e10vq
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
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þ |
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Quarterly Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 |
For the quarterly period ended September 30, 2011
OR
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o |
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Transition Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 |
For the transition period from to
Commission file number: 001-33304
Converted Organics Inc.
(Exact name of registrant as specified in its charter)
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Delaware
(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
(Registrants telephone number, including area code)
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for
such shorter period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. YES þ NO o
Indicate by check mark whether the registrant has submitted electronically and posted on its
corporate Web site, if any, every Interactive Data File required to be submitted and posted
pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months
(or for such shorter period that the registrant was required to
submit and post such files). YES
þ
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 issuers classes of common stock, as of
the latest practicable date: As of November 11, 2011, there were
23,176,211 shares of our common
stock outstanding.
Item 1. Financial Statements
CONVERTED ORGANICS INC.
CONSOLIDATED BALANCE SHEETS
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September 30, 2011 |
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December 31, 2010 |
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(Unaudited) |
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(As Restated) |
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ASSETS |
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CURRENT ASSETS |
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Cash |
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$ |
989,629 |
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$ |
3,039,941 |
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Accounts receivable, net |
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555,150 |
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522,946 |
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Inventories |
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226,715 |
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126,406 |
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Prepaid expenses and other assets |
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317,523 |
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251,589 |
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Deferred financing costs, net |
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140,798 |
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276,667 |
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Current assets of discontinued operations |
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14,500 |
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Total current assets |
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2,229,815 |
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4,232,049 |
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Deposits and other non-current assets |
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587,831 |
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575,596 |
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Property and equipment, net |
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2,904,787 |
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1,477,589 |
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Goodwill |
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223,787 |
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2,359,378 |
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Intangible assets, net |
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11,242,993 |
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11,879,265 |
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Total assets |
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$ |
17,189,213 |
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$ |
20,523,877 |
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LIABILITIES AND STOCKHOLDERS EQUITY |
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CURRENT LIABILITIES |
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Term note payable |
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$ |
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$ |
350,000 |
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Notes payable related party |
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72,351 |
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72,351 |
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Accounts payable |
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2,067,579 |
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2,393,388 |
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Accrued expenses |
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652,929 |
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656,412 |
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Convertible notes payable, net of unamortized discount |
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2,384,959 |
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306,404 |
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Obligation to issue shares |
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205,357 |
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1,560,715 |
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Derivative liabilities current |
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4,949,019 |
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5,199,572 |
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Deferred revenue |
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50,000 |
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Liabilities of discontinued operations |
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564,418 |
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2,438,253 |
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Total current liabilities |
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10,946,612 |
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12,977,095 |
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Derivative liabilities |
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955,708 |
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3,476,047 |
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Total liabilities |
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11,902,320 |
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16,453,142 |
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COMMITMENTS AND CONTINGENCIES |
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STOCKHOLDERS EQUITY |
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Preferred stock, $1,000 stated value, authorized 10,000,000 shares |
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13,281,000 |
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17,500,000 |
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Common stock, $.0001 par value, authorized 500,000,000 shares at
September 30, 2011 and 250,000,000 shares at December 31, 2010 |
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14,230 |
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8,547 |
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Additional paid-in capital |
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99,156,204 |
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84,882,411 |
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Accumulated deficit |
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(107,554,226 |
) |
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(98,973,192 |
) |
Accumulated other comprehensive income (loss) |
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56,341 |
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(1,109 |
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4,953,549 |
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3,416,657 |
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Noncontrolling interests |
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333,344 |
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654,078 |
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Total stockholders equity |
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5,286,893 |
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4,070,735 |
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Total liabilities and stockholders equity |
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$ |
17,189,213 |
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$ |
20,523,877 |
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The accompanying notes are an integral part of these consolidated financial statements.
3
CONVERTED ORGANICS INC.
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
(UNAUDITED)
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Three month periods ended |
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Nine month periods ended |
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September 30, 2011 |
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September 30, 2010 |
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September 30, 2011 |
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September 30, 2010 |
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Revenues |
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$ |
687,659 |
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$ |
808,582 |
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$ |
2,806,545 |
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$ |
2,765,641 |
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Cost of goods sold |
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515,284 |
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583,703 |
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1,973,710 |
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2,020,752 |
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Gross profit |
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172,375 |
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224,879 |
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832,835 |
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744,889 |
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Operating expenses |
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Selling, general and administrative expenses |
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1,361,634 |
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4,011,974 |
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7,480,445 |
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10,413,049 |
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Research and development |
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35,000 |
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16,023 |
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176,650 |
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Amortization of intangible assets |
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221,457 |
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72,001 |
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664,099 |
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216,006 |
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Goodwill impairment |
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2,135,021 |
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1,583,091 |
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4,118,975 |
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10,295,588 |
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10,805,705 |
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Loss from continuing operations |
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(1,410,716 |
) |
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(3,894,096 |
) |
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(9,462,753 |
) |
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(10,060,816 |
) |
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Other income/(expenses) |
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Other income (expense) |
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(21,396 |
) |
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7,339 |
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7,557 |
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|
7,871 |
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Gain on obligations to issue shares revaluation |
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82,143 |
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1,355,358 |
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Gain on settlement of debt |
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225,000 |
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Derivative gain (loss) |
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(2,297,229 |
) |
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661,982 |
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6,952,284 |
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1,160,711 |
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Loss on debt modification |
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(936,776 |
) |
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(936,776 |
) |
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Interest expense |
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(1,411,805 |
) |
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(4,627 |
) |
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(7,252,051 |
) |
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(15,883 |
) |
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(4,585,063 |
) |
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|
664,694 |
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(351,372 |
) |
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|
1,152,699 |
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Loss from continuing operations before
provision for income taxes |
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|
(5,995,779 |
) |
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(3,229,402 |
) |
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(9,111,381 |
) |
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(8,908,117 |
) |
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Provision for income taxes |
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Net loss from continuing operations |
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|
(5,995,779 |
) |
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|
(3,229,402 |
) |
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|
(9,111,381 |
) |
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|
(8,908,117 |
) |
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Income (loss) from discontinued operations |
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49,447 |
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(18,685,007 |
) |
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|
195,918 |
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(22,711,406 |
) |
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Net loss |
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|
(5,946,332 |
) |
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(21,914,409 |
) |
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(8,915,463 |
) |
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(31,619,523 |
) |
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Net loss attributable to noncontrolling interests |
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|
(187,904 |
) |
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(334,429 |
) |
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Net loss attributable to Converted Organics Inc.
before other comprehensive loss |
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|
(5,758,428 |
) |
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|
(21,914,409 |
) |
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|
(8,581,034 |
) |
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|
(31,619,523 |
) |
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Other comprehensive income: |
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Foreign currency translation adjustment |
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|
85,449 |
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|
71,145 |
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Comprehensive loss |
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|
(5,672,979 |
) |
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(21,914,409 |
) |
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|
(8,509,889 |
) |
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|
(31,619,523 |
) |
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|
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|
Comprehensive income attributable to noncontrolling interests |
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|
16,449 |
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|
|
|
|
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|
13,695 |
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Comprehensive loss attributable to Converted Organics Inc. |
|
$ |
(5,689,428 |
) |
|
$ |
(21,914,409 |
) |
|
$ |
(8,523,584 |
) |
|
$ |
(31,619,523 |
) |
|
|
|
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|
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|
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Earnings (loss) per share, basic and diluted |
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Continuing operations |
|
$ |
(0.43 |
) |
|
$ |
(0.75 |
) |
|
$ |
(0.80 |
) |
|
$ |
(2.21 |
) |
Discontinued operations |
|
$ |
|
|
|
$ |
(4.33 |
) |
|
$ |
0.02 |
|
|
$ |
(5.63 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
(0.43 |
) |
|
$ |
(5.08 |
) |
|
$ |
(0.78 |
) |
|
$ |
(7.84 |
) |
|
|
|
|
|
|
|
|
|
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|
|
|
|
|
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|
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|
Weighted average common shares outstanding |
|
|
14,059,866 |
|
|
|
4,318,744 |
|
|
|
11,500,199 |
|
|
|
4,035,456 |
|
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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 STOCKHOLDERS EQUITY
FOR THE NINE MONTH PERIOD ENDED SEPTEMBER 30, 2011
(UNAUDITED)
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|
|
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|
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|
|
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|
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Accumulated |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Preferred Stock Series A |
|
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Common Stock |
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|
|
|
|
|
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Other |
|
|
|
|
|
|
|
|
|
|
Total |
|
|
|
Shares Issued and |
|
|
|
|
|
|
Shares Issued and |
|
|
|
|
|
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Additional |
|
|
Accumulated |
|
|
Comprehensive |
|
|
|
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|
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Non-Controlling |
|
|
Stockholders |
|
|
|
Outstanding |
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Amount |
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Outstanding |
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Amount |
|
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Paid-in Capital |
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Deficit |
|
|
Loss |
|
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Total |
|
|
Interests |
|
|
Equity |
|
Balance, December 31, 2010 (As restated) |
|
|
17,500 |
|
|
$ |
17,500,000 |
|
|
|
8,546,813 |
|
|
$ |
8,547 |
|
|
$ |
84,882,411 |
|
|
$ |
(98,973,192 |
) |
|
$ |
(1,109 |
) |
|
$ |
3,416,657 |
|
|
$ |
654,078 |
|
|
$ |
4,070,735 |
|
Common stock issued to settle convertible notes obligations |
|
|
|
|
|
|
|
|
|
|
4,029,373 |
|
|
|
4,029 |
|
|
|
6,408,928 |
|
|
|
|
|
|
|
|
|
|
|
6,412,957 |
|
|
|
|
|
|
|
6,412,957 |
|
Common stock issued as compensation |
|
|
|
|
|
|
|
|
|
|
506,570 |
|
|
|
506 |
|
|
|
1,557,319 |
|
|
|
|
|
|
|
|
|
|
|
1,557,825 |
|
|
|
|
|
|
|
1,557,825 |
|
Issuance of employee stock options |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
669,444 |
|
|
|
|
|
|
|
|
|
|
|
669,444 |
|
|
|
|
|
|
|
669,444 |
|
Issuance of common stock as payment of accounts payable |
|
|
|
|
|
|
|
|
|
|
50,833 |
|
|
|
51 |
|
|
|
76,199 |
|
|
|
|
|
|
|
|
|
|
|
76,250 |
|
|
|
|
|
|
|
76,250 |
|
Issuance of common stock as payment to settle obligations of discontinued operations |
|
|
|
|
|
|
|
|
|
|
320,000 |
|
|
|
320 |
|
|
|
1,343,680 |
|
|
|
|
|
|
|
|
|
|
|
1,344,000 |
|
|
|
|
|
|
|
1,344,000 |
|
Issuance of
common stock in connection with conversion of preferred stock |
|
|
(4,219 |
) |
|
|
(4,219,000 |
) |
|
|
776,980 |
|
|
|
777 |
|
|
|
4,218,223 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Foreign currency translation adjustment |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
57,450 |
|
|
|
57,450 |
|
|
|
13,695 |
|
|
|
71,145 |
|
Net loss |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(8,581,034 |
) |
|
|
|
|
|
|
(8,581,034 |
) |
|
|
(334,429 |
) |
|
|
(8,915,463 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, September 30, 2011 |
|
|
13,281 |
|
|
$ |
13,281,000 |
|
|
|
14,230,568 |
|
|
$ |
14,230 |
|
|
$ |
99,156,204 |
|
|
$ |
(107,554,226 |
) |
|
$ |
56,341 |
|
|
$ |
4,953,549 |
|
|
$ |
333,344 |
|
|
$ |
5,286,893 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The accompanying notes are an integral part of these consolidated financial statements.
5
CONVERTED ORGANICS INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
|
|
|
|
|
|
|
|
|
|
|
Nine month periods ended |
|
|
|
September 30, 2011 |
|
|
September 30, 2010 |
|
CASH FLOWS FROM OPERATING ACTIVITIES: |
|
|
|
|
|
|
|
|
Net loss |
|
$ |
(8,915,463 |
) |
|
$ |
(31,619,523 |
) |
Adjustments to reconcile net loss to net cash
used in operating activities: |
|
|
|
|
|
|
|
|
Amortization expense of intangibles and other assets |
|
|
1,057,849 |
|
|
|
251,757 |
|
Depreciation and amortization of property and equipment |
|
|
210,571 |
|
|
|
1,394,249 |
|
(Recovery of) provision for losses on accounts receivable |
|
|
(75,875 |
) |
|
|
|
|
Amortization of discounts on notes payable |
|
|
6,967,644 |
|
|
|
|
|
Interest expense in connection with issuance of convertible debt |
|
|
268,486 |
|
|
|
|
|
Common stock issued as compensation |
|
|
1,557,825 |
|
|
|
349,639 |
|
Common stock
issued as payment of accounts payable |
|
|
76,250 |
|
|
|
|
|
Stock option compensation expense |
|
|
669,444 |
|
|
|
1,305,812 |
|
Obligations to issue shares revaluation |
|
|
(1,355,358 |
) |
|
|
|
|
Gain on settlement of debt |
|
|
(225,000 |
) |
|
|
|
|
Gain on settlements of accounts payable |
|
|
(302,057 |
) |
|
|
|
|
Loss on write-down of construction costs |
|
|
113,543 |
|
|
|
|
|
Loss on debt modification |
|
|
936,776 |
|
|
|
|
|
Loss on impairment of long-term assets |
|
|
2,135,021 |
|
|
|
15,430,685 |
|
Derivative gain |
|
|
(6,952,284 |
) |
|
|
(1,160,711 |
) |
Changes in operating assets and liabilities: |
|
|
|
|
|
|
|
|
(Increase) decrease in: |
|
|
|
|
|
|
|
|
Accounts receivable |
|
|
58,171 |
|
|
|
(567,244 |
) |
Inventories |
|
|
(100,309 |
) |
|
|
337,833 |
|
Prepaid expenses and other current assets |
|
|
(73,335 |
) |
|
|
(129,024 |
) |
Deposits and other non-current assets |
|
|
(15,140 |
) |
|
|
(48,240 |
) |
Increase (decrease) in: |
|
|
|
|
|
|
|
|
Accounts payable |
|
|
(1,023,474 |
) |
|
|
1,469,926 |
|
Accrued expenses |
|
|
(231,269 |
) |
|
|
2,854,432 |
|
Deferred revenue |
|
|
50,000 |
|
|
|
|
|
|
|
|
|
|
|
|
Net cash used in operating activities |
|
|
(5,167,984 |
) |
|
|
(10,130,409 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
CASH FLOWS FROM INVESTING ACTIVITIES: |
|
|
|
|
|
|
|
|
Purchase of property and equipment |
|
|
(1,060,988 |
) |
|
|
(446,930 |
) |
Patent costs |
|
|
(27,828 |
) |
|
|
|
|
Purchase of other assets |
|
|
|
|
|
|
(500,000 |
) |
|
|
|
|
|
|
|
Net cash used in investing activities |
|
|
(1,088,816 |
) |
|
|
(946,930 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
CASH FLOWS FROM FINANCING ACTIVITIES: |
|
|
|
|
|
|
|
|
Repayment of debt obligations |
|
|
(125,000 |
) |
|
|
(1,540,009 |
) |
Repayment of capital lease obligations |
|
|
|
|
|
|
(8,751 |
) |
Net proceeds from exercise of options |
|
|
|
|
|
|
34,000 |
|
Net proceeds from stock offering |
|
|
|
|
|
|
2,366,360 |
|
Deferred
financing costs for short-term notes |
|
|
(255,000 |
) |
|
|
|
|
Net proceeds from short-term notes |
|
|
4,500,000 |
|
|
|
|
|
|
|
|
|
|
|
|
Net cash provided by financing activities |
|
|
4,120,000 |
|
|
|
851,600 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net effect of exchange rate changes on cash |
|
|
86,488 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
NET DECREASE IN CASH |
|
|
(2,050,312 |
) |
|
|
(10,225,739 |
) |
|
|
|
|
|
|
|
|
|
Cash, beginning of period |
|
|
3,039,941 |
|
|
|
10,708,807 |
|
|
|
|
|
|
|
|
Cash, end of period |
|
$ |
989,629 |
|
|
$ |
483,068 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Supplemental cash flow information: |
|
|
|
|
|
|
|
|
Cash paid during the period for: |
|
|
|
|
|
|
|
|
Interest |
|
$ |
23,267 |
|
|
$ |
808,679 |
|
|
|
|
|
|
|
|
|
|
Non-cash financing activities: |
|
|
|
|
|
|
|
|
Equipment acquired through assumption of accounts payable |
|
$ |
696,329 |
|
|
$ |
|
|
Common stock issued to settle convertible notes obligations |
|
|
6,395,624 |
|
|
|
413,959 |
|
Fair value of derivatives issued in conjuction with debt and equity financing |
|
|
4,667,269 |
|
|
|
968,096 |
|
Common stock and warrants issued as payment for accounts payable |
|
|
|
|
|
|
1,501,600 |
|
Common stock issued as settlement of obligations of discontinued operations |
|
|
1,344,000 |
|
|
|
|
|
Common stock
issued in connection with conversion of preferred stock |
|
|
4,219,000 |
|
|
|
|
|
The accompanying notes are an integral part of these consolidated financial statements.
6
CONVERTED ORGANICS INC.
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS
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 (US GAAP) for interim financial information and the instructions to Form 10-Q and Rule 8-03 of Regulation S-X.
Accordingly, these interim consolidated financial statements do not include all of the information and disclosures required by U.S. GAAP for complete financial
statements. In managements 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 for the periods presented.
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 Converted Organics Inc.s Form 10-K
as of and for the year ended December 31, 2010.
NATURE OF OPERATIONS
Converted Organics Inc. and its subsidiaries (collectively the Company) utilize innovative clean
technologies to establish and operate environmentally friendly businesses. The Company is dedicated
to creating a cleaner, greener future, and operates using sustainable business practices that
support this vision. The Company operates in three business areas: Organic Fertilizer, Industrial
Wastewater Treatment and Vertical Farming.
Organic Fertilizer: The Company operates a processing facility that converts food waste and other
raw materials into all-natural fertilizers, biostimulants, and soil amendment products.
Industrial Wastewater Treatment: Utilizing an innovative wastewater treatment process, Converted
Organics Industrial Wastewater Resources business (IWR) provides a means of treating aqueous
waste streams. This technology, which can use waste heat and renewable
energy as fuel, produces only two byproducts: clean water vapor and landfill-appropriate solid
residuals.
Vertical Farming: The Company engages in vertical farming through our TerraSphere business, which
builds efficient systems for growing pesticide-free organic produce in a controlled indoor
environment using its patented technology.
A summary of the Companys subsidiaries is as follows:
Converted Organics of California, LLC (the Gonzales facility) is a California limited liability
company and wholly-owned subsidiary. The Gonzales facility operates a plant in Gonzales,
California, in the Salinas Valley and produces approximately 25 tons of organic fertilizer per day,
which is sold primarily to the California agricultural market. The Gonzales
7
CONVERTED ORGANICS INC.
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS
facility employs a
proprietary method called High Temperature Liquid Composting (HTLC). The facility has been
upgraded to enable it to accept larger amounts of food waste from waste haulers and may be
upgraded, depending on demand, to have the capability to produce a dry product in addition to the
current liquid fertilizer it produces.
Converted Organics of Woodbridge, LLC (the Woodbridge facility) is a New Jersey limited liability
company and wholly-owned subsidiary, which was formed for the purpose of owning, constructing and
operating the Companys facility in Woodbridge, New Jersey. During 2010, the Company discontinued
operations at the Woodbridge plant. The Company has reported the results of operations of Converted
Organics of Woodbridge, LLC as discontinued operations within the consolidated financial statements
(See Note 5).
Converted Organics of Rhode Island, LLC (RILLC) is an inactive subsidiary of Converted Organics
Inc. RILLC has no assets or liabilities. RILLC was originally established for the purpose of
operating a food waste to fertilizer plant in Rhode Island. The only asset that RILLC had acquired
was an operating lease from the Rhode Island Resource Recovery Corporation (RIRRC) for a parcel
of land which was intended to serve as the site for the planned plant. The Company did not
have the resources to begin construction on a plant and therefore entered into a letter of intent
to sell the operating lease rights to a third party who would also obtain a license from Converted
Organics Inc. to operate the proposed facility. The letter of intent does not remain in effect, as
the operating lease reverted back to the RIRRC in the fourth quarter of 2010. The RIRRC is a
separate and distinct corporation, operated by the state of Rhode Island for the purpose of
operating recycling facilities and the Company has no related party or affiliated relationship with
that entity.
Converted
Organics of Mississippi, LLC is a Mississippi limited liability company and wholly-owned
subsidiary, which was formed for the purpose of hiring a sales force and adding a poultry litter-based
fertilizer product to the Companys existing product lines. The Company does not expect to have
operating activity in this subsidiary during 2011.
TerraSphere Inc. (TerraSphere), a Delaware corporation and a wholly-owned subsidiary, was formed
for the purpose of acquiring the membership interests of TerraSphere Systems LLC (TerraSphere
Systems). On November 12, 2010, TerraSphere acquired a 95% membership interest in TerraSphere
Systems (See Note 4). TerraSphere Systems has two subsidiaries; wholly
owned PharmaSphere, LLC (PharmaSphere) and majority owned TerraSphere Systems Canada, Inc.
(TerraSphere Canada). PharmaSpheres business plan is to utilize TerraSphere Systems patented
technology for the production of high value biocompounds sourced from plants and used as active
pharmaceutical ingredients and for the production of transgenic plants (genetically engineered
plants) for the biotechnology market. PharmaSphere has a wholly-owned subsidiary PharmaSphere
Worcester, LLC, which was formed to build a facility in Worcester, Massachusetts utilizing
PharmaSpheres business plan. The building of the facility has not commenced. PharmaSphere has no
revenue to date. TerraSphere Canada, located in Vancouver, British Columbia, operates the research
and manufacturing facility for TerraSphere and is eighty-five percent owned by TerraSphere Systems.
GoLocalProduceRI, LLC On December 30, 2010, Converted Organics, Inc. purchased a majority ownership interest of the
vertical farming entity GoLocalProduceRI, LLC located in Rhode Island, marking its entrance
8
CONVERTED ORGANICS INC.
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS
into
the vertical farming industry as owners and operators of what is expected to be the first
TerraSphere facility in the United States (See Note 4).
PRINCIPLES OF CONSOLIDATION
The accompanying consolidated financial statements include the balances of Converted Organics Inc.
and its wholly-owned subsidiaries, Converted Organics of California, LLC, Converted Organics of
Woodbridge, LLC, Converted Organics of Mississippi, LLC, TerraSphere Inc. and its majority-owned
subsidiaries Converted Organics of Rhode Island, LLC and GoLocalProduceRI, LLC. The minority-owned
interests in its consolidated subsidiaries are included in the Companys consolidated financial
statements as noncontrolling interests. All intercompany transactions and balances have been
eliminated in consolidation.
REVENUE RECOGNITION
Revenue is recognized when (i) persuasive evidence of a sales arrangement exists, (ii) delivery of
the product or service has occurred, (iii) the sales price is fixed or determinable, and (iv)
collectability is reasonably assured.
The Companys organic fertilizer operation generates revenues from two sources: product sales and
tip fees. Product sales revenue comes from the sale of fertilizer products. Tip fee revenue is
derived from waste haulers who pay the Company tip fees for accepting food waste generated by
food distributors such as grocery stores, produce docks and fish markets, food processors and
hospitality venues such as hotels, restaurants, convention centers and airports.
The IWWR operation will generate revenue by setting up treatment systems on customers sites and
processing their wastewater on a price-per-gallon basis.
The Companys vertical farming operation derives its revenues from licensing fees, and in the
future expects to also derive revenues from license royalties, the sale of equipment and sales from
the operation of the Companys own growing facilities using the Companys patented technology.
The Company grants exclusive licenses to use the vertical farming Growth System for the remaining
term of the associated patents. The licenses provide for (i) the payment of an initial license fee
in installments over periods ranging from nine months to one year, and (ii) the payment of
continuing royalties based on a percentage of the licensees sales, subject to an annual minimum.
The licenses are generally not transferable without the permission of the Company.
In order to grow plants using the technology granted by the license, the licensee will also be
required to purchase equipment which incorporates the Growth system, either from the Company or from a
manufacturer licensed or contracted by the Company.
The licenses are therefore part of a multi-element arrangement, for which revenue cannot be
recognized until the delivered elements have stand alone value. The Company has determined that
the elements delivered under these arrangements will have stand alone value at such time as the
licensee has received both the license and the equipment, or the license and the Companys
permission to resell the license.
License
fees received in cash or recorded as a receivable prior to the time the delivered
elements have stand alone value are deferred as deferred revenue.
In
addition, receivable installments due under the licenses which are
not deemed to be
reasonably assured of collection when the license was initially granted are recorded as an asset offset by a valuation allowance. When payments of
such installments are received the related revenue is deferred if the elements delivered under that
license do not yet have stand alone value.
RECLASSIFICATIONS
As a result of the Woodbridge facility operations being discontinued during the third quarter of
2010, certain items of the comparative interim period have been reclassified as discontinued
operations. These reclassifications have no affect on previously reported net loss. See Note 14 for discussion of restated financial information.
IMPAIRMENTS
At June 30, 2011 the Company determined that the operating results for its vertical farming
business, which is comprised principally of TerraSphere, together with revised projections of the
near term operating results, required that the long-lived assets (principally patents subject to
amortization) and goodwill of that business be tested for impairment. The projected undiscounted
cash flows for the vertical farming business over the remaining life of the patents exceeded the
carrying amount of the long-lived assets, and therefore no impairment of long lived assets was
recorded. However, the June 30, 2011 fair value of the vertical farming goodwill, calculated on
the basis of discounted cash flows, is less than the carrying amount of the vertical farming business
goodwill, and therefore the Company recorded a goodwill impairment charge of $2.1 million at June
30, 2011 reflecting the impairment of all of the goodwill resulting from the November, 2010
acquisition of TerraSphere.
USE OF ESTIMATES
Among the most significant estimates used in the preparation of the Companys consolidated
financial statements are the projections of future cash flows from the Companys business segments
used in assessing whether there has been any impairment to the Companys long-lived assets,
intangible assets or goodwill and the assumptions utilized in the Companys calculation of the fair value of derivative liabilities. These estimates are inherently uncertain and may require significant
adjustments based on future events. The effect of any such adjustments could be significant.
9
CONVERTED ORGANICS INC.
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS
Note 2
GOING CONCERN/ MANAGEMENTS PLAN OF OPERATIONS
The accompanying consolidated financial statements have been prepared assuming that the Company
will continue as a going concern. As reflected in the consolidated financial statements, the
Company has an accumulated deficit, has suffered significant net losses and negative cash flows
from operations, and has negative working capital, which circumstances raise substantial doubt
about the Companys ability to continue as a going concern. The consolidated financial statements
do not include any adjustments that might result should the Company be unable to continue as a
going concern.
As reflected in the consolidated financial statements, the Company incurred a net loss
of approximately $8.9 million for the nine months ended
September 30, 2011, and as of September
30, 2011 has an accumulated deficit of approximately $107.6 million and a working capital
deficiency of approximately $8.7 million. During 2010, the Company discontinued the operations at
its Woodbridge facility, acquired a license to treat Industrial Waste Water and acquired the
TerraSphere business. In addition, the Company currently has manufacturing capabilities at its
Gonzales facility as a means to generate revenues and cash. Although the Gonzales facility is
currently cash flow positive, the anticipated costs associated with corporate overhead and for the
operations of TerraSphere will cause the Company to have negative
cash flow in 2011. In addition,
the Company feels that it will require cash, either through financing or equity transactions, in
order to build out the IWR and TerraSphere projects planned for 2011.
Presently, the Companys liquidity is limited to cash on hand at September 30, 2011. In addition,
in connection with recent financings, the Company has warrants outstanding that if exercised could
provide the Company with additional cash. However, the Companys stock price has closed at both
above and below the exercise price of these warrants, and it is not likely that any warrants would
be exercised unless the price of its common stock was greater than the exercise price of the
warrants. There is no assurance that the holders of the warrants will exercise the warrants in the
near term, and as such, we may not receive these funds.
If the Company does not receive additional funds, whether as a result of the exercise of
outstanding warrants, or otherwise, the Company will not have sufficient cash to be able to
continue its operations. The Company has projected that there is sufficient cash to operate until
the end of 2011 assuming there is no expenditures of cash on future IWR, TerraSphere, or fertilizer
capital projects. However, the Companys business strategy involves growing the IWR and TerraSphere
divisions, and expects that the Company will require additional cash
prior to the end of 2011. At
this time, the Company does not have any commitments for additional financing, and there is no
assurance that capital in any form will be available on terms and conditions that are acceptable or
at all. If the Company docs not raise funds before it exhausts its current cash position the
Company will be unable to continue operations. The Company anticipates that it will exhaust its
cash position as of December 31, 2011 and unless additional financing can be secured (for which
there are no commitments) the Company will not be able to continue operations after
December 31, 2011. Therefore, in the fourth quarter of 2011, in
order to conserve cash, the Company began to implement plans to
continue California operations while curtailing all
but essential personnel at the Corporate level and cease all operations at the TerraSphere division
and all operations at the IWW division other than the operations at the South Canyon Land fill. In
addition, the Company is in negotiations, with an investor, whereby the Company would spin off the
TerraSphere division. These negotiations have not been completed.
10
CONVERTED ORGANICS INC.
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS
NOTE 3 NEW ACCOUNTING STANDARDS
In May 2011, the FASB issued ASU No. 2011-04 Fair Value Measurement (Topic 820) Amendments to
Achieve Common Fair Value Measurements and Disclosure Requirements in U.S. GAAP and IFRSs (ASU
No. 2011-04) which will supersede most of the accounting guidance currently found in Topic 820 of
FASBs ASC. The amendments will improve comparability of fair value measurements presented and
disclosed in financial statements prepared in accordance with GAAP and International Financial
Reporting Standards (IFRS). The amendments also clarify the application of existing fair value
measurement requirements. These amendments include (1) the application of the highest and best use
and valuation premise concepts, (2) measuring the fair value of an instrument classified in a
reporting entitys shareholders equity and (3) disclosing quantitative information about the
unobservable inputs used within the Level 3 hierarchy. The guidance is effective for the Companys
interim and annual periods beginning after December 15, 2011 and will be applied prospectively.
In June 2011, the FASB issued ASU No. 2011-05, Comprehensive Income (Topic 220) Presentation of
Comprehensive Income (ASU No. 2011-05) which eliminates the option to present the components of
other comprehensive income as part of the statement of stockholders equity. The amendments require
that all nonowner changes in stockholders equity must be presented in a single continuous
statement of comprehensive income or in two separate but consecutive statements. Regardless of
whether an entity chooses to present comprehensive income in a single continuous statement or in
two separate but consecutive statements the entity is required to present on the face of the
financial statements reclassification adjustments for items that are reclassified from other
comprehensive income to net income in the statement(s) where the components of net income and the
components of other comprehensive income are presented. The guidance is effective for the Companys
interim and annual periods beginning after December 15, 2011 and will be applied prospectively.
In September 2011, the FASB issued ASU No. 2011-08, Testing Goodwill for Impairment (ASU No.
2011-08). The provisions of ASU No. 2011-08 permits an entity an option to first perform a
qualitative assessment to determine whether it is more likely than not that the fair value of a
reporting unit is less than its carrying amount. If an entity believes, as a result of its
qualitative assessment, that it is more likely than not that the fair value of a reporting unit is
less than its carrying amount, the quantitative impairment test is required. Otherwise, no further
impairment testing is required. ASU No. 2011-08 includes examples of events and circumstances that
may indicate that a reporting units fair value is less than its carrying amount. The provisions
of ASU No. 2011-08 are effective for annual and interim goodwill impairment tests performed for
fiscal years beginning after December 15, 2011. Early adoption is permitted provided that the
entity has not yet performed its annual impairment test for goodwill.
11
CONVERTED ORGANICS INC.
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS
NOTE 4 ACQUISITIONS
TERRASPHERE SYSTEMS, LLC
On November 12, 2010, the Company acquired 95% of the membership interests of TerraSphere Systems,
LLC. The acquisition will enable the Company to license TerraSpheres patented Growth System, which
is a system of modules and processes for growing plants in a controlled environment. The system
uses and controls precise combinations of light, water, nutrition, gravity, centrifugal forces, and
gasses to produce growing conditions that can be controlled and manipulated to result in desired
plant growth and maximum crop production.
GOLOCALPRODUCERI, LLC
On December 30, 2010, the Company acquired 83.34% of GoLocalProduceRI, LLC, marking its entrance
into the vertical farming industry as owners and operators of what is expected to be the first
TerraSphere facility in the United States.
The unaudited pro forma consolidated financial information including continuing and discontinued
operations for the three and nine month periods ended September 30, 2010 as though the above
acquisitions had been completed at the beginning of the interim period is as follows:
|
|
|
|
|
|
|
|
|
|
|
For the Three |
|
|
For the Nine |
|
|
|
Months Ended |
|
|
Months Ended |
|
|
|
September 30, |
|
|
September 30, |
|
|
|
2010 |
|
|
2010 |
|
Revenue |
|
$ |
817,765 |
|
|
$ |
3,468,190 |
|
Net loss |
|
$ |
(31,389,145 |
) |
|
$ |
(33,286,590 |
) |
Net loss per share, basic and diluted |
|
$ |
(4.55 |
) |
|
$ |
(5.03 |
) |
Weighted-average shares |
|
|
6,898,307 |
|
|
|
6,615,019 |
|
12
CONVERTED ORGANICS INC.
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS
NOTE 5 DISCONTINUED OPERATIONS
In 2010, the Company discontinued operations at its facility in Woodbridge, New Jersey. The
following table summarizes the components of the income (loss) from discontinued operations:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Three Months Ended |
|
|
For the Nine Months Ended |
|
|
|
September 30, |
|
|
September 30, |
|
|
|
2011 |
|
|
2010 |
|
|
2011 |
|
|
2010 |
|
Revenue from
discontinued operations |
|
$ |
|
|
|
$ |
105,714 |
|
|
$ |
|
|
|
$ |
834,089 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) from
discontinued operations |
|
$ |
49,447 |
|
|
$ |
(18,685,007 |
) |
|
$ |
195,918 |
|
|
$ |
(22,711,406 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
The Company recognized income from discontinued operations for the three and nine month periods
ended September 30, 2011 as a result of favorable settlements with certain of its creditors. The
Company does not expect to have any continuing positive cash flows from operations associated with
the Woodbridge facility.
The following table provides the assets and liabilities of the Woodbridge facility, classified as
discontinued operations, in the consolidated balance sheets dated September 30, 2011 and December
31, 2010:
|
|
|
|
|
|
|
|
|
|
|
Sept 30, |
|
|
Dec 31, |
|
|
|
2011 |
|
|
2010 |
|
Accounts receivable, net |
|
$ |
|
|
|
$ |
14,500 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Assets of discontinued operations |
|
$ |
|
|
|
$ |
14,500 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accounts payable |
|
$ |
535,645 |
|
|
$ |
837,606 |
|
Accrued expenses |
|
|
|
|
|
|
1,571,874 |
|
Other liabilities |
|
|
28,773 |
|
|
|
28,773 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities of discontinued operations |
|
$ |
564,418 |
|
|
$ |
2,438,253 |
|
|
|
|
|
|
|
|
On
January 25, 2011, the Company paid cash of $150,000 and issued
320,000 shares of Company
common stock with a fair value of $1,344,000 in payment for consulting services accrued at December
31, 2010 related to the settlement of certain Woodbridge obligations. The Company is actively
working with its creditors to settle the remaining liabilities outstanding at September 30, 2011.
13
CONVERTED ORGANICS INC.
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS
NOTE 6 FAIR VALUE MEASUREMENTS
The Company applies Accounting Standards Codification Topic 820 Fair Value Measurements and
Disclosures (ASC 820), which defines fair value, establishes a framework for measuring fair
value, and expands disclosures about fair value measurements. ASC 820 applies to reported balances
that are required or permitted to be measured at fair value under existing accounting
pronouncements.
ASC 820 emphasizes that fair value is a market-based measurement, not an entity-specific
measurement. Therefore, a fair value measurement should be determined based on the assumptions that
market participants would use in pricing the asset or liability. As a basis for considering market
participant assumptions in fair value measurements, ASC 820 establishes a fair value hierarchy that
distinguishes between market participant assumptions based on market data obtained from sources
independent of the reporting entity (observable inputs that are classified within Levels 1 and 2 of
the hierarchy) and the reporting entitys own assumptions about market participant assumptions
(unobservable inputs classified within Level 3 of the hierarchy).
Level 1 inputs utilize quoted prices (unadjusted) in active markets for identical assets or
liabilities that the Company has the ability to access. Level 2 inputs are inputs other than quoted
prices included in Level 1 that are observable for the asset or liability, either directly or
indirectly. Level 2 inputs may include quoted prices for similar assets and liabilities in active
markets, as well as inputs that are observable for the asset or liability (other than quoted
prices), such as interest rates, foreign exchange rates and yield curves that are observable at
commonly quoted intervals. Level 3 inputs are unobservable inputs for the asset or liability, which
are typically based on an entitys own assumptions, as there is little, if any, related market
activity. In instances where the determination of the fair value measurement is based on inputs
from different levels of the fair value hierarchy, the level in the fair value hierarchy within
which the entire fair value measurement falls is based on the lowest level input that is
significant to the fair value measurement in its entirety which requires judgment, and considers
factors specific to the asset or liability.
The Companys balances that are reported at fair value in the accompanying consolidated balance
sheets as of September 30, 2011 and December 31, 2010 were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Level of |
|
|
Balance |
|
|
|
Hierarchy |
|
|
Sept 30, 2011 |
|
|
Dec 31, 2010 |
|
Obligations to issue shares |
|
Level 2 |
|
$ |
205,357 |
|
|
$ |
1,560,715 |
|
Derivative warrants and
anti-dilution provision
liabilities |
|
Level 3 |
|
|
5,904,727 |
|
|
|
8,675,619 |
|
14
CONVERTED ORGANICS INC.
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS
The following table reflects the change in Level 3 fair value of the Companys derivative
liabilities for the three and nine months ended September 30, 2011:
|
|
|
|
|
|
|
|
|
|
|
Three |
|
|
Nine |
|
|
|
months |
|
|
months |
|
|
|
ended |
|
|
ended |
|
Balance, beginning of period |
|
$ |
(2,812,630 |
) |
|
$ |
(8,675,619 |
) |
Settlements |
|
|
124,575 |
|
|
|
1,405,320 |
|
Issuances |
|
|
|
|
|
|
(4,667,269 |
) |
Loss on debt
modification |
|
|
(919,443 |
) |
|
|
(919,443 |
) |
|
Net gains
(loss) |
|
|
(2,297,229 |
) |
|
|
6,952,284 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, end of period |
|
$ |
(5,904,727 |
) |
|
$ |
(5,904,727 |
) |
|
|
|
|
|
|
|
The Company has other non-derivative financial instruments, such as cash, accounts receivable,
accounts payable, accrued expenses, notes payable and convertible notes payable, for which carrying
amounts approximate fair value.
15
CONVERTED ORGANICS INC.
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS
NOTE 7 INVENTORIES
The Companys inventories consisted of the following at:
|
|
|
|
|
|
|
|
|
|
|
September 30, |
|
|
December 31, |
|
|
|
2011 |
|
|
2010 |
|
Finished goods |
|
$ |
190,268 |
|
|
$ |
104,690 |
|
Raw materials |
|
|
36,447 |
|
|
|
21,716 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total inventories |
|
$ |
226,715 |
|
|
$ |
126,406 |
|
|
|
|
|
|
|
|
16
CONVERTED ORGANICS INC.
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS
NOTE 8 DEBT
TERM NOTES
In connection with the Companys acquisition of TerraSphere Systems, the Company assumed a note
payable from a third party in the amount of $350,000, with a fixed interest rate of 15% per annum.
On March 9, 2011, the Company entered into an agreement whereby in consideration of receiving a
lump sum cash payment of $125,000, the third party released and discharged the Company from all
obligations under the note.
NOTE PAYABLES RELATED PARTY
In connection with the Companys acquisition of TerraSphere Systems, the Company assumed unsecured
note payables to William Gildea, Secretary of the Company and Edward Gildea, President of the
Company, each of which have an interest rate of 10% per annum. The principal amount due totaled
$72,351 at September 30, 2011 and December 31, 2010.
CONVERTIBLE NOTES PAYABLE
On December 17, 2010, the Company entered into a Securities Purchase Agreement (Purchase
Agreement) with certain institutional investors (the Buyers) whereby, the Company agreed to sell
to the Buyers certain notes and warrants. Pursuant to the terms of the Purchase Agreement, the
Company agreed to sell to the Buyers convertible notes in the aggregate original principal amount
of $4,990,000 (the Notes), which are convertible into shares of common stock. These Notes are to
be purchased by Buyers in two tranches, the first of which involved the sale of Notes in the
aggregate original principal amount of $3,939,473 (the Initial Notes). The Initial Notes are non
interest bearing and were issued with an original issue discount of approximately 4.8%. The Company
recorded the initial fair values of the conversion feature and the warrants up to the proceeds of
the note ($3,750,000) as a discount on the Note which was amortized ratably over the six-month
term.
On March 7, 2011 the second tranche of the sale of Notes was completed in the aggregate original
principal amount of $1,050,527 (the Additional Notes) and was completed upon the satisfaction of
the conditions to closing set forth in the Purchase Agreement. The Additional Notes were issued
with an original issue discount of approximately 4.8%, and the proceeds from the Additional Notes
were $1,000,000, with proceeds net of costs totaling $920,000. The Additional Notes are not
interest bearing, unless the Company is in default on the Notes, in which case the Additional Notes
carry an interest rate of 18% per annum.
The Notes
were initially convertible into shares of Common Stock at a conversion price of $10.00 per
share, provided that if the Company makes certain dilutive issuances (with limited exceptions), the
conversion price of the Notes will be lowered to the per share price for the dilutive issuances.
The Company also had the right, at its option, to permit the holder of the Notes to convert at a
lower price specified by the Company for a period specified by the
Company. The Company was required
to repay the Notes in six equal installments commencing
17
CONVERTED ORGANICS INC.
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS
February 1, 2011 (with respect to the Initial Notes) and six equal installments commencing April 8,
2011 (with respect to the Additional Notes), either in cash or in shares of is common stock. If the
Company chooses to utilize shares of its common stock for the payment, the Company must make an
irrevocable decision to use shares 22 trading days prior to the installment payment date, and the
value of its shares will be equal to the lower of (i) the conversion price then in effect or (ii)
85% of the average of the three lowest closing sale prices of its common stock during the 20
trading day period prior to payment of the installment amount. If the Company chooses to make an
installment payment in shares of its common stock, it must make a pre-installment payment of shares
to the Note holder 20 trading days prior to the applicable installment date based on the value of
its shares during the 20 trading days preceding the delivery of the notice to elect to pay in its
shares.
On the installment date, to the extent the Company owed the Note holder additional shares in excess
of the pre-installment shares to satisfy the installment payment, it issued the Note holder
additional shares, and to the extent the Company issued excess shares, such shares were
applied to future payments.
If an event of default occurs under the Notes, the Company must redeem the Notes in cash at the
greater of 135% of the unconverted principal amount or 135% of the greatest equity value of the
shares of common stock underlying the Notes from the date of the default until the redemption is
completed. The conversion price of the Notes is subject to adjustment in the case of stock splits,
stock dividends, combinations of shares and similar recapitalization transactions. The
convertibility of the Notes may be limited if, upon exercise, the holder or any of its affiliates
would beneficially own more than 4.9% of our Common Stock. No default occurred under these notes
and they were paid in full prior to the end of September 30, 2011.
In connection with the sale of convertible notes and the issuance of the associated warrants to
purchase common stock on March 7, 2011, the Company established a debt discount equal to the full
amount of the notes, which reflects the original issue discount, the relative fair value of the
warrants to the debt and reflects that the debt is classified as a derivative liability as the
ability to repay the note in cash is deemed not to be within the Companys control and the number
of shares required to settle the obligation is not determinable. The total debt discount recognized
was $1,050,527 and the interest expense recognized in addition to that amount was $268,486. The
discount was being amortized over the term of the convertible notes. In addition, certain financing
costs associated with the notes have been recorded as deferred financing costs and are being
amortized over the term of the notes.
At September 30, 2011, these notes are fully paid off and the Company
issued 4,029,373 shares of its common stock as loan repayments on these notes.
On April 1, 2011, the Company entered into a Securities Purchase Agreement (Agreement) with an
institutional investor (the Buyer) whereby, the Company agreed to sell to the Buyer certain notes
and warrants. Pursuant to the terms of the Agreement, the Company agreed to sell to the Buyer a
convertible note in the aggregate original principal amount of $3,850,000 (the Original Note),
which is convertible into shares of common stock. The Original Note is non interest bearing and
was issued with an original issue discount of approximately 9%. The Company recorded the initial
fair values of the conversion feature and the warrants up to the gross proceeds of the note
($3,500,000) as a discount on the Original Note which will be amortized ratably over the six-month
term. Net proceeds of the note were $3,325,000 at September 30,
18
CONVERTED ORGANICS INC.
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS
2011, the carrying value of the Original note was $2,384,959 and the associated unamortized discount
was $1,328,260.
The Original Note is initially convertible into
shares of Common Stock at a conversion price of $4.00
per share, provided that if the Company makes certain dilutive issuances (with limited exceptions),
the conversion price of the Original Note will be lowered to the per share price for the dilutive
issuances. The Company also has the right, at its option, to permit the holder of the Original Note
to convert at a lower price specified by the Company for a period specified by the Company. The
Company is required to repay the Original Note in five equal installments commencing August 1, 2011.
If the Company chooses to utilize shares of its common stock for the payment, the Company must make
an irrevocable decision to use shares 23 trading days prior to the installment payment date, and
the value of its shares will be equal to the lower of (i) the
conversion price then in effect or
(ii) 85% of the average of the three lowest closing sale prices of its common stock during the 20
trading day period prior to payment of the installment amount. If the Company chooses to make an
installment payment in shares of its common stock, it must make a pre-installment payment of shares
to the Original Note holder 20 trading days prior to the applicable installment date based on the
value of its shares during the 20 trading days preceding the delivery of the notice to elect to pay
in its shares. On June 24, 2011, the Company filed a registration statement in order to issue
shares of its common stock to make the required loan repayments. The registration statement has not
yet been declared effective. On August 9, 2011, the Company amended the payment due dates on its
April 1, 2011 convertible note. The lender has agreed to extend the first payment (originally due
August 1, 2011) to the earlier of the date that the underlying registration statement becomes
effective or until six months after the issuance of the note when the restrictions on the shares lapse. In consideration of this amendment
the Company has agreed to reprice certain of the warrants held by the lender to an exercise price
of $0.50.
On the installment date, to the extent the Company owes the Note holder additional shares in excess
of the pre-installment shares to satisfy the installment payment, it will issue the Note holder
additional shares, and to the extent the Company has issued excess shares, such shares will be
applied to future payments. Through September 30, 2011, the Company has not issued any shares of
its common stock in satisfaction of loan repayments on the Original Note.
If an event of default occurs under the Original Note, the
Company must redeem the Note in cash at
the greater of 135% of the unconverted principal amount or 135% of the greatest equity value of the
shares of common stock underlying the Note from the date of the default until the redemption is
completed. The conversion price of the Original Note is subject to adjustment in the case of stock
splits, stock dividends, combinations of shares and similar recapitalization transactions. The
convertibility of the Note may be limited if, upon exercise, the holder or any of its affiliates
would beneficially own more than 4.9% of our Common Stock.
In connection with the sale of convertible notes and the issuance of the associated warrants to
purchase common stock on April 1, 2011, the Company established a debt discount equal to the full
amount of the note, which reflects the original issue discount, the relative fair value of the
warrants to the debt and reflects that the debt is classified as a derivative liability as the
ability to repay the note in cash is deemed not to be within the Companys control and the number
of shares required to settle the obligation is not determinable. The total debt discount recognized
was $3,398,783. The discount is being amortized over the term of the convertible notes. In
addition, certain financing costs associated with the note has been recorded as deferred
financing costs and are being amortized over the term of the notes.
The Company applies Accounting Standards Codification Topic 470
Modifications and Extinguishments (ASC 470), which defines a debt modification and provides guidance on whether an exchange
of debt instruments with the same creditor constitutes an extinguishment and whether a modification of a debt instrument should be
accounted for in the
same manner as an extinguishment. ASC 470 establishes that a modification exists if the terms of the embedded conversion
option from which the change in the fair value of the embedded conversion option (calculated as the difference between the fair value of the embedded conversion option immediately before and after the
modification or exchange) is at least 10
percent of the carrying amount of the
original debt instrument immediately before the modification or exchange. On July 31, 2011, the effective date of the April 2011 convertible
note
amendment, the Company measured the fair value of the embedded conversion option and determined that the change in fair value immediately before and after the modification was greater than 10 percent resulting in a debt modification. In accordance with ASC 470 the Company recognized a loss of $936,776 on the accompanying consolidated statement of operations and comprehensive loss.
19
CONVERTED ORGANICS INC.
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS
NOTE 9 DERIVATIVE INSTRUMENTS
On December 17, 2010, pursuant to the terms of the Purchase Agreement, the Company issued to the
Buyers warrants to acquire shares of common stock, in the form of three warrants: (i) Series A
Warrants, (ii) Series B Warrants, and (iii) Series C Warrants (collectively, the December
Warrants). The Warrants were issued in two tranches on the dates the Initial Notes and Additional
Notes were issued, on a pro rata basis based on the principal amount being issued in the applicable
closing based on the aggregate principal amount that could be issued at both closings.
The Series B Warrants became exercisable on February 28, 2011, the date upon which shareholder
approval was obtained in connection with the financing, and expire on November 28, 2011. The Series
B Warrants provide that the holders are initially entitled to purchase an aggregate of 499,000
shares (warrants to purchase 393,947 shares of Common Stock were issued at the Initial Closing
and a warrant to purchase 105,053 shares of Common Stock were issued at the Additional Closing
which occurred on March 7, 2011) at an initial exercise price of $10.00 per share. If the Company
makes certain dilutive issuances (with limited exceptions), the exercise price of the Series B
Warrants will be lowered to the per share price for the dilutive issuances. In addition, the
exercise price of the Series B Warrants will adjust to the average of the Installment Conversion
Prices used to repay the Initial Notes. The floor price for the exercise price of the Series B
Warrants is $3.45. The number of shares underlying the Series B Warrants will adjust whenever the
exercise price adjusts, such that at all times the aggregate exercise price of the Series B
Warrants will be $4,990,000 ($3,939,473 for the Series B Warrants issued in the Initial Closing and
$1,050,527 for the Series B Warrants issued at the Additional Closing). During August 2011, in
connection with amending its April 2011 convertible note, these Series B Warrants were repriced to
$0.50 therefore, as of September 30, 2011, the exercise price of the Series B Warrants is $0.50 per
share and there are 1,467,647 shares underlying the Series B Warrants.
The Series A and Series C Warrants became exercisable on February 28, 2011, the date upon which
shareholder approval was obtained in connection with the financing, and have a five year term. The
Series A Warrants provide that the holders are initially entitled to purchase an aggregate of
249,500 shares (warrants to purchase 196,974 shares of common stock were issued at the Initial
Closing and warrants to purchase 52,526 shares of common stock were issued at the Additional
Closing which occurred on March 7, 2011) at an initial exercise price of $10.00 per share. The
Series C Warrants provide that the holders are initially entitled to purchase an aggregate of
249,500 shares (warrants to purchase 196,974 shares of common stock were issued at the Initial
Closing and warrants to purchase 52,526 shares of common stock were issued at the Additional
Closing) at an exercise price of $10.00 per share; provided that the Series C Warrants may only be
exercised by each holder in the same proportion as such holder has already exercised its Series B
Warrants.
If the Company makes certain dilutive issuances (with limited exceptions), the exercise price of
the Series A and Series C Warrants will be lowered to the per share price for the dilutive
issuances. In addition, the exercise price of the Series A and Series C Warrants will adjust to the
average of the Installment Conversion Prices used to repay the Initial Notes. During August 2011,
in connection with amending its April 2011 convertible note these Series A and C
20
CONVERTED ORGANICS INC.
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS
Warrants were repriced to $0.50, therefore as of September 30, 2011, the exercise price of the
Series A Warrants and Series C Warrants is $0.50 per share.
On
April 17, 2011, pursuant to the terms of the Purchase Agreement, the Company issued to the Buyer
warrants to acquire shares of common stock, in the form of three warrants: (i) Series A Warrants,
(ii) Series B Warrants, and (iii) Series C Warrants (collectively, the April Warrants).
The Series B Warrants became exercisable on June 13, 2011, the date upon which shareholder approval
was obtained in connection with the financing, and expire on March 13, 2012. The Series B Warrants
provide that the holders are initially entitled to purchase an aggregate of 914,375 shares at an
initial exercise price of $4.125 per share. If the Company makes certain dilutive issuances (with
limited exceptions), the exercise price of the Series B Warrants will be lowered to the per share
price for the dilutive issuances. In addition, the exercise price of the Series B Warrants will
adjust to the average of the Installment Conversion Prices used to repay the Notes. The floor price
for the exercise price of the Series B Warrants is $3.40. The number of shares underlying the
Series B Warrants will adjust whenever the exercise price adjusts, such that at all times the
aggregate exercise price of the Series B Warrants will be $3,771,797. During August 2011, in
connection with amending its April 2011 convertible note these Series B Warrants were repriced to
$0.50, therefore as September 30, 2011, the exercise price of the Series B Warrants is $0.50 per
share and there are 1,109,352 shares underlying the Series B Warrants.
To the extent the Company enters into a fundamental transaction (as defined in the Series B
Warrants and which include, without limitation, the Company entering into a merger or consolidation
with another entity, selling all or substantially all of its assets, or a person acquiring 50% of
the Companys common stock), the Company has agreed to purchase the Series B Warrants from the
holders at their Black-Scholes value.
If the Companys common stock trades at a price at least 200% above the Series B Warrants exercise
price for a period of 10 trading days at any time after the Company obtains shareholder approval
(as discussed above), the Company may force the exercise of the Series B Warrants if the Company
meets certain conditions.
The Series A and Series C Warrants are exercisable six months and one day after issuance and have a
five year term commencing on June 13, 2011. The Series A Warrants provide that the holders are
initially entitled to purchase an aggregate of 481,250 shares. The Series C Warrants provide that
the holders are initially entitled to purchase an aggregate of 434,329 shares. If on the
expiration date of the Series B Warrants, a holder of such warrant has not exercised such warrant
for at least 50% of the shares underlying such warrant, the Company has the right to redeem from
such holder its Series C Warrant for $10,000 under certain circumstances. On August 9, 2011, as part
of the restructuring of the Note described above, the Company agreed to lower the exercise price of
the Series A and Series C Warrants to $0.50 per share.
If the Company makes certain dilutive issuances (with limited exceptions), the exercise price of
the Series A and Series C Warrants will be lowered to the per share price for the dilutive
issuances. In addition, the exercise price of the Series A and Series C Warrants will adjust to the
21
CONVERTED ORGANICS INC.
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS
average of the Installment Conversion Prices used to repay the Initial Notes. As of the September
30, 2011, the exercise price of the Series A Warrants and Series C Warrants is $0.50 per share.
To the extent the Company enters into a fundamental transaction (as defined in the Series A and
Series C Warrants and which include, without limitation, the Company entering into a merger or
consolidation with another entity, selling all or substantially all of its assets, or a person
acquiring 50% of the Companys common stock), the Company has agreed to purchase the Series A and
Series C Warrants from the holder at their Black-Scholes value.
The exercise price of all the Warrants is subject to adjustment in the case of stock splits, stock
dividends, combination of shares and similar recapitalization transactions. The exercisability of
the Warrants may be limited if, upon exercise, the holder or any of its affiliates would
beneficially own more than 4.9% of the Companys common stock. The Note may not be converted if the
total number of shares that would be issued would exceed 19.99% of the Companys common stock on
the date the Purchase Agreement was executed prior to the Company receiving shareholder approval
(as discussed above).
As of September 30, 2011, the Company has recognized the following warrants as derivative
instruments:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair |
|
|
|
|
|
|
|
|
|
|
|
Outstanding |
|
|
|
|
|
|
Exercised |
|
|
Outstanding |
|
|
Exercisable |
|
|
Value at |
|
|
|
Class/ |
|
|
|
|
|
|
at Dec 31, |
|
|
|
|
|
|
or |
|
|
at Sept 30, |
|
|
at Sept 30, |
|
|
Sept 30, |
|
Issue Date |
|
Series |
|
|
Price |
|
|
2010 |
|
|
Issued |
|
|
Canceled |
|
|
2011 |
|
|
2011 |
|
|
2011 |
|
05/07/09** |
|
Class C |
|
$ |
0.50 |
|
|
|
88,500 |
|
|
|
|
|
|
|
|
|
|
|
88,500 |
|
|
|
88,500 |
|
|
$ |
27,279 |
|
05/07/09** |
|
Class D |
|
$ |
0.50 |
|
|
|
41,500 |
|
|
|
|
|
|
|
|
|
|
|
41,500 |
|
|
|
41,500 |
|
|
$ |
12,747 |
|
09/08/09 |
|
Class G |
|
$ |
0.50 |
|
|
|
250,000 |
|
|
|
|
|
|
|
|
|
|
|
250,000 |
|
|
|
250,000 |
|
|
$ |
94,041 |
|
04/22/10 |
|
Class I |
|
$ |
0.50 |
|
|
|
116,336 |
|
|
|
|
|
|
|
|
|
|
|
116,336 |
|
|
|
|
|
|
$ |
45,148 |
|
12/17/10 * |
|
Series A |
|
$ |
0.50 |
|
|
|
196,974 |
|
|
|
52,526 |
|
|
|
|
|
|
|
249,500 |
|
|
|
249,500 |
|
|
$ |
97,830 |
|
12/17/10 * |
|
Series B |
|
$ |
0.50 |
|
|
|
393,947 |
|
|
|
1,073,700 |
|
|
|
|
|
|
|
1,467,647 |
|
|
|
1,467,647 |
|
|
$ |
265,086 |
|
12/17/10 * |
|
Series C |
|
$ |
0.50 |
|
|
|
196,974 |
|
|
|
52,526 |
|
|
|
|
|
|
|
249,500 |
|
|
|
249,500 |
|
|
$ |
97,830 |
|
04/01/11 |
|
Series A |
|
$ |
0.50 |
|
|
|
|
|
|
|
481,250 |
|
|
|
|
|
|
|
481,250 |
|
|
|
481,250 |
|
|
$ |
191,975 |
|
04/01/11 |
|
Series B |
|
$ |
0.50 |
|
|
|
|
|
|
|
1,109,352 |
|
|
|
|
|
|
|
1,109,352 |
|
|
|
1,109,352 |
|
|
$ |
245,661 |
|
04/01/11 |
|
Series C |
|
$ |
0.50 |
|
|
|
|
|
|
|
434,329 |
|
|
|
|
|
|
|
434,329 |
|
|
|
434,329 |
|
|
$ |
173,258 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,250,855 |
|
|
|
|
|
* |
|
Includes warrants issued on March 7, 2011 |
|
** |
|
The above table reflects repricing of all warrants to $0.50
in August 2011, except 13,500 |
22
CONVERTED ORGANICS INC.
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS
Class C
and 6.500 Class D warrants which remained at $10.00 and $10.20 respectively.
In August 2011, the Company amended certain provisions of its April 2011 convertible note financing
and as a result all of the warrants listed above, with the exception of certain Class C and Class D
warrants, were repriced to $0.50. The Company recorded a charge in its statement of operations for
the three months ended September 30, 2011 of $919,443 associated with the debt modification.
The Company also recognized certain conversion features issued in conjunction with debt as
derivative instruments:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding |
|
|
|
|
|
|
|
|
|
|
Outstanding |
|
|
Exerciseable |
|
|
Fair Value |
|
|
|
|
|
|
|
at |
|
|
|
|
|
|
|
|
|
|
at |
|
|
at |
|
|
at |
|
|
|
|
|
|
|
December 31, |
|
|
|
|
|
|
Exercised |
|
|
September 30, |
|
|
September 30, |
|
|
September 30, |
|
Issue Date |
|
Price |
|
|
2010 |
|
|
Issued |
|
|
or Canceled |
|
|
2011 |
|
|
2011 |
|
|
2011 |
|
December 17, 2010 |
|
$ |
10.00 |
|
|
|
1,428,398 |
|
|
|
|
|
|
|
1,428,398 |
|
|
|
|
|
|
|
|
|
|
$ |
|
|
March 7, 2011 |
|
$ |
10.00 |
|
|
|
|
|
|
|
345,159 |
|
|
|
345,159 |
|
|
|
|
|
|
|
|
|
|
$ |
|
|
April 1, 2011 |
|
$ |
4.00 |
|
|
|
|
|
|
|
11,267,193 |
|
|
|
|
|
|
|
11,267,193 |
|
|
|
11,267,193 |
|
|
$ |
4,438,272 |
|
The amount
of conversion features issued during 2011 on the April 2011
derivative instrument has increased as the conversion stock price has
decreased from the original conversion price of $4.00.
The warrants and conversion features above were revalued at September 30, 2011 using a
binomial lattice pricing model using certain assumptions related to the probability of exercise and
the following:
|
|
|
|
|
|
|
|
|
|
Risk free interest rate |
|
|
0.10% 2.55 |
% |
Dividend yield |
|
|
-0- |
|
Volatility |
|
|
78%205 |
% |
Expected term |
|
3 months to 5 years |
In addition to the above derivative transactions, on November 12, 2010, the Company completed the
acquisition of TerraSphere Systems LLC, where it determined that as a result of an anti-dilution
provision included in the purchase agreement, certain additional shares may have to be issued. The
Company estimated that approximately 440,000 shares could be issued and classified the
anti-dilution provision as a derivative liability. As of September 30, 2011, the Company revalued
the derivative liability to $215,600 based on the closing share price of the stock on that date.
The derivative liability reflected on the consolidated balance sheet at September 30, 2011 totaled
$5,904,727 and the derivative gain(loss) for the three and nine month periods ended September 30,
2011 was ($2,297,229) and $6,952,284, respectively.
23
CONVERTED ORGANICS INC.
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS
NOTE 10 STOCKHOLDERS EQUITY
STOCK ISSUANCES
On January 25, 2011 the Company issued 320,000 shares of its common stock to a consultant
satisfying a $1,344,000 accrual for services rendered in connection with the settlement of certain
Woodbridge obligations.
On
February 23, 2011, the Company issued 216,500 restricted shares
at $3.70 (the closing price as
of the date of issuance) to certain employees under the Amended and Restated 2006 Stock Option
Plan. The statement of operations and comprehensive loss for the nine month period ended September 30,
2011 includes a charge of $801,050 for this compensation.
During
April 2011, the Company issued 290,070 shares of its common stock as compensation under
its stock option plan. These shares were issued to employees and directors and are restricted for a
period of two years from issuance. The Company recorded compensation expense of $756,775 in its
statement of operations and comprehensive loss for the nine month period ended September 30, 2011, based
upon the closing price of the shares on the commitment date.
On
June 20, 2011, the Company issued 776,980 shares of its common stock in exchange for the
return of 4,219 shares of its preferred stock.
On
June 10, 2011, the Company issued 50,833 shares of its common stock to vendors for services.
The shares are restricted for a period of six months. The Company
reduced the vendor payables by
$76,250 based upon the closing price of the shares on the commitment date.
During the
nine month period ended September 30, 2011 the Company issued
4,029,373 shares of its
common stock as loan repayments which reduced the balance on the convertible notes by $6,412,957.
WARRANTS
In addition to the warrants classified as derivatives, the Company has also recognized certain
warrants as equity instruments.
The following table sets forth the outstanding warrants classified as equity instruments as of
September 30, 2011:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding |
|
|
Exercisable |
|
|
|
|
|
|
|
at |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
at |
|
|
at |
|
|
|
|
|
|
|
December 31, |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 30, |
|
|
September 30, |
|
Warrants |
|
Price |
|
|
2010 |
|
|
Issued |
|
|
Exercised |
|
|
Canceled |
|
|
2011 |
|
|
2011 |
|
Class B |
|
$ |
110.00 |
|
|
|
264,803 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
264,803 |
|
|
|
264,803 |
|
Class E |
|
$ |
16.30 |
|
|
|
150,000 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
150,000 |
|
|
|
150,000 |
|
Class F |
|
$ |
0.50 |
|
|
|
58,500 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
58,500 |
|
|
|
58,500 |
|
Class H |
|
$ |
13.00 |
|
|
|
1,725,000 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,725,000 |
|
|
|
1,725,000 |
|
Class J |
|
$ |
5.40 |
|
|
|
162,333 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
162,333 |
|
|
|
162,333 |
|
Class K |
|
$ |
5.40 |
|
|
|
115,741 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
115,741 |
|
|
|
115,741 |
|
24
CONVERTED ORGANICS INC.
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS
In the event all outstanding warrants are exercised, including those classified as derivatives and
those classified as equity, the Company has adequate shares authorized to meet these obligations.
In August 2011, the Company amended certain provisions of its April 2011 convertible note financing
and as a result the Class F Warrants listed above were repriced from $10.25 to $0.50. The Company
recorded a charge in its statement of operations for the three months ended September 30, 2011 of
$17,333 associated with the modification.
STOCK OPTIONS
During the nine month period ended September 30, 2011, the Company issued
317,570 stock options to employees and directors under its stock option plan. The Company calculated a compensation
expense associated with the issuance of these options of $699,444 using the Black-Scholes pricing
model. The Company assumed a five year term, risk free interest rate of 1.9%, average volatility of
113.6% and exercise prices of $1.50 to $2.70.
Stock option activity for the nine month period ended September 30, 2011 is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted |
|
|
Weighted |
|
|
|
|
|
|
|
Average |
|
|
Average |
|
|
|
|
|
|
|
Exercise |
|
|
Remaining |
|
|
|
Stock |
|
|
Price per |
|
|
Life |
|
|
|
Options |
|
|
Share |
|
|
(Years) |
|
Outstanding and
exercisable at
December 31, 2010 |
|
|
364,380 |
|
|
$ |
16.40 |
|
|
|
8.8 |
|
Granted |
|
|
282,802 |
|
|
|
2.70 |
|
|
|
|
|
Granted |
|
|
21,868 |
|
|
|
2.20 |
|
|
|
|
|
Granted |
|
|
12,900 |
|
|
|
1.50 |
|
|
|
|
|
Forfeited |
|
|
(2,400 |
) |
|
|
6.10 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding and
exercisable at
September 30, 2011 |
|
|
679,550 |
|
|
$ |
10.00 |
|
|
|
8.2 |
|
|
|
|
|
|
|
|
|
|
|
|
|
25
CONVERTED ORGANICS INC.
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS
NOTE 11 SEGMENT REPORTING
The Company has three lines of business, which are (1) organic fertilizer, (2) vertical farming and
(3) industrial wastewater treatment and based on the nature of products and services offered, the
Company has determined each line of business is a reportable segment at September 30, 2011.
The Company evaluates performance based on several factors, of which the primary financial measure
is business segment operating income. There were no intersegment sales for the three and nine
months ended September 30, 2011. The discreet financial information is presented below as of and
for the three and nine month periods ended September 30, 2011:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Three Months Ended September 30, 2011 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Corporate |
|
|
|
|
|
|
Organic |
|
|
Vertical |
|
|
Industrial |
|
|
and |
|
|
|
|
|
|
Fertilizer |
|
|
Farming |
|
|
Wastewater |
|
|
Eliminations |
|
|
Consolidated |
|
Revenues |
|
$ |
579,831 |
|
|
$ |
|
|
|
$ |
107,828 |
|
|
$ |
|
|
|
$ |
687,659 |
|
Operating loss (1) |
|
|
(186,274 |
) |
|
|
(465,529 |
) |
|
|
(53,260 |
) |
|
|
(705,653 |
) |
|
|
(1,410,716 |
) |
Depreciation and
amortization(2) |
|
|
106,662 |
|
|
|
161,821 |
|
|
|
33,335 |
|
|
|
55,568 |
|
|
|
357,386 |
|
Interest expense(3) |
|
|
|
|
|
|
1,824 |
|
|
|
|
|
|
|
1,409,981 |
|
|
|
1,411,805 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss |
|
|
(186,274 |
) |
|
|
(512,277 |
) |
|
|
(53,260 |
) |
|
|
(5,194,521 |
) |
|
|
(5,946,332 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Nine Months Ended September 30, 2011 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Corporate |
|
|
|
|
|
|
Organic |
|
|
Vertical |
|
|
Industrial |
|
|
and |
|
|
|
|
|
|
Fertilizer |
|
|
Farming |
|
|
Wastewater |
|
|
Eliminations |
|
|
Consolidated |
|
Revenues |
|
$ |
2,497,923 |
|
|
$ |
|
|
|
$ |
308,622 |
|
|
$ |
|
|
|
$ |
2,806,545 |
|
Operating loss (1) |
|
|
(256,828 |
) |
|
|
(4,023,305 |
) |
|
|
(104,324 |
) |
|
|
(5,078,296 |
) |
|
|
(9,462,753 |
) |
Depreciation and
amortization(2) |
|
|
317,946 |
|
|
|
484,753 |
|
|
|
72,222 |
|
|
|
393,499 |
|
|
|
1,268,420 |
|
Interest expense(3) |
|
|
|
|
|
|
13,898 |
|
|
|
|
|
|
|
7,238,153 |
|
|
|
7,252,051 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss |
|
|
(256,828 |
) |
|
|
(3,841,893 |
) |
|
|
(104,324 |
) |
|
|
(4,712,418 |
) |
|
|
(8,915,463 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total assets (4) |
|
|
3,556,195 |
|
|
|
10,667,097 |
|
|
|
2,049,482 |
|
|
|
916,439 |
|
|
|
17,189,213 |
|
Goodwill |
|
|
|
|
|
|
223,787 |
|
|
|
|
|
|
|
|
|
|
|
223,787 |
|
Property and
equipment additions |
|
|
155,062 |
|
|
|
2,255 |
|
|
|
1,600,000 |
|
|
|
|
|
|
|
1,757,317 |
|
|
|
|
(1) |
|
Operating income (loss) of the principal businesses exclude corporate compensation, marketing expense, professional fees and other unallocated expenses.
|
26
CONVERTED ORGANICS INC.
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS
|
(2) |
|
Depreciation and
amortization expense
associated with
property and equipment,
intangibles and
deferred financing
fees. Corporate
amortization expense
relates to deferred
financing fees. |
|
|
(3) |
|
Corporate interest
expense is primarily
related to amortization
of discounts on
convertible notes
payable. |
|
|
(4) |
|
Total business assets
are the owned or
allocated assets used
by each business.
Corporate assets
consist of cash,
prepaid expenses,
certain other assets
and deferred financing
costs. |
As of September 30, 2010, the Company was a single reportable segment.
Revenues are attributable to geographic areas based on the locations of the customers, which are primarily
within the continental United States. The fertilizer segment derived approximately $390,000 or 67% of its
revenues from three customers (AO Farming Operations 30%; NH3
Service Company 20%; and Verdi Tech Services 17%); the
industrial wastewater segment derived 100% of its revenue from one customer, South Canyon Waste Systems, Inc. for
the three month period ended September 30, 2011. For the nine month period ended September 30, 2011, the
fertilizer segment derived approximately $1,327,000 or 54% of its revenues from four
customers (Verdi Tech 12%; American Farms 13%; NH3 Servcies 13%; and
Crop Production Services 16%); and the industrial wastewater segment derived 100% of its
revenue from one customer, South Canyon Waste Systems, Inc. In
both the three and nine month period ended September 30, 2011, the TerraSphere segment had no reportable income.
27
CONVERTED ORGANICS INC.
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS
NOTE 12 LEGAL PROCEEDINGS
The Company is not currently aware of any pending or threatened legal proceeding to which it is or
would be a party, or any proceedings being contemplated by governmental authorities against it, or
any of its executive officers or directors relating to the services performed on the Companys
behalf, except as follows.
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 Companys 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 Companys 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 was denied on November 22, 2010. On March 3, 2011, the court denied the Companys motion for
partial summary judgment. On March 25, 2011, some individual investors filed a new complaint
against the Company asserting similar claims to those in the Leeseberg litigation. The Court
consolidated this case with the existing lawsuit and, on May 12, 2011, Plaintiffs filed an Amended
Complaint. On June 6, 2011, the Company filed its answer to consolidated complaint and counter
claims against Plaintiffs. The Parties have been engaged in settlement negotiations and have reached a settlement agreement. It is
anticipated that the settlement will be funded by the insurance provider and,
accordingly, no loss has been recorded related to these matters.
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.
Holland and Knight 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 estimate any loss/gain.
28
CONVERTED ORGANICS INC.
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS
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 filed a motion to transfer the
action back to the original court in Middlesex County, which was granted and sought to have the
lawsuit dismissed, which was granted in part on August 27, 2010. The Court limited the plaintiffs
claims to the events in part that occurred after the dismissal of the prior action. Plaintiffs appealed the order dismissing their first
lawsuit with prejudice, and the appellate court reversed the dismissal with prejudice but the first lawsuit still remains dismissed without prejudice.
Due to the appellate decision, plaintiffs filed a motion to reconsider the decision made in the action, which
was granted in part on July 28, 2011. The nuisance damages issue
was reopened for 60 days. At the expiration of the 60 day period, we renewed the summary judgement motion, our motion for summary judgement was granted on November 4, 2011 and the only claim that remains
before the court is the plantiffs right to make an application for legal fees. We plan to vigorously defend this matter and are unable to
estimate any losses that may be incurred as a result of this litigation and upon its eventual
disposition. Accordingly, no loss has been recorded related to this matter.
On August 25, 2011, TerraSphere, Inc, our wholly owned subsidiary, was named as a defendant in an action filed in the
United States district court for the eastern district of Michigan against TerraSphere Systems, LLC and TerraSphere, Inc.
The plantiff, alleges, among other things breach of fiduciary responsibilities regarding a joint venture agreement.
The parties have agreed to an extension until November 30, 2011 to try and resolve the matter. In the event that the lawsuit
cant be resolved we plan to vigorously defend this matter. At this time we are unable to estimate any losses that may be
incurred as a result of this litigation and upon its eventual disposition. Accordingly, no loss has been recorded relating
to this matter.
NOTE 13 SUBSEQUENT EVENTS
On October 19, 2011, the Company entered into an agreement, with its lender, pursuant to which the
convertible note issued on April 1, 2011, as previously amended on August 9, 2011, in the
aggregate original principal amount of $3,850,000 was amended. Pursuant to the original terms of
the Note, the conversion price (Conversion Price) of the Note was $4.00, subject to adjustment as
set forth in the Note. Pursuant to the Agreement, the parties agreed to change the definition of
Conversion Price to mean, as of any conversion date or other date of determination, the lowest of
(i) $4.00 (subject to adjustment as provided in the Note), (ii) the price which is equal to the
product of (1) 85% multiplied by (2) the quotient of (A) the sum of each of the three (3) lowest
closing sale prices of the common stock during the twenty consecutive trading day period
immediately preceding the applicable conversion date or other date of determination (as the case
may be) divided by (B) three (3) and (iii) the price which is equal to the product of (I) 85%
multiplied by (II) the closing sale price of the common stock on the trading day immediately
preceding the applicable conversion date or other date of determination (as the case may be).
On November 2, 2011, The Company entered into an agreement, with its lender, to exchange the
convertible note issued on April 1, 2011, and amended on
August 9, 2011 and October 19, 2011, in
the aggregate original principal amount of $3,850,000, which had $3,474,797 of principal
outstanding on November 2, 2011, for a senior secured convertible note in the aggregate original
29
CONVERTED ORGANICS INC.
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS
principal amount of $3,474,797 (the New Note). The terms of the New Note are substantially
identical to the terms of the Original Note (with amendments), provided that the Company is not
required to amortize payment for the New Note and the principal and interest on the New Note is now
due on May 2, 2012, instead of February 17, 2012. The lender may convert all or part of the new note prior to maturity.
On October 20, 2011 the Company began to issue shares of its common stock to convert, first the
convertible note dated April 1, 2011 and then the New Note dated November 2, 2011. The Company
has issued 8,945,643 for principal reduction on these notes.
On October
31, 2011, the Company announced that its Board of Directors agreed to
separate converted Organics, Inc and TerraSphere Systems Inc and
declared a special stock dividend of common stock of TerraSphere Systems Inc, to the converted
Organics shareholders.
On November 7, 2011, the Company implimented a one for ten (1:10) reverse split of its common stock.
The effect of the reverse stock split is
retroactively
reflected in the accompanying financial statements and footnotes.
On November 8, 2011, the Company announced the resignation of one of its outside directors.
30
CONVERTED ORGANICS INC.
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS
NOTE 14 RESTATEMENT OF PRIOR PERIOD FINANCIAL STATEMENTS
The accompanying financial statements as of and for the nine months ended September 30, 2011
reflect the effects of the Companys restatement of its financial statements for the year ended
December 31, 2010 and for the six months ended June 30, 2011.
The Company restated its financial statements for the year ended December 31, 2010 to correct the
amounts recorded in the Companys preliminary allocation related
to the November
12, 2010 acquisition of TerraSphere as the result, among other things, of TerraSpheres restatement
of its own financial statements for the nine months ended September 30, 2010 to correct its revenue
recognition accounting. The Company has corrected its preliminary allocation related
to the TerraSphere accounts receivable accordingly. The Company also corrected its assessment of the
likelihood of the payment of the Milestone Two contingent payment (payable if TerraSphere
receivables of $2 million are collected by February 28, 2011), and the resulting amount recorded as
the fair value of this element of the acquisition cost. The net effect of these changes in the
acquisition accounting affected the goodwill recorded when TerraSphere was acquired.
The following sets forth the changes to the determination of the acquisition costs and the
preliminary allocation of the acquisition cost:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As previously |
|
|
Restatement |
|
|
As |
|
|
|
reported |
|
|
adjustment |
|
|
restated |
|
Components of acquisition cost |
|
|
|
|
|
|
|
|
|
|
|
|
Election of option one |
|
$ |
2,961,000 |
|
|
|
|
|
|
$ |
2,961,000 |
|
Election of option two |
|
|
4,490,000 |
|
|
|
|
|
|
|
4,490,000 |
|
Milestone One |
|
|
1,403,000 |
|
|
|
|
|
|
|
1,403,000 |
|
Milestone two |
|
|
711,000 |
|
|
|
(673,579 |
) |
|
|
37,421 |
|
Milestone three and four |
|
|
1,684,000 |
|
|
|
|
|
|
|
1,684,000 |
|
Anti-dilution |
|
|
837,000 |
|
|
|
|
|
|
|
837,000 |
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
12,086,000 |
|
|
|
|
|
|
$ |
11,412,421 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Allocation of acquistion cost |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash |
|
$ |
41,679 |
|
|
|
|
|
|
$ |
41,679 |
|
Accounts receivable |
|
|
2,690,000 |
|
|
|
(1,615,000 |
) |
|
|
1,075,000 |
|
Other assets |
|
|
274,313 |
|
|
|
|
|
|
|
274,313 |
|
Leasehold improvements |
|
|
176,181 |
|
|
|
|
|
|
|
176,181 |
|
Construction in progress |
|
|
97,306 |
|
|
|
|
|
|
|
97,306 |
|
Patents |
|
|
10,000,000 |
|
|
|
|
|
|
|
10,000,000 |
|
Goodwill |
|
|
1,193,600 |
|
|
|
941,421 |
|
|
|
2,135,021 |
|
Assumption of liabilities |
|
|
(1,738,435 |
) |
|
|
|
|
|
|
(1,738,435 |
) |
Non-controlling interest |
|
|
(648,644 |
) |
|
|
|
|
|
|
(648,644 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
$ |
12,086,000 |
|
|
|
|
|
|
$ |
11,412,421 |
|
|
|
|
|
|
|
|
|
|
|
In addition, as the result of the reduction in the amount assigned to the accounts receivable
upon the acquisition of TerraSphere, the bad debt expense the Company recorded for those
31
CONVERTED ORGANICS INC.
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS
receivables during the period November 12, 2010 to December 31, 2010 was reduced from $2,283,000 to
$725,000.
The Company also restated its preliminary allocation of the purchase price for GoLocalProduceRI,
LLC to allocate $250,000 of the purchase price previously allocated to goodwill to the license
rights which the Company sold to GoLocalProduceRI, LLC in November, 2010 and reacquired as the
result of this acquisition.
The following sets forth the effect of the restatement on the affected financial statement line
items:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As previously |
|
|
Restatement |
|
|
As |
|
|
|
reported |
|
|
adjustment |
|
|
restated |
|
For the year ended December 31, 2010 |
|
|
|
|
|
|
|
|
|
|
|
|
Selling, general and administrative expenses |
|
$ |
14,625,568 |
|
|
$ |
(1,558,000 |
) |
|
$ |
13,067,568 |
|
Loss from continuing operations |
|
|
(14,277,559 |
) |
|
|
1,558,000 |
|
|
|
(12,719,559 |
) |
Loss from continuing operations before provision for income taxes |
|
|
(16,039,025 |
) |
|
|
1,558,000 |
|
|
|
(14,481,025 |
) |
Loss from continuing operations |
|
|
(16,039,025 |
) |
|
|
1,558,000 |
|
|
|
(14,481,025 |
) |
Net loss |
|
|
(50,729,383 |
) |
|
|
1,558,000 |
|
|
|
(49,171,383 |
) |
Net loss attributable to noncontrolling interest |
|
|
(168,156 |
) |
|
|
77,900 |
|
|
|
(90,256 |
) |
Net loss attributable to Converted Organics, Inc. before other comprehensive income |
|
|
(50,561,227 |
) |
|
|
1,480,100 |
|
|
|
(49,081,127 |
) |
Comprehensive loss |
|
|
(50,562,600 |
) |
|
|
1,480,100 |
|
|
|
(49,004,500 |
) |
Comprehensive loss attributable to Converted
Organics, Inc. |
|
|
(50,562,336 |
) |
|
|
1,480,100 |
|
|
|
(49,082,236 |
) |
Net loss per share, basic and diluted |
|
|
|
|
|
|
|
|
|
|
|
|
Continuing operations |
|
|
(3.40 |
) |
|
|
|
|
|
|
(3.10 |
) |
Discontinued operations |
|
|
(7.40 |
) |
|
|
|
|
|
|
(7.40 |
) |
|
|
|
|
|
|
|
|
|
|
Net loss per share |
|
$ |
(10.80 |
) |
|
|
|
|
|
$ |
(10.50 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of December 31, 2010 |
|
|
|
|
|
|
|
|
|
|
|
|
Accounts receivable, net |
|
$ |
579,946 |
|
$ |
|
(57,000 |
) |
|
$ |
522,946 |
|
Intangible assets, net |
|
|
11,629,265 |
|
|
|
250,000 |
|
|
|
11,879,265 |
|
Goodwill |
|
|
1,667,957 |
|
|
|
691,421 |
|
|
|
2,359,378 |
|
Additional paid-in capital |
|
|
85,555,990 |
|
|
|
(673,579 |
) |
|
|
84,882,411 |
|
Accumulated deficit |
|
|
(100,453,292 |
) |
|
|
1,480,100 |
|
|
|
(98,973,192 |
) |
Noncontrolling interests |
|
|
576,178 |
|
|
|
77,900 |
|
|
|
654,078 |
|
Total stockholders equity |
|
|
3,186,314 |
|
|
|
884,421 |
|
|
|
4,070,735 |
|
The Company also restated its financial statements for the three and six months ended June 30,
2011 to correct the Companys accounting for the goodwill recorded in connection with the
acquisition of TerraSphere in November, 2010. The Company restated those financial statements to
record a charge of $2.1 million at June 30, 2011 reflecting the impairment of that goodwill. See
Note 1.
The following sets forth the effect of the restatement on the affected financial statement line
items as of and for the three and six months ended June 30, 2011:
32
CONVERTED ORGANICS INC.
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As previously |
|
|
Restatement |
|
|
As |
|
|
As previously |
|
|
Restatement |
|
|
As |
|
|
|
reported |
|
|
adjustment |
|
|
restated |
|
|
reported |
|
|
adjustment |
|
|
restated |
|
|
|
Three months ended June 30, 2011 |
|
|
Six months ended June 30, 2011 |
|
For the three and six months ended June 30, 2011 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Impairment |
|
$ |
|
|
|
$ |
2,135,021 |
|
|
$ |
2,135,021 |
|
|
$ |
|
|
|
$ |
2,135,021 |
|
|
$ |
2,135,021 |
|
Loss from continuing operations |
|
|
(3,547,413 |
) |
|
|
(2,135,021 |
) |
|
|
(5,682,434 |
) |
|
|
(5,867,016 |
) |
|
|
(2,135,021 |
) |
|
|
(8,002,037 |
) |
Income (loss) from continuing operations before provision for income taxes |
|
|
869,392 |
|
|
|
(2,135,021 |
) |
|
|
(1,265,629 |
) |
|
|
(930,581 |
) |
|
|
(2,135,021 |
) |
|
|
(3,065,602 |
) |
Income (loss) from continuing operations |
|
|
869,392 |
|
|
|
(2,135,021 |
) |
|
|
(1,265,629 |
) |
|
|
(930,581 |
) |
|
|
(2,135,021 |
) |
|
|
(3,065,602 |
) |
Net income (loss) |
|
|
1,016,362 |
|
|
|
(2,135,021 |
) |
|
|
(1,118,659 |
) |
|
|
(784,110 |
) |
|
|
(2,135,021 |
) |
|
|
(2,919,131 |
) |
Net loss attributable to noncontrolling interest |
|
|
(85,530 |
) |
|
|
(106,751 |
) |
|
|
(192,281 |
) |
|
|
(146,525 |
) |
|
|
(106,751 |
) |
|
|
(253,276 |
) |
Net income (loss) attributable to Converted
Organics, Inc. before other comprehensive income |
|
|
1,101,892 |
|
|
|
(2,028,270 |
) |
|
|
(926,378 |
) |
|
|
(637,585 |
) |
|
|
(2,028,270 |
) |
|
|
(2,665,855 |
) |
Comprehensive income (loss) |
|
|
1,098,084 |
|
|
|
(2,135,021 |
) |
|
|
(1,036,937 |
) |
|
|
(651,889 |
) |
|
|
(2,135,021 |
) |
|
|
(2,786,910 |
) |
Comprehensive income (loss) attributable to |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Converted Organics, Inc. |
|
|
1,098,818 |
|
|
|
(2,028,270 |
) |
|
|
(929,452 |
) |
|
|
(649,135 |
) |
|
|
(2,028,270 |
) |
|
|
(2,677,405 |
) |
Earnings
(loss) per share, basic and diluted |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Continuing operations |
|
$ |
0.10 |
|
|
|
|
|
|
$ |
(0.10 |
) |
|
$ |
(0.10 |
) |
|
|
|
|
|
$ |
(0.30 |
) |
Discontinued operations |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
0.10 |
|
|
|
|
|
|
$ |
(0.10 |
) |
|
$ |
(0.10 |
) |
|
|
|
|
|
$ |
(0.30 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of June 30, 2011 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accounts receivable, net |
|
$ |
1,075,509 |
|
|
$ |
(57,000 |
) |
|
$ |
1,018,509 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Goodwill |
|
|
1,668,369 |
|
|
|
(1,193,600 |
) |
|
|
474,769 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Additional paid-in capital |
|
|
99,470,282 |
|
|
|
(673,579 |
) |
|
|
98,796,703 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Accumulated deficit |
|
|
(101,090,877 |
) |
|
|
(548,170 |
) |
|
|
(101,639,047 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
Noncontrolling interests |
|
|
426,899 |
|
|
|
(28,851 |
) |
|
|
398,048 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Total stockholders equity |
|
|
12,087,391 |
|
|
|
(1,143,849 |
) |
|
|
10,943,542 |
|
|
|
|
|
|
|
|
|
|
|
|
|
33
ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the consolidated interim financial
statements and related notes to the consolidated interim financial statements included elsewhere in
this report. This discussion contains forward-looking statements that relate to future events or
our future financial performance. These statements involve known and unknown risks, uncertainties
and other factors that may cause our actual results, levels of activity, performance or
achievements to be materially different from any future results, levels of activity, performance or
achievements expressed or implied by these forward-looking statements. These forward-looking
statements are based largely on our current expectations and are subject to a number of
uncertainties and risks including the Risk Factors identified in our Annual Report on Form 10-K for
the year ended December 31, 2010. 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
Converted Organics Inc. (the Company or COIN) has three lines of business, (1) organic
fertilizer, (2) vertical farming and (3) industrial wastewater treatment. Based on the nature of
products and services offered, the Company has determined that all three lines of business are
reportable segments at September 30, 2011.
The Company evaluates performance based on several factors, of which the primary financial measure
is business segment operating income. There were no intersegment sales for the three and nine months
ended September 30, 2011. The discreet financial information is presented below as of and for the
three and nine month periods ended September 30, 2011:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Three Months Ended September 30, 2011 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Corporate |
|
|
|
|
|
|
Organic |
|
|
Vertical |
|
|
Industrial |
|
|
and |
|
|
|
|
|
|
Fertilizer |
|
|
Farming |
|
|
Wastewater |
|
|
Eliminations |
|
|
Consolidated |
|
Revenues |
|
$ |
579,831 |
|
|
$ |
|
|
|
$ |
107,828 |
|
|
$ |
|
|
|
$ |
687,659 |
|
Operating loss (1) |
|
|
(186,274 |
) |
|
|
(465,529 |
) |
|
|
(53,260 |
) |
|
|
(705,653 |
) |
|
|
(1,410,716 |
) |
Depreciation and
amortization(2) |
|
|
106,662 |
|
|
|
161,821 |
|
|
|
33,335 |
|
|
|
55,568 |
|
|
|
357,386 |
|
Interest expense(3) |
|
|
|
|
|
|
1,824 |
|
|
|
|
|
|
|
1,409,981 |
|
|
|
1,411,805 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss |
|
|
(186,274 |
) |
|
|
(512,277 |
) |
|
|
(53,260 |
) |
|
|
(5,194,521 |
) |
|
|
(5,946,332 |
) |
34
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Nine Months Ended September 30, 2011 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Corporate |
|
|
|
|
|
|
Organic |
|
|
Vertical |
|
|
Industrial |
|
|
and |
|
|
|
|
|
|
Fertilizer |
|
|
Farming |
|
|
Wastewater |
|
|
Eliminations |
|
|
Consolidated |
|
Revenues |
|
$ |
2,497,923 |
|
|
$ |
|
|
|
$ |
308,622 |
|
|
$ |
|
|
|
$ |
2,806,545 |
|
Operating loss (1) |
|
|
(256,828 |
) |
|
|
(4,023,305 |
) |
|
|
(104,324 |
) |
|
|
(5,078,296 |
) |
|
|
(9,462,753 |
) |
Depreciation and
amortization(2) |
|
|
317,946 |
|
|
|
484,753 |
|
|
|
72,222 |
|
|
|
393,499 |
|
|
|
1,268,420 |
|
Interest expense(3) |
|
|
|
|
|
|
13,898 |
|
|
|
|
|
|
|
7,238,153 |
|
|
|
7,252,051 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss |
|
|
(256,828 |
) |
|
|
(3,841,893 |
) |
|
|
(104,324 |
) |
|
|
(4,712,418 |
) |
|
|
(8,915,463 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total assets (4) |
|
|
3,556,195 |
|
|
|
10,667,097 |
|
|
|
2,049,482 |
|
|
|
916,439 |
|
|
|
17,189,213 |
|
Goodwill |
|
|
|
|
|
|
223,787 |
|
|
|
|
|
|
|
|
|
|
|
223,787 |
|
Property and
equipment additions |
|
|
155,062 |
|
|
|
2,255 |
|
|
|
1,600,000 |
|
|
|
|
|
|
|
1,757,317 |
|
|
|
|
(1) |
|
Operating income (loss)
of the principal
businesses exclude
corporate compensation,
marketing expense,
professional fees and
other unallocated
expenses. |
|
(2) |
|
Depreciation and
amortization expense
associated with
property and equipment,
intangibles and
deferred financing
fees. Corporate
amortization expense
relates to deferred
financing fees. |
|
(3) |
|
Corporate interest
expense is primarily
related to amortization
of discounts on
convertible notes
payable. |
|
(4) |
|
Total business assets
are the owned or
allocated assets used
by each business.
Corporate assets
consist of cash,
prepaid expenses,
certain other assets
and deferred financing
costs. |
As of September 30, 2010, the Company was a single reportable segment.
Revenues are attributable to geographic areas based on the locations of the customers, which are
primarily within the continental United States. The fertilizer segment derived approximately
$390,000 or 67% of its revenues from three customers (AO Farming Operations 30%; NH3 Service
Company 20%; and Verdi Tech Services 17%); the industrial wastewater segment derived 100% of
its revenue from one customer, South Canyon Waste Systems, Inc. for the three month period ended
September 30, 2011. For the nine month period ended September 30, 2011, the fertilizer segment
derived approximately $1,327,000 or 54% of its revenues from four customers (Verdi Tech 12%;
American Farms 13%; NH3 Servcies 13%; and Crop Production Services 16%); and the
industrial wastewater segment derived 100% of its revenue from one customer, South Canyon Waste
Systems, Inc. In both the three and nine month period ended
September 30, 2011, the Terrasphere
segment had no reportable income.
Our operating structure is composed of our parent company, Converted Organics Inc. and the
subsidiaries listed below. The current subsidiaries of COIN are as follows:
|
|
|
Converted Organics of California, LLC, a wholly-owned subsidiary of
COIN, which includes the operation of our Gonzales, California
facility. |
35
|
|
|
Converted Organics of Woodbridge, LLC, a wholly-owned subsidiary of
COIN, which includes the discontinued operation of our Woodbridge, New
Jersey facility. |
|
|
|
|
Converted Organics of Mississippi, LLC, a wholly-owned subsidiary of
COIN, established for the purpose of adding a poultry litter-based
fertilizer product to the Companys existing product lines. This
entity is currently inactive. |
|
|
|
|
Converted Organics of Rhode Island, LLC, a 92.5% owned subsidiary of
COIN , which currently has no operating activity and which was
originally established to include the operation of a previously
planned fertilizer facility in Rhode Island. On February 25, 2010, we
signed a letter of intent with the non-controlling member in Converted
Organics of RI to sell substantially all of the assets and a limited
select amount of liabilities of Converted Organics of RI. The letter
of intent has since been terminated. This entity is currently inactive
and has no assets or liabilities. |
|
|
|
|
TerraSphere Inc. (TerraSphere Inc), a Delaware C corporation and
wholly owned subsidiary of COIN, was established to hold an
investment in TerraSphere Systems, LLC (TerraSphere Systems) in
which a 95% interest was acquired on November 12, 2010. Systems, LLC
owns 85% of TerraSphere Systems Canada Inc. and 100% of PharmaSphere,
LLC, which in turn owns 100% of PharmaSphere Worcester, LLC. COINs
acquisition of its interest in TerraSphere Systems was approved by our
shareholders at a special meeting held on September 16, 2010. |
|
|
|
|
GoLocalProduceRI, LLC, a 83.34% owned subsidiary of COIN, which we
acquired on December 30, 2010 for the purpose of building and
operating a TerraSphere facility. |
Organic Fertilizer Business
We operate a processing facility (Gonzales, CA) that uses food and agricultural waste as raw
materials to manufacture all-natural fertilizer and soil amendment products combining nutritional
and disease suppression characteristics for sale to the agribusiness market. During the first
quarter of 2011 we also contracted with a third party manufacturer and packager to produce an 8-1-4
dry fertilizer product. This product was manufactured for the purpose of continuing to supply our
established retail and turf management customers that were previously serviced by our Woodbridge,
NJ facility, which closed in 2010.
Converted Organics of California, LLC Gonzales Facility
The Gonzales facility is our production facility that services our West Coast agribusiness customer
base through established distribution channels. This facility uses our proprietary technology and
process known as High Temperature Liquid Composting, or HTLC ®, which processes various
biodegradable waste products into liquid and food waste-based fertilizer and a limited amount of
solids that could be further processed into a useable form for use in agriculture, retail, and
professional turf markets.
36
The Gonzales facility began to generate positive cash flow in June 2009 and has continued to do so
through September 2011. For the nine month period ended September 30, 2011, the Gonzales facility
generated revenues of approximately $2,216,000 and had a positive gross margin of approximately
$724,000, or 33% (based on no allocation of corporate overhead). Gross margin for the three month
period ended September 30, 2011 was approximately $116,000 or 20%. We plan to continue to improve
this operating margin by maximizing the production capacity at the facility, as discussed below, by
generating tip fees from receiving additional quantities of solid food waste for processing and by
reducing the amount of raw material and freight costs currently associated with the production
process. We estimate that the plant, in its current configuration and based on current market
prices, has the capacity to generate monthly sales in the range of $350,000 to $400,000. In
addition, we have plans to triple production capacity of the Gonzales plant and further modify it
to enable production of both liquid and solid fertilizers. We have completed certain aspects of the
planned upgrades which allow us to receive solid food waste for processing, but have delayed the
upgrades which would allow us to produce dry product due to a lack of market demand for a dry
product within the area the Gonzales facility serves. We believe that additional liquid production
capacity could be achieved by adding storage tanks, and that dry product capacity could be added by
installing a drying and bagging line. We estimate costs to increase liquid capacity by adding
storage tanks would be approximately $200,000 to $300,000 and dry line costs would approximate
$500,000 to $600,000. At this time we have not committed to any such costs and have not developed a
precise timeline for the completion of these projects,
and given our current cash position (see liquidity section) it is
not likely that we would begin work on these additions.
In addition to sales of fertilizer product from our Gonzales facility, we sold approximately
$282,000 of dry fertilizer product for the nine month period ended September 30, 2011. We produced
this dry 8-1-4 product using a third party manufacturer in order to supply product to our major
retail customer and landscaping customers. Through June 30, 2011 the sales of our dry product
resulted in a negative operating margin of $79,000. The selling season for this product has ended
and we did not sell any of this product in the three month period ended September 30, 2011 and we dont
expect to sell any of this product in the fourth quarter of 2011.
Industrial Wastewater Treatment Business
In March 2010, we began to operate an Industrial Wastewater Resources (IWR) business of the Company
to leverage our exclusive license of the LM-HT ® Concentrator technology for the treatment of
industrial wastewater (IW). Due to its unique, energy efficient design, the LM-HT ® Concentrator
provides a highly cost-effective alternative to traditional IW treatment technology. Once the LM-HT
® Concentrators are installed, we plan to apply for carbon credits and government grants based on
the technologys ability to reduce carbon emissions and energy consumption through its use of waste
heat and renewable energy as thermal fuel.
On March 23, 2010, we entered into a loan and license agreement with Heartland Technology Partners,
LLC (HTP). The loan agreement required us to advance $500,000 to HTP in three
37
monthly installments that commenced upon signing of the loan. The outstanding principal balance of
the loan is due only 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.
If neither of these occur then the loan does not have to be repaid. We have classified this amount as an
other non-current asset on our balance sheet. In consideration for entering into the loan
agreement, we were granted an exclusive, irrevocable license to utilize HTPs patented LM-HT ®
Concentrator technology in the U.S. industrial wastewater market. The IW market involves the
treatment of waters that have been contaminated by anthropogenic industrial or commercial
activities, prior to their reuse or release into the environment. The LM-HT® Concentrator reduces
carbon emissions compared to traditional technologies by using waste heat and renewable energy as
thermal fuel. We have hired a senior executive in the wastewater processing industry and have begun
to develop plans to operate our Industrial Wastewater Resources division. On July 30, 2010, we
signed a letter of intent with Spirit Services, Inc. to jointly develop an energy and IW treatment
facility using our exclusively licensed technology to evaporate waste
water at a facility in South Boston,
Virginia.
IWR currently operates an industrial wastewater concentrator on Glenwood Springs Landfill
Enterprises South Canyon Landfill in Glenwood Springs, CO as a result of an agreement signed on
January 11, 2011. This facility is designed to treat 15,000 gallons of aqueous waste per day and is
fueled by the combustion of biomass diverted from disposal in the
landfill. Among the waste water to be
treated by the plant are septic, wash waters, process waters, man-camp wastewaters, and wastewaters
from oil and gas exploration activities. Under this agreement we are paid a per gallon fee for the
amount of industrial wastewater that we treat and we pay the labor costs to operate (the unit is operated by employees of South Canyon) the unit and a
marketing fee to generate the industrial wastewater delivered to the facility. In addition, we own
the evaporator unit and are responsible for repairing and maintaining it. The unit was manufactured
by HTP. As of January 2011 we began to generate revenue under this agreement from South Canyon
Landfills traditional method of wastewater treatment as we waited for conditional air permits.
Such permits were received in March 2011, since which time we paid $950,000 of the $1.6 million
purchase price of the new evaporator and the unit commenced operations. The equipment is being
financed from the monthly cash flow generated by the business and it is expected that the remaining
balance will be paid off in the next twelve months. For the nine months ended September 30, 2011 we
recorded revenues of approximately $309,000 and have had gross margin of approximately $129,000 or
42% from treatment of industrial wastewater at this facility.
Our plan to increase business and revenues for IWR is to seek out municipal and industrial
locations to locate our owned evaporator units and to charge a per gallon fee to treat industrial
wastewater. We plan to follow the current agreement model where we would pay for labor, repairs and
marketing (if required) at the location. We will have to seek specific project financing for each
evaporator unit. Presently, we are in discussion with four potential owners of locations where an
evaporator unit could be located. If we are able to secure project financing, we will be able to
begin operations on a further evaporator units, in addition to the one being operated at the South
Canyon Landfill.
38
Vertical Farming Business
On May 20, 2010, we formed TerraSphere Inc., a Delaware corporation and a wholly owned subsidiary
of the Company, for the purpose of acquiring the membership interests of TerraSphere Systems, LLC
(TerraSphere Systems). On July 6, 2010, a membership interest purchase agreement was entered into
by the Company, TerraSphere Inc., TerraSphere Systems, and the members of TerraSphere Systems,
pursuant to which we agreed to acquire the membership interests of TerraSphere Systems. The maximum
total shares that could be issued for TerraSphere Systems is estimated to be 3,416,667 shares of
our common stock, which includes earn-out share payments of up to 1,460,318 shares of our common
stock. Pursuant to the purchase agreement, the acquisition was approved by our shareholders on
September 16, 2010, and the Company acquired 95% of the membership interest of TerraSphere Systems
on November 12, 2010. We agreed to issue up to 3,277,778 shares of our common stock to the members
of TerraSphere Systems in exchange for 95% of the units of TerraSphere Systems, subject to certain
anti-dilution adjustments. Of these shares, 1,817,460 shares were issued on November 12, 2010, the
closing of the acquisition, and the remainder of the shares will be issued if TerraSphere achieves
four milestones. As of the filing date of this report, only one of the four milestones,
TerraSpheres collection of $2.0 million of its accounts receivable by February 28, 2011, was
subject to measurement. This milestone was not met, and as a result we will not issue the 182,540
shares of our common stock associated with that milestone. Two of the three remaining milestones
(market capitalization and gross margin), are to be measured as of December 31, 2011, and the final
milestone (gross margin) is to be measured at December 31, 2012. On December 30, 2010 we also
acquired an 83.34% ownership in GoLocalProduceRI, LLC (an independent TerraSphere licensee) for the
purpose of building and owning a TerraSphere facility.
The minority shareholder in GoLocalProduceRI LLC, is the spouce of
the president of our PhamaSphere operation.
TerraSphere Systems is in the business of designing, building, and operating highly efficient and
scalable systems, featuring a patented, proprietary technology that utilizes vertically-stacked
modules to house rows of plants, which are then placed perpendicular to an interior light source to
grow pesticide and chemical-free organic fruits and vegetables. Due to a controlled, indoor
environment, the system generates fresh produce year-round in any location or climate world-wide.
During 2011 we have not achieved the planned revenue that we anticipated from the TerraSphere
acquisition and have not been able to secure the necessary financing to build our own TerraSphere
facility. Therefore, at June 30, 2011, we recorded an impairment
loss related to the goodwill recognized with the TerraSphere acquisition.
In addition, in November 2011 the company entered into discussions, with an
investor, to spin off the TerraSphere segment.
The following pro forma condensed statement of operations information is presented to illustrate
the effects upon the quarter ended September 30, 2010 had the acquisitions of TerraSphere and
GoLocalProduceRI been completed on January 1, 2010. The pro forma presentation is based upon available information and certain assumptions
that we believe are reasonable. The unaudited supplemental pro forma information does not purport
to represent what the Companys results of operations would actually have been had these
transactions in fact occurred as of the dates indicated above or to project the Companys results
of operations for the period indicated or for any other period.
39
The unaudited pro forma consolidated financial information for the three and nine month periods ended September 30, 2010 as though the above
acquisitions had been completed at the beginning of the interim period is as follows:
|
|
|
|
|
|
|
|
|
|
|
For the |
|
|
|
|
|
|
Three |
|
|
|
|
|
|
Months |
|
|
For the Nine |
|
|
|
Ended |
|
|
Months Ended |
|
|
|
September |
|
|
September 30, |
|
|
|
30, 2010 |
|
|
2010 |
|
Revenue |
|
$ |
817,765 |
|
|
$ |
3,468,190 |
|
Net loss |
|
$ |
(31,389,145 |
) |
|
$ |
(33,286,590 |
) |
Net loss per share, basic and diluted |
|
$ |
(4.55 |
) |
|
$ |
(5.03 |
) |
Weighted-average shares |
|
|
6,898,307 |
|
|
|
6,615,019 |
|
Recent Financing Activities
December 17, 2010 and March 7, 2011 Notes and Warrants
On December 17, 2010, we entered into a Securities Purchase Agreement (the Agreement) with
certain institutional investors whereby we sold to the investors convertible notes in the aggregate
original principal amount of $4,990,000 (the Notes), which were convertible into shares of our
common stock. The Notes were issued with an original issue discount of approximately 4.8%, and the
purchase price of the Notes was $4,750,000. The Notes were not interest bearing, unless we are in
default on the Notes, in which case the Notes carry an interest rate of 18% per annum. On December
17, 2010 we sold to the Buyer $3,940,000 of the Notes and on March 7, 2011 we sold the investors
the remaining $1,050,000 of the Notes. We repaid the Notes in six equal installments commencing
February 1, 2011, with respect to $3.94 million of the Notes, and with respect to $1.05 million of
the Notes, we commenced repayment in six equal installments on April 8, 2011. The repayment of the
Notes was eligible to be made either in cash or in shares of our common stock. If we chose to utilize shares of
our common stock for the payment, the value of our shares was equal to the lower of (i) the
conversion price then in effect or (ii) 85% of the average of the three lowest closing sale prices
of our common stock during the 20 trading day period prior to payment of the installment amount. We
also have the right, at our option, to permit the holder of the Notes to convert at a lower price
specified by us for a period specified by us.
In addition, we also issued to the investors warrants to acquire shares of common stock, in the
form of three warrants: (i) Series A Warrants, (ii) Series B Warrants, and (iii) Series C
Warrants (collectively, the December Warrants).
The Series B Warrants became exercisable on February 28, 2011, the date upon which shareholder
approval was obtained in connection with the financing, and expire on November 28, 2011. On August
9, 2011, as part of the restructuring of our outstanding debt to the holder of the Series B Warrants, we agreed to lower the exercise price of the Series B
40
Warrants to $0.50 per share. As of the date hereof, the exercise price of the Series B
Warrants is $0.50 per share and there are 1,446,377 shares underlying the Series B Warrants.
The Series A and Series C Warrants became exercisable on February 28, 2011, the date upon which
shareholder approval was obtained in connection with the financing, and have a five year term.
Should we make certain dilutive issuances (with limited exceptions), the exercise price of the
Series A and Series C Warrants will be lowered to the per share price for the dilutive issuances.
In addition, the exercise price of the Series A and Series C Warrants will adjust to the average of
the conversion prices used to repay the Notes as discussed above. On August 8, 2011, as part of
the restructuring of our outstanding debt to the holder of the Series A and Series C Warrants, we
agreed to lower the exercise price of the Series A and Series C Warrants to $0.50 per share.
April 1, 2011 and November 2, 2011 Notes and Warrants
On April 1, 2011, we entered into a Securities Purchase Agreement with an institutional investor
whereby we sold to the investor a convertible note in the aggregate original principal amount of
$3,850,000 (the Original Note), which is convertible into shares of our common stock. The
Original Note was issued with an original issue discount of approximately 9.1%, and the proceeds
from the Original Note were $3,500,000. The Original Note was non interest bearing. On November 2,
2011, we entered into an agreement pursuant to which we agreed with the holder of the Original Note
to exchange Original Note, which had $3,474,797 of principal outstanding on November 2, 2011,
for a senior secured convertible in the aggregate original principal amount of $3,474,797 (the
Note).
Pursuant to the original terms of the Original Note, we were required to repay the Original Note in
five equal monthly installments, commencing July 31, 2011, either in cash or in shares of our
common stock. We were not permitted to utilize shares of common stock for repayment prior to
meeting certain conditions, including the registration statement registering the resale of the
shares of common stock underlying the Original Note being declared effective by the Securities and
Exchange Commission (SEC). As of the date hereof, such registration statement has not been
declared effective, and as such, we would have been required to make the monthly Original Note
repayment in cash. On August 9, 2011 we and the Original Note holder agreed to delay the repayment
dates and on October 19, 2011 we agree to change the conversion price to the lowest of (i) $4.00
(subject to certain adjustment), (ii) the price which is equal to the product of (1) 85% multiplied
by (2) the quotient of (A) the sum of each of the three lowest closing sale prices of the common
stock during the twenty consecutive trading day period immediately preceding the applicable
conversion date or other date of determination (as the case may be) divided by (B) three and (iii)
the price which is equal to the product of (I) 85% multiplied by (II) the closing sale price of the
common stock on the trading day immediately preceding the applicable conversion date or other date
of determination (as the case may be).
41
The terms of the Note we issued in November 2, 2011 are substantially identical to the terms of the
Original Note, provided that we are not required to amortize payment for the Note and the principal
and interest on the Note is now due on May 2, 2012, instead of February 17, 2012.
If an event of default occurs under the Note, we must redeem the Note in cash at the greater of
135% of the unconverted principal amount or 135% of the greatest equity value of the shares of
common stock underlying the Note from the date of the default until the redemption is completed.
The conversion price of the Note is subject to adjustment in the case of stock splits, stock
dividends, combinations of shares and similar recapitalization transactions. The convertibility of
the Note may be limited if, upon exercise, the holder or any of its affiliates would beneficially
own more than 4.9% of our common stock.
Pursuant to the terms of the Purchase Agreement, we also agreed to issue to the Note holder
warrants to acquire shares of common stock, in the form of three warrants: (i) Series A Warrants,
(ii) Series B Warrants and (iii) Series C Warrants (collectively, the April Warrants).
The Series B Warrants are exercisable six months and one day after issuance and expire nine months
after the date we obtain shareholder approval to issue in excess of 20% of our common stock for the
April financing and to permit us to adjust the exercise price of the Series A and Series C
Warrants. The Series B Warrants provide that the holders are initially entitled to purchase an
aggregate of 914,375 shares at an initial exercise price of $4.125 per share. On August 9, 2011,
as part of the restructuring of the Note described above, we agreed to lower the exercise price of
the Series B Warrants to $0.50 per share. If we make certain dilutive issuances (with limited
exceptions), the exercise price of the Series B Warrants will be lowered to the per share price for
the dilutive issuances. In addition, the exercise price of the Series B Warrants was adjusted to
the average of the conversion prices we used to repay the Original Note. Based upon our current stock price the holder of the
Note is now entitled to 1,109,352 shares of our common stock.
To the extent we enter into a fundamental transaction (as defined in the Series B Warrants and
which include, without limitation, our entering into a merger or consolidation with another entity,
our selling all or substantially all of our assets, or a person acquiring 50% of our common stock),
we have agreed to purchase the Series B Warrants from the holders at their Black-Scholes value.
42
If our common stock trades at a price at least 200% above the Series B Warrants exercise price for
a period of 10 trading days at any time after we obtain shareholder approval (as discussed above),
we may force the exercise of the Series B Warrants if we meet certain conditions.
The Series A and Series C Warrants are exercisable six months and one day after issuance and have a
five year term commencing on the initial exercise date. The Series A Warrants provide that the
holders are initially entitled to purchase an aggregate of 481,250 shares. The Series C Warrants
provide that the holders are initially entitled to purchase an aggregate of 434,329 shares. If on
the expiration date of the Series B Warrants, a holder of such warrant has not exercised such
warrant for at least 50% of the shares underlying such warrant, we have the right to redeem from
such holder its Series C Warrant for $10,000 under certain circumstances. On August 9, 2011, as part
of the restructuring of the Original Note described above, we agreed to lower the exercise price of
the Series A and Series C Warrants to $0.50 per share.
If we make certain dilutive issuances (with limited exceptions), the exercise price of the Series A
and Series C Warrants will be lowered to the per share price for the dilutive issuances. In
addition, the exercise price of the Series A and Series C Warrants was adjusted to the average of
the conversion prices we used to repay the Original Note. The number of shares underlying the
Series A and Series C Warrants will not be adjusted due to an adjustment of the exercise price
pursuant to the preceding two sentences.
To the extent we enter into a fundamental transaction (as defined in the Series A and Series C
Warrants and which include, without limitation, our entering into a merger or consolidation with
another entity, our selling all or substantially all of our assets, or a person acquiring 50% of
our common stock), we have agreed to purchase the Series A and Series C Warrants from the holder at
their Black-Scholes value.
The exercise price of all the Warrants is subject to adjustment in the case of stock splits, stock
dividends, combinations of shares and similar recapitalization transactions. The exercisability of
the Warrants may be limited if, upon exercise, the holder or any of its affiliates would
beneficially own more than 4.9% of our common stock. The Note may not be converted if the total
number of shares that would be issued would exceed 19.99% of our common stock on the date the
Purchase Agreement was executed prior to our receiving shareholder approval (as discussed above).
Future Development
Our long term strategic plans have been severely limited
by our current cash position (see liquidity section). If we are
unable to secure additional financing we will not be
able to carry out our plans for growth. Until and if additional financing can be arranged the Company has begun to implement plans to curtail all but essential corporate functions and to cease future investment in the TerraSphere and IWW divisions.
The Company expects the organic fertilizer division and the IWW facility at the South Canyon Landfill will continue to operate and generate revenues without additional investment. However, cash
generated from those continuing operations is not sufficient to finance the continued operations of the Company or to finance the growth of the operating businesses.
In addition, the Company announced it will spin off the TerraSphere division and it is exploring all available options to raise cash from the remaining assets and operations.
43
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 we
expect. In addition, supply of organic fertilizer products from the use of other technologies or
other competitors may adversely affect our selling prices and consequently our overall
profitability. In addition, a significant part of our growth strategy is based upon generating
revenues from both our Industrial Wastewater business and from the acquisition of TerraSphere
44
Systems, both of which are in early stages of development. This strategy requires licensees to
raise the funding necessary to construct facilities, which has proven difficult. Furthermore our
plan calls for raising additional debt and/or equity financing to construct additional operating
facilities. Currently there has been a slowdown in lending in both the equity and bond markets,
which may hinder our ability to raise the required funds. Our growth strategy may not be achieved due to these cash constraints.
In addition, we have entered into discussions to spin off our Terrasphere business.
RESTATEMENT OF PRIOR PERIOD FINANCIAL STATEMENTS
We
restated our financial statements for the year ended December 31, 2010 to correct the amounts
recorded in our preliminary allocation of the acquisition costs
related to the November 12, 2010
acquisition of TerraSphere as the result, among other things, of TerraSpheres restatement of its
own financial statements for the nine months ended September 30, 2010 to correct its revenue
recognition accounting. We have corrected our preliminary allocation
of the acquisition cost related to the
TerraSphere accounts receivable, accordingly. We also corrected our assessment of the likelihood of the payment
of the Milestone Two contingent payment (payable if TerraSphere receivables of $2 million are
collected by February 28, 2010), and the resulting amount recorded as the fair value of this
element of the acquisition cost. The net effect of these changes in the acquisition accounting
affected the goodwill recorded when TerraSphere was acquired.
The following sets forth the changes to the determination of the acquisition costs and the
preliminary allocation of the acquisition cost:
45
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As previously |
|
|
Restatement |
|
|
As |
|
|
|
reported |
|
|
adjustment |
|
|
restated |
|
Components of acquisition cost |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Election of option one |
|
$ |
2,961,000 |
|
|
|
|
|
|
$ |
2,961,000 |
|
Election of option two |
|
|
4,490,000 |
|
|
|
|
|
|
|
4,490,000 |
|
Milestone One |
|
|
1,403,000 |
|
|
|
|
|
|
|
1,403,000 |
|
Milestone two |
|
|
711,000 |
|
|
|
(673,579 |
) |
|
|
37,421 |
|
Milestone three and four |
|
|
1,684,000 |
|
|
|
|
|
|
|
1,684,000 |
|
Anti-dilution |
|
|
837,000 |
|
|
|
|
|
|
|
837,000 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
12,086,000 |
|
|
|
|
|
|
$ |
11,412,421 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Allocation of acquistion cost |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash |
|
$ |
41,679 |
|
|
|
|
|
|
$ |
41,679 |
|
Accounts receivable |
|
|
2,690,000 |
|
|
|
(1,615,000 |
) |
|
|
1,075,000 |
|
Other assets |
|
|
274,313 |
|
|
|
|
|
|
|
274,313 |
|
Leasehold improvements |
|
|
176,181 |
|
|
|
|
|
|
|
176,181 |
|
Construction in progress |
|
|
97,306 |
|
|
|
|
|
|
|
97,306 |
|
Patents |
|
|
10,000,000 |
|
|
|
|
|
|
|
10,000,000 |
|
Goodwill |
|
|
1,193,600 |
|
|
|
941,421 |
|
|
|
2,135,021 |
|
Assumption of liabilities |
|
|
(1,738,435 |
) |
|
|
|
|
|
|
(1,738,435 |
) |
Non-controlling interest |
|
|
(648,644 |
) |
|
|
|
|
|
|
(648,644 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
12,086,000 |
|
|
|
|
|
|
$ |
11,412,421 |
|
|
|
|
|
|
|
|
|
|
|
|
In addition, as the result of the reduction in the amount assigned to the accounts receivable
upon the acquisition of TerraSphere, the bad debt expense we recorded for those receivables
during the period November 12, 2010 to December 31, 2010 was reduced from $2,283,000 to $725,000.
We also
restated the preliminary allocation of the purchase price for GoLocalProduceRI, LLC to
allocate $250,000 of the purchase price previously allocated to goodwill to the license rights
which we sold to GoLocalProduceRI, LLC in November, 2010 and reacquired as the result of this
acquisition.
The following sets forth the effect of the restatement on the affected financial statement line
items:
46
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As previously |
|
|
Restatement |
|
|
As |
|
|
|
reported |
|
|
adjustment |
|
|
restated |
|
For the year ended December 31, 2010 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling, general and administrative expenses |
|
$ |
14,625,568 |
|
|
$ |
(1,558,000 |
) |
|
$ |
13,067,568 |
|
Loss from continuing operations |
|
|
(14,277,559 |
) |
|
|
1,558,000 |
|
|
|
(12,719,559 |
) |
Loss from continuing operations before provision for income taxes |
|
|
(16,039,025 |
) |
|
|
1,558,000 |
|
|
|
(14,481,025 |
) |
Loss from continuing operations |
|
|
(16,039,025 |
) |
|
|
1,558,000 |
|
|
|
(14,481,025 |
) |
Net loss |
|
|
(50,729,383 |
) |
|
|
1,558,000 |
|
|
|
(49,171,383 |
) |
Net loss attributable to noncontrolling interest |
|
|
(168,156 |
) |
|
|
77,900 |
|
|
|
(90,256 |
) |
Net loss attributable to Converted Organics, Inc. before other comprehensive income |
|
|
(50,561,227 |
) |
|
|
1,480,100 |
|
|
|
(49,081,127 |
) |
Comprehensive loss |
|
|
(50,562,600 |
) |
|
|
1,480,100 |
|
|
|
(49,004,500 |
) |
Comprehensive loss attributable to Converted Organics, Inc. |
|
|
(50,562,336 |
) |
|
|
1,480,100 |
|
|
|
(49,082,236 |
) |
Net loss per share, basic and diluted |
|
|
|
|
|
|
|
|
|
|
|
|
Continuing operations |
|
|
(3.40 |
) |
|
|
|
|
|
|
(3.10 |
) |
Discontinued operations |
|
|
(7.40 |
) |
|
|
|
|
|
|
(7.40 |
) |
|
|
|
|
|
|
|
|
|
|
|
Net loss per share |
|
$ |
(10.80 |
) |
|
|
|
|
|
$ |
(10.50 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of December 31, 2010 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accounts receivable, net |
|
$ |
579,946 |
|
|
$ |
(57,000 |
) |
|
$ |
522,946 |
|
Intangible assets, net |
|
|
11,629,265 |
|
|
|
250,000 |
|
|
|
11,879,265 |
|
Goodwill |
|
|
1,667,957 |
|
|
|
691,421 |
|
|
|
2,359,378 |
|
Additional paid-in capital |
|
|
85,555,990 |
|
|
|
(673,579 |
) |
|
|
84,882,411 |
|
Accumulated deficit |
|
|
(100,453,292 |
) |
|
|
1,480,100 |
|
|
|
(98,973,192 |
) |
Noncontrolling interests |
|
|
576,178 |
|
|
|
77,900 |
|
|
|
654,078 |
|
Total stockholders equity |
|
|
3,186,314 |
|
|
|
884,421 |
|
|
|
4,070,735 |
|
We also
restated our financial statements for the three and six months ended June 30,
2011 to correct our accounting for the goodwill recorded in connection with the
acquisition of TerraSphere in November, 2010. We restated those financial statements to
record a charge of $2.1 million at June 30, 2011 reflecting the impairment of that
goodwill. See Note 1.
The following sets forth the effect of the restatement on the affected financial statement line
items as of and for the three and six months ended June 30, 2011:
47
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As previously |
|
|
Restatement |
|
|
As |
|
|
As previously |
|
|
Restatement |
|
|
As |
|
|
|
reported |
|
|
adjustment |
|
|
restated |
|
|
reported |
|
|
adjustment |
|
|
restated |
|
|
|
Three months ended June 30, 2011 |
|
|
Six months ended June 30, 2011 |
|
For the three and six months ended June 30, 2011 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Impairment |
|
$ |
|
|
|
$ |
2,135,021 |
|
|
$ |
2,135,021 |
|
|
$ |
|
|
|
$ |
2,135,021 |
|
|
$ |
2,135,021 |
|
Loss from continuing operations |
|
|
(3,547,413 |
) |
|
|
(2,135,021 |
) |
|
|
(5,682,434 |
) |
|
|
(5,867,016 |
) |
|
|
(2,135,021 |
) |
|
|
(8,002,037 |
) |
Income (loss) from continuing operations before provision for income taxes |
|
|
869,392 |
|
|
|
(2,135,021 |
) |
|
|
(1,265,629 |
) |
|
|
(930,581 |
) |
|
|
(2,135,021 |
) |
|
|
(3,065,602 |
) |
Income (loss) from continuing operations |
|
|
869,392 |
|
|
|
(2,135,021 |
) |
|
|
(1,265,629 |
) |
|
|
(930,581 |
) |
|
|
(2,135,021 |
) |
|
|
(3,065,602 |
) |
Net income (loss) |
|
|
1,016,362 |
|
|
|
(2,135,021 |
) |
|
|
(1,118,659 |
) |
|
|
(784,110 |
) |
|
|
(2,135,021 |
) |
|
|
(2,919,131 |
) |
Net loss attributable to noncontrolling interest |
|
|
(85,530 |
) |
|
|
(106,751 |
) |
|
|
(192,281 |
) |
|
|
(146,525 |
) |
|
|
(106,751 |
) |
|
|
(253,276 |
) |
Net income (loss) attributable to Converted Organics, Inc. before other comprehensive income |
|
|
1,101,892 |
|
|
|
(2,028,270 |
) |
|
|
(926,378 |
) |
|
|
(637,585 |
) |
|
|
(2,028,270 |
) |
|
|
(2,665,855 |
) |
Comprehensive income (loss) |
|
|
1,098,084 |
|
|
|
(2,135,021 |
) |
|
|
(1,036,937 |
) |
|
|
(651,889 |
) |
|
|
(2,135,021 |
) |
|
|
(2,786,910 |
) |
Comprehensive income (loss) attributable to Converted Organics, Inc. |
|
|
1,098,818 |
|
|
|
(2,028,270 |
) |
|
|
(929,452 |
) |
|
|
(649,135 |
) |
|
|
(2,028,270 |
) |
|
|
(2,677,405 |
) |
Earnings
(loss) per share, basic and diluted |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Continuing operations |
|
$ |
0.10 |
|
|
|
|
|
|
$ |
(0.10 |
) |
|
$ |
(0.10 |
) |
|
|
|
|
|
$ |
(0.30 |
) |
Discontinued operations |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
0.10 |
|
|
|
|
|
|
$ |
(0.10 |
) |
|
$ |
(0.10 |
) |
|
|
|
|
|
$ |
(0.30 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of June 30, 2011 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accounts receivable, net |
|
$ |
1,075,509 |
|
|
$ |
(57,000 |
) |
|
$ |
1,018,509 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Goodwill |
|
|
1,668,369 |
|
|
|
(1,193,600 |
) |
|
|
474,769 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Additional paid-in capital |
|
|
99,470,282 |
|
|
|
(673,579 |
) |
|
|
98,796,703 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Accumulated deficit |
|
|
(101,090,877 |
) |
|
|
(548,170 |
) |
|
|
(101,639,047 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
Noncontrolling interests |
|
|
426,899 |
|
|
|
(28,851 |
) |
|
|
398,048 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Total stockholders equity |
|
|
12,087,391 |
|
|
|
1,143,849 |
|
|
|
10,943,542 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Liquidity and Capital Resources
At September 30, 2011, we had total current assets of approximately $2.2 million consisting
primarily of cash, accounts receivable, inventory and prepaid assets and had current liabilities of
approximately $10.9 million, consisting primarily of convertible notes payable, accounts payable,
derivative liabilities and liabilities from discontinued operations leaving us with negative
working capital of approximately $8.7 million. Non-current assets totaled
approximately $15.0 million and consisted primarily of property and equipment and intangible
assets. Non-current liabilities consist of derivative liabilities totaling approximately $1.0
million at September 30, 2011. We have an accumulated deficit at September 30, 2011 of
approximately $107.6 million. Stockholders equity at September 30, 2011 was approximately $5.3
million. For the three months ended September 30, 2011, we generated revenues from continuing
operations of approximately $688,000 as compared to revenue from continuing operations of
approximately $809,000 for the same period in 2010. For the nine months ended June 30, 2011, we
generated revenues from continuing operations of approximately $2.8 million as compared to revenue
from continuing operations of $2.76 million for the same period in 2010.
48
Although the California fertilizer business is currently cash flow positive and the closing of the
Woodbridge facility in the third quarter of 2010 will save us approximately $6.0 million per year
in net cash expenditures, we believe that we will continue to have negative cash flow from
operations in 2011 due to the costs associated with corporate operations and funding the operations
of TerraSphere. In addition, we believe that we will require additional cash to finance capital
growth activities in order to build out the IWR projects planned for 2011.
Presently, our liquidity is limited to our cash on hand at September 30, 2011. In addition, in
connection with our recent financings, we have warrants outstanding that if exercised could provide
us with additional cash. However, our stock price has closed at both above and below the exercise price of these warrants,
and it is not likely that any warrants would be exercised unless the price of our stock was greater
than the exercise price of the warrants. There is no assurance that the holders of the warrants
will exercise the warrants in the near term, and as such, we may not receive these funds.
If we do not receive additional funds, whether as a result of the exercise of outstanding warrants
issued in our recent financings, or otherwise, we will not have sufficient cash to be able to
continue our operations. We have projected our net cash out flows to be approximately $350,000 per
month, and therefore, based on the cash on hand as of the filing date of this report, we have
sufficient cash to operate until the end of 2011 assuming we expend no cash on future IWR,
TerraSphere, or fertilizer capital projects. However, as our business strategy involves growing our
IWR division, we expect that we will require additional cash prior to the end of
2011. At this time, we do not have any commitments for additional financing, and there is no
assurance that capital in any form will be available to us on terms and conditions that are
acceptable or at all. If we do not raise funds before we exhaust our current cash position we will
be unable to continue certain operations. As of the filing date of this report, we are scheduled to exhaust
our cash position as of December 31, 2011 and unless additional financing can be secured (for which
we have no commitments) we will not be able to continue operations
after December 31, 2011. Therefore in the fourth quarter of
2011, in order to conserve cash, we have began to curtail
all but essential personnel at the Corporate level and cease all operations at the TerraSphere
division and all operations at the IWR division other than the operations at the South Canyon Land
fill. In addition, we are currently in negotiations, whereby
we would spin off our TerraSphere division. These negotiations have not been completed at time of
filing this report.
Results of Continuing Operations for the Three Month Period Ended September 30, 2011
Revenue
Our revenue from continuing operations for the three month period ended September 30, 2011, was
approximately $688,000 compared to approximately $809,000 for the same period ended
49
September 30,
2010. We had a loss from continuing operations of $1,411,000 for the three month period ended
September 30, 2011 compared to a loss from continuing operations of $3,894,000 for the same period
in 2010. The various components are described below.
Revenue from fertilizer sales was $580,000 for the three month period ended September 30, 2011 (all
from liquid fertilizer from our Gonzales facility) compared to $790,000 for the same period ended
September 30, 2010. This decrease of $210,000 in fertilizer sales revenue is due to a decrease in
sales at the Gonzales facility. We feel that the decrease in sales from Gonzales was
caused by bad weather, and as a result of this decrease our expectations for increased sales in
2011 over 2010 may not be achieved. We had no sales from our dry product being produced by an
outside vendor during the third quarter of 2011.
Converted Organics of Mississippi, formed in January 26, 2010, generated revenues of $19,000 during
the third quarter of 2010. In the third quarter of 2011 this entity had no revenue as the company
that we purchased the product from has filed for bankruptcy protection and the product is no longer
available.
The Industrial Wastewater Resources segment of our business recognized revenues in the amount of
$108,000 in the three month period ended September 30, 2011. This segment had no revenues in 2010,
as it was in the start up phase of operations.
Our TerraSphere segment reported no revenues for the three month period ended September 30, 2011.
TerraSphere continues to seek opportunities whereby it will generate license revenues from new
licensees, generate equipment revenues from current licensees, and is also seeking financing to
complete a production facility in Rhode Island, whereby we would generate revenues from the sale of
produce. We do not expect to generate revenues from TerraSphere in 2011. Due to less than expected
revenues from our TerraSphere segment, mainly due to the inability of ourselves or the various
licensees to obtain financing for the projects, we have taken an impairment charge as of June 30,
2011 related to certain TerraSphere goodwill.
Cost of Goods Sold
For the three month period ended September 30, 2011, we had cost of goods of approximately $515,000
compared to $584,000 for the same period in 2010. The decrease of $69,000 in cost of goods sold is
detailed below.
Cost of goods sold related to fertilizer at the Gonzales facility was approximately $464,000 for
the three months ended September 30, 2011, leaving an operating margin of $116,000 or 20%, compared
to cost of goods of $584,000 for the same period in 2010 and an operating margin of 26%. This
unfavorable variance is due to lower sales volume in this quarter (year over year) while certain
production costs remain fixed in amount. Although there were no sales in the third quarter for our
dry fertilizer product which was produced by an outside supplier, we did incur
50
product costs of $12,000 related to finalizing the activity associated with that revenue producing activity.
Cost of goods for our IWR segment was $70,000 for the three months ended September 30, 2011
resulting in an operating margin of 35%. There was no comparable activity in 2010 as the business
was in the start of operations.
General and Administrative Expenses
General
and administrative expenses for the three month period ended September 30, 2011 were
approximately $1.4 million compared to approximately $4.0 million for the same period in 2010. The
decrease of approximately $2.6 million is primarily comprised of a $1.7 million non-cash decrease in
consulting expense related to strategic planning activity, along with decreases in professional
fees associated with acquisition activity of approximately $850,000, cost reduction initiatives of
$400,000 offset by an increase in overhead expenses associated with our TerraSphere segment of
approximately $400,000.
Interest expense for the three months ended September 30, 2011 was approximately $1.4 million
compared to approximately $4,000 for the same period in 2010. The increase of approximately $1.4
million is associated with the amortization of debt discounts related to our convertible notes and
is a non-cash item.
Amortization of Intangible Assets
For the
three months ended September 30, 2011 we had amortization expense of
$221,000 compared to $72,000 for the same period in 2010. The
increase is due to additional amortization expense associated with
patents acquired in our TerraSphere acquisition.
Loss on Debt Modification
During the three months ended September 30, 2011 were recorded a loss on debt modification of
$937,000. This loss is a non-cash loss and is related to the valuation of certain derivative
features included in our April 2011 convertible debt obligations.
Derivative Gain (Loss)
For the three months ended September 30, 2011, we had a derivative loss of approximately $2.3
million compared to a derivative gain of approximately $662,000 for the same period in 2010. This
is a non-cash loss and is related to the valuation of certain derivative features included in
certain of our warrants and convertible debt obligations, and included in an anti-dilution
provision related to shares issued in the TerraSphere acquisition. The major factor creating the
loss on these derivative features is the decrease in our stock price during the quarter. In
addition, certain derivative instruments were issued and settled during the quarter, which impacted the
derivative loss.
Results of Continuing Operations for the Nine Month Period Ended September 30, 2011
Revenue
Our revenues from continuing operations for the nine month period ended September 30, 2011, was
$2,806,000 compared to $2,765,000 for the same period ended September 30, 2010. We had a loss from
continuing operations of $7,328,000 for the nine month period ended September 30,
51
2011 compared to
a loss from continuing operations of $10,061,000 for the same period in 2010. The various
components are described below.
Revenue from fertilizer was $2,498,000 for the nine month period ended September 30, 2011
($2,216,000 for liquid fertilizer from Gonzales and $282,000 from the outsourced dry fertilizer)
compared to $2,511,000 for the same period ended September 30, 2010. This decrease of $13,000 in
revenues is due to an increase in the sale of dry product produced by an outside vendor of $282,000
offset by a decrease in sales at the Gonzales facility of $295,000. We feel that the decrease in
sales from Gonzales was caused by bad weather, and as a result of this decrease our expectations
for increased sales in 2011 over 2010 may not be achieved. The sales from our dry product being
produced by an outside vendor generated a negative margin of approximately $78,000, however, this
program was initiated to satisfy two large customers who historically only purchase product in the
first half of the year and therefore we did not have further negative margin in the third quarter
of 2011 nor do we expect further negative margin in the last quarter of 2011.
Converted Organics of Mississippi, formed in January 26, 2010, generated revenues of $254,000
during the first nine months of 2010. In the first nine months of 2011 this entity had no revenue
as the company that we purchased the product from has filed for bankruptcy protection and the
product is no longer available.
The Industrial Wastewater Resources segment of our business recognized revenues in the amount of
$308,000 in the nine month period ended September 30, 2011. This segment had no revenues in 2010,
as it was in the start up phase of operations.
Our TerraSphere segment reported no revenues for the nine month period ended September 30, 2011.
TerraSphere continues to seek opportunities whereby it will generate license revenues from new
licensees, generate equipment revenues from current licensees, and is also seeking financing to
complete a production facility in Rhode Island, whereby we would generate revenues from the sale of
produce. We do not expect to generate revenues from TerraSphere in 2011. Due to less than
expected revenues from our TerraSphere segment, mainly due to our inability and the
various licensees to obtain financing for the projects, we have taken an impairment charge as of
June 30, 2011 related to certain TerraSphere intangible assets. The impairment charge is more fully
explained in the restatement of financial statements footnote included in our financial statements
and in the introduction to item 2 of this report.
Cost of Goods Sold
For the nine month period ended September 30, 2011, we had cost of goods of approximately
$1,974,000 compared to $2,021,000 for the same period in 2010. The decrease in cost of goods sold
of approximately $47,000 is detailed below.
Cost of goods sold related to fertilizer at the Gonzales facility was approximately $1,492,000 for
the nine months ended September 30, 2011, leaving an operating margin of $724,000 or 33%, compared
to cost of goods of $1,883,000 for the same period in 2010 and an operating margin of
52
25%. This
favorable variance is due to decreased materials and production costs in the first nine months of
2011.
Cost of goods for our dry fertilizer product (produced by an outside supplier) was approximately
$375,000 for the nine months ended September 30, 2011, leaving an operating margin of negative 28%.
There was no comparable activity in 2010 as the business was in the start of operations. We do not
expect further losses in this product line as we have completed filling 2011 orders for these
customers and do not expect further sales in 2011.
Converted Organics of Mississippi, formed in January 26, 2010, had cost of goods of $138,000 during
the first nine months of 2010. In the first nine months of 2011 this entity had no revenue as the
company that we purchased the product from has filed for bankruptcy protection and the product is
no longer available.
Cost of
goods for our IWR segment was $106,000 for the nine months ended September 30, 2011
resulting in an operating margin of 42%.
General and Administrative Expenses
General and administrative expenses for the nine month period ended September 30, 2011 were
approximately $7.5 million compared to approximately $10.4 million for the same period in 2010. The
decrease of approximately $2.9 million is primarily comprised of an increase in the expenses
related to operating our TerraSphere segment of $1.4 million offset by decreases in marketing costs
of $750,000, consulting expenses of $1,700,000, professional fees of $1,400,000 associated with
2010 acquisition activities and results of various cost savings activities of $450,000.
Loss on Impairment
At June 30, 2011 we recorded a charge of $2.1 million to reflect the impairment of the goodwill
recorded when we acquired TerraSphere in November, 2010. We determined that the operating results
for its vertical farming business, which is comprised principally of TerraSphere, together with
revised projections of the near term operating results, required that the long-lived assets
(principally patents subject to amortization) and goodwill of TerraSphere be tested for impairment.
We performed those impairment tests using projections that had been revised to reflect the
difficulties both we and our licensees have experienced in securing the financing needed to
construct TerraSphere facilities. In revising our projections from those used when we acquired
TerraSphere in November, 2010, we revised until later dates the projected sale of additional
licenses, and we also postponed until later years the projected dates at which licensees would
complete the construction and commence commercial operations. We projected that we would first
complete and begin to commercially operate a company owned facility, and we projected that the
existence of a facility that was then operating commercially would assist licensees in obtaining
financing for their facilities and also facilitate our sale of additional licenses. In order to
complete this company owned facility, we will need to obtain new financing, and there is no
assurance that we will be successful in obtaining such financing. The projected undiscounted cash
flows for TerraSphere over the remaining life of its patents exceeded the carrying amount of its
long-lived assets, and therefore no impairment of long lived assets was recorded. However, the
fair value of TerraSpheres goodwill at June 30, 2011, calculated on the basis of discounted cash
flows, is less than the carrying amount of TerraSpheres goodwill, and therefore we recorded the
goodwill impairment charge.
Interest Expense
Interest
expense for the nine months ended September 30, 2011 was approximately $7.3 million
compared to approximately $15,000 for the same period in 2010. This increase of approximately $7.3
million is associated with the amortization of debt discounts related to our convertible notes and
is a non-cash item.
Other Income
Other Income, comprised primarily of gain on the value of obligations to issue shares for the nine
months ended September 30, 2011 was approximately $1.3 million compared to $0 for the same period in
2010. This increase of approximately $1.3 million of other income is directly associated with the
current market valuation of the liability associated with milestone payments due under the
TerraSphere acquisition, caused by the decline in our stock price during the period, and is a
non-cash item.
53
Derivative Gain (Loss)
For the nine months ended September 30, 2011, we had a derivative gain of approximately $6.9
million compared to a derivative gain of approximately $1.1 million for the same period in 2010.
This is a non-cash gain and is related to the valuation of certain derivative features included in
certain of our warrants and convertible debt obligations, and included in an anti-dilution
provision related to shares issued in the TerraSphere acquisition. The major factor creating the
gain on these derivative features is the decrease in our stock price during the period. In
addition, certain derivative instruments were issued and settled during the quarter, which impacted
the derivative gain.
Results of Discontinued Operations
In 2010, the Company discontinued operations at its facility in Woodbridge, New Jersey. The
following table summarizes the components of the income (loss) from discontinued operations:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Three Months |
|
|
For the Nine Months |
|
|
|
Ended September 30, |
|
|
Ended September 30, |
|
|
|
2011 |
|
|
2010 |
|
|
2011 |
|
|
2010 |
|
Revenue from
discontinued
operations |
|
$ |
|
|
|
$ |
105,714 |
|
|
$ |
|
|
|
$ |
834,089 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) from
discontinued
operations |
|
$ |
49,447 |
|
|
$ |
(18,685,007 |
) |
|
$ |
195,918 |
|
|
$ |
(22,711,406 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
54
The Company recognized income from discontinued operations for the three and nine month periods
ended September 30, 2011 as a result of favorable settlements with certain of its creditors. The
Company does not expect to have any continuing positive cash flows from operations associated with
the Woodbridge facility.
The following table provides the assets and liabilities of the Woodbridge facility, classified as
discontinued operations, in the consolidated balance sheets dated September 30, 2011 and December
31, 2010:
|
|
|
|
|
|
|
|
|
|
|
September 30, |
|
|
December 31, |
|
|
|
2011 |
|
|
2010 |
|
Accounts receivable, net |
|
$ |
|
|
|
$ |
14,500 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Assets of discontinued operations |
|
$ |
|
|
|
$ |
14,500 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accounts payable |
|
$ |
535,645 |
|
|
$ |
837,606 |
|
Accrued expenses |
|
|
|
|
|
|
1,571,874 |
|
Other liabilities |
|
|
28,773 |
|
|
|
28,773 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities of discontinued operations |
|
$ |
564,418 |
|
|
$ |
2,438,253 |
|
|
|
|
|
|
|
|
On January 25, 2011, the Company paid cash of $150,000 and issued 320,000 shares of Company
common stock with a fair value of $1,344,000 in payment for consulting services accrued at December
31, 2010 related to the settlement of certain Woodbridge obligations. The Company is actively
working with its creditors to settle the remaining liabilities outstanding at September 30, 2011.
Critical Accounting policies
The following is a brief discussion of our critical accounting policies and methods, and the
judgments and estimates used by us in their application:
55
Revenue Recognition
Revenue is recognized when (i) persuasive evidence of a sales arrangement exists, (ii) delivery of
the product or service has occurred, (iii) the sales price is fixed or determinable, and (iv)
collectability is reasonably assured.
The Companys organic fertilizer operation generates revenues from two sources: product sales and
tip fees. Product sales revenue comes from the sale of fertilizer products. Tip fee revenue is
derived from waste haulers who pay the Company tip fees for accepting food waste generated by
food distributors such as grocery stores, produce docks and fish markets, food processors and
hospitality venues such as hotels, restaurants, convention centers and airports.
The IWWR operation will generate revenue by setting up treatment systems on customers sites and
processing their wastewater on a price-per-gallon basis.
The Companys vertical farming operation derives its revenues from licensing fees, and in the
future expects to also derive revenues from license royalties, the sale of equipment and sales from
the operation of the Companys own growing facilities using the Companys patented technology.
The Company grants exclusive licenses to use the vertical farming Growth System for the remaining
term of the associated patents. The licenses provide for (i) the payment of an initial license fee
in installments over periods ranging from nine months to one year, and (ii) the payment of
continuing royalties based on a percentage of the licensees sales, subject to an annual minimum.
The licenses are generally not transferable without the permission of the Company.
In order to grow plants using the technology granted by the license, the licensee will also be
required to purchase equipment which incorporates the growth system, either from the Company or from a
manufacturer licensed or contracted by the Company.
The licenses are therefore part of a multi-element arrangement, for which revenue cannot be
recognized until the delivered elements have stand alone value. The Company has determined that
the elements delivered under these arrangements will have stand alone value at such time as the
licensee has received both the license and the equipment, or the license and the Companys
permission to resell the license.
License fees received in cash or recorded as a receivable prior to the time the delivered
elements have stand alone value are deferred as deferred revenue.
In addition, receivables due in some of the installments under the licenses which are not deemed to not be
reasonably assured of collection when the license was initially granted are recorded as an asset offset by a valuation allowance. When payments of
such installments are received the related revenue is deferred if the elements delivered under that
license do not yet have stand alone value.
56
Share-Based Compensation
We account for equity instruments exchanged for services in accordance with Financial Accounting
Standards Board (FASB) Accounting Standards Codification (ASC) 718 Compensation Stock
Compensation (ASC 718) regarding share-based compensation. Under the provisions of ASC 718,
share-based compensation issued to employees is measured at the grant date, based on the fair value
of the award, and is recognized as an expense over the requisite service period (generally the
vesting period of the grant). Share-based compensation issued to non-employees is measured at the grant
date, based on the fair value of the consideration received or the fair value of the equity
instruments issued, whichever is more readily measurable, and is recognized as an expense over the
requisite service period.
Long-Lived Assets
We account for our long-lived assets
(excluding goodwill and intangible assets) in accordance with ASC 360 Property,
Plant and Equipment (ASC 360), which requires that long-lived assets be reviewed for impairment
annually and whenever events or changes in circumstances indicate that the carrying amount may not
be recoverable, such as technological changes or significantly increased competition. If
undiscounted expected future cash flows are less than the carrying value of the assets, an
impairment loss is to be recognized based on the fair value of the assets, calculated using an
undiscounted cash flow model. There is inherent subjectivity and judgments involved in cash flow
analyses such as estimating revenue and cost growth rates, residual or terminal values and discount
rates, which can have a significant impact on the amount of any impairment.
Goodwill
We evaluate the carrying value of goodwill during the fourth quarter of each year and when events
occur or circumstances change that would more likely than not reduce the fair value of the
reporting unit below its carrying amount. Such circumstances could include, but are not limited to
(1) a significant adverse change in legal factors or in business climate, (2) unanticipated
competition, or (3) an adverse action or assessment by a regulator. When evaluating whether
goodwill is impaired, we compare the fair value of the reporting unit to which the goodwill is
assigned to the reporting units carrying amount, including goodwill. The fair value of the
reporting unit is estimated using a combination of the income, or discounted cash flows, approach
and the market approach, which utilizes comparable companies data. If the carrying amount of a
reporting unit exceeds its fair value, then the amount of the impairment loss must be measured. The
impairment loss would be calculated by comparing the implied fair value of reporting unit goodwill
to its carrying amount. In calculating the implied fair value of reporting unit goodwill, the fair
value of the reporting unit is allocated to all of the other assets and liabilities of that unit
based on their fair values. The excess of the fair value of a reporting unit over the amount
assigned to its other assets and liabilities is the implied fair value of goodwill. An impairment
loss would be recognized when the carrying amount of goodwill exceeds its
implied fair value. At June 30, 2011 we performed an impairment test and determined that a charge
of $2.1 million was required. See the discussion in the results of operations section.
57
Intangible Assets
We account for intangible assets in accordance with ASC 350 Intangibles Goodwill and Other (ASC
350), which requires that intangible assets with finite lives, such as our license and patents, be
capitalized and amortized over their respective estimated lives and reviewed for impairment
whenever events or other changes in circumstances indicate that the carrying amount may not be
recoverable. Intangible assets deemed to have indefinite lives are not amortized and are subject to
impairment testing annually or whenever events or other changes in circumstances indicate that the
carrying amount may not be recoverable. This testing compares carrying values to fair values and
when appropriate, the carrying value of these assets is reduced to fair value.
Derivative Instruments
We account for derivative instruments in accordance with ASC 815 Derivatives and Hedging (ASC
815), which establishes accounting and reporting standards for derivative instruments and hedging
activities, including certain derivative instruments embedded in other financial instruments or
contracts and requires recognition of all derivatives on the balance sheet at fair value.
Accounting for changes in the fair value of derivative instruments depends on whether the
derivatives qualify as hedge relationships and the types of relationships designated are based on
the exposures hedged. At September 30, 2011 and December 31, 2010, we did not have any derivative
instruments that were designated as hedges.
Discontinued Operations
We discontinued the operations of our Woodbridge facility during the third quarter of 2010. Assets
and liabilities related to the Woodbridge facility have been classified as discontinued operations
on the consolidated balance sheets at September 30, 2011 and December 31, 2010, and its operations have
been classified as loss from discontinued operations on the consolidated statements of operations
and comprehensive loss for the periods ended September 30, 2011 and 2010.
Fair Value Measurements
Fair value is a market-based measurement, not an entity-specific measurement. Therefore, a fair
value measurement should be determined based on the assumptions that market participants would use
in pricing the asset or liability. As a basis for considering market participant assumptions in
fair value measurements, ASC 820 Fair Value Measurements and Disclosure (ASC 820) establishes a
fair value hierarchy that distinguishes between market participant assumptions based on market data
obtained from sources independent of the reporting entity (observable inputs that are classified
within Levels 1 and 2 of the hierarchy) and the reporting entitys own assumptions about market
participant assumptions (unobservable inputs classified within Level 3 of the hierarchy):
|
|
|
Level 1 inputs utilize quoted prices (unadjusted) in active markets
for identical assets or liabilities that we have the ability to
access. |
|
|
|
|
Level 2 inputs are inputs other than quoted prices included in Level 1
that are observable for the asset or liability, either directly or
indirectly. Level 2 inputs may include quoted prices for similar
assets and liabilities in active markets, as well as inputs that are |
58
|
|
|
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. |
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Level 3 inputs are unobservable inputs for the asset or liability
which are typically based on an entitys own assumptions, as there is
little, if any, related market activity. |
In instances where the determination of the fair value measurement is based on inputs from
different levels of the fair value hierarchy, the level in the fair value hierarchy within which
the entire fair value measurement falls is based on the lowest level input that is significant to
the fair value measurement in its entirety. Our assessment of the significance of a particular
input to the fair value measurement in its entirety requires judgment, and considers factors
specific to the asset or liability.
Income Taxes
We consider the valuation allowance for deferred tax assets to be a significant accounting
estimate. In applying ASC 740 Income Taxes, management estimates future taxable income from
operations and tax planning strategies in determining if it is more likely than not that we will
realize the benefits of our deferred tax assets. Management believes the Company does not have any
uncertain tax positions.
Off-Balance Sheet Transactions
We do not engage in material off-balance sheet transactions.
59
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Not applicable.
60
Item 4. Controls and Procedures
Our management is responsible for establishing and maintaining adequate internal
control over financial reporting (as defined in Exchange Act Rule 13a-15(f)). Under the
supervision and with the participation of our management, including our Chief Executive
Officer and Chief Financial Officer, we conducted an evaluation of our internal control
over financial reporting as of December 31, 2010, based on the framework in Internal
Control Integrated Framework issued by the Committee of Sponsoring Organizations
(COSO) of the Treadway Commission.
Because of its inherent limitations, internal control over financial reporting may not
prevent or detect misstatements. Therefore, even those systems determined to be
effective can provide only reasonable assurance with respect to financial statement
preparation and presentation.
A material weakness in internal control over financial reporting is a deficiency, or
combination of deficiencies, in internal control, such that there is a reasonable possibility
that a material misstatement of the Companys financial statements will not be prevented, or
detected and corrected on a timely basis. A significant deficiency is a deficiency, or a
combination of deficiencies, in internal control over financial reporting that is less severe
than a material weakness, yet important enough to merit attention by those responsible
for oversight of the Companys financial reporting.
At the time that the Company originally filed its Annual Report on Form 10-K for
the year ended December 31, 2010 and Quarterly Report on Form 10-Q for the period
ended June 30, 2011, based upon the evaluation described above, our Chief Executive
Officer and Chief Financial Officer concluded that under the framework in Internal
ControlIntegrated Framework, our internal control over financial reporting was
effective as of December 31, 2010 and June 30, 2011.
However,
in connection with the restatement of the Companys December 31, 2010 and June 30,
2011 financial statements, our Chief Executive Officer and Chief Financial Officer
reassessed that conclusion in light of the restatement of the aforementioned
financial statements, and concluded that there existed a material weakness in our internal
controls over financial reporting as of December 31, 2010 and June 30, 2011. That
material weakness identified pertains to a lack of appropriate
technical resources engaged by the
Company to evaluate the proper accounting for non-routine and complex accounting and
financial reposting issues. The Company has taken steps to augment the technical
resources available to it.
The managements assessment of internal controls over financial reporting was not
subject to auditor attestation as of December 31, 2010 pursuant to the
rules of the Securities and Exchange Commission. Accordingly, the Annual Report on
Form 10-K does not include an attestation report by our independent registered public
accounting firm regarding internal control over financial reporting.
There
were no changes in our internal control over financial reporting
during the three months ended September 30, 2011 that have materially
affected, or a 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 likelyhood 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.
61
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 was denied on November 22, 2010. On March 3, 2011, the
court denied our motion for partial summary judgment. On March 25, 2011, some individual investors
filed a new complaint against us asserting similar claims to those in the Leeseberg litigation. The
Court consolidated this case with the existing lawsuit and, on May 12, 2011, Plaintiffs filed an
Amended Complaint. On June 6, 2011, we filed our answers to the consolidated complaint and counter
claims against plaintiffs.
The parties have been engaged in settlement negotiations and have reached a settlement agreement.
It is anticipated that the settlement will be funded by the insurance provider and, accordingly, no loss has been recorded related to these matters.
Related to the above matter, in December 2009, we filed a complaint in the Superior Court of
Massachusetts for the County of Suffolk, captioned Converted Organics Inc. v. Holland & Knight LLP.
We claim that in the event we are required to pay any monies to Mr. Leeseberg and his proposed
class in the matter of Gerald S. Leeseberg, et al. v. Converted Organics, Inc., that Holland &
Knight should make us whole, because its handling of the registration of the securities at issue in
the Leeseberg lawsuit caused any loss that Mr. Leeseberg and other putative class members claim to
have suffered. Holland & Knight has not yet responded to the complaint. Holland and Knight has
threatened to bring counterclaims against Converted Organics for legal fees allegedly owed, which
we would contest vigorously. On May 12, 2010, the Superior Court stayed the proceedings, pending
resolution of the Leeseberg litigation. At this early stage in the case, the Company is unable to
predict the likelihood of an unfavorable outcome, or estimate any related loss.
On May 19, 2009, 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
62
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 filed a motion to
transfer the action back to the original court in Middlesex County, which was granted and sought to
have the lawsuit dismissed, which was granted in part on August 27, 2010. The Court limited the
plaintiffs claims to the events in part that occurred after the dismissal of the prior action. Plaintiffs appealed the order dismissing their
first lawsuit with prejudice, and the appellate court reversed the dismissal with prejudice but the first lawsuit still
remains dismissed without prejudice. Due to the appellate
decision, plaintiffs filed a motion to reconsider the decision made in the action, which was
granted in part on July 28, 2011. The nuisance damages issue was reopened for 60 days. At the
expiration of the 60 day period, we renewed the summary judgement motion, our motion for summary
judgement was granted on November 4, 2011 and the only claim that remains before the court is the
plantiffs right to make an application for legal fees.
We plan to vigorously defend this matter and are unable to
estimate any losses that may be incurred as a result of this litigation and upon its eventual
disposition. Accordingly, no loss has been recorded related to this matter.
On August 25, 2011, TerraSphere, Inc, our wholly owned subsidiary, was named as a defendant in an action filed in the
United States district court for the eastern district of Michigan against TerraSphere Systems, LLC and TerraSphere, Inc.
The plantiff, alleges, among other things breach of fiduciary responsibilities regarding a joint venture agreement.
The parties have agreed to an extension until November 30, 2011 to try and resolve the matter. In the event that the lawsuit
cant be resolved we plan to vigorously defend this matter.
At this time we are unable to estimate any losses that may be
incurred as a result of this litigation and upon its eventual disposition. Accordingly, no loss has been recorded relating
to this matter.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
None.
Item 3. Defaults upon Senior Securities
None.
Item 4. [Removed and Reserved]
Item 5. Other Information.
Effective November 8, 2011, our previously approved implementation of a
1-for-10 reverse split of our common stock became effective . On such date, every ten shares of pre-split common stock was
automatically converted into one share of post-split common stock. The reverse split affects all issued and outstanding shares immediately
prior to the effective date of the reverse split.
63
Item 6. Exhibits
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Exhibit |
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No. |
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Description of Exhibit |
31.1
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Certification of Chief Executive Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 2002 |
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31.2
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Certification of Chief Financial Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 2002 |
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32.1
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Certification of Chief Executive Officer pursuant to Section 906 |
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32.2
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Certification of Chief Financial Officer pursuant to Section 906 |
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101.INS
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XBRL Instance Document |
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101.SCH
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XBRL Taxonomy Extension Schema Document |
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101.CAL
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XBRL Taxonomy Extension Calculation Linkbase Document |
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101.LAB
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XBRL Taxonomy Extension Label Linkbase Document |
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101.PRE
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XBRL Taxonomy Extension Presentation Linkbase Document |
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101.DEF
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XBRL Taxonomy Extension Definition Linkbase Document |
64
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused
this report to be signed on its behalf by the undersigned, thereunto duly authorized.
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Converted Organics Inc.
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Date: November 14, 2011 |
/s/ Edward J. Gildea
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Edward J. Gildea |
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President and Chief Executive
Officer, Principal Executive Officer |
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Date: November 14, 2011 |
/s/ David R. Allen
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David R. Allen |
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Chief Financial Officer and Executive
Vice President of Administration and
Principal Accounting Officer |
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65