UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

Form 10-Q

 

þ

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

 

For the quarterly period ended March 31, 2013

 

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)

 

180 South Street, Suite 104, New Providence, NJ 07974

(Address of principal executive offices)

 

908-542-0888

(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 þ      No ¨

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes þ No   ¨

 

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 þ

 

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

Yes ¨   No þ

 

The number of outstanding shares of the registrant’s common stock, without par value, as of May 14, 2013 was 29,603,766.

 

 

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	23
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	30
Item 4.	Controls and Procedures	30
	PART II. OTHER INFORMATION
Item 1.	Legal Proceedings	33
Item 2.	Unregistered Sales of Securities and Use of Proceeds	33
Item 3.	Defaults Upon Senior Securities	33
Item 4.	Mine Safety Disclosures	34
Item 5.	Other Information	34
Item 6.	Exhibits	35
	SIGNATURES	36

 

  

PART I. FINANCIAL INFORMATION

 

Item 1. Financial Statements.

 

AXION INTERNATIONAL HOLDINGS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

 

		March 31,				December 31,
		2013				2012
		(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents		$	1,139,163			$	346,905
Accounts receivable, net of allowance			551,877				192,015
Inventories			2,498,141				3,088,953
Prepaid expenses and deposits			105,662				165,339
Total current assets			4,294,843				3,793,212
Property and equipment, net			1,996,461				2,005,215
Other long-term and intangible assets			-				68,284
Total assets		$	6,291,304			$	5,866,711
LIABILITIES AND STOCKHOLDERS' DEFICIT
Current liabilities:
Accounts payable		$	711,660			$	890,394
Accrued liabilities			500,595				446,434
Derivative liabilities – 8% convertible promissory notes			7,100,000				830,000
Total current liabilities			8,312,254				2,166,828
8% convertible promissory notes, net of discounts			6,770,478				5,671,162
Fair value of 10% convertible preferred stock warrants			216,016				81,716
Total liabilities			15,298,748				7,919,706
Commitments and contingencies
10% convertible preferred stock, no par value; authorized 880,000 shares; 702,123 and 706,023 shares issued and outstanding at March 31, 2013 and December 31, 2012, respectively, net of discounts			6,112,913				5,922,612
Stockholders' deficit:
Common stock, no par value; authorized, 100,000,000 shares; 28,984,173 and 28,820,173 shares issued and outstanding at March 31, 2013 and December 31, 2012, respectively			26,828,772				27,103,454
Accumulated deficit			(41,949,129	)			(35,079,061	)
Total stockholders' deficit			(15,120,357	)			(7,975,607	)
Total liabilities and stockholders' deficit		$	6,291,304			$	5,866,711

 

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

 

 

AXION INTERNATIONAL HOLDINGS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

FOR THE THREE MONTHS ENDED MARCH 31,

(Unaudited)

 

		2013				2012
Revenue		$	1,759,635			$	2,296,573
Costs of sales			1,522,421				2,285,450
Gross margin			237,214				11,123
Operating expenses:
Product development and quality management			218,223				235,479
Marketing and sales			244,929				138,772
General and administrative			718,111				835,391
Total operating costs and expenses			1,181,263				1,209,642
Loss from operations			(944,049	)			(1,198,519	)
Other expenses:
Interest expense			172,404				37,974
Amortization of debt discount			143,891				170,082
Change in fair value of derivative liabilities			5,609,724				2,995
Total other expenses			5,926,019				211,051
Net loss			(6,870,068	)			(1,409,570	)
Accretion of preferred stock dividends and beneficial conversion feature			(410,830	)			(345,526	)
Net loss attributable to common shareholders		$	(7,280,898	)		$	(1,755,096	)
Weighted average common shares - basic and diluted			28,862,062				25,630,321
Basic and diluted net loss per share		$	(0.25	)		$	(0.07	)

  

(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, 2013 THROUGH MARCH 31, 2013

(Unaudited)

 

		Common Shares				Additional Paid-in Capital and Common Stock				Accumulated Deficit				Total
Balance, January 1, 2013			28,820,173			$	27,103,454			$	(35,079,061	)		$	(7,975,607	)
Shares issued upon conversion of 10% convertible preferred stock			39,000				39,000								39,000
Shares issued for services rendered			125,000				78,750								78,750
Share-based compensation							18,398								18,398
Dividend on 10% convertible preferred stock							(181,529	)							(181,529	)
Amortization of beneficial conversion feature of 10% convertible preferred stock							(229,301	)							(229,301	)
Net loss											(6,870,068	)			(6,870,068	)
Balance, March 31, 2013			28,984,173			$	26,828,772			$	(41,949,129	)		$	(15,120,357	)

 

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

 

 

AXION INTERNATIONAL HOLDINGS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE THREE MONTHS ENDED MARCH 31,

(Unaudited)

 

		2013				2012
Cash flow from operating activities:
Net loss		$	(6,870,068	)		$	(1,409,570	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization			24,376				34,244
Amortization of convertible debt discount			143,891				-
Amortization of preferred stock discount			-				68,347
Amortization of revolving credit agreement discount			-				101,735
Change in fair value of derivative liabilities			5,475,424				2,995
Change in fair value of 10% convertible preferred stock warrants			134,300				(242,558	)
Share-based compensation			97,148				336,257
Changes in operating assets and liability:
Accounts receivable			(359,862	)			(162,118	)
Inventories			590,812				360,119
Prepaid expenses and deposits			127,961				(142,941	)
Accounts payable			(178,735	)			837,720
Accrued liabilities			(127,368	)			39,909
Net cash used in operating activities			(942,121	)			(175,861	)
Cash flows from investing activities:
Purchase of property and equipment			(15,622	)			(526,574	)
Net cash used in investing activities			(15,622	)			(526,574	)
Cash flows from financing activities:
Proceeds from issuance of 8% convertible promissory notes, net			1,750,001
Repayments of convertible debt							(172,500	)
Net cash provided by (used in) financing activities			1,750,001				(172,500	)
Net (decrease) increase in cash			792,258				(874,935	)
Cash and cash equivalents at beginning of period			346,905				1,982,772
Cash and cash equivalents at end of period		$	1,139,163			$	1,107,837
Supplemental disclosures of cash flow information:
Cash paid for interest		$	610			$	37,974
Conversion of 10% convertible preferred stock and debt			39,000				62,500
Dividends on 10% convertible preferred stock			181,529				171,751
Amortization of 10% convertible preferred stock discount			229,301				173,775
Fair value of warrants issued with 8% convertible promissory notes			249,151				-
Fair value of conversion option of 8% convertible promissory notes			545,425				-

 

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

 

 

AXION INTERNATIONAL HOLDINGS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2013

(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.

 

We develop, manufacture, market and sell composite rail ties and structural building products, such as pilings, I-beams, T-beams and boards, which, based upon patented technology developed at Rutgers University, 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, moisture impervious, non-chemical leaching and insect and rot resistant. Our products possess superior lifecycles and generally have greater durability and require less maintenance than competitive products made from wood, steel or concrete. We market our products through two lines - ECOTRAX™, our line of rail ties, and STRUXURE™, our line of structural building products.

 

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

 

The accompanying unaudited condensed consolidated financial statements of the Company 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 months ended March 31, 2013, are not necessarily indicative of the results that may be expected for the year ending December 31, 2013. The unaudited condensed consolidated financial statements should be read in conjunction with the consolidated December 31, 2012 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 March 31, 2013 and December 31, 2012, 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.  Our allowance for doubtful accounts at March 31, 2013 and December 31, 2012 was approximately $132,000.

 

 

(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:

 

		March 31, 2013				December 31, 2012
Equipment		$	13,754			$	13,754
Machinery and equipment			2,623,315				2,611,933
Purchased software			133,993				129,753
Furniture and fixtures			13,090				13,090
Subtotal – property and equipment, at cost			2,784,152				2,768,530
Less accumulated depreciation			(787,691	)			(763,315	)
Net property and leasehold improvements		$	1,996,461			$	2,005,215

 

Depreciation expense charged to income during the three months ended March 31, 2013 and 2012 was approximately $24,400 and $34,200, respectively. Of the amount charged to income during the three months ended March 31, 2013 and 2012, approximately $20,600 and $33,900, respectively was charged to costs of sales and the remainder to operating expenses.

 

(e)

Exclusive Agreement

 

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 such as pilings, I-beams, T-beams and boards of various sizes.

 

Royalties incurred and payable to Rutgers, for the three months ended March 31, 2013 and 2012 were $50,000 for each three month period. 

 

(f)

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.

 

We recognize revenue when a fixed commitment to purchase the products is received, title or ownership has passed to the customer and we do not have any 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.

 

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 third-party manufacturer producing the finished product. Under one arrangement, we purchase and supply the raw materials to the third-party manufacturer who we pay a per-pound cost to produce the finished product. Under our other arrangement the third-party manufacturer sources and pays for the raw materials and we purchase the finished product from them at a cost per unit. In addition, for that arrangement, we are responsible for any costs of raw materials purchased by the third-party manufacturer in excess of the arrangement’s reference prices and we share any savings for purchases below the reference prices.  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, and do not believe we will in the future.

 

(g)

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, 2012, 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 have not remained current with our filings of our federal and state income tax returns. Due to these delinquent filings, our income tax returns are open to examination by federal and state authorities, generally for the tax years ended September 30, 2008 and later.

 

(h)

Impairment of Long-Lived Assets Other Than Goodwill

 

We assess the potential for impairment in the carrying values of our long-term assets whenever events or changes in circumstances indicate such impairment may have occurred.  An impairment charge to current operations is recognized when the estimated undiscounted future net cash flows of the asset are less than its carrying value. Any such impairment is recognized based on the differences in the carrying value and estimated fair value of the impaired asset.

 

 

(i)

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.

 

(j)

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.

 

(k)

Loss Per Share

 

Basic loss per share are computed by dividing loss available to common shareholders by the weighted average number of common shares outstanding for the period.  Diluted earnings per share includes the effects of the potential dilution of outstanding options, warrants, and convertible debt on our common stock as determined using the treasury stock method. For the three months ended March 31, 2013 and 2012, there were no dilutive effects of such securities because we incurred a net loss in each period.  As of March 31, 2013, we have approximately 67.2 million potential common shares issuable under our convertible instruments, warrant and stock option agreements.

 

(l)

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.

  

(m)

Concentration of Credit Risk

 

We maintain our cash with two major U.S. domestic banks. The amount held in both of the banks exceeds the insured limit of $250,000 from time to time. The amount which exceeded the insured limit was approximately $0.8 million and $0.3 million at March 31, 2013 and December 31, 2012, respectively.  We have not incurred losses related to these deposits.

 

(n)

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 March 31, 2013, we had a working capital deficit of $4.0 million, a stockholders’ deficit of $15.1 million and have accumulated losses to date of $41.9 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 - 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:

 

		March 31, 2013				December 31, 2012
Finished products		$	1,922,355			$	2,509,797
Production materials			575,786				579,156
Total inventories		$	2,498,141			$	3,088,953

 

Since we also engage third-party contract manufacturers to produce our finished products, and in certain situations we provide them the raw materials, our inventories at March 31, 2013 and December 31, 2012 are located at the third-party contract manufacturing locations. We carry adequate insurance for loss on this inventory. 

 

Note 4 - Accrued Liabilities

 

The components of accrued liabilities are:

 

		March 31, 2013				December 31, 2012
Royalties		$	108,246			$	351,846
10% convertible preferred stock dividends			181,529				-
Interest			171,794				-
Payroll			39,026				77,757
Miscellaneous			-				16,831
Total accrued liabilities		$	500,595			$	446,434

    

Note 5 - Derivative Liabilities

 

8% Convertible Promissory Notes – Conversion Option and Warrants

 

During the three months ended March 31, 2013, we issued 8% convertible promissory notes (the “8% Notes”). See Note 6 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 during the three months ended March 31, 2013 and the aggregate fair value of all the conversion options on March 31, 2013 was approximately $545,400 and $4.8 million, respectively. The increase in fair value of $3.6 million was recorded as a change in derivative liability in the statement of operations during the three months ended March 31, 2013. The fair value of the warrants derivative liability on the various dates of issuance during the three months ended March 31, 2013 and the aggregate fair value of all the warrants issued on March 31, 2013 was approximately $249,200 and $2.3 million, respectively. The increase in fair value of $1.8 million was recorded as a change in fair value of derivative liability in the statement of operations during the three months ended March 31, 2013.

 

The estimated fair values of the derivative liabilities for the conversion options on the 8% Notes issued during the three months ended March 31, 2013 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				March 31, 2013
Volatility			50.0	%			50.0	%
Risk-free interest rate			0.4	%			0.3	%
Dividend yield			0.0	%			0.0	%
Expected life			2.4 to 2.6 years				2.4 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 initial fair value 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 129%, (iii) a risk-free interest rate 2.1%, and (iv) an expected life of five years. The fair value of the warrant liability at March 31, 2013 and December 31, 2012 was approximately $216,000 and $81,700, respectively and we recognized a charge to our statement of operations for the change in fair value of the warrant liability for the three months ended March 31, 2013 of $134,300.

 

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 March 31, 2013 and December 31, 2012 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.

 

 

Additional Disclosures Regarding Fair Value Measurements

 

The carrying value of cash and cash equivalents, accounts receivable and accounts payable approximate their fair value due to the short-term maturity of those items.

 

The fair value of our debt, which approximates its carrying value, as of March 31, 2013 and December 31, 2012 was estimated at $6.8 million and $5.7 million, respectively. Factors that we considered when estimating the fair value of our debt include market conditions, liquidity levels in the private placement market, variability in pricing from multiple lenders and term of debt. The level would be considered as level 2.

 

The following table summarizes the financial liabilities measured at fair value on a recurring basis as of March 31, 2013 and December 31, 2012, segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value:

 

		As of March 31, 2013
														Derivative
														Liabilities at
		Level 1				Level 2				Level 3				Fair Value
8% Convertible promissory notes:
Conversion option		$	-			$	-			$	4,790,000			$	4,790,000
Warrants			-				-				2,310,000				2,310,000
Derivative liabilities - Current			-				-				7,100,000				7,100,000
Placement agent warrants - Non-current			-				-				216,016				216,016
Derivative liabilities - Total		$	-			$	-			$	7,316,016			$	7,316,016

  

		As of December 31, 2012
														Derivative
														Liabilities at
		Level 1				Level 2				Level 3				Fair Value
8% Convertible promissory notes:
Conversion option		$	-			$	-			$	610,000			$	610,000
Warrants			-				-				220,000				220,000
Derivative liabilities - Current			-				-				830,000				830,000
Placement agent warrants - Non-current			-				-				81,716				81,716
Derivative liabilities - Total		$	-			$	-			$	911,716			$	911,716

 

 

The following table is a reconciliation of the derivative liabilities for which Level 3 inputs were used in determining fair value during the three months ended March 31, 2013 and 2012:

 

 

		For the Three Months Ended March 31, 2013
														Credited to
														Common
		Balance -				Fair Value of								Stock				Balance -
		January 1,				Derivative				Change in				Upon Issuance				March 31,
		2013				Liability				Fair Value				of Warrants				2013
8% Convertible promissory notes:
Conversion option		$	610,000			$	545,425			$	3,634,575			$	-			$	4,790,000
Warrants			220,000				249,151				1,840,849				-				2,310,000
Derivative liabilities - Current			830,000				794,576				5,475,424				-				7,100,000
Placement agent warrants - Non-current			81,716				-				134,300				-				216,016
Derivative liabilities - Total		$	911,716			$	794,576			$	5,609,724			$	-			$	7,316,016

  

		For the Three Months Ended March 31, 2012
														Credited to
														Common
		Balance -				Fair Value of								Stock				Balance -
		January 1,				Derivative				Change in				Upon Issuance				March 31,
		2012				Liability				Fair Value				of Warrants				2012
12% Convertible revolving credit agreement:
Conversion option		$	113,271			$	-			$	13,800			$	-			$	127,071
10% convertible preferred stock:
Warrants			1,875,463				-				-				(1,875,463	)			-
10% convertible debentures:
Warrants			70,343				-				(10,805	)			(38,093	)			21,445
Derivative liabilities - Current			2,059,077				-				2,995				(1,913,556	)			148,516
Placement agent warrants - Non-current			487,555				-				(242,558	)			-				244,997
Derivative liabilities - Total		$	2,546,632			$	-			$	(239,563	)		$	(1,913,556	)		$	393,513

 

 

Note 6 - Convertible Debt

 

The components of our convertible debt are summarized as follows:

 

		Due		March 31, 2013				December 31, 2012
8% convertible promissory notes		Beginning August 2017		$	8,878,188			$	7,128,187
Less debt discount					(2,107,710	)			(1,457,025	)
Total – long term debt				$	6,770,478			$	5,671,162

 

8% Convertible Promissory Notes

 

During the three months ended March 31, 2013 pursuant to the same terms of our existing 8% convertible promissory notes (the “Notes”), we issued and sold to Melvin Lenkin, Samuel Rose and others (collectively the “Investors”, see Note 14 regarding related party transactions) (i) an aggregate principal amount of $1,750,001 of our 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 Notes, and (ii) associated warrants to purchase, in the aggregate, 4,375,004 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.

 

Accrued but unpaid interest due on March 31, 2013 for the three months ended March 31, 2013, was paid with approximately 252,700 shares of common stock, in lieu of cash, which were issued subsequent to March 31, 2013 with a value of approximately $171,800.

 

The warrants are exercisable at an exercise price of $0.60 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.

 

The issuance costs of approximately $124,700, 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 months ended March 31, 2013, we amortized approximately $143,900 of the discount to other expenses in our statement of operations. There was no corresponding transaction for the three months ended March 31, 2012. See Note 5 for further discussion of these derivative liabilities.

 

 

Note 7 - 10% Convertible Redeemable Preferred Stock

 

The components of our Preferred Stock, classified as temporary equity in our balance sheet, are summarized as follows:

 

		March 31,				December 31,
		2013				2012
10% convertible preferred stock - face value		$	7,021,230			$	7,060,230
Unamortized discount			(908,317	)			(1,137,618	)
10% convertible preferred stock, net of discount			6,112,913				5,922,612

  

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 shall be redeemable for cash by the holder any time after the three-year anniversary from the initial purchase. 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 6 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 March and April 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 approximately $828,300, 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 are 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. During the three months ended March 31, 2013 and 2012 we amortized approximately $229,300 and $173,800, respectively to additional paid-in capital. At March 31, 2013, the unamortized Preferred Stock discount balance was approximately $908,300.

 

 

During the three months ended March 31, 2013 and the year ended December 31, 2012, we issued 39,000 and 462,500 shares of our common stock, respectively upon conversion of 3,900 and 46,250 shares of our Preferred Stock, respectively.

 

The Preferred Stock outstanding at March 31, 2013, is convertible into 7.0 million shares of our common stock. 

 

Since the Preferred Stock at March 31, 2013 may ultimately be redeemed at the option of the holder, the carrying value of the Preferred Stock, net of unamortized discount has been classified as temporary equity.

 

Our dividend payable on March 31, 2013 was paid with approximately 267,000 shares of common stock in lieu of cash, which were issued subsequent to March 31, 2013, and with a value of approximately $181,500. 

 

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 5 for further discussion of derivative liabilities. 

 

Note 8 - Stockholders’ Equity

 

We are authorized to issue up to 100,000,000 shares of Common Stock, no par value, and up to 2,500,000 shares of Preferred Stock, no par value. There were 28,984,173 and 28,820,173 shares of common stock issued and outstanding at March 31, 2013 and December 31, 2012, 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 702,123 and 706,073 shares of 10% convertible preferred stock at March 31, 2013 and December 31, 2012, respectively. 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 Three Months Ended March 31, 2013

 

During February 2013, we issued 39,000 shares of common stock upon conversion of 3,900 shares of our 10% convertible preferred stock, with a value of $39,000.

 

During March 2013, we issued 125,000 shares of common stock to a consultant. The shares of common stock had a fair value on the date of issuance of $78,750, which was charged to general and administrative expenses in our statement of operations upon issuance. 

 

Note 9 - Share-based Compensation

 

Options

 

We have two nonqualified stock option plans approved by shareholders with an aggregate of approximately 2.1 million shares remaining available for grant as of March 31, 2013.  The exercise price of the options are established by the Board of Directors on the date of grant and are 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.

 

We estimate the fair value of each option award at the grant date by using the Black-Scholes option pricing model. We did not award any options during the three months ended March 31, 2013.

 

Certain options awarded prior to the year ended December 31, 2012 are amortized over vesting periods encompassing the three months ended March 31, 2013, and consequently we charged to operating expenses approximately $4,700 during the three months ended March 31, 2013.

 

 

The following table summarizes our stock option activity for the three months ended March 31, 2013:

 

						Weighted-
		Number				Average
		of Shares				Exercise
		Issuable				Price
Balance, January 1, 2013			5,710,125			$	1.10
Granted			-				-
Exercised			-				-
Cancelled			(762,076	)			*
Balance, March 31, 2013			4,948,049			$	1.27

 

* less than $0.01 

 

The following table summarizes options outstanding at March 31, 2013:

 

						Weighted-				Weighted-
		Number				Average				Average				Aggregate
		of Shares				Exercise				Remaining				Intrinsic
		Issuable				Price				Term (Years)				Value
Exercisable			3,438,049			$	1.09				3.0			$	53,000
Not vested			1,510,000			$	1.70				4.3			$	-
Balance, March 31, 2013:			4,948,049			$	1.27				3.4			$	53,000

 

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 three months ended March 31, 2013:

 

						Weighted-
		Number				Average
		of Shares				Exercise
		Issuable				Price
Balance, January 1, 2013			27,353,151			$	0.76
Granted			4,375,004			$	0.60
Exercised			-			$	-
Cancelled			-			$	-
Balance, March 31, 2013			31,728,155			$	0.74

  

 

The following table sets forth the warrants outstanding at March 31 2013:

 

						Weighted-
		Number				Average
		of Shares				Exercise
		Issuable				Price
10% convertible debenture - bonus warrants			483,357			$	0.60
10% convertible preferred stock - warrants			3,761,365			$	1.00
8% convertible promissory notes - warrants			22,195,474			$	0.60
Consultants			5,287,959			$	1.16
Total			31,728,155			$	0.74

 

During the three months ended March 31, 2013, pursuant to our 8% convertible promissory notes, we issued warrants to purchase 4,375,004 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 $249,200 which was recorded as a credit to derivative liabilities and a charge to debt discount associated with our 8% convertible promissory notes. See Notes 5 and 6 for further discussion of these warrants. The estimated fair value of the warrants was computed by a third party using Monte Carlo simulation models.

 

In addition, the fair value of a previously issued warrant which is 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 months ended March 31, 2013, we increased the fair value by approximately $13,700 and recorded a charge in our statement of operations. 

 

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, 2012, we had U.S. federal net operating loss carryforwards of approximately $17.4 million, which, if unused, expire through 2032. 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, 2012, 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 months ended March 31, 2013 and 2012, we sold our products to 15 and 9 different customers, respectively and with sales of our ECOTRAX rail ties to one customer representing approximately 24% and 76%, respectively of our total revenue.

 

Our purchases of raw materials and contract manufacturing services and products, was concentrated in approximately twenty vendors, during the three months ended March 31, 2013 and 2012. 

 

Note 13 - Commitments and Contingencies

 

Operating leases

 

We lease our office space in New Providence, New Jersey pursuant to a one-year extension of our prior three-year lease agreement for monthly lease payments of approximately $3,800.  These premises serve as our corporate headquarters. The lease expires on October 31, 2013.  Facility rent expense totaled approximately $11,400 and $11,300 for the three months ended March 31, 2013 and 2012, 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 March 31, 2013 and 2012, we accrued royalties payable to Rutgers on product sales of approximately $27,400 and $36,500, respectively. In addition, for the three months ended March 31, 2013 and 2012, since we did not meet the minimum royalty due pursuant to the license, we accrued approximately $22,600 and $13,500, respectively which was charged to operating expenses in our statement of operations. We also pay annual membership dues to Rutgers Center for Advanced Materials via Immiscible Polymer Processing, or AMIPP, a department of Rutgers.  The membership allows us to use AMIPP for basic research and development at no additional cost, with access to more comprehensive R&D services available to us for fees determined on a per-project basis.

 

Litigation

 

In April 2006, we commenced an action against Tonga Partners, L.P. (“Tonga”), Cannell Capital, L.L.C. and J. Carlo Cannell in the United States District Court of New York, for disgorgement of short-swing profits pursuant to Section 16 of the Securities Exchange Act of 1934, as amended.  On November 10, 2004, Tonga converted a convertible promissory note into 1,701,341 shares of Common Stock, and thereafter, between November 10 and November 15, 2004, sold such shares for short-swing profits.  In September 2008, the District Court granted us summary judgment against Tonga for disgorgement of short-swing profits in the amount of $5.0 million.  The defendants appealed the order granting the summary judgment to the U.S. Court of Appeals for the 2nd Circuit. The three judge panel held in our favor. The defendants petitioned the Court for a full judge review.  The petition was denied.   The defendants’ petition to the United States Supreme Court for a writ of certiorari was denied.  As a result, the defendants have exhausted all opportunities for judicial review of the District Court’s summary judgment, however we cannot access the approximately $5.0 million cash bond that the defendants posted until the District Court releases those funds.

 

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.

 

8% Convertible Promissory Notes. During the three months ended March 31, 2013, we issued and sold to Mr. Rose an aggregate principal amount of $416,667 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, 1,041,668 shares of common stock, subject to adjustment as provided on the terms of the 8% Note Warrants.

 

The 8% 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 8% Notes). We may prepay the 8% Notes, in whole or in part, upon 60 calendar days prior written notice to the holders thereof. Interest accrues on the 8% Notes at a rate of 8.0% per annum, payable during the first three years that the 8% 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 8% Notes. During the fourth and fifth years that the 8% Notes are outstanding, interest that accrues under the 8% Notes shall be payable in cash.

 

Accrued but unpaid interest due on March 31, 2013 for the three months ended March 31, 2013, was paid in lieu of cash, with approximately 84,400 shares of common stock, which were issued subsequent to March 31, 2013 with a value of approximately $57,400.

 

 

The 8% Note Warrants are exercisable at an exercise price of $0.60 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 8% Notes to which the applicable 8% Note Warrant is related has been repaid in full.

 

In connection with the entry into the Purchase Agreement, pursuant to the terms thereof, on August 24, 2012, we granted to the Note Purchase Agreement Investors (i) certain demand and piggyback registration rights with respect to the registration of certain Company securities under the Securities Act and the rules and regulations promulgated thereunder, and (ii) a security interest and lien in all of our assets and rights to secure our obligations under the 8% Notes.

 

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. During the three months ended March 31, 2013, we issued and sold to MLTM Lending, LLC an aggregate principal amount of $391,667 of our 8% Notes and associated 8% Note Warrants to purchase, in the aggregate, 979,168 shares of common stock, subject to adjustment as provided on the terms of the 8% Note Warrants.

 

Accrued but unpaid interest due on March 31, 2013 for the three months ended March 31, 2013, was paid in lieu of cash, with approximately 75,100 shares of common stock, which were issued subsequent to March 31, 2013 with a value of approximately $51,100.

 

The terms of the 8% Notes and the 8% Note Warrants are described above.

 

Judy Lenkin Lerner Revocable Trust

 

The Judy Lenkin Lerner Revocable Trust beneficially owns in excess of 5% of our outstanding stock.

 

8% Convertible Promissory Notes. During the three months ended March 31, 2013, we issued and sold to the Lerner Trust an aggregate principal amount of $25,000 of our 8% Notes and associated 8% Note Warrants to purchase, in the aggregate, 62,500 shares of common stock, subject to adjustment as provided on the terms of the 8% Note Warrants.

 

Accrued but unpaid interest due on March 31, 2013 for the three months ended March 31, 2013, was paid in lieu of cash, with approximately 5,100 shares of common stock, which were issued subsequent to March 31, 2013 with a value of approximately $3,400.

 

The terms of the 8% Notes and the 8% Note Warrants are described above.

 

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. During the three months ended March 31, 2013, we issued and sold to Mr. Kronstadt an aggregate principal amount of $916,667 of our 8% Notes and 8% Note Warrants to purchase, in the aggregate, 2,291,668 shares of common stock, subject to adjustment as provided on the terms of the 8% Note Warrants.

 

Accrued but unpaid interest due on March 31, 2013 for the three months ended March 31, 2013, was paid in lieu of cash, with approximately 83,800 shares of common stock, which were issued subsequent to March 31, 2013 with a value of approximately $57,000.

 

 

The terms of the 8% Notes and the 8% Note Warrants are described above.

 

Michael Dodd

 

Mr. Dodd, who was a member of our board of directors from September 2010 until his resignation in August 2012, was also serving as the Chief Executive Officer of 3D Global Solutions Inc. (3D).  3D provided professional program management services to governments, corporations and global organizations. During the year ended December 31, 2011, 3D purchased approximately $102,200 of our composite rail ties on terms similar to our other customers and which remains uncollected. We have provided an allowance due to its prospect for collectability. We have initiated legal action in an effort to collect the balance due.

 

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

 

Our predecessor company was formed in 1981 under the name Analytic Surveys, Inc. On March 20, 2008, Analytic Surveys, Inc. consummated an Agreement and Plan of Merger (or the Merger) with Axion International, Inc. In the Merger, the stockholders of Axion International, Inc. succeeded to approximately 90.7% of Analytic Survey, Inc.’s issued and outstanding common stock and Analytics Survey changed its name to Axion International Holdings, Inc. The Merger has been accounted for as a reverse merger in the form of a recapitalization with Axion as the successor.

 

We develop, manufacture, market and sell composite rail ties and structural building products, such as pilings, I-beams, T-beams, boards, and construction mats which, based upon patented technology developed at Rutgers University, 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, moisture impervious, non-chemical leaching and insect and rot resistant. Our products possess superior lifecycles and generally have greater durability and require less maintenance than competitive products made from wood, steel or concrete. We market our products through two lines (i) ECOTRAX™, our line of rail ties, and (ii) STRUXURE™, our line of structural building products.

 

 

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 Company’s 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 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 and Cost 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 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.

 

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 Months Ended March 31, 2013 and 2012

 

Revenues

 

We derive our revenues through the sale of our ECOTRAX rail ties and STRUXURE building products. Our strategic focus is to continue to advance the sale of our ECOTRAX rail ties and to create a broad-based market for our STRUXURE building products. We have been undertaking 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 have been concentrating our activities on advancing from a 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. Our strategic focus is on the continued growth of sales, within both the rail tie and the structural building products sectors, 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 March 31, 2013 and 2012, we recognized revenue of $1.8 million and $2.3 million, respectively. Revenue from the sale of our ECOTRAX rail ties was approximately $1.7 million and $2.2 million for the three months ended March 31, 2013 and 2012, respectively with the remainder resulting from the sale of our STRUXURE composite structural building products. For the three months ended March 31, 2013 and 2012, approximately 24% and 76%, respectively of our ECOTRAX sales were to one Class 1 railroad customer pursuant to a three-year supply agreement. During the three months ended March 31, 2013 and 2012, we recognized revenue for the sale of 4,020 and 17,700 rail ties, respectively for their maintenance program.

 

Based on sources and properties of certain raw materials we began using in the production of our rail ties during the year ended December 31, 2012, we delivered rail ties with improved properties to our Class 1 railroad customer. During the three months ended September 30, 2012, this customer notified us they wished to further evaluate these improved rail ties for use in their track maintenance programs. Although the ECOTRAX rail ties that we have supplied to this customer to date have met the specifications they required pursuant to the agreement, we halted production for the three months ended December 31, 2012 at our Texas facility which had been brought on line initially for the primary purpose of producing the ECOTRAX rail ties for this three-year supply agreement. We restarted production at our Texas facility in February 2013 for further delivery under the agreement. As disclosed in prior periods, this contract contains challenging pricing terms resulting in minimal gross margin, but it has provided us with a base to develop and expand our manufacturing capacity and processes.

 

To date, we have made the necessary investments in tooling, molds and other production equipment to run a maximum of three production lines which would be capable of producing $30 to $40 million in revenue of our ECOTRAX and STRUXURE products. This equipment is located at our Pennsylvania contract manufacturer’s facilities and our Texas facility. During the shutdown at our Texas facility, we evaluated the feasibility, costs and benefits of replacing our existing subcontracted production model with a production model where we staff, manage and direct the manufacture of our products with our own employees, management and processes. Upon restart in February 2013, production within our Texas facility was under this new production model and whereby we leased the facility and equipment on a month-to-month basis while a formal lease-purchase arrangement is negotiated for use of the facility over a multi-year period and the purchase of the existing production equipment.

 

 

 

 

During the three months ended March 31, 2013, we shipped products to eleven existing customers and to 4 new customers. 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 products may be beneficial when compared to traditional products. For example, we’ve assembled our ECOTRAX composite rail ties into heavy equipment or construction mats. Historically, these mats have been constructed from traditional lumber. Our STRUXURE Mats can withstand the impact of heavy construction equipment and will last longer than traditional mats. Testing of our STRUXURE Mats with multiple oil and gas pipeline contractors has proven successful and we continue to seek out other applications of this product concept. 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 ECOTRAX rail ties. 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 STRUXURE composite structural building products.

 

Since the products produced utilizing our technology are new to the various markets and regions we’ve 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.

 

Cost of Sales and Operating Expenses

 

Costs of Sales

 

Our costs of sales are primarily comprised of the cost of raw materials and the costs and expenses associated with our manufacturing arrangements.  The price of the raw materials depends principally on the stage and source of the supply. 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 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.

 

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 our 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. But dealing in the recycled plastics market, whether through intermediaries or bulk purchases, we encountered and 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, we continue to seek out (i) agreements with sources of cheaper raw materials, while ensuring those materials meet or exceed our quality standards as well as (ii) expanding our research and development effort of different raw materials which may provide a cost and/or performance advantage over existing materials.

 

We continually evaluate the costs and benefits of our manufacturing arrangements. Our manufacturing arrangements have allowed for the production of our products utilizing our manifolds, molds and controllers. Under one arrangement with our initial contract manufacturer, we source, purchase and supply them with the raw materials and pay a per pound manufacturing cost to them to produce the finished products. This production model, although expensive, provides flexibility in matching production to order flow without the investment in personnel, facilities and equipment. Initially under the arrangement with our second contract manufacturer, they were responsible for sourcing and purchasing the raw materials and producing the finished product, which we then purchased from them at a predetermined cost. During the three months ended December 31, 2012 when the production at the Texas facility was halted pursuant to the request of our Class 1 railroad customer, this manufacturing arrangement was terminated. Upon the restart of manufacturing during the three months ended March 31, 2013, we initiated a new manufacturing arrangement and now we source our raw materials and provide the personnel to produce our products and have reimbursed the owner for the use of the facility and the equipment which we do not own. We are currently negotiating a long-term lease for the facility as well as the purchase of the equipment we use but do not currently own. Under this new manufacturing model, we anticipate reducing the costs of our products by spreading our costs of production, such as the personnel costs, facility rental, and equipment maintenance and depreciation, over a larger volume of business by adding additional production lines. We continually monitor our production capacity requirements and will adjust our production capacity as the need arises.

 

 

Additionally, we continued our efforts in driving unnecessary costs and expenses out of our manufacturing processes. Each step of the manufacturing process, from raw material handling and storage through the quality control review and inventory handling steps, we continue to examine best practices and other methods to improve and streamline the processes to eliminate unnecessary costs and expenses. We continue to search out ways to continue to reduce the costs of manufacturing our products.

 

Cost of sales $1.5 million and $2.3 million for the three months ended March 31, 2013 and 2012, respectively, resulting in gross margins of approximately $237,200 and $11,100, respectively. These gross margins of 13.5% and 0.5%, respectively, are a result of the fixed pricing impact of our three-year supply agreement. During the three months ended March 31, 2013, sales pursuant to that three-year supply agreement were 24% of our revenue compared to 76% in the corresponding quarter of the previous year. Because we are in the early stages of commercial activities, cost of sales may not be indicative of cost of sales in the future, which may vary significantly and are highly dependent on the price of raw materials, concurrent production activities, use of subcontractors and timing and mix of the sales and services.

 

Product Development and Quality Management.

 

Product development and quality management expenses are incurred as we perform oversight of our contract manufacturing relationships and ongoing evaluations of materials and processes for existing 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 two product lines. 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, we continue to work, from time to time, 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 $218,200 and $235,500 for the three months ended March 31, 2013 and 2012, respectively. This may increase as we expand our efforts to innovate our manufacturing processes, enhance our product formulations, develop new innovative products, and expand the reach of our existing products.

 

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

 

Marketing and sales expenses increased to approximately $244,900 for the three months ended March 31, 2013 compared to approximately $138,800 for the three months ended March 31, 2012. The increase was primarily due to additional personnel and the development and implementation of our branding strategy and marketing efforts in support thereof.

 

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 $0.7 million and $0.8 million for the three months ended March 31, 2013 and 2012, respectively. During the three months ended March 31, 2013 and 2012, we recorded approximately $97,100 and $336,000, respectively, in charges related to the fair value of the issuances of shares of our common stock, and options or warrants providing the right to purchase shares of our common stock at a predetermined price, in the future.

 

 

Depreciation and Amortization.

 

For the three months ended March 31, 2013 and 2012, we recorded depreciation expense for manufacturing and production equipment as a charge to cost of sales. As we continue to increase our production capacity, we anticipate acquiring additional production equipment and would anticipate an increase in depreciation and amortization expenses as a component of cost of sales. Additionally, certain of our office equipment and acquired software which is depreciated and charged general and administrative expenses.

 

Depreciation and amortization totaled approximately $24,400, including approximately $20,600 charged to costs of sales for the three months ended March 31, 2013, compared to approximately $35,300, including approximately $33,900 charged to costs of sales for the three months ended March 31, 2012. We depreciate our production equipment as it is run and used in producing our products. As the production equipment was idle for certain period during the three months ended March 31, 2013, the depreciation associated with our production equipment decreased from the same period in 2012.

 

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 March 31, 2013 and 2012, was approximately $172,400 and $38,000, respectively, and represented the contractual interest rates payable on our debt obligations. During the three months ended March 31, 2013, we had an average outstanding balance of $8.5 million of our 8% convertible promissory notes which compares to an average balance outstanding of $657,500 of various other convertible debt during the three months ended March 31, 2012.

 

Amortization of Debt Discounts.

 

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

 

During the three months ended March 31, 2013 and 2012, we recognized approximately $143,900 and $170,100, respectively, for the amortization of various convertible security discounts. At the time of issuance, we recorded discounts on our convertible securities primarily due to the fair value of 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 over the term of the underlying convertible security, to expense. Any unamortized discount remaining when the security is repaid or converted is written off to expense in that period.

 

At March 31, 2013, the unamortized discounts for our 8% convertible promissory notes were approximately $2.1 million. This unamortized discount is amortized to expense over the five year lives of the underlying convertible promissory notes.

  

Change in Fair Value of Derivative Liabilities.

 

8% Convertible Promissory Notes – Conversion Option and Warrants. During the year ended December 31, 2012 and through March 31, 2013, we issued and sold $8.9 million of our 8% convertible promissory notes, which gives the holders the right to convert the outstanding debt into shares of our common stock. We recorded the initial fair values of the conversion options of $1.6 million on the dates of issuance, as a derivative liability and recognized the amounts as a discount of our 8% convertible promissory notes. The fair value of this derivative liability at March 31, 2013 was estimated to be $4.8 million. We account for this derivative liability pursuant to ASC 815, and accordingly, we recognized approximately $3.6 million during the three months ended March 31, 2013 as a change in fair value of this derivative liability which was recognized in our statements of operations.

 

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 initial fair value of the warrants to be approximately $692,500 on the dates of issuance and recorded a derivative liability and recognized the amount as a discount of our 8% convertible promissory notes. At March 31, 2013, we estimated the fair value of this derivative to be $2.3 million. This derivative liability does not qualify as a fair value or cash flow hedge under ASC 815, and accordingly, we recognized approximately $1.8 million during the three months ended March 31, 2013 as a change in the fair value of this derivative liability which was recognized in our statements of operations.

 

 

10% Convertible Preferred Stock 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 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 March 31, 2013, we recorded loss in fair value of this derivative liability in our statement of operations of approximately $134,300

 

10% Convertible Debentures – Warrants. Effective January 14, 2011, we agreed to amend the terms of our 10% convertible debentures, which among other things extended the maturity dates and required us to issue warrants for each calendar month after the original maturity dates that these debentures remained outstanding. Since it was probable that we would issue these warrants, we calculated the fair value of the warrants and recorded a derivative liability of approximately $797,200 on the date of amendment and recognized the amount as a loss in our statement of operations. This derivative liability did not qualify as a fair value or cash flow hedge under ASC 815, and accordingly, changes in the fair value of the derivative liability were immediately recognized in earnings and classified as a gain or loss from change in fair value in the statements of operations. During the three months ended March 31, 2012, we recorded a gain in fair value of the derivative liability in our statement of operations of approximately $10,800.

 

Revolving Credit Agreement – Conversion Option. During the year ended December 31, 2011, we entered into a revolving credit agreement which gave the holder the right to convert a portion of the outstanding debt into shares of our common stock. We recognized the fair value of this beneficial conversion feature as a derivative liability. During the three months ended March 31, 2012, we recognized the change in fair value of the derivative liability as a loss of approximately $13,800 in our statement of operations.

 

Income Taxes.

 

We have unused net operating loss carry forwards, which included losses incurred from inception through December 31, 2012. 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, 2012 has been recorded.

 

Liquidity and Capital Resources

 

At March 31, 2013 we had $4.3 million in current assets and $8.3 million in current liabilities resulting in a deficit in working capital of $4.0 million. This compares to working capital of $1.6 million as of December 31, 2012. The deficit in our working capital at March 31, 2013 is primarily a result of the recognition of the fair value of the derivative liabilities associated with our 8% convertible promissory notes (“8% Notes”). These derivative liabilities represent the estimated fair value of the conversion feature of the 8% Notes and the warrants issued in conjunction with the 8% Notes. If or when the 8% Notes convert, the fair value of the imbedded conversion feature will become zero. No use of working capital will be necessary to extinguish this liability. Likewise, if or when the note holders exercise their warrants to purchase shares of our common stock, the corresponding derivative liabilities will be valued at zero, and no use of working capital will have occurred.

 

We used approximately $942,100 and $175,900 in our operating activities during the three months ended March 31, 2013 and 2012, respectively. During the three months ended March 31, 2013, for our sales transactions, we shipped more from inventory than our production added to it, thereby reducing inventory by approximately $590,800, which compares to the decrease of approximately $360,100 for the corresponding period in 2012.

 

To increase production capacity, during the three months ended March 31, 2012, we purchased property and equipment of $0.5 million. During the corresponding period in 2013, we added minimal equipment. We anticipate purchasing additional property and equipment during the next twelve months as we continue to expand our manufacturing capacity. We spend approximately $1.0 million to have a typical production line made, delivered and installed. Additional orders for production equipment have been and will be made, for which we will be required to make substantial additional payments.

 

 

During three months ended March 31, 2013, we issued and sold to certain investors an aggregate principal amount of $1.8 million of our 8% Notes, due on the five year anniversary of the date of the 8% Note. At March 31, 2013, we had aggregate principal of 8% convertible promissory notes of $8.9 million. 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.

 

Pursuant to the terms of our 10% convertible preferred stock, the preferred stock may be redeemed for cash by the holder any time after the three-year anniversary from the initial purchase. We initially sold the preferred stock via several closings in March and April 2011. The outstanding principal of $7.0 million may be redeemed beginning in March 2014. 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.

 

Our ability to redeem our convertible preferred stock when, and if, redeemed by the holders, pay principal and interest on our 8% convertible promissory notes 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 March 31, 2013, we had a working capital deficit of $4.0 million, cumulative face value of redeemable preferred stock and promissory notes of $15.9 million, a stockholders’ deficit of $15.1 million and have accumulated losses to date of $41.9 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 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.

 

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, 2012 and 2011, 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 weaknesses described below, as of March 31, 2013, 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 weaknesses, which relate to internal control over financial reporting, that were identified are:

 

(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, and

 

 

(ii)

Due to our small size, we do not have a proper segregation of duties in certain areas of our financial reporting and other accounting processes and procedures. This control deficiency results in a reasonable possibility that material misstatements of our consolidated financial statements will not be prevented or detected on a timely basis.

 

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.

 

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 three months ended March 31, 2013 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.

 

On April 15, 2013, the United States Supreme Court denied a petition for a writ of certiorari filed by the defendants in the legal proceeding described in Note 13 to our condensed consolidated financial statements included in this Form 10-Q. As a result, the defendants have exhausted all opportunities for judicial review of the District Court’s summary judgment. However, we cannot access the approximately $5.0 million cash bond posted by the defendants until the District Court releases those funds.

  

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

 

During February 2013, we issued 39,000 shares of common stock upon conversion of 3,900 shares of our 10% convertible preferred stock, with a value of $39,000.

 

During March 2013, we issued 125,000 shares of common stock with a fair value on the date of issuance of $78,750, to a consultant pursuant to the terms of an agreement to provide services.

 

During January 2013, pursuant to our 8% convertible promissory notes, we issued warrants to purchase 4,375,004 shares of our common stock at an exercise price of $0.60 per share. These warrants had a fair value at the date of issuance of $249,200. 

 

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: May 15, 2013		/s/ Steven Silverman
		Steven Silverman
		Chief Executive Officer
Date: May 15, 2013		/s/ Donald Fallon
		Donald Fallon
		Chief Financial Officer