e10vk
UNITED STATES SECURITIES AND
EXCHANGE COMMISSION
Washington, D.C.
20549
Form 10-K
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(Mark One)
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þ
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ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
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For the fiscal year ended
December 31, 2008
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OR
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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
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Commission File Number:
001-33304
Converted Organics
Inc.
(Exact Name of registrant as
specified in its charter)
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Delaware
(State or other jurisdiction
of
incorporation or organization)
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20-4075963
(I.R.S. Employer
Identification No.)
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7A Commercial Wharf West, Boston, MA 02110
(Address of Principal Executive
Offices and Zip Code)
(617) 624-0111
(Registrants telephone
number, including area code)
Securities
Registered Pursuant to Section 12(b) of the Act:
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Title of Each Class
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Name of Each Exchange on Which Registered
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Converted Organics Inc.
Common Stock $0.0001 Par Value
Class B Warrants to purchase one share of Common Stock
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NASDAQ Capital Market
and the Boston Stock Exchange
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Securities
Registered Pursuant to Section 12(g) of the Act:
None
Indicate by checkmark if the registrant is a well-known seasoned
issuer, as defined in Rule 405 of the Securities
Act. Yes o No þ
Indicate by checkmark if the registrant is not required to file
reports pursuant to Section 13 or 15(d) of the
Act. Yes o No þ
Indicate by checkmark whether the registrant (1) has filed
all reports required to be filed by Section 13 of 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 checkmark if disclosure of delinquent filers
pursuant to Item 405 of
Regulation S-K
(§ 229.405 of this chapter) is not contained herein,
and will not be contained, to the best of registrants
knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this
Form 10-K
or any amendment to this
Form 10-K. 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
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Accelerated
filer o
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Non-accelerated
filer o
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Smaller
reporting
company þ
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(Do not check if a smaller reporting company)
Indicate by check mark whether the registrant is a shell company
(as defined in
Rule 12b-2
of the Exchange
Act). Yes o No þ
The aggregate market value of the voting and non-voting common
equity held by non-affiliates computed by reference to the price
at which the common equity was last sold, or the average bid and
asked price of such common equity, as of the last business day
of the registrants most recently completed second fiscal
quarter was $14,775,861.
Documents Incorporated by Reference:
Portions of the registrants definitive proxy statement to
be filed subsequent to the date hereof in connection with the
registrants 2009 annual meeting are incorporated by
reference into Part III of this Report.
Table of
Contents
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1
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BUSINESS
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2
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RISK FACTORS
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14
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UNRESOLVED STAFF COMMENTS
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21
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PROPERTIES
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LEGAL PROCEEDINGS
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22
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SUBMISSION OF MATTERS TO A VOTE OF SECURITY
HOLDERS
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22
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PART II
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23
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MARKET FOR REGISTRANTS COMMON EQUITY,
RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY
SECURITIES
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23
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SELECTED FINANCIAL DATA
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24
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MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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24
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QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
MARKET RISK
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34
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FINANCIAL STATEMENTS AND SUPPLEMENTAL
DATA
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37
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CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
ON ACCOUNTING AND FINANCIAL DISCLOSURE
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67
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CONTROLS AND PROCEDURES
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67
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OTHER INFORMATION
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68
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PART III
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68
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DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE
GOVERNANCE
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68
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EXECUTIVE COMPENSATION
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68
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SECURITY OWNERSHIP OF CERTAIN BENEFICIAL
OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
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68
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CERTAIN RELATIONSHIPS AND RELATED
TRANSACTIONS, AND DIRECTOR INDEPENDENCE
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69
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PRINCIPAL ACCOUNTANT FEES AND SERVICES
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69
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PART IV
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70
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EXHIBITS AND FINANCIAL STATEMENT
SCHEDULES
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70
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SIGNATURES
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72
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EX-4.13 EX-4.13 Form of First Amendment to the Secured Convertible Debenture dated January 24, 2008 |
EX-4.14 Debenture dated January 24, 2008 |
EX-4.15 Form of Second Amendment to the Secured Convertible Debenture dated January 24, 2008 |
EX-10.13 New Jersey Economic Development Authority $17,500,000 Solid Waste Facilities Revenue Bonds |
EX-23.1 Consent of CCR LLP |
EX-31.1 Certification of Chief Executive Officer pursuant to Rule 13a-14(a)/15d-14(a) |
EX-31.2 Certification of Chief Financial Officer pursuant to Rule 13a-14(a)/15d-14(a) |
EX-32.1 Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 |
EX-32.2 Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 |
i
PART I
Forward-Looking
Statements
We make forward-looking statements in this report that are
subject to risks and uncertainties. These forward-looking
statements include information about possible or assumed future
results of our business, financial condition, liquidity, results
of operations, plans and objectives. In some cases, you may
identify forward-looking statements by words such as
may, should, plan,
intend, potential, continue,
believe, expect, predict,
anticipate and estimate, the negative of
these words or other comparable words. These statements are only
predictions. You should not place undue reliance on these
forward-looking statements. The forward-looking statements are
qualified by their terms
and/or
important factors, many of which are outside our control and
involve a number of risks, uncertainties and other factors that
could cause actual results and events to differ materially from
the statements made. Such factors include, among other things,
those described elsewhere in this report and the following:
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Development of our business is dependent on our ability to
obtain additional debt and equity financing which may not be
available on acceptable terms.
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We have received a going concern opinion from our auditors. Our
ability to raise additional funds or enter in contracts with
normal credit terms may be hindered while we are operating under
this opinion.
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If we are unable to manage our transition to an operating
company effectively, our operating results will be adversely
affected.
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Our plan to develop relationships with strategic partners and
vendors may not be successful.
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Our future success is dependent on our existing key employees,
and hiring and assimilating new key employees, and our inability
to attract or retain key personnel in the future would
materially harm our business and results of operations.
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We license technology from a third party, and our failure to
perform under the terms of the license could result in material
adverse consequences.
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Our Woodbridge and Gonzales sites may have unknown environmental
problems that could be expensive and time consuming to correct.
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We may not be able to manufacture our products in commercial
quantities or sell them at competitive prices in the markets in
which we wish to sell the products.
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We may be unable to establish marketing and sales capabilities
necessary to commercialize and gain market acceptance for our
products.
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Pressure by our customers to reduce prices and agree to
long-term supply arrangements may adversely affect our net sales
and profit margins.
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Defects in our products or failures in quality control could
impair our ability to sell our products or could result in
product liability claims, litigation and other significant
events with substantial additional costs.
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Energy and fuel cost variations could adversely affect operating
results and expenses.
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We may not be able to obtain sufficient organic material.
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Our agreements with our bond investors may hinder our ability to
operate our business by imposing restrictive loan covenants,
which may prohibit us from paying dividends or taking other
actions to manage or expand our business.
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The mandatory redemption of our bonds as a result of breaches of
the terms of such funds due to our current financial condition
could have a material adverse effect on our liquidity and cash
reserves.
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The communities where our facilities may be located may be
averse to hosting waste handling and manufacturing facilities.
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Our facilities will require certain permits to operate, which we
may not be able to obtain or obtain on a timely basis.
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If we are unable to come to agreements with our construction
vendors, the vendors may attempt to take actions against us or
the Woodbridge facility, which could result in interruptions to
the operations of the Woodbridge facility.
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Changes in environmental regulations or violations of such
regulations could result in increased expense and could have a
material negative effect on our financial performance.
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Our strategic plan for the development and construction of
operating facilities in Rhode Island and Massachusetts requires
additional debt
and/or
equity financing and working capital during the construction
period.
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The forward-looking statements are based on our beliefs,
assumptions and expectations of our future performance, taking
into account information currently available to us. These
beliefs, assumptions and expectations can change as a result of
many possible events or factors, including those events and
factors detailed in our filings with the Securities and Exchange
Commission, not all of which are known to us. Neither we nor any
other person assumes responsibility for the accuracy or
completeness of these statements. We will update this report
only to the extent required under applicable securities laws. If
a change occurs, our business, financial condition, liquidity
and results of operations may vary materially from those
expressed in our forward-looking statements.
For further information about these risks, uncertainties and
factors, please review the disclosure included in this report
under the caption Business Risk Factors.
Overview
During 2008, Converted Organics Inc. transitioned from a
development stage company (first reported revenues were in
February 2008) to a fully operational company that operates
processing facilities that use food waste as raw material to
manufacture all-natural soil amendment products combining
nutritional and disease suppression characteristics. In addition
to our sales in the agribusiness market, we sell and distribute
our products in the turf management and retail markets. We
currently operate two facilities:
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Woodbridge facility. A facility in Woodbridge,
New Jersey that we have equipped as our first internally
constructed organic waste conversion facility (the
Woodbridge facility). Operations at the Woodbridge
facility began in late June of 2008 and we are processing solid
waste and are producing both liquid and dry fertilizer and soil
enhancement products.
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Gonzales facility. A facility in Gonzales,
California that we acquired in January 2008, which is
operational and began to generate revenue for us in February
2008 (the Gonzales facility).
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We were incorporated under the laws of the state of Delaware in
January 2006. In February 2006, we merged with our predecessor
organizations, Mining Organics Management, LLC (MOM)
and Mining Organics Harlem River Rail Yard, LLC
(HRRY), in transactions accounted for as a
recapitalization. These predecessor organizations provided
initial technical and organizational research that led to the
foundation of the current business plan.
On February 16, 2007, we successfully completed an initial
public offering of stock and successfully completed a bond
offering with the New Jersey Economic Development Authority. The
net proceeds of the stock offering of $8.9 million,
together with the net proceeds of the bond offering of
$16.5 million, were used to develop and construct the
Woodbridge facility, fund our marketing and administrative
expenses during the construction period and fund specific
principal and interest reserves as specified in the bond
offering. Of the total net proceeds of the stock and bond
offerings of $25.4 million, $14.6 million was used
towards the construction of the Woodbridge facility and the
remaining $10.8 million was used for items detailed above.
On January 24, 2008, we acquired the assets, including the
intellectual property, of Waste Recovery Industries, LLC
(WRI). This acquisition makes us the exclusive owner
of the proprietary technology and process known as
2
the High Temperature Liquid Composting (HTLC)
system, which processes various biodegradable waste products
into liquid and solid organic-based fertilizer and feed products.
Also on January 24, 2008, we acquired the net assets of
United Organic Products, LLC (UOP), which was under
common ownership with WRI. With this acquisition, we acquired a
leading liquid fertilizer product line, as well as the Gonzales
facility, which is a production facility that services a West
Coast agribusiness customer base through established
distribution channels.
Our
Revenue Sources
Our revenue comes from two sources: tip fees and
product sales. Waste haulers pay the tip fees to us for
accepting food waste generated by food distributors such as
grocery stores, produce docks, fish markets and food processors,
and by hospitality venues such as hotels, restaurants,
convention centers and airports. Revenue also comes from the
customers who purchase our products. Our products possess a
combination of nutritional, disease suppression and soil
amendment characteristics. The products are sold in both dry and
liquid form and will be stable with an extended shelf life
compared to other organic fertilizers. Among other uses, the
liquid product is expected to be used to mitigate powdery
mildew, a leaf fungus that restricts the flow of water and
nutrients to the plant. These products can be used either on a
stand-alone basis or in combination with more traditional
petrochemical-based fertilizers and crop protection products.
Based on growth trial performance, increased environmental
awareness, trends in consumer food preferences and
company-sponsored research, we believe our products will have
demand in the agribusiness, turf management and retail markets.
We also expect to benefit from increased regulatory focus on
organic waste processing and on environmentally friendly growing
practices.
Our
Woodbridge Facility
We obtained a
10-year
lease and exercised an additional
10-year
option to renew for approximately 60,000 square feet at a
site in a portion of an industrial building in Woodbridge, New
Jersey that was modified and equipped as our first internally
constructed organic waste conversion facility. Operations began
in late June of 2008 at the Woodbridge facility and we are
processing solid waste and are producing both liquid and dry
fertilizer and soil enhancement products. Construction is still
in process on certain aspects of the facility, mainly relating
to installation of automated control systems and we are not
currently producing to full capacity. 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 product
annually. We are in the process of completing additional
upgrades to the Woodbridge facility, which are expected to be
completed by June 2009, and which we believe will allow us to
increase capacity at the facility to approximately 70% of full
capacity. 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 the
70% capacity ranges from approximately $700,000 to $1,100,000.
Converted Organics of Woodbridge, LLC, a New Jersey limited
liability company and our wholly owned subsidiary, was formed
for the purpose of owning, constructing and operating the
Woodbridge facility.
During the first ten weeks of 2009, we generated revenue from
the Woodbridge facility in the form of tip fees of approximately
$50,000 and product sales of approximately $126,000. 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. Any
cash flow generated by exceeding these sales would be used to
fund operations at the corporate level and to pay down the
payables related to construction activity at this facility.
As of December 31, 2008, we have incurred approximately
$4.2 million in additional unanticipated construction costs
and design changes for the Woodbridge facility. In addition, we
committed an additional $1.5 million for the upgrades to
the Woodbridge facility discussed above. We currently estimate
that we will be able to fund approximately $500,000 of the
foregoing upgrade costs. To finance the additional
$5.2 million in upgrades, design changes and construction
costs, we will need to enter into agreements with the various
construction vendors as we do not currently have the funds
available to pay these amounts, which are listed as accounts
payable in our December 31, 2008 balance sheet. If we are
unable to come to agreements with our construction vendors, the
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vendors may attempt to take actions against us or the Woodbridge
facility, which could result in interruptions to the operations
of the Woodbridge facility.
Our Woodbridge facility receives raw material from the New
York-Northern New Jersey metropolitan area. It is located near
the confluence of two major highways in northern New Jersey,
providing efficient access for the delivery of feedstock from
throughout this geographic area. This facility has been approved
for inclusion in the Middlesex County and New Jersey State Solid
Waste Management Plans.
We have agreements with eleven waste-hauling companies to
provide food waste to the Woodbridge facility, which we feel
will give us an adequate supply to operate the plant at full
capacity.
Our conversion process has been approved for inclusion in the
Middlesex County and New Jersey State Solid Waste Management
Plan. We have been granted our Class C recycling permit,
which is the primary environmental permit for this project. The
remaining required permits are primarily those associated with
the construction and operation of any manufacturing business.
The Woodbridge facility uses significant amounts of electricity,
natural gas and steam. We use the services of an energy
management firm to purchase natural gas and electricity, and
water will be provided by the Town of Woodbridge. Wastewater
will be discharged by permit into the local sewage system.
Our
Gonzales Facility
On January 24, 2008, we acquired the Gonzales facility and
formed Converted Organics of California, LLC a California
limited liability company and wholly-owned subsidiary of the
Company, for the purpose of owning, upgrading and operating the
Gonzales facility. We generated revenue during 2008 of
approximately $1,525,000, with a negative operating margin. We
plan to improve this operating margin by channeling sales into
the profitable turf and retail markets, 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. We estimate that the sales level required to
obtain break even cash flow at the Gonzales facility is in the
range of $150,000 to $200,000 per month for 2009. We further
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 break even level, we expect the
additional cash flow from the Gonzales facility will be used to
offset operating expenses at the corporate level.
On January 24, 2008, we entered into a
10-year
lease for land in Gonzales, California, where our Gonzales
facility is located. The land is leased from Valley Land
Holdings, LLC (VLH), a California LLC whose sole
member is a former officer and director of our Company. The
lease provides for a monthly rent of $9,000. The lease is also
renewable for three
5-year terms
after the expiration of the initial
10-year
term. In addition, we own the Gonzales facility and the
operating equipment used in the facility. VLH had been
determined to be a variable interest entity of UOP in prior
years as UOP was the primary beneficiary of that variable
interest entity. We determined that VLH is a variable interest
entity of the Company subsequent to the acquisition. VLHs
assets and liabilities consist primarily of land and a mortgage
note payable on the land. Its operations consist of rental
income on the land from us and related operating expenses. As
such, VLH has been consolidated with our consolidated financial
statements. All intercompany balances and activity have been
eliminated.
We are currently seeking building permits on our Gonzales
facility. If these permits are not obtained it will not affect
our ability to produce product and achieve the above sales.
Pro Forma
Financial Information
Introduction
The following unaudited pro forma consolidated financial
information gives effect to our acquisition of the assets of UOP
and WRI and should be read in conjunction with the historical
consolidated financial statements of
4
Converted Organics Inc., and the audited financial statements of
United Organic Products, LLC, Waste Recovery Industries, LLC and
Valley Land Holdings, LLC for the years ended December 31,
2007 and 2006. These financial statements can be found in our
Form 10-KSB/A
for year ended December 31, 2007. The unaudited pro forma
consolidated statement of operations for the year ended
December 31, 2008 gives effect to the acquisitions and the
related financing as if they had occurred on January 1,
2008.
The unaudited pro forma consolidated financial statement
includes all material pro forma adjustments necessary for their
preparation, as required by Article 11 of
Regulation S-X
and, accordingly, do not assume any benefits from cost savings
or synergies of operations of the combined Company.
The pro forma adjustments are based upon available information
and certain assumptions that we believe are reasonable. The
unaudited pro forma consolidated financial statement does not
purport to represent what our results of operations would
actually have been had these transactions in fact occurred as of
the date indicated above or to project our results of operations
for the period indicated or for any other period.
5
CONVERTED
ORGANICS INC.
UNAUDITED
PRO FORMA CONSOLIDATED STATEMENT OF OPERATIONS
for the
Year Ended December 31, 2008
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Historical
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Converted
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Organics
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Inc. and
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Pro forma
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Pro forma
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subsidiaries
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Adjustments
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Reference
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Consolidated
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Revenues
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$
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1,547,981
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$
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(1
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$
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1,547,981
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Cost of good sold
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1,981,084
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20,288
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(1
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)
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2,001,372
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Gross loss
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(433,103
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(20,288
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(453,391
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Costs and expenses
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9,948,630
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33,091
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(1
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9,981,721
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Loss from operations
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(10,381,733
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)
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(53,379
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(10,435,112
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)
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Other income/(expenses)
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(5,797,365
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)
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(37,000
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(2
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)
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(5,834,365
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Loss before provision for income taxes
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(16,179,098
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)
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(90,379
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(16,269,477
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)
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Provision for income taxes
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Net loss
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$
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(16,179,098
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$
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(90,379
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)
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$
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(16,269,477
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)
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Net loss per share, basic and diluted
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$
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(2.70
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)
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$
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(2.72
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)
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Weighted average common shares outstanding
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5,985,017
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|
|
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5,985,017
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See accompanying notes.
CONVERTED
ORGANICS INC.
NOTES TO
UNAUDITED PRO FORMA CONSOLIDATED FINANCIAL STATEMENT
The following numbered notes are referenced on the Unaudited
Pro Forma Consolidated Statement of Operations.
(1) Represents costs incurred by UOP and WRI during the
period January 1, 2008 through the date of acquisition. No
revenues were generated, and approximately $53,000 of costs and
expenses were incurred.
(2) Represents interest expense associated with the
convertible debt issued through the private financing, the
convertible note to the former owner of UOP and the short-term
note to the former owner of WRI, for the
24-day
period prior to the acquisition.
6
Future
Expansion of Business
In addition to our Gonzales and Woodbridge facilities, our
strategic plan calls for the development and construction of
facilities in Rhode Island and Massachusetts. We currently are
planning to operate these new facilities using the technology
that we acquired in our acquisition of WRI. We anticipate that
we will be able to use much of the engineering and design work
used in our Gonzales facility. Any plans to further expand our
Gonzales facility, or to construct any future facilities is
dependent on our ability to raise additional financing.
In each of our contemplated locations, we have:
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Engaged a local businessperson well acquainted with the
community to assist us in the permitting process and development
of support from community groups;
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Participated in numerous meetings with state, county and local
regulatory bodies as well as environmental and economic
development authorities; and
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Identified potential facility sites.
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If we are able to build new facilities, we anticipate we will
achieve economies of scale in marketing and selling our
fertilizer products as the cost of these activities is spread
over a larger volume of product. If our overall volume of
production increases, we also believe we may be able to more
effectively approach larger agribusiness customers who may
require larger quantities of fertilizer to efficiently utilize
their distribution systems.
To date, we have undertaken the following activities in the
following markets to prepare to develop additional facilities:
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The Rhode Island Industrial Facilities Corporation gave initial
approval to our Revenue Bond Financing Application for up to
$15 million for the construction of our proposed Rhode
Island facility. In addition, the Rhode Island Resource Recovery
Corporation gave us final approval to lease nine acres of land
in the newly created Lakeside Commerce Industrial Park in
Johnston, 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. We have
established a Converted Organics of Rhode Island, LLC of which
we are 92.5% owners. The minority share is owned by a local
business man who has assisted us with the process of developing
a Rhode Island facility.
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In Massachusetts, we have performed initial development work in
connection with construction of three manufacturing facilities
to serve the eastern Massachusetts market. Our proposals to
develop these facilies is currently under review by the property
owners. The Massachusetts Strategic Envirotechnology Partnership
Program has completed a favorable review of our technology.
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Conversion
Process
The process used in the Woodbridge facility to convert food
waste into our solid and liquid fertilizer products is based on
technology called Enhanced Autothermal Thermophilic
Aerobic Digestion (EATAD). The EATAD process
was developed by International Bio-Recovery Corporation
(IBRC), a British Columbia company that possesses
technology in the form of know-how integral to the process and
that has licensed to us their technology for organic waste
applications in the metropolitan New York and Northern New
Jersey area. In simplified terms, EATAD means that once the
prepared foodstock is heated to a certain temperature, it
self-generates additional heat (autothermal), rising to very
high, pathogen-destroying temperature levels (thermophilic).
Bacteria added to the feedstock use vast amounts of oxygen
(aerobic) to convert the food waste (digestion) to a rich blend
of nutrients and single cell proteins. Foodstock preparation,
digestion temperature, rate of oxygen addition, acidity and
inoculation of the microbial regime are carefully controlled to
produce products that are highly consistent from batch to batch.
The products we manufacture using our process are:
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A stand-alone fertilizer with plant nutrition, disease
suppression and soil enhancements (amendment) benefits. The
solid and liquid forms have a nutrient composition of
approximately 3% nitrogen, 2% phosphorous and 1% potassium
(3-2-1 NPK); or
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7
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A blend to be added to conventional fertilizers and various soil
enhancements to improve the soil as required by the end users.
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The efficacy of our products has been demonstrated both in
university laboratories and multi-year growth trials funded by
us and by IBRC. These field trials have been conducted on more
than a dozen crops including potatoes, tomatoes, squash,
blueberries, grapes, cotton and turf grass. The results of these
trials are available to shareholders at no charge by contacting
us at 7A Commercial Wharf West, Boston, Massachusetts 02110.
While these studies have not been published, peer-reviewed or
otherwise subject to third-party scrutiny, we believe the trials
and other data show our solid and liquid products produced using
the EATAD process have several valuable attributes:
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Plant nutrition. Historically, growers have
focused on the nitrogen (N), phosphorous (P) and potassium
(K) content of fertilizers. As agronomists have gained a
better understanding of the importance of soil culture, they
have turned their attention to humic and fulvic acids,
phytohormones and other micronutrients and growth regulators not
present in petrochemical-based fertilizers. Our products have
NPK content of approximately 3-2-1 and will be rich in
micronutrients. Both products can be modified or fortified to
meet specific user requirements.
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Disease suppression. Based on field trials
using product produced by the licensed technology, we believe
our products combine nutrition with disease suppression
characteristics to eliminate or significantly reduce the need
for fungicides and other crop protection products. The
products disease suppression properties have been observed
under controlled laboratory conditions and in documented field
trials. We also have other field reports that have shown the
liquid concentrate to be effective in reducing the severity of
powdery mildew on grapes, reducing verticillium pressure on
tomatoes and reducing scab in potatoes.
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Soil amendment. As a result of its
slow-release nature, our dry fertilizer product increases the
organic content of soil, improving granularity and water
retention and thus reducing NPK leaching and run-off.
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Pathogen-free. Due to high processing
temperatures, our products are virtually pathogen-free and have
extended shelf life.
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We plan to apply to the U.S. Department of Agriculture (the
USDA) and various state agencies to have our
products produced by the EATAD process to be labeled as an
organic fertilizer or separately as an organic fungicide. We
expect organic labeling, if obtained, to have a significant
positive impact on pricing. We believe our products are
positioned for the commercial market as a fertilizer supplement
or as a material to be blended into traditional nutrition and
disease suppression applications.
We use the HTLC system at our Gonzales facility to process
various biodegradable waste products into liquid organic-based
fertilizer and feed products. The HTLC technology used in our
Gonzales facility can be used in all of our future operating
plants. We have adopted the HTLC technology for certain aspects
at the Woodbridge facility even though that facility and any
future facility in the New York City metropolitan area is
licensed to use the EATAD technology, and as such we will be
required to pay royalties on those facilities to the owners of
the EATAD technologies. As exclusive owner of the HTLC
technology, we expect to achieve the same or better operating
results as we would with the licensed EATAD technology at a
lower operating cost. Pursuant to the terms of the acquisition
of the assets of WRI, we pay a fee for each ton of additional
capacity added to our current or planned expansion. We
anticipate that over time this fee will be less than the royalty
expense paid for use of the licensed EATAD technology. In
addition, we believe the product produced by the HTCL technology
will be equal to or better in terms of quality when compared to
the EATAD technology.
IBRC
License
Pursuant to a know-how license agreement dated July 15,
2003, as amended, IBRC granted us an exclusive license for a
term of 40 years to use its proprietary EATAD technology
for the design, construction and operation of facilities within
a 31.25 mile radius from City Hall in New York City for the
conversion of organic waste into solid and liquid organic
material. The license permits us to use the technology at our
Woodbridge facility site; restricts the ability of IBRC and an
affiliated company, Shearator Corporation, to grant another
know-how or patent license related to the EATAD technology
within the exclusive area; and restricts our ability to
advertise or contract for a
8
supply of organic waste originating outside the same exclusive
area. The licensed know-how relates to machinery and apparatus
used in the EATAD process.
We are obligated to pay IBRC an aggregate royalty equal to 9% of
the gross revenues from the sale of product produced by the
Woodbridge facility. We currently estimate to begin paying
royalties in the first quarter of 2009, as product shipments
from Woodbridge commenced at that time. We are also obligated to
purchase IBRCs patented macerators and shearators, as
specified by or supplied by IBRC or Shearator Corporation for
use at the Woodbridge facility.
In addition, we paid a non-refundable deposit of $139,978 to
IBRC in 2007 on a second plant licensing agreement, which is
included in non-current deposits on our consolidated balance
sheets at December 31, 2008 and 2007. We also agreed to pay
IBRC approximately $338,000 in twelve monthly installments for
market research, growth trails and other services. For the year
ended December 31, 2008 and 2007, we had paid approximately
$22,000 and $276,000, respectively, of this amount which has
been included in research and development in our consolidated
statements of operations. We are currently negotiating the
remainder of the payments with IBRC.
Also, pursuant to the license agreement, we have granted a
proposed cooperative called Genica, which has yet to be formed
and of which IBRC will be a member, a right of first refusal to
market all of our products in accordance with the terms and upon
payment to us of the price listed on our then current price
list. If we propose to sell end products to a third party for a
price lower or otherwise on terms more favorable than such
published price and terms, Genica also has a right of first
refusal to market such products on the terms and upon payment to
us of the price proposed to the third party. The license
agreement does not specify the duration of such rights.
Marketing
and Sales
Target
Markets
According to the U.S. Fertilizer Institute,
U.S. fertilizer demand is 58 million tons per year,
with agribusiness consuming the majority of product and the
professional turf and retail segments consuming the remainder.
The concern of farmers, gardeners and landscapers about nutrient
runoffs, soil health and other long-term effects of conventional
chemical fertilizers has increased demand for organic
fertilizer. We have identified three target markets for our
products:
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Agribusiness: conventional farms, organic
farms, horticulture, hydroponics and aquaculture;
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Turf management: professional lawn
care & landscaping, golf courses, sod farms,
commercial, government & institutional
facilities; and
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Retail sales: home improvement outlets, garden
supply stores, nurseries, Internet sales and shopping networks.
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Agribusiness: There are two primary business
drivers influencing commercial agriculture. First, commercial
farmers are focused on improving the economic yield of their
land: maximizing the value derived from crop output (quantity
and quality). Second, commercial farmers are focused on reducing
the use of chemical products, while also meeting the demand for
cost-effective, environmentally responsible alternatives. We
believe this change in focus is the result of:
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Consumer demand for safer, higher quality food;
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The restriction on use of registered chemical products. Several
U.S. government authorities, including the Environmental
Protection Agency, the Food and Drug Administration, and the
USDA regulate the use of fertilizers. There are more than 14
separate regulations governing the use of fertilizers;
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Environmental concerns and the demand for sustainable
technologies;
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Demand for more food for the growing world population; and
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The cost effectiveness and efficacy of non-chemical based
products to growers.
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9
Consumer demand for organic food products increased throughout
the 1990s to date at approximately 20% or more per annum. In the
wake of USDAs implementation of national organic standards
in October 2002, the organic food industry has continued to
grow. According to the Organic Trade Association, United
States sales of organic food and beverages have grown from
$1 billion in 1990 to approximately $20 billion in
2007 and are expected to grow at an average of 18% per year
through 2010. Furthermore, the Organic Trade Association reports
that organic foods represented approximately 2.8% of total food
and beverage sales in 2006, growing 26% in 2006, one of the
fastest growing categories. According to the Nutrition Business
Journal, consumer demand is driving organic sector expansion,
particularly for fruit, vegetables and dairy products. This
demand, in turn, is driving commercial farmers to shift more of
their acreage from conventional practices, which predominantly
use synthetic fertilizers, to organic practices, which require
the use of certified organic fertilizers or other natural
organic materials to facilitate crop growth. The USDAs
National Agricultural Statistics Service reports that the number
of certified organic farm acres has grown from 0.9 million
in 1992 to 4.1 million in 2005, a compound annual growth
rate of 12% per year.
Farmers are facing pressures to change from conventional
production practices to more environmentally friendly practices.
U.S. agricultural producers are turning to certified
organic farming methods as a potential way to lower production
costs, decrease reliance on nonrenewable resources such as
chemical fertilizers, increase market share with an
organically grown label and capture premium prices,
thereby boosting farm income.
Turf management: We believe that the more than
sixteen thousand golf courses in the U.S. will continue to
reduce their use of chemicals and chemical-based fertilizers to
limit potentially harmful effects, such as chemical fertilizer
runoff. The United States Golf Association (USGA)
provides guidelines for effective environmental course
management. These guidelines include using nutrient products and
practices that reduce the potential for contamination of ground
and surface water. Strategies include using slow-release
fertilizers and selected organic products and the application of
nutrients through irrigation systems. Further, the USGA advises
that the selection of chemical control strategies should be
utilized only when other strategies are inadequate. We believe
that our all-natural, slow-release fertilizer products will be
well received in this market.
Retail sales: The Freedonia Groups
report on Lawn & Garden Consumables indicates that the
U.S. market for packaged lawn & garden
consumables is $7.5 billion and is expected to grow 4.5%
per year to $9.3 billion in 2012. Fertilizers are the
largest product category, generating $2.85 billion, or 38%,
of total lawn and garden consumables sales. Fertilizers, mulch
and growing media will lead gains, especially rubber mulch,
colored mulch and premium soils. Organic formulations are
expected to experience more favorable growth than conventional
formulations across all product segments, due to increased
consumer concern with regard to how synthetic chemical
fertilizers and pesticides on lawns and gardens may affect
human/pet health and the environment.
Product
Sales and Distribution
Our license with IBRC restricts the sale of products from our
Woodbridge facility to the Eastern Seaboard states, including
Maine, New Hampshire, Vermont, Massachusetts, Rhode Island,
Connecticut, New York, New Jersey, Pennsylvania, Delaware,
Maryland, Virginia, District of Columbia, North Carolina, South
Carolina, Georgia and Florida. Our Gonzales facility and future
plants will not be subject to these territory restraints as they
will operate using the HTLC technology that we acquired from WRI.
We plan to sell and distribute our products through our sales
organization that will target large purchasers of fertilizer
products for distribution in our target geographic and product
markets. We have determined that our product will not only be
sold to the organic fertilizer market but to the much larger
conventional fertilizer markets as our products disease
suppression characteristics make us attractive to those markets.
Key activities of the sales organization include introduction of
the Company and our products and the development of
relationships with targeted clients. In addition, we have signed
distribution agreements with six distributors to sell our
products to numerous outlets in all of our target markets.
Furthermore, weve had preliminary discussions with
manufacturers representatives to explore sales of our
products in appropriate retail outlets. In order to develop a
consistent sales and distribution strategy, we have hired a
seasoned professional to serve as Vice President of Marketing
and have hired five in house salespeople to assist with product
pull-through into all of our targeted markets. In addition, with
our acquisition of UOP, we have retained the services of
employees who are currently selling product into the
agribusiness market.
10
Environmental
Impact of Our Business Model
Organic food waste, the raw material of our manufacturing
process, comes from a variety of sources. Prior to preparation,
food must be grown or raised, harvested, packaged, shipped,
unpacked, sorted, selected and repackaged before it finds its
way into markets, restaurants or home kitchens. Currently, this
process creates a large amount of food waste, particularly in
densely populated metropolitan areas such as New York City,
Northern New Jersey, and Eastern Massachusetts. Traditionally,
the majority of food waste is disposed of in either landfills or
incinerators that do not produce a product from this recyclable
resource. We use a demonstrated technology that is
environmentally benign to convert waste into valuable
all-natural soil amendment products.
Food waste comprises 15% to 20% of the nations waste
stream. Disposing of or recycling food waste should be simple,
since organic materials grow and decompose readily in nature.
However, the large volumes of food wastes generated in urban
areas combined with a lack of available land for traditional
recycling methods, such as composting, make disposal of food
wastes increasingly expensive and difficult. Landfill capacity
is a significant concern, particularly in densely populated
areas. In addition, landfills may create negative environmental
effects including liquid wastes migrating into groundwater,
landfill gas, consumption of open space, and air pollution
associated with trucking waste to more remote sites. The
alternative of incineration may produce toxic air pollutants and
climate-changing gases, as well as ash containing heavy metals.
Incineration also fails to recover the useful materials from
organic wastes that can be recycled. Traditional composting is a
slow process that uses large tracts of land, may generate
offensive odors, and may attract vermin. In addition, composting
usually creates an inconsistent product with lower economic
value than the fertilizer products we will produce.
Our process occurs in enclosed digesters housed
within a building that will use effective emissions control
equipment, which we believe will result in minimal amounts of
dust and noise. By turning food waste into a fertilizer product
using an environmentally benign process, we anticipate that we
will be able to reduce the total amount of solid waste that goes
to landfills and incinerators, which may in turn reduce the
release of greenhouse gases such as methane and carbon dioxide.
11
The following table summarizes some of the advantages of our
process compared with currently available methods employed to
dispose of organic food waste:
Comparison
of Methods for Managing Food Waste
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Method
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Environmental Impacts
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Products
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Landfilling
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Loss of land
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Landfill gas (minimal energy generation at some landfills)
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Groundwater threat
Methane gas
Air pollution from trucks
Useful materials not recycled
Undesirable land use
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Incineration
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Air pollution
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Electricity (only at some facilities)
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Toxic emissions
Useful materials not recycled
Disposal of ash still required
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Composting
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Groundwater threat
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Low value compost
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Odor
Vermin
Slow takes weeks
Substantial land required
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Converted Organics
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No air pollution or solid waste
No harmful by-products
Removal of waste from waste stream
Consumption of electricity and natural gas
Discharge of treated wastewater into sewage system
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Natural fertilizer
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Environmental regulators and other governmental authorities in
our target markets have also focused more recently on the
potential benefits of recycling increased amounts of food waste.
For example, the New Jersey Department of Environmental
Protection (the NJDEP) estimates nearly
1.5 million tons, or just over 15% of the states
total waste stream, is food waste, but in 2003, only 221,000
tons were recycled. The 2005 NJDEP Statewide Solid Waste
Management Plan focuses particularly on the food
waste recycling stream as one of the most effective ways
to create significant increases in recycling tonnages and rates.
In New York, state and local environmental agencies are taking
measures to encourage the diversion of organics from landfills
and are actively seeking processes consistent with health and
safety codes. The goal is to further reduce the amount of waste
going to landfills and other traditional disposal facilities,
particularly waste that is hauled great distances, especially in
densely populated areas in the Northeast. In 2005, the Rhode
Island Resource Recovery Corporation (RIRRC) began
an examination of the bulk food waste processing technology of
our technology licensor to determine whether using our licensed
technology would be economically feasible, cost-effective,
practicable, and an appropriate application in Rhode Island. The
RIRRC completed its review and included the technology in their
2006 Solid Waster Master Plan. In Massachusetts, the State Solid
Waste Master Plan has also identified a need for increased
organics-processing capacity within the state and has called for
a streamlined regulatory approval path.
Competition
We operate in a very competitive environment in our
businesss three dimensions organic wastestream
feedstock, technology and end products each of which
is quickly evolving. We believe we will be able to compete
effectively because of the abundance of the supply of food waste
in our geographic markets, the pricing of our tip fees and the
quality of our products and technology.
12
Organic Wastestream. Competition for the
organic waste stream feedstock includes landfills, incinerators
and traditional composting operations. Organic waste streams are
generally categorized as pre- and post-consumer food waste, lawn
and garden waste, and bio-solids, including sewage sludge or the
by-product of wastewater treatment. Some states, including New
Jersey, have begun to regulate the manner in which food waste
may be composted. New Jersey has created specific requirements
for treatment in tanks, and we believe our Woodbridge facility
is the first approved in-vessel processing facility in the
state. In Massachusetts, state regulators are considering a ban
on the disposal of organic materials at landfills and
incinerators once sufficient organic processing capacity exists
within the state, which if adopted would provide a competitive
advantage for organic processes such as our process.
Technology. There are a variety of
technologies used to treat organic wastes including composting,
digestion, hydrolysis and thermal processing. Companies using
these technologies may compete with us for organic material.
Composting is a natural process of decomposition that can be
enhanced by mounding the waste into windrows to retain heat,
thereby accelerating decomposition. Large-scale compost
facilities require significant amounts of land for operations
that may not be readily available or that may be only available
at significant cost in major metropolitan areas. Given the
difficulties in controlling the process or the consistent
ability to achieve germ-killing temperatures, the resulting
compost is often inconsistent and generally would command a
lower market price than our product.
Digestion may be either aerobic, like the EATAD process, or
anaerobic. Anaerobic digestion is, in simple terms, mechanized
in-vessel composting. In addition to compost, most anaerobic
digestion systems are designed to capture the methane generated.
While methane has value as a source of energy, it is generally
limited to
on-site use,
as it is not readily transported.
Hydrolysis is an energy-intensive chemical process that produces
a by product, most commonly ethanol. Thermal technologies
extract the Btu content of the waste to generate electricity.
Food waste, which is typically 75%-90% water, is generally not a
preferred feedstock. Absent technological breakthroughs, neither
hydrolysis nor thermal technologies are expected to be accepted
for organic food waste processing on a large-scale in the near
term.
End Products. The organic fertilizer business
is relatively new, highly fragmented, under-capitalized and
growing rapidly. We are not aware of any dominant producers or
products currently in the market. There are a number of single
input, protein-based products, such as fish, bone and cottonseed
meal, that can be used alone or mixed with chemical additives to
create highly formulated fertilizer blends that target specific
soil and crop needs. In this sense they are similar to our
products but have odor, stability and shelf life or seasonality
problems.
Most of the 58 million tons of fertilizer consumed annually
in North America is mined or derived from petroleum. These
petroleum-based products generally have higher nutrient content
(NPK) and cost less than organic fertilizers. However, as
agronomists better understand how soil, root and stem/leaf
systems interact, we believe the importance of micronutrients is
becoming more highly valued. Petrochemical additives have been
shown to deaden the soil, which ironically contributes to higher
nutritional requirements. Traditional petrochemical fertilizers
are highly soluble and readily leach from the soil. Slow release
products that are coated or specially processed command a
premium. However, the economic value offered by petrochemicals,
especially for field crops including corn, wheat, hay and
soybeans, will not be supplanted in the foreseeable future.
Despite a large number of new products in the end market, we
believe that our products have a unique set of characteristics.
We believe positioning and branding the combination of nutrition
and disease suppression characteristics will differentiate our
products from other organic fertilizer products to develop
market demand, while maintaining or increasing pricing. In view
of the barriers to entry created by the supply of organic waste,
regulatory controls and the cost of constructing facilities, we
do not foresee a dominant manufacturer or product emerging in
the near-term.
13
Government
Regulation
Our end products may be regulated or controlled by state, county
and local governments as well as various agencies of the Federal
government, including the Food and Drug Administration and the
Department of Agriculture.
In addition to the regulations governing the sale of our end
products, our facilities will be subject to extensive
regulation. We will need certain permits to operate solid waste
or recycling facilities as well as permits for our sewage
connection, water supply, land use, air emission, and wastewater
discharge. The specific permit and approval requirements are set
by the state and the various local jurisdictions, including but
not limited to city, town, county, and township and state
agencies having control over the specific properties.
For our Woodbridge facility, we have obtained various permits
and approvals to operate a recycling center and a manufacturing
facility, including among others: a Class C recycling
permit; land use and site plan approval; an air quality permit;
a discharge permit; treatment works approval and a storm water
runoff permit; building construction permits; a soil
conservation district permit and our certificate of occupancy.
Environmental regulations will also govern the operation of our
facilities. Our future facilities will most likely be located in
urban industrial areas where contamination may be present.
Regulatory agencies may require us to remediate environmental
conditions at our locations.
We have contracted with a company to explore our ability to
create carbon credits as a result of our manufacturing process
and our diverting food waste from landfills. As of the filing of
this report we have not determined the value, if any, of the
potential carbon credits associated with our business.
Employees
As of March 27, 2009, we had 39 full-time employees,
16 of whom were in sales, management and administration and 9 of
whom were employed in our Gonzales facility and 14 who were
employed in our Woodbridge facility. Once the Woodbridge
facility reaches its initial design capacity of 250 tons per
day, we expect to have another 14 full-time employees at
that location, working in the areas of general plant management,
equipment operation, quality control, maintenance, laborers, and
administrative support. We are also planning for additional
employees in the sales, marketing, finance, technology and
administrative areas of the Company.
You should carefully consider the risks, uncertainties and other
factors described below because they could materially and
adversely affect our business, financial condition, operating
results and prospects and could negatively affect the market
price of our securities. Also, you should be aware that the
risks and uncertainties described below are not the only ones
facing us. Additional risks and uncertainties that we do not yet
know of, or that we currently think are immaterial, may also
impair our business operations. You should also refer to the
other information contained in this Annual Report on
Form 10-K,
including our consolidated financial statements and the related
notes.
We
could fail to remain a going concern. We will need to raise
additional capital to fund our operations through the near term,
and we do not have any commitments for that
capital.
There exists substantial doubt regarding our ability to continue
as a going concern. Our independent registered public accounting
firm has modified their report for our fiscal year ended
December 31, 2008 with respect to our ability to continue
as a going concern. Our consolidated financial statements have
been prepared on the basis of a going concern, which
contemplates the realization of assets and the satisfaction of
liabilities in the normal course of business. If we became
unable to continue as a going concern, we would have to
liquidate our assets and we might receive significantly less
than the values at which they are carried on our consolidated
financial statements. The inclusion of a going concern
modification in our independent registered public accounting
firms audit opinion for the year ended December 31,
2008 may materially and adversely affect our stock price
and our ability to raise new capital.
14
As reflected in our financial statements, as of
December 31, 2008, we incurred a net loss of approximately
$16.2 million, had an accumulated deficit of
$26.6 million, and had a working capital deficiency. We
will need additional capital
and/or
increased sales to execute our business strategy, and if we are
unsuccessful in either raising additional capital or achieving
desired sales levels we will be unable to fully execute our
business strategy on a timely basis, if at all. If we raise
additional capital through the issuance of debt securities, the
debt securities may be secured and any interest payments would
reduce the amount of cash available to operate and grow our
business. If we raise additional capital through the issuance of
equity securities, such issuances will likely cause dilution to
our stockholders, particularly if we are required to do so
during periods when our common stock is trading at historically
low price levels.
Additionally, we do not know whether any financing, if obtained,
will be adequate to meet our capital needs and to support our
growth. If adequate capital cannot be obtained on satisfactory
terms, we may curtail or delay the implementation of updates to
our facilities or delay the expansion of our sales and marketing
capabilities, any of which could cause our business to fail.
We
will need to obtain additional debt and equity financing to
complete subsequent stages of our business plan.
We require significant additional financing to finalize upgrades
to our Woodbridge facility, to satisfy construction vendor
payables, and to operate our business. In March 2009, we entered
into an agreement with an investor to purchase $1,500,000 of
convertible term notes, subject to shareholder approval. The
issuance and sale of shares of our common stock to the investor
would likely have a dilutive effect on a stockholders
percentage voting power in us. As the convertible note is
convertible at prices below the then market price of our common
stock, if we were to issue additional shares upon conversion of
the convertible note, the dilution caused by such issuances
could lead to a decrease in the market price of our common
stock. In addition, since the conversion prices will be below
the market price of our common stock, even if conversions do not
take place, the existence of the conversion rights could lead to
a decrease in the market price of our common stock.
We may issue additional securities in the future with rights,
terms and preferences designated by our Board of Directors,
without a vote of stockholders, which could adversely affect
stockholder rights. Additional financing will likely cause
dilution to our stockholders and could involve the issuance of
securities with rights senior to the outstanding shares. There
is no assurance that such funds will be sufficient, that the
financing will be available on terms acceptable to us and at
such times as required, or that we will be able to obtain the
additional financing required, if any, for the continued
operation and growth of our business. Any inability to raise
necessary capital will have a material adverse effect on our
ability to meet our projections, deadlines and goals and will
have a material adverse effect on our revenues and net income.
Constructing
and equipping our Woodbridge facility has taken longer and cost
more than we expected, which has resulted in significant amounts
being owed to construction vendors for which we do not have the
cash resources to satisfy.
Our Woodbridge facility became operational in June 2008. We
incurred approximately $5.7 million in additional
unanticipated construction costs and design changes in
constructing the Woodbridge facility. We are in the process of
completing additional upgrades to the Woodbridge facility, which
are expected to be completed by June 2009, and which we believe
will allow us to increase capacity at the facility to
approximately 70% of full capacity.
Of the $5.7 million in upgrades, design changes and
construction costs discussed above, we currently estimate that
we will be able to fund approximately $500,000 in costs. In
order to finance the additional $5.2 million in upgrades,
design changes and construction costs, we will need to enter
into agreements with the various construction vendors as we do
not currently have the funds available to pay these amounts,
which are listed as accounts payable in our December 31,
2008 balance sheet. If we are unable to come to agreements with
our construction vendors, the vendors may attempt to take
actions against us or the Woodbridge facility, which could
result in interruptions to the operations of the Woodbridge
facility, which would adversely effect our business results.
15
We
have limited operating history, and our prospects are difficult
to evaluate.
We have not operated any facility other than our Gonzales
facility, which we purchased in January 2008, and our Woodbridge
facility, which became operational in June 2008. Our activities
to date have been primarily limited to developing our business,
and consequently there is limited historical financial
information related to operations available upon which you may
base your evaluation of our business and prospects. The revenue
and income potential of our business is unproven. If we are
unable to develop our business, we will not achieve our goals
and could suffer economic loss or collapse, which may have a
material negative effect on our financial performance.
We
expect to incur significant losses for some time, and we may
never operate profitably.
For the period from January 1, 2007 through
December 31, 2008, we incurred an accumulated net loss of
approximately $20,263,000. Despite generating revenue from our
Gonzales facility beginning in February 2008, we will continue
to incur significant losses. There is no assurance that we will
be successful in our efforts to operate organic waste conversion
facilities.
If we
are unable to manage our transition to an operating company
effectively, our operating results will be adversely
affected.
Failure to manage effectively our transition to an operating
company will harm our business. To date, substantially all of
our activities and resources have been directed at developing
our business plan, arranging financing, licensing technology,
obtaining permits and approvals, securing a lease for our
Woodbridge facility and options for additional facilities, and
purchasing our Gonzales facility. The transition to a converter
of waste and manufacturer and vendor of fertilizer products
requires effective planning and management. In addition, future
expansion will be expensive and will likely strain our
management and other resources. We may not be able to easily
transfer our skills to operating a facility or otherwise
effectively manage our transition to an operating company.
Our
plan to develop relationships with strategic partners and
vendors may not be successful.
As part of our business strategy, we will need to develop short-
and long-term relationships with strategic partners and vendors
to conduct growth trials and other research and development
activities, to assess technology, to engage in marketing
activities, and to enter into waste collection, real estate
development and construction agreements. For these efforts to
succeed, we must identify partners and vendors whose
competencies complement ours. We must also enter into agreements
with them on attractive terms and integrate and coordinate their
resources and capabilities with our own. If we are unsuccessful
in our collaborative efforts, our ability to develop and market
products could be severely limited or delayed.
We may
be unable to effectively implement new transaction accounting,
operational and financial systems.
To manage our operations, we will be required to implement
complex transaction accounting, operational and financial
systems, procedures and controls, and to retain personnel
experienced in the use of these systems. Deficiencies in the
design and operation of our systems, procedures and controls,
including internal controls, could adversely affect our ability
to record, process, summarize and report material financial
information. Our planned systems, procedures and controls may be
inadequate to support our future operations.
We are
exposed to risks from legislation requiring companies to
evaluate internal control over financial
reporting.
Section 404 of the Sarbanes-Oxley Act of 2002
(Section 404) requires our management to begin
to report on the operating effectiveness of our internal control
over financial reporting for the year ended December 31,
2008. CCR LLP, our independent registered public accounting
firm, will be required to attest to the effectiveness of our
internal control over financial reporting beginning with the
year ending December 31, 2009. We must continue an ongoing
program to perform the system and process evaluation and testing
necessary to comply with these requirements. We expect that this
program will require us to incur expenses and to devote
resources to Section 404 compliance on an ongoing annual
basis.
16
It is difficult for us to predict how long it will take to
complete managements assessment of the effectiveness of
our internal control over financial reporting each year and to
remediate any deficiencies in our internal control over
financial reporting, if any. As a result, we may not be able to
complete the assessment process on a timely basis each year. In
the event that our Chief Executive Officer, Chief Financial
Officer or independent registered public accounting firm
determines that our internal control over financial reporting is
not effective as defined under Section 404, we cannot
predict how regulators will react or how the market prices of
our securities will be affected.
Our
future success is dependent on our existing key employees, and
hiring and assimilating new key employees, and our inability to
attract or retain key personnel in the future would materially
harm our business and results of operations.
Our success depends on the continuing efforts and abilities of
our current management team. In addition, our future success
will depend, in part, on our ability to attract and retain
highly skilled employees, including management, technical and
sales personnel. The loss of services of any of our key
personnel, the inability to attract or retain key personnel in
the future, or delays in hiring required personnel could
materially harm our business and results of operations. We may
be unable to identify and attract highly qualified employees in
the future. In addition, we may not be able to successfully
assimilate these employees or hire qualified personnel to
replace them.
We
have little or no experience in the organic waste or fertilizer
industries, which increases the risk of our inability to build
and operate our facilities.
We are currently, and are likely for some time to continue to
be, dependent upon our present management team. Most of these
individuals are experienced in business generally, and in
governing and operating a public company. However, our present
management team does not have experience organizing the
construction, equipping and start up of an organic waste
conversion facility. In addition, none of our directors has any
experience in the organic waste or fertilizer products
industries. As a result, we may not develop our business
successfully.
We
license certain technology from a third party, and our failure
to perform under the terms of the license could result in
material adverse consequences.
We use certain licensed technology and patented pieces of
process equipment in our Woodbridge facility that have been
obtained from IBRC. The license contains various performance
criteria, and if we fail to perform under the terms of the
license, the license may be terminated by the licensor, and we
will have to modify our process and employ other equipment that
may not be available on a timely basis or at all. If we are
unable to use different technology and equipment, we may not be
able to operate the Woodbridge facility successfully. If the
license agreement is terminated or held invalid for any reason,
or if it is determined that IBRC has improperly licensed its
process to us, the occurrence of such event will adversely
affect our Woodbridge operations and revenues therefrom.
The
EATAD technology we will use to operate our Woodbridge facility
is unproven at the scale we intend to operate.
While IBRC has operated a facility in British Columbia using the
EATAD process, its plant is smaller than our planned Woodbridge
facility. IBRC developed the initial drawings for our Woodbridge
facility, but neither IBRC nor we have operated a plant of the
proposed size.
Our
Woodbridge and Gonzales facility sites may have unknown
environmental problems that could be expensive and time
consuming to correct.
There can be no assurance that we will not encounter hazardous
environmental conditions at the Woodbridge and Gonzales facility
sites or any additional future facility sites that may delay the
construction of our future organic waste conversion facilities.
Upon encountering a hazardous environmental condition, our
contractor may suspend work in the affected area. If we receive
notice of a hazardous environmental condition, we may be
required to correct the condition prior to continuing
construction. The presence of a hazardous environmental
condition will likely delay construction of the particular
facility and may require significant expenditures to correct the
17
environmental condition. If we encounter any hazardous
environmental conditions during construction that require time
or money to correct, such event could delay our ability to
generate revenue.
We may
not be able to successfully operate our Woodbridge
facility.
Our Woodbridge facility is the first commercial facility of its
kind in the United States and may not function as anticipated.
In addition, the control of the manufacturing process will
require operators with extensive training and experience which
may be difficult to attain.
Our
lack of business diversification may have a material negative
effect on our financial performance.
We have two products to sell to customers to generate revenue:
dry and liquid soil amendment products. We do not expect to have
any other products. Although we also expect to receive
tip fees, our lack of business diversification could
have a material adverse effect on our operations.
We may
not be able to manufacture products from our facilities in
commercial quantities or sell them at competitive
prices.
To date, we have not produced any products other than from our
Gonzales facility since February 2008 and from our Woodbridge
facility since June 2008. We may not be able to manufacture
products from our facilities in commercial quantities or sell
them at prices competitive with other similar products.
We may
be unable to establish marketing and sales capabilities
necessary to commercialize and gain market acceptance for our
potential products.
We currently have limited resources to expand our sales and
marketing capabilities. We will need to either hire sales
personnel with expertise in the markets we intend to address or
contract with others to provide sales support. Co-promotion or
other marketing arrangements to commercialize our planned
products could significantly limit the revenues we derive from
our products, and these parties may fail to commercialize these
products successfully. Our planned products address different
markets and can be offered through multiple sales channels.
Addressing each market effectively will require sales and
marketing resources tailored to the particular market and to the
sales channels that we choose to employ, and we may not be able
to develop such specialized marketing resources.
Pressure
by our customers to reduce prices and agree to long-term supply
arrangements may adversely affect our net sales and profit
margins.
Our current and potential customers, especially large
agricultural companies, are often under budgetary pressure and
are very price sensitive. Our customers may negotiate supply
arrangements with us well in advance of delivery dates, thereby
requiring us to commit to product prices before we can
accurately determine our final costs. If this happens, we may
have to reduce our conversion costs and obtain higher volume
orders to offset lower average sales prices. If we are unable to
offset lower sales prices by reducing our costs, our gross
profit margins will decline, which could have a material
negative effect on our financial performance.
The
fertilizer industry is highly competitive, which may adversely
affect our ability to generate and grow sales.
Chemical fertilizers are manufactured by many companies and are
plentiful and relatively inexpensive. In addition, the number of
fertilizer products registered as organic with the
Organic Materials Review Institute increased by approximately
50% from 2002 to 2005. If we fail to keep up with changes
affecting the markets that we intend to serve, we will become
less competitive, adversely affecting our financial performance.
Defects
in our products or failures in quality control could impair our
ability to sell our products or could result in product
liability claims, litigation and other significant events with
substantial additional costs.
Detection of any significant defects in our products or failure
in our quality control procedures may result in, among other
things, delay in time-to-market, loss of sales and market
acceptance of our products, diversion of
18
development resources, and injury to our reputation. The costs
we may incur in correcting any product defects may be
substantial. Additionally, errors, defects or other performance
problems could result in financial or other damages to our
customers, which could result in litigation. Product liability
litigation, even if we prevail, would be time consuming and
costly to defend. We presently maintain product liability
insurance, however it may not be adequate to cover claims.
Energy
and fuel cost variations could adversely affect operating
results and expenses.
Energy costs, particularly electricity and natural gas, are
expected to constitute a substantial portion of our operating
expenses. The price and supply of energy and natural gas are
unpredictable and fluctuate based on events outside our control,
including demand for oil and gas, weather, actions by OPEC and
other oil and gas producers, and conflict in oil-producing
countries. Price escalations in the cost of electricity or
reductions in the supply of natural gas could increase operating
expenses and negatively affect our results of operations. We may
not be able to pass through all or part of the increased energy
and fuel costs to our customers.
We may
not be able to obtain sufficient organic material.
Competing disposal outlets for organic food waste and increased
demand for applications such as biofuels may develop and
adversely affect our business. To fully utilize the tip floor
and to manufacture our products, we are dependent on a stable
supply of organic food waste. Insufficient food waste feedstock
will adversely affect our efficiency and may cause us to
increase our tip fee discount from prevailing rates, likely
resulting in reduced revenues and net income.
Our
license agreement with IBRC restricts the territory into which
we may sell our products and grants a cooperative a right of
first refusal to purchase our products.
We have entered into a license agreement with IBRC which among
other terms contains a restriction on our right to sell our
planned products outside a territory defined generally as the
Eastern Seaboard of the United States. The license agreement
also grants a proposed cooperative of which IBRC is a member a
right of first refusal to purchase the products sold from our
Woodbridge facility under certain circumstances. While we
believe that the territory specified in the license agreement is
broad enough to absorb the amount of product we plan to produce
and that the right of first refusal will not impair our ability
to sell our products, these restrictions may have a material
adverse effect on the volume and price of our product sales. We
may in addition become completely dependent on a third party for
the sale of our products.
Successful
infringement claims by third parties could result in substantial
damages, lost product sales and the loss of important
proprietary rights.
We may have to defend ourselves against patent and other
infringement claims asserted by third parties regarding the
technology we have licensed, resulting in diversion of
management focus and additional expenses for the defense of
claims. In addition, as a result of a patent infringement suit,
we may be forced to stop or delay developing, manufacturing or
selling potential products that are claimed to infringe a patent
covering a third partys intellectual property unless that
party grants us rights to use its intellectual property. We may
be unable to obtain these rights on terms acceptable to us, if
at all. If we cannot obtain all necessary licenses on
commercially reasonable terms, we may be unable to continue
selling such products. Even if we are able to obtain rights to a
third partys patented intellectual property, these rights
may be non-exclusive, and therefore our competitors may obtain
access to the same intellectual property. Ultimately, we may be
unable to commercialize our potential products or may have to
cease some or all of our business operations as a result of
patent infringement claims, which could severely harm our
business.
Our
license agreement with IBRC imposes obligations on us related to
infringement actions that may become burdensome or result in
termination of our license agreement.
If our use of the licensed technology is alleged to infringe the
intellectual property of a third party, we may become obligated
to defend such infringement action. Although IBRC has agreed to
bear the costs of such defense,
19
if the licensed technology is found by a court to be infringing,
IBRC may terminate the license agreement, which may prevent us
from continuing to operate our conversion facility. In such an
event, we may become obligated to find alternative technology or
to pay a royalty to a party other than IBRC to continue to
operate.
If a third party is allegedly infringing on any of the licensed
technology, then either we or IBRC may attempt to enforce the
IBRC intellectual property rights. In general, our possession of
rights to use the know-how related to the licensed technology
will not be sufficient to prevent others from employing similar
technology that we believe is infringing. Any such enforcement
action against alleged infringers, whether by us or by IBRC, may
be required to be maintained at our expense under the terms of
the license agreement. The costs of such an enforcement action
may be prohibitive, reduce our net income, if any, or prevent us
from continuing operations.
Our
HTLC technology imposes obligations on us related to
infringement actions that may become burdensome.
If our use of our HTLC technology is alleged to infringe the
intellectual property of a third party, we may become obligated
to defend such infringement action. In such an event, we may
become obligated to find alternative technology or to pay a
royalty to a third party to continue to operate.
If a third party is allegedly infringing any of our HTLC
technology, then we may attempt to enforce our intellectual
property rights. In general, our possession of rights to use the
know-how related to our HTLC technology will not be sufficient
to prevent others from employing similar technology that we
believe is infringing. Any such enforcement action against
alleged infringers may be required at our expense. The costs of
such an enforcement action may be prohibitive, reduce our net
income, if any, or prevent us from continuing operations.
Development
of our business is dependent on our ability to obtain additional
debt financing which may not be available on acceptable
terms.
We may need to obtain significant debt financing in order to
develop new manufacturing facilities. Each facility will likely
be individually financed and require considerable debt. While we
believe state government-sponsored debt programs will be
available to finance our requirements, market rate or
non-government sponsored debt could also be used. However,
public or private debt may not be available at all or on terms
acceptable to us for the development of future facilities.
Our
agreements with our bond investors may hinder our ability to
operate our business by imposing restrictive loan covenants,
which may prohibit us from paying dividends or taking other
actions to manage or expand our business.
The terms of the bond guaranty executed by the Company on behalf
of Converted Organics of Woodbridge LLC, prohibit the Company
from repaying debt and other obligations that funded the
Companys working capital until certain ratios of EBITDA to
debt service are met.
Mandatory
redemption of our bonds could have a material adverse effect on
our liquidity and cash resources.
The bonds issued are subject to mandatory redemption by us if
the Woodbridge facility is condemned, we cease to operate the
facility, the bonds become taxable, a change in control of the
company occurs and under certain other circumstances. Depending
upon the circumstances, such an event could require a payment to
our bondholders ranging between 100% and 110% of the principal
amount of the bonds outstanding, plus interest. If we are unable
to obtain additional financing from other sources, the
requirement that we pay cash in connection with such mandatory
redemption will have a material adverse effect on our liquidity
and cash resources, and may impair our ability to continue to
operate.
20
The
communities where our facilities may be located may be averse to
hosting waste handling and manufacturing
facilities.
Local residents and authorities in communities where our
facilities may be located may be concerned about odor, vermin,
noise, increased truck traffic, air pollution, decreased
property values, and public health risks associated with
operating a manufacturing facility in their area. These
constituencies may oppose our permitting applications or raise
other issues regarding our proposed facilities.
Our
facilities will require certain permits to operate, which we may
not be able to obtain or obtain on a timely basis.
For our Woodbridge facility, we obtained various permits and
approvals to operate a recycling center and a manufacturing
facility, including among others a Class C recycling
permit, land use and site plan approval, an air quality permit,
a water discharge permit, a storm water runoff permit, and
building construction permits. We may not be able to secure all
the necessary permits for future facilities on a timely basis or
at all, which may prevent us from operating the facility
according to our business plan.
For our facilities, we may need certain permits to operate solid
waste or recycling facilities as well as permits for our sewage
connection, water supply, land use, air emission, and wastewater
discharge. The specific permit and approval requirements are set
by the state and the various local jurisdictions, including but
not limited to city, town, county, township and state agencies
having control over the specific properties. Lack of permits to
construct, operate or maintain our facilities will severely and
adversely affect our business.
Changes
in environmental regulations or violations of such regulations
could result in increased expense and could have a material
negative effect on our financial performance.
We are subject to extensive air, water and other environmental
regulations and will need to obtain a number of environmental
permits to construct and operate our planned facilities. If for
any reason any of these permits are not granted, construction
costs for our organic waste conversion facilities may increase,
or the facilities may not be constructed at all. Additionally,
any changes in environmental laws and regulations, both at the
federal and state level, could require us to invest or spend
considerable resources in order to comply with future
environmental regulations. The expense of compliance could be
significant enough to reduce our net income and have a material
negative effect on our financial performance.
Our
strategic plan for development and construction of operating
facilities in Rhode Island and Massachusetts requires additional
debt and/or equity financing and working capital during the
construction periods.
Our strategic plan calls for us to develop and build future
operating facilities. These facilities will require us to raise
additional fund for the development and construction of these
facilities and for working capital during the construction
process. There is no guarantee that we will be able to raise
those funds.
ITEM 1B. UNRESOLVED
STAFF COMMENTS
Not applicable.
We entered a
10-year
lease on June 2, 2006 and subsequently in February 2007
exercised an option to renew for an additional 10 years on
property located in an industrial area of Woodbridge, New
Jersey, on which our Woodbridge facility is located. The lease
covers 60,000 square feet of a 300,000 square foot
building. The rent is $32,500 per month for the first
5 years. In year 6, the rent increases by 5% and will
increase 2% per year in years 7 through 10. On January 18,
2007, the Company executed a lease amendment to compensate the
landlord for costs incurred in connection with a buildout of the
leased space. During years 2 through 10, we will pay an
additional $45,402 per month under the amendment, for total rent
expense of $77,902 per month. In year 11, the rent will increase
by 5% and will increase an additional 2% per year in years 12
through 15. The rent will increase 5% in year
21
16 and thereafter, will increase 2% per year through the
remainder of the term. We are responsible for payment of common
area maintenance fees and taxes based upon our percentage of use
relative to the whole facility and for our separately metered
utilities. The additional rent associated with the buildout of
the facility is approximately $4.6 million and will be
repaid as discussed above. This buildout allowance represents
additional financing to the Company and is not included in the
estimated costs of $14.6 million to initially complete the
Woodbridge facility or the additional $5.7 million in
upgrades, design changes and unanticipated construction costs.
On January 24, 2008, we entered into a
10-year
lease for land in Gonzales, California, where our Gonzales
facility is located. The land is leased from VLH, a California
LLC whose sole member is a former officer and director of the
Company. The lease provides for a monthly rent of $9,000. The
lease is renewable for three
5-year terms
after the expiration of the initial
10-year
term. In addition, we own the Gonzales facility and the
operating equipment used in the facility. VLH has been
determined to be a variable interest entity of our Company and,
as such, has been consolidated as part of our consolidated
financial statements. All inter-Company balances and
transactions have been eliminated in consolidation. VLHs
assets and liabilities consist primarily of land and a mortgage
note payable on the land. Its operations consist of rental
income on the land from us and related operating expenses.
We currently lease, on a month-to-month basis, approximately
2,500 square feet of office space for our headquarters in
Boston, Massachusetts. We pay rent of $2,800 per month for this
space. We may terminate the office lease at any time upon
30 days advance written notice.
We have signed a lease for a parcel of land in Rhode Island for
construction of our next operating facility. We pay rent of
$9,167 per month and the lease term is for 20 years.
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ITEM 3.
|
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.
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ITEM 4.
|
SUBMISSION
OF MATTERS TO A VOTE OF SECURITY HOLDERS
|
No matters were submitted to a vote of security holders during
the fourth quarter of the year ended December 31, 2008.
22
PART II
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ITEM 5.
|
MARKET
FOR REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS
AND ISSUER PURCHASES OF EQUITY SECURITIES
|
Market
Information
Our common stock has been listed on the Nasdaq Capital Market
under the symbol COIN since March 16, 2007.
Prior to March 16, 2007, there was no public market for our
common stock. The following table sets forth the range of high
and low sales prices per share as reported on Nasdaq for the
periods indicated.
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|
|
|
|
|
2008
|
|
High
|
|
|
Low
|
|
|
First Quarter
|
|
$
|
14.17
|
|
|
$
|
3.52
|
|
Second Quarter
|
|
$
|
10.37
|
|
|
$
|
4.50
|
|
Third Quarter
|
|
$
|
7.83
|
|
|
$
|
2.99
|
|
Fourth Quarter
|
|
$
|
6.46
|
|
|
$
|
2.00
|
|
|
|
|
|
|
|
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2007
|
|
High
|
|
|
Low
|
|
|
First Quarter
|
|
$
|
2.86
|
|
|
$
|
2.31
|
|
Second Quarter
|
|
$
|
2.72
|
|
|
$
|
2.02
|
|
Third Quarter
|
|
$
|
2.83
|
|
|
$
|
1.86
|
|
Fourth Quarter
|
|
$
|
4.39
|
|
|
$
|
2.05
|
|
Holders
As of March 23, 2009, there were approximately 33 holders
of record of the Companys common stock.
Dividends
Beginning with the first quarter of 2007, at the end of each
calendar quarter holders of record of our common stock received
a 5% common stock dividend until the Woodbridge facility
commenced commercial operations on June 30, 2008. We did
not issue fractional shares as a part of the dividend program
nor did we issue shares with respect to the calendar quarter in
which we commenced commercial operations. We also issued a
special 15% common stock dividend, payable on December 1,
2008 for all holders of record of our common stock on
November 17, 2008. During 2008, we issued
1,232,552 shares as stock dividends.
We have not declared or paid any cash dividends and do not
intend to pay any cash dividends in the foreseeable future. We
intend to retain any future earnings for use in the operation
and expansion of our business. The terms of our New Jersey bond
issue restrict our ability to pay cash dividends. Any future
decision to pay cash dividends on common stock will be at the
discretion of our Board of Directors and will depend upon, in
addition to the terms of the New Jersey bond financing, as well
as any future bond or bank financings, our financial condition,
results of operation, capital requirements and other factors our
Board of Directors may deem relevant.
Recent
Sales of Unregistered Securities
During the fourth quarter of 2008, we issued 45,480 shares
of common stock for consulting services. This transaction was
exempt from the registration requirements 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 recipient is an accredited investor as
defined in the 1933 Act.
Use of
Proceeds from Registered Securities
See the discussion below under Managements
Discussion and Analysis or Plan of Operation
Construction and
Start-up
Period.
23
Purchase
of Equity Securities by the Small Business Issuer and Affiliated
Purchasers
None.
|
|
ITEM 6.
|
SELECTED
FINANCIAL DATA
|
As a smaller reporting company, we are not required to provide
information typically disclosed under this section.
|
|
ITEM 7.
|
MANAGEMENTS
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATION
|
The following discussion of our plan of operation should be read
in conjunction with the consolidated financial statements and
related notes to the consolidated 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 risks and
other factors include, among others, those listed under
Risk Factors and those included elsewhere in this
document.
Background
Introduction
Our independent registered public accountants have issued a
going concern opinion on our financial statements as of
December 31, 2008. As shown in the accompanying
consolidated financial statements, the Company has incurred a
net loss of approximately $16.2 million during the year
ended December 31, 2008, has a working capital deficiency
as of December 31, 2008 and an accumulated deficit of
approximately $26.6 million. These factors raise
substantial doubt about the Companys ability to continue
as a going concern. The consolidated financial statements do not
include any adjustments that might result from the outcome of
this uncertainty.
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 operating activity of our
Gonzales, California facility. The 92.5% owned subsidiary is
Converted Organics of Rhode Island, LLC which currently has no
operating activity. We transitioned from a development stage
company (first reported revenues were in February 2008) to
a fully operational company that constructs and operates
processing facilities that will 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
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 currently have
limited operation at that facility and in the first two months
of 2009 have begun to record tip fee and product sales revenue.
Also, we are currently producing both liquid and dry product 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 concentrate annually. We are
in the process of completing additional upgrades to the
Woodbridge facility, which are expected to be completed by June
2009, and which we believe will allow us to increase capacity at
the facility to approximately 70% of full capacity. During the
first ten weeks of 2009 we generated revenue from this facility
in the form of tip fees of approximately $50,000 and product
sales of approximately $126,000. 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
24
potential monthly sales from this facility, at 70% capacity
ranges from approximately $700,000 to $1,100,000. Cash flow
generated by exceeding that sales number would be used to fund
operations at the corporate level and to pay down the payables
related to construction activity at this facility.
WRI
Acquisition
On January 24, 2008, we 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.
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 WRI. With this acquisition, 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.
The Gonzales facility generated revenue during 2008 of
approximately $1,525,000, with a negative operating margin. We
plan 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
$150,000 to $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 that level, we expect the additional cash flow from the
Gonzales facility will be used to offset operating expenses at
the corporate level. Based on 2009 sales as of the date of this
report, we will need to increase sales volumes to achieve
breakeven sales levels, and as such we have added additional
sales personnel. There is no assurance that we will be
successful in increasing sales volumes.
25
Recent
Financing Activities
January
2008 and March 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 has been
extended to July 24, 2009. In addition, we issued to the
investors an aggregate of 750,000 Class A Warrants and
750,000 Class B Warrants which may be exercised at $8.25
and $11.00 per warrant share, respectively. A placement fee of
$225,000 was paid out of the proceeds of this loan. The
investors have 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 the filing of this report, the investors have converted
approximately 2,113,786 shares reducing the principal debt
amount by approximately $1,593,334.
In connection with the 2008 Financing, we entered into a
Security Agreement with the investors whereby we granted the
investors a security interest in Converted Organics of
California, LLC and any and all assets that are acquired by the
use of funds from the 2008 Financing. In addition, we 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.
On March 6, 2009, we entered into an agreement with an
investor to purchase a series of convertible term notes of up to
$1,500,000 with a 10% original issue discount. The investor
placed funds into escrow on March 10, 2009 to acquire
$500,000 in principal amount of the convertible notes to be
released upon receiving stockholder approval, and will acquire
four additional $250,000 increments in principal amount of the
note with the first increment occurring on the 30th day
after receiving stockholder approval, and the remaining three
increments occurring monthly, thereafter.
The convertible notes will be convertible at an initial rate of
85% of the closing bid price of our common stock for the trading
day immediately preceding any conversion (the Conversion
Price); provided that if we issue securities in an equity
financing transaction at a lower price than the Conversion
Price, the Conversion Price will be reduced to such lower price;
provided further that if we default on the convertible notes,
the Conversion Price will be the lowest of the above prices or
70% of the average of the three lowest market prices of our
common stock during the
20-day
trading period immediately prior to any conversion.
The series of convertible notes all, collectively, mature one
year from the date the first $500,000 increment of funding is
released to us after the initial approval of the transaction by
our stockholders. During the period leading up to the maturity
date, the 10% interest payable on the series of convertible
notes will become owed in its entirety on the day of funding
(assuming each convertible note was outstanding for a period of
one year) and added to the principal amount of the convertible
note. If an event of default has occurred, all the convertible
notes then outstanding will automatically become immediately due
and payable, and the interest rate will increase to 18% per
annum during the pendency of the event of default.
As additional consideration for the financing, we will issue the
investor an aggregate of 1,713,307 Class B warrants in pro
rata increments upon the issuance of each increment of the
convertible notes. The Class B warrants are exercisable at
$11.00 per warrant share.
On March 6, 2009, we also 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 thru July 30, 2009. These
funds had been held in a reserve for bond principal and interest
payments along with a reserve for lease payments. As
consideration for the release of the reserve funds, we issued
the bond holders 2,284,409 Class B warrants. The
Class B warrants are exercisable at $11.00 per warrant
share.
26
Development
Period
We are no longer a development-stage company. Since the
formation of one of our predecessors on May 2, 2003 through
December 31, 2008, we and our predecessor organizations
spent approximately $3.1 million of seed capital,
$1.8 million of bridge loan proceeds, $25.4 million of
proceeds from our public offering and the issuance on New Jersey
Economic Development Bonds, $4.5 million from the issuance
of convertible debentures and $11.3 million from the
exercise of our Class A Warrants to accomplish the
following:
|
|
|
|
|
acquire the IBRC technology license;
|
|
|
|
develop engineering plans;
|
|
|
|
identify appropriate sites for development;
|
|
|
|
enter into a lease for the site for our Woodbridge facility;
|
|
|
|
prepare certain environmental permit applications;
|
|
|
|
contract for third-party evaluation and validation of the
technology;
|
|
|
|
contract for two third-party studies analyzing the pricing and
market demand for our products;
|
|
|
|
pursue various environmental permits and licenses;
|
|
|
|
negotiate a long-term supply contract for source-separated
organic waste;
|
|
|
|
garner public/community support;
|
|
|
|
develop markets for our products by meeting with distributors of
organic products, wholesalers, and prior users of similar
products;
|
|
|
|
sponsor growth and efficacy trials for products produced by the
licensor;
|
|
|
|
issue our securities;
|
|
|
|
substantially complete construction on our Woodbridge facility;
|
|
|
|
make interest payments on our New Jersey Economic Development
Bonds
|
|
|
|
acquire the assets of UOP and WRI;
|
|
|
|
perform initial upgrades to our Gonzales facility; and
|
|
|
|
fund administrative, sales, marketing, operations and
development expenses.
|
These activities have been funded through a combination of
contributions of capital by our founders, private sales of
interests in our predecessor companies, and borrowings. Weston
Solutions, Inc. contributed approximately $2.3 million in
cash; ECAP, LLC, a boutique investment firm, of which William A.
Gildea, a former director of the Company, is the managing
member, contributed $300,000 in cash; and the balance came from
borrowings of $250,000 in 2004 and again in 2005 from individual
lenders at annual interest rates of 12% and 15%, respectively.
Additional funding for the above activities came from proceeds
of Bridge Loans of $1.8 million which were received in 2006
and subsequently repaid in 2007, and approximately
$25.4 million of funding from our initial public offering
of stock and the issuance of New Jersey Economic Development
Bonds, both of which closed on February 16, 2007, along
with a $4.5 million private financing agreement which
closed on January 24, 2008 and various exercises of
Class A Warrants which occurred during 2008 amounting to
$11.3 million in cash receipts.
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 is still in process on certain aspects of
the facility, mostly the installation of process control
systems, 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 expect the plant to be
operating at 70% of full capacity by June 2009. We had budgeted
27
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 product, which is in high demand by the
retail market. The estimated cost of this additional equipment
is approximately $1.5 million. We have decided to
incorporate the HTLC technology acquired from WRI into the
Woodbridge facility. We estimate that these costs could be
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. When this
did not occur, we began to seek extended payment terms with the
construction vendors. (As of the filing date of this report, we
have not negotiated revised payment terms with a majority of our
construction vendors. This 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 by product can be used in the
production process and sold as additional product.
Full-scale
Operations
Full capacity at the Woodbridge facility would provide capacity
of approximately 250 tons per day. As discussed above, we are in
the process of completing additional upgrades to the Woodbridge
facility, which are expected to be completed by June 2009, and
which we believe will 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 organic 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 will be 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.
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 2008 was
approximately $1,525,000 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 while completing
construction of our Woodbridge facility. 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.
28
Trends
and Uncertainties Affecting our Operations
We will be subject to a number of factors that may affect our
operations and financial performance. These factors include, but
are not limited to, the available supply and price of organic
food waste, the market for liquid and solid organic fertilizer,
increasing energy costs, the unpredictable cost of compliance
with environmental and other government regulation, and the time
and cost of obtaining USDA, state or other product labeling
designations. Demand for organic fertilizer and the resulting
prices customers are willing to pay also may not be as high as
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 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 December 31, 2008, we had total current assets of
approximately $7.2 million consisting primarily of cash,
restricted cash, and prepaid assets, and had current liabilities
of approximately $9.5 million, consisting primarily of
accounts payable, accrued expenses and notes payable leaving us
with negative working capital of approximately
$2.3 million. Non-current assets totaled $27.6 million
and consisted primarily of restricted cash, construction in
process and property and equipment. Non-current liabilities
consist primarily of notes payable of $597,000 and bonds payable
of $17,500,000 at December 31, 2008. We have an accumulated
deficit at December 31, 2008 of approximately
$26.6 million. Owners equity at December 31,
2008 was approximately $5.0 million. For 2008, we generated
revenues from operations of approximately $1.5 million.
Prior to 2008, the Company had no revenues.
We issued 1,800,000 Class A warrants as part of our initial
public offering. We also issued an additional 293,629
Class A warrants and 375,000 Class A warrants as part
of the February 16, 2007 and January 24, 2008
financings, respectively. The exercise price of each
Class A warrant was $8.25 per share. In the first nine
months of 2008, 756,000 of the Class A warrants were
voluntarily exercised, providing us with approximately
$6.1 million in cash. The remaining Class A warrants
(1,029,609 from the initial public offering, 293,629 from the
February 2007 financing, and 375,000 from the January 2008
financing) were redeemable at our option, at a redemption price
of $0.25 per warrant. On September 16, 2008, we notified
warrant holders that we were calling the Class A warrants
for redemption, and unless the warrants were exercised prior to
the redemption date, we would redeem them for $0.25 per warrant.
We subsequently extended the redemption date to
November 14, 2008. In connection with the redemption, we
received proceeds of approximately $5.5 million upon the
exercise of approximately 673,000 Class A warrants. The
remaining Class A Warrants (approximately 1.0 million)
were redeemed by us for $0.25 each and will no longer be
exercisable into shares of common stock. The exercise of
warrants under the Class A redemption call is now complete
and will not generate any additional proceeds. Of the
approximately, $11.3 million raised in 2008 from the
exercise and redemption of the Class A Warrants,
approximately $3.3 million remains as of December 31,
2008 and the remainder was used to finance operations, pay
interest on debt, retire $300,000 of short term notes, finance
sales and marketing efforts and pay some of the construction
costs, upgrades and design changes at the Woodbridge facility.
We also issued 1,800,000 Class B warrants as part of our
initial public offering, and 293,629 Class B warrants and
375,000 Class B warrants as part of the February 16,
2007 and January 24, 2008 financings, respectively, all of
which have the same expiration date as the Class A
warrants, which is February 16, 2012. The Class B
warrants are not redeemable by the Company and, as such, we can
provide no assurance that they will ever be exercised. The
exercise price of the Class B Warrants is $11.00 per share,
however, when the cumulative effect of the stock dividends is
taken into consideration the exercise price is $7.48, or for
each Class B warrant exercised at $11.00 we will issue
1.47 shares of common stock.
On March 6, 2009, we entered into an agreement with an
investor to purchase a series of convertible term notes of up to
$1,500,000 with a 10% original issue discount. The investor
placed funds into escrow on March 10, 2009 to acquire
$500,000 in principal amount of the convertible notes to be
released upon receiving stockholder approval, and will acquire
four additional $250,000 increments in principal amount of the
note with the first increment occurring on the 30th day
after receiving stockholder approval, and the remaining three
increments monthly
29
thereafter. Assuming we receive stockholder approval for the
transaction, the series of convertible notes will provide us
with $1,350,000 in gross proceeds. As additional consideration
for the financing, we will issue the investor an aggregate of
1,713,307 Class B warrants in pro rata increments upon the
issuance of each increment of the convertible notes.
On March 6, 2009, we also entered into an agreement with
the holders of our $17.5 million of 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 thru July 30, 2009. As
consideration for the release of the reserve funds, we issued
the bond holders 2,284,409 Class B warrants.
Our current liabilities are greater than our current assets by
approximately $2.2 million, of which $4.3 million of
current liabilities is composed of the convertible debentures
from the 2008 Financing which have a due date of July 24,
2009 and are convertible into shares of our common stock. As of
March 27, 2009, approximately $1,593,000 in principal
amount of the debentures has been converted into shares of
common stock. We also have trade accounts payable of
approximately $3.6 million of which approximately
$2.8 million relates to construction at the Woodbridge
facility. We expect this $2.8 million to increase to
approximately $5.7 million by March 31, 2009. We will
need to enter into agreements with the various construction
vendors as we do not currently have the funds available to pay
these amounts. If we are unable to come to agreements with our
construction vendors, the vendors may attempt to take actions
against us or the Woodbridge facility, which could result in
interruptions to the operations of the Woodbridge facility,
which would adversely effect our business results.
We currently have manufacturing capabilities in our Woodbridge
and Gonzales facilities as a means to generate revenues,
although neither facility is currently generating positive cash
flow from operations. If the remaining $3.6 million of
convertible debentures from our 2008 Financing is converted into
shares of our common stock, we believe the release of the
$2.0 million of escrowed funds by the holders of the NJEDA
bonds, along with the cash from estimated sales from the
Woodbridge and Gonzales facilities of at least $750,000 will
provide us enough working capital until the upgrades to the
Woodbridge facility is complete and until we hold a shareholder
vote to allow an investor to purchase $1,500,000 of convertible
term notes assuming we receive such approval and achieve the
$750,000 sales level by May 31, 2009; provided that we are
able to come to agreements with our construction vendors
allowing us to delay payments to such vendors. If we obtain
shareholder approval for the purchase of the convertible term
notes but do not achieve the required sales level from
Woodbridge and Gonzales we will need to seek additional sources
of working capital. Currently we estimate that the monthly
breakeven sales for the Gonzales and Woodbridge facilities is in
the range of $600,000 to $750,000 and in addition our current
cash requirement at the corporate level is in a range of
$250,000 to $300,000 giving us a total monthly cash requirement
in the range of $850,000 to $1,050,000. We plan to produce, at
Gonzales and Woodbridge, sufficient product to generate sales in
the range of $1,050,000 to $1,550,000. Cash for use as working
capital at the corporate level would not be available from
operations until we achieved such monthly breakeven sales
levels. If shareholder approval is received for the issuance of
the convertible notes we would have to achieve breakeven sales
levels by July 31, 2009 or the proceeds of the notes would
not be provide sufficient working capital for us to operate and
if shareholder approval is not obtained and we do not achieve
breakeven sales level we would not have sufficient working
capital to operate past May 31, 2009. Based on 2009 sales
as of the date of this report, we will need increase sales
volumes to achieve such break even sales levels, and there is no
assurance that we will be successfully in increasing sales
volumes.
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.
30
Critical
Accounting Policies and Estimates
Our plan of operation is based in part upon the Companys
consolidated financial statements, which have been prepared in
accordance with accounting principles generally accepted in the
United States of America. The preparation of financial
statements in accordance with generally accepted accounting
principles requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities,
including the recoverability of tangible and intangible assets,
disclosure of contingent assets and liabilities as of the date
of the financial statements, and the reported amounts of
expenses during the periods covered. A summary of accounting
policies that have been applied to the historical financial
statements can be found in the notes to the consolidated
financial statements.
We evaluate our estimates on an on-going basis. The most
significant estimates relate to intangible assets, deferred
financing and issuance costs, and the fair value of financial
instruments. We base our estimates on historical Company and
industry experience and on various other assumptions that we
believe to be reasonable under the circumstances, the results of
which, form the basis for making judgments about the carrying
values of assets and liabilities that are not readily apparent
from other sources. Actual results may differ materially from
those estimates.
The following is a brief discussion of our critical accounting
policies and methods, and the judgments and estimates used by us
in their application:
Revenue
Recognition
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.
Share-Based
Compensation
We account for equity instruments exchanged for services in
accordance with Statement of Financial Accounting Standards
(SFAS) No. 123R, Share-Based
Payment. Under the provisions of SFAS No. 123R,
share-based compensation issued to employees is measured at the
grant date, based on the fair value of the award, and is
recognized as an expense over the requisite service period
(generally the vesting period of the grant). Share-based
compensation issued to non-employees is measured at grant date,
based on the fair value of the consideration received or the
fair value of the equity instruments issued, whichever is more
readily measurable, and is recognized as an expense over the
requisite service period. Stock options granted in 2008 were
calculated at the date of grant using a Black-Scholes pricing
model with the following assumptions: risk-free interest rate of
3.52%; no dividend yield; expected volatility factor of 52.3%;
and an expected term of five years. The fair value for the
10,000 immediately vesting stock options granted in 2007 was
estimated at the date of grant using a Black-Scholes pricing
model with the following assumptions; risk-free interest rate of
4.9%; no dividend yield; expected volatility factor of 16.9%;
and an expected term of five years. Estimates and judgments used
in the preparation of our financial statements are, by their
nature, uncertain and unpredictable, and depend upon, among
other things, many factors outside of our control, such as the
results of our operations and other economic conditions.
Accordingly, our estimates and judgments may prove to be
incorrect and actual results may differ, perhaps significantly,
from these estimates under different estimates, assumptions or
conditions.
31
Other
Long-Lived Assets
We account for our long-lived assets (excluding goodwill) in
accordance with SFAS No. 144, Accounting for the
Impairment of Long-lived Assets and for Long-lived Assets to be
Disposed of, which requires that long-lived assets and
certain intangible assets be reviewed for impairment whenever
events or changes in circumstances indicate that the carrying
amount may not be recoverable, such as technological changes or
significantly increased competition. If undiscounted expected
future cash flows are less than the carrying value of the
assets, an impairment loss is to be recognized based on the fair
value of the assets, calculated using a discounted cash flow
model. There is inherent subjectivity and judgments involved in
cash flow analyses such as estimating revenue and cost growth
rates, residual or terminal values and discount rates, which can
have a significant impact on the amount of any impairment.
Other long-lived assets, such as identifiable intangible assets,
are amortized over their estimated useful lives. These assets
are reviewed for impairment whenever events or circumstances
provide evidence that suggests that the carrying amount of the
assets may not be recoverable, with impairment being based upon
an evaluation of the identifiable undiscounted cash flows. If
impaired, the resulting charge reflects the excess of the
assets carrying cost over its fair value. As described
above, there is inherent subjectivity involved in estimating
future cash flows, which can have a significant impact on the
amount of any impairment. Also, if market conditions become less
favorable, future cash flows (the key variable in assessing the
impairment of these assets) may decrease and as a result we may
be required to recognize impairment charges in the future.
Estimates and judgments used in the preparation of our financial
statements are, by their nature, uncertain and unpredictable,
and depend upon, among other things, many factors outside of our
control, such as the results of our operations and other
economic conditions. Accordingly, our estimates and judgments
may prove to be incorrect and actual results may differ, perhaps
significantly, from these estimates under different estimates,
assumptions or conditions.
Capitalization
of Interest Costs
We have capitalized interest costs, net of certain interest
income, in accordance with Statement of Financial Accounting
Standards No. 62, Capitalization of Interest Cost
Involving Certain Tax-Exempt Borrowings and Certain Gifts and
Grants, related to its New Jersey Economic Development
Authority Bonds in the amount of $1,077,689 and $403,573 as of
December 31, 2008 and December 31, 2007, respectively.
Capitalized interest costs during the construction phase are
included in construction in progress on the consolidated balance
sheets.
Construction-in-Progress
Construction-in-progress
includes amounts incurred for construction costs, equipment
purchases and capitalized interest costs for items still under
construction related to the construction of the Companys
Woodbridge facility.
Restricted
Cash
As of December 31, 2008, we had remaining approximately
$2,608,000 of restricted cash as required by our bond agreement.
This cash was raised by the Company in its initial public
offering and bond financing, both of which closed on
February 16, 2007, and is set aside in three separate
accounts consisting of $34,000 for the construction of the
Woodbridge facility, $8,000 for the working capital requirements
of the Woodbridge subsidiary while the facility is under
construction and $2,028,000 in reserve for bond principal and
interest payments along with a reserve for lease payments. In
March 2009, the bondholder released $2,000,000 of these
restricted funds for the Company to use and therefore we have
classified cash as a current asset on our balance sheet as of
December 31, 2008. 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.
Fair
Value of Financial Instruments
Statement of Financial Accounting Standards (SFAS) No. 107,
Fair Value of Financial Instruments, requires
disclosure of the fair value of financial instruments for which
the determination of fair value is practicable.
32
SFAS No. 107 defines the fair value of a financial
instrument as the amount at which the instrument could be
exchanged in a current transaction between willing parties. The
carrying amount of the Companys financial instruments
consisting of cash, accounts payable, and accrued expenses
approximate their fair value because of the short maturity of
those instruments. The fair value of the Companys term
notes payable and New Jersey Economic Development Authority bond
were estimated by discounting the future cash flows using
current rates offered by lenders for similar borrowings with
similar credit ratings. The fair value of the term notes payable
and the New Jersey Economic Development Authority bonds
approximate their carrying value. The Companys financial
instruments are held for other than trading purposes.
Results
of Operations
For the period from inception (May 3, 2003) until
December 31, 2007, we were a development stage company with
no revenues. We began to earn revenues from our Gonzales and
Woodbridge facilities during 2008, and production has begun at
our Woodbridge facility and therefore we are no longer reporting
as a development stage company.
During the year ended December, 2008, we had sales of
approximately $1.5 million compared to $0 for the same
period in 2007. During 2008 we had cost of goods sold of
approximately $2 million, leaving a negative gross margin
of approximately $433,000 compared to $0 cost of goods sold and
$0 gross margin for the same period in 2007. The sales and
negative gross margins were derived primarily from both our
Gonzales and Woodbridge facilities. The negative gross margin
was generated in the third and fourth quarters and is further
explained below. We expect the gross margin to improve in the
future as we increase production and expand our sales efforts
into more profitable markets. Of the $433,000 negative gross
margin in the year ended December 31, 2008, approximately
$275,000 was generated at our Gonzales facility due to lower
than expected sales volume and higher than anticipated
production and transportation costs, and approximately $158,000
in negative gross margin was generated at our Woodbridge
facility due to low sales volume and the
start-up
nature of the facility.
We incurred operating expenses of approximately
$10.3 million and $3.7 million for the year ended
December 31, 2008 and 2007, respectively. The principal
components of the $6.6 million increase in operating
expenses is an increase in general and administrative expenses
of $6.3 million (due mainly to an increase in general and
administrative expenses of $1.4 million for additional
personnel and other costs associated with the
start-up of
the New Jersey facility, $829,000 in additional expenses
associated with the California facility, $500,000 in additional
personnel at the corporate offices, $290,000 in expense related
to the issuance of stock for remuneration for services rendered,
$200,000 in professional fees relating to private placement
financing, $150,000 relating to recognition of liquidated
damages associated with the private placement financing, an
additional $200,000 in amortization of intangible assets
acquired from UOP and WRI and $2.3 million recognized as
compensation expense upon the issuance of employee stock options
as calculated using the Black-Scholes pricing model), offset by
a $350,000 reduction in research and development costs.
Interest expense for the years ended December 31, 2008 and
2007 was $5.8 and $1.2 million, respectively. The increase
is due to the interest payments on the convertible debentures
issued in the 2008 Financing described herein; amortization of
the original issue discount on the convertible debentures issued
in the 2008 Financing; and amortization of the discount related
to the beneficial conversion feature of the convertible
debentures issued in the 2008 Financing and other convertible
debt. Interest income was $290,000 in the year ended
December 31, 2008 and $824,000 for the same period in 2007.
The decrease is due to our declining balances in restricted cash.
Amortization of other intangible assets expense was $399,000 for
the year ended December 31, 2008 and $62,000 during the
same period in 2007. The increase is due to amortization of
costs associated with the convertible debentures issued in the
2008 Financing, which are being amortized over the life of the
loan.
For the year ended December 31, 2008, net loss was
$16.2 million compared to $4.1 million for the same
period in 2007. The increase in net loss primarily represents
the effects of the increase in our operating costs and interest
expense, as discussed above.
As of December 31, 2008, we had current assets of
approximately $7.2 million compared to $3.2 million as
of December 31, 2007. Our total assets were approximately
$32.6 million as of December 31, 2008 compared to
33
approximately $22.2 million as of December 31, 2007.
The majority of the increase in both current and total assets
from December 31, 2007 to December 31, 2008 is due to
receipt of approximately $11.3 million in cash from the
voluntary exercise of our Class A warrants and
$3.0 million in net assets acquired with our acquisitions
of UOP and WRI.
As of December 31, 2008, we had current liabilities of
approximately $9.5 million compared to $2.5 million at
December 31, 2007. This significant increase is due largely
to the convertible debentures issued in the 2008 Financing, net
of discounts of $230,000 and loans issued in association with
our acquisitions of UOP and WRI and an increase in accounts
payable to construction related vendors. In addition, we had
long-term liabilities of approximately $18.1 million as of
December 31, 2008 as compared to $17.6 million at
December 31, 2007. This increase is primarily due to the
issuance of long term notes payable in association with our
acquisition of UOP and WRI.
For the twelve months ended December 31, 2008 we had
negative cash flow from operating activity of approximately
$7.3 million, comprising primarily loss from operations
offset by certain non-cash items such as depreciation,
amortization of deferred financing fees and amortization of
discounts on private financing, $2.3 million in expense
associated with the grant of stock options and an increase in
accounts payable and accrued expenses. We also had negative cash
flow from investing activities of $4.7 million, primarily
related to the purchase of UOP assets and construction at the
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
$15 million in positive cash flow from financing activities
comprising approximately $11.3 million from the exercise of
warrants, and $3.7 million from the proceeds of the January
2008 private financing.
|
|
ITEM 7A.
|
QUANTITATIVE
AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
|
Not applicable.
34
CONVERTED
ORGANICS INC.
INDEX TO
CONSOLIDATED FINANCIAL STATEMENTS
35
REPORT OF
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Stockholders and Board of Directors of Converted Organics
Inc.
We have audited the accompanying consolidated balance sheets of
Converted Organics Inc. (the Company) as of
December 31, 2008 and 2007, and the related consolidated
statements of operations, changes in owners equity
(deficit) and cash flows for the years then ended. These
consolidated financial statements are the responsibility of the
Companys management. Our responsibility is to express an
opinion on these consolidated financial statements based on our
audits.
We conducted our audits in accordance with the standards of the
Public Company Accounting Oversight Board (United States). Those
standards require that we plan and perform the audits to obtain
reasonable assurance about whether the consolidated financial
statements are free of material misstatement. The Company is not
required to have, nor were we engaged to perform, an audit of
its internal control over financial reporting. Our audits
included consideration of internal control over financial
reporting as a basis for designing audit procedures that are
appropriate in the circumstances, but not for the purpose of
expressing an opinion on the effectiveness of the Companys
internal control over financial reporting. Accordingly, we
express no such opinion. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the
consolidated financial statements, assessing the accounting
principles used and significant estimates made by management, as
well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the consolidated financial statements referred
to above present fairly, in all material respects, the financial
position of Converted Organics Inc. as of December 31, 2008
and 2007, and the results of their operations and their cash
flows for the years then ended, in conformity with accounting
principles generally accepted in the United States of America.
The accompanying consolidated financial statements have been
prepared assuming that the Company will continue as a going
concern. As shown in the accompanying consolidated financial
statements, the Company has incurred a net loss of approximately
$16.2 million during the year ended December 31, 2008,
has a working capital deficiency as of December 31, 2008
and an accumulated deficit of approximately $26.6 million.
These factors raise substantial doubt about the Companys
ability to continue as a going concern. Managements plans
in regards to these matters are described in Note 2. These
consolidated financial statements do not include any adjustments
that might result from the outcome of this uncertainty.
Glastonbury, Connecticut
March 27, 2009
36
|
|
Item 8.
|
Financial
Statements
|
CONVERTED
ORGANICS INC.
CONSOLIDATED
BALANCE SHEETS
|
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
|
December 31,
|
|
|
|
2008
|
|
|
2007
|
|
|
ASSETS
|
CURRENT ASSETS
|
|
|
|
|
|
|
|
|
Cash and cash equivalents
|
|
$
|
3,357,940
|
|
|
$
|
287,867
|
|
Restricted cash
|
|
|
2,547,557
|
|
|
|
2,590,053
|
|
Accounts receivable, net
|
|
|
313,650
|
|
|
|
|
|
Inventories
|
|
|
289,730
|
|
|
|
|
|
Prepaid rent
|
|
|
389,930
|
|
|
|
190,600
|
|
Other prepaid expenses
|
|
|
73,937
|
|
|
|
40,282
|
|
Deposits
|
|
|
141,423
|
|
|
|
|
|
Other receivables
|
|
|
94,250
|
|
|
|
55,450
|
|
Deferred financing and issuance costs, net
|
|
|
22,042
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total current assets
|
|
|
7,230,459
|
|
|
|
3,164,252
|
|
|
|
|
|
|
|
|
|
|
Deposits
|
|
|
912,054
|
|
|
|
554,978
|
|
Restricted cash
|
|
|
60,563
|
|
|
|
12,006,359
|
|
Property and equipment, net
|
|
|
19,725,146
|
|
|
|
|
|
Construction-in-progress
|
|
|
974,900
|
|
|
|
4,947,067
|
|
Capitalized bond costs, net
|
|
|
862,010
|
|
|
|
909,679
|
|
Intangible assets, net
|
|
|
2,852,876
|
|
|
|
585,750
|
|
Deferred financing and issuance costs, net
|
|
|
|
|
|
|
8,642
|
|
|
|
|
|
|
|
|
|
|
Total assets
|
|
$
|
32,618,008
|
|
|
$
|
22,176,727
|
|
|
|
|
|
|
|
|
|
|
|
LIABILITIES AND OWNERS EQUITY (DEFICIT)
|
CURRENT LIABILITIES
|
|
|
|
|
|
|
|
|
Term notes payable current
|
|
$
|
89,170
|
|
|
$
|
375,000
|
|
Accounts payable
|
|
|
3,583,030
|
|
|
|
898,270
|
|
Accrued compensation officers, directors and
consultants
|
|
|
430,748
|
|
|
|
397,781
|
|
Accrued legal and other expenses
|
|
|
164,620
|
|
|
|
199,261
|
|
Accrued interest
|
|
|
601,166
|
|
|
|
630,890
|
|
Convertible notes payable, net of unamortized discount
|
|
|
4,602,660
|
|
|
|
|
|
Mortgage payable, current
|
|
|
3,006
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total current liabilities
|
|
|
9,474,400
|
|
|
|
2,501,202
|
|
|
|
|
|
|
|
|
|
|
Term note payable, net of current portion
|
|
|
|
|
|
|
89,170
|
|
Mortgage payable, net of current portion
|
|
|
245,160
|
|
|
|
|
|
Convertible note payable, net of current portion
|
|
|
351,516
|
|
|
|
|
|
Bonds payable
|
|
|
17,500,000
|
|
|
|
17,500,000
|
|
|
|
|
|
|
|
|
|
|
Total liabilities
|
|
|
27,571,076
|
|
|
|
20,090,372
|
|
|
|
|
|
|
|
|
|
|
COMMITMENTS AND CONTINGENCIES
|
|
|
|
|
|
|
|
|
OWNERS EQUITY (DEFICIT)
|
|
|
|
|
|
|
|
|
Preferred stock, $.0001 par value, authorized
10,000,000 shares; no shares issued and outstanding
|
|
|
|
|
|
|
|
|
Common stock, $.0001 par value, authorized
40,000,000 shares; 7,431,436 and 4,229,898 shares
issued and outstanding at December 31, 2008 and
December 31, 2007
|
|
|
743
|
|
|
|
423
|
|
Additional paid-in capital
|
|
|
31,031,647
|
|
|
|
12,460,357
|
|
Members equity
|
|
|
619,657
|
|
|
|
|
|
Accumulated deficit
|
|
|
(26,605,115
|
)
|
|
|
(10,374,425
|
)
|
|
|
|
|
|
|
|
|
|
Total owners equity
|
|
|
5,046,932
|
|
|
|
2,086,355
|
|
|
|
|
|
|
|
|
|
|
Total liabilities and owners equity
|
|
$
|
32,618,008
|
|
|
$
|
22,176,727
|
|
|
|
|
|
|
|
|
|
|
The accompanying notes are an integral part of these
consolidated financial statements.
37
CONVERTED
ORGANICS INC.
CONSOLIDATED
STATEMENTS OF OPERATIONS
|
|
|
|
|
|
|
|
|
|
|
Year Ended
|
|
|
|
December 31,
|
|
|
December 31,
|
|
|
|
2008
|
|
|
2007
|
|
|
Revenues
|
|
$
|
1,547,981
|
|
|
$
|
|
|
Cost of goods sold
|
|
|
1,981,084
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross loss
|
|
|
(433,103
|
)
|
|
|
|
|
Operating expenses
|
|
|
|
|
|
|
|
|
General and administrative expenses
|
|
|
9,309,976
|
|
|
|
3,009,678
|
|
Research and development
|
|
|
375,267
|
|
|
|
648,664
|
|
Amortization of license and intangible assets
|
|
|
263,387
|
|
|
|
16,500
|
|
|
|
|
|
|
|
|
|
|
Loss from operations
|
|
|
(10,381,733
|
)
|
|
|
(3,674,842
|
)
|
|
|
|
|
|
|
|
|
|
Other income/(expenses)
|
|
|
|
|
|
|
|
|
Interest income
|
|
|
290,125
|
|
|
|
824,466
|
|
Other income
|
|
|
146,677
|
|
|
|
|
|
Amortization of capitalized costs
|
|
|
(399,269
|
)
|
|
|
(62,429
|
)
|
Interest expense
|
|
|
(5,834,898
|
)
|
|
|
(1,171,207
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
(5,797,365
|
)
|
|
|
(409,170
|
)
|
|
|
|
|
|
|
|
|
|
Loss before provision for income taxes
|
|
|
(16,179,098
|
)
|
|
|
(4,084,012
|
)
|
Provision for income taxes
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss
|
|
|
(16,179,098
|
)
|
|
|
(4,084,012
|
)
|
|
|
|
|
|
|
|
|
|
Net loss per share, basic and diluted
|
|
$
|
(2.70
|
)
|
|
|
(0.87
|
)
|
|
|
|
|
|
|
|
|
|
Weighted average common shares outstanding
|
|
|
5,985,017
|
|
|
|
4,716,378
|
|
|
|
|
|
|
|
|
|
|
The accompanying notes are an integral part of these
consolidated financial statements.
38
CONVERTED
ORGANICS INC.
CONSOLIDATED
STATEMENTS OF CHANGES IN OWNERS EQUITY (DEFICIT)
Years
Ended December 31, 2008 and 2007
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Common Stock
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
|
Shares Issued
|
|
|
|
|
|
Additional
|
|
|
|
|
|
|
|
|
Owners
|
|
|
|
and
|
|
|
|
|
|
Paid-in
|
|
|
Members
|
|
|
Accumulated
|
|
|
Equity
|
|
|
|
Outstanding
|
|
|
Amount
|
|
|
Capital
|
|
|
Equity
|
|
|
Deficit
|
|
|
(Deficit)
|
|
|
Balance, December 31, 2006
|
|
|
1,333,333
|
|
|
$
|
133
|
|
|
$
|
4,113,385
|
|
|
$
|
|
|
|
$
|
(6,290,413
|
)
|
|
$
|
(2,176,895
|
)
|
Issuance of common stock and warrants in connection with the
Companys initial public offering, net of issuance costs of
$1,736,715
|
|
|
1,800,000
|
|
|
|
180
|
|
|
|
8,163,105
|
|
|
|
|
|
|
|
|
|
|
|
8,163,285
|
|
Common stock and warrants issued in connection with bridge units
|
|
|
293,629
|
|
|
|
29
|
|
|
|
(29
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
Common stock issued in connection with extension of bridge
financing
|
|
|
55,640
|
|
|
|
6
|
|
|
|
178,042
|
|
|
|
|
|
|
|
|
|
|
|
178,048
|
|
Issuance of stock options
|
|
|
|
|
|
|
|
|
|
|
5,929
|
|
|
|
|
|
|
|
|
|
|
|
5,929
|
|
Stock dividends
|
|
|
747,296
|
|
|
|
75
|
|
|
|
(75
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(4,084,012
|
)
|
|
|
(4,084,012
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, December 31, 2007
|
|
|
4,229,898
|
|
|
|
423
|
|
|
|
12,460,357
|
|
|
|
|
|
|
|
(10,374,425
|
)
|
|
|
2,086,355
|
|
Consolidation of variable interest entity
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
23,965
|
|
|
|
|
|
|
|
23,965
|
|
Common stock issued upon exercise of warrants
|
|
|
1,780,506
|
|
|
|
178
|
|
|
|
11,435,476
|
|
|
|
|
|
|
|
|
|
|
|
11,435,654
|
|
Common stock issued upon exercise of options
|
|
|
143,000
|
|
|
|
14
|
|
|
|
536,236
|
|
|
|
|
|
|
|
|
|
|
|
536,250
|
|
Common stock issued for services rendered
|
|
|
45,480
|
|
|
|
5
|
|
|
|
212,614
|
|
|
|
|
|
|
|
|
|
|
|
212,619
|
|
Warrants issued in connection with financings, net of
cancellations
|
|
|
|
|
|
|
|
|
|
|
1,113,750
|
|
|
|
|
|
|
|
|
|
|
|
1,113,750
|
|
Beneficial conversion features on convertible notes
|
|
|
|
|
|
|
|
|
|
|
2,943,386
|
|
|
|
|
|
|
|
|
|
|
|
2,943,386
|
|
Stock dividends
|
|
|
1,232,552
|
|
|
|
123
|
|
|
|
(123
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
Issuance of stock options
|
|
|
|
|
|
|
|
|
|
|
2,329,951
|
|
|
|
|
|
|
|
|
|
|
|
2,329,951
|
|
Members contributions
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
544,100
|
|
|
|
|
|
|
|
544,100
|
|
Net income (loss)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
51,592
|
|
|
|
(16,230,690
|
)
|
|
|
(16,179,098
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, December 31, 2008
|
|
|
7,431,436
|
|
|
$
|
743
|
|
|
$
|
31,031,647
|
|
|
$
|
619,657
|
|
|
$
|
(26,605,115
|
)
|
|
$
|
5,046,932
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The accompanying notes are an integral part of these
consolidated financial statements.
39
CONVERTED
ORGANICS INC.
CONSOLIDATED
STATEMENTS OF CASH FLOWS
|
|
|
|
|
|
|
|
|
|
|
Years Ended
|
|
|
|
December 31,
|
|
|
December 31,
|
|
|
|
2008
|
|
|
2007
|
|
|
CASH FLOWS FROM OPERATING ACTIVITIES:
|
|
|
|
|
|
|
|
|
Net loss
|
|
$
|
(16,179,098
|
)
|
|
$
|
(4,084,012
|
)
|
Adjustments to reconcile net loss to net cash used in operating
activities:
|
|
|
|
|
|
|
|
|
Consolidation of variable interest entity
|
|
|
6,164
|
|
|
|
|
|
Amortization of intangible asset license
|
|
|
16,500
|
|
|
|
16,500
|
|
Amortization of other intangible assets
|
|
|
246,887
|
|
|
|
|
|
Amortization of capitalized bond costs
|
|
|
47,669
|
|
|
|
43,696
|
|
Amortization of deferred financing fees
|
|
|
331,600
|
|
|
|
18,733
|
|
Depreciation and amortization of property and equipment
|
|
|
411,843
|
|
|
|
|
|
Amortization of beneficial conversion features
|
|
|
2,712,009
|
|
|
|
|
|
Amortization of discounts on private financing
|
|
|
1,563,750
|
|
|
|
|
|
Stock option compensation expense
|
|
|
2,329,951
|
|
|
|
5,929
|
|
Stock issued for services rendered
|
|
|
212,619
|
|
|
|
|
|
Forgiveness of debt and accrued interest
|
|
|
(146,677
|
)
|
|
|
|
|
Loss on sale of fixed asset
|
|
|
176
|
|
|
|
|
|
Stock issued for extension of bridge financing
|
|
|
|
|
|
|
178,048
|
|
Changes in operating assets and liabilities:
|
|
|
|
|
|
|
|
|
(Increase) decrease in:
|
|
|
|
|
|
|
|
|
Accounts receivable
|
|
|
(284,948
|
)
|
|
|
|
|
Inventories
|
|
|
(278,616
|
)
|
|
|
|
|
Prepaid expenses and other current assets
|
|
|
(242,983
|
)
|
|
|
(144,329
|
)
|
Other assets
|
|
|
(38,800
|
)
|
|
|
|
|
Deposits
|
|
|
(507,500
|
)
|
|
|
(350,000
|
)
|
Increase (decrease) in:
|
|
|
|
|
|
|
|
|
Accounts payable and other accrued expenses
|
|
|
2,425,206
|
|
|
|
71,191
|
|
Accrued compensation officers, directors and
consultants
|
|
|
32,967
|
|
|
|
97,781
|
|
Accrued interest
|
|
|
(8,048
|
)
|
|
|
488,271
|
|
Other
|
|
|
25,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash used in operating activities
|
|
|
(7,324,329
|
)
|
|
|
(3,658,192
|
)
|
|
|
|
|
|
|
|
|
|
CASH FLOWS FROM INVESTING ACTIVITIES
|
|
|
|
|
|
|
|
|
Release of restricted cash
|
|
|
11,988,292
|
|
|
|
6,050,199
|
|
Cash paid for acquisitions
|
|
|
(1,500,000
|
)
|
|
|
|
|
Purchase of property and equipment
|
|
|
(14,233,823
|
)
|
|
|
|
|
Proceeds from sale of fixed assets
|
|
|
24,000
|
|
|
|
|
|
Capitalized interest
|
|
|
(72,438
|
)
|
|
|
(403,572
|
)
|
Construction costs
|
|
|
(902,462
|
)
|
|
|
(4,543,495
|
)
|
Restrictions of cash
|
|
|
|
|
|
|
(20,646,611
|
)
|
Deposit on license
|
|
|
|
|
|
|
(139,978
|
)
|
|
|
|
|
|
|
|
|
|
Net cash used in investing activities
|
|
|
(4,696,431
|
)
|
|
|
(19,683,457
|
)
|
|
|
|
|
|
|
|
|
|
CASH FLOWS FROM FINANCING ACTIVITIES
|
|
|
|
|
|
|
|
|
Net proceeds from exercise of warrants
|
|
|
11,435,654
|
|
|
|
|
|
Proceeds from private financing, net of original issue discount
|
|
|
3,715,000
|
|
|
|
|
|
Net proceeds from exercise of options
|
|
|
536,250
|
|
|
|
|
|
Members contributions
|
|
|
544,100
|
|
|
|
|
|
Payments made for deferred issuance costs
|
|
|
|
|
|
|
(42,916
|
)
|
Payments made on mortgage payable
|
|
|
(6,124
|
)
|
|
|
|
|
Repayment of term notes issued for acquisition
|
|
|
(814,447
|
)
|
|
|
|
|
Net proceeds from bond financing
|
|
|
|
|
|
|
16,546,625
|
|
Net proceeds from initial public offering of stock
|
|
|
|
|
|
|
8,859,784
|
|
Proceeds from term notes
|
|
|
|
|
|
|
89,170
|
|
Repayment of term notes
|
|
|
(250,000
|
)
|
|
|
(125,000
|
)
|
Repayment of demand notes
|
|
|
(69,600
|
)
|
|
|
(250,000
|
)
|
Repayment of bridge loan
|
|
|
|
|
|
|
(1,515,000
|
)
|
|
|
|
|
|
|
|
|
|
Net cash provided by financing activities
|
|
|
15,090,833
|
|
|
|
23,562,663
|
|
|
|
|
|
|
|
|
|
|
NET INCREASE IN CASH
|
|
|
3,070,073
|
|
|
|
221,014
|
|
CASH AND CASH EQUIVALENTS, beginning of period
|
|
|
287,867
|
|
|
|
66,853
|
|
|
|
|
|
|
|
|
|
|
CASH AND CASH EQUIVALENTS, end of period
|
|
$
|
3,357,940
|
|
|
$
|
287,867
|
|
|
|
|
|
|
|
|
|
|
Supplemental cash flow information:
|
|
|
|
|
|
|
|
|
Cash paid during the period for:
|
|
|
|
|
|
|
|
|
Interest
|
|
$
|
5,864,622
|
|
|
$
|
908,456
|
|
Non-cash financing activities:
|
|
|
|
|
|
|
|
|
Financing costs paid from proceeds of private financing
|
|
$
|
335,000
|
|
|
$
|
|
|
Issuance costs paid from proceeds of initial public offering
|
|
|
|
|
|
|
1,040,216
|
|
Issuance costs paid from proceeds of bond financing
|
|
|
|
|
|
|
953,375
|
|
Beneficial conversion discount on convertible notes
|
|
|
2,943,386
|
|
|
|
|
|
Warrants issued in connection with financing
|
|
|
1,113,750
|
|
|
|
|
|
The accompanying notes are an integral part of these
consolidated financial statements.
40
CONVERTED
ORGANICS INC.
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
|
|
NOTE 1
|
NATURE OF
OPERATIONS
|
Converted Organics Inc. (the Company) uses food and
other waste as a raw material to manufacture, sell and
distribute all-natural soil amendment products combining disease
suppression and nutrition characteristics. The Company
transitioned from a development stage company to an operating
company in the second quarter of 2008 as operations commenced
and the Company has approximately $1.5 million in revenue
for the year ended December 31, 2008. The Companys
revenues come from two sources: tip fees and product sales.
Waste haulers pay the Company tip fees for accepting
food waste generated by food distributors such as grocery
stores, produce docks and fish markets, food processors, and
hospitality venues such as hotels, restaurants, convention
centers and airports. Revenue also comes from the sale of the
Companys fertilizer products. The Companys products
possess a combination of nutritional, disease suppression and
soil amendment characteristics.
Converted Organics of California, LLC, (California)
a California limited liability company and wholly-owned
subsidiary of the Company, was formed when the Company acquired
the assets of United Organics Products, LLC. The California
plant is located in Gonzales, California, in the Salinas Valley.
California produces approximately 25 tons of organic fertilizer
per day, and sells primarily to the California agricultural
market. The California facility employs a proprietary method
called High Temperature Liquid Composting (HTLC).
The facility is currently being upgraded to expand its capacity
and to enable it to accept larger amounts of food waste from
waste haulers, thereby increasing tip fee revenue.
The Companys second facility, located in Woodbridge, New
Jersey (Woodbridge), is designed to service the New
York-Northern New Jersey metropolitan area. The Company
constructed this facility and it became partially operational in
the second quarter of 2008. Converted Organics of Woodbridge,
LLC, a New Jersey limited liability company and wholly owned
subsidiary of the Company, was formed for the purpose of owning,
constructing and operating the Woodbridge, New Jersey facility.
Converted Organics of Rhode Island, LLC (Rhode Island), a
Rhode Island limited liability company and subsidiary of the
Company, was formed for the purpose of developing a facility at
the Rhode Island central landfill.
|
|
NOTE 2
|
MANAGEMENTS
PLAN OF OPERATION
|
The Company currently has manufacturing capabilities in its
Woodbridge and Gonzales facilities as a means to generate
revenues and cash, although neither facility is currently
generating positive cash flow from operations. If the remaining
$3.6 million of convertible debentures from the
Companys 2008 Financing is converted into shares of common
stock, the Company believes the release of $2.0 million of
escrowed funds by the holders of the NJEDA bonds (Note 18),
along with the cash from estimated sales from the Woodbridge and
Gonzales facilities will provide enough working capital until
the upgrades to the Woodbridge facility are complete and until
the Company holds a shareholder vote to allow an investor
(Note 18) to purchase $1,500,000 of convertible term
notes assuming they receive such approval and achieve the
$750,000 sales level by May 31, 2009; and provided that the
Company is able to come to agreements with its construction
vendors allowing them to delay payments to such vendors. If the
Company obtains shareholder approval for the purchase of the
convertible term notes but does not achieve the required sales
level from Woodbridge and Gonzales, the Company will need to
seek additional sources of working capital. Currently the
Company estimates that the monthly breakeven sales for the
Gonzales and Woodbridge facilities is in the range of $600,000
to $750,000 and in addition current cash requirement at the
corporate level is in a range of $250,000 to $300,000 per month
for a total monthly cash requirement in the range of $850,000 to
$1,050,000. The Company plans to produce, at Gonzales and
Woodbridge, sufficient product to generate sales in the range of
$1,050,000 to $1,550,000. Cash for use as working capital at the
corporate level would not be available from operations until the
Company achieved such monthly breakeven sales levels. If
shareholder approval is received for the issuance of the
convertible notes the Company would have to achieve breakeven
sales levels by July 31, 2009 or the proceeds of the notes
would not provide sufficient working capital for operations and
if shareholder approval is not obtained and breakeven sales
levels are not achieved, the Company will not have sufficient
working capital to operate past May 31, 2009. Based on 2009
sales as of the date of this report, the
41
CONVERTED
ORGANICS INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
|
|
NOTE 2
|
MANAGEMENTS
PLAN OF OPERATION Continued
|
Company will need to increase sales volumes to achieve such
break even sales levels, and there is no assurance that such
efforts will be successful.
During this period of limited cash availability the company
plans to lower costs in the administrative areas and to
concentrate on production in both Woodbridge and Gonzales. In
addition they will also have to curtail certain production and
sales costs until sales orders begin to increase to the desired
levels; most notably, the Company will have to limit the
production of product to two variations of liquid and dry
product and the desired sales level will have to be derived from
those products.
The Company does not have any commitments for additional equity
or debt funding and there is no assurance that capital in any
form would be available and, if available, on terms and
conditions that are acceptable. Moreover, the Company is not
permitted to borrow any future funds unless they obtain the
consent of the bondholders of the New Jersey Economic
Development Bond. The Company has obtained such consent for
prior financing, but there is no guarantee that they can obtain
such consent in the future.
|
|
NOTE 3
|
SIGNIFICANT
ACCOUNTING POLICIES
|
CONSOLIDATION
The accompanying consolidated financial statements include the
transactions and balances of Converted Organics Inc. and its
subsidiaries, Converted Organics of Woodbridge, LLC, Converted
Organics of California, LLC, and Converted Organics of Rhode
Island, LLC. The transactions and balances of Valley Land
Holdings, LLC, a variable interest entity, have also been
consolidated therein. All intercompany transactions and balances
have been eliminated in consolidation.
DEVELOPMENT
STAGE COMPANY
Until the second quarter of 2008, the Company was a development
stage company as defined by Statement of Financial Accounting
Standards (SFAS) No. 7, Accounting and Reporting
by Development Stage Enterprises, as it had no
principal operations or significant revenue. During the second
quarter of 2008, the Companys California facility was
operating near capacity and recognized revenue from the sale of
its product. Also during the second quarter of 2008, the tip
floor of the New Jersey facility commenced operations and began
to accept food waste on a limited basis. During the second half
of 2008, operations have increased at both facilities, and the
Company is no longer a development stage company.
VARIABLE
INTEREST ENTITY
The consolidated financial statements include Valley Land
Holdings, LLC (VLH), as VLH has been deemed to be a
variable interest entity of the Company as it is the primary
beneficiary of that variable interest entity following the
acquisition of the net assets of United Organic Products, LLC
(Note 4). VLHs assets and liabilities consist
primarily of cash, land and a mortgage note payable on the land
on which the California facility is located. Its operations
consist of rental income on the land from the Company and
related operating expenses. VLHs activities support the
operations of the California facility and do not have sufficient
equity at risk to remain viable without the support of the
Company.
USE OF
ESTIMATES
The preparation of consolidated financial statements in
conformity with accounting principles generally accepted in the
United States of America requires management to make estimates
and assumptions that affect the reported amounts and disclosures
in the consolidated financial statements. Actual results could
differ from those estimates.
42
CONVERTED
ORGANICS INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
|
|
NOTE 3
|
SIGNIFICANT
ACCOUNTING POLICIES Continued
|
CASH
AND CASH EQUIVALENTS
The Company considers financial instruments with an original
maturity date of three months or less from the date of purchase
to be cash equivalents. The Company had cash equivalents of
$534,800 and $0 at December 31, 2008 and December 31,
2007, respectively, consisting of certificates of deposit. These
certificates of deposit are held by VLH.
RESTRICTED
CASH
As of December 31, 2008 and 2007, the Company had remaining
approximately $2,608,000 and $14,596,000, respectively, of cash
which is restricted under its bond agreement (Note 11).
This cash was raised by the Company in its initial public
offering and bond financing on February 16, 2007 and is set
aside in three separate accounts at December 31, 2008 and
2007, consisting of $34,000 and $10,032,000, respectively, for
the construction of the Woodbridge operating facility; $8,000
and $1,541,000, respectively, for the working capital
requirements of the Woodbridge subsidiary while the facility is
under construction; and $2,566,000 and $3,023,000, respectively,
in reserve for bond principal and interest payments along with a
reserve for lease payments. The Company has classified this
restricted cash as non-current to the extent that such funds are
to be used to acquire non-current assets or are to be used to
service non-current liabilities. Third party trustee approval is
required for disbursement of all restricted funds. Subsequent to
December 31, 2008, $2,000,000 of the restricted cash was
made available to the Company for use other than its restricted
purpose (Note 18).
ACCOUNTS
RECEIVABLE
Accounts receivable represents balances due from customers, net
of applicable reserves for doubtful accounts. In determining the
need for an allowance, objective evidence that a single
receivable is uncollectible, as well as historical collection
patterns for accounts receivable are considered at each balance
sheet date. At December 31, 2008, an allowance for doubtful
accounts of $16,000 has been established against certain
receivables that management has identified as uncollectible. A
charge of $16,000 is reflected in the consolidated statements of
operations for the year ended December 31, 2008. There was
no allowance for doubtful accounts deemed necessary at
December 31, 2007.
INVENTORIES
Inventories are valued at the lower of cost or market, with cost
determined by the first in, first out method. Inventory consists
primarily of raw materials, packaging materials and finished
goods, which consist of soil amendment products. Inventory
balances are presented net of applicable reserves. There were no
inventory reserves at December 31, 2008 and
December 31, 2007.
PREPAID
RENT
The Company has recorded prepaid rent on its consolidated
balance sheets which represents the difference between actual
lease rental payments made as of December 31, 2008 and 2007
and the straight line rent expense recorded in the
Companys consolidated statements of operations for the
years then ended relating to the Companys facilities in
Woodbridge, New Jersey and Gonzales, California.
DEPOSITS
The Company has made deposits totaling $415,000 for its
Woodbridge facility in accordance with the terms of that lease
and has made a deposit of $139,986 for a license at its planned
Rhode Island facility. The Gonzales facility has deposits on
equipment of $346,668. The Company has various security deposits
relating to operating leases of $10,400. These amounts are
recorded as noncurrent assets on the Companys consolidated
balance sheets. The
43
CONVERTED
ORGANICS INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
|
|
NOTE 3
|
SIGNIFICANT
ACCOUNTING POLICIES Continued
|
Company also has made deposits on packaging materials ordered
for product to be manufactured in its New Jersey facility of
$141,423, which is recorded as a current asset on the
Companys consolidated balance sheets.
CONSTRUCTION-IN-PROGRESS
Construction-in-progress
on the consolidated balance sheets includes amounts incurred for
construction costs, equipment purchases and capitalized interest
costs related to the construction of the Companys
Woodbridge, New Jersey facility, and expansion of its Gonzales,
California plant that have not yet been placed in service.
INTANGIBLE
ASSETS LICENSE AND OTHER INTANGIBLES
The Company accounts for its intangible assets in accordance
with SFAS No. 142, Goodwill and Other
Intangible Assets. SFAS No. 142 requires
that intangible assets with finite lives, such as the
Companys license, be capitalized and amortized over their
respective estimated lives and reviewed for impairment whenever
events or other changes in circumstances indicate that the
carrying amount may not be recoverable.
LONG-LIVED
ASSETS
In accordance with SFAS No. 144, Accounting
for the Impairment or Disposal of Long-Lived Assets,
long-lived assets are reviewed for impairment whenever
events or changes in circumstances indicate that the carrying
amount of an asset may not be recoverable. Such reviews are
based on a comparison of the assets undiscounted cash
flows to the recorded carrying value of the asset. If the
assets recorded carrying value exceeds the sum of the
undiscounted cash flows expected to result from the use and
eventual disposition of the asset, the asset is written down to
its estimated fair value. Impairment charges, if any, are
recorded in the period in which the impairment is determined. No
impairment charges were deemed necessary during the years ended
December 31, 2008 and 2007.
PROPERTY
AND EQUIPMENT
Property and equipment are stated at cost. Depreciation is
computed on the straight-line basis over the estimated useful
lives of 7 to 20 years.
DEFERRED
FINANCING AND ISSUANCE COSTS
In connection with the private financing arrangement of
January 24, 2008, the Company incurred legal and placement
fees of $345,000, $10,000 of which was paid in the year ended
December 31, 2007, and $335,000 of which was paid from the
proceeds of the loan. These fees are being amortized over one
year. Amortization expense totaled $322,958 during the year
ended December 31, 2008 related to these costs.
CAPITALIZED
BOND COSTS
In connection with its $17.5 million bond financing on
February 16, 2007, the Company has capitalized bond
issuance costs of $953,375 and is amortizing these costs over
the life of the bond. Amortization expense of $47,669 and
$43,696 was recorded during the years ended December 31,
2008 and 2007, respectively, related to these bond issuance
costs.
REVENUE
RECOGNITION
In accordance with Staff Accounting Bulletin 104,
Revenue Recognition in Financial Statements,
(SAB 104) revenue is recognized when each
of the following criteria is met:
|
|
|
|
|
Persuasive evidence of a sales arrangement exists;
|
|
|
|
Delivery of the product has occurred;
|
44
CONVERTED
ORGANICS INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
|
|
NOTE 3
|
SIGNIFICANT
ACCOUNTING POLICIES Continued
|
|
|
|
|
|
The sales price is fixed or determinable, and:
|
|
|
|
Collectability is reasonably assured.
|
In those cases where all four criteria are not met, the Company
defers recognition of revenue until the period these criteria
are satisfied. Revenue is generally recognized upon shipment.
SHARE
BASED COMPENSATION
The Company accounts for share based compensation in accordance
with Statement of Financial Accounting Standards
(SFAS) No. 123(R), Share-Based
Payment. Under the provisions of
SFAS No. 123(R), share-based compensation issued to
employees is measured at the grant date, based on the fair value
of the award, and is recognized as an expense over the requisite
service period (generally the vesting period of the grant).
Share-based compensation issued to non-employees is measured at
the grant date, based on the fair value of the equity
instruments issued and is recognized as an expense over the
requisite service period.
RESEARCH
AND DEVELOPMENT COSTS
Research and development costs include the costs of engineering,
design, feasibility studies, outside services, personnel and
other costs incurred in development of the Companys
manufacturing facilities. All such costs are charged to expense
as incurred.
INCOME
TAXES
Deferred income taxes are computed in accordance with
SFAS No. 109, Accounting for Income
Taxes and reflect the net tax effects of temporary
differences between the financial reporting carrying amounts of
assets and liabilities for financial reporting and income tax
purposes. The Company establishes a valuation allowance if it
believes that it is more likely than not that some or all of the
deferred tax assets will not be realized (see Note 14).
The Company is subject to U.S. federal income tax as well
as income tax of certain state jurisdictions. The Company has
not been audited by the I.R.S. or any states in connection with
income taxes. The periods from inception through 2008 remain
open to examination by the I.R.S. and state authorities.
On January 1, 2007, the Company adopted the provisions of
FASB interpretation No. 48, Accounting for
Uncertainty in Income Taxes- an interpretation of FASB Statement
No. 109 (FIN No. 48). The
Interpretation contains a two step approach to recognizing and
measuring uncertain tax positions accounted for in accordance
with FASB Statement No. 109. The first step is to evaluate
the tax position for recognition by determining if the weight of
the available evidence indicates that it is more likely than not
that the position will be sustained on audit, including
resolution of related appeals or litigation process, if any. The
second step is to measure the tax benefit as the largest amount
which is more than 50% likely of being realized upon ultimate
settlement. The adoption of FIN No. 48 did not have
any material impact on the Companys consolidated financial
statements.
The Company recognizes interest accrued related to unrecognized
tax benefits in interest expense. Penalties, if incurred, are
recognized as a component of income tax expense.
FAIR
VALUE MEASUREMENTS
The Company has partially implemented SFAS No. 157,
Fair Value Measurements
(SFAS No. 157) for financial assets and
financial liabilities. SFAS No. 157 defines fair
value, establishes a framework for measuring fair value, expands
disclosure about fair value measurements and is effective for
fiscal years beginning after November 15, 2007, except as
it relates to nonrecurring fair value measurements of
nonfinancial assets and liabilities. This standard only applies
when other standards require or permit the fair value
measurement of assets and liabilities. It
45
CONVERTED
ORGANICS INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
|
|
NOTE 3
|
SIGNIFICANT
ACCOUNTING POLICIES Continued
|
does not increase the use of fair value measurement. The Company
has determined that none of its financial assets or liabilities
are measured at fair value on a recurring basis therefore the
disclosures required by SFAS No. 157 do not currently
apply. With regard to nonfinancial assets and liabilities which
are not recognized or disclosed at fair value in the
Companys financial statements on a recurring basis (at
least annually), the standard is effective for fiscal years
beginning after November 15, 2008. The major categories of
assets and liabilities that have not been measured and disclosed
using SFAS No. 157 fair value guidance are property
and equipment in certain circumstances and goodwill.
ACCOUNTING
STANDARDS NOT YET ADOPTED
In February 2007, the FASB issued SFAS No. 159,
Fair Value Option for Financial Assets and Financial
Liabilities (SFAS No. 159), which
permits entities to choose to measure many financial assets and
financial liabilities at fair value. Unrealized gains and losses
on items for which the fair value option has been elected would
be reported in earnings. SFAS No. 159 is effective for
financial statements issued for fiscal years beginning after
November 15, 2007. The Company has not elected to measure
any financial assets or liabilities at fair value, and
therefore, the consolidated financial statements were not
affected by adoption of SFAS No. 159.
In December 2007, the FASB issued SFAS No. 160,
Noncontrolling Interests in Consolidated Financial
Statements an amendment of ARB No. 51
(SFAS No. 160). SFAS No. 160
is effective for fiscal years, and interim periods within those
fiscal years, beginning on or after December 15, 2008. The
objective of this Statement is to improve the relevance,
comparability and transparency of the financial information that
a reporting entity provides in its consolidated financial
statements. The Company anticipates that the adoption of
SFAS No. 160 will not have a significant impact on the
consolidated financial statements.
In December 2007, the FASB issued SFAS No. 141R,
Business Combinations (SFAS No. 141R), which
changes how business acquisitions are accounted for.
SFAS No. 141R requires the acquiring entity in a
business combination to recognize all (and only) the assets
acquired and liabilities assumed in the transaction and
establishes the acquisition-date fair value as the measurement
objective for all assets acquired and liabilities assumed in a
business combination. Certain provisions of this standard will,
among other things, impact the determination of acquisition-date
fair value of consideration paid in a business combination
(including contingent consideration); exclude transaction costs
from acquisition accounting; and change accounting practices for
acquired contingencies, acquisition-related restructuring costs,
in-process research and development, indemnification assets and
tax benefits. SFAS No. 141R is effective for business
combinations and adjustments to an acquired entitys
deferred tax asset and liability balances occurring after
December 31, 2008. The Company is currently evaluating the
future impacts and disclosures of this standard.
In March 2008, the FASB issued SFAS No. 161,
Disclosures about Derivative Instruments and Hedging
Activities an amendment of FASB Statement
No. 133 (SFAS No. 161).
SFAS No. 161 requires enhanced disclosures about an
entitys derivative instruments and hedging activities with
a view toward improving the transparency of financial reporting
and is effective for financial statements issued for fiscal
years and interim periods beginning after November 15,
2008, with early application encouraged. SFAS No. 161
encourages, but does not require, comparative disclosures for
earlier periods at initial adoption. The Company anticipates
that the adoption of SFAS No. 161 will not have a
significant impact on the consolidated financial statements.
In April 2008, the FASB issued FASB Staff Position (FSP)
No. FAS 142-3,
Determination of the Useful Life of Intangible Assets.
This FSP amends the factors that should be considered in
developing renewal or extension assumptions used to determine
the useful life of a recognized asset under
SFAS No. 142, Goodwill and Other Intangible Assets
(SFAS No. 142). The objective of this FSP is
to improve the consistency between the useful life of a
recognized intangible asset under SFAS No. 142 and the
period of expected cash flows used to measure the fair value of
the asset under SFAS No. 141R and other accounting
principles generally accepted in the United States of America.
This FSP applies to all intangible assets, whether acquired in a
business combination or otherwise; and
46
CONVERTED
ORGANICS INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
|
|
NOTE 3
|
SIGNIFICANT
ACCOUNTING POLICIES Continued
|
shall be effective for financial statements issued for fiscal
years beginning after December 15, 2008 and interim periods
within those fiscal years and applied prospectively to
intangible assets acquired after the effective date. Early
adoption is prohibited. The Company is currently evaluating this
new FSP and anticipates that it will not have a significant
impact on the consolidated financial statements.
EARNINGS
(LOSS) PER SHARE
Basic earnings (loss) per share (EPS) is computed by
dividing the net income (loss) attributable to the common
stockholders (the numerator) by the weighted average number of
shares of common stock outstanding (the denominator) during the
reporting periods. Diluted income (loss) per share is computed
by increasing the denominator by the weighted average number of
additional shares that could have been outstanding from
securities convertible into common stock, such as stock options
and warrants (using the treasury stock method), and
convertible preferred stock and debt (using the
if-converted method), unless their effect on net
income (loss) per share is antidilutive. Under the
if-converted method, convertible instruments are
assumed to have been converted as of the beginning of the period
or when issued, if later. The effect of computing the
Companys diluted income (loss) per share is antidilutive
and, as such, basic and diluted earnings (loss) per share are
the same for each of the years ended December 31, 2008 and
2007.
PROFIT
SHARING PLAN
In November 2007, the Company instituted a 401(k) plan for its
employees. The plan allows for employees to have a pretax
deduction of up to 15% of pay set aside for retirement. The plan
also allows for a Company match and profit sharing contribution.
As of December 31, 2008 and 2007, the Company has not
provided a match of employee contributions nor did the Company
contribute a profit sharing amount to the plan.
RECLASSIFICATIONS
Certain prior year amounts have been reclassified to conform to
the current year presentation.
SEGMENT
REPORTING
The Company has no reportable segments as defined by
SFAS No. 131, Disclosure about Segments of an
Enterprise and Related Information.
On January 24, 2008, the Company acquired the assets,
including the intellectual property, of Waste Recovery
Industries, LLC of Paso Robles, CA. This acquisition allows the
Company to be the exclusive owner of the proprietary technology
and process known as the High Temperature Liquid Composting
system, which processes various biodegradable waste products
into liquid and solid organic-based fertilizer and feed
products. The purchase price of $500,000 was paid with a 7%
short term note that matured on May 1, 2008 and was repaid
on that date. Interest on that note was payable monthly. In
addition, the purchase price provides for future contingent
payments of $5,500 per ton of capacity, when and if additional
tons of waste-processing capacity are added to the
Companys existing current or planned capacity, using the
acquired technology.
In addition, Waste Recovery Industries, LLC had begun discussion
with a third party (prior to the Company acquiring it) to
explore the possibility of building a facility to convert fish
waste into organic fertilizer using the HTLC technology. The
Company has completed those negotiations and has entered into an
agreement with Pacific Choice Seafoods whereby the Company will
be required to pay 50% of the Companys profits (as
defined) to the former owner, that are earned from the facility.
The contingent profit-sharing payments under this agreement will
be accounted for as expenses of the appropriate period, in
accordance with
EITF 95-8,
Accounting for Contingent
47
CONVERTED
ORGANICS INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
|
|
NOTE 4
|
ACQUISITIONS Continued)
|
Consideration Paid to the Shareholders of an Acquired
Enterprise in a Purchase Business Combination. If the
Company becomes obligated to make certain technology payments
under its purchase agreement with WRI, the Company estimated
that no such payments will be payable in the twelve months
following the acquisition. Payments, if any, after that will be
expensed as incurred. The maximum payment due under these
arrangements is $7,000,000, with no minimum.
On January 24, 2008, the Company formed Converted Organics
of California, LLC, a wholly-owned subsidiary of Converted
Organics Inc. who acquired the net assets of United Organic
Products, LLC of Gonzales, CA (UOP). With this
acquisition, the Company acquired a liquid fertilizer product
line, as well as a production facility that services a West
Coast agribusiness customer base through established
distribution channels. This facility is operational and began to
generate revenues for the Company immediately upon acquisition.
The purchase price of $2,500,000 was paid in cash of $1,500,000
and a note payable of $1,000,000. This note matures on
February 1, 2011, has an interest rate of 7%, payable
monthly in arrears and is convertible to common stock six months
after the acquisition date for a price equal to the
five-day
average closing price of the stock on Nasdaq for the five days
preceding conversion.
The acquisitions have been accounted for in the first quarter of
2008 using the purchase method of accounting in accordance with
SFAS No. 141, Business
Combinations. Accordingly, the net assets have been
recorded at their estimated fair values, and operating results
have been included in the Companys consolidated financial
statements from the date of acquisition.
The allocation of the purchase price based on the appraisal is
as follows:
|
|
|
|
|
Inventories
|
|
$
|
11,114
|
|
Accounts receivable
|
|
|
28,702
|
|
Technological know-how
|
|
|
271,812
|
|
Trade name
|
|
|
228,188
|
|
Existing customer relationships
|
|
|
2,030,513
|
|
Building
|
|
|
111,584
|
|
Equipment and machinery
|
|
|
543,000
|
|
Assumption of liabilities
|
|
|
(224,913
|
)
|
|
|
|
|
|
Total allocation of purchase price
|
|
$
|
3,000,000
|
|
|
|
|
|
|
The assets acquired from UOP were valued separately from the
assets acquired from WRI. The sum of the amounts assigned to
assets acquired and liabilities assumed did exceed the cost of
the acquired assets. The excess was allocated as a pro rata
reduction of the amounts that otherwise would have been assigned
to all of the acquired noncurrent assets, including intangibles.
The unaudited supplemental pro forma information discloses the
results of operations for the current year and for the preceding
year as though the business combination had been completed as of
the beginning of the year reported on.
48
CONVERTED
ORGANICS INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
|
|
NOTE 4
|
ACQUISITIONS Continued)
|
The pro forma condensed consolidated financial information is
based upon available information and certain assumptions that
the Company believes are reasonable. The unaudited supplemental
pro forma information does not purport to represent what the
Companys financial condition or results of operations
would actually have been had these transactions in fact occurred
as of the dates indicated above or to project the Companys
results of operations for the period indicated or for any other
period.
|
|
|
|
|
|
|
|
|
|
|
Twelve months ending December 31,
|
|
|
|
2008
|
|
|
2007
|
|
|
Revenues (in thousands)
|
|
$
|
1,548
|
|
|
$
|
1,423
|
|
Net loss (in thousands)
|
|
|
16,269
|
|
|
|
(4,889
|
)
|
Net loss per share basic and diluted
|
|
|
(2.72
|
)
|
|
|
(1.04
|
)
|
Current assets (in thousands)
|
|
|
7,230
|
|
|
|
5,410
|
|
Total assets (in thousands)
|
|
|
32,618
|
|
|
|
28,278
|
|
Current liabilities (in thousands)
|
|
|
(9,474
|
)
|
|
|
(7,570
|
)
|
Total liabilities (in thousands)
|
|
|
(27,571
|
)
|
|
|
(25,070
|
)
|
Total equity (deficit) (in thousands)
|
|
|
5,047
|
|
|
|
3,208
|
|
|
|
NOTE 5
|
FAIR
VALUE OF FINANCIAL INSTRUMENTS
|
CONCENTRATIONS
OF CREDIT RISK
The Companys financial instruments that are exposed to a
concentration of credit risk are cash, including restricted
cash, and accounts receivable. Currently, the Company maintains
its cash accounts with balances in excess of the federally
insured limits. The Company mitigates this risk by selecting
high quality financial institutions to hold such cash deposits.
At December 31, 2008 and 2007, the Companys cash
balances on deposit exceeded federal depository insurance limits
by approximately $5,812,000 and $14,500,000.
The Company maintains allowances for doubtful accounts for
estimated losses resulting from the inability of its customers
to make required payments. If the financial condition of the
Companys customers were to deteriorate, resulting in an
impairment of their ability to make such payments, additional
allowances may be required. An increase in allowances for
customer non-payment would increase the Companys expenses
during the period in which such allowances are made. Based upon
the Companys knowledge at December 31, 2008 and 2007,
a reserve for doubtful accounts was recorded of approximately
$16,000 and $0, respectively.
FAIR
VALUE OF FINANCIAL INSTRUMENTS
Statement of Financial Accounting Standards (SFAS) No. 107,
Fair Value of Financial Instruments, requires
disclosure of the fair value of financial instruments for which
the determination of fair value is practicable.
SFAS No. 107 defines the fair value of a financial
instrument as the amount at which the instrument could be
exchanged in a current transaction between willing parties. The
carrying amount of the Companys financial instruments
consisting of cash, accounts receivable, inventories, accounts
payable, and accrued expenses approximate their fair value
because of the short maturity of those instruments. The fair
value of the Companys convertible notes payable, term
notes payable and New Jersey Economic Development Authority
Bonds were estimated by discounting the future cash flows using
current rates offered by lenders for similar borrowings with
similar credit ratings. The fair value of the companys
convertible notes payable is estimated to approximate its
carrying value. The fair value of the term notes payable and the
New Jersey Economic Development Authority bonds approximate
their carrying value. The Companys financial instruments
are held for other than trading purposes.
49
CONVERTED
ORGANICS INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
|
|
NOTE 5
|
FAIR
VALUE OF FINANCIAL
INSTRUMENTS Continued
|
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 financial assets and liabilities that are
reported at fair value in the accompanying consolidated balance
sheets as of December 31, 2008 were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
Assets
|
|
Level 1
|
|
|
Level 2
|
|
|
Level 3
|
|
|
2008
|
|
|
Certificate of deposit
|
|
$
|
|
|
|
$
|
534,821
|
|
|
|
|
|
|
$
|
534,821
|
|
The Company does not have any fair value measurements using
quoted prices in active markets (Level 1) or
significant unobservable inputs (Level 3) as of
December 31, 2008.
The Companys inventories consisted of the following at
December 31:
|
|
|
|
|
|
|
|
|
|
|
2008
|
|
|
2007
|
|
|
Finished goods
|
|
$
|
214,053
|
|
|
$
|
|
|
Raw materials
|
|
|
18,785
|
|
|
|
|
|
Packaging materials
|
|
|
56,892
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total inventories
|
|
$
|
289,730
|
|
|
$
|
|
|
|
|
|
|
|
|
|
|
|
|
|
NOTE 7
|
CONSTRUCTION-IN-PROGRESS
|
The Company is currently constructing an operating facility in
Woodbridge, New Jersey. The funds for construction of this plant
came from the issuance of New Jersey Economic Development Bonds
on February 16, 2007 and a condition of this bond offering
was that the Company place in trust approximately
$14 million to be used for plant construction and
associated equipment purchases. As of December 31, 2007,
the Company has incurred approximately $4.9 million in
plant construction costs, equipment purchases and capitalized
interest costs. The Company has recorded those costs as
construction-in-progress
on its consolidated balance sheets as of December 31,
50
CONVERTED
ORGANICS INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
|
|
NOTE 7
|
CONSTRUCTION-IN-PROGRESS
Continued
|
2007. At the end of the second quarter of 2008, portions of the
Woodbridge facility became operational and certain fixed assets
were placed in service commencing June 30, 2008. During the
remainder of 2008, approximately $19 million in assets were
transferred from
Construction-in-Progress
to Leasehold Improvements and Machinery and equipment accounts
and depreciation commenced on those assets placed in service.
|
|
NOTE 8
|
PROPERTY
AND EQUIPMENT
|
The Companys property and equipment at December 31
consisted of the following:
|
|
|
|
|
|
|
|
|
|
|
2008
|
|
|
2007
|
|
|
Land and improvements
|
|
$
|
357,692
|
|
|
$
|
|
|
Building and improvements
|
|
|
5,754,163
|
|
|
|
|
|
Machinery and equipment
|
|
|
13,968,134
|
|
|
|
|
|
Vehicles
|
|
|
42,570
|
|
|
|
|
|
Office equipment and furniture
|
|
|
7,837
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
20,130,396
|
|
|
|
|
|
Less: Accumulated depreciation and amortization
|
|
|
(405,250
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Property and equipment, net
|
|
$
|
19,725,146
|
|
|
$
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation and amortization of property and equipment totaled
$411,843 and $0 for the years ended December 31, 2008 and
2007, respectively.
|
|
NOTE 9
|
DEFERRED
AND CAPITALIZED COSTS
|
DEFERRED
FINANCING AND OFFERING COSTS
In connection with its initial public offering (IPO) on
February 16, 2007, the Company incurred issuance costs
totaling $1,736,715. The Company had previously capitalized
issuance costs, consisting of underwriting, legal and accounting
fees and printing costs cumulatively totaling $696,499 in
anticipation of its initial public offering. The Company also
incurred additional issuance costs of $1,040,216 that was paid
from the proceeds of the initial public offering. The total
issuance costs of $1,736,715 have been netted against the
$9.9 million of gross proceeds of the IPO in the statements
of changes in owners equity (deficit).
In connection with its repayment of the bridge notes, the
Company paid to the bridge lender a Letter of Credit fee of
$27,375. The fee has been recorded as a deferred financing fee
to be amortized over the term of the Letter of Credit. The
Letter of Credit was nullified by the Companys borrowing
of funds from a private investor in January, 2008. Amortization
of these deferred financing fees totaled $8,642 and $18,733 for
the years ended December 31, 2008 and 2007, respectively.
In connection with its private financing in January of 2008, the
Company incurred fees of $345,000 which were capitalized and
which are being amortized over the one year term of the loan.
Amortization expense associated with these fees of $322,958 was
recorded during the year ended December 31, 2008.
CAPITALIZED
BOND COSTS
In connection with its $17.5 million bond financing on
February 16, 2007, the Company has capitalized bond
issuance costs of $953,375 and is amortizing those costs over
the life of the bond. Amortization of capitalized bond issuance
costs totaled $47,669 and $43,696 for the years ended
December 31, 2008 and 2007, respectively.
51
CONVERTED
ORGANICS INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
|
|
NOTE 10
|
INTANGIBLE
ASSETS
|
Pursuant to a license agreement with an effective date of
July 15, 2003 and amended effective February 9, 2006,
by and between the Company and International Bio-Recovery
Corporation (IBRC), the Company entered into an
exclusive license to use IBRCs Enhanced Autogenous
Thermophylic Aerobic Digestion process (EATAD) technology for
the design, construction and operation of facilities for the
conversion of food waste into solid and liquid organic material.
The license is recorded at its acquisition cost of $660,000 less
accumulated amortization of $90,750 and $74,250 as of
December 31, 2008 and 2007, respectively. Amortization is
provided using the straight-line method over the life of the
license. Amortization expense for the years ended
December 31, 2008 and 2007 was $16,500 and $16,500,
respectively. The Company expects the licenses annual
amortization expense to be $16,500 until fully amortized at the
end of the 40 year license period.
The Company is obligated to pay IBRC an aggregate royalty equal
to nine percent of the gross revenues from the sale of product
produced by the Woodbridge facility. The Company will begin to
pay royalties during the first quarter of 2009, as product sales
commenced during that quarter. The Company is also obligated to
purchase IBRCs patented macerators and shearators as
specified by or supplied by IBRC or Shearator Corporation for
use at the Woodbridge facility.
In addition, the Company paid a non-refundable deposit of
$139,978 to IBRC in 2007 on a second plant licensing agreement,
which is included in non-current deposits on the Companys
consolidated balance sheets at December 31, 2008 and 2007.
The Company also agreed to pay IBRC approximately $338,000 in
twelve monthly installments for market research, growth trails
and other services. For the year ended December 31, 2008
and 2007, the Company had paid approximately $22,000 and
$276,000, respectively, of this amount which has been included
in research and development in the Companys consolidated
statements of operations. The Company is currently negotiating
the remainder of the payments with IBRC.
The Company identified certain intangible assets as a part of
its valuation performed pursuant to SFAS No. 141,
Business Combinations. The following
intangible assets were identified and values and estimated
useful lives were assigned as follows:
|
|
|
|
|
|
|
|
|
|
|
Assigned
|
|
|
Estimated
|
|
|
|
value
|
|
|
useful life
|
|
|
Existing customer relationships
|
|
$
|
2,030,513
|
|
|
|
8 years
|
|
Technological know-how
|
|
|
271,812
|
|
|
|
8 years
|
|
Trade name
|
|
|
228,188
|
|
|
|
Indefinite
|
|
|
|
|
|
|
|
|
|
|
Intangibles acquired
|
|
$
|
2,530,513
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The consolidated statements of operations include amortization
expense of $246,887 related to these intangible assets for the
year ending December 31, 2008. Accumulated amortization at
December 31, 2008 was $246,887.
TERM
NOTES PAYABLE
The Company had three term notes payable: (1) $250,000
unsecured term note dated August 27, 2004, due
December 31, 2008, with interest at 12%, (2) $125,000
unsecured term note dated September 6, 2005, due
December 31, 2008, with interest at 15%, and
(3) $89,170 unsecured term note dated May 2, 2007 with
a maturity of May 2, 2009 and interest at 12%. On all
notes, interest accrues without payment until maturity. The
agreement on the term loan dated August 27, 2004 required
accrued interest of $89,170 to be paid immediately in order to
refinance and extend the maturity. As the Company was precluded
under the terms of the agreement with the bondholders of the New
Jersey Economic Development Authority Bonds from paying the
accrued interest available
52
CONVERTED
ORGANICS INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
|
|
NOTE 11
|
DEBT Continued
|
funds, the Company borrowed funds to repay this accrued interest
by entering into the May 2, 2007 term loan in the amount of
$89,170 with its CEO, Edward J. Gildea. This note is unsecured
and subordinate to the bonds, and has a two-year term. This
interest rate is equal to or less than interest paid on the
Companys other term loans. The Company obtained the
necessary bondholder consents to enter into this agreement.
During December 2008, the balance of the term note dated
August 27, 2004, plus accrued interest of $47,500 was paid
with funds raised through exercise of warrants related to our
common stock. The Company also negotiated the forgiveness of the
balance of the unsecured term note dated September 6, 2005,
plus accrued interest. Total principal and interest forgiven was
$146,677, and this amount is recorded as other income on the
consolidated statements of operations for the year ended
December 31, 2008.
As of December 31, 2008, the total of unpaid accrued
interest on the remaining note is $17,834. Accrued interest on
all notes as of December 31, 2007 was $47,500.
A schedule of outstanding principal amounts of the term notes as
of December 31, 2008 and 2007 is as follows:
|
|
|
|
|
|
|
|
|
|
|
2008
|
|
|
2007
|
|
|
Term note dated August 27, 2004
|
|
$
|
|
|
|
$
|
250,000
|
|
Term note dated September 6, 2005
|
|
|
|
|
|
|
125,000
|
|
Term note dated May 2, 2007
|
|
|
89,170
|
|
|
|
89,170
|
|
|
|
|
|
|
|
|
|
|
|
|
|
89,170
|
|
|
|
464,170
|
|
Less: current portion
|
|
|
89,170
|
|
|
|
(375,000
|
)
|
|
|
|
|
|
|
|
|
|
|
|
$
|
|
|
|
$
|
89,170
|
|
|
|
|
|
|
|
|
|
|
BRIDGE
LOANS PAYABLE
On March 2, 2006, the Company completed a $500,000 bridge
loan (Bridge Loan) from lenders (Bridge
Noteholders) to help meet the Companys working
capital needs. The bridge loan accrued interest at an annual
rate of 8%, which was payable in arrears quarterly, and was
originally due and payable on the earlier of October 16,
2006 or the completion of a public offering of equity securities
(Qualified Public Offering). The bridge loan was
refinanced with an extended maturity date of February 19,
2007 or the completion of a Qualified Public Offering. The
placement agent for the bridge loan received a commission equal
to 5% of the gross proceeds. The Company received the $500,000
bridge loan net of the commission to the placement agent of
$25,000. The Company classified this cost as a deferred
financing cost.
In April, May and June 2006, the Company received additional
proceeds totaling $1,015,000 (net of a $50,750 commission to the
placement agent) from a series of promissory notes executed with
the Bridge Noteholders (Bridge Financing).
In connection with the Bridge Financing, the Company issued
bridge notes (Bridge Notes) and securities of the
Company (Bridge Equity Units) to the Bridge
Noteholders, stating that if a Qualified Public Offering
occurred before October 16, 2006 (extended to
February 19, 2007), the Bridge Noteholders would be
entitled to receive Bridge Equity Units consisting of securities
identical in form to the securities being offered in the
Qualified Public Offering. Each Bridge Noteholder would be
entitled to receive Bridge Equity Units equal to the principal
of the Bridge Noteholders bridge loan divided by the
initial public offering price of the securities comprising the
Bridge Equity Units.
The Bridge Loans and the Bridge Equity Units were allocated for
accounting purposes based on the relative fair values at the
time of issuance of (i) the Bridge Loans without the Bridge
Equity Units and (ii) the Bridge Equity Units themselves.
The fair value of the Bridge Loans and the Bridge Equity Units
was computed at $1,515,000 each.
53
CONVERTED
ORGANICS INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
|
|
NOTE 11
|
DEBT Continued
|
The $1,515,000 fair value was determined since the Company
obtained $1,515,000 in Bridge Financing from Bridge Noteholders.
At the closing of a public offering on or before
February 19, 2007 bridge lenders would be entitled to
receive units identical to the units being offered in the
Companys initial public offering. Each bridge lender would
be entitled to receive that number of units equal to the
principal of the lenders note divided by the initial
public offering price. Stated differently, upon closing of an
initial public offering on or before February 19, 2007, the
Company would be obligated to issue to the bridge lenders a
number of units commensurate with a market value of $1,515,000.
Since they were of equal value, the $1,515,000 was allocated 50%
to the Bridge Loans and 50% to the Bridge Equity Units. The
Bridge Equity Units of $757,500 were accounted for as paid-in
capital. The Bridge Loans of $1,515,000 were recorded on the
balance sheet net of the $757,500 discount on the Bridge Loans.
The discount for the Bridge Equity Units ($757,500) was
amortized into interest expense over the original life of the
Bridge Loans. For the year ended December 31, 2007, the
Company recorded $757,500 in interest expense related to the
amortization of this discount.
On February 16, 2007 the Company completed its initial
public offering and issued 293,629 Bridge Equity Units to the
Bridge Noteholders. In addition, the Company and the Bridge
Noteholders, agreed under the terms of a concurrent bond
offering at the time of the initial public offering, not to
repay the principal or accrued interest on the Bridge Notes at
that time.
The Company had $1,515,000 of outstanding Bridge Loans that
accrued interest at a rate of 18%, and under the terms of the
loans, were to be repaid on the earlier of February 19,
2007 or the date of the Companys initial public offering.
Due to certain covenants relating to the offering of bonds on
February 16, 2007, which prohibited the Company from
repaying these bridge loans, the Company entered into an
agreement whereby it could repay the Bridge Loans if the Bridge
Noteholders agreed to obtain a letter of credit in favor of the
Company. The Company reached agreements with the Bridge
Noteholders and the demand note lender to repay the entire
principal and accrued interest on these debts. The principal of
the Bridge Loans of $1,515,000 plus accrued interest of
approximately $160,000, along with principal of the demand note
of $150,000 plus accrued interest of approximately $7,000, was
repaid by the Company on May 23, 2007 from unrestricted
cash. In addition, for the various term extensions granted by
the Bridge Noteholders, the Company issued approximately
56,000 shares of common stock, which represents 10% of the
principal and interest repaid, divided by the
five-day
average share price prior to repayment of the debt. The
consolidated statements of operations for the year ended
December 31, 2007 includes interest expense of $178,048
related to the issuance of this stock.
In order for the repayment of bridge and demand loans to comply
with the terms of the covenants of the bondholders of the New
Jersey Economic Development Authority Bonds, the Bridge
Noteholders obtained a letter of credit in favor of the Company
for $1,825,000. This letter of credit was due to expire on
April 7, 2008, and allows for a one-time draw down during
the thirty days prior to expiration. Subsequent to
December 31, 2007 and prior to the expiration date of the
letter of credit (April 7, 2008), in conjunction with the
private financing described below, the letter of credit
agreement was terminated with no cost to the Company.
BOND
FINANCING
On February 16, 2007, concurrent with its initial public
offering, the Companys wholly-owned subsidiary, Converted
Organics of Woodbridge, LLC, (the Subsidiary)
completed the sale of $17,500,000 of New Jersey Economic
Development Authority Bonds. Direct financing costs related to
this issuance totaled $953,375, which have been capitalized and
are being amortized over the term of the bonds. The bonds carry
a stated interest rate of 8% and mature on August 1, 2027.
The bonds are secured by a leasehold mortgage and a first lien
on the equipment of the Subsidiary. In addition, the Subsidiary
has agreed to, among other things, establish a fifteen month
capitalized interest reserve and to comply with certain
financial statement ratios. The Company has provided a guarantee
to the bondholders on behalf of its wholly-owned Subsidiary for
the entire bond offering.
54
CONVERTED
ORGANICS INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
|
|
NOTE 11
|
DEBT Continued
|
The New Jersey Economic Development Bonds have certain
covenants, which among other things, preclude the Company from
making any dividends, payments or other cash distributions until
such time as (i) the Company has achieved, over the course
of a full fiscal year, a maximum annual debt service coverage
ratio greater than 1.50, and (ii) at least $1,200,000 is on
deposit with the Trustee in the operations and maintenance
reserve fund and is available to satisfy ongoing maintenance,
repair and replacement costs associated with the project
facilities. In addition, the Company is precluded from borrowing
additional funds under any debt agreements, without the consent
of the bondholders. During 2007, the Company received consent
from the bondholder prior to borrowing additional funds for a
two year term note. During 2008, the Company again received
consent from the bondholder prior to borrowing additional funds
in a private investment. Under the terms of the bond agreement,
the lender has the right, upon 30 days written notice, to
demand full payment of all outstanding principal and interest
amounts owed under the agreement if specific covenants are not
met. As of December 31, 2008 and 2007, the Company is in
compliance with these covenants of the bond agreement.
PRIVATE
FINANCING
On January 24, 2008, the Company entered into a private
financing with three investors (the Investors) for a
total amount of $4,500,000 (the Financing). The
Financing was offered at an original issue discount of 10%. The
Company used the proceeds to fund the acquisitions described
above, to fund further development activities and to provide
working capital. As consideration for the Financing, the
Investors received a note issued by the Company in the amount of
$4,500,000 with interest accruing at 10% per annum to be paid
monthly and the principal balance to be paid in full one year
from the closing date (the Note). In addition, the
Company issued to the Investors 750,000 Class A Warrants
and 750,000 Class B Warrants, which may be exercised at
$8.25 and $11.00 per warrant share, respectively (the
Warrants). The Company further agreed not to call
any Warrants until a registration statement registering all of
the Warrants is declared effective. A placement fee of $225,000
was paid from the proceeds of this loan.
In connection with the Financing, the Company had agreed that
within 75 days of the closing date, the Company would have
a shareholder vote to seek approval to issue a convertible
debenture with an interest rate of 10% per annum which would be
convertible into common stock pursuant to terms of the debenture
agreement, or such other price as permitted by the debenture
(the Convertible Debenture). Upon shareholder
approval, the Note was replaced by this Convertible Debenture
and one half of each of the Class A Warrants and of the
Class B Warrants issued were returned to the Company. Under
the conversion option, the Investors shall have the option, at
any time on or before the maturity date (January 24, 2009),
to convert the outstanding principal of this Convertible
Debenture into fully-paid and non assessable shares of common
stock at the conversion price equal to the lowest of
(i) the fixed conversion price of $6.00 per share,
(ii) the lowest fixed conversion price (the lowest price,
conversion price or exercise price set by the Company in any
equity financing transaction, convertible security, or
derivative instrument issued after January 24, 2008), or
(iii) the default conversion price (if and so long as there
exists an event of default, then 70% of the average of the three
lowest closing prices of common stock during the twenty day
trading period immediately prior to the notice of conversion).
The Company held a special shareholders meeting on
April 3, 2008 to vote on this matter, at which time it was
approved.
In connection with the financing, the Company entered into a
Security Agreement with the Investors whereby the Company
granted the Investors a security interest in Converted Organics
of California, LLC and any and all assets that are acquired by
the use of the funds from the Financing. In addition, the
Company granted the Investors a security interest in Converted
Organics of Woodbridge, LLC and all assets subordinate only to
the current lien held by the holder of the bonds issued in
connection with the Woodbridge facility of approximately
$17,500,000.
In connection with this borrowing, the Company issued
1.5 million warrants to purchase common stock, which were
deemed to have a fair value of $5,497,500. The Company recorded
the relative fair value of the warrants to the underlying notes
of $2,227,500 in accordance with Accounting Principles Board
(APB) Opinion No. 14,
55
CONVERTED
ORGANICS INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
|
|
NOTE 11
|
DEBT Continued
|
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 noteholders to replace the original notes
dated January 24, 2008. The Company is required to
recognize a discount for the intrinsic value of the beneficial
conversion feature of the notes which is to be recognized as
interest expense through the redemption date of the notes, which
is January 24, 2009. That amount was calculated to be
$3,675,000, and recognition was limited to $2,936,250 in
accordance with
EITF 98-5,
Accounting for Convertible Securities with Beneficial
Conversion Features or Contingently Adjustable Conversion
Ratios, as the debt discount is limited to the
proceeds allocated to the convertible instrument of $4,500,000.
That discount is being amortized over the life of the loan.
During the year ending December 31, 2008, the Company
recognized interest expense of $2,705,759 related to this
discount.
On January 24, 2009 the Company entered into an amendment
on its $4.5 million convertibles debentures which became
due on January 24, 2009. The lenders extended the due date
of these notes until July 24, 2009 and began to convert
these notes into shares of the Companys common stock using
the default conversion rate. The Company and the lenders further
agreed that no interest would be charged during the six-month
extension and that it is the lenders intention to convert
the loan into shares sufficient to pay off the balance of the
debt.
On March 6, 2009, the Company entered into an agreement
with the holders of its $17.5 million of New Jersey
Economic Development Authority Bonds to release
$2.0 million for capital expenditures and lease payments on
its New Jersey facility and to defer interest payments on the
bonds thru July 30, 2009. These funds had been held in a
reserve for bond principal and interest payments along with a
reserve for lease payments. As consideration for the release of
the reserve funds, the Company issued the bond holders 2,284,409
Class B warrants. The Class B warrants are exercisable
at $11.00 per warrant share.
REGISTRATION
RIGHTS AGREEMENT
In connection with the January 24, 2008 private financing,
the Company entered into a registration rights agreement with
the Investors which called for the Company to register the
securities within certain time periods. The Company had
10 days from shareholder approval, with an additional
7 day extension, to register the shares issuable under the
Convertible Debenture and 90 days from the filing of a
registration statement (filed on February 13,
2008) for the Warrants and the underlying shares to be
declared effective by the SEC. The Company has filed the
registration statement relative to the Convertible Debenture as
of the filing date of this report and the registration statement
filed for the Warrants has been declared effective. However, the
registration statement filed for the convertible debt and the
date the warrant registration statement was declared effective
by the SEC did not occur within the timelines agreed to in the
registration rights agreement. The registration rights agreement
calls for $90,000 per month in liquidated damages, payable in
cash, if the Company doesnt file the registration
statement for the Convertible Debenture and liquidated damages
equal to the average closing price of 375,000 Class A
warrants and 375,000 Class B warrants for each 30 day
period, commencing May 13, 2008, and multiplying that
average by 2% for each 30 day period that the registration
statement is not declared effective.
Therefore, on April 24, 2008, the Company began to incur
liquidated damages in connection with the Convertible Debenture
of $90,000 per month and as of May 13, 2008 the Company
began to incur liquidated damage obligations in connection with
the Warrants according to the formula described above. The
maximum amount of liquidated damages relative to the Warrant
Registration Statement and the Convertible Debenture is
56
CONVERTED
ORGANICS INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
|
|
NOTE 11
|
DEBT Continued
|
equal to 10% of the face amount of the Convertible Debenture or
$450,000 (10% of $4,500,000). The Company paid a total of
approximately $158,000 in liquidated damages related to the
Convertible Debentures, which are recorded as interest expense
on the consolidated statements of operations for year ended
December 31, 2008. On June 7, 2008 the warrant
registration statement was declared effective. At this time, the
Company is not subject to further liquidated damages.
CONVERTIBLE
NOTE PAYABLE
On January 24, 2008, in conjunction with the purchase of
the net assets of UOP, the Company issued a note payable to the
former sole member in the amount of $1,000,000. The note bears
interest of 7% and matures on February 1, 2011; monthly
principal and interest payments are $30,877. Interest expense of
$57,850 has been recorded in the year ending December 31,
2008 related to this note. The note is convertible by the holder
six months after issuance. The Company is required to recognize
a discount related to the intrinsic value of the beneficial
conversion feature of the note as interest expense through the
stated redemption date of the note. That amount was calculated
to be $7,136, and has been recorded as a component of additional
paid-in capital.
MORTGAGE
NOTE PAYABLE
The Company has a mortgage note payable on the land upon which
the California facility resides. The note, in the original
amount of $250,000, bears interest at 6.75%. Monthly payments of
principal and interest of $1,638 are due based on an
amortization of twenty years. The note matures in May, 2013.
FIVE-YEAR
MATURITY OF DEBT
Principal due during the next five years on all the
Companys long-term and current debt is as follows:
|
|
|
|
|
2009
|
|
$
|
4,925,328
|
|
2010
|
|
|
329,721
|
|
2011
|
|
|
28,450
|
|
2012
|
|
|
3,679
|
|
2013
|
|
|
234,826
|
|
Thereafter
|
|
|
17,500,000
|
|
|
|
|
|
|
Subtotal
|
|
|
23,022,004
|
|
Less: discount
|
|
|
(230,492
|
)
|
|
|
|
|
|
Total
|
|
$
|
22,791,512
|
|
|
|
|
|
|
|
|
NOTE 12
|
CAPITALIZED
INTEREST COSTS
|
The Company has capitalized interest costs, net of certain
interest income, in accordance with Statement of Financial
Accounting Standards No. 62, Capitalization of
Interest Cost Involving Certain Tax-Exempt Borrowings and
Certain Gifts and Grants, related to its New Jersey
Economic Development Authority Bonds in the amount of $1,317,438
and $403,572 as of December 31, 2008 and December 31,
2007, respectively. Capitalized interest costs are included in
construction in progress initially on the consolidated balance
sheets. As assets are placed in service, the capitalized
interest is allocated among the cost basis of the assets
ratably. During the year ending December 31, 2008,
capitalized interest of $1,245,000 was allocated to assets
placed in service and is being depreciated with the related
assets.
57
CONVERTED
ORGANICS INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
|
|
NOTE 13
|
OWNERS
EQUITY (DEFICIT)
|
AUTHORIZED
SHARES
At its April 3, 2008 special meeting of shareholders, the
shareholders approved a resolution to decrease the number of
common shares that the Company is authorized to issue from
75,000,000 to 40,000,000, and the number of preferred shares
that the Company is authorized to issue from 25,000,000 to
10,000,000. The Company did this to realize saving on certain
taxes that are based on the number of shares authorized, and the
Company believes that 40,000,000 shares of common stock
would be sufficient to meet its future needs.
STOCK
ISSUANCES
The Company is authorized to issue 40,000,000 shares of
$0.0001 par value common stock. Of the authorized shares,
733,333 of the authorized shares were issued to the founders of
the Company (founders shares) on
January 13, 2006. The Company did not receive any
consideration for the founders shares. Because the Company
had a negative estimated value on January 13, 2006, the
Company recognized compensation expense at par value totaling
$73 in connection with the issuance of the founders shares
as par value represents the statutory minimum share value in the
state of Delaware.
On February 21, 2006, the Company merged with Mining
Organics Management LLC (MOM) and Mining Organics
Harlem River Rail Yard LLC (HRRY). At that time, MOM
was a fifty-percent owner of HRRY. The mergers were accounted
for as a recapitalization of the Company. As a result of the
recapitalization, 600,000 shares were issued to the members
of HRRY.
On February 16, 2007 the Company successfully completed an
initial public offering of 1,800,000 common shares and 3,600,000
warrants for a total offering of $9,900,000, before issuance
costs. The Companys initial public offering is presented
net of issuance costs and expenses of $1,736,715 in the
statements of changes in owners equity (deficit). The
warrants consist of 1,800,000 redeemable Class A warrants
and 1,800,000 non-redeemable Class B warrants, each warrant
to purchase one share of common stock. The common stock and
warrants traded as one unit until March 13, 2007 when they
began to trade separately.
On February 16, 2007, as part of its initial public
offering and under the original terms of the bridge loan
agreement (Note 11), the Company issued 293,629 Bridge
Equity Units to the Bridge Noteholders. On May 23, 2007, as
consideration for extensions of the Bridge Loans, the Company
issued 55,640 shares of common stock to the Bridge
Noteholders, which represents 10% of the principal and interest
repaid, divided by the
five-day
average share price prior to repayment of the debt. The
statement of operations reflects an expense of $178,048 related
to the issuance of these shares.
On February 16, 2007, as part of its initial public
offering, the Company agreed to pay a 5% quarterly stock
dividend, commencing March 31, 2007, and every full quarter
thereafter until the Woodbridge, New Jersey facility is
operational. As of December 31, 2007, the Company has
declared four such quarterly dividends amounting to
747,296 shares. As of December 31, 2008, the Company
has declared one additional quarterly dividend in the amount of
263,239 shares.
On October 1, 2008, the Company issued 45,480 shares
of its common stock to a consultant as remuneration for services
rendered. The related services were substantially complete when
the stock was issued. The Company recognized $212,619 of expense
related to the fair value of this issuance.
On October 22, 2008, the Company declared a stock dividend
of 15% payable to shareholders of record as of November 17,
2008. This dividend resulted in the issuance of
969,318 shares of common stock.
58
CONVERTED
ORGANICS INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
|
|
NOTE 13
|
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 10,
the Company issued 750,000 Class A and 750,000 Class B
Warrants to the Investors. Such warrants are exercisable for one
share of the Companys common stock, adjusted for
dividends, at $8.25 and $11.00, respectively. Once the
Companys registration statement related to the underlying
shares was declared effective, one-half of the warrants were
returned to the Company by the Investors, as described in
Note 11.
WARRANT
EXERCISE
The Company has received net proceeds of approximately
$11,344,000 as a result of the exercise of approximately
1,381,000 Class A (which includes the warrant redemption
discussed below) warrants and 600 Class B warrants in the
year ended December 31, 2008. The Company issued
approximately 1,781,000 shares of common stock in
connection with the exercise of these warrants due to the
cumulative effect of the Companys stock dividends.
WARRANT
REDEMPTION
On September 16, 2008, the Company announced the redemption
of its outstanding Class A Warrants. The redemption date
was set for October 17, 2008, and was subsequently extended
a total of 31 days voluntarily by the Company to
November 17, 2008. Any outstanding Class A warrants
that had not been exercised before that date expired and are
redeemable by the Company for $0.25 per warrant.
Until the redemption date, the Class A warrants were
convertible into common stock at an exercise price of $8.25.
Each warrant exercised at this price received 1.276 shares
of common stock. Prior to the notification of redemption,
approximately 756,000 Class A warrants had been exercised.
After the redemption, an additional 683,000 warrants were
exercised. In total, from both the exercise and redemption of
warrants, the Company received proceeds of approximately
$11,344,000. The Company is obligated to remit to its transfer
agent funds sufficient to compensate warrant holders for the
remaining warrants, which may be redeemed for $.25 each for an
indefinite period. This amount of $284,237 was subtracted from
the cash received for exercise of the warrants, representing the
amount necessary to redeem the remaining warrants.
59
CONVERTED
ORGANICS INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
|
|
NOTE 13
|
OWNERS
EQUITY (DEFICIT) Continued
|
Class A warrant activity for the year ended
December 31, 2008 and 2007 is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
|
|
|
|
|
|
|
|
|
|
Exercise
|
|
|
Average
|
|
|
Weighted Average
|
|
|
|
|
|
|
Price per
|
|
|
Exercise
|
|
|
Remaining
|
|
|
|
Warrants
|
|
|
Warrant
|
|
|
Price
|
|
|
Life (Years)
|
|
|
Outstanding at December 31, 2006
|
|
|
|
|
|
$
|
|
|
|
|
|
|
|
|
|
|
Issued:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
February 16, 2007, in conjunction with initial public
offering
|
|
|
1,800,000
|
|
|
|
8.25
|
|
|
|
8.25
|
|
|
|
|
|
February 16, 2007, in conjunction With bridge loans
|
|
|
293,629
|
|
|
|
8.25
|
|
|
|
8.25
|
|
|
|
|
|
February 16, 2007, in conjunction with underwriter units
|
|
|
180,000
|
|
|
|
8.25
|
|
|
|
8.25
|
|
|
|
|
|
Expired
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercised
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at December 31, 2007
|
|
|
2,273,629
|
|
|
|
8.25
|
|
|
|
8.25
|
|
|
|
4.2
|
|
Issued:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
January 24, 2008, in conjunction with private financing
|
|
|
750,000
|
|
|
|
8.25
|
|
|
|
8.25
|
|
|
|
|
|
Returned to the Company upon shareholder approval of exchange of
term note for convertible note
|
|
|
(375,000
|
)
|
|
$
|
8.25
|
|
|
|
|
|
|
|
|
|
Exercised
|
|
|
(1,380,768
|
)
|
|
$
|
8.25
|
|
|
|
|
|
|
|
|
|
Expired
|
|
|
(1,267,861
|
)
|
|
$
|
8.25
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at December 31, 2008
|
|
|
|
|
|
$
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The fair value of Class A warrants totaled $2,387,310 at
December 31, 2007 based on quoted market prices on that
date. As of December 31, 2008, the Class A warrants
have been removed from market trading.
60
CONVERTED
ORGANICS INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
|
|
NOTE 13
|
OWNERS
EQUITY (DEFICIT) Continued
|
Class B warrant activity for the years ended
December 31, 2008 and 2007 is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
|
|
|
Weighted Average
|
|
|
|
|
|
|
Exercise
|
|
|
Average
|
|
|
Remaining
|
|
|
|
|
|
|
Price per
|
|
|
Exercise
|
|
|
Life
|
|
|
|
Warrants
|
|
|
Warrant
|
|
|
Price
|
|
|
(Years)
|
|
|
Outstanding at December 31, 2006
|
|
|
|
|
|
$
|
0
|
|
|
|
|
|
|
|
|
|
Issued:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
February 16, 2007, in conjunction with initial public
offering
|
|
|
1,800,000
|
|
|
|
11.00
|
|
|
|
11.00
|
|
|
|
|
|
February 16, 2007, in conjunction with bridge loans
|
|
|
293,629
|
|
|
|
11.00
|
|
|
|
11.00
|
|
|
|
|
|
February 16, 2007, in conjunction with underwriter shares
|
|
|
180,000
|
|
|
|
11.00
|
|
|
|
11.00
|
|
|
|
|
|
Expired
|
|
|
|
|
|
|
0
|
|
|
|
|
|
|
|
|
|
Exercised
|
|
|
|
|
|
|
0
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at December 31, 2007
|
|
|
2,273,629
|
|
|
|
11.00
|
|
|
|
11.00
|
|
|
|
4.2
|
|
Issued:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
January 24, 2008, in conjunction with private financing
|
|
|
750,000
|
|
|
|
11.00
|
|
|
|
11.00
|
|
|
|
|
|
Returned to the Company upon shareholder approval of exchange of
term note for convertible note
|
|
|
(375,000
|
)
|
|
|
11.00
|
|
|
|
11.00
|
|
|
|
|
|
Exercised
|
|
|
600
|
|
|
|
11.00
|
|
|
|
11.00
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at December 31, 2008
|
|
|
2,648,029
|
|
|
$
|
11.00
|
|
|
|
11.00
|
|
|
|
3.2
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The fair value of Class B warrants totaled $3,442,438 and
$3,410,444 at December 31, 2008 and 2007, respectively,
based on quoted market prices on that date.
STOCK
OPTION PLAN
In June 2006, the Companys Board of Directors and
stockholders approved the 2006 Stock Option Plan (the
Option Plan). The Option Plan authorizes the grant
and issuance of options and other equity compensation to
employees, officers and consultants. A total of
666,667 shares of common stock are reserved for issuance
under the Option Plan. The Option Plan is administered by the
Compensation Committee of the Board of Directors (the
Committee). Subject to the provisions of the Option
Plan, the Committee determines who will receive the options, the
number of options granted, the manner of exercise and the
exercise price of the options. The term of incentive stock
options granted under the Option Plan may not exceed ten years,
or five years for options granted to an optionee owning more
than 10% of the Companys voting stock. The exercise price
of an incentive stock option granted under the Option Plan must
be equal to or greater than the fair market value of the shares
of the Companys common stock on the date the option is
granted. The exercise price of a non-qualified option granted
under the Option Plan must be equal to or greater than 85% of
the fair market value of the shares of the Companys common
stock on the date the option is granted. An incentive stock
option granted to an optionee owning more than 10% of the
Companys voting stock must have an exercise price equal to
or greater than 110% of the fair market value of the
Companys common stock on the date the option is granted.
Stock options issued under the option plan vest immediately upon
date of grant.
61
CONVERTED
ORGANICS INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
|
|
NOTE 13
|
OWNERS
EQUITY (DEFICIT) Continued
|
At a Special Meeting of Shareholders on April 3, 2008, the
shareholders approved an amendment to the 2006 Stock Option Plan
to include an evergreen provision pursuant to which
on January 1st of each year, commencing in 2009, the
number of shares authorized for issuance under the 2006 Stock
Option Plan shall automatically be increased to an amount equal
to 20% of the shares of the common stock outstanding on the last
day of the prior fiscal year. The Shareholders also approved an
amendment to the Plan to increase the number of options
available under the plan from 666,667 to 1,666,667. On
June 27, 2008, an additional 736,735 options were granted,
and vested on that date. Taking into account all options issued,
the Company has 276,932 options available to grant under the
plan.
The options granted on June 27, 2008 have an exercise price
of $5.02 and expire ten years from the grant date. The exercise
price was based on the closing price of the stock on the date of
grant. The fair value of the options was estimated using a
Black-Scholes pricing model with the following assumptions:
risk-free interest rate of 3.52%; no dividend yield; volatility
factor of 52.3%; and an expected term of 5 years. The
resulting expense of approximately $2.3 million is included
in general and administrative expenses in the consolidated
statements of operations for the year ended December 31,
2008.
During the year ended December 31, 2007, in accordance with
the director compensation policy of the Committee, an additional
10,000 options were granted to a Director upon his appointment
to the Board. The options vested on the grant date, have an
exercise price of $3.75 per share and expire five years from the
grant date. The fair value for the 10,000 immediately vesting
stock options granted in 2007 was estimated at the date of grant
using a Black-Scholes pricing model with the following
assumptions: risk-free interest rate of 4.9%; no dividend yield;
expected volatility factor of 16.9%; and an expected term of
five years. The Companys stock option compensation expense
totaling $5,929 has been included in general and administrative
expenses in the consolidated statements of operations for the
year ended December 31, 2007.
Stock option activity for the period January 1, 2007
through December 31, 2008 is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
|
|
|
|
|
|
|
|
|
|
|
|
|
Average
|
|
|
Average
|
|
|
|
Stock
|
|
|
Price per
|
|
|
Exercise
|
|
|
Remaining
|
|
|
|
Options
|
|
|
Share
|
|
|
Price
|
|
|
Life (Years)
|
|
|
Outstanding and exercisable at December 31, 2006
|
|
|
643,000
|
|
|
$
|
3.75
|
|
|
$
|
3.75
|
|
|
|
|
|
Granted
|
|
|
10,000
|
|
|
|
3.75
|
|
|
|
3.75
|
|
|
|
|
|
Expired
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercised
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding and exercisable at December 31, 2007
|
|
|
653,000
|
|
|
|
3.75
|
|
|
|
3.75
|
|
|
|
4.2
|
|
Granted
|
|
|
736,735
|
|
|
|
5.02
|
|
|
|
|
|
|
|
|
|
Expired
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercised
|
|
|
(143,000
|
)
|
|
|
3.75
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding and exercisable at December 31, 2008
|
|
|
1,246,735
|
|
|
$
|
|
|
|
$
|
4.50
|
|
|
|
4.0
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The aggregate intrinsic value of options outstanding and
exercisable at December 31, 2008 and 2007 is $0 and
$946,850, respectively. The aggregate intrinsic value represents
the total pretax intrinsic value, based on options with an
exercise price less than the Companys closing stock price
of $3.54 and $5.20 as of December 31, 2008 and 2007,
respectively, which would have been received by the option
holders had those option holders exercised their options as of
that date.
As of December 31, 2008 and 2007, there was no unrecognized
compensation cost related to non-vested share-based compensation
arrangements granted under the Companys stock option plan.
During the year ended
62
CONVERTED
ORGANICS INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
|
|
NOTE 13
|
OWNERS
EQUITY (DEFICIT) Continued
|
December 31, 2008, the Company has received approximately
$536,000 as a result of the exercise of 143,000 options.
At December 31, 2008, the Company had accumulated net
operating losses of approximately $26,553,000, of which
approximately $16,700,000 may be offset against future taxable
income, if any, ratably through 2028.
The Company has fully reserved the approximately $7,588,000 tax
benefit of these losses with a valuation allowance of the same
amount, because the likelihood of realization of the tax benefit
cannot be determined to be more likely than not.
There is a minimum current tax provision for the years ended
December 31, 2008 and 2007.
The effective tax rate based on the federal and state statutory
rates is reconciled to the actual tax rate for the years ended
December 31, 2008 and 2007 as follows:
|
|
|
|
|
|
|
|
|
|
|
2008
|
|
|
2007
|
|
|
Statutory federal income tax rate
|
|
|
34
|
%
|
|
|
34
|
%
|
Statutory state income tax rate
|
|
|
6
|
|
|
|
6
|
|
Valuation allowance on net deferred tax assets
|
|
|
(40
|
)
|
|
|
(40
|
)
|
|
|
|
|
|
|
|
|
|
Effective tax rate
|
|
|
|
%
|
|
|
|
%
|
|
|
|
|
|
|
|
|
|
The components of the net deferred tax asset (liability) at
December 31, 2008 and 2007 are as follows:
|
|
|
|
|
|
|
|
|
|
|
2008
|
|
|
2007
|
|
|
Deferred tax assets:
|
|
|
|
|
|
|
|
|
Net operating losses
|
|
$
|
6,148,000
|
|
|
$
|
2,120,000
|
|
Accrued compensation
|
|
|
120,000
|
|
|
|
120,000
|
|
Stock options
|
|
|
1,320,000
|
|
|
|
400,000
|
|
Valuation allowance
|
|
|
(7,588,000
|
)
|
|
|
(2,640,000
|
)
|
|
|
|
|
|
|
|
|
|
|
|
$
|
|
|
|
$
|
|
|
|
|
|
|
|
|
|
|
|
The Companys valuation allowance increased $4,948,000 and
$1,140,000 for the years ended December 31, 2008 and 2007,
respectively.
The Company has a tax benefit of approximately $1,320,000
related to the grant of common stock to certain key employees
and advisors. Pursuant to SFAS No. 123(R), the benefit
will be recognized and recorded to APIC when the benefit is
realized through the reduction of taxes payable.
The Company complies with the provisions of FASB Interpretation
No. 48, Accounting for Uncertainty in Income
Taxes an interpretation of FASB Statement
No. 109 (FIN No. 48).
FIN 48 addresses the determination of whether tax benefits
claimed or expected to be claimed on a tax return should be
recorded in the financial statements. Under FIN 48, the
Company may recognize the tax benefit from an uncertain tax
position only if it is more likely than not that the tax
position will be sustained on an examination by the taxing
authorities, based on the technical merits of the position. The
Company has determined that the Company has no uncertain tax
positions requiring recognition under FIN No. 48.
The Company is subject to U.S. federal income tax as well
as income tax of certain state jurisdictions. The Company has
not been audited by the U.S. Internal Revenue Service or
any states in connection with its income
63
CONVERTED
ORGANICS INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
|
|
NOTE 14
|
INCOME
TAXES Continued
|
taxes. The periods from January 1, 2005 to
December 31, 2008 remain open to examination by the
U.S. Internal Revenue Service and state authorities.
The Company recognizes interest accrued related to unrecognized
tax benefits and penalties, if incurred, as a component of
income tax expense.
|
|
NOTE 15
|
SEGMENT
REPORTING
|
In June 1997, SFAS 131, Disclosure about Segments
of an Enterprise and Related Information was issued,
which amends the requirements for a public enterprise to report
financial and descriptive information about its reportable
operating segments. Operating segments, as defined in the
pronouncement, are components of an enterprise about which
separate financial information is available that is evaluated
regularly by the Company in deciding how to allocate resources
and in assessing performance. The financial information is
required to be reported on the basis that is used internally for
evaluating segment performance and deciding how to allocate
resources to segments. The Company has no reportable segments at
December 31, 2008 and 2007.
|
|
NOTE 16
|
RELATED
PARTY TRANSACTIONS
|
OPERATING
LEASE-HEADQUARTERS
The Company is renting the premises under a verbal agreement
with ECAP, LLC, a related party. The managing member of ECAP,
LLC was a director and is a shareholder of the Company and is
also the brother of the Companys President and CEO. The
rental agreement provides for rent and support, as agreed
between the Company and ECAP, LLC and for reimbursement of
expenses by the Company for office and other expenses. These
expenses totaled $5,600 for the period from January 1, 2007
to February 28, 2007.
As of March 1, 2007, the Company began to pay the $2,800
per month rental payment directly to the unrelated landlord for
this office space. There is no lease term and rental of the
office space is on a month to month basis. Rent expense for the
period from March 1, 2007 to December 31, 2007 totaled
$28,000 relating to this lease. In the year ending
December 31, 2008, the Company incurred $33,600 of expense
related to this lease.
SERVICE
AGREEMENT
The Company has entered into a services agreement dated
May 29, 2003, as modified October 6, 2004, with one of
its principal stockholders, Weston Solutions, Inc.
(Weston). Weston has been engaged to provide
engineering and design services in connection with the
construction of the Woodbridge organic waste conversion
facility. The total amounts incurred by the Company for services
provided by Weston were $0 and $116,480 for the years ended
December 31, 2008 and 2007, respectively.
LEGAL
FEES
During the year ended 2007, the Company incurred legal fees
totaling $10,000 to a law firm affiliated with the
Companys President and CEO and partially owned by a
brother of the Companys CEO. These fees of $10,000 were
paid in 2008.
ACCRUED
COMPENSATION-OFFICERS, DIRECTORS AND CONSULTANTS
As of December 31, 2008 and 2007 the Company has an accrued
liability totaling $430,748 and $397,781, respectively,
representing accrued compensation to officers, directors and
consultants.
64
CONVERTED
ORGANICS INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
|
|
NOTE 16
|
RELATED
PARTY TRANSACTIONS Continued
|
CONVERTED
ORGANICS OF RHODE ISLAND, LLC
Converted Organics of Rhode Island, LLC was formed for the
purpose of developing and operating a waste to fertilizer
facility in Johnston, Rhode Island. A development consultant who
has provided services to the Company is a 10% minority owner of
Converted Organics of Rhode Island, LLC. For the years ending
December 31, 2008 and 2007, the consultant was paid $60,000
and $60,000, respectively, for services rendered.
PACKAGING
VENDOR
The Company has purchased packaging materials from a vendor
which is partially owned by an employee of the Company. The
Company made purchases of $141,000 from this vendor in the year
ending December 31, 2008.
NOTE 17
COMMITMENTS AND CONTINGENCIES
LEASES
In addition to the Companys IBRC commitment
(Note 10) and operating lease commitment for its
headquarters (Note 16), the Company signed a lease during
June 2006 for its Woodbridge, New Jersey facility. The lease
term is for ten years with an option to renew for an additional
ten years. Future minimum lease payments under this lease are as
follows:
|
|
|
|
|
For years ended December 31,
|
|
|
|
|
2009
|
|
$
|
934,820
|
|
2010
|
|
|
934,820
|
|
2011
|
|
|
946,195
|
|
2012
|
|
|
959,097
|
|
2013
|
|
|
967,383
|
|
2014 and thereafter
|
|
|
7,410,639
|
|
|
|
|
|
|
|
|
$
|
12,152,954
|
|
|
|
|
|
|
For the years ended December 31, 2008 and 2007, the Company
has recorded rent expense of $740,351 and $745,633,
respectively, in relation to this lease.
In September, 2008, the Company entered into a lease agreement
for 9 acres of land at the central landfill in Johnston,
RI, with the Rhode Island Resource Recovery Corporation. The
Company plans to build its next facility at this location. The
lease requires monthly payments of $9,167. Once the facility is
operational, the monthly rent will also include a charge of $8
per ton of fertilizer sold from the facility. The term of the
lease is twenty years. Future minimum payments under this lease
are as follows:
|
|
|
|
|
For years ended December 31,
|
|
|
|
|
2009
|
|
$
|
110,000
|
|
2010
|
|
|
110,000
|
|
2011
|
|
|
110,000
|
|
2012
|
|
|
110,000
|
|
2013
|
|
|
110,000
|
|
2014 and thereafter
|
|
|
1,613,334
|
|
|
|
|
|
|
|
|
$
|
2,163,334
|
|
|
|
|
|
|
65
CONVERTED
ORGANICS INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
NOTE 17
COMMITMENTS AND
CONTINGENCIES Continued
The Company recognized $36,667 of expense related to this lease
in 2008, which is included in Research & Development
on the consolidated statement of operations.
LEGAL
PROCEEDINGS
The Company is not currently aware of any pending or threatened
legal proceeding to which it is or would be a party, or any
proceedings being contemplated by governmental authorities
against it, or any of its executive officers or directors
relating to the services performed on the Companys behalf
except that the Company received notice that a complaint had
been filed in a putative class action lawsuit on behalf of
59 persons or entities that purchased units pursuant to a
financing terms agreement dated April 11, 2006
(FTA), captioned Gerald S. Leeseberg, et al. v.
Converted Organics, Inc., filed in the U.S. District Court
for the District of Delaware. The lawsuit alleges breach of
contract, conversion, unjust enrichment, and breach of the
implied covenant of good faith in connection with the alleged
failure to register certain securities issued in the FTA, and
the redemption of our Class A warrants in November 2008.
The lawsuit seeks damages related to the failure to register
certain securities, including alleged late fee payments, of
approximately $5.25 million, and unspecified damages
related to the redemption of the Class A warrants. In
February 2009, the Company filed a Motion for Partial Dismissal
of Complaint. It is uncertain when the Court will rule on this
motion. The Company plans to vigorously defend itself in this
matter and is unable to estimate any contingent losses that may
or may not be incurred as a result of this litigation and its
eventual disposition. Accordingly, no contingent loss has been
recorded by the Company related to this matter.
|
|
NOTE 18
|
SUBSEQUENT
EVENTS
|
On January 24, 2009, the Company entered into an amendment
on its $4.5 million convertibles debentures, which became
due on January 24, 2009. The lenders extended the due date
of these notes until July 24, 2009 and began to convert
these notes into shares of the Companys common stock using
the default conversion rate as described in Note 11. The
Company and the lenders further agreed that no interest would be
charged during the six-month extension and that it is the
lenders intention to convert the loan into shares
sufficient to pay-off the balance of the debt.
On March 6, 2009, the Company entered into an agreement
with the holders of its $17.5 million of New Jersey
Economic Development Authority Bonds to release
$2.0 million for capital expenditures and lease payments on
its New Jersey facility and to defer interest payments on the
bonds thru July 30, 2009. These funds had been held in a
reserve for bond principal and interest payments along with a
reserve for lease payments. As consideration for the release of
the reserve funds, the Company issued the bond holders 2,284,409
Class B warrants. The Class B warrants are exercisable
at $11.00 per warrant share.
On March 6, 2009, the Company entered into a into an
agreement with a private investor under which, upon stockholder
approval, will issue a series of 10% convertible notes in an
aggregate principal amount of up to $1,500,000 with a 10%
original issue discount. The investor placed funds into escrow
on March 10, 2009 to acquire $500,000 in principal amount
of the convertible notes to be released upon receiving
stockholder approval, and will acquire four additional $250,000
increments in principal amount of the note with the first
increment occurring on the 30th day after receiving
stockholder approval, and the remaining three increments
occurring monthly, thereafter.
66
|
|
ITEM 9.
|
CHANGES
IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
|
There have been no disagreements with our accountants on
accounting and financial disclosures.
|
|
ITEM 9A.
|
CONTROLS
AND PROCEDURES
|
Evaluation
of Disclosure Controls and Procedures
The Companys management, with the participation and under
the supervision of its Principal Executive Officer and Principal
Financial Officer, reviewed and evaluated the effectiveness of
the Companys disclosure controls and procedures, as
defined by
Rule 13a-15(e)
of the Exchange Act, as of the end of the fiscal year covered by
this report. Based upon their evaluation, the Companys
principal executive and financial officer concluded that, as of
the end of such period, our disclosure controls and procedures
are effective and sufficient to ensure that we record, process,
summarize, and report information required to be disclosed in
the reports we file under the Securities Exchange Act of 1934
within the time periods specified by the Securities and Exchange
Commissions rules and regulations.
Managements
Report on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining
adequate internal control over financial reporting, as defined
in
Rules 13a-15(f)
and
15d-15(f)
under the Exchange Act. Our system of internal control over
financial reporting is designed to provide reasonable assurance
regarding the reliability of financial reporting and the
preparation of financial statements for external purposes in
accordance with generally accepted accounting principles in the
United States of America and includes policies and procedures
that:
|
|
|
|
|
pertain to the maintenance of records that, in reasonable
detail, accurately and fairly reflect the transactions and
dispositions of our assets;
|
|
|
|
provide reasonable assurance that transactions are recorded as
necessary to permit preparation of financial statements in
accordance with generally accepted accounting principles, and
that our receipts and expenditures are being made only in
accordance with authorizations of our management and
directors; and
|
|
|
|
provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use or disposition of our
assets that could have a material effect on our financial
statements.
|
Our management conducted an evaluation of the effectiveness of
our internal control over financial reporting as of
December 31, 2008, based on the framework in Internal
Control Integrated Framework issued by the Committee
of Sponsoring Organizations of the Treadway Commission. Based on
this evaluation, our management concluded that our internal
control over financial reporting was effective as of
December 31, 2008.
On January 24, 2008, we completed our acquisition of the
assets of United Organic Products, LLC and Waste Recovery
Industries, LLC. In connection with these acquisitions, we were
required by
Regulation S-X,
Rule 11, to file, no later than April 10, 2008,
unaudited pro forma consolidated financial statements of
Converted Organics Inc., United Organic Products, LLC and Waste
Recovery Industries, LLC. We filed a
Form 10-KSB/A
containing information relative to the acquisition that we and
our advisors deemed sufficient to comply with
Regulation S-X,
Rule 11. We were subsequently advised by the SEC that the
filing was insufficient. We then filed the required financial
statements on a
Form 8-K/A
dated May 8, 2008. We believe that late filing was an
isolated event, and that, as of the date of this report, we have
sufficient internal and external personnel available to us to
conclude that our disclosure controls and procedures are
effective. We further note that the late filing described above
did not have any effect on the accuracy of our financial
statements for the reporting period in question.
This annual report does not include an attestation report of the
Companys registered public accounting firm regarding
internal control over financial reporting. Managements
report was not subject to attestation by the Companys
registered public accounting firm pursuant to temporary rules of
the Securities and Exchange Commission that permit the Company
to provide only managements report in this annual report.
67
Changes
in Internal Control over Financial Reporting
There have been no significant changes in our internal control
over financial reporting (as defined in
Rules 13a-15(f)
and
15d-15(f)
under the Exchange Act) or in other factors that occurred during
the period of our evaluation or subsequent to the date we
carried out our evaluation which have significantly affected, or
are reasonably likely to significantly affect, our internal
control over financial reporting.
|
|
ITEM 9B.
|
OTHER
INFORMATION
|
None.
PART III
|
|
ITEM 10.
|
DIRECTORS,
EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
|
The information required by Item 10 regarding directors,
executive officers, promoters and control persons is
incorporated by reference to the information appearing under the
caption Directors and Executive Officers in the
Companys definitive Proxy Statement relating to its 2009
Annual Meeting of Stockholders to be filed with the Securities
and Exchange Commission within 120 days after the close of
its fiscal year.
|
|
ITEM 11.
|
EXECUTIVE
COMPENSATION
|
The information required by Item 11 is incorporated by
reference to the information appearing under the caption
Executive Compensation in the Companys
definitive Proxy Statement relating to its 2009 Annual Meeting
of Stockholders to be filed with the Securities and Exchange
Commission within 120 days after the close of its fiscal
year.
|
|
ITEM 12.
|
SECURITY
OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
|
Securities
authorized for issuance under equity compensation
plans
Our Amended and Restated 2006 Stock Option Plan (Amended
Option Plan) currently authorizes the grant of up to
1,666,667 shares of common stock (subject to adjustment for
stock splits and similar capital changes) in connection with
restricted stock awards, incentive stock option grants and
non-qualified stock option grants. Employees and, in the case of
nonqualified stock options, directors, consultants or any
affiliate are eligible to receive grants under our plans. The
2006 Stock Option Plan was approved by our board of directors
and by our shareholders on June 15, 2006 and was amended
and approved by our board of directors and by our shareholders
on April 7, 2008. Under the Amended Option Plan, the option
exercise price generally shall be no less than 110% or no less
than 100%, depending upon the optionee and the reason for which
the option was granted, of the Fair Market Value (defined in the
Amended Option Plan) per share on the date of grant. The options
immediately vest at the date the options are granted and expire
after ten years, except that incentive stock options granted to
an optionee that owns stock representing more than 10% of the
total combined voting power of all classes of stock of the
Company or any parent or subsidiary of the Company expire five
years from the date of grant.
68
Equity
Compensation Plan Information
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Number of Securities
|
|
|
|
|
|
|
|
|
|
Remaining Available
|
|
|
|
|
|
|
Weighted-Average
|
|
|
for Future Issuance
|
|
|
|
Number of Securities to be
|
|
|
Exercise Price of
|
|
|
Under Equity
|
|
|
|
Issued Upon Exercise of
|
|
|
Outstanding
|
|
|
Compensation Plans
|
|
|
|
Outstanding Options,
|
|
|
Options, Warrants
|
|
|
(Excluding Securities
|
|
Plan Category
|
|
Warrants and Rights
|
|
|
and Rights
|
|
|
Reflected in Column (a))
|
|
|
|
(a)
|
|
|
(b)
|
|
|
(c)
|
|
|
Equity compensation plans approved by security holders
June 15, 2006
|
|
|
653,000
|
|
|
$
|
3.75
|
|
|
|
13,667
|
|
Equity compensation plans approved by security holders
April 7, 2008
|
|
|
736,735
|
|
|
$
|
5.02
|
|
|
|
263,265
|
|
Equity compensation plans not approved by security holders
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
1,389,735
|
|
|
$
|
4.43
|
|
|
|
276,932
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The rest of the information required by Item 12 is
incorporated by reference to the information appearing under the
caption Security Ownership in the Companys
definitive Proxy Statement relating to its 2009 Annual Meeting
of Stockholders to be filed with the Securities and Exchange
Commission within 120 days after the close of its fiscal
year.
|
|
ITEM 13.
|
CERTAIN
RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR
INDEPENDENCE
|
The information required by Item 13 is incorporated by
reference to the information appearing under the caption
Certain Relationships and Related Transactions in
the Companys definitive Proxy Statement relating to its
2009 Annual Meeting of Stockholders to be filed with the
Securities and Exchange Commission within 120 days after
the close of the fiscal year.
|
|
ITEM 14.
|
PRINCIPAL
ACCOUNTANT FEES AND SERVICES
|
The information required by Item 14 is incorporated by
reference to the information appearing under the caption
Principal Accountant Fees and Services in the
Companys definitive Proxy Statement relating to its 2009
Annual Meeting of Stockholders to be filed with the Securities
and Exchange Commission within 120 days after the close of
its fiscal year.
69
PART IV
|
|
ITEM 15.
|
EXHIBITS AND
FINANCIAL STATEMENT SCHEDULES
|
|
|
|
|
|
Exhibit
|
|
|
Number
|
|
Description
|
|
|
1
|
.1
|
|
Underwriting Agreement between the Registrant and Paulson
Investment Company, Inc., dated February 13, 2007
(incorporated by reference to Exhibit 1.1 on Post-Effective
Amendment No. 1 to our Registration Statement on
Form SB-2
filed February 20, 2007)
|
|
2
|
.1
|
|
Asset Purchase Agreement between the Registrant and United
Organic Products, LLC, dated January 21, 2008 (incorporated
by reference to Exhibit 2.02 to our current report on
Form 8-K
filed January 29, 2008)
|
|
2
|
.2
|
|
Asset Purchase Agreement between the Registrant and Waste
Recovery Industries, LLC, dated January 21, 2008
(incorporated by reference to Exhibit 2.03 to our current
report on
Form 8-K
filed January 29, 2008)
|
|
3
|
.1
|
|
Registrants Certificate of Incorporation (incorporated by
reference to Exhibit 3.1 to our Registration Statement on
Form SB-2
filed June 21, 2006)
|
|
3
|
.2
|
|
Registrants Bylaws (incorporated by reference to
Exhibit 3.2 to our Registration Statement on
Form SB-2
filed June 21, 2006)
|
|
4
|
.1
|
|
Form of Common Stock Certificate (incorporated by reference to
Exhibit 4.1 to our
Form SB-2/A
filed January 25, 2007)
|
|
4
|
.2
|
|
Form of Class B Warrant (incorporated by reference to
Exhibit B to Exhibit 4.5 on Post-Effective Amendment
No. 1 to our Registration Statement on
Form SB-2
filed February 20, 2007)
|
|
4
|
.3
|
|
Form of Unit Certificate (incorporated by reference to
Exhibit 4.4 on Post-Effective Amendment No. 1 to our
Registration Statement on
Form SB-2
filed February 20, 2007)
|
|
4
|
.4
|
|
Warrant Agreement between the Registrant and Computershare
Shareholder Services, Inc. and Computershare Trust Company
N.A., dated February 16, 2007 (incorporated by reference to
Exhibit 4.5 on Post-Effective Amendment No. 1 to our
Registration Statement on
Form SB-2
filed February 20, 2007)
|
|
4
|
.5
|
|
Form of Representatives Purchase Warrant (incorporated by
reference to Exhibit 4.6 to our Registration Statement on
Form SB-2
filed June 21, 2006)
|
|
4
|
.6
|
|
Registration Rights Agreement between the Registrant and
Professional Offshore Opportunity Fund, Ltd., Professional
Traders Fund, LLC and High Capital Funding, LLC, dated
January 24, 2008 (incorporated by reference to
Exhibit 2.06 to our current report on
Form 8-K
filed January 29, 2008)
|
|
4
|
.7
|
|
Loan and Securities Purchase Agreement between the Registrant
and each of Professional Offshore Opportunity Fund, Ltd.,
Professional Traders Fund, LLC and High Capital Funding, LLC,
dated January 24, 2008 (incorporated by reference to
Exhibit 2.10 to our current report on
Form 8-K
filed January 29, 2008)
|
|
4
|
.8
|
|
Secured Convertible Debenture to High Capital Funding, LLC,
dated January 24, 2008 (incorporated by reference to
Exhibit 2.07 to our current report on
Form 8-K
filed January 29, 2008)
|
|
4
|
.9
|
|
Secured Convertible Debenture to Professional Offshore
Opportunity Fund, LLC, dated January 24, 2008 (incorporated
by reference to Exhibit 2.09 to our current report on
Form 8-K
filed January 29, 2008)
|
|
4
|
.10
|
|
Purchase Agreement dated March 6, 2009 by and among
Converted Organics Inc. and Professional Offshore Opportunity
Fund, Ltd. (incorporated by reference to Exhibit 10.1 to
our current report on
Form 8-K
filed March 12, 2009)
|
|
4
|
.11
|
|
Convertible Note dated March 6, 2009 by Converted Organics
Inc. payable to Professional Offshore Opportunity Fund, Ltd.
(incorporated by reference to Exhibit 10.1 to our current
report on
Form 8-K
filed March 12, 2009)
|
|
4
|
.12
|
|
Registration Rights Agreement dated March 6, 2009 by and
among Converted Organics Inc. and Professional Offshore
Opportunity Fund, Ltd. (incorporated by reference to
Exhibit 10.1 to our current report on
Form 8-K
filed March 12, 2009)
|
|
*4
|
.13
|
|
Form of First Amendment to the Secured Convertible Debenture
dated January 24, 2008
|
|
*4
|
.14
|
|
Form of Second Amendment to the Secured Convertible Debenture
dated January 24, 2008 used for Professional Offshore
Opportunity Fund, Ltd.
|
70
|
|
|
|
|
Exhibit
|
|
|
Number
|
|
Description
|
|
|
*4
|
.15
|
|
Form of Second Amendment to the Secured Convertible Debenture
dated January 24, 2008 used for High Capital Funding, LLC
|
|
10
|
.1
|
|
Form of Bridge Loan Documents dated March 2, 2006
(incorporated by reference to Exhibit 10.1 to our
Registration Statement on
Form SB-2
filed June 21, 2006)
|
|
10
|
.1A
|
|
Form of Bridge Loan Documents dated April 11, 2006
(incorporated by reference to Exhibit 10.1A to our
Registration Statement on
Form SB-2
filed June 21, 2006)
|
|
10
|
.2
|
|
Amended and Restated 2006 Stock Option Plan and Form of Stock
Option Agreement (incorporated by reference to Exhibit 10.2
to Annex A of our Definitive Proxy Statement filed
March 5, 2008)
|
|
10
|
.3
|
|
Service Agreement between the Registrant and ECAP, LLC, dated
March 1, 2006 (incorporated by reference to
Exhibit 10.3 to our Registration Statement on
Form SB-2
filed June 21, 2006)
|
|
10
|
.4
|
|
Lease Agreement between the Registrant and Recycling Technology
Development, LLC, dated June 2, 2006 (incorporated by
reference to Exhibit 10.4 to our Registration Statement on
Form SB-2
filed June 21, 2006)
|
|
10
|
.4A
|
|
Amendment to the Lease Agreement between the Registrant and
Recycling Technology Development dated January 18, 2007
(incorporated by reference to Exhibit 10.4A to our
Form SB-2/A
filed January 25, 2007)
|
|
10
|
.5
|
|
Employment Agreement between the Registrant and Edward J.
Gildea, dated March 2, 2006 (incorporated by reference to
Exhibit 10.5 to our Registration Statement on
Form SB-2
filed June 21, 2006)
|
|
10
|
.6
|
|
Employment Agreement between the Registrant and John A.
Walsdorf, dated March 2, 2006 (incorporated by reference to
Exhibit 10.7 to our Registration Statement on
Form SB-2
filed June 21, 2006)
|
|
10
|
.7
|
|
Agreement between the Registrant and Weston Solutions, Inc.,
dated May 29, 2003 and modification dated October 6,
2004 (incorporated by reference to Exhibit 10.9 to our
Registration Statement on
Form SB-2
filed June 21, 2006)
|
|
10
|
.8
|
|
IBR Plant License Agreement between International Bio Recovery
Corporation and Mining Organics Management LLC, dated
July 15, 2003 (incorporated by reference to
Exhibit 10.10 to our
Form SB-2/A
filed July 5, 2006)
|
|
10
|
.9
|
|
Revision dated February 9, 2006 to IBR Plant License
Agreement dated July 15, 2003 (incorporated by reference to
Exhibit 10.11 to our
Form SB-2/A
filed July 5, 2006)
|
|
10
|
.10
|
|
Security Agreement between the Registrant and Professional
Offshore Opportunity Fund, Ltd., Professional Traders Fund, LLC
and High Capital Funding, LLC, dated January 24, 2008
(incorporated by reference to Exhibit 2.11 to our current
report on
Form 8-K
filed January 29, 2008)
|
|
10
|
.11
|
|
Secured Convertible Promissory Note in favor of United Organic
Products, LLC, dated January 24, 2008 (incorporated by
reference to Exhibit 2.04 to our current report on
form 8-K
filed January 29, 2008)
|
|
10
|
.12
|
|
Secured Promissory Note in favor of Waste Recovery Industries,
LLC, dated January 24, 2008 (incorporated by reference to
Exhibit 2.05 to our current report on
form 8-K
filed January 29, 2008)
|
|
*10
|
.13
|
|
New Jersey Economic Development Authority $17,500,000 Solid
Waste Facilities Revenue Bonds (Converted Organics of
Woodbridge, LLC 2007 Project), dated
February 16, 2007
|
|
*23
|
.1
|
|
Consent of CCR LLP
|
|
*31
|
.1
|
|
Certification of Chief Executive Officer pursuant to
Rule 13a-14(a)/15d-14(a)
|
|
*31
|
.2
|
|
Certification of Chief Financial Officer pursuant to
Rule 13a-14(a)/15d-14(a)
|
|
*32
|
.1
|
|
Certification pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002
|
|
*32
|
.2
|
|
Certification pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002
|
|
|
|
* |
|
Filed as an Exhibit herein. |
71
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act,
the registrant caused this report to be signed on its behalf by
the undersigned, thereunto duly authorized.
Converted Organics Inc.
Name: Edward J. Gildea
|
|
|
|
Title:
|
President, Chief Executive Officer,
|
Chairman of the Board
Date: March 27, 2009
In accordance with the Exchange Act, this report has been signed
below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.
Name: Edward J. Gildea
|
|
|
|
Title:
|
President, Chief Executive Officer,
|
Chairman of the Board
Date: March 27, 2009
Name: David R. Allen
|
|
|
|
Title:
|
Chief Financial Officer,
|
Executive Vice President of Administration
Date: March 27, 2009
Name: Ellen P. ONeil
|
|
|
|
Title:
|
Chief Accounting Officer
|
Date: March 27, 2009
Name: Robert E. Cell
Date: March 27, 2009
72
By:
/s/ John
P. DeVillars
Name: John P. DeVillars
Date: March 27, 2009
By:
/s/ Edward
A. Stoltenberg
Name: Edward A. Stoltenberg
Date: March 27, 2009
73