e10vq
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
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þ |
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Quarterly Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 |
For the quarterly period ended June 30, 2009
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o |
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Transition Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 |
For the transition period from to
Commission file number: 001-33304
Converted Organics Inc.
(Exact name of registrant as specified in its charter)
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Delaware
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20-4075963 |
(State or other jurisdiction of incorporation or organization)
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(I.R.S. Employer Identification No.) |
7A Commercial Wharf W, Boston, MA 02110
(Address of principal executive offices) (Zip Code)
(617) 624-0111
(Registrants telephone number, including area code)
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for
such shorter period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. YES þ NO o
Indicate by check mark whether the registrant has submitted electronically and posted on its
corporate Web site, if any, every Interactive Data File required to be submitted and posted
pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months
(or for such shorter period that the registrant was required to submit and post such files). YES
o NO o
Indicate by check mark whether the registrant is a large
accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See 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 | |
Accelerated filer
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Non-accelerated filer o | |
Smaller reporting company
þ |
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(Do not check if a smaller reporting company) |
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Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the
Exchange Act). YES o NO þ
Indicate the number of shares outstanding of each of the issuers classes of common stock, as of
the latest practicable date: As of August 14, 2009, there were 20,412,708 shares of our common
stock outstanding.
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Item 1. |
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Financial Statements |
CONVERTED ORGANICS INC.
CONSOLIDATED BALANCE SHEETS
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June 30, 2009 |
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December 31, 2008 |
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(Unaudited) |
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(Audited) |
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ASSETS |
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CURRENT ASSETS |
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Cash and cash equivalents |
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$ |
1,808,156 |
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$ |
3,357,940 |
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Restricted cash |
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50,941 |
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2,547,557 |
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Accounts receivable, net |
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503,998 |
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313,650 |
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Inventories |
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407,973 |
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289,730 |
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Prepaid rent |
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490,286 |
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389,930 |
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Other prepaid expenses |
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128,399 |
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73,937 |
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Deposits |
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92,520 |
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141,423 |
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Other receivables |
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94,250 |
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Deferred financing and issuance costs, net |
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22,042 |
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Total current assets |
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3,482,273 |
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7,230,459 |
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Deposits |
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861,244 |
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912,054 |
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Restricted cash |
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29,716 |
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60,563 |
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Property and equipment, net |
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22,825,134 |
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19,725,146 |
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Construction-in-progress |
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217,564 |
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974,900 |
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Capitalized bond costs, net |
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838,175 |
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862,010 |
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Intangible assets, net |
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2,709,961 |
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2,852,876 |
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Total assets |
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$ |
30,964,067 |
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$ |
32,618,008 |
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LIABILITIES AND OWNERS EQUITY (DEFICIT) |
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CURRENT LIABILITIES |
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Term notes payable current |
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$ |
1,261,089 |
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$ |
89,170 |
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Accounts payable |
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4,279,836 |
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3,583,030 |
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Accrued compensation, officers, directors and consultants |
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389,849 |
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430,748 |
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Accrued legal and other expenses |
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363,545 |
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164,620 |
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Accrued interest |
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616,249 |
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601,166 |
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Convertible notes payable, net of unamortized discount |
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342,984 |
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4,602,660 |
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Capital lease obligations current |
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11,284 |
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Mortgage payable |
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3,006 |
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Total current liabilities |
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7,264,836 |
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9,474,400 |
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Capital lease obligation, net of current portion |
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34,806 |
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Term notes payable, net of current portion |
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1,008,094 |
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Mortgage payable, net of current portion |
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245,160 |
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Convertible note payable, net of current portion |
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198,466 |
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351,516 |
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Bonds payable |
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17,500,000 |
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17,500,000 |
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Total liabilities |
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26,006,202 |
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27,571,076 |
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COMMITMENTS AND CONTINGENCIES |
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OWNERS EQUITY (DEFICIT) |
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Preferred stock, $.0001 par value, authorized
10,000,000 shares; no shares issued and outstanding |
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Common stock, $.0001 par value, authorized
40,000,000 shares at December 31, 2008 and
75,000,000 at June 30, 2009 |
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1,835 |
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743 |
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Additional paid-in capital |
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40,668,709 |
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31,031,647 |
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Members equity |
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619,657 |
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Accumulated deficit |
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(35,712,679 |
) |
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(26,605,115 |
) |
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Total owners equity |
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4,957,865 |
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5,046,932 |
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Total liabilities and owners equity |
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$ |
30,964,067 |
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$ |
32,618,008 |
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The accompanying notes are an integral part of these consolidated financial statements.
3
CONVERTED ORGANICS INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
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Three months ended |
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Six months ended |
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June 30, 2009 |
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June 30, 2008 |
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June 30, 2009 |
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June 30, 2008 |
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Revenues |
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$ |
992,364 |
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$ |
492,864 |
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$ |
1,484,203 |
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$ |
752,907 |
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Cost of good sold |
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2,113,074 |
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402,552 |
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3,757,264 |
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624,548 |
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Gross (loss) profit |
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(1,120,710 |
) |
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90,312 |
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(2,273,061 |
) |
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128,359 |
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Operating expenses |
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General and administrative expenses |
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2,502,643 |
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3,759,197 |
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4,175,661 |
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5,346,419 |
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Research and development |
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12,116 |
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70,540 |
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179,500 |
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198,387 |
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Depreciation expense |
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306,036 |
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3,051 |
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626,216 |
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6,889 |
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Amortization of capitalized costs |
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79,251 |
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99,834 |
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180,542 |
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186,083 |
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Amortization of license |
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4,125 |
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4,125 |
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8,250 |
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8,250 |
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Loss from operations |
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(4,024,881 |
) |
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(3,846,435 |
) |
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(7,443,230 |
) |
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(5,617,669 |
) |
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Other income/(expenses) |
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Interest income |
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11,952 |
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77,807 |
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22,247 |
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206,627 |
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Derivative gain |
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2,153,106 |
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3,565,091 |
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Other income |
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39,201 |
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39,201 |
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Interest expense |
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(1,202,959 |
) |
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(2,374,165 |
) |
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(3,109,711 |
) |
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(3,127,332 |
) |
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1,001,300 |
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(2,296,358 |
) |
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516,828 |
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(2,920,705 |
) |
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Loss before provision for income taxes |
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|
(3,023,581 |
) |
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|
(6,142,793 |
) |
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(6,926,402 |
) |
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(8,538,374 |
) |
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Provision for income taxes |
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Net loss |
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$ |
(3,023,581 |
) |
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$ |
(6,142,793 |
) |
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$ |
(6,926,402 |
) |
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$ |
(8,538,374 |
) |
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Net loss per share, basic and diluted |
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(0.19 |
) |
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(1.02 |
) |
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(0.58 |
) |
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(1.49 |
) |
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Weighted average common shares outstanding |
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15,937,329 |
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6,009,919 |
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11,985,904 |
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5,747,616 |
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The accompanying notes are an integral part of these consolidated financial statements.
4
CONVERTED ORGANICS INC.
CONSOLIDATED STATEMENT OF CHANGES IN OWNERS EQUITY (DEFICIT)
Six months ended June 30, 2009
(Unaudited)
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Common Stock |
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Total |
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Shares Issued and |
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Additional |
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Members |
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Accumulated |
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Owners Equity |
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Outstanding |
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Amount |
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Paid-in Capital |
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Equity |
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Deficit |
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(Deficit) |
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Balance, January 1, 2009, before cumulative effect of change in accounting principle |
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|
7,431,436 |
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|
$ |
743 |
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|
$ |
31,031,647 |
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|
$ |
619,657 |
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|
$ |
(26,605,115 |
) |
|
$ |
5,046,932 |
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|
Cumulative effect of change in accounting principle |
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|
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(2,936,250 |
) |
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(2,146,858 |
) |
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(5,083,108 |
) |
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Balance, January 1, 2009, after cumulative effect of change in accounting principle |
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7,431,436 |
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|
743 |
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|
28,095,397 |
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|
619,657 |
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(28,751,973 |
) |
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(36,176 |
) |
Members contributions |
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|
915,651 |
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|
915,651 |
|
Members distributions |
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(201,630 |
) |
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(201,630 |
) |
Deconsolidation of former variable interest entity |
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|
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(1,367,982 |
) |
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|
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|
(1,367,982 |
) |
Common stock issued to holders of convertible notes payable in connection with
extension |
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|
200,000 |
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|
20 |
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|
561,980 |
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|
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|
562,000 |
|
Common stock issued upon conversion of convertible notes payable |
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|
7,600,644 |
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|
760 |
|
|
|
6,224,835 |
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|
|
6,225,595 |
|
Common stock issued as compensation |
|
|
121,528 |
|
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|
12 |
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|
120,301 |
|
|
|
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|
|
|
|
|
|
|
120,313 |
|
Warrants issued in connection with release of restricted cash |
|
|
|
|
|
|
|
|
|
|
662,479 |
|
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|
|
|
|
|
|
|
662,479 |
|
Warrants issued in connection with financing short-term non-convertible note |
|
|
|
|
|
|
|
|
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|
920,995 |
|
|
|
|
|
|
|
|
|
|
|
920,995 |
|
Issuance of stock options |
|
|
|
|
|
|
|
|
|
|
190,022 |
|
|
|
|
|
|
|
|
|
|
|
190,022 |
|
Common stock issued upon exercise of warrants |
|
|
1,500,000 |
|
|
|
150 |
|
|
|
1,964,850 |
|
|
|
|
|
|
|
|
|
|
|
1,965,000 |
|
Issuance of common stock |
|
|
1,500,000 |
|
|
|
150 |
|
|
|
1,927,850 |
|
|
|
|
|
|
|
|
|
|
|
1,928,000 |
|
Net income (loss) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
34,304 |
|
|
|
(6,960,706 |
) |
|
|
(6,926,402 |
) |
|
|
|
|
|
|
|
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|
|
|
|
|
|
|
|
|
|
|
Balance, June 30, 2009 |
|
|
18,353,608 |
|
|
$ |
1,835 |
|
|
$ |
40,668,709 |
|
|
$ |
|
|
|
$ |
(35,712,679 |
) |
|
$ |
4,957,865 |
|
|
|
|
|
|
|
|
|
|
|
|
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|
The accompanying notes are an integral part of these consolidated financial statements.
5
CONVERTED ORGANICS INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
|
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|
Six months ended |
|
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|
June 30, 2009 |
|
|
June 30, 2008 |
|
CASH FLOWS FROM OPERATING ACTIVITIES: |
|
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|
|
|
|
|
|
Net loss |
|
$ |
(6,926,402 |
) |
|
$ |
(8,538,374 |
) |
Adjustments to reconcile net loss to net cash
used in operating activities: |
|
|
|
|
|
|
|
|
Consolidation of variable interest entity |
|
|
|
|
|
|
6,164 |
|
Deconsolidation of variable interest entity |
|
|
(596,170 |
) |
|
|
|
|
Amortization of intangible asset license |
|
|
8,250 |
|
|
|
8,250 |
|
Amortization of capitalized bond costs |
|
|
23,835 |
|
|
|
23,835 |
|
Amortization of deferred financing fees |
|
|
22,042 |
|
|
|
159,100 |
|
Amortization of intangible assets |
|
|
134,665 |
|
|
|
|
|
Depreciation of fixed assets |
|
|
1,015,444 |
|
|
|
98,194 |
|
Beneficial conversion feature |
|
|
230,492 |
|
|
|
858,064 |
|
Amortization of discounts on private financing |
|
|
147,813 |
|
|
|
1,563,750 |
|
Common stock issued for extension of convertible note payable |
|
|
562,000 |
|
|
|
|
|
Common stock issued as compensation |
|
|
120,313 |
|
|
|
|
|
Stock option compensation expense |
|
|
190,022 |
|
|
|
2,329,951 |
|
Warrants issued in connection with private financing and equity transactions |
|
|
1,583,474 |
|
|
|
|
|
Derivative gain |
|
|
(3,565,091 |
) |
|
|
|
|
Changes in operating assets and liabilities: |
|
|
|
|
|
|
|
|
(Increase) decrease in: |
|
|
|
|
|
|
|
|
Accounts receivable |
|
|
(262,558 |
) |
|
|
(238,340 |
) |
Inventory |
|
|
(118,243 |
) |
|
|
(265,187 |
) |
Prepaid expenses and other current assets |
|
|
(154,818 |
) |
|
|
(576,152 |
) |
Other assets |
|
|
94,250 |
|
|
|
9,115 |
|
Deposits |
|
|
108,713 |
|
|
|
(147,397 |
) |
Increase (decrease) in: |
|
|
|
|
|
|
|
|
Accounts payable and other accrued expenses |
|
|
3,195,195 |
|
|
|
598,309 |
|
Accrued compensation officers, directors and consultants |
|
|
(40,899 |
) |
|
|
(38,423 |
) |
Accrued interest |
|
|
133,467 |
|
|
|
29,729 |
|
Other |
|
|
(39,201 |
) |
|
|
25,000 |
|
|
|
|
|
|
|
|
Net cash used in operating activities |
|
|
(4,133,407 |
) |
|
|
(4,094,412 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
CASH FLOWS FROM INVESTING ACTIVITIES |
|
|
|
|
|
|
|
|
Release of restricted cash |
|
|
2,527,463 |
|
|
|
6,194,617 |
|
Cash paid for acquisitions |
|
|
|
|
|
|
(1,500,000 |
) |
Purchase of fixed assets |
|
|
(3,512,559 |
) |
|
|
(131,222 |
) |
Capitalized interest |
|
|
|
|
|
|
(398,570 |
) |
Construction costs |
|
|
|
|
|
|
(5,329,283 |
) |
|
|
|
|
|
|
|
Net cash used in investing activities |
|
|
(985,096 |
) |
|
|
(1,164,458 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
CASH FLOWS FROM FINANCING ACTIVITIES |
|
|
|
|
|
|
|
|
Members contributions |
|
|
230,983 |
|
|
|
425,000 |
|
Members distributions |
|
|
(201,630 |
) |
|
|
|
|
Net proceeds from exercise of options |
|
|
|
|
|
|
536,250 |
|
Net proceeds from exercise of warrants |
|
|
1,965,000 |
|
|
|
6,159,580 |
|
Net proceeds from stock offering |
|
|
1,928,000 |
|
|
|
|
|
Net proceeds from nonconvertible short-term note |
|
|
1,183,500 |
|
|
|
|
|
Repayment of nonconvertible short-term note |
|
|
(1,331,313 |
) |
|
|
|
|
Proceeds from private financing, net of original issue discount |
|
|
|
|
|
|
3,715,000 |
|
Repayment of capital lease obligations |
|
|
(6,888 |
) |
|
|
|
|
Repayment of term notes |
|
|
(197,990 |
) |
|
|
(657,276 |
) |
Repayment of mortgage payable |
|
|
(943 |
) |
|
|
(4,833 |
) |
|
|
|
|
|
|
|
Net cash provided by financing activities |
|
|
3,568,719 |
|
|
|
10,173,721 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
NET (DECREASE) INCREASE IN CASH |
|
|
(1,549,784 |
) |
|
|
4,914,851 |
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents, beginning of period |
|
|
3,357,940 |
|
|
|
287,867 |
|
|
|
|
|
|
|
|
Cash and cash equivalents, end of period |
|
$ |
1,808,156 |
|
|
$ |
5,202,718 |
|
|
|
|
|
|
|
|
|
Supplemental cash flow information: |
|
|
|
|
|
|
|
|
Cash paid during the period in: |
|
|
|
|
|
|
|
|
Interest |
|
$ |
1,031,973 |
|
|
$ |
893,571 |
|
|
|
|
|
|
|
|
|
|
Non-cash financing activities: |
|
|
|
|
|
|
|
|
Financing costs paid from proceeds of private financing |
|
$ |
|
|
|
$ |
335,000 |
|
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 |
|
|
6,225,595 |
|
|
|
|
|
Beneficial conversion discount on convertible note |
|
|
|
|
|
|
2,943,386 |
|
Discount on warrants issued in connection with financing |
|
|
|
|
|
|
1,113,750 |
|
The accompanying notes are an integral part of these consolidated financial statements.
6
CONVERTED ORGANICS INC.
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1 BASIS OF PRESENTATION AND NATURE OF OPERATIONS
The accompanying unaudited interim consolidated financial statements have been prepared in
accordance with accounting principles generally accepted in the United States of America and the
rules and regulations of the Securities and Exchange Commission (the SEC) for interim financial
reporting. Certain information and footnote disclosures normally included in the annual financial
statements of Converted Organics Inc. (the Company) have been condensed or omitted. In the
Companys opinion, the unaudited interim consolidated financial statements and accompanying notes
reflect all adjustments, consisting of normal and recurring adjustments that are necessary for a
fair presentation of its financial position and operating results as of and for the three and six
month interim periods ended June 30, 2009 and 2008.
The results of operations for the interim periods are not necessarily indicative of the
results to be expected for the entire year. This Form 10-Q should be read in conjunction with the
audited financial statements and notes thereto included in the Companys Form 10-K as of and for
the year ended December 31, 2008.
NATURE OF OPERATIONS
Converted Organics Inc. uses food and other waste as a raw material to manufacture, sell and
distribute all-natural soil amendment products combining disease suppression and nutrition
characteristics. The Company generates revenues from two sources: product sales and tip fees.
Product sales revenue comes from the sale of the Companys fertilizer products. The Companys
products possess a combination of nutritional, disease suppression and soil amendment
characteristics. 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.
Converted Organics of California, LLC (California), a California limited liability company
and wholly-owned subsidiary of the Company, was formed when the Company acquired the assets of
United Organics Products, LLC. California operates a plant in Gonzales, California, in the Salinas
Valley. California produces approximately 25 tons of organic fertilizer per day, and sells
primarily to the California agricultural market. The California facility employs a proprietary
method called High Temperature Liquid Composting (HTLC). The facility is currently being upgraded
to expand its capacity and to enable it to accept larger amounts of food waste from waste haulers,
thereby increasing revenue.
The Companys second facility, located in Woodbridge, New Jersey (Woodbridge), is designed
to service the New York-Northern New Jersey metropolitan area. The Company constructed this
facility and it became partially operational in the second quarter of 2008. Converted Organics of
Woodbridge, LLC, a New Jersey limited liability company and wholly owned subsidiary of the Company,
was formed for the purpose of owning, constructing and operating the Woodbridge, New Jersey
facility.
Converted Organics of Rhode Island, LLC (Rhode Island), a Rhode Island limited liability
company and subsidiary of the Company, was formed in July 2008 for the purpose of developing a
facility at the Rhode Island central landfill.
NOTE 2 GOING CONCERN MANAGEMENTS PLAN OF OPERATION
As of December 31, 2008, the Company had incurred a net loss of approximately $16.2 million
during the year ended December 31, 2008, had a working capital deficiency as of December 31, 2008
and an accumulated deficit of approximately $26.6 million. As of June 30, 2009, the Company
continued to have a working capital deficiency and for the six months ended June 30, 2009 the
Company had a net loss of $6.9 million and an accumulated deficit of approximately $35.7 million.
The report of our independent registered public accounting firm as of and for the year ended
December 31, 2008 contains an explanatory paragraph raising substantial doubt about the Companys
ability to continue as a going concern. The consolidated financial statements do not include
adjustments that might result from the outcome of this uncertainty.
The Company currently has manufacturing capabilities in its Woodbridge and Gonzales facilities
as a means to generate revenues and cash. The Companys cash requirements on a monthly basis are
approximately $275,000 at the corporate level, $500,000 for Woodbridge and $175,000 for Gonzales.
Currently, only the Gonzales facility is generating enough cash flow to cover its cash
requirements, leaving the Company with a cash shortfall of approximately $725,000 per month. The
Company estimates, that at current production capacity, it could provide enough product to achieve
additional sales of $1,000,000 to $1,500,000 per month which, at those levels, would provide
sufficient cash flow to cover the Companys operating requirements, including additional variable
costs associated with increased production. Until such sales levels are achieved and the Company is
cash flow positive, the Company will have to seek additional means of financing in order to cover
the shortfall.
7
CONVERTED ORGANICS INC.
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS CONTINUED
(UNAUDITED)
NOTE 2 GOING CONCERN MANAGEMENTS PLAN OF OPERATION CONTINUED
During the first six months of 2009, the Company has settled the entire $4.5 million
convertible debenture balance from the Companys private financing in 2008 (the 2008 Financing)
by converting the balance into shares of its common stock. In addition, during the first six months
of 2009, the holders of the NJEDA bonds released $2.0 million of escrowed funds for the Company to
use and the Company has secured $1,331,000 of secured debt financing. In addition, the Company has
filed a shelf registration statement which will allow the Company to sell shares into the market to
raise additional financing. The Company plans to use the proceeds from the $1,331,000 secured debt
and the shelf registration statement to fund working capital requirements, retire debt and to add
additional sales and marketing personnel in order to achieve increased sales levels during the
remainder of 2009. During the second quarter of 2009, the Company raised approximately $4.2 million
from the sale of common stock registered under the shelf registration statement. These funds were
used to retire the $1,331,000 secured debt and to provide additional working capital for the
Company.
There can be no assurance that the Company can raise additional funds from the sale of common
stock registered under the shelf registration statement or achieve the desired sales levels and, if
neither were achieved, the Company estimates that it would have sufficient cash to last through
October 2009. In addition, the Company has outstanding amounts due to its New Jersey construction
vendors of approximately $4.2 million. The Company does not anticipate that funds from the sale of
common stock registered under the shelf registration statement will be used towards payment of
these amounts. The Company has negotiated with all, except one, contractor to issue notes for the
outstanding amount owed. The Company has not finalized negotiations with the remaining contractor
who has placed a lien on the Woodbridge facility and has commenced a lawsuit in the matter.
NOTE 3 SIGNIFICANT ACCOUNTING POLICIES
CONSOLIDATION
The accompanying unaudited interim consolidated financial statements include the transactions
and balances of Converted Organics Inc. and its subsidiaries, Converted Organics of California,
LLC, Converted Organics of Woodbridge, LLC and Converted Organics of Rhode Island, LLC. The
transactions and balances of Valley Land Holdings, LLC, a variable interest entity of Converted
Organics of California, LLC, were also consolidated therein until April 1, 2009. All intercompany
transactions and balances have been eliminated in consolidation.
The consolidated financial statements included Valley Land Holdings, LLC (VLH), as VLH had
been deemed to be a variable interest entity of the Company as it was the primary beneficiary of
that variable interest entity following the acquisition of the net assets of United Organic
Products, LLC. VLHs assets and liabilities consist primarily of cash, land and a mortgage note
payable on the land on which the California facility is located. Its operations consist of rental
income on the land from the Company and related operating expenses. In 2009, the sole member of
VLH contributed cash and property to VLH in a recapitalization. VLH has henceforth been
sufficiently capitalized and is no longer considered to be a variable interest entity of the
Company. The Company has deconsolidated VLH as a variable interest entity as of April 1, 2009 in
its financial statements.
USE OF ESTIMATES
The preparation of consolidated financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make estimates and
assumptions that affect the reported amounts and disclosures in the consolidated financial
statements. Actual results could differ from those estimates.
CASH AND CASH EQUIVALENTS
The Company considers financial instruments with an original maturity date of three months or
less from the date of purchase to be cash equivalents. The Company had cash equivalents of $0 at
June 30, 2009 and $534,800 at December 31, 2008 consisting of certificates of deposit. These
certificates of deposit were held by VLH.
8
CONVERTED ORGANICS INC.
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS CONTINUED
(UNAUDITED)
NOTE 3 SIGNIFICANT ACCOUNTING POLICIES CONTINUED
RESTRICTED CASH
As of June 30, 2009, the Company had remaining approximately $81,000 of restricted cash as
required by its bond agreement with the New Jersey Economic Development Authority. This cash was
raised by the Company in its initial public offering and bond financing on February 16, 2007 and is
set aside in reserve for bond principal and interest payments along with a reserve for lease
payments. The Company has classified this restricted cash as non-current to the extent that such
funds are to be used to acquire non-current assets or are to be used to service non-current
liabilities. Third party trustee approval is required for disbursement of all restricted funds.
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 June 30, 2009 and December 31, 2008, an allowance for
doubtful accounts of $16,000 has been established against certain receivables that management has
identified as uncollectible.
INVENTORIES
Inventories are valued at the lower of cost or market, with cost determined by the first in,
first out basis. Inventory consists primarily of raw materials and finished goods, which consist of
soil amendment products. Inventory balances are presented net of applicable reserves. There were no
inventory reserves deemed necessary by management at June 30, 2009 and December 31, 2008.
PREPAID RENT
The Company has recorded prepaid rent on its consolidated balance sheets which represents the
difference between actual lease rental payments made as of June 30, 2009 and December 31, 2008, and
the straight-line rent expense recorded in the Companys consolidated statements of operations for
the periods then ended relating to the Companys facilities in Woodbridge, New Jersey and Gonzales,
California.
DEFERRED FINANCING COSTS
In connection with the private financing arrangement of January 24, 2008, the Company incurred
legal and placement fees of $345,000. These fees were amortized over one year. Amortization expense
of $22,042 and $150,458 was recorded during the six months ended June 30, 2009 and 2008,
respectively, related to these costs. These costs have been fully amortized into expense as of
June 30, 2009.
INTANGIBLE ASSETS
The Company accounts for its intangible assets in accordance with SFAS No. 142, Goodwill and
Other Intangible Assets. SFAS No. 142 requires that intangible assets with finite lives, such as
the Companys license, be capitalized and amortized over their respective estimated lives and
reviewed for impairment whenever events or other changes in circumstances indicate that the
carrying amount may not be recoverable.
LONG-LIVED ASSETS
In accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived
Assets, long-lived assets are reviewed for impairment whenever events or changes in circumstances
indicate that the carrying amount of an asset may not be recoverable. Such reviews are based on a
comparison of the assets undiscounted cash flows to the recorded carrying value of the asset. If
the assets recorded carrying value exceeds the sum of the undiscounted cash flows expected to
result from the use and eventual disposition of the asset, the asset is written down to its
estimated fair value. Impairment charges, if any, are recorded in the period in which the
impairment is determined. No impairment charges were deemed necessary during the three and six
month periods ended June 30, 2009 or 2008.
9
CONVERTED ORGANICS INC.
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS CONTINUED
(UNAUDITED)
NOTE 3 SIGNIFICANT ACCOUNTING POLICIES CONTINUED
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost. Depreciation is computed on the straight-line
basis over the estimated useful lives of seven to twenty years.
CAPITALIZED BOND COSTS
In connection with its $17.5 million bond financing on February 16, 2007, the Company has
capitalized bond issuance costs of $953,375 and is amortizing these costs over the life of the
bond. Amortization expense of $11,917 and $23,835 was recorded in each of the three and six month
periods ended June 30, 2009 and 2008, respectively.
REVENUE RECOGNITION
In accordance with Staff Accounting Bulletin 104, Revenue Recognition in Financial Statements,
(SAB 104) revenue is recognized when each of the following criteria is met:
|
|
|
Persuasive evidence of a sales arrangement exists; |
|
|
|
|
Delivery of the product has occurred; |
|
|
|
|
The sales price is fixed or determinable, and |
|
|
|
|
Collectability is reasonably assured. |
In those cases where all four criteria are not met, the Company defers recognition of revenue until
the period these criteria are satisfied. Revenue is generally recognized upon shipment.
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.
FAIR VALUE MEASUREMENTS
The Company has partially implemented SFAS No. 157, Fair Value Measurements (SFAS No. 157)
for assets and liabilities. SFAS No. 157 defines fair value, establishes a framework for measuring
fair value, and expands disclosure about fair value. This standard only applies when other
standards require or permit the fair value measurement of assets and liabilities. It does not
increase the use of fair value measurement. The standard is effective for fiscal years beginning
after November 15, 2008. The major categories of assets and liabilities that have not been
measured and disclosed using SFAS No. 157 fair value guidance are property and equipment and
goodwill.
NEWLY ADOPTED ACCOUNTING STANDARDS
In January 2009, the Company adopted Statement of Financial Accounting Standards (SFAS), No.
161, Disclosures about Derivative Instruments and Hedging Activities (SFAS 161), which changes
the disclosure requirements for Derivative instruments and hedging activities. SFAS 161 requires
enhanced disclosures about (a) how and why an entity uses derivative instruments, (b) how
derivative instruments and related hedged items are accounted for under SFAS No. 133, Accounting
for Derivative Instruments and Hedging Activities and its related interpretations, and (c) how
derivative instruments and related hedged items affect an entitys financial position, financial
performance, and cash flows. The adoption of SFAS 161 did not have a material impact on the
condensed consolidated financial statements.
In January 2009, the Company adopted Emerging Issues Task Force (EITF) Issue No. 07-5,
Determining Whether an Instrument (or Embedded Feature) is Indexed to an Entitys Own Stock (EITF
07-5) effective January 1, 2009. The adoption of EITF 07-5s requirements can affect the
accounting for warrants and many convertible instruments with certain provisions
10
CONVERTED ORGANICS INC.
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS CONTINUED
(UNAUDITED)
NOTE 3 SIGNIFICANT ACCOUNTING POLICIES CONTINUED
that protect holders from a decline in the stock price (or down-round provisions). Warrants and
convertible instruments with such provisions may no longer be recorded in equity. The Company
evaluated whether its stock warrants and the conversion feature in its convertible notes contain
provisions that protect holders from declines in the stock price or otherwise could results in
modification of the exercise price and/or shares to be issued under the respective agreements based
on a variable that is not an input to the fair value of a fixed-for-fixed option. The Company
determined that the conversion features in the convertible notes issued in the January 2008 private
financing contain such provisions.
In accordance with EITF 07-5, the Company, beginning on January 1, 2009, bifurcated and
recognized these embedded conversion features as derivative liabilities at their fair value on each
reporting date. The cumulative effect of the change in accounting for these instruments of
$5,083,108 was recognized as an adjustment to the opening balance of accumulated deficit and
additional paid-in capital at January 1, 2009. The cumulative effect adjustment was the difference
between the amounts recognized in the consolidated balance sheet before initial adoption of EITF
07-5 and the amounts recognized in the consolidated balance sheet upon the initial application of
EITF 07-5. The amounts recognized in the balance sheet as a result of the initial application of
EITF 07-5 on January 1, 2009 were determined based on the amounts that would have been recognized
if EITF 07-5 had been applied from the issuance date of conversion features.
In April 2009, the FASB issued FASB Staff Position No. FAS 107-1 and APB 28-1, Interim
Disclosures about Fair Value of Financial Instruments (FSP No. 107-1). FSP No. 107-1 requires
summarized disclosure in interim periods of the fair value of all financial instruments for which
it is practicable to estimate that value, whether recognized or not recognized in the financial
statements, as required by SFAS No. 107, Disclosures about Fair Value of Financial Instruments and
Accounting Principles Board Opinion No. 28, Interim Financial Reporting. Previous to FSP No.
107-1, such disclosures were required only for annual periods. The adoption of FSP No. 107-1 on
April 1, 2009 resulted in additional disclosures in the Companys consolidated financial
statements.
In May 2009, the FASB issued SFAS No. 165, Subsequent Events (SFAS No. 165). SFAS No. 165
establishes general standards of accounting for and disclosure of events that occur after the
balance sheet date but before financial statements are issued or are available to be issued. The
adoption of SFAS No. 165 on June 30, 2009 required the Company to disclose the date through which
they have evaluated subsequent events and whether that date is the date the financials were issued.
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
diluted income (loss) per share is antidilutive and, as such, basic and diluted earnings (loss) per
share are the same for the three and six month periods ended June 30, 2009 and 2008.
SEGMENT REPORTING
The Company has no reportable segments as defined by SFAS No. 131, Disclosure about Segments
of an Enterprise and Related Information.
11
CONVERTED ORGANICS INC.
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS CONTINUED
(UNAUDITED)
NOTE 4 INVENTORIES
The Companys inventories consisted of the following at June 30, 2009 and December 31, 2008:
|
|
|
|
|
|
|
|
|
|
|
2009 |
|
|
2008 |
|
Finished goods |
|
$ |
114,580 |
|
|
$ |
214,053 |
|
Raw materials |
|
|
152,016 |
|
|
|
18,785 |
|
Packaging materials |
|
|
141,377 |
|
|
|
56,892 |
|
|
|
|
|
|
|
|
Total inventories |
|
$ |
407,973 |
|
|
$ |
289,730 |
|
|
|
|
|
|
|
|
NOTE 5 FAIR VALUE MEASUREMENTS
SFAS No. 157, Fair Value Measurements (SFAS No. 157), defines fair value as the price that
would be received to sell an asset or paid to transfer a liability in an orderly transaction
between market participants, as of the measurement date. The standard specifies a hierarchy of
valuation techniques based upon whether the inputs to those valuation techniques reflect
assumptions other market participants would use based upon market data obtained from independent
sources (also referred to as observable inputs). In accordance with SFAS No. 157, the following
summarizes the fair value hierarchy:
|
|
|
Level 1 Quoted prices in active markets that are unadjusted and accessible at the
measurement date for identical, unrestricted assets or liabilities; |
|
|
|
|
Level 2 Quoted prices for identical assets and liabilities in markets that are not
active, quoted prices for similar assets and liabilities in active markets or financial
instruments for which significant observable inputs are available, either directly or
indirectly such as interest rates and yield curves that are observable at commonly quoted
intervals; and |
|
|
|
|
Level 3 prices or valuations that require inputs that are unobservable. |
In certain cases, the inputs used to measure fair value may fall into different levels of the
fair value hierarchy. In such cases, the level in the fair value hierarchy within which the fair
value measurement in its entirety falls has been determined based on the lowest level input that is
significant to the fair value measurement in its entirety. The Companys assessment of the
significance of a particular input to the fair value measurement in its entirety requires judgment,
and considers factors specific to the asset or liability.
The Companys assets and liabilities that are reported at fair value in the accompanying
consolidated balance sheets as of June 30, 2009 and December 31, 2008 were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance |
|
|
Observable Inputs |
|
June 30, 2009 |
|
December 31, 2008 |
Assets |
|
|
|
|
|
|
|
|
|
|
Certificate of
Deposit
|
|
Level 2
|
|
$ |
0 |
|
|
$ |
534,821 |
|
The Company has other non-derivative financial instruments, such as cash, accounts receivable,
accounts payable, accrued expenses and long-term debt, whose carrying amounts approximate fair
value.
NOTE 6 DEBT
TERM NOTES
The Company has a term note payable to its CEO, Edward J. Gildea. The unsecured term note for
$89,170 is dated April 30, 2007 with an original maturity of April 30, 2009 and accrues interest at
12% per annum. The note has been extended for one year until April 30, 2010. The Company paid
accrued interest of $21,400 upon extension of the notes due date. This note is subordinate to the
New Jersey EDA bonds.
12
CONVERTED ORGANICS INC.
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS CONTINUED
(UNAUDITED)
NOTE 6 DEBT CONTINUED
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.
On April 1, 2009, the Company agreed to convert certain accounts payable into a 12 month note
with its 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 September 30 and December 31, 2009,
to be applied first to accrued interest and then to principal. A final installment of $318,832 is
due on March 31, 2010.
On June 17, 2009, the Company agreed to convert certain accounts payable into a 24 month note
with SNC-Lavalin Project Services, Inc. (SNC-Lavalin) for $888,000. The terms of the Note require
a $100,000 down payment, interest only payments for six months and the remaining principal balance
to be repaid in 18 monthly installments of $43,778 commencing January 16, 2010. The Note has a
stated interest rate of 6% for the first six months and 0% for months seven through twenty four.
SNC-Lavalins lien will be released upon full and final payment of the Note. The Company has
recorded a discount on the note representing imputed interest of $39,200, which will be amortized
during the non-interest bearing period of the note repayment.
On June 19, 2009, the Company also agreed to convert certain accounts payable into a 24 month
note with Hatzel & Buehler, Inc. (Hatzel & Buehler) for $620,235. The terms of the Note require a
$65,560 down payment, interest only payments for six months and the remaining principal and
interest balance to be repaid in 18 monthly installments of $32,300 commencing February 1, 2009.
The Note has a stated interest rate of 6% for the entire 24 month term. Hatzel & Buehlers lien
will be released upon full and final payment of the Note.
The Company obtained the necessary bondholder consents to enter into these agreements.
BOND FINANCING
On February 16, 2007, concurrent with its initial public offering, the Companys wholly-owned
subsidiary, Woodbridge, completed the sale of $17,500,000 of New Jersey Economic Development
Authority Bonds. Direct financing costs related to this issuance totaled approximately $953,000,
which have been capitalized and are being amortized over the life of the bonds. The bonds carry a
stated interest rate of 8% and mature on August 1, 2027. The bonds are secured by a leasehold
mortgage and a first lien on the equipment of Woodbridge. 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 capitalized interest reserve has been depleted and is now
being funded monthly by the Company. The Company has provided a guarantee to the bondholders on
behalf of Woodbridge for the entire bond offering.
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 for the six months ended June 30, 2009. On July 30, 2009 the
deferred interest payments were paid in full.
CONVERTIBLE NOTE PAYABLE
On January 24, 2008, in conjunction with the purchase of the net assets of UOP, the Company
issued a note payable to the former sole member in the amount of $1,000,000. The note bears
interest of 7% per annum and matures 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 as interest expense through the stated redemption date of the note. That amount was calculated
to be $7,136, and has been recorded as a component of additional paid-in capital. The balance of
this note and the related interest expense had been eliminated in the consolidation of VLH, a
variable interest entity, during the three month period ended March 31, 2009, as the related
convertible note receivable was contributed to VLH by its member. As of June 30, 2009, VLH is no
longer considered to be a variable interest entity of the Company, and therefore the balance of the
note and the related interest are no longer eliminated in the consolidation.
13
CONVERTED ORGANICS INC.
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS CONTINUED
(UNAUDITED)
NOTE 6 DEBT CONTINUED
During the six months ending June 30, 2009, the holder of the note commenced converting the
principal and interest payments to shares of common stock. Accordingly, the Company issued 102,500
shares of common stock to the note holder, representing principal and interest payments of
approximately $138,000.
MORTGAGE NOTE PAYABLE
The Company had a mortgage note payable on the land upon which the California facility
resides, through consolidation of VLH. The note is for $250,000, bears interest at 6.75% per annum
and matures five years from inception. Monthly payments of $2,871 are based on a ten year
amortization. This mortgage payable is no longer reflected in the financial statements of the
Company as the former variable interest entity has been deconsolidated.
PRIVATE FINANCING
On January 24, 2008, the Company entered into a private financing with three investors (the
Investors) for a total amount of $4,500,000 (the Financing). The Financing was offered at an
original issue discount of 10%. The Company used the proceeds to fund the acquisitions described
above, to fund further development activities and to provide working capital. As consideration for
the Financing, the Investors received a note issued by the Company in the amount of $4,500,000 with
interest accruing at 10% per annum to be paid monthly and the principal balance to be paid in full
one year from the closing date (the Note). In addition, the Company issued to the Investors
750,000 Class A Warrants and 750,000 Class B Warrants, which may be exercised at $8.25 and $11.00
per warrant, 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 of the Class B Warrants issued were
returned to the Company. Under the conversion option, the Investors shall have the option, at
any time on or before the maturity date (January 24, 2009), to convert the outstanding
principal of this Convertible Debenture into fully-paid and non assessable shares of 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 of approximately $17,500,000.
In connection with this borrowing, the Company issued 1.5 million warrants to purchase common
stock, which were deemed to have a fair value of $5,497,500. The Company recorded the relative fair
value of the warrants to the underlying notes of $2,227,500 in accordance with Accounting
Principles Board (APB) Opinion No. 14, Accounting for Convertible Debt and Debt Issued with
Stock Purchase Warrants as additional paid-in capital and established a discount on the debt. The
discount was being amortized over the life of the note (12 months). On April 17, 2008, the
Investors returned to the Company 750,000 warrants that had been held in escrow. This reduced the
value assigned to the warrants and, accordingly, the value assigned to the debt discount
attributable to the warrants by $1,113,750. In addition, the remaining original issue discount of
approximately $366,000 was recognized as expense on April 7, 2008.
On April 7, 2008, the shareholders of the Company approved the issuance of additional shares
so that convertible notes could be issued to the note holders to replace the original notes dated
January 24, 2008. The Company is required to recognize a discount for the intrinsic value of the
beneficial conversion feature of the notes, which is to be recognized as interest expense through
the redemption date of the notes, which is January 24, 2009. That amount was calculated to be
$3,675,000, and recognition was limited to $2,936,250 in accordance with EITF 98-5, Accounting for
Convertible Securities with Beneficial
14
CONVERTED ORGANICS INC.
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS CONTINUED
(UNAUDITED)
NOTE 6 DEBT CONTINUED
Conversion Features or Contingently Adjustable Conversion Ratios, as the debt discount is limited
to the proceeds allocated to the convertible instrument of $4,500,000. That discount is being
amortized over the life of the loan. During the six month periods ending June 30, 2009 and 2008,
the Company recognized interest expense of $230,492 and $0 related to this discount.
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 March 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 for the six
months ended June 30, 2009 for this stock grant, which represents the market value of 200,000
shares on the date they were granted. In addition, the notes accrue interest at 10% of their
declining balance as they are 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
not been converted to shares of common stock.
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 $1,200,000,
six-month non-convertible original issue discount notes with principal amounts totaling $1,331,000
(the Note). The agreement provides that if the Company raises over $1.33 million while the Notes
are outstanding, the first $1,331,000 must be used to repay the note. Additionally, in connection
with the Note issued pursuant to the agreement, 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, respectively, subject to certain anti-dilution rights for issuance
below the exercise prices. These warrants are not registered and cannot be traded. The expense
associated with the issuance of these warrants was calculated using a Black-Scholes model with the
following assumptions: risk-free interest rate of 2.05%; no dividend yield; volatility factor of
96.7%; and a term of 5 years. The Company determined that the warrants issued have a fair value of
$1,557,953. The Company recorded the relative fair value of the warrants to the underlying notes of
$1,330,313 in accordance with Accounting Principles Board (APB) Opinion No. 14, Accounting for
Convertible Debt and Debt Issued with Stock Purchase Warrants as additional-paid-in capital and
established a discount on the debt. The discount was fully amortized at the repayment of the note
(12 days later) and at such time the entire amortization totaled approximately $637,850 for the
three months ended June 30, 2009.
Also pursuant to this agreement, the investment banker was issued five-year warrants to
purchase 135,000 and 65,000 shares of Company common stock with exercise prices of $1.00 per share
and $1.50 per share, respectively. The expense associated with these warrants was calculated in
the same manner as described above. The expense of $285,000 is included in general and
administrative expense on the consolidated statements of operations for the three and six month
periods ending June 30, 2009 and 2008.
DERIVATIVE INSTRUMENTS
Upon the adoption of EITF 07-5 on January 1, 2009, the Company determined that the conversion
features within the convertible notes payable issued in the January 2008 private financing to be an
embedded derivative which was 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 the 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 accounting change in the
Companys consolidated statement of changes in owners equity (deficit).
During the six months ended June 30, 2009, all conversion features were converted to common
stock at the default rate in accordance with the agreement dated January 29, 2009 with the note
holders. The effect of the derivative instruments in the six months ended June 30, 2009 was
recorded in the Companys consolidated statements of operations and was a derivative gain of
$3,565,091. No derivative liability is recorded as of June 30, 2009 as all derivative instruments
have been converted into common stock.
NOTE 7 CAPITALIZATION OF INTEREST COSTS
The Company has capitalized interest costs, net of certain interest income, in accordance with
SFAS No. 62, Capitalization of Interest Cost in Situations Involving Certain Tax-Exempt Borrowings
and Certain Gifts and Grants, related to its New Jersey Economic Development Authority Bonds in
the amount of $1,077,686 as of June 30, 2009 and December 31, 2008,
15
CONVERTED ORGANICS INC.
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS CONTINUED
(UNAUDITED)
NOTE 7 CAPITALIZATION OF INTEREST COSTS CONTINUED
respectively. Capitalized interest is initially included with construction-in-progress on the
consolidated balance sheets. As assets are placed in service, the capitalized interest is added to
the value of the assets on a pro-rata basis.
NOTE 8 OWNERS EQUITY (DEFICIT)
On February 21, 2006, the Company merged with Mining Organics Management (MOM) and Mining
Organics Management Harlem River Rail Yard (HRRY). At that time, MOM was a fifty-percent owner
of HRRY. The mergers were accounted for as a recapitalization of the Company. As a result of the
recapitalization, 600,000 shares were issued to the members of HRRY, with 300,000 shares
distributed to Weston Solutions, Inc. and 300,000 shares distributed among the individual members
of MOM, each of whom was a founder of the Company.
On February 16, 2007, the Company successfully completed an initial public offering of
1,800,000 common shares and 3,600,000 warrants for a total offering of $9,900,000, before issuance
costs. The Companys initial public offering is recorded net of issuance costs and expenses of
approximately $1,736,715. The warrants consist of 1,800,000 redeemable Class A warrants and
1,800,000 non-redeemable Class B warrants, each warrant to purchase one share of common stock. The
common stock and warrants traded as one unit until March 13, 2007 when they began to trade
separately.
On February 16, 2007, as part of its initial public offering and under the original terms of
the bridge loan agreement, the Company issued 293,629 Bridge Equity Units to the Bridge
Noteholders. On May 23, 2007, as part of the repayment of the bridge loans, the Company issued
55,640 shares of common stock to the Bridge Noteholders, which represents 10% of the principal and
interest repaid, divided by the five-day average share price prior to repayment of the debt. The
statement of operations for the year ended December 31, 2007 reflects an expense of $178,048
related to the issuance of these shares.
On February 16, 2007, as part of its initial public offering, the Company agreed to pay a 5%
quarterly stock dividend, commencing March 31, 2007, and every full quarter thereafter, until
Woodbridge is operational. The Company declared five such quarterly dividends amounting to
1,010,535 shares through March, 2008. As the New Jersey facility was operating as of June 30, 2008,
no further dividends were declared under this agreement.
At its April 3, 2008 special meeting of shareholders, the shareholders approved a resolution
to decrease the number of common shares that the Company is authorized to issue from 75,000,000 to
40,000,000, and the number of preferred shares that the Company is authorized to issue from
25,000,000 to 10,000,000. At the time, the Company believed that 40,000,000 shares of common stock
would be sufficient to meet its future needs.
On October 1, 2008, the Company issued 45,480 shares of its common stock to a consultant as
remuneration for services rendered. The related services were substantially complete when the
stock was issued. The Company recognized $212,619 of expense related to the fair value of this
issuance.
On October 22, 2008, the Company declared a stock dividend of 15% payable to shareholders of
record as of November 17, 2008. This dividend resulted in the issuance of 969,318 shares of common
stock.
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 above. The Company
recognized interest expense of $562,000 related to this issuance.
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 6 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.
At its 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, given that the Company had the opportunity to raise capital through the issuance of
additional shares.
16
CONVERTED ORGANICS INC.
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS CONTINUED
(UNAUDITED)
NOTE 8 OWNERS EQUITY (DEFICIT) CONTINUED
WARRANTS
On February 16, 2007, in connection with the Companys public offering, the Company sold
1,800,000 equity units consisting of one share of common stock, one Class A warrant and one Class B
warrant. On March 13, 2007, the Class A and Class B warrants began to trade as separate securities.
The Class A warrants are exercisable for one share of common stock, plus accumulated stock
dividends, for $8.25. The Class A warrants expire on February 16, 2012 and, if certain conditions
are met, the Company may redeem these warrants at a price of $0.25 per warrant prior to the
expiration date. The Class B warrants are exercisable for one share of common stock, plus
accumulated stock dividends, for $11.00. The Class B warrants expire on February 16, 2012 and there
is no provision for the Company to redeem these warrants prior to the expiration date.
On January 24, 2008, in conjunction with the private financing arrangement of the Company
described in Note 6, 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 6.
WARRANT EXERCISE
The Company received net proceeds of approximately $11,344,000 as a result of the exercise of
approximately 1,381,000 Class A warrants (which includes the warrant redemption discussed below)
and 600 Class B warrants in the year ended December 31, 2008. The Company issued approximately
1,781,000 shares of common stock in connection with the exercise of these warrants due to the
cumulative effect of the Companys stock dividends.
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. In addition, and as an inducement to enter into this transaction, the Company issued the
Investor an additional 1,500,000 warrants with a strike price of $1.63 and an expiration date of
May 27, 2014.
WARRANT REDEMPTION
On September 16, 2008, the Company announced the redemption of its outstanding Class A
Warrants. The redemption date was set for October 17, 2008, and was subsequently extended a total
of 31 days voluntarily by the Company to November 17, 2008. Any outstanding Class A warrants that
had not been exercised before that date expired and are redeemable by the Company for $0.25 per
warrant.
Until the redemption date, the Class A warrants were convertible into common stock at an
exercise price of $8.25. Each warrant exercised at this price received 1.276 shares of common
stock. Prior to the notification of redemption, approximately 756,000 Class A warrants had been
exercised. After the redemption, an additional 673,000 warrants were exercised. In total, from
both the exercise and redemption of warrants, the Company received proceeds of approximately
$11,344,000. The Company was obligated to remit to its transfer agent funds sufficient to
compensate warrant holders for the remaining warrants, which may be redeemed for $.25 each for an
indefinite period. This amount of $284,237 was subtracted from the cash received for exercise of
the warrants, representing the amount necessary to redeem the remaining warrants.
17
CONVERTED ORGANICS INC.
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS CONTINUED
(UNAUDITED)
NOTE 8 OWNERS EQUITY (DEFICIT) CONTINUED
The following table sets forth the outstanding warrants as of June 30, 2009:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Class B Warrants |
|
Warrants |
|
Warrants |
|
Warrants |
|
Warrants |
|
|
Exercise Price |
|
Exercise |
|
Exercise Price |
|
Exercise Price |
|
Exercise Price |
|
|
$11.00 |
|
Price $1.00 |
|
$1.50 |
|
$1.40 |
|
$1.63 |
Outstanding at
January 1, 2009 |
|
|
2,648,029 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Issued in
connection with
agreement with bond
holders on March 6,
2009 |
|
|
2,284,409 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Issued in
connection with
securing debt on
May 5, 2009 |
|
|
|
|
|
|
885,000 |
|
|
|
415,000 |
|
|
|
|
|
|
|
|
|
|
Issued in
connection with
issuance of shares
on May 19, 2009 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,500,000 |
|
|
|
|
|
|
Warrants exercised
May 26, 2009 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1,500,000 |
) |
|
|
|
|
|
Issued in
connection with May
26 warrants
exercised |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,500,000 |
|
|
|
|
|
Outstanding at June
30, 2009 |
|
|
4,932,438 |
|
|
|
885,000 |
|
|
|
415,000 |
|
|
|
|
|
|
|
1,500,000 |
|
|
|
|
NOTE 9 STOCK OPTION PLAN
The following table presents the activity under the 2006 Stock Option Plan from January 1,
2009 through June 30, 2009:
|
|
|
|
|
|
|
|
|
|
|
Weighted Average |
|
|
|
|
|
|
Shares |
|
|
Price per Share |
|
Outstanding at January 1, 2009 |
|
|
1,246,735 |
|
|
$ |
4.50 |
|
Granted |
|
|
233,500 |
|
|
|
1.10 |
|
Exercised |
|
|
|
|
|
|
|
|
Canceled |
|
|
(231,340 |
) |
|
|
4.75 |
|
|
|
|
|
|
|
|
Outstanding and exercisable at June 30, 2009 |
|
|
1,248,895 |
|
|
$ |
3.82 |
|
|
|
|
|
|
|
|
On June 27, 2009, the Company granted 233,500 stock options under its 2006 Stock Option Plan.
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%.
The resulting expense of $190,000 is included in general and administrative expense on the
consolidated statements of operations for the three and six month periods ended June 30, 2009 and
2008. As of June 30, 2009, there was no unrecognized compensation cost related to non-vested
share-based compensation arrangements granted under the Companys stock option plan.
18
CONVERTED ORGANICS INC.
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS CONTINUED
(UNAUDITED)
NOTE 10 ACQUISITIONS
On January 24, 2008, the Company acquired the assets, including the intellectual property, of
Waste Recovery Industries, LLC of Paso Robles, CA. The purchase price was $500,000.
On January 24, 2008, the Company also formed Converted Organics of California, LLC, a
wholly-owned subsidiary of Converted Organics Inc., who acquired the net assets of United Organic
Products, LLC of Gonzales, CA (UOP). This facility is operational and began to generate revenues
for the Company immediately upon acquisition. The purchase price was $2,500,000.
The acquisitions have been accounted for in the first quarter of 2008 using the purchase
method of accounting in accordance with SFAS No. 141, Business Combinations. Accordingly, the net
assets have been recorded at their estimated fair values, and operating results have been included
in the Companys consolidated financial statements from the date of acquisition.
The allocation of the purchase price based on the appraisal is as follows:
|
|
|
|
|
Inventories |
|
$ |
11,114 |
|
Accounts receivable |
|
|
28,702 |
|
Technological know-how |
|
|
271,812 |
|
Trade name |
|
|
228,188 |
|
Existing customer relationships |
|
|
2,030,513 |
|
Building |
|
|
111,584 |
|
Equipment and machinery |
|
|
543,000 |
|
Assumption of liabilities |
|
|
(224,913 |
) |
|
|
|
|
|
|
|
|
|
Total purchase price |
|
$ |
3,000,000 |
|
|
|
|
|
The unaudited supplemental pro forma information discloses the results of operations for the
current fiscal year up to the date of the most recent interim period presented (and for the
corresponding period in the preceding year) as though the business combination had been completed
as of the beginning of that period.
The pro forma condensed consolidated financial information is based upon available information
and certain assumptions that the Company believes are reasonable. The unaudited supplemental pro
forma information does not purport to represent what the Companys financial condition or results
of operations would actually have been had these transactions in fact occurred as of the dates
indicated above or to project the Companys results of operations for the period indicated or for
any other period.
|
|
|
|
|
|
|
|
|
|
|
Six months ended June 30, |
|
|
2009 |
|
2008 |
Revenues (in thousands) |
|
$ |
1,484 |
|
|
$ |
753 |
|
Net loss (in thousands) |
|
|
(6,926 |
) |
|
|
(8,592 |
) |
Net loss per share basic and diluted |
|
|
(.58 |
) |
|
|
(1.56 |
) |
NOTE 11 RELATED PARTY TRANSACTIONS
ACCRUED COMPENSATION-OFFICERS, DIRECTORS AND CONSULTANTS
As of June 30, 2009 and December 31, 2008, the Company has an accrued liability totaling
approximately $390,000 and $431,000, respectively, representing accrued compensation to employees,
officers, directors and consultants.
CONVERTED ORGANICS OF RHODE ISLAND, LLC
Converted Organics of Rhode Island, LLC was formed for the purpose of developing and operating
a waste-to-fertilizer facility in Johnston, Rhode Island. A development consultant who has
provided services to the Company is a minority owner of Converted Organics of Rhode Island, LLC.
For the six month period ending June 30, 2009 the consultant was paid $60,000, and received 121,528
shares of the Companys common stock for services rendered.
19
CONVERTED ORGANICS INC.
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS CONTINUED
(UNAUDITED)
NOTE 11 RELATED PARTY TRANSACTIONS CONTINUED
PACKAGING VENDOR
The Company has purchased packaging materials from a vendor which is partially owned by an
employee of the Company. The Company made purchases of $28,000 from this vendor in the six month
period ended June 30, 2009.
NOTES PAYABLE
The Company has a term note due to its CEO in the amount of $89,170 at June 30, 2009 and
December 31, 2008. The note matured in April, 2009, and the term was extended for one year. The
Company paid accrued interest of $21,400 upon extension of the note.
NOTE 12 COMMITMENTS AND CONTINGENCIES
In addition to the operating lease commitment for its headquarters, the Company signed an
operating lease during June 2006 for Woodbridge. The lease term is for ten years and the Company
has exercised an option to renew for an additional ten years. In 2008, the Company signed a
ten-year lease for land with the Rhode Island Resource Recovery Council. Future minimum lease
payments under these leases are as follows:
|
|
|
|
|
For years ended December 31, 2009 (July 1, 2009 through December 31, 2009) |
|
|
522,400 |
|
2010 |
|
|
1,044,800 |
|
2011 |
|
|
1,056,200 |
|
2012 |
|
|
1,069,100 |
|
2013 |
|
|
1,077,400 |
|
2014 and thereafter |
|
|
9,024,000 |
|
|
|
|
|
|
|
|
|
|
|
|
$ |
13,793,900 |
|
|
|
|
|
LEGAL PROCEEDINGS
The Company is not currently aware of any pending or threatened legal proceeding to which it
is or would be a party, or any proceedings being contemplated by governmental authorities against
it, or any of its executive officers or directors relating to the services performed on the
Companys behalf except as follows. The Company received notice that a complaint had been filed in a
putative class action lawsuit on behalf of 59 persons or entities that purchased units pursuant to
a financing terms agreement dated April 11, 2006 (FTA), captioned Gerald S. Leeseberg, et al. v.
Converted Organics, Inc., filed in the U.S. District Court for the District of Delaware. The
lawsuit alleges breach of contract, conversion, unjust enrichment, and breach of the implied
covenant of good faith in connection with the alleged failure to register certain securities issued
in the FTA, and the redemption of our Class A warrants in November 2008. The lawsuit seeks damages
related to the failure to register certain securities, including alleged late fee payments, of
approximately $5.25 million, and unspecified damages related to the redemption of the Class A
warrants. In February 2009, the Company filed a Motion for Partial Dismissal of Complaint. It is
uncertain when the Court will rule on this motion. The Company plans to vigorously defend itself
in this matter, and is unable to estimate any contingent losses that may or may not be incurred as
a result of this litigation and its eventual disposition. Accordingly, no contingent loss has been
recorded related to this matter.
On May 19, 2009, the Company received notice that a complaint had been filed in the Middlesex
County Superior Court of New Jersey, captioned Lefcourt Associates, Ltd., et al. v. Converted
Organics of Woodbridge, et al. The lawsuit alleges private and public nuisances, negligence,
continuing trespasses and consumer common-law fraud in connection with the odors emanating from the
Woodbridge facility and the Companys alleged, intentional failure to disclose to adjacent property
owners the possibility of the facility causing pollution. The lawsuit seeks enjoinment of any and
all operations which in any way cause or contribute to the alleged pollution, compensatory and
punitive damages, counsel fees and costs of suit and any and all other relief the Court deems
equitable and just. In response to these allegations, the Company has filed opposition papers with
the Court and has complied with the plaintiffs requests for information.
20
CONVERTED ORGANICS INC.
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS CONTINUED
(UNAUDITED)
NOTE 12 COMMITMENTS AND CONTINGENCIES CONTINUED
On May 28, 2009, the Company received notice that a Lien Claim Foreclosure Complaint had been
filed in the Middlesex County Superior Court of New Jersey, captioned Armistead Mechanical, Inc. v.
Converted Organics Inc., et al. Armistead filed this Lien Claim Foreclosure Complaint in order to
perfect its previously filed lien claim. In connection with the Complaint, Armistead also filed a
Demand for Arbitration in order to preserve its status quo and right to submit a contract dispute
claim to binding arbitration. Armistead has indicated that it wishes to continue settlement
discussions and has offered to cooperate with the Companys efforts to secure financing for a
mutually agreeable settlement. The Company intends to continue working towards an agreeable
settlement with Armistead. On July 10, 2009, the Company received an Amended Lien Claim
Foreclosure Complaint from Armistead Mechanical. The amended complaint did not make any
substantial changes to the suit. On August 3, 2009, the Company filed a response to the complaint
whereby the Company denied certain claims and at this time management is unable to estimate any
contingent losses.
OTHER
The Middlesex County Health Department (MCHD) issued a number of notices of violation (NOV)
to the Company for alleged violations of New Jersey State Air Pollution Control Act, which
prohibits certain off-site odors. The NOV alleged that odors emanating from the facility had
impacted surrounding businesses and those odors were of sufficient intensity and duration to
constitute air pollution under the Act. The penalties assessed total $320,250 of which the Company
has paid $87,750. Of the remaining $232,500 of penalties, the Company is either contesting or
negotiating individual penalties based on the date of issuance. The Company has recorded a
liability of $75,000 in it financial statements, as of June 30, 2009 relating to the unpaid potion
of the penalties. In addition, based on a change in operational procedures and working with two
outside odor-control consultants, the Company believes it has significantly rectified the odor
issues.
The NJDEP Bureau of Air Compliance and Enforcement issued an Administrative Order (the A.O.)
to the Company for alleged violations of the Companys Air permit issued pursuant to the Air
Pollution Control Act. The A.O. alleged that the Company was not operating in compliance with its
Air Permit. No penalties were assessed in the A.O. However, the A.O. remains an open matter,
because, as NJDEP stated in the A.O., the provisions of the order remain in effect during pendency
of the hearing request. Additionally, any corrective action taken by the Company does not preclude
the State from initiating a future enforcement action or seeking penalties with respect the
violations listed in the A.O.
The NJDEP Bureau of Solid Waste Compliance and Enforcement issued a NOV to the Company for
alleged violations of the New Jersey State Solid Waste Management Act. The NOV alleged that the
facility was not operating in accordance with the terms of the General Class C Permit Approval. No
penalties were assessed by the NOV. However, the NOV is notification that the facility is
allegedly out of compliance with certain provisions of the General Class C Permit and/or the NJDEP
Solid Waste regulations. The NOV remains an open matter, because, as NJDEP stated in the NOV, any
corrective action taken by the Company does not preclude the State from initiating a future
enforcement action with respect the violations listed in the NOV.
NOTE 13 SUBSEQUENT EVENTS
The Company has evaluated subsequent events through August 14, 2009, which is the date the
accompanying financial statements were issued.
On July 16, 2009, the Company sold 1,961,000 shares of its common stock at $1.02 per share
under its shelf registration statement. In addition, the Company issued 585,000 warrants, with an
exercise price of $1.25 per warrant in association with the issuance of stock. These warrants have a five year life from the date of issuance and
cannot be exercised until six months from the date of issuance.
21
Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
The following discussion should be read in conjunction with the consolidated interim financial
statements and related notes to the consolidated interim financial statements included elsewhere in
this report. This discussion contains forward-looking statements that relate to future events or
our future financial performance. These statements involve known and unknown risks, uncertainties
and other factors that may cause our actual results, levels of activity, performance or
achievements to be materially different from any future results, levels of activity, performance or
achievements expressed or implied by these forward-looking statements. These forward-looking
statements are based largely on our current expectations and are subject to a number of
uncertainties and risks including the Risk Factors identified in our Annual Report on Form 10-K for
the year ended December 31, 2008. Actual results could differ materially from these forward-looking
statements. Converted Organics Inc. is sometimes referred to herein as we, us, our and the
Company.
Introduction
Our operating structure is composed of our parent company, Converted Organics Inc., two
wholly-owned operating subsidiaries and a 92.5% owned non-operating subsidiary. The first operating
subsidiary is Converted Organics of Woodbridge, LLC, which includes the operation of our
Woodbridge, New Jersey facility. The second operating subsidiary is Converted Organics of
California, LLC, which includes the operation of our Gonzales, California facility. The 92.5% owned
subsidiary is Converted Organics of Rhode Island, LLC, which currently has no operating activity.
We construct and operate processing facilities that use food waste as raw material to manufacture
all-natural soil amendment products combining nutritional and disease suppression characteristics.
In addition to our current sales in the agribusiness and retail markets, we plan to sell and
distribute our products in the turf management market. We have hired experienced sales and
marketing personnel in these markets and have begun to introduce the product to the marketplace. We
plan to hire additional experienced sales personnel during 2009. We also hope to achieve additional
revenue by licensing the use of our technology to others.
Woodbridge Facility
We obtained a long-term lease for a site in a portion of an industrial building in Woodbridge,
New Jersey that the landlord has modified and that we have equipped as our first internally
constructed organic waste conversion facility. We are currently producing both liquid and dry
product at that facility. In the first half of 2009, we began to record tip fee and product sales
revenue, nevertheless we are currently operating at less than full capacity at that facility. At
full capacity, the Woodbridge facility is expected to process approximately 78,000 tons of organic
food waste and produce approximately 9,900 tons of dry product and approximately 10,000 tons of
liquid annually. We have substantially completed upgrades to the Woodbridge facility, and we are
presently bringing equipment on-line to fulfill our commitment to overcome operational difficulties
that hampered the efficiency of the plant at opening. We believe these upgrades will allow us to
achieve capacity at the facility of approximately 70% of full capacity. During the first half of
2009, we generated revenue from this facility in the form of tip fees of approximately $75,000 and
product sales of approximately $277,000. In order for this facility to be cash flow positive, we
estimate that sales would need to be in a range of $450,000 to $550,000 per month. We estimate that
the product can be sold in the range of $400 to $700 per ton based on the market to which it is
sold. Therefore the potential monthly sales from this facility, at 70% capacity ranges from
approximately $700,000 to $1,100,000. Based on the above, we would have to produce and sell
approximately 45-55% of the capacity of the Woodbridge facility to be cash flow positive and until
our sales and production volume reach that level we will not be cash flow positive and therefore
may require additional funding. Cash flow generated by exceeding that sales/production number would
be used to fund operations at the corporate level and to pay down approximately $2.4 million of the payables related to
construction activity at this facility.
22
UOP Acquisition; Gonzales Facility
On January 24, 2008, we acquired the net assets of United Organic Products, LLC (UOP), which
was under common ownership with Waste Recovery Industries, LLC (WRI). With this transaction, we
acquired a leading liquid fertilizer product line, as well as the Gonzales facility, which is a
state-of-the-art production facility that services a strong West Coast agribusiness customer base
through established distribution channels. This facility is operational and began to generate
revenues for us in February 2008. The purchase price of $2,500,000 was paid in cash of $1,500,000
and notes payable of $1,000,000. The note matures on February 1, 2011, has an interest rate of 7%
per annum, is payable monthly in arrears, and is convertible into our common stock six months after
the acquisition date for a price equal to the average closing price of the stock on NASDAQ for the
five days preceding conversion. As of the filing date of this report, the note payable has a
remaining principal balance of approximately $541,000 and the holder has converted approximately
$138,000 in principal and interest on the note into 102,500 shares of our common stock.
The Gonzales facility generated revenue during the first half of 2009 of approximately
$1,079,000 with a negative operating margin of approximately $77,000. In the three months ended
June 30, 2009, the facility generated approximately $809,000 in sales, with a positive operating
margin of approximately $68,000. We plan to continue to improve this operating margin by channeling
sales into the turf and retail markets, which we believe to be more profitable, by generating tip
fees from receiving additional quantities of food waste and by reducing the amount of raw material
and freight costs currently associated with the production process. In addition, we have plans to
add capacity to the Gonzales plant, whereby the plant will produce approximately three times its
current production and will be capable of producing both liquid and solid products. We have
completed certain aspects of the planned upgrades which allow us to receive solid food waste for
processing but have delayed the upgrades which would allow us to produce dry product. The remaining
upgrades have been delayed due to cash flow constraints.
In order for the Gonzales facility to begin to generate cash flow from operations, it would
need to generate sales levels of $200,000 per month for 2009. We estimate that the plant under its
current configuration could generate monthly sales in the range of $350,000 to $400,000. If sales
increase above the $200,000 per month level, we expect the additional cash flow from the Gonzales
facility will be used to offset operating expenses at the corporate level. Based on sales in the
latter months of the second quarter of 2009, we have achieved breakeven sales levels.
WRI Acquisition
On January 24, 2008, we also acquired the net assets, including the intellectual property, of
Waste Recovery Industries, LLC. This acquisition makes us the exclusive owner of the proprietary
technology and process known as the High Temperature Liquid Composting (HTLC) system, which
processes various biodegradable waste products into liquid and solid organic-based fertilizer and
feed products. The purchase price of $500,000 was paid with a 7% short-term note that matured and
was paid on May 1, 2008. Interest on that note is payable monthly. In addition, the purchase price
provides for a technology fee payment of $5,500 per ton of waste-processing capacity that is added
to plants that were not planned at the time of this acquisition and that use this new technology.
The per-ton fee is not payable on the Woodbridge facility, the facility that is being planned in
Rhode Island, or the Gonzales facility acquired in the acquisition or the currently planned
addition thereto, except to the extent that capacity (in excess of the currently planned addition)
is added to the Gonzales facility in the future. Also, the purchase agreement provides that if we
decide to exercise our right, obtained in the WRI acquisition, to enter into a joint venture with Pacific Seafood Inc. for the development of a fish waste-processing product
(the Eureka product), we will pay 50% of our net profits earned from this Eureka product to the
seller of WRI. Combined payments of both the $5,500 per ton technology fee and the profits paid
from the Eureka product, if any, is capped at $7.0 million with no minimum payment required. In
April, 2008 we entered into an agreement with Pacific Seafoods Inc. whereby we will pay Pacific
Seafoods Inc. 50% of the net profits from the Eureka product. As of the filing date of this report
no profits have been earned from the Eureka product. It is our intention to expense the payments,
if any, that are paid on either the profits from the Eureka product or the $5,500 per ton
technology fee.
Pro Forma Financial Information
The unaudited supplemental pro forma information discloses the results of operations for the
current fiscal year up to the date of the most recent interim period presented (and for the
corresponding period in the preceding year) as though the business combination had been completed
as of the beginning of the period reported on.
23
The pro forma condensed consolidated financial information is based upon available information
and certain assumptions that the Company believes are reasonable. The unaudited supplemental pro
forma information does not purport to represent what the Companys financial condition or results
of operations would actually have been had these transactions in fact occurred as of the dates
indicated above or to project the Companys results of operations for the period indicated or for
any other period.
|
|
|
|
|
|
|
|
|
|
|
Six months ended June 30, |
|
|
2009 |
|
2008 |
Revenues (in thousands) |
|
$ |
1,484 |
|
|
$ |
753 |
|
Net loss (in thousands) |
|
|
(6,926 |
) |
|
|
(8,592 |
) |
Net loss per share basic and diluted |
|
|
(.58 |
) |
|
|
(1.56 |
) |
Rhode Island Facility
The Rhode Island Industrial Facilities Corporation has provided initial approval to the
Companys Revenue Bond Financing Application for up to $15 million for the construction of the new
facility. In addition, the Rhode Island Resource Recovery Corporation (RIRRC) gave us final
approval to lease nine acres of land in the newly created Lakeside Commerce Industrial Park in
Johnston, RI. We previously filed an application with the Rhode Island Department of Environmental
Management for the operation of a Putrescible Waste Recycling Center at that site. On September 1,
2008, we entered into a twenty year ground lease with the RIRRC under which we are obligated to pay
$9,167 per month, plus $8 per ton of fertilizer (liquid or solid) sold from the facility.
Recent Financing Activities
January 2008, March 2009, May 2009 and July 2009 Financings
On January 24, 2008, we entered into private financing with three investors for a total amount
of $4,500,000 (the 2008 Financing). We used the proceeds to fund the acquisition of assets
described above, to fund further development activities and to provide working capital. The 2008
Financing was offered at an original issue discount of 10%. The investors were issued convertible
debentures in the amount of $4,500,000, with interest accruing at 10% per annum and with the
principal balance to be paid by January 24, 2009, which was extended to July 24, 2009. In addition,
we issued to the investors an aggregate of 375,000 Class A Warrants and 375,000 Class B Warrants
which may be exercised at $8.25 and $11.00 per warrant share, respectively. A placement fee of
$225,000 was paid out of the proceeds of this loan. The investors had the option, at any time on or
before the extended maturity date (July 24, 2009) to convert the outstanding principal of the
convertible debentures into shares of our common stock at the rate per share equal to 70% of the
average of the three lowest closing prices of common stock during the 20-day trading period
immediately prior to a notice of conversion. As of June 30, 2009, the investors converted
7,366,310 shares reducing the principal amount of the debt to $0. In addition, the
investors received 131,834 shares as interest on the note balance during the pay-off period.
On March 6, 2009, we entered into an agreement with the holders of our $17.5 million New
Jersey Economic Development Authority Bonds to release $2.0 million for capital expenditures on 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, we issued the bond holders
2,284,409 Class B warrants. The Class B warrants are exercisable at $11.00 per warrant. These warrants are not registered
and cannot be traded.
On May 7, 2009, we entered into a formal agreement with an institutional investor, wherein the
Company agreed to sell to the Investor, for the sum of $1,200,000, six-month nonconvertible
original issue discount notes with principal amounts of $1,331,000 (the Note). The agreement
provides that if we raise over $1.33 million while the Notes are outstanding, the first $1,331,000
must be used to repay the Note. Additionally, in connection with the Note issued pursuant to the
agreement, 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, respectively,
subject to certain anti-dilution rights for issuance below the exercise prices. These warrants are
not registered and cannot be traded. The expense associated with the issuance of these warrants
was calculated using a Black-Scholes model with the following assumptions: risk-free interest rate
of 2.05%; no dividend yield; volatility factor of 96.7%; and a term of 5 years. We determined that
the warrants issued have a fair value of $1,557,953. We recorded the relative fair value of the
warrants to the underlying notes of $1,330,313 in accordance with Accounting Principles Board
(APB) Opinion No. 14, Accounting for Convertible Debt and Debt Issued with Stock Purchase
Warrants as additional-paid-in capital and established a discount on the debt. The discount was
fully amortized at repayment of the note (12 days later) and at such time the entire amortization
totaled approximately $637,850 for the three months ended June 30, 2009.
24
Also pursuant to this agreement, the investment banker was issued five-year warrants
to purchase 135,000 and 65,000 shares of Company common stock with exercise prices of $1.00 per
share and $1.50 per share, respectively. The expense associated with these warrants was calculated
in the same manner as described above. The expense of $285,000 is included in general and
administrative expense on the consolidated statements of operations for the three and six month
periods ended June 30, 2009 and 2008.
On May 19, 2009, we entered into an agreement with four institutional investors whereby the
investors agreed to purchase 1,500,000 shares of our common stock for $1.40 per share, providing
$2.2 million before fees and expenses. The May 7, 2009 nonconvertible short-term note described
above was immediately repaid with the proceeds of this offering as required under such an
instrument. 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. We made the
offering and sale of these shares and the shares underlying the warrants pursuant to a shelf
registration statement.
On May 26, 2009, we entered into an amended agreement with the same investors, discussed in
the paragraph above, pursuant to which the warrants issued at $1.40 were exercised in full for
proceeds of $2.1 million. Pursuant to such amended agreement, we agreed to issue to these Investors
in the aggregate warrants to purchase an additional 1,500,000 shares of our common stock at an
exercise price of $1.63 per share. These warrants are callable by us at any time after our common
stock has closed at or above $2.42 for five consecutive trading days. These warrants are
exercisable six months after their date of issuance and expire May 27, 2014. We made the offering
and sale of these warrants and the shares underlying the warrants pursuant to a shelf registration
statement.
On July, 16, 2009, the Company sold 1,961,000 shares of its common stock at $1.02 per share
under its shelf registration statement. In addition, the Company issued 585,000 warrants, with an
exercise price of $1.25 per share in association with the issuance of stock. These warrants have a
five year life from the date of issuance and cannot be exercised until six months from the date of
issuance.
Construction and Start-up Period
We commenced plant operations at our Woodbridge facility in June 2008. We are processing
liquid and solid waste and we are producing both liquid and solid fertilizer and soil enhancement
products. Construction has been substantially completed on all aspects of the facility and as of
the filing of this report we are generating both tip fee and product sales revenue and although the
plant is operating at less than full capacity we have substantially completed all plant upgrades
which will allow us to operate at 70% capacity. We had budgeted approximately $14.6 million for the
design, building, and testing of our facility, including related non-recurring engineering costs.
The capital outlay of $14.6 million came from the $25.4 million raised by our initial public
offering of stock and the issuance of New Jersey Economic Development Bonds, both of which closed
on February 16, 2007 and does not include $4.6 million of lease financing provided by the New
Jersey landlord.
The total cost of the plant is expected to exceed the estimate of $14.6 million by
approximately $2.2 million (which does not include $4.6 million of lease financing). Also, we have
purchased additional equipment, which will allow us to produce additional dry product, which is in
high demand by the retail market. The cost of this additional equipment is approximately $1.5
million. We decided to incorporate the HTLC technology acquired from WRI into the Woodbridge
facility. These costs are approximately $2.0 million, bringing the total plant cost to $20.3
million, not including lease financing. Installation of the HTLC technology and additional
equipment was dependent on our ability to raise additional capital and negotiate extended payment
terms with our construction vendors. As of the filing date of this report, we have negotiated
revised payment terms with all but one of our construction vendors. This vendor has placed a lien
on the property in New Jersey, which is further discussed in the liquidity and capital resources
section. The purpose of adding the HTLC technology to the Woodbridge facility is two fold: first,
we believe it will significantly lower operating costs, most notably utility costs as the need to
evaporate significant amounts of liquid byproduct would no longer be necessary, and two, the non
evaporated liquid can be used in the production process and sold as additional product.
During the start up phase at the Woodbridge facility, we experienced emissions violations
related to odor issues. We were fined by the Middlesex County Health department for these
violations and we subsequently hired additional consultants to assist with the correction process.
As of the filing date of this report, we have paid $87,750 in penalties related to odor emissions.
In late July we began implementing operational procedures at the plant which were recommended by
the odor control consultants and since then we have not experienced significant odor issues;
however, we have not obtained release from the Middlesex County Health department concerning this
issue and there is no assurance that we can obtain such a release. The total amount of fines
levied by the Middlesex County Health Department total $320,250 , and we are either contesting or
negotiating the unpaid balance of $232,500, based on the date of violation. The financial
statements at June 30, 2009, include an accrued liability of $75,000 related to the unpaid balance.
25
Full-scale Operations
Full capacity at the Woodbridge facility would provide capacity of approximately 250 tons per
day. As discussed above, we have completed the necessary upgrades to the Woodbridge facility, which
are expected to allow us to increase capacity at the facility to approximately 70% of full
capacity. We have two revenue streams: (i) tip fees that in our potential markets range from $40 to
$80 per ton, and (ii) product sales. Tip fees are paid to us to receive the food waste stream from
the waste hauler; the hauler pays us, instead of a landfill, to take the waste. If the haulers
source separate and pay in advance, they are charged tip fees that are up to 20% below market. As
of the filing of this report we are accepting solid waste for processing, we are recording tip fee
revenue, we are producing both solid and liquid product and we are recording solid and liquid
product sales revenue. During the first half of 2009 we had approximately $75,000 of tip fee
revenue and $277,000 of product sale revenue from the Woodbridge facility.
Operations at the Gonzales facility began in February 2008 with the production of
approximately 25 tons per day of liquid fertilizer. This output is presently being sold into the
California agricultural market. Revenue for the first half of 2009 was approximately $1,079,000
from this facility and we have completed certain upgrades to the plant which allow us to accept
solid food waste for processing. We have not completed the upgrades that allow us to produce a
solid fertilizer product as we have delayed those enhancements due to cash flow restrictions.
Future Development
Subject to the availability of development capital for which we have no current commitments,
we intend to commence development and construction of other facilities. Assuming needed capital is
available, the timing of our next facility is dependent on many factors, including locating
property suited for our use, negotiating favorable terms for lease or purchase, obtaining
regulatory approvals, and procuring raw material at favorable prices.
We anticipate that our next facility will be located in Rhode Island. We have signed a ground
lease with the Rhode Island Resource Recovery Corporation for a proposed facility in Johnston,
Rhode Island. Other locations in Massachusetts, as well as other states, will be considered as
determined by management.
In each contemplated market, we have started development activity to secure a facility
location. We have also held preliminary discussions with state and local regulatory officials and
raw material suppliers. We believe that this preliminary development work will allow us to develop
and operate a third facility in the next 18 months subject to the availability of debt financing
for which we have no current commitments. We believe we will be able to use much of the engineering
and design work done for our Woodbridge facility for subsequent facilities, thus reducing both the
time and costs associated with these activities. We expect to form a separate subsidiary for each
facility to facilitate necessary bond financing and manage risk.
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 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 our
market studies suggest. 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. Furthermore our plan calls for raising additional debt and/or equity
financing to operate our current facilities and to construct additional operating facilities.
Currently there has been a slow down in lending in both the equity and bond markets which may
hinder our ability to raise the required funds.
Liquidity and Capital Resources
At June 30, 2009, we had total current assets of approximately $3.5 million consisting
primarily of cash, accounts receivable, inventories and prepaid assets, and had current liabilities
of approximately $7.3 million, consisting primarily of accounts payable, accrued expenses and notes
payable leaving us with negative working capital of approximately $3.7 million. Non-current assets
totaled $27.4 million and consisted primarily of property and equipment, intangible assets and
construction in process. Non-current liabilities of $18.7 million consist primarily of bonds
payable of $17.5 million and the long-term portion of our term notes payable of $1.2 million at
June 30, 2009. We have an accumulated deficit at June 30, 2009 of approximately $35.7 million.
Owners equity at
June 30, 2009 was approximately $5.0 million. For the first half of 2009, we generated
revenues from operations of approximately $1,484,000.
26
At June 30, 2009, our current liabilities are greater than our current assets by approximately
$3.8 million. We have trade accounts payable of approximately $4.3 million of which approximately
$2.4 million relates to construction at the Woodbridge facility. We have come to agreement with
three of our four construction vendors for extended payment terms with interest. Those vendors
have agreed to release their liens upon receipt of final payment. We continue to negotiate with
the fourth vendor, who has filed a lien against our assets and has commenced a lawsuit for breach
of contract.
Our independent registered public accountants have issued a going-concern opinion on our
financial statements as of December 31, 2008. The Company had incurred a net loss of approximately
$16.2 million during the year ended December 31, 2008, had a working capital deficiency as of
December 31, 2008 and an accumulated deficit of approximately $26.6 million. As of June 30, 2009
the Company continued to have a working capital deficiency and for the six months ended June 30,
2009 the Company had a net loss of $6.9 million and an accumulated deficit of approximately $35.7
million.
Our plan to become cash flow positive and to work through our current working capital deficit
is as follows. We currently have manufacturing capabilities in our Woodbridge and Gonzales
facilities as a means to generate revenues and cash. Our cash requirements on a monthly basis are
approximately $275,000 at the corporate level, $500,000 for Woodbridge and $200,000 for Gonzales.
Currently, only the Gonzales facility is generating enough cash flow to cover its cash
requirements, leaving us with a cash shortfall of approximately $775,000 per month. We estimate,
that at the current production capacity, we could provide enough product to achieve additional
sales of $1,000,000 to $1,500,000 per month, which at those levels, would provide sufficient cash
flow to cover our cash requirements, including additional variable costs associated with increased
production. Until such sales levels are achieved and we are cash flow positive, we will have to
seek additional means of financing in order to cover the shortfall. During the first half of 2009,
we reduced the entire $4.5 million convertible debenture balance from the Companys January 2008
financing by converting the balance into shares of our common stock. In addition, during the first
quarter of 2009, the holders of the NJEDA bonds released $2.0 million of escrowed funds for us to
use and we obtained $1,331,000 of secured debt financing. We raised another $4.2 million in capital
through the issuance of common stock and the exercise of warrants. In addition, we have a shelf
registration statement which would allow us to sell shares into the market to raise additional
financing of up to $2.0 million, provided that pursuant to SEC rules we may not access the $2.0
million available under the shelf registration statement until our stock price is $1.86.We plan to
use the proceeds from the secured debt and the shelf registration statement to fund working capital
requirements and to add additional sales and marketing personnel in order to achieve increased
sales levels during the remainder of 2009. Specifically we are seeking sales personnel to assist
with sales of liquid product into the agricultural market. Also, we continue to expand our sales
efforts into the retail market by increasing the number of sales presentations to the retail
channel for orders to be placed for early 2010 delivery. The initial results of these sales
efforts have indicated that one large current retail customer will double the number of outlets in
which the product is carried.
There can be no assurance that we can raise additional funds from the shelf registration
statement or achieve the desired sales levels, and if neither were achieved, we estimate that we
would have sufficient cash to last through the end of October 2009. In addition, we have an
outstanding amount due to one of our New Jersey construction vendors in the amount of approximately
$2.44 million for which a lawsuit has been filed. The funds from the $1,331,000 secured debt or the
shelf registration statement have not been used towards payment of the construction vendor amounts
and we are currently negotiating with the contractor to issue a note for the outstanding amounts
owed.
During this period of limited cash availability we plan to lower costs in the administrative
areas of the company and to concentrate on production in both Woodbridge and Gonzales. In addition,
we will also have to curtail certain production and sales costs until sales orders begin to
increase to the desired levels, most notably we will have to limit the production of product to two
variations of liquid and dry product and the desired sales level will have to be derived from those
products.
We do not have any commitments for additional equity or debt funding, and there is no
assurance that capital in any form would be available to us, and if available, on terms and
conditions that are acceptable. Moreover, we are not permitted to borrow any future funds unless we
obtain the consent of the bondholders of the New Jersey Economic Development Bond. We have obtained
such consent for prior financing, but there is no guarantee that we can obtain such consent in the
future.
27
Results of Operations
During the six months ended June 30, 2009, we had sales of approximately $1,484,000 compared
to $753,000 for the same period in 2008. During 2009, we had cost of goods sold of approximately
$3,757,000, leaving a negative gross margin of approximately $2,273,000 compared to $625,000 cost
of goods sold and $128,000 gross margin for the same period in 2008. The negative gross margins in
2009 were generated due to high production costs (salaries, rents, depreciation, supplies, etc.) at
both our Woodbridge and Gonzales facilities and low sales and production volume. We expect the
gross margin to improve in the future as we increase production and expand our sales efforts into
the more profitable retail and agricultural markets. Of the $2,273,000 negative gross margin in the
six months ended June 30, 2009, approximately $77,000 was generated at our Gonzales facility due to
sales volumes not yet being high enough to cover all fixed production costs, higher than
anticipated production and transportation costs, and approximately $2,215,000 in negative gross
margin was generated at our Woodbridge facility due to low sales volume and fixed costs associated
with the facility.
During the three months ended June 30, 2009, we had sales of approximately $992,000 compared
to $493,000 for the same period in 2008. During 2009, we had cost of good sold of approximately
$2,113,000, leaving a negative gross margin of approximately $1,120,000 compared to $403,000 cost
of goods sold and $90,000 gross margin for the same period in 2008. Of the $1,120,000 negative
gross margin in the three months ended June 30, 2009, approximately $68,000 positive gross margin
was generated at our Gonzales facility, and the Woodbridge facility generated $1,180,000 of
negative gross margin.
We incurred general and administrative expenses of approximately $4,175,000 and $5,346,000 for
the six month periods ended June 30, 2009 and 2008, respectively. The principal components of the
approximately $1,171,000 decrease in general and administrative expenses is due to allocation of
rent, production salaries and utilities to cost of sales in 2009, along with a decrease in
compensation expense associated with the issuance of stock options of $2,140,000. This was offset
by an increase in professional fees associated with financing activities and general costs of
growing the business.
We incurred general and administrative expenses of approximately $2.503,000 and $3,759,000 for
the three month periods ended June 30, 2009 and 2008, respectively. The principal components of
the approximately $1,256,000 decrease in general and administrative expenses are similar in nature
to the decrease in the six month activity described above.
We incurred depreciation expense of approximately $626,000 and $7,000 for the six months ended
June 30, 2009 and 2008, respectively, and $306,000 and $3,000 for the three months ended June 30,
2009 and 2008, respectively. The increase in depreciation expense is due to assets placed in
service and depreciated, particularly at the Woodbridge facility.
We recognized derivative accounting gains of $3,565,000 and $0 in the six month periods ending
June 30, 2009 and 2008, respectively, and derivative gains of $2,153,000 and $0 in the three months
ending June 30, 2009 and 2008, respectively. These gains are non-cash in nature, and are recorded
due to our adoption of EITF 07-5 on January 1, 2009, and are more fully described in Item 1.
Financial Statements of this quarterly report on Form 10Q.
Interest expense for the six months ended June 30, 2009 and 2008 was $3,110,000 and
$3,127,000, respectively. The components of interest expense for the period ended June 30, 2009
are: (i) recognition of $562,000 of interest expense associated with the extension of the
convertible debentures issued in January 2008, which became due in January 2009 and which were
extended until July 2009 (200,000 shares of common stock were issued in connection with such
extension), (ii) recognition of approximately $660,000 of interest expense associated with the
issuance of warrants in connection with the March 6, 2009 financing arrangement with the holders of
our bonds, and approximately $920,000 of interest expense associated with the issuances of warrants
related to the short-term non-convertible notes, and (iii)
recognition of $700,000 in interest expense on our NJ EDA bonds,
and approximately $268,000 on our other various borrowings during the six months ending June 30,
2009.
Interest expense for the six months ended June 30, 2008 comprised (i) $176,000 of interest
expense on various short-term notes; recognition of approximately $2,093,000 in connection with
borrowing transactions, primarily non-cash items; $700,000 on our NJ EDA bonds; and approximately
$158,000 in penalties associated with convertible debt.
As a result of the variances described above, for the six months ended June 30, 2009, net loss
was $6.9 million compared to $8.5 million for the same period in 2008. For the three months ended
June 30, 2009, the net loss was $3.0 million versus $6.1 million for the same period in 2008.
As of June 30, 2009, we had current assets of approximately $3.5 million compared to $7.2
million as of December 31, 2008. Our total assets were approximately $30.9 million as of June 30,
2009 compared to approximately $32.6 million as of December 31, 2008.
28
The majority of the decrease in current assets from December 31, 2008 to June 30, 2009 is due
to the use of cash for working capital requirements.
As of June 30, 2009, we had current liabilities of approximately $7.3 million compared to $9.5
million at December 31, 2008. This decrease is due largely to the conversion of debt into shares of
our commons stock, and the negotiation of term notes with our construction vendors which moved some
of that liability from current to non-current. In addition, we had long-term liabilities of
approximately $18.8 million as of June 30, 2009 as compared to $18.1 million at December 31, 2008.
The increase is due to the reclassification of amounts owed to construction vendors to long-term
liabilities.
For the six months ended June 30, 2009 we had negative cash flow from operating activity of
approximately $4.1 million, comprising primarily loss from operations offset by certain non-cash
items such as depreciation, non-cash interest expense associated with the issuance of warrants,
amortization of deferred financing fees and amortization of discounts on private financing, and an
increase in accounts payable and accrued expenses. We also had negative cash flow from investing
activities of $985,000, primarily related to construction at the 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 $3.6 million in positive cash flow from
financing activities comprising proceeds from our various equity transactions.
Off-Balance Sheet Transactions
We do not engage in material off-balance sheet transactions.
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Item 3. |
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Quantitative and Qualitative Disclosures about Market Risk |
Not applicable.
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Item 4. |
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Controls and Procedures |
Under the supervision, and with the participation of our management, including the Principal
Executive Officer and Principal Financial Officer, we have evaluated the effectiveness of our
disclosure controls and procedures pursuant to Exchange Act Rules 13a-15 and 15d-15 as of the end
of the period covered by this report. Based on that evaluation, the Principal Executive Officer and
Principal Financial Officer have concluded that these disclosure controls and procedures were
effective such that the material information required to be filed in our SEC reports is recorded,
processed, summarized and reported within the required time periods specified in the SEC rules and
forms. This conclusion was based on the fact that the business operations to date have been limited
and the Principal Executive Officer and Principal Financial Officer have had complete access to all
records and financial information.
There were no changes in our internal control over financial reporting during the three months
ended June 30, 2009 that have materially affected, or are reasonably likely to materially affect,
our internal control over financial reporting. Potential investors should be aware that the design
of any system of controls and procedures is based in part upon certain assumptions about the
likelihood of future events. There can be no assurance that any system of controls and procedures
will succeed in achieving its stated goals under all potential future conditions, regardless of how
remote.
29
PART II OTHER INFORMATION
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Item 1. |
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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 dated April 11, 2006 (FTA), captioned Gerald S. Leeseberg, et al. v. Converted
Organics, Inc., filed in the U.S. District Court for the District of Delaware. The lawsuit alleges
breach of contract, conversion, unjust enrichment, and breach of the implied covenant of good faith
in connection with the alleged failure to register certain securities issued in the FTA, and the
redemption of our Class A warrants in November 2008. The lawsuit seeks damages related to the
failure to register certain securities, including alleged late fee payments, of approximately $5.25
million, and unspecified damages related to the redemption of the Class A warrants. In February
2009, we filed a Motion for Partial Dismissal of Complaint. It is uncertain when the Court will
rule on this motion. We plan to vigorously defend this matter and are unable to estimate any
contingent losses that may or may not be incurred as a result of this litigation and its eventual
disposition. Accordingly, no contingent loss has been recorded related to this matter.
On May 19, 2009, we received notice that a complaint had been filed in the Middlesex County
Superior Court of New Jersey, captioned Lefcourt Associates, Ltd., et al. v. Converted Organics of
Woodbridge, et al. The lawsuit alleges private and public nuisances, negligence, continuing
trespasses and consumer common-law fraud in connection with the odors emanating from the Woodbridge
facility and our alleged, intentional failure to disclose to adjacent property owners the
possibility of our facility causing pollution. The lawsuit seeks enjoinment of any and all
operations which in any way cause or contribute to the alleged pollution, compensatory and punitive
damages, counsel fees and costs of suit and any and all other relief the Court deems equitable and
just. In response to these allegations, we have filed opposition papers with the Court and have
complied with the plaintiffs requests for information. We have also paid to the Middlesex County
Health Department penalties in the amount of $87,750 . We plan to vigorously defend this matter
and are unable to estimate any contingent losses that may or may not be incurred as a result of
this litigation and its eventual disposition. Accordingly, no contingent loss has been recorded
related to this matter.
On May 28, 2009, we received notice that a Lien Claim Foreclosure Complaint had been filed in
the Middlesex County Superior Court of New Jersey, captioned Armistead Mechanical, Inc. v.
Converted Organics Inc., et al. Armistead filed this Lien Claim Foreclosure Complaint in order to
perfect its previously filed lien claim. In connection with the Complaint, Armistead also filed a
Demand for Arbitration in order to preserve its status quo and right to submit a contract dispute
claim to binding arbitration. Armistead has indicated to us that it wishes to continue settlement
discussions and has offered to cooperate with our efforts to secure financing for a mutually
agreeable settlement. We intend to continue working towards an agreeable settlement with Armistead.
On July 10, 2009, we received an Amended Lien Claim Foreclosure Complaint from Armistead
Mechanical. The amended complaint did not make any substantial changes to the suit. On August 3,
2009, we filed a response to the complaint whereby we denied certain claims and at this time we are
unable to estimate any contingent losses.
See
Footnote 12 for further information.
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Item 2. |
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Unregistered Sales of Equity Securities and Use of Proceeds |
During the three months ending June 30, 2009, we issued an aggregate of 1,300,000 warrants
(885,000 warrants valued at $1.00 and 415,000 Warrants valued at $1.50, respectively) to Iroquois
Master Fund, Ltd. and Chardan Capital Markets, LLC in connection with the May 7, 2009 financing.
During the three months ending June 30, 2009, we issued approximately 102,000 shares to the holder
of a convertible note, representing approximately $138,000 in principal and interest due on the
note. These transactions were exempt from the registration requirement of the Securities Act of
1933, as amended (the 1933 Act), pursuant to Section 4(2) and Regulation D under the 1933 Act, as
the recipients are accredited investors as defined in the 1933 Act.
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Item 3. |
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Defaults upon Senior Securities |
None.
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Item 4. |
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Submission of Matters to a Vote of Security Holders |
On June 25, 2009, we held the Annual meeting of Stockholders. The following matters were
voted upon:
Proposal 1. To elect Edward J. Gildea to the Board of Directors to serve until his terms
expire in 2012 and until his successor is duly elected and qualified.
30
Proposal 2. To ratify the appointment of CCR LLP as the Companys independent auditor for the
fiscal year ending December 31, 2009;
Proposal 3. To approve an amendment to the Companys Certificate of Incorporation, which would
increase the number of authorized shares of common stock from 40,000,000 to 75,000,000
The results of the vote were as follows:
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For |
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Withheld |
Proposal 1 |
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11,041,940 |
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1,161,757 |
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For |
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Against |
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Abstain |
Proposal 2 |
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11,943,178 |
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154,664 |
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105,855 |
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Proposal 3 |
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10,441,940 |
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1,471,360 |
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290,397 |
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Item 5. |
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Other Information. |
None.
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Exhibit No. |
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Description of Exhibit |
10.14
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Secured Convertible Promissory Note in favor of SNC-Lavalin Project Services, Inc., dated June 16, 2009
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10.15
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Secured Convertible Promissory Note in favor of Hatzel & Buehler, Inc. |
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10.16
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Secured Convertible Promissory Note in favor of Recycling Technology Development, LLC dated March 31, 2009 |
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31.1
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Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes Oxley Act of 2002 |
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31.2
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Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
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32.1
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Certification of Chief Executive Officer pursuant to Section 906 |
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32.2
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Certification of Chief Financial Officer pursuant to Section 906 |
31
SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant caused this report to be
signed on its behalf by the undersigned, thereunto duly authorized.
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Converted Organics Inc.
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Date: August 14, 2009 |
/s/ Edward J. Gildea
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Edward J. Gildea |
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President and Chief Executive Officer |
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Date: August 14, 2009 |
/s/ David R. Allen
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David R. Allen |
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Chief Financial Officer and Executive Vice President of
Administration |
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Date: August 14, 2009 |
/s/ Ellen P. ONeil
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Ellen P. ONeil |
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Vice President of Finance & Accounting |
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32