value of the asset. If the
assets recorded carrying value exceeds the sum of the
undiscounted cash flows expected to result from the use and
eventual disposition of the asset, the asset is written down to
its estimated fair value. Impairment charges, if any, are
recorded in the period in which the impairment is determined. No
impairment charges were deemed necessary during the years ended
December 31, 2008 and 2007.
PROPERTY
AND EQUIPMENT
Property and equipment are stated at cost. Depreciation is
computed on the straight-line basis over the estimated useful
lives of 7 to 20 years.
DEFERRED
FINANCING AND ISSUANCE COSTS
In connection with the private financing arrangement of
January 24, 2008, the Company incurred legal and placement
fees of $345,000, $10,000 of which was paid in the year ended
December 31, 2007, and $335,000 of which was paid from the
proceeds of the loan. These fees are being amortized over one
year. Amortization expense totaled $322,958 during the year
ended December 31, 2008 related to these costs.
CAPITALIZED
BOND COSTS
In connection with its $17.5 million bond financing on
February 16, 2007, the Company has capitalized bond
issuance costs of $953,375 and is amortizing these costs over
the life of the bond. Amortization expense of $47,669 and
$43,696 was recorded during the years ended December 31,
2008 and 2007, respectively, related to these bond issuance
costs.
REVENUE
RECOGNITION
In accordance with Staff Accounting Bulletin 104,
Revenue Recognition in Financial Statements,
(SAB 104) revenue is recognized when each
of the following criteria is met:
|
|
|
|
|
Persuasive evidence of a sales arrangement exists;
|
|
|
|
Delivery of the product has occurred;
|
F-9
CONVERTED
ORGANICS INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
|
|
|
|
|
The sales price is fixed or determinable, and:
|
|
|
|
Collectability is reasonably assured.
|
In those cases where all four criteria are not met, the Company
defers recognition of revenue until the period these criteria
are satisfied. Revenue is generally recognized upon shipment.
SHARE
BASED COMPENSATION
The Company accounts for share based compensation in accordance
with Statement of Financial Accounting Standards
(SFAS) No. 123(R), Share-Based
Payment. Under the provisions of
SFAS No. 123(R), share-based compensation issued to
employees is measured at the grant date, based on the fair value
of the award, and is recognized as an expense over the requisite
service period (generally the vesting period of the grant).
Share-based compensation issued to non-employees is measured at
the grant date, based on the fair value of the equity
instruments issued and is recognized as an expense over the
requisite service period.
RESEARCH
AND DEVELOPMENT COSTS
Research and development costs include the costs of engineering,
design, feasibility studies, outside services, personnel and
other costs incurred in development of the Companys
manufacturing facilities. All such costs are charged to expense
as incurred.
INCOME
TAXES
Deferred income taxes are computed in accordance with
SFAS No. 109, Accounting for Income
Taxes and reflect the net tax effects of temporary
differences between the financial reporting carrying amounts of
assets and liabilities for financial reporting and income tax
purposes. The Company establishes a valuation allowance if it
believes that it is more likely than not that some or all of the
deferred tax assets will not be realized (see Note 14).
The Company is subject to U.S. federal income tax as well
as income tax of certain state jurisdictions. The Company has
not been audited by the I.R.S. or any states in connection with
income taxes. The periods from inception through 2008 remain
open to examination by the I.R.S. and state authorities.
On January 1, 2007, the Company adopted the provisions of
FASB interpretation No. 48, Accounting for
Uncertainty in Income Taxes- an interpretation of FASB Statement
No. 109 (FIN No. 48). The
Interpretation contains a two step approach to recognizing and
measuring uncertain tax positions accounted for in accordance
with FASB Statement No. 109. The first step is to evaluate
the tax position for recognition by determining if the weight of
the available evidence indicates that it is more likely than not
that the position will be sustained on audit, including
resolution of related appeals or litigation process, if any. The
second step is to measure the tax benefit as the largest amount
which is more than 50% likely of being realized upon ultimate
settlement. The adoption of FIN No. 48 did not have
any material impact on the Companys consolidated financial
statements.
The Company recognizes interest accrued related to unrecognized
tax benefits in interest expense. Penalties, if incurred, are
recognized as a component of income tax expense.
FAIR
VALUE MEASUREMENTS
The Company has partially implemented SFAS No. 157,
Fair Value Measurements
(SFAS No. 157) for financial assets and
financial liabilities. SFAS No. 157 defines fair
value, establishes a framework for measuring fair value, expands
disclosure about fair value measurements and is effective for
fiscal years beginning after November 15, 2007, except as
it relates to nonrecurring fair value measurements of
F-10
CONVERTED
ORGANICS INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
nonfinancial assets and liabilities. This standard only applies
when other standards require or permit the fair value
measurement of assets and liabilities. It does not increase the
use of fair value measurement. The Company has determined that
none of its financial assets or liabilities are measured at fair
value on a recurring basis therefore the disclosures required by
SFAS No. 157 do not currently apply. With regard to
nonfinancial assets and liabilities which are not recognized or
disclosed at fair value in the Companys financial
statements on a recurring basis (at least annually), the
standard is effective for fiscal years beginning after
November 15, 2008. The major categories of assets and
liabilities that have not been measured and disclosed using
SFAS No. 157 fair value guidance are property and
equipment in certain circumstances and goodwill.
ACCOUNTING
STANDARDS NOT YET ADOPTED
In February 2007, the FASB issued SFAS No. 159,
Fair Value Option for Financial Assets and Financial
Liabilities (SFAS No. 159), which
permits entities to choose to measure many financial assets and
financial liabilities at fair value. Unrealized gains and losses
on items for which the fair value option has been elected would
be reported in earnings. SFAS No. 159 is effective for
financial statements issued for fiscal years beginning after
November 15, 2007. The Company has not elected to measure
any financial assets or liabilities at fair value, and
therefore, the consolidated financial statements were not
affected by adoption of SFAS No. 159.
In December 2007, the FASB issued SFAS No. 160,
Noncontrolling Interests in Consolidated Financial
Statements an amendment of ARB No. 51
(SFAS No. 160). SFAS No. 160
is effective for fiscal years, and interim periods within those
fiscal years, beginning on or after December 15, 2008. The
objective of this Statement is to improve the relevance,
comparability and transparency of the financial information that
a reporting entity provides in its consolidated financial
statements. The Company anticipates that the adoption of
SFAS No. 160 will not have a significant impact on the
consolidated financial statements.
In December 2007, the FASB issued SFAS No. 141R,
Business Combinations (SFAS No. 141R), which
changes how business acquisitions are accounted for.
SFAS No. 141R requires the acquiring entity in a
business combination to recognize all (and only) the assets
acquired and liabilities assumed in the transaction and
establishes the acquisition-date fair value as the measurement
objective for all assets acquired and liabilities assumed in a
business combination. Certain provisions of this standard will,
among other things, impact the determination of acquisition-date
fair value of consideration paid in a business combination
(including contingent consideration); exclude transaction costs
from acquisition accounting; and change accounting practices for
acquired contingencies, acquisition-related restructuring costs,
in-process research and development, indemnification assets and
tax benefits. SFAS No. 141R is effective for business
combinations and adjustments to an acquired entitys
deferred tax asset and liability balances occurring after
December 31, 2008. The Company is currently evaluating the
future impacts and disclosures of this standard.
In March 2008, the FASB issued SFAS No. 161,
Disclosures about Derivative Instruments and Hedging
Activities an amendment of FASB Statement
No. 133 (SFAS No. 161).
SFAS No. 161 requires enhanced disclosures about an
entitys derivative instruments and hedging activities with
a view toward improving the transparency of financial reporting
and is effective for financial statements issued for fiscal
years and interim periods beginning after November 15,
2008, with early application encouraged. SFAS No. 161
encourages, but does not require, comparative disclosures for
earlier periods at initial adoption. The Company anticipates
that the adoption of SFAS No. 161 will not have a
significant impact on the consolidated financial statements.
In April 2008, the FASB issued FASB Staff Position (FSP)
No. FAS 142-3,
Determination of the Useful Life of Intangible Assets.
This FSP amends the factors that should be considered in
developing renewal or extension assumptions used to determine
the useful life of a recognized asset under
SFAS No. 142, Goodwill and Other Intangible Assets
(SFAS No. 142). The objective of this FSP is
to improve the consistency between the useful life of a
recognized intangible asset under SFAS No. 142 and the
period of expected cash flows used to measure the fair value of
the asset under SFAS No. 141R and other accounting
principles generally
F-11
CONVERTED
ORGANICS INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
accepted in the United States of America. This FSP applies to
all intangible assets, whether acquired in a business
combination or otherwise; and shall be effective for financial
statements issued for fiscal years beginning after
December 15, 2008 and interim periods within those fiscal
years and applied prospectively to intangible assets acquired
after the effective date. Early adoption is prohibited. The
Company is currently evaluating this new FSP and anticipates
that it will not have a significant impact on the consolidated
financial statements.
EARNINGS
(LOSS) PER SHARE
Basic earnings (loss) per share (EPS) is computed by
dividing the net income (loss) attributable to the common
stockholders (the numerator) by the weighted average number of
shares of common stock outstanding (the denominator) during the
reporting periods. Diluted income (loss) per share is computed
by increasing the denominator by the weighted average number of
additional shares that could have been outstanding from
securities convertible into common stock, such as stock options
and warrants (using the treasury stock method), and
convertible preferred stock and debt (using the
if-converted method), unless their effect on net
income (loss) per share is antidilutive. Under the
if-converted method, convertible instruments are
assumed to have been converted as of the beginning of the period
or when issued, if later. The effect of computing the
Companys diluted income (loss) per share is antidilutive
and, as such, basic and diluted earnings (loss) per share are
the same for each of the years ended December 31, 2008 and
2007.
PROFIT
SHARING PLAN
In November 2007, the Company instituted a 401(k) plan for its
employees. The plan allows for employees to have a pretax
deduction of up to 15% of pay set aside for retirement. The plan
also allows for a Company match and profit sharing contribution.
As of December 31, 2008 and 2007, the Company has not
provided a match of employee contributions nor did the Company
contribute a profit sharing amount to the plan.
RECLASSIFICATIONS
Certain prior year amounts have been reclassified to conform to
the current year presentation.
SEGMENT
REPORTING
The Company has no reportable segments as defined by
SFAS No. 131, Disclosure about Segments of an
Enterprise and Related Information.
NOTE 4
ACQUISITIONS
On January 24, 2008, the Company acquired the assets,
including the intellectual property, of Waste Recovery
Industries, LLC of Paso Robles, CA. This acquisition allows the
Company to be the exclusive owner of the proprietary technology
and process known as the High Temperature Liquid Composting
system, which processes various biodegradable waste products
into liquid and solid organic-based fertilizer and feed
products. The purchase price of $500,000 was paid with a 7%
short term note that matured on May 1, 2008 and was repaid
on that date. Interest on that note was payable monthly. In
addition, the purchase price provides for future contingent
payments of $5,500 per ton of capacity, when and if additional
tons of waste-processing capacity are added to the
Companys existing current or planned capacity, using the
acquired technology.
In addition, Waste Recovery Industries, LLC had begun discussion
with a third party (prior to the Company acquiring it) to
explore the possibility of building a facility to convert fish
waste into organic fertilizer using the HTLC technology. The
Company has completed those negotiations and has entered into an
agreement with Pacific Choice Seafoods whereby the Company will
be required to pay 50% of the Companys
F-12
CONVERTED
ORGANICS INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
profits (as defined) to the former owner, that are earned from
the facility. The contingent profit-sharing payments under this
agreement will be accounted for as expenses of the appropriate
period, in accordance with
EITF 95-8,
Accounting for Contingent Consideration Paid to the
Shareholders of an Acquired Enterprise in a Purchase Business
Combination. If the Company becomes obligated to make
certain technology payments under its purchase agreement with
WRI, the Company estimated that no such payments will be payable
in the twelve months following the acquisition. Payments, if
any, after that will be expensed as incurred. The maximum
payment due under these arrangements is $7,000,000, with no
minimum.
On January 24, 2008, the Company formed Converted Organics
of California, LLC, a wholly-owned subsidiary of Converted
Organics Inc. who acquired the net assets of United Organic
Products, LLC of Gonzales, CA (UOP). With this
acquisition, the Company acquired a liquid fertilizer product
line, as well as a production facility that services a West
Coast agribusiness customer base through established
distribution channels. This facility is operational and began to
generate revenues for the Company immediately upon acquisition.
The purchase price of $2,500,000 was paid in cash of $1,500,000
and a note payable of $1,000,000. This note matures on
February 1, 2011, has an interest rate of 7%, payable
monthly in arrears and is convertible to common stock six months
after the acquisition date for a price equal to the
five-day
average closing price of the stock on Nasdaq for the five days
preceding conversion.
The acquisitions have been accounted for in the first quarter of
2008 using the purchase method of accounting in accordance with
SFAS No. 141, Business
Combinations. Accordingly, the net assets have been
recorded at their estimated fair values, and operating results
have been included in the Companys consolidated financial
statements from the date of acquisition.
The allocation of the purchase price based on the appraisal is
as follows:
|
|
|
|
|
Inventories
|
|
$
|
11,114
|
|
Accounts receivable
|
|
|
28,702
|
|
Technological know-how
|
|
|
271,812
|
|
Trade name
|
|
|
228,188
|
|
Existing customer relationships
|
|
|
2,030,513
|
|
Building
|
|
|
111,584
|
|
Equipment and machinery
|
|
|
543,000
|
|
Assumption of liabilities
|
|
|
(224,913
|
)
|
|
|
|
|
|
Total allocation of purchase price
|
|
$
|
3,000,000
|
|
|
|
|
|
|
The assets acquired from UOP were valued separately from the
assets acquired from WRI. The sum of the amounts assigned to
assets acquired and liabilities assumed did exceed the cost of
the acquired assets. The excess was allocated as a pro rata
reduction of the amounts that otherwise would have been assigned
to all of the acquired noncurrent assets, including intangibles.
The unaudited supplemental pro forma information discloses the
results of operations for the current year and for the preceding
year as though the business combination had been completed as of
the beginning of the year reported on.
F-13
CONVERTED
ORGANICS INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
The pro forma condensed consolidated financial information is
based upon available information and certain assumptions that
the Company believes are reasonable. The unaudited supplemental
pro forma information does not purport to represent what the
Companys financial condition or results of operations
would actually have been had these transactions in fact occurred
as of the dates indicated above or to project the Companys
results of operations for the period indicated or for any other
period.
|
|
|
|
|
|
|
|
|
|
|
Twelve Months Ending December 31,
|
|
|
|
2008
|
|
|
2007
|
|
|
Revenues (in thousands)
|
|
$
|
1,548
|
|
|
$
|
1,423
|
|
Net loss (in thousands)
|
|
|
16,269
|
|
|
|
(4,889
|
)
|
Net loss per share basic and diluted
|
|
|
(2.72
|
)
|
|
|
(1.04
|
)
|
Current assets (in thousands)
|
|
|
7,230
|
|
|
|
5,410
|
|
Total assets (in thousands)
|
|
|
32,618
|
|
|
|
28,278
|
|
Current liabilities (in thousands)
|
|
|
(9,474
|
)
|
|
|
(7,570
|
)
|
Total liabilities (in thousands)
|
|
|
(27,571
|
)
|
|
|
(25,070
|
)
|
Total equity (deficit) (in thousands)
|
|
|
5,047
|
|
|
|
3,208
|
|
NOTE 5
FAIR VALUE OF FINANCIAL INSTRUMENTS
CONCENTRATIONS
OF CREDIT RISK
The Companys financial instruments that are exposed to a
concentration of credit risk are cash, including restricted
cash, and accounts receivable. Currently, the Company maintains
its cash accounts with balances in excess of the federally
insured limits. The Company mitigates this risk by selecting
high quality financial institutions to hold such cash deposits.
At December 31, 2008 and 2007, the Companys cash
balances on deposit exceeded federal depository insurance limits
by approximately $5,812,000 and $14,500,000.
The Company maintains allowances for doubtful accounts for
estimated losses resulting from the inability of its customers
to make required payments. If the financial condition of the
Companys customers were to deteriorate, resulting in an
impairment of their ability to make such payments, additional
allowances may be required. An increase in allowances for
customer non-payment would increase the Companys expenses
during the period in which such allowances are made. Based upon
the Companys knowledge at December 31, 2008 and 2007,
a reserve for doubtful accounts was recorded of approximately
$16,000 and $0, respectively.
FAIR
VALUE OF FINANCIAL INSTRUMENTS
Statement of Financial Accounting Standards (SFAS) No. 107,
Fair Value of Financial Instruments, requires
disclosure of the fair value of financial instruments for which
the determination of fair value is practicable.
SFAS No. 107 defines the fair value of a financial
instrument as the amount at which the instrument could be
exchanged in a current transaction between willing parties. The
carrying amount of the Companys financial instruments
consisting of cash, accounts receivable, inventories, accounts
payable, and accrued expenses approximate their fair value
because of the short maturity of those instruments. The fair
value of the Companys convertible notes payable, term
notes payable and New Jersey Economic Development Authority
Bonds were estimated by discounting the future cash flows using
current rates offered by lenders for similar borrowings with
similar credit ratings. The fair value of the companys
convertible notes payable is estimated to approximate its
carrying value. The fair value of the term notes payable and the
New Jersey Economic Development Authority bonds approximate
their carrying value. The Companys financial instruments
are held for other than trading purposes.
SFAS No. 157, Fair Value Measurements
(SFAS No. 157), defines fair value as the price
that would be received to sell an asset or paid to transfer a
liability in an orderly transaction between market participants,
as
F-14
CONVERTED
ORGANICS INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
of the measurement date. The standard specifies a hierarchy of
valuation techniques based upon whether the inputs to those
valuation techniques reflect assumptions other market
participants would use based upon market data obtained from
independent sources (also referred to as observable inputs). In
accordance with SFAS No. 157, the following summarizes
the fair value hierarchy:
|
|
|
|
|
Level 1 Quoted prices in active markets
that are unadjusted and accessible at the measurement date for
identical, unrestricted assets or liabilities;
|
|
|
|
Level 2 Quoted prices for identical
assets and liabilities in markets that are not active, quoted
prices for similar assets and liabilities in active markets or
financial instruments for which significant observable inputs
are available, either directly or indirectly such as interest
rates and yield curves that are observable at commonly quoted
intervals; and
|
|
|
|
Level 3 prices or valuations that
require inputs that are unobservable.
|
In certain cases, the inputs used to measure fair value may fall
into different levels of the fair value hierarchy. In such
cases, the level in the fair value hierarchy within which the
fair value measurement in its entirety falls has been determined
based on the lowest level input that is significant to the fair
value measurement in its entirety. The Companys assessment
of the significance of a particular input to the fair value
measurement in its entirety requires judgment, and considers
factors specific to the asset or liability.
The Companys financial assets and liabilities that are
reported at fair value in the accompanying consolidated balance
sheets as of December 31, 2008 were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at
|
|
|
|
|
|
|
|
|
December 31,
|
Assets
|
|
Level 1
|
|
Level 2
|
|
Level 3
|
|
2008
|
|
Certificate of deposit
|
|
$
|
|
|
|
$
|
534,821
|
|
|
|
|
|
|
$
|
534,821
|
|
The Company does not have any fair value measurements using
quoted prices in active markets (Level 1) or
significant unobservable inputs (Level 3) as of
December 31, 2008.
NOTE 6
INVENTORIES
The Companys inventories consisted of the following at
December 31:
|
|
|
|
|
|
|
|
|
|
|
2008
|
|
|
2007
|
|
|
Finished goods
|
|
$
|
214,053
|
|
|
$
|
|
|
Raw materials
|
|
|
18,785
|
|
|
|
|
|
Packaging materials
|
|
|
56,892
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total inventories
|
|
$
|
289,730
|
|
|
$
|
|
|
|
|
|
|
|
|
|
|
|
NOTE 7
CONSTRUCTION-IN-PROGRESS
The Company is currently constructing an operating facility in
Woodbridge, New Jersey. The funds for construction of this plant
came from the issuance of New Jersey Economic Development Bonds
on February 16, 2007 and a condition of this bond offering
was that the Company place in trust approximately
$14 million to be used for plant construction and
associated equipment purchases. As of December 31, 2007,
the Company has incurred approximately $4.9 million in
plant construction costs, equipment purchases and capitalized
interest costs. The Company has recorded those costs as
construction-in-progress
on its consolidated balance sheets as of December 31, 2007.
At the end of the second quarter of 2008, portions of the
Woodbridge facility became operational and certain fixed assets
were placed in service commencing June 30, 2008. During the
remainder of 2008, approximately $19 million in assets were
transferred from
Construction-in-Progress
to Leasehold Improvements and Machinery and equipment accounts
and depreciation commenced on those assets placed in service.
F-15
CONVERTED
ORGANICS INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
NOTE 8
PROPERTY AND EQUIPMENT
The Companys property and equipment at December 31
consisted of the following:
|
|
|
|
|
|
|
|
|
|
|
2008
|
|
|
2007
|
|
|
Land and improvements
|
|
$
|
357,692
|
|
|
$
|
|
|
Building and improvements
|
|
|
5,754,163
|
|
|
|
|
|
Machinery and equipment
|
|
|
13,968,134
|
|
|
|
|
|
Vehicles
|
|
|
42,570
|
|
|
|
|
|
Office equipment and furniture
|
|
|
7,837
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
20,130,396
|
|
|
|
|
|
Less: Accumulated depreciation and amortization
|
|
|
(405,250
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Property and equipment, net
|
|
$
|
19,725,146
|
|
|
$
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation and amortization of property and equipment totaled
$411,843 and $0 for the years ended December 31, 2008 and
2007, respectively.
NOTE 9
DEFERRED AND CAPITALIZED COSTS
DEFERRED
FINANCING AND OFFERING COSTS
In connection with its initial public offering (IPO) on
February 16, 2007, the Company incurred issuance costs
totaling $1,736,715. The Company had previously capitalized
issuance costs, consisting of underwriting, legal and accounting
fees and printing costs cumulatively totaling $696,499 in
anticipation of its initial public offering. The Company also
incurred additional issuance costs of $1,040,216 that was paid
from the proceeds of the initial public offering. The total
issuance costs of $1,736,715 have been netted against the
$9.9 million of gross proceeds of the IPO in the statements
of changes in owners equity (deficit).
In connection with its repayment of the bridge notes, the
Company paid to the bridge lender a Letter of Credit fee of
$27,375. The fee has been recorded as a deferred financing fee
to be amortized over the term of the Letter of Credit. The
Letter of Credit was nullified by the Companys borrowing
of funds from a private investor in January, 2008. Amortization
of these deferred financing fees totaled $8,642 and $18,733 for
the years ended December 31, 2008 and 2007, respectively.
In connection with its private financing in January of 2008, the
Company incurred fees of $345,000 which were capitalized and
which are being amortized over the one year term of the loan.
Amortization expense associated with these fees of $322,958 was
recorded during the year ended December 31, 2008.
CAPITALIZED
BOND COSTS
In connection with its $17.5 million bond financing on
February 16, 2007, the Company has capitalized bond
issuance costs of $953,375 and is amortizing those costs over
the life of the bond. Amortization of capitalized bond issuance
costs totaled $47,669 and $43,696 for the years ended
December 31, 2008 and 2007, respectively.
NOTE 10
INTANGIBLE ASSETS
Pursuant to a license agreement with an effective date of
July 15, 2003 and amended effective February 9, 2006,
by and between the Company and International Bio-Recovery
Corporation (IBRC), the Company entered into an
exclusive license to use IBRCs Enhanced Autogenous
Thermophylic Aerobic Digestion process (EATAD) technology for
the design, construction and operation of facilities for the
conversion of food waste into solid and liquid organic material.
The license is recorded at its acquisition cost of $660,000 less
F-16
CONVERTED
ORGANICS INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
accumulated amortization of $90,750 and $74,250 as of
December 31, 2008 and 2007, respectively. Amortization is
provided using the straight-line method over the life of the
license. Amortization expense for the years ended
December 31, 2008 and 2007 was $16,500 and $16,500,
respectively. The Company expects the licenses annual
amortization expense to be $16,500 until fully amortized at the
end of the 40 year license period.
The Company is obligated to pay IBRC an aggregate royalty equal
to nine percent of the gross revenues from the sale of product
produced by the Woodbridge facility. The Company will begin to
pay royalties during the first quarter of 2009, as product sales
commenced during that quarter. The Company is also obligated to
purchase IBRCs patented macerators and shearators as
specified by or supplied by IBRC or Shearator Corporation for
use at the Woodbridge facility.
In addition, the Company paid a non-refundable deposit of
$139,978 to IBRC in 2007 on a second plant licensing agreement,
which is included in non-current deposits on the Companys
consolidated balance sheets at December 31, 2008 and 2007.
The Company also agreed to pay IBRC approximately $338,000 in
twelve monthly installments for market research, growth trails
and other services. For the year ended December 31, 2008
and 2007, the Company had paid approximately $22,000 and
$276,000, respectively, of this amount which has been included
in research and development in the Companys consolidated
statements of operations. The Company is currently negotiating
the remainder of the payments with IBRC.
The Company identified certain intangible assets as a part of
its valuation performed pursuant to SFAS No. 141,
Business Combinations. The following
intangible assets were identified and values and estimated
useful lives were assigned as follows:
|
|
|
|
|
|
|
|
|
|
|
Assigned
|
|
|
Estimated
|
|
|
|
Value
|
|
|
Useful Life
|
|
|
Existing customer relationships
|
|
$
|
2,030,513
|
|
|
|
8 years
|
|
Technological know-how
|
|
|
271,812
|
|
|
|
8 years
|
|
Trade name
|
|
|
228,188
|
|
|
|
Indefinite
|
|
|
|
|
|
|
|
|
|
|
Intangibles acquired
|
|
$
|
2,530,513
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The consolidated statements of operations include amortization
expense of $246,887 related to these intangible assets for the
year ending December 31, 2008. Accumulated amortization at
December 31, 2008 was $246,887.
NOTE 11
DEBT
TERM
NOTES PAYABLE
The Company had three term notes payable: (1) $250,000
unsecured term note dated August 27, 2004, due
December 31, 2008, with interest at 12%, (2) $125,000
unsecured term note dated September 6, 2005, due
December 31, 2008, with interest at 15%, and
(3) $89,170 unsecured term note dated May 2, 2007 with
a maturity of May 2, 2009 and interest at 12%. On all
notes, interest accrues without payment until maturity. The
agreement on the term loan dated August 27, 2004 required
accrued interest of $89,170 to be paid immediately in order to
refinance and extend the maturity. As the Company was precluded
under the terms of the agreement with the bondholders of the New
Jersey Economic Development Authority Bonds from paying the
accrued interest available funds, the Company borrowed funds to
repay this accrued interest by entering into the May 2,
2007 term loan in the amount of $89,170 with its CEO, Edward J.
Gildea. This note is unsecured and subordinate to the bonds, and
has a two-year term. This interest rate is equal to or less than
interest paid on the Companys other term loans. The
Company obtained the necessary bondholder consents to enter into
this agreement.
F-17
CONVERTED
ORGANICS INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
During December 2008, the balance of the term note dated
August 27, 2004, plus accrued interest of $47,500 was paid
with funds raised through exercise of warrants related to our
common stock. The Company also negotiated the forgiveness of the
balance of the unsecured term note dated September 6, 2005,
plus accrued interest. Total principal and interest forgiven was
$146,677, and this amount is recorded as other income on the
consolidated statements of operations for the year ended
December 31, 2008.
As of December 31, 2008, the total of unpaid accrued
interest on the remaining note is $17,834. Accrued interest on
all notes as of December 31, 2007 was $47,500.
A schedule of outstanding principal amounts of the term notes as
of December 31, 2008 and 2007 is as follows:
|
|
|
|
|
|
|
|
|
|
|
2008
|
|
|
2007
|
|
|
Term note dated August 27, 2004
|
|
$
|
|
|
|
$
|
250,000
|
|
Term note dated September 6, 2005
|
|
|
|
|
|
|
125,000
|
|
Term note dated May 2, 2007
|
|
|
89,170
|
|
|
|
89,170
|
|
|
|
|
|
|
|
|
|
|
|
|
|
89,170
|
|
|
|
464,170
|
|
Less: current portion
|
|
|
89,170
|
|
|
|
(375,000
|
)
|
|
|
|
|
|
|
|
|
|
|
|
$
|
|
|
|
$
|
89,170
|
|
|
|
|
|
|
|
|
|
|
BRIDGE
LOANS PAYABLE
On March 2, 2006, the Company completed a $500,000 bridge
loan (Bridge Loan) from lenders (Bridge
Noteholders) to help meet the Companys working
capital needs. The bridge loan accrued interest at an annual
rate of 8%, which was payable in arrears quarterly, and was
originally due and payable on the earlier of October 16,
2006 or the completion of a public offering of equity securities
(Qualified Public Offering). The bridge loan was
refinanced with an extended maturity date of February 19,
2007 or the completion of a Qualified Public Offering. The
placement agent for the bridge loan received a commission equal
to 5% of the gross proceeds. The Company received the $500,000
bridge loan net of the commission to the placement agent of
$25,000. The Company classified this cost as a deferred
financing cost.
In April, May and June 2006, the Company received additional
proceeds totaling $1,015,000 (net of a $50,750 commission to the
placement agent) from a series of promissory notes executed with
the Bridge Noteholders (Bridge Financing).
In connection with the Bridge Financing, the Company issued
bridge notes (Bridge Notes) and securities of the
Company (Bridge Equity Units) to the Bridge
Noteholders, stating that if a Qualified Public Offering
occurred before October 16, 2006 (extended to
February 19, 2007), the Bridge Noteholders would be
entitled to receive Bridge Equity Units consisting of securities
identical in form to the securities being offered in the
Qualified Public Offering. Each Bridge Noteholder would be
entitled to receive Bridge Equity Units equal to the principal
of the Bridge Noteholders bridge loan divided by the
initial public offering price of the securities comprising the
Bridge Equity Units.
The Bridge Loans and the Bridge Equity Units were allocated for
accounting purposes based on the relative fair values at the
time of issuance of (i) the Bridge Loans without the Bridge
Equity Units and (ii) the Bridge Equity Units themselves.
The fair value of the Bridge Loans and the Bridge Equity Units
was computed at $1,515,000 each. The $1,515,000 fair value was
determined since the Company obtained $1,515,000 in Bridge
Financing from Bridge Noteholders. At the closing of a public
offering on or before February 19, 2007 bridge lenders
would be entitled to receive units identical to the units being
offered in the Companys initial public offering. Each
bridge lender would be entitled to receive that number of units
equal to the principal of the lenders note divided by the
initial public offering price. Stated differently, upon closing
F-18
CONVERTED
ORGANICS INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
of an initial public offering on or before February 19,
2007, the Company would be obligated to issue to the bridge
lenders a number of units commensurate with a market value of
$1,515,000. Since they were of equal value, the $1,515,000 was
allocated 50% to the Bridge Loans and 50% to the Bridge Equity
Units. The Bridge Equity Units of $757,500 were accounted for as
paid-in capital. The Bridge Loans of $1,515,000 were recorded on
the balance sheet net of the $757,500 discount on the Bridge
Loans. The discount for the Bridge Equity Units ($757,500) was
amortized into interest expense over the original life of the
Bridge Loans. For the year ended December 31, 2007, the
Company recorded $757,500 in interest expense related to the
amortization of this discount.
On February 16, 2007 the Company completed its initial
public offering and issued 293,629 Bridge Equity Units to the
Bridge Noteholders. In addition, the Company and the Bridge
Noteholders, agreed under the terms of a concurrent bond
offering at the time of the initial public offering, not to
repay the principal or accrued interest on the Bridge Notes at
that time.
The Company had $1,515,000 of outstanding Bridge Loans that
accrued interest at a rate of 18%, and under the terms of the
loans, were to be repaid on the earlier of February 19,
2007 or the date of the Companys initial public offering.
Due to certain covenants relating to the offering of bonds on
February 16, 2007, which prohibited the Company from
repaying these bridge loans, the Company entered into an
agreement whereby it could repay the Bridge Loans if the Bridge
Noteholders agreed to obtain a letter of credit in favor of the
Company. The Company reached agreements with the Bridge
Noteholders and the demand note lender to repay the entire
principal and accrued interest on these debts. The principal of
the Bridge Loans of $1,515,000 plus accrued interest of
approximately $160,000, along with principal of the demand note
of $150,000 plus accrued interest of approximately $7,000, was
repaid by the Company on May 23, 2007 from unrestricted
cash. In addition, for the various term extensions granted by
the Bridge Noteholders, the Company issued approximately
56,000 shares of common stock, which represents 10% of the
principal and interest repaid, divided by the
five-day
average share price prior to repayment of the debt. The
consolidated statements of operations for the year ended
December 31, 2007 includes interest expense of $178,048
related to the issuance of this stock.
In order for the repayment of bridge and demand loans to comply
with the terms of the covenants of the bondholders of the New
Jersey Economic Development Authority Bonds, the Bridge
Noteholders obtained a letter of credit in favor of the Company
for $1,825,000. This letter of credit was due to expire on
April 7, 2008, and allows for a one-time draw down during
the thirty days prior to expiration. Subsequent to
December 31, 2007 and prior to the expiration date of the
letter of credit (April 7, 2008), in conjunction with the
private financing described below, the letter of credit
agreement was terminated with no cost to the Company.
BOND
FINANCING
On February 16, 2007, concurrent with its initial public
offering, the Companys wholly-owned subsidiary, Converted
Organics of Woodbridge, LLC, (the Subsidiary)
completed the sale of $17,500,000 of New Jersey Economic
Development Authority Bonds. Direct financing costs related to
this issuance totaled $953,375, which have been capitalized and
are being amortized over the term of the bonds. The bonds carry
a stated interest rate of 8% and mature on August 1, 2027.
The bonds are secured by a leasehold mortgage and a first lien
on the equipment of the Subsidiary. In addition, the Subsidiary
has agreed to, among other things, establish a fifteen month
capitalized interest reserve and to comply with certain
financial statement ratios. The Company has provided a guarantee
to the bondholders on behalf of its wholly-owned Subsidiary for
the entire bond offering.
The New Jersey Economic Development Bonds have certain
covenants, which among other things, preclude the Company from
making any dividends, payments or other cash distributions until
such time as (i) the Company has achieved, over the course
of a full fiscal year, a maximum annual debt service coverage
F-19
CONVERTED
ORGANICS INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
ratio greater than 1.50, and (ii) at least $1,200,000 is on
deposit with the Trustee in the operations and maintenance
reserve fund and is available to satisfy ongoing maintenance,
repair and replacement costs associated with the project
facilities. In addition, the Company is precluded from borrowing
additional funds under any debt agreements, without the consent
of the bondholders. During 2007, the Company received consent
from the bondholder prior to borrowing additional funds for a
two year term note. During 2008, the Company again received
consent from the bondholder prior to borrowing additional funds
in a private investment. Under the terms of the bond agreement,
the lender has the right, upon 30 days written notice, to
demand full payment of all outstanding principal and interest
amounts owed under the agreement if specific covenants are not
met. As of December 31, 2008 and 2007, the Company is in
compliance with these covenants of the bond agreement.
PRIVATE
FINANCING
On January 24, 2008, the Company entered into a private
financing with three investors (the Investors) for a
total amount of $4,500,000 (the Financing). The
Financing was offered at an original issue discount of 10%. The
Company used the proceeds to fund the acquisitions described
above, to fund further development activities and to provide
working capital. As consideration for the Financing, the
Investors received a note issued by the Company in the amount of
$4,500,000 with interest accruing at 10% per annum to be paid
monthly and the principal balance to be paid in full one year
from the closing date (the Note). In addition, the
Company issued to the Investors 750,000 Class A Warrants
and 750,000 Class B Warrants, which may be exercised at
$8.25 and $11.00 per warrant share, respectively (the
Warrants). The Company further agreed not to call
any Warrants until a registration statement registering all of
the Warrants is declared effective. A placement fee of $225,000
was paid from the proceeds of this loan.
In connection with the Financing, the Company had agreed that
within 75 days of the closing date, the Company would have
a shareholder vote to seek approval to issue a convertible
debenture with an interest rate of 10% per annum which would be
convertible into common stock pursuant to terms of the debenture
agreement, or such other price as permitted by the debenture
(the Convertible Debenture). Upon shareholder
approval, the Note was replaced by this Convertible Debenture
and one half of each of the Class A Warrants and of the
Class B Warrants issued were returned to the Company. Under
the conversion option, the Investors shall have the option, at
any time on or before the maturity date (January 24, 2009),
to convert the outstanding principal of this Convertible
Debenture into fully-paid and non assessable shares of common
stock at the conversion price equal to the lowest of
(i) the fixed conversion price of $6.00 per share,
(ii) the lowest fixed conversion price (the lowest price,
conversion price or exercise price set by the Company in any
equity financing transaction, convertible security, or
derivative instrument issued after January 24, 2008), or
(iii) the default conversion price (if and so long as there
exists an event of default, then 70% of the average of the three
lowest closing prices of common stock during the twenty day
trading period immediately prior to the notice of conversion).
The Company held a special shareholders meeting on
April 3, 2008 to vote on this matter, at which time it was
approved.
In connection with the financing, the Company entered into a
Security Agreement with the Investors whereby the Company
granted the Investors a security interest in Converted Organics
of California, LLC and any and all assets that are acquired by
the use of the funds from the Financing. In addition, the
Company granted the Investors a security interest in Converted
Organics of Woodbridge, LLC and all assets subordinate only to
the current lien held by the holder of the bonds issued in
connection with the Woodbridge facility of approximately
$17,500,000.
In connection with this borrowing, the Company issued
1.5 million warrants to purchase common stock, which were
deemed to have a fair value of $5,497,500. The Company recorded
the relative fair value of the warrants to the underlying notes
of $2,227,500 in accordance with Accounting Principles Board
(APB) Opinion No. 14, Accounting for
Convertible Debt and Debt Issued with Stock Purchase
Warrants as
F-20
CONVERTED
ORGANICS INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
additional paid-in capital and established a discount on the
debt. The discount was being amortized over the life of the note
(12 months). On April 17, 2008, the Investors returned
to the Company 750,000 warrants that had been held in escrow.
This reduced the value assigned to the warrants and,
accordingly, the value assigned to the debt discount
attributable to the warrants by $1,113,750. In addition, the
remaining original issue discount of approximately $366,000 was
recognized as expense on April 7, 2008.
On April 7, 2008, the shareholders of the Company approved
the issuance of additional shares so that convertible notes
could be issued to the noteholders to replace the original notes
dated January 24, 2008. The Company is required to
recognize a discount for the intrinsic value of the beneficial
conversion feature of the notes which is to be recognized as
interest expense through the redemption date of the notes, which
is January 24, 2009. That amount was calculated to be
$3,675,000, and recognition was limited to $2,936,250 in
accordance with
EITF 98-5,
Accounting for Convertible Securities with Beneficial
Conversion Features or Contingently Adjustable Conversion
Ratios, as the debt discount is limited to the
proceeds allocated to the convertible instrument of $4,500,000.
That discount is being amortized over the life of the loan.
During the year ending December 31, 2008, the Company
recognized interest expense of $2,705,759 related to this
discount.
On January 24, 2009 the Company entered into an amendment
on its $4.5 million convertibles debentures which became
due on January 24, 2009. The lenders extended the due date
of these notes until July 24, 2009 and began to convert
these notes into shares of the Companys common stock using
the default conversion rate. The Company and the lenders further
agreed that no interest would be charged during the six-month
extension and that it is the lenders intention to convert
the loan into shares sufficient to pay off the balance of the
debt.
On March 6, 2009, the Company entered into an agreement
with the holders of its $17.5 million of New Jersey
Economic Development Authority Bonds to release
$2.0 million for capital expenditures and lease payments on
its New Jersey facility and to defer interest payments on the
bonds thru July 30, 2009. These funds had been held in a
reserve for bond principal and interest payments along with a
reserve for lease payments. As consideration for the release of
the reserve funds, the Company issued the bond holders 2,284,409
Class B warrants. The Class B warrants are exercisable
at $11.00 per warrant share.
REGISTRATION
RIGHTS AGREEMENT
In connection with the January 24, 2008 private financing,
the Company entered into a registration rights agreement with
the Investors which called for the Company to register the
securities within certain time periods. The Company had
10 days from shareholder approval, with an additional
7 day extension, to register the shares issuable under the
Convertible Debenture and 90 days from the filing of a
registration statement (filed on February 13,
2008) for the Warrants and the underlying shares to be
declared effective by the SEC. The Company has filed the
registration statement relative to the Convertible Debenture as
of the filing date of this report and the registration statement
filed for the Warrants has been declared effective. However, the
registration statement filed for the convertible debt and the
date the warrant registration statement was declared effective
by the SEC did not occur within the timelines agreed to in the
registration rights agreement. The registration rights agreement
calls for $90,000 per month in liquidated damages, payable in
cash, if the Company doesnt file the registration
statement for the Convertible Debenture and liquidated damages
equal to the average closing price of 375,000 Class A
warrants and 375,000 Class B warrants for each 30 day
period, commencing May 13, 2008, and multiplying that
average by 2% for each 30 day period that the registration
statement is not declared effective.
Therefore, on April 24, 2008, the Company began to incur
liquidated damages in connection with the Convertible Debenture
of $90,000 per month and as of May 13, 2008 the Company
began to incur liquidated damage obligations in connection with
the Warrants according to the formula described above. The
maximum amount of liquidated damages relative to the Warrant
Registration Statement and the Convertible Debenture is
F-21
CONVERTED
ORGANICS INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
equal to 10% of the face amount of the Convertible Debenture or
$450,000 (10% of $4,500,000). The Company paid a total of
approximately $158,000 in liquidated damages related to the
Convertible Debentures, which are recorded as interest expense
on the consolidated statements of operations for year ended
December 31, 2008. On June 7, 2008 the warrant
registration statement was declared effective. At this time, the
Company is not subject to further liquidated damages.
CONVERTIBLE
NOTE PAYABLE
On January 24, 2008, in conjunction with the purchase of
the net assets of UOP, the Company issued a note payable to the
former sole member in the amount of $1,000,000. The note bears
interest of 7% and matures on February 1, 2011; monthly
principal and interest payments are $30,877. Interest expense of
$57,850 has been recorded in the year ending December 31,
2008 related to this note. The note is convertible by the holder
six months after issuance. The Company is required to recognize
a discount related to the intrinsic value of the beneficial
conversion feature of the note as interest expense through the
stated redemption date of the note. That amount was calculated
to be $7,136, and has been recorded as a component of additional
paid-in capital.
MORTGAGE
NOTE PAYABLE
The Company has a mortgage note payable on the land upon which
the California facility resides. The note, in the original
amount of $250,000, bears interest at 6.75%. Monthly payments of
principal and interest of $1,638 are due based on an
amortization of twenty years. The note matures in May, 2013.
FIVE-YEAR
MATURITY OF DEBT
Principal due during the next five years on all the
Companys long-term and current debt is as follows:
|
|
|
|
|
2009
|
|
$
|
4,925,328
|
|
2010
|
|
|
329,721
|
|
2011
|
|
|
28,450
|
|
2012
|
|
|
3,679
|
|
2013
|
|
|
234,826
|
|
Thereafter
|
|
|
17,500,000
|
|
|
|
|
|
|
Subtotal
|
|
|
23,022,004
|
|
Less: discount
|
|
|
(230,492
|
)
|
|
|
|
|
|
Total
|
|
$
|
22,791,512
|
|
|
|
|
|
|
NOTE 12
CAPITALIZED INTEREST COSTS
The Company has capitalized interest costs, net of certain
interest income, in accordance with Statement of Financial
Accounting Standards No. 62, Capitalization of
Interest Cost Involving Certain Tax-Exempt Borrowings and
Certain Gifts and Grants, related to its New Jersey
Economic Development Authority Bonds in the amount of $1,317,438
and $403,572 as of December 31, 2008 and December 31,
2007, respectively. Capitalized interest costs are included in
construction in progress initially on the consolidated balance
sheets. As assets are placed in service, the capitalized
interest is allocated among the cost basis of the assets
ratably. During the year ending December 31, 2008,
capitalized interest of $1,245,000 was allocated to assets
placed in service and is being depreciated with the related
assets.
F-22
CONVERTED
ORGANICS INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
NOTE 13
OWNERS EQUITY (DEFICIT)
AUTHORIZED
SHARES
At its April 3, 2008 special meeting of shareholders, the
shareholders approved a resolution to decrease the number of
common shares that the Company is authorized to issue from
75,000,000 to 40,000,000, and the number of preferred shares
that the Company is authorized to issue from 25,000,000 to
10,000,000. The Company did this to realize saving on certain
taxes that are based on the number of shares authorized, and the
Company believes that 40,000,000 shares of common stock
would be sufficient to meet its future needs.
STOCK
ISSUANCES
The Company is authorized to issue 40,000,000 shares of
$0.0001 par value common stock. Of the authorized shares,
733,333 of the authorized shares were issued to the founders of
the Company (founders shares) on
January 13, 2006. The Company did not receive any
consideration for the founders shares. Because the Company
had a negative estimated value on January 13, 2006, the
Company recognized compensation expense at par value totaling
$73 in connection with the issuance of the founders shares
as par value represents the statutory minimum share value in the
state of Delaware.
On February 21, 2006, the Company merged with Mining
Organics Management LLC (MOM) and Mining Organics
Harlem River Rail Yard LLC (HRRY). At that time, MOM
was a fifty-percent owner of HRRY. The mergers were accounted
for as a recapitalization of the Company. As a result of the
recapitalization, 600,000 shares were issued to the members
of HRRY.
On February 16, 2007 the Company successfully completed an
initial public offering of 1,800,000 common shares and 3,600,000
warrants for a total offering of $9,900,000, before issuance
costs. The Companys initial public offering is presented
net of issuance costs and expenses of $1,736,715 in the
statements of changes in owners equity (deficit). The
warrants consist of 1,800,000 redeemable Class A warrants
and 1,800,000 non-redeemable Class B warrants, each warrant
to purchase one share of common stock. The common stock and
warrants traded as one unit until March 13, 2007 when they
began to trade separately.
On February 16, 2007, as part of its initial public
offering and under the original terms of the bridge loan
agreement (Note 11), the Company issued 293,629 Bridge
Equity Units to the Bridge Noteholders. On May 23, 2007, as
consideration for extensions of the Bridge Loans, the Company
issued 55,640 shares of common stock to the Bridge
Noteholders, which represents 10% of the principal and interest
repaid, divided by the
five-day
average share price prior to repayment of the debt. The
statement of operations reflects an expense of $178,048 related
to the issuance of these shares.
On February 16, 2007, as part of its initial public
offering, the Company agreed to pay a 5% quarterly stock
dividend, commencing March 31, 2007, and every full quarter
thereafter until the Woodbridge, New Jersey facility is
operational. As of December 31, 2007, the Company has
declared four such quarterly dividends amounting to
747,296 shares. As of December 31, 2008, the Company
has declared one additional quarterly dividend in the amount of
263,239 shares.
On October 1, 2008, the Company issued 45,480 shares
of its common stock to a consultant as remuneration for services
rendered. The related services were substantially complete when
the stock was issued. The Company recognized $212,619 of expense
related to the fair value of this issuance.
On October 22, 2008, the Company declared a stock dividend
of 15% payable to shareholders of record as of November 17,
2008. This dividend resulted in the issuance of
969,318 shares of common stock.
F-23
CONVERTED
ORGANICS INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
WARRANTS
On February 16, 2007, in connection with the Companys
public offering, the Company sold 1,800,000 equity units
consisting of one share of common stock, one Class A
warrant and one Class B warrant. On March 13, 2007,
the Class A and Class B warrants began to trade as
separate securities. The Class A warrants are exercisable
for one share of common stock, plus accumulated stock dividends,
for $8.25. The Class A warrants expire on February 16,
2012 and, if certain conditions are met, the Company may redeem
these warrants at a price of $0.25 per warrant prior to the
expiration date. The Class B warrants are exercisable for
one share of common stock, plus accumulated stock dividends, for
$11.00. The Class B warrants expire on February 16,
2012 and there is no provision for the Company to redeem these
warrants prior to the expiration date.
On January 24, 2008, in conjunction with the private
financing arrangement of the Company described in Note 10,
the Company issued 750,000 Class A and 750,000 Class B
Warrants to the Investors. Such warrants are exercisable for one
share of the Companys common stock, adjusted for
dividends, at $8.25 and $11.00, respectively. Once the
Companys registration statement related to the underlying
shares was declared effective, one-half of the warrants were
returned to the Company by the Investors, as described in
Note 11.
WARRANT
EXERCISE
The Company has received net proceeds of approximately
$11,344,000 as a result of the exercise of approximately
1,381,000 Class A (which includes the warrant redemption
discussed below) warrants and 600 Class B warrants in the
year ended December 31, 2008. The Company issued
approximately 1,781,000 shares of common stock in
connection with the exercise of these warrants due to the
cumulative effect of the Companys stock dividends.
WARRANT
REDEMPTION
On September 16, 2008, the Company announced the redemption
of its outstanding Class A Warrants. The redemption date
was set for October 17, 2008, and was subsequently extended
a total of 31 days voluntarily by the Company to
November 17, 2008. Any outstanding Class A warrants
that had not been exercised before that date expired and are
redeemable by the Company for $0.25 per warrant.
Until the redemption date, the Class A warrants were
convertible into common stock at an exercise price of $8.25.
Each warrant exercised at this price received 1.276 shares
of common stock. Prior to the notification of redemption,
approximately 756,000 Class A warrants had been exercised.
After the redemption, an additional 683,000 warrants were
exercised. In total, from both the exercise and redemption of
warrants, the Company received proceeds of approximately
$11,344,000. The Company is obligated to remit to its transfer
agent funds sufficient to compensate warrant holders for the
remaining warrants, which may be redeemed for $.25 each for an
indefinite period. This amount of $284,237 was subtracted from
the cash received for exercise of the warrants, representing the
amount necessary to redeem the remaining warrants.
F-24
CONVERTED
ORGANICS INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
Class A warrant activity for the year ended
December 31, 2008 and 2007 is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
|
|
|
Weighted
|
|
|
|
|
|
|
Exercise
|
|
|
Average
|
|
|
Average
|
|
|
|
|
|
|
Price per
|
|
|
Exercise
|
|
|
Remaining
|
|
|
|
Warrants
|
|
|
Warrant
|
|
|
Price
|
|
|
Life (Years)
|
|
|
Outstanding at December 31, 2006
|
|
|
|
|
|
$
|
|
|
|
|
|
|
|
|
|
|
Issued:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
February 16, 2007, in conjunction with initial public
offering
|
|
|
1,800,000
|
|
|
|
8.25
|
|
|
|
8.25
|
|
|
|
|
|
February 16, 2007, in conjunction With bridge loans
|
|
|
293,629
|
|
|
|
8.25
|
|
|
|
8.25
|
|
|
|
|
|
February 16, 2007, in conjunction with underwriter units
|
|
|
180,000
|
|
|
|
8.25
|
|
|
|
8.25
|
|
|
|
|
|
Expired
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercised
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at December 31, 2007
|
|
|
2,273,629
|
|
|
|
8.25
|
|
|
|
8.25
|
|
|
|
4.2
|
|
Issued:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
January 24, 2008, in conjunction with private financing
|
|
|
750,000
|
|
|
|
8.25
|
|
|
|
8.25
|
|
|
|
|
|
Returned to the Company upon shareholder approval of exchange of
term note for convertible note
|
|
|
(375,000
|
)
|
|
$
|
8.25
|
|
|
|
|
|
|
|
|
|
Exercised
|
|
|
(1,380,768
|
)
|
|
$
|
8.25
|
|
|
|
|
|
|
|
|
|
Expired
|
|
|
(1,267,861
|
)
|
|
$
|
8.25
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at December 31, 2008
|
|
|
|
|
|
$
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The fair value of Class A warrants totaled $2,387,310 at
December 31, 2007 based on quoted market prices on that
date. As of December 31, 2008, the Class A warrants
have been removed from market trading.
F-25
CONVERTED
ORGANICS INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
Class B warrant activity for the years ended
December 31, 2008 and 2007 is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
|
|
|
Weighted Average
|
|
|
|
|
|
|
Exercise
|
|
|
Average
|
|
|
Remaining
|
|
|
|
|
|
|
Price per
|
|
|
Exercise
|
|
|
Life
|
|
|
|
Warrants
|
|
|
Warrant
|
|
|
Price
|
|
|
(Years)
|
|
|
Outstanding at December 31, 2006
|
|
|
|
|
|
$
|
0
|
|
|
|
|
|
|
|
|
|
Issued:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
February 16, 2007, in conjunction with initial public
offering
|
|
|
1,800,000
|
|
|
|
11.00
|
|
|
|
11.00
|
|
|
|
|
|
February 16, 2007, in conjunction with bridge loans
|
|
|
293,629
|
|
|
|
11.00
|
|
|
|
11.00
|
|
|
|
|
|
February 16, 2007, in conjunction with underwriter shares
|
|
|
180,000
|
|
|
|
11.00
|
|
|
|
11.00
|
|
|
|
|
|
Expired
|
|
|
|
|
|
|
0
|
|
|
|
|
|
|
|
|
|
Exercised
|
|
|
|
|
|
|
0
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at December 31, 2007
|
|
|
2,273,629
|
|
|
|
11.00
|
|
|
|
11.00
|
|
|
|
4.2
|
|
Issued:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
January 24, 2008, in conjunction with private financing
|
|
|
750,000
|
|
|
|
11.00
|
|
|
|
11.00
|
|
|
|
|
|
Returned to the Company upon shareholder approval of exchange of
term note for convertible note
|
|
|
(375,000
|
)
|
|
|
11.00
|
|
|
|
11.00
|
|
|
|
|
|
Exercised
|
|
|
600
|
|
|
|
11.00
|
|
|
|
11.00
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at December 31, 2008
|
|
|
2,648,029
|
|
|
$
|
11.00
|
|
|
|
11.00
|
|
|
|
3.2
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The fair value of Class B warrants totaled $3,442,438 and
$3,410,444 at December 31, 2008 and 2007, respectively,
based on quoted market prices on that date.
STOCK
OPTION PLAN
In June 2006, the Companys Board of Directors and
stockholders approved the 2006 Stock Option Plan (the
Option Plan). The Option Plan authorizes the grant
and issuance of options and other equity compensation to
employees, officers and consultants. A total of
666,667 shares of common stock are reserved for issuance
under the Option Plan. The Option Plan is administered by the
Compensation Committee of the Board of Directors (the
Committee). Subject to the provisions of the Option
Plan, the Committee determines who will receive the options, the
number of options granted, the manner of exercise and the
exercise price of the options. The term of incentive stock
options granted under the Option Plan may not exceed ten years,
or five years for options granted to an optionee owning more
than 10% of the Companys voting stock. The exercise price
of an incentive stock option granted under the Option Plan must
be equal to or greater than the fair market value of the shares
of the Companys common stock on the date the option is
granted. The exercise price of a non-qualified option granted
under the Option Plan must be equal to or greater than 85% of
the fair market value of the shares of the Companys common
stock on the date the option is granted. An incentive stock
option granted to an optionee owning more than 10% of the
Companys voting stock must have an exercise price equal to
or greater than 110% of the fair market value of the
Companys common stock on the date the option is granted.
Stock options issued under the option plan vest immediately upon
date of grant.
At a Special Meeting of Shareholders on April 3, 2008, the
shareholders approved an amendment to the 2006 Stock Option Plan
to include an evergreen provision pursuant to which
on January 1st of each year, commencing in 2009, the
number of shares authorized for issuance under the 2006 Stock
Option Plan shall
F-26
CONVERTED
ORGANICS INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
automatically be increased to an amount equal to 20% of the
shares of the common stock outstanding on the last day of the
prior fiscal year. The Shareholders also approved an amendment
to the Plan to increase the number of options available under
the plan from 666,667 to 1,666,667. On June 27, 2008, an
additional 736,735 options were granted, and vested on that
date. Taking into account all options issued, the Company has
276,932 options available to grant under the plan.
The options granted on June 27, 2008 have an exercise price
of $5.02 and expire ten years from the grant date. The exercise
price was based on the closing price of the stock on the date of
grant. The fair value of the options was estimated using a
Black-Scholes pricing model with the following assumptions:
risk-free interest rate of 3.52%; no dividend yield; volatility
factor of 52.3%; and an expected term of 5 years. The
resulting expense of approximately $2.3 million is included
in general and administrative expenses in the consolidated
statements of operations for the year ended December 31,
2008.
During the year ended December 31, 2007, in accordance with
the director compensation policy of the Committee, an additional
10,000 options were granted to a Director upon his appointment
to the Board. The options vested on the grant date, have an
exercise price of $3.75 per share and expire five years from the
grant date. The fair value for the 10,000 immediately vesting
stock options granted in 2007 was estimated at the date of grant
using a Black-Scholes pricing model with the following
assumptions: risk-free interest rate of 4.9%; no dividend yield;
expected volatility factor of 16.9%; and an expected term of
five years. The Companys stock option compensation expense
totaling $5,929 has been included in general and administrative
expenses in the consolidated statements of operations for the
year ended December 31, 2007.
Stock option activity for the period January 1, 2007
through December 31, 2008 is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
|
|
|
|
|
|
|
|
|
|
|
|
|
Average
|
|
|
Average
|
|
|
|
Stock
|
|
|
Price per
|
|
|
Exercise
|
|
|
Remaining
|
|
|
|
Options
|
|
|
Share
|
|
|
Price
|
|
|
Life (Years)
|
|
|
Outstanding and exercisable at December 31, 2006
|
|
|
643,000
|
|
|
$
|
3.75
|
|
|
$
|
3.75
|
|
|
|
|
|
Granted
|
|
|
10,000
|
|
|
|
3.75
|
|
|
|
3.75
|
|
|
|
|
|
Expired
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercised
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding and exercisable at December 31, 2007
|
|
|
653,000
|
|
|
|
3.75
|
|
|
|
3.75
|
|
|
|
4.2
|
|
Granted
|
|
|
736,735
|
|
|
|
5.02
|
|
|
|
|
|
|
|
|
|
Expired
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercised
|
|
|
(143,000
|
)
|
|
|
3.75
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding and exercisable at December 31, 2008
|
|
|
1,246,735
|
|
|
$
|
|
|
|
$
|
4.50
|
|
|
|
4.0
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The aggregate intrinsic value of options outstanding and
exercisable at December 31, 2008 and 2007 is $0 and
$946,850, respectively. The aggregate intrinsic value represents
the total pretax intrinsic value, based on options with an
exercise price less than the Companys closing stock price
of $3.54 and $5.20 as of December 31, 2008 and 2007,
respectively, which would have been received by the option
holders had those option holders exercised their options as of
that date.
As of December 31, 2008 and 2007, there was no unrecognized
compensation cost related to non-vested share-based compensation
arrangements granted under the Companys stock option plan.
During the year ended December 31, 2008, the Company has
received approximately $536,000 as a result of the exercise of
143,000 options.
F-27
CONVERTED
ORGANICS INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
NOTE 14
INCOME TAXES
At December 31, 2008, the Company had accumulated net
operating losses of approximately $26,553,000, of which
approximately $16,700,000 may be offset against future taxable
income, if any, ratably through 2028.
The Company has fully reserved the approximately $7,588,000 tax
benefit of these losses with a valuation allowance of the same
amount, because the likelihood of realization of the tax benefit
cannot be determined to be more likely than not.
There is a minimum current tax provision for the years ended
December 31, 2008 and 2007.
The effective tax rate based on the federal and state statutory
rates is reconciled to the actual tax rate for the years ended
December 31, 2008 and 2007 as follows:
|
|
|
|
|
|
|
|
|
|
|
2008
|
|
|
2007
|
|
|
Statutory federal income tax rate
|
|
|
34
|
%
|
|
|
34
|
%
|
Statutory state income tax rate
|
|
|
6
|
|
|
|
6
|
|
Valuation allowance on net deferred tax assets
|
|
|
(40
|
)
|
|
|
(40
|
)
|
|
|
|
|
|
|
|
|
|
Effective tax rate
|
|
|
|
%
|
|
|
|
%
|
|
|
|
|
|
|
|
|
|
The components of the net deferred tax asset (liability) at
December 31, 2008 and 2007 are as follows:
|
|
|
|
|
|
|
|
|
|
|
2008
|
|
|
2007
|
|
|
Deferred tax assets:
|
|
|
|
|
|
|
|
|
Net operating losses
|
|
$
|
6,148,000
|
|
|
$
|
2,120,000
|
|
Accrued compensation
|
|
|
120,000
|
|
|
|
120,000
|
|
Stock options
|
|
|
1,320,000
|
|
|
|
400,000
|
|
Valuation allowance
|
|
|
(7,588,000
|
)
|
|
|
(2,640,000
|
)
|
|
|
|
|
|
|
|
|
|
|
|
$
|
|
|
|
$
|
|
|
|
|
|
|
|
|
|
|
|
The Companys valuation allowance increased $4,948,000 and
$1,140,000 for the years ended December 31, 2008 and 2007,
respectively.
The Company has a tax benefit of approximately $1,320,000
related to the grant of common stock to certain key employees
and advisors. Pursuant to SFAS No. 123(R), the benefit
will be recognized and recorded to APIC when the benefit is
realized through the reduction of taxes payable.
The Company complies with the provisions of FASB Interpretation
No. 48, Accounting for Uncertainty in Income
Taxes an interpretation of FASB Statement
No. 109 (FIN No. 48).
FIN 48 addresses the determination of whether tax benefits
claimed or expected to be claimed on a tax return should be
recorded in the financial statements. Under FIN 48, the
Company may recognize the tax benefit from an uncertain tax
position only if it is more likely than not that the tax
position will be sustained on an examination by the taxing
authorities, based on the technical merits of the position. The
Company has determined that the Company has no uncertain tax
positions requiring recognition under FIN No. 48.
The Company is subject to U.S. federal income tax as well
as income tax of certain state jurisdictions. The Company has
not been audited by the U.S. Internal Revenue Service or
any states in connection with its income taxes. The periods from
January 1, 2005 to December 31, 2008 remain open to
examination by the U.S. Internal Revenue Service and state
authorities.
The Company recognizes interest accrued related to unrecognized
tax benefits and penalties, if incurred, as a component of
income tax expense.
F-28
CONVERTED
ORGANICS INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
NOTE 15
SEGMENT REPORTING
In June 1997, SFAS 131, Disclosure about Segments
of an Enterprise and Related Information was issued,
which amends the requirements for a public enterprise to report
financial and descriptive information about its reportable
operating segments. Operating segments, as defined in the
pronouncement, are components of an enterprise about which
separate financial information is available that is evaluated
regularly by the Company in deciding how to allocate resources
and in assessing performance. The financial information is
required to be reported on the basis that is used internally for
evaluating segment performance and deciding how to allocate
resources to segments. The Company has no reportable segments at
December 31, 2008 and 2007.
NOTE 16
RELATED PARTY TRANSACTIONS
OPERATING
LEASE-HEADQUARTERS
The Company is renting the premises under a verbal agreement
with ECAP, LLC, a related party. The managing member of ECAP,
LLC was a director and is a shareholder of the Company and is
also the brother of the Companys President and CEO. The
rental agreement provides for rent and support, as agreed
between the Company and ECAP, LLC and for reimbursement of
expenses by the Company for office and other expenses. These
expenses totaled $5,600 for the period from January 1, 2007
to February 28, 2007.
As of March 1, 2007, the Company began to pay the $2,800
per month rental payment directly to the unrelated landlord for
this office space. There is no lease term and rental of the
office space is on a month to month basis. Rent expense for the
period from March 1, 2007 to December 31, 2007 totaled
$28,000 relating to this lease. In the year ending
December 31, 2008, the Company incurred $33,600 of expense
related to this lease.
SERVICE
AGREEMENT
The Company has entered into a services agreement dated
May 29, 2003, as modified October 6, 2004, with one of
its principal stockholders, Weston Solutions, Inc.
(Weston). Weston has been engaged to provide
engineering and design services in connection with the
construction of the Woodbridge organic waste conversion
facility. The total amounts incurred by the Company for services
provided by Weston were $0 and $116,480 for the years ended
December 31, 2008 and 2007, respectively.
LEGAL
FEES
During the year ended 2007, the Company incurred legal fees
totaling $10,000 to a law firm affiliated with the
Companys President and CEO and partially owned by a
brother of the Companys CEO. These fees of $10,000 were
paid in 2008.
ACCRUED
COMPENSATION-OFFICERS, DIRECTORS AND CONSULTANTS
As of December 31, 2008 and 2007 the Company has an accrued
liability totaling $430,748 and $397,781, respectively,
representing accrued compensation to officers, directors and
consultants.
CONVERTED
ORGANICS OF RHODE ISLAND, LLC
Converted Organics of Rhode Island, LLC was formed for the
purpose of developing and operating a waste to fertilizer
facility in Johnston, Rhode Island. A development consultant who
has provided services to the Company is a 10% minority owner of
Converted Organics of Rhode Island, LLC. For the years ending
December 31, 2008 and 2007, the consultant was paid $60,000
and $60,000, respectively, for services rendered.
F-29
CONVERTED
ORGANICS INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
PACKAGING
VENDOR
The Company has purchased packaging materials from a vendor
which is partially owned by an employee of the Company. The
Company made purchases of $141,000 from this vendor in the year
ending December 31, 2008.
NOTE 17
COMMITMENTS AND CONTINGENCIES
LEASES
In addition to the Companys IBRC commitment
(Note 10) and operating lease commitment for its
headquarters (Note 16), the Company signed a lease during
June 2006 for its Woodbridge, New Jersey facility. The lease
term is for ten years with an option to renew for an additional
ten years. Future minimum lease payments under this lease are as
follows:
|
|
|
|
|
For years ended December 31,
|
|
|
|
|
2009
|
|
$
|
934,820
|
|
2010
|
|
|
934,820
|
|
2011
|
|
|
946,195
|
|
2012
|
|
|
959,097
|
|
2013
|
|
|
967,383
|
|
2014 and thereafter
|
|
|
7,410,639
|
|
|
|
|
|
|
|
|
$
|
12,152,954
|
|
|
|
|
|
|
For the years ended December 31, 2008 and 2007, the Company
has recorded rent expense of $740,351 and $745,633,
respectively, in relation to this lease.
In September, 2008, the Company entered into a lease agreement
for 9 acres of land at the central landfill in Johnston,
RI, with the Rhode Island Resource Recovery Corporation. The
Company plans to build its next facility at this location. The
lease requires monthly payments of $9,167. Once the facility is
operational, the monthly rent will also include a charge of $8
per ton of fertilizer sold from the facility. The term of the
lease is twenty years. Future minimum payments under this lease
are as follows:
|
|
|
|
|
For years ended December 31,
|
|
|
|
|
2009
|
|
$
|
110,000
|
|
2010
|
|
|
110,000
|
|
2011
|
|
|
110,000
|
|
2012
|
|
|
110,000
|
|
2013
|
|
|
110,000
|
|
2014 and thereafter
|
|
|
1,613,334
|
|
|
|
|
|
|
|
|
$
|
2,163,334
|
|
|
|
|
|
|
The Company recognized $36,667 of expense related to this lease
in 2008, which is included in Research & Development
on the consolidated statement of operations.
LEGAL
PROCEEDINGS
The Company is not currently aware of any pending or threatened
legal proceeding to which it is or would be a party, or any
proceedings being contemplated by governmental authorities
against it, or any of its executive officers or directors
relating to the services performed on the Companys behalf
except that the
F-30
CONVERTED
ORGANICS INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
Company received notice that a complaint had been filed in a
putative class action lawsuit on behalf of 59 persons or
entities that purchased units pursuant to a financing terms
agreement dated April 11, 2006 (FTA), captioned
Gerald S. Leeseberg, et al. v. Converted Organics, Inc.,
filed in the U.S. District Court for the District of
Delaware. The lawsuit alleges breach of contract, conversion,
unjust enrichment, and breach of the implied covenant of good
faith in connection with the alleged failure to register certain
securities issued in the FTA, and the redemption of our
Class A warrants in November 2008. The lawsuit seeks
damages related to the failure to register certain securities,
including alleged late fee payments, of approximately
$5.25 million, and unspecified damages related to the
redemption of the Class A warrants. In February 2009, the
Company filed a Motion for Partial Dismissal of Complaint. It is
uncertain when the Court will rule on this motion. The Company
plans to vigorously defend itself in this matter and is unable
to estimate any contingent losses that may or may not be
incurred as a result of this litigation and its eventual
disposition. Accordingly, no contingent loss has been recorded
by the Company related to this matter.
NOTE 18
SUBSEQUENT EVENTS
On January 24, 2009, the Company entered into an amendment
on its $4.5 million convertibles debentures, which became
due on January 24, 2009. The lenders extended the due date
of these notes until July 24, 2009 and began to convert
these notes into shares of the Companys common stock using
the default conversion rate as described in Note 11. The
Company and the lenders further agreed that no interest would be
charged during the six-month extension and that it is the
lenders intention to convert the loan into shares
sufficient to pay-off the balance of the debt.
On March 6, 2009, the Company entered into an agreement
with the holders of its $17.5 million of New Jersey
Economic Development Authority Bonds to release
$2.0 million for capital expenditures and lease payments on
its New Jersey facility and to defer interest payments on the
bonds thru July 30, 2009. These funds had been held in a
reserve for bond principal and interest payments along with a
reserve for lease payments. As consideration for the release of
the reserve funds, the Company issued the bond holders 2,284,409
Class B warrants. The Class B warrants are exercisable
at $11.00 per warrant share.
On March 6, 2009, the Company entered into a into an
agreement with a private investor under which, upon stockholder
approval, will issue a series of 10% convertible notes in an
aggregate principal amount of up to $1,500,000 with a 10%
original issue discount. The investor placed funds into escrow
on March 10, 2009 to acquire $500,000 in principal amount
of the convertible notes to be released upon receiving
stockholder approval, and will acquire four additional $250,000
increments in principal amount of the note with the first
increment occurring on the 30th day after receiving
stockholder approval, and the remaining three increments
occurring monthly, thereafter.
F-31
CONVERTED
ORGANICS INC.
|
|
|
|
|
|
|
|
|
|
|
June 30,
|
|
|
December 31,
|
|
|
|
2009
|
|
|
2008
|
|
|
|
(Unaudited)
|
|
|
(Audited)
|
|
|
ASSETS
|
CURRENT ASSETS
|
|
|
|
|
|
|
|
|
Cash and cash equivalents
|
|
$
|
1,808,156
|
|
|
$
|
3,357,940
|
|
Restricted cash
|
|
|
50,941
|
|
|
|
2,547,557
|
|
Accounts receivable, net
|
|
|
503,998
|
|
|
|
313,650
|
|
Inventories
|
|
|
407,973
|
|
|
|
289,730
|
|
Prepaid rent
|
|
|
490,286
|
|
|
|
389,930
|
|
Other prepaid expenses
|
|
|
128,399
|
|
|
|
73,937
|
|
Deposits
|
|
|
92,520
|
|
|
|
141,423
|
|
Other receivables
|
|
|
|
|
|
|
94,250
|
|
Deferred financing and issuance costs, net
|
|
|
|
|
|
|
22,042
|
|
|
|
|
|
|
|
|
|
|
Total current assets
|
|
|
3,482,273
|
|
|
|
7,230,459
|
|
|
|
|
|
|
|
|
|
|
Deposits
|
|
|
861,244
|
|
|
|
912,054
|
|
Restricted cash
|
|
|
29,716
|
|
|
|
60,563
|
|
Property and equipment, net
|
|
|
22,825,134
|
|
|
|
19,725,146
|
|
Construction-in-progress
|
|
|
217,564
|
|
|
|
974,900
|
|
Capitalized bond costs, net
|
|
|
838,175
|
|
|
|
862,010
|
|
Intangible assets, net
|
|
|
2,709,961
|
|
|
|
2,852,876
|
|
|
|
|
|
|
|
|
|
|
Total assets
|
|
$
|
30,964,067
|
|
|
$
|
32,618,008
|
|
|
|
|
|
|
|
|
|
|
|
LIABILITIES AND OWNERS EQUITY (DEFICIT)
|
CURRENT LIABILITIES
|
|
|
|
|
|
|
|
|
Term notes payable current
|
|
$
|
1,261,089
|
|
|
$
|
89,170
|
|
Accounts payable
|
|
|
4,279,836
|
|
|
|
3,583,030
|
|
Accrued compensation, officers, directors and consultants
|
|
|
389,849
|
|
|
|
430,748
|
|
Accrued legal and other expenses
|
|
|
363,545
|
|
|
|
164,620
|
|
Accrued interest
|
|
|
616,249
|
|
|
|
601,166
|
|
Convertible notes payable, net of unamortized discount
|
|
|
342,984
|
|
|
|
4,602,660
|
|
Capital lease obligations current
|
|
|
11,284
|
|
|
|
|
|
Mortgage payable
|
|
|
|
|
|
|
3,006
|
|
|
|
|
|
|
|
|
|
|
Total current liabilities
|
|
|
7,264,836
|
|
|
|
9,474,400
|
|
|
|
|
|
|
|
|
|
|
Capital lease obligation, net of current portion
|
|
|
34,806
|
|
|
|
|
|
Term notes payable, net of current portion
|
|
|
1,008,094
|
|
|
|
|
|
Mortgage payable, net of current portion
|
|
|
|
|
|
|
245,160
|
|
Convertible note payable, net of current portion
|
|
|
198,466
|
|
|
|
351,516
|
|
Bonds payable
|
|
|
17,500,000
|
|
|
|
17,500,000
|
|
|
|
|
|
|
|
|
|
|
Total liabilities
|
|
|
26,006,202
|
|
|
|
27,571,076
|
|
|
|
|
|
|
|
|
|
|
COMMITMENTS AND CONTINGENCIES
|
|
|
|
|
|
|
|
|
OWNERS EQUITY (DEFICIT)
|
|
|
|
|
|
|
|
|
Preferred stock, $.0001 par value, authorized 10,000,000
shares; no shares issued and outstanding
|
|
|
|
|
|
|
|
|
Common stock, $.0001 par value, authorized
40,000,000 shares at December 31, 2008 and 75,000,000
at June 30, 2009
|
|
|
1,835
|
|
|
|
743
|
|
Additional paid-in capital
|
|
|
40,668,709
|
|
|
|
31,031,647
|
|