e10vq
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
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þ |
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Quarterly Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 |
For the quarterly period ended September 30, 2010
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o |
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Transition Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 |
For
the transition period from _______________ to _______________
Commission file number: 001-33304
Converted Organics Inc.
(Exact name of registrant as specified in its charter)
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Delaware
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20-4075963 |
(State or other jurisdiction of incorporation or organization)
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(I.R.S. Employer Identification No.) |
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 o NO o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a
non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated
filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act.
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Large accelerated filer o
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Accelerated filer o
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Non-accelerated filer o
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Smaller reporting company þ |
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(Do not check if a smaller reporting company) |
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Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the
Exchange Act). YES o NO þ
Indicate the number of shares outstanding of each of the issuers classes of common stock, as of
the latest practicable date: As of November 15, 2010, there were 56,721,249 shares of our common
stock outstanding.
Item 1. Financial Statements
CONVERTED ORGANICS INC.
CONSOLIDATED BALANCE SHEETS
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September 30, 2010 |
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(Unaudited) |
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December 31, 2009 |
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ASSETS
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CURRENT ASSETS |
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Cash |
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$ |
483,068 |
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$ |
10,708,807 |
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Restricted cash |
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613,295 |
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613,162 |
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Accounts receivable, net |
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414,824 |
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80,911 |
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Inventories |
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110,915 |
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176,351 |
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Other prepaid expenses |
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53,406 |
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73,194 |
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Assets of discontinued operations |
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2,598,230 |
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962,075 |
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Total current assets |
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4,273,738 |
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12,614,500 |
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Deposits |
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336,357 |
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336,357 |
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Other assets |
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500,000 |
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Property and equipment, net |
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676,260 |
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691,694 |
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Construction-in-progress |
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357,118 |
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311,015 |
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Intangible assets, net |
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1,779,613 |
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1,995,619 |
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Non-current assets of discontinued operations |
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1,271,158 |
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19,193,886 |
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Total assets |
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$ |
9,194,244 |
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$ |
35,143,071 |
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LIABILITIES AND SHAREHOLDERS EQUITY (DEFICIT)
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CURRENT LIABILITIES |
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Accounts payable |
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$ |
1,294,798 |
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$ |
552,057 |
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Accrued compensation, officers, directors and consultants |
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513,745 |
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697,602 |
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Accrued legal and other expenses |
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216,914 |
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136,153 |
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Accrued interest |
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9,448 |
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Convertible note payable |
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355,164 |
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Liabilities of discontinued operations |
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6,047,844 |
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4,475,303 |
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Total current liabilities |
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8,073,301 |
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6,225,727 |
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Derivative liabilities |
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1,434,127 |
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1,626,742 |
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Convertible note payable, net of current portion |
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17,767 |
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Non-current liabilities of discontinued operations |
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17,531,311 |
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18,501,081 |
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Total liabilities |
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27,038,739 |
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26,371,317 |
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COMMITMENTS AND CONTINGENCIES |
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SHAREHOLDERS EQUITY (DEFICIT) |
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Preferred stock, $.0001 par value, authorized
10,000,000 shares; no shares issued and outstanding |
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Common stock, $.0001 par value, authorized 250,000,000 shares
at September 30, 2010 and 75,000,000 shares at December 31, 2009 |
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4,414 |
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3,777 |
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Additional paid-in capital |
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63,662,679 |
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58,660,042 |
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Accumulated deficit |
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(81,511,588 |
) |
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(49,892,065 |
) |
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Total shareholders equity (deficit) |
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(17,844,495 |
) |
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8,771,754 |
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Total liabilities and shareholders equity (deficit) |
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$ |
9,194,244 |
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$ |
35,143,071 |
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The accompanying notes are an integral part of these consolidated financial statements.
3
CONVERTED ORGANICS INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
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Three month periods ended |
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Nine month periods ended |
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September 30, 2010 |
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September 30, 2009 |
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September 30, 2010 |
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September 30, 2009 |
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Revenues |
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$ |
808,582 |
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$ |
694,123 |
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$ |
2,765,641 |
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$ |
1,801,046 |
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Cost of goods sold |
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583,703 |
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608,882 |
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2,020,752 |
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1,773,785 |
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Gross income |
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224,879 |
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85,241 |
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744,889 |
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27,261 |
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Operating expenses |
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General and administrative expenses |
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4,011,974 |
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1,514,739 |
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10,413,049 |
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5,061,205 |
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Research and development |
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35,000 |
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87,500 |
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176,650 |
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267,000 |
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Amortization of capitalized costs |
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72,001 |
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72,002 |
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216,006 |
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228,709 |
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4,118,975 |
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1,674,241 |
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10,805,705 |
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5,556,914 |
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Loss from continuing operations |
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(3,894,096 |
) |
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(1,589,000 |
) |
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(10,060,816 |
) |
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(5,529,653 |
) |
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Other income/(expenses) |
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Other income |
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7,339 |
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7,871 |
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21,785 |
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Derivative gain/(loss) |
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661,982 |
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(241,448 |
) |
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1,160,711 |
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4,056,997 |
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Interest expense |
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(4,627 |
) |
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(726,227 |
) |
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(15,883 |
) |
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(4,029,446 |
) |
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664,694 |
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(967,675 |
) |
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1,152,699 |
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49,336 |
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Loss from continuing operations before
provision for income taxes |
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(3,229,402 |
) |
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(2,556,675 |
) |
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(8,908,117 |
) |
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(5,480,317 |
) |
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Provision for income taxes |
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Net loss from continuing operations |
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(3,229,402 |
) |
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(2,556,675 |
) |
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(8,908,117 |
) |
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(5,480,317 |
) |
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Loss from discontinued operations |
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(18,685,007 |
) |
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(2,253,613 |
) |
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(22,711,406 |
) |
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(6,443,121 |
) |
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Net loss |
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$ |
(21,914,409 |
) |
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$ |
(4,810,288 |
) |
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$ |
(31,619,523 |
) |
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$ |
(11,923,438 |
) |
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Net loss per share, basic and diluted |
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Continuing operations |
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$ |
(0.07 |
) |
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$ |
(0.13 |
) |
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$ |
(0.22 |
) |
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$ |
(0.37 |
) |
Discontinued operations |
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(0.43 |
) |
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(0.11 |
) |
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(0.56 |
) |
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(0.44 |
) |
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$ |
(0.50 |
) |
|
$ |
(0.24 |
) |
|
$ |
(0.78 |
) |
|
$ |
(0.81 |
) |
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Weighted average common shares outstanding |
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43,187,437 |
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20,065,306 |
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40,354,562 |
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14,708,633 |
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The accompanying notes are an integral part of these consolidated financial statements.
4
CONVERTED ORGANICS INC.
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS EQUITY (DEFICIT)
FOR THE NINE MONTH PERIOD ENDED SEPTEMBER 30, 2010
(UNAUDITED)
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Common Stock |
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Total |
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Shares Issued and |
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Additional |
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Accumulated |
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Owners Equity |
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Outstanding |
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Amount |
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Paid-in Capital |
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Deficit |
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(Deficit) |
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Balance, December 31, 2009 |
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37,774,208 |
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$ |
3,777 |
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$ |
58,660,042 |
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$ |
(49,892,065 |
) |
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$ |
8,771,754 |
|
Stock options |
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|
1,305,812 |
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1,305,812 |
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Common stock issued upon conversion of
convertible notes payable and accrued
interest |
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|
645,500 |
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|
65 |
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|
413,894 |
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|
413,959 |
|
Common stock issued as compensation |
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|
485,830 |
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49 |
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|
349,590 |
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|
349,639 |
|
Issuance of common stock and warrants, net of
fair value of derivatives issued of $968,096 |
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2,400,000 |
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240 |
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1,398,024 |
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|
1,398,264 |
|
Issuance of common stock and warrants as
payment of accounts payable |
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|
2,780,740 |
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|
278 |
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|
1,501,322 |
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|
1,501,600 |
|
Common stock issued upon exercise of
employee stock options |
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|
50,000 |
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|
5 |
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|
33,995 |
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|
34,000 |
|
Net loss |
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|
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|
|
|
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(31,619,523 |
) |
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(31,619,523 |
) |
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Balance, September 30, 2010 |
|
|
44,136,278 |
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|
$ |
4,414 |
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|
$ |
63,662,679 |
|
|
$ |
(81,511,588 |
) |
|
$ |
(17,844,495 |
) |
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The accompanying notes are an integral part of these consolidated financial statements.
5
CONVERTED ORGANICS INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
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Nine month periods ended |
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|
September 30, 2010 |
|
|
September 30, 2009 |
|
CASH FLOWS FROM OPERATING ACTIVITIES: |
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Net loss |
|
$ |
(31,619,523 |
) |
|
$ |
(11,923,438 |
) |
Adjustments to reconcile net loss to net cash
used in operating activities: |
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Deconsolidation of variable interest entity |
|
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|
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|
|
(596,170 |
) |
Amortization of intangible assets license |
|
|
25,645 |
|
|
|
12,375 |
|
Amortization of capitalized bond costs |
|
|
35,751 |
|
|
|
35,752 |
|
Amortization of deferred financing fees |
|
|
|
|
|
|
22,042 |
|
Amortization of intangible assets |
|
|
190,361 |
|
|
|
206,667 |
|
Depreciation of fixed assets |
|
|
1,394,249 |
|
|
|
1,559,960 |
|
Beneficial conversion feature |
|
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|
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|
230,492 |
|
Amortization of discounts attributable to warrants on private financing |
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|
1,458,647 |
|
Non-cash interest expense private financing |
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|
1,245,186 |
|
Common stock issued for extension of convertible note payable |
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|
562,000 |
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Common stock issued as compensation |
|
|
349,639 |
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|
120,313 |
|
Stock option compensation expense |
|
|
1,305,812 |
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|
190,022 |
|
Warrants issued in connection with private financing and equity transactions |
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|
|
662,479 |
|
Loss on impairment of long-term assets |
|
|
15,430,685 |
|
|
|
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|
Derivative gain |
|
|
(1,160,711 |
) |
|
|
(4,056,997 |
) |
Changes in operating assets and liabilities: |
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|
|
|
|
|
|
(Increase) decrease in: |
|
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|
|
|
|
|
|
Accounts receivable |
|
|
(567,244 |
) |
|
|
(61,659 |
) |
Inventories |
|
|
337,833 |
|
|
|
(174,554 |
) |
Prepaid expenses and other current assets |
|
|
(129,024 |
) |
|
|
(217,605 |
) |
Other assets |
|
|
|
|
|
|
94,250 |
|
Deposits |
|
|
(48,240 |
) |
|
|
165,122 |
|
Increase (decrease) in: |
|
|
|
|
|
|
|
|
Accounts payable and other accrued expenses |
|
|
4,217,011 |
|
|
|
3,157,897 |
|
Accrued compensation officers, directors and consultants |
|
|
(255,311 |
) |
|
|
(86,802 |
) |
Accrued interest |
|
|
362,658 |
|
|
|
(181,018 |
) |
Other |
|
|
|
|
|
|
(53,955 |
) |
|
|
|
|
|
|
|
Net cash used in operating activities |
|
|
(10,130,409 |
) |
|
|
(7,628,994 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
CASH FLOWS FROM INVESTING ACTIVITIES: |
|
|
|
|
|
|
|
|
Purchase of fixed assets |
|
|
(400,827 |
) |
|
|
(3,623,823 |
) |
Release of restricted cash |
|
|
|
|
|
|
2,578,338 |
|
Construction costs |
|
|
(46,103 |
) |
|
|
(54,081 |
) |
Other assets |
|
|
(500,000 |
) |
|
|
|
|
|
|
|
|
|
|
|
Net cash used in investing activities |
|
|
(946,930 |
) |
|
|
(1,099,566 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
CASH FLOWS FROM FINANCING ACTIVITIES: |
|
|
|
|
|
|
|
|
Repayment of term notes |
|
|
(1,540,009 |
) |
|
|
(243,956 |
) |
Repayment of capital lease obligations |
|
|
(8,751 |
) |
|
|
(9,614 |
) |
Members contributions |
|
|
|
|
|
|
230,983 |
|
Members distributions |
|
|
|
|
|
|
(201,630 |
) |
Net proceeds from exercise of options |
|
|
34,000 |
|
|
|
|
|
Net proceeds from stock offering |
|
|
2,366,360 |
|
|
|
3,806,272 |
|
Net proceeds from exercise of warrants |
|
|
|
|
|
|
1,965,000 |
|
Net proceeds from nonconvertible short-term note |
|
|
|
|
|
|
1,182,500 |
|
Net proceeds from convertible short-term note |
|
|
|
|
|
|
1,400,000 |
|
Repayment of nonconvertible short-term note |
|
|
|
|
|
|
(1,330,313 |
) |
Repayment of mortgage payable |
|
|
|
|
|
|
(943 |
) |
|
|
|
|
|
|
|
Net cash provided by financing activities |
|
|
851,600 |
|
|
|
6,798,299 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
NET DECREASE IN CASH |
|
|
(10,225,739 |
) |
|
|
(1,930,261 |
) |
|
|
|
|
|
|
|
|
|
Cash, beginning of period |
|
|
10,708,807 |
|
|
|
3,357,940 |
|
|
|
|
|
|
|
|
Cash, end of period |
|
$ |
483,068 |
|
|
$ |
1,427,679 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Supplemental cash flow information: |
|
|
|
|
|
|
|
|
Cash paid during the period for: |
|
|
|
|
|
|
|
|
Interest |
|
$ |
808,679 |
|
|
$ |
1,587,253 |
|
|
|
|
|
|
|
|
|
|
Non-cash financing activities: |
|
|
|
|
|
|
|
|
Equipment acquired through assumption of capital lease |
|
$ |
|
|
|
$ |
52,979 |
|
Equipment acquired through assumption of term note |
|
|
|
|
|
|
118,250 |
|
Common stock issued upon conversion of convertible notes payable and accrued interest |
|
|
413,959 |
|
|
|
6,323,095 |
|
Fair value of derivative issued |
|
|
968,096 |
|
|
|
3,827,686 |
|
Common stock and warrants issued as payment for accounts payable |
|
|
1,501,600 |
|
|
|
|
|
Discount on warrants issued in connection with financings |
|
|
|
|
|
|
2,870,313 |
|
Members contribution of convertible note |
|
|
|
|
|
|
684,668 |
|
Conversion of accounts payable into notes payable |
|
|
|
|
|
|
2,634,039 |
|
The accompanying notes are an integral part of these consolidated financial statements.
6
CONVERTED ORGANICS INC.
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1 BASIS OF PRESENTATION AND NATURE OF OPERATIONS
The accompanying unaudited interim consolidated financial statements have been prepared in
accordance with accounting principles generally accepted in the United States of America and the
rules and regulations of the Securities and Exchange Commission (the SEC) for interim financial
reporting. Certain information and footnote disclosures normally included in the annual financial
statements of Converted Organics Inc. (the Company) have been condensed or omitted. In the
Companys opinion, the unaudited interim consolidated financial statements and accompanying notes
reflect all adjustments, consisting of normal and recurring adjustments, that are necessary for a
fair presentation of its financial position and operating results as of and for the three and nine
month interim periods ended September 30, 2010 and 2009.
The results of operations for the interim periods are not necessarily indicative of the
results to be expected for the entire year. This Form 10-Q should be read in conjunction with the
audited consolidated financial statements and notes thereto included in the Companys Form 10-K as
of and for the year ended December 31, 2009.
NATURE OF OPERATIONS
Converted Organics Inc. uses food and other waste as a raw material to manufacture, sell and
distribute all-natural fertilizer products with nutrition characteristics which have been shown to
support disease suppression. The Company generates revenues from two sources: product sales and tip
fees. Product sales revenue comes from the sale of fertilizer products. Tip fee revenue is derived
from waste haulers who pay the Company tip fees for accepting food waste generated by food
distributors such as grocery stores, produce docks and fish markets, food processors and
hospitality venues such as hotels, restaurants, convention centers and airports.
Converted Organics of California, LLC, a California limited liability company and wholly-owned
subsidiary of the Company, which operates the Companys facility in Gonzales, California (the
Gonzales facility) was formed when the Company acquired the assets of United Organics Products,
LLC (UOP) and Waste Recovery Industries, LLC (WRI). The Gonzales facility produces
approximately 25 tons of organic fertilizer per day, which is sold primarily to the California
agricultural market. The Gonzales facility employs a proprietary method called High Temperature
Liquid Composting (HTLC). The Gonzales facility has been upgraded to enable it to accept larger
amounts of food waste from waste haulers and may be further upgraded, depending on demand, to have
the capability to produce a dry product in addition to the current liquid fertilizer it produces.
Converted Organics of Woodbridge, LLC, is a New Jersey limited liability company and
wholly-owned subsidiary of the Company, which was formed for the purpose of owning, constructing
and operating the Companys facility in Woodbridge, New Jersey (the Woodbridge facility). The
Woodbridge facility was designed to service the New York-Northern New Jersey metropolitan area. On
July 30, 2010, the Company temporarily halted production at its Woodbridge facility in order to
undertake steps to lower its cost structure at the Woodbridge facility. Specifically the Company
attempted to negotiate more favorable terms under its operating lease and to lower certain utility
costs. The Company was unable to lower such costs and therefore, management determined
that the Company could not sustain the negative cash flow from the Woodbridge facility and
discontinued operations at the Woodbridge plant.
The Company has reported the results of operations of Converted Organics of Woodbridge, LLC as
discontinued operations for the three and nine month periods ended September 30, 2010 and 2009
within the consolidated financial statements (See Note 4).
Converted Organics of Rhode Island, LLC, a Rhode Island limited liability company and
subsidiary of the Company, was formed in July 2008 for the purpose of developing a facility at the
Rhode Island central landfill. Converted Organics of Rhode Island, LLC has not had any activity
since its formation. On February 25, 2010, the Company signed a letter of intent with the owners
of the non-controlling interest in Converted Organics of Rhode Island, LLC to sell substantially
all of its assets and a limited select amount of liabilities, and assign the Companys lease with
the Rhode Island Resource Recovery Corporation (RIRRC).
On January 26, 2010, the Company formed Converted Organics of Mississippi, LLC, a Mississippi
limited liability company and a wholly-owned subsidiary of the Company, for the purpose of hiring a
sales force and adding a poultry litter-based fertilizer product to the Companys existing product
lines. The Company outsources production of this product.
On February 25, 2010, the Company signed a memorandum of understanding with MassOrganics I,
under which MassOrganics I would operate the new manufacturing facility to be constructed at the
Sutton Commerce Park in Sutton, Massachusetts. MassOrganics I has agreed to enter into a license
agreement under which MassOrganics I will pay a licensing fee to the Company.
7
CONVERTED ORGANICS INC.
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS CONTINUED
(UNAUDITED)
NOTE 1 BASIS OF PRESENTATION AND NATURE OF OPERATIONS
NATURE OF OPERATIONS (Continued)
On May 20, 2010, the Company formed TerraSphere Inc., a Delaware corporation and a
wholly-owned subsidiary of the Company, for the purpose of acquiring TerraSphere Systems LLC.
On July 6, 2010, a membership interest purchase agreement was entered into by TerraSphere,
Inc., TerraSphere Systems LLC (TerraSphere) and the members of TerraSphere, pursuant to which the
Company agreed to acquire 100% of the membership interests of TerraSphere. Pursuant to the purchase agreement, which was approved by the Companys stockholders at a
special meeting held on September 16, 2010, the Company could issue up to 34,166,667 shares of its
common stock to the members of TerraSphere in exchange for 100% of the membership interest of
TerraSphere, subject to certain anti-dilution adjustments. On November 12, 2010, the Company
acquired 95% of the membership interest of TerraSphere. Pursuant to
the purchase agreement, 18,174,603 shares were issued at the closing and the remainder of the shares will be issued if
TerraSphere achieves certain milestones (See Note 12). TerraSphere designs, builds and operates
highly efficient and scalable systems, featuring a patented, proprietary technology that utilizes
vertically-stacked modules to house rows of plants, which are then placed perpendicular to an
interior light source to grow pesticide-free, organic fruits and vegetables. Due to a controlled,
indoor environment, the system generates fresh produce year-round in any location or climate
world-wide.
Mr. Edward
J. Gildea, the Companys Chairman and Chief Executive Officer,
had an 8.75% membership interest in TerraSphere, and family members of
Mr. Gildea held significant units of
TerraSphere and served as officers of TerraSphere.
SEGMENTS
On March 23, 2010, the Company entered into a loan and license agreement with Heartland
Technology Partners, LLC (HTP). In consideration for entering the loan agreement, the Company
was granted an exclusive, irrevocable license to utilize HTPs patented LM-HT(TM) Concentrator
technology in the U.S. industrial wastewater (IWW) market. The IWW market involves the treatment of
waters that have been contaminated by anthropogenic industrial or commercial activities, prior to
their reuse or release into the environment. The Company has begun to develop plans to operate its
Industrial Wastewater Resources division. On July 30, 2010, the Company signed a letter of intent
with Spirit Services, Inc. to jointly develop an energy and IWW treatment facility using the
exclusively licensed technology to evaporate IWW at a facility in South Boston, Virginia. The
segment is in the developmental stage and there is no discreet financial information to report at
September 30, 2010.
RECLASSIFICATION
As a result of the Woodbridge Facility operations being discontinued during the quarter ended
September 30, 2010, the comparative periods have been reclassified to conform with the current
quarter presentation. These reclassifications have no affect on previously reported net income,
specifically, the Company has reclassified certain items as discontinued operations.
NOTE 2 MANAGEMENTS PLAN OF OPERATION
On July 30, 2010 the Company announced a 50% reduction of its work force which included
employees at the corporate level and the Woodbridge facility (the restructuring). The Company
expects those salary reductions to save approximately $2.1 million over the next twelve months.
The Company recorded restructuring charges totaling approximately $313,000 during the quarter ended
September 30, 2010 and is included in general and administrative expense on the consolidated
statements of operations. In addition on July 30, 2010, the Company temporarily halted production
at its Woodbridge facility in order to undertake steps to lower its cost structure at the
Woodbridge facility. Specifically the Company attempted to negotiate more favorable terms under
its operating lease and to lower certain utility costs. The Company
was unable to lower such costs and therefore, management determined that the Company could not sustain the negative
cash flow from the Woodbridge facility and discontinued operations at
the Woodbridge plant.
8
CONVERTED ORGANICS INC.
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS CONTINUED
(UNAUDITED)
NOTE 2 MANAGEMENTS PLAN OF OPERATION (Continued)
The Company currently has manufacturing capabilities at its Gonzales facility. The Gonzales
facility is cash flow positive and is currently producing at approximately 60% of its capacity.
The Company is focusing its current sales efforts on taking advantage of the additional production
capacity. The additional production capacity could produce approximately $175,000 of additional
positive cash flow a month. Previously, the Company estimated its negative cash flow requirements
on a monthly basis were approximately $400,000 at the corporate level. The Company estimates that
the current cost reduction efforts will lower the monthly cash flow requirements at the corporate
level to $150,000. If the Company is unable to increase sales levels at Gonzales to offset the
corporate level cash flow requirement, the Company will need to seek additional financing.
On July 6, 2010, the Company reached an agreement to acquire TerraSphere Systems LLC (Note 1).
The transaction was approved by the Companys stockholders on September 16, 2010. The closing of
the transaction acquiring 95% of TerraSphere was finalized on November 12, 2010 (See Note 12). The Company anticipates there
will be cash available to the Company from the acquired entity. Any cash acquired by the Company
would reduce amounts that otherwise need to be raised through a financing.
The Company believes the restructuring and the discontinued operations of the Woodbridge
facility and increased capacity utilization in Gonzales will allow the Company to pursue growth by
developing its industrial wastewater business and developing the recent TerraSphere acquisition.
Increasing capacity utilization at the Gonzales facility would result in additional positive cash
flow without the need to fund an expansion at the facility. The Company is focusing its current
sales efforts on taking advantage of the additional production capacity. The Company may require
additional financing until the Company achieves the desired production capacity and sales levels
and assuming it does not encounter additional costs or expenses, either unforeseen or resulting
from any proposed mergers and/or acquisitions. To date, the Company has not achieved the desired
sales levels required to offset the corporate level cash requirements. Therefore, the Company may
require additional financing prior to achieving cash flow from operations for which it has no
commitments.
On July 2, 2010, a shelf registration statement was filed on Form S-3 to register $75,000,000
of common stock, which was declared effective on July 15, 2010. There is no assurance that capital
in any form will be available to the Company, and if available, on terms and conditions that are
acceptable.
NOTE 3 NEWLY ADOPTED ACCOUNTING STANDARDS
There are no new accounting standards significantly affecting the Company in the three and
nine month periods ended September 30, 2010.
NOTE 4 DISCONTINUED OPERATIONS
On July 30, 2010, the Company temporarily halted production at its Woodbridge facility in
order to undertake steps to lower its cost structure at the Woodbridge facility. Specifically the
Company attempted to negotiate more favorable terms under its operating lease and to lower certain
utility costs. The Company was unable to lower such costs and therefore, management determined
that the Company could not sustain the negative cash flow from the Woodbridge facility and
discontinued operations at the Woodbridge plant during the third quarter ended September 30, 2010.
On October 18, 2010, the Company entered into a Termination and Surrender Agreement with the
Woodbridge facilitys landlord (Lessor) transferring all equipment, tools and fixtures owned by
the Company to the Lessor in lieu of its obligations to the Lessor (See Note 12). As a result, the
Company impaired the Woodbridge facilitys assets to reduce the carrying value to approximately
$1.5 million, which is the value expected to be received from the sale of those assets. The
consolidated statements of operations includes an impairment charge of approximately $15.4 million
for the three and nine month periods ended September 30, 2010 in loss from discontinued operations.
The following table provides the revenue and loss from the Woodbridge Facility discontinued
operations:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the three months ended |
|
|
For the nine months ended |
|
|
|
September 30, |
|
|
September 30, |
|
|
|
2010 |
|
|
2009 |
|
|
2010 |
|
|
2009 |
|
Revenue from discontinued operations |
|
$ |
105,714 |
|
|
$ |
53,123 |
|
|
$ |
834,089 |
|
|
$ |
430,403 |
|
Loss from discontinued operations |
|
$ |
(18,685,007 |
) |
|
$ |
(2,253,613 |
) |
|
$ |
(22,711,406 |
) |
|
$ |
(6,443,121 |
) |
9
CONVERTED ORGANICS INC.
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS CONTINUED
(UNAUDITED)
NOTE 4 DISCONTINUED OPERATIONS (Continued)
The Company does not expect to have any continuing cash flows from 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, 2010 and
December 31, 2009:
|
|
|
|
|
|
|
|
|
|
|
2010 |
|
|
2009 |
|
Accounts receivable |
|
$ |
293,077 |
|
|
$ |
59,746 |
|
Inventory |
|
|
|
|
|
|
272,396 |
|
Prepaid expenses |
|
|
778,610 |
|
|
|
629,933 |
|
Property and equipment |
|
|
1,526,543 |
|
|
|
17,935,216 |
|
Other assets |
|
|
1,271,158 |
|
|
|
1,258,670 |
|
|
|
|
|
|
|
|
Assets of discontinued operations |
|
$ |
3,869,388 |
|
|
$ |
20,155,961 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Term notes payable |
|
$ |
1,707,743 |
|
|
$ |
3,247,752 |
|
Accounts payable |
|
|
1,964,459 |
|
|
|
1,237,275 |
|
Accrued expenses |
|
|
2,375,129 |
|
|
|
950,782 |
|
Other liabilities |
|
|
31,824 |
|
|
|
40,575 |
|
Bonds payable |
|
|
17,500,000 |
|
|
|
17,500,000 |
|
|
|
|
|
|
|
|
Liabilities of discontinued operations |
|
$ |
23,579,155 |
|
|
$ |
22,976,384 |
|
|
|
|
|
|
|
|
On October 18, 2010, the Company entered into a series of transactions whereby assets of
discontinued operations totaling approximately $3,500,000 and liabilities of discontinued
operations totaling approximately $22,600,000 at September 30, 2010 were assigned, transferred and
or extinguished (See Note 12).
At September 30, 2010, assets of discontinued operations totaling $1,526,147 were classified
as held for sale. The assets held for sale consist of the Woodbridge facilitys property and
equipment. These assets were transferred to the Lessor on October 18, 2010 to satisfy certain
obligations (see Note 12). No gain or loss was recognized on the sale.
NOTE 5 INVENTORIES
The Companys inventories consisted of the following at September 30, 2010 and December 31,
2009:
|
|
|
|
|
|
|
|
|
|
|
2010 |
|
|
2009 |
|
Finished goods |
|
$ |
69,041 |
|
|
$ |
137,027 |
|
Raw materials |
|
|
41,874 |
|
|
|
39,324 |
|
|
|
|
|
|
|
|
Total inventories |
|
$ |
110,915 |
|
|
$ |
176,351 |
|
|
|
|
|
|
|
|
10
CONVERTED ORGANICS INC.
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS CONTINUED
(UNAUDITED)
NOTE 6 DEBT
TERM NOTES
The Company entered into a financing agreement with an equipment financing company to acquire
equipment for its Woodbridge facility. The note is for $118,250, bears an imputed interest rate of
9% and has a three year term, maturing January 2012. The outstanding balance of the equipment term
note was approximately $50,000 and $71,000 at September 30, 2010 and December 31, 2009,
respectively.
During 2009, the Company agreed to convert certain accounts payable totaling approximately
$2,634,000, related to the construction of the Woodbridge facility (the construction term notes),
into term notes ranging from 12 to 24 months at various rates ranging from 0% to 9% with payment
terms maturing through September 2011. The Company has recorded a discount on certain of the notes
representing imputed interest of approximately $54,000, which is being amortized during the
non-interest bearing period of the notes. The outstanding balance of these term notes was
approximately $1,660,000 and $3,176,000 at September 30, 2010
and December 31, 2009. On October 18, 2010, the construction
term notes were extinguished (See Note 12).
The above term notes are classified in the current and non-current liabilities of discontinued operations on the consolidated balance sheets at September 30, 2010 and December 31, 2009.
CONVERTIBLE NOTE PAYABLE
During the nine month period ended September 30, 2010, the Company issued 645,500 shares of
common stock representing principal and interest payments of approximately $414,000 in satisfaction
of its convertible debt obligation issued in connection with the acquisition of UOP and WRI.
BOND FINANCING
On February 16, 2007, concurrent with its initial public offering, the Companys wholly-owned
subsidiary, Converted Organics of Woodbridge (Woodbridge), completed the sale of $17,500,000 of
New Jersey Economic Development Authority Bonds (the Bonds). The Bonds carried a stated interest
rate of 8% and were set to mature on August 1, 2027. The Bonds are classified in the liabilities
of discontinued operations on the consolidated balance sheets at September 30, 2010 and December 31, 2009. On October 18,
2010, the Bonds payable were settled and extinguished (See Note 12).
NOTE 7 DERIVATIVE INSTRUMENTS
On May 7, 2009, in connection with notes issued pursuant to a financing agreement an investor
received five-year warrants to purchase 750,000 shares and 350,000 shares of Company common stock,
with an original exercise price of $1.00 per share and $1.50 per share, respectively, (Class C and
D warrants, respectively) subject to certain anti-dilution provisions. The placement agent used for
the offering was issued 135,000 Class C warrants and 65,000 Class D warrants. These warrants are
subject to certain anti-dilution rights for issuance below the exercise prices and are not
registered and cannot be traded. The exercise price for the Class C and D warrants are $1.00 per
share and $1.02 per share, respectively, at September 30, 2010. The Company has determined that
the warrant provisions providing for protection for issuances below the warrant exercise prices
could result in modification of the exercise price based on a variable that is not an input to the
fair value for a fixed-for-fixed option. Therefore, the Company determined the warrants issued in
connection with this financing are a derivative instrument which is subject to mark-to-market
adjustment each reporting period. At December 31, 2009, the fair value of the warrants was
determined using a Black-Scholes model with the following assumptions: risk-free interest rate of
2.35%; no dividend yield; volatility of 98.6% resulting in a derivative liability of approximately
$563,500. The liability was revalued as of September 30, 2010 using a Black-Scholes model and the
following assumptions: risk-free interest rate of 1.27%; no dividend yield; and volatility of
122.3%, resulting in a revalued liability of approximately $359,000 and a derivative gain of
approximately $173,000 and $205,000 on the consolidated statements of operations for the three and
nine month periods ended September 30, 2010, respectively.
11
CONVERTED ORGANICS INC.
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS CONTINUED
(UNAUDITED)
NOTE 7 DERIVATIVE INSTRUMENTS (Continued)
On September 8, 2009, in connection with notes issued pursuant to a financing agreement on
that date, an investor received a five-year warrant to purchase 2,500,000 shares of the Companys
common stock, with an original exercise price of $1.25 per share. These warrants are subject to
certain anti-dilution rights for issuances below the exercise price; provided that absent
shareholder approval, the exercise price may not be reduced to less than $1.08 per share (Class G
warrants). These warrants are not registered and cannot be traded. The Class G warrants are
exercisable at $1.25 per share at September 30, 2010 as the Company has received a one time waiver
for the Class G anti-dilution provision relating to the triggering event which occurred on April
22, 2010 (Class I Warrants). The Company has determined the warrant provisions providing for
protection for issuances below the warrant exercise price could result in modification of the
exercise price based on a variable that is not an input to the fair value for a fixed-for-fixed
option. The Company has determined that the warrants issued in connection with this financing are a
derivative instrument which is required to be shown as a derivative liability subject to
mark-to-market adjustment each reporting period. At December 31, 2009, the fair value of the
warrants was determined using a Black-Scholes model with the following assumptions: risk-free
interest rate of 2.35%; no dividend yield; volatility of 98.6% resulting in a derivative liability
of approximately $1,063,200. The liability was revalued as of September 30, 2010 using a
Black-Scholes model and the following assumptions: risk-free interest rate of 1.27%; no dividend
yield; and volatility of 122.3%, resulting in a revalued liability of approximately $715,000 and a
derivative gain of approximately $327,000 and $348,000, on the consolidated statements of
operations for the three and nine month periods ended September 30, 2010, respectively.
On April 22, 2010, in connection with common stock issued pursuant to a financing agreement on
that date, an investor received a five-year warrant to purchase 1,163,362 shares of the Companys
common stock, with an original exercise price of $1.06 per share, subject to certain anti-dilution
rights for issuances below such exercise price (Class I warrants). These warrants are not
registered and cannot be traded. The Class I warrants are exercisable one year from the date of
issuance. The Company has determined that the warrant provisions providing for protection for
issuances below the warrant exercise price could result in modification of the exercise price based
on a variable that is not an input to the fair value for a fixed-for-fixed option. The Company has
determined the warrants issued in connection with this financing are a derivative instrument which
is subject to mark-to-market adjustment each reporting period. At April 22, 2010, the fair value of
the warrants was determined to be approximately $968,000. At September 30, 2010, the fair value of
the warrants was determined using a Black-Scholes model with the following assumptions: risk-free
interest rate of 1.27%; no dividend yield; and volatility of 122.3% resulting in a derivative
liability of approximately $360,000 and a derivative gain of approximately $162,000 and $608,000,
on the consolidated statements of operations for the three and nine month periods ended September
30, 2010, respectively (also see Note 8).
NOTE 8 OWNERS EQUITY (DEFICIT)
On March 17, 2010, the Company granted 165,000 shares of common stock to a consultant who
provided investor relations consulting services to the Company. The grant was measured using the
closing price of the Companys stock on the date of grant. The statements of operations includes a
charge of $160,050 for the nine months ended September 30, 2010 related to this grant, which was
credited to common stock and additional paid-in capital.
On April 22, 2010, Converted Organics Inc. entered into a Securities Purchase Agreement with a
single institutional investor. Pursuant to the Securities Purchase Agreement, the Company agreed
to issue to the investor: (a) 2,400,000 shares of its common stock at $1.06 per share and (b)
five-year warrants to purchase 1,163,362 shares of its common stock at an exercise price of $1.06
per share (Class I Warrants). The warrants may be exercised at any time on or following a date one
year after the date of issuance and will expire five years from the date of issuance. The
transaction provided the Company with net proceeds of approximately $2.4 million.
On June 30, 2010, the Companys stockholders approved the amendment to the Companys
Certificate of Incorporation to increase the number of shares of common stock that the Company is
authorized to issue from 75,000,000 shares to 250,000,000 shares.
12
CONVERTED ORGANICS INC.
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS CONTINUED
(UNAUDITED)
NOTE 8 OWNERS EQUITY (DEFICIT) (Continued)
On July 19, 2010, the Company issued 1,623,333 shares of its common stock and warrants (Class
J Warrants) to acquire 1,623,333 shares of common stock to Atlas Advisors, LLC (Atlas). The
warrants will expire five years from the date of issuance and have a strike price of $0.54 per
share. The issuance to Atlas was made pursuant to an agreement between the parties regarding
payments due to Atlas pursuant to a Business Development Agreement dated January 29, 2010. Under
the Business Development Agreement, the Company had agreed to compensate Atlas in the event of any
mergers and/or acquisitions that were a result of the services provided by Atlas, such payment was
to have included both cash payments and equity payments. Pursuant to the agreement reached between
the parties, in exchange for the equity consideration listed herein, Atlas agreed that no further
consideration be paid to it in connection with the Companys proposed acquisition of TerraSphere
Systems, LLC. The stock and warrant payment was made to Atlas at a share price of $0.54, which was
the closing price of the Companys common stock on the date of the TerraSphere acquisition
agreement. The warrants issued to Atlas were issued at an exercise price equal to the price at
which the common shares were issued.
The Company issued 320,830 shares of its common stock related to its restructuring during the
quarter ended September 30, 2010. The statements of operations includes a charge of approximately
$190,000 for the nine months ended September 30, 2010, which was credited to common stock and
additional paid-in capital.
On August 30, 2010, the Company issued 1,157,407 shares of its common stock and warrants
(Class K Warrants) to acquire 1,157,407 shares of common stock to Atlas. The warrants will expire
five years from the date of issuance and have a strike price of $0.54. The issuance to Atlas was
made as consideration for the termination of a Business Development Agreement dated January 29,
2010 by and between the Company and Atlas.
The following table sets forth the outstanding warrants as of September 30, 2010:
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Class B Warrants |
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Class C Warrants |
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Class D Warrants |
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Class E Warrants |
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Class F Warrants |
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Class G Warrants |
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Class H Warrants |
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Class I Warrants |
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Class J Warrants |
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|
Class K Warrants |
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|
Exercise Price |
|
|
Exercise Price |
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|
Exercise Price |
|
|
Exercise Price |
|
|
Exercise Price |
|
|
Exercise Price |
|
|
Exercise Price |
|
|
Exercise Price |
|
|
Exercise Price |
|
|
Exercise Price |
|
|
|
$11.00 |
|
|
$1.00 |
|
|
$1.02 |
|
|
$1.63 |
|
|
$1.25 |
|
|
$1.25 |
|
|
$1.30 |
|
|
$1.06 |
|
|
$0.54 |
|
|
$0.54 |
|
Outstanding at 12/31/09 |
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|
4,932,438 |
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|
885,000 |
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|
415,000 |
|
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|
1,500,000 |
|
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585,000 |
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|
2,500,000 |
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|
17,250,000 |
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Issued |
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|
1,163,362 |
|
|
|
1,623,333 |
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|
1,157,407 |
|
Exercised |
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Canceled |
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Outstanding at 09/30/10 |
|
|
4,932,438 |
|
|
|
885,000 |
|
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|
415,000 |
|
|
|
1,500,000 |
|
|
|
585,000 |
|
|
|
2,500,000 |
|
|
|
17,250,000 |
|
|
|
1,163,362 |
|
|
|
1,623,333 |
|
|
|
1,157,407 |
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Exercisable at 09/30/10 |
|
|
4,932,438 |
|
|
|
885,000 |
|
|
|
415,000 |
|
|
|
1,500,000 |
|
|
|
585,000 |
|
|
|
2,500,000 |
|
|
|
17,250,000 |
|
|
|
1,163,362 |
|
|
|
1,623,333 |
|
|
|
1,157,407 |
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On October 18, 2010, 2,284,409 Class B warrants were retired by the Bond holder (see Note 12).
NOTE 9 FAIR VALUE MEASUREMENTS
The Company applies Financial Accounting Standards Boards Accounting Standard Codification,
Topic 820 Fair Value Measurement 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).
13
CONVERTED ORGANICS INC.
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS CONTINUED
(UNAUDITED)
NOTE 9 FAIR VALUE MEASUREMENTS (Continued)
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.
The Companys liabilities that are reported at fair value in the accompanying consolidated
balance sheets as of September 30, 2010 and December 31, 2009 were as follows:
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Balance |
|
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|
Level of Hierarchy |
|
|
September 30, 2010 |
|
|
December 31, 2009 |
|
Derivative liabilities |
|
Level 3 |
|
$ |
1,434,127 |
|
|
$ |
1,626,742 |
|
The following table reflects the change in Level 3 fair value of the Companys derivative
liabilities for the three and nine month periods ended September 30, 2010:
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Three months ended |
|
|
Nine months ended |
|
Balance, beginning of period |
|
$ |
2,096,109 |
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|
$ |
1,626,742 |
|
Fair value of derivatives issued |
|
|
|
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|
968,096 |
|
Derivative (gain) loss |
|
|
(661,982 |
) |
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(1,160,711 |
) |
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Balance, end of period |
|
$ |
1,434,127 |
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|
$ |
1,434,127 |
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|
The Company has other non-derivative financial instruments, such as cash, accounts receivable,
accounts payable, accrued expenses and long-term debt, for which the carrying amounts approximate
fair value.
NOTE 10 STOCK OPTION PLAN
The following table presents the activity under the 2006 Stock Option Plan from January 1,
2010 through September 30, 2010:
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Options Outstanding |
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|
Price Per Share |
|
Outstanding at December 31, 2009 |
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1,230,295 |
|
|
$ |
3.54 |
|
Granted |
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|
2,508,500 |
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|
.68 |
|
Exercised |
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|
(50,000 |
) |
|
|
.97 |
|
Canceled |
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|
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|
Outstanding at September 30, 2010 |
|
|
3,688,795 |
|
|
$ |
1.63 |
|
|
|
|
|
|
|
|
|
|
|
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|
|
|
|
|
Exercisable at September 30, 2010 |
|
|
3,638,795 |
|
|
$ |
1.63 |
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|
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|
|
The expense associated with granting these options was calculated using a Black-Scholes model.
The resulting expense of the above options granted was $6,660 and $1,305,812 for the three and
nine month periods ended September 30, 2010, respectively, and is included in general and
administrative expense on the consolidated statements of operations. As of September 30, 2010,
there was unrecognized compensation cost of approximately $4,000 related to non-vested share-based
compensation arrangements granted under the Companys stock option plan. There was no intrinsic
value of the Companys outstanding stock options at September 30, 2010.
14
CONVERTED ORGANICS INC.
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS CONTINUED
(UNAUDITED)
NOTE 11 COMMITMENTS AND CONTINGENCIES
LEASE COMMITMENTS
The Companys future minimum lease payments are as follows:
|
|
|
|
|
Years ending December 31,
2010 (October 1, 2010 through December 31, 2010) |
|
$ |
85,459 |
|
2011 |
|
|
344,988 |
|
2012 |
|
|
338,748 |
|
2013 |
|
|
234,898 |
|
2014 |
|
|
238,645 |
|
2015 and thereafter |
|
|
1,924,633 |
|
|
|
|
|
|
|
$ |
3,167,371 |
|
|
|
|
|
The Woodbridge facility future minimum lease payments have been excluded from the above table
(See 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 is pending before the District Court. A jury trial has been set for May 17, 2011. The
Company plans to vigorously defend this matter and is unable to estimate any losses that may or may
not be incurred as a result of this litigation and its eventual disposition. Accordingly, no loss
has been recorded related to this matter.
Related to the above matter, in December 2009, the Company filed a complaint in the Superior
Court of Massachusetts for the County of Suffolk, captioned Converted Organics Inc. v. Holland &
Knight LLP. The Company claims that in the event it is required to pay any monies to Mr. Leeseberg
and his proposed class in the matter of Gerald S. Leeseberg, et al. v. Converted Organics, Inc.,
that Holland & Knight should make the Company whole, because its handling of the registration of
the securities at issue in the Leeseberg lawsuit caused any loss that Mr. Leeseberg and other
putative class members claim to have suffered. Holland & Knight has not yet responded to the
complaint. 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.
15
CONVERTED ORGANICS INC.
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS CONTINUED
(UNAUDITED)
NOTE 11 COMMITMENTS AND CONTINGENCIES (Continued)
LEGAL PROCEEDINGS (Continued)
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.
NOTE 12 SUBSEQUENT EVENTS
WOODBRIDGE TRANSACTION
On October 18, 2010, Converted Organics Inc. entered into an Exchange Agreement (the Exchange
Agreement) with the sole Bond Holder of $17,500,000 New Jersey Economic Development Authority
Bonds (the Bonds) that were issued on behalf of Woodbridge. Pursuant to the Exchange Agreement,
the Bond Holder agreed to exchange: (i) the Bonds (which represented 100% of all Bonds), and (ii)
class B warrants to purchase 2,284,409 shares the Companys common stock (the Class B Warrants)
for 17,500 shares of the Companys newly authorized 1% Series A Convertible Preferred Stock (the
Series A Preferred Stock). In addition, the Bond Holder agreed to waive all interest accrued and
unpaid from February 1, 2010 until the date of the Exchange Agreement on the Bonds, and agreed to
transfer to the Company approximately $600,000 that the Company had previously deposited into
certain reserve accounts in connection with the Bonds.
The Series A Preferred Stock is convertible into the number of shares of Common Stock equal to
(1) the stated value of the share ($1,000), divided by (2) $0.543 (the Conversion Price).
Holders of the Series A Preferred are entitled to receive cumulative dividends at the rate per
share (as a percentage of the stated value per share) of 1% per annum (subject to increase in
certain circumstances), payable annually and on each conversion date. The dividends are payable,
during the first three years after issuance, at the election of the Company, and thereafter, at the
election of the holder, in cash or in shares of Company common stock valued at the Conversion Price
(or in some combination thereof).
On October 18, 2010, the Company and the Woodbridge Facilitys landlord (Lessor) entered
into a Termination and Surrender Agreement (Termination Agreement) related to the termination of
the Woodbridge Facility lease. Under the lease, there were approximately $9.1 million of future
rental payments. In addition, the Lessor asserted claims for (i) unpaid sewer and trash removal
charges; (ii) unpaid rent due Lessor for prior periods; (iii) certain costs and expenses incurred
by Lessor in connection with certain litigation; (iv) damages that may result from the condition of
the premises at the time of surrender; and (v) the required removal and disposal of abandoned
inventory and materials totaling approximately $1,500,000. Pursuant to the Termination Agreement,
the Lessor and the Company agreed to terminate the lease surrendering the premises and transferring
all equipment, tools and fixtures owned by the Company and presently located at the premises.
Pursuant to the terms of the Termination Agreement, the Company agreed to issue the Lessor a total
of 892,857 shares of Company common stock valued at $0.56 per share. In addition, the Company has
deposits totaling $415,000 with the Lessor which will not be returned to the Company.
On October 18, 2010, the Superior Court of the State of California for the County of Los
Angeles entered an Order in the matter entitled American Capital Management, LLC (ACM) v.
Converted Organics Inc. and Converted Organics of Woodbridge, LLC and Does 1-10 Inclusive (the
Order). The Order provides for the full and final settlement of $11.3 million of claims against
the Company held by ACM. The claims include the future rental payments discussed above, which were
acquired by ACM from the Lessor, as well as the acquisition of approximately $1.7 million of
promissory notes issued by the Company to four contractors that had provided services to the
Woodbridge Facility. ACM purchased the claims from these parties pursuant to separate claims
purchase agreements. Pursuant to the terms of the Order, the Company agreed to issue to ACM a total
of 20,726,980 shares of Company
common stock valued at $0.543 per share in full and final settlement of the claims.
16
CONVERTED ORGANICS INC.
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS CONTINUED
(UNAUDITED)
NOTE 12 SUBSEQUENT EVENTS (Continued)
TERRASPHERE
SYSTEMS LLC ACQUISITION
On
November 12, 2010, the Company acquired 95% of the membership interest
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.
The membership interest purchase agreement (Agreement) entered on July 6, 2010 allows for an
election by TerraSphere members to accept 1) 27,777,778 shares of Company common
stock upon closing of the transaction (with a 6 month holding period) (Option One) or 2) 15,873,016 shares of Company common stock upon closing of the transaction with an
option to earn an additional 21,164,021 shares of Company common stock in contingent consideration based upon TerraSphere
achieving certain milestones and agreeing to an 18 month holding period on stock distributed to
them (Option Two). Based on 26% of TerraSphere members electing Option One and 69% electing
Option Two, the maximum total shares that could be issued is
32,777,778 in the
Companys common stock. Per the Agreement, TerraSphere members who elected Option One received
7,222,222 shares of Company common stock upon closing and members electing Option Two received 10,952,381 shares of Company common stock upon closing and up to
an additional 14,603,175 shares of Company common stock based on achieving the defined milestones (contingent consideration).
Milestone One Payment: 4,563,492 shares of Company common stock, if, and only if, between the date
of the Agreement and the 90th day following the closing date or the 180th day following the date of
the Agreement, the following occurs (such shares to be payable within ten (10) business days of
achievement of the following or the closing date, whichever is later): For a period of five (5)
consecutive trading days, the Companys market capitalization exceeds the sum of: (1) the Companys
initial market capitalization on the date of execution of the Agreement, plus (2) the closing price
per share, multiplied by the number of shares of Company common stock to be issued at
closing pursuant to the Agreement, and, if such calculation is being made prior to the closing
date, including this Milestone One. If between the date of the Agreement and the 90th day following
the closing date or the 180th day following the date of the Agreement, the Company completes an
equity financing, the cash received from the equity financing during such period shall be added to
the market capitalization. If between the closing date and December 31, 2011, the Buyer sells
equity of either the Company or any of the Companys subsidiaries, any cash received from such
equity sales during such period shall be added to the market capitalization;
Milestone Two Payment: 1,825,397 shares of Company common stock, if, and only if, $2,000,000 of
TerraSpheres accounts receivable as of the date of the Agreement are received prior to February
28, 2011;
Milestone Three Payment: 4,563,492 shares of Company common stock, if, and only if, the Company
generates gross margin of $6,000,000 (gross margin target) from its operations during the period
commencing as of the date of the Agreement and ending on December 31, 2011; provided that, if the
Company generates gross margin of at least $4,200,000 (gross margin threshold) from its operations
during such period, the Sellers shall be entitled to a pro rata portion of the Company common
stock; and
Milestone Four Payment: 3,650,794 shares of Company common stock, if, and only if, the Company
generates gross margin of $4,000,000 from its operations during any nine-month period commencing on
the Agreement date and ending on December 31, 2012; provided that, if the Company achieves the
Milestone Three gross margin threshold, but does not achieve the Milestone Three gross margin
target, 83.3% of the difference between the Milestone Three gross margin target and the actual
gross margins achieved pursuant to the Agreement (the Milestone Three Deficiency) may be added by
the Sellers to the Milestone Four Payment and the Milestone Four gross margin target.
Notwithstanding anything to the contrary herein, the total amounts payable pursuant to the
Milestone Three Payment and Milestone Four Payment shall be no more than 8,214,286 shares of Company
common stock.
On
November 12, 2010, the Company acquired 95% of TerraSphere
issuing 18,174,603 shares of Company common stock at the closing and additional shares will be issued if TerraSphere achieves the above milestones.
17
CONVERTED ORGANICS INC.
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS CONTINUED
(UNAUDITED)
NOTE 12 SUBSEQUENT EVENTS (Continued)
TERRASPHERE
SYSTEMS LLC ACQUISITION (Continued)
The unaudited pro forma consolidated financial information for the three and nine months ended
September 30, 2010 and 2009 as though the acquisition had been completed at the beginning of the
respective periods are as follows:
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|
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|
|
|
|
|
|
|
|
|
|
For the three months ended |
|
|
For the nine months ended |
|
|
|
September 30, |
|
|
September 30, |
|
|
|
2010 |
|
|
2009 |
|
|
2010 |
|
|
2009 |
|
Revenue |
|
$ |
817,765 |
|
|
$ |
703,306 |
|
|
$ |
7,268,190 |
|
|
$ |
1,828,595 |
|
Net loss |
|
$ |
(22,304,569 |
) |
|
$ |
(5,156,798 |
) |
|
$ |
(29,330,290 |
) |
|
$ |
(13,038,842 |
) |
Net loss per
share, basic and diluted |
|
|
(0.36 |
) |
|
|
(0.13 |
) |
|
|
(0.50 |
) |
|
|
(0.43 |
) |
18
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, 2009. Actual results could differ materially from these forward-looking
statements. Converted Organics Inc. is sometimes referred to herein as we, us, our and the
Company.
Introduction
Our operating structure is composed of our parent company, Converted Organics Inc., three
wholly-owned operating subsidiaries, a newly formed wholly-owned subsidiary, TerraSphere Inc. and a
92.5% owned non-operating subsidiary. The first operating subsidiary is Converted Organics of
California, LLC, which includes the operation of our Gonzales, California facility. The second
operating subsidiary is Converted Organics of Woodbridge, LLC, which includes the discontinued
operation of our Woodbridge, New Jersey facility. The third operating subsidiary is Converted
Organics of Mississippi, LLC (Converted Organics of Mississippi), a Mississippi limited liability
company, established for the purpose of adding a poultry litter-based fertilizer product to the
Companys existing product lines. On May 20, 2010, we formed TerraSphere Inc. (TerraSphere Inc),
a Delaware corporation, to acquire 100% of the membership interests of TerraSphere Systems LLC, a
transaction which was approved by our shareholders at a special meeting held on September 16, 2010
and acquired 95% of the membership interest of TerraSphere on November 12, 2010. The 92.5% owned subsidiary is Converted Organics of Rhode
Island, LLC (Converted Organics of RI), which currently has no operating activity. On February
25, 2010, 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. We operate a processing facility that uses food and agricultural waste as raw
materials to manufacture all-natural fertilizer and soil amendment products combining nutritional
and disease suppression characteristics. In addition, we have sales from a poultry litter based
fertilizer product. We have current sales in the agribusiness, retail and turf management markets.
We also hope to achieve additional revenue by licensing the use of our technology to others,
developing our Industrial Waterwaste Resources division and expanding our newly acquired division
TerraSphere Inc.
In addition to our fertilizer manufacturing and sales operations, we have also begun to
operate an Industrial Wastewater Resources division of the Company (IWWR). Converted Organics is
the exclusive licensee of LM-HT Concentrator technology for the treatment of Industrial Wastewater.
Due to its unique, energy efficient design, the LM-HT Concentrator provides a highly cost-effective
alternative to traditional IWW treatment technology. Since IWWRs inception in March of 2010, we
have entered into multiple strategic relationships to build waste water treatment facilities on
landfills and other waste processing facilities across the nation. Once the LM-HT Concentrators are
installed at facilities, Converted Organics plans 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.
Converted Organics of California, LLC Gonzales Facility
The Gonzales facility is a state-of-the-art production facility that services a strong West
Coast agribusiness customer base through established distribution channels. This facility uses our
proprietary technology and process known as the High Temperature Liquid Composting, or HTLC,
system, which processes various biodegradable waste products into liquid and solid food waste-based
fertilizer and feed products.
The Gonzales facility began to generate positive cash flow in June 2009 which has continued
through September 2010. For the nine month period ended September 30, 2010, the Gonzales facility
generated revenues of $2,511,000 and a positive gross margin of $628,000, or 25% (based on no
allocation of corporate overhead). We plan to continue to improve this operating margin by
maximizing the production capacity at the facility, by generating tip fees from receiving
additional quantities of food processing waste and by reducing the amount of raw material and
freight costs currently associated with the production process. We estimate that the plant in its
current configuration, and based on current market prices, has the capacity to generate monthly
sales in the range of $350,000 to $400,000. In addition, we have plans to add capacity to the
Gonzales plant, whereby the plant will be able to produce approximately three times its current
production and will be capable of producing both liquid and solid products. We have completed
19
certain aspects of the planned upgrades which allow us to receive solid food waste for processing
but have delayed the upgrades which would allow us to produce dry product. The remaining upgrades
have been delayed due to a lack of market demand for a dry product within the area the Gonzales
facility serves. Because we will have to obtain the proper building permits for continued
expansion, further development of the Gonzales facility will be delayed until further market
research is completed and those permits are obtained.
Converted Organics of Woodbridge, LLC Woodbridge Facility
On July 30, 2010, we temporarily halted production at our Woodbridge facility in order to
undertake steps to lower our cost structure at the Woodbridge facility. Specifically we attempted
to negotiate more favorable terms under our operating lease and to lower certain utility costs. We
were unable to lower such costs and therefore, management determined the Company could
not sustain the negative cash flow from the Woodbridge facility and discontinued the operations at
the Woodbridge plant. As a result, we impaired the
Woodbridge facilitys assets thereby reducing the carrying value to approximately $1.5 million
which is the value expected to be received from the sale of those assets. The consolidated
statements of operations reflect the impairment charge of approximately $15.4 million for the three
and nine month periods ended September 30, 2010 in loss from discontinued operations. On October
18, 2010, we entered into a Termination and Surrender Agreement with the Woodbridge facilitys
landlord (Lessor) transferring all equipment, tools and fixtures owned by us to the Lessor in
lieu of our obligations to the Lessor. The completion of our restructuring coupled with the
expense reduction measures we implemented in July 2010 are expected to yield total cash savings of
approximately $6.0 million per year, providing us with the operational and financial flexibility
necessary to drive Converted Organics to its next phase of corporate development
Converted Organics of Mississippi, LLC
On January 26, 2010, we formed Converted Organics of Mississippi, LLC, a Mississippi limited
liability company and a wholly owned subsidiary of the Company, for the purpose of adding a poultry
litter-based fertilizer product to our existing product lines. We have outsourced production
of this new product line. From the date of inception through September 30, 2010, Converted
Organics of Mississippi, LLC recorded product sales revenue of approximately $255,000.
TerraSphere Inc.
On May 20, 2010, we formed TerraSphere Inc., a Delaware corporation and a wholly owned
subsidiary of the Company, for the purpose of acquiring 100% of the membership interests of
TerraSphere Systems LLC (TerraSphere). On July 6, 2010, a membership interest purchase agreement
was entered into by the Company, TerraSphere Inc., TerraSphere and the members of TerraSphere,
pursuant to which we agreed to acquire 100% of the membership interest of TerraSphere. The maximum
total shares that could be issued for TerraSphere is estimated to be
34,166,667 shares of Company Common Stock, which includes earn-out
share payments of up to 14,603,175 shares of Company common stock. Pursuant to the purchase agreement, the acquisition was approved by our shareholders on
September 16, 2010. The Company acquired 95% of the membership
interest of TerraSphere on November 12, 2010. We will
issue up to 32,777,778 shares of our common stock to the members of TerraSphere in exchange for
95% of the units of TerraSphere, subject to certain anti-dilution adjustments. Of these shares,
18,174,603 shares were issued on November 12, 2010, the closing of the acquisition, and the
remainder of the shares will be issued if TerraSphere achieves certain milestones. TerraSphere
designs, builds and operates highly efficient and scalable systems, featuring a patented,
proprietary technology that utilizes vertically-stacked modules to house rows of plants, which are
then placed perpendicular to an interior light source to grow pesticide 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. We believe the acquisition of TerraSphere will
expand our portfolio of sustainable, environmentally-friendly businesses, and will provide us with
an immediate revenue stream.
Industrial Wastewater Resources Division
On March 23, 2010, we entered into a loan and license agreement with Heartland Technology
Partners, LLC (HTP). The loan agreement requires us to advance $500,000 to HTP in three monthly
installments that commenced upon signing of the loan. The outstanding principal balance of the loan
is due if either a change of control of HTP or the completion by HTP of a financing in excess of
$10 million occurs on or before June 30, 2012. In consideration for entering into the loan
agreement, we were granted an exclusive, irrevocable license to utilize HTPs patented LM-HT(TM)
Concentrator technology in the U.S. industrial wastewater (IWW) market. The IWW market involves the
treatment of waters that have been contaminated by anthropogenic industrial or commercial
activities, prior to their reuse or release into the environment. A breakthrough wastewater
treatment process, the LM-HT(TM) Concentrator reduces carbon emissions compared to traditional
technologies by using waste heat and renewable energy as thermal fuel. In addition,
20
we have hired a
senior executive in the waste water processing industry and have begun to develop plans to operate
our Industrial Wastewater Resources division. On July 30, 2010, we signed a letter of intent with
Spirit Services, Inc. to jointly develop an energy and IWW treatment facility using our exclusively
licensed technology to evaporate IWW at a facility in South Boston, Virginia. We have subsequently
signed additional agreements to establish relationships to jointly develop IWW treatment facilities
at certain established waste treatment facilities in the United States. Such relationships are in
the development stage and we expect to build upon them, as well as secure new partnerships,
throughout the remainder of this year and in 2011.
Recent Financing Activities
On April 20, 2010, we entered into an agreement with a single institutional investor,
pursuant to which we issued to the investor: (a) 2,400,000 shares of common stock and (b) five-year
warrants to purchase 1,163,362 shares of common stock at an exercise price of $1.06 per share. The
warrants may be exercised at any time on or following a date one year after the date of issuance
and expire five years from the date of issuance. The transaction closed on April 22, 2010 and
provided us with net proceeds of approximately $2.4 million.
Future Development
Our long-term strategic plan calls for growth of our organic fertilizer business as well as
expansion of our portfolio of sustainable, environmentally-friendly businesses. To grow our
existing fertilizer business, we plan to develop and license additional organic fertilizer
manufacturing facilities and utilize the remaining capacity of our Gonzales facility which
currently operates at approximately 60% capacity. In connection with our plan to expand the
capacity of our Gonzales facility, we plan to increase production to approximately three times the
facilitys current production and, based on market demand, we may expand the capability of the
plant to have the ability to produce both liquid and solid products. In connection with the plan
for additional facilities, we have completed preliminary work aimed at establishing facilities in
Massachusetts, where we have performed initial development work in connection with construction of
three manufacturing facilities to serve the eastern Massachusetts market. Two of our proposals to
develop facilities are currently under review by the property owners. The third proposal has
evolved into the MassOrganics I transaction described below. The Massachusetts Strategic
Envirotechnology Partnership Program has completed a review of our technology.
We also plan to strengthen our green technology portfolio with the TerraSphere acquisition and
grow our Industrial Wastewater Resources Division. Through the TerraSphere acquisition, we will
expand our business into the market of building highly efficient systems for growing pesticide and
chemical-free, organic fruits and vegetables in controlled indoor environments. TerraSphere will
provide us with an immediate revenue stream and its clean technology helps to promote the
sustainable consumption of natural resources by accelerating plant production and maximizing crop
yields, while improving environmental footprints through the reduction of carbon emissions and fuel
use associated with traditional crop production and distribution. Also, we will continue to grow
our Industrial Wastewater Resources Division by working to form industry and/or project-based
partnerships that utilize our exclusively licensed, irrevocable technology to treat industrial
wastewaters.
We have developed smaller capacity operating units, namely the Scalable Modular AeRobic
Technology (SMART) units that are suitable for processing 5 to 50 tons of waste per day. The
semi-portable units are capable of operating indoors or outdoors and may be as sophisticated or as
basic in design and function as the owner/user requires. The SMART units will be delivered to
jobsites in pre-assembled, pre-tested components, and will include a license to use the HTLC
technology. Our target market is users who seek to address waste problems on a smaller scale than
would be addressed by a large processing facility. Our plan contemplates that purchasers of the
SMART units would receive tip fees for accepting waste and would sell fertilizer and soil amendment
products in the markets where their units operate. We plan to market and sell the SMART units in
both the United States and abroad.
We have also begun the development of a licensing program, under which we will license to
third parties, the right to use our proprietary technology. The licensing program consists of a
know-how license, which could be complemented with SMART unit sales so that any individual or
entity buying a SMART unit would also receive a license agreement to use our technology. We are
working to patent our process and technology and anticipate that we will expand upon the licensing
program when the necessary patent registrations are achieved. We are currently in negotiations
with MassOrganics I, LLC
(MassOrganics I) regarding the use of Converted Organics proprietary technology for the
manufacture of organic fertilizer products. On January 25, 2010, we signed a memorandum of
understanding under which MassOrganics I would install and operate the system at a new
manufacturing facility to be constructed at The Sutton Commerce Park in Sutton, Massachusetts.
MassOrganics I has agreed to enter into a licensing agreement under which MassOrganics I will pay a
licensing fee to Converted Organics.
21
Trends and Uncertainties Affecting our Operations
We are subject to a number of factors that may affect our operations and financial
performance. These factors include, but are not limited to, the available supply and price of
organic food waste, the market for liquid and solid organic fertilizer, increasing energy costs,
the unpredictable cost of compliance with environmental and other government regulation, and the
time and cost of obtaining USDA, state or other product labeling designations. Demand for organic
fertilizer and the resulting prices customers are willing to pay also may not be as high as our
market studies suggest. In addition, supply of organic fertilizer products from the use of other
technologies or other competitors may adversely affect our selling prices and consequently our
overall profitability. Furthermore our plan calls for raising additional debt and/or equity
financing to construct additional operating facilities. Currently there has been a slowdown in
lending in both the equity and bond markets which may hinder our ability to raise the required
funds.
Liquidity and Capital Resources
At
September 30, 2010, we had total current assets of approximately
$4.3 million consisting
primarily of cash, accounts receivable, assets of discontinued
operations, and had current liabilities
of approximately $8.1 million, consisting primarily of accounts
payable, accrued expenses and liabilities of discontinued operations,
leaving us with a negative working capital of approximately $3.8 million. Non-current
assets totaled approximately $4.9 million and consisted primarily of property and equipment, intangible assets
and non-current assets of discontinued operations. Non-current
liabilities of approximately $19.0 million consisted primarily
of non-current liabilities of discontinued operations of $17.5 million and a $1.4 million derivative liability. We had an accumulated deficit at
September 30, 2010 of approximately $81.5 million. Shareholders deficit at September 30, 2010 was
approximately $17.8 million. We have completed a series of transactions in October 2010 which will
provide approximately $15.4 million in positive Shareholders equity in the fourth quarter of 2010.
We also acquired 95% of the membership interest of TerraSphere on November 12, 2010 which provided
approximately $7.5 million in positive Shareholders equity in the fourth quarter of 2010 with an
additional $6.0 million in positive Shareholders equity if certain future milestones are met. The
effects of these transactions on the balance sheet at September 30, 2010 are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Woodbridge Transactions |
|
|
|
|
|
|
September 30, 2010 |
|
|
and TerraSphere Acquisition |
|
|
Total |
|
Assets |
|
$ |
9,200,000 |
|
|
$ |
6,100,000 |
|
|
$ |
15,300,000 |
|
Liabilities |
|
|
27,000,000 |
|
|
|
(16,800,000 |
) |
|
|
10,200,000 |
|
Shareholders equity
(deficit) |
|
|
(17,800,000 |
) |
|
|
22,900,000 |
|
|
|
5,100,000 |
|
During the nine month period ended September 30, 2010, we used approximately $10.2
million in cash on hand. The significant cash expenditures during the first nine months of 2010
were as follows:
|
|
|
$1,561,000
|
|
to fund future revenue generating activities, including the
purchase of chicken litter-based fertilizer product
($615,000), a deposit for a license to treat Industrial
Wastewater ($500,000) and to fund capital equipment
purchases ($446,000). |
|
|
|
$1,100,000
|
|
related to funding acquisition activities. |
|
|
|
$1,540,000
|
|
to repay debt principal and interest on term notes related
to discontinued operations of the Woodbridge facility. |
|
|
|
$4,460,000
|
|
to fund operations related to the discontinued operations of
the Woodbridge facility. |
|
|
|
$1,500,000
|
|
to fund ongoing operations during the first nine months of
2010, including $600,000 of marketing costs to implement a
formal marketing program. |
On July 30, 2010 we announced that we reduced our work force by 50% which included
employees at the corporate level and the Woodbridge facility. We expect those salary reductions to
save approximately $2.1 million over the next twelve months. Also, on July 30, 2010, we temporarily
halted production at our Woodbridge facility in order to undertake steps to lower our cost
structure at the Woodbridge facility. Specifically we attempted to negotiate more favorable terms
under our operating lease and to lower certain utility costs. We were not successful in lowering
such costs and therefore, management determined the Company could not sustain the
22
negative cash
flow from the Woodbridge facility and discontinued the operations at the Woodbridge plant. We
expect the closing of the Woodbridge facility and debt restructuring of its related debt will save
us approximately $6.0 million per year. On October 18, 2010, we entered into an Exchange Agreement
with the sole bond holder of $17.5 million bonds whereby we exchanged the Bonds for 17,500 shares
of our newly authorized 1% Series A Convertible Preferred Stock, which is convertible into an
aggregate of 32,228,361 shares of our common stock. In addition, the Bond Holder agreed to waive
all interest accrued and unpaid from February 1, 2010 until the date of the Exchange Agreement on
the Bonds totaling approximately $933,000, and agreed to transfer to the us approximately $600,000
that we had previously deposited into certain reserve accounts in connection with the Bonds.
We and the Woodbridge Facilitys landlord ( Lessor ) entered into a Termination and
Surrender Agreement on October 18, 2010 whereby we agreed to transfer all equipment, tools and
fixtures owned by us and presently located at the premises and 892,857 shares our common stock
valued at $500,000 to the Lessor in satisfaction of claims of approximately $1.5 million. In
addition, we have deposits totaling $415,000 with the Lessor which will not be returned to us. On
October 18, 2010, a court order was entered whereby we agreed to issue to a third party a total of
20,726,980 shares of our common stock in full settlement of approximately $1.7 million of
promissory notes issued by us to four contractors that had provided services to the Woodbridge
Facility. After the above transactions, Woodbridge will have approximately $1.3 million in current
payables remaining.
We have additional manufacturing capabilities at our Gonzales facility currently
operating at approximately 60% of its production capacity. The Gonzales facility is cash flow
positive and the additional production capacity would produce approximately $175,000 a month in
positive cash flow. We are focusing our current sales efforts on taking advantage of the
additional production capacity. Previously, we estimated our negative cash flow requirements on a
monthly basis were approximately $400,000 at the corporate level. We estimate that the current
cost reduction efforts will lower the monthly cash flow requirements at the corporate level to
$150,000, excluding current payable obligations of approximately $1.6 million. If we are unable to
increase sales levels at Gonzales to offset the corporate level cash flow requirement, we will need
to seek additional financing.
On July 6, 2010 we reached an agreement to acquire 100% of the membership interests of
TerraSphere Systems LLC. The transaction was approved by our shareholders at a special meeting on
September 16, 2010. The closing of the transaction was executed on November 12, 2010. Any cash
acquired by us would reduce amounts that otherwise need to be raised through a financing.
On April 22, 2010, we raised net proceeds of $2.4 million through the issuance of (a)
2,400,000 shares of common stock and (b) a five-year warrants to purchase 1,163,362 shares of
common stock at an exercise price of $1.06 per share. We previously disclosed that we believed the
funds received through our secondary public offering of 17,250,000 units which raised $16.4 million
after expenses and the April 2010 financing would be sufficient to operate our current business
until we were cash flow positive assuming we achieved our desired production capacity and sales
levels and assuming we did not
encounter additional costs or expenses, either unforeseen or resulting from any proposed
mergers and/or acquisitions. To date, we have not achieved the desired sales levels needed to meet
our cash flow requirements. Therefore, we may require additional financing prior to achieving cash
flow from operations for which we have no commitments. On July 2, 2010, we filed a registration
statement on Form S-3 to register $75,000,000 of our common stock, which was declared effective on
July 15, 2010. There is no assurance that capital in any form will be available to us, and if
available, on terms and conditions that are acceptable.
Results of Continuing Operations
Sales
Our sales increased $115,000 or 16%, and $964,000 or 54% for the three and nine month periods
ended September 30, 2010, respectively, compared to the same periods ended September 30, 2009. We
attribute our significant growth to our targeted marketing efforts, and to the increasing
recognition nationwide regarding the importance of using organic fertilizer products for lawn care,
professional turf, and agricultural applications.
Sales at the Gonzales facility increased $96,000 or 24% and $737,000 or 42% for the three and
nine month periods ended September 30, 2010 compared to the same periods ended September 30, 2009.
Since its inception on January 26, 2010, Converted Organics of Mississippi has generated sales
of $255,000.
Cost of Sales
For the three and nine month periods ended September 30, 2010 cost of goods sold decreased
approximately $25,000 and increased $247,000, respectively, compared to the same periods in 2009.
23
Cost of goods sold at the Gonzales facility decreased $26,000 or 4% for the three month period
ended September 30, 2010. Cost of goods sold increased $118,000 or 8% for the nine month period
ended September 30, 2010 compared to the same period ended September 30, 2009 due to an increase in
raw materials used to meet increased sales demand while the current level of fixed costs remained
relatively unchanged. The Gonzales facility generated a 25% gross margin for the nine months ended
September 30, 2010 compared to a 1% gross margin for the same period in 2009.
Converted Organics of Mississippi generated a gross margin $117,000 or 46% on sales of
$255,000 for the nine months ended September 30, 2010.
General and Administrative Expenses
General and administrative expenses for the three month periods ended September 30, 2010
increased approximately $2.5 million compared to the same period in 2009 is primarily composed of
$1.6 million related to compensation expense in connection with the issuance of common stock for
M&A advisory services and an increase in legal and professional fees of approximately $300,000.
The approximately $5.3 million increase in general and administrative expenses for the nine months
ended September 30, 2010 compared to the same period in 2009 is composed of increases related to
compensation expense in connection with the issuance of common stock for M&A advisory services of
$1.6 million and issuance of stock options and restricted shares of $1.4 million, an increase in
professional and legal fees of approximately $1,100,000 related to acquisition activities and an
increase in marketing costs of approximately $600,000.
Interest Expense
Interest expense decreased approximately $723,000 or 99% and $4.0 million or 99% for the three
and nine month periods ended September 30, 2010, respectively, compared to the same periods ended
September 30, 2009. The significant increase in 2009 was due to interest expense associated with
the issuance of warrants and interest recognized in connection with borrowing transactions,
primarily non-cash items.
Derivative gain (loss)
We recognized derivative gains of approximately $662,000 and $1,161,000 in the three and nine
month periods ended September 30, 2010, respectively. These gains are non-cash in nature and
represent mark-to-market adjustments due to changes in fair value of warrants.
Results of Discontinued Operations
On July 30, 2010, the Company temporarily halted production at its Woodbridge
facility in order to undertake steps to lower its cost structure at the Woodbridge facility.
Specifically the Company attempted to negotiate more favorable terms under its operating lease and
to lower certain utility costs. The Company was unable to lower such costs and therefore,
management determined that the Company could not sustain the negative cash flow from the Woodbridge
facility and discontinued operations at the Woodbridge plant. On October 18, 2010, the Company entered into a Termination and Surrender
Agreement with the Woodbridge facilitys landlord (Lessor) transferring all equipment, tools and
fixtures owned by the Company to the Lessor in lieu of its obligations to the Lessor. As a result,
the Company impaired the Woodbridge facilitys assets to reduce the carrying value to approximately
$1.5 million, which is the value expected to be received from the sale of those assets. The
consolidated statements of operations includes an impairment charge of approximately $15.4 million
for the three and nine month periods ended September 30, 2010 in loss from discontinued operations.
The following table provides the revenue and loss from the Woodbridge Facility discontinued
operations:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the three months ended |
|
|
For the nine months ended |
|
|
|
September 30, |
|
|
September 30, |
|
|
|
2010 |
|
|
2009 |
|
|
2010 |
|
|
2009 |
|
Revenue from discontinued operations |
|
$ |
105,714 |
|
|
$ |
53,123 |
|
|
$ |
834,089 |
|
|
$ |
430,403 |
|
Loss from discontinued operations |
|
$ |
(18,685,007 |
) |
|
$ |
(2,253,613 |
) |
|
$ |
(22,711,406 |
) |
|
$ |
(6,443,121 |
) |
24
The following table provides the assets and liabilities of the Woodbridge Facility, classified
as discontinued operations, in the consolidated balance sheets dated September 30, 2010 and
December 31, 2009:
|
|
|
|
|
|
|
|
|
|
|
2010 |
|
|
2009 |
|
Accounts receivable |
|
$ |
293,077 |
|
|
$ |
59,746 |
|
Inventory |
|
|
|
|
|
|
272,396 |
|
Prepaid expenses |
|
|
778,610 |
|
|
|
629,933 |
|
Property and equipment |
|
|
1,526,543 |
|
|
|
17,935,216 |
|
Other assets |
|
|
1,271,158 |
|
|
|
1,258,670 |
|
|
|
|
|
|
|
|
Assets of discontinued operations |
|
$ |
3,869,388 |
|
|
$ |
20,155,961 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Term notes payable |
|
$ |
1,707,743 |
|
|
$ |
3,247,752 |
|
Accounts payable |
|
|
1,964,459 |
|
|
|
1,237,275 |
|
Accrued expenses |
|
|
2,375,129 |
|
|
|
950,782 |
|
Other liabilities |
|
|
31,824 |
|
|
|
40,575 |
|
Bonds payable |
|
|
17,500,000 |
|
|
|
17,500,000 |
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|
|
|
|
|
|
|
Liabilities of discontinued operations |
|
$ |
23,579,155 |
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|
$ |
22,976,384 |
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|
|
|
|
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Critical Accounting Policies
Use of Estimates
The preparation of consolidated financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make estimates and
assumptions that affect the reported amounts and disclosures in the consolidated financial
statements. Actual results could differ from those estimates.
Accounts Receivables
Accounts receivable represents balances due from customers, net of applicable reserves for
doubtful accounts. In determining the need for an allowance, objective evidence that a single
receivable is uncollectible, as well as historical collection patterns for accounts receivable are
considered at each balance sheet date.
Inventories
Inventories are valued at the lower of cost or market, with cost determined by the first in,
first out basis. Inventories consist primarily of raw materials and finished goods, which consist
of soil amendment products. Inventory balances are presented net of applicable reserves.
Intangible Assets
We account for our intangible assets in accordance with ASC section 350 which requires that
intangible assets with finite lives, such as our license, be capitalized and amortized over their
respective estimated lives and reviewed for impairment whenever events or other changes in
circumstances indicate that the carrying amount may not be recoverable.
Derivative Instruments
We account for derivative instruments in accordance with ASC 815, which establishes accounting
and reporting standards for derivative instruments and hedging activities, including certain
derivative instruments embedded in other financial instruments or contracts and requires
recognition of all derivatives on the balance sheet at fair value.
Revenue Recognition
Revenue is recognized when each of the following criteria is met: persuasive evidence of a
sales arrangement exists; delivery of the product has occurred; the sales price is fixed or
determinable, and collectability is reasonably assured. In those cases where all four criteria are
not met, we defer recognition of revenue until the period these criteria are satisfied. Revenue is
generally recognized upon shipment.
25
Share Based Compensation
We account for share based compensation paid to employees in accordance with ASC 718.
Under the provisions of the guidance, share-based compensation issued to employees is measured at
the grant date, based on the fair value of the award, and is recognized as an expense over the
requisite service period (generally the vesting period of the grant). We account for share based
compensation issued to non-employees in accordance with ASC 505. Under the provisions of the
guidance, such compensation is measured at the grant date, based on the fair value of the equity
instruments issued and is recognized as an expense over the requisite service period.
Off-Balance Sheet Transactions
We do not engage in material off-balance sheet transactions.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Not applicable.
Item 4. Controls and Procedures
Under the supervision, and with the participation of our management, including the Principal
Executive Officer and Principal Financial Officer, we have evaluated the effectiveness of our
disclosure controls and procedures pursuant to Exchange Act Rules 13a-15 and 15d-15 as of the end
of the period covered by this report. Based on that evaluation, the Principal Executive Officer and
Principal Financial Officer have concluded that these disclosure controls and procedures were
effective such that the material information required to be filed in our SEC reports is recorded,
processed, summarized and reported within the required time periods specified in the SEC rules and
forms. This conclusion was based on the fact that the business operations to date have been limited
and the Principal Executive Officer and Principal Financial Officer have had complete access to all
records and financial information.
There were no changes in our internal control over financial reporting during the three months
ended September 30, 2010 that have materially affected, or are reasonably likely to materially
affect, our internal control over financial reporting. Potential investors should be aware that the
design of any system of controls and procedures is based in part upon certain assumptions about the
likelihood of future events. There can be no assurance that any system of controls and procedures
will succeed in achieving its stated goals under all potential future conditions, regardless of how
remote.
PART II OTHER INFORMATION
Item 1. Legal Proceedings
On December 11, 2008, we received notice that a complaint had been filed in a
putative class action lawsuit on behalf of 59 persons or entities that purchased units pursuant to
a financing terms agreement, or FTA, dated April 11, 2006, captioned Gerald S. Leeseberg, et al. v.
Converted Organics, Inc., filed in the U.S. District Court for the District of Delaware. The
lawsuit alleges breach of contract, conversion, unjust enrichment, and breach of the implied
covenant of good faith in connection with
the alleged failure to register certain securities issued in the FTA, and the redemption of our
Class A warrants in November 2008. The lawsuit seeks damages related to the failure to register
certain securities, including alleged late fee payments, of approximately $5.25 million, and
unspecified damages related to the redemption of the Class A warrants. In February 2009, we filed a
Motion for Partial Dismissal of Complaint. On October 7, 2009, the Court concluded that Leeseberg
has properly stated a claim for actual damages resulting from our alleged breach of contract, but
that Leeseberg has failed to state claims for conversion, unjust enrichment and breach of the
implied covenant of good faith, and the Court dismissed such claims. On November 6, 2009, we filed
our answer to the Complaint with the Court. On March 4, 2010, the parties participated in a
conference, and began discussing discovery issues. Plaintiff filed a Motion for Class Certification
on June 22, 2010, which is pending before the District Court. A jury trial has been set for May
17, 2011.We plan to vigorously defend this matter and are unable to estimate any losses that may or
may not be incurred as a result of this litigation and its eventual disposition. Accordingly, no
loss has been recorded related to this matter.
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
26
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.
On May 19, 2009, we received notice that a complaint had been filed in the Middlesex County
Superior Court of New Jersey, captioned Lefcourt Associates, Ltd. v. Converted Organics of
Woodbridge, et al. The lawsuit alleged private and public nuisances, negligence, continuing
trespasses and consumer common-law fraud in connection with the odors emanating from our Woodbridge
facility and our alleged, intentional failure to disclose to adjacent property owners the
possibility of our facility causing pollution and was later amended to allege adverse possession,
acquiescence and easement. The lawsuit sought enjoinment of any and all operations which in any way
cause or contribute to the alleged pollution, compensatory and punitive damages, counsel fees and
costs of suit and any and all other relief the Court deems equitable and just. On April 12, 2010,
the Middlesex County Superior Court of New Jersey issued an administrative order settlement
dismissing without prejudice the matter of Lefcourt Associates, Ltd. v. Converted Organics of
Woodbridge, et al. On June 8, 2010, Lefcourt Associates, Ltd re-filed their lawsuit but before a
different court, the Chancery Division in Bergen County. We filed a motion to transfer the action
back to the original court in Middlesex County, which was granted and we sought to have the lawsuit
dismissed, which was granted in part on August 27, 2010. The Court limited the plaintiffs claims
to the events in part that occurred after the dismissal of the prior action.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
In October 2010, we issued 165,000 unregistered shares of common stock to New Castle
Consulting, LLC for consulting services with regard to investor relations. This transaction was
exempt from the registration requirement of the Securities Act of 1933, as amended (the 1933
Act), pursuant to Section 4(2) under the 1933 Act, as the recipient is an accredited investor as
defined in the 1933 Act.
Item 3. Defaults upon Senior Securities
None.
Item 4. [Removed and Reserved]
Item 5. Other Information.
None.
Item 6. Exhibits
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Exhibit 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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99.1
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Unaudited pro forma consolidated
financial statements and consolidated financial statements of
TerraSphere Systems LLC as of September 30, 2010 and
December 31, 2009 and for the three and nine month periods ended
September 30, 2010 and 2009. |
27
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 15, 2010 |
/s/ Edward J. Gildea
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Edward J. Gildea |
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President and Chief Executive Officer |
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Date: November 15, 2010 |
/s/ David R. Allen
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|
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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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28