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As
filed with the Securities and Exchange Commission on July 29, 2011
Registration No. 333-175134
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Pre-Effective Amendment No. 1
FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
Converted Organics Inc.
(Exact name of registrant as specified in its charter)
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Delaware
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2873
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20-4075963 |
(State or other jurisdiction of
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(Primary Standard Industrial
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(I.R.S. Employer |
incorporation or organization)
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Classification Code Number)
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Identification Number) |
137A Lewis Wharf
Boston, MA 02110
(617) 624-0111
(Address, including zip code, and telephone number, including area code, of registrants principal executive offices)
Edward J. Gildea
Chief Executive Officer
137A Lewis Wharf
Boston, MA 02110
(617) 624-0111
(Name, address, including zip code, and telephone number, including area code, of agent for service)
Copies to:
Ralph V. De Martino, Esq.
Cavas S. Pavri, Esq.
Cozen OConnor
The Army & Navy Club Building
1627 I Street, NW, Suite 1100
Washington, DC 20006
(215) 665-5542
Facsimile: (215) 701-2478
Approximate date of commencement of proposed sale to the public: As soon as practicable
after the effective date of this Registration Statement.
If any of the securities being registered on this Form are to be offered on a delayed or
continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box.
þ
If this Form is filed to register additional securities for an offering pursuant to Rule
462(b) under the Securities Act, check the following box and list the Securities Act registration
statement number of the earlier effective registration statement for the same offering. o
If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities
Act, check the following box and list the Securities Act registration statement number of the
earlier effective registration statement for the same offering. o
If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities
Act, check the following box and list the Securities Act registration statement number of the
earlier effective registration statement for the same offering. o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated
filer, a non-accelerated filer or a smaller reporting company. See the definitions of large
accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the
Exchange Act. (Check one):
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Large accelerated filer o
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Accelerated filer o
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Non-accelerated filer o
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Smaller reporting company þ |
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(Do not check if a smaller reporting company) |
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CALCULATION OF REGISTRATION FEE
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Proposed |
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Proposed |
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maximum |
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maximum |
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offering |
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aggregate |
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Amount to be |
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price per |
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offering |
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Amount of |
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Title of each class of securities to be registered |
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registered (1) |
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security (2) |
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price(2) |
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registration fee (3) |
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Common Stock, $0.001 par value (2) |
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87,172,755 Shares of Common Stock |
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0.105 |
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9,153,139.28 |
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1,062.68 (3) |
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(1) |
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All of the shares are offered by the selling stockholder. This registration statement
includes an indeterminate number of additional shares of common stock issuable for no
additional consideration pursuant to any stock dividend, stock split, recapitalization or
other similar transaction effected without the receipt of consideration, which results in an
increase in the number of outstanding shares of our common stock. In the event of a stock
split, stock dividend or similar transaction involving our common stock, in order to prevent
dilution, the number of shares registered shall be automatically increased to cover the
additional shares in accordance with Rule 416(a) under the Securities Act of 1933. |
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(2) |
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Estimated solely for the purpose of calculating the registration fee pursuant to Rule 457(c)
under the Securities Act of 1933, using the average of the high and low prices as reported on
the NASDAQ Capital Market on June 20, 2011, which was $0.105 per share. |
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(3) |
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Previously paid |
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The Registrant hereby amends this Registration Statement on such date or dates as may be
necessary to delay its effective date until the Registrant shall file a further amendment which
specifically states that this Registration Statement shall thereafter become effective in
accordance with Section 8(a) of the Securities Act of 1933 or until the Registration Statement
shall become effective on such date as the Commission, acting pursuant to Section 8(a), may
determine.
This information in this prospectus is not complete and may be changed. We may not sell these
securities until the registration statement filed with the Securities and Exchange Commission is
effective. This prospectus is not an offer to sell these securities and it is not soliciting an
offer to buy these securities in any state where the offer or sale is not permitted.
PRELIMINARY
PROSPECTUS SUBJECT TO COMPLETION, DATED JULY 29, 2011
87,172,755 Shares of Common Stock
This prospectus relates to the resale of 87,172,755 shares of our common stock by one of our
stockholders, or selling stockholder, named in the section of this prospectus titled Selling
Stockholder. The following shares may be offered for resale under this prospectus: 60,241,177
shares underlying convertible notes and 26,931,578 shares underlying warrants issued to the selling
stockholder in a private placement.
Although we will pay all of the expenses incident to the registration of the shares, we will
not receive any proceeds from the sales by the selling stockholder. We will, however, to the extent
the warrants are exercised for cash, as opposed to being exercised on a cashless basis, receive
proceeds from such exercises. To the extent we receive such proceeds, they will be used for
working capital purposes.
Our common stock is listed on the OTC Bulletin Board under the symbol COIN. On July 25,
2011, the closing sale price of our common stock on the OTC Bulletin Board was $0.07 per share.
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 the
section entitled Risk Factors.
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.
The date of this prospectus is
, 2011
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 section
entitled Risk Factors. Reference to we, us, our, Converted Organics or the Company
means Converted Organics Inc. and its subsidiaries.
Our Company
Converted Organics Inc. utilizes innovative clean technologies to establish and operate
environmentally friendly businesses. We are dedicated to creating a cleaner, greener future, and we
operate using sustainable business practices that support this vision.
Converted Organics currently operates in three business areas: Organic Fertilizer, Industrial
Wastewater Treatment, and Vertical Farming.
Organic Fertilizer. The Company operates a processing facility that converts food waste and
other feedstock into all-natural fertilizers, biostimulants, and soil amendment products. Using
these products allows agricultural businesses, lawn care professionals, and home gardeners to grow
healthier crops while simultaneously supporting the recycling of food waste.
Industrial Wastewater Treatment. Utilizing an innovative wastewater treatment process,
Converted Organics Industrial Wastewater Resources division (IWR) provides a means of treating
aqueous waste streams. This technology, which can use waste heat and renewable energy as fuel,
produces only two byproducts: clean water vapor and landfill-appropriate residual solids.
Vertical Farming. We also engage in vertical farming through our TerraSphere business, which
builds efficient systems for growing pesticide-free organic produce in a controlled indoor
environment. TerraSpheres clean technology helps to promote the sustainable consumption of natural
resources by accelerating plant production and maximizing crop yields. This technology also lessens
environmental footprints through the reduction of carbon emissions and fuel use associated with
traditional crop production and distribution.
Recent Financial Results. For
the years ended December 31, 2010 and 2009, we incurred a net loss of approximately $50.7 million and $21.1 million,
respectively, had an accumulated deficit of $100.5 million and $49.9 million, respectively, and had outstanding debt
of approximately $729,000 and $21,121,000 respectively. For the three months ended March 31, 2011 and 2010, we incurred
a net loss of approximately $1.8 million and $6.4 million, respectively, had an accumulated deficit of $102.2 million
and $56.3 million, respectively, and had outstanding debt of $320,000 and $20,109,000 respectively.
Going Concern. There exists
substantial doubt regarding our ability to continue as a going concern. Our independent registered public accounting firm
has added an emphasis of matter paragraph to their report for our fiscal year ended December 31, 2010 with respect to our
ability to continue as a going concern. 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, 2010 may materially and adversely affect our stock or our ability to raise new capital.
Need for Additional Capital. If
we do not receive additional funds in excess of the amount of cash on hand, whether as a result of the exercise of
outstanding warrants issued in our December 2010 financing, or otherwise, we will not be able to continue our operations.
We have projected our net cash out flows to be approximately $350,000 per month, and therefore, based on the cash on hand
as of the filing date of this report, we have sufficient cash to operate until the end of 2011 assuming we expend no cash
on future IWR, TerraSphere, or fertilizer capital projects. However, as our business strategy involves growing our IWR and
TerraSphere divisions, we expect that we will require additional cash prior to the end of 2011. At this time, we do not
have any commitments for additional financing, and there is no assurance that capital in any form will be available to us
on terms and conditions that are acceptable or at all.
Woodbridge Facility Closing.
On July 30, 2010, we temporarily halted production at our facility in Woodbridge, New Jersey (the Woodbridge facility)
in order to undertake steps to lower our cost structure at the Woodbridge facility. The Woodbridge facility was designed to service the
New York-Northern New Jersey metropolitan area. Specifically we attempted to negotiate more favorable terms under our
operating lease and to lower certain utility costs. We were unable to lower such costs and therefore, our management
determined that we could not sustain the negative cash flow from the Woodbridge facility and discontinued operations
at the Woodbridge plant.
Our principal executive office is located at 137A Lewis Wharf, Boston, MA 02110, and our phone
number is (617) 624-0111. Our website address is www.convertedorganics.com. Information contained
on our website does not constitute part of this prospectus.
Recent Developments
On July 7, 2011 our common stock
was delisted from the NASDAQ Capital Market and commenced trading on the OTC Bulletin Board. Over-the-counter markets are
generally considered to be less efficient than, and not as broad as, a stock exchange. There may be a limited market for
our stock now that it is quoted on the OTC Bulletin Board, trading in our stock may become more difficult and our share
price could decrease. Our common stock is also subject to penny stock rules, which impose additional sales practice
requirements on broker-dealers who sell our common stock. The SEC
generally defines penny stock as an equity security
that has a market price of less than $5.00 per share, subject to certain exceptions. The ability of broker-dealers to sell
our common stock and the ability of our stockholders to sell their shares in the secondary market will be limited and, as
a result, the market liquidity for our common stock will likely be adversely affected.
Private Placement of Notes and Warrants
In April 2011, we sold to an institutional investor a note and three warrants. We sold a
convertible note in the aggregate original principal amount of $3,850,000, which note is
convertible into shares of our common stock. The note was issued with an original issue discount of
approximately 9.1%, and the purchase price of the note was $3,500,000. The note is not interest
bearing, unless we are in default on the note, in which case the note carries an interest rate of
18% per annum.
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The note is initially convertible into shares of common stock at a conversion price of $0.40
per share, provided that if we make certain dilutive issuances (with limited exceptions), the
conversion price of the note will be lowered to the per share price for the dilutive issuances. We
are required to repay the note in five equal installments on
July 31, 2011; August 31, 2011; September 30, 2011; October 31, 2011; and November 30, 2011, either in cash
or in shares of our common stock. If we choose to utilize shares of our common stock for the
payment, we must make an irrevocable decision to use shares 23 trading days prior to the
installment payment date, and the value of our shares will be equal to 85% of the average of the
three lowest closing sale prices of our common stock during the 20 trading day period prior to
payment of the installment amount (the Installment Conversion Price). If we choose to make an
installment payment in shares of common stock, we must make a pre-installment payment of shares
(the Pre-Installment Shares) to the note holder 20 trading days prior to the applicable
installment date based on the value of our shares equal to 85% of the average of the three lowest
closing sale prices of our common stock during the 20 trading day period prior to payment of the
installment amount. On the installment date, to the extent we owe the note holder additional shares
in excess of the Pre-Installment Shares to satisfy the installment payment, we will issue the note
holder additional shares, and to the extent we have issued excess shares, such shares will be
applied to future payments.
If an event of default occurs under the note, we must redeem the note in cash at the greater
of 135% of the unconverted principal amount or 135% of the greatest equity value of the shares of
common stock underlying the note from the date of the default until the redemption is completed.
The conversion price of the note is subject to adjustment in the case of stock splits, stock
dividends, combinations of shares and similar recapitalization transactions. The convertibility of
the note may be limited if, upon exercise, the holder or any of its affiliates would beneficially
own more than 4.9% of our common stock.
Pursuant to the terms of the agreement governing the issuance of the above note, we also
issued to the investor warrants to acquire shares of common stock, in the form of three warrants:
(i) Series A Warrants, (ii) Series B Warrants and (iii) Series C Warrants (collectively, the
Warrants).
The Series B Warrants are exercisable six months and one day after issuance and expire March
13, 2012. The Series B Warrants provide that the holders are initially entitled to purchase an
aggregate of 9,143,750 shares at an initial exercise price of $0.4125 per share. If we make certain
dilutive issuances (with limited exceptions), the exercise price of the Series B Warrants will be
lowered to the per share price for the dilutive issuances. In addition, the exercise price of the
Series B Warrants will adjust to the average of the Installment Conversion Prices used to repay the
note discussed above. The floor price for the exercise price of the Series B Warrants is $0.34. The
number of shares underlying the Series B Warrants will adjust whenever the exercise price adjusts,
such that at all times the aggregate exercise price of the Series B Warrants will be $3,771,797.
To the extent we enter into a fundamental transaction (as defined in the Series B Warrants and
which include, without limitation, our entering into a merger or consolidation with another entity,
our selling all or substantially all of our assets, or a person acquiring 50% of our common stock),
we have agreed to purchase the Series B Warrants from the holders at their Black-Scholes value.
If our common stock trades at a price at least 200% above the Series B Warrants exercise price
for a period of 10 trading days, we may force the exercise of the Series B Warrants if we meet
certain conditions.
The Series A and Series C Warrants are exercisable six months and one day after issuance and
have a five year term commencing on the initial exercise date. The Series A Warrants provide that
the holders are initially entitled to purchase an aggregate of 4,812,500 shares at an initial
exercise price of $0.40 per share. The Series C Warrants provide that the holders are initially
entitled to purchase an aggregate of 4,343,285 shares at an initial exercise price of $0.425 per
share. If on the expiration date of the Series B Warrants, a holder of such warrant has not
exercised such warrant for at least 50% of the shares underlying such warrant, we have the right to
redeem from such holder its Series C Warrant for $1,000 under certain circumstances.
If we make certain dilutive issuances (with limited exceptions), the exercise price of the
Series A and Series C Warrants will be lowered to the per share price for the dilutive issuances.
In addition, the exercise price of the Series A and Series C Warrants will adjust to the average of
the Installment Conversion Prices used to repay the
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note discussed above. The number of shares underlying the Series A and Series C Warrants will
not be adjusted due to an adjustment of the exercise price pursuant to the preceding two sentences.
To the extent we enter into a fundamental transaction (as defined in the Series A and Series C
Warrants and which include, without limitation, our entering into a merger or consolidation with
another entity, our selling all or substantially all of our assets, or a person acquiring 50% of
our common stock), we have agreed to purchase the Series A and Series C Warrants from the holder at
their Black-Scholes value.
The exercise price of all the Warrants is subject to adjustment in the case of stock splits,
stock dividends, combinations of shares and similar recapitalization transactions. The
exercisability of the Warrants may be limited if, upon exercise, the holder or any of its
affiliates would beneficially own more than 4.9% of our common stock.
We and our subsidiaries entered into a security agreement with the investor pursuant to which
we and our subsidiaries granted the investor a security interest in all of our respective assets
securing our obligations under the above note. In addition, our subsidiaries entered into guaranty
agreements with the investor pursuant to which the subsidiaries guaranteed our obligations under
the note.
We entered into a registration rights agreement with the investor pursuant to which we agreed
to register the resale of 133% of the shares of common stock underlying the note and Warrants. We
agreed to file a registration statement within 10 days after we obtained shareholder approval of
the financing, which occurred on June 13, 2011. To the extent we fail to file the registration
statement on a timely basis or if the registration statement is not declared effective within 90
days after we obtained shareholder approval, we agreed to make certain payments to the investor.
The registration statement of which this prospectus is a part is being filed to satisfy the
foregoing obligations.
Shareholder Meeting
On June 13, 2011, we held our 2011 Annual Meeting of Stockholders at which our shareholders
approved, among other matters:
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the amendment of our Certificate of Incorporation to increase the number of shares
of common stock we are authorized to issue from 250,000,000 to 500,000,000; |
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the authorization of the Board to further amend the Certificate of Incorporation to
effect a reverse split of the our common stock within a range of 1-for-2 and 1-for-10; |
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the issuance of 20% or more of our common stock related to the note and Warrants
discussed above; |
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the future adjustments of the exercise prices of both the Series A and Series C
Warrants discussed above below their floor prices; and |
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the future adjustments of the exercise prices of certain of our currently
outstanding Class E and Class F Warrants. |
Reverse Split
On June 15, 2011, at a special meeting of the Board of Directors, our Board voted in favor of
not proceeding at this time with the reverse split approved by our shareholders on June 13,
2011.
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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.
We could fail to remain a going concern. We will need to raise additional capital to
fund our operations through the near term, and we do not have any commitments for that capital.
There exists substantial doubt regarding our ability to continue as a going concern.
Our independent registered public accounting firm has added an emphasis of matter paragraph to
their report for our fiscal year ended December 31, 2010 with respect to our ability to continue as
a going concern. 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,
2010 may materially and adversely affect our stock or our ability to raise new capital.
As reflected in our financial statements, for the year ended December 31, 2010, we incurred a
net loss of approximately $50.7 million and as of December 31, 2010, had an accumulated deficit of
$100.5 million, and had a working capital deficiency. If the Series B warrants issued in our
December 17, 2010 convertible note financing are exercised, we believe we will have sufficient
capital to fund our current operations through the end of 2011. However, in the months following
the issuance of the Series B warrants, our stock price has closed at both above and below the
exercise price of these warrants. It is unlikely that any warrants will be exercised at a time when
the price of our stock is below that of the exercise price.
We will need additional capital and/or increased sales to execute our business strategy, and
if we are unsuccessful in either raising additional capital or achieving desired sales levels we
will be unable to fully execute our business strategy on a timely basis, if at all. 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.
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.
Additionally, we do not know whether any financing, if obtained, will be adequate to meet our
capital needs and to support our growth. If we are unsuccessful in raising additional capital, we
may be unable to fully execute our business strategy on a timely basis, if at all. If adequate
capital cannot be obtained on satisfactory terms, we may curtail or delay 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.
Our common stock has been delisted from the NASDAQ
Capital Market, which may decrease the liquidity of our common stock and subject us to the SECs penny stock rules.
On July 7, 2011 our common stock
was delisted from the NASDAQ Capital Market and commenced trading on the OTC Bulletin Board. Over-the-counter markets are
generally considered to be less efficient than, and not as broad as, a stock exchange. There may be a limited market for
our stock now that it is quoted on the OTC Bulletin Board, trading in our stock may become more difficult and our share
price could decrease. Specifically, shareholders may not be able to resell their shares of common stock at or above the
price paid for such shares or at all.
In addition, our ability to raise
additional capital may be impaired because of the less liquid nature of the over-the-counter markets. While we cannot
guarantee that we would be able to complete an equity financing on acceptable terms, or at all, we believe that dilution
from any equity financing while our shares are quoted on an over-the-counter market could be substantially greater than
if we were to complete a financing while our common stock is traded on a national securities exchange. Further, now that
our stock is not traded on an exchange, upon the filing of our annual report for the year ended December 31, 2011, we will
no longer be eligible to use our outstanding shelf registration statement on Form S-3 for the registration of our
securities, which could impair our ability to raise additional capital as needed.
Our common stock is also
subject to penny stock rules, which impose additional sales practice requirements on broker-dealers who sell our
common stock. The SEC generally defines penny stock as an equity security that has a market price of less than $5.00
per share, subject to certain exceptions. The ability of broker-dealers to sell our common stock and the ability of our
stockholders to sell their shares in the secondary market will be limited and, as a result, the market liquidity for our
common stock will likely be adversely affected.
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We will need to obtain additional debt and equity financing to complete subsequent stages of
our business plan, including the funds required to expand our Fertilizer, Industrial Wastewater and
Vertical Farming businesses.
To meet future capital requirements necessary for the expansion of our business, 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.
If the National Organic Program changes its standards with respect to the use of corn steep liquor
in organic crop production, we may no longer be allowed to sell certain of our products into the
organic markets, which would materially lower our sales at our Gonzales facility.
In April 2011, the National Organic Standards Board (NOSB) did not vote in favor of
classifying corn steep liquor as synthetic, and as such it is still an acceptable product for us in
organic crop production. However, it is still possible that the NOSB could reverse this decision
in the future, which would have a significant negative effect on approximately 60% of our current
sales from the Gonzales facility. The two products that currently account for the majority of our
sales from the Gonzales facility into the organic agriculture market are both derived from corn
steep liquor. If corn steep liquor were to be classified as synthetic, we would have to reformulate
our highest selling products and then have the products certified for sale into the organic market.
Organic certification can take months to achieve and it is unclear if we would be able to find an
ingredient suitable to replace corn steep liquor.
We expect to incur significant losses for some time, and we may never operate profitably.
From inception through December 31, 2010, we have incurred an accumulated net loss of
approximately $100.5 million. The revenues that we began to generate from our Gonzales facility in
February 2008 and from our TerraSphere acquisition have not yet resulted in our earning 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.
We have limited operating history, we have recently added new lines of unproven businesses, 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 we operated in 2009 and part of 2010. In addition,
during the last year we added our IWR business and our vertical farming business, each of which are
unproven businesses. 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 not
achieve our goals and could suffer economic loss or collapse, which may have a material negative
effect on our financial performance.
If we are unable to manage our transition to a diversified operating company effectively, our
operating results will be adversely affected.
Failure to effectively manage our transition to a diversified 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
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options for additional facilities, hiring and training a sales force, and purchasing our
Gonzales facility. The transition to a diversified company with three divisions 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 effectively manage our transition to
operating a diversified company.
We currently operate three businesses, only one of which is cash flow positive.
We currently operate
three businesses, only one of which is cash flow positive. If we fail to generate sufficient undiscounted cash flows from the assets
acquired or purchased for these businesses, we may have to recognize any impairment of the value of those associated
assets in the future. Any such impairment would result in a charge to our operating results.
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, 2009. We must continue an ongoing program of 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 additional resources to Section 404 compliance on an
ongoing annual basis. We cannot predict how regulators will react or how the market prices of our
securities will be affected in the event that our Chief Executive Officer and Chief Financial
Officer determine that our internal control over financial reporting is not effective as defined
under Section 404.
Our future success is dependent on our existing key employees and hiring and assimilating new key
employees; 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 the 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 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. 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.
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.
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 own or 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
6
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 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.
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.
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 our environmental permits, 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 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 former 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
adversely affect our operation and have a material negative effect on our financial
performance.
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 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 or potential licensees from operating such facilities
according to our business plan.
For future facilities, particularly in the organic fertilizer and IWR areas, 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.
The fertilizer industry is highly competitive, which may adversely affect our ability to
generate and grow sales.
Chemical fertilizers are manufactured by many companies, are plentiful, and are
relatively inexpensive. In addition, there are over 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.
7
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.
Our High Temperature Liquid Composting, or 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.
Our Gonzales and discontinued Woodbridge facilities, 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 Gonzales facility site 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.
Although we have discontinued our operations at our former Woodbridge facility,
terminated our lease agreement, and surrendered the property to the landlord, we have received no
formal notification from the New Jersey Department of Environmental Protection (NJDEP) that the
plant shut-down has been deemed to be final. As such, there is still a possibility that the NJDEP
could determine that additional closure activities may be required at the site to complete the
final permit termination.
We have little or no experience in the fertilizer industry, which increases the risk of our
inability to build or license 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 both in business generally and
in the government and operation of 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, except for our Gonzales and our former Woodbridge facilities. In addition, none of our
directors has any prior experience in the food waste conversion or fertilizer products industries.
As a result, we may not develop our business successfully.
8
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 former Woodbridge facility, we experienced odor-related
issues. As a result of these issues, we were 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 have negotiated a settlement agreement
for the full amount of fines assessed. 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. Even though we have discontinued the operations at our Woodbridge facility these
issues could occur at future owned or licensed facilities.
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 facility relies on a few major
customers for a
majority of their revenues.
For the three month period
ended March 31, 2011, approximately 62% of its revenues were derived
from four customers Verdi Tech 25%; American Farms
15%; New
England pottery 12%; and Crop Production Services 10%.
We do not have any long-term agreements with any of our customers.
The loss of any of our major customers could adversely affect our
results of operations.
The operation of our Concentrators will require routine ongoing maintenance, which we are
responsible for.
Our current and future agreements with customers will require us to operate the Concentrators
and make repairs as necessary. Hiring employees local to the operating site that are capable of
performing these tasks is essential to our success.
Expansion of our IWR business is dependent upon our ability to secure project financing for the
building of new Concentrators.
Even if we are able to enter into an agreement with a new customer to provide wastewater
treatment services, we would be unable to perform under the contract should we be unable to finance
the building of a unit to be used at the customers site. Our IWR business is new and to date we
have not obtained financing for any IWR project. As such, we do not know whether we will be able to
obtain such project financing in the future, or what the terms of such project financing would be
if we were able to obtain the financing. We will not be able to finance the purchase of new
Concentrators from our internal working capital. Therefore, the failure to obtain project financing
in the future is critical to our ability to develop and commercialize our IWR business.
TerraSphere has a limited operating history and its prospects are difficult to
evaluate.
When we acquired TerraSphere in November of 2010, it was an early stage company whose
activities had been primarily limited to the development of its technology. As such, there is
limited historical financial information available, and the revenue and income potential of
TerraSpheres business is unproven. If TerraSphere is unable to develop its business and
consequently suffers economic loss or collapse, there may be a material negative effect on the
Companys financial performance.
TerraSpheres licensees are generally early stage companies and the failure of such licensees
to be successful may adversely affect TerraSpheres future revenues.
TerraSphere generates revenues from its licensee partners initially from license fees,
followed by such partners purchasing equipment from TerraSphere and finally from royalties from
product sales. If these licensees are not successful in securing the initial capital required to
begin operations, they may not be in a position to pay
9
TerraSphere future license fees, purchase equipment, or pay royalties. The failure of
TerraSpheres licensees may have a material adverse effect on TerraSpheres future revenues.
TerraSphere is dependent on a small number of major customers for its revenues.
To date, TerraSphere has relied on a few major customers for a majority of its revenues. We
have established a reserve for certain TerraSphere customer accounts receivable balances due us as
of December 31, 2010, and the loss of any of TerraSpheres major customers could slow down or
curtail our plans for growing the business. Since December 31, 2010, TerraSphere had not signed
any new licensees.
Sale of product produced from a TerraSphere facility will be subject to certain food safety
regulations.
In order to sell our produce, we must follow applicable food safety regulations. At
minimum, we must comply with laws enforced by federal agencies such as the FDA and USDA, and some
states may impose stricter standards than those of the federal government. In Canada we must also
comply with laws enforced by the Canadian Food Inspection Agency and other regulatory bodies.
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 and price-protection provisions that may result in the
reduction of their exercise prices in the future.
As of June 20, 2011, we have outstanding warrants to purchase 95,874,655 shares of common
stock. The holders of these warrants are given the opportunity to profit from a rise in the market
price of our common stock. 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 majority of these warrants contain price-protection provisions under
which, if were to issue securities at a price lower than the exercise price of such warrants, the
exercise price of the warrants would be reduced, with certain exceptions, to the lower price. In
the past, we have entered into transactions that have resulted in the reduction of the exercise
price of our outstanding warrants.
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 additional 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.
10
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 2010 and 2011, we issued a significant number of shares of our common stock,
warrants to acquire shares of our common stock, preferred stock convertible into 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 to decline, and could materially impair our ability to
raise capital through the sale of additional securities.
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.
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; |
|
|
|
|
our ability to attract and retain key personnel; |
|
|
|
|
adoption of new accounting regulations and standards; |
|
|
|
|
|
adverse changes in the securities markets; and |
|
|
|
|
|
|
|
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
11
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.
USE OF PROCEEDS
If exercised, we will receive gross proceeds of approximately $3.8 million from the exercise
of the Series B Warrants. If exercised, we will receive a maximum of approximately $3.8 million
from the exercise of the Series A and Series C Warrants. If we make certain dilutive issuances
(with limited exceptions), the exercise price of the Series A and Series C Warrants will be lowered
to the per share price for the dilutive issuances. However, the number of shares underlying the
Series A and Series C Warrants will not be adjusted due to an adjustment of the exercise price. As
such, the proceeds we receive from the Series A and Series C Warrants may be reduced if the
exercise price of the Series A and Series C Warrants is lowered.
We will retain discretion over the use of the net proceeds we may receive, but we currently
intend to use such proceeds, if any, for working capital purposes.
We will not receive any proceeds from the
resale of shares of our common stock by the selling stockholder.
12
PRICE RANGE OF COMMON STOCK
Market Information
Our
common stock has been quoted on the OTC Bulletin Board since July 7, 2011. Our common stock was
listed on the NASDAQ Capital Market under the symbol COIN from
March 16, 2007 until July 7, 2011. Prior to March
16, 2007, there was no public market for our common stock. The following table presents the high and low bid price for
our
common
stock during the periods while our common stock was listed on the OTC Bulletin Board and the range
of high and low sales prices per share as reported on NASDAQ for the periods indicated
while our common stock traded on such exchange.
|
|
|
|
|
|
|
|
|
2009 |
|
High |
|
Low |
First Quarter |
|
$ |
4.05 |
|
|
$ |
0.76 |
|
Second Quarter |
|
$ |
2.19 |
|
|
$ |
0.76 |
|
Third Quarter |
|
$ |
1.48 |
|
|
$ |
0.95 |
|
Fourth Quarter |
|
$ |
1.30 |
|
|
$ |
0.59 |
|
|
2010 |
|
|
|
|
|
|
|
|
First Quarter |
|
$ |
1.14 |
|
|
$ |
0.68 |
|
Second Quarter |
|
$ |
1.18 |
|
|
$ |
0.61 |
|
Third Quarter |
|
$ |
0.72 |
|
|
$ |
0.39 |
|
Fourth Quarter |
|
$ |
0.58 |
|
|
$ |
0.32 |
|
|
2011 |
|
|
|
|
|
|
|
|
First Quarter |
|
$ |
0.49 |
|
|
$ |
0.30 |
|
Second Quarter (through July 25, 2011) |
|
|
$0.30 |
|
|
$ |
0.05 |
|
Holders
As of April 18, 2011, there were approximately 1,000 beneficial holders of our common stock.
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 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.
13
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 financial statements included elsewhere in this prospectus.
Introduction
Converted Organics Inc. (the Company or COIN) has three lines of business, (1) organic
fertilizer, (2) vertical farming and (3) industrial wastewater treatment. Based on the nature of
products and services offered, the Company has determined that all three lines of business are
reportable segments at March 31, 2011.
The Company evaluates performance based on several factors, of which the primary financial
measure is business segment operating income. There were no intersegment sales for the three months
ended March 31, 2011. The discreet financial information presented below is for the three month
period ended March 31, 2011.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Organic |
|
Vertical |
|
Industrial |
|
Corporate and |
|
|
|
|
Fertilizer |
|
Farming |
|
Wastewater |
|
Eliminations |
|
Consolidated |
Revenues |
|
$ |
644,000 |
|
|
$ |
|
|
|
$ |
95,176 |
|
|
$ |
|
|
|
$ |
739,176 |
|
Operating loss (1) |
|
|
(82,001 |
) |
|
|
(599,441 |
) |
|
|
(2,823 |
) |
|
|
(1,635,338 |
) |
|
|
(2,319,603 |
) |
Depreciation and
amortization(2) |
|
|
105,089 |
|
|
|
161,297 |
|
|
|
5,556 |
|
|
|
149,109 |
|
|
|
421,051 |
|
Interest expense(3) |
|
|
|
|
|
|
6,642 |
|
|
|
|
|
|
|
2,267,820 |
|
|
|
2,274,462 |
|
Net loss |
|
|
(82,001 |
) |
|
|
(381,080 |
) |
|
|
(2,823 |
) |
|
|
(1,334,568 |
) |
|
|
(1,800,472 |
) |
Total assets (4) |
|
|
3,744,506 |
|
|
|
12,354,315 |
|
|
|
2,108,468 |
|
|
|
991,607 |
|
|
|
19,198,896 |
|
Goodwill |
|
|
|
|
|
|
1,667,957 |
|
|
|
|
|
|
|
|
|
|
|
1,667,957 |
|
Property and
equipment additions |
|
|
123,564 |
|
|
|
2,255 |
|
|
|
1,600,000 |
|
|
|
|
|
|
|
1,725,819 |
|
|
|
|
(1) |
|
Operating loss of the principal businesses exclude corporate compensation, marketing expense,
professional fees and other unallocated expenses. |
|
(2) |
|
Depreciation and amortization expense associated with property and equipment,
intangibles and deferred financing fees. Corporate amortization expense relates to intangible asset
technological know-how. |
|
(3) |
|
Corporate interest expense is primarily related to amortization of discounts on convertible
notes payable. |
|
(4) |
|
Total business assets are the owned or allocated assets used by each business. Corporate assets
consist of cash, prepaid expenses, certain other assets, and deferred financing costs. |
14
Revenues are attributable to geographic areas based on the locations of the customers, which
are primarily within the continental United States. The fertilizer segment derived approximately
62% of its revenues from four customers (Verdi Tech 25%;
American Farms 15%; New England
pottery 12%; and Crop Production Services 10%)
and the industrial wastewater segment derived
100% of its revenue from one customer, South Canyon Waste Systems, Inc. for the three months ended March 31, 2011.
As of March 31, 2010, the Company was a single reportable segment.
Our operating structure is composed of our parent company, Converted Organics Inc. and the
subsidiaries listed below. Cash flow at the corporate level includes management and public company
expenses, revenues and expenses associated with the Industrial Wastewater Resources (IWR)
segment, and the revenues and costs of producing and selling the outsourced dry product fertilizer
product. It is the intention of management to transfer the operations of IWR and the dry fertilizer
product to a subsidiary level when business volumes become appropriate. The current subsidiaries of
COIN are as follows:
|
|
|
Converted Organics of California, LLC, a wholly-owned subsidiary of COIN, which
includes the operation of our Gonzales, California facility. |
|
|
|
|
Converted Organics of Woodbridge, LLC, a wholly-owned subsidiary of COIN, which
includes the discontinued operation of our Woodbridge, New Jersey facility. |
|
|
|
|
Converted Organics of Mississippi, LLC, a wholly-owned subsidiary of COIN,
established for the purpose of adding a poultry litter-based fertilizer product to the
Companys existing product lines. |
|
|
|
|
Converted Organics of Rhode Island, LLC, a 92.5% owned subsidiary of COIN , which
currently has no operating activity and which was originally established to include the
operation of a previously planned fertilizer facility in Rhode Island. On February 25,
2010, we signed a letter of intent with the non-controlling member in Converted
Organics of RI to sell substantially all of the assets and assign a limited select
amount of liabilities of Converted Organics of RI. This entity is currently inactive. |
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TerraSphere Inc. (TerraSphere Inc), a Delaware C corporation and wholly owned
subsidiary of COIN, was established to hold COINs investment in TerraSphere Systems
LLC (Systems LLC) in which COIN acquired a 95% interest on November 12, 2010. Systems
LLC owns 85% of TerraSphere Canada, LLC and 100% of Pharmasphere LLC, which in turn
owns 100% of PharmaSphere Worcester, LLC. COINs acquisition of its interest in Systems
LLC was approved by our shareholders at a special meeting held on September 16, 2010. |
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GoLocalProduceRI, LLC, a 83.34% owned subsidiary of COIN, which we acquired on
December 30, 2010 for the purpose of building and operating a TerraSphere facility. |
Organic Fertilizer Business
We operate a processing facility (Gonzales, CA) that uses food and agricultural waste as raw
materials to manufacture all-natural fertilizer and soil amendment products combining nutritional
and disease suppression characteristics for sale to our agribusiness market. During the first
quarter of 2011 we also contracted with a third party manufacturer and packager to produce an 8-1-4
dry fertilizer product. This product was manufactured for the purpose of continuing to supply our
established retail and turf management customers that were previously serviced by our Woodbridge,
NJ facility, which closed in 2010.
Converted Organics of California, LLC Gonzales Facility
15
The Gonzales facility is our production facility that services a strong West Coast
agribusiness customer base through established distribution channels. This facility uses our
proprietary technology and process known as High Temperature Liquid Composting, or HTLC
® , which processes various biodegradable waste products into liquid and food
waste-based fertilizer and a limited amount of solids that could be further processed into a
useable form for use in agriculture, retail, and professional turf markets.
The Gonzales facility began to generate positive cash flow in June 2009 and has continued to
do so through March 2011. For the three month period ended March 31, 2011, the Gonzales facility
generated revenues of $564,000 and had a positive gross margin of $184,000, or 33% (based on no
allocation of corporate overhead). We plan to continue to improve this operating margin by
maximizing the production capacity at the facility, as discussed below, by generating tip fees from
receiving additional quantities of solid food waste for processing and by reducing the amount of
raw material and freight costs currently associated with the production process. 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. In addition, we have plans to triple
production capacity of the Gonzales plant and further modify it to enable production of both liquid
and solid fertilizers. 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 due to a lack of market demand for a dry product within the area the Gonzales
facility serves.
We believe that additional liquid production capacity could be achieved by adding storage tanks and dry
product capacity could be added by installing a drying and bagging line. We estimate costs to increase liquid
capacity by adding storage tanks would be approximately $200,000 to $300,000 and dry line costs would approximate
$500,000 to $600,000. At this time we have not committed to any such costs and have not developed a precise timeline
for the completion of these projects, if they should begin.
In addition, we will have to obtain the proper building permits for continued expansion,
further development of the Gonzales facility will be delayed until additional market research has
been completed and those permits are obtained. If sales increase above the current per month level,
we expect the additional cash flow from the Gonzales facility will be used to offset operating
expenses at the corporate level.
In addition to sales of fertilizer product from our Gonzales facility, we sold approximately
$80,000 of dry fertilizer product for the three month period ended March 31, 2011. We produced this
dry 8-1-4 product using a third party manufacturer in order to supply product to our major retail
customer and landscaping customers. Through March 31, 2011 we have produced enough of this
fertilizer to supply a further $130,000 of orders, which will ship during the second quarter or
2011.
Industrial Wastewater Resources Business
In March 2010, we began to operate an Industrial Wastewater Resources (IWR) division of the
Company to leverage our exclusive license of the LM-HT ® Concentrator technology for the
treatment of industrial wastewater (IW). Due to its unique, energy efficient design, the LM-HT
® Concentrator provides a highly cost-effective alternative to traditional IW treatment
technology. Once the LM-HT ® Concentrators are installed, we plan to apply for carbon
credits and government grants based on the technologys ability to reduce carbon emissions and
energy consumption through its use of waste heat and renewable energy as thermal fuel.
On March 23, 2010, we entered into a loan and license agreement with Heartland Technology
Partners, LLC (HTP). The loan agreement required us to advance $500,000 to HTP in three monthly
installments that commenced upon signing of the loan. The outstanding principal balance of the loan
is due if either a change of control of HTP or the completion by HTP of a financing in excess of
$10 million occurs on or before June 30, 2012. In consideration for entering into the loan
agreement, we were granted an exclusive, irrevocable license to utilize HTPs patented LM-HT
® Concentrator technology in the U.S. industrial wastewater market. The IW market
involves the treatment of waters that have been contaminated by anthropogenic industrial or
commercial activities, prior to their reuse or release into the environment. The LM-HT ®
Concentrator reduces carbon emissions compared to traditional technologies by using waste heat and
renewable energy as thermal fuel. We have hired a senior executive in the wastewater processing
industry and have begun to develop plans to operate our Industrial Wastewater Resources division.
On July 30, 2010, we signed a letter of intent with Spirit Services, Inc. to jointly develop an
energy and IW treatment facility using our exclusively licensed technology to evaporate IW at a
facility in South Boston, Virginia. In addition we have entered into discussions with various
parties to establish relationships to jointly develop IW treatment facilities at certain
established waste treatment facilities in the United States. Such relationships are in the
development stage and we expect to build upon them, as well as secure new partnerships in 2011.
IWR currently operates an industrial wastewater concentrator on Glenwood Springs Landfill
Enterprises South Canyon Landfill in Glenwood Springs, CO as a result of an agreement signed on
January 11, 2011. This
16
facility is designed to treat 15,000 gallons of aqueous waste per day and is fueled by the
combustion of biomass diverted from disposal in the landfill. Among the IWs to be treated by the
plant are septic, wash waters, process waters, man-camp wastewaters, and wastewaters from oil and
gas exploration activities. Under this agreement we are paid a per gallon fee for the amount of IW
that we treat, less labor costs to operate the unit and a marketing fee to generate IW delivered to
the facility. In addition, we own the evaporator unit and are responsible for repairing and
maintaining it. As of January 2011 we began to generate revenue under this agreement from South
Canyon Landfills traditional method of wastewater treatment as we waited for conditional air
permits. Such permits were received in March 2011, at which time we paid $600,000 of the $1.6
million purchase price of the evaporator and the unit commenced operations. For the three months
ended March 31, 2011 we recorded revenues of approximately $95,000 and gross margin of
approximately $69,000 or 72% from treatment of industrial waste water at this facility.
Our plan to increase business and revenues for IWR is to seek out municipal and industrial
locations to locate our owned evaporator units and to charge a per gallon fee to treat industrial
wastewater. We plan to follow the current agreement model where we would pay for labor, repairs and
marketing (if required) at the location. We will have to seek specific project financing for each
evaporator unit. Presently, we are in discussion with four potential owners of locations where an
evaporator unit could be located. We expect that in 2011, if we are able to secure project
financing, we will be able to begin operations on a second evaporator unit, in addition to the one
being operated at the Glenwood Springs Landfill.
Vertical Farming Business
On May 20, 2010, we formed TerraSphere Inc., a Delaware C corporation and a wholly owned
subsidiary of the Company, for the purpose of acquiring the membership interests of TerraSphere
Systems LLC (Systems LLC). On July 6, 2010, a membership interest purchase agreement was entered
into by the Company, TerraSphere Inc., Systems LLC, and the members of Systems LLC, pursuant to
which we agreed to acquire the membership interests of Systems LLC. The maximum total shares that
could be issued for Systems LLC is estimated to be 34,166,667 shares of our common stock, which
includes earn-out share payments of up to 14,603,175 shares of our common stock. Pursuant to the
purchase agreement, the acquisition was approved by our shareholders on September 16, 2010, and the
Company acquired 95% of the membership interest of Systems LLC on November 12, 2010. We agreed to
issue up to 32,777,778 shares of our common stock to the members of Systems LLC in exchange for 95%
of the units of Systems LLC, subject to certain anti-dilution adjustments. Of these shares,
18,174,603 shares were issued on November 12, 2010, the closing of the acquisition, and the
remainder of the shares will be issued if TerraSphere achieves four milestones. As of the filing
date of this report, only one of the four milestones, TerraSpheres collection of $2.0 million of
its accounts receivable by February 28, 2011, was subject to measurement. This milestone was not
met, and as a result we will not issue the 1,825,397 shares of our common stock associated with
that milestone. Two of three remaining milestones (market capitalization and gross margin), are to
be measured as of December 31, 2011, and the final milestone (gross margin) is to be measured at
December 31, 2012.
For more information regarding the TerraSphere milestone payments, please see Note 4 Acquisitions
TerraSphere Systems LLC Acquisition of our audited financial statements for the year ended December 31, 2010 set forth in this prospectus.
On December 30, 2010 we also acquired an 83.34% ownership in GoLocalProduceRI,
LLC (an independent TerraSphere licensee) for the purpose of building and owning a TerraSphere
facility.
Systems LLC is in the business of designing, building, and operating highly efficient and
scalable systems, featuring a patented, proprietary technology that utilizes vertically-stacked
modules to house rows of plants, which are then placed perpendicular to an interior light source to
grow pesticide and chemical-free organic fruits and vegetables. Due to a controlled, indoor
environment, the system generates fresh produce year-round in any location or climate world-wide.
The following pro forma condensed statement of operations information is presented to
illustrate the effects upon the quarter ended March 31, 2010 had the acquisitions of TerraSphere
and GoLocalProduceRI been completed on January 1, 2010. The pro forma presentation 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 the Companys 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.
17
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For the |
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Quarter |
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Ended |
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March 31, |
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2010 |
Revenue |
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$ |
2,544,009 |
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Net loss |
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$ |
(6,000,008 |
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Net loss per share, basic and diluted |
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$ |
(0.11 |
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Weighted average common shares outstanding |
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56,389,068 |
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Recent Financing Activities
December 17, 2010 and March 7, 2011 Notes and Warrants
On December 17, 2010, we entered into a Securities Purchase Agreement (the Agreement) with
certain institutional investors whereby we agreed to sell to the investors convertible notes in the
aggregate original principal amount of $4,990,000 (the Notes), which are convertible into shares
of our common stock. The Notes were issued with an original issue discount of approximately 4.8%,
and the purchase price of the Notes was $4,750,000. The Notes are not interest bearing, unless we
are in default on the Notes, in which case the Notes carry an interest rate of 18% per annum. On
December 17, 2010 we sold to the Buyer $3,940,000 of the Notes and on March 7, 2011 we sold the
investors the remaining $1,050,000 of the notes. We were required to repay the Notes in six equal
installments commencing February 1, 2011, with respect to $3.94 million of the Notes, and April 8,
2011, with respect to $1.05 million of the Notes, either in cash or in shares of our common stock.
If we choose to utilize shares of our common stock for the payment, the value of our shares will be
equal to the lower of (i) the conversion price then in effect or (ii) 85% of the average of the
three lowest closing sale prices of our common stock during the 20 trading day period prior to
payment of the installment amount. We also have the right, at our option, to permit the holder of
the Notes to convert at a lower price specified by us for a period specified by us.
In addition, we also issued to the investors warrants to acquire shares of common stock, in
the form of three warrants: (i) Series A Warrants, (ii) Series B Warrants, and (iii) Series C
Warrants (collectively, the Warrants).
The Series B Warrants became exercisable on February 28, 2011, the date upon which shareholder
approval was obtained in connection with the financing, and expire on November 28, 2011. The Series
B Warrants provided that the holders were initially entitled to purchase an aggregate of 4,990,000
shares at an initial exercise price of $1.00 per share. The Series B Warrants were also subject to
certain protections against certain dilutive issuances (with limited exceptions), and the exercise
price of the Series B Warrants was subject to adjustment to the average of the conversion prices
used to repay the Notes discussed above. The floor price for the exercise price of the Series B
Warrants is $0.34 and the number of shares underlying the Series B Warrants adjusts whenever the
exercise price adjusts, such that at all times the aggregate exercise price of the Series B
Warrants will be $4,990,000. As of the date hereof, the exercise price of the Series B Warrants is
$0.345 per share and there are 14,463,768 shares underlying the Series B Warrants.
The Series A and Series C Warrants became exercisable on February 28, 2011, the date upon
which shareholder approval was obtained in connection with the financing, and have a five year
term. Should we make
certain dilutive issuances (with limited exceptions), the exercise price of the Series A and
Series C Warrants will be lowered to the per share price for the dilutive issuances. In addition,
the exercise price of the Series A and Series C Warrants will adjust to the average of the
conversion prices used to repay the Notes as discussed above. As of the date hereof, the exercise
price of the Series A Warrants and Series C Warrants is $0.22 per share.
18
April 1, 2011 Notes and Warrants
On April 1, 2011, we entered into a Securities Purchase Agreement with an institutional
investor whereby we agreed to sell to the investor a convertible note in the aggregate original
principal amount of $3,850,000 (the Note), which is convertible into shares of our common stock.
The Note was issued with an original issue discount of approximately 9.1%, and the proceeds from
the Note was $3,500,000. The Note is not interest bearing, unless we are in default on the Note, in
which case the Note carries an interest rate of 18% per annum.
The Note is initially convertible into shares of common stock at a conversion price of $0.40
per share, provided that if we make certain dilutive issuances (with limited exceptions), the
conversion price of the Note will be lowered to the per share price for the dilutive issuances. We
are required to repay the Note in five equal installments commencing July 31, 2011, either in cash
or in shares of our common stock. If we choose to utilize shares of our common stock for the
payment, we must make an irrevocable decision to use those shares 23 trading days prior to the
installment payment date, and the value of our shares will be equal to 85% of the average of the
three lowest closing sale prices of our common stock during the 20 trading day period prior to
payment of the installment amount (the Installment Conversion Price). If we choose to make an
installment payment in shares of common stock, we must make a pre-installment payment of shares
(the Pre-Installment Shares) to the Note holder 20 trading days prior to the applicable
installment date based on the value of our shares equal to 85% of the average of the three lowest
closing sale prices of our common stock during the 20 trading day period prior to payment of the
installment amount. On the installment date, to the extent we owe the Note holder additional shares
in excess of the Pre-Installment Shares to satisfy the installment payment, we will issue the Note
holder additional shares, and to the extent we have issued excess shares, such shares will be
applied to future payments. If an event of default occurs under the Note, we must redeem the Note
in cash at the greater of 135% of the unconverted principal amount or 135% of the greatest equity
value of the shares of common stock underlying the Note from the date of the default until the
redemption is completed.
The conversion price of the Note is subject to adjustment in the case of stock splits, stock
dividends, combinations of shares and similar recapitalization transactions. The convertibility of
the Note may be limited if, upon exercise, the holder or any of its affiliates would beneficially
own more than 4.9% of our common stock.
Pursuant to the terms of the Purchase Agreement, we also agreed to issue to the Buyer warrants
to acquire shares of common stock, in the form of three warrants: (i) Series A Warrants, (ii)
Series B Warrants and (iii) Series C Warrants (collectively, the Warrants).
The Series B Warrants are exercisable six months and one day after issuance and expire on
March 13, 2011. The Series B Warrants provide that the holders are initially entitled to purchase
an aggregate of 9,143,750 shares at an initial exercise price of $0.4125 per share. If we make
certain dilutive issuances (with limited exceptions), the exercise price of the Series B Warrants
will be lowered to the per share price for the dilutive issuances. In addition, the exercise price
of the Series B Warrants will adjust to the average of the Installment Conversion Prices used to
repay the Note (see above for a discussion of the Note installment payments). The floor price for
the exercise price of the Series B Warrants is $0.34. The number of shares underlying the Series B
Warrants will adjust whenever the exercise price adjusts, such that at all times the aggregate
exercise price of the Series B Warrants will be $3,771,797.
To the extent we enter into a fundamental transaction (as defined in the Series B Warrants and
which include, without limitation, our entering into a merger or consolidation with another entity,
our selling all or substantially all of our assets, or a person acquiring 50% of our common stock),
we have agreed to purchase the Series B Warrants from the holders at their Black-Scholes value.
If our common stock trades at a price at least 200% above the Series B Warrants exercise price
for a period of 10 trading days at any time after we obtain shareholder approval (as discussed
above), we may force the exercise of the Series B Warrants if we meet certain conditions.
The Series A and Series C Warrants are exercisable six months and one day after issuance and
have a five year term commencing on the initial exercise date. The Series A Warrants provide that
the holders are initially entitled to purchase an aggregate of 4,812,500 shares at an initial
exercise price of $0.40 per share. The Series C
19
Warrants provide that the holders are initially
entitled to purchase an aggregate of 4,343,285 shares at an initial exercise price of $0.425 per
share. If on the expiration date of the Series B Warrants, a holder of such warrant has not
exercised such warrant for at least 50% of the shares underlying such warrant, we have the right to
redeem from such holder its Series C Warrant for $1,000 under certain circumstances.
If we make certain dilutive issuances (with limited exceptions), the exercise price of the
Series A and Series C Warrants will be lowered to the per share price for the dilutive issuances.
In addition, the exercise price of the Series A and Series C Warrants will adjust to the average of
the Installment Conversion Prices used to repay the Note (see above for a discussion of the Note
installment payments). Until we obtain shareholder approval (as discussed above), the floor price
of the Series A and Series C Warrants is $0.34. The number of shares underlying the Series A and
Series C Warrants will not be adjusted due to an adjustment of the exercise price pursuant to the
preceding two sentences.
To the extent we enter into a fundamental transaction (as defined in the Series A and Series C
Warrants and which include, without limitation, our entering into a merger or consolidation with
another entity, our selling all or substantially all of our assets, or a person acquiring 50% of
our common stock), we have agreed to purchase the Series A and Series C Warrants from the holder at
their Black-Scholes value.
The exercise price of all the Warrants is subject to adjustment in the case of stock splits,
stock dividends, combinations of shares and similar recapitalization transactions. The
exercisability of the Warrants may be limited if, upon exercise, the holder or any of its
affiliates would beneficially own more than 4.9% of our common stock. The Note may not be converted
if the total number of shares that would be issued would exceed 19.99% of our common stock on the
date the Purchase Agreement was executed prior to our receiving shareholder approval (as discussed
above).
Future Development
Our long-term strategic plan calls for growth of our organic fertilizer business as well as
expansion of our portfolio of sustainable, environmentally-friendly businesses. To grow our
existing fertilizer business, we plan to develop and license additional organic fertilizer
manufacturing facilities and utilize the remaining capacity of our Gonzales facility which
currently operates at approximately 60% capacity. In connection with our plan to expand the
capacity of our Gonzales facility, we plan to increase production to approximately three times the
facilitys current production and, based on market demand, we may expand the capability of the
plant to have the ability to produce both liquid and solid products. In connection with the plan
for additional facilities, we have completed preliminary work aimed at establishing facilities in
Massachusetts, where we have performed initial development work in connection with construction of
three manufacturing facilities to serve the eastern Massachusetts market. Two of our proposals to
develop facilities are currently under review by the property owners. The third proposal has
evolved into the MassOrganics I transaction described below. The Massachusetts Strategic
Envirotechnology Partnership Program has completed a review of our technology.
We also plan to grow both our TerraSphere and Industrial Wastewater Resources divisions.
Through the TerraSphere acquisition, our plan is to expand our business into the market of building
highly efficient systems for growing pesticide and chemical-free, organic fruits and vegetables in
controlled indoor environments. TerraSpheres clean technology helps to promote the sustainable
consumption of natural resources by accelerating plant production and maximizing crop yields, while
improving environmental footprints through the reduction of carbon emissions and fuel use
associated with traditional crop production and distribution. Also, we will continue to grow our
Industrial Wastewater Resources division by working to form industry and/or project-based
partnerships that utilize our exclusively licensed, irrevocable technology to treat industrial
wastewaters.
We have developed 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. The
semi-portable units are capable of operating indoors or outdoors and may be as sophisticated or as
basic in design and function as the owner/user requires. The SMART units will be delivered to
jobsites in 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
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where their units operate. We plan to market and sell the SMART units in
both the United States and abroad. We have also begun the development of a licensing program, under
which we will license to third parties, the right to use our proprietary HTLC technology. The
licensing program consists of a know-how license, which could be complemented with SMART unit sales
so that any individual or entity buying a SMART unit would also receive a license agreement to use
our technology. We are working to patent our process and technology and anticipate that we will
expand upon the licensing program when the necessary patent registrations are achieved. To date, we
have had neither sales of these units nor licenses.
Trends and Uncertainties Affecting our Operations
We will be subject to a number of factors that may affect our operations and financial
performance. These factors include, but are not limited to, the available supply and price of
organic food waste, the market for liquid and solid organic fertilizer, increasing energy costs,
the unpredictable cost of compliance with environmental and other government regulation, and the
time and cost of obtaining USDA, state or other product labeling designations. Demand for organic
fertilizer and the resulting prices customers are willing to pay also may not be as high as we
expect. In addition, supply of organic fertilizer products from the use of other technologies or
other competitors may adversely affect our selling prices and consequently our overall
profitability. In addition, a significant part of our growth strategy is based upon generating
revenues from both our Industrial Wastewater business and from the acquisition of TerraSphere
Systems, both of which are in early stages of development. This strategy requires licensees to
raise the funding necessary to construct facilities, which has proven difficult. Furthermore our
plan calls for raising additional debt and/or equity financing to construct additional operating
facilities. Currently there has been a slowdown in lending in both the equity and bond markets
which may hinder our ability to raise the required funds.
Liquidity and Capital Resources
At March 31, 2011, we had total current assets of approximately $2.4 million consisting
primarily of cash, accounts receivable, inventory and prepaid assets and had current liabilities of
approximately $10.0 million, consisting primarily of convertible notes payable, accounts payable,
derivative liabilities and liabilities from discontinued operations leaving us with negative
working capital of approximately $7.6 million. Non-current assets totaled approximately $16.8
million and consisted primarily of property and equipment and intangible assets. Non-current
liabilities consist of derivative liabilities totaling approximately $3.0 million at March 31,
2011. We have an accumulated deficit at March 31, 2011 of approximately $102 million. Owners
equity at March 31, 2011 was approximately $6.2 million. For the three months ended March 31, 2011,
we generated revenues from continuing operations of approximately $739,000 as compared to revenue
from continuing operations of $712,000 for the same period in 2010.
Although the California fertilizer business is currently cash flow positive and the closing of
the Woodbridge facility in the third quarter of 2010 will save us approximately $6.0 million per
year in net cash expenditures, we believe that we will continue to have negative cash flow from
operations in 2011 due to the costs associated with corporate operations and funding the operations
of TerraSphere. In addition, we believe that we will require additional cash to finance capital
growth activities in order to build out the IWR and TerraSphere projects planned for 2011.
However, we could lose that revenue in the future if we fail to finance the required equipment purchase estimated to
be $1.0 million, of which we have paid $200,000 and of which $300,000 is currently overdue. We believe that we could
complete a TerraSphere facility in 6-8 months if we were able to obtain the required financing.
We
believe that if we achieve planned sales from our California facility, establish additional
operational Industrial Wastewater sites, and complete the construction of a TerraSphere facility,
then we can become cash flow positive in the future. In order to achieve these goals, however, we
will need significant additional financing for which we have no commitments.
Presently, our liquidity is limited to our cash on hand at March 31, 2011 and the $3.5 million
that we received on April 20, 2011 as a result of the sale of convertible notes under a financing
agreement entered into on
April 1, 2011. In addition, in connection with our December 2010 financing, we have warrants
outstanding that if exercised could provide us with an additional $4.9 million. However, since
receiving shareholder approval our stock price has closed at both above and below the exercise
price of these warrants, and it is not likely that any warrants would be exercised unless the price
of our stock was greater than the exercise price of the warrants. There is no assurance that the
holders of the warrants will exercise the warrants in the near term, and as such, we may not
receive these funds.
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If we do not receive additional funds in excess of the amount of cash on hand, whether as
a result of the exercise of outstanding warrants issued in our December 2010 financing, or
otherwise, we will not be able to continue our operations. We have projected our net cash out flows
to be approximately $350,000 per month, and therefore, based on the cash on hand as of the filing
date of this report, we have sufficient cash to operate until the end of 2011 assuming we expend no
cash on future IWR, TerraSphere, or fertilizer capital projects. However, as our business strategy
involves growing our IWR and TerraSphere divisions, we expect that we will require additional cash
prior to the end of 2011. At this time, we do not have any commitments for additional financing,
and there is no assurance that capital in any form will be available to us on terms and conditions
that are acceptable or at all.
Results of Continuing Operations
Results of OperationsComparison of Three Months Ending March 31, 2011 and 2010
Revenue
Our revenues from continuing operations for the three month period ended March 31, 2011, was
$739,000 compared to $712,000 for the same period ended March 31, 2010. The various components are
described below.
Revenue from fertilizer was $644,000 for the three month period ended March 31, 2011 ($565,000
for liquid fertilizer from Gonzales and $79,000 from the outsourced dry fertilizer) compared to
$595,000 for the same period ended March 31, 2010. This increase of $49,000 in revenues is due to
an increase in the sale of dry product produced by an outside vendor of $79,000 offset by a
decrease in sales at the Gonzales facility of $30,000. We feel that the slight decrease in sales
from Gonzales was immaterial and was caused by bad weather during the period, and our expectations for increased sales in
2011 over 2010 will be achieved as we enter the active selling season. We expect sales from our dry
product being produced by an outside vendor at a negative margin will continue through the second
quarter of 2011, but as this program was initiated to satisfy two large customers who historically
only purchase product in the first half of the year.
Converted Organics of Mississippi, formed in January 26, 2010, generated revenues of $117,000
during the first quarter of 2010. In the first quarter of 2011, this entity had no revenue as the
Company that we purchased the product from has filed for bankruptcy protection and the product is
no longer available.
The Industrial Wastewater Resources segment of our business recognized revenues in the amount
of $96,000 in the three month period ended March 31, 2011. This segment had no revenues in 2010, as
it was in the start up phase of operations.
Our TerraSphere segment did not report any revenues for the three month period ended March 31,
2011. TerraSphere continues to seek opportunities whereby it will generate license revenues from
new licensees, generate equipment revenues from current licensees, and is also seeking financing to
complete a production facility in Rhode Island, whereby we would generate revenues from the sale of
produce. We do expect to generate revenues from TerraSphere in 2011.
Cost of Goods Sold
For the three month period ended March 31, 2011, we had cost of goods of approximately
$504,000 compared to $565,000 for the same period in 2010. The decrease in cost of goods sold is
detailed below.
Cost of goods sold related to fertilizer at the Gonzales facility was approximately $380,000
for the three months ended March 31, 2011, leaving an operating margin of $184,000 or 33%, compared
to cost of goods of $498,000 for the same period in 2010 and an operating margin of 16% . This
favorable variance is due to decreased materials and production costs in the first quarter of 2011.
Cost of goods for our dry fertilizer product (produced by an outside supplier) was
approximately $98,000 for the three months ended March 31, 2011, leaving an operating margin of
negative 22%. There was no comparable activity in 2010. We expect that this negative trend will continue as we undertook this line
of business in order to
22
satisfy the requirements of two major customers that we did not want to
lose due to the closure of our New Jersey facility.
Cost of goods for our IWR segment was $26,000 for the three months ended March 31, 2011
leaving an operating margin of 73%. There was no comparable activity in 2010 as the business was in
the start of operations.
General and Administrative Expenses
General and administrative expenses for the three month period ended March 31, 2011 were
approximately $2.3 million compared to approximately $3.8 million for the same period in 2010. The
decrease of approximately $1.5 million is primarily comprised of a $700,000 non-cash decrease in
compensation expense, as stock options were not granted in the three months ended March 31, 2011,
but were in the months ended March 31, 2010; a decrease in marketing costs of $550,000; and a
decrease in professional fees of $250,000 associated with acquisition activity.
Interest Expense
Interest expense for the three months ended March 31, 2011 was approximately $2.3 million
compared to approximately $4,000 for the same period in 2010. This increase of approximately $2.3
million is directly associated with the amortization of debt discounts related to our convertible
notes and is a non-cash item.
Derivative gain (loss)
For the three months ended March 31, 2011, we had a derivative gain of approximately $2.4
million compared to a derivative loss of approximately $635,000 for the same period in 2010. This
is a non-cash gain and is related to the valuation of certain derivative features included in
certain of our warrants and convertible debt obligations, and included in an anti-dilution
provision related to shares issued in the TerraSphere acquisition. In addition, certain derivative
instruments were issued and settled during the quarter, which impacted the derivative gain (loss).
Results of OperationsComparison of the Years Ended December 31, 2010 and 2009
Summary of Comprehensive Loss from All Operations
For the year ended December 31, 2010 we reported a comprehensive loss attributable to
Convertible Organics Inc. of $50,562,336 compared to $21,105,788 for the year ended December 31,
2009. The major components of this loss are as follows:
|
|
|
|
|
|
|
|
|
|
|
Twelve months ending December 31, |
|
|
|
2010 |
|
|
2009 |
|
Loss from Continuing Operations |
|
$ |
16,039,025 |
|
|
$ |
7,642,304 |
|
Loss from Discontinued Operations |
|
|
34,690,358 |
|
|
|
13,463,484 |
|
Non-Controlling Interest and Foreign Currency |
|
|
(167,047 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Comprehensive Loss Attributable to Converted Organics, Inc |
|
|
50,562,336 |
|
|
|
21,105,788 |
|
|
|
|
|
|
|
|
23
Detail discussion of the above items is as follows:
For the year ended December 31, 2010 we had an after tax net loss from continuing operations
of $16.0 million compared to $7.6 million for the year ended December 31, 2009. The increase in the
net loss of $8.4 million is made up of the following favorable and (unfavorable) major components,
with further explanation and details following the table:
|
|
|
|
|
$ |
1,400,000 |
|
|
Increase in Sales |
$ |
(440,000 |
) |
|
Increase in Cost of Goods |
$ |
(7,500,000 |
) |
|
Increase in General and Administrative Expenses |
$ |
340,000 |
|
|
Decrease in R&D Expenses |
$ |
(6,000,000 |
) |
|
Decrease in Derivative Gains |
$ |
3,800,000 |
|
|
Decrease in Interest Expense |
|
|
|
|
$ |
(8,400,000 |
) |
|
Total Variance from Continuing Operations |
|
|
|
|
For the year ended December, 2010, we had sales from continuing operations of approximately
$3.5 million compared to $2.1 million for the year ended December 31. 2009. The $1.4 million
increase is composed of a $900,000 increase in sales from our Gonzales facility (attributed to both
an increase in volume and price increases for some of our products), and a $254,000 increase in
sales from sales of our chicken litter-based fertilizer product and $250,000 in sales from
TerraSphere licensing activities.
For the year ended December 31, 2010 we had cost of goods sold from continuing operations of
approximately $2.5 million compared to $2.1 million cost of goods sold for the same period in 2009.
Of the approximately $443,000 increase in cost of goods, $309,000 is related to our Gonzales
facility and $134,000 is related to chicken litter fertilizer product. For the Gonzales facility,
in 2010 we had sales of $3.0 million and cost of sales of $2.4 million, or a gross margin of 20%
(compared to only 1% gross margin in 2009). However, for the $900,000 increase in sales over 2009
from Gonzales, the cost of goods increased $309,000, generating a gross margin of 65% on those
incremental sales. We feel that further increases in sales at the Gonzales facility will help
overall margin to increase as the increased sales are spread over fixed costs at the facility.
During 2010 we had sales from our chicken based fertilizer products of $254,000 and cost of goods of $134,000
generating a gross margin of 45%. We do not expect sales from this product to continue into 2011.
We incurred General and Administrative expenses of approximately $14.6 million and $7.1
million for the years ended December 31, 2010 and 2009, respectively. The approximately $7.5
million increase in general and administrative expenses is due to increases of $1.5 million at the
corporate level related to additional personnel, non cash compensation expense for the issuance of
stock options, and occupancy expenses; increased professional and consulting fees of approximately
$2.7 million due mainly to costs associated with seeking potential acquisition candidates, as well
as increased sales and marketing costs of $1.0 million. In addition, we incurred approximately
24
$2.3 million of General and Administrative expenses at Terrasphere as we provided a reserve for certain
accounts receivable. We provided the reserve for accounts receivable at December 31, 2010 as
certain facts and circumstances relating to collectibility of the receivables had changed since the
fair value was determined on the acquisition date.
We incurred Research and Development costs of $287,000 and $626,000 for the years ended
December 31, 2010 and 2009, respectively. A major part of the decrease of $339,000 is related to
the impairment of a deposit on a second license of $139,000, which was expensed in 2009. The
remaining portion of the decrease is due to less spending, as we had completed most of our field
testing on our products.
During 2010 we recognized derivative losses of approximately $166,000 compared to derivative
gains of $5.8 million for 2009 due to the mark-to-market adjustments of certain financial
instruments. This item is a noncash loss and did not use cash for the 2010 loss nor did it
contribute cash for the gain recorded in 2009.
Interest expense for the years ended December 31, 2010 and 2009 was $1.7 million and $5.5
million, respectively. Interest expense in 2010 was associated with various notes held by the
company of approximately $200,000 and a non cash interest expense of approximately $1,500,000
associated with the derivative elements contained in our convertible debt, while the components of
interest expense for the year ended December 31, 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 $800,000 of interest expense
associated with the issuances of warrants related to the short-term non-convertible notes, (iii)
recognition of approximately $279,000 on our other various borrowings, and (iv) recognition of
approximately $3.2 million in amortization of discounts on our financing arrangement during the
year ended December 31, 2009.
As of December 31, 2010, we had current assets of approximately $4.3 million compared to $12.6
million as of December 31, 2009. Our total assets were approximately $19.6 million as of December
31, 2010 compared to approximately $35.1 million as of December 31, 2009. The majority of the
decrease in current assets from December 31, 2009 to December 31, 2010 is due to a decrease in cash
used to operate the business and a majority of the decrease in long term assets is represented by
the impairment of our Woodbridge, NJ facility of $15.4 million offset by an increase in intangible
assets if approx $10.4 million generated as a result of the TerraSphere Systems acquisition.
As of December 31, 2010, we had current liabilities of approximately $7.7 million compared to
$6.2 million at December 31, 2009. This increase is due largely to an increase in accounts payable
and term notes payable offset by a decrease in liabilities relating to discontinued operations. In
addition, we had long-term liabilities of approximately $8.6 million as of December 31, 2010 as
compared to $20.1 million at December 31, 2009. The decrease is due to settlement of long term
liabilities associated with discontinued operations ($18.5 million) offset by an increase in
derivative liabilities ($7.0 million).
For the year ended December 31, 2010 we had negative cash flows from operating activities of
approximately $11.5 million, comprising loss from operations of $50.7 million adjusted for certain
non-cash items such as depreciation, non-cash interest expense associated with the issuance of
convertible debt, the write-down of impaired assets at our Woodbridge facility, amortization of
deferred financing fees, an early termination lease penalty and an increase in accounts payable and
accrued expenses. We also had negative cash flows from investing
activities of $400,000, primarily related to purchase of fixed assets off-set by the release
of restricted cash The negative cash flows from both operating and investing activities was offset
by approximately $4.3 million in positive cash flows from financing activities comprising proceeds
from our various debt and equity transactions. The result of the above activities decreased our
cash position by approximately $7.6 million from December 31, 2009.
For the year ended December 31, 2009 we had negative cash flow from operating activity of
approximately $11 million, comprising loss from operations of $21 million adjusted for certain
non-cash items such as derivative gains, depreciation, non-cash interest expense associated with
the issuance of warrants, the write-down of impaired assets, amortization of deferred financing
fees and amortization of discounts on private financing, and an increase in
25
accounts payable and accrued expenses. We also had negative cash flow from investing activities of $2.5 million,
primarily related to construction at the New Jersey 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 $20.7 million in positive cash flow from financing
activities comprising proceeds from our various debt and equity transactions. The result of the
above activities increased our cash position approximately $7.3 million over our balance at
December 31, 2008.
Results of Discontinued Operations Comparison of the Years Ended December 31, 2010 and 2009
On July 30, 2010, the Company temporarily halted production at its Woodbridge facility in
order to undertake steps to lower its cost structure at the Woodbridge facility. Specifically, the
Company attempted to negotiate more favorable terms under its operating lease and to lower certain
utility costs. The Company was unable to lower such costs and therefore, management determined that
the Company could not sustain the negative cash flow from the Woodbridge facility and discontinued
operations at the Woodbridge plant during the quarter ended September 30, 2010. As a result, during
the quarter ended September 30, 2010, the Company recognized an impairment charge on the long-lived
assets of the Woodbridge facility to reduce the carrying value of the those assets to approximately
$1.5 million, which is the value that was expected to be received from the disposition of those
assets. The consolidated statements of operations and comprehensive loss includes an impairment
charge pertaining to those long-lived assets of approximately $15.4 million which is included in
loss from discontinued operations.
On October 18, 2010, the bonds payable and related accrued interest totaling approximately
$18.5 million were settled and extinguished for $17.5 million of Company preferred stock (See Note
11). In addition, as described below, the Company entered into a series of transactions on October
18, 2010 whereby certain assets and liabilities were assigned, transferred and or extinguished.
On October 18, 2010, the Company and the Woodbridge facilitys landlord (Lessor) entered
into a Termination and Surrender Agreement (Termination Agreement) related to the termination of
the Woodbridge Facility lease. Pursuant to the Termination Agreement, the Lessor and the Company
agreed to terminate the lease surrendering the premises and transferring all equipment, tools and
fixtures owned by the Company and presently located at the premises. Under the lease, there were
approximately $9.1 million of future rental payments. In addition, the Lessor asserted claims for
(i) unpaid sewer and trash removal charges; (ii) unpaid rent due Lessor for prior periods; (iii)
certain costs and expenses incurred by Lessor in connection with certain litigation; (iv) damages
that may result from the condition of the premises at the time of surrender; and (v) the required
removal and disposal of abandoned inventory and materials totaling approximately $2.4 million.
Pursuant to the terms of the Termination Agreement, the Company agreed to transfer the Woodbridge
facilitys assets to the Lessor with a carrying value of approximately $1.5 million and to issue
the Lessor a total of 892,857 shares of Company common stock valued at $0.56 per share totaling
$500,000 and to surrender deposits totaling $415,000 with the Lessor in exchange for settlement of
the asserted claims of approximately $2.4 million.
On October 18, 2010, the Superior Court of the State of California for the County of Los
Angeles entered an Order in the matter entitled American Capital Management, LLC (ACM) v.
Converted Organics Inc. and Converted Organics of Woodbridge, LLC and Does 1-10 Inclusive (the
Order). The Order provides for the full and final settlement of $11.3 million of claims against
the Company held by ACM. The claims include the future rental payments of $9.1 million discussed
above, as well as approximately $1.7 million of promissory notes issued by the Company to four
contractors that had provided services to the Woodbridge Facility (See Note 11) and
approximately $400,000 for other facility costs which were acquired by ACM from the Lessor.
ACM purchased the claims from these parties pursuant to separate claims purchase agreements.
Pursuant to the terms of the Order, the Company agreed to issue to ACM a total of 20,726,980 shares
of Company common stock valued at $0.543 per share totaling $11.3 million in full and final
settlement of the claims.
The loss recognized on disposal includes the $9.1 million loss on early termination of the
lease, approximately $796,000 of prepaid facility costs and approximately $400,000 of other
facility costs, net of a gain of $1.0 million for bond interest waived in conjunction with the
settlement and extinguishment of the bonds payable as described above.
26
The following table summarizes the components of the loss from discontinued operations for
year ended December 31, 2010 and 2009:
|
|
|
|
|
|
|
|
|
|
|
2010 |
|
|
2009 |
|
Revenue from discontinued operations |
|
$ |
830,814 |
|
|
$ |
497,062 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Results from discontinued
operations including write downs to fair
value of $15.4 million in 2010 and $3.9
million in 2009 |
|
$ |
(25,352,449 |
) |
|
$ |
(13,463,484 |
) |
Loss recognized on disposal |
|
|
(9,337,909 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
34,690,358 |
|
|
$ |
13,463,484 |
|
|
|
|
|
|
|
|
The Company does not expect to have any continuing cash flows from operations associated
with the Woodbridge facility.
The following table provides the assets and liabilities of the Woodbridge facility, classified
as discontinued operations, in the consolidated balance sheets dated December 31, 2010 and 2009:
|
|
|
|
|
|
|
|
|
|
|
2010 |
|
|
2009 |
|
Accounts receivable, net |
|
$ |
14,500 |
|
|
$ |
59,746 |
|
Inventories |
|
|
|
|
|
|
272,396 |
|
Prepaid expenses |
|
|
|
|
|
|
629,933 |
|
Property and equipment, net |
|
|
|
|
|
|
17,935,216 |
|
Deposits |
|
|
|
|
|
|
444,329 |
|
Capitalized bond costs, net |
|
|
|
|
|
|
814,341 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Assets of discontinued operations |
|
$ |
14,500 |
|
|
$ |
20,155,961 |
|
|
|
|
|
|
|
|
27
|
|
|
|
|
|
|
|
|
|
|
2010 |
|
|
2009 |
|
Term notes payable |
|
$ |
|
|
|
$ |
3,247,752 |
|
Accounts payable |
|
|
837,606 |
|
|
|
1,237,275 |
|
Accrued expenses |
|
|
1,571,874 |
|
|
|
950,782 |
|
Other liabilities |
|
|
28,773 |
|
|
|
40,575 |
|
Bonds payable |
|
|
|
|
|
|
17,500,000 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities of discontinued operations |
|
$ |
2,438,253 |
|
|
$ |
22,976,384 |
|
|
|
|
|
|
|
|
The following table summarizes the components of the loss from discontinued operations
for the three months ended March 31, 2011 and 2010:
|
|
|
|
|
|
|
|
|
|
|
For the Three Months Ended |
|
|
|
March 31, |
|
|
|
2011 |
|
|
2010 |
|
Revenue from discontinued operations |
|
$ |
|
|
|
$ |
147,949 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss from discontinued operations |
|
$ |
(499 |
) |
|
$ |
(1,909,291 |
) |
|
|
|
|
|
|
|
The following table provides the assets and liabilities of the Woodbridge facility,
classified as discontinued operations, in the consolidated balance sheets dated March 31, 2011 and
December 31, 2010:
|
|
|
|
|
|
|
|
|
|
|
March 31, |
|
|
December |
|
|
|
2011 |
|
|
31, 2010 |
|
Accounts receivable, net |
|
$ |
|
|
|
$ |
14,500 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Assets of discontinued operations |
|
$ |
|
|
|
$ |
14,500 |
|
|
|
|
|
|
|
|
28
|
|
|
|
|
|
|
|
|
|
|
March 31, |
|
|
December |
|
|
|
2011 |
|
|
31, 2010 |
|
Accounts payable |
|
$ |
828,712 |
|
|
$ |
837,606 |
|
Accrued expenses |
|
|
77,874 |
|
|
|
1,571,874 |
|
Other liabilities |
|
|
28,773 |
|
|
|
28,773 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities of discontinued operations |
|
$ |
935,359 |
|
|
$ |
2,438,253 |
|
|
|
|
|
|
|
|
On January 25, 2011, the Company paid cash of $150,000 and issued 3.2 million shares of
Company common stock with a fair value of $1,344,000 in payment for consulting services accrued at
December 31, 2010 related to the settlement of certain Woodbridge obligations. The Company is
actively working with its creditors to settle the liabilities outstanding at March 31, 2011.
Critical Accounting policies
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
Our organic fertilizer operation generates revenues from two sources: product sales and tip
fees. Product sales revenue comes from the sale of fertilizer products. Tip fee revenue is derived
from waste haulers who pay us 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. The IWR operation generates revenue by
setting up treatment systems on customers sites and processing their wastewater on a
price-per-gallon basis. Our vertical farming operation is expected to derive its revenue from
licensing fees and royalties, as well as the sale of equipment and expects future revenue from
operating facilities using our patented technology.
Revenue is recognized when all of the following criteria are 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, the Company defers recognition of revenue
until the period in which these criteria are satisfied. Revenue is generally recognized upon
shipment of product for our fertilizer business, and for TerraSphere we expect to recognize
technology license revenue immediately upon completed performance if the term of exclusive
technology licenses is equal to the life of the associated intellectual property, otherwise license
revenue would be recognized over the term of the license.
29
We recognize deferred revenue when payment has been received for product sales but the revenue
recognition criteria have not been met. In addition, we defer revenue when payment has been
received for future services to be provided.
Share-Based Compensation
We account for equity instruments exchanged for services in accordance with Financial
Accounting Standards Board (FASB) Accounting Standards Codification (ASC) 718 Compensation
Stock Compensation (ASC 718) regarding share-based compensation. Under the provisions of ASC 718,
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.
Long-Lived Assets
We account for our long-lived assets (excluding goodwill and intangible assets) in accordance
with ASC 360 Property, Plant and Equipment, which requires that long-lived assets and certain
intangible assets be reviewed for impairment annually and 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 an undiscounted cash flow model. There is inherent
subjectivity and judgments 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.
Goodwill
We evaluate the carrying value of goodwill during the fourth quarter of each year and when
events occur or circumstances change that would more likely than not reduce the fair value of the
reporting unit below its carrying amount. Such circumstances could include, but are not limited to
(1) a significant adverse change in legal factors or in business climate, (2) unanticipated
competition, or (3) an adverse action or assessment by a regulator. When evaluating whether
goodwill is impaired, we compare the fair value of the reporting unit to which the goodwill is
assigned to the reporting units carrying amount, including goodwill. The fair value of the
reporting unit is estimated using a combination of the income, or discounted cash flows, approach
and the market approach, which utilizes comparable companies data. If the carrying amount of a
reporting unit exceeds its fair value, then the amount of the impairment loss must be measured. The
impairment loss would be calculated by comparing the implied fair value of reporting unit goodwill
to its carrying amount. In calculating the implied fair value of reporting unit goodwill, the fair
value of the reporting unit is allocated to all of the other assets and liabilities of that unit
based on their fair values. The excess of the fair value of a reporting unit over the amount
assigned to its other assets and liabilities is the implied fair value of goodwill. An impairment
loss would be recognized when the carrying amount of goodwill exceeds its implied fair value. No
events or change in circumstances occurred that would impair the carrying value of goodwill for the
three month period ended March 31, 2011.
Intangible Assets
We account for intangible assets in accordance with ASC 350 Intangibles Goodwill and Other,
which requires that intangible assets with finite lives, such as our license and patents, 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. Intangible assets deemed to have indefinite lives are not amortized and are subject to
impairment testing annually or whenever events or other changes in circumstances indicate that the
carrying amount may not be recoverable. This testing compares carrying values to fair values and
when appropriate, the carrying value of these assets is reduced to fair value. During the three
month period ended March 31, 2011, there was no impairment on intangible assets deemed to have
indefinite lives.
30
Derivative Instruments
We account for derivative instruments in accordance with ASC 815 Derivatives and Hedging,
which establishes accounting and reporting standards for derivative instruments and hedging
activities, including certain derivative instruments embedded in other financial instruments or
contracts and requires recognition of all derivatives on the balance sheet at fair value.
Accounting for changes in the fair value of derivative instruments depends on whether the
derivatives qualify as hedge relationships and the types of relationships designated are based on
the exposures hedged. At March 31, 2011 and December 31, 2010, we did not have any derivative
instruments that were designated as hedges.
Discontinued Operations
We discontinued the operations of our Woodbridge facility during the third quarter of 2010.
Assets and liabilities related to the Woodbridge facility have been classified as discontinued
operations on the consolidated balance sheets at March 31, 2011 and December 31, 2010, and its
operations have been classified as loss from discontinued operations on the consolidated statements
of operations and comprehensive loss for the periods ended March 31, 2011 and 2010.
Fair Value Measurements
Fair value is a market-based measurement, not an entity-specific measurement. Therefore, a
fair value measurement should be determined based on the assumptions that market participants would
use in pricing the asset or liability. As a basis for considering market participant assumptions in
fair value measurements, ASC 820 Fair Value Measurements and Disclosures establishes a fair value
hierarchy that distinguishes between market participant assumptions based on market data obtained
from sources independent of the reporting entity (observable inputs that are classified within Levels 1 and 2 of the hierarchy) and the reporting entitys
own assumptions about market participant assumptions (unobservable inputs classified within Level 3
of the hierarchy):
|
|
|
Level 1 inputs utilize quoted prices (unadjusted) in active markets for identical
assets or liabilities that we have the ability to access. |
|
|
|
|
Level 2 inputs are inputs other than quoted prices included in Level 1 that are
observable for the asset or liability, either directly or indirectly. Level 2 inputs
may include quoted prices for similar assets and liabilities in active markets, as well
as inputs that are observable for the asset or liability (other than quoted prices),
such as interest rates, foreign exchange rates, and yield curves that are observable at
commonly quoted intervals. |
|
|
|
|
Level 3 inputs are unobservable inputs for the asset or liability which are
typically based on an entitys own assumptions, as there is little, if any, related
market activity. |
In instances where the determination of the fair value measurement is based on inputs from
different levels of the fair value hierarchy, the level in the fair value hierarchy within which
the entire fair value measurement falls is based on the lowest level input that is significant to
the fair value measurement in its entirety. Our 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.
Income Taxes
We consider the valuation allowance for the deferred tax assets to be a significant accounting
estimate. In applying ASC 740 Income Taxes , management estimates future taxable income from
operations and tax planning strategies in determining if it is more likely than not that we will
realize the benefits of our deferred tax assets. Management believes the Company does not have any
uncertain tax positions.
Off-Balance Sheet Transactions
We do not engage in material off-balance sheet transactions.
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BUSINESS
General
Converted Organics Inc. (Converted Organics, we, us, our, or the Company) utilizes
innovative clean technologies to establish and operate environmentally friendly businesses. We are
dedicated to creating a cleaner, greener future, and we operate using sustainable business
practices that support this vision.
Converted Organics currently operates in three business areas: Organic Fertilizer, Industrial
Wastewater Treatment, and Vertical Farming.
Organic Fertilizer. The Company operates a processing facility that converts food waste and
other feedstock into all-natural fertilizers, biostimulants, and soil amendment products. Using
these products allows agricultural businesses, lawn care professionals, and home gardeners to grow
healthier crops while simultaneously supporting the recycling of food waste.
Industrial Wastewater Treatment. Utilizing an innovative wastewater treatment process,
Converted Organics Industrial Wastewater Resources division (IWR) provides a means of treating
aqueous waste streams. This technology, which can use waste heat and renewable energy as fuel,
produces only two byproducts: clean water vapor and landfill-appropriate residual solids.
Vertical Farming. We also engage in vertical farming through our TerraSphere business,
which builds efficient systems for growing pesticide-free organic produce in a controlled indoor
environment. TerraSpheres clean technology helps to promote the sustainable consumption of natural
resources by accelerating plant production and maximizing crop yields. This technology also lessens
environmental footprints through the reduction of carbon emissions and fuel use associated with
traditional crop production and distribution.
In addition to the business areas listed above, we are constantly looking for new
innovative technologies with which to supplement and expand our business.
The Development of Our Company
Converted Organics Inc. was incorporated in Delaware in January of 2006 for the purpose of
establishing a waste-to-fertilizer business. In February 2007, we successfully completed both a
$9.9 million initial public offering of stock and a $17.5 million bond offering with the New Jersey
Economic Development Authority. The net proceeds of these offerings were used to develop and
construct a fertilizer manufacturing facility in Woodbridge, NJ. In January of 2008, we acquired
the assets of both Waste Recovery Industries, LLC (WRI) and United Organic Products, LLC (UOP),
making us the exclusive owner of the High Temperature Liquid Composting (HTLC) process, as well
as a leading liquid fertilizer line and a processing facility in Gonzales, CA. Also in 2008,
operations commenced at the Woodbridge plant, with the production of dry fertilizer product
beginning in 2009. We subsequently began distribution of the dry product in the professional turf
and retail markets through professional landscaping companies and well known retailers like Home
Depot and Whole Foods. In 2009, we also raised $27 million of additional capital and the Gonzales
facility became cash flow positive. In 2010, we closed the Woodbridge plant, making the Gonzales
plant our sole fertilizer manufacturing facility.
In 2010, the Converted Organics industrial wastewater treatment division, IWR, was developed
as the result of the agreements we entered into with Heartland Technology Partners, LLC (HTP) on
March 23, 2010. This transaction provided us with an exclusive, irrevocable license to utilize
HTPs LM-HT ® Concentrator technology in the U.S. industrial wastewater (IW)
market.
On November 12, 2010, the Company acquired 95% of TerraSphere Systems LLC (TerraSphere)
to establish a presence in the urban farming sector. TerraSpheres patented technology enables the
design, building, and operation of highly efficient and scalable systems consisting of
vertically-stacked modules, with individual
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interior light sources, for the housing of rows of plants. Due to a controlled indoor
environment, the system is capable of generating fresh, pesticide-free organic produce year-round,
regardless of climate or location.
Our Businesses
The Company is currently composed of three distinct lines of business: organic fertilizer,
industrial wastewater treatment, and vertical farming, with the latter two established in 2010. As
of December 2010, only the organic fertilizer and vertical farming lines were producing revenue
(revenues for the organic fertilizer business began in 2008). In early 2011, we began to generate
revenue from our industrial waste water business.
Organic Fertilizer
Since July 2010, when operations at our Woodbridge, NJ facility ceased, our organic
fertilizer has been produced exclusively at our Gonzales, CA plant. At present, the facility is
operating at approximately 60% capacity and produces around 25 tons of organic fertilizer per day.
The plant is currently only equipped to produce our liquid products, but it may be modified to
enable production of our dry products as well. Revenue from our fertilizer manufacturing operations
is predominately generated from the sale of liquid product to the agribusiness market in
California, though we do generate a small amount of revenue from tip fees associated with the
receipt of food waste at the facility. Total revenue generated from the facility in 2010 was
approximately $3.0 million.
We sell and distribute the fertilizer manufactured at the Gonzales plant through a small
group of sales professionals who seek out large purchasers of fertilizer for distribution in our
target geographic and product markets. Key activities of the sales organization include the
introduction of our products to target clients and the development of our relationships with them.
Due to our small size, we believe that the most efficient means of distributing our products is
through regional distributors, and this method currently accounts for the majority of our sales. To
the extent that we make sales directly to customers, we generally require our customers to handle
delivery of the product.
Technology. To generate product for sale, we use our proprietary HTLC ®
process to convert food waste and other feedstock into fertilizer. In simplified terms, the process
operates by encouraging naturally-occurring microbes to consume prepared feedstock. The action of
the microbes on the feedstock is exothermic (heat-releasing), and causes the temperature of the
feedstock to rise to very high, pathogen-destroying levels. Subsequently, thermophilic
(heat-loving) bacteria naturally occurring in the food waste utilize oxygen to convert the waste
into a rich blend of nutrients and single-cell proteins (aerobic digestion). Feedstock 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. The
HTLC ® method can be used in any future operating plants, whether owned by us or
licensed.
Operations. As mentioned above, since the closing of the Woodbridge plant, our Gonzales
facility has been our sole producer of our fertilizer product. In 2010, we realized approximately
$3.0 million of revenue from the sale of fertilizer from this facility.
During the third quarter of 2010, manufacturing activities at our New Jersey plant were
halted. Prior to the closing of this plant, in 2010 we had achieved sales of our dry product of
approximately $772,000 and revenue from tip fees of approximately $82,000 from this facility. We
did not achieve significant sales of liquid product from this location. Sales of the dry product
were primarily to retail and professional lawn care customers, and in order to maintain
relationships with those customers in the coming year, we outsourced the production of a dry
fertilizer product to be sold to some of our existing retail and professional lawn care customers
in the spring of 2011. We expect negative operating profit, as our main objective is to
continue to supply the customer base that we have established. It is our long-range plan to have
these customers supplied by licensed plants that may be built in the future (see Future
Development below).
During 2010 we also achieved fertilizer sales of approximately $250,000 from the
distribution of a poultry-litter-based fertilizer product. However, the company to which we
outsourced the production of this fertilizer has since filed for bankruptcy protection and we do
not expect further sales of this product.
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Benefits of Our Fertilizer Products and Technology. The efficacy of our products has been
demonstrated both in university laboratories and multi-year growth trials. 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 that the trials and other data show our solid
and liquid products to have several valuable attributes:
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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. We believe that the presence
of such ingredients in our fertilizer may cause its use to have significant beneficial
effects on soil and plant health. |
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Disease Suppression. Based on field trials using product produced using
our technology, we believe our products possess disease suppression characteristics
that may 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
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. |
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Soil amendment. As a result of its slow-release nature, our dry fertilizer product
increases the organic content of soil, which improves granularity and water retention
and thus reduces NPK leaching and run-off. |
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Pathogen-free. Due to high processing temperatures, our products are virtually
pathogen-free and have an extended shelf life. |
In addition to these agricultural benefits, we have also achieved Organic Materials
Review Institute (OMRI) and/or Washington State Department of Agriculture (WSDA) certification
for many of our products, allowing growers to use them in certified organic farming.
Competition. We operate in a very competitive environment. The organic fertilizer
business requires us to compete in three separate areas 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.
Technology. There are a variety of methods used to treat organic wastes, including
composting, digestion, hydrolysis, and thermal processing. Companies using these technologies may
compete with us for organic material.
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Composting. Composting is a natural process of decomposition that can be
accelerated through the mounding of waste into windrows to retain the heat given off by
bacteria involved in the decomposition process. Given the difficulties in controlling
this process, the resulting compost is often inconsistent and generally would command a
lower market price than our product. Further, large-scale composting facilities require
significant amounts of land for operations, which, particularly in major metropolitan
areas, may either not be readily available or may be too costly. |
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Digestion. Digestion may be either aerobic (requiring oxygen) like the HTLC
® process, or anaerobic (occurring without oxygen). Anaerobic digestion
generally takes longer and produces significantly more odor as a result of the
production of ammonia and methane, the latter of which
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is also a greenhouse gas. The methane gas produced has some value as a source of
energy, but it is not readily transported and is thus generally limited to on-site
use. |
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Hydrolysis. Hydrolysis is a chemical process by which water reacts with another
substance, and it is usually catalyzed through the introduction of an acid. This
reaction is used to convert cellulose present in the organic waste into sugars, which
in turn may be converted into ethanol. |
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Thermal. Thermal technologies work by either completely or partially combusting
organic materials for the purpose of generating electricity. Partial combustion methods
may also lead to the production of useful and saleable byproducts, such as a variety of
gases (e.g. hydrogen, carbon monoxide, carbon dioxide) and organic liquids. |
End Products. The organic fertilizer business is highly fragmented, under-capitalized, and
growing rapidly. We are unaware 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, and these companies are generally better-capitalized and have greater financial and
marketing resources than we do.
Most of the 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, and slow-release products, which must be coated or specially processed,
command a premium. 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-organic fertilizers, many of which are significantly larger and
better-capitalized than we are. 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 fertilizers to develop market demand, while maintaining or increasing pricing.
Target Markets. In the U.S., the majority of fertilizer is consumed by agribusiness,
with 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, and sod
farms, as well as commercial, government, and institutional facilities. |
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Retail Sales. Home improvement outlets, garden supply stores, nurseries, Internet
sales, and shopping networks. |
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
i.e., maximizing the value derived from crop output (quantity and quality). Second, commercial
farmers have begun to recognize the importance of 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 limitation on the use of certain synthetic products by government authorities,
including nutrients such as nitrogen and chemicals such as methyl bromide; |
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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. |
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. In 2011, we expect that a
significant part of our revenues will be derived from this specific market.
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. For
similar reasons, we believe that our fertilizer products will be desirable to professional lawn
care companies, who are trending towards the use of organic fertilizers. We believe that our
all-natural, slow-release fertilizer products will be well-received in the turf management
market.
Governmental Regulation. Our end products are regulated by federal, state, county, and
local governments, as well as various agencies thereof, including the United States Department of
Agriculture.
In addition to the regulations governing the sale of our end products, our current
facility and any future facilities are subject to extensive regulation. Specific permit and
approval requirements are set by the state and state agencies, as well as local jurisdictions
including but not limited to cities, towns, and counties. Any changes to our plant or procedures
would likely require permit modifications.
Environmental regulations will also govern the operation of our current facility and any
future facilities. Regulatory agencies may require us to remediate environmental conditions at our
locations.
Future Development. In addition to the tip fees and product sales revenue we receive as
a result of our fertilizer, the Company is exploring a number of new fertilizer-related ventures
that may provide us with additional streams of revenue in the future.
SMART Units. Our Scalable Modular AeRobic Technology (SMART) units will allow
third-parties to produce their own organic fertilizer, and will be suitable for processing 5 to 50
tons of waste per day. These semi-portable devices will be capable of operating indoors or outdoors
and may be as sophisticated or as basic in design and function as the owner/user requires. The
SMART units will be delivered to jobsites in pre-assembled, pre-tested components, and will include
a license to use the HTLC ® technology. Our target market consists of users who seek to
address waste problems on a smaller scale than would be addressed by a large processing facility.
Our plan
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contemplates that purchasers of the devices 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, and are presently in
discussions with a former employee to establish a distributorship outside North America.
Licensing. We have also begun the development of a licensing program, under which we
will license the right to use our proprietary technology to third parties. The licensing program
consists of a know-how license, which could be complemented with SMART unit sales so that any
individual or entity buying a SMART unit would also receive a license agreement to use our
technology. We are working to patent our process and technology and anticipate that we will expand
upon the licensing program when the necessary patent registrations are achieved.
Mass Organics I. We are currently in negotiations with MassOrganics I, LLC
(MassOrganics I) regarding the use of Converted Organics proprietary technology for the
manufacture of organic fertilizer products. On January 25, 2010, we signed a memorandum of
understanding under which MassOrganics I would install and operate an HTLC ® system at a
new manufacturing facility to be constructed at The Sutton Commerce Park in Sutton, MA. The
memorandum of understanding provides that MassOrganics I would enter into a licensing agreement
under which MassOrganics I would pay a licensing fee to Converted Organics. As of the filing date
of this report, construction of the facility has not yet commenced.
Industrial Wastewater Treatment
Industrial Wastewater Treatment Resources was formed as the result of a loan and license
agreement with Heartland Technology Partners, LLC (HTP) that Converted Organics entered into in
March of 2010. The agreement provided us with the exclusive right to utilize HTPs patented means
of treating industrial wastewater in the U.S. IWR will generate revenue by setting up
self-contained treatment systems on customers sites and processing their wastewater on a
price-per-gallon basis.
Technology. Our IWR business utilizes the LM-HT ® Concentrator system (the
Concentrator), which operates by making use of a variety of fuel sources, including waste heat
and renewable fuel, to separate industrial wastewater (IW) into clean water vapor and residuals.
The Concentrator equipment operates without consumables and has very few moving parts, allowing the
equipment to work with minimal maintenance and oversight. Simply, IW is fed into the Concentrator
and heated to release clean water vapor, which is then either released into the air or fed into a
condenser. The resulting concentrated wastewater is then fed through separators, which isolate the
contaminants that have solidified in the evaporation process from the concentrated wastewater. The
concentrated wastewater is then fed back into the Concentrator to be retreated, releasing more
clean water and more solid contaminants. Materials captured as a result of the process are suitable
for recycling or ready to be taken to a landfill.
Operations. IWR currently operates an industrial wastewater concentrator on Glenwood
Springs Landfill Enterprises South Canyon Landfill in Glenwood Springs, CO as a result of an
agreement signed in January of 2011. Under this agreement, we are paid a per-gallon fee for the
amount of IW that we treat, less labor costs to operate the unit and a marketing fee to generate IW
delivered to the facility. As the owner of the unit we are also responsible for repairs and
maintenance of the Concentrator. This facility is designed to treat 15,000 gallons of aqueous waste
per day and is fueled by the combustion of biomass diverted from disposal in the landfill. Among
the IWs to be treated by the plant are septic, wash waters, process waters, man-camp wastewaters,
and wastewaters from oil and gas exploration activities.
Benefits of the Technology.
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Fuel Source Flexibility. The LM-HT ® Concentrator can run on a
wide range of thermal energy options, from waste heat, to bio fuels, to conventional
fossil fuels. |
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Reduced Carbon Emissions. Utilization of waste heat and renewable energy sources
results in a reduction of carbon emissions. |
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Simple to Run and Maintain. The equipment is robust, resistant to corrosion,
compact, easy to maintain, has no membranes or heat exchangers to foul, and has very
few moving parts. |
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Portability. The equipment may be strategically placed, in locations such as
landfills, to significantly reduce transportation costs. |
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Widely Applicable. The direct hot gas evaporation technology employed makes it
possible to treat a wide range of industrial waste waters, including IWs with a high
concentration of suspended solids. |
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Clean Water Byproduct. The equipment may be fitted with a condenser to capture the
resultant water vapor and transform it into clean, non-potable water. |
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Zero Liquid Discharge. The only by-products of the LM-HT ® process are
clean water vapor and the solidified contaminants present in the IW. |
Competition. There are a wide range of technologies that are currently being used or
developed for the purpose of treating wastewater. The following are some of the more common methods
in practice.
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Physical. The most simple of treatment methods, physical treatment of wastewater
includes both the coarse screening process and sedimentation. Coarse screening is an
active method that involves running the water through screens of various pore size to
filter out debris. Sedimentation (also called clarification) is a passive process by
which wastewater is held in tanks under quiescent conditions, allowing many of the
solids to settle to the bottom. Both methods are merely effective for removing the
larger and/or heavier solid contaminants. Other processes in this category include
filtering and skimming, the latter of which is useful for separating
floating/water-insoluble contaminants. |
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Chemical. The addition of chemicals to wastewater is usually for the purpose of
either disinfection (typically by chlorination or oxidation) or neutralization of
acidic or basic wastewater. Chemical treatment can also consist of coagulation, where
the addition of a chemical forms an insoluble end-product with waste substances in the
water for the purpose of later removal. |
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Solidification/Stabilization. This method involves curing the waste into solid
form to prevent it from leaching. This can be accomplished either through mixing in
cement or other inorganic setting material. |
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Deep Well Injection. Drilling thousands of feet below the Earths surface allows
access to permeable areas of extreme salinity, which can absorb aqueous waste. These
areas are buffered by impermeable strata that can prevent the wastewater from reaching
and contaminating any aquifers. |
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Reverse Osmosis. Reverse osmosis operates by separating two containers, one of
contaminated water and the other clean, by a semi-permeable membrane that allows free
flow of water (the solvent) but not elements dissolved in it (the solute). Applying
high pressure to the waste water side forces solvent across the membrane barrier and
results in separating water from waste. This process is dependent upon the proper
functioning of the selective membrane, and wastewater must often be pretreated to
remove any agents that are capable of fouling the membrane. |
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Incineration. Wastewater sludge may be treated by incineration, but this method is
not as common due to the emissions produced, fuel required, and the difficulty in
burning this type of waste. |
Target Markets. The benefits of the LM-HT ® system are best applied to situations
where there are significant transportation costs associated with treating the wastewater or the
wastewater contains many suspended
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solids, high biochemical oxygen demand (BOD) values, problematic pH levels, or recoverable
contaminants. Specifically, we are targeting the following IWs:
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Quench water and boiler/scrubber blow-down wastewater; |
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Process water from the manufacturing/processing of pharmaceuticals, metals, pulp and
paper, petrochemicals, foods, inks and paints; and |
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Any other IWs where a zero-liquid discharge with an inside-the-fence option is
desirable. |
Government Regulation. The processing of wastewater is regulated by federal,
state, county and local governments as well as various agencies thereof, including the
Environmental Protection Agency. Due to the lack of contaminants released into surface water from
our method, no National Pollution Discharge Elimination System (NPDES) permits are required.
However, air permits and other operational permits will need to be obtained prior to commencement
of waste processing.
Future Development. Led by a seasoned professional in the wastewater treatment business
we hired in March 2010 to serve as President and General Manager of IWR, IWR is seeking customers
for its wastewater treatment services and intends to operate on a build-own-operate business model
whereby we provide inside-the-fence industrial wastewater treatment solutions. We anticipate such
arrangements being under terms similar to those in the Glenwood Springs Landfill agreement, where
we would pay for labor, repairs, and marketing (if required) at the site and derive revenue from
the per-gallon fee that would be charged for the treatment of customers aqueous waste. As new
agreements are signed, we will have to obtain specific project financing for each Concentrator. We
expect that in 2011 we will be able to begin operations on at least one other site in addition to
the CO facility if adequate financing can be obtained.
Vertical Farming
Converted Organics vertical farming business commenced operations in November 2010
with our acquisition of 95% of TerraSphere Systems LLC, which currently operates a research and
manufacturing facility in Vancouver, British Columbia. We plan on leveraging TerraSpheres
technology to generate revenue through selling produce grown at facilities that we
build-own-and-operate, as well as from licensing our technology. Selling licenses not only provides
us with an up-front licensing fee, but also opens up additional revenue streams from sales of
specialized equipment to licensees and receipt of royalties from their product sales. In December
of 2010, we purchased a majority stake in a Terrasphere licensee so that we could build and own the
facility that the licensee would operate.
Technology. TerraSpheres patented system grows crops in an arrangement of rows of
plants in stacked, collapsible tray racks. Each tray has an individual light source, which can be
adjusted to promote maximum growth by conforming its output to meet plants needs at their given
level of maturation. The plants are watered by a high pressure system that ensures an even
distribution of water and nutrients. Farming in this controlled environment results in an abundance
of plants with strong, compact, even growth, and this technology may be used to grow a variety of
crops, from lettuce, to tree seedlings, to rare medicinal herbs.
Operations. We currently operate one vertical farm, located in Vancouver, British Columbia,
under an agreement with our licensee, the Squamish Indian Nation. This facility serves as both a
research and small-scale manufacturing facility. The produce grown at this site is sold locally to
Choices Markets in the greater Vancouver area, the largest natural foods grocer in Western Canada.
Benefits of the Products and Technology.
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Higher Productivity. Growing in three dimensions allows for a vastly more
efficient use of growing space, enabling more crops to be grown at once. Additionally,
growing in a highly-regulated environment enables greater yields as a result of the
absence of pests, disease, and variable weather/soil conditions. The ability to grow
crops year-round also increases productivity. |
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Lower Energy Costs. We believe that a TerraSphere facility will use less energy
than traditional agricultural methods. |
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Controlled Environment. TerraSpheres closed-system method of growing plants
prevents the cross-contamination of products, eliminates the danger of water
contamination, and allows complete control of fertilizer type and quality. |
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Versatility in Facility Placement and Products. With this system, crops may be
grown in any location, regardless of geography or climate, year round. Additionally,
the TerraSphere system is designed to be installed in existing structures, and is
compatible with any industrial/warehouse building with a minimum clearance of 25 feet. |
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Extended Produce Shelf Life. The ability to locate facilities near end markets,
regardless of geography or climate, means that produce that is fresher for the consumer
and has a longer shelf life, which means less spoilage for the retailer. |
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Lower Cleaning and Product Preparation Costs. By controlling growing conditions,
we can avoid exposing our plants to impurities and thus minimize cleaning and product
preparation costs during harvest. TerraSphere products are free from exposure to the
pesticides, fuel/oil leakage from machinery, and impurities from the soil and rain that
are associated with traditional field farming methods. |
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Minimal Fertilizer and No Pesticides. As a result of our controlled growth
conditions, plants grown in the TerraSphere system require less fertilizer than plants
grown in the field or in a greenhouse, and pesticides are not required. |
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Water Conservation. The TerraSphere system uses significantly less water than
traditional growing methods, and the watering injection system enables the recycling of
water and the generation of very little wastewater. Not only is wastewater a major
environmental concern, but water represents a significant cost for traditional farms
and greenhouses. |
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Lessened Transportation Costs. Growing and selling locally will greatly
reduce the cost of transporting goods, as well as lessen the carbon footprint, of many
common crops. |
Competition. We face considerable competition from both users of traditional growing
methods and from other companies with competing innovative growing technologies.
|
|
|
Field Agriculture. The overwhelming majority of the produce sold today is
still generated using traditional field agriculture methods, and the infrastructure
required is generally already in place and considerably less than that of the vertical
farms we envision. As such, the up-front cost of growing produce via traditional
methods is likely less than that of our method. Further, the rise in organic growing
standards has already presented consumers with a more naturally-grown and arguably
higher-quality product option, albeit at an often substantially higher cost. However,
field agriculture is limited by the availability of land that is suitable for growing
crops. Crop quality is also affected by a substantial number of variables, from weather
and temperature fluctuations to infestations of pests and disease. Field-grown produce
must also often travel to reach consumers, which reduces shelf life and increases
costs. |
|
|
|
|
Greenhouses/Hydroponic Growers. Some produce is already grown indoors, which
provides the advantage of being able to better regulate growing conditions through the
elimination of many environmental factors. However, building greenhouses large enough
to grow substantial amounts of produce is not incredibly cost-effective considering the
energy required to regulate the indoor environment versus the product yield. Further,
light exposure must be carefully monitored, and the location of a greenhouse is still a
very important factor if natural light is used instead of artificial light. |
40
|
|
|
Other Urban Farming Technologies. There are a small number of other companies
who have developed or are in the process of developing technology that enables the
growing of crops in environments that lack available land or proper growing conditions.
This includes variations of our vertical farming method and other modes of controlled
indoor environment agriculture. |
Target Markets. We intend to operate our vertical farming business by supplying food
sellers with our produce that are local to our farms. This includes natural products retailers,
supermarket chains, as well as restaurants and schools.
Government Regulation. In order to sell our produce, we must follow applicable food safety
regulations. At minimum we must comply with laws enforced by federal agencies such as the FDA and
USDA, and some states may impose stricter standards than those of the federal government. In
Canada, we must also comply with laws enforced by the Canadian Food Inspection Agency and other
regulatory bodies.
Future Development. To expand our business, TerraSphere will seek financing in order to
build and operate TerraSphere facilities and continue to market its exclusive licensing agreements
to interested third parties throughout North America, Asia and Europe. On December 30, 2010 we
acquired an 83.34% ownership in GoLocalProduceRI, LLC (an independent TerraSphere licensee) for the
purpose of building and owning a TerraSphere facility.
In addition to growing produce, TerraSphere also plans on using its growing technology
for the production of high-value medicinal biocompounds sourced from plants. This venture, to be
operated by PharmaSphere, LLC, a wholly-owned subsidiary of TerraSphere, will sell these isolated
biocompounds for use as active pharmaceutical agents and grow its own transgenic plants for sale in
the biotechnology industry. PharmaSphere has a subsidiary, PharmaSphere Worcester, LLC, which was
formed to build a facility in Worcester, MA utilizing PharmaSpheres business plan. The building of
the facility has not commenced and PharmaSphere has no revenue to date.
PRO FORMA CONDENSED FINANCIAL INFORMATION FOR TERRASPHERE AND
GOLOCALPRODUCERI
(In thousands, except per share information)
The following pro forma condensed statement of operations information is
presented to illustrate the effects upon the full year 2010 and 2009 had the
Terrasphere and GoLocalProduceRI acquisitions had been completed on January 1, 2009.
The pro forma presentation 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 the Companys 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. Pro forma balance sheet information is not
presented as the acquisitions are presented in the 2010 historical balance sheet.
|
|
|
|
|
|
|
|
|
|
|
For the Year Ended December 31, |
|
|
2010 |
|
2009 |
Revenue |
|
$ |
8,862,980 |
|
|
$ |
2,670,514 |
|
Net loss |
|
$ |
(48,629,191 |
) |
|
$ |
(22,321,742 |
) |
Net loss per share, basic and diluted |
|
$ |
(0.65 |
) |
|
$ |
(0.47 |
) |
Weighted average common shares outstanding |
|
|
74,276,495 |
|
|
|
47,094,769 |
|
41
Properties
We have a lease for land in Gonzales, California, where our Gonzales facility is located. The
land is leased from VLH, a California LLC whose sole member is a former officer and director of the
Company, and which was consolidated in our financial statements from January 2008 through April
2009. The lease provides for a monthly rent of $9,300. The lease is renewable for three 5-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.
On November 24, 2009 we signed a lease for office space for our headquarters in Boston,
Massachusetts. The lease is for 3 years and provides 4,510 square feet of usable space for a
monthly rent of $9,772. In addition, we lease, on a month-to-month basis, approximately 2,500
square feet of additional office space in Boston, Massachusetts.
We pay rent of $2,800 per month for this space. We may terminate this additional lease at any
time upon 30 days advance written notice.
On November 12, 2010, we assumed the lease of TerraSphere, LLCs Vancouver facility, which
commenced November 1, 2009 and has a five year term. Rent is $89,900 per year for 2011 through
2013, and $74,990 for 2014. Under the operating lease agreement, the Company has the right to
extend this lease for an additional five years.
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. On November 6,
2009, we filed our answer to the Complaint with the Court. On March 4, 2010, the parties
participated in a conference, and began discussing discovery issues. Plaintiff filed a Motion for
Class Certification on June 22, 2010, which was denied on November 22, 2010. On March 3, 2011, the
court denied our motion for partial summary judgment. On March 25, 2011, some individual investors
filed a new complaint against us asserting similar claims to those in the Leeseberg litigation. On
March 25, 2011, a number of other investors filed a new complaint against Converted Organics. The
Court consolidated this case with the existing lawsuit and, on May 12, 2011, Plaintiffs filed an
Amended Complaint. On June 6, 2011, Converted Organics filed its
Answer to Consolidated Complaint and Counterclaims against
Plaintiffs. We plan to vigorously defend these matters and are unable to estimate any losses
that may be incurred as a result of this litigation and new complaint and upon their eventual
disposition. Accordingly, no loss has been recorded related to these matters.
Related to the above matter, in December 2009, we filed a complaint in the Superior Court of
Massachusetts for the County of Suffolk, captioned Converted Organics Inc. v. Holland & Knight LLP.
We claim that in the event we are required to pay any monies to Mr. Leeseberg and his proposed
class in the matter of Gerald
S. Leeseberg, et al. v. Converted Organics, Inc., that Holland & Knight should make us whole,
because its handling of the registration of the securities at issue in the Leeseberg lawsuit caused
any loss that Mr. Leeseberg and other putative class members claim to have suffered. Holland &
Knight has not yet responded to the complaint. Holland and Knight has threatened to bring
counterclaims against Converted Organics for legal fees allegedly owed, which
42
we would contest
vigorously. On May 12, 2010, the Superior Court stayed the proceedings, pending resolution of the
Leeseberg litigation. At this early stage in the case, the Company is unable to predict the
likelihood of an unfavorable outcome, or estimate any related loss.
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. v. Converted Organics of
Woodbridge, et al. The lawsuit alleged 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 sought 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. On April 12, 2010,
the Middlesex County Superior Court of New Jersey issued an administrative order settlement
dismissing without prejudice the matter of Lefcourt Associates, Ltd. v. Converted Organics of
Woodbridge, et al. On June 8, 2010, Lefcourt Associates, Ltd re-filed their lawsuit but before a
different court, the Chancery Division in Bergen County. We filed a motion to transfer the action
back to the original court in Middlesex County, which was granted and we sought to have the lawsuit
dismissed, which was granted in part on August 27, 2010. The Court limited the plaintiffs claims
to the events in part that occurred after the dismissal of the prior action. The case was recently
transferred to the Law Division and a trial date as to damages was scheduled for June 6, 2011, but
has since been postponed until September 12, 2011, and an evidentiary Learning will be held on or prior to this date. Additionally, Plaintiffs appealed the order
dismissing their first lawsuit with prejudice, and the appellate court reversed the dismissal with prejudice. Due to the appellate decision, plaintiffs filed a motion to
reconsider the decision made in the action, which was granted in part on July 28, 2011. We plan to vigorously defend
this matter and are unable to estimate any losses that may be incurred as a result of this
litigation and upon its eventual disposition. Accordingly, no loss has been recorded related to
this matter.
Employees
As
of June 24, 2011, we had 26 employees, 3 of whom were in sales, 14 in management and
administration, and 9 in operations (6 employees at our Gonzales facility and 3 employees at our
TerraSphere Vancouver TerraSphere facility).
Our Website and Availability of SEC Reports and Other Information
Our corporate website is located at www.convertedorganics.com. We file with or furnish
to the SEC Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K
and any amendment to those reports, proxy statements and annual reports to shareholders, and, from
time to time, other documents. The reports and other documents filed with or furnished to the SEC
are available to investors on or through our corporate website free of charge as soon as reasonably
practicable after we electronically file them with or furnish them to the SEC. In addition, the
public may read and copy any of the materials we file with the SEC at the SECs Public Reference
Room at 100 F Street, NE, Washington DC 20549. The public may obtain information on the operation
of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an internet
site that contains reports, proxy and information statements and other information regarding
issuers, such as the company, that file electronically with the SEC. The address of that website is
http://www.sec.gov. Our SEC filings and our Code of Ethics may be found on the Investor
Relations page of our website at ir.convertedorganics.com. These documents are available in
print to any shareholder who requests a copy by writing or calling our corporate headquarters.
43
PRINCIPAL STOCKHOLDERS
The following table sets forth information regarding the beneficial ownership of our
outstanding common stock as of April 18, 2011 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 the date above 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.
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.
|
|
|
|
|
|
|
|
|
Name of |
|
No. of Shares |
|
|
Beneficial |
|
Beneficially |
|
|
Owner(1) |
|
Owned |
|
Percent of Class(2) |
Edward J. Gildea |
|
|
3,409,815 |
(3) |
|
|
2.7 |
% |
David R. Allen |
|
|
710,417 |
(4) |
|
|
* |
|
Robert E. Cell |
|
|
573,340 |
(5) |
|
|
* |
|
John P. DeVillars |
|
|
573,340 |
(5) |
|
|
* |
|
Marshal S. Sterman |
|
|
437,340 |
(6) |
|
|
* |
|
Edward A. Stoltenberg |
|
|
578,208 |
(7)(8) |
|
|
* |
|
All directors and officers as a group (six persons) |
|
|
6,282,460 |
|
|
|
4.8 |
% |
5% Shareholders |
|
|
|
|
|
|
|
|
OppenheimerFunds, Inc. |
|
|
32,228,361 |
(9) |
|
|
9.9 |
%(9) |
44
|
|
|
* |
|
Less than 1% |
|
(1) |
|
The address of all persons named in this table, with the exception of Oppenheimer Funds, Inc.
is: c/o Converted Organics Inc., 137A Lewis Wharf, Boston, MA 02110. |
|
(2) |
|
Assumes 127,457,556 shares as of June 24, 2011. |
|
(3) |
|
Includes 1,400 Class B Warrants and options to purchase 1,260,178 shares. |
|
(4) |
|
Includes options to purchase 536,333 shares. |
|
(5) |
|
Includes options to purchase 388,670 shares. |
|
(6) |
|
Includes options to purchase 218,670 shares. |
|
(7) |
|
Includes options to purchase 378,670 shares. |
|
(8) |
|
Includes 2,965 shares beneficially owned and held in trust. |
|
|
(9) |
|
Consists of 7,769,798 shares of common stock and 13,281 shares of Series A Convertible
Preferred Stock that is convertible into 24,458,563 shares of common stock held by Oppenheimer New Jersey Municipal
Fund and Oppenheimer Rochester Municipal Fund; provided that we are
not permitted to effect any conversion of the preferred stock, and the holder does not have the
right to convert any portion of the preferred stock, to the extent that, after giving effect to the
conversion the holder (together with any of holders affiliates would beneficially own in excess of
9.9% of the total issued and outstanding shares of our common stock. The business address of
OppenheimerFunds, Inc. is Two World Financial Center, 225 Liberty Street, New York, NY 10281. Mr.
Scott Cottier exercises voting and dispositive power over the shares held by Oppenheimer Rochester Municipal Fund, and Mr. Michael
Camarella exercises voting and dispositive power over the shares held by Oppenheimer New Jersey Municipal Fund. |
|
45
MANAGEMENT
Directors, Executive Officers and Key Employees
The Companys executive officers and directors and certain information about them, including
their ages as of July 27, 2011, are as follows:
|
|
|
|
|
Name |
|
Age |
|
Position |
Edward J. Gildea |
|
59 |
|
President, Chief Executive Officer, and Chairman of the Board |
David R. Allen |
|
56 |
|
Chief Financial Officer and Executive Vice-President of Administration |
Marshall S. Sterman |
|
79 |
|
Director |
Edward A. Stoltenberg |
|
72 |
|
Director |
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 Quality Metric
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. The Company believes that Mr. Gildeas financial and
business expertise, including a diversified background of counseling and managing both public and
private companies, gives him the qualifications and skills to serve as a Director.
David R. Allen has been our Chief Financial Officer since March 2007. He was previously a
director of the Company from June 2006 to March 2007, where he served as our audit committee
chairman. From 1999 to 2004, he served as first the Chief Financial Officer and then as Chief
Executive Officer of The Millbrook Press Inc., a publicly held publisher of childrens books. From
2004 until 2007, Mr. Allen has acted as a management consultant and advisor to small public
companies. Mr. Allen holds a B.S. degree in Accounting and an M.S. degree in Taxation from Bentley
University in Waltham, Massachusetts. Mr. Allen is a Certified Public Accountant.
46
Marshall S. Sterman joined Converted Organics Board of Directors in July of 2010 after
working with the Company as a consultant since November of 2009. Mr. Sterman has advised numerous
companies on issues related to mergers and acquisitions and other capital markets matters during
his fifty-year career in investment banking and consulting. In addition, Mr. Sterman has extensive
experience managing and helping develop and execute the growth strategies for public companies. He
is the founder of The Mayflower Group, Ltd., a consulting firm that has served as an active
principle to many start-up companies, and was recently honored by the Sino-American Pharmaceuticals
Professional Association for his presentations on entrepreneurialism at the Massachusetts Institute
of Technology. Mr. Sterman is also currently Chairman of the Board, Chief Executive Officer, and
Acting Chief Financial Officer of Urban Ag Corp, which licenses Converted Organics TerraSphere
technology. Sterman holds a B.A. from Brandeis University and an MBA from Harvard University.
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. The Company believes that Mr. Stoltenbergs financial and business
expertise, including a diversified background of managing financial service firms and providing
investment services for public companies gives him the qualifications and skills to serve as a
Director.
There are no family relationships among our officers and directors.
Board Independence
Our Board of Directors comprises five members divided into three classes. Currently, Mr.
Stoltenberg serves as a Class 1 director, whose term expires
in 2013; Mr.
Sterman serves as Class 2 director, whose term expires in 2014; 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.
Pursuant to the requirements, the Board 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 five members of the
Board, Messrs. Sterman and Stoltenberg were determined to be independent
directors as defined by the NASDAQ Stock Market. In making an independence determination with
regard to Mr. Sterman, the Board considered his relationship with Urban Ag Corp., which is a
TerraSphere licensee.
47
Compensation Committee and Insider Participation
None of the members of our Compensation Committee is one of our officers or employees. 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.
Executive Compensation
The following table sets forth certain information concerning total compensation received by
our Chief Executive Officer and the other most highly compensated officer (named executives)
during 2010 for services rendered to Converted Organics in all capacities for the last two fiscal
years.
Summary Compensation Table 2010
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nonqual. |
|
|
|
|
Name and |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-Equity |
|
Deferred |
|
All |
|
|
Principal |
|
Fiscal |
|
|
|
|
|
|
|
|
|
Stock |
|
Option Awards |
|
Incentive |
|
Comp. |
|
Other |
|
|
Position |
|
Year |
|
Salary ($) |
|
Bonus ($) |
|
Awards |
|
($)(1) |
|
Plan Comp. |
|
Earnings |
|
Comp. |
|
Total ($) |
Edward J. Gildea, |
|
|
2010 |
|
|
|
221,800 |
|
|
|
|
|
|
|
|
|
|
|
256,400 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
478,200 |
|
President and Chief
Executive Officer |
|
|
2009 |
|
|
|
222,879 |
|
|
|
50,000 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
272,879 |
|
|
David Allen, |
|
|
2010 |
|
|
|
176,200 |
|
|
|
|
|
|
|
|
|
|
|
128,200 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
304,400 |
|
Chief Financial
Officer |
|
|
2009 |
|
|
|
152,376 |
|
|
|
15,000 |
|
|
|
|
|
|
|
40,500 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
207,876 |
|
|
|
|
(1) |
|
Represents the full grant date fair value of the option grant calculated in accordance
with FASB ASC Topic 718. For the purposes of making the option calculation, the assumptions set
forth in Note 12 of the Notes to Consolidated Financial Statements for the year ended December 31,
2010 were utilized; provided that we excluded the assumed forfeiture rate for the purposes of the
calculations in the table. |
48
Outstanding Equity Awards at Fiscal Year End-2010
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Number of Securities |
|
|
|
|
|
|
Underlying Unexercised |
|
Option Exercise |
|
|
|
|
Options (#) |
|
Price |
|
Option Expiration |
Name |
|
Exercisable |
|
Unexercisable |
|
($ per share) |
|
Date |
Edward J. Gildea |
|
|
100,000 |
|
|
|
0 |
|
|
$ |
3.75 |
|
|
June 15, 2011 |
|
|
|
125,000 |
|
|
|
0 |
|
|
$ |
5.02 |
|
|
June 27, 2018 |
|
|
|
500,000 |
|
|
|
0 |
|
|
$ |
0.68 |
|
|
January 4, 2020 |
David R. Allen |
|
|
10,000 |
|
|
|
0 |
|
|
$ |
3.75 |
|
|
June 15, 2011 |
|
|
|
71,195 |
|
|
|
0 |
|
|
$ |
5.02 |
|
|
June 27, 2018 |
|
|
|
50,000 |
|
|
|
0 |
|
|
$ |
1.10 |
|
|
June 25, 2019 |
|
|
|
250,000 |
|
|
|
0 |
|
|
$ |
0.68 |
|
|
January 4, 2020 |
Stock Option Plan
At the Annual Meeting of Shareholders on June 30, 2010, shareholders approved the Omnibus
Stock Compensation Plan (2010 Plan), pursuant to which there were 3,458,047 shares authorized for
issuance, subject to adjustment. Commencing January 1, 2011 and on the first day of each fiscal
year thereafter, the number of shares authorized for issuance under the 2010 Plan is automatically
recalculated to be equal to 20% of the shares of the Companys common stock outstanding on the last
day of the prior fiscal year, less any issuances made under both the 2006 Plan and the 2010 Plan.
The 2010 Plan replaced the 2006 Plan and no additional shares will be issued under the 2006 Plan.
However, the Company reserved the right to issue pursuant to the 2006 Plan, new options to the
extent that, and in the amount of, any currently outstanding options are forfeited under that plan.
Under the 2010 Plan, the Compensation Committee may grant awards in the form of incentive
stock options, as defined in Section 422 of the Code, as well as options which do not so qualify,
stock units, stock awards, stock appreciation rights and other stock-based awards.
Other awards may be granted that are based on or measured by common stock to employees,
consultants and non-employee directors, on such terms and conditions as the Compensation Committee
deems appropriate. Other stock-based awards may be granted subject to achievement of performance
goals or other conditions and may be payable in common stock or cash, or in a combination of the
two.
Employment Agreements
Effective as of April 20, 2011, the Company entered into severance agreements with Mr. Gildea
and Mr. Allen, under which, should a change in control of the Company occur, Messrs. Gildea and
Allen shall be entitled to a continuation of payment of their base salary for a term of thirty-six
months, payable in bi-weekly installments in accordance with the Companys regular payroll
practices. Change of Control, shall mean the consummation of any of the following events: (i) a
sale, lease or disposition of all or substantially all of the assets of the Company, or (ii) a
merger or consolidation (in a single transaction or a series of related transactions) of the
Company with or into any other corporation or corporations or other entity, or any other corporate
reorganization, where the stockholders of the Company immediately prior to such event do not retain
(in substantially the same percentages) beneficial ownership, directly or indirectly, of more than
fifty percent (50%) of the voting power of and interest in the successor entity or the entity that
controls the successor entity; provided, however, that a Change in Control shall not include a
sale, lease, transfer or other disposition of all or substantially all of the capital stock,
assets, properties or business of the Company (by way of merger, consolidation, reorganization,
recapitalization, sale of assets, stock purchase, contribution or other similar transaction) that
involves the Company, on the one hand, and Converted Organics Inc. or any Converted Organics
Subsidiary.
In the event a Change in Control occurs, and the employment of either Mr. Gildea or Mr. Allen
is terminated (i) by the Company for a reason other than for Cause (as defined below) or (ii) by
the Executive for Good Reason (as defined below), then the Executive shall be eligible for
severance pay as described above.
Resignation for good reason means the occurrence of any of the following conditions without
the Executives consent, which condition continues after notice by the Executive to the Company and
a reasonable opportunity to cure such condition: (i) a decrease in the Executives
base salary, (ii) relocation of the Executives
49
work place to a location more than 50 miles from the Executives
business location at the time of the Change of Control, or (iii) the Executives assignment to a
position where the duties of the position are outside his area of professional competence.
Cause means a good faith finding by the Company of: (i) gross negligence or willful
misconduct by the Executive in connection with the Executives employment duties, (ii) failure by
the Executive to perform his duties or responsibilities required pursuant to the Executives
employment after written notice and a 30-day opportunity to cure, (iii) misappropriation by the
Executive for the Executives personal use of the assets or business opportunities of the Company,
or its affiliates, (iv) embezzlement or other financial fraud committed by the Executive, (v) the
Executive knowingly allowing any third party to commit any of the acts described in any of the
preceding clauses (iii) or (iv), or (vi) the Executives indictment for, conviction of, or entry of
a plea of no contest with respect to, any felony.
Mr. Gildea and Mr. Allen have no employment contracts other than the above described severance
agreements, and as such are at-will employees.
Director Compensation 2010
In fiscal 2010, our independent directors received options to purchase an aggregate of 450,000
shares and an aggregate of $210,000 in fees for their service on the Board of Directors, which
included meeting fees of $1,500 per meeting. Directors who are also employees do not receive
compensation for their services as directors.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fees Earned or Paid |
|
|
|
|
Name |
|
in Cash |
|
Option Awards(1) |
|
Total |
Edward A. Stoltenberg |
|
$ |
68,500 |
|
|
$ |
76,920 |
(2) |
|
$ |
145,420 |
|
Robert Cell |
|
$ |
68,500 |
|
|
$ |
76,920 |
(3) |
|
$ |
145,420 |
|
John DeVillars |
|
$ |
59,250 |
|
|
$ |
76,920 |
(4) |
|
$ |
136,170 |
|
Marshall Sterman |
|
$ |
13,750 |
|
|
$ |
0 |
(5) |
|
$ |
13,750 |
|
|
|
|
(1) |
|
Represents the full grant date fair value of the option grant calculated in accordance
with FASB ASC Topic 718. For the purposes of making the option calculation, the assumptions set
forth in Note 12 of the Notes to Consolidated Financial Statements for the year ended December 31,
2010 were utilized; provided that we excluded the assumed forfeiture rate for the purposes of the
calculations in the table. |
|
(2) |
|
As of December 31, 2010, Mr. Stoltenberg held options to purchase 194,000 shares of common
stock. |
|
(3) |
|
As of December 31, 2010, Mr. Cell held options to purchase 194,000 shares of common stock. |
|
(4) |
|
As of December 31, 2010, Mr. DeVillars held options to purchase 194,000 shares of common stock. |
|
(5) |
|
As of December 31, 2010, Mr. Sterman held no options to purchase shares of
common stock. |
50
RELATED PARTY TRANSACTIONS
As of December 31, 2010 and 2009 the Company has an accrued liability totaling $395,001
and $697,602, respectively, representing accrued compensation to officers, directors and
consultants.
The Company had a term note payable to its CEO, Edward J. Gildea. The unsecured term note for
$89,170 was dated April 30, 2007 with an original maturity of April 30, 2009 and accrued interest
at 12% per annum. The note had been extended for one year until April 30, 2010. The Company paid
accrued interest of $21,400 upon extension of the notes due date on June 30, 2009. This note was
subordinate to the New Jersey EDA bonds. On December 18, 2009, the Company repaid the principal
balance of the note plus accrued interest of $6,777.
In connection with the Companys acquisition of TerraSphere Systems, the Company assumed
an unsecured note payable to William Gildea, Secretary of the Company and brother of Edward Gildea,
the Companys Chairman and Chief Executive Officer, that has an interest rate of 10% per annum. The
principal amount due totaled $72,351 at December 31, 2010. The Company has accrued interest
totaling $18,973 at December 31, 2010 and incurred interest expense totaling $3,486 for the year
ended December 31, 2010.
The President of TerraSphere Inc. is Mark Gildea, a brother of Edward Gildea, the Companys
Chairman and Chief Executive Officer and of William Gildea, Secretary. In addition, one of the
members of the Companys Board of Directors, Marshal Sterman, is an officer, shareholder and
director of a TerraSphere licensee.
51
SELLING STOCKHOLDER
The shares of common stock being offered by the selling stockholder are those issuable to the
selling stockholder upon conversion of the notes and exercise of the warrants. For additional
information regarding the issuance of the notes and the warrants, see Prospectus Summary
Private Placement of Notes and Warrants above. We are registering the shares of common stock in
order to permit the selling stockholder to offer the shares for resale from time to time. Except
for the ownership of the notes and the warrants issued pursuant to the Securities Purchase
Agreement, the selling stockholder has not had any material relationship with us within the past
three years.
The table below lists the selling stockholder and other information regarding the selling
stockholders beneficial ownership (as determined under Section 13(d) of the Securities Exchange
Act of 1934, as amended, and the rules and regulations thereunder) of the common stock. The second
column lists the number of shares of common stock beneficially owned by the selling stockholder,
based on its respective ownership of shares of common stock, notes
and warrants, as of June 24,
2011, assuming conversion of the notes and exercise of the warrants held by each such selling
stockholder on that date but taking account of any limitations on conversion and exercise set forth
therein.
The third column lists the shares of common stock being offered by this prospectus by the
selling stockholder and does not take into account any limitations on (i) conversion of the notes
set forth therein or (ii) exercise of the warrants set forth therein.
In accordance with the terms of a registration rights agreement with the holders of the notes
and the warrants, this prospectus generally covers the resale of 133% of the sum of (i) the maximum
number of shares of common stock issuable upon conversion of the notes and (ii) the maximum number
of shares of common stock issuable upon exercise of the warrants, in each case, determined as if
the outstanding notes and warrants were converted or exercised (as the case may be) in full
(without regard to any limitations on conversion or exercise contained therein) as of the trading
day immediately preceding the date this registration statement was initially filed with the SEC.
Because the conversion price of the notes and the exercise price of the warrants may be adjusted,
the number of shares that will actually be issued may be more or less than the number of shares
being offered by this prospectus. The fourth column assumes the sale of all of the shares offered
by the selling stockholder pursuant to this prospectus.
Under the terms of the notes and the warrants, a selling stockholder may not convert the notes
or exercise the warrants to the extent (but only to the extent) such selling stockholder or any of
its affiliates would beneficially own a number of shares of our common stock which would exceed
4.9%. The number of shares in the second column reflects these limitations. The selling stockholder
may sell all, some or none of their shares in this offering. See Plan of Distribution.
|
|
|
|
|
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|
|
|
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|
|
|
|
|
|
|
|
|
Maximum Number |
|
|
|
|
Number of Shares |
|
of Shares of |
|
Number of Shares |
|
|
of Common Stock |
|
Common Stock to |
|
of Common Stock |
|
|
Owned Prior to |
|
be Sold Pursuant to |
|
Owned After |
Name of Selling Stockholder |
|
Offering |
|
this Prospectus |
|
Offering |
Iroquois Master Fund, Ltd. |
|
|
6,245,420 |
(1)(2) |
|
|
87,172,755 |
|
|
|
10,965,294 |
(1) |
(1) Iroquois Capital Management
L.L.C. (Iroquois Capital) is the investment manager of Iroquois Master Fund, Ltd (IMF). Consequently,
Iroquois Capital has voting control and investment discretion over securities held by IMF. As managing
members of Iroquois Capital, Joshua Silverman and Richard Abbe make voting and investment decisions
on behalf of Iroquois Capital in its capacity as investment manager to IMF. As a result of the foregoing,
Mr. Silverman and Mr. Abbe may be deemed to have beneficial ownership (as determined under Section 13(d)
of the Securities Exchange Act of 1934, as amended) of the securities held by IMF.
(2) Includes 4,431,344 shares of common stock issuable
upon conversion of a secured convertible note held by IMF. Excludes (i) 5,539,144 shares of
common stock issuable upon conversion of secured and unsecured convertible notes held by IMF
and Iroquois Capital Opportunity Fund, LP (ICOF) and (ii) 43,724,967 shares of common stock
issuable upon exercise of warrants held by IMF and ICOF because each of such notes and warrants
contain a blocker provision under which the holder thereof does not have the right to convert each
such note or exercise each such warrant to the extent (but only to the extent) that such conversion
or exercise would result in beneficial ownership by the holder thereof, or any of its affiliates, of
more than 4.9% of the common stock.
52
PLAN OF DISTRIBUTION
We are registering the shares of common stock issuable upon conversion of the notes and
exercise of the warrants to permit the resale of these shares of common stock by the holders of the
notes and warrants from time to time after the date of this prospectus. We will not receive any of
the proceeds from the sale by the selling stockholder of the shares of common stock. We will bear
all fees and expenses incident to our obligation to register the shares of common stock.
The selling stockholder may sell all or a portion of the shares of common stock held by it and
offered hereby from time to time directly or through one or more underwriters, broker-dealers or
agents. If the shares of common stock are sold through underwriters or broker-dealers, the selling
stockholder will be responsible for underwriting discounts or commissions or agents commissions.
The shares of common stock may be sold in one or more transactions at fixed prices, at prevailing
market prices at the time of the sale, at varying prices determined at the time of sale or at
negotiated prices. These sales may be effected in transactions, which may involve crosses or block
transactions, pursuant to one or more of the following methods:
|
|
|
on any national securities exchange or quotation service on which the securities may
be listed or quoted at the time of sale; |
|
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|
in the over-the-counter market; |
|
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|
|
in transactions otherwise than on these exchanges or systems or in the
over-the-counter market; |
|
|
|
|
through the writing or settlement of options, whether such options are listed on an
options exchange or otherwise; |
|
|
|
|
ordinary brokerage transactions and transactions in which the broker-dealer solicits
purchasers; |
|
|
|
|
block trades in which the broker-dealer will attempt to sell the shares as agent but
may position and resell a portion of the block as principal to facilitate the
transaction; |
|
|
|
|
purchases by a broker-dealer as principal and resale by the broker-dealer for its
account; |
|
|
|
|
an exchange distribution in accordance with the rules of the applicable exchange; |
|
|
|
|
privately negotiated transactions; |
|
|
|
|
short sales made after the date the Registration Statement is declared effective by
the SEC; |
|
|
|
|
broker-dealers may agree with the selling stockholder to sell a specified number of
such shares at a stipulated price per share; |
|
|
|
|
a combination of any such methods of sale; and |
|
|
|
|
any other method permitted pursuant to applicable law. |
The selling stockholder may also sell shares of common stock under Rule 144 promulgated under
the Securities Act of 1933, as amended, if available, rather than under this prospectus. In
addition, the selling stockholder may transfer the shares of common stock by other means not
described in this prospectus. If the selling stockholder effects such transactions by selling
shares of common stock to or through underwriters, broker-dealers or agents, such underwriters,
broker-dealers or agents may receive commissions in the form of discounts, concessions or
commissions from the selling stockholder or commissions from purchasers of the shares of common
stock for whom they may act as agent or to whom they may sell as principal (which discounts,
concessions or
53
commissions as to particular underwriters, broker-dealers or agents may be in excess of those
customary in the types of transactions involved). In connection with sales of the shares of common
stock or otherwise, the selling stockholder may enter into hedging transactions with
broker-dealers, which may in turn engage in short sales of the shares of common stock in the course
of hedging in positions they assume. The selling stockholder may also sell shares of common stock
short and deliver shares of common stock covered by this prospectus to close out short positions
and to return borrowed shares in connection with such short sales. The selling stockholder may also
loan or pledge shares of common stock to broker-dealers that in turn may sell such shares.
The selling stockholder may pledge or grant a security interest in some or all of the notes,
warrants or shares of common stock owned by it and, if it defaults in the performance of its
secured obligations, the pledgees or secured parties may offer and sell the shares of common stock
from time to time pursuant to this prospectus or any amendment to this prospectus under Rule
424(b)(3) or other applicable provision of the Securities Act amending, if necessary, the list of
selling stockholders to include the pledgee, transferee or other successors in interest as selling
stockholders under this prospectus. The selling stockholder also may transfer and donate the shares
of common stock in other circumstances in which case the transferees, donees, pledgees or other
successors in interest will be the selling beneficial owners for purposes of this prospectus.
To the extent required by the Securities Act and the rules and regulations thereunder, the
selling stockholder and any broker-dealer participating in the distribution of the shares of common
stock may be deemed to be underwriters within the meaning of the Securities Act, and any
commission paid, or any discounts or concessions allowed to, any such broker-dealer may be deemed
to be underwriting commissions or discounts under the Securities Act. At the time a particular
offering of the shares of common stock is made, a prospectus supplement, if required, will be
distributed, which will set forth the aggregate amount of shares of common stock being offered and
the terms of the offering, including the name or names of any broker-dealers or agents, any
discounts, commissions and other terms constituting compensation from the selling stockholder and
any discounts, commissions or concessions allowed or re-allowed or paid to broker-dealers.
Under the securities laws of some states, the shares of common stock may be sold in such
states only through registered or licensed brokers or dealers. In addition, in some states the
shares of common stock may not be sold unless such shares have been registered or qualified for
sale in such state or an exemption from registration or qualification is available and is complied
with.
There can be no assurance that any selling stockholder will sell any or all of the shares of
common stock registered pursuant to the registration statement, of which this prospectus forms a
part.
The selling stockholder and any other person participating in such distribution will be
subject to applicable provisions of the Securities Exchange Act of 1934, as amended, and the rules
and regulations thereunder, including, without limitation, to the extent applicable, Regulation M
of the Exchange Act, which may limit the timing of purchases and sales of any of the shares of
common stock by the selling stockholder and any other participating person. To the extent
applicable, Regulation M may also restrict the ability of any person engaged in the distribution of
the shares of common stock to engage in market-making activities with respect to the shares of
common stock. All of the foregoing may affect the marketability of the shares of common stock and
the ability of any person or entity to engage in market-making activities with respect to the
shares of common stock.
We will pay all expenses of the registration of the shares of common stock pursuant to the
registration rights agreement, estimated to be $23,062.68 in total, including, without limitation,
Securities and Exchange Commission filing fees and expenses of compliance with state securities or
blue sky laws; provided, however, a selling stockholder will pay all underwriting discounts and
selling commissions, if any. We will indemnify the selling stockholder against liabilities,
including some liabilities under the Securities Act in accordance with the registration rights
agreements or the selling stockholder will be entitled to contribution. We may be indemnified by
the selling stockholder against civil liabilities, including liabilities under the Securities Act
that may arise from any written information furnished to us by the selling stockholder specifically
for use in this prospectus, in accordance with the related registration rights agreement or we may
be entitled to contribution.
Once sold under the registration statement, of which this prospectus forms a part, the shares
of common stock will be freely tradable in the hands of persons other than our affiliates.
54
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 500,000,000 shares of common stock, $0.0001 par value
per share, and 10,000,000 shares of preferred stock, $0.0001 par value per share.
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.
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.
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.
The only series of preferred stock we have authorized are 17,500 shares of 1% Series A
Convertible Preferred Stock (Series A Preferred), of which 13,281 shares our outstanding as of
June 20, 2011. Our Board of Directors approved, and on October 18, 2010, we filed with the
Delaware Secretary of State, a Certificate of Designation of Preferences, Rights and Limitations of
Series A Preferred Stock (the Certificate of Designation). Each share of Series A Preferred is
convertible into a number of shares of Common Stock equal to (1) the stated value of the share
($1,000), divided by (2) $0.543 (the Conversion Price). Holders of the Series A Preferred are
entitled to receive cumulative dividends at the rate per share (as a percentage of the stated value
per share) of 1% per annum (subject to increase in certain circumstances), payable annually and on
each conversion date. The dividends are payable, during the first three years after issuance, at
our election, and thereafter, at the election of the holder, in cash or in shares of our common
stock valued at the Conversion Price (or in some combination thereof). Upon any liquidation,
dissolution or winding-up of the Company, whether voluntary or involuntary, the holders of the
Series A Preferred shall be entitled to receive out of the assets, whether capital or surplus, of
the Company an amount equal to the greater of: (i) $0.01 for each share of common stock underlying
the Series A Preferred Stock then held by holders, or (ii) the amount the holders would have
received had the holders converted the Series A Preferred Stock
55
then held into common stock immediately prior to the liquidation, dissolution or winding-up,
in each case, before any distribution or payment shall be made to the holders of any junior
securities, and if the assets of the Company are insufficient to pay in full such amounts, then the
entire assets to be distributed to the holders of the Series A Preferred shall be ratably
distributed among the holders in accordance with the respective amounts that would be payable on
such shares if all amounts payable thereon were paid in full. The holders of the Series A
Preferred have no voting rights except with respect to specified matters affecting the rights of
the Series A Preferred. As long as any shares of Series A Preferred Stock are outstanding, unless
the holders of a majority-in-interest of the Series A Preferred Stock shall have otherwise given
prior written consent, we may not amend our charter documents, including, without limitation, our
certificate of incorporation and bylaws, in any manner that materially and adversely affects any
rights of the holders.
December 2010 Note and Warrant Offering
In December 2010, we sold to certain institutional investors certain notes and warrants
pursuant to a shelf registration statement on Form S-3. We sold to the investors convertible notes
in the aggregate original principal amount of $4,990,000, which notes are convertible into shares
of our common stock. The notes were purchased in two tranches, the first of which involved the
sale of notes in the aggregate original principal amount of $3,939,473.68, which were issued with
an original issue discount of approximately 4.8%, and the purchase price of $3,750,000. The second
tranche were issued in March 2011 in the aggregate original principal amount of $1,050,526.32 with
an original issue discount of approximately 4.8%, and the purchase price of $1,000,000. The notes
are not interest bearing, unless we are in default on the notes, in which case the notes carry an
interest rate of 18% per annum.
The notes are initially convertible into shares of common stock at a conversion price of $1.00
per share; provided that if we make certain dilutive issuances (with limited exceptions), the
conversion price of the notes will be lowered to the per share price for the dilutive issuances. We
also have the right, at our option, to permit the holder of the notes to convert at a lower price
specified by us for a period specified by us. We were required to repay the notes in six equal
installments commencing February 1, 2011 (with respect to the initial notes issued in December
2010) and April 8, 2011 (with respect to the notes issued in March 2011), either in cash or in
shares of our common stock. If we choose to utilize shares of our common stock for the payment, we
must make an irrevocable decision to use shares 22 trading days prior to the installment payment
date, and the value of our shares will be equal to the lower of (i) the conversion price then in
effect and (ii) 85% of the average of the three lowest closing sale prices of our common stock
during the 20 trading day period prior to payment of the installment amount (the Installment
Conversion Price). If we choose to make an installment payment in shares of common stock, we must
make a pre-installment payment of shares (the Pre-Installment Shares) to the note holder 20
trading days prior to the applicable installment date based on the value of our shares during the
20 trading days preceding the delivery of the notice elect to pay in our shares. On the installment
date, to the extent we owe the note holder additional shares in excess of the Pre-Installment
Shares to satisfy the installment payment, we will issue the note holder additional shares, and to
the extent we have issued excess shares, such shares will be applied to future payments.
If an event of default occurs under the notes, we must redeem the notes in cash at the greater
of 135% of the unconverted principal amount or 135% of the greatest equity value of the shares of
common stock underlying the notes from the date of the default until the redemption is completed.
The conversion price of all the Notes is subject to adjustment in the case of stock splits,
stock dividends, combinations of shares and similar recapitalization transactions. The
convertibility of the notes may be limited if, upon exercise, the holder or any of its affiliates
would beneficially own more than 4.9% of our common stock.
Pursuant to the terms of the agreement governing the issuance of the above notes, we also
issued to the investors warrants to acquire shares of common stock, in the form of three warrants:
(i) Series A Warrants, (ii) Series B Warrants and (iii) Series C Warrants (collectively, the
Warrants).
The Series B Warrants became exercisable on February 28, 2011 and expire on November 28, 2011.
The Series B Warrants provide that the holders are initially entitled to purchase an aggregate of
4,990,000 shares at an initial exercise price of $1.00 per share. If we make certain dilutive
issuances (with limited exceptions), the exercise price of the Series B Warrants will be lowered to
the per share price for the dilutive issuances. In addition, the
56
exercise price of the Series B Warrants will adjust to the average of the conversion prices
used to repay the notes discussed above. The floor price for the exercise price of the Series B
Warrants is $0.345. The number of shares underlying the Series B Warrants will adjust whenever the
exercise price adjusts, such that at all times the aggregate exercise price of the Series B
Warrants will be $4,990,000. As of the date hereof, the exercise price of the Series B Warrants is
$0.345 per share and there are 14,463,768 shares underlying the Series B Warrants.
To the extent we enter into a fundamental transaction (as defined in the Series B Warrants and
which include, without limitation, our entering into a merger or consolidation with another entity,
our selling all or substantially all of our assets, or a person acquiring 50% of our common stock),
we have agreed to purchase the Series B Warrant from the holder at its Black-Scholes value.
If our common stock trades at a price at least 200% above the Series B Warrants exercise price
for a period of 10 trading days, we may force the exercise of the Series B Warrants if we meet
certain conditions.
The Series A and Series C Warrants became exercisable on February 28, 2011 and have a five
year term. Should we make certain dilutive issuances (with limited exceptions), the exercise price
of the Series A and Series C Warrants will be lowered to the per share price for the dilutive
issuances. In addition, the exercise price of the Series A and Series C Warrants will adjust to the
average of the conversion prices used to repay the notes discussed above. As of the date hereof,
the exercise price of the Series A Warrants and Series C Warrants is $0.22 per share.
To the extent we enter into a fundamental transaction (as defined in the Series A and Series C
Warrants and which include, without limitation, our entering into a merger or consolidation with
another entity, our selling all or substantially all of our assets, or a person acquiring 50% of
our common stock), we have agreed to purchase the Series A and Series C Warrants from the holder at
its Black-Scholes value.
The exercise price of all the Warrants is subject to adjustment in the case of stock splits,
stock dividends, combinations of shares and similar recapitalization transactions. The
exercisability of the Warrants may be limited if, upon exercise, the holder or any of its
affiliates would beneficially own more than 4.9% of our common stock.
April 2011 Note and Warrant Offering
In April 2011, we sold to an institutional investor a note and warrants. We sold to the
investor a convertible note in the aggregate original principal amount of $3,850,000, which note is
convertible into shares of our common stock. The note was be issued with an original issue discount
of approximately 9.1%, and the purchase price of the note was $3,500,000. The note is not interest
bearing, unless we are in default on the note, in which case the note carries an interest rate of
18% per annum.
The note is initially convertible into shares of common stock at a conversion price of $0.40
per share, provided that if we make certain dilutive issuances (with limited exceptions), the
conversion price of the note will be lowered to the per share price for the dilutive issuances. We
are required to repay the note in five equal installments commencing July 31, 2011, either in cash
or in shares of our common stock. If we choose to utilize shares of our common stock for the
payment, we must make an irrevocable decision to use shares 23 trading days prior to the
installment payment date, and the value of our shares will be equal to 85% of the average of the
three lowest closing sale prices of our common stock during the 20 trading day period prior to
payment of the installment amount (the Installment Conversion Price). If we choose to make an
installment payment in shares of common stock, we must make a pre-installment payment of shares
(the Pre-Installment Shares) to the note holder 20 trading days prior to the applicable
installment date based on the value of our shares equal to 85% of the average of the three lowest
closing sale prices of our common stock during the 20 trading day period prior to payment of the
installment amount. On the installment date, to the extent we owe the note holder additional shares
in excess of the Pre-Installment Shares to satisfy the installment payment, we will issue the note
holder additional shares, and to the extent we have issued excess shares, such shares will be
applied to future payments.
If an event of default occurs under the note, we must redeem the note in cash at the greater
of 135% of the unconverted principal amount or 135% of the greatest equity value of the shares of
common stock underlying the note from the date of the default until the redemption is completed.
57
The conversion price of the note is subject to adjustment in the case of stock splits, stock
dividends, combinations of shares and similar recapitalization transactions. The convertibility of
the note may be limited if, upon exercise, the holder or any of its affiliates would beneficially
own more than 4.9% of our common stock.
Pursuant to the terms of the agreement governing the issuance of the above notes, we also
issued to the investors warrants to acquire shares of common stock, in the form of three warrants:
(i) Series A Warrants, (ii) Series B Warrants and (iii) Series C Warrants (collectively, the
Warrants).
The Series B Warrants are exercisable six months and one day after issuance and expire March
13, 2012. The Series B Warrants provide that the holders are initially entitled to purchase an
aggregate of 9,143,750 shares at an initial exercise price of $0.4125 per share. If we make certain
dilutive issuances (with limited exceptions), the exercise price of the Series B Warrants will be
lowered to the per share price for the dilutive issuances. In addition, the exercise price of the
Series B Warrants will adjust to the average of the Installment Conversion Prices used to repay the
note discussed above. The floor price for the exercise price of the Series B Warrants is $0.34. The
number of shares underlying the Series B Warrants will adjust whenever the exercise price adjusts,
such that at all times the aggregate exercise price of the Series B Warrants will be $3,771,797.
To the extent we enter into a fundamental transaction (as defined in the Series B Warrants and
which include, without limitation, our entering into a merger or consolidation with another entity,
our selling all or substantially all of our assets, or a person acquiring 50% of our common stock),
we have agreed to purchase the Series B Warrants from the holders at their Black-Scholes value.
If our common stock trades at a price at least 200% above the Series B Warrants exercise price
for a period of 10 trading days, we may force the exercise of the Series B Warrants if we meet
certain conditions.
The Series A and Series C Warrants are exercisable six months and one day after issuance and
have a five year term commencing on the initial exercise date. The Series A Warrants provide that
the holders are initially entitled to purchase an aggregate of 4,812,500 shares at an initial
exercise price of $0.40 per share. The Series C Warrants provide that the holders are initially
entitled to purchase an aggregate of 4,343,285 shares at an initial exercise price of $0.425 per
share. If on the expiration date of the Series B Warrants, a holder of such warrant has not
exercised such warrant for at least 50% of the shares underlying such warrant, we have the right to
redeem from such holder its Series C Warrant for $1,000 under certain circumstances.
If we make certain dilutive issuances (with limited exceptions), the exercise price of the
Series A and Series C Warrants will be lowered to the per share price for the dilutive issuances.
In addition, the exercise price of the Series A and Series C Warrants will adjust to the average of
the Installment Conversion Prices used to repay the note discussed above. The number of shares
underlying the Series A and Series C Warrants will not be adjusted due to an adjustment of the
exercise price pursuant to the preceding two sentences.
To the extent we enter into a fundamental transaction (as defined in the Series A and Series C
Warrants and which include, without limitation, our entering into a merger or consolidation with
another entity, our selling all or substantially all of our assets, or a person acquiring 50% of
our common stock), we have agreed to purchase the Series A and Series C Warrants from the holder at
their Black-Scholes value.
The exercise price of all the Warrants is subject to adjustment in the case of stock splits,
stock dividends, combinations of shares and similar recapitalization transactions. The
exercisability of the Warrants may be limited if, upon exercise, the holder or any of its
affiliates would beneficially own more than 4.9% of our common stock.
We and our subsidiaries entered into a security agreement with the investor pursuant to which
we and our subsidiaries granted the investor a security interest in all of our respective assets
securing our obligations under the above note. In addition, our subsidiaries entered into guaranty
agreements with the investor pursuant to which the subsidiaries guaranteed our obligations under
the note.
We entered into a registration rights agreement with the investor pursuant to which we agreed
to register the resale of 133% of the shares of common stock underlying the note and Warrants. We
agreed to file a registration
58
statement within 10 days after we obtained shareholder approval of the financing, which
occurred on June 13, 2011. To the extent we fail to file the registration statement on a timely
basis or if the registration statement is not declared effective within 90 days after we obtained
shareholder approval, we agreed to make certain payments to the investor. The registration
statement of which this prospectus is a part is being filed to satisfy the foregoing obligations.
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 16, 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 1.47 shares of common stock for each warrant
exercised, except for approximately 2.3 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. 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.
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
59
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, and have exercise prices of $1.63 and $1.25,
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.
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.
60
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 H Warrants
General. In connection with our public offering completed in October 2009, we issued Class H
warrants to purchase an aggregate of 17,250,000 shares of common stock at an exercise price of
$1.30 per share. 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 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.
Exercise. 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 Issued in October 2009 Offering
We agreed to sell to the representative of the underwriters in our October 2009 public
offering an option to purchase up to a total of 300,000 units at a per-unit price of $1.749, with
each unit consisting of one share of common stock and one Class H 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, 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
61
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.
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:
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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. |
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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. |
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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 66 2/3% 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-
62
takeover effect with respect to transactions our Board of Directors does not approve 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:
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for any breach of the officers or directors duty of loyalty to us or our
stockholders; |
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for acts or omissions not in good faith or which involve intentional misconduct or a
knowing violation of law; |
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for unlawful payments of dividends or unlawful stock repurchases or redemptions as
provided in Section 174 of the DGCL; or |
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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, Class B warrants, and Class H warrants are quoted on the NASDAQ Capital
Market under the symbols COIN, COINZ, and COINW respectively.
63
LEGAL MATTERS
The validity of the securities offered in this prospectus is being passed upon for us by Cozen
OConnor.
EXPERTS
The consolidated financial statements as of December 31, 2010 and 2009 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 common
stock included in 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.
64
CONVERTED
ORGANICS INC.
INDEX TO
CONSOLIDATED FINANCIAL STATEMENTS
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Page
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F-2
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F-3
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F-4
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F-5
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F-6
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F-7
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F-1
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. and subsidiaries (the
Company) as of December 31, 2010 and 2009, and
the related consolidated statements of operations and
comprehensive loss, changes in stockholders equity 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. and subsidiaries as of
December 31, 2010 and 2009, 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 Converted Organics Inc. and subsidiaries
will continue as a going concern. As reflected in the
consolidated financial statements, the Company has an
accumulated deficit at December 31, 2010 and has suffered
significant net losses and negative cash flows from operations,
which raise substantial doubt about the Companys ability
to continue as a going concern. Managements plans with
regard to these matters are disclosed in Note 2 to the
consolidated financial statements. The consolidated financial
statements do not include any adjustments that might result from
the outcome of this uncertainty.
Glastonbury, Connecticut
March 31, 2011
F-2
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Item 1.
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Financial
Statements
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CONVERTED
ORGANICS INC.
DECEMBER 31, 2010 AND 2009
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2010
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2009
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ASSETS
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CURRENTASSETS
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Cash
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$
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3,039,941
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$
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10,708,807
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Restricted cash
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613,162
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Accounts receivable, net
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579,946
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80,911
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Inventories
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126,406
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176,351
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Prepaid expenses and other assets
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251,589
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73,194
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Deferred financing costs, net
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276,667
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Current assets of discontinued operations
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|
|
14,500
|
|
|
|
962,075
|
|
|
|
|
|
|
|
|
|
|
Total current assets
|
|
|
4,289,049
|
|
|
|
12,614,500
|
|
|
|
|
|
|
|
|
|
|
Deposits and other non-current assets
|
|
|
575,596
|
|
|
|
336,357
|
|
Property and equipment, net
|
|
|
1,477,589
|
|
|
|
1,002,709
|
|
Goodwill
|
|
|
1,667,957
|
|
|
|
|
|
Intangible assets, net
|
|
|
11,629,265
|
|
|
|
1,995,619
|
|
Non-current assets of discontinued operations
|
|
|
|
|
|
|
19,193,886
|
|
|
|
|
|
|
|
|
|
|
Total assets
|
|
$
|
19,639,456
|
|
|
$
|
35,143,071
|
|
|
|
|
|
|
|
|
|
|
|
LIABILITIES AND STOCKHOLDERS EQUITY
|
CURRENT LIABILITIES
|
|
|
|
|
|
|
|
|
Term note payable
|
|
$
|
350,000
|
|
|
$
|
|
|
Note payables related party
|
|
|
72,351
|
|
|
|
|
|
Accounts payable
|
|
|
2,393,388
|
|
|
|
552,057
|
|
Accrued expenses
|
|
|
656,412
|
|
|
|
843,203
|
|
Convertible notes payable, net of unamortized discount
|
|
|
306,404
|
|
|
|
355,164
|
|
Obligation to issue shares
|
|
|
1,560,715
|
|
|
|
|
|
Derivative liabilities current
|
|
|
5,199,572
|
|
|
|
|
|
Liabilities of discontinued operations
|
|
|
2,438,253
|
|
|
|
4,475,303
|
|
|
|
|
|
|
|
|
|
|
Total current liabilities
|
|
|
12,977,095
|
|
|
|
6,225,727
|
|
|
|
|
|
|
|
|
|
|
Derivative liabilities
|
|
|
3,476,047
|
|
|
|
1,626,742
|
|
Convertible note payable, net of current portion
|
|
|
|
|
|
|
17,767
|
|
Non-current liabilities of discontinued operations
|
|
|
|
|
|
|
18,501,081
|
|
|
|
|
|
|
|
|
|
|
Total liabilities
|
|
|
16,453,142
|
|
|
|
26,371,317
|
|
|
|
|
|
|
|
|
|
|
COMMITMENTS AND CONTINGENCIES
|
|
|
|
|
|
|
|
|
STOCKHOLDERS EQUITY
|
|
|
|
|
|
|
|
|
Preferred stock, $.0001 par value, authorized
10,000,000 shares; 17,500 ($1,000 stated value) shares
issued and outstanding
|
|
|
17,500,000
|
|
|
|
|
|
Common stock, $.0001 par value, authorized
250,000,000 shares at December 31, 2010 and
75,000,000 shares at December 31, 2009
|
|
|
8,547
|
|
|
|
3,777
|
|
Additional paid-in capital
|
|
|
85,555,990
|
|
|
|
58,660,042
|
|
Accumulated deficit
|
|
|
(100,453,292
|
)
|
|
|
(49,892,065
|
)
|
Accumulated other comprehensive loss
|
|
|
(1,109
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2,610,136
|
|
|
|
8,771,754
|
|
Noncontrolling interests
|
|
|
576,178
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total stockholders equity
|
|
|
3,186,314
|
|
|
|
8,771,754
|
|
|
|
|
|
|
|
|
|
|
Total liabilities and stockholders equity
|
|
$
|
19,639,456
|
|
|
$
|
35,143,071
|
|
|
|
|
|
|
|
|
|
|
The accompanying notes are an integral part of these
consolidated financial statements.
F-3
CONVERTED
ORGANICS INC.
FOR THE YEARS ENDED DECEMBER 31, 2010 AND
2009
|
|
|
|
|
|
|
|
|
|
|
2010
|
|
|
2009
|
|
|
Revenues
|
|
$
|
3,525,325
|
|
|
$
|
2,136,720
|
|
Cost of goods sold
|
|
|
2,522,305
|
|
|
|
2,079,740
|
|
|
|
|
|
|
|
|
|
|
Gross income
|
|
|
1,003,020
|
|
|
|
56,980
|
|
Operating expenses
|
|
|
|
|
|
|
|
|
Selling, general and administrative expenses
|
|
|
14,625,568
|
|
|
|
7,123,603
|
|
Research and development
|
|
|
287,550
|
|
|
|
626,652
|
|
Amortization of intangibles
|
|
|
367,461
|
|
|
|
288,007
|
|
|
|
|
|
|
|
|
|
|
|
|
|
15,280,579
|
|
|
|
8,038,262
|
|
|
|
|
|
|
|
|
|
|
Loss from continuing operations
|
|
|
(14,277,559
|
)
|
|
|
(7,981,282
|
)
|
Other income/(expenses)
|
|
|
|
|
|
|
|
|
Other income
|
|
|
131,197
|
|
|
|
23,524
|
|
Derivative gain (loss)
|
|
|
(166,712
|
)
|
|
|
5,766,035
|
|
Interest expense
|
|
|
(1,725,951
|
)
|
|
|
(5,450,581
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
(1,761,466
|
)
|
|
|
338,978
|
|
|
|
|
|
|
|
|
|
|
Loss from continuing operations before provision for income taxes
|
|
|
(16,039,025
|
)
|
|
|
(7,642,304
|
)
|
Provision for income taxes
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss from continuing operations
|
|
|
(16,039,025
|
)
|
|
|
(7,642,304
|
)
|
Loss from discontinued operations
|
|
|
(34,690,358
|
)
|
|
|
(13,463,484
|
)
|
|
|
|
|
|
|
|
|
|
Net loss
|
|
|
(50,729,383
|
)
|
|
|
(21,105,788
|
)
|
Net loss attributable to noncontrolling interest
|
|
|
(168,156
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss attributable to Converted Organics Inc. before other
comprehensive loss
|
|
|
(50,561,227
|
)
|
|
|
(21,105,788
|
)
|
Other comprehensive loss:
|
|
|
|
|
|
|
|
|
Foreign currency translation adjustment
|
|
|
(1,373
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive loss
|
|
|
(50,562,600
|
)
|
|
|
(21,105,788
|
)
|
Comprehensive loss attributable to noncontrolling interest
|
|
|
(264
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive loss attributable to Converted Organics Inc.
|
|
$
|
(50,562,336
|
)
|
|
$
|
(21,105,788
|
)
|
|
|
|
|
|
|
|
|
|
Net loss per share, basic and diluted
|
|
|
|
|
|
|
|
|
Continuing operations
|
|
$
|
(0.34
|
)
|
|
$
|
(0.39
|
)
|
Discontinued operations
|
|
|
(0.74
|
)
|
|
|
(0.69
|
)
|
|
|
|
|
|
|
|
|
|
|
|
$
|
(1.08
|
)
|
|
$
|
(1.08
|
)
|
|
|
|
|
|
|
|
|
|
Weighted average common shares outstanding
|
|
|
46,838,001
|
|
|
|
19,569,853
|
|
|
|
|
|
|
|
|
|
|
The accompanying notes are an integral part of these
consolidated financial statements.
F-4
CONVERTED
ORGANICS INC.
FOR THE YEARS ENDED DECEMBER 31, 2010 AND
2009
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Converted Organics Inc.
|
|
|
|
|
|
|
|
|
|
Preferred Stock Series A
|
|
|
Common Stock
|
|
|
|
|
|
|
|
|
|
|
|
Accumulated
|
|
|
|
|
|
|
|
|
|
|
|
|
Shares
|
|
|
|
|
|
Shares
|
|
|
|
|
|
Additional
|
|
|
|
|
|
|
|
|
Other
|
|
|
|
|
|
Non-
|
|
|
Total
|
|
|
|
Issued and
|
|
|
|
|
|
Issued and
|
|
|
|
|
|
Paid-in
|
|
|
Members
|
|
|
Accumulated
|
|
|
Comprehensive
|
|
|
|
|
|
Controlling
|
|
|
Stockholders
|
|
|
|
Outstanding
|
|
|
Amount
|
|
|
Outstanding
|
|
|
Amount
|
|
|
Capital
|
|
|
Equity
|
|
|
Deficit
|
|
|
Loss
|
|
|
Total
|
|
|
Interests
|
|
|
Equity
|
|
|
Balance, January 1, 2009, before cumulative effect of
change in accounting principle
|
|
|
|
|
|
$
|
|
|
|
|
7,431,436
|
|
|
$
|
743
|
|
|
$
|
31,031,647
|
|
|
$
|
619,657
|
|
|
$
|
(26,605,115
|
)
|
|
$
|
|
|
|
$
|
5,046,932
|
|
|
$
|
|
|
|
$
|
5,046,932
|
|
Cumulative effect of a change in accounting principle
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(2,936,250
|
)
|
|
|
|
|
|
|
(2,146,858
|
)
|
|
|
|
|
|
|
(5,083,108
|
)
|
|
|
|
|
|
|
(5,083,108
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, January 1, 2009, after cumulative effect of change
in accounting principle
|
|
|
|
|
|
|
|
|
|
|
7,431,436
|
|
|
|
743
|
|
|
|
28,095,397
|
|
|
|
619,657
|
|
|
|
(28,751,973
|
)
|
|
|
|
|
|
|
(36,176
|
)
|
|
|
|
|
|
|
(36,176
|
)
|
Members contributions
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
915,651
|
|
|
|
|
|
|
|
|
|
|
|
915,651
|
|
|
|
|
|
|
|
915,651
|
|
Members distributions
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(201,630
|
)
|
|
|
|
|
|
|
|
|
|
|
(201,630
|
)
|
|
|
|
|
|
|
(201,630
|
)
|
Deconsolidation of former variable interest entity
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1,367,982
|
)
|
|
|
|
|
|
|
|
|
|
|
(1,367,982
|
)
|
|
|
|
|
|
|
(1,367,982
|
)
|
Common stock issued to holders of convertible notes payable in
connection with extension
|
|
|
|
|
|
|
|
|
|
|
200,000
|
|
|
|
20
|
|
|
|
561,980
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
562,000
|
|
|
|
|
|
|
|
562,000
|
|
Common stock issued upon conversion of convertible notes payable
|
|
|
|
|
|
|
|
|
|
|
7,779,644
|
|
|
|
778
|
|
|
|
6,419,473
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
6,420,251
|
|
|
|
|
|
|
|
6,420,251
|
|
Common stock issued as compensation for services
|
|
|
|
|
|
|
|
|
|
|
151,528
|
|
|
|
15
|
|
|
|
139,198
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
139,213
|
|
|
|
|
|
|
|
139,213
|
|
Warrants issued in connection with release of restricted cash
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
662,479
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
662,479
|
|
|
|
|
|
|
|
662,479
|
|
Issuance of stock options
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
222,064
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
222,064
|
|
|
|
|
|
|
|
222,064
|
|
Common stock issued upon exercise of warrants
|
|
|
|
|
|
|
|
|
|
|
1,500,000
|
|
|
|
150
|
|
|
|
1,964,850
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,965,000
|
|
|
|
|
|
|
|
1,965,000
|
|
Issuance of common stock
|
|
|
|
|
|
|
|
|
|
|
20,711,600
|
|
|
|
2,071
|
|
|
|
20,594,601
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
20,596,672
|
|
|
|
|
|
|
|
20,596,672
|
|
Net income (loss)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
34,304
|
|
|
|
(21,140,092
|
)
|
|
|
|
|
|
|
(21,105,788
|
)
|
|
|
|
|
|
|
(21,105,788
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, December 31, 2009
|
|
|
|
|
|
|
|
|
|
|
37,774,208
|
|
|
|
3,777
|
|
|
|
58,660,042
|
|
|
|
|
|
|
|
(49,892,065
|
)
|
|
|
|
|
|
|
8,771,754
|
|
|
|
|
|
|
|
8,771,754
|
|
Issuance of stock options
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,310,252
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,310,252
|
|
|
|
|
|
|
|
1,310,252
|
|
Common stock issued upon conversion of convertible notes payable
and accrued interest
|
|
|
|
|
|
|
|
|
|
|
646,500
|
|
|
|
65
|
|
|
|
413,894
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
413,959
|
|
|
|
|
|
|
|
413,959
|
|
Common stock issued as compensation for services
|
|
|
|
|
|
|
|
|
|
|
650,811
|
|
|
|
66
|
|
|
|
441,974
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
442,040
|
|
|
|
|
|
|
|
442,040
|
|
Issuance of common stock and warrants, net of
fair value of derivatives issued of $968,096
|
|
|
|
|
|
|
|
|
|
|
2,400,000
|
|
|
|
240
|
|
|
|
1,398,024
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,398,264
|
|
|
|
|
|
|
|
1,398,264
|
|
Issuance of common stock and warrants as
payment of accounts payable
|
|
|
|
|
|
|
|
|
|
|
2,780,740
|
|
|
|
278
|
|
|
|
1,501,322
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,501,600
|
|
|
|
|
|
|
|
1,501,600
|
|
Common stock issued upon exercise of employee stock options
|
|
|
|
|
|
|
|
|
|
|
50,000
|
|
|
|
5
|
|
|
|
33,995
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
34,000
|
|
|
|
|
|
|
|
34,000
|
|
Issuance of common stock as payment to settle obligations of
discontinued operations
|
|
|
|
|
|
|
|
|
|
|
21,619,837
|
|
|
|
2,162
|
|
|
|
11,752,588
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
11,754,750
|
|
|
|
|
|
|
|
11,754,750
|
|
Issuance of common stock related to the acquisition of
TerraSphere Systems, LLC
|
|
|
|
|
|
|
|
|
|
|
18,174,603
|
|
|
|
1,817
|
|
|
|
9,564,036
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
9,565,853
|
|
|
|
648,644
|
|
|
|
10,214,497
|
|
Issuance of common stock related to the acquisition of
GoLocalProduceRI, LLC
|
|
|
|
|
|
|
|
|
|
|
1,371,428
|
|
|
|
137
|
|
|
|
479,863
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
480,000
|
|
|
|
95,954
|
|
|
|
575,954
|
|
Issuance of preferred stock as payment of bond obligation
|
|
|
17,500
|
|
|
|
17,500,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
17,500,000
|
|
|
|
|
|
|
|
17,500,000
|
|
Foreign currency translation adjustment
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1,109
|
)
|
|
|
(1,109
|
)
|
|
|
(264
|
)
|
|
|
(1,373
|
)
|
Net loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(50,561,227
|
)
|
|
|
|
|
|
|
(50,561,227
|
)
|
|
|
(168,156
|
)
|
|
|
(50,729,383
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, December 31, 2010
|
|
|
17,500
|
|
|
$
|
17,500,000
|
|
|
|
85,468,127
|
|
|
$
|
8,547
|
|
|
$
|
85,555,990
|
|
|
$
|
|
|
|
$
|
(100,453,292
|
)
|
|
$
|
(1,109
|
)
|
|
$
|
2,610,136
|
|
|
$
|
576,178
|
|
|
$
|
3,186,314
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The accompanying notes are an integral part of these
consolidated financial statements.
F-5
CONVERTED
ORGANICS INC.
|
|
|
|
|
|
|
|
|
|
|
Years Ended December 31,
|
|
|
|
2010
|
|
|
2009
|
|
|
CASH FLOWS FROM OPERATING ACTIVITIES:
|
|
|
|
|
|
|
|
|
Net loss
|
|
$
|
(50,729,383
|
)
|
|
$
|
(21,105,788
|
)
|
Adjustments to reconcile net loss to net cash used in operating
activities:
|
|
|
|
|
|
|
|
|
Amortization expense
|
|
|
1,210,580
|
|
|
|
374,218
|
|
Depreciation and amortization expense of property and equipment
|
|
|
1,435,086
|
|
|
|
2,155,994
|
|
Provision for losses on accounts receivable
|
|
|
2,457,478
|
|
|
|
81,000
|
|
Amortization of discounts attributable to notes and warrants on
private financing
|
|
|
360,359
|
|
|
|
2,870,313
|
|
Interest expense in relation to issuance of convertible debt
|
|
|
1,368,695
|
|
|
|
1,475,678
|
|
Loss on disposal of discontinued operations
|
|
|
9,337,909
|
|
|
|
|
|
Common stock issued for extension of convertible note payable
|
|
|
|
|
|
|
562,000
|
|
Common stock issued as compensation
|
|
|
442,040
|
|
|
|
139,213
|
|
Stock option compensation expense
|
|
|
1,310,252
|
|
|
|
222,064
|
|
Loss on impairment of long lived assets
|
|
|
15,383,925
|
|
|
|
3,928,129
|
|
Warrants issued in connection with release of restricted cash
|
|
|
|
|
|
|
662,479
|
|
Obligations to issue shares revaluation
|
|
|
(123,214
|
)
|
|
|
|
|
Derivative loss (gain)
|
|
|
166,712
|
|
|
|
(5,766,035
|
)
|
Changes in operating assets and liabilities:
|
|
|
|
|
|
|
|
|
(Increase) decrease in:
|
|
|
|
|
|
|
|
|
Accounts receivable
|
|
|
(104,792
|
)
|
|
|
19,784
|
|
Inventories
|
|
|
322,342
|
|
|
|
(159,018
|
)
|
Prepaid expenses and other current assets
|
|
|
(130,958
|
)
|
|
|
(239,261
|
)
|
Deposits and other non-current assets
|
|
|
280,551
|
|
|
|
376,042
|
|
Increase (decrease) in:
|
|
|
|
|
|
|
|
|
Accounts payable
|
|
|
2,804,450
|
|
|
|
2,869,851
|
|
Accrued expenses
|
|
|
2,705,381
|
|
|
|
714,900
|
|
|
|
|
|
|
|
|
|
|
Net cash used in operating activities
|
|
|
(11,502,587
|
)
|
|
|
(10,818,437
|
)
|
|
|
|
|
|
|
|
|
|
CASH FLOWS FROM INVESTING ACTIVITIES:
|
|
|
|
|
|
|
|
|
Purchase of property and equipment
|
|
|
(656,095
|
)
|
|
|
(3,923,715
|
)
|
Release of restricted cash
|
|
|
613,162
|
|
|
|
1,994,958
|
|
Deconsolidation of variable interest entity
|
|
|
|
|
|
|
(596,170
|
)
|
Patent costs
|
|
|
(1,106
|
)
|
|
|
|
|
Cash acquired in acquisitions
|
|
|
98,276
|
|
|
|
|
|
Purchase of other assets
|
|
|
(500,000
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash used in investing activities
|
|
|
(445,763
|
)
|
|
|
(2,524,927
|
)
|
|
|
|
|
|
|
|
|
|
CASH FLOWS FROM FINANCING ACTIVITIES:
|
|
|
|
|
|
|
|
|
Repayment of debt obligations
|
|
|
(1,542,753
|
)
|
|
|
(4,466,891
|
)
|
Repayment of capital lease obligations
|
|
|
(11,802
|
)
|
|
|
(12,403
|
)
|
Members contributions
|
|
|
|
|
|
|
230,983
|
|
Members distributions
|
|
|
|
|
|
|
(201,630
|
)
|
Advances from (payments to) related party
|
|
|
(10,000
|
)
|
|
|
|
|
Net proceeds from exercise of options
|
|
|
34,000
|
|
|
|
|
|
Net proceeds from stock offering
|
|
|
2,366,360
|
|
|
|
20,596,672
|
|
Net proceeds from exercise of warrants
|
|
|
|
|
|
|
1,965,000
|
|
Net proceeds from short-term notes
|
|
|
3,444,555
|
|
|
|
2,582,500
|
|
|
|
|
|
|
|
|
|
|
Net cash provided by financing activities
|
|
|
4,280,360
|
|
|
|
20,694,231
|
|
|
|
|
|
|
|
|
|
|
Net effect of exchange rate changes on cash
|
|
|
(876
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
NET INCREASE (DECREASE) IN CASH
|
|
|
(7,668,866
|
)
|
|
|
7,350,867
|
|
Cash, beginning of year
|
|
|
10,708,807
|
|
|
|
3,357,940
|
|
|
|
|
|
|
|
|
|
|
Cash, end of year
|
|
$
|
3,039,941
|
|
|
$
|
10,708,807
|
|
|
|
|
|
|
|
|
|
|
Supplemental cash flow information:
|
|
|
|
|
|
|
|
|
Cash paid during the period for:
|
|
|
|
|
|
|
|
|
Interest
|
|
$
|
952,350
|
|
|
$
|
1,665,990
|
|
Non-cash financing activities:
|
|
|
|
|
|
|
|
|
Equipment acquired through assumption of capital lease
|
|
$
|
|
|
|
$
|
52,979
|
|
Equipment acquired through assumption of term note
|
|
|
|
|
|
|
118,250
|
|
Common stock issued upon conversion of convertible notes payable
and accrued interest
|
|
|
413,959
|
|
|
|
6,420,251
|
|
Fair value of derivatives issued in conjunction with debt and
equity financing
|
|
|
6,882,165
|
|
|
|
3,827,686
|
|
Common stock and warrants issued as payment for accounts payable
|
|
|
1,501,600
|
|
|
|
|
|
Fair value of contingent consideration in relation to acquisition
|
|
|
1,683,929
|
|
|
|
|
|
Issuance of common stock in conjunction with the acquisitions
|
|
|
10,045,853
|
|
|
|
|
|
Discount on convertible note issued in connection with financings
|
|
|
3,750,000
|
|
|
|
2,870,313
|
|
Preferred stock issued in satisfaction of bonds payable
|
|
|
17,500,000
|
|
|
|
|
|
Common stock issued as settlement of discontinued operations
obligations
|
|
|
11,754,750
|
|
|
|
|
|
Members contribution of convertible note
|
|
|
|
|
|
|
684,668
|
|
Conversion of accounts payable into notes payable
|
|
|
|
|
|
|
4,663,039
|
|
The accompanying notes are an integral part of these
consolidated financial statements.
F-6
CONVERTED
ORGANICS INC.
NOTE 1
NATURE OF OPERATIONS
Converted Organics Inc. and its subsidiaries (collectively
the Company) utilize innovative clean
technologies to establish and operate environmentally friendly
businesses. The Company is dedicated to creating a cleaner,
greener future, and operates using sustainable business
practices that support this vision. The Company operates in
three business areas: Organic Fertilizer, Industrial Wastewater
Treatment and Vertical Farming.
Organic Fertilizer: The Company operates a
processing facility that converts food waste and other raw
materials into all-natural fertilizers, biostimulants, and soil
amendment products.
Industrial Wastewater Treatment: Utilizing an
innovative wastewater treatment process, Converted
Organics Industrial Wastewater Resources business
(IWWR) provides a means of treating aqueous waste
streams. This technology, which can use waste heat and renewable
energy as fuel, produces only two byproducts: clean water vapor
and landfill-appropriate solid residuals. IWWR is in the
developmental stage at December 31, 2010.
Vertical Farming: The Company engages in
vertical farming through our TerraSphere business, which builds
efficient systems for growing pesticide-free organic produce in
a controlled indoor environment using its patented technology.
A summary of the subsidiaries that comprise of the Company are
as follows:
Converted Organics of California, LLC (the Gonzales
facility), is a California limited liability company and
wholly-owned subsidiary of the Company. The Gonzales facility
operates a plant in Gonzales, California, in the Salinas Valley
and produces approximately 25 tons of organic fertilizer per
day, which is sold primarily to the California agricultural
market. The Gonzales facility employs a proprietary method
called High Temperature Liquid Composting (HTLC).
The facility has been upgraded to enable it to accept larger
amounts of food waste from waste haulers and may be upgraded,
depending on demand, to have the capability to produce a dry
product in addition to the current liquid fertilizer it produces.
Converted Organics of Woodbridge, LLC, is a New Jersey limited
liability company and wholly-owned subsidiary of the Company,
which was formed for the purpose of owning, constructing and
operating the Companys facility in Woodbridge, New Jersey
(the Woodbridge facility). The Woodbridge facility
was designed to service the New York-Northern New Jersey
metropolitan area. During the third quarter of 2010, the Company
discontinued operations at the Woodbridge plant. The Company has
reported the results of operations of Converted Organics of
Woodbridge, LLC as discontinued operations for the years ended
December 31, 2010 and 2009 within the consolidated
financial statements (See Note 5).
Converted Organics of Rhode Island, LLC, a Rhode Island limited
liability company and subsidiary of the Company, was formed in
July 2008 for the purpose of developing a facility at the Rhode
Island central landfill. Converted Organics of Rhode Island, LLC
has not had any activity since its formation. On
February 25, 2010, the Company signed a letter of intent
with the owners of the non-controlling interest in Converted
Organics of Rhode Island, LLC to sell substantially all of its
assets and a limited select amount of liabilities to the Rhode
Island Resource Recovery Corporation (RIRRC). No
sale has not taken place as of December 31, 2010.
On January 26, 2010, the Company formed Converted Organics
of Mississippi, LLC, a Mississippi limited liability company and
a wholly-owned subsidiary of the Company, for the purpose of
hiring a sales force and adding a poultry litter-based
fertilizer product to the Companys existing product lines.
The Company outsourced production of this product.
On May 20, 2010, the Company formed TerraSphere
Inc.(TerraSphere), a Delaware corporation and a
wholly-owned subsidiary of the Company, for the purpose of
acquiring the membership interests of TerraSphere Systems LLC
(TerraSphere Systems). On November 12, 2010,
TerraSphere acquired a 95% membership interest in TerraSphere
Systems (See Note 4). TerraSphere Systems has two
subsidiaries, wholly owned PharmaSphere, LLC
(PharmaSphere) and majority owned TerraSphere
Systems Canada, Inc. (TerraSphere Canada).
F-7
CONVERTED
ORGANICS INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
NOTE 1
NATURE OF OPERATIONS Continued
PharmaSpheres business plan is to utilize the TerraSphere
Systems patented technology for the production of high
value biocompounds sourced from plants and used as active
pharmaceutical ingredients and for the production of transgenic
plants (genetically engineered plants) for the biotechnology
market. PharmaSphere has a wholly-owned subsidiary PharmaSphere
Worcester, LLC, which was formed to build a facility in
Worcester, Massachusetts utilizing PharmaSpheres business
plan. The building of the facility has not commenced.
PharmaSphere has no revenue to date. TerraSphere Canada, located
in Vancouver, British Columbia, operates the research and
manufacturing facility for TerraSphere and is eighty-five
percent owned by TerraSphere Systems.
On December 30, 2010, Converted Organic, Inc. purchased a
majority ownership interest of the vertical farming entity,
GoLocalProduceRI, LLC located in Rhode Island, marking its
entrance into the vertical farming industry as owners and
operators of what is expected to be the first TerraSphere
facility in the United States (See Note 4).
NOTE 2
GOING CONCERN
As reflected in consolidated financial statements for the year
ended December 31, 2010, the Company incurred a net loss of
approximately $50.7 million, and as of December 31,
2010 had an accumulated deficit of $100.5 million and had a
working capital deficiency of $8.7 million. During 2010,
the Company discontinued the operations at its Woodbridge
facility, acquired a license to treat Industrial Waste Water and
acquired the TerraSphere business. In addition to these events
the Company currently has manufacturing capabilities at its
Gonzales facility as a means to generate revenues and cash.
Although the California operations are currently cash flow
positive, the anticipated costs associated with corporate
overhead and for the operations of TerraSphere will cause the
Company to have negative cash flow in 2011. In addition, the
Company feels that it will require cash, either through
financing or equity transactions, in order to build out the IWWR
and TerraSphere projects planned for 2011. The Company feels
that if it achieves planned sales from its California facility,
establishes additional operational Industrial Wastewater sites,
and completes the construction of a TerraSphere facility, then
the Company will become cash flow positive in the future. In
order to achieve these goals, however, additional financing will
be needed.
Presently, our liquidity is limited to our cash on hand at
December 31, 2010 ($3.0 million) and the
$1.0 million that we received on March 3, 2011 as a
result of the sale of the additional notes available under our
December 17, 2010 financing agreement. In addition, on
February 28, 2011 we received shareholder approval to
permit the investor in the December 17, 2010 financing
agreement to exercise certain of its warrants, which could
provide us with an additional $4.9 million. However, since
receiving shareholder approval our stock price has closed at
both above and below the exercise price of these warrants, and
it is not likely that any warrants would be exercised unless the
price of our stock was greater than the exercise price of the
warrants. There is no assurance that the investor will exercise
the warrants, and as such, we may not receive these funds. As a
result of this uncertainty, we have entered into discussions
with an investor who would make funds available with a
convertible note under similar terms to our December 17,
2010 financing agreement, though such an arrangement has not
been finalized.
If we do not receive additional funds in excess of the amount of
cash on hand, whether as a result of the exercise of the
warrants issued in our December 2010 financing, execution of the
contemplated convertible note, or otherwise, we will not be able
to continue our operations once the cash on hand is utilized.
Even in the event that we do receive additional funds, there is
no guarantee that such funds will be sufficient to continue
operations until we achieve a positive cash flow position. At
this time we do not have any commitments for additional
financing, and there is no assurance that capital in any form
will be available to us on terms and conditions that are
acceptable or at all.
The Company has entered into discussions with an investor, who
would execute a convertible note under an agreement similar to
our December 17, 2010 financing agreement. There is no
guarantee that this transaction will be completed. Even if the
Company does receive this cash, it may be insufficient to last
until the Company becomes cash flow positive, in which case it
would not be able to continue operating.
F-8
CONVERTED
ORGANICS INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
NOTE 3
SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES
OF CONSOLIDATION AND BASIS OF PRESENTATION
The accompanying consolidated financial statements include the
balances of Converted Organics Inc. and its wholly-owned
subsidiaries, Converted Organics of California, LLC, Converted
Organics of Woodbridge, LLC, Converted Organics of Mississippi,
LLC and its majority-owned subsidiaries TerraSphere Inc.,
Converted Organics of Rhode Island, LLC and GoLocalProduceRI,
LLC. The minority-owned interest owned in its subsidiaries is
included in the Companys consolidated financial statements
as noncontrolling interest. All intercompany transactions and
balances have been eliminated in consolidation.
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.
FOREIGN
OPERATIONS
The accounting records of TerraSphere Canada are maintained in
Canadian dollars, its functional currency. Revenue and expense
transactions are translated to U.S. dollars using the
average exchange rate of the month in which the transaction took
place. Assets and liabilities are translated to
U.S. dollars using the exchange rate in effect as of the
balance sheet date. Equity transactions are translated to
U.S. dollars using the exchange rate in effect as of the
date of the equity transaction. Translation gains and losses are
reported as a component of accumulated other comprehensive
income or loss. Gains and losses resulting from transactions
which are denominated in other than functional currencies are
reported as foreign currency exchange gain or loss in the
statements of operations and comprehensive loss in the period
the gain or loss occurred.
CASH
AND CASH EQUIVALENTS
The Company defines cash equivalents as highly liquid
instruments with an original maturity of three months or less.
The Company had no cash equivalents at December 31, 2010
and 2009.
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, 2010 and 2009, an allowance for
doubtful accounts of approximately $2,370,000 and $50,000 has
been established, respectively, against certain receivables that
management has identified as uncollectible. A charge of
approximately $2,320,000 and $34,000 is reflected in the
consolidated statements of operations and comprehensive loss for
the years ended December 31, 2010 and 2009, respectively,
to provide for doubtful accounts.
INVENTORIES
Inventories are valued at the lower of cost or market, with cost
determined by the first in, first out method. Inventories
consist 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, 2010 or
2009.
GOODWILL
The Company evaluates the carrying value of goodwill during the
fourth quarter of each year and when events occur or
circumstances change that would more likely than not reduce the
fair value of the reporting unit below its
F-9
CONVERTED
ORGANICS INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
NOTE 3
SIGNIFICANT ACCOUNTING
POLICIES Continued
carrying amount. Such circumstances could include, but are not
limited to (1) a significant adverse change in legal
factors or in business climate, (2) unanticipated
competition, or (3) an adverse action or assessment by a
regulator. When evaluating whether goodwill is impaired, the
Company compares the fair value of the reporting unit to which
the goodwill is assigned to the reporting units carrying
amount, including goodwill. The fair value of the reporting unit
is estimated using a combination of the income, or discounted
cash flows, approach and the market approach, which utilizes
comparable companies data. If the carrying amount of a
reporting unit exceeds its fair value, then the amount of the
impairment loss must be measured. The impairment loss would be
calculated by comparing the implied fair value of reporting unit
goodwill to its carrying amount. In calculating the implied fair
value of reporting unit goodwill, the fair value of the
reporting unit is allocated to all of the other assets and
liabilities of that unit based on their fair values. The excess
of the fair value of a reporting unit over the amount assigned
to its other assets and liabilities is the implied fair value of
goodwill. An impairment loss would be recognized when the
carrying amount of goodwill exceeds its implied fair value. The
Company does not believe the goodwill it is carrying as of
December 31, 2010 is impaired as it was recorded at fair
value in the 4th quarter of 2010.
INTANGIBLE
ASSETS
The Company accounts for its intangible assets in accordance
with ASC 350 Intangibles Goodwill and Other
(ASC 350), which requires that intangible assets
with finite lives, such as the Companys license and
patents, 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. Intangible assets deemed to have
indefinite lives are not amortized and are subject to annual
impairment testing. This testing compares carrying values to
fair values and when appropriate, the carrying value of these
assets is reduced to fair value. During 2010 and 2009, there was
no impairment on intangible assets deemed to have indefinite
lives.
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. The Company has incurred
impairment charges of $15.4 million and $3.9 million
related to its discontinued operations for the years ended
December 31, 2010 and 2009, respectively, as more fully
described in Note 5 and Note 8.
PROPERTY
AND EQUIPMENT
Property and equipment are stated at cost. Depreciation is
computed on the straight-line basis over estimated useful lives
of 7 to 20 years.
Construction-in-progress
includes construction costs, equipment purchases and capitalized
interest costs for assets not yet been placed in service at the
Gonzales facility and TerraSphere Canada.
CONVERTIBLE
DEBT
The Company accounts for its convertible debt by recognizing
discounts for the intrinsic value of beneficial conversion
features, if applicable, and discounts for the relative fair
value of any warrants issued in conjunction with the debt.
Discounts are amortized to interest expense over the related
term of the note.
F-10
CONVERTED
ORGANICS INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
NOTE 3
SIGNIFICANT ACCOUNTING
POLICIES Continued
DERIVATIVE
INSTRUMENTS
The Company accounts for derivative instruments in accordance
with ASC 815 Derivatives and Hedging (ASC
815), which establishes accounting and reporting standards
for derivative instruments and hedging activities, including
certain derivative instruments embedded in other financial
instruments or contracts and requires recognition of all
derivatives on the balance sheet at fair value. Accounting for
changes in the fair value of derivative instruments depends on
whether the derivatives qualify as hedge relationships and the
types of relationships designated are based on the exposures
hedged. At December 31, 2010 and 2009, the Company did not
have any derivative instruments that were designated as hedges.
DISCONTINUED
OPERATIONS
The Company discontinued the operations of its Woodbridge
facility during the third quarter of 2010 (see Note 5).
Assets and liabilities related to the Woodbridge facility have
been classified as discontinued operations on the consolidated
balance sheets at December 31, 2010 and 2009 and its
operations have been classified as loss from discontinued
operations on the consolidated statements of operations and
comprehensive loss for the years ended December 31, 2010
and 2009.
REVENUE
RECOGNITION
The Companys organic fertilizer operation generates
revenues from two sources: product sales and tip fees. Product
sales revenue comes from the sale of fertilizer products. Tip
fee revenue is derived from waste haulers who 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. The IWWR operation
will generate revenue by setting up treatment systems on
customers sites and processing their wastewater on a
price-per-gallon
basis. The Companys vertical farming operation derives its
revenues from licensing fees and royalties, as well as the sale
of equipment and expects future revenue from operating
facilities using the Companys patented technology.
Revenue is recognized when all 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, the Company
defers recognition of revenue until the period in which these
criteria are satisfied. Revenue is generally recognized upon
shipment of product for its fertilizer business, and for
Terrasphere, the Company recognizes technology license revenue
immediately upon completed performance if the term of exclusive
technology licenses is equal to the life of the associated
intellectual property, otherwise license revenue would be
recognized over the term of the license.
SHIPPING
AND HANDLING COSTS
The Company records freight billed to customers for shipment of
product as revenue with an offsetting charge to cost of goods
sold for freight paid on shipments to customers.
F-11
CONVERTED
ORGANICS INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
NOTE 3
SIGNIFICANT ACCOUNTING
POLICIES Continued
SHARE
BASED COMPENSATION
The Company accounts for share based compensation paid to
employees in accordance with ASC 718
Compensation Stock Compensations (ASC
718). Under ASC 718 guidance, 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). The Company accounts for share based
compensation issued to non-employees in accordance with
ASC 505 Equity (ASC 505). Under
ASC 505 guidance, such compensation 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
The Company accounts for income taxes following the asset and
liability method in accordance with ASC 740 Income
Taxes. Under such method, deferred tax assets and
liabilities are recognized for the future tax consequences
attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their
respective tax bases. Deferred tax assets and liabilities are
measured using enacted tax rates expected to apply to taxable
income in the years that the asset is expected to be recovered
or the liability settled. See Note 14 for additional
information.
The provisions of ASC 740 address the determination of
whether tax benefits claimed or expected to be claimed on a tax
return should be recorded in the financial statements. Under
ASC 740, 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 examination by taxing
authorities, based on the technical merits of the position. The
Company has determined that it has no significant uncertain tax
positions.
FAIR
VALUE MEASUREMENTS
The Company applies ASC 820 Fair Value Measurements and
Disclosures (ASC 820), which defines fair value,
establishes a framework for measuring fair value, and expands
disclosures about fair value measurements. ASC 820 applies
to reported balances that are required or permitted to be
measured at fair value under existing accounting pronouncements.
ASC 820 emphasizes that fair value is a market-based
measurement, not an entity-specific measurement. Therefore, a
fair value measurement should be determined based on the
assumptions that market participants would use in pricing the
asset or liability. As a basis for considering market
participant assumptions in fair value measurements, ASC 820
establishes a fair value hierarchy that distinguishes between
market participant assumptions based on market data obtained
from sources independent of the reporting entity (observable
inputs that are classified within Levels 1 and 2 of the
hierarchy) and the reporting entitys own assumptions about
market participant assumptions (unobservable inputs classified
within Level 3 of the hierarchy).
Level 1 inputs utilize quoted prices (unadjusted) in active
markets for identical assets or liabilities that the Company has
the ability to access. Level 2 inputs are inputs other than
quoted prices included in Level 1 that are observable for
the asset or liability, either directly or indirectly.
Level 2 inputs may include quoted prices for similar assets
and liabilities in active markets, as well as inputs that are
observable for the asset or liability (other than quoted
prices), such as interest rates, foreign exchange rates and
yield curves that are observable at commonly
F-12
CONVERTED
ORGANICS INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
NOTE 3
SIGNIFICANT ACCOUNTING
POLICIES Continued
quoted intervals. Level 3 inputs are unobservable inputs
for the asset or liability, which are typically based on an
entitys own assumptions, as there is little, if any,
related market activity. In instances where the determination of
the fair value measurement is based on inputs from different
levels of the fair value hierarchy, the level in the fair value
hierarchy within which the entire fair value measurement falls
is based on the lowest level input that is significant to the
fair value measurement in its entirety which requires judgment,
and considers factors specific to the asset or liability.
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 was antidilutive
and, as such, basic and diluted earnings (loss) per share are
the same for each of the years ended December 31, 2010 and
2009.
RECLASSIFICATIONS
As a result of the Woodbridge Facility operations being
discontinued during the third quarter of 2010, the comparative
years have been reclassified to conform with the current
presentation and has reclassified certain items as discontinued
operations. These reclassifications have no affect on previously
reported net income.
RECENTLY
ADOPTED ACCOUNTING PRONOUNCEMENTS
In April 2010, the FASB issued ASU
No. 2010-17,
Milestone Method of Revenue Recognition. This ASU allows
entities to make a policy election to use the milestone method
of revenue recognition and provides guidance on defining a
milestone and the criteria that should be met for applying the
milestone method. The scope of this ASU is limited to the
transactions involving milestones relating to research and
development deliverables. The guidance includes enhanced
disclosure requirements about each arrangement, individual
milestones and related contingent consideration, substantive
milestones and factors considered in that determination. The
amendments in this ASU are effective prospectively to milestones
achieved in fiscal years, and interim periods within those
years, beginning after June 15, 2010. Early application and
retrospective application are permitted. The Company has
evaluated this new ASU and has determined that it will not have
a significant impact on the determination or reporting of its
financial results.
In December 2010, the FASB issued ASU
2010-28
(Topic 350) When to Perform Step 2 of the Goodwill
Impairment Test for Reporting Units with Zero or Negative
Carrying Amounts. The amendments in ASU
2010-28
modify Step 1 of the goodwill impairment test for reporting
units with zero or negative carrying amounts. For those
reporting units, an entity is required to perform Step 2 of the
goodwill impairment test if it is more likely than not that a
goodwill impairment exists. In determining whether it is more
likely than not that goodwill impairment exists, an entity
should consider whether there are any adverse qualitative
factors indicating that impairment may exist. ASU
2010-28 is
effective for fiscal years, and interim periods within those
years, beginning after December 15, 2010 for public
entities. Early adoption is not permitted. The Company will
apply the provisions of ASU
2010-29 on a
prospective basis.
In December 2010, the FASB issued ASU
2010-29,
Business Combinations (Topic 805): Disclosure of Supplementary
Pro Forma Information for Business Combinations. ASU
2010-29
specifies that when a public
F-13
CONVERTED
ORGANICS INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
NOTE 3
SIGNIFICANT ACCOUNTING
POLICIES Continued
company completes a business combination, the company should
disclose revenue and earnings of the combined entity as though
the business combination occurred as of the beginning of the
comparable prior annual reporting period. The update also
expands the supplemental pro forma disclosures under Topic 805
to include a description of the nature and amount of material,
non-recurring pro forma adjustments directly attributable to the
business combination included in the pro forma revenue and
earnings. The requirements in ASU
2010-29 are
effective for business combinations that occur after the
beginning of the first annual reporting period beginning on or
after December 15, 2010. The Company will apply the
provisions of ASU
2010-29 on a
prospective basis.
NOTE 4
ACQUISITIONS
TERRASPHERE
SYSTEMS LLC ACQUISITION
On November 12, 2010, we acquired 95% of the membership
interests of TerraSphere Systems LLC. The acquisition will
enable us to license TerraSpheres patented Growth System,
which is a system of modules and processes for growing plants in
a controlled environment. The system uses and controls precise
combinations of light, water, nutrition, gravity, centrifugal
forces, and gasses to produce growing conditions that can be
controlled and manipulated to result in desired plant growth and
maximum crop production.
The membership interest purchase agreement
(Agreement) entered on July 6, 2010 allows for
an election by TerraSphere members to accept
1) 27,777,778 shares of common stock upon closing of
the transaction (with a 6 month holding period)
(Option One) or 2) 15,873,016 shares of
Company common stock upon closing of the transaction with an
option to earn an additional 21,164,021 shares of Company
common stock in contingent consideration based upon TerraSphere
achieving certain milestones and agreeing to an 18 month
holding period on stock distributed to them (Option
Two). Based on 26% of TerraSphere members electing
Option One and 69% electing Option Two, the maximum total shares
that could be issued is 32,777,778 of Company common stock. Per
the Agreement, TerraSphere members who elected Option One
received 7,222,222 shares of Company common stock upon
closing and members electing Option Two received
10,952,381 shares of Company common stock upon closing with
an additional 14,603,175 shares of Company common stock
issueable upon achieving the following milestones (contingent
consideration):
Milestone One Payment: 4,563,492 shares
of Company common stock, if between the date of the Agreement
and the 90th day following the closing date or the
180th day following the date of the Agreement, the
following occurs: for a period of five consecutive trading days,
the Companys market capitalization exceeds the sum of:
(1) the Companys initial market capitalization on the
date of execution of the Agreement, plus (2) the closing
price per share, multiplied by the number of shares of Company
common stock to be issued at closing pursuant to the Agreement.
If between the date of the Agreement and the 90th day
following the closing date or the 180th day following the
date of the Agreement, the Company completes an equity
financing, the cash received from the equity financing during
such period shall be added to the market capitalization. If
between the closing date and December 31, 2011, the Company
sells equity of either the Company or any of the Companys
subsidiaries, any cash received from such equity sales during
such period shall be added to the market capitalization;
Milestone Two Payment: 1,825,397 shares
of Company common stock, if $2,000,000 of TerraSpheres
accounts receivable as of the date of the Agreement are received
prior to February 28, 2011. This Milestone was not met;
Milestone Three Payment: 4,563,492 shares
of Company common stock, if we generate gross margin of
$6,000,000 (gross margin target) from our operations during the
period commencing as of the date of the Agreement and ending on
December 31, 2011; provided that, if we generates gross
margin of at least $4,200,000 (gross margin threshold) from our
operations during such period, a pro rata portion of the Company
common stock shall be granted the applicable TerraSphere
members; and
F-14
CONVERTED
ORGANICS INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
NOTE 4
ACQUISITIONS Continued
Milestone Four Payment: 3,650,794 shares
of Company common stock, if the Company generates gross margin
of $4,000,000 from its operations during any nine-month period
commencing on the Agreement date and ending on December 31,
2012; provided that, if the Company achieves the Milestone Three
gross margin threshold, but does not achieve the Milestone Three
gross margin target, 83.3% of the difference between the
Milestone Three gross margin target and the actual gross margins
achieved pursuant to the Agreement (the Milestone Three
Deficiency) may be added by the Sellers to the Milestone
Four Payment and the Milestone Four gross margin target.
Notwithstanding anything to the contrary herein, the total
amounts payable pursuant to the Milestone Three Payment and
Milestone Four Payment shall be no more than
8,214,286 shares of Company common stock.
In addition, the Agreement contains an anti-dilution provision
due to which the Company estimated it would need to issue an
additional 2,040,000 shares of Company common stock.
The estimated purchase price at fair value is as follows:
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|
|
|
|
Election of Option One
|
|
$
|
2,961,000
|
|
Election of Option Two
|
|
|
4,490,000
|
|
Milestone one payment
|
|
|
1,403,000
|
|
Milestone two payment
|
|
|
711,000
|
|
Milestones three and four payments
|
|
|
1,684,000
|
|
Anti-dilution provision
|
|
|
837,000
|
|
|
|
|
|
|
|
|
$
|
12,086,000
|
|
|
|
|
|
|
The estimated purchase price has been allocated to the assets
acquired and liabilities assumed on a preliminary basis using
estimated fair value information currently available. The
allocation of the purchase price to the assets and liabilities
will be finalized within a year as the Company obtains more
information regarding asset valuations, liabilities assumed,
contingent consideration and revisions of preliminary estimates
of fair value made at the date of purchase. The fair value of
the noncontrolling interest totaling $648,644 was determined
based on the fair value assigned for the 95% of TerraSphere
Systems that the Company acquired.
The preliminary purchase price allocation for TerraSphere is as
follows:
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|
|
|
|
Cash
|
|
$
|
41,679
|
|
Accounts receivable
|
|
|
2,690,000
|
|
Other assets
|
|
|
274,313
|
|
Leasehold improvements
|
|
|
176,181
|
|
Construction-in-process
|
|
|
97,306
|
|
Patents and patent related costs
|
|
|
10,000,000
|
|
Goodwill
|
|
|
1,193,600
|
|
Assumption of liabilities
|
|
|
(1,738,435
|
)
|
Noncontrolling interest
|
|
|
(648,644
|
)
|
|
|
|
|
|
Total allocation of purchase price
|
|
$
|
12,086,000
|
|
|
|
|
|
|
Changes in the fair value of contingent consideration that the
Company recognizes after the acquisition date may be the result
of additional information about facts and circumstances that
existed at the acquisition date that the Company obtained after
that date. Such changes are considered to be measurement period
adjustments and would adjust the purchase price to the extent
they occur within one year from the acquisition date. Contingent
F-15
CONVERTED
ORGANICS INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
NOTE 4
ACQUISITIONS Continued
consideration classified as an asset or a liability that changes
beyond a year from the acquisition date is remeasured at fair
value and recognized in earnings.
Converted Organics, Inc recorded the investment in its
subsidiary, TerraSphere as follows on November 12, 2010:
|
|
|
|
|
Obligations to issue shares (Milestones Three and Four)
|
|
|
1,684,000
|
|
Derivative liability related to anti-dilution provision
|
|
|
837,000
|
|
Equity
|
|
|
9,565,000
|
|
|
|
|
|
|
Total
|
|
$
|
12,086,000
|
|
|
|
|
|
|
The Company determined that Milestones three and four contained
in the Agreement meet the definition of a liability under
ASC 480 Distinguishing Liabilities from Equity and
therefore this obligation to issue shares is treated as a
liability rather than equity when recording the fair value of
the acquisition. Obligations to issue shares represents the
estimated fair value of shares to be issued for Milestones three
and four as described above. In addition, the Company determined
that the anti-dilution provision contained in the Agreement
meets the definition of a derivative liability. The Company
considered various scenarios and possibilities of an occurrence
of an event that would trigger the anti-dilution provision.
Based on the various scenarios and possibilities the Company
estimated it would need to issue an additional
2,040,000 shares to the former members of TerraSphere
Systems related to this provision. All other aspects of the
transaction were recorded as equity.
GoLocalProduceRI,
LLC ACQUISITION
On December 30, 2010, the Company acquired 83.34% of
GoLocalProduceRI, LLC issuing 1,371,428 shares of Company
common stock valued at approximately $480,000, marking its
entrance into the vertical farming industry as owners and
operators of what is expected to be the first TerraSphere
facility in the United States.
The estimated purchase price has been allocated to the assets
acquired and liabilities assumed on a preliminary basis using
estimated fair value information currently available. The
allocation of the purchase price to the assets and liabilities
will be finalized within a year as the Company obtains more
information regarding asset valuations, liabilities assumed,
contingent consideration and revisions of preliminary estimates
of fair value made at the date of purchase. The fair value of
the noncontrolling interest totaling $95,954 was determined
based on the fair value assigned for the 83.34% of
GoLocalProduceRI, LLC that the Company acquired.
The preliminary purchase price allocation is as follows:
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|
|
|
|
Cash
|
|
$
|
56,597
|
|
Prepaid and other current assets
|
|
|
45,000
|
|
Goodwill
|
|
|
474,357
|
|
Noncontrolling interest
|
|
|
(95,954
|
)
|
|
|
|
|
|
Total
|
|
$
|
480,000
|
|
|
|
|
|
|
F-16
CONVERTED
ORGANICS INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
NOTE 4
ACQUISITIONS Continued
The unaudited pro forma consolidated financial information for
the years ended December 31, 2010 and 2009 as though the
above acquisitions had been completed at the beginning of the
respective years are as follows:
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|
|
|
|
|
|
|
|
|
|
For the Year Ended
|
|
|
December 31,
|
|
|
2010
|
|
2009
|
|
Revenue
|
|
$
|
8,862,980
|
|
|
$
|
2,670,514
|
|
Net loss
|
|
$
|
(48,629,191
|
)
|
|
$
|
(22,321,742
|
)
|
Net loss per share, basic and diluted
|
|
$
|
(0.65
|
)
|
|
$
|
(047
|
)
|
Weighted-average shares
|
|
|
74,276,495
|
|
|
|
47,094,769
|
|
NOTE 5
DISCONTINUED OPERATIONS
On July 30, 2010, the Company temporarily halted production
at its Woodbridge facility in order to undertake steps to lower
its cost structure at the Woodbridge facility. Specifically, the
Company attempted to negotiate more favorable terms under its
operating lease and to lower certain utility costs. The Company
was unable to lower such costs and therefore, management
determined that the Company could not sustain the negative cash
flow from the Woodbridge facility and discontinued operations at
the Woodbridge plant during the quarter ended September 30,
2010. As a result, during the quarter ended September 30,
2010, the Company recognized an impairment charge on the
long-lived assets of the Woodbridge facility to reduce the
carrying value of the those assets to approximately
$1.5 million, which is the value that was expected to be
received from the disposition of those assets. The consolidated
statements of operations and comprehensive loss includes an
impairment charge pertaining to those long-lived assets of
approximately $15.4 million which is included in loss from
discontinued operations.
On October 18, 2010, the bonds payable and related accrued
interest totaling approximately $18.5 million were settled
and extinguished for $17.5 million of Company preferred
stock (See Note 11). In addition, as described below, the
Company entered into a series of transactions on
October 18, 2010 whereby certain assets and liabilities
were assigned, transferred and or extinguished.
On October 18, 2010, the Company and the Woodbridge
facilitys landlord (Lessor) entered into a
Termination and Surrender Agreement (Termination
Agreement) related to the termination of the Woodbridge
Facility lease. Pursuant to the Termination Agreement, the
Lessor and the Company agreed to terminate the lease
surrendering the premises and transferring all equipment, tools
and fixtures owned by the Company and presently located at the
premises. Under the lease, there were approximately
$9.1 million of future rental payments. In addition, the
Lessor asserted claims for (i) unpaid sewer and trash
removal charges; (ii) unpaid rent due Lessor for prior
periods; (iii) certain costs and expenses incurred by
Lessor in connection with certain litigation; (iv) damages
that may result from the condition of the premises at the time
of surrender; and (v) the required removal and disposal of
abandoned inventory and materials totaling approximately
$2.4 million. Pursuant to the terms of the Termination
Agreement, the Company agreed to transfer the Woodbridge
facilitys assets to the Lessor with a carrying value of
approximately $1.5 million and to issue the Lessor a total
of 892,857 shares of Company common stock valued at $0.56
per share totaling $500,000 and to surrender deposits totaling
$415,000 with the Lessor in exchange for settlement of the
asserted claims of approximately $2.4 million.
On October 18, 2010, the Superior Court of the State of
California for the County of Los Angeles entered an Order in the
matter entitled American Capital Management, LLC
(ACM) v. Converted Organics Inc. and Converted
Organics of Woodbridge, LLC and Does 1-10 Inclusive (the
Order). The Order provides for the full and final
settlement of $11.3 million of claims against the Company
held by ACM. The claims include the future rental payments of
$9.1 million discussed above, as well as approximately
$1.7 million of promissory notes issued by the Company to
four contractors that had provided services to the Woodbridge
Facility (See Note 11) and approximately $400,000 for
other facility costs which were acquired by ACM from the Lessor.
ACM purchased the
F-17
CONVERTED
ORGANICS INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
NOTE 5
DISCONTINUED
OPERATIONS Continued
claims from these parties pursuant to separate claims purchase
agreements. Pursuant to the terms of the Order, the Company
agreed to issue to ACM a total of 20,726,980 shares of
Company common stock valued at $0.543 per share
totaling $11.3 million in full and final settlement of the
claims.
The loss recognized on disposal includes the $9.1 million
loss on early termination of the lease, approximately $796,000
of prepaid facility costs and approximately $400,000 of other
facility costs, net of a gain of $1.0 million in bond
interest waived in conjunction with the settlement and
extinguishment of the bonds payable as described above.
The following table summarizes the components of the loss from
discontinued operations:
|
|
|
|
|
|
|
|
|
|
|
2010
|
|
|
2009
|
|
|
Revenue from discontinued operations
|
|
$
|
830,814
|
|
|
$
|
497,062
|
|
|
|
|
|
|
|
|
|
|
Results from discontinued operations including write downs to
fair value of $15.4 million in 2010 and $3.9 million
in 2009
|
|
$
|
(25,352,449
|
)
|
|
$
|
(13,463,484
|
)
|
Loss recognized on disposal
|
|
|
(9,337,909
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
34,690,358
|
|
|
$
|
13,463,484
|
|
|
|
|
|
|
|
|
|
|
The Company does not expect to have any continuing cash flows
from operations associated with the Woodbridge facility.
The following table provides the assets and liabilities of the
Woodbridge facility, classified as discontinued operations, in
the consolidated balance sheets dated December 31, 2010 and
2009:
|
|
|
|
|
|
|
|
|
|
|
2010
|
|
|
2009
|
|
|
Accounts receivable, net
|
|
$
|
14,500
|
|
|
$
|
59,746
|
|
Inventories
|
|
|
|
|
|
|
272,396
|
|
Prepaid expenses
|
|
|
|
|
|
|
629,933
|
|
Property and equipment, net
|
|
|
|
|
|
|
17,935,216
|
|
Deposits
|
|
|
|
|
|
|
444,329
|
|
Capitalized bond costs, net
|
|
|
|
|
|
|
814,341
|
|
|
|
|
|
|
|
|
|
|
Assets of discontinued operations
|
|
$
|
14,500
|
|
|
$
|
20,155,961
|
|
|
|
|
|
|
|
|
|
|
Term notes payable
|
|
$
|
|
|
|
$
|
3,247,752
|
|
Accounts payable
|
|
|
837,606
|
|
|
|
1,237,275
|
|
Accrued expenses
|
|
|
1,571,874
|
|
|
|
950,782
|
|
Other liabilities
|
|
|
28,773
|
|
|
|
40,575
|
|
Bonds payable
|
|
|
|
|
|
|
17,500,000
|
|
|
|
|
|
|
|
|
|
|
Liabilities of discontinued operations
|
|
$
|
2,438,253
|
|
|
$
|
22,976,384
|
|
|
|
|
|
|
|
|
|
|
As of December 31, 2010, the Company wrote-off accounts
receivable totaling approximately $193,000 which is included in
the consolidated statements of operations and comprehensive loss
as loss from discontinued operations. The Company is actively
working with its vendors to satisfy the liabilities outstanding
at December 31, 2010. On January 25, 2011, the Company
paid cash of $150,000 and issued 3.2 million shares of
Company common stock totaling $1,494,000 in payment for
consulting services accrued at December 31, 2010 related to
the settlement of certain Woodbridge obligations (See Note 19).
F-18
CONVERTED
ORGANICS INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
NOTE 6
FINANCIAL MEASUREMENTS
CONCENTRATIONS
OF CREDIT RISK
The Companys financial instruments that are exposed to a
concentration of credit risk are cash and accounts receivable.
The Company places its cash in highly rated financial
institutions, which are continually reviewed by senior
management for financial stability. Effective December 31,
2010, extending through December 31, 2012, all
noninterest-bearing transaction accounts are fully insured,
regardless of the balance of the account. Generally the
Companys cash and cash equivalents in interest-bearing
accounts exceeds financial depository insurance limits. However,
the Company has not experienced any losses in such accounts and
believes that its cash and cash equivalents are not exposed to
significant credit risk. As of December 31, 2009, the
Company had approximately $613,000 of cash which was restricted
under its bond agreement. Restrictions on these cash balances
were released in 2010 (Note 11).
In 2010 and 2009, three customers accounted for 55% and 69% of
sales, respectively. One customer and four customers accounted
for 47% and 97% of accounts receivable at December 31, 2010
and 2009, respectively. 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, 2010 and 2009 a reserve for doubtful accounts
was recorded of approximately $2,370,000 and $50,000,
respectively.
FAIR
VALUE MEASUREMENTS
The Companys liabilities that are reported at fair value
in the accompanying consolidated balance sheets as of
December 31, 2010 and 2009 were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Level of
|
|
Balance
|
|
|
Hierarchy
|
|
2010
|
|
2009
|
|
Derivative warrants and anti-dilution provision liabilities
|
|
|
Level 3
|
|
|
$
|
8,675,619
|
|
|
$
|
1,626,742
|
|
The following table reflects the change in Level 3 fair
value of the Companys derivative liabilities for the years
ended December 31, 2010 and 2009:
|
|
|
|
|
|
|
|
|
|
|
2010
|
|
|
2009
|
|
|
Balance, beginning of year
|
|
$
|
(1,626,742
|
)
|
|
$
|
|
|
Cumulative effect of change in accounting principle
|
|
|
|
|
|
|
(5,083,108
|
)
|
Settlements
|
|
|
|
|
|
|
1,518,017
|
|
Issuances
|
|
|
(6,882,165
|
)
|
|
|
(3,827,686
|
)
|
Net gains (losses)
|
|
|
(166,712
|
)
|
|
|
5,766,035
|
|
|
|
|
|
|
|
|
|
|
Balance, end of year
|
|
$
|
(8,675,619
|
)
|
|
$
|
(1,626,742
|
)
|
|
|
|
|
|
|
|
|
|
The Company has other non-derivative financial instruments, such
as cash, accounts receivable, accounts payable, accrued expenses
and long-term debt, for which carrying amounts approximate fair
value.
F-19
CONVERTED
ORGANICS INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
NOTE 7
INVENTORIES
The Companys inventories consisted of the following at
December 31:
|
|
|
|
|
|
|
|
|
|
|
2010
|
|
|
2009
|
|
|
Finished goods
|
|
$
|
104,690
|
|
|
$
|
137,027
|
|
Raw materials
|
|
|
21,716
|
|
|
|
39,324
|
|
|
|
|
|
|
|
|
|
|
Total inventories
|
|
$
|
126,406
|
|
|
$
|
176,351
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
NOTE 8
PROPERTY AND EQUIPMENT
The Companys property and equipment, excluding assets of
discontinued operations at December 31 consisted of the
following:
|
|
|
|
|
|
|
|
|
|
|
2010
|
|
|
2009
|
|
|
Building and improvements
|
|
$
|
840,562
|
|
|
$
|
147,894
|
|
Machinery and equipment
|
|
|
755,831
|
|
|
|
687,125
|
|
Vehicles
|
|
|
42,570
|
|
|
|
42,570
|
|
Office equipment and furniture
|
|
|
17,925
|
|
|
|
7,838
|
|
Construction-in-progress
|
|
|
136,607
|
|
|
|
311,046
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,793,495
|
|
|
|
1,196,473
|
|
Less: Accumulated depreciation and amortization
|
|
|
(315,906
|
)
|
|
|
(193,764
|
)
|
|
|
|
|
|
|
|
|
|
Property and equipment, net
|
|
$
|
1,477,589
|
|
|
$
|
1,002,709
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The components of depreciation and amortization expense for the
years ended December 31, 2010 and 2009 are as follows:
|
|
|
|
|
|
|
|
|
|
|
2010
|
|
|
2009
|
|
|
Continuing operations cost of goods sold
|
|
$
|
104,158
|
|
|
$
|
96,241
|
|
Continuing operations operating expenses
|
|
|
17,984
|
|
|
|
11,511
|
|
|
|
|
|
|
|
|
|
|
|
|
|
122,142
|
|
|
|
107,752
|
|
Discontinued operations (See Note 5)
|
|
|
1,312,944
|
|
|
|
2,048,242
|
|
|
|
|
|
|
|
|
|
|
Total depreciation and amortization expense
|
|
|
1,435,086
|
|
|
|
2,155,994
|
|
|
|
|
|
|
|
|
|
|
Changes in accumulated depreciation and amortization at
December 31, 2010 and 2009 are as follows:
|
|
|
|
|
|
|
|
|
|
|
2010
|
|
|
2009
|
|
|
Balance, beginning of year
|
|
$
|
1,934,324
|
|
|
$
|
405,250
|
|
Additions
|
|
|
1,435,086
|
|
|
|
2,155,994
|
|
Disposals
|
|
|
(3,053,504
|
)
|
|
|
(626,920
|
)
|
|
|
|
|
|
|
|
|
|
Balance, end of year
|
|
$
|
315,906
|
|
|
$
|
1,934,324
|
)
|
|
|
|
|
|
|
|
|
|
During the third quarter of 2010, the Company discontinued
operations at its Woodbridge facility (See Note 5). As a
result, the Company impaired the Woodbridge facilitys
assets to reduce the carrying value to approximately
$1.5 million, which is the value expected to be received
from the transfer of those assets. The consolidated statements
of operations and comprehensive loss includes an impairment
charge in loss from discontinued operations pertaining to
long-lived assets of approximately $15.4 million as of
December 31, 2010.
F-20
CONVERTED
ORGANICS INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
NOTE 8
PROPERTY AND
EQUIPMENT Continued
In November 2009, the Company discovered corrosion in the walls
of one of its Woodbridge facilitys 120,000 gallon
digesters and determined that the corrosion was due to the
manufacturing process and the unsatisfactory performance of a
protective coating that was applied at the time of installation.
Through subsequent ultrasound wall thickness testing it was
determined that the corrosion was significant in two digesters
and that the Company would not be able to use those digesters
for their intended purpose in the manufacturing process and that
they would have to be repaired or replaced. The Company
determined that repair of the digesters was not feasible and, as
such, they would have to be replaced, accordingly, those assets
have been fully impaired. The consolidated statements of
operations and comprehensive loss, includes a charge in loss
from discontinued operations of $3.9 million in the year
ended December 31, 2009, comprising the net book value of
the impaired property and equipment of $3.4 million and the
related intellectual property of $500,000.
NOTE 9
DEFERRED FINANCING COSTS
In connection with its various private financings, the Company
incurs fees which are capitalized and are being amortized over
the term of the related loans. Amortization expense associated
with private financings totaled $28,778 and $22,042 for the
years ended December 31, 2010 and 2009, respectively.
NOTE 10
INTANGIBLE ASSETS
The Company entered into a license technology agreement with a
third party related to its Woodbridge facility. The Company
determined at December 31, 2009 that the value of this
license was impaired due to corrosion of the machinery that is
utilized in the technology (see Note 8), and its subsequent
decision to use its own technology to manufacture product in the
Woodbridge facility. Accordingly, the carrying value of the
license of $552,750 was fully impaired and charged off at
December 31, 2009 and a non-refundable deposit of $139,978
to purchase a second license was expensed for the year ended
December 31, 2009. The consolidated statements of
operations and comprehensive loss, loss from discontinued
operations includes $16,500 of amortization expense and an
expense of $692,728 in the year ended December 31, 2009
related to these charges.
The Company identified and assigned a value of $10 million
to the patents acquired in its purchase of TerraSpherre Systems
(See Note 4). The fair value of these patents is being
amortized over their various expected remaining lives of
14-20 years.
Intangible assets consist of the following at December 31:
|
|
|
|
|
|
|
|
|
|
|
2010
|
|
|
2009
|
|
|
Definite-lived intangible assets:
|
|
|
|
|
|
|
|
|
Existing customer relationships
|
|
$
|
2,030,513
|
|
|
$
|
2,030,513
|
|
Technological know-how
|
|
|
271,812
|
|
|
|
271,812
|
|
Patents and related patent costs
|
|
|
10,001,107
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
12,303,432
|
|
|
|
2,302,325
|
|
Less: accumulated amortization
|
|
|
(902,355
|
)
|
|
|
(534,894
|
)
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
11,401,077
|
|
|
|
1,767,431
|
|
Indefinite-lived intangible assets:
|
|
|
|
|
|
|
|
|
Trade name
|
|
|
228,188
|
|
|
|
228,188
|
|
|
|
|
|
|
|
|
|
|
Net intangibles assets
|
|
$
|
11,629,265
|
|
|
$
|
1,995,619
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The consolidated statements of operations and comprehensive loss
include amortization expense of $367,461 and $288,007
related to these intangible assets for the years ended
December 31, 2010 and 2009,
F-21
CONVERTED
ORGANICS INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
NOTE 10
INTANGIBLE ASSETS Continued
respectively. Amortization expense for these intangibles is
estimated to be $884,734 annually for each of the next five
years and $6,977,407 thereafter.
NOTE 11
DEBT
TERM
NOTES
The Company entered into a financing agreement with an equipment
financing company to acquire equipment for its Woodbridge
facility. The note is for $118,250, bears an imputed interest
rate of 9% and has a three year term, maturing January, 2012.
During the fourth quarter of 2010, the Company was in default of
the note and the equipment was repossessed. The value of the
equipment repossessed exceeded the Companys obligation
therefore the Company was released from its financing agreement.
At December 31, 2009 the amount outstanding is $70,720
which is classified as liabilities of discontinued operations in
the consolidated balance sheet at December 31, 2009 (See
Note 5). Interest expense of $3,530 and $7,629 has been
recorded related to this note during the years ended
December 31, 2010 and 2009, respectively and included in
the consolidated statements of operations and comprehensive
loss, loss from discontinued operations.
On April 1, 2009, the Company agreed to convert certain
accounts payable into a 12 month note with its former
landlord at the New Jersey facility, Recycling Technology
Development Corporation (Recycling Technology). The
note bears interest at 9%, payable quarterly in arrears
commencing September 30, 2009. The note requires payments
of $263,573 on October 1, 2009 and January 1, 2010, to
be applied first to accrued interest and then to principal. A
final installment of $318,832 was due on March 31, 2010.
The note was paid in full in accordance with its terms as of
December 31, 2010. The outstanding balance at
December 31, 2009 totaled $562,728 which is classified as
liabilities of discontinued operations in the consolidated
balance sheet at December 31, 2009 (See Note 5).
During 2009, the Company agreed to convert certain accounts
payable to four contractors totaling approximately $3,872,000,
related to the construction of the Woodbridge facility (the
construction term notes), into term notes ranging
from 12 to 24 months at various rates ranging from 0% to 9%
with payment terms maturing through September 2011. The Company
has recorded a discount on certain of the notes representing
imputed interest of approximately $54,000, which is being
amortized during the non-interest bearing period of the notes.
The outstanding balance of these term notes was approximately
$2,614,000 at December 31, 2009 and they are classified as
current and non-current liabilities of discontinued operations
in the consolidated balance sheet at December 31, 2009. On
October 18, 2010, the term notes were extinguished (See
Note 5).
In connection with the Companys acquisition of TerraSphere
Systems, the Company assumed a note payable from a third party
in the amount of $350,000, with a fixed interest rate of 15% per
annum. Interest only payments totaling $4,375 are due monthly
with the principal balance due August, 27, 2011. The Company has
accrued interest and incurred interest expense totaling $4,459
as of December 31, 2010. Subsequent to December 31,
2010, the above note was extinguished by the holder for a
payment of $125,000 (See Note 19).
|
|
NOTE PAYABLE
|
RELATED
PARTY
|
The Company had a term note payable to its CEO, Edward J.
Gildea. The unsecured term note for $89,170 was dated
April 30, 2007 with an original maturity of April 30,
2009 and accrued interest at 12% per annum. The note had been
extended for one year until April 30, 2010. The Company
paid accrued interest of $21,400 upon extension of the
notes due date on June 30, 2009. This note was
subordinate to the New Jersey EDA bonds. On December 18,
2009, the Company repaid the principal balance of the note plus
accrued interest of $6,777.
In connection with the Companys acquisition of TerraSphere
Systems, the Company assumed an unsecured note payable to
William Gildea, Secretary of the Company and brother of Edward
Gildea, President of the
F-22
CONVERTED
ORGANICS INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
NOTE 11
DEBT Continued
Company, that has an interest rate of 10% per annum. The
principal amount due totaled $72,351 at December 31, 2010.
The Company incurred interest expense totaling $3,486 for the
year ended as of December 31, 2010.
BOND
FINANCING
On February 16, 2007, concurrent with its initial public
offering, the Companys wholly-owned subsidiary, Converted
Organics of Woodbridge, LLC, completed the sale of $17,500,000
of New Jersey Economic Development Authority Bonds. The Bonds
are classified as liabilities of discontinued operations in the
consolidated balance sheet at December 31, 2009 (See
Note 5). Direct financing costs related to this issuance
totaled approximately $953,000 and were being amortized over the
term of the bond. Capitalized bond costs, net of amortization
totaling $814,341 has been classified as non-current assets of
discontinued operations at December 31, 2009 (See
Note 5). On October 18, 2010, the Bonds payable were
settled and extinguished, resulting in the expensing of the
remaining unamortized capitalized bond costs of $774,617 and
included in the loss from discontinued operations in the
consolidated statement of operations and comprehensive loss for
the year ended December 31, 2010. Amortization of
capitalized bond issuance costs totaled $39,720 and $47,669 for
the years ended December 31, 2010 and 2009, respectively,
and are included in the loss from discontinued operations in the
consolidated statement of operations and comprehensive loss for
the years ended December 31, 2010 and 2009. The bonds
carried a stated interest rate of 8% and were to mature on
August 1, 2027. The bonds were secured by a leasehold
mortgage and a first lien on the equipment of the Woodbridge
facility. In addition, Woodbridge had agreed to, among other
things, establish a fifteen month capitalized interest reserve
and to comply with certain financial statement ratios. The
Company provided a guarantee to the bondholders on behalf of
Woodbridge for the entire bond offering. The bonds also had
certain covenants requirements.
On March 6, 2009, the Company entered into an agreement
with the holders of the New Jersey Economic Development
Authority Bonds to release $2.0 million for capital
expenditures on its New Jersey 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, the Company
issued the bond holders 2,284,409 Class B warrants. The
Class B warrants are exercisable at $11.00 per warrant. The
expense associated with these warrants of $662,000 is reflected
as interest expense and classified in the consolidated
statements of operations and comprehensive loss, as loss from
discontinued operations for the year ended December 31,
2009. On July 30, 2009 the deferred interest payments were
paid in full. In September of 2009, the holders of the bonds
agreed to continue to defer monthly deposits to the interest
escrow through January, 2010. The Company funded the escrow
following its secondary public offering in October, 2009. The
escrow balance of approximately $613,000 is reflected as current
restricted cash in the balance sheet as of December 31,
2009.
On October 18, 2010, Converted Organics Inc. entered into
an Exchange Agreement (the Exchange Agreement) with
the sole Bond Holder of $17,500,000 New Jersey Economic
Development Authority Bonds (the Bonds) that were
issued on behalf of Woodbridge. Pursuant to the Exchange
Agreement, the Bond Holder agreed to exchange: (i) the
Bonds, and (ii) class B warrants to purchase
2,284,409 shares the Companys common stock (the
Class B Warrants) for 17,500 shares of the
Companys newly authorized 1% Series A Convertible
Preferred Stock (the Series A Preferred Stock).
In addition, the Bond Holder agreed to waive all interest
accrued and unpaid from February 1, 2010 until the date of
the Exchange Agreement on the Bonds totaling approximately
$1 million, and agreed to transfer to the Company
approximately $600,000 that the Company had previously deposited
into certain escrow accounts in connection with the Bonds.
The Series A Preferred Stock is convertible into the number
of shares of Common Stock equal to (1) the stated value of
the share ($1,000), divided by (2) $0.543 (the
Conversion Price). Holders of the Series A
Preferred are entitled to receive cumulative dividends at the
rate per share (as a percentage of the stated value per share)
of 1% per annum (subject to increase in certain circumstances),
payable annually and on each conversion date. The dividends
F-23
CONVERTED
ORGANICS INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
NOTE 11
DEBT Continued
are payable, during the first three years after issuance, at the
election of the Company, and thereafter, at the election of the
holder, in cash or in shares of Company common stock valued at
the Conversion Price (or in some combination thereof).
CONVERTIBLE
NOTES PAYABLE
On January 24, 2008, in conjunction with the purchase of
the net assets of the Gonzales facility, the Company issued a
note payable to the former sole member in the amount of
$1,000,000. The note bore interest of 7% per annum and was to
mature on February 1, 2011; monthly principal and interest
payments are $30,877. The note became convertible by the holder
six months after issuance. The Company recognized a discount
related to the intrinsic value of the beneficial conversion
feature of the note. That amount was calculated to be $7,136,
and has been recorded as a component of additional paid-in
capital.
During the year ended December 31, 2009, the holder of the
note commenced converting the principal and accrued interest to
shares of common stock. During the year ended 2009, the Company
issued 281,500 shares of common stock to the note holder,
representing principal and accrued interest of approximately
$316,000. The principal balance of the note was approximately
$373,000 at December 31, 2009. During the year ended 2010,
the Company issued 646,500 shares of common stock
representing principal and accrued interest of approximately
$414,000 in satisfaction of its convertible debt obligation
issued in connection with the acquisition of the Gonzales
facility.
On December 17, 2010, the Company entered into a Securities
Purchase Agreement (Purchase Agreement) with certain
institutional investors (the Buyers). Upon the terms
and subject to the Purchase Agreement, the Company agreed to
sell to Buyers certain notes and warrants. Pursuant to the terms
of the Purchase Agreement, the Company agreed to sell to Buyers
convertible notes in the aggregate original principal amount of
$4,990,000 (the Notes), which are convertible into
shares of common stock. These Notes are to be purchased by
Buyers in two tranches, the first of which involved the sale of
Notes in the aggregate original principal amount of $3,939,473
(the Initial Notes). The closing of the purchase of
the Initial Notes occurred simultaneously with the execution of
the Purchase Agreement. The Initial Notes are non interest
bearing and were issued with an original issue discount of
approximately 4.8%, and the proceeds from the Initial Notes were
$3,444,555. The Company recorded the initial fair values of the
conversion feature and the warrants up to the net proceeds of
the note ($3,750,000) as a discount on the Note (see
Note 12) which will be amortized ratably over the
six-month term. At December 31, 2010, the carrying value of
this convertible debt totaled $306,404, which was attributable
to the amortization of the debt discount for the year ended
December 31, 2010.
The second tranche will involve the sale of Notes in the
aggregate original principal amount of $1,050,527 (the
Additional Notes) and shall be consummated upon the
satisfaction (or waiver) of the conditions to closing set forth
in the Purchase Agreement. The Additional Notes will also be
issued with an original issue discount of approximately 4.8%,
and the proceeds from the Additional Notes was $1,000,000 (see
Note 19). The Notes are not interest bearing, unless the Company
is in default on the Notes, in which case the Notes carry an
interest rate of 18% per annum.
The Notes are initially convertible into shares of Common Stock
at a conversion price of $1.00 per share, provided that if the
Company makes certain dilutive issuances (with limited
exceptions), the conversion price of the Notes will be lowered
to the per share price for the dilutive issuances. The Company
also has the right, at its option, to permit the holder of the
Notes to convert at a lower price specified by the Company for a
period specified by the Company. The Company is required to
repay the Notes in six equal installments commencing
February 1, 2011 (with respect to the Initial Notes),
either in cash or in shares of is common stock. If the Company
chooses to utilize shares of its common stock for the payment,
the Company must make an irrevocable decision to use shares
22 trading days prior to the installment payment date, and
the value of its shares will be equal to the lower of
(i) the conversion price then in effect and (ii) 85%
of the average of the three lowest closing sale prices of its
common stock during the 20 trading day period prior to payment
of the installment amount. If the Company chooses to make
F-24
CONVERTED
ORGANICS INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
NOTE 11
DEBT Continued
an installment payment in shares of its common stock, it must
make a pre-installment payment of shares to the Note holder 20
trading days prior to the applicable installment date based on
the value of its shares during the 20 trading days preceding the
delivery of the notice to elect to pay in its shares. On the
installment date, to the extent the Company owes the Note holder
additional shares in excess of the pre-installment shares to
satisfy the installment payment, it will issue the Note holder
additional shares, and to the extent we have issued excess
shares, such shares will be applied to future payments.
If an event of default occurs under the Note, the Company must
redeem the Notes in cash at the greater of 135% of the
unconverted principal amount or 135% of the greatest equity
value of the shares of common stock underlying the Notes from
the date of the default until the redemption is completed. The
conversion price of all the Notes is subject to adjustment in
the case of stock splits, stock dividends, combinations of
shares and similar recapitalization transactions. The
convertibility of the Notes may be limited if, upon exercise,
the holder or any of its affiliates would beneficially own more
than 4.9% of our Common Stock.
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%. 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, respectively (the Warrants). The Company
further agreed not to call any Warrants until a registration
statement registering all of the Warrants was 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
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 the
Companys 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.
In connection with the Financing, 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 as 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
F-25
CONVERTED
ORGANICS INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
NOTE 11
DEBT Continued
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.
On April 7, 2008, the shareholders of the Company approved
the issuance of additional shares so that convertible notes
could be issued to the note holders to replace the original
notes dated January 24, 2008. The Company recognized 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, as the
debt discount was limited to the proceeds allocated to the
convertible instrument of $4,500,000. That discount is being
amortized over the life of the loan. The Company recognized
interest expense of $-0- and $230,492 related to this discount
for the years ended December 31, 2010 and 2009,
respectively.
On January 24, 2009 the convertible notes became due.
Because the Company did not have sufficient cash to repay the
notes, the Company agreed to convert the notes to shares at the
default rate, although no event of default had occurred. As of
December 31, 2009, the note holders had converted the full
principal amount of $4,500,000 into 7,366,310 shares of
common stock. In consideration for entering into this agreement,
the Company granted 200,000 shares of common stock to the
note holders. An expense of $562,000 is included in the
statement of operations and comprehensive loss for the year
ended December 31, 2009 for this stock grant, which
represents the market value of 200,000 shares on the date
they were granted. In addition, the notes accrued interest at
10% of their declining balance as they were paid off through the
issuance of stock. An additional 131,834 shares of common
stock were issued on April 23, 2009 for accrued interest.
Accrued interest of $7,232 has been converted to shares of
common stock during 2010.
PRIVATE
FINANCING
On May 7, 2009, the Company entered into an agreement with
an institutional investor (the Investor), wherein
the Company agreed to sell to the Investor, for the sum of
$1,182,500, six-month non-convertible original issue discount
notes with principal amounts totaling $1,330,313 (the
Notes). The agreement provides that if the Company
raises over $1.33 million while the Notes are outstanding,
the first $1,330,313 must be used to repay the Notes. The Notes
were repaid on May 22, 2009, with the proceeds from the
issuance of the Companys common stock on May 19, 2009
(see Note 13). See Note 13 for a description of
warrants issued to the Investor in consideration for this
transaction.
On September 8, 2009, the Company entered into an agreement
with an institutional investor (the Investor),
wherein the Company agreed to sell to the Investor, for the sum
of $1,400,000, six-month convertible original issue discount
notes with principal amounts totaling $1,540,000 (the
Notes). The agreement provides that if the Company
raises over $1.54 million while the Notes are outstanding,
the first $1,540,000 must be used to repay the Notes. The Notes
were repaid on October 20, 2009, from the proceeds of the
Companys secondary public offering of common stock (see
Note 13). See Note 13 for a description of warrants
issued to the Investor in consideration for this transaction.
NOTE 12
DERIVATIVE INSTRUMENTS
On January 1, 2009, the Company adopted the guidance of
ASC 815 related to derivatives and hedging activities and
at that time, determined that the conversion features within the
convertible notes payable issued in the January 2008 Financing
to be embedded derivatives which were required to be bifurcated
and shown as a derivative liability subject to
mark-to-market
adjustment each reporting period. The fair value of the
conversion feature was determined using a Black-Scholes model
and resulted in a fair value of $5,083,108. The fair value at
January 1, 2009 was recognized as a cumulative effect of a
change in accounting principle in the Companys
consolidated statement of changes in stockholders equity.
F-26
CONVERTED
ORGANICS INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
NOTE 12
DERIVATIVE
INSTRUMENTS Continued
During the year ended December 31, 2009, the convertible
note and all conversion features for the above financing were
converted to common stock at the default rate in accordance with
the agreement dated January 29, 2009 with the note holders,
resulting in a derivative gain of $3,565,091 being recognized in
the Companys consolidated statements of operations and
comprehensive loss.
In addition, after January 1, 2009 the Company entered into
transactions which also required the estimation of the fair
value of warrant and conversion feature derivatives. For the
period from January 1, 2009 to September 30, 2010, the
Company estimated the fair value of these derivatives using the
Black-Scholes valuation method. During the fourth quarter of
2010, the Company determined that the binomial lattice option
pricing model was a more appropriate valuation technique and
used it to estimate the fair value of its December 17, 2010
financing transaction and also applied this new valuation
technique in calculating the 2010
mark-to-market
adjustment for all of its warrants and conversion features
recognized as derivative instruments. The effect of the change
in valuation techniques on previous financial statements was
immaterial.
In addition to the convertible note above, the Company
recognized the following warrant and conversion features as
derivatives in 2009:
On May 7, 2009, in connection with the Notes issued
pursuant to the financing agreement described in Note 10,
the Investor received five-year warrants to purchase
750,000 shares and 350,000 shares of Company common
stock, with exercise prices of $1.00 per share and $1.50 per
share (which were subsequently repriced to $1.02 per share),
respectively, (Class C and D warrants, respectively). An
investment banker also was issued 135,000 Class C warrants
and 65,000 Class D warrants. These warrants are subject to
certain anti-dilution right for issuance below the exercise
prices and are not registered and cannot be traded. The Company
has determined that the warrant provisions providing for
protection for issuances below the warrant exercise prices could
result in modification of the exercise price based on a variable
that is not an input to the fair value for a
fixed-for-fixed
option. Therefore the Company has determined that the warrants
issued in connection with this financing to be a derivative
instrument which is required to be shown as a derivative
liability subject to
mark-to-market
adjustment each reporting period. The fair value of the warrants
was determined using a Black-Scholes model with the following
assumptions: risk-free interest rate of 2.05%; no dividend
yield; volatility of 96.7% and an expected term of 5 years.
The resulting derivative liability on May 7, 2009 was
approximately $1,841,100 of which $1,558,000 was recorded as
interest expense, because of the immediate payment of the notes,
and $283,000 was recorded as general and administrative expense
on the consolidated statement of operations and comprehensive
loss for the year ended December 31, 2009. The liability
was revalued as of December 31, 2009 using a Black-Scholes
model and the following assumptions: risk-free interest rate of
2.35%; no dividend yield, volatility of 98.6%, resulting in a
revalued liability of approximately $563,500 and a derivative
gain of approximately $1,278,000. The liability was revalued as
of December 31, 2010 using the binomial lattice pricing
option method with the following assumptions: risk-free interest
rate of 1.02%; no dividend yield, volatility of 136.2%,
resulting in a revalued liability of approximately $338,255.
On September 8, 2009, in connection with the Notes issued
pursuant to the financing agreement on that date described more
fully in Note 10, the Investor received a five-year warrant
to purchase 2,500,000 shares of the Companys common
stock, with an exercise price of $1.25 per share, subject to
certain anti-dilution rights for issuances below such exercise
price; provided that absent shareholder approval, the exercise
price may not be reduced to less than $1.08 per share
(Class G warrants). These warrants are not registered and
cannot be traded. The Company has determined that the warrant
provisions providing for issuances below the warrant exercise
price could result in modification of the exercise price based
on a variable that is not an input to the fair value for a
fixed-for-fixed
option. The Company has determined that the warrants issued in
connection with this financing are a derivative instrument which
is required to be shown as a derivative liability subject to
mark-to-market
adjustment each reporting period. The fair value of the
derivative liability was determined on September 8, 2009
using a Black-Scholes model and the following assumptions;
risk-free interest rate of 2.38%; no dividend yield; volatility
of
F-27
CONVERTED
ORGANICS INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
NOTE 12
DERIVATIVE
INSTRUMENTS Continued
94.3%; expected term of 5 years. The resulting liability of
$1,986,600 was recorded as a discount on the Note to the extent
of the Note balance of $1.4 million, and was amortized over
the six month note term, and the remaining $587,000 was recorded
as interest expense in the year ended December 31, 2009.
The derivative liability was revalued as of December 31,
2009 using a Black-Scholes model and the following assumptions:
risk-free interest rate of 2.35%; no dividend yield; volatility
of 98.6%, resulting in a revalued liability of approximately
$1,063,200 and a derivative gain of approximately $923,000. The
liability was revalued as of December 31, 2010 using the
binomial lattice pricing option method with the following
assumptions: risk-free interest rate of 1.02%; no dividend
yield, volatility of 136.2%, resulting in a revalued liability
of approximately $696,760
The total derivative liability as of December 31, 2009
relating to the above two issuances was approximately $1,626,700
and the derivative gain for the year ended December 31,
2009 relating to the above two transactions and the January 2008
convertible note was approximately $5,766,000.
In addition to the above 2009 transactions, the Company entered
into the following warrant and conversion feature derivatives
transactions in 2010:
On April 22, 2010, in connection with common stock issued
pursuant to a financing agreement on that date, an investor
received a five-year warrant to purchase 1,163,362 shares
of the Companys common stock, with an original exercise
price of $1.06 per share, subject to certain anti-dilution
rights for issuances below such exercise price (Class I
warrants). These warrants are not registered and cannot be
traded. The Class I warrants are exercisable one year from
the date of issuance. The Company has determined that the
warrant provisions providing for protection for issuances below
the warrant exercise price could result in modification of the
exercise price based on a variable that is not an input to the
fair value for a
fixed-for-fixed
option. The Company has determined the warrants issued in
connection with this financing are a derivative instrument which
is subject to
mark-to-market
adjustment each reporting period. On April 22, 2010 the
fair value of the derivative liability was determined to be
$968,000 using a Black-Scholes model and the following
assumptions; risk-free interest rate of 1.27%; no dividend
yield; volatility of 122.3%; expected term of 5 years. The
liability was revalued as of December 31, 2010 using the
binomial lattice pricing option method with the following
assumptions: risk-free interest rate of 2.01%; no dividend
yield, volatility of 136.2%, resulting in a revalued liability
of approximately $347,441.
On December 17, 2010, the Company issued notes convertible
into shares of the Companys common stock (see
Note 11) at the lower of i) the conversion price
then in effect or (ii) 85% of the average of the three
lowest closing sales price of the Companys common stock
during a 20 trading day prior to payment. The initial conversion
price of $1.00 is subject to certain anti-dilution provisions
which the Company identified as embedded derivatives. At
December 17, 2010 the Company determined a fair value of
the debt derivative to be $2,057,184 using the Binomial Lattice
Option Pricing Model based on the following assumptions:
risk-free interest rate of 2.01%; no dividend yield; volatility
of 136.2%; expected term of 6 months and assumptions of
possible exercise prices and a probability of occurrence of
each. The debt derivative liability was revalued as of
December 31, 2010 using the binomial lattice pricing option
method with the following assumptions: risk-free interest rate
of 2.01%; no dividend yield; volatility of 136.2%; expected term
of 5 months, and assumption of three possible exercise
prices and a probability of occurrence of each, resulting in a
revalued liability of approximately $2,900,204.
In connection with the December 17, 2010 convertible notes
issuance the Company issued three series of warrants
(Series A, Series B, Series C) for an
aggregate of 7,876,948 warrants to purchase the Companys
common stock at exercise prices of $1.00 a share for one to five
years. These warrants contain certain anti-dilution provisions,
therefore the Company classified the fair value of these
warrants as a derivative liability at the date of issuance. At
December 17, 2010 the Company determined the fair value of
the debt derivative to be $3,020,486 using the Binomial Lattice
Option Pricing Model based on the following assumptions:
risk-free interest rate of 2.01%; no dividend yield; volatility
of 136.2%; expected term of 6 months and assumptions of
possible exercise prices and a probability of occurrence of
each. The debt derivative liability was revalued as of
December 31, 2010 using the binomial lattice pricing option
method with the
F-28
CONVERTED
ORGANICS INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
NOTE 12
DERIVATIVE
INSTRUMENTS Continued
following assumptions: risk-free interest rate of 2.01%; no
dividend yield, volatility of 136.2%, expected term of
5 months, and assumption of three possible exercise prices
and a probability of occurrence of each, resulting in a revalued
liability of approximately $3,617,758.
The Company recorded the initial fair values of the conversion
feature ($2,057,184) and the warrants $(3,020,486) up to the net
proceeds of the note ($3,750,000) as a discount on the Note
which is amortized ratably over the six-month term. The excess
fair value of $1,327,670 was charged to interest expense in the
consolidated statement of operations and comprehensive loss at
the date of issuance.
In addition to the above derivative transactions that were
valued on December 31, 2010 using the Binomial Lattice
option pricing model, on November 12, 2010, the Company
completed the acquisition of Terrasphere Systems LLC, ( See
Note 4 ) where it determined that as a result of an
anti-dilution provision included in the purchase agreement that
certain additional shares may have to be issued. The Company
estimated that approximately 2,040,000 shares could be
issued, and based on the closing day market price of $.41 on
that date, classified the potential issuance as a derivative
liability of $836,000. As of December 31, 2010 the Company
revalued the derivative liability to $775,200, based on the
closing share price of the stock on that date.
The total derivative liability reflected on the consolidated
balance sheet at December 31, 2010 taking into account all
of the 2009 and 2010 transactions listed above and revalued at
December 31, 2010 totaled $8,675,619 and the derivative
loss for the year ended December 31, 2010 was $166,712
NOTE 13
STOCKHOLDERS EQUITY
AUTHORIZED
SHARES
At the June 25, 2009 annual meeting of shareholders, the
shareholders approved a resolution to increase the number of
common shares that the Company is authorized to issue from
40,000,000 to 75,000,000. On June 30, 2010, the
Companys stockholders approved the amendment to the
Companys Certificate of Incorporation to increase the
number of shares of common stock that the Company is authorized
to issue from 75,000,000 shares to 250,000,000 shares.
On October 18, 2010, the Board approved the issuance
17,500 shares of the Companys preferred stock which
was then designated Series A Preferred stock. Each share of
Series A Preferred is convertible into a number of shares
of common stock equal to (1) the stated value of the share
($1,000), divided by (2) $0.543 (the Conversion
Price) which aggregates to 32,228,361 shares of
Company common stock. Holders of the Series A Preferred are
entitled to receive cumulative dividends at the rate per share
(as a percentage of the stated value per share) of 1% per annum
(subject to increase in certain circumstances), payable annually
and on each conversion date. The dividends are payable, during
the first three years after issuance, at the election of the
Company, and thereafter, at the election of the holders, in cash
or in shares of common stock valued at the Conversion Price (or
in some combination thereof).
STOCK
ISSUANCES
On January 24, 2009, the Company issued 200,000 shares
of its common stock to the holders of its convertible debentures
as consideration for the refinancing described in Note 11.
On March 10, 2009, the Company granted 121,528 shares
of common stock to a consultant providing development services
related to the Companys proposed Rhode Island facility.
The grant was measured using the closing price of the
Companys stock on the date of grant. The statement of
operations and comprehensive loss includes a charge of $120,316
for the year ended December 31, 2009 related to this grant,
which was credited to additional paid-in capital.
F-29
CONVERTED
ORGANICS INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
NOTE 13
STOCKHOLDERS
EQUITY Continued
On May 19, 2009, the Company entered into an agreement with
an institutional investor (the Investor) whereby the
Investor agreed to purchase 1,500,000 shares of the
Companys common stock under its shelf registration
statement, for $1.40 per share, providing the Company with
$2.1 million before fees and expenses of $172,000, which
were charged to additional paid-in capital. The May 7, 2009
non-convertible short-term note described in Note 10 was
immediately paid off with proceeds of this offering. In
addition, and as an inducement to enter into this transaction,
the Company issued the Investor 1,500,000 warrants, with a
strike price of $1.40 and a 90 day term. On May 26,
2009, the Investor exercised the warrants and received
1,500,000 shares of common stock, providing net proceeds to
the Company of $2.1 million before expenses of $135,000.
On July 15, 2009, the Company entered into a Securities
Purchase Agreement with an institutional investor. Pursuant to
the Securities Purchase Agreement, the Company agreed to issue
to the investor: (a) 1,961,000 shares of the
Companys common stock at $1.02 per share; and
(b) warrants to purchase an additional 585,000 shares
of the Companys common stock at an exercise price of $1.25
per share. The Warrants may be exercised commencing
January 15, 2010 until July 15, 2014.
On October 20, 2009, the Company closed its second public
offering of 17,250,600 units, including
2,250,000 units reflecting the exercise in full of the
underwriters over-allotment option, at a price per unit of
$1.06 to the public. Each unit consists of one share of common
stock and one newly created Class H warrant, with each
Class H warrant exercisable for one share of common stock
at an exercise price of $1.30 per share. The warrants will
expire on October 14, 2014. The net proceeds of
approximately $16.4 million, after deducting the
underwriting discounts and commissions and other estimated
offering expenses, were used to further develop and execute the
Companys sales and marketing plan, strategic growth
initiatives, other general corporate purposes, and to repay the
six-month note the Company issued in September 2009 in the
principal amount of $1,540,000.
On December 15, 2009, the Company granted
30,000 shares of common stock to a consultant who provides
professional services to the Company as remuneration for
services rendered. The grant was measured using the closing
price of the Companys stock on the date of grant. The
statement of operations and comprehensive loss includes a charge
of $18,897 for the year ended December 31, 2009 related to
this grant, which was credited to additional paid-in capital.
On March 17, 2010, the Company granted 165,000 shares
of common stock to a consultant who provided investor relations
consulting services to the Company. The grant was measured using
the closing price of the Companys stock on the date of
grant. The statements of operations and comprehensive loss
includes a charge of $160,050 for the year ended
December 31, 2010 related to this grant, which was credited
to common stock and additional paid-in capital.
On April 22, 2010, Converted Organics Inc. entered into a
Securities Purchase Agreement with a single institutional
investor. Pursuant to the Securities Purchase Agreement, the
Company agreed to issue to the investor:
(a) 2,400,000 shares of its common stock at $1.06 per
share and (b) five-year warrants to purchase
1,163,362 shares of its common stock at an exercise price
of $1.06 per share (Class I Warrants). The warrants may be
exercised at any time on or following a date one year after the
date of issuance and will expire five years from the date of
issuance. The transaction provided the Company with net proceeds
of approximately $2.4 million.
On July 19, 2010, the Company issued 1,623,333 shares
of its common stock and warrants (Class J Warrants) to
acquire 1,623,333 shares of common stock to Atlas Advisors,
LLC (Atlas). The warrants will expire five years
from the date of issuance and have a strike price of $0.54 per
share. The issuance to Atlas was made pursuant to an agreement
between the parties regarding payments due to Atlas pursuant to
a Business Development Agreement dated January 29, 2010.
Under the Business Development Agreement, the Company had agreed
to compensate Atlas in the event of any mergers
and/or
acquisitions that were a result of the services provided by
Atlas, such payment was to have included both cash payments and
equity payments. Pursuant to the agreement reached between the
parties, in exchange for the equity consideration listed herein,
Atlas agreed that no further
F-30
CONVERTED
ORGANICS INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
NOTE 13
STOCKHOLDERS
EQUITY Continued
consideration be paid to it in connection with the
Companys proposed acquisition of TerraSphere Systems, LLC.
The stock and warrant payment was made to Atlas at a share price
of $0.54, which was the closing price of the Companys
common stock on the date of the TerraSphere acquisition
agreement. The warrants issued to Atlas were issued at an
exercise price equal to the price at which the common shares
were issued.
During the year ended 2010, the Company issued
646,500 shares of common stock representing principal and
interest payments of approximately $414,000 in satisfaction of
its convertible debt obligation issued in connection with the
acquisition of the Gonzales facility.
The Company issued 320,811 shares of its common stock as
severance payments to certain employees during the third quarter
of 2010. The statements of operations and comprehensive loss
includes a charge of approximately $190,000 for the year ended
December 31, 2010, which was credited to common stock and
additional paid-in capital.
On August 30, 2010, the Company issued
1,157,407 shares of its common stock and warrants
(Class K Warrants) to acquire 1,157,407 shares of
common stock to Atlas. The warrants will expire five years from
the date of issuance and have a strike price of $0.54. The
issuance to Atlas was made as consideration for the termination
of a Business Development Agreement dated January 29, 2010
by and between the Company and Atlas. The statements of
operations and comprehensive loss includes a charge of
approximately $625,000 for the year ended December 31,
2010, which was credited to common stock and additional paid-in
capital.
On October 18, 2010, the Company granted
165,000 shares of common stock to a consultant who provided
investor relations consulting services to the Company. The grant
was measured using the closing price of the Companys stock
on the date of grant. The statements of operations and
comprehensive loss includes a charge of $92,400 for the year
ended December 31, 2010 related to this grant, which was
credited to common stock and additional paid-in capital.
On October 18, 2010, Converted Organics Inc. entered into
an Exchange Agreement (the Exchange Agreement) with
the sole Bond Holder of $17,500,000 New Jersey Economic
Development Authority Bonds (the Bonds) that were
issued on behalf of Woodbridge. Pursuant to the Exchange
Agreement, the Bond Holder agreed to exchange: (i) the
Bonds, and (ii) class B warrants to purchase
2,284,409 shares the Companys common stock (the
Class B Warrants) for 17,500 shares of the
Companys newly desiganted 1% Series A Convertible
Preferred Stock (the Series A Preferred Stock).
The Series A Preferred Stock is convertible into the number
of shares of Common Stock equal to (1) the stated value of
the share ($1,000), divided by (2) $0.543 (the
Conversion Price) which aggregates to
32,228,361 shares of Company common stock. Holders of the
Series A Preferred are entitled to receive cumulative
dividends at the rate per share (as a percentage of the stated
value per share) of 1% per annum (subject to increase in certain
circumstances), payable annually and on each conversion date.
The dividends are payable, during the first three years after
issuance, at the election of the Company, and thereafter, at the
election of the holder, in cash or in shares of Company common
stock valued at the Conversion Price (or in some combination
thereof).
On October 18, 2010, the Company and the Woodbridge
Facilitys landlord (Lessor) entered into a
Termination and Surrender Agreement (Termination
Agreement) related to the termination of the Woodbridge
Facility lease. Pursuant to the terms of the Termination
Agreement, the Company agreed to issue the Lessor a total of
892,857 shares of Company common stock valued at $0.56 per
share totaling $500,000 (see Note 5).
On October 18, 2010, the Superior Court of the State of
California for the County of Los Angeles entered an Order in the
matter entitled American Capital Management, LLC
(ACM) v. Converted Organics Inc. and Converted
Organics of Woodbridge, LLC and Does 1-10 Inclusive (the
Order). Pursuant to the terms of the Order, the
Company agreed to issue to ACM a total of 20,726,980 shares
of Company common stock valued at $0.543 per
F-31
CONVERTED
ORGANICS INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
NOTE 13
STOCKHOLDERS
EQUITY Continued
share totaling approximately $11,255,000 in full and final
settlement of the claims related to the Woodbridge facility (see
Note 5).
On November 12, 2010, the Company acquired 95% of
TerraSphere Systems, LLC by issuing 18,174,603 shares of
Company common stock at the closing valued at approximately
$9,565,000. The Company is obligated to issue additional shares
of common stock if certain milestones are met and/or certain
anti-dilution provisions are triggered (see Note 4).
On December 31, 2010, the Company acquired 83.34% of
GoLocalProduceRI, LLC for $480,000 issuing 1,371,428 shares
of Company common stock at $0.35 based on the 30 day
average at the time of the agreement (Note 4).
WARRANTS
On February 16, 2007, in connection with the Companys
initial 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 warrants were redeemed during 2008, as more
fully described below. 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 11,
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.
On March 6, 2009, the Company entered into an agreement
with the holders of the New Jersey Economic Development
Authority Bonds to release $2.0 million for capital
expenditures on its New Jersey 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, the Company
issued the bond holders 2,284,409 Class B warrants. The
Class B warrants are exercisable at $11.00 per warrant. The
expense associated with these warrants of $662,000 is reflected
as interest expense in the consolidated statements of operations
and comprehensive loss for the year ended December 31, 2009.
On May 7, 2009, the Company issued 885,000 Class C
warrants and 415,000 Class D warrants in connection with
securing a private financing agreement more fully described in
Note 10. Each Class C and Class D warrant may be
exchanged for one share of common stock at an exercise price of
$1.00 and $1.02, respectively. The shares underlying these
warrants have not been registered and these warrants cannot be
traded.
On May 19, 2009, in connection with the issuance of
1,500,000 shares of common stock, the Company issued
1,500,000 warrants with an exercise price of $1.40. These
warrants were exercised on May 26, 2009.
On May 26, 2009, as an inducement for the Investor to
exercise 1,500,000 warrants at $1.40, the Company issued the
Investor an additional 1,500,000 Class E warrants with an
exercise price of $1.63 and an expiration date of May 27,
2014. Each warrant may be exchanged for one share of common
stock.
F-32
CONVERTED
ORGANICS INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
NOTE 13
STOCKHOLDERS
EQUITY Continued
On July 15, 2009, in connection with the issuance of
1,961,000 shares to an institutional investor, the Company
issued Class F warrants to purchase 585,000 shares of
the Companys common stock at an exercise price of
$1.25 per share. The Warrants may be exercised commencing
January 15, 2010 until July 15, 2014.
On September 8, 2009, the Company issued 2,500,000
Class G warrants in connection with the Notes issued
pursuant to the financing agreement described more fully in
Note 11. Each Class G warrant may be exchanged for one
share of common stock at an exercise price of $1.25 per share,
subject to certain anti-dilution rights for issuances below such
exercise price; provided that absent shareholder approval, the
exercise price may not be reduced to less than $1.08 per share.
The shares underlying these warrants have not been registered
and these warrants cannot be traded.
On October 20, 2009, the Company issued 17,250,000
Class H warrants in conjunction with its secondary public
offering, described above. Each Class H warrant may be
exchanged for one share of common stock at an exercise price of
$1.30, and have an expiration date of October 14, 2014.
Each warrant may be exchanged for one share of common stock.
On April 22, 2010, in connection with the issuance of
2,400,000 shares to an institutional investor, the Company
issued Class I warrants to purchase 1,163,362 shares
of its common stock at an exercise price of $1.06 per share. The
Warrants may be exercised commencing April 22, 2011 until
April 21, 2016.
On July 19, 2010, in connection with the issuance of
1,623,333 shares to Atlas, the Company issued Class J
warrants to purchase 1,623,333 shares of its common stock
at an exercise price of $0.54 per share. The Warrants may be
exercised commencing July 19, 2010 until July 18, 2015.
On August 30, 2010, in connection with the issuance of
1,157,407 shares to Atlas, the Company issued Class K
warrants to purchase 1,157,407 shares of its common stock
at an exercise price of $0.54 per share. The Warrants may be
exercised commencing August 30, 2010 until August 29,
2015.
On December 17, 2010, pursuant to the terms of the Purchase
Agreement, the Company issued to the Buyers warrants to acquire
shares of common stock, in the form of three warrants:
(i) Series A Warrants,
(ii) Series B Warrants, and
(iii) Series C Warrants (collectively, the
Warrants). The Warrants will be issued in two
tranches on the dates the Initial Notes and Additional Notes are
issued, on a pro rata basis based on the principal amount being
issued in the applicable closing based on the aggregate
principal amount that could be issued at both closings.
The Series B Warrants are exercisable anytime after the
occurrence of the earlier of obtaining shareholder approval or
the date on which the Initial Notes are no longer outstanding
and expires upon the earlier to occur of: (i) the first
anniversary of the date on which it becomes exercisable and
(ii) the nine (9) month anniversary of the date on
which shareholder approval is obtained. The Series B
Warrants provide that the holders are initially entitled to
purchase an aggregate of 4,990,000 shares (warrants to
purchase 3,939,473 shares of Common Stock were issued at
the Initial Closing and a warrant to purchase
1,050,527 shares of Common Stock will be issued at the
Additional Closing if it occurs) at an initial exercise price of
$1.00 per share. If the Company makes certain dilutive issuances
(with limited exceptions), the exercise price of the
Series B Warrants will be lowered to the per share price
for the dilutive issuances. In addition, the exercise price of
the Series B Warrants will adjust to the average of the
Installment Conversion Prices used to repay the Initial Notes.
The floor price for the exercise price of the Series B
Warrants is $0.345. The number of shares underlying the
Series B Warrants will adjust whenever the exercise price
adjusts, such that at all times the aggregate exercise price of
the Series B Warrants will be $4,990,000 ($3,939,473 for
the Series B Warrants issued in the Initial Closing and
$1,050,527 for the Series B Warrants to be issued at the
Additional Closing if it occurs).
To the extent we enter into a fundamental transaction (as
defined in the Series B Warrants and which include, without
limitation, our entering into a merger or consolidation with
another entity, our selling all or substantially all
F-33
CONVERTED
ORGANICS INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
NOTE 13
STOCKHOLDERS
EQUITY Continued
of our assets, or a person acquiring 50% of our Common Stock),
the Company has agreed to purchase the Series B Warrant
from the holder at its Black-Scholes value.
If the Companys common stock trades at a price at least
200% above the Series B Warrants exercise price for a
period of 10 trading days at any time after it gets shareholder
approval, the Company may force the exercise of the
Series B Warrants if it meets certain conditions.
The Series A and Series C Warrants are exercisable
anytime after the earlier to occur of: (i) the date on
which shareholder approval is obtained and (ii) the six
month and one day anniversary of the Initial Closing and have a
five year term. The Series A Warrants provide that the
holders are initially entitled to purchase an aggregate of
2,495,000 shares (warrants to purchase
1,969,737 shares of common stock were issued at the Initial
Closing and warrants to purchase 525,263 shares of common
stock will be issued at the Additional Closing if it occurs) at
an initial exercise price of $1.00 per share. The Series C
Warrants provide that the holders are initially entitled to
purchase an aggregate of 2,495,000 shares (warrants to
purchase 1,969,737 shares of common stock were issued at
the Initial Closing and warrants to purchase 525,263 shares
of common stock will be issued at the Additional Closing if it
occurs) at an exercise price of $1.00 per share; provided that
the Series C Warrants may only be exercised by each holder
in the same proportion as such holder has already exercised its
Series B Warrants.
If the Company makes certain dilutive issuances (with limited
exceptions), the exercise price of the Series A and
Series C Warrants will be lowered to the per share price
for the dilutive issuances. In addition, the exercise price of
the Series A and Series C Warrants will adjust to the
average of the Installment Conversion Prices used to repay the
Initial Notes. Until the Company obtains shareholder approval,
the floor price of the Series A and Series C Warrants
is $0.345.
To the extent the Company enters into a fundamental transaction
(as defined in the Series A and Series C Warrants and
which include, without limitation, our entering into a merger or
consolidation with another entity, our selling all or
substantially all of our assets, or a person acquiring 50% of
our Common Stock), the Company has agreed to purchase the
Series A and Series C Warrants from the holder at its
Black-Scholes value.
The exercise price of all the Warrants is subject to adjustment
in the case of stock splits, stock dividends, combinations of
shares and similar recapitalization transactions. The
exercisability of the Warrants may be limited if, upon exercise,
the holder or any of its affiliates would beneficially own more
than 4.9% of our Common Stock. Neither the Notes nor the
Series B Warrants may be converted or exercised, as
applicable, if the total number of shares that would be issued
would exceed 19.99% of the Company common stock on the date the
Purchase Agreement was executed prior to our receiving
shareholder approval.
WARRANT
EXERCISE
On May 26, 2009, the Investor exercised its 1,500,000
warrants at $1.40, providing the Company with $2.1 million
before fees and expenses of $135,000, which were charged to
Additional Paid-in Capital. The Company issued
1,500,000 shares of common stock upon exercise of these
warrants.
The intrinsic value of the Companys warrants is $0 as of
December 31, 2010 and 2009.
F-34
CONVERTED
ORGANICS INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
NOTE 13
STOCKHOLDERS
EQUITY Continued
The following table sets forth the outstanding warrants as of
December 31, 2010 and 2009.
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Outstanding at
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Outstanding at
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Outstanding at
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Excercisable at
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January 1,
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December 31,
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December 31,
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December 31,
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Warrants
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|
Price
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2009
|
|
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Issued
|
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Excercised
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Canceled
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2009
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|
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Issued
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Excercised
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Canceled
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2010
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|
2010
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|
Class B
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|
$
|
11.00
|
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2,648,029
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2,284,409
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4,932,438
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*
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(2,284,409
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)
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2,648,029
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2,648,029
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|
Class C
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$
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1.00
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885,000
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885,000
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885,000
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|
885,000
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Class D
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$
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1.02
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415,000
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415,000
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415,000
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415,000
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|
May 19, 2009 Warrants
|
|
$
|
1.40
|
|
|
|
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1,500,000
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(1,500,000
|
)
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Class E
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$
|
1.63
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1,500,000
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1,500,000
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1,500,000
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1,500,000
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|
Class F
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|
$
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1.25
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585,000
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585,000
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|
|
|
|
|
585,000
|
|
|
|
585,000
|
|
Class G
|
|
$
|
1.25
|
|
|
|
|
|
|
|
2,500,000
|
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|
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2,500,000
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2,500,000
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|
2,500,000
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|
Class H
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|
$
|
1.30
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17,250,000
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17,250,000
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17,250,000
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17,250,000
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|
Class I
|
|
$
|
1.06
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1,163,362
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1,163,362
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|
|
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|
Class J
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$
|
0.54
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1,623,333
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|
1,623,333
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|
|
|
1,623,333
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|
Class K
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|
$
|
0.54
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|
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1,157,407
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|
|
|
|
|
1,157,407
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|
1,157,407
|
|
December 17, 2010 Series A
|
|
$
|
0.345
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|
|
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1,969,737
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|
1,969,737
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|
1,969,737
|
|
December 17, 2010 Series B
|
|
$
|
0.345
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3,939,474
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|
3,939,474
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|
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|
3,939,474
|
|
December 17, 2010 Series C
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|
$
|
0.345
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1,969,737
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|
1,969,737
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|
1,969,737
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|
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|
* |
|
On October 18, 2010, 2,284,409 Class B warrants were
retired by the Bond holder (see Note 12). |
In the event all outstanding warrants are exercised, the Company
has adequate shares authorized to meet these obligations.
STOCK
OPTIONS
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.
On June 27, 2009, the Company granted 233,500 stock options
under its 2006 Stock Option Plan. The options have an exercise
price of $1.10 and expire ten years from the date of grant. The
exercise price was based on the closing price of the stock on
the date of grant. The expense associated with this option grant
was calculated using a Black-Scholes model and the following
assumptions: risk-free interest rate of 2.85%; no dividend
yield; volatility of 96.7%; and an expected term of
5 years. The resulting expense of $190,000 is included in
general and administrative expense on the consolidated statement
of operations and comprehensive loss for the year ended
December 31, 2009.
On November 19, 2009, the Company granted 100,000 stock
options under its 2006 Stock Option Plan to a consultant of the
Company who provides odor control services. The options may be
exercised for a price of $.75 per share. One half of the options
vested upon grant, and one half will vest on November 30,
2010 if the consultant continues to be retained by the Company.
The Company is recording the issuance of these options in
accordance with ASC
Section 505-50.
The expense associated with the options that vest immediately
was calculated using a Black-Scholes model and the following
assumptions: risk-free interest rate of 2.35%; no dividend
yield; volatility of 96.6%; expected term of 5 years. The
resulting expense of $27,602 is included in general and
administrative expense on the consolidated statement of
operations and comprehensive loss for the year ended
December 31, 2009. The expense associated with the options
that vest on November 30, 2010, was calculated with a
Black-Scholes model and the same assumptions, except an expected
term of 4.5 years. The resulting expense of $26,639 will be
recognized as expense ratably over the vesting period.
Accordingly, an expense of $22,000 and $4,440 is included in
general and administrative expense on the consolidated statement
of operations and comprehensive loss for the years ended
December 31, 2010 and 2009.
F-35
CONVERTED
ORGANICS INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
NOTE 13
STOCKHOLDERS
EQUITY Continued
On January 4, 2010, the Companys Compensation
Committee approved an employee and director stock option grant
under the Amended and Restated 2006 Stock Option Plan. A total
of 2,458,500 options were granted with an exercise price of
$.68, which was the closing price as of the date of grant. The
cost associated with this option grant was calculated using a
Black-Scholes model and the following assumptions: risk-free
interest rate of 2.35%; no dividend yield; volatility of 98.6%;
expected term of 5 years. The resulting expense of
approximately $1,188,000 is reflected in the Companys
consolidated statement of operations and comprehensive loss for
the year ended December 31, 2010.
On March 12, 2010, the Companys Compensation
Committee approved a stock option grant under the Amended and
Restated 2006 Stock Option Plan. A total of 50,000 options were
granted with an exercise price of $.97, which was the closing
price as of the date of grant. The cost associated with this
option grant was calculated using a Black-Scholes model and the
following assumptions: risk-free interest rate of 2.35%; no
dividend yield; volatility of 98.6%; expected term of
5 years. The resulting expense of approximately $48,500 is
reflected in the Companys consolidated statement of
operations and comprehensive loss for the year ended
December 31, 2010.
As of December 31, 2010, the Company had 3,638,047 options
available to grant under the plan.
Stock option activity for 2010 and 2009 is as follows:
|
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
|
|
|
Weighted
|
|
|
|
|
|
|
|
|
|
Average
|
|
|
Average
|
|
|
Average
|
|
|
|
Stock
|
|
|
Price per
|
|
|
Exercise
|
|
|
Remaining
|
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|
Options
|
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|
Share
|
|
|
Price
|
|
|
Life (Years)
|
|
|
Outstanding and exercisable at January 1, 2009
|
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|
1,256,735
|
|
|
$
|
4.50
|
|
|
$
|
4.50
|
|
|
|
9.5
|
|
Granted
|
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|
233,500
|
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1.10
|
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|
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Granted
|
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100,000
|
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|
.75
|
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|
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|
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|
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Forfeited
|
|
|
(359,940
|
)
|
|
|
5.02
|
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|
|
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|
|
|
Exercised
|
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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|
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|
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|
Outstanding and exercisable at December 31, 2009
|
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|
1,230,295
|
|
|
$
|
3.54
|
|
|
$
|
3.54
|
|
|
|
8.5
|
|
Granted
|
|
|
2,458,500
|
|
|
|
.68
|
|
|
|
|
|
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Granted
|
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50,000
|
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|
.97
|
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|
|
|
|
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Forfeited
|
|
|
(45,000
|
)
|
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|
.89
|
|
|
|
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Exercised
|
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|
(50,000
|
)
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|
.68
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Outstanding and exercisable at December 31, 2010
|
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|
3,643,795
|
|
|
$
|
1.64
|
|
|
$
|
1.64
|
|
|
|
8.8
|
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|
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|
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The aggregate intrinsic value of options outstanding and
exercisable at December 31, 2010 and 2009 is $0 and $0,
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 $0.38 and
$0.67 as of December 31, 2010 and 2009, respectively, which
would have been received by the option holders had those option
holders exercised their options as of that date.
At December 31, 2010, there was no unrecognized
compensation cost related to non-vested share-based compensation
arrangements granted under the Companys stock option plan.
As of December 31, 2009 the Company has estimated that its
unrecognized compensation cost related to non-vested share-based
compensation arrangements was approximately $22,000. During the
year ended December 31, 2010, the Company has received
approximately $34,000 as a result of the exercise of 50,000
options. No options were exercised in the year ended
December 31, 2009.
F-36
CONVERTED
ORGANICS INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
NOTE 14
INCOME TAXES
At December 31, 2010, the Company had accumulated net
operating losses of approximately $88,300,000 which may be
offset against future taxable income, if any, expiring at
various dates through 2030.
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, 2010 and 2009 as follows:
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|
|
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|
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2010
|
|
|
2009
|
|
|
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, 2010 and 2009 are as follows:
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2010
|
|
|
2009
|
|
|
Deferred tax assets:
|
|
|
|
|
|
|
|
|
Net operating losses
|
|
$
|
33,255,000
|
|
|
$
|
13,470,000
|
|
Accrued compensation
|
|
|
120,000
|
|
|
|
120,000
|
|
Stock options
|
|
|
1,925,000
|
|
|
|
1,410,000
|
|
Valuation allowance
|
|
|
(35,300,000
|
)
|
|
|
(15,000,000
|
)
|
|
|
|
|
|
|
|
|
|
|
|
$
|
|
|
|
$
|
|
|
|
|
|
|
|
|
|
|
|
The Company has fully reserved the approximately $35,300,000
deferred tax benefit 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.
The Companys valuation allowance increased $20,300,000 and
$7,412,000 for the years ended December 31, 2010 and 2009,
respectively.
The Company has a tax benefit of approximately $1,925,000
related to the grant of common stock to certain key employees
and advisors. Pursuant to guidance provided by Sections 505
and 718 of the ASC, 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 ASC
Section 740. The guidance 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
Section 740, 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 the guidance.
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, 2007 to December 31, 2009 remain open to
examination by the U.S. Internal Revenue Service and state
authorities.
The Companys net operating loss carryforwards may be
limited subject to the provisions of Section 382 the
Internal Revenue Code.
F-37
CONVERTED
ORGANICS INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
NOTE 15
SEGMENT REPORTING
The Company has three lines of business, which are
(1) organic fertilizer, (2) vertical farming and
(3) industrial wastewater treatment. Based on the nature of
products and services offered, the Company has determined that
there are two reportable segments: (1) organic fertilizer
and (2) vertical farming at December 31, 2010. The
industrial wastewater treatment segment is not separately
reported as it is in the developmental stage and there is no
discreet financial information to report at December 31,
2010.
The Company evaluates performance based on several factors, of
which the primary financial measure is business segment
operating income. There were no intersegment sales as of
December 31, 2010. The discreet financial information
presented below is derived from the continuing operations as of
December 31, 2010.
|
|
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Organic
|
|
Vertical
|
|
Corporate and
|
|
|
|
|
Fertilizer
|
|
Farming
|
|
Eliminations
|
|
Consolidated
|
|
Revenues
|
|
$
|
3,275,325
|
|
|
$
|
250,000
|
|
|
$
|
|
|
|
$
|
3,525,325
|
|
Operating loss from continuing operations(1)
|
|
|
(1,279,055
|
)
|
|
|
(2,562,517
|
)
|
|
|
(12,197,453
|
)
|
|
|
(16,039,025
|
)
|
Depreciation and amortization(2)
|
|
|
369,544
|
|
|
|
85,403
|
|
|
|
34,656
|
|
|
|
489,603
|
|
Interest expense(3)
|
|
|
|
|
|
|
11,169
|
|
|
|
1,714,782
|
|
|
|
1,725,951
|
|
Total assets net of discontinued operations(4)
|
|
|
2,973,568
|
|
|
|
12,618,892
|
|
|
|
4,032,496
|
|
|
|
19,624,956
|
|
Goodwill
|
|
|
|
|
|
|
1,667,957
|
|
|
|
|
|
|
|
1,667,957
|
|
Property and equipment additions
|
|
|
294,878
|
|
|
|
29,157
|
|
|
|
|
|
|
|
324,035
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) |
|
Operating loss from continuing operations of the principal
businesses exclude corporate compensation, marketing expense,
professional fees and other unallocated expenses. |
|
(2) |
|
Depreciation and amortization expense associated with property
and equipment and intangibles. Corporate amortization expense
relates to intangible asset technological know-how. |
|
(3) |
|
Corporate interest expense is primarily related to a convertible
note payable. |
|
(4) |
|
Total business assets are the owned or allocated assets used by
each business. Corporate assets consist of cash, intangibles and
certain other assets. |
Revenues are attributable to geographic areas based on location
of the customer, primarily within the continental United States.
Converted Organics derived approximately $1.9 million or
63% of its revenues from three customers and TerraSphere Inc.
derived 100% of its revenue from one customer as of
December 31, 2010.
As of December 31, 2009, the Company was a single
reportable segment.
NOTE 16
RELATED PARTY TRANSACTIONS
As of December 31, 2010 and 2009 the Company has an accrued
liability totaling $395,001 and $697,602, respectively,
representing accrued compensation to officers, directors and
consultants.
The Company had a term note payable to its CEO, Edward J.
Gildea. The unsecured term note for $89,170 was dated
April 30, 2007 with an original maturity of April 30,
2009 and accrued interest at 12% per annum. The note had been
extended for one year until April 30, 2010. The Company
paid accrued interest of $21,400 upon extension of the
notes due date on June 30, 2009. This note was
subordinate to the New Jersey EDA bonds. On December 18,
2009, the Company repaid the principal balance of the note plus
accrued interest of $6,777.
In connection with the Companys acquisition of TerraSphere
Systems, the Company assumed an unsecured note payable to
William Gildea, Secretary of the Company and brother of Edward
Gildea, the Companys Chairman and Chief Executive Officer,
that has an interest rate of 10% per annum. The principal amount
due totaled $72,351 at December 31, 2010. The Company has
accrued interest totaling $18,973 at December 31, 2010 and
incurred interest expense totaling $3,486 for the year ended
December 31, 2010.
F-38
CONVERTED
ORGANICS INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
NOTE 16
RELATED PARTY
TRANSACTIONS Continued
The Pr