UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

Form 10-Q

 

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended June 30, 2014

 

OR

 

¨	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:     0-13111

 

AXION INTERNATIONAL HOLDINGS, INC

(Exact name of registrant as specified in its charter)

 

Colorado		84-0846389
(State or other jurisdiction of incorporation or		(IRS Employer Identification No.)
organization)

 

4005 All American Way, Zanesville, Ohio 43701

(Address of principal executive offices)

 

740-452-2500

(registrant’s telephone number, including area code)

 

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 ¨      No x

 

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 x No   ¨

 

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.

 

	Large accelerated filer ¨	Accelerated filer ¨
	Non-accelerated filer ¨	Smaller reporting company x

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes ¨   No x

 

The number of outstanding shares of the registrant’s common stock, without par value, as of August 13, 2014 was 69,050,800.

 

 

TABLE OF CONTENTS

 

		PAGE
	PART I. FINANCIAL INFORMATION
Item 1.	Financial Statements	3
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	31
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	41
Item 4.	Controls and Procedures	41
	PART II. OTHER INFORMATION
Item 1.	Legal Proceedings	43
Item 2.	Unregistered Sales of Securities and Use of Proceeds	43
Item 3.	Defaults Upon Senior Securities	44
Item 4.	Mine Safety Disclosures	44
Item 5.	Other Information	44
Item 6.	Exhibits	44
	SIGNATURES	45

 

 

PART I. FINANCIAL INFORMATION

 

Item 1. Financial Statements.

 

AXION INTERNATIONAL HOLDINGS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

 

		June 30,				December 31,
		2014				2013
		(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents		$	1,342,015			$	883,936
Accounts receivable, net of allowance			1,373,657				888,214
Inventories			3,347,011				3,955,515
Prepaid expenses and deposits			199,188				280,140
Total current assets			6,261,871				6,007,805
Property and equipment, net			8,076,012				7,899,486
Goodwill			1,492,132				1,492,132
Intangible assets			570,500				610,000
Total assets		$	16,400,515			$	16,009,423
LIABILITIES AND STOCKHOLDERS' DEFICIT
Current liabilities:
Accounts payable		$	2,647,693			$	1,879,760
Accrued liabilities			1,341,988				896,740
Derivative liabilities – 8% convertible promissory notes			10,695,000				17,190,000
Current portion of long term debt			186,635				185,347
Total current liabilities			14,871,316				20,151,847
8% convertible promissory notes, net of discounts			12,444,526				11,030,913
12% revolving credit agreement, net of discounts			1,970,636				1,873,716
4.25% bank term loans			4,400,000				4,400,000
Other debt			236,201				300,127
Fair value of 10% convertible preferred stock warrants			119,703				296,194
Total liabilities			34,042,382				38,052,797
Commitments and contingencies
10% convertible preferred stock, no par value; authorized 880,000 shares; 694,623 shares issued and outstanding at June 30, 2014 and December 31, 2013, net of discounts			6,946,230				6,724,844
Stockholders' deficit:
Common stock, no par value; authorized, 250,000,000 shares; 68,197,143 and 31,168,905 shares issued and outstanding at June 30, 2014 and December 31, 2013, respectively			51,543,123				30,500,445
Accumulated deficit			(76,131,220	)			(59,268,663	)
Total stockholders' deficit			(24,588,097	)			(28,768,218	)
Total liabilities and stockholders' deficit		$	16,400,515			$	16,009,423

 

(See accompanying notes to the unaudited condensed consolidated financial statements.)

 

 

AXION INTERNATIONAL HOLDINGS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

FOR THE THREE MONTHS ENDED JUNE 30,

(Unaudited)

 

		2014				2013
Revenue		$	4,054,054			$	1,499,950
Costs of sales:
Production			5,208,692				1,433,415
Excess capacity & inventory adjustments			994,228				100,799
Gross margin (loss)			(2,148,866	)			(34,264	)
Operating expenses:
Product development and quality management			94,572				250,393
Marketing and sales			374,875				256,166
General and administrative			20,125,270				766,118
Total operating expenses			20,594,717				1,272,677
Loss from operations			( 22,743,583	)			(1,306,941	)
Other (income) expenses:
Interest expense			457,974				180,249
Amortization of debt discount			422,678				138,137
Fair value of common shares issued in excess of fair value of warrants tendered			883,476				-
Change in fair value of derivative liabilities			(4,075,518	)			(5,133,660	)
Total other (income)			( 2,311,390	)			(4,815,274	)
Net income (loss)			(20,432,193	)			3,508,333
Accretion of preferred stock dividends and beneficial conversion feature			(184,195	)			(401,507	)
Net income (loss) attributable to common shareholders		$	(20,616,388	)		$	3,106,826
Weighted average common shares -
Basic			37,799,845				29,563,990
Diluted			37,799,845				58,821,822
Net income (loss) per share -
Basic		$	(0.55	)		$	0.11
Diluted			(0.55	)			0.06

  

(See accompanying notes to the unaudited condensed consolidated financial statements.)

 

  

AXION INTERNATIONAL HOLDINGS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

FOR THE SIX MONTHS ENDED JUNE 30,

(Unaudited)

 

		2014				2013
Revenue		$	8,904,997			$	3,259,585
Costs of sales:
Production			10,816,117				2,955,836
Excess capacity & inventory adjustments			1,459,894				100,799
Gross margin (loss)			(3,371,014	)			202,950
Operating expenses:
Product development and quality management			174,054				468,616
Marketing and sales			675,586				501,095
General and administrative			21,105,704				1,484,229
Total operating expenses			21,955,344				2,453,940
Loss from operations			(25,326,358	)			(2,250,990	)
Other (income) expenses:
Interest expense			841,631				352,653
Amortization of debt discount			859,087				282,028
Fair value of common shares issued in excess of fair value of warrants tendered			883,476				-
Change in fair value of derivative liabilities			(11,047,995	)			476,064
Total other (income) expenses			(8,463,801	)			1,110,745
Net (loss)			(16,862,557	)			(3,361,735	)
Accretion of preferred stock dividends and beneficial conversion feature			(565,378	)			(812,337	)
Net (loss) attributable to common shareholders		$	(17,427,935	)		$	(4,174,072	)
Weighted average common shares - basic and diluted			50,650,392				29,214,965
Net (loss) per share - basic and diluted		$	(0.34	)		$	(0.14	)

 

(See accompanying notes to the unaudited condensed consolidated financial statements.)

 

 

AXION INTERNATIONAL HOLDINGS, INC.

CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ DEFICIT

FOR THE PERIOD FROM JANUARY 1, 2014 THROUGH JUNE 30, 2014

(Unaudited)

 

		Common Shares				Additional Paid-in Capital and Common Stock				Accumulated Deficit				Total
Balance, January 1, 2014			31,168,905			$	30,500,445			$	(59,268,663	)		$	(28,768,218	)
Shares issued as payment in kind for dividends			397,473				343,143								343,143
Shares issued as payment in kind for interest			874,246				688,465								688,465
Share-based compensation			303,540				618,594								618,594
Dividend on 10% convertible preferred stock							(343,992	)							(343,992	)
Amortization of beneficial conversion feature of 10% convertible preferred stock							(221,386	)							(221,386	)
Fair value of warrants tendered and cancelled							(4,859,232	)							(4,859,232	)
Fair value of common stock issued in exchange for warrants tendered and cancelled			35,452,979				24,817,086								24,817,086
Net (loss)											(16,862,557	)			(16,862,557	)
Balance, June 30, 2014			68,197,143			$	51,543,123			$	(76,131,220	)		$	(24,588,097	)

 

(See accompanying notes to the unaudited condensed consolidated financial statements.)

 

 

AXION INTERNATIONAL HOLDINGS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE SIX MONTHS ENDED JUNE 30,

(Unaudited)

  

		2014				2013
Cash flow from operating activities:
Net (loss)		$	(16,862,557	)		$	(3,361,735	)
Adjustments to reconcile net (loss) to net cash used in operating activities:
Depreciation and amortization			512,916				72,567
Amortization of identifiable intangible assets			39,500				-
Amortization of convertible debt discount			859,086				282,028
Change in fair value of derivative liabilities			(10,871,504	)			435,424
Change in fair value of 10% convertible preferred stock warrants			(176,491	)			40,641
Change in allowance for doubtful account			154,280				(131,996	)
Interest expense paid in shares of common stock			688,465				-
Share-based compensation			618,594				141,492
Fair value of common stock issued in excess of fair value of warrants tendered			19,957,854				-
Changes in operating assets and liability:
Accounts receivable			(639,723	)			67,082
Inventories			608,504				46,718
Prepaid expenses and deposits			80,952				78,486
Accounts payable			767,933				270,064
Accrued liabilities			444,399				146,418
Net cash used in operating activities			(3,817,792	)			(1,912,811	)
Cash flows from investing activities:
Purchase of property and equipment			(689,442	)			(352,708	)
Net cash used in investing activities			(689,442	)			(352,708	)
Cash flows from financing activities:
Proceeds from issuance of 8% convertible promissory notes, net			5,027,951				1,750,001
Recovery of shareholder short swing profits			-				3,095,308
Repayments of other debt			(62,638	)			-
Net cash provided by financing activities			4,965,313				4,845,309
Net increase in cash			458,079				2,579,790
Cash and cash equivalents at beginning of period			883,936				346,905
Cash and cash equivalents at end of period		$	1,342,015			$	2,926,695
Supplemental disclosures of cash flow information:
Cash paid for interest		$	150,124			$	1,322
Conversion of 10% convertible preferred stock and debt			-				39,000
Dividends on 10% convertible preferred stock			343,992				356,579
Amortization of 10% convertible preferred stock discount			221,386				455,758
Fair value of warrants issued with 8% convertible promissory notes			391,365				249,151
Fair value of conversion option of 8% convertible promissory notes			3,985,139				545,425
Fair value of common stock issued in exchange for warrants tendered and cancelled		$	24,817,086				-

 

(See accompanying notes to the unaudited condensed consolidated financial statements.) 

 

 

AXION INTERNATIONAL HOLDINGS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Note 1 - Summary of Significant Accounting Policies

 

(a)

Business and Basis of Financial Statement Presentation

 

Axion International Holdings, Inc. (“Holdings”) was formed in 1981.   In November 2007, Holdings entered into an Agreement and Plan of Merger, among Holdings, Axion Acquisition Corp., a Delaware corporation and a newly created direct wholly-owned subsidiary of Holdings (the “Merger Sub”), and Axion International, Inc., a Delaware corporation which incorporated on August 6, 2006 with operations commencing in November 2007 (“Axion”).  On March 20, 2008 Holdings consummated the merger (the “Merger”) of Merger Sub into Axion, with Axion continuing as the surviving corporation and a wholly-owned subsidiary of Holdings.

 

Axion Recycled Plastics Incorporated, an Ohio corporation and a recently created direct wholly-owned subsidiary of Axion, was established to purchase certain tangible and intangible assets of a plastics recycling company during November 2013.

 

We are a green technology company, which delivers tested, proven and superior green solutions to plastics manufacturers and infrastructure needs around the globe. Through Axion International, Inc., our engineered products business segment, we manufacture, market and sell ECOTRAX ^TM - our composite rail ties and STRUXURE ^TM - our structural building products, such as heavy construction and laminated temporary road mats, boards, pilings, I-beams, and T-beams. Axion Recycled Plastics Incorporated, our reprocessed plastics business segment, repurposes waste plastics into re-useable plastic raw materials, which are sold to manufactures or transferred for use in the production of our engineered products. Both our ECOTRAX and STRUXURE products are based upon patented technology and are fully derived from common recycled plastics and high-density polymers, such as polyethylene, polystyrene and polypropylene. These recycled plastics, which are combined with recycled plastic composites containing encapsulated fiberglass, achieve structural thickness and strength and are resistant to changing shape under constant stress. Our products, manufactured through an extrusion process, are eco-friendly, non-corrosive, impervious to moisture, do not leach chemicals and are resistant to insects and rot. Our engineered products possess superior lifecycles and generally have greater durability and require less maintenance than competitive products made from wood, steel or concrete.

 

Our consolidated financial statements include the accounts of our wholly-owned subsidiaries and all intercompany balances and transactions have been eliminated in consolidation.

 

The accompanying unaudited condensed consolidated financial statements of Holdings have been prepared in accordance with Rule S-X of the Securities and Exchange Commission and with the instructions to Form 10-Q, and accordingly, they do not include all of the information and footnotes which may be required by generally accepted accounting principles for complete financial statements.

 

In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. However, the results from operations for the three and six months ended June 30, 2014, are not necessarily indicative of the results that may be expected for the year ending December 31, 2014. The unaudited condensed consolidated financial statements should be read in conjunction with the consolidated December 31, 2013 financial statements and footnotes thereto included in the Company's Form 10-K filed with the SEC.

 

(b)

Cash and Cash Equivalents

 

For purposes of our balance sheet and statement of cash flows, we consider all highly liquid debt instruments, purchased as an investment, with an original maturity of three months or less to be cash equivalents. At June 30, 2014 and December 31, 2013, we maintained all of our cash in demand or interest-bearing accounts at commercial banks.

 

 

(c)

Allowance for Doubtful Accounts

 

We accrue a reserve on a receivable when, based upon the judgment of management, it is probable that a receivable will not be collected and the amount of any reserve may be reasonably estimated.  At June 30, 2014 we accrued a reserve of uncollectable accounts receivables in the amount of approximately $154,300. We did not provide for an allowance at December 31, 2013.

 

(d)

Property and Equipment

 

Property and equipment are recorded at cost and depreciated and amortized using the straight-line method over estimated useful lives of two to twenty years.  Costs incurred that extend the useful life of the underlying asset are capitalized and depreciated over the remaining useful life. Repairs and maintenance are charged directly to operations as incurred.

 

Our property and equipment is comprised of the following:

 

		June 30, 2014				December 31, 2013
Equipment		$	17,893			$	18,700
Machinery and equipment			9,487,114				8,803,087
Purchased software			166,443				145,622
Furniture and fixtures			-				14,599
Subtotal – property and equipment, at cost			9,671,450				8,982,008
Less accumulated depreciation			(1,595,438	)			(1,082,522	)
Net property and leasehold improvements		$	8,076,012			$	7,899,486

 

Depreciation expense charged to income during the three and six months ended June 30, 2014 was approximately $258,100 and $512,900, respectively and for the corresponding periods of 2013 was $48,200 and 72,600, respectively.

 

(e)

Exclusive Agreement

 

In February 2007, we acquired an exclusive, royalty-bearing license (subject to minimum royalties) in specific but broad global territories to make, have made, use, sell, offer for sale, modify, develop, import, and export products made using patent applications owned by Rutgers University (“Rutgers”).  We are using these patented technologies in the production of our composite rail ties and structural building products such as pilings, I-beams, T-beams and boards of various sizes.

 

Royalties incurred and payable to Rutgers, for the three and six months ended June 30, 2014 were $50,000 and $100,000, respectively. For the corresponding periods of 2013, the amounts were $50,000 and $100,000, respectively

 

(f)

Definite Life Intangible Assets

 

In accordance with FASB ASC topic, “Goodwill and Other Intangible Assets”, acquired intangibles, are subject to amortization over their useful lives. The method of amortization selected reflects the pattern in which the economic benefits of the specific intangible asset is consumed or otherwise used up. Since that pattern cannot be reliably determined, a straight-line amortization method has been used over the estimated useful life. Intangible assets that are subject to amortization are reviewed for potential impairment at least annually or whenever events or circumstances indicate that carrying amounts may not be recoverable. For the three and six month periods ended June 30, 2014 we amortized approximately $19,800 and $39,500, respectively of these intangible assets

 

 

(g)

Indefinite Life Intangible Assets - Goodwill

 

In accordance with the FASB ASC topic, “Goodwill and Other Intangible Assets”, indefinite life assets, such as goodwill, acquired as a result of a business acquisition and which are not subject to amortization are tested for impairment annually, or more frequently if events and circumstances indicate that the asset might be impaired. An impairment loss is recognized to the extent that the carrying amount exceeds the asset’s fair value. The fair value is determined by subtracting the fair value of all the identified tangible and intangible assets included in the business acquisition from the fair value of the purchase price.

 

Based on the results of six months ended June 30, 2014, we determined that our recent experience of financial results for our reprocessed plastics reporting segment represents a triggering event requiring goodwill and related intangible assets impairment tests. The goodwill and related intangible assets associated with our reprocessed plastics reporting segment totaled $2.1 million as of both June 30, 2014 and December 31, 2013. We were unable to reasonably estimate the amount of goodwill impairment, if any, during the six months ended June 30, 2014 and will complete our impairment test on all of our reporting units during the three months ended September 30, 2014.

 

(h)

Revenue and Related Cost Recognition

 

In accordance with FASB ASC 605 “Revenue Recognition”, revenue is recognized when persuasive evidence of an agreement with the customer exists, products are shipped or title passes pursuant to the terms of the agreement with the customer, the amount due from the customer is fixed or determinable, collectability is reasonably assured, and there are no significant future performance obligations. In most cases, we receive a purchase order from our customer specifying the products requested and delivery instructions. We recognize revenue upon our delivery or shipment of the products as specified in the purchase order. In other cases where we have a contract which provides for a large number of products and few actual deliveries, the revenues are recorded each month as the products are produced and the risk of ownership passes to the customer upon pre-delivery acceptance. Prior to deliveries, our customer’s products are segregated from our inventory and not available for fulfilling other orders.

 

Our costs of sales are predominately comprised of the cost of raw materials and the costs and expenses associated with the production of the finished product. Prior to 2013, we utilized third-party manufacturers, where under one arrangement we purchased and supplied the raw materials to the third-party manufacturer and we paid them a per-pound cost to produce the finished product. Under another arrangement, the third-party manufacturer sourced and paid for the raw materials and we purchased the finished product from them at a cost per unit. Beginning in 2013, we initiated production of our finished products within a leased facility utilizing our own employees. Additionally, in late 2013 we acquired the assets of a plastics recycling company and began to reprocess recycled plastics for use in our own finished products and to sell to customers for use in their finished products.  Our costs of sales may vary significantly as a result of the variability in the cost of our raw materials and the efficiency with which we plan and execute our manufacturing processes.

 

Historically, we have not had significant warranty replacements, but during the year ended December 31, 2013 due to the improper installation of certain of our rail ties, we agreed to replace the rail ties. We do not anticipate additional situations where we might again replace improperly installed products and therefore do not provide for future warrant expenses.

 

(i)

Income Taxes

 

Income tax provision consists of federal and state corporate income taxes resulting from our operations in the United States. The income tax provision differs from the expected tax provisions computed by applying the U.S. Federal statutory rate to loss before income taxes primarily because we have historically maintained a full valuation allowance on our deferred tax assets and to a lesser extent because of the impact of state income taxes. As described in our Form 10-K for the year ended December 31, 2013, we maintain a full valuation allowance in accordance with ASC 740, “Accounting for Income Taxes”, on our net deferred tax assets. Until we achieve and sustain an appropriate level of profitability, we plan to maintain a valuation allowance on our net deferred tax assets.

 

We are current with the filing of our federal and state income tax returns. Our income tax returns are open to examination by federal and state authorities, based on statute of limitations, which is three years.

 

 

(j)

Derivative Instruments

 

For derivative instruments that are accounted for as liabilities, the derivative instrument is initially recorded at its fair value and is then re-valued at each reporting date, with changes in fair value recognized in earnings each reporting period as a charge or credit to other expenses. We use the Monte Carlo simulation, and other models, as appropriate to value the derivative instruments at inception and subsequent valuation dates and the value is re-assessed at the end of each reporting period, in accordance with FASB ASC Topic 815, “Derivatives and Hedging”. Derivative instrument liabilities are classified in the balance sheet as current or non-current based on whether or not the net-cash settlement of the derivative instrument could be required within twelve months of the balance sheet date.

 

(k)

Share-Based Compensation

 

We record share-based compensation for transactions in which we exchange our equity instruments (shares of common stock, options and warrants) for services of employees, consultants and others based on the fair value of the equity instruments issued on the measurement date.  The fair value of common stock awards is based on the observed market value of our stock.  We calculate the fair value of options and warrants using the Black-Scholes option pricing model.  Expense is recognized, net of expected forfeitures, over the period of performance.  When the vesting of an award is subject to performance conditions, no expense is recognized until achievement of the performance condition is deemed to be probable. Awards to consultants are marked to market at each reporting period as they vest, and the resulting value is recognized as an adjustment against our earnings for the period.

 

(l)

Earnings and Loss Per Share

 

Basic earnings or loss per share are computed by dividing income or loss available to common shareholders by the weighted average number of common shares outstanding for the period.  Diluted earnings per share include the effects on our weighted average number of common shares outstanding of the potential dilution of (i) outstanding options and warrants, as determined using the treasury stock method and (ii) convertible securities as determined using the as-if converted method. For the three and six months ended June 30, 2014 there was no dilutive effects of such securities as we incurred a net loss for the periods. 

 

 

(m)

Fair Value of Financial Instruments

 

Fair value is defined as an exit price, which is the price that would be received upon sale of an asset or paid upon transfer of a liability in an orderly transaction between market participants at the measurement date.  The degree of judgment utilized in measuring the fair value of assets and liabilities generally correlates to the level of pricing observability.  Financial assets and liabilities with readily available, actively quoted prices or for which fair value can be measured from actively quoted prices in active markets generally have more pricing observability and require less judgment in measuring fair value.  Conversely, financial assets and liabilities that are rarely traded or not quoted have less price observability and are generally measured at fair value using valuation models that require more judgment.  These valuation techniques involve some level of management estimation and judgment, the degree of which is dependent on the price transparency of the asset, liability or market and the nature of the asset or liability.  We have categorized our financial assets and liabilities that are recurring at fair value into a three-level hierarchy in accordance with these provisions.

  

(n)

Concentration of Credit Risk

 

We maintain our cash with several major U.S. domestic banks. The amount held in these banks exceeds the insured limit of $250,000 from time to time. The amount which exceeded the insured limit was approximately $0.9 million and $0.3 million at June 30, 2014 and December 31, 2013, respectively.  We have not incurred losses related to these deposits.

 

(o)

Use of Estimates

 

The preparation of our financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in these financial statements and accompanying notes. Actual results could differ from those estimates.

 

Note 2 - Going Concern

 

The accompanying financial statements have been prepared in conformity with generally accepted accounting principles in the United States of America, which contemplates our continuation as a going concern.  At June 30, 2014, we had a working capital deficit of $8.6 million, a stockholders’ deficit of $24.6 million and have accumulated losses to date of $76.1 million.  This raises substantial doubt about our ability to continue as a going concern.  In view of these matters, realization of certain of the assets in the accompanying balance sheet is dependent upon our ability to meet our financing requirements, either by raising additional capital or the success of our business plan and future operations.   We may seek additional means of financing to fund our business plan.  There is no assurance that we will be successful in raising sufficient funds to assure our eventual profitability.  We believe that actions planned and presently being taken to revise our operating and financial requirements provide us the opportunity to continue as a going concern. The financial statements do not include any adjustments that might result from these uncertainties.

 

Note 3 – Reportable Business Segments

 

Our segment reporting is consistent with the current manner of how our Chief Operating Decision Maker (“CODM”) and our board of directors view our business. Our business model has consisted of reprocessing recycled or waste plastics into plastic products to be sold to manufacturers who require certain plastics in their processes and we transfer certain of these reprocessed plastics to our other segment which produces engineered products utilizing recycled plastics and plastic composites. In order to allow our CODM and management to make business decisions, we report two segments – Axion Recycled Plastics, our reprocessed plastics segment and Axion International, our engineered products segment. Decisions regarding allocation of resources and investment of capital have been made based on the reportable segments contribution to the financial success of the consolidated enterprise.

 

The significant accounting policies of each segment are described in note 1.

 

 

Segment Reporting - For the Three Months Ended June 30, 2014

 

		Engineered				Reprocessed				Corporate
		Products				Plastics				Activities				Combined
Statement of Operations
Revenue		$	2,185,811			$	1,868,243			$	-			$	4,054,054
Costs of sales:
Production			1,908,140				3,300,552				-				5,208,692
Excess capacity & inventory adjustments			994,228				-				-				994,228
Gross margin (loss)			(716,557	)			(1,432,309	)			-				(2,148,866	)
Product development & quality management			-				-				94,572				94,572
Marketing & sales			-				-				374,875				374,875
General & administrative			-				-				20,125,270				20,125,270
Total operating expenses			-				-				20,594,717				20,594,717
Loss from operations			(716,557	)			(1,432,309	)			(20,594,717	)			(22,743,583	)
Interest expense			-				-				457,974				457,974
Amortization of debt discounts			-				-				422,678				422,678
Fair value of common shares issued in excess of fair value of warrants tendered			-				-				883,476				883,476
Change in fair value of derivative liabilities			-				-				(4,075,518	)			(4,075,518	)
Total other (income)			-				-				(2,311,390	)			(2,311,390	)
Net (loss)		$	(716,557	)		$	(1,432,309	)		$	(18,283,327	)		$	(20,432,193	)
Total assets		$	6,788,540			$	8,070,771			$	1,541,204			$	16,400,515

 

 

Segment Reporting - For the Six Months Ended June 30, 2014

 

		Engineered				Reprocessed				Corporate
		Products				Plastics				Activities				Combined
Statement of Operations
Revenue		$	4,962,374			$	3,942,623			$	-			$	8,904,997
Costs of sales:
Production			4,698,535			$	6,117,582				-				10,816,117
Excess capacity & inventory adjustments			1,459,894				-				-				1,459,894
Gross margin (loss)			(1,196,055	)			(2,174,959	)			-				(3,371,014	)
Product development & quality management			-				-				174,054				174,054
Marketing & sales			-				-				675,586				675,586
General & administrative			-				-				21,105,704				21,105,704
Total operating expenses			-				-				21,955,344				21,955,344
Loss from operations			(1,196,055	)			(2,174,959	)			(21,955,344	)			(25,326,358	)
Interest expense			-				-				841,631				841,631
Amortization of debt discounts			-				-				859,087				859,087
Fair value of common shares issued in excess of fair value of warrants tendered			-				-				883,476				883,476
Change in fair value of derivative liabilities			-				-				(11,047,995	)			(11,047,995	)
Total other (income)			-				-				( 8,463,801	)			(8,463,801	)
Net (loss)		$	(1,196,055	)		$	(2,174,959	)		$	(13,491,543	)		$	(16,862,557	)

 

(1) Since the acquisition of the plastics recycling company which provided the second segment to our business was acquired in November 2013, we did not report segment information for the three or six months ended June 30, 2013. 

 

Note 4 - Inventories

 

Inventories are priced at the lower of cost or market and consist primarily of raw materials, parts for assembling our finished products and finished products.

 

Our inventories consisted of:

 

		June 30, 2014				December 31, 2013
Finished products		$	2,720,278			$	2,930,753
Production materials			626,733				1,024,762
Total inventories		$	3,347,011			$	3,955,515

 

Since we engaged third-party contract manufacturers to produce our finished products in the past, certain inventories at June 30, 2014 and December 31, 2013 are located at these third-party contract manufacturing locations. We carry adequate insurance for loss on this inventory. 

 

 

Note 5 - Accrued Liabilities

 

The components of accrued liabilities are:

 

		June 30, 2014				December 31, 2013
Royalties		$	398,487			$	235,772
Interest			392,700				248,763
Rent			209,804				78,797
10% convertible preferred stock dividends			184,195				183,346
Payroll			113,033				119,937
Miscellaneous			43,769				30,125
Total accrued liabilities		$	1,341,988			$	896,740

    

Note 6 - Derivative Liabilities

 

8% Convertible Promissory Notes – Conversion Option and Warrants

 

Prior to, and through June 30, 2014, we issued 8% convertible promissory notes (the “8% Notes”). See Note 7 for further discussion. The 8% Notes met the definition of a hybrid instrument, as defined in the ASC Topic 815 “Derivatives and Hedging” (“ASC 815”). The hybrid instrument was composed of a debt instrument, as the host contract, and an option to convert the debt outstanding under the terms of the 8% Notes, into shares of our common stock. The 8% Notes were issued with a warrant to purchase shares of our common stock. Both the conversion option and the warrants are derivative liabilities. The conversion option derives its value based on the underlying fair value of the shares of our common stock which is not clearly and closely related to the underlying host debt instrument since the economic characteristics and risk associated with the conversion option derivative are based on the common stock fair value. The warrants do not qualify as equity under ASC 815. Accordingly, changes in the fair value of these warrant and conversion option liabilities are immediately recognized in earnings and classified as a change in fair value in the statement of operations.

 

We determined the fair value of the conversion option and warrant derivative liabilities on the various dates of issuance and recorded these fair values as a discount to the debt and a derivative liability. The fair value of the conversion option derivative liability on the dates of issuance for those 8% Notes sold during the three months ended June 30, 2014 and the aggregate fair value of all the conversion options on June 30, 2014 was $3.0 million and $10.7 million, respectively. The $669,000 decrease in the fair value of this derivative liability during the three months ended June 30, 2014 was recorded as a change in derivative liability in the statement of operations.

 

During the three months ended June 30, 2014, we offered all warrant holders the right to exchange their warrants for their fair value, as calculated using the Black-Scholes option pricing model, for shares of common stock. All warrants associated with the 8% Notes were exchanged for shares of common stock resulting in no derivative liability for the warrants at June 30, 2014. This decrease in fair value of $3.4 million during the three months ended June 30, 2014 was recorded as a change in fair value of derivative liability in the statement of operations. The fair value of common stock issued in exchange for warrants tendered exceeded the fair value of the warrant liability which resulted in compensation expense for all warrant holder considered affiliates of $19.1 million and approximately $883,500 of additional expense classified as fair value of common stock issued in excess of fair value of warrants tendered for the three and six months ended June 30, 2014.

 

The estimated fair values of the derivative liabilities for the conversion options on the 8% Notes issued during the six months ended June 30, 2014 and the warrants issued therewith, were computed by a third party using Monte Carlo simulations based on the following ranges for each assumption:

 

		At Issuances				June 30, 2014
Volatility			40.0% to 45.0	%			40.0	%
Risk-free interest rate			0.2% to 0.3	%			0.2	%
Dividend yield			0.0	%			0.0	%
Expected life			1.2 to 1.6 years				1.2 years

  

 

Placement Agent Warrants

 

We issued warrants to the placement agents for the sale of our 10% convertible preferred stock, to purchase 58,352 shares of 10% convertible preferred stock at $10 per share. Since the underlying 10% convertible preferred stock is redeemable by the holder after three years from the date of purchase, we recorded the fair value of the warrants at issuance, as a liability on our balance sheet and we re-measure this warrant liability at each reporting date, with changes in fair value recognized in earnings each reporting period. We estimated the fair value at June 30, 2014 of this derivative liability by using the Black-Scholes option pricing model with the following assumptions - (i) no dividend yield, (ii) an expected volatility of 85%, (iii) a risk-free interest rate 0.47%, and (iv) an expected life of approximately two years. The fair value of the warrant liability at June 30, 2014 and December 31, 2013 was approximately $119,700 and $296,200, respectively and we recognized a credit to our statement of operations for the decrease in fair value of the warrant liability for the three and six months ended June 30, 2014 of approximately $55,500 and $176,500, respectively.

 

Accounting for Fair Value Measurements

 

We are required to disclose the fair value measurements required by Accounting for Fair Value Measurements. The derivative liabilities recorded at fair value in the balance sheet as of June 30, 2014 and December 31, 2013 is categorized based upon the level of judgment associated with the inputs used to measure its fair value. Hierarchical levels, defined by Accounting for Fair Value Measurements are directly related to the amount of subjectivity associated with the inputs to fair valuation of the liability is as follows:

 

Level 1 -	Inputs are unadjusted, quoted prices in active markets for identical assets or liabilities at the measurement date;
Level 2 -	Inputs other than Level 1 inputs that are either directly or indirectly observable; and
Level 3 -	Unobservable inputs, for which little or no market data exist, therefore requiring an entity to develop its own assumptions.

 

The following table summarizes the financial liabilities measured at fair value on a recurring basis as of June 30, 2014 and December 31, 2013, segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value:

 

		As of June 30, 2014
														Derivative
														Liabilities at
		Level 1				Level 2				Level 3				Fair Value
8% Convertible promissory notes:
Conversion option		$	-			$	-			$	10,695,000			$	10,695,000
Warrants			-				-				-				-
Derivative liabilities - Current			-				-				10,695,000				10,695,000
Placement agent warrants - Non-current			-				-				119,703				119,703
Derivative liabilities - Total		$	-			$	-			$	10,814,703			$	10,814,703

  

  

		As of December 31, 2013
														Derivative
														Liabilities at
		Level 1				Level 2				Level 3				Fair Value
8% Convertible promissory notes:
Conversion option		$	-			$	-			$	12,400,000			$	12,400,000
Warrants			-				-				4,790,000				4,790,000
Derivative liabilities - Current			-				-				17,190,000				17,190,000
Placement agent warrants - Non-current			-				-				296,194				296,194
Derivative liabilities - Total		$	-			$	-			$	17,486,194			$	17,486,194

 

The following table is a reconciliation of the derivative liabilities for which Level 3 inputs were used in determining fair value during the three and six months ended June 30, 2014 and 2013: 

 

		For the Three Months Ended June 30, 2014
		Balance -				Fair Value of								Balance -
		April 1,				Derivative				Change in				June 30,
		2014				Liability				Fair Value				2014
8% Convertible promissory notes:
Conversion option		$	8,404,000			$	2,960,000			$	(669,000	)		$	10,695,000
Warrants			3,351,000				-				(3,351,000	)			-
Derivative liabilities - Current			11,755,000				2,960,000				(4,020,000	)			10,695,000
Placement agent warrants - Non-current			175,221				-				(55,518	)			119,703
Derivative liabilities - Total		$	11,930,221			$	2,960,000			$	(4,075,518	)		$	10,814,703

 

  

		For the Six Months Ended June 30, 2014
		Balance -				Fair Value of								Balance -
		January 1,				Derivative				Change in				June 30,
		2014				Liability				Fair Value				2014
8% Convertible promissory notes:
Conversion option		$	12,400,000			$	3,985,139			$	(5,690,139	)		$	10,695,000
Warrants			4,790,000				391,365				(5,181,365	)			-
Derivative liabilities - Current			17,190,000				4,376,504				(10,871,504	)			10,695,000
Placement agent warrants - Non-current			296,194				-				(176,491	)			119,703
Derivative liabilities - Total		$	17,486,194			$	4,376,504			$	(11,047,995	)		$	10,814,703

 

 

		For the Three Months Ended June 30, 2013
		Balance -				Fair Value of								Balance -
		April 1,				Derivative				Change in				June 30,
		2013				Liability				Fair Value				2013
8% Convertible promissory notes:
Conversion option		$	4,790,000			$	-			$	(3,270,000	)		$	1,520,000
Warrants			2,310,000				-				(1,770,000	)			540,000
Derivative liabilities - Current			7,100,000				-				(5,040,000	)			2,060,000
Placement agent warrants - Non-current			216,017				-				(93,660	)			122,357
Derivative liabilities - Total		$	7,316,017			$	-			$	(5,133,660	)		$	2,182,357

  

 

		For the Six Months Ended June 30, 2013
		Balance -				Fair Value of								Balance -
		January 1,				Derivative				Change in				June 30,
		2013				Liability				Fair Value				2013
8% Convertible promissory notes:
Conversion option		$	610,000			$	545,425			$	364,575			$	1,520,000
Warrants			220,000				249,151				70,849				540,000
Derivative liabilities - Current			830,000				794,576				435,424				2,060,000
Placement agent warrants - Non-current			81,717				-				40,640				122,357
Derivative liabilities - Total		$	911,717			$	794,576			$	476,064			$	2,182,357

 

 

Note 7 - Debt

 

The components of our convertible debt are summarized as follows:

 

		Due		June 30, 2014				December 31, 2013
8% convertible promissory notes (2012)		Beginning in August 2017		$	16,628,188			$	13,078,188
12% revolving credit facility		December 31, 2015			2,000,000				2,000,000
3% promissory note		February 1, 2018			322,836				385,474
4.25% bank term loans		November 15, 2018			4,500,000				4,500,000
8% convertible promissory notes (2014)		June 11, 2019			1,500,000				-
Subtotal					24,951,024				19,963,662
Less debt discount					(5,713,026	)			(2,173,559	)
Subtotal – net of debt discount					19,237,998				17,790,103
Less current portion					186,635				185,347
Total – long term debt				$	19,051,363			$	17,604,756

 

8% Convertible Promissory Notes (2012)

 

During the six months ended June 30, 2014 pursuant to the same terms of our existing 8% convertible promissory notes (the “Notes”), we issued and sold to Melvin Lenkin, Samuel Rose and Allen Kronstadt collectively the “Investors”, (see Note 14 regarding related party transactions) and an unaffiliated investor (i) an aggregate principal amount of $2,550,000 and $1,000,000, respectively of our Notes which are initially convertible into shares of our common stock at a conversion price equal to $0.40 and $0.74, respectively per share of common stock, subject to adjustment as provided on the terms of the Notes, and (ii) associated warrants to purchase, in the aggregate, 7.3 million shares of common stock, subject to adjustment as provided on the terms of the warrants.

 

The Notes, including all outstanding principal and accrued and unpaid interest, are due and payable on the earlier of five years from date of issuance or upon the occurrence of an Event of Default (as defined in the Notes). We may prepay the Notes, in whole or in part, upon 60 calendar-days prior written notice to the holders thereof. Interest accrues on the Notes at a rate of 8.0% per annum, payable during the first three years that the Notes are outstanding in shares of common stock, valued at the weighted average price of a share of common stock for the twenty consecutive trading days prior to the interest payment date, pursuant to the terms of the Notes. During the fourth and fifth years that the Notes are outstanding, interest that accrues under the Notes shall be payable in cash.

 

Interest expense for the three and six months ended June 30, 2014 was approximately $340,000 and $605,900, respectively. Accrued interest at June 30, 2014 of approximately $340,000 was paid with 507,483 shares of common stock, in lieu of cash, which were issued subsequent to June 30, 2014.

 

Of the warrants to purchase 7.3 million shares of common stock, 6.4 million were exercisable at an exercise price of $0.60 per share of common stock and the remainder of 900,901 were exercisable at an exercise price of $1.11 per share of common stock, subject to adjustment as provided for by the terms thereof, for a period commencing on the date of issuance and ending on the earlier to occur of the date that is (i) three years after the date upon which the weighted average price of a share of common stock for the 90 consecutive trading days prior to such date is at least $2.00 per share, and (ii) five years after the date on which the Note to which the applicable warrant is related has been repaid in full. During the three months ended June 30, 2014, we offered all warrant holders the right to exchange their warrants for their fair value, as calculated using the Black-Scholes option pricing model, for shares of common stock. All warrants associated with the Notes were exchanged for shares of common stock.

 

 

The issuance costs of approximately $146,700, plus the fair values of the conversion option derivative liability and the warrants derivative liability were recorded as a discount to the Notes. This debt discount is amortized to other expenses in our statement of operations over the initial term of the 8% Notes. During the three and six months ended June 30, 2014, we amortized approximately $382,400 and $762,200, respectively of the discount to other expenses in our statement of operations. For the corresponding periods for 2013, we amortized approximately $138,100 and $282,000 to other expenses in our statement of operations. At June 30, 2014, the unamortized discount was approximately $5.7 million. See Note 6 for further discussion of these derivative liabilities.

 

12% Revolving Credit Agreement

 

During the year ended December 31, 2013, we entered into a Revolving Credit and Letter of Credit Support Agreement (the “Revolving Loan Agreement”) with MLTM Lending, LLC, a Maryland limited liability company (“MLTM”), and Samuel G. Rose (“Rose” and together with MLTM, the “Lenders”), pursuant to which the Lenders have agreed to lend us up to $2,000,000 on a revolving basis. In addition, the Revolving Loan Agreement provides that MLTM will provide letter of credit support to us of up to $500,000 (the “LC Sublimit”). Each revolving loan made under the Revolving Loan Agreement bears interest at 12% per annum, of which 4% is payable by us in cash on the first business day of each month, and 8% is payable by us in shares of our common stock on the first business day of each calendar quarter, valued at a price equal to the average of the Weighted Average Price (as such term is defined in the Revolving Loan Agreement) of a share of our common stock for 20 consecutive trading days prior to the interest payment date. Under the terms of the Revolving Loan Agreement, we may prepay the revolving loans at any time, in whole or in part, together with all accrued and unpaid interest, without premium or penalty. The Lenders may accelerate all amounts due under the Revolving Loan Agreement, together with accrued and unpaid interest, upon the occurrence of an Event of Default, as defined in the Revolving Loan Agreement. The maturity date of the Revolving Loan Agreement is December 31, 2015 (the “Maturity Date”). During the year ended December 31, 2013, we borrowed $2,000,000 less fees, under the Revolving Loan Agreement which remained outstanding through June 30, 2014.

 

As consideration for the revolving loans extended under the Revolving Loan Agreement, with respect to the year ending December 31, 2013, and prior to each of December 31, 2014 and 2015, we are required to issue to the Lenders an aggregate of 200,000 shares of our common stock during each such calendar year, up to a total of 600,000 shares of our common stock. As consideration for MLTM providing letter of credit support, we are required to pay a letter of credit commission fee on the date of the Revolving Loan Agreement, and on each one year anniversary of the date of the Revolving Loan Agreement prior to the Maturity Date, in the amount equal to (i) 2% of the LC Sublimit in cash and (ii) shares of our common stock, with an aggregate value of 4% of the LC Sublimit, with each such share of our common stock valued at a price equal to the average of the Weighted Average Price of a share of our common stock for the 20 consecutive trading days prior to the date of payment. The payment of the letter of credit commission fee in cash and the issuance of the shares of common stock in payment of these fees results in additional interest expense.

 

Interest expense for the three and six months ended June 30, 2014 was approximately $60,100 and $127,100. Of the $127,100 of interest expense for the six months ended June 30, 2014, approximately $50,200 was paid in cash or is to be paid in cash and the balance of approximately $76,900 was or will be paid in shares of common stock.

 

In connection with the entry into the Revolving Loan Agreement, pursuant to the terms thereof, we and the Lenders entered into a Security Agreement pursuant to which the Borrowers were granted a security interest and lien in all of our accounts receivable and inventory to secure the Borrowers’ obligations under the Revolving Loan Agreement. 

 

The issuance costs of approximately $7,800, plus the fair values of the shares of our common stock of approximately $140,900, issued as consideration for the revolving loans and the letter of credit support, were recorded as a discount to the revolving loans. This debt discount is amortized to other expenses in our statement of operations over the twelve month period ended November 30, 2014. During the three and six months ended June 30, 2014, we amortized approximately $40,300 and $96,900, respectively of the discount to other expenses in our statement of operations. At June 30, 2014, the unamortized discount was approximately $29,400.

 

 

3% Promissory Note

 

On November 15, 2013, our subsidiary, Axion Recycled Plastics Incorporated (“Axion Recycling”), entered into an Asset Purchase Agreement (the “Purchase Agreement”), among Y City Recycling, LLC (“Y City”), and Brian Coll and Renee Coll (collectively, the “Sellers”). See note 3. Pursuant to the terms of the Purchase Agreement, Axion Recycling acquired certain assets from the Sellers relating to the operation of Y City’s recycled plastics facility located in Zanesville, Ohio (the “Facility”). As a component of the consideration paid by Axion Recycling for these asset was the assumption of a 3% promissory note (the “Promissory Note”) with a remaining principal balance of approximately $322,800 as of June 30, 2014. The principal and interest at 3% per annum, is payable in eighty-four monthly installments with the last installment due on February 1, 2018.

 

The payment of the Promissory Note and all interest thereon is secured by a first interest in certain equipment owned by Axion Recycling. We may prepay the Promissory Note at any time, in whole or in part, together with all accrued and unpaid interest, without premium or penalty.

 

Interest expense for the three and six months ended June 30, 2014 of approximately $2,500 and $5,200, respectively was paid in cash.

  

4.25% Bank Term Loans

 

During the year ended December 31, 2013, we purchased certain tangible and intangible assets including property and equipment of Y City Recycling LLC, a plastics recycling company, which were funded, in part, by term loans (the “Bank Term Loans”) in the aggregate principal amounts of $1,000,000 and $3,500,000. Each of the Bank Term Loans bears interest at 4.25% per annum and matures on November 15, 2018. With respect to principal payments under the Bank Loans, $100,000 is due on each of November 15, 2014 and 2015, $250,000 is due on each of November 15, 2016 and 2017, and the balance of the principal amounts outstanding under the Bank Term Loans is due on November 15, 2018. The Bank Term Loans may be prepaid in full or in part at any time without premium or penalty. The holder may accelerate all amounts due under the Bank Term Loans, together with accrued and unpaid interest, upon the occurrence of an Event of Default, as defined in the documents. We were in compliance with the term of the Bank Term Loans at June 30, 2014.

 

The Bank Term Loans are secured by a security interested in all of the equipment we purchased pursuant to this transaction and in certain of our equipment located at our Waco, Texas facility.

 

Interest expense for the three and six months ended June 30, 2014 of approximately $48,900 and $96,700, respectively was paid in cash.

 

8% Convertible Promissory Notes (2014)

 

During the three months ended June 30, 2014 pursuant to the terms of our 8% convertible promissory notes (the “8% Notes”), we issued and sold to MLTM Lending, LLC, Samuel Rose and Allen Kronstadt collectively the “Investors”, (see Note 14 regarding related party transactions) an aggregate principal amount of $1,500,000 of our 8% Notes which are initially convertible into approximately 5.6 million shares of our common stock, subject to adjustment as provided on the terms of the 8% Notes, (i) at any time prescribed by the Investors or (ii) upon any date prior to June 11, 2019 (the “Maturity Date”) which the Company’s common shares are listed on a U.S. based stock exchange.

 

The 8% Notes, including all outstanding principal and accrued and unpaid interest, are due and payable on the Maturity Date or upon the occurrence of an Event of Default (as defined in the 8% Notes). We may prepay the 8% Notes, in whole or in part, upon notice to the holders thereof. Interest accrues on the 8% Notes at a rate of 8.0% per annum, payable quarterly starting with September 30, 2014. For the quarter ended December 31, 2014 and for each subsequent quarter that the 8% Notes are outstanding, the Investors shall have the right to have the interest paid in shares of common stock, valued at the weighted average price of a share of common stock for the twenty consecutive trading days ending with the end of the quarter, pursuant to the terms of the 8% Notes.

 

Interest expense for the three months ended June 30, 2014 was approximately $6,400, and was paid in cash subsequent to June 30, 2014.

 

 

Note 8 - 10% Convertible Redeemable Preferred Stock

 

The components of our 10% convertible preferred stock, classified as temporary equity in our balance sheet, are summarized as follows:

 

		June 30,				December 31,
		2014				2013
10% convertible preferred stock - face value		$	6,946,230			$	6,946,230
Unamortized discount			-				(221,386	)
10% convertible preferred stock, net of discount		$	6,946,230			$	6,724,844

  

During the year ended December 31, 2011, we designated 880,000 shares of preferred stock as 10% convertible redeemable preferred stock (the “Preferred Stock”). The Preferred Stock has a stated value (the “Stated Value”) of $10.00 per share. The Preferred Stock and any dividends thereon may be converted into shares of our common stock at any time by the holder at a conversion rate, as adjusted (the “Conversion Rate”). The holders of the Preferred Stock are entitled to receive dividends at the rate of ten percent per annum payable quarterly. Dividends shall not be declared, paid or set aside for any series or other class of stock ranking junior to the Preferred Stock, until all dividends have been paid in full on the Preferred Stock. The dividends on the Preferred Stock are payable, at our option, in cash, if permissible, or in additional shares of common stock. The Preferred Stock is not subject to any anti-dilution provisions other than for stock splits and stock dividends or other similar transactions. The holders of the Preferred Stock shall have the right to vote with our stockholders in any matter. The number of votes that may be cast by a holder of our Preferred Stock shall equal the Stated Value of the Preferred Stock purchased divided by the Conversion Rate.

 

The Preferred Stock is redeemable for cash by the holder any time after the three-year anniversary from the initial purchase. The Preferred Stock were purchased during the six months ended June 30, 2011, therefore holders of the Preferred Stock have the right to redeem their Preferred Stock during the six months ended June, 2014. Since we were precluded by Colorado law from redeeming any Preferred Stock upon the attainment of the redemption dates, during the three months ended June 30, 2014, in exchange for extending the redemption date to after December 31, 2016, we’ve offered to reduce the conversion price to $0.80 for any conversion in 2014, to $0.70 for any conversions in 2015 and to $0.60 for any conversions in 2016 (the “Revised Conversion Terms”). We also offered to extend the expiration date of the preferred stock warrants an additional two years. In exchange, the Preferred Stock Holders agreed to automatically convert their Preferred Stock on the date our common shares are listed on a U.S. based stock exchange (the “Up-listing Date”). In addition, any Preferred Stock Warrants remaining outstanding at the Up-listing Date, will be cancelled and the holder issued a number of shares of common stock equivalent to the fair value of those warrants. Holders of $6,079,980 of the outstanding Preferred Stock have accepted this offer.

 

The Preferred Stock may be converted by us, provided that the variable weighted average price of our common stock has closed at $4.00 per share or greater, for sixty consecutive trading days and during such sixty-day period, the shares of common stock issuable upon conversion of the Preferred Stock have either been registered for resale or are issuable without restriction pursuant to Rule 144 of the Securities Act of 1933, as amended.

 

 

The Preferred Stock when issued was a hybrid instrument comprised of a (i) a preferred stock, (ii) an option to convert the preferred stock into shares of our common stock (the “Conversion Option”) and (iii) a warrant to purchase shares of our common stock to be issued if a certain revenue milestone (the “Revenue Milestone”) was not achieved (the “Make Good Warrant”), as an embedded derivative liability. The Conversion Option derives its value based on the underlying fair value of the shares of our common stock as does the Preferred Stock, and therefore is clearly and closely related to the underlying preferred stock. Since, at issuance the number of shares of common stock which the Make Good Warrant would be exercisable into, was not determinable, and since the fair value of the Make Good Warrants was deemed improbable, we did not record a derivative liability. See Note 7 for further discussion on these derivative liabilities.

  

Since our Revenue Milestone for the twelve months ended December 31, 2011 was not achieved (i) the Conversion Rate was reduced to $1.00, and (ii) each holder received a Make Good Warrant to purchase a number of shares of our common stock equal to fifty percent of the number of shares of common stock issuable upon conversion of the Preferred Stock at the Conversion Rate. The Make Good Warrants expire December 31, 2015, have an initial exercise price of $1.00 per share and provide for cashless exercise at any time the underlying shares of common stock have not been registered for resale under the Securities Act of 1933 or are issuable without restriction pursuant to Rule 144 of the Securities Act. During the three months ended June 30, 2014, we offered all warrant holders the right to exchange their warrants for their fair value, as calculated using the Black-Scholes option pricing model, for shares of common stock. Warrant holders holding approximately 84% of these outstanding warrants elected the exchange offer.

 

During the year ended December 31, 2011, we sold 759,773 shares of Preferred Stock at a price per share of $10, for gross proceeds of $7,597,730. We paid commissions, legal fees and other expenses of issuance of $828,340, which has been recorded as a discount and deducted from the face value of the Preferred Stock. At issuance of the Preferred Stock, we attributed a conversion option to the Preferred Stock based upon the difference between the Conversion Rate at the time of issuance and the closing price of our common stock on the date of issuance, which was recorded as a discount and deducted from the face value of the Preferred Stock. Pursuant to the Make Good adjustment of the Conversion Rate to $1.00, at December 31, 2011 the conversion option was recalculated as if the $1.00 Conversion Rate was in affect at issuance which amounted to $2.1 million, and the amortization of the related discount was adjusted for the year ended December 31, 2011. These discounts were amortized over three years consistent with the initial redemption terms, as a charge to additional paid-in capital, due to our deficit in retained earnings. For the three months ended March 31, 2014 and for the three and six months ended June 30, 2013, we amortized approximately $221,400, $226,500 and $455,800, respectively of these discounts to additional paid-in capital. At March 31, 2014, the Preferred Stock discount was fully amortized.

 

During the three months ended March 31, 2013, we issued 39,000 shares of our common stock upon conversion of 3,900 shares of our Preferred Stock. There were no conversions during the three or six months ended June 30, 2014.

 

The Preferred Stock outstanding at June 30, 2014, is convertible into 8.5 million shares of our common stock pursuant to the Revised Conversion Terms or the original terms.

 

Since the Preferred Stock may ultimately be redeemed at the option of the holder, the carrying value of the shares, net of unamortized discount and accumulated dividends, has been classified as temporary equity.

 

Our dividend payable on June 30, 2014 of approximately $184,200 was paid, in lieu of cash, with approximately 274,900 shares of common stock, which were issued subsequent to June 30, 2014.

 

Placement Agent Warrants

 

We issued warrants to the placement agents for the sale of our Preferred Stock, to purchase 58,352 shares of 10% convertible preferred stock at $10 per share. Since at issuance, the number of shares of common stock which these warrants would be exercisable into was not determinable, we recorded the fair value of the warrants at issuance, as a liability on our balance sheet and we re-value this warrant liability at each reporting date, with changes in fair value recognized in earnings each reporting period. See Note 6 for further discussion of derivative liabilities.

 

 

Note 9 - Stockholders’ Equity

 

We are authorized to issue up to 250,000,000 shares of Common Stock, no par value, and up to 2,500,000 shares of Preferred Stock, no par value. There were 68,197,143 and 31,168,905 shares of common stock issued and outstanding at June 30, 2014 and December 31, 2013, respectively.  During the year ended December 31, 2011, we designated 880,000 shares of preferred stock as 10% convertible preferred stock and had issued and outstanding 694,623 shares of 10% convertible preferred stock at both June 30, 2014 and December 31, 2013. We may issue additional shares of preferred stock, with dividend requirements, voting rights, redemption prices, liquidation preferences and premiums, conversion rights and other terms without a vote of the shareholders.

 

Common Stock Issuances for the Six Months Ended June 30, 2014

 

During January 2014, we issued 181,531 shares of common stock as payment of our dividends on our 10% convertible preferred stock, in lieu of cash, with a fair value on the date of issue of $183,346.

 

During January 2014, we issued 235,853 shares of common stock as payment of our interest on our 8% convertible notes, in lieu of cash, with a fair value on the date of issue of $235,853.

 

During January 2014, we issued 107,461 shares of common stock upon cashless exercise of a previously awarded stock options and warrants. 

 

During January 2014, we issued 220,147 shares of common stock as payment of various commitment fees pursuant to our 12% revolving credit agreement, in lieu of cash, with a fair value on the date of issue of $140,894.

 

During January 2014, we issued 8,522 shares of common stock as payment of our interest on our 12% revolving credit agreement, in lieu of cash, with a fair value on the date of issue of $8,522.

 

During April 2014, we issued 215,942 shares of common stock as payment of our dividends on our 10% convertible preferred stock, in lieu of cash, with a fair value on the date of issue of $159,797.

 

During April 2014, we issued 359,300 shares of common stock as payment of our interest on our 8% convertible notes, in lieu of cash, with a fair value on the date of issue of $265,882.

 

During April 2014, we issued 50,424 shares of common stock as payment of our interest on our 12% revolving credit agreement, in lieu of cash, with a fair value on the date of issue of $37,314.

 

During April 2014, we issued 196,079 shares of common stock to a consultant pursuant to terms of an agreement, with a fair value on the date of issue of $100,000.

 

During June 2014, we issued 35,452,979 shares of common stock with a fair value on the date of issue of $24,817,086, in exchange for previously outstanding warrants which were cancelled pursuant to a tender offer, with a fair value of $4,859,232.

 

Note 10 - Share-based Compensation

 

Options

 

At our Annual Meeting of Shareholders during the year ended December 31, 2013, our shareholders approved an amendment to our 2010 Stock Plan to increase the number of shares of common stock reserved thereunder by 2,000,000 shares. In addition, during the three months ended March 31, 2014 the board approved an additional 2,000,000 shares to be available for award under the 2010 Stock Plan, subject to shareholder approval, which brought the total available for award under the 2010 Stock Plan to 7,000,000 shares. The exercise price of an option is established by the Board of Directors on the date of grant and is generally equal to the market price of the stock on the grant date.  The Board of Directors may determine the vesting period for each new grant. Options issued are exercisable in whole or in part for a period as determined by the Board of Directors of up to ten years from the date of grant. 

 

 

During the year ended December 31, 2013, our 2003 Stock Plan expired and no further awards are allowed.

 

During the six months ended June 30, 2014, we awarded options to purchase 175,000 shares of our common stock at a weighted average exercise price of $0.54 to an employee and two of our directors. The right to exercise these options is on the date of award. We estimated the fair value of these options to be approximately $102,500 which was charged to expense in our statement of operations during the period. We use the Black-Scholes option pricing model to estimate the fair values, with the following range of assumptions: (i) no dividend yield, (ii) expected volatility of 90%, (iii) risk-free interest rates of 1.5%, and (iv) expected lives of five years.

 

Certain options awarded prior to the three and six months ended June 30, 2014 are amortized over vesting periods encompassing the three and six months ended June 30, 2014. We charged to operating expenses approximately $274,300 and $345,200 during the three and six months ended June 30, 2014, respectively.

 

The following table summarizes our stock option activity for the six months ended June 30, 2014:

 

						Weighted-
		Number				Average
		of Shares				Exercise
		Issuable				Price
Balance, January 1, 2014			7,502,421			$	1.00
Granted			175,000				0.54
Exercised			(186,225	)			0.88
Cancelled			(313,068	)			1.06
Balance, June 30, 2014			7,178,128			$	1.00

 

The following table summarizes options outstanding at June 30, 2014:

 

						Weighted-				Weighted-
		Number				Average				Average				Aggregate
		of Shares				Exercise				Remaining				Intrinsic
		Issuable				Price				Term (Years)				Value
Exercisable			3,768,128			$	0.97				3.7			$	100,000
Not vested			3,410,000				1.03				6.1				258,000
Balance, June 30, 2014			7,178,128			$	1.00				4.8			$	358,000

 

Warrants

 

From time to time, we compensate consultants, advisors and investors with warrants to purchase shares of our common stock, in lieu of cash payments. Net share settlement is available to warrant holders.

 

The following table sets forth our warrant activity during the six months ended June 30, 2014:

 

						Weighted-
		Number				Average
		of Shares				Exercise
		Issuable				Price
Balance, January 1, 2014			41,595,655			$	0.69
Granted			7,435,901				0.70
Exercised			(155,568	)			0.60
Expired			(1,333,066	)			0.90
Cancelled pursuant to Tender Offer			(46,245,524	)			0.67
Balance, June 30, 2014			1,297,398			$	1.09

 

 

The following table sets forth the warrants outstanding at June 30 2014:

 

						Weighted-
		Number				Average
		of Shares				Exercise
		Issuable				Price
10% convertible debenture - bonus warrants			183,337			$	0.60
10% convertible preferred stock – warrants			611,250				1.00
Consultants			502,811				1.37
Total			1,297,398			$	1.09

 

During the six months ended June 30, 2014, we issued warrants to purchase 7,275,901 shares of our common stock pursuant to our issuance and sale of our 8% convertible promissory notes, at an initial exercise price of $0.60 per share. These warrants had fair values on their dates of issuances of approximately $391,400 which was recorded as a credit to derivative liabilities and a charge to debt discount associated with our 8% convertible promissory notes. See Notes 6 and 7 for further discussion of these warrants. The estimated fair value of the warrants was computed by a third party using Monte Carlo simulation models. The following ranges of assumptions were used for the simulation models: (i) no dividend yield, (ii) expected volatility of 45%, (iii) risk-free interest rate of 0.2%, and (iv) an expected life of approximately one and one-half years.

 

During the six months ended June 30, 2014, we issued a warrant to purchase 160,000 shares of our common stock at an exercise price of $1.20 in payment of amounts due a consultant. We estimated the fair value of this warrant to be approximately $84,700, which was charged to expense in our statement of operations during the period. We used the Black-Scholes option pricing model to estimate the fair value, with the following range of assumptions: (i) no dividend yield, (ii) expected volatility of 90%, (iii) risk-free interest rate of 0.8%, and (iv) an expected life of approximately three years.

 

In addition, the fair value of a previously issued warrant which was being amortized over a service period spanning multiple reporting periods, was revalued using the Black-Scholes option pricing model, at the end of each reporting period. During the three and six months ended June 30, 2014, we decreased the fair value by approximately $14,900 and recorded a charge in our statement of operations. We used the Black-Scholes option pricing model to estimate the fair value, with the following range of assumptions: (i) no dividend yield, (ii) expected volatility of 90%, (iii) risk-free interest rate of approximately 0.8%, and (iv) an expected life of less than one year.

 

Tender Offer to Exchange Warrants for Shares of Common Stock

 

During June 2014, we extended an offer to exchange for shares of our common stock any and all of our outstanding warrants from the holders thereof (the “Tender Offer”). Each warrant holder was provided with the terms of the Tender Offer regarding their outstanding warrants. For every $10 of value attributed to the warrant, we offered to exchange 14.17707 shares of our common stock. The value of the warrants was derived from third parties using Monte Carlo simulation models and the Black-Scholes Option Pricing Model. The Tender Offer expired at 11:59P.M. on June 16, 2014.

 

Of the warrants to purchase 47.7 million shares of our common stock subject to the Tender Offer, warrants to purchase 46.2 million shares of our common stock were tendered with fair value of $4.9 million and exchanged for 35.5 million shares with a fair value on date of issuance of $24.8 million. The warrants were cancelled upon tender. See note 5.

 

 

Note 11 - Income Taxes

 

The income tax provision consists of federal and state corporate income taxes resulting from our operations in the United States. The income tax provision differs from the expected tax provisions computed by applying the U.S. Federal statutory rate to loss before income taxes primarily because we have historically maintained a full valuation allowance on our deferred tax assets. We expect income tax expense to vary each reporting period depending upon taxable income fluctuations and the availability of tax benefits from net loss carryforwards.

 

As of December 31, 2013, we had U.S. federal net operating loss carryforwards of approximately $25.7 million, which, if unused, expire through 2033. We do not believe that we have had a change in control as defined by Section 382 of the Internal Revenue Code, which could potentially limit our ability to utilize these net operating losses. At December 31, 2013, we recorded a valuation allowance against the full amount of our deferred tax assets, as our management believes it is uncertain that they will be fully realized. If we determine in the future that we will be able to realize all or a portion of our net operating loss, an adjustment to our net operating loss carryforwards would increase net income in the period in which we make such a determination.

 

Note 12 - Business Concentration

 

During the three and six months ended June 30, 2014, we sold our ECOTRAX rail ties to one customer representing approximately 17% and 24%, respectively of our total revenue.

 

Note 13 - Commitments and Contingencies

 

Operating leases

 

During the year ended December 31, 2013, we entered into an assignment of the original lease for our recycled plastics processes facility, effective November 15, 2013 at a monthly lease payment of $25,750. The original term of the lease expires at the end of April 2018, but provides two additional five-year extensions and includes an annual rent escalation clause based on the greater of the change in a certain Consumer Price Index or 3%. We record rent expense based on the straight-line amortization of the full 15-year term of the initial lease plus all extensions. Our rent expense, for the three and six months ended June 30, 2014 was approximately $95,000 and $190,800, respectively and our deferred rent at June 30, 2014 was approximately $44,800. This facility currently serves as our corporate headquarters.

 

Effective September 1, 2013, we signed a ten year lease for our production facility in Waco, Texas which provides five additional five-year extensions. Monthly rent expense for the first year of the lease is $21,875. The lease includes an annual rent escalation clause based on the greater of the change in a certain Consumer Price Index or 3%. We record rent expense based on the straight-line amortization of the full 35-year term of the initial lease plus all extensions. Our rent expense for the three and six months ended June 30, 2014 was approximately $113,400 and $226,700, respectively and our deferred rent at June 30, 2014 was approximately $165,000.

 

We lease office space in New Providence, New Jersey which previously served as our corporate headquarters, pursuant to a one-year extension of our prior three-year lease agreement for monthly lease payments of approximately $3,800. The lease expires on October 31, 2014. Facility rent expense totaled approximately $11,500 and $23,100 for the three and six months ended June 30, 2014, respectively.

 

Royalty Agreements

 

In February 2007, we acquired an exclusive, royalty-bearing license in specific but broad global territories to make, have made, use, sell, offer for sale, modify, develop, import, and export products made using patent applications owned by Rutgers University (Rutgers”).  We are using these patented technologies in the production of our composite rail ties and structural building products. The term of the License Agreement runs until the expiration of the last-to-expire issued patent within the Rutgers’ technologies licensed under the License Agreement, unless terminated earlier.

 

 

We are obligated to pay Rutgers royalties ranging from 1.5% to 3.0% on various product sales, subject to certain minimum payments each year and to reimburse Rutgers for certain patent defense costs in the case of patent infringement claims made against the Rutgers patents.  For the three months ended June 30, 2014 and 2013, we accrued royalties payable to Rutgers on product sales of approximately $29,200 and $26,800, respectively. In addition, for the three months ended June 30, 2014 and 2013, since we did not meet the minimum royalty due pursuant to the license, we accrued approximately $20,800 and $23,200, respectively which was charged to operating expenses in our statement of operations.

 

We also pay a royalty for the use of certain production practices for a rail tie products. For the three months ended June 30, 2014 and 2013, we paid approximately $23,100 and $20,100, respectively under this arrangement.

 

Litigation

 

From time to time we may be subject to various other routine legal matters incidental to our business, but we do not believe that they would have a material adverse effect on our financial condition or results of operations. 

  

Note 14 - Related Party Transactions

 

Samuel G. Rose and Julie Walters

 

Samuel G. Rose and Julie Walters beneficially own in excess of 5% of our outstanding stock.

 

10% Convertible Redeemable Preferred Stock. During the year ended December 31, 2011, we sold to Mr. Rose 100,000 shares of our Preferred Stock for $1.0 million. Subsequently, pursuant to the terms of the Preferred Stock, we issued to Mr. Rose a warrant to purchase 500,000 shares of common stock at an exercise price of $1.00 per share. See Note 8 for a complete description of our Preferred Stock. Including the dividend accrued through June 30, 2014, Mr. Rose has received an aggregate of approximately 535,200 shares of common stock as dividend payments, on the Preferred Stock held by them. During the three months ended June 30, 2014, pursuant to our Tender Offer to all warrant holders to exchange the fair value of any warrants then outstanding, for shares of our common stock, Mr. Rose and Ms. Walters received approximately 259,300 shares of common stock in exchange for the warrants to purchase 500,000 shares of common stock. See notes 5 and 10 for a further discussion of the Tender Offer.

 

8% Convertible Promissory Notes (2012). On August 24, 2012, we entered into a Note Purchase Agreement (the “Purchase Agreement”) with Mr. Rose, MLTM Lending, LLC, Allen Kronstadt, the Judy Lenkin Lerner Revocable Trust and certain other investors (the “Note Purchase Agreement Investors”), pursuant to which, as of June 30, 2014, we have issued and sold to Mr. Rose and Ms. Walters an aggregate principal amount of approximately $5,209,300 of our 8.0% convertible promissory notes (the “8% Notes”) which are initially convertible into shares of our common stock, at a conversion price equal to $0.40 per share of common stock, subject to adjustment as provided on the terms of the 8% Notes, and associated warrants (the “8% Note Warrants”) to purchase, in the aggregate, approximately 13,023,200 shares of common stock, subject to adjustment as provided on the terms of the 8% Note Warrants. See Note 7 for a complete description of our 8% Notes. Including the interest accrued on our 8% Notes through June 30, 2014, Mr. Rose and Ms. Walters have received an aggregate of approximately 837,800 shares of common stock as interest payments under the 8% Notes held by them. During the three months ended June 30, 2014, pursuant to our Tender Offer to all warrant holders to exchange the fair value of any warrants then outstanding, for shares of our common stock, Mr. Rose and Ms. Walters received 10.9 million shares of common stock in exchange for the warrants to purchase 13.0 million shares of common stock. See notes 5 and 10 for a further discussion of the Tender Offer.

  

 

Revolving Credit and Letter of Credit Support Agreement. During the year ended December 31, 2013, we entered into a Revolving Credit and Letter of Credit Support Agreement (the “Revolving Loan Agreement”) pursuant to which Mr. Rose and MLTM Lending LLC (the “Lenders”) have agreed to lend us up to $2,000,000 on a revolving basis. Each revolving loan made under the Revolving Loan Agreement bears interest at 12% per annum, of which 4% is payable by us in cash on the first business day of each month, and 8% is payable by us in shares of common stock on the first business day of each calendar quarter, valued at a price equal to the average of the Weighted Average Price (as such term is defined in the Revolving Loan Agreement) of a share of common stock for 20 consecutive trading days prior to the interest payment date. See Note 7 for a complete description of our Revolving Loan Agreement.

 

As consideration for the revolving loans extended under the Revolving Loan Agreement, we agreed to issue to the Lenders an aggregate of 200,000 shares of common stock at signing of the Revolving Loan Agreement, of which during the three months ended March 31, 2014, Mr. Rose received 100,000 shares of common stock, and prior to December 31, 2014 and December 31, 2015 the Lenders will receive an additional 200,000 shares of common stock, for up to a total of 600,000 shares of common stock.

  

We have paid, or will pay subsequent to June 30, 2014, Mr. Rose accrued interest of approximately $30,000 and $58,600 for the three and six months ended June 30, 2014, respectively on the Revolving Loan Agreement with approximately $20,000 in cash and issued approximately 55,900 shares of common stock.

 

8% Convertible Promissory Notes (2014). During the three months ended June 30, 2014 pursuant to the terms of our 8% convertible promissory notes (the “8% Notes”), we issued and sold to Samuel Rose, (see Note 14 regarding related party transactions) an aggregate principal amount of $500,000 of our 8% Notes which are initially convertible into approximately 1.9 million shares of our common stock, subject to adjustment as provided on the terms of the 8% Notes, (i) at any time prescribed by the Investors or (ii) upon any date prior to June 11, 2019 (the “Maturity Date”) which the Company’s common shares are listed on a U.S. based stock exchange. See Note 7 for a complete description of our 8% Notes.

 

Interest expense for the three months ended June 30, 2014 was approximately $2,200, and was paid in cash.

 

MLTM Lending, LLC and the ML Dynasty Trust

 

MLTM Lending, LLC and the ML Dynasty Trust beneficially own in excess of 5% of our outstanding stock. Pursuant to the Schedule 13D filings made by MLTM Lending, LLC and the ML Dynasty Trust, the ML Dynasty Trust shares with MLTM the power to vote or direct the vote of, and to dispose or direct the disposition of, greater than 5% of our outstanding stock. Thomas Bowersox, a member of our board of directors, is a trustee of the ML Dynasty Trust.

 

8% Convertible Promissory Notes (2012). Pursuant to the Purchase Agreement, as of June 30, 2014, we have issued and sold to MLTM Lending, LLC an aggregate principal amount of approximately $4,888,400 of our 8% Notes and associated 8% Note Warrants to purchase, in the aggregate, approximately 12,221,100 shares of common stock, subject to adjustment as provided on the terms of the 8% Note Warrants. See Note 7 for a complete description of our 8% Notes. Including the interest accrued on our 8% Notes through June 30, 2014, MLTM Lending, LLC has received an aggregate of approximately 767,400 shares of common stock as interest payments under the 8% Notes held by them. During the three months ended June 30, 2014, pursuant to our Tender Offer to all warrant holders to exchange the fair value of any warrants then outstanding, for shares of our common stock, MLTM Lending, LLC received 10.2 million shares of common stock in exchange for the warrants to purchase 12.2 million shares of common stock. See note 10 for a further discussion of the Tender Offer.

 

Revolving Credit and Letter of Credit Support Agreement. During the year ended December 31, 2013, we entered into a Revolving Credit and Letter of Credit Support Agreement (the “Revolving Loan Agreement”) pursuant to which MLTM Lending LLC and Mr. Rose (the “Lenders”) have agreed to lend us up to $2,000,000 on a revolving basis. In addition, the Revolving Loan Agreement provides that MLTM Lending, LLC will provide letter of credit support to us of up to $500,000 (the “LC Sublimit”). Each revolving loan made under the Revolving Loan Agreement bears interest at 12% per annum, of which 4% is payable by us in cash on the first business day of each month, and 8% is payable by us in shares of common stock on the first business day of each calendar quarter, valued at a price equal to the average of the Weighted Average Price (as such term is defined in the Revolving Loan Agreement) of a share of common stock for 20 consecutive trading days prior to the interest payment date. See Note 7 for a complete description of our Revolving Loan Agreement.

 

 

As consideration for the revolving loans extended under the Revolving Loan Agreement, we agreed to issue to the Lenders an aggregate of 200,000 shares of common stock, of which MLTM Lending, LLC received 100,000 shares of common stock, at signing of the Revolving Loan Agreement and prior to December 31, 2014 and December 31, 2015, up to a total of 600,000 shares of Common Stock. As consideration for MLTM Lending, LLC providing letter of credit support, we are required to pay a letter of credit commission fee on the date of the Revolving Loan Agreement, and on each one year anniversary of the date of the Revolving Loan Agreement prior to the Maturity Date, in the amount equal to (i) 2% of the LC Sublimit in cash and (ii) shares of common stock, with an aggregate value of 4% of the LC Sublimit, with each such share of common stock valued at a price equal to the average of the Weighted Average Price of a share of Common Stock for the 20 consecutive trading days prior to the date of payment.

 

We have paid, or will pay subsequent to June 30, 2014, MLTM Lending, LLC accrued interest and fees of approximately $30,000 and $68,600 for the three and six months ended June 30, 2014, respectively on the Revolving Loan Agreement with approximately $30,100 in cash and issued approximately 55,900 shares of common stock.

 

8% Convertible Promissory Notes (2014). During the three months ended June 30, 2014 pursuant to the terms of our 8% convertible promissory notes (the “8% Notes”), we issued and sold to MLTM Lending, LLC, (see Note 14 regarding related party transactions) an aggregate principal amount of $500,000 of our 8% Notes which are initially convertible into approximately 1.9 million shares of our common stock, subject to adjustment as provided on the terms of the 8% Notes, (i) at any time prescribed by the Investors or (ii) upon any date prior to June 11, 2019 (the “Maturity Date”) which the Company’s common shares are listed on a U.S. based stock exchange. See Note 7 for a complete description of our 8% Notes.

 

Interest expense for the three months ended June 30, 2014 was approximately $2,200, and was paid in cash.

 

Allen Kronstadt

 

Allen Kronstadt beneficially owns in excess of 5% of our outstanding stock and was appointed to our board of directors on September 11, 2012 pursuant to the terms of the Purchase Agreement.

  

8% Convertible Promissory Notes (2012). Pursuant to the Purchase Agreement, as of June 30, 2014, we have issued and sold to Mr. Kronstadt an aggregate principal amount of approximately $5,209,300 of our 8% Notes and associated 8% Note Warrants to purchase, in the aggregate, approximately 13,023,200 shares of common stock, subject to adjustment as provided on the terms of the 8% Note Warrants. See Note 7 for a complete description of our 8% Notes. Including the interest accrued on our 8% Notes through June 30, 2014, Mr. Kronstadt has received an aggregate of approximately 817,000 shares of common stock as interest payments under the 8% Notes held by him. During the three months ended June 30, 2014, pursuant to our Tender Offer to all warrant holders to exchange the fair value of any warrants then outstanding, for shares of our common stock, Mr. Kronstadt received 10.9 million shares of common stock in exchange for the warrants to purchase 13.0 million shares of common stock. See notes 5 and 10 for a further discussion of the Tender Offer.

 

8% Convertible Promissory Notes (2014). During the three months ended June 30, 2014 pursuant to the terms of our 8% convertible promissory notes (the “8% Notes”), we issued and sold to Mr. Kronstadt, (see Note 14 regarding related party transactions) an aggregate principal amount of $500,000 of our 8% Notes which are initially convertible into approximately 1.9 million shares of our common stock, subject to adjustment as provided on the terms of the 8% Notes, (i) at any time prescribed by the Investors or (ii) upon any date prior to June 11, 2019 (the “Maturity Date”) which the Company’s common shares are listed on a U.S. based stock exchange. See Note 7 for a complete description of our 8% Notes.

 

Interest expense for the three months ended June 30, 2014 was approximately $2,000, and was paid in cash.

 

 

Note 15 – Subsequent Events

 

8% Convertible Promissory Notes (2014)

 

Subsequent to June 30, 2014, pursuant to the terms of our 8% convertible promissory notes (the “8% Notes”), we issued and sold to MLTM Lending, LLC, Samuel Rose and Allen Kronstadt collectively the “Investors”, (see notes 7 and 14 regarding or debt instruments and related party transactions, respectively) an aggregate principal amount of $500,000 of our 8% Notes which are initially convertible into approximately 1.9 million shares of our common stock, subject to adjustment as provided on the terms of the 8% Notes, (i) at any time prescribed by the Investors or (ii) upon any date prior to June 11, 2019 (the “Maturity Date”) which the Company’s common shares are listed on a U.S. based stock exchange. See Note 7 for a complete description of our 8% Notes.

 

Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

The discussion of our financial condition and results of operations set forth below should be read in conjunction with the consolidated financial statements and related notes thereto included elsewhere in this Form 10-Q. This Form 10-Q contains forward-looking statements that involve risk and uncertainties. The statements contained in this Form 10-Q that are not purely historical are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, Section 21E of the Securities Exchange Act of 1934, as amended, and the Private Securities Litigation Reform Act of 1995. When used in this Form 10-Q, or in the documents incorporated by reference into this Form 10-Q, the words “anticipate,” “believe,” “estimate,” “intend”, “expect”, “may”, “will” and similar expressions are intended to identify such forward-looking statements. Such forward-looking statements include, without limitation, statements relating to competition, management of growth, our strategy, future sales, future expenses and future liquidity and capital resources. All forward-looking statements in this Form 10-Q are based upon information available to us on the date of this Form 10-Q, and we assume no obligation to update any such forward-looking statements. Our actual results, performance and achievements could differ materially from those discussed in this Form 10-Q. Factors that could cause or contribute to such differences (“Cautionary Statements”) include, but are not limited to, those discussed in Item 1A. “Risk Factors” and elsewhere in our Annual Report on Form 10-K.  All subsequent written and oral forward-looking statements attributable to us, or persons acting on our behalf, are expressly qualified in their entirety by the Cautionary Statements.

 

Basis of Presentation

 

The financial information presented in this Form 10-Q is not audited and is not necessarily indicative of our future consolidated financial position, results of operations or cash flows. Our fiscal year-end is December 31, and our fiscal quarters end on March 31, June 30 and September 30. Unless otherwise stated, all dates refer to our fiscal year and fiscal periods.

 

Overview

 

Axion International Holdings, Inc. (“Holdings”) was formed in 1981 under the name Analytical Surveys, Inc.   In November 2007, Holdings entered into an Agreement and Plan of Merger, among Holdings, Axion Acquisition Corp., a Delaware corporation and a newly created direct wholly-owned subsidiary of Holdings (the “Merger Sub”), and Axion International, Inc., a Delaware corporation which incorporated on August 6, 2006 with operations commencing in November 2007 (“Axion”).  On March 20, 2008 Holdings consummated the merger of Merger Sub into Axion, with Axion continuing as the surviving corporation and a wholly-owned subsidiary of Holdings. The Merger has been accounted for as a reverse merger in the form of a recapitalization with Axion as the successor.

 

 

During the year ended December 31, 2013, Axion Recycled Plastics Incorporated, an Ohio corporation and a newly created direct wholly-owned subsidiary of Axion (“Axion Recycled Plastics”) was established to purchase the certain tangible and intangible assets of a plastics recycling company during November 2013.

 

We are a green technology company, which delivers tested, proven and superior green solutions to plastics manufacturers and infrastructure needs around the globe. Through Axion International, Inc., our engineered products business segment, we manufacture, market and sell ECOTRAX ^TM - our composite rail ties and STRUXURE ^TM - our structural building products, such as heavy- and light-equipment construction mats, boards, pilings, I-beams, and T-beams. Axion Recycled Plastics Incorporated, our reprocessed plastics business segment, repurposes waste plastics into re-useable plastic raw materials, which are sold to manufactures or transferred to our engineered products facility for use in the production of our engineered products. Both our ECOTRAX and STRUXURE products are based upon patented technology and are fully derived from common recycled plastics and high-density polymers, such as polyethylene, polystyrene and polypropylene. These recycled plastics, which are combined with recycled plastic composites containing encapsulated fiberglass, achieve structural thickness and strength and are resistant to changing shape under constant stress. Our products, manufactured through an extrusion process, are eco-friendly, non-corrosive, impervious to moisture, do not leach chemicals and are resistant to insects and rot. Our engineered products possess superior lifecycles and generally have greater durability and require less maintenance than competitive products made from wood, steel or concrete.

 

Critical Accounting Policies

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations are based upon our financial statements, which have been prepared in accordance with generally accepted accounting principles (or GAAP) in the U.S. The preparation of financial statements in conformity with GAAP requires management to make estimates, judgments and assumptions that affect the amounts reported in our consolidated financial statements and accompanying notes. Our critical accounting policies are those that affect our financial statements materially and involve difficult, subjective or complex judgments by management.

 

An accounting policy is deemed to be critical if it requires an accounting estimate to be made based on assumptions about matters that are highly uncertain at the time the estimate is made, and if different estimates that reasonably could have been used or changes in the accounting estimate that are reasonably likely to occur could materially change the financial statements.

 

Use of Estimates.

 

The preparation of the our financial statements in conformity with generally accepted accounting principles in the United States of America, requires management to make estimates and assumptions. These estimates and assumptions affect the reported amounts of assets and liabilities including fair values of acquired tangible and intangible assets in a business combination, valuation allowances for receivables and deferred income tax assets, derivative liabilities, stock-based compensation as well as the reported amounts of expenses during the reporting period. The statements are evaluated on an ongoing basis and estimates are based on historical experience, current conditions and various other assumptions believed to be reasonable under the circumstances. Actual results can differ from those estimates, and it is possible that the differences could be material.

 

Revenue Recognition.

 

We recognize revenue when a fixed commitment to purchase our products is received, title or ownership has passed to the customer, the amount due from the customer is fixed or determinable, collectability is reasonably assured, and we do not have any specific performance obligations remaining, such that the earnings process is complete. In most cases, we receive a purchase order from our customer specifying the products requested and delivery instructions. We recognize revenue upon our delivery or shipment of the products as specified in the purchase order.

 

We had a contract which provided for a large number of products and few actual deliveries, the revenues are recorded each month as the products are produced and the risk of ownership passes to the customer upon pre-delivery acceptance. Prior to deliveries, our customer’s products are segregated from our inventory and not available for fulfilling other orders. This contract was completed during the three months ended June 30, 2014, but we continue to hold certain of the products previously sold to this customer and awaiting pick-up pursuant to the terms of the contract.

 

 

Share-based Compensation.

 

We recognize share-based compensation for transactions in which we exchange our equity instruments (shares of common stock, options and warrants) for services of directors, employees, consultants and others based on the fair value of the equity instruments issued on the measurement date.  The fair value of common stock awards is based on the observed market value of our stock.  We calculate the fair value of options and warrants using the Black-Scholes option pricing model. The Black-Scholes model requires the input of subjective assumptions including volatility, expected term, risk-free interest rate and dividend yield. We use a measure of volatility based on the historical volatility of our common stock over a similar period to the expected life of the award. The expected term of an award is based on the vesting period.  We base the risk-free rate on the rate of U.S. Treasury obligations with maturities similar to the expected term used in the model. Historically, we have not, and do not anticipate paying in the foreseeable future, dividends on our common stock, and accordingly use an expected dividend yield of zero.

 

Derivative Instruments.

 

For derivative instruments that are accounted for as liabilities, the derivative instrument is initially recorded at its fair value and is then re-valued at each reporting date, with changes in fair value recognized in earnings each reporting period. We use various simulation models, including Black-Scholes and Monte Carlo, to value the derivative instruments at inception and subsequent valuation dates. The classification of derivative instruments, including whether such instruments should be recorded as a liability or as equity, is re-assessed at the end of each reporting period, in accordance with FASB ASC Topic 815, “Derivatives and Hedging”. Derivative instrument liabilities are classified in the balance sheet as current or non-current based on whether or not the net-cash settlement of the derivative instrument could be required within twelve months of the balance sheet date.

 

Results of Operations

 

The following discussion should be read in conjunction with the information set forth in the consolidated financial statements and the related notes thereto appearing elsewhere in this Form 10-Q. 

 

Comparison of the Three and Six Months Ended June 30, 2014 and 2013

 

Revenues

 

We derive our revenues through the sale of our ECOTRAX rail ties, STRUXURE building products and reprocessed plastics. Our strategic focus is to continue to expand the sales of our ECOTRAX rail ties and to create a broad-based market for our STRUXURE building products, such as our heavy construction mats and laminated mats. We continue other strategic initiatives, including the ongoing development and deployment of guidance materials, such as supporting documentation, research and other publications of the structural properties and performance of our products, with the goal to educate engineers, developers and others who might use our products in projects for their clients, as well as potential customers.

 

 

Having completed a number of commercially engineered solution projects prior to 2011, we began concentrating our activities on advancing from proof-of-concept stage to a strategically focused, sales-oriented growth company. Over the past several years, our activities centered upon advancing the development of our technology and products.  As proof-of-concept, we completed the deployment of our products across multiple customers, applications and industries. Beginning late in 2010 we began introducing our ECOTRAX rail products to mass markets globally and, during the year ended December 31, 2011, we developed and began implementing a sales strategy for our STRUXURE building products to other public- and private-sector buyers and in 2013 we launched our heavy construction mat products. As our strategy is to expand our capacity and product offerings of higher margin engineered products - ECOTRAX and STRUXURE, during the year ended December 31, 2013, we acquired a plastics recycling business. This was to bridge our growth and transition to higher margin product offerings with additional revenue opportunities through the sale of our reprocessed plastics. In addition, we added the capability to procure a potentially less expensive and more consistent source of raw materials for our expanded engineered product offerings. Our strategic focus is on the continued growth of sales, within products segments, the expansion of our technology within and across markets, and the expansion of our infrastructure in order to manufacture our products and support our growing sales order pipeline.

 

For the three months ended June 30, 2014 and 2013, we recognized revenue of $4.1 million and $1.5 million, respectively, of which $2.2 million for the three months ended June 30, 2014, was attributable to our engineered products segment with the remainder of $1.9 million attributable to our reprocessed plastics segment. For the three months ended June 30, 2014 and 2013, 17% and 66%, respectively of our sales were to one Class 1 railroad customer pursuant to a three-year supply agreement.

 

For the six months ended June 30, 2014 and 2013, we recognized revenue of $8.9 million and $3.3 million, respectively, of which $5.0 million for the six months ended June 30, 2014, was attributable to our engineered products segment with the remainder of $3.9 million attributable to our reprocessed plastics segment. For the six months ended June 30, 2014 and 2013, 24% and 43%, respectively of our sales were to one Class 1 railroad customer pursuant to a three-year supply agreement. Over the term of this supply agreement, we have recognized $10.3 million of revenue, representing approximately 104,500 rail ties. The last sales under this three-year supply agreement during the three months ended June 30, 2014, and we continue our discussion with this customer.

 

As of June 30, 2014, we’ve invested in tooling, molds and other production equipment to run three or four production lines which would be capable of producing up to $50 million in annual revenue of our engineered products and this equipment is located at our Waco, Texas and Zanesville, Ohio facilities.

 

We continued to receive repeat orders from existing customers as well as from new customers for our engineered products. Our ECOTRAX rail ties are currently in track test or undergoing purchase approval with leading passenger and freight lines in the following countries – Australia, Brazil, Chile, Mexico, New Zealand, Russia and Singapore as well as various other countries in Europe. We continue to expand the possibilities where our STRUXURE heavy construction mats may be beneficial when compared to traditional products and continue to build awareness through test orders, in support of this business opportunity. There can be no assurance that the results of these and other test orders or the approval processes currently underway for other orders will materialize into additional orders for our engineered products. Our focus will continue to be on diversifying our customer base and the pricing of our products, as well as the continuing development of opportunities we foresee with our ECOTRAX and STRUXURE composite products.

 

With the acquisition of the plastics recycling business during 2013, we have continued selling reprocessed plastics to existing customers as well as new customers and have initiated an internal strategic review to determine our most advantageous products to focus these and our other resources on. In addition, we continue the installation and development of the equipment, processes and procedures necessary to maximize our reprocessed plastics capabilities in our Waco, Texas facility.

 

Since the products utilizing our technology are new to the various markets and regions we have identified, we continue to work with various organizations to create the necessary specifications for use of our products. This is a time-consuming process and varies by product line and geographic region.

 

 

Costs of Sales and Operating Expenses

 

Costs of Sales – Production

 

For both our engineered products and reprocessed products segments, our costs of sales are primarily comprised of the cost of raw materials and the costs associated with our manufacturing and production efforts.  The price of the raw materials depends principally on the stage and source of the supply. Historically, within our engineered products segment, we purchase the raw materials in various stages, from recycled plastic containers purchased in bulk, which require further processing before use, to ready-for-production material. Typically, the more processed raw material is more expensive, on a per-pound basis, than less processed material, but the less expensive and less processed material requires additional costs to prepare it for production. Likewise, raw materials purchased through third-party brokers or other intermediaries are more expensive than materials purchased directly from the source or collection point. For our reprocessed plastics segment, our focus has been on purchasing raw materials in unprocessed bulk, with our reprocessed plastics segment turning that recycled waste into processed raw materials for sale to customers requiring reprocessed plastics for their further use.

 

Our strategy to reduce our raw material costs includes broadening our raw materials sources and purchasing other low-cost, unprocessed materials, such as other scrap materials containing specific raw materials from unique sources and recycled materials from municipal and other recycling collection sources. Previously, due to the limited amount of time and personnel we could devote to raw materials sourcing, we acquired our raw materials primarily from intermediaries, and purchased production-stage material, which resulted in the acquisition of raw materials at less-than favorable prices. Dealing in the recycled plastics market, whether through intermediaries or our own bulk purchases, we will continue to encounter increasing and decreasing prices typically seen in a commodities market. But since the cost of our raw materials is the single largest determinant of our costs of sales in our engineered products segment, we continue to seek out (i) expand our own recycled plastics processing capabilities (ii) agreements with sources of cheaper raw materials, while ensuring those materials meet or exceed our quality standards as well as (iii) continue to expand our research and development effort of different raw materials which may provide a cost and/or performance advantage over existing materials. We are continuing to take steps to reduce our production costs and expenses, while increasing capacity, as necessary. 

 

Central to our initial business model, we did not own or operate the manufacturing facilities for the production of our engineered products as we believed that our outsourced contract manufacturing model provided us the business flexibility to maximize utilization of manufacturing capacity available in the market, respond to the geographic diversity of our customers and minimize our capital requirements. During 2013 based on our evaluation of the benefits of operating our own facility, from both a cost-benefit perspective as well as a quality control perspective, we abandoned the third-party manufacturing model and we leased and staffed a production facility in Waco, Texas which previously served as a contract manufacturing facility for us.

 

Historically, our engineered products have been manufactured at facilities in Pennsylvania and Texas. The production facilities were on direct industrial rail links or spurs, to allow for efficient product deliveries to customers and particularly to rail customers. Flatbed and container trucks are also used to transport our products. Because of the weather-resistant properties inherent in our products, we use outdoor storage extensively. These initial facilities supported the manufacture of large products and were involved in the recycling business and therefore met our requirements. Under those contract manufacturing arrangements, we designed and retained ownership of certain production equipment such as molds, manifolds or dies that were provided to our contract manufacturers during production runs.  All such production equipment is designed as component parts and can be transferred between facilities or used interchangeably in a plug-and-play system as production needs dictate. We continued the third-party contract manufacturing model into the second half of 2013 at our Pennsylvania facility. We purchased and provided the raw materials used in the production of our products, directly to our contract manufacturer and paid them a per-pound rate to produce our products. During the second half of 2013, we decided to terminate this manufacturing relationship and relocate all of our production to our facility in Texas.

 

 

At our Waco, Texas facility, prior to 2013, we purchased a finished product directly from the contract manufacturer. In late 2012, the contract manufacturer at this facility made a business decision to vacate the facility and cease producing our engineered products for us. In order to maintain production, in early 2013 we hired a production and quality workforce to continue to operate the facility and initially had an understanding with the owner of the facility that enabled us to continue to utilize the facility on a month-to-month basis until we entered into a more formal lease arrangement in late 2013. At the end of 2013, all of our engineered products production was at our leased facility in Waco, Texas. This business model will allow us to control costs of production and insure the manufacture of a quality product.

 

Late in 2013, we acquired the business assets and operations of a plastic recycling company in Zanesville, Ohio in order to financially bridge our transition to a production and manufacturing process that would result in the reduction of the costs of the raw materials necessary to produce our engineered products. During 2014, we have been evaluating the equipment, systems, processes and raw material sources to acquire and process our own raw materials for both our use in production of our engineered products, and as an additional revenue stream when sold as reprocessed plastic products to existing and new customers for their production needs. This evaluation remains underway and there can be no assurance that we will abandon or continue to reprocess plastics as a source of raw materials for our engineered products or a source of additional revenue or if we will or will not transition these production resources capabilities to the production of higher margin engineered products.

 

During the three months ended June 30, 2014 and 2013, the costs of sales – production was $5.2 million and $1.4 million, respectively. For the three months ended June 30, 2014, costs of sales – production for the engineered products segment was $1.9 million with remaining $3.3 attributable to the reprocessed plastics segment.

 

Costs of Sales - Excess Capacity & Inventory Adjustments

 

During the year ended December 31, 2013, we initiated production of our engineered products at a facility we leased, staffed and managed, in Waco, Texas. This production facility includes capacity for approximately four production lines and ancillary equipment and related services. Production costs are aggregated during the period and applied to the inventory produced during that period based on a standard cost per pound. This standard cost per pound is based on an assumption that the facility is operating at or near capacity. Any production costs incurred in excess of this standard is charged to costs of sales – excess capacity in the period incurred.

 

During the three and six months ended June 30, 2014, we charged to costs of sales approximately $461,600 and $927,300, respectively, relating to the excess to provide production capacity at our Waco, Texas facility for our engineered products in excess of the volume of production realized. The amounts for the corresponding periods in 2013 are $100,800 for both the three months and six months ended June 30, 2013, as we had just initiated our manufacturing operations.

 

During the three months ended June 30, 2014, we determined that certain inventory was being carried at more than realizable value, and accordingly, we adjusted the carrying value of that inventory which resulted in a charge to costs of sales –inventory adjustment of $532,600. We did not have similar issues in either the prior year or the prior three month period.

 

Gross Margin (Loss) - Combined 

 

Because we are in the early stages of commercial activities, gross margin (loss) may vary significantly and are highly dependent on the our ability to price our products properly, price of raw materials, concurrent production activities and timing and mix of the sales and services. Our gross margin (loss) was impacted by our reprocessed plastics segment costs of sales, the excess capacity within our Waco, TX production facility, the fixed pricing impact of our three-year supply agreement within our engineered products segment and still being in the early stages of our manufacturing and commercial activities and included, among other factors, inefficient manufacturing processes and methods and additional costs and expenses incurred to fulfill certain orders. Due to the nature of the reprocessed plastics segment requiring higher volume of production than we were able to achieve in the relatively short period post-acquisition, substantial negative margins were recognized for the three and six months ended June 30, 2014.

 

 

Product Development and Quality Management.

 

Product development and quality management expenses are incurred as we perform oversight of our own and previously, our contract manufacturing relationships and ongoing evaluations of materials and processes for existing engineered products, as well as the development of new products and processes. Such expenses typically include costs associated with the design and the required testing procedures associated with our engineer product lines – ECOTRAX and STRUXURE. In addition to our investment in both our product development efforts and insuring the products we produce meet the high quality specifications we have set, from time to time we work with the scientific team at Rutgers University to enhance our product formulations, develop innovative products and expand the reach of our existing products.

 

Product development and quality management expenses were approximately $94,600 and $250,400 for the three months ended June 30, 2014 and 2013, respectively. For the six months ended June 30, 2014 and 2013, these expenses were approximately $174,100 and $468,600, respectively. These decreases are due to allocating more time and effort to our own manufacturing processes resulting in more costs being charged into production rather than product development. We continue to focus on enhancing our product formulations, developing new innovative products, and expanding the reach of our existing engineered products as time and resources allow which may result in higher product development and quality management expenses in the future.

 

Marketing and Sales.

 

Expenses related to marketing and sales consist primarily of compensation for our sales and marketing personnel, sales commissions and incentives, advertising, trade shows and related travel and the effect of the minimum royalty required under our licensing agreements for certain engineered products. We have increased our marketing and sales effort and anticipate incurring significant marketing and sales expenses in the future. The strategy we employ in reaching out to our target markets-whether through collaborative approaches, such as joint ventures, by building our own sales and marketing infrastructure, or by sub-licensing our technology to others-will have a significant effect on our marketing and sales expenses. 

 

Marketing and sales expenses were approximately $374,900 for the three months ended June 30, 2014 compared to $256,200 for the three months ended June 30, 2013. For the six months ended June 30, 2014 and 2013, our marketing and sales expenses were $675,600 and $501,100, respectively. The slight increase for both periods was primarily due to efforts within primarily our engineered products segment in the development and implementation of sales and customer development strategy and the continuation of our branding strategy and marketing efforts and all of which is primarily associated with personnel costs.

 

We expect that in the future, marketing and sales expenses will increase in absolute dollars.

 

General and Administrative.

 

General and administrative expenses consist of compensation and related expenses for executive, finance, accounting, administrative, legal, shareholder services and other corporate expenses. In addition, we anticipate as we continue to grow our business, our general and administrative expenses will increase, including the effects of using share-based compensation arrangements with consultants in certain situations. As a result, we expect that in subsequent periods, general and administrative expenses will increase in absolute dollars as revenue increases.

 

General and administrative costs totaled approximately $20.1 million and $766,100 for the three months ended June 30, 2014 and 2013, respectively. For the six months ended June 30, 2014, these expenses were $21.1 million and $1.5 million, respectively. The significant increase from year to year for both periods was due to the difference in the fair value of the common stock issued to affiliated shareholders in exchange for warrants tendered pursuant to a tender offer we initiated during the three months ended June 30, 2014. This difference was $19.1 million.

 

During the three months ended June 30, 2014 and 2013, we recorded approximately $396,800 and $44,300, respectively in share-based compensation charges related to the fair value of the issuances of shares of our common stock, options or warrants providing the right to purchase shares of our common stock at a predetermined price, in the future. For the six months ended June 30, 2014 and 2013, we recorded similar charges of $618,600 and 141,500, respectively. Historically, we issued shares of common stock or options to purchase our common stock, in lieu of cash payments in connection with a licensing agreement, commitment fees for financing transactions, compensation for our directors, officers and employees, as well as to several consultants.

 

 

Depreciation and Amortization.

 

For the three and six months ended June 30, 2014 and 2013, we recorded depreciation expense for manufacturing and production equipment as a charge to production. As we continue to increase our production capacity, we anticipate acquiring additional production equipment and would anticipate an increase in depreciation and amortization expenses.

 

Depreciation and amortization totaled approximately $258,100 and $48,200 for the three months ended June 30, 2014 and 2013, respectively. For the six months ended June 30, 2014 and 2013, depreciation and amortization was approximately $512,900 and 72,600, respectively. The increase from year to year for both periods is a result of the additional equipment from the reprocessed plastics business acquisition. As the investment in molds and other production equipment, including the production equipment acquired pursuant to our acquisition of the plastics recycling business, increased during the year ended December 31, 2013, depreciation expense increased in 2014.

 

Other Expenses

 

Interest Expense.

 

Interest expense primarily consists of the contractual interest rate we pay on our debt instruments. Interest expense recognized during the three months ended June 30, 2014 and 2013, was approximately $458,000 and $180,200, respectively, and represented the contractual interest rates payable on our debt obligations. For the three months ended June 30, 2014, approximately $346,500 was attributable to our 8% convertible promissory notes, approximately $60,100 associated with our 12% revolving credit agreement and the balance associated with our 4.25% bank term loans and other debt. For the six months ended June 30, 2014 and 2013, our interest expense was approximately $841,600 and $352,700, respectively. During both comparative periods we increased our debt to continue to fund operations and acquire fixed assets.

 

Amortization of Debt Discounts.

 

Amortization of debt discounts consists of the periodic amortization of the debt discounts associated with our debt.

 

During the three months ended June 30, 2014 and 2013, we recognized approximately $422,700 and $138,100, respectively, for the amortization of various debt discounts. At the time of issuance, we recorded discounts on our debt securities primarily due to the imbedded conversion features, the fair value of any related warrants issued in conjunction with the securities and any costs incurred in issuing the security. These discounts are amortized to expense over the term of the underlying convertible security. Any unamortized discount remaining when the security is repaid or converted is written off to expense in that period. For the three months ended June 30, 2014 and 2013 the amortization primarily related to the discounts associated with our 8% convertible promissory notes. For the six months ended June 30, 2014 and 2013, we recognized approximately $859,100 and $282,000, respectively for the amortization of these various debt discounts.

 

At June 30, 2014, the unamortized discounts for our convertible debt securities was $5.7 million, primarily associated with our 8% convertible promissory notes. This unamortized discount will be expensed over the five year lives of the underlying convertible promissory notes.

 

Fair Value of Common Shares Issued in Excess of Fair Value of Warrants Tendered.

 

During June 2014, we extended an offer to exchange all of our outstanding warrants for shares of our common stock. We issued common stock with a fair value of $2.3 million to non-affiliated warrant holders in exchange for their warrants with a face value of $1.4 million, with the difference of $0.9 million charged to this account.

 

 

Change in Fair Value of Derivative Liabilities.

 

Through June, 2014, we issued and sold $18.1 million of our various convertible promissory notes, which gives the holders the right to convert the outstanding debt into shares of our common stock. We recorded the fair value of the conversion options on the dates of issuance as a derivative liability and recognized that amount as a discount of our 8% convertible promissory notes. We account for this derivative liability pursuant to ASC 815, and accordingly, we recognized a gain of $0.7 million and a gain of $3.3 million for the three months ended June 30, 2014 and 2013, respectively as a change in fair value of this derivative liability which was recognized in our statements of operations. For the six months ended June 30, 2014 and 2013, we recognized a gain of $5.7 million and a loss of approximately $364,600, respectively as a change in fair value of this derivative liability in our statement of operations. The fair value of this derivative liability at June 30, 2014 was estimated to be $10.7 million.

 

In addition, in conjunction with the sale and issuance of these 8% convertible promissory notes, we issued warrants to purchase our common stock for which we calculated the fair value of the warrants on the dates of issuance and recorded a derivative liability and recognized the amount as a discount of our 8% convertible promissory notes. This derivative liability does not qualify as a fair value or cash flow hedge under ASC 815, and accordingly, we recognized a gain of $3.4 million and $1.8 million for the three months ended June 30, 2014 and 2013, respectively as a change in the fair value of this derivative liability which was recognized in our statements of operations. For the six months ended June 30, 2014 and 2013, we recognized a gain of $5.2 million and a loss of approximately $70,800, respectively as a change in fair value of this derivative liability in our statement of operations. During June 2014, pursuant to the Tender Offer to exchange all outstanding warrants for shares of common stock, these warrants were tendered and therefore was no derivative liability at June 30, 2014.

 

We issued warrants to the placement agents for the sale of our 10% convertible preferred stock, to purchase 58,352 shares of 10% convertible preferred stock at $10 per share. Since at issuance, the number of shares of common stock which these warrants would be exercisable into was not determinable, we recorded the fair value of the warrants at issuance, as a liability on our balance sheet and we re-value this warrant liability at each reporting date, with changes in fair value recognized in earnings each reporting period. During the three months ended June 30, 2014 and 2013, we recorded the change in fair value of this derivative liability in our statement of operations of gains of approximately $55,600 and $93,700, respectively. For the six months ended June 30, 2014 and 2013, we recorded the change in fair value of this derivative liability in our statement of operations of a gain of approximately $176,500 and a loss of approximately $40,600, respectively.

 

Income Taxes.

 

We have unused net operating loss carry forwards, which included losses incurred from inception through December 31, 2013. Due to the uncertainty that sufficient future taxable income will be recognized to realize associated deferred tax assets, no income tax benefit from inception through December 31, 2013 has been recorded.

 

Liquidity and Capital Resources

 

At June 30, 2014 we had $6.3 million in current assets and $14.9 million in current liabilities resulting in working capital deficit of $8.6 million. This compares to a working capital deficit of $14.1 million as of December 31, 2013. Recorded as a current liability, our derivative liabilities associated with our 8% convertible promissory notes at June 30, 2014 totaled $10.7 million. Since the satisfaction of this liability will not require the use of working capital, without this current liability included in the working capital calculation, our working capital at June, 2014 would be $2.1 million. In addition, our 10% convertible preferred stock shown as temporary equity on our balance sheet at June 30, 2014 in the amount of $6.9 million, are not redeemable by most of the preferred shareholders until after December 31, 2016 pursuant to an agreement entered into by preferred shareholders representing $6.1 million of this temporary equity. Furthermore, these same preferred shareholders have agreed to automatically convert their preferred upon the Company listing its stock on an exchange among several other requirements. In our current financial condition, Colorado law does not allow us to redeem any of the preferred stock.

 

 

We used $3.8 million and $1.9 million in our operating activities during the six months ended June 30, 2014 and 2013, respectively, with the increase primarily the result of the operations of our plastics reprocessing business acquired in late 2013.

 

Our net loss for the three months ended June 30, 2014 of approximately $20.4 million included the impact of several significant non-cash transactions including the effect of the change in fair value of the derivative liabilities associated with our 8% convertible promissory notes. This credit was $4.1 million in our consolidated statement of operations for the period. For the six months ended June 30, 2014, we recognized a gain of $11.0 million in regards to this same non-cash change in fair value of the derivative liabilities transaction. In addition during the three months ended June 30, 2014, we charged operations for the excess of the fair value of common stock issued in exchanged for warrants tendered of $20.0 million. There was no such charge in 2013.

 

To enhance and increase production capacity, we purchased equipment of $0.7 million during the three months ended June 30, 2014. As we evaluate our business plans and strategy, we may purchase additional property and equipment during the next twelve months as we continue to expand our manufacturing capacity. An extrusion line for our engineered products manufacturing business typically costs upwards of $1.0 million, including installation and auxiliary parts and equipment. These purchases may be financed with working capital, if available or through additional debt.

 

During six months ended June 30, 2014, we issued and sold to certain investors an aggregate principal amount of $5.0 million of our various convertible promissory notes. We may prepay the notes, in whole or in part, upon prior written notice to the holders thereof. Interest accrues on the notes at a rate of 8.0% per annum, payable for the majority of the notes, during the first three years that the notes are outstanding in shares of common stock, valued at the weighted average price of a share of common stock for the twenty consecutive trading days prior to the interest payment date, pursuant to the terms of the notes. During the fourth and fifth years that the notes are outstanding, interest that accrues under the notes shall be payable in cash.

 

We entered into a revolving credit agreement and borrowed $2.0 million during the year ended December 31, 2013, which remains outstanding at June 30, 2014. These funds were used to support our working capital needs upon our acquisition of the reprocessed plastics business in November 2013.

 

Pursuant to the terms of the 10% convertible preferred stock, to date we have elected to pay our quarterly dividends in shares of our common stock, rather than in cash. Whether or not we make the same election for future quarters will have an impact on our cash balances.

 

At June 30, 2014, we had $6.9 million of our 10% convertible preferred stock outstanding of which $6.1 million may not be redeemed by the holder until after December 31, 2016, pursuant to an agreement entered into between the Company and the preferred stock holder. Due to our current financial condition, Colorado law will not allow us to redeem the balance. Our ability to pay principal and interest on our various 8% convertible promissory notes, which mature beginning in 2017, repay our 12% revolving credit agreement balance of $2.0 million and our $4,500,000 of 4.25% bank term loans, among other debt and to fund our planned operations, including certain minimum royalties pursuant to our license agreement with Rutgers University, depends on our future operating performance and our ability to raise capital. The timing and amount of our financing needs will be highly dependent on our ability to manufacture our products at a cost which provides for an appropriate return, the success of our sales and marketing programs, our ability to obtain purchase commitments, the size of such purchase commitments and any associated working capital requirements.

 

At June 30, 2014, we had a working capital deficit of $8.6 million, cumulative face value of redeemable preferred stock and various debt instruments of $31.9 million, a stockholders’ deficit of $24.6 million and have accumulated losses to date of $76.1 million.  This raises substantial doubt about our ability to continue as a going concern.  In view of these matters, realization of certain of the assets in the accompanying balance sheet is dependent upon our ability to meet our financing requirements, raise additional capital, and the success of our business plan and future operations. Our current operating plans are to enhance and expand our manufacturing capacity when necessary to meet our customer commitments, continue to expand our marketing and sales capabilities to increase our pipeline of sales orders, and continue to develop innovative solutions for our customers. Although we have raised additional funds through the issuance of our various 8% convertible promissory notes and continue exploring other financing sources, there can be no assurance that we will achieve our financing needs at all or upon terms acceptable to us.  Further, if we issue additional equity or debt securities, stockholders may experience additional dilution or the new equity securities may have rights, preferences or privileges senior to those of existing holders of our common stock.

 

Based on the results of six months ended June 30, 2014, we determined that our recent experience of financial results for our reprocessed plastics reporting segment represents a triggering event requiring goodwill and related intangible assets impairment tests. The goodwill and related intangible assets associated with our reprocessed plastics reporting segment totaled $2.1 million as of both June 30, 2014 and December 31, 2013. We were unable to reasonably estimate the amount of goodwill impairment, if any, during the six months ended June 30, 2014 and will complete our impairment test on all of our reporting units during the three months ended September 30, 2014.

 

Our independent registered public accountants issued an explanatory paragraph expressing substantial doubt about our ability to continue as a going concern on our financial statements for the years ended December 31, 2013 and 2012, based on the significant operating losses and a lack of external financing.  Our financial statements do not include any adjustments that resulted from the outcome of this uncertainty.

 

 

Disclosure About Off-Balance Sheet Arrangements

 

We do not have any transactions, agreements or other contractual arrangements that constitute off-balance sheet arrangements.

 

Item 3.  Quantitative and Qualitative Disclosures About Market Risks.

 

Not applicable.

 

Item 4. Controls and Procedures.

 

(a) Evaluation of disclosure controls and procedures.

 

With the participation of our principal executive officer and principal financial officer, we evaluated the effectiveness of our disclosure controls and procedures pursuant to Rule 13a-15 under the Exchange Act. In designing and evaluating the disclosure controls and procedures, we recognize that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. In addition, the design of disclosure controls and procedures must reflect the fact that there are resource constraints and that we are required to apply our judgment in evaluating the benefits of possible controls and procedures relative to their costs.

 

Based on our evaluation, our principal executive officer and principal financial officer concluded that, as a result of the material weakness described below, as of June 30, 2014, we did not maintain effective internal control over financial reporting, based on criteria issued by the Committee of Sponsoring Organizations of the Treadway Commission. The material weakness, which relates to internal control over financial reporting, that was identified is:

 

(i)

We did not maintain sufficient personnel with an appropriate level of technical accounting knowledge, experience, and training in the application of GAAP commensurate with our complexity and our financial accounting and reporting requirements. We have limited experience in the areas of financial reporting regarding complex financial instruments.  As a result, there is a reasonable possibility that material misstatements of the consolidated financial statements, including disclosures, will not be prevented or detected on a timely basis.  For example, on May 10, 2012, we became aware that we had failed to recognize a warrant derivative liability with respect to our 10% Convertible Preferred Stock and the subsequent measurement of fair value of the warrant derivative liability, as required by Accounting Standards Codification 815-40.  As a result, we determined that our consolidated financial statements for the year ended December 31, 2011 filed in the Annual Report on Form 10-K and our consolidated financial statements as of and for the three month period ended September 30, 2011 filed in the quarterly report on Form 10-Q (collectively, the “Reports”) should not be relied upon and needed to be restated; and on August 15, 2012, we became aware that we had failed (i) to initially record and subsequently fair value our derivative liabilities for our bonus warrants and (ii) to properly account for the loss on extinguishment of the debentures upon amendment. As a result, we determined that our consolidated financial statements for the interim periods ended March 31, 2011, June 30, 2011, September 30, 2011, for the year ended December 31, 2011, and for the interim period ended March 31, 2012 should not be relied upon and needed to be restated.

 

 

We are committed to improving our financial organization, and we have adopted additional processes and procedures over financial reporting. If the issuance of any securities is contemplated, we will consult with legal counsel and appropriate accounting resources to evaluate the financial statement impact that the issuance of such financial instruments may have prior to issuance. Additional measures may be implemented as we evaluate the effectiveness of these efforts.  We cannot assure you that these remediation efforts will be successful or that our internal control over financial reporting will be effective in accomplishing the control objectives.

 

Prior to 2014, due to our limited number of accounting and administrative personnel, we did not have proper segregation of duties in certain areas of our financial reporting and other accounting processes and procedures. This control deficiency resulted in a reasonable possibility that material misstatements of the consolidated financial statements would not be prevented or detected on a timely basis. Based on our evaluation at the time, we concluded this was a material weakness. Since the relocation of our accounting and administrative functions to our recently acquired reprocessed plastics business in Ohio, has allowed for the proper segregation of duties and provided more checks and balances within the department, we have concluded this material weakness no longer exists. The additional personnel will also allow for the cross training needed to support us if personnel turn-over occurs within the department. We believe this will greatly decrease any control and procedure issues we may encounter in the future.

  

In addition, we will continue to evaluate the need and costs to increase our personnel resources and technical accounting expertise within the accounting function to resolve non-routine or complex accounting matters.  As our operations are relatively small and we continue to have net cash losses each quarter, we do not anticipate being able to hire additional internal personnel until such time as our operations are profitable on a cash basis or until our operations are large enough to justify the hiring of additional accounting personnel. As necessary, we may engage consultants in the future in order to ensure proper accounting for our consolidated financial statements.

 

We believe that engaging additional knowledgeable personnel with specific technical accounting expertise will remedy the following material weakness: insufficient personnel with an appropriate level of technical accounting knowledge, experience, and training in the application of GAAP commensurate with our complexity and our financial accounting and reporting requirements.

 

We believe that, when the circumstances allow, the hiring of additional personnel who have the technical expertise and knowledge with the non-routine or technical accounting issues we have encountered in the past will result in both proper recording of these transactions and a much more knowledgeable finance department as a whole. Due to the fact that we have a limited internal accounting staff, additional personnel will also allow for the proper segregation of duties and provide more checks and balances within the department. Additional personnel will also provide the cross training needed to support us if personnel turn-over occurs within the department. We believe this will greatly decrease any control and procedure issues we may encounter in the future. 

 

(b) Changes in internal control over financial reporting.

 

We regularly review our system of internal control over financial reporting and make changes to our processes and systems to improve controls and increase efficiency, while ensuring that we maintain an effective internal control environment. Changes may include such activities as implementing new, more efficient systems, consolidating activities, and migrating processes. There were no changes in our internal control over financial reporting that occurred during the six months ended June 30, 2014 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

 

PART II. OTHER INFORMATION

 

Item 1. Legal Proceedings.

 

None

  

Item 2. Unregistered Sales of Securities and Use of Proceeds.

 

During January 2014, we issued 181,531 shares of common stock as payment of our dividends on our 10% convertible preferred stock, in lieu of cash, with a fair value on the date of issue of $183,346.

 

During January 2014, we issued 235,853 shares of common stock as payment of our interest on our 8% convertible notes, in lieu of cash, with a fair value on the date of issue of $235,853.

 

During January 2014, we issued 107,461 shares of common stock upon cashless exercise of a previously awarded stock options and warrants. 

 

During January 2014, we issued 220,147 shares of common stock as payment of various commitment fees pursuant to our 12% revolving credit agreement, in lieu of cash, with a fair value on the date of issue of $140,894.

 

During January 2014, we issued 8,522 shares of common stock as payment of our interest on our 12% revolving credit agreement, in lieu of cash, with a fair value on the date of issue of $8,522.

 

During January 2014, we granted a warrant to purchase 160,000 shares of common stock at an exercise price of $1.20 per share to a previous consultant in settlement of an outstanding obligation. Based on the Black-Scholes option pricing model, this warrant had a fair value of approximately $84,700.

 

During January 2014, pursuant to the purchase of $1.0 million of our 8% convertible promissory notes, we issued a warrant to purchase 900,901 shares of our common stock to the note holder. The exercise price of these warrants was $1.11 per share.

 

During March 2014, pursuant to the purchase of $1.7 million of our 8% convertible promissory notes, we issued warrants to purchase 4,250,000 shares of our common stock to the note holder. The exercise price of these warrants was $0.60 per share.

 

During April 2014, pursuant to the purchase of $850,000 of our 8% convertible promissory notes, we issued warrants to purchase 2,125,000 shares of our common stock to the note holder. The exercise price of these warrants was $0.60 per share.

 

During April 2014, we issued 215,942 shares of common stock as payment of our dividends on our 10% convertible preferred stock, in lieu of cash, with a fair value on the date of issue of $159,797.

 

During April 2014, we issued 359,300 shares of common stock as payment of our interest on our 8% convertible notes, in lieu of cash, with a fair value on the date of issue of $265,882.

 

During April 2014, we issued 50,424 shares of common stock as payment of our interest on our 12% revolving credit agreement, in lieu of cash, with a fair value on the date of issue of $37,314.

 

During April 2014, we issued 196,079 shares of common stock to a consultant pursuant to terms of an agreement, with a fair value on the date of issue of $100,000.

 

During June 2014, we issued 35,452,979 shares of common stock with a fair value on the date of issue of $24,817,086, in exchange for previously outstanding warrants which were cancelled pursuant to a tender offer, with a fair value of $4,859,232.

 

We relied upon Section 4(2) of the Securities Act and Regulation D under the Securities Act in connection with the issuance of the above described securities.

 

 

Item 3. Defaults Upon Senior Securities.

 

None.

 

Item 4. Mine Safety Disclosures.

 

(Not Applicable)

 

Item 5. Other Information.

 

None.

 

Item 6. Exhibits.

 

Exhibits:
31.1	Section 302 Certification of Chief Executive Officer
31.2	Section 302 Certification of Principal Financial Officer
32.1	Section 906 Certification of Chief Executive Officer and Chief Financial Officer

 

 

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.

 

		Axion International Holdings, Inc.
Date: August 14, 2014		/s/ Claude Brown
		Claude Brown
		Chief Executive Officer
Date: August 14, 2014		/s/ Donald Fallon
		Donald Fallon
		Chief Financial Officer