SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
--------------------
FORM 10- KSB/A3
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended: Commission File No.:
June 30, 1997 000-28198
----------------------
CONVERSION TECHNOLOGIES INTERNATIONAL, INC.
(Exact name of Small Business Issuer as specified in its charter)
Delaware 13-3754366
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) I.D. Number)
3452 Lake Lynda Drive
Orlando, Florida 32817
(Address of principal executive offices) (Zip Code)
(407) 207-5900
(Issuer's telephone number including area code)
-------------------------
Securities registered under Section 12(b) of the Exchange Act: None
Securities registered under Section 12(g) of the Exchange Act:
Common Stock, Redeemable Class A Warrants and Redeemable Class B Warrants
Check whether the issuer: (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 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 past 90 days.
Yes X No
----- -----
<PAGE>
Check if there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B contained in this form, and no disclosure will be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-KSB or any
amendment to this Form 10-KSB.
-------
Issuer's revenues for the fiscal year ended June 30, 1997 were $1,429,008.
The aggregate market value of voting stock held by non-affiliates of registrant
was $11,941,310 as of September 19, 1997, based on the average of the closing
bid and closing ask price of the Common Stock on the Nasdaq SmallCap Market on
such date, and assuming the conversion of all outstanding shares of Series A
Convertible Preferred Stock held by non-affiliates of registrant into Common
Stock.
As of September 19, 1997, the issuer had outstanding 5,539,745 shares of Common
Stock, $.00025 par value.
Item 6. Management's Discussion and Analysis of Financial Condition
and Results of Operations
-----------------------------------------------------------
Overview
Since inception through June 30, 1997, the Company has sustained cumulative
losses of approximately $30,034,000. Such amount includes (i) a one-time,
non-cash charge to operations of approximately $6,232,000 relating to the
write-off of research and development (in-process) technologies that had not
reached technological feasibility and, in the opinion of management, had no
alternative use, which were purchased in conjunction with the Company's
acquisition of Dunkirk in 1994, (ii) approximately $2,528,000 expensed as
process development costs related to research and development of the Company's
CRT glass processing and ALUMAGLASS product lines, (iii) a non-cash charge to
operations of approximately $5,712,000 relating to the write-off of
non-productive fixed assets during the quarter ended June 30, 1997 and (iv)
other expenses, net of revenue, of approximately $15,562,000. The Company will
continue to incur losses until such time as revenues are sufficient to fund its
continuing operations.
Although the Company has not yet achieved profitability, the Company has taken a
number of recent steps in an effort to preserve cash, reduce its costs and
increase revenues. In late fiscal 1997 and early fiscal 1998, the Company
obtained a new management team that includes senior executives with significant
experience in the engineering, construction and marketing fields. As discussed
elsewhere, the Company's long-term debt has been reduced through the redemption,
at a discount, of the IDA Bonds, reducing interest expense and cash required for
principal repayments significantly and, with respect to the Key Bank loans,
renegotiated debt to defer payments until maturity which defers the required
cash outlays. Raw material costs will be reduced through the use of third party
tollers and the application of lower cost alternative
-2-
<PAGE>
substrates. Investments in product development have been curtailed and
investments in sales and marketing will be increased. Manufacturing and
operating overheads have also been reduced through payroll reductions and
savings associated with non-productive equipment and processes that have been
shut-down, such as the Company's melter. The Company has begun to sell limited
amounts of the decorative particles produced by its APT subsidiary and hopes to
increase revenue from this product line. The Company will also strive to
increase sales of other abrasives and aggregates as new marketing efforts are
implemented. Although management believes these steps will allow the Company to
continue as a going concern for at least 12 months, there can be no assurance
that the foregoing steps will result in the Company ever achieving
profitability.
The Company has continued to experience limited revenue and negative cash flow
from operations. The Company had revenues of approximately $277,000 for the
quarter ended June 30, 1997 and expects revenues to be approximately $300,000
for the quarter ending September 30, 1997. In general, revenues have been
reduced from prior periods due to the loss of Thomson as a CRT customer in March
1997. The Company has recently begun to sell increased amounts of certain
recycled glass and hopes to obtain modest increases in CRT revenue as a result.
In addition, the Company has recently begun sales of limited amounts of
decorative particles manufactured by its APT subsidiary. Although the Company
plans to maintain its CRT recycling revenue, the Company will focus its efforts
on sales of decorative particles, abrasives and other substrates. The Company
anticipates that these efforts will result in increased revenue for the quarter
ending December 31, 1997 as compared to the quarter ending September 30, 1997,
however, there can be no assurance that such results will actually be achieved.
Since the Company has had limited revenue and has incurred significant losses
which has resulted in a working capital deficiency and a stockholders'
deficiency at June 30, 1997, the Report of Independent Auditors includes an
explanatory paragraph indicating there is substantial doubt as to the Company's
ability to continue as a going concern. See Report of Independent Auditors.
Results of Operations
Fiscal Year Ended June 30, 1997 Compared to Fiscal Year Ended June 30, 1996
Consolidated revenues for the year ended June 30, 1997 ("fiscal 1997") were
approximately $1,429,000, consisting primarily of CRT glass recycling fees and
related clean cullet sales and approximately $248,000 of ALUMAGLASS sales. For
fiscal 1996, the Company had consolidated revenues of approximately $2,680,000,
of which approximately $214,000 was from sales of ALUMAGLASS and the remainder
was CRT recycling fees and related clean cullet sales. This decrease in revenue
during fiscal 1997 primarily reflects reduced beginning inventory of unprocessed
CRT glass and the loss of Thomson as a CRT customer.
Cost of goods sold was approximately $3,952,000 for fiscal 1997 versus
approximately $3,094,000 for the prior fiscal year. Included in the fiscal 1997
cost was a $24,000 decrease in the Company's reserve for potential disposal
costs of raw materials, as compared to a $623,000 decrease in the reserve for
fiscal 1996 reflecting a significantly larger decrease in the Company's
beginning raw
-3-
<PAGE>
materials inventory, plus approximately $392,000 of costs for starting up
operations at the Company's particle coating facility in St. Augustine, Florida.
Excluding the effect of the change in the Company's reserve for disposal during
fiscal 1997 and fiscal 1996, and the St. Augustine start-up costs, cost of goods
sold decreased only approximately $133,000 in fiscal 1997 versus fiscal 1996,
despite the over 40% decrease in revenues noted above. Major factors
contributing to the higher relative fiscal 1997 cost as compared to sales were
higher depreciation costs due to increased equipment purchases, an approximately
$97,000 write-off of raw material and in-process inventories related to
discontinued processes and the fact that under the prevailing operating
conditions in both periods a significant portion of the cost of production was
fixed in nature. Some savings were realized as a result of lower freight costs,
resulting from a change in product pricing policy whereby customers now pay
freight on most shipments.
The Company's gross loss on sales of approximately $(2,523,000) during fiscal
1997 compares with a loss of approximately $(414,000) for the prior fiscal year
and reflects the lower revenue and higher costs detailed above.
Selling, general and administrative expenses for fiscal 1997 increased to
approximately $3,919,000 from $1,821,000 for fiscal 1996. This increase includes
(i) approximately $988,000 in higher consulting costs of which approximately
$705,000 was directly related to the terminated merger with Octagon and $90,000
was an accrued severance payment to the former President and Chief Executive
Officer of the Company, (ii) approximately $369,000 in higher legal costs and
approximately $181,000 in outside service costs (primarily financial printing)
both of which also relate to the terminated merger activities, (iii)
approximately $165,000 in compensation expenses relating to capital stock, (iv)
approximately $135,000 for the purchase of the APT particle coating technology
that had not reached technological feasibility at the time of purchase, (v) a
$99,000 settlement received in fiscal 1996 from a former officer of Dunkirk and
(vi) approximately $93,000 in higher insurance costs.
A charge against operations of approximately $5,712,000 was recorded in the
fourth quarter of fiscal 1997 to write down fixed assets to their estimated fair
market value for processes which have been shut down and no longer appear to be
viable for the forseeable future. Most of these processes relate to the
manufacture of ALUMAGLASS. There had been no comparable expense in fiscal 1996.
The shut-down of the melter used to manufacture ALUMAGLASS and its related
processing equipment is expected to improve the operating results and liquidity
of the Company by reducing its operating expenses. The expenses estimated to be
associated with the melter operations were approximately $1,100,000 for the year
ended June 30, 1997. The revenues included for that year were approximately
$248,000 for the sale of products produced by the melter. The Company has
located a source of material that is comparable to that produced by the melter
which can be obtained at a significantly lower cost which is expected to improve
future operating results and liquidity.
The Company incurred process development costs of approximately $996,000 for
fiscal 1996. There were no similar charges in fiscal 1997.
-4-
<PAGE>
Interest expense increased to approximately $1,277,000 for fiscal 1997 from
approximately $1,077,000 for fiscal 1996, reflecting the capitalization of
approximately $440,000 in interest during fiscal 1996. No interest expense was
capitalized during fiscal 1997. Partially offsetting this cost increase was
approximately $240,000 in lower interest expense in fiscal 1997 as a result of
reductions in debt principal.
Interest income of approximately $227,000 in fiscal 1997 compares with
approximately $114,000 in fiscal 1996. The increase reflects higher earnings on
cash received from the Company's initial public offering in May 1996.
Other income of approximately $349,000 in fiscal 1997 was approximately $267,000
higher than fiscal 1996, due entirely to a $331,547 New York State net
investment tax credit recognized in June 1997. (A cash refund of $566,547 was
received, but provision has been made for the return of an estimated $235,000 of
this to the State as a result of the shut down of related fixed assets.)
The fiscal 1996 Statement of Operations includes an extraordinary item amounting
to $442,000. This charge includes underwriting, debt discount, legal and
accounting costs relating to Bridge Notes issued in December, 1995 to provide
interim working capital until the initial public offering could be closed.
Liquidity and Capital Resources
The Company's business is capital intensive. The Company has funded its
operations principally from debt financing, the private placement of preferred
stock and the proceeds of the IPO. At June 30, 1997, the Company had
approximately $11,315,000 in principal amount of long-term indebtedness
(excluding capital lease obligations) and net working capital deficiency of
approximately $(3,394,554). As of June 30, 1997, the Company had cash and
marketable securities of approximately $325,000.
In August and September 1997, the Company raised aggregate gross proceeds of
$4,145,000 in a private placement of Preferred Stock. An aggregate of 414,500
shares of Preferred Stock were issued. Each share of Preferred Stock is
initially convertible into eight shares of Common Stock at a conversion price of
$1.25 per share, subject to adjustment based on the lesser of $1.25 and the
prevailing average market price of the Common Stock immediately preceding any
subsequent closing, if any. The maximum amount of such offering, including gross
proceeds received to date, would result in gross proceeds of $5,000,000
($8,000,000 if the Placement Agent's over-allotment option is exercised in
full), although there can be no assurance that any additional closings under the
offering will occur.
The Company received net proceeds of $3,606,150 from the placement of the
Preferred Stock (after deducting the placement agent's commissions and
non-accountable expense allowance). Of such net proceeds, $1,620,000 was used to
redeem the IDA Bonds and $500,000 plus accrued interest was used to repay the
1997 Bridge Loan, with the remainder to be used for transaction
-5-
<PAGE>
expenses estimated at $150,000 and general working capital purposes, including
accrued payables.
In July and August 1997, the 1997 Bridge Loan provided the Company with an
aggregate of $500,000 which was used for general working capital purposes. The
1997 Bridge Loan was repaid, together with accrued interest at the rate of 12%
per annum, on September 8, 1997 out of the proceeds of the Preferred Stock
placement. In connection with such 1997 Bridge Loan, the Company issued warrants
to purchase 100,000 shares of Common Stock to the Aries Funds at an exercise
price equal to $1 5/16 per share.
In September 1997, the $8,000,000 principal amount of IDA Bonds were redeemed in
full in exchange for a cash payment of $1,620,000 and Dunkirk's forfeiture of
its interest in a related debt service reserve fund (which had a then current
balance of approximately $190,000).
In July 1997, ESDC agreed to honor its guarantee of approximately $1,888,000
outstanding principal amount of term loans owing by the Company's Dunkirk
subsidiary to Key Bank, and ESDC is in the process of assuming from Key Bank,
and Key Bank is assigning to ESDC, such loans. ESDC has agreed to defer all
interest and principal payments due under the loans through January 1, 1998
until the maturity date of the loans, with interest continuing to accrue on such
deferred amounts payable at maturity. ESDC has also agreed to allow Dunkirk to
reduce the principal amount of such loans by the amount of a debt service
reserve fund (the balance at June 30, 1997 was $449,190) that will be forfeited
by Dunkirk.
As of September 19, 1997, the Company had approximately $3,287,000 in principal
amount of long-term indebtedness (excluding capital lease obligations),
consisting of (i) approximately $1,888,000 outstanding principal amount under
the Key Bank term loans guaranteed by ESDC, which loans bear interest at the
prime rate and are payable in monthly installments through December 2001
(subject to the deferral through January 1, 1998 described above), (ii)
approximately $695,000 aggregate outstanding principal amount under various
mortgage and secured equipment loans and (iii) approximately $704,000 aggregate
outstanding principal amount under subordinated indebtedness from certain of the
Company's CRT glass customers who provided financial assistance to the Company
during its start-up phase. The Company's long-term indebtedness is secured by
liens on its fixed assets. The Company's long-term indebtedness has been used to
finance its facility, equipment and related capital expenditures. Certain of the
agreements related to such long-term indebtedness contain customary covenants
and default provisions.
The following unaudited pro forma balance sheet data reflects the following
transactions as if they had occurred as of June 30, 1997: (i) the private
placement of 414,500 shares of Preferred Stock resulting in gross proceeds of
$4,145,000 less commissions and a non-accountable expense allowance totaling
$538,850 and placement expenses estimated at $150,000 (of which $60,000 was paid
from the proceeds and $32,522 had been recorded by the Company at June 30,
1997), and (ii) retirement of the $8,000,000 principal amount of IDA Bonds for a
payment of $1,620,000 plus $190,000 representing debt service reserve funds
forfeited by Dunkirk upon such retirement in September 1997 plus $230,000
removed from the debt service fund on
-6-
<PAGE>
September 1, 1997 for payment of interest (with the assumption that there was no
related tax on the gain), and (iii) write-off of $330,361 of deferred finance
charges related to the $8,000,000 retired IDA Bonds.
<TABLE>
<CAPTION>
June 30, 1997
---------------------------------------------------
Pro Forma
Actual Adjustments As Adjusted
------------ ------------- ------------
(unaudited) (unaudited)
ASSETS
<S> <C> <C> <C>
Cash .............................................................. $ 325,092 $ 1,868,672(1) $ 2,193,764
Other current assets .............................................. 855,810 (32,522) 823,288
------------ ------------ ------------
Total current assets ......................................... 1,180,902 1,836,150 3,017,052
Property, plant and equipment (net) ............................... 6,939,782 -- 6,939,782
Noncurrent assets ................................................. 446,929 (330,361) 116,568
Restricted assets ................................................. 869,311 (419,964) 449,347
------------ ------------ ------------
$ 9,436,924 $ 1,085,825 $ 10,522,749
============ ============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIENCY)
Accrued expenses .................................................. $ 858,447 (76,667) $ 781,780
All other current liabilities ..................................... 3,717,009 -- 3,717,009
------------ ------------ ------------
Total current liabilities .................................... 4,575,456 (76,667) 4,498,789
Capital lease obligations, less current portion 39,414 -- 39,414
Long-term debt, less current portion .............................. 10,784,343 (8,000,000) 2,784,343
Stockholders' equity (deficiency):
Common stock, $.00025 par value, authorized 25,00,000
shares, issued and outstanding 5,539,745 shares ........... 1,385 -- 1,385
Additional paid-in capital, common stock ..................... 24,186,932 -- 24,186,932
Preferred stock, $.001 par value, authorized 15,000,000
shares, issued and outstanding 414,500 shares ............. 415 415
Additional paid-in capital, preferred stock .................. -- 3,455,735 3,455,735
Unearned stock compensation .................................. (116,369) -- (116,369)
Accumulated deficit .......................................... (30,034,237) 5,706,342(2) (24,327,895)
------------ ------------ ------------
Total stockholders' equity (deficiency) ........................... (5,962,289) 9,162,492 3,200,203
------------ ------------ ------------
$ 9,436,924 $ 1,085,825 $ 10,522,749
============ ============ ============
<FN>
- ----------
(1) Reflects gross proceeds of $4,145,000 on the sale of Preferred Stock, less
commissions and estimated expenses totaling $656,328 and $1,620,000 paid to
retire the IDA Bonds.
(2) Reflects a pre-tax gain on retirement of $8,000,000 IDA Bonds based on (i)
payments of $1,620,000 cash, (ii) forfeiture of $419,964 in debt service
reserve funds, (iii) $76,667 accrued interest recorded at June 30, 1997 on
the IDA Bonds which was paid from the debt service reserve fund subsequent
to June 30, 1997, and (iv) a write-off of $330,361 for deferred finance
charges related to the retired IDA Bonds. The pro forma adjustment does not
include the related tax, if any, that may be payable with respect to the
debt retirement. If Dunkirk is deemed to be solvent immediately prior to
the retirement of the IDA Bonds, the Company will recognize taxable income
for the debt forgiveness in its tax year ending June 30, 1998. The amount
of such income may be offset by net operating loss carryforwards ("NOLs"),
subject to possible limitations (see below). Even if sufficient NOLs were
available to offset such taxable income, the Company may still be subject
to alternative minimum tax. To the extent that Dunkirk is deemed to be
insolvent immediately prior to such repayment by an amount which equals or
exceeds the amount of debt forgiveness, the Company will not recognize
taxable income from such repayment; however, certain of Dunkirk's tax
attributes (such as NOLs) would be subject to reduction and would not be
available to offset future income from operations, if any. For this
purpose, the amount of insolvency is defined to be the excess of Dunkirk's
liabilities over the fair value of its assets. An independent appraisal of
the fair value of Dunkirk' assets has not been completed at this time to
determine Dunkirk's solvency.
</FN>
</TABLE>
The Company's capital lease payments were approximately $84,000 for the year
ended June 30, 1997 and are estimated to be approximately $41,000, $27,000 and
$23,000 for the fiscal years
-7-
<PAGE>
ending June 30, 1998, 1999 and 2000, respectively, under current commitments.
The Company's utility expenses average approximately $35,000 per month at its
current level of operations.
The Company's base annual fixed expenses include approximately $447,000 in
aggregate annual base compensation for the current executive officers of the
Company and debt service obligations relating to the Company's outstanding
indebtedness, which are estimated to aggregate approximately $489,000 for the
fiscal year ending June 30, 1998, excluding capital lease obligations.
The Company's short-term and long-term liquidity will depend on its ability to
achieve cash-flow break even on its operations and to increase sales of its
products. The Company currently is not profitable and therefore relies on cash
from its financing activities to fund its operations. As discussed above under
the heading "Overview", the Company has taken a number of steps to preserve
cash, reduce costs and increase its revenues, but there can be no assurance that
the Company will ever achieve profitability. In addition, the Company has not
yet achieved sufficient sales to replace all the revenue lost from the
termination of the Company's relationship with Thomson in March 1997, and will
not achieve the levels of revenue it experienced during the period when Thomson
was a customer until such time as additional revenue is obtained. The Company is
not aware of any other matters which are likely to have a material impact on the
Company's short-term or long-term liquidity.
The Company receives waste materials for processing into finished goods
inventory, which then can be sold to its customers. The Company has recorded a
reserve for disposal for the probable disposal costs of waste material it has
received which cannot be processed through the Company's current processing
methods, net of the amount of deferred revenue recorded with respect to such
materials. The Company is continually attempting to refine existing processes to
increase yields and/or develop new processes for the waste materials on hand
which have not been able to be processed, and therefore has not disposed of any
waste materials to date. The Company records a disposal reserve with respect to
materials it cannot process because it is probable it will incur these costs on
the ultimate disposition of the waste materials. The Company estimates that the
disposal costs for material received by the Company that the Company cannot
process, if and when incurred, will exceed the fees the Company was paid to
accept such materials.
The Company sells its recycled glass to Techneglas pursuant to a Clean Cullet
Sale Agreement (the "Cullet Agreement") and an open purchase order arrangement.
The Cullet Agreement had an initial term of three years expiring August 1998 and
automatically renews for additional one year terms unless either party gives the
other written notice of termination at least 120 days prior to the end of any
term. The Cullet Agreement includes provisions relating to specifications,
delivery and acceptance of processed CRT glass. The Cullet Agreement also
requires the Company to sell, and Techneglas to purchase, various amounts of the
CRT glass processed by the Company. The Cullet Agreement also contains pricing
and other customary terms. Techneglas has been purchasing substantially all of
the CRT glass processed by the Company since the loss of Thomsen as a customer.
-8-
<PAGE>
The Company has no material commitments for capital expenditures.
The Company has federal net operating loss carryforwards that amounted to
approximately $20.6 million at June 30, 1997, which expire between 2006 and
2012. Pursuant to Section 382 of the Internal Revenue Code of 1986, as amended
(the "Code"), utilization of net operating loss carryforwards is limited if
there has been a change in control (ownership) of the Company. Although a
comprehensive evaluation has not yet been performed, it is likely that due to
prior shifts in ownership (the Dunkirk merger and the completion of the IPO) and
anticipated shifts in ownership (the Preferred Stock offering), the Company's
ability to utilize its net operating loss carryforwards could be severely
limited.
Pending Accounting Pronouncements
SFAS No. 128 "Earning Per Share," SFAS No. 130 "Reporting Comprehensive Income"
and SFAS No. 131 "Disclosure about segments of an Enterprise and Related
Information" are not effective for the Company until December 31, 1997, June 30,
1999 and June 30, 1999, respectively. Management believes these standards will
not have a material impact on the Company.
-9-
<PAGE>
INDEX TO FINANCIAL STATEMENTS
Report of Independent Auditors.......... ....................................F-2
Consolidated Balance Sheets of Conversion Technologies
International, Inc. and Subsidiaries as of June 30,
1997 and June 30, 1996....................................................F-3
Consolidated Statements of Operations of Conversion
Technologies International, Inc. and Subsidiaries for
the years ended June 30, 1997 and June 30, 1996...........................F-4
Consolidated Statements of Stockholders' Equity of
Conversion Technologies International, Inc. and Subsidiaries
for the years ended June 30, 1997 and June 30, 1996.......................F-5
Consolidated Statements of Cash Flows of Conversion Technologies
International, Inc. and Subsidiaries for the years ended
June 30, 1997 and June 30, 1996...........................................F-6
Notes to Consolidated Financial Statements...................................F-8
F-1
<PAGE>
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Stockholders
Conversion Technologies International, Inc.
We have audited the accompanying consolidated balance sheets of Conversion
Technologies International, Inc. and Subsidiaries (Company) at June 30, 1997 and
1996, and the related consolidated statements of operations, stockholders'
equity and cash flows for the years then ended. These financial statements are
the responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Conversion
Technologies International, Inc. and Subsidiaries at June 30, 1997 and 1996, and
the consolidated results of their operations and cash flows for the years then
ended in conformity with generally accepted accounting principles.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As more fully described in Note 1, the
Company has generated only minimal revenue, has incurred significant losses, has
a working capital deficiency and has a stockholders' deficiency. These
conditions raise substantial doubt about the Company's ability to continue as a
going concern. The financial statements do not include any adjustments to
reflect the possible future effects on the recoverability and classification of
assets or the amounts and classification of liabilities that may result from the
possible inability of the Company to continue as a going concern.
Metro Park, New Jersey ERNST & YOUNG LLP
September 18, 1997
F-2
<PAGE>
<TABLE>
<CAPTION>
Conversion Technologies International, Inc.
and Subsidiaries
Consolidated Balance Sheets
June 30,
------------------------------
1997 1996
------------- ------------
ASSETS
<S> <C> <C>
Cash and cash equivalents ........................................... $ 325,092 $ 4,539,464
Marketable securities ............................................... -- 2,009,632
Accounts receivable, less allowance for doubtful accounts
of $18,000 at June 30, 1997 and $25,000 at June 30, 1996 ....... 146,225 343,214
Inventories ......................................................... 521,060 337,736
Prepaid expenses and other current assets ........................... 188,525 205,984
------------ ------------
Total current assets ................................................ 1,180,902 7,436,030
Property, plant and equipment:
Land ........................................................... 75,000 75,000
Building and improvements ...................................... 1,578,293 1,609,832
Machinery and equipment ........................................ 6,713,599 11,573,933
Construction in progress ....................................... 29,500 1,008,480
------------ ------------
8,396,392 14,267,245
Less accumulated depreciation .................................. (1,456,610) (1,630,639)
------------ ------------
6,939,782 12,636,606
Deferred finance charges, less accumulated amortization of
$135,786 at June 30, 1997 and $81,272 at June 30, 1996 ......... 443,829 494,843
Other noncurrent assets ............................................. 3,100 38,304
Restricted assets
Project Fund ................................................... 158 72,859
Debt service reserve funds ..................................... 869,153 1,268,457
------------ ------------
$ 9,436,924 $ 21,947,099
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIENCY)
Accounts payable .................................................... $ 1,711,212 $ 1,279,280
Deferred revenue .................................................... 491,944 557,907
Reserve for disposal ................................................ 713,100 737,000
Accrued expenses .................................................... 858,447 778,306
Investment tax credit payable ....................................... 235,000 --
Current portion of capital lease obligations 35,495 72,914
Current portion of long-term debt ................................... 530,258 437,285
------------ ------------
Total current liabilities ........................................... 4,575,456 3,862,692
Capital lease obligations, less current portion ..................... 39,414 74,693
Long-term debt, less current portion ................................ 10,784,343 11,281,715
Stockholders' equity (deficiency):
Class A common stock, $.00025 par value, authorized 25,000,000 shares,
issued and outstanding 5,539,745 shares at June 30,
1997 and 5,449,745 shares at June 30, 1996 .................. 1,385 1,362
Additional paid-in capital ..................................... 24,186,932 23,905,705
Unearned Stock Compensation .................................... (116,369) --
Accumulated deficit ............................................ (30,034,237) (17,179,068)
------------ ------------
Total stockholders' equity (deficiency) ............................. (5,962,289) 6,727,999
------------ ------------
$ 9,436,924 $ 21,947,099
============ ============
See accompanying notes.
</TABLE>
F-3
<PAGE>
<TABLE>
<CAPTION>
Conversion Technologies International, Inc.
and Subsidiaries
Consolidated Statements of Operations
Year ended June 30,
------------------------------
1997 1996
------------ ------------
<S> <C> <C>
Revenues:
Product sales $ 945,871 $ 2,075,118
Recycling fees 483,137 604,869
------------ ------------
Total revenue 1,429,008 2,679,987
Cost of goods sold 3,952,374 3,093,560
------------ ------------
Gross loss on sales (2,523,366) (413,573)
Selling, general and administrative 3,918,726 1,821,179
Process development costs -- 996,259
Write-off of fixed assets 5,711,567 --
------------ ------------
Loss from operations (12,153,659) (3,231,011)
Interest expense (1,277,310) (1,076,077)
Interest income 226,505 114,326
Other income 349,295 81,811
------------ ------------
Loss before extraordinary item (12,855,169) (4,110,951)
Extraordinary item -- 442,000
------------ ------------
Net loss $(12,855,169) $ (4,552,951)
============ ============
Net loss per common share
before extraordinary item $ (2.69) $ (2.64)
============ ============
Net loss per common share $ (2.69) $ (2.92)
============ ============
</TABLE>
See accompanying notes.
F-4
<PAGE>
<TABLE>
<CAPTION>
Conversion Technologies International, Inc.
and Subsidiaries
Consolidated Statements of Stockholders' Equity
Years ended June 30, 1997 and June 30, 1996
Preferred Stock Class A Common Stock
------------------------------------------ ----------------------------------------
Additional Additional
Number Paid-In Number Paid-In
of Shares Amount Capital of Shares Amount Capital
--------- ------ ------- --------- ------ -------
<S> <C> <C> <C> <C> <C> <C>
Balance at July 1, 1995 ........ 2,958,000 $ 2,958 $5,994,271 909,404 $ 227 4,427,710
Issuance of Class A
common stock ............ 3,527,050 882 13,526,159
Converted to Common Stock . (2,958,000) (2,958) (5,994,271) 1,023,054 255 5,996,974
Surrendered and canceled .. (7,308) (1) (98,999)
Repurchased and canceled .. (2,455) (1) (12,889)
Debt discount on Bridge ... 66,750
Net Loss ..................
--------- ---------- ---------- --------- ------ ------------
Balance at June 30, 1996 ....... -- -- -- 5,449,745 1,362 23,905,705
Issuance of Class A
common stock ............ 90,000 23
Stock Compensation ........ 281,227
Net Loss ..................
--------- ---------- ---------- --------- ------ ------------
Balance at June 30, 1997 ....... -- $ -- $ -- 5,539,749 $1,385 $ 24,186,932
========= ========== ========== ========= ====== ============
Total
Unearned Stockholders'
Stock Accumulated Equity
Compensation Deficit (Deficiency)
------------ ----------- ------------
<S> <C> <C> <C>
Balance at July 1, 1995 ........ $ -- $(12,626,117) $ (2,200,951)
Issuance of Class A
common stock ............ 13,527,041
Converted to Common Stock . --
Surrendered and canceled .. (99,000)
Repurchased and canceled .. (12,890)
Debt discount on Bridge ... 66,750
Net Loss .................. (4,552,951) (4,552,951)
--------- ------------ ------------
Balance at June 30, 1996 ....... -- (17,179,068) 6,727,999
Issuance of Class A
common stock ............ 23
Stock Compensation ........ (116,369) 164,858
Net Loss .................. (12,855,169) (12,855,169)
--------- ------------ ------------
Balance at June 30, 1997 ....... $(116,369) $(30,034,237) $ (5,962,289)
========= ============ ============
See accompanying notes.
</TABLE>
F-5
<PAGE>
<TABLE>
<CAPTION>
Conversion Technologies International, Inc.
and Subsidiaries
Consolidated Statements of Cash Flows
Year ended June 30,
-------------------------------
1997 1996
------------- -------------
OPERATING ACTIVITIES
<S> <C> <C>
Net loss ................................................... $(12,855,169) $ (4,552,951)
Adjustments to reconcile net loss to net cash provided by (used in) operating
activities:
Depreciation expense .................................. 1,036,416 886,863
Amortization of deferred financing and patent costs ... 54,514 54,302
Write-down of fixed assets ............................ 5,711,567 --
Write-off of inventories .............................. 96,752 --
Stock compensation expense ............................ 164,858 --
Settlement with former officer ........................ (99,000)
Debt discount on Bridge Notes ......................... 66,750
Changes in operating assets and liabilities:
Decrease (increase) in accounts receivable ......... 196,989 (59,643)
Increase in inventories ............................ (280,076) (110,012)
Decrease (increase) in other current assets ........ 17,459 (72,952)
Decrease (increase) in other noncurrent assets ..... 35,204 (7,038)
Decrease in deferred revenue ....................... (65,963) (386,323)
Increase (decrease) in accounts payable, reserve
for disposal and other accrued expenses ...... 723,173 (811,824)
------------ ------------
Net cash used in operating activities ...................... (5,164,276) (5,091,828)
INVESTING ACTIVITIES
Sale (purchase) of marketable securities ................... 2,009,632 (2,009,632)
Capital expenditures ....................................... (1,051,159) (4,396,016)
------------ ------------
Net cash provided by (used in) investing activities ........ 958,473 (6,405,648)
FINANCING ACTIVITIES
Increase in deferred finance and registration costs ........ (3,500) (40,427)
Issuance of notes payable .................................. -- 2,675,000
Payment of notes payable ................................... -- (3,061,500)
Issuance of long-term debt ................................. 8,282 3,056,476
Decrease (increase) in restricted assets ................... 472,005 (347,408)
Principal payments on long-term debt ....................... (412,681) (399,445)
Principal payments under capital lease obligations ......... (72,698) (93,750)
Issuance of common stock ................................... 23 13,514,151
------------ ------------
Net cash (used in) provided by financing activities ........ (8,569) 15,303,097
------------ ------------
(Decrease) increase in cash and cash equivalents ........... (4,214,372) 3,805,621
Cash and cash equivalents at beginning of period ........... 4,539,464 733,843
------------ ------------
Cash and cash equivalents at end of period ................. $ 325,092 $ 4,539,464
============ ============
See accompanying notes.
</TABLE>
F-6
<PAGE>
<TABLE>
<CAPTION>
Conversion Technologies International, Inc.
and Subsidiaries
Consolidated Statements of Cash Flows (continued)
Year ended June 30,
----------------------------
1997 1996
------------ ------------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
<S> <C> <C>
Interest paid, net of amount capitalized ............. $ 1,320,882 $ 1,009,746
=========== ===========
SUPPLEMENTAL DISCLOSURE OF NON CASH TRANSACTIONS
Surrender and cancellation of common stock ........... -- (99,000)
Issuance of warrants in connection with bridge notes.. -- 66,750
See accompanying notes.
</TABLE>
F-7
<PAGE>
Conversion Technologies International, Inc.
and Subsidiaries
Notes to Consolidated Financial Statements
June 30, 1997
1. ORGANIZATION
Conversion Technologies International, Inc. (the "Company") is engaged in the
business of manufacturing, recycling and processing various substrates and
advanced materials. These substrates and materials include (i) industrial
abrasives which can be used for surface cleaning and surface preparation
applications such as in cleaning steel structures, railcars, aircraft parts, and
equipment in loose grain blasting operations; (ii) decorative particles that
visually enhance structural materials such as plasters, tiles, grouts, wall
systems and roofing and flooring; and (iii) performance aggregates which can be
used as structural and textural enhancers, fillers and additives and to
strengthen and add consistency to materials such as cements, plasters, grouts,
roofing and flooring and glass and ceramic materials. The Company is also
engaged in the business of recycling cathode ray tube ("CRT") glass produced in
the manufacture of televisions for resale to such manufacturers and others.
Although substantially all of the Company's revenues to date have been derived
from its CRT recycling operations, the Company intends to focus its efforts on
its substrates and advanced materials products. The Company's revenue streams
are a combination of waste conversion fees and manufactured product sales.
On November 9, 1995, the Board of Directors approved an approximate
0.1218-for-one reverse split of its common stock. The accompanying consolidated
financial statements have been retroactively restated to reflect this reverse
stock split.
On May 16, 1996 the Company completed its initial public offering ("IPO"). The
funds generated by this offering became available at the closing on May 21,
1996, and included the proceeds from 3,067,000 shares of common stock sold at
$4.40 per share, 3,067,000 Class A Warrants sold at $0.05 each and 3,067,000
Class B Warrants sold at $0.05 each. On June 7, 1996 the Company closed on the
underwriter's over-allotment option for sales of 460,050 of each of the
foregoing securities at identical pricing. (See Note 7).
In November 1996, the Company entered into an Agreement and Plan of
Reorganization with Octagon, Inc. ("Octagon") pursuant to which a wholly-owned
subsidiary of the Company would be merged with and into Octagon (the "Merger"),
whereby, Octagon would become a wholly-owned subsidiary of the Company. On June
30, 1997, the Company and Octagon mutually terminated the Merger. Pursuant to
the terms of a Termination Agreement, the Company agreed to forgive remaining
bridge loans, including interest, in the approximate amount of $630,000 it made
to Octagon in fiscal 1997 in payment for certain services provided by Octagon to
the Company prior to the termination of the Merger and Octagon agreed to provide
certain services
F-8
<PAGE>
1. Organization (continued)
to the Company. This amount is included in Selling, General and Administrative
expenses in the Consolidated Statement of Operations.
The accompanying consolidated financial statements have been prepared on a going
concern basis which contemplates the realization of assets and the liquidation
of liabilities in the ordinary course of business. The Company has had limited
revenue and has incurred significant losses which has resulted in a working
capital deficiency and a stockholders' deficiency. In view of the foregoing,
there is substantial doubt about the Company's ability to continue as a going
concern. The accompanying consolidated financial statements do not include any
adjustments relating to the realization of assets and liquidation of liabilities
that might be necessary should the Company be unable to continue as a going
concern.
In late fiscal 1997 and early fiscal 1998 the Company engaged new management.
The Company's new management team has initiated a plan to reverse the history of
limited revenues and continued losses through a series of deliberate actions
based upon the following five elements. Long term debt has been renegotiated to
reduce interest expense (see Note 9). Raw material costs are being cut through
the use of third party tollers and the application of lower cost alternative
substrates. Revenues from colored substrates are anticipated to increase as the
Company's decorative particle production facility in St. Augustine, Florida
becomes fully operational. Investments in product development have been
curtailed and investments in sales and marketing will be increased.
Manufacturing and operating overheads have been reduced. Although management
believes the foregoing course of action would allow the Company to continue as a
going concern for the next year, there are no assurances that management will be
successful in implementing the plans and eliminating the substantial doubt as to
its ability to continue as a going concern.
2. Summary of Significant Accounting Policies
Basis of Presentation
The accompanying consolidated financial statements have been prepared in
accordance with generally accepted accounting principles and include the
accounts of Conversion Technologies International, Inc. and its wholly-owned
subsidiaries, Dunkirk International Glass and Ceramics Corporation and Advanced
Particle Technologies, Inc. Intercompany accounts and transactions have been
eliminated in consolidation.
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions
which affect the amounts
F-9
<PAGE>
2. Summary of Significant Accounting Policies (continued)
reported in the financial statements and accompanying notes. Actual results
could differ from those estimates.
Revenue Recognition
The Company derives most of its revenue from fees charged to accept waste
materials and from the sale of its products. With respect to revenue from fees
charged to accept waste materials, the Company initially records the fees it
receives for accepting waste materials for processing as deferred revenue. After
the materials have been processed into finished goods inventory, the deferred
revenue is recognized as fee revenue based upon the amount of finished goods
inventory produced (by tonnage) valued at the fee charged for accepting the
waste material. With respect to revenue from product sales, including products
created from processed waste materials, revenue is recognized only upon shipment
of products to customers.
For the year ended June 30, 1997, 61.2% of the Company's revenue was derived
from two major customers. Revenue generated from each of these customers
amounted to $621,830 and $252,686 which represents 43.5% and 17.7% of total
revenue, respectively. For the year ended June 30, 1996, 87.6% of the Company's
revenue was derived from three major customers. Revenue generated from each of
these customers amounted to $1,395,568, $677,648 and $273,709 which represents
52.1%, 25.3% and 10.2% of total revenue, respectively. The Company's customer
who generated the 17.7% and 25.3% of the total revenue for fiscal 1997 and 1996,
respectively, ceased shipping CRT glass and purchasing recycled CRT glass from
the Company in March 1997.
Reserve for Disposal
Dunkirk began accepting waste materials (primarily CRT glass) in early 1994.
Upon accepting the waste materials, Dunkirk established a reserve for the
probable disposal costs for the unprocessed waste materials on hand in the event
the conversion processes being developed were not successful. To date, the
Company has not yet disposed of the materials which it has not been able to
process. The amount of unprocessed waste materials on hand was 7,232 tons at
June 30, 1996 and 6,732 tons at June 30, 1997. From July 1, 1995 to June 30,
1996, the Company reduced the reserve by approximately $623,000; and from July
1, 1996 to June 30, 1997 the Company further reduced the reserve by
approximately $24,000. The decrease in the reserve, which resulted from the
reduction in the quantities of unprocessed waste materials on hand, as they were
subsequently processed, have been credited against operations. The Company
intends to adjust the reserve for disposal if and when it can refine existing
processes to increase yields and/or develop new processes for the unprocessed
waste materials on hand.
F-10
<PAGE>
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Inventories consisted of the following:
June 30,
------------------------
1997 1996
---- ----
Raw materials ....... $ 61,949 $ 79,237
Work-in-process...... 111,961 135,536
Finished goods....... 347,150 122,963
-------- --------
$521,060 $337,736
======== ========
Property, Plant and Equipment
Property, plant and equipment is stated at cost. The Company capitalized
interest costs of $439,932 in the year ended June 30, 1996 with respect to the
construction of certain long-term assets. Depreciation and amortization is
computed on the straight-line method over the estimated useful lives of the
assets. Amortization on assets under capital leases is provided on a
straight-line basis over the lesser of the useful lives of the related assets or
the terms of the leases.
During fiscal 1997, the Company experienced reduced levels of revenue and
increased costs. Also in fiscal 1997, the Company shut down its melter and
certain related equipment which it does not intend to use in the foreseeable
future, and accordingly, the Company has adjusted these asset values to their
estimated fair value which was determined to be zero as it is estimated that the
cost to disassemble, transport and reassemble the melter and peripheral
equipment would approximate any remaining fair value of those assets. As a
result, the Company has taken a charge in the fourth quarter pursuant to SFAS
No. 121 "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed of" in the amount of $5,711,567.
Cash Equivalents
The Company considers all highly-liquid investments with an original maturity of
three months or less to be cash equivalents.
F-11
<PAGE>
2. Summary of Significant Accounting Policies (continued)
Marketable Securities
The Company considers all marketable securities to be available for sale. These
securities were carried at cost which approximated fair value at June 30, 1996.
Deferred Financing Costs
Deferred costs include costs related to obtaining debt financing, and are being
amortized under the interest method of accounting. (See Note 9).
Income Taxes
Deferred income tax assets and liabilities are recorded for differences between
the financial statement and tax bases of assets and liabilities that will result
in taxable or deductible amounts in the future based on enacted tax laws and
rates applicable to the periods in which the differences are expected to affect
taxable income. Valuation allowances are established when necessary to reduce
deferred tax assets to the amount expected to be realized. Income tax expense is
the tax payable or refundable for the period plus or minus the change during the
period in deferred tax assets and liabilities.
Process Development Costs
Process development costs represent research and development associated with the
Company's CRT glass processing and ALUMAGLASS(TM) product lines (technologies)
in fiscal 1996. No such costs were incurred in fiscal 1997.
Investment Tax Credit
The Company received a gross cash refund of $566,547 related to a New York State
investment tax credit in June 1997. However, the Company has recorded a $235,000
reserve against this amount as the Company may be required to refund such amount
pursuant to a recapture provision. The net amount of $331,547 is included in
"Other Income."
Extraordinary Item
The consolidated statement of operations for the fiscal year ended June 30, 1996
includes an extraordinary charge of $442,000, representing the costs of
obtaining bridge financing in the form of Bridge Notes totaling $2,225,000 which
were repaid out of the proceeds of the Company's IPO (see Note 4).
F-12
<PAGE>
2. Summary of Significant Accounting Policies (continued)
Net Loss Per Common Share
The net loss per common share is based on the net loss for the year, divided by
the weighted average number of common shares outstanding during the year
(excluding the common shares that were deposited into escrow in connection with
the Company's initial public offering -see Note 7). Common Stock equivalents
such as stock options and warrants are not included as their effect is
anti-dilutive. However, immediately prior to the closing of the Company's
initial public offering, the Company's Series A Preferred Stock was converted
into 1,023,054 shares of common stock (see Note 7). The weighted average number
of these converted shares, at June 30, 1997 and 1996 were 1,023,054, and they
have been included in the related net loss per common share calculation.
Therefore, the weighted average number of common shares outstanding at June 30,
1997 and 1996 were 4,773,311 and 1,559,908, respectively.
Employee Stock Option Plan
The Company has elected to follow Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees" ("APB 25"), and related
Interpretations in accounting for its employee stock options. Under APB 25, when
the exercise price of the Company's employee stock options equals or is greater
than the market price of the underlying stock on the date of grant, no
compensation expense is recognized.
Pending Accounting Pronouncements
SFAS No. 128 "Earnings Per Share," SFAS No. 130 "Reporting Comprehensive Income"
and SFAS No. 131 "Disclosure about segments of an Enterprise and Related
Information" are not effective for the Company until December 31, 1997, June 30,
1999 and June 30, 1999, respectively. Management believes these standards will
not have a material impact on the Company.
F-13
<PAGE>
<TABLE>
<CAPTION>
3. DEBT
Long-term debt consists of the following obligations as of June 30, 1997 and 1996:
June 30,
------------------------
1997 1996
----------- ----------
<S> <C> <C>
Dunkirk--Chautauqua Region Industrial Development
Corporation (CRIDA) mortgage note (collateralized by a
mortgage on real property having a carrying value of
approximately $1,510,100 at June 30, 1997) payable in
monthly installments of $4,285 including interest at a
variable rate (6% at June 30, 1997) through October 1,
2004. $ 304,432 $ 336,529
Dunkirk--Term loans with a bank payable in 84 monthly
installments of $40,944 including principal and
interest at the prime rate (8.50% at June 30, 1997)
through December 27, 2001. Collateral for this loan is
a first purchase money lien on the Company's machinery
and equipment, and repayment is guaranteed by the
former Dunkirk president and the New York State Job
Development Authority (JDA). (See Note 9). 1,887,871 2,192,379
Dunkirk--Subordinated mortgage note (collateralized by a
mortgage on real property having a carrying value of
approximately $1,510,100 at June 30, 1997) payable in
monthly installments of $4,956 including interest at
10% through January 21, 2004. 288,516 317,517
Dunkirk--Chautauqua County Industrial Development
Agency (CCIDA) subordinated note payable in monthly
payments of $1,485 including interest at 7% through
June 1, 1999. The note contains various restrictive
covenants, is guaranteed by the former Dunkirk
president and is collateralized by a subordinated
security interest in certain machinery and equipment
having a carrying value of approximately $5,163,200. 33,170 49,295
F-14
<PAGE>
Conversion Technologies International, Inc.
and Subsidiaries
Notes to Consolidated Financial Statements
June 30, 1997
3. DEBT (CONTINUED)
June 30,
------------------------
1997 1996
----------- ----------
Dunkirk--Southern Tier Enterprise Development Organization
(STEDO) subordinated note payable in monthly payments
of $1,169 including interest at 8% through July 1,
2002. The note contains various restrictive covenants,
is guaranteed by the former Dunkirk president and is
collateralized by a subordinated security interest in
certain equipment having a carrying value of
approximately $5,163,200. 48,727 59,974
Dunkirk--New York Job Development Authority (Al Tech)
subordinated note payable in monthly payments of $1,887
including interest at 5% through September 1, 1999. The
note contains various restrictive covenants, is
guaranteed by the former Dunkirk president and is
collateralized by a subordinated security interest in
certain equipment having a carrying value of
approximately $5,163,200. 48,096 67,799
Dunkirk--Chautauqua County Industrial Development Agency
solid waste disposal facility bonds payable in
quarterly payments of interest only through September
1, 1998 at a rate of 11.5% subject to adjustment upon
the achievement of stated debt service coverage ratio.
Beginning December 1, 1998 and annually through
December 1, 2010 principal payments which increase from
$325,000 to $1,025,000 are payable with interest
continuing to be paid quarterly. The bond security
agreement contains various restrictive covenants and is
collateralized by a security interest in the equipment
acquired with the proceeds (see Notes 5 and 9). 8,000,000 8,000,000
F-15
<PAGE>
Conversion Technologies International, Inc.
and Subsidiaries
Notes to Consolidated Financial Statements
June 30, 1997
3. DEBT (CONTINUED)
June 30,
------------------------
1997 1996
----------- ----------
Dunkirk--Subordinated unsecured debt from various electronic
companies; OI-NEG TV Products, Inc. (Techneglas),
Thomson Consumer Electronics, Sanyo Manufacturing
Corp., Toshiba Display Devices and Hitachi Electronic
Devices (USA), begin with quarterly payments of
interest only at prime plus 2% (10.50% at June 30,
1997) through a range of dates ending January 1, 1999.
Beginning between March 31, 1998 and April 1, 1999 and
going through a range of dates with the final
subordinate debt issue ending January 1, 2004 quarterly
installments of principal plus interest at prime plus
2% are payable. The first five quarterly interest
payments for a portion of the debt has been converted
by the Company into subordinated notes ($43,789
converted at June 30, 1997) payable in quarterly
payments of interest only at 8% for nineteen quarters
and the principal amount plus interest being due
between April 1, 1999 through April 1, 2000. 703,789 695,507
----------- -----------
Total Debt 11,314,601 11,719,000
Less current maturities 530,258 437,285
----------- -----------
$10,784,343 $11,281,715
=========== ===========
</TABLE>
The Company has agreed to indemnify and hold harmless the former Dunkirk
president with respect to guarantees made by him for obligations of Dunkirk. In
addition, the Company has agreed to use its reasonable efforts to cause the
release of such guarantees.
Maturities on long-term debt for the next five years are as follows (see Note
9):
June 30,
1998 $ 530,258
1999 1,044,448
2000 1,107,982
2001 990,836
2002 865,939
Thereafter 6,775,138
------------
$ 11,314,601
============
F-16
<PAGE>
Conversion Technologies International, Inc.
and Subsidiaries
Notes to Consolidated Financial Statements
June 30, 1997
3. DEBT (CONTINUED)
The carrying amounts and fair values of long-term borrowings consisted of the
following at June 30, 1997:
Carrying Amount Fair Value
--------------- ----------
5% subordinated note .............. $ 48,096 $ 45,206
6% mortgage note .................. 304,432 262,189
7% subordinated note .............. 33,170 32,023
8% subordinated note .............. 48,727 46,420
8.50% secured bank loan ........... 1,887,871 1,887,871
10% subordinated mortgage note .... 288,516 284,256
Variable rate debt ................ 703,789 703,789
11.5% solid waste disposal bonds .. 8,000,000 8,000,000
----------- -----------
Total Long-Term Borrowings ... $11,314,601 $11,261,754
========== ==========
The fair values of fixed long-term borrowings were calculated as the present
value of future cash flows discounted at the Company's estimated current
borrowing rate of the respective issues ranging from prime plus 2% to prime plus
3% (See Note 9).
4. NOTES PAYABLE
During the period commencing September 1995 and ending November 1995, the
Company issued $700,000 of 6% convertible promissory notes, in anticipation of
additional equity financing, of which $50,000 was paid during fiscal 1996 (see
below).
During the period commencing December 7, 1995 and ending December 15, 1995, the
Company obtained additional bridge financing ("bridge loan") in the principal
amount of $2,225,000, (recorded, net of the value assigned to the attached
warrants, at $2,158,250) which includes the conversion of $650,000 of the
$700,000 convertible promissory notes discussed above. The bridge loan was
issued through a private placement arranged by the underwriter of the Company's
IPO. This bridge loan was comprised of bridge units, each consisting of a bridge
note in the principal amount of $50,000 bearing interest at the rate of 10% per
annum, and warrants to purchase 25,000 shares of the Company's common stock at
an exercise price of $4.00 per share commencing one year from the date of
issuance and expiring three years after the initial closing date of the bridge
loan offering.
F-17
<PAGE>
Conversion Technologies International, Inc.
and Subsidiaries
Notes to Consolidated Financial Statements
June 30, 1997
4. NOTES PAYABLE (CONTINUED)
In March 1996, the Company issued $200,000 of promissory notes, due upon the
earlier of the closing of the IPO and six months from the date issued, to
certain directors, officers and security holders which bore interest at 10% per
annum. In May 1996, the Company issued an additional $200,000 of promissory
notes to a securityholder with identical terms to the notes issued in March
1996.
All of the outstanding bridge notes and promissory notes were repaid at the
closing of the IPO from the proceeds thereof. Concurrent with the closing of the
offering, the common stock warrants issued to the bridge note holders were
converted into an equivalent number (1,112,500) of Class A warrants, each of
which entitles the holder to purchase, at an exercise price of $5.85, subject to
adjustment, one share of common stock and one Class B warrant. Each Class B
warrant entitles the holder to purchase one share of common stock at an exercise
price, subject to adjustment, of $7.80 (see Note 7).
During fiscal 1996 Dunkirk repaid a $262,500 balance plus accrued interest to
close a $300,000 line of credit arrangement with a bank. In June, 1996 Dunkirk
repaid a $124,000 demand note plus accrued interest payable to a bank.
5. RESTRICTED ASSETS
Dunkirk has $158 and $72,859 of project funds available at June 30, 1997 and
June 30, 1996, respectively, for the acquisition of qualified machinery and
equipment from the unexpended balance on the sale of the solid waste disposal
facility bonds. In addition, a debt service reserve fund equivalent to 10% of
the bonds plus interest is required to be deposited in escrow ($419,963 at June
30, 1997 and $840,442 at June 30, 1996), and may be released under certain
conditions (see Note 9).
Dunkirk also has a debt service reserve fund of $449,190 at June 30, 1997 and
$428,015 at June 30, 1996, including interest, deposited in escrow as required
by the JDA for payment of the final installments due on the related debt (see
Note 9).
6. COMMITMENTS AND CONTINGENCIES
The Company is a party to litigation commenced by the Company in the Supreme
Court of New York, County of Chautauqua, against a general contractor hired to
construct the improved abrasives finishing area, which was a part of the
Company's capital expansion program. The contractor commenced work in April
1995, but was asked to stop work in November 1995 following significant cost
overruns, problems and delays in construction and disputes with the
F-18
<PAGE>
Conversion Technologies International, Inc.
and Subsidiaries
Notes to Consolidated Financial Statements
June 30, 1997
6. COMMITMENTS AND CONTINGENCIES (CONTINUED)
Company over the scope of the work to be performed by the contractor. The
Company has served the contractor with its complaint, alleging, among other
things, breach of contract, fraud and defamation, and seeks damages in excess of
$1,000,000. The contractor has served an answer with affirmative defenses and
counterclaims against the Company for breach of contract. The aggregate amount
of the claims by the contractor against the Company is $483,000 plus interest.
The Company does not believe that there will be a material adverse outcome in
the foregoing dispute.
The Company has entered into capital leases for machinery and equipment that may
be purchased on expiration of the leases on various dates through 2000. The net
asset value of property under capitalized leases, included in property, plant
and equipment, is as follows:
June 30,
------------------------
1997 1996
---- ----
Machinery and equipment ............ $353,686 $354,352
Less accumulated amortization....... 289,382 217,375
-------- --------
$ 64,304 $136,977
======== ========
Lease amortization of $72,637 and $101,531 for the years ended June 30, 1997 and
1996, respectively, is included in cost of goods sold.
Future minimum lease payments together with the present value of the net minimum
lease payments for capitalized leases as of June 30, 1997 is as follows:
Capitalized Operating
Leases Leases
----------- ---------
June 30,
1998......................................... $41,486 $75,780
1999......................................... 27,179 75,780
2000......................................... 22,854 50,520
2001......................................... -- --
2002......................................... -- --
-------- --------
Total net minimum lease payments............. 91,519 $202,080
========
Less amount representing interest............ 16,610
-------
Present value of net minimum lease payments.. $74,909
=======
Total rent expense of the Company for the periods ended June 30, 1997 and 1996
was $73,674 and $99,530, respectively.
F-19
<PAGE>
Conversion Technologies International, Inc.
and Subsidiaries
Notes to Consolidated Financial Statements
June 30, 1997
7. CAPITAL STOCK
On May 16, 1996, the Company completed an initial public offering of the
Company's common stock, Class A warrants and Class B warrants. Concurrent with
the closing of the IPO, the Company's Preferred Stock ($.001 par value,
authorized 15,000,000 shares) was converted into 1,023,054 shares of common
stock as a result of the restatement of the Company's Certificate of
Incorporation which adjusted the Preferred Stock conversion ratio due to
anti-dilution provisions. In addition, preferred stock warrants became
exercisable for common stock (adjusted for a 0.1218-for-one reverse common stock
split-see Note 1) and the number of common shares into which certain common
stock warrants and all preferred stock warrants are convertible increased by a
factor of approximately 2.84 upon the effective date of the IPO due to the fact
that those warrants had protection against the dilutive effect of the valuation
placed on the Company upon the IPO. Also, upon the effective date of the IPO,
the Company adjusted the exercise price of all the options and warrants
outstanding prior to the IPO to $4.40 with some warrants having an exercise
price equal to $4.40 plus a premium in certain circumstances. All amounts
disclosed related to options and warrants have been restated to reflect the
adjusted exercise prices.
In connection with the IPO, 740,559 shares of the Company's common stock and
options to purchase 71,923 shares of Common Stock (the "Escrow Securities") were
deposited into escrow by the holders thereof. The Escrow Securities will only be
released from escrow when the Company attains certain earnings levels or the
market price of the Company's common stock achieves certain levels. These Escrow
Securities are subject to cancellation if such conditions are not achieved. In
the event that the Escrow Securities are released from escrow to the
stockholders of the Company who are officers, directors, employees or
consultants of the Company, compensation expense will be recorded for financial
reporting purposes. This non-cash charge to earnings will be equal to the fair
value of such securities on the date of their release.
F-20
<PAGE>
Conversion Technologies International, Inc.
and Subsidiaries
Notes to Consolidated Financial Statements
June 30, 1997
7. CAPITAL STOCK (CONTINUED)
The Company has issued the following common stock purchase warrants, all of
which expire between the fifth and seventh anniversary of the date of grant:
<TABLE>
<CAPTION>
Number of Exercise
Shares Price
--------- --------
<S> <C> <C>
Outstanding at July 1, 1995 ........................... 316,771 4.77-5.28
Granted July 21, 1995 through December 15, 1995 .... 1,114,933 4.00-4.40
Canceled ........................................... (1,112,500) 4.00
----------
Outstanding at June 30, 1996 .......................... 319,204 4.40-5.28
Granted July 1, 1996 through June 30, 1997 ......... -- --
Canceled July 1, 1996 through June 30, 1997 ........ -- --
----------
Outstanding at June 30, 1997 .......................... 319,204 4.40-5.28
==========
</TABLE>
In conjunction with its initial public offering, the Company has issued the
following Class A and Class B warrants, all of which expire on the fifth
anniversary of the date issued:
<TABLE>
<CAPTION>
Class A Class B
---------------------- ----------------------
Number of Exercise Number of Exercise
Shares Price Shares Price
--------- -------- --------- --------
<S> <C> <C> <C> <C>
Outstanding at July 1, 1995 ............ -- -- -- --
Issued May 16, 1996 and June 7, 1996.. 4,639,550 $ 5.85 3,527,050 $ 7.80
--------- ---------
Outstanding at June 30, 1997 and 1996... 4,639,550 3,527,050
========= =========
</TABLE>
The Company maintains an Employee Stock Option Plan (the "Employee Plan") and a
Non-Employee Director Stock Option Plan (the "Non-Employee Plan"). Stock options
may be granted at the discretion of the Board of Directors. The Company has
reserved 440,000 and 70,400 shares of its common stock for issuance upon the
exercise of options granted under the Employee and Non-Employee Plans,
respectively. The Non-Employee Plan options are exercisable in full one year
after the date of grant and expire ten years from the date of grant. The
Employee Plan options primarily vest one-third on each of the first three
anniversaries of the date of grant and expire on the seventh anniversary of the
date of grant. The Company grants stock options at exercise prices equal to or
greater than the fair market value of the Company's common stock on the date of
grant.
On April 21, 1996, the Company granted, effective as of the effective date of
the IPO, non-qualified options to purchase 50,000 shares of its common stock at
an exercise price of $4.40 per share to an executive officer and director. These
options are not part of the Employee Plan and Non-Employee Plan, and were
canceled in June of 1997 with the resignation of the executive officer and
director.
F-21
<PAGE>
Conversion Technologies International, Inc.
and Subsidiaries
Notes to Consolidated Financial Statements
June 30, 1997
7. CAPITAL STOCK (CONTINUED)
The following table summarizes the activity in options under the Employee and
Non-Employee Plans, plus options granted on a non-qualified basis:
Weighted
Average
Number Exercise
of Shares Price
--------- --------
EMPLOYEE PLAN OPTIONS
Outstanding at July 1, 1995... 38,083 4.40
Granted ................... 38,424 4.40
Canceled and expired ...... (6,884) 4.40
-------
Outstanding at June 30, 1996.. 69,623 4.40
Granted ................... 148,000 4.40
Canceled .................. (48,543) 4.40
-------
Outstanding at June 30, 1997.. 169,080 4.40
=======
NON-EMPLOYEE PLAN OPTIONS
Outstanding at July 1, 1995 6,266 4.40
Granted ................... 1,217 4.40
-------
Outstanding at June 30, 1996 7,483 4.40
Granted ................... 50,847 3.16
-------
Outstanding at June 30, 1997.. 58,330 3.32
=======
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
at June 30, 1997 At June 30, 1997
----------------------------------- ----------------------------
Weighted Average
Number of Weighted Average Contractual Life Number of Weighted Average
Range Shares Exercise Price (Years) Shares Exercise Price
--------- ---------------- ---------------- --------- ----------------
<S> <C> <C> <C> <C> <C>
$3.125 50,000 $3.13 10.00
$4.40-$5.00 177,410 4.40 6.39 75,557 $4.40
------- ------
TOTAL 227,410 $4.12 7.18 75,557 $4.40
======= ======
</TABLE>
Of the total options outstanding under the plans, 75,557 and 24,081 were
exercisable at June 30, 1997 and 1996, respectively.
F-22
<PAGE>
Conversion Technologies International, Inc.
and Subsidiaries
Notes to Consolidated Financial Statements
June 30, 1997
7. CAPITAL STOCK (CONTINUED)
At June 30, 1997, the Company has reserved 510,400 shares of Common Stock for
the exercise of options.
Pro forma information regarding net loss and net loss per share is required by
SFAS No. 123, and has been determined as if the Company had been accounting for
its employee and non-employee director stock options under the fair value method
of that Statement. The fair value of these options was estimated at the date of
grant using a Black-Scholes option pricing model for 1997 and the Minimum Value
Method for 1996 prior to becoming a public company in May 1996, with the
following assumptions for 1997 and 1996, respectively: weighted-average
risk-free interest rate of 6.0% for both years; volatility factors of the
expected market price of the Company's common stock of .778 for fiscal 1997 and
a weighted average expected life of the options of 7.36 for fiscal 1997 and 6.08
for fiscal 1996.
The Black-Scholes option valuation model was developed for use in estimating the
fair value of traded options which have no vesting restrictions and are fully
transferable. In addition, option valuation models require the input of highly
subjective assumptions including the expected stock price volatility. Because
the Company's employee and non-employee director stock options have
characteristics significantly different from those of traded options, and
because changes in the subjective input assumptions can materially affect the
fair value estimate, in management's opinion, the existing models do not
necessarily provide a reliable single measure of the fair value of its employee
and non-employee director options.
For purposes of pro forma disclosures, the estimated fair value of the options
granted in 1997 and 1996 is amortized to expense over the options' vesting
period. The weighted-average grant date fair value of options granted during
fiscal years 1997 and 1996 were $2.79 and $1.30, respectively. The Company's pro
forma information follows:
1997 1996
---- ----
Pro Forma net loss..................... $(13,127,518) $(4,576,091)
Pro Forma loss per common share........ $(2.75) $(2.93)
The pro forma disclosures presented above for fiscal year 1996 reflect
compensation expense only for options granted in fiscal 1996 and for fiscal 1997
only for options granted in fiscal years 1996 and 1997. These amounts may not
necessarily be indicative of the pro forma effect of SFAS No. 123 for future
periods in which options may be granted.
F-23
<PAGE>
Conversion Technologies International, Inc.
and Subsidiaries
Notes to Consolidated Financial Statements
June 30, 1997
7. CAPITAL STOCK (CONTINUED)
Effective as of August 26, 1996 ("Effective Date"), the Company approved and
adopted the 1996 Long-Term Employee Incentive Plan (the "Plan"). Under the Plan,
payment of awards may be in cash or the common stock of the Company or a
combination of both, at the option of the Company. The maximum number of shares
of the Company's common stock available for awards under the Plan is 800,000,
subject to adjustments as provided in the Plan. The Plan will terminate without
further action of the board of directors on the tenth anniversary of the
Effective Date. In October 1996, the Company issued a total of 90,000 shares (at
par value and, accordingly, compensation expense is being recognized) to two
former officers of the Company under the Plan which shares vest January 1, 1998.
Effective in July 1997, the Company issued a total of 600,000 options to two
officers of the Company which vest 20% at date of grant and 20% for each of the
next four years.
8. INCOME TAXES
There was no income tax expense/benefit for the Company for the years ended June
30, 1997 and 1996.
Following is a reconciliation of income tax expense (credit) to the amount based
on the U.S. statutory rate of 34% for the years ended June 30, 1997 and 1996:
<TABLE>
<CAPTION>
For the year ended June 30,
---------------------------
1997 1996
----------- -----------
<S> <C> <C>
Income tax benefit based on U.S. statutory rate... $(4,370,758) $(1,548,003)
Current year addition to the (federal) valuation
allowance ...................................... 4,370,758 1,548,003
----------- -----------
$ -- $ --
=========== ===========
</TABLE>
F-24
<PAGE>
Conversion Technologies International, Inc.
and Subsidiaries
Notes to Consolidated Financial Statements
June 30, 1997
8. INCOME TAXES (CONTINUED)
The significant components of the Company's deferred tax assets and liabilities
are as follows:
June 30,
---------------------------
1997 1996
----------- -----------
Deferred tax assets:
Deferred revenue ..................... $ 196,778 $ 223,163
Reserve for disposal ................. 285,240 294,800
Start-up costs ....................... 57,334 86,000
Fixed assets ......................... 1,422,000
Tax loss carryforward ................ 8,228,700 4,584,808
----------- -----------
Total deferred tax assets .............. 10,190,052 5,188,771
Valuation allowances (federal & state).. 10,190,052 5,188,771
----------- -----------
Net deferred tax assets ................ $ -- $ --
=========== ===========
The above net deferred tax assets have been reserved because it is not more
likely than not that they would be recognized.
At June 30, 1997, the Company has approximately $20.6 million of net operating
loss carryforwards, which expire between 2006 and 2012. The Tax Reform Act of
1986 enacted a complex set of rules (Section 382) limiting the potential
utilization of net operating loss carryforwards in periods following a corporate
"ownership change". In general, an ownership change is deemed to occur if the
percentage of stock of a loss corporation owned (actually, constructively and,
in some cases, deemed) by one or more "5% shareholders" has increased by more
than 50 percentage points over the lowest percentage of such stock owned during
a three year testing period. Although a comprehensive evaluation has not yet
been performed, it is likely that due to prior shifts in ownership (the Dunkirk
merger and the completion of the IPO) and anticipated shifts in ownership (See
Note 9), the Company's ability to utilize its net operating loss carryforwards
could be severely limited.
9. SUBSEQUENT EVENTS
In September 1997 the beneficial holders of Dunkirk's $8,000,000 Chautauqua
County Industrial Development Agency Solid Waste Disposal Facility Bonds (the
"IDA Bonds") retired the IDA Bonds in exchange for receipt of a cash payment of
$1,620,000 and the remaining balance of a related debt service reserve fund
which has been reduced for interest payments made to the beneficial holders
during fiscal 1997 through September 1, 1997. The cash payment was made
utilizing proceeds from the private placement discussed below. This retirement
will result in a net pretax gain to the Company of approximately $6,190,000
which will be recorded in the first
F-25
<PAGE>
Conversion Technologies International, Inc.
and Subsidiaries
Notes to Consolidated Financial Statements
June 30, 1997
9. SUBSEQUENT EVENTS (CONTINUED)
quarter of fiscal 1998. The Company will also write-off approximately $330,000
of deferred financing costs relating to such debt. If Dunkirk is deemed to be
solvent immediately prior to the time of such repayment, the Company will
recognize taxable income for the debt forgiveness in its tax year ending June
30, 1998. The amount of such income may be offset by net operating loss
carryforwards ("NOLs"), subject to the possible limitations discussed in Note 8.
Even if sufficient NOLs were available to offset such taxable income after the
limitations described below, the Company may still be subject to alternative
minimum tax. To the extent that Dunkirk is deemed to be insolvent immediately
prior to such repayment by an amount which equals or exceeds the amount of debt
forgiveness, the Company will not recognize taxable income from such repayment;
however, certain of Dunkirk's tax attributes (such as NOLs) would be subject to
reduction and would not be available to offset future income from operations, if
any. For this purpose, the amount of insolvency is defined to be the excess of
Dunkirk's liabilities over the fair value of its assets. An independent
appraisal of the fair value of Dunkirk's assets has not been completed at this
time to determine Dunkirk's solvency.
The New York State Job Development Authority (JDA) issued its guaranties (the
"Guaranties)") in favor of Key Bank of New York ("Key Bank") with respect to two
promissory notes (the "term loans") issued by Dunkirk and payable to the order
of Key Bank. The JDA has agreed to exercise its option under the Guaranties to
make the payments required under the term loans directly to Key Bank, provided
that Key Bank applies the amount currently held in the Company's related debt
service reserve fund to reduce the principal amount of the term loans. Upon the
assignment of the term loans and related loan documents to the JDA, the JDA has
also agreed to defer monthly payments of principal and interest due from Dunkirk
under each term loan through January 1998 until the maturity date of such loans.
Interest will continue to accrue on the principal amount and interest so
deferred will be payable at maturity.
In July and August 1997, the Company borrowed an aggregate of $500,000 (the
"1997 Bridge Loan") for general working capital purposes. In connection with the
1997 Bridge Loan, the Company issued warrants to purchase 100,000 shares of
Common Stock at an exercise price equal to $1 5/16. The 1997 Bridge Loan was
repaid in full plus accrued interest at 12% per annum on September 8, 1997 from
proceeds from the private placement discussed below.
The Company has entered into a placement agency agreement for a private
placement of the Company's preferred stock. The private placement consists of a
minimum of 300,000 and a maximum of 500,000 shares of Series A Convertible
Preferred Stock (the "Preferred Stock") with an option for the Placement Agent
to sell up to an additional 300,000 shares to cover over-allotments, if any,
(the Preferred Stock is to be sold in units of 10,000) with a par value of $.001
per share and a stated value of $10 per share. Each share of Preferred Stock is
initially convertible into eight shares of common stock at a conversion price of
$1.25 per share, subject to
F-26
<PAGE>
Conversion Technologies International, Inc.
and Subsidiaries
Notes to Consolidated Financial Statements
June 30, 1997
9. SUBSEQUENT EVENTS (CONTINUED)
adjustment based on the lesser of $1.25 and the prevailing average market price
of the common stock immediately preceding any subsequent closing, if any.
Commencing 12 months from the final closing of the private placement, the
holders of the Preferred Stock are entitled to receive dividends payable in cash
or, at the option of the Company, in additional shares of Preferred Stock at the
rate of 10% per annum. The Placement Agent is entitled to receive a cash
commission of 9% and a non-accountable expense allowance of 4% of the total
proceeds. The Placement Agent is also entitled to receive warrants to purchase
shares of the Company's Preferred Stock equal to 10% of the total shares issued
at an exercise price equal to 110% of the offering price of such shares. Through
September 18, 1997, 414,500 shares of Preferred Stock had been sold, with net
proceeds (after deducting the placement agent commissions and expenses - see
above) to the Company of $3,606,150.
In August 1997, The Company's Board of Directors authorized an increase of the
authorized number of the Company's common shares of up to a maximum of 60
million. This is subject to ratification of the Company's stockholders.
F-27
<PAGE>
SIGNATURES
Pursuant to the requirement of Section 13 or 15 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.
CONVERSION TECHNOLOGIES INTERNATIONAL, INC.
Dated: February 12, 1998 /s/ William L. Amt
-------------------------------------------
William L. Amt
President and Chief Executive Officer
Dated: February 12, 1998 /s/ John G. Murchie
-------------------------------------------
John G. Murchie
Controller and Principal Financial Officer
-10-
