e10vq
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
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Quarterly Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 |
For the quarterly period ended June 30, 2010
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Transition Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 |
For the transition period from to
Commission file number:001-33304
Converted Organics Inc.
(Exact name of registrant as specified in its charter)
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Delaware
(State or other jurisdiction of incorporation or organization)
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20-4075963
(I.R.S. Employer Identification No.) |
137A Lewis Wharf, Boston, MA 02110
(Address of principal executive offices) (Zip Code)
(617) 624-0111
(Registrant’s telephone number, including area code)
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for
such shorter period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. YES þ NO o
Indicate by check mark whether the registrant has submitted electronically and posted on its
corporate Web site, if any, every Interactive Data File required to be submitted and posted
pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months
(or for such shorter period that the registrant was required to submit and post such files). YES
o NO o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a
non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated
filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
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| Large accelerated filer o
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Accelerated filer o
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Non-accelerated filer o
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Smaller reporting company þ |
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(Do not check if a smaller reporting company) |
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Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the
Exchange Act). YES o NO þ
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of
the latest practicable date: As of August 9, 2010, there were 42,607,871 shares of our common stock
outstanding.
Item 1. Financial Statements
CONVERTED ORGANICS INC.
CONSOLIDATED BALANCE SHEETS
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June 30, 2010 |
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December 31, 2009 |
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(Unaudited) |
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(Audited) |
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ASSETS |
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CURRENT ASSETS |
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Cash |
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$ |
2,053,028 |
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$ |
10,708,807 |
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Restricted cash |
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583,393 |
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583,393 |
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Accounts receivable, net |
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1,071,195 |
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140,657 |
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Inventories |
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213,519 |
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448,748 |
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Prepaid rent |
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692,928 |
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600,684 |
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Other prepaid expenses |
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669,809 |
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102,442 |
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Total current assets |
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5,283,872 |
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12,584,731 |
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Deposits |
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815,390 |
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780,686 |
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Restricted cash |
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29,769 |
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29,769 |
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Other assets |
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500,000 |
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— |
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Property and equipment, net |
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18,068,637 |
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18,626,910 |
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Construction-in-progress |
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354,521 |
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311,015 |
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Capitalized bond costs, net |
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790,507 |
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814,341 |
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Intangible assets, net |
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1,851,615 |
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1,995,619 |
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Total assets |
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$ |
27,694,311 |
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$ |
35,143,071 |
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LIABILITIES AND SHAREHOLDERS’ EQUITY (DEFICIT) |
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CURRENT LIABILITIES |
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Term notes payable — current |
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$ |
1,777,468 |
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$ |
2,274,413 |
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Accounts payable |
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1,980,104 |
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1,789,332 |
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Accrued compensation, officers, directors and consultants |
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652,696 |
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769,056 |
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Accrued legal and other expenses |
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601,492 |
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406,403 |
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Accrued interest |
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598,588 |
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618,526 |
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Convertible note payable |
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198,447 |
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355,164 |
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Capital lease obligations — current |
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12,342 |
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12,833 |
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Total current liabilities |
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5,821,137 |
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6,225,727 |
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Capital lease obligation, net of current portion |
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22,464 |
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27,742 |
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Term notes payable, net of current portion |
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102,151 |
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973,339 |
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Derivative liabilities |
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2,096,109 |
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1,626,742 |
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Convertible note payable, net of current portion |
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— |
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17,767 |
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Bonds payable |
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17,500,000 |
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17,500,000 |
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Total liabilities |
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25,541,861 |
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26,371,317 |
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COMMITMENTS AND CONTINGENCIES |
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— |
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— |
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SHAREHOLDERS’ EQUITY (DEFICIT) |
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Preferred stock, $.0001 par value, authorized
10,000,000 shares; no shares issued and outstanding |
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— |
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— |
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Common stock, $.0001 par value, authorized 250,000,000 shares
at June 30, 2010 and 75,000,000 shares at December 31, 2009 |
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4,057 |
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3,777 |
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Additional paid-in capital |
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61,745,571 |
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58,660,042 |
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Accumulated deficit |
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(59,597,178 |
) |
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(49,892,065 |
) |
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Total shareholders’ equity |
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2,152,450 |
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8,771,754 |
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Total liabilities and shareholders’ equity |
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$ |
27,694,311 |
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$ |
35,143,071 |
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The accompanying notes are an integral part of these consolidated financial statements.
3
CONVERTED ORGANICS INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
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Three month periods ended |
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Six month periods ended |
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June 30, 2010 |
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June 30, 2009 |
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June 30, 2010 |
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June 30, 2009 |
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Revenues |
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$ |
1,825,607 |
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$ |
992,364 |
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$ |
2,685,433 |
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$ |
1,484,203 |
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Cost of goods sold |
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3,239,316 |
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2,113,074 |
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5,205,417 |
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3,757,264 |
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Gross loss |
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(1,413,709 |
) |
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(1,120,710 |
) |
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(2,519,984 |
) |
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(2,273,061 |
) |
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Operating expenses |
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General and administrative expenses |
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2,489,216 |
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2,502,643 |
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6,578,717 |
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4,175,661 |
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Research and development |
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79,800 |
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12,116 |
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|
143,859 |
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|
179,500 |
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Depreciation expense |
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2,911 |
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|
306,036 |
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5,730 |
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|
626,216 |
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Amortization of capitalized costs |
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75,370 |
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|
79,251 |
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150,741 |
|
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|
180,542 |
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Amortization of license |
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8,549 |
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|
4,125 |
|
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|
17,097 |
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|
8,250 |
|
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Loss from operations |
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|
(4,069,555 |
) |
|
|
(4,024,881 |
) |
|
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(9,416,128 |
) |
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(7,443,230 |
) |
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Other income/(expenses) |
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Interest income |
|
|
253 |
|
|
|
11,952 |
|
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|
534 |
|
|
|
22,247 |
|
Derivative gain/(loss) |
|
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1,133,884 |
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2,886,460 |
|
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|
498,729 |
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4,298,445 |
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Other income |
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|
69 |
|
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|
39,201 |
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69 |
|
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|
39,201 |
|
Interest expense |
|
|
(390,071 |
) |
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|
(2,123,061 |
) |
|
|
(788,317 |
) |
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(4,029,813 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
744,135 |
|
|
|
814,552 |
|
|
|
(288,985 |
) |
|
|
330,080 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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Loss before provision for income taxes |
|
|
(3,325,420 |
) |
|
|
(3,210,329 |
) |
|
|
(9,705,113 |
) |
|
|
(7,113,150 |
) |
|
|
|
|
|
|
|
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|
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|
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Provision for income taxes |
|
|
— |
|
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|
— |
|
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|
— |
|
|
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— |
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Net loss |
|
$ |
(3,325,420 |
) |
|
$ |
(3,210,329 |
) |
|
$ |
(9,705,113 |
) |
|
$ |
(7,113,150 |
) |
|
|
|
|
|
|
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|
|
|
|
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Net loss per share, basic and diluted |
|
$ |
(0.08 |
) |
|
$ |
(0.20 |
) |
|
$ |
(0.25 |
) |
|
$ |
(0.59 |
) |
|
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Weighted average common shares outstanding |
|
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39,930,049 |
|
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|
15,937,329 |
|
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|
38,902,816 |
|
|
|
11,985,904 |
|
|
|
|
|
|
|
|
|
|
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The accompanying notes are an integral part of these consolidated financial statements.
4
CONVERTED ORGANICS INC.
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY (DEFICIT)
FOR THE SIX MONTH PERIOD ENDED JUNE 30, 2010
(UNAUDITED)
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| |
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Common Stock |
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|
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Total |
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Shares Issued and |
|
|
|
|
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Additional |
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Accumulated |
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Owners’ Equity |
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Outstanding |
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Amount |
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Paid-in Capital |
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Deficit |
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(Deficit) |
|
Balance, December 31, 2009 |
|
|
37,774,208 |
|
|
$ |
3,777 |
|
|
$ |
58,660,042 |
|
|
$ |
(49,892,065 |
) |
|
$ |
8,771,754 |
|
Stock options |
|
|
— |
|
|
|
— |
|
|
|
1,299,152 |
|
|
|
— |
|
|
|
1,299,152 |
|
Common stock issued upon conversion of convertible notes payable and accrued
interest |
|
|
181,500 |
|
|
|
18 |
|
|
|
194,325 |
|
|
|
— |
|
|
|
194,343 |
|
Common stock issued as compensation |
|
|
165,000 |
|
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|
17 |
|
|
|
160,033 |
|
|
|
— |
|
|
|
160,050 |
|
Issuance of common stock and warrants |
|
|
2,400,000 |
|
|
|
240 |
|
|
|
1,398,024 |
|
|
|
— |
|
|
|
1,398,264 |
|
Common stock issued upon exercise of
employee stock options |
|
|
50,000 |
|
|
|
5 |
|
|
|
33,995 |
|
|
|
— |
|
|
|
34,000 |
|
Net loss |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
(9,705,113 |
) |
|
|
(9,705,113 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, June 30, 2010 |
|
|
40,570,708 |
|
|
$ |
4,057 |
|
|
$ |
61,745,571 |
|
|
$ |
(59,597,178 |
) |
|
$ |
2,152,450 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The accompanying notes are an integral part of these consolidated financial statements.
5
CONVERTED ORGANICS INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
| |
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| |
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Six month periods ended |
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| |
|
June 30, 2010 |
|
|
June 30, 2009 |
|
CASH FLOWS FROM OPERATING ACTIVITIES: |
|
|
|
|
|
|
|
|
Net loss |
|
$ |
(9,705,113 |
) |
|
$ |
(7,113,150 |
) |
Adjustments to reconcile net loss to net cash
used in operating activities: |
|
|
|
|
|
|
|
|
Deconsolidation of variable interest entity |
|
|
— |
|
|
|
(596,170 |
) |
Amortization of intangible assets — license |
|
|
17,097 |
|
|
|
8,250 |
|
Amortization of capitalized bond costs |
|
|
23,834 |
|
|
|
23,835 |
|
Amortization of deferred financing fees |
|
|
— |
|
|
|
22,042 |
|
Amortization of intangible assets |
|
|
126,907 |
|
|
|
134,665 |
|
Depreciation of fixed assets |
|
|
879,123 |
|
|
|
1,015,444 |
|
Beneficial conversion feature |
|
|
— |
|
|
|
230,492 |
|
Amortization of discounts attributable to warrants on private financing |
|
|
— |
|
|
|
1,330,313 |
|
Non-cash interest expense — private financing |
|
|
— |
|
|
|
658,597 |
|
Common stock issued for extension of convertible note payable |
|
|
— |
|
|
|
562,000 |
|
Common stock issued as compensation |
|
|
160,050 |
|
|
|
120,313 |
|
Stock option compensation expense |
|
|
1,299,152 |
|
|
|
190,022 |
|
Warrants issued in connection with private financing and equity transactions |
|
|
— |
|
|
|
662,479 |
|
Derivative gain |
|
|
(498,729 |
) |
|
|
(4,298,445 |
) |
Changes in operating assets and liabilities: |
|
|
|
|
|
|
|
|
(Increase) decrease in: |
|
|
|
|
|
|
|
|
Accounts receivable |
|
|
(930,538 |
) |
|
|
(262,558 |
) |
Inventory |
|
|
235,229 |
|
|
|
(118,243 |
) |
Prepaid expenses and other current assets |
|
|
(659,611 |
) |
|
|
(154,818 |
) |
Other assets |
|
|
— |
|
|
|
94,250 |
|
Deposits |
|
|
(34,704 |
) |
|
|
108,713 |
|
Increase (decrease) in: |
|
|
|
|
|
|
|
|
Accounts payable and other accrued expenses |
|
|
385,861 |
|
|
|
3,195,195 |
|
Accrued compensation — officers, directors and consultants |
|
|
(116,360 |
) |
|
|
(40,899 |
) |
Accrued interest |
|
|
(79 |
) |
|
|
133,467 |
|
Other |
|
|
— |
|
|
|
(39,201 |
) |
|
|
|
|
|
|
|
Net cash used in operating activities |
|
|
(8,817,881 |
) |
|
|
(4,133,407 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
CASH FLOWS FROM INVESTING ACTIVITIES |
|
|
|
|
|
|
|
|
Purchase of fixed assets |
|
|
(320,850 |
) |
|
|
(3,512,559 |
) |
Release of restricted cash |
|
|
— |
|
|
|
2,527,463 |
|
Construction costs |
|
|
(43,506 |
) |
|
|
— |
|
Other assets |
|
|
(500,000 |
) |
|
|
— |
|
|
|
|
|
|
|
|
Net cash used in investing activities |
|
|
(864,356 |
) |
|
|
(985,096 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
CASH FLOWS FROM FINANCING ACTIVITIES |
|
|
|
|
|
|
|
|
Repayment of term notes |
|
|
(1,368,133 |
) |
|
|
(197,990 |
) |
Repayment of capital lease obligations |
|
|
(5,769 |
) |
|
|
(6,888 |
) |
Member’s contributions |
|
|
— |
|
|
|
230,983 |
|
Member’s distributions |
|
|
— |
|
|
|
(201,630 |
) |
Net proceeds from exercise of options |
|
|
34,000 |
|
|
|
1,965,000 |
|
Net proceeds from stock offering |
|
|
2,366,360 |
|
|
|
1,928,000 |
|
Net proceeds from nonconvertible short-term note |
|
|
— |
|
|
|
1,182,500 |
|
Repayment of nonconvertible short-term note |
|
|
— |
|
|
|
(1,330,313 |
) |
Repayment of mortgage payable |
|
|
— |
|
|
|
(943 |
) |
|
|
|
|
|
|
|
Net cash provided by financing activities |
|
|
1,026,458 |
|
|
|
3,568,719 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
NET DECREASE IN CASH |
|
|
(8,655,779 |
) |
|
|
(1,549,784 |
) |
|
|
|
|
|
|
|
|
|
Cash, beginning of period |
|
|
10,708,807 |
|
|
|
3,357,940 |
|
|
|
|
|
|
|
|
Cash, end of period |
|
$ |
2,053,028 |
|
|
$ |
1,808,156 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Supplemental cash flow information: |
|
|
|
|
|
|
|
|
Cash paid during the period in: |
|
|
|
|
|
|
|
|
Interest |
|
$ |
788,396 |
|
|
$ |
1,031,973 |
|
|
|
|
|
|
|
|
|
|
Non-cash financing activities: |
|
|
|
|
|
|
|
|
Equipment acquired through assumption of capital lease |
|
$ |
— |
|
|
$ |
52,979 |
|
Equipment acquired through assumption of term note |
|
|
— |
|
|
|
118,250 |
|
Common stock issued upon conversion of convertible notes payable and accrued interest |
|
|
194,343 |
|
|
|
6,225,595 |
|
Fair value of derivative issued |
|
|
968,096 |
|
|
|
1,841,097 |
|
Discount on warrants issued in connection with financings |
|
|
— |
|
|
|
1,330,313 |
|
The accompanying notes are an integral part of these consolidated financial statements.
6
CONVERTED ORGANICS INC.
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1 — BASIS OF PRESENTATION AND NATURE OF OPERATIONS
The accompanying unaudited interim consolidated financial statements have been prepared in
accordance with accounting principles generally accepted in the United States of America and the
rules and regulations of the Securities and Exchange Commission (the “SEC”) for interim financial
reporting. Certain information and footnote disclosures normally included in the annual financial
statements of Converted Organics Inc. (the “Company”) have been condensed or omitted. In the
Company’s opinion, the unaudited interim consolidated financial statements and accompanying notes
reflect all adjustments, consisting of normal and recurring adjustments, that are necessary for a
fair presentation of its financial position and operating results as of and for the three and six
month interim periods ended June 30, 2010 and 2009.
The results of operations for the interim periods are not necessarily indicative of the
results to be expected for the entire year. This Form 10-Q should be read in conjunction with the
audited consolidated financial statements and notes thereto included in the Company’s Form 10-K as
of and for the year ended December 31, 2009.
NATURE OF OPERATIONS
Converted Organics Inc. uses food and other waste as a raw material to manufacture, sell and
distribute all-natural fertilizer products with nutrition characteristics and which have been shown
to support disease suppression. The Company generates revenues from two sources: product sales and
tip fees. Product sales revenue comes from the sale of fertilizer products. Tip fee revenue is
derived from waste haulers who pay the Company “tip” fees for accepting food waste generated by
food distributors such as grocery stores, produce docks and fish markets, food processors and
hospitality venues such as hotels, restaurants, convention centers and airports.
Converted Organics of California, LLC, a California limited liability company and wholly-owned
subsidiary of the Company, which operates the Company’s facility in Gonzales, California (the
“Gonzales facility”) was formed when the Company acquired the assets of United Organics Products,
LLC (“UOP”) and Waste Recovery Industries, LLC (“WRI”). The Gonzales facility produces
approximately 25 tons of organic fertilizer per day, which is sold primarily to the California
agricultural market. The Gonzales facility employs a proprietary method called High Temperature
Liquid Composting (“HTLC”). The Gonzales facility has been upgraded to enable it to accept larger
amounts of food waste from waste haulers and may be further upgraded, depending on demand, to have
the capability to produce a dry product in addition to the current liquid fertilizer it produces.
Converted Organics of Woodbridge, LLC, is a New Jersey limited liability company and
wholly-owned subsidiary of the Company, which was formed for the purpose of owning, constructing
and operating the Company’s second facility in Woodbridge, New Jersey (the “Woodbridge facility”).
The Woodbridge facility is designed to service the New York-Northern New Jersey metropolitan area
and is currently operating at less than full capacity. This facility also employs HTLC.
Converted Organics of Rhode Island, LLC, a Rhode Island limited liability company and
subsidiary of the Company, was formed in July 2008 for the purpose of developing a facility at the
Rhode Island central landfill. Converted Organics of Rhode Island, LLC has not had any activity
since its formation. On February 25, 2010, the Company signed a letter of intent with the owners
of the non-controlling interest in Converted Organics of Rhode Island, LLC to sell substantially
all of its assets and a limited select amount of liabilities, a transaction that would include an
assignment of the Company’s lease with the Rhode Island Resource Recovery Corporation (“RIRRC”).
On January 26, 2010, the Company formed Converted Organics of Mississippi, LLC, a Mississippi
limited liability company and a wholly-owned subsidiary of the Company, for the purpose of hiring a
sales force and adding a poultry litter-based fertilizer product to the Company’s existing product
lines. The Company has outsourced production of this product.
On February 25, 2010, the Company signed a memorandum of understanding with MassOrganics I,
under which MassOrganics I would operate the new manufacturing facility to be constructed at the
Sutton Commerce Park in Sutton, Massachusetts. MassOrganics I has agreed to enter into a license
agreement under which MassOrganics I will pay a licensing fee to the Company.
On May 20, 2010, the Company formed TerraSphere Inc., a Delaware corporation and a
wholly-owned subsidiary of the Company, for the purpose of acquiring TerraSphere Systems LLC (see
Note 11).
7
CONVERTED ORGANICS INC.
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS — CONTINUED
(UNAUDITED)
NOTE 2 – MANAGEMENT’S PLAN OF OPERATION
On July 30, 2010 the Company announced a reduction of its work force
by 50% which included employees at the corporate level and the Woodbridge facility. The Company
expects those salary reductions to save approximately $2.1 million over the next twelve months. In
addition, the Company is working with creditors to restructure or eliminate debt and lease payments
to reduce costs in order to evaluate the revised cost structure and projected revenue from the
Woodbridge facility. The Company has not completed that evaluation and therefore have not
determined the extent of savings available to the Company from this restructuring. To facilitate
the evaluation, the Company has temporarily halted production at the Woodbridge facility until the
evaluation has been completed. As of the date of filing this report, the Company has been granted
forbearance of principal payments on certain contractor notes payable, but have not reached
agreement with the holder of the New Jersey Economic Development Bonds and the Company has not made
approximately $234,000 of required interest payments on that debt. In addition, the Company did not
make certain payments on the lease obligations to the Woodbridge facility landlord.
The Company currently has manufacturing capabilities at its Gonzales facility. The
Gonzales facility is cash flow positive and has additional production capacity. The Company is
focusing its current sales efforts on taking advantage of the additional production capacity.
Previously, the Company estimated its negative cash flow requirements on a monthly basis were
approximately $400,000 at the corporate level and $500,000 for Woodbridge. The Company estimated
the current cost reduction efforts will lower the monthly cash flow requirements at the corporate
level to $200,000. The Company does not have a final estimate on the revised cash flow requirements
for the Woodbridge facility and will not have such until the current restructure negotiations are
completed. If the Company is unable to increase sales levels at Gonzales and if the current plans
to restructure certain costs and expenses are not successful, then the Company will need to seek
additional financing.
On July 6, 2010, the Company reached an agreement to acquire TerraSphere Systems LLC (Note
11). The transaction is subject to shareholder approval at a meeting currently scheduled for
August 31, 2010. If the transaction is approved and if all the closing conditions are met,
including a condition renegotiating the terms of its debt obligations in connection with the
operations in New Jersey, then the Company anticipates there will be cash available to the Company
from the acquired entity. The amount of cash that will be available is uncertain. However, any
amount available to the Company would reduce any amounts that otherwise may be needed to be raised
through a financing.
The Company previously disclosed that it believed the funds received through its October
2009 secondary public offering and the April 2010 financing would be sufficient to operate the
current business until the Company was cash flow positive assuming it achieved the desired
production capacity and sales levels and assuming it did not encounter additional costs or
expenses, either unforeseen or through any proposed mergers and/or acquisitions. To date, the
Company has not achieved the desired sales levels relating to the liquid product produced at its
Woodbridge facility and the chicken litter based fertilizer product that the Company contracted to
sell. Therefore, the Company may require additional financing prior to achieving cash flow from
operations for which it has no commitments. On July 2, 2010, a registration statement was filed on
Form S-3 to register $75,000,000 of common stock, which was declared
effective on July 15, 2010. There is no assurance that capital
in any form would be available to the Company, and if available, on terms and conditions that are
acceptable. Moreover, the Company is not permitted to borrow any future funds unless it obtains the
consent of the holders of the New Jersey Economic Development Authority bonds. The Company has
obtained such consent for prior financing, but there is no guarantee that it can obtain such
consent in the future.
NOTE 3 — NEWLY ADOPTED ACCOUNTING STANDARDS
There are no new accounting standards significantly affecting the Company in the three
and six month periods ended June 30, 2010.
NOTE 4 — INVENTORIES
The Company’s inventories consisted of the following at June 30, 2010 and December 31, 2009:
| |
|
|
|
|
|
|
|
|
| |
|
2010 |
|
|
2009 |
|
Finished goods |
|
$ |
174,852 |
|
|
$ |
252,860 |
|
Raw materials |
|
|
38,667 |
|
|
|
195,888 |
|
|
|
|
|
|
|
|
Total inventories |
|
$ |
213,519 |
|
|
$ |
448,748 |
|
|
|
|
|
|
|
|
8
CONVERTED ORGANICS INC.
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS — CONTINUED
(UNAUDITED)
NOTE 5 — DEBT
TERM NOTES
The Company entered into a financing agreement with an equipment financing company to acquire
equipment for its Woodbridge facility. The note is for $118,250, bears an imputed interest rate of
9% and has a three year term, maturing January 2012.
During 2009, the Company agreed to convert certain accounts payable totaling approximately
$4,718,000, related to the construction of the Woodbridge facility, into term notes ranging from 12
to 24 months at various rates ranging from 0% to 9% and payment terms maturing through September
2011. Certain of these notes carry liens which will be released upon full and final payment of the
note. The Company has recorded a discount on certain of the notes representing imputed interest of
approximately $54,000, which is being amortized during the non-interest bearing period of the notes
repayments. The outstanding balance of these term notes was approximately $1,880,000 and
$3,250,000 at June 30, 2010 and December 31, 2009, respectively.
The Company obtained the necessary bondholder consents to enter into these agreements.
BOND FINANCING
On February 16, 2007, concurrent with its initial public offering, the Company’s wholly-owned
subsidiary, Converted Organics of Woodbridge (“Woodbridge”), completed the sale of $17,500,000 of
New Jersey Economic Development Authority Bonds. The bonds carry a stated interest rate of 8% and
mature on August 1, 2027. The bonds are secured by a leasehold mortgage and a first lien on the
equipment of Woodbridge. In addition, Woodbridge had agreed to, among other things, establish a
fifteen month capitalized interest reserve and to comply with certain financial statement ratios.
The capitalized interest reserve has been depleted and is now being funded monthly by the Company.
The Company has provided a guarantee to the bondholders on behalf of Woodbridge for the entire bond
offering.
CONVERTIBLE NOTE PAYABLE
The holder of the convertible note issued in connection with the acquisition of UOP and WRI
commenced converting the principal and interest payments to shares of common stock. During the six
month period ended June 30, 2010, the Company issued 181,500 shares of common stock representing
principal and interest payments of approximately $194,000. The principal balance of the note is
approximately $198,000 at June 30, 2010.
NOTE 6 – DERIVATIVE INSTRUMENTS
On May 7, 2009, in connection with notes issued pursuant to a financing agreement an investor
received five-year warrants to purchase 750,000 shares and 350,000 shares of Company common stock,
with an original exercise price of $1.00 per share and $1.50 per share, respectively, (Class C and
D warrants, respectively) subject to certain anti-dilution provisions. The placement agent used for
the offering was issued 135,000 Class C warrants and 65,000 Class D warrants. These warrants are
subject to certain anti-dilution rights for issuance below the exercise prices and are not
registered and cannot be traded. The exercise price for the Class C and D warrants are $1.00 per
share and $1.02 per share, respectively, at June 30, 2010. The Company has determined that the
warrant provisions providing for protection for issuances below the warrant exercise prices could
result in modification of the exercise price based on a variable that is not an input to the fair
value for a fixed-for-fixed option. Therefore, the Company determined the warrants issued in
connection with this financing are a derivative instrument which is subject to mark-to-market
adjustment each reporting period. At December 31, 2009, the fair value of the warrants was
determined using a Black-Scholes model with the following assumptions: risk-free interest rate of
2.35%; no dividend yield; volatility of 98.6% resulting in a derivative liability of approximately
$563,500. The liability was revalued as of June 30, 2010 using a Black-Scholes model and the
following assumptions: risk-free interest rate of 1.79%; no dividend yield, volatility of 108.3%,
resulting in a revalued liability of approximately $532,600 and has recognized a derivative gain of
approximately $237,000 and $31,000 on the consolidated statements of operations for the three and
six month periods ended June 30, 2010, respectively.
9
CONVERTED ORGANICS INC.
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS — CONTINUED
(UNAUDITED)
NOTE 6 – DERIVATIVE INSTRUMENTS (Continued)
On September 8, 2009, in connection with notes issued pursuant to a financing agreement on
that date, an investor received a five-year warrant to purchase 2,500,000 shares of the Company’s
common stock, with an original exercise price of $1.25 per share. These warrants are subject to
certain anti-dilution rights for issuances below the exercise price; provided that absent
shareholder approval, the exercise price may not be reduced to less than $1.08 per share (Class G
warrants). These warrants are not registered and cannot be traded. The Class G warrants are
exercisable at $1.25 per share at June 30, 2010 as the Company has received a one time waiver for
the Class G anti-dilution provision relating to the triggering event which occurred on April 22,
2010 (Class I Warrants). The Company has determined the warrant provisions providing for issuances
below the warrant exercise price could result in modification of the exercise price based on a
variable that is not an input to the fair value for a fixed-for-fixed option. The Company has
determined that the warrants issued in connection with this financing are a derivative instrument
which is required to be shown as a derivative liability subject to mark-to-market adjustment each
reporting period. At December 31, 2009, the fair value of the warrants was determined using a
Black-Scholes model with the following assumptions: risk-free interest rate of 2.35%; no dividend
yield; volatility of 98.6% was a derivative liability of approximately $1,063,200. The liability
was revalued as of June 30, 2010 using a Black-Scholes model and the following assumptions:
risk-free interest rate of 1.79%; no dividend yield, volatility of 108.3%, resulting in a revalued
liability of approximately $1,041,500 and a derivative gain of approximately $451,000 and $21,700,
on the consolidated statements of operations for the three and six month periods ended June 30,
2010, respectively.
On April 22, 2010, in connection with notes issued pursuant to a financing agreement on that
date, an investor received a five-year warrant to purchase 1,163,362 shares of the Company’s common
stock, with an original exercise price of $1.06 per share, subject to certain anti-dilution rights
for issuances below such exercise price (Class I warrants) and are not registered and cannot be
traded. The Class I warrants are exercisable one year from the date of issuance. The Company has
determined that the warrant provisions providing for issuances below the warrant exercise price
could result in modification of the exercise price based on a variable that is not an input to the
fair value for a fixed-for-fixed option. The Company has determined the warrants issued in
connection with this financing are a derivative instrument which is subject to mark-to-market
adjustment each reporting period. At April 22, 2010, the fair value of the warrants was determined
to be approximately $968,000. At June 30, 2010, the fair value of the warrants was determined
using a Black-Scholes model with the following assumptions: risk-free interest rate of 1.79%; no
dividend yield; volatility of 108.3% resulting in a derivative liability of approximately $522,000
and a derivative gain of $446,000, on the consolidated statements of operations for both the three
and six month periods ended June 30, 2010. (also see Note 7)
NOTE 7 — OWNERS’ EQUITY (DEFICIT)
On March 17, 2010, the Company granted 165,000 shares of common stock to a consultant who
provides consulting services to the Company as remuneration for services previously rendered. The
grant was measured using the closing price of the Company’s stock on the date of grant. The
statements of operations includes a charge of $160,050 for the six months ended June 30, 2010
related to this grant, which was credited to common stock and additional paid-in capital.
On April 22, 2010, Converted Organics Inc. entered into a Securities Purchase Agreement with a
single institutional investor. Pursuant to the Securities Purchase Agreement, the Company agreed
to issue to the investor: (a) 2,400,000 shares of its common stock at $1.06 per share and (b)
five-year warrants to purchase 1,163,362 shares of its common stock at an exercise price of $1.06
per share. The warrants may be exercised at any time on or following a date one year after the
date of issuance and will expire five years from the date of issuance. The transaction provided the
Company with net proceeds of approximately $2.4 million.
On June 30, 2010, the Company’s stockholders approved the amendment to the Company’s Certificate of
Incorporation to increase the number of shares of common stock that the Company is authorized to
issue from 75,000,000 shares to 250,000,000 shares.
10
CONVERTED ORGANICS INC.
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS — CONTINUED
(UNAUDITED)
NOTE 7 — OWNERS’ EQUITY (DEFICIT) (Continued)
WARRANTS
The following table sets forth the outstanding warrants as of June 30, 2010:
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Class B |
|
|
Class C |
|
|
Class D |
|
|
Class E |
|
|
Class F |
|
|
Class G |
|
|
Class H |
|
|
Class I |
|
| |
|
Warrants |
|
|
Warrants |
|
|
Warrants |
|
|
Warrants |
|
|
Warrants |
|
|
Warrants |
|
|
Warrants |
|
|
Warrants |
|
| |
|
Exercise |
|
|
Exercise |
|
|
Exercise |
|
|
Exercise |
|
|
Exercise |
|
|
Exercise |
|
|
Exercise |
|
|
Exercise |
|
| |
|
Price $11.00 |
|
|
Price $1.00 |
|
|
Price $1.02 |
|
|
Price $1.63 |
|
|
Price $1.25 |
|
|
Price $1.25 |
|
|
Price $1.30 |
|
|
Price $1.06 |
|
Outstanding at
December 31, 2009 |
|
|
4,932,438 |
|
|
|
885,000 |
|
|
|
415,000 |
|
|
|
1,500,000 |
|
|
|
585,000 |
|
|
|
2,500,000 |
|
|
|
17,250,000 |
|
|
|
— |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Issued |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
1,163,362 |
|
Exercised |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
Canceled |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at
June 30, 2010 |
|
|
4,932,438 |
|
|
|
885,000 |
|
|
|
415,000 |
|
|
|
1,500,000 |
|
|
|
585,000 |
|
|
|
2,500,000 |
|
|
|
17,250,000 |
|
|
|
1,163,362 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercisable at June
30, 2010 |
|
|
4,932,438 |
|
|
|
885,000 |
|
|
|
415,000 |
|
|
|
1,500,000 |
|
|
|
585,000 |
|
|
|
2,500,000 |
|
|
|
17,250,000 |
|
|
|
— |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
NOTE 8 — FAIR VALUE MEASUREMENTS
The Company applies ASC 820, which defines fair value, establishes a framework for
measuring fair value and expands disclosures about fair value measurements. ASC 820 applies to
reported balances that are required or permitted to be measured at fair value under existing
accounting pronouncements.
ASC 820 emphasizes that fair value is a market-based measurement, not an entity-specific
measurement. Therefore, a fair value measurement should be determined based on the assumptions that
market participants would use in pricing the asset or liability. As a basis for considering market
participant assumptions in fair value measurements, ASC 820 establishes a fair value hierarchy that
distinguishes between market participant assumptions based on market data obtained from sources
independent of the reporting entity (observable inputs that are classified within Levels 1 and 2 of
the hierarchy) and the reporting entity’s own assumptions about market participant assumptions
(unobservable inputs classified within Level 3 of the hierarchy).
Level 1 inputs utilize quoted prices (unadjusted) in active markets for identical assets
or liabilities that the Company has the ability to access. Level 2 inputs are inputs other than
quoted prices included in Level 1 that are observable for the asset or liability, either directly
or indirectly. Level 2 inputs may include quoted prices for similar assets and liabilities in
active markets, as well as inputs that are observable for the asset or liability (other than quoted
prices), such as interest rates, foreign exchange rates and yield curves that are observable at
commonly quoted intervals. Level 3 inputs are unobservable inputs for the asset or liability, which
is typically based on an entity’s own assumptions, as there is little, if any, related market
activity. In instances where the determination of the fair value measurement is based on inputs
from different levels of the fair value hierarchy, the level in the fair value hierarchy within
which the entire fair value measurement falls is based on the lowest level input that is
significant to the fair value measurement in its entirely requires judgment, and considers factors
specific to the asset or liability.
The Company’s liabilities that are reported at fair value in the accompanying consolidated
balance sheets as of June 30, 2010 and December 31, 2009 were as follows:
| |
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
Balance |
|
| |
|
Observable Inputs |
|
|
June 30, 2010 |
|
|
December 31, 2009 |
|
Derivative liabilities |
|
Level 3 |
|
$ |
2,096,109 |
|
|
$ |
1,626,742 |
|
11
CONVERTED ORGANICS INC.
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS — CONTINUED
(UNAUDITED)
NOTE 8 — FAIR VALUE MEASUREMENTS (Continued)
The following table reflects the change in Level 3 fair value of the Company’s derivative
liabilities for the three and six month periods ended June 30, 2010:
| |
|
|
|
|
|
|
|
|
| |
|
Three months ended |
|
|
Six months ended |
|
Balance, beginning of period |
|
$ |
2,261,897 |
|
|
$ |
1,626,742 |
|
Fair value of derivatives issued |
|
|
968,096 |
|
|
|
968,096 |
|
Derivative (gain) loss |
|
|
(1,133,884 |
) |
|
|
(498,729 |
) |
|
|
|
|
|
|
|
Balance, end of period |
|
$ |
2,096,109 |
|
|
$ |
2,096,109 |
|
|
|
|
|
|
|
|
The Company has other non-derivative financial instruments, such as cash, accounts receivable,
accounts payable, accrued expenses and long-term debt, which carrying amounts approximate fair
value.
NOTE 9 — STOCK OPTION PLAN
The following table presents the activity under the 2006 Stock Option Plan from January 1,
2010 through June 30, 2010:
| |
|
|
|
|
|
|
|
|
| |
|
Options Outstanding |
|
|
Price Per Share |
|
Outstanding at December 31, 2009 |
|
|
1,230,295 |
|
|
$ |
3.54 |
|
Granted |
|
|
2,508,500 |
|
|
|
.68 |
|
Exercised |
|
|
50,000 |
|
|
|
.68 |
|
Canceled |
|
|
— |
|
|
|
— |
|
|
|
|
|
|
|
|
Outstanding at June 30, 2010 |
|
|
3,788,795 |
|
|
$ |
1.63 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercisable at June 30, 2010 |
|
|
3,638,795 |
|
|
$ |
1.63 |
|
|
|
|
|
|
|
|
The expense associated with granting these options was calculated using a Black-Scholes model.
The resulting expense of the above options granted was $1,286,532 is included in general and
administrative expense on the consolidated statements of operations for the three and six month
periods ended June 30, 2010. As of June 30, 2010, there was unrecognized compensation cost of
approximately $11,000 related to non-vested share-based compensation arrangements granted under the
Company’s stock option plan. There was no intrinsic value of the Company’s outstanding stock
options at June 30, 2010.
NOTE 10 —COMMITMENTS AND CONTINGENCIES
LEASE COMMITMENT
The Company’s future minimum lease payments are as follows:
| |
|
|
|
|
|
Years ending December 31, |
|
|
|
|
2010 (July 1, 2010 through December 31, 2010) |
|
$ |
638,189 |
|
2011 |
|
|
1,291,182 |
|
2012 |
|
|
1,297,845 |
|
2013 |
|
|
1,202,281 |
|
2014 |
|
|
1,214,479 |
|
2015 and thereafter |
|
|
8,359,440 |
|
|
|
|
|
|
|
$ |
14,003,416 |
|
|
|
|
|
LOAN COMMITMENT
On March 23, 2010, the Company entered into a bridge loan and license agreement with Heartland
Technology Partners, LLC (“HTP”). The bridge loan agreement requires the Company to advance
$500,000 to HTP in three monthly installments commencing upon signing of the loan. The Company has
advanced HTP $500,000, classified as non-current other assets at June 30, 2010.
12
CONVERTED ORGANICS INC.
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS — CONTINUED
(UNAUDITED)
NOTE 10 —COMMITMENTS AND CONTINGENCIES (Continued)
PURCHASE COMMITMENT
On January 25, 2010, Converted Organics of Mississippi, LLC, a wholly-owned subsidiary of the
Company entered into a purchase order for 4700 tons of chicken litter based fertilizer for
$615,700. At June 30, 2010, the Company has made deposits of $615,700 to the contractor and has
taken delivery of $103,000 of product.
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
Company’s behalf except as follows.
On December 11, 2008, 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, or FTA, dated April 11, 2006, captioned Gerald S. Leeseberg, et al. v.
Converted Organics, Inc., filed in the U.S. District Court for the District of Delaware. The
lawsuit alleges breach of contract, conversion, unjust enrichment, and breach of the implied
covenant of good faith in connection with the alleged failure to register certain securities issued
in the FTA, and the redemption of the Company’s 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.
On October 7, 2009, the Court concluded that Leeseberg has properly stated a claim for actual
damages resulting from the Company’s alleged breach of contract, but that Leeseberg has failed to
state claims for conversion, unjust enrichment and breach of the implied covenant of good faith,
and the Court dismissed such claims. On November 6, 2009, the Company filed its answer to the
Complaint with the Court. On March 4, 2010, the parties participated in a conference, and began
discussing discovery issues. Plaintiff filed a Motion for Class Certification on June 22, 2010,
which is pending before the District Court. A jury trial has been set for May 17, 2011. The
Company plans 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.
Related to the above matter, in December 2009, the Company filed a complaint in the Superior
Court of Massachusetts for the County of Suffolk, captioned Converted Organics Inc. v. Holland &
Knight LLP. The Company claims that in the event it is required to pay any monies to Mr. Leeseberg
and his proposed class in the matter of Gerald S. Leeseberg, et al. v. Converted Organics, Inc.,
that Holland & Knight should make the Company whole, because its handling of the registration of
the securities at issue in the Leeseberg lawsuit caused any loss that Mr. Leeseberg and other
putative class members claim to have suffered. Holland & Knight has not yet responded to the
complaint. It has threatened to bring counterclaims against Converted Organics for legal fees
allegedly owed, which we would contest vigorously. On May 12, 2010, the Superior Court stayed the
proceedings, pending resolution of the Leeseberg litigation. At this early stage in the case, the
Company is unable to predict the likelihood of an unfavorable outcome, or to estimate the amount or
range of potential loss.
On May 19, 2009, the Company received notice that a complaint had been filed in the Middlesex
County Superior Court of New Jersey, captioned Lefcourt Associates, Ltd. v. Converted Organics of
Woodbridge, et al. The lawsuit alleged private and public nuisances, negligence, continuing
trespasses and consumer common-law fraud in connection with the odors emanating from the Woodbridge
facility and its alleged, intentional failure to disclose to adjacent property owners the
possibility of the facility causing pollution and was later amended to allege adverse possession,
acquiescence and easement. The lawsuit sought enjoinment of any and all operations which in any way
cause or contribute to the alleged pollution, compensatory and punitive damages, counsel fees and
costs of suit and any and all other relief the Court deems equitable and just. On April 12, 2010,
the Middlesex County Superior Court of New Jersey issued an administrative order settlement
dismissing without prejudice the matter of Lefcourt Associates, Ltd. v. Converted Organics of
Woodbridge, et al. On June 8, 2010, Lefcourt Associates, Ltd re-filed their lawsuit but before a
different court, the Chancery Division in Bergen County. The Company has filed a motion to
transfer the action back to the original court in Middlesex County and will seek to have the
lawsuit dismissed.
13
CONVERTED ORGANICS INC.
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS — CONTINUED
(UNAUDITED)
NOTE 11 – SUBSEQUENT EVENTS
On July 6, 2010, a membership interest purchase agreement was entered into by TerraSphere,
Inc., a wholly-owned subsidiary of the Company, TerraSphere Systems LLC (“TerraSphere”) and the
members of TerraSphere, to which the Company agreed to acquire 100% of TerraSphere. The maximum
total purchase price for TerraSphere is estimated to be $25,830,000, which includes earn-out
payments of up to $11,040,000, payable solely in shares of the Company’s common stock valued at
$0.756 per share. Pursuant to the purchase agreement, if the acquisition is approved by the
Company’s stockholders, the Company will issue up to 34,166,667 shares of its common stock to the
members of TerraSphere in exchange for 100% of the membership interest of TerraSphere, subject to
certain anti-dilution adjustments. Of these shares, 19,563,492 shares will be issued at the
closing of the acquisition, and the remainder of the shares will be issued if TerraSphere achieves
certain milestones. Upon completion of the proposed acquisition, TerraSphere would become a
wholly-owned subsidiary of the Company. TerraSphere designs, builds and operates highly efficient
and scalable systems, featuring a patented, proprietary technology that utilizes vertically-stacked
modules to house rows of plants, which are then placed perpendicular to an interior light source to
grow pesticide-free, organic fruits and vegetables. Due to a controlled, indoor environment, the
system generates fresh produce year-round in any location or climate world-wide.
Mr. Edward J. Gildea, the Company’s Chairman and Chief Executive Officer,
has an interest in 8.75% of the units of TerraSphere, and family members of Mr. Gildea
hold significant units of TerraSphere and serve as officers of TerraSphere.
On July 19, 2010, the Company issued 1,623,333 shares of its common stock and a warrant to
acquire 1,623,333 shares of common stock to Atlas Advisors, LLC (“Atlas”). The warrant will expire
five years from the date of issuance, or July 19, 2015, and has a strike price of $0.54 per share.
The issuance to Atlas was made pursuant to an agreement between the parties regarding payments due
to Atlas pursuant to a Business Development Agreement dated January 29, 2010. Under the Business
Development Agreement, the Company had agreed to compensate Atlas in the event of any mergers
and/or acquisitions that were a result of the services provided by Atlas, such payment to have
included both cash payments and equity payments. Pursuant to the agreement reached between the
parties, in exchange for the equity consideration listed herein, Atlas agreed that no further
consideration be paid to it in connection with the Company’s proposed acquisition of TerraSphere
Systems, LLC. The all stock payment was made to Atlas at a share price of $0.54, which was the
closing price of the Company’s common stock on the date of the TerraSphere acquisition agreement.
The warrant issued to Atlas was issued at an exercise price equal to the price at which the common
shares were issued. The Company and Atlas have also agreed to terminate the Business Development
Agreement for additional equity consideration pending agreement between the parties of a mutually
acceptable termination agreement.
On July 30, 2010, the Company restructured certain functions at its headquarters in Boston, MA and
its manufacturing facility in Woodbridge, NJ. The corporate restructuring represents a reduction
of the Company’s workforce. The estimated annual salary and benefit savings related to this
restructuring is approximately $2.1 million.
14
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion should be read in conjunction with the consolidated interim financial
statements and related notes to the consolidated interim financial statements included elsewhere in
this report. This discussion contains forward-looking statements that relate to future events or
our future financial performance. These statements involve known and unknown risks, uncertainties
and other factors that may cause our actual results, levels of activity, performance or
achievements to be materially different from any future results, levels of activity, performance or
achievements expressed or implied by these forward-looking statements. These forward-looking
statements are based largely on our current expectations and are subject to a number of
uncertainties and risks including the Risk Factors identified in our Annual Report on Form 10-K for
the year ended December 31, 2009. Actual results could differ materially from these forward-looking
statements. Converted Organics Inc. is sometimes referred to herein as “we”, “us”, “our” and the
“Company”.
Introduction
Our operating structure is composed of our parent company, Converted Organics Inc., three
wholly-owned operating subsidiaries, a newly formed wholly-owned subsidiary, TerraSphere Inc. and a
92.5% owned non-operating subsidiary. The first operating subsidiary is Converted Organics of
Woodbridge, LLC, which includes the operation of our Woodbridge, New Jersey facility. The second
operating subsidiary is Converted Organics of California, LLC, which includes the operation of our
Gonzales, California facility. The third operating subsidiary is Converted Organics of Mississippi,
LLC (“Converted Organics of Mississippi), a Mississippi limited liability company, established for
the purpose of adding a poultry litter-based fertilizer product to the Company’s existing product
lines. On May 20, 2010, the Company formed TerraSphere Inc. (“TerraSphere Inc”), a Delaware
corporation, to acquire TerraSphere Systems LLC, subject to approval of our shareholders at a
special meeting to be held on August 31, 2010. The 92.5% owned subsidiary is Converted Organics of
Rhode Island, LLC (“Converted Organics of RI”), which currently has no operating activity. On
February 25, 2010, the Company signed a letter of intent with the non-controlling member in
Converted Organics of RI to sell substantially all of the assets and a limited select amount of
liabilities of Converted Organics of RI. We construct and operate processing facilities that use
food waste as raw material to manufacture all-natural fertilizer and soil amendment products
combining nutritional and disease suppression characteristics. In addition, we have sales of a
poultry litter based fertilizer product. We have current sales in the agribusiness, retail and
turf management markets. We also hope to achieve additional revenue by licensing the use of our
technology to others.
Converted Organics of California, LLC — Gonzales Facility
The Gonzales facility is a state-of-the-art production facility that services a strong West
Coast agribusiness customer base through established distribution channels. This facility uses our
proprietary technology and process known as the High Temperature Liquid Composting, or HTLC,
system, which processes various biodegradable waste products into liquid and solid food waste-based
fertilizer and feed products.
The Gonzales facility began to generate positive cash flow in June 2009 and has continued to
through June 2010. In the six month period ending June 30, 2010, the Gonzales facility generated
revenues of $1,722,000 and a positive gross margin of $422,000, or 25% (based on no allocation of
corporate overhead). We plan to continue to improve this operating margin by channeling sales into
the turf and retail markets, by generating tip fees from receiving additional quantities of food
processing waste and by reducing the amount of raw material and freight costs currently associated
with the production process. We estimate that the plant in its current configuration, and based on
current market prices, has the capacity to generate monthly sales in the range of $350,000 to
$400,000. In addition, we have plans to add capacity to the Gonzales plant, whereby the plant will
be able to produce approximately three times its current production and will be capable of
producing both liquid and solid products. We have completed certain aspects of the planned upgrades
which allow us to receive solid food waste for processing but have delayed the upgrades which would
allow us to produce dry product. The remaining upgrades have been delayed due to a lack in market
demand for a dry product within the area the Gonzales facility serves. Because we will have to
obtain the proper building permits for continued expansion, further development of the Gonzales
facility will be delayed until further market research is completed and those permits are obtained.
Converted Organics of Woodbridge, LLC — Woodbridge Facility
The Woodbridge facility is our first internally constructed waste conversion facility. We
have the ability to produce both liquid and dry product at the facility. We have two revenue
streams: (1) tip fees that in our potential markets range from $25 to $80 per ton, and (2) product
sales. Tip fees are paid to us to receive the food waste stream from waste haulers; the hauler
pays us, instead of a
landfill, to take the waste. If the haulers source, separate and pay in advance, they are
charged tip fees that are up to 20% below
15
market. In the first six months of 2010, we recorded tip
fees and product sales revenue of approximately $728,000. During the first six months of 2010, we
generated revenue from this facility in the form of tip fees of approximately $70,000 and product
sales of approximately $658,000. 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.
Based on the above, we would have to produce and sell approximately 45-55% of the capacity of the
Woodbridge facility to be cash flow positive. As of the date of filing, we have not achieved
45-55% of capacity and therefore, have begun implementing a plan to reduce costs and restructure
the debt of the Woodbridge facility. See the Liquidity and Capital Resources section for more
information.
Converted Organics of Mississippi, LLC
On January 26, 2010, the Company formed Converted Organics of Mississippi, LLC, a Mississippi
limited liability company and a wholly owned subsidiary of the Company, for the purpose of adding a
poultry litter-based fertilizer product to our existing product lines. The Company has outsourced
production of this new product line. From the date of inception through June 30, 2010, Converted
Organics of Mississippi, LLC recorded product sales revenue of approximately $235,000. To date,
the sales of this product have not met our original estimates and we are evaluating the
continuation of this product line.
TerraSphere Inc.
On May 20, 2010, the Company formed TerraSphere Inc., a Delaware corporation and a wholly
owned subsidiary of the Company, for the purpose of acquiring TerraSphere Systems LLC
(“TerraSphere”). On July 6, 2010, a membership interest purchase agreement was entered into by the
Company, TerraSphere Inc., TerraSphere and the members of TerraSphere, pursuant to which the
Company agreed to acquire 100% of the membership interest of TerraSphere. The maximum total
purchase price for TerraSphere is estimated to be $25,830,000, which includes earn-out payments of
up to $11,040,000, payable solely in shares of the Company’s common stock valued at $0.756 per
share. Pursuant to the purchase agreement, if the acquisition is approved by the Company’s
stockholders, the Company will issue up to 34,166,667 shares of its common stock to the members of
TerraSphere in exchange for 100% of the units of TerraSphere, subject to certain anti-dilution
adjustments. Of these shares, 19,563,492 shares will be issued at the closing of the acquisition,
and the remainder of the shares will be issued if TerraSphere achieves certain milestones. Upon
completion of the proposed acquisition, TerraSphere would become a wholly-owned subsidiary of the
Company. TerraSphere designs, builds and operates highly efficient and scalable systems, featuring
a patented, proprietary technology that utilizes vertically-stacked modules to house rows of
plants, which are then placed perpendicular to an interior light source to grow pesticide-free,
organic fruits and vegetables. Due to a controlled, indoor environment, the system generates fresh
produce year-round in any location or climate world-wide. We believe the acquisition of
TerraSphere will expand our portfolio of sustainable, environmentally-friendly businesses, and will
provide us with an immediate revenue stream.
Industrial Wastewater Resources Division
On March 23, 2010, we entered into a loan and license agreement with Heartland Technology
Partners, LLC (“HTP”). The loan agreement requires the Company to advance $500,000 to HTP in three
monthly installments that commenced upon signing of the loan. The outstanding principal balance of
the loan is due if either a change of control of HTP or the completion by HTP of a financing in
excess of $10 million occurs on or before June 30, 2012. In consideration for entering the loan
agreement, the Company was granted an exclusive, irrevocable license to utilize HTP’s patented
LM-HT™ Concentrator technology in the U.S. industrial wastewater (IWW) market. The IWW market
involves the treatment of waters that have been contaminated by anthropogenic industrial or
commercial activities, prior to their reuse or release into the environment. A breakthrough
wastewater treatment process, the LM-HT™ Concentrator reduces carbon emissions compared to
traditional technologies by using waste heat and renewable energy as thermal fuel. In addition, we
have hired a senior executive in the waste water processing industry and have begun to develop
plans to operate our Industrial Wastewater Resources division. On July 30, 2010, we signed a letter
of intent with Spirit Services, Inc. to jointly develop an energy and IWW treatment facility using
our exclusively licensed technology to evaporate IWW at a facility in South Boston, Virginia.
Recent Financing Activities
On April 20, 2010, we entered into an agreement with a single institutional investor, pursuant
to which we issued to the investor: (a) 2,400,000 shares of common stock and (b) a five-year
warrant to purchase 1,163,362 shares of common stock at an exercise price
of $1.06 per share. The warrant may be exercised at any time on or following a date one year
after the date of issuance and expires
16
five years from the date of issuance. The transaction closed
on April 22, 2010 and provided the Company with net proceeds of approximately $2.4 million.
Future Development
Our long-term strategic plan calls for growth of our organic fertilizer business as well as
expansion of our portfolio of sustainable, environmentally-friendly businesses. To grow our
existing fertilizer business, we plan to develop and license additional organic fertilizer
manufacturing facilities and expand the capacity of our Gonzales facility. In connection with the
plan for additional facilities, we have completed preliminary work aimed at establishing facilities
in Massachusetts, where we have performed initial development work in connection with construction
of three manufacturing facilities to serve the eastern Massachusetts market. Two of our proposals
to develop facilities are currently under review by the property owners. The third proposal has
evolved into the MassOrgnaics I transaction described below. The Massachusetts Strategic
Envirotechnology Partnership Program has completed a review of our technology. In connection with
our plan to expand the capacity of our Gonzales facility, we plan to increase production to
approximately three times the facility’s current production and to expand the capability of the
plant to have the ability to produce both liquid and solid products.
We also plan to strengthen our green technology portfolio by completing the TerraSphere
acquisition and growing our Industrial Wastewater Resources Division. Through the TerraSphere
acquisition, we will expand our business into the market of building highly efficient systems for
growing pesticide-free, organics fruits and vegetables in controlled indoor environments.
TerraSphere will provide us with an immediate revenue stream and its clean technology helps to
promote the sustainable consumption of natural resources by accelerating plan production and
maximizing crop yields, while improving environmental footprints through the reduction of carbon
emissions and fuel use associated with traditional crop production and distribution. Also, we will
continue to grow our Industrial Wastewater Resources Division by working to form industry and/or
project-based partnerships that utilize our exclusively licensed technology to treat industrial
wastewaters.
In addition to the above listed growth opportunities, we have also initiated a restructuring
plan for the Woodbridge facility under which we are working with creditors to restructure or
eliminate debt and lease payments to reduce costs associated with that facility. As a result of
this restructuring plan, we hope to evaluate the revised cost structure and projected revenue from
the Woodbridge facility. As of the date of this report, we have not completed that evaluation,
however plan to continue with it in order to determine the extent of savings available to us from
this restructuring.
We have developed smaller capacity operating units, namely the Scalable Modular AeRobic
Technology (SMART) units, that are suitable for processing 5 to 50 tons of waste per day, depending
on owner/user preference. The semi-portable units are capable of operating indoors or outdoors and
may be as sophisticated or as basic in design and function as the owner/user requires. The SMART
units will be delivered to jobsites in pre-assembled, pre-tested components, and will include a
license to use the HTLC technology. Our target market is users who seek to address waste problems
on a smaller scale than would be addressed by a large processing facility. Our plan contemplates
that purchasers of the SMART units would receive tip fees for accepting waste and would sell
fertilizer and soil amendment products in the markets where their units operate. We plan to market
and sell the SMART units in both the United States and abroad.
We have also begun the development of a licensing program, under which we will license to
third parties, the right to use our proprietary technology. The licensing program consists of a
know-how license, which could be complemented with SMART unit sales so that any individual or
entity buying a SMART unit would also receive a license agreement to use our technology. We are
working to patent our process and technology and anticipate that we will expand upon the licensing
program when the necessary patent registrations are achieved. We are currently in negotiations
with MassOrganics I, LLC (“MassOrganics I”) regarding the use of Converted Organics’ proprietary
technology for the manufacture of organic fertilizer products. On January 25, 2010, we signed a
memorandum of understanding under which MassOrganics I would install and operate the system at a
new manufacturing facility to be constructed at The Sutton Commerce Park in Sutton, Massachusetts.
MassOrganics I has agreed to enter into a licensing agreement under which MassOrganics I will pay a
licensing fee to Converted Organics.
Trends and Uncertainties Affecting our Operations
We are 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
17
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 slowdown in lending in both the equity and bond markets which may hinder
our ability to raise the required funds.
Liquidity and Capital Resources
At June 30, 2010, we had total current assets of approximately $5.3 million consisting
primarily of cash, accounts receivable, inventories and prepaid assets, and had current liabilities
of approximately $5.8 million, consisting primarily of accounts payable, accrued expenses and notes
payable, leaving us with a negative working capital of approximately $500,000. Non-current assets
totaled $22.4 million and consisted primarily of property and equipment, intangible assets and
deposits. Non-current liabilities of approximately $19.7 million consist primarily of bonds payable
of $17.5 million and a $2.1 million derivative liability. We have an accumulated deficit at June
30, 2010 of approximately $59.6 million. Shareholders’ equity at June 30, 2010 was approximately
$2.2 million.
During the six month period ended June 30, 2010, we used approximately $8.7 million in cash on
hand. The significant cash expenditures during the first six months of 2010 were as follows:
| |
|
|
|
|
|
| $ |
1,435,000 |
|
|
to fund future revenue generating activities, including the
purchase of chicken litter-based fertilizer product
($615,000), a deposit for a license to treat Industrial
Wastewater ($500,000) and to fund capital equipment
purchases ($320,000). |
| |
|
|
|
|
| $ |
1,400,000 |
|
|
to repay debt principal and interest on term notes. |
| |
|
|
|
|
| $ |
1,400,000 |
|
|
to reduce accounts payable and accruals. |
| |
|
|
|
|
| $ |
4,465,000 |
|
|
to fund ongoing operations during the first six months of
2010, including $600,000 of marketing costs to implement a
formal marketing program. |
On July 30, 2010 we announced that we reduced our work force by 50% which included employees
at the corporate level and the Woodbridge facility. We expect those salary reductions to save
approximately $2.1 million over the next twelve months. In addition, we are working with creditors
to restructure or eliminate debt and lease payments to reduce costs as much as possible in order to
evaluate the revised cost structure and projected revenue from the Woodbridge facility. We have not
completed that evaluation and therefore have not determined the extent of savings available to us
from this restructuring. To facilitate the evaluation, we have temporarily halted production at
our Woodbridge facility until we complete the evaluation. As of the date of filing this report, we
have been granted forbearance of principal payments on certain contractor notes payable, but have
not reached agreement with the holder of the New Jersey Economic Development Bonds and we have not
made approximately $234,000 of required interest payments on that debt. In addition, we did not
make certain payments on our lease obligations to the Woodbridge facility landlord.
We currently have manufacturing capabilities at our Gonzales facility. The Gonzales facility
is cash flow positive and has additional production capacity. We are focusing our current sales
efforts on taking advantage of the additional production capacity. Previously, we estimated our
negative cash flow requirements on a monthly basis were approximately $400,000 at the corporate
level and $500,000 for Woodbridge. We estimate that the current cost reduction efforts will lower
the monthly cash flow requirements at the corporate level to $200,000. We do not have a final
estimate on the revised cash flow requirements for the Woodbridge facility and will not have such
until the current restructure negotiations are completed. If we are unable to increase sales levels
at Gonzales and if the current plans to restructure certain costs and expenses are not successful,
then we will need to seek additional financing.
On July 6, 2010 we reached an agreement to acquire TerraSphere Systems LLC. The transaction
is subject to approval by our shareholder’s at a meeting currently scheduled for August 31, 2010.
If the transaction is approved and if all the closing conditions are met, including a condition
that we renegotiate the terms of our debt obligations in connection with the operations in New
Jersey, then we anticipate there will be cash available to the company from the acquired entity.
The amount of cash that will be available is uncertain. However, any amount available to the
company would reduce any amounts that otherwise may be needed to be raised through a financing.
On April 20, 2010, we raised net proceeds of $2.4 million by through the issuance of (a)
2,400,000 shares of common stock and (b) a five-year warrant to purchase 1,163,362 shares of common
stock at an exercise price of $1.06 per share. We previously disclosed
18
that we believed the funds
received through our secondary public offering of 17,250,000 units which raised $16.4 million after
expenses and the April 2010 financing would be sufficient to operate our current business until we
were cash flow positive assuming we achieved our desired production capacity and sales levels and
assuming we did not encounter additional costs or expenses, either unforeseen or through any
proposed mergers and/or acquisitions. To date, we have not achieved the desired sales levels
relating to the liquid product produced at our Woodbridge facility and the chicken litter based
fertilizer product that we contracted to sell. Therefore, we may require additional financing prior
to achieving cash flow from operations for which we have no commitments. On July 2, 2010, we filed
a registration statement on Form S-3 to register $75,000,000 of our common stock, which was
declared effective on July 15, 2010. There is no assurance that capital in any form would be
available to us, and if available, on terms and conditions that are acceptable. Moreover, we are
not permitted to borrow any future funds unless we obtain the consent of the holders of the New
Jersey Economic Development Authority bonds. We have obtained such consent for prior financing, but
there is no guarantee that we can obtain such consent in the future.
Results of Operations
Sales
The Company’s sales increased $834,000 or 84%, and $1,201,000 or 81% for the three and six
month periods ended June 30, 2010, respectively, compared to the same periods ended June 30, 2009.
The Company attributes its significant growth to the Company’s targeted marketing efforts, and to
the increasing recognition nationwide regarding the importance of using organic fertilizer products
for lawncare, professional turf, and agricultural applications.
The Company’s sales by location were as follows:
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
For the three months ended June 30 |
|
|
For the six months ended June 30 |
|
| Location |
|
2010 |
|
|
2009 |
|
|
Change |
|
|
2010 |
|
|
2009 |
|
|
Change |
|
Gonzales, CA |
|
$ |
1,127,000 |
|
|
$ |
809,000 |
|
|
$ |
318,000 |
|
|
$ |
1,722,000 |
|
|
$ |
1,079,000 |
|
|
$ |
615,000 |
|
Woodbridge, NJ |
|
|
580,000 |
|
|
|
155,000 |
|
|
|
425,000 |
|
|
|
728,000 |
|
|
|
377,000 |
|
|
|
351,000 |
|
Mississippi |
|
|
118,000 |
|
|
|
n/a |
|
|
|
118,000 |
|
|
|
235,000 |
|
|
|
n/a |
|
|
|
235,000 |
|
Sales at the Gonzales facility increased $318,000 or 39% and $615,000 or 57% for the three and
six month periods ended June 30, 2010 compared to the same periods ended June 30, 2009.
Sales at the Woodbridge facility increased $425,000 or 274% and $351,000 or 93% for the three
and six month periods ended June 30, 2010 compared to the same periods ended June 30, 2009.
Since its inception on January 26, 2010, Mississippi has generated sales of $235,000.
Cost of Sales
For the three and six month periods ended June 30, 2010 cost of goods sold increased
approximately $1.1 million and $1.4 million, respectively, compared to the same periods in 2009.
The Company’s cost of goods sold by location were as follows:
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
For the three months ended June 30 |
|
|
For the six months ended June 30 |
|
| Location |
|
2010 |
|
|
2009 |
|
|
Change |
|
|
2010 |
|
|
2009 |
|
|
Change |
|
Gonzales, CA |
|
$ |
801,000 |
|
|
$ |
741,000 |
|
|
$ |
60,000 |
|
|
$ |
1,299,000 |
|
|
$ |
1,156,000 |
|
|
$ |
143,000 |
|
Woodbridge, NJ |
|
|
2,367,000 |
|
|
|
1,336,000 |
|
|
|
1,031,000 |
|
|
|
3,768,000 |
|
|
|
2,592,000 |
|
|
|
1,176,000 |
|
Mississippi |
|
|
71,000 |
|
|
|
n/a |
|
|
|
71,000 |
|
|
|
138,000 |
|
|
|
n/a |
|
|
|
138,000 |
|
Cost of goods sold at the Gonzales facility increased 8% and 12% for the three and six month
periods ended June 30, 2010 compared to the same periods ended June 30, 2009 due to an increase in
raw materials used to meet increase sales demand while the current level of fixed costs remained
relatively unchanged. The Gonzales facility generated a 25% gross margin for the six months ended
June 30, 2010 compared to a negative gross margin in the same period in 2009.
Cost of goods sold at the Woodbridge facility increased $1,031,000 or 77% and $1,176,000 or
45% for three and six month periods ended June 30, 2010 compared to the same periods ended June 30,
2009 due to assets placed in service and depreciated and an
19
increase in waste disposal costs due to
an increase in sales and higher waste disposal charges. The Woodbridge facility continues to
generate a negative gross margin due to sales not meeting the volume required to cover all fixed
costs associated with the facility.
Mississippi generated a gross margin of 42% on sales of $235,000 for the six months ended June
30, 2010.
General and Administrative Expenses
General and Administrative expenses for the three month periods ended June 30, 2010 and 2009
remained flat. The approximately $2.4 million increase in general and administrative expenses for
the six months ended June 30, 2010 compared to the same period in 2009 is composed of increases
related to compensation expense related to the issuance of stock options and restricted shares of
$1.4 million along with an increase in marketing costs of approximately $600,000.
Interest Expense
Interest expense decreased approximately $1.7 million or 82% and $3.2 million or 80% for the
three and six month periods ended June 30, 2010, respectively, compared to the same periods ended
June 30, 2009. The increases in 2009 were due to interest expense associated with the issuance of
warrants and interest recognized in connection with borrowing transactions, primarily non-cash
items. The interest expense for the three and six month periods ended June 30, 2010 was primarily
the interest on the NJ EDA bonds.
Derivative gain (loss)
We recognized derivative gains of approximately $1,134,000 and $499,000 in the three and six
month periods ended June 30, 2010, respectively. These gains are non-cash in nature and represent
mark-to-market adjustments due to changes in fair value.
Critical Accounting Policies
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.
Accounts Receivables
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.
Inventories
Inventories are valued at the lower of cost or market, with cost determined by the first in,
first out basis. Inventories consist primarily of raw materials and finished goods, which consist
of soil amendment products. Inventory balances are presented net of applicable reserves.
Intangible Assets
The Company accounts for its intangible assets in accordance with ASC section 350. The
standard requires that intangible assets with finite lives, such as the Company’s 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.
Derivative Instruments
The Company accounts for derivative instruments in accordance with ASC 815, which establishes
accounting and reporting standards for derivative instruments and hedging activities, including
certain derivative instruments embedded in other financial instruments or contracts and requires
recognition of all derivatives on the balance sheet at fair value, regardless of the hedging
relationship designation. Accounting for changes in the fair value of the derivative instruments
depends on whether the derivatives qualify as hedge relationships and the types of relationships
designated are based on the exposures hedged.
Revenue Recognition
20
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
The Company accounts for share based compensation paid to employees in accordance
with ASC 718. Under the provisions of the guidance, share-based compensation issued to employees is
measured at the grant date, based on the fair value of the award, and is recognized as an expense
over the requisite service period (generally the vesting period of the grant). The Company accounts
for share based compensation issued to non-employees in accordance with ASC 505. Under the
provisions of the guidance, such compensation is measured at the grant date, based on the fair
value of the equity instruments issued and is recognized as an expense over the requisite service
period.
Off-Balance Sheet Transactions
We do not engage in material off-balance sheet transactions.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Not applicable.
Item 4. Controls and Procedures
Under the supervision, and with the participation of our management, including the Principal
Executive Officer and Principal Financial Officer, we have evaluated the effectiveness of our
disclosure controls and procedures pursuant to Exchange Act Rules 13a-15 and 15d-15 as of the end
of the period covered by this report. Based on that evaluation, the Principal Executive Officer and
Principal Financial Officer have concluded that these disclosure controls and procedures were
effective such that the material information required to be filed in our SEC reports is recorded,
processed, summarized and reported within the required time periods specified in the SEC rules and
forms. This conclusion was based on the fact that the business operations to date have been limited
and the Principal Executive Officer and Principal Financial Officer have had complete access to all
records and financial information.
There were no changes in our internal control over financial reporting during the six months
ended June 30, 2010 that have materially affected, or are reasonably likely to materially affect,
our internal control over financial reporting. Potential investors should be aware that the design
of any system of controls and procedures is based in part upon certain assumptions about the
likelihood of future events. There can be no assurance that any system of controls and procedures
will succeed in achieving its stated goals under all potential future conditions, regardless of how
remote.
PART II — OTHER INFORMATION
Item 1. Legal Proceedings
On December 11, 2008, we received notice that a complaint had been filed in a putative class
action lawsuit on behalf of 59 persons or entities that purchased units pursuant to a financing
terms agreement, or FTA, dated April 11, 2006, captioned Gerald S. Leeseberg, et al. v. Converted
Organics, Inc., filed in the U.S. District Court for the District of Delaware. The lawsuit alleges
breach of contract, conversion, unjust enrichment, and breach of the implied covenant of good faith
in connection with the alleged failure to register certain securities issued in the FTA, and the
redemption of our Class A warrants in November 2008. The lawsuit seeks damages related to the
failure to register certain securities, including alleged late fee payments, of approximately $5.25
million, and unspecified damages related to the redemption of the Class A warrants. In February
2009, we filed a Motion for Partial Dismissal of Complaint. On October 7, 2009, the Court concluded
that Leeseberg has properly stated a claim for actual damages resulting from our alleged breach of
contract, but that Leeseberg has failed to state claims for conversion, unjust enrichment and
breach of the implied covenant of good faith, and the Court dismissed such claims. On November 6,
2009, we filed our answer to the Complaint with the Court. On March 4, 2010, the parties
participated in a conference, and began discussing discovery issues. Plaintiff filed a Motion for
Class Certification on June 22, 2010, which is pending before the District Court. A jury trial has
been set for May 17, 2011.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.
21
Related to the above matter, in December 2009, we filed a complaint in the Superior Court of
Massachusetts for the County of Suffolk, captioned Converted Organics Inc. v. Holland & Knight LLP.
We claim that in the event we are required to pay any monies to Mr. Leeseberg and his proposed
class in the matter of Gerald S. Leeseberg, et al. v. Converted Organics, Inc., that Holland &
Knight should make us whole, because its handling of the registration of the securities at issue in
the Leeseberg lawsuit caused any loss that Mr. Leeseberg and other putative class members claim to
have suffered. Holland & Knight has not yet responded to the complaint. It has threatened to
bring counterclaims against Converted Organics for legal fees allegedly owed, which we would
contest vigorously. On May 12, 2010, the Superior Court stayed the proceedings, pending resolution
of the Leeseberg litigation. At this early stage in the case, we are unable to predict the
likelihood of an unfavorable outcome, or to estimate the amount or range of potential loss.
On May 19, 2009, we received notice that a complaint had been filed in the Middlesex County
Superior Court of New Jersey, captioned Lefcourt Associates, Ltd. v. Converted Organics of
Woodbridge, et al. The lawsuit alleged private and public nuisances, negligence, continuing
trespasses and consumer common-law fraud in connection with the odors emanating from our Woodbridge
facility and our alleged, intentional failure to disclose to adjacent property owners the
possibility of our facility causing pollution and was later amended to allege adverse possession,
acquiescence and easement. The lawsuit sought enjoinment of any and all operations which in any way
cause or contribute to the alleged pollution, compensatory and punitive damages, counsel fees and
costs of suit and any and all other relief the Court deems equitable and just. On April 12, 2010,
the Middlesex County Superior Court of New Jersey issued an administrative order settlement
dismissing without prejudice the matter of Lefcourt Associates, Ltd. v. Converted Organics of
Woodbridge, et al. On June 8, 2010, Lefcourt Associates, Ltd re-filed their lawsuit but before a
different court, the Chancery Division in Bergen County. We have filed a motion to transfer the
action back to the original court in Middlesex County and will seek to have the lawsuit dismissed.
On July 28, 2010 we received notice that a complaint had been filed in the District Court,
Third Division, State of Rhode Island and Providence Plantations captioned Rhode Island Resource
Recovery Corporation v. Converted Organics Inc. The lawsuit alleged nonpayment of rent under a
Ground Lease between the parties dated September 1, 2008. The lawsuit sought eviction and the grant
of possession to the Plaintiff, the payment of back rent in the sum of $55,000.02, the payment of
aggregate late charges of $1,200.00, the payment of all other sums due and owing pursuant to the
Ground Lease including interest, costs and attorney’s fees and such other relief as the Court may
deem just and proper. We have twenty days to provide an answer to the complaint. We plan to
vigorously defend this matter. No loss has been recorded related to this matter.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
During the first quarter 2010, we issued 165,000 unregistered shares of common stock to New
Castle Consulting, LLC for consulting services with regard to investor relations. This transaction
was exempt from the registration requirement of the Securities Act of 1933, as amended (the “1933
Act”), pursuant to Section 4(2) under the 1933 Act, as the recipient is an “accredited investor” as
defined in the 1933 Act.
Item 3. Defaults upon Senior Securities
None.
Item 4. [Removed and Reserved]
Item 5. Other Information.
None.
Item 6. Exhibits
| |
|
|
| Exhibit No. |
|
Description of Exhibit |
3.1
|
|
Certificate of Amendment of the Certificate of Incorporation (incorporated by reference from
Exhibit 3.1 of the Company’s Form 8-K dated June 30, 2010) |
|
|
|
4.1
|
|
Form of Warrant issued pursuant to Securities Purchase Agreement dated April 20, 2010
(incorporated by reference from Exhibit 4.1 of the Company’s Form 8-K dated April 21, 2010) |
|
|
|
10.1
|
|
Form of Securities Purchase Agreement dated April 20, 2010 (incorporated by reference from Exhibit 10.1 of the the Company’s Form 8-K dated April 21, 2010) |
22
| |
|
|
| Exhibit No. |
|
Description of Exhibit |
10.2
|
|
Form of Registration Rights Agreement dated April 20, 2010 (incorporated by reference from
Exhibit 10.2 of the Company’s Form 8-K dated April 21, 2010) |
|
|
|
31.1
|
|
Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
|
|
|
31.2
|
|
Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
|
|
|
32.1
|
|
Certification of Chief Executive Officer pursuant to Section 906 |
|
|
|
32.2
|
|
Certification of Chief Financial Officer pursuant to Section 906 |
23
SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant caused this report to be
signed on its behalf by the undersigned, thereunto duly authorized.
| |
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|
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Converted Organics Inc.
|
|
| Date: August 13, 2010 |
/s/ Edward J. Gildea
|
|
| |
Edward J. Gildea |
|
| |
President and Chief Executive Officer |
|
| |
| |
|
|
| Date: August 13, 2010 |
/s/ David R. Allen
|
|
| |
David R. Allen |
|
| |
Chief Financial Officer and Executive Vice President of
Administration and Principal Accounting Officer |
|
14