PART I - FINANCIAL INFORMATION

 

ITEM 1.   FINANCIAL STATEMENTS

 

 

 

 

 

 

		Three Months Ended						Nine Months Ended
		September 30,						September 30,
		2013			2012			2013			2012
Net sales		$	2,185,699		$	2,178,077		$	7,111,812		$	6,690,502
Cost of sales			1,931,321			2,014,731			6,212,531			6,014,886
Gross profit			254,378			163,346			899,281			675,616
Operating expenses			2,362,188			2,313,827			6,997,784			7,055,156
Other (income) expense			3,836			(2,787)			(321,159)			(1,421)
Operating loss			(2,111,646)			(2,147,694)			(5,777,344)			(6,378,119)
Change in value of senior warrants, gain			(535,926)			-			(2,091,226)			-
Change in value conversion feature senior notes, gain			(112,750)			-			(1,504,597)			-
Debt discount amortization expense			1,333,470			-			2,051,198			-
Interest expense, note payable			4,064			5,484			15,551			13,313
Extinguishment loss on senior notes conversion			1,087,822			-			1,283,322			-
Derivative revaluations (gain) loss			-			(17,176)			(1,217)			(12,465)
Interest on convertible notes			586,573			-			795,797			-
Financing costs on convertible notes			206,948			-			336,903			-
Net (loss)			(4,681,847)			(2,136,002)			(6,663,075)			(6,378,967)
Foreign Currency Translation adjustment			-			(1)			(64)			(4)
Comprehensive (loss)		$	(4,681,847)		$	(2,136,003)		$	(6,663,139)		$	(6,378,971)
Basic and diluted net loss per share		$	(0.04)		$	(0.02)		$	(0.06)		$	(0.06)
Weighted average common shares outstanding			132,929,067			113,249,335			114,928,123			109,826,629

 

 

 

 

		Nine Months Ended
		September 30,
		2013			2012
Operating Activities
Net loss		$	(6,663,075)		$	(6,378,967)
Adjustments to reconcile deficit accumulated for noncash items
Depreciation expense			1,128,200			1,035,336
Derivative revaluations (gain) loss			(1,217)			(12,465)
Change in value of senior warrants, gain			(2,091,226)			-
Change in value conversion feature senior notes, gain			(1,504,597)			-
Debt discount amortization expense			2,051,198			-
Interest accrued, senior convertible notes paid in common stock			727,217			-
Debt discount amortization expense on subordinated note			42,579			-
Extinguishment loss on senior notes conversion			1,283,322			-
Amortization deferred finance costs			336,903			-
Stock based compensation expense			168,244			311,637
Changes in operating assets & liabilities
Accounts receivable			441,362			3,169
Other receivables			-			140,389
Other current assets			(89,298)			(85,575)
Inventory, net			(415,839)			(512,002)
Accounts payable			17,100			219,559
Other current liabilities			(8,748)			(116,489)
Accrued interest			32,001			-
Deferred revenue			(254,950)			(226,682)
Cash (used) by operating activities			(4,800,824)			(5,622,090)
Investing Activities
Other receivables			9,000			5,000
Capital expenditures			(151,570)			(742,834)
Cash (used) by investing activities			(142,570)			(737,834)
Financing Activities
Repayment of note payable			(92,474)			(80,870)
Proceeds from senior and subordinated convertible notes			10,000,000			-
Net Proceeds from sale of common stock			-			8,625,979
Payment of debt issuance costs			(485,735)			-
Amount deposited into restricted cash account			(5,420,901)			-
Cash provided by financing activities			4,000,890			8,545,109
Net increase in cash and cash equivalents			(942,504)			2,185,185
Effect of exchange rate on cash			(64)			(4)
Cash and cash equivalents – beginning			2,004,391			1,987,637
Cash and cash equivalents – ending		$	1,061,823		$	4,172,818
Supplemental Schedule of Non Cash Investing and Financing Activities:
Common stock issued for principal payments on senior notes		$	3,075,000
Warrants issued for placement agent fees		$	143,777

 

 

 

 

Inventories consist of the following:

 

 

Inventory reserves include a provision for inventory valuation and obsolescence.

3.              Warrants

 

Warrants consist of the following:

 

		Shares		Weighted  average  exercise price			Weighted average  remaining contract  term (years)
Warrants outstanding at December 31, 2012		11,712,315		$	0.83		1.1
Granted		20,110,320			0.30		5.0
Exercised		-			-		-
Forfeited or lapsed		(11,666,654)			0.86		-
Warrants outstanding at September 30, 2013		20,155,981		$	0.31		4.6

 

As of September 30, 2013, there are 17,281,107 warrants classified as derivative liabilities relating to senior convertible notes of the Company issued on May 8, 2013, which were exercisable November 8, 2013. Of the 20,155,981 warrants outstanding, 45,661 are exercisable. For each reporting period, the warrants classified as derivatives are revalued with the change in value reported as a change in value of senior warrants on the consolidated condensed statements of operations. (See Footnote 6)

 

 

				Weighted Average
		Number of  Options		Exercise			Fair  Value			Remaining  Life  (years)		Aggregate  Intrinsic  Value
Options outstanding at December 31, 2012		4,076,145		$	1.70		$	0.56		3.8		$	-
Granted		498,501			0.12			0.08		5.0			-
Exercised		-			-			-		-			-
Forfeited or lapsed		(214,301)		$	2.91			0.79		-			-
Options outstanding at September 30, 2013		4,360,345		$	1.48		$	0.55		3.4		$	-
Options exercisable at September 30, 2013		3,468,725		$	1.69		$	0.58		2.8		$	-

All non-vested compensatory stock options consist of the following:		All Options
		Shares		Fair Value
Options subject to future vesting at December 31, 2012		1,110,147		$	0.24
Options granted		498,501			0.56
Options forfeited or lapsed		(214,301)			0.11
Options vested		(502,727)			0.32
Options subject to future vesting at September 30, 2013		891,620		$	0.41

5.        Earnings (Loss) Per Share

 

Basic earnings per share is computed by dividing income available to common shareholders (the numerator) by the weighted-average number of common shares outstanding (the denominator) for the period. Diluted earnings per share are computed by assuming that any dilutive convertible securities outstanding were converted, with related preferred stock dividend requirements and outstanding common shares adjusted accordingly. It also assumes that outstanding common shares were increased by shares issuable upon exercise of those stock options for which the market price exceed the exercise prices, less shares which could have been purchased by us with the related proceeds. In periods of losses, diluted loss per share is computed on the same basis as basic loss per share as the inclusion of any other potential shares outstanding would be anti-dilutive.

 

If the Company had generated earnings during the nine months ended September 30, 2013 and 2012, the Company would have added 5,332,532 and 517,617 respectively, of common equivalent shares to the weighted average shares outstanding to compute the diluted weighted average shares outstanding.

 

 

 

6.         Senior Convertible Notes and Warrants, and Subordinated Notes and Warrants

 

On May 8, 2013, the Company consummated the sale of $9 million in aggregate principal amount of senior convertible notes (the “Senior Notes”) due on February 8, 2015 and warrants (the “Senior Warrants”) to various institutional investors (“Investors”). At closing, the Company received $2.76 million in net proceeds, after deducting placement agent fees of $240,000. Total offering expenses were $494,500 and were recorded as deferred financing fees. The $6,000,000 balance of the gross proceeds from the sale of Senior Notes was deposited into a series of control accounts in the Company’s name. Withdrawals from the control accounts are permitted (i) in connection with certain conversions of the Senior Notes or (ii) otherwise, as follows: $500,000 on each 30 day anniversary of the closing date (May 8, 2013) commencing on the 60^th day after the closing date until there are no more funds in the control accounts. The Senior Notes and Senior Warrants and the Subordinated Notes and Subordinated Warrants described below were issued in transactions exempt from registration under Section 4(2) of the Securities Act of 1933, as amended. As of September 30, 2013, we have received one $500,000 funds release and an additional $75,000 due to accelerated note conversions by two investors.

 

The following is intended to provide a summary of the terms of the agreements and securities described above. This summary is qualified in its entirety by reference to the full text of the agreements, each of which is attached as an exhibit to our Current Report on Form 8-K filed with the SEC on May 8, 2013. Readers should review those agreements for a complete understanding of the terms and conditions associated with these transactions.

 

Securities Purchase Agreement

 

The Senior Convertible Notes and Senior Warrants were issued pursuant to the terms of a Securities Purchase Agreement (“Purchase Agreement”) entered into among us and the Investors. The Purchase Agreement provided for the sale of the Senior Convertible Notes and Senior Warrants for gross proceeds of $9 million to us.

 

Ranking - The Senior Notes are senior unsecured obligations of the Company, subject only to certain secured obligations of the Company for up to a maximum of $1 million of government issued indebtedness for purchase of plant and machinery and other purchase money financing for property, plant and equipment.

 

Maturity Date - Unless earlier converted or redeemed, the Senior Notes mature 21 months from the closing date subject to the right of the investors to extend the date (i) if an event of a default under the Senior Notes has occurred and (ii) for a period of 20 business days after the consummation of a fundamental transaction if certain events occur.

 

Interest - The Senior Notes bear interest at the rate of 8% per year, compounded monthly on the first calendar day of each calendar month. The interest rate will increase to 18% per year upon the occurrence and continuance of an event of default (as described below). 

 

Conversion - The Senior Notes are convertible at any time at the option of the holders, into shares of the Company’s common stock at an initial conversion price of $0.264 per share (subsequent conversions are based on the company’s volume weighted average price per share).  The conversion price is subject to adjustment for stock splits, combinations or similar events. In addition, the conversion price is also subject to a “full ratchet” anti-dilution adjustment if the company issues or is deemed to have issued securities at a price lower than the then applicable conversion price. In the event certain equity conditions are not met, the company may be prevented from issuing shares to satisfy the installments due on the note.

 

The Senior Notes may not be converted with respect to any note holder if, after giving effect to the conversion or issuance, the holder together with its affiliates would beneficially own in excess of 4.99% of the Company’s outstanding shares of common stock. At each holder’s option, the limit on percentage ownership may be raised or lowered to any other percentage not in excess of 9.99%, except that any raise will only be effective upon 61-days’ prior notice to the Company.

 

Events of Default

 

The Senior Notes contain standard and customary events of default including but not limited to: (i) failure to register our Common Stock within certain time periods; (ii) failure to make payments when due under the Senior Notes; and (iii) bankruptcy or insolvency of the Company.

 

If an event of default occurs, the Senior Note holders may require the Company to redeem all or any portion of the Senior Notes (including all accrued and unpaid interest thereon), in cash, at a price equal to the greater of (i) up to 125% of the amount being redeemed, depending on the nature of the default, and (ii) the intrinsic value of the shares of Common Stock then issuable upon conversion of the Convertible Note.

 

 

 

 

Fundamental Transactions

 

The Senior Notes prohibit the Company from entering into specified transactions involving a change of control, unless the successor entity assumes in writing all obligations under the Senior Notes under a written agreement.

 

In the event of transactions involving a change of control, the Senior Notes will be redeemable whole or in part (including all accrued and unpaid thereon) at a price equal to the greater 125% of the amount of the face value of the Senior Note being redeemed and the intrinsic value of the shares of Common Stock then issuable upon conversion of the Senior Note being redeemed.

 

Warrants

 

The Warrants entitle the holders to purchase, in the aggregate, 17,281,107 shares of common stock. The Warrants were exercisable November 8, 2013 and will expire 5 years from the Closing Date. The Warrants were exercisable at an exercise price equal to $0.302, subject to certain adjustments.

 

The Warrants may be exercised for cash, provided that, if there is no effective registration statement available registering the exercise of the Warrants, the Warrants may be exercised on a cashless basis.

 

The exercise price of the Warrants is subject to adjustment for stock splits, combinations or similar events. In addition, the exercise price is also subject to a “full ratchet” anti-dilution adjustment if we issue or are deemed to have issued securities at a price lower than the then applicable exercise price.

 

The Warrants may not be exercised with respect to any warrant holder if, after giving effect to the exercise, the warrant holder together with its affiliates would beneficially own in excess of 4.99% of our outstanding shares of common stock. At each Warrant holder’s option, the limit on percentage ownership may be raised or lowered to any other percentage not in excess of 9.99%, except that any increase will only be effective upon 61-days’ prior notice to the Company.

 

The Senior Warrants prohibit the Company from entering into specified transactions involving a change of control, unless the successor entity assumes all obligations under the Senior Warrants under a written agreement before the transaction is completed. When there is a transaction involving a permitted change of control, a Senior Warrant holder will have the right to require us to repurchase their Senior Warrant for a purchase price in cash equal to the Black-Scholes value of the then unexercised portion of the Senior Warrant.

Accounting for the Conversion Option and Warrants

 

The Company first considered whether the notes met the criteria under ASC 480-10-25-14 to be recorded as a liability and determined that, due to the note’s differing potential settlement features, it did not meet the criteria. The Company next considered whether the conversion option met the definition of a derivative, requiring it to be bifurcated and recorded as a liability. Pursuant to ASC 815-40, due to full-ratchet down-round price protection on the conversion price of the Senior Notes and the exercise price of the Warrants, the Company determined that the conversion features of the Senior Notes and the exercise price of the Senior Warrants, the Company determined that the conversion features of the Senior Notes and the exercise features of the Senior Warrants are not indexed to the Company’s owned stock and must be recognized separately as a derivative liability in the consolidated balance sheet, measured at fair value and marked to market each reporting period until the Senior Notes have been fully paid or converted and the Senior Warrants fully exercised.

 

The conversion feature of the Senior Notes was valued using the Monte Carlo simulation model under the following assumptions; (i) expected life of 0.9 years, (ii) volatility of 60%, (iii) risk-free interest rate of 0.10%, and (iv) dividend rate of 0.  The Senior Warrants were also valued using the Monte Carlo simulation model, under the following assumptions: (i) expected life of 5 years, (ii) volatility of 0.80%, (iii) risk-free interest rate of 0.75%, and (iv) dividend rate of zero.  The initial fair values of the conversion feature and the warrants were estimated to be $2.9 million and $1.5 million, respectively, totaling $4.4 million.  This amount was recorded as debt discount on May 8, 2013 and is being amortized over the term of the note using the interest method. In addition, debt issuance costs totaling $494,500 are being amortized over the term of the note using the effective interest method.

 

 

 

As of September 30, 2013, the conversion feature was valued at $7,403 and the Senior Warrants were valued at $847,000. The change in fair value of $3.6 million was recorded as a non-cash (gain) in change in value of these derivatives for the quarter ended September 30, 2013.  The Senior Warrants and the conversion feature of the Senior Notes are classified as a liability in the consolidated condensed balance sheet as follows:

 

		Warrants			Conversion Feature			Total
Original valuation – May 8, 2013		$	2,938,000		$	1,512,000		$	4,450,000
Adjustment to fair value			(2,091,226)			(1,504,597)			(3,595,823)
Ending Balance – September 30, 2013		$	846,774		$	7,403		$	854,177

 

Pursuant to the terms of the Senior Notes, the Company opted to pay the installment payments due prior to September 30, 2013 with shares of the Company’s common stock.  As of September 30, the Company issued 28.8 million shares of common stock at a weighted average conversion price of $0.1224 for the first $3.1 million in principal and $470,000 of interest. In addition 625,000 shares were issued for accelerated conversions netted a release of $75 thousand. A loss on extinguishment was recognized in the amount of $1,283,322, for the difference between the installment amount and the fair value of the shares at the issuance date. As of September 30, 2013, the principal balance of the Senior Notes (net of discount) was as follows:

 

		Convertible Note			Debt  Discount			Net Total
Original valuation – May 8, 2013		$	9,000,000		$	(4,450,000)		$	4,550,000
Installment Payments in Shares			(3,075,000)			-			(3,075,000)
Amortization of debt discount			-			2,051,198			2,051,198
Ending Balance – September 30, 2013		$	5,925,000		$	(2,398,802)		$	3,526,198

 

Placement Agent Warrants

 

Upon the closing of the issuance of the Senior Notes and Senior Warrants, the Company issued 909,090 warrants to its placement agent and is obligated to issue additional warrants when and if the Company receives further proceeds from the sale of the Senior Notes and Senior Warrants which are currently being held in the control accounts described above. The initial placement agent warrants have been recognized as additional financing fees and are being amortized over the life of the Senior Notes. These warrants were determined not to be derivative instruments, and as such they have been recorded as equity. The fair value of the initial issuance of 909,090 placement agent warrants was estimated to be $144,000 using the Black-Scholes model with the following assumptions: (i) expected life of 5 years, (ii) volatility of 80%, (iii) risk free interest rate of 0.75% and (iv) dividend yield of zero.

 

Subordinated Convertible Notes and Subordinated Warrants

 

Simultaneously with the closing of the $9 million principal amount Senior Note transaction, the Company sold $1 million principal amount of its Subordinated Convertible Notes (the “Subordinated Notes”) to investors consisting of management and directors of the Company and one individual investor. The sale of the Subordinated Notes did not carry any additional fees and expenses, so the Company received the entire $1 million in proceeds from the Subordinated Notes at closing. The Subordinated Notes are subordinated in right of repayment to the Senior Notes and mature 91 days subsequent to the maturity date of the Senior Notes. The Subordinated Notes bear interest at the rate of 8% per year. Once 2/3 of the Senior Notes have been repaid, then the Subordinated Notes may be converted and/or prepaid in cash so long as there is no Event of Default with respect to the Senior Notes and all Equity Conditions (as defined in the securities purchase agreement for the Senior Notes) are met. The conversion price for the Subordinated Notes is $0.264 per share. The holders of the Subordinated Convertible Notes were issued five year warrants to purchase 1,920,123 shares of Company common stock (“Subordinated Warrants”). Each Subordinated Warrant has an exercise price of $0.302 per share.

 

As the conversion feature of the Subordinated Notes and the related warrants were determined not to be derivative instruments, in accordance with the guidance in ASC Topic 470-20 Debt with Conversion and Other Options (“ASC 470”), the Company first calculated the fair value of the warrants issued and then calculated the relative value of the note and determined that there was a beneficial conversion feature in the amount of $246,000. However, as conversion of the Subordinated Notes is conditioned upon 2/3 of the Senior Notes being repaid, the beneficial conversion feature was determined to be contingent and therefore will not be booked unless and until the contingency is resolved.

 

 

 

 

The fair value of the warrants, issued in connection with the Subordinated Notes is $304,000 in the aggregate and was calculated using the Black-Scholes option pricing model with the following assumptions: (i) expected life of 5 years, (ii) volatility of 80%, (iii) risk free interest rate of 0.75% and (iv) dividend yield of zero.

 

The relative value of the warrants to the note was $263,000, which was the amount recorded as original debt discount.

 

The balance at September 30, 2013 related to the Subordinated Notes was comprised of:

 

 

Fair Value Disclosure

 

The Company has two Level 3 financial instruments, Senior Warrants and the conversion feature associated with the Senior Notes, which are both recorded at fair value on a periodic basis.  The Senior Warrants and the conversion feature are evaluated under the hierarchy of FASB ASC Subtopic 480-10, FASB ASC Paragraph 815-25-1 and FASB ASC Subparagraph 815-10-15-74 addressing embedded derivatives. The fair value of the warrants and the conversion feature are estimated using the Monte Carlo simulation model. As of September 30, 2013, the following table represents the Company’s fair value hierarchy for items that are required to be measured at fair value on a recurring basis:

 

8. Subsequent Events

 

On October 9, 2013, the Company appointed Stephen Graham as its new Chief Financial Officer, effective as of October 21, 2013.

 

 

ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

(1)

EBITDA, a non-GAAP financial measure, is defined as earnings before interest expense and interest income, income taxes, depreciation, amortization, stock based compensation, derivative revaluations, change in value of senior warrants, change in value of conversion feature of senior warrants, extinguishment loss on senior notes conversion and impairment of assets. EBITDA is used by management to internally measure our operating and management performance and by investors as a supplemental financial measure to evaluate the performance of our business that, when viewed with our GAAP results and the accompanying reconciliation, we believe provides additional information that is useful to gain an understanding of the factors and trends affecting our business.

ITEM 1 .

LEGAL PROCEEDINGS

ITEM 1A.

RISK FACTORS

ITEM 4.

MINE SAFETY DISCLOSURES

ITEM 6.

EXHIBITS

3.7		Amendment to Articles of Incorporation, dated September 26, 2013 (34)
10.44		Securities Purchase Agreement, dated May 7, 2013, between Axion Power International, Inc. and the Investors (31)
10.45		Form of Note (31)
10.46		Form of Warrant (31)
10.47		Registration Rights Agreement, dated May 8, 2013, between Axion Power International, Inc. and the Investors (31)
10.48		Subordinated Note Purchase Agreement, dated May 7, 2013, between Axion Power International, Inc. and the Subordinated Investors (31)
10.49		Form of Subordinated Note (31)
10.50		Form of Subordinated Note Warrant (31)
10.51		Subordination Agreement, dated May 8, 2013, by and among Axion Power International, Inc., the Investors and the Subordinated Investors (31)
10.52		Executive Employment Agreement of Thomas Granville, effective April 1, 2013 (32)
10.53		Executive Employment Agreement of Charles Trego, effective April 1, 2013 (32)
10.54		Executive Employment Agreement of Phillip Baker, effective April 1, 2013 (32)
10.55		Executive Employment Agreement of Vani Dantam, effective April 1, 2013 (32)
		10.56  Executive Employment Agreement of Stephen Graham, effective October 21, 2013 (33)
		(31) Incorporated by reference from our Form 8-K, filed with the Securities and Exchange Commission on May 8, 2013
		(32) Incorporated by reference from our 10-Q, filed with the Securities and Exchange Commission on May 14, 2013
		(33) Incorporated by reference from our Form 8-K, filed with the Securities and Exchange Commission on October 15, 2013
		(34) Incorporated  by reference from our Registration Statement on Form S-1, filed with the Securities and Exchange Commission on October 16, 2013
31.1		Certification of Principal Executive Officer Pursuant to Rule 13a-14(a)
31.2		Certificate of Principal Financial Officer Pursuant to Rule 13a-14(a)
32.1		Statement of Principal Executive Officer Pursuant to Section 1350 of Title 18 of the United States Code
32.2		Statement of Principal financial Officer Pursuant to Section 1350 of Title 18 of the United States Code

101.INS		XBRL Instance Document
101.SCH		XBRL Taxonomy Extension Schema
101.CAL		XBRL Taxonomy Extension Calculation Linkbase
101.DEF		XBRL Taxonomy Extension Definition Linkbase
101.LAB		XBRL Taxonomy Extension Label Linkbase
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AXION POWER INTERNATIONAL, INC.
/s/ Thomas Granville
Thomas Granville, Principal Executive Officer
Dated: November 14, 2013
/s/ Stephen Graham
Stephen Graham, Principal Financial Officer and
Principal Accounting Officer
Dated: November 14, 2013