UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

SCHEDULE 14A

 

Proxy Statement Pursuant to Section 14(a) of the Securities

Exchange Act of 1934 (Amendment No.  )

 

Filed by the Registrant þ

 

Filed by a Party other than the Registrant o

 

Check the appropriate box:

o  Preliminary Proxy Statement

o  Confidential, For Use of the Commission Only (As Permitted by Rule 14a-6(e)(2))

þ  Definitive Proxy Statement

o  Definitive Additional Materials

o  Soliciting Material Pursuant to Rule 14a-11(c) or Rule 14a-12

 

CONVERTED ORGANICS INC.

(Name of Registrant as Specified In Its Charter)

 

(Name of Person(s) Filing Proxy Statement, if other than the Registrant)

 

Payment of Filing Fee (Check the appropriate box):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

This proxy statement is dated July 30, 2010 and is first being mailed to stockholders on or about July 30, 2010.

 

Converted Organics Inc.
137A Lewis Wharf
Boston, MA 02110
617 624 0111

 

 

Dear Stockholder:

 

A Special Meeting of Stockholders of Converted Organics Inc. (the “Company”) will be held at Renaissance Boston Waterfront Hotel, 606 Congress Street, Boston, MA, 02210, on August 31, 2010 at 9:30 a.m. local time. The attached material includes the Notice of Special Meeting and the Proxy Statement, which describes the business to be transacted at the meeting. We ask that you give them your careful attention.

 

On July 6, 2010, a Membership Interest Purchase Agreement was entered into by and among the Company, TerraSphere, Inc., a wholly owned subsidiary of the Company, TerraSphere Systems LLC (“TerraSphere”) and the members of TerraSphere, pursuant to which the Company agreed to acquire 100% of TerraSphere. The maximum total purchase price for TerraSphere will be $25,830,000, which includes earn-out payments of up to $11,040,000, payable solely in shares of common stock valued at $0.756 per share. Pursuant to the purchase agreement, if the acquisition is approved by the Company’s stockholders, the Company will issue up to 34,166,667 shares of its common stock to the members of TerraSphere in exchange for 100% of the units of TerraSphere, subject to certain anti-dilution adjustments described in this proxy statement. Of these shares, 19,563,492 shares will be issued at the closing of the acquisition, and the remainder of the shares will be issued if TerraSphere achieves certain milestones described in this proxy statement. Upon completion of the proposed acquisition, TerraSphere would become a wholly-owned subsidiary of the Company. TerraSphere designs, builds and operates highly efficient and scalable systems, featuring a patented, proprietary technology that utilizes vertically-stacked modules to house rows of plants, which are then placed perpendicular to an interior light source to grow pesticide-free, organic fruits and vegetables. Due to a controlled, indoor environment, the system generates fresh produce year-round in any location or climate world-wide.

 

Pursuant to the rules of the NASDAQ Stock Market, the TerraSphere acquisition requires the approval of the Company’s stockholders.

 

Your vote is important. Please sign, date and return your proxy card as soon as possible to make sure that your shares are represented at the special meeting. You may also vote by telephone or the internet, as described on the proxy card. If you are a stockholder of record, you may also cast your vote in person at the special meeting. If your shares are held in an account at a brokerage firm or bank, you must instruct your broker or bank how to vote your shares, or you may cast your vote in person at the special meeting by obtaining a proxy from your brokerage firm or bank.

 

This proxy statement sets forth more information about TerraSphere, the TerraSphere members and the purchase agreement. We encourage you to carefully read this proxy statement before voting, including the section entitled “Risk Factors” beginning on page 12.

 

On behalf of the Board of Directors, I would like to thank you for your continued support and confidence.

 

Sincerely,

 

Edward J. Gildea

President, Chief Executive Officer and

Chairman of the Board

 

Important Notice Regarding the Availability of Proxy Materials
for the Special Stockholder Meeting to be Held on August 31, 2010:
The Proxy Statement is available at [http://ir.convertedorganics.com/annuals.cfm]

 

Converted Organics Inc.
137A Lewis Wharf
Boston, MA 02110
617 624 0111

 

NOTICE OF SPECIAL MEETING OF STOCKHOLDERS

TO BE HELD AUGUST 31, 2010

 

TO THE STOCKHOLDERS OF CONVERTED ORGANICS INC.:

 

NOTICE IS HEREBY GIVEN that a special meeting of stockholders of Converted Organics Inc., a Delaware corporation (the “Company”), relating to the proposed acquisition with TerraSphere Systems LLC, a Massachusetts limited liability company (“TerraSphere”), will be held at 9:30 a.m. Eastern time on August 31, 2010, at Renaissance Boston Waterfront Hotel, 606 Congress Street, Boston, MA, 02210, to consider and vote upon the following matter:

 

Proposal 1.  The issuance of up to 34,166,667 shares of Company common stock to the members of TerraSphere in exchange for 100% of the units of TerraSphere, subject to upward adjustment based on certain anti-dilution protections described in this proxy statement. This proposal is called the “TerraSphere Proposal.”

 

Proposal 2.  Any adjournment of the special meeting for the purpose of soliciting additional proxies. This proposal is called the “Adjournment Proposal.”

 

On July 6, 2010, a Membership Interest Purchase Agreement was entered into by and among the Company, TerraSphere, Inc., a wholly owned subsidiary of the Company, TerraSphere and the members of TerraSphere, pursuant to which the Company agreed to acquire 100% of TerraSphere. The maximum total purchase price for TerraSphere will be $25,830,000, which includes earn-out payments of up to $11,040,000, payable solely in shares of common stock valued at $0.756 per share. Pursuant to the purchase agreement, if the acquisition is approved by the Company’s stockholders, the Company will issue up to 34,166,667 shares of its common stock, subject to upward adjustment based on certain anti-dilution protections, to the members of TerraSphere in exchange for 100% of the units of TerraSphere. Of these shares, 19,563,492 shares will be issued at the closing of the acquisition, and the remainder of the shares will be issued if TerraSphere achieves certain milestones described in this proxy statement. Upon completion of the proposed acquisition, TerraSphere would become a wholly-owned subsidiary of the Company. The acquisition of TerraSphere will require the issuance of approximately 84.6% of the outstanding shares of Company before the issuance and would represent 45.7% of our voting shares following the issuance, assuming the maximum number of shares are issued in the transaction.

 

Pursuant to the rules of the NASDAQ Stock Market, the TerraSphere acquisition requires the approval by a majority of the total votes cast at a special meeting of stockholders at which a quorum is present.

 

Mr. Edward J. Gildea, the Company’s Chairman and Chief Executive Officer, has an interest in 8.75% of the units of TerraSphere, and family members of Mr. Gildea hold significant units of TerraSphere and serve as officers of TerraSphere. Our board of directors formed an Acquisition Committee of disinterested directors to evaluate and, if appropriate, negotiate the proposed TerraSphere acquisition because of Mr. Gildea’s interest in TerraSphere. The Acquisition Committee obtained valuation advice and a fairness opinion from an independent investment bank, and negotiated the terms of the TerraSphere acquisition with TerraSphere management. Mr. Gildea did not participate in the negotiations. The Acquisition Committee unanimously determined that the terms of the TerraSphere acquisition are advisable, fair to, and in the best interests of our stockholders. Upon the Acquisition Committee’s unanimous recommendation, our board of directors then unanimously (with Mr. Gildea abstaining) determined that the terms of the TerraSphere acquisition are advisable, fair to, and in the best interests of, our stockholders.

 

After careful consideration, and upon the unanimous recommendation of an Acquisition Committee of the disinterested directors, our board of directors has unanimously (with Mr. Gildea abstaining) approved the proposal referred to above and concluded that it is advisable, fair to, and in the best interests of our stockholders. The Acquisition Committee and our board of directors unanimously

recommend that our stockholders vote “FOR” the TerraSphere Proposal referred to above, and “FOR” the Adjournment Proposal.

 

The Company’s board of directors has fixed the record date as the close of business on July 21, 2010, as the date for determining stockholders entitled to receive notice of and to vote at the special meeting and any adjournment thereof. The holders of record of the Company’s common stock on the record date are entitled to have their votes counted at the special meeting or any adjournment.

 

The proxy statement accompanying this notice sets forth more information about TerraSphere, the TerraSphere members, the purchase agreement and the interests of Mr. Gildea in the acquisition. The accompanying materials also provide instructions on how to vote your shares in person at the special meeting or by proxy.

 

Dated: July 30, 2010

 

By Order of the Board of Directors

 

Edward J. Gildea

President, Chief Executive Officer and

Chairman of the Board

 

Boston, Massachusetts

 

July 30, 2010

 

 

 

TABLE OF CONTENTS

 

 

 

This section summarizes information related to the proposal to be voted on at the special meeting. The proposal is described in greater detail elsewhere in this proxy statement. You should carefully read this entire proxy statement and the other documents to which you are referred.

 

 

These Questions and Answers below are only summaries of matters described in this proxy statement. They do not contain all of the information that may be important to you. You should read carefully the entire document, including the annexes to this proxy statement. The terms “Converted,” “Company,” “we,” or “our” refer to Converted Organics Inc.

 

 

 

 

 

This summary highlights selected information from this proxy statement and does not contain all of the information that is important to you. To better understand the TerraSphere acquisition, you should read carefully this entire document and the other documents to which this proxy statement refers you, including the purchase agreement attached as Annex A to this proxy statement. The purchase agreement is the legal document that governs the TerraSphere acquisition. The purchase agreement is also described in detail elsewhere in this proxy statement. See “Where You Can Find More Information.”

 

Converted Organics Inc.

 

We operate processing facilities that use food waste and other raw materials to manufacture all-natural fertilizer and soil amendment products combining nutritional and disease suppression characteristics. In addition to our sales in the agribusiness market, we sell and distribute our products in the turf management and retail markets. We also hope to achieve additional revenue by licensing the use of our technology to others. We currently operate two facilities:

 

 

Our principal executive office is located at 137A Lewis Wharf, Boston, MA 02110, and our phone number is (617) 624-0111.

 

TerraSphere Inc.

 

TerraSphere Inc. is a Delaware corporation that is our wholly owned subsidiary formed for the sole purpose of holding the units of TerraSphere.

 

TerraSphere Systems LLC

 

TerraSphere is dedicated to building highly efficient systems for growing pesticide-free, organic fruits and vegetables in a controlled indoor environment. TerraSphere’s clean technology helps to promote the sustainable consumption of natural resources by accelerating plant production and maximizing crop yields, while improving environmental footprints through the reduction of carbon emissions and fuel use associated with traditional crop production and distribution.

 

TerraSphere’s principal executive office is located at 137A Lewis Wharf, Boston, MA 02110, and its phone number is (617) 557-5440 .

 

We have agreed to acquire 100% of the equity interests in TerraSphere pursuant to a purchase agreement we entered into with TerraSphere and its members. Upon completion of the acquisition, TerraSphere would become a wholly-owned subsidiary of the Company.

 

Purchase Price

 

The maximum total purchase price for TerraSphere will be $25,830,000, which includes earn-out payments of up to $11,040,000, payable solely in shares of common stock valued at $0.756 per share. We will

issue up to 34,166,667 shares of our common stock, subject to upward adjustment based on certain anti-dilution protections, in consideration for 100% of the outstanding units of TerraSphere, which represents 84.6% of our voting shares prior to the issuance and would represent 45.7% of our voting shares following the issuance, assuming the maximum number of shares are issued in the transaction, based on our outstanding capital stock at July 6, 2010.

 

Pursuant to the terms of the purchase agreement, each TerraSphere member was given the option to receive either:

 

 

The earn-out payment is structured such that the TerraSphere members electing to receive Option Two Shares will be paid their respective pro rata portion of our common stock, valued at the Closing Price Per Share, in accordance with the following schedule:

 

(1) on the date of the closing, $12,000,000 of our common stock;

 

(2) $5,000,000 of our common stock, if, and only if, between the date of the purchase agreement and the earlier of the 90th day following the closing or the 180th day following the date of the purchase agreement, for a period of five consecutive trading days, our Market Capitalization (as defined in the section entitled “The TerraSphere Acquisition — Description of the TerraSphere Acquisition”) exceeds the sum of: (1) our Initial Market Capitalization (as defined in the section entitled “The TerraSphere Acquisition — Description of the TerraSphere Acquisition”) on the date of the purchase agreement plus (2) the Closing Price Per Share multiplied by the number of shares of our common stock to be issued to TerraSphere members electing Option One Shares, the number of shares of our common stock to be issued pursuant to paragraph 1 above and, if such calculation is being made prior to the closing, the number of shares of our common stock to be issued pursuant to this paragraph 2. Notwithstanding the foregoing, if between the date of the purchase agreement and the earlier of the 90th day following the closing or the 180th day following the date of the purchase agreement, we complete a debt or equity financing with a third party other than project financing, unless such project financing is completed for TerraSphere (referred to as a “Financing”), the cash received from the Financing during such period shall be added to the Market Capitalization. In addition, if between the closing and December 31, 2011, we sell equity of either the TerraSphere or any of TerraSphere’s subsidiaries, any cash received from such equity sales during such period shall be added to the Market Capitalization.

 

(3) $2,000,000 of our common stock, if, and only if, $2,000,000 of TerraSphere’s accounts receivable as of the date of the purchase agreement are received prior to February 28, 2011;

 

(4) $5,000,000 of our common stock, or the Milestone Three Payment, if TerraSphere generates Gross Margin (as defined in the section entitled “The TerraSphere Acquisition — Description of the TerraSphere Acquisition”) of $6,000,000 from its operations during the period from the date of the purchase agreement through December 31, 2011; provided that, if TerraSphere generates Gross Margin of at least $4,200,000, or the Milestone Three Gross Margin Threshold, from its operations during such period, the TerraSphere members will be entitled to a pro rata portion of the common stock; and

 

(5) $4,000,000 of our common stock, or the Milestone Four Payment, if, and only if, TerraSphere generates Gross Margin of $4,000,000, or the Milestone Four Gross Margin Target, from its operations during any six-month period commencing on the date of the purchase agreement and ending on

December 31, 2012; provided that, if TerraSphere achieves the Milestone Three Gross Margin Threshold, but does not achieve the Milestone Three Gross Margin Target, 83.3% of the difference between the Milestone Three Gross Margin Target and the actual Gross Margins achieved pursuant to paragraph 4 above may be added by the TerraSphere members to the Milestone Four Payment and the Milestone Four Gross Margin Target.

 

Lock-Up of Shares

 

With limited exceptions, the shares to be issued to the TerraSphere members are subject to the following sale restrictions absent our approval:

 

 

Anti-Dilution Protection

 

During the applicable lock-up period described above, we have agreed to provide the TerraSphere members anti-dilution rights. The rights provide that if we issue shares of our common stock for cash consideration in connection with a financing transaction at a price less than the Closing Price Per Share, or $0.756 per share, then the TerraSphere members shall receive additional shares of our common stock based on a weighted average dilution formula. See the section entitled “The TerraSphere Acquisition — Description of the TerraSphere Acquisition — Anti-Dilution Protection” for details about the formula. Messrs. Edward Gildea and William Gildea have not been provided this anti-dilution protection.

 

The purchase agreement, which is the legal document governing the TerraSphere acquisition, is attached at Annex A to this document. You should read the agreement carefully and in its entirety.

 

You will be entitled to vote or direct votes to be cast at the special meeting if you owned shares of our common stock at the close of business on July 21, 2010, the record date for the special meeting. You will have one vote for each share of common stock you owned at the close of business on the record date. On the record date, there were 42,359,041 shares of common stock outstanding.

 

All of the TerraSphere members have approved the transactions contemplated in the purchase agreement. Accordingly, no further action by the TerraSphere members is needed to approve the acquisition.

 

 

Proxies may be solicited by mail, telephone or in person. If you grant a proxy, you may revoke your proxy before it is exercised at the special meeting by sending a notice of revocation to our corporate secretary, submitting a later-dated proxy statement or voting in person at the special meeting.

 

After careful consideration, the Acquisition Committee of our board of directors, which was delegated the authority to evaluate and, if appropriate, negotiate the proposed acquisition of TerraSphere, has unanimously determined that the terms of the TerraSphere acquisition are advisable, fair to and in the best interests of our stockholders, has unanimously recommended that our board of directors approve the TerraSphere acquisition, has unanimously recommended that our board of directors recommend the TerraSphere acquisition, including the issuance of the shares contemplated in the purchase agreement, to our stockholders, and has unanimously recommended that you vote “FOR” the issuance of the shares contemplated in the purchase agreement, as described in this proxy.

 

Based solely upon the unanimous recommendations of the Acquisition Committee, our board of directors has also unanimously (with Mr. Gildea abstaining) determined that the terms of the TerraSphere acquisition are advisable, fair to and in the best interests of our stockholders, has unanimously approved the TerraSphere acquisition, and authorized us to enter into the purchase agreement, and has unanimously recommended that you vote “FOR” the issuance of the shares contemplated in the purchase agreement, as described in this proxy.

 

The factors that our board of directors and the Acquisition Committee relied upon to approve the TerraSphere acquisition and to recommend stockholder approval are described in more detail under the headings “The TerraSphere Acquisition Our Reasons for the TerraSphere Acquisition” beginning on page 28 and “The TerraSphere Acquisition — Recommendations of our Board of Directors” beginning on page 29.

 

The Company engaged Duff & Phelps, LLC (“Duff & Phelps”) to serve as the financial advisor to the Acquisition Committee, and to provide an opinion as to the fairness, from a financial point of view, to the Company, and, accordingly, to the holders of the Company’s common stock, other than those holders who also own units of TerraSphere, of the consideration to be paid by the Company in the TerraSphere acquisition. On June 28, 2010, Duff & Phelps rendered its oral opinion to the Acquisition Committee, which opinion was subsequently confirmed in a written opinion dated July 6, 2010, to the effect that, subject to the limitations, exceptions, assumptions and qualifications set forth therein, as of July 6, 2010, the consideration to be paid by the Company in the TerraSphere acquisition was fair, from a financial point of view, to the Company and, accordingly, to the holders of the Company’s common stock, other than those holders who also own units of TerraSphere.

 

The Duff & Phelps opinion was directed to the Acquisition Committee and addresses only the fairness, from a financial point of view, to the Company and, accordingly, to the holders of the Company’s common stock, other than those holders who also own units of TerraSphere, of the consideration to be paid by the Company in the TerraSphere acquisition. The Duff & Phelps opinion:

 

 

Instead, the Duff & Phelps opinion merely states whether the consideration in the TerraSphere acquisition is within a range suggested by certain financial analyses. The decision as to whether to proceed with the TerraSphere acquisition or any related transaction may depend on an assessment of factors unrelated to the financial analysis on which the Duff & Phelps opinion is based.

 

The full text of the written opinion of Duff & Phelps, which sets forth, among other things, the assumptions made, procedures followed, matters considered and qualifications and limitations of the review undertaken in rendering the opinion, is attached as Annex B to this proxy statement. The Company encourages its stockholders to read the full text of the Duff & Phelps opinion carefully and in its entirety.

 

Neither we nor TerraSphere, as a matter of course, publish our respective business plans and strategies or make public projections as to future revenues, earnings, or other results other than our periodic revenue and earnings guidance. However, TerraSphere’s management prepared the respective prospective financial information referenced in this proxy statement to present certain projections of financial performance for the respective companies, and these projections were provided to our Acquisition Committee, Duff & Phelps and our board of directors in connection with their financial analysis of the proposed acquisition. The projections were prepared by TerraSphere management solely for the purpose of evaluating the TerraSphere acquisition.

 

This prospective financial information was not prepared with a view toward public disclosure or with a view toward complying with U.S. generally accepted accounting principles, or GAAP, the published guidelines of the Securities and Exchange Commission, or SEC, or the guidelines established by the American Institute of Certified Public Accountants for preparation and presentation of prospective financial information, but, in the view of TerraSphere’s management, was prepared on a reasonable basis, reflects the best estimates and judgments available as of the date of their preparation, and presents, to the best of TerraSphere management’s knowledge and belief, a potential course of action and potential future financial performance of the company at the time the projections were prepared. However, this information is not fact and should not be relied upon as being necessarily indicative of future results, and readers of this proxy statement are cautioned not to place undue reliance on the prospective financial information.

 

Neither our nor TerraSphere’s independent auditors, nor any other independent accountants, have compiled, examined, or performed any procedures with respect to the prospective financial information contained herein, nor have they expressed any opinion or any other form of assurance on such information or its achievability, and assume no responsibility for, and disclaim any association with, the prospective financial information.

 

The assumptions and estimates underlying the prospective financial information are inherently uncertain and, though considered reasonable by TerraSphere’s management as of the date of its preparation, are subject to a wide variety of significant business, economic, and competitive risks and uncertainties that could cause actual results to differ materially from those contained in the prospective financial information, including, among others, the risks and uncertainties described in “Risk Factors” and “Special Note Regarding Forward-Looking Statements.” Accordingly, there can be no assurance that the prospective results are indicative of our future performance or that of the combined company or that actual results will not differ materially from those presented in the prospective financial information. Inclusion of the prospective financial information in this proxy statement should not be regarded as a representation by any person that the results contained in the prospective financial information will be achieved.

 

Neither we nor TerraSphere intends to update or otherwise revise the prospective financial information to reflect circumstances existing or events occurring, including changes in general economic or industry conditions, since its preparation, even if any or all of the underlying assumptions are shown to be in error.

 

When you consider the unanimous recommendation of our board of directors (with Mr. Gildea abstaining) in favor of the TerraSphere acquisition you should note that Mr. Gildea has an interest in 8.75% of the units of

TerraSphere. In addition, relatives of Mr. Gildea hold an additional 30.75% of the units of TerraSphere. If the acquisition is completed and assuming all milestones are achieved, Mr. Gildea would receive 3,240,741 shares of our common stock in exchange for his TerraSphere units and his relatives would receive an additional 10,775,463 of our common stock in exchange for their TerraSphere units. Furthermore, Mark C. Gildea, the brother of Edward Gildea, is the President and Chief Executive Officer of TerraSphere, and William A. Gildea, also the brother of Edward Gildea, is an independent contractor of TerraSphere.

 

Because of Mr. Gildea’s relationship with TerraSphere, our board of directors formed the Acquisition Committee to evaluate and, if appropriate, negotiate the proposed TerraSphere acquisition. The Acquisition Committee obtained valuation advice and a fairness opinion from an independent investment bank, and negotiated the terms of the TerraSphere acquisition with the TerraSphere management. Mr. Gildea did not participate in the negotiations.

 

Consummation of the purchase agreement is conditioned upon certain closing conditions, including, without limitation:

 

 

The purchase agreement may be terminated and/or abandoned at any time prior to the closing by:

 

 

In the event of termination and abandonment by either party, all further obligations of the parties shall terminate, no party shall have any right against the other party, and each party shall bear its own costs and expenses.

 

No gain or loss will be recognized by us or by holders of shares of our common stock as a result of the TerraSphere acquisition.

 

We will account for the TerraSphere acquisition as a purchase under U.S. generally accepted accounting principles. Under the acquisition method of accounting, the assets and liabilities of TerraSphere will be recorded as of the date of the closing of the TerraSphere acquisition, at their respective fair values, and

consolidated with those of us. The results of operations of TerraSphere will be consolidated with ours beginning on the date of the closing of the TerraSphere acquisition.

 

We are not aware of any governmental or regulatory approval required for completion of the TerraSphere acquisition, other than compliance with applicable corporate laws of Delaware, compliance with securities laws and filing with the NASDAQ Stock Market, with respect to the shares of our common stock to be issued to the TerraSphere stockholders pursuant to the purchase agreement. If any other governmental approvals or actions are required, we intend to try to obtain them. We cannot assure you, however, that we will be able to obtain any such approvals or actions.

 

In evaluating the proposals to be voted on at the special meeting, you should carefully read this proxy statement and especially consider the factors discussed in the section entitled “Risk Factors.”

 

You should carefully consider the following risk factors, together with all of the other information included in this proxy statement, before you decide whether to vote or direct your vote to be cast to approve the TerraSphere acquisition. In assessing these risks, you should also refer to the other information included in this proxy statement, including the consolidated financial statements and the accompanying notes of TerraSphere, as well as the pro forma financial information set forth herein.

 

We will issue a large number of shares of common stock in connection with the acquisition, which will result in substantial dilution to our existing stockholders. Our stockholders may not realize a benefit from the TerraSphere acquisition commensurate with the ownership dilution they will experience in connection with the shares issued to acquire TerraSphere.

 

If the TerraSphere acquisition is approved and assuming all milestones are achieved by TerraSphere, we will issue up to 34,166,667 shares of our common stock to the members of TerraSphere in exchange for 100% of the units of TerraSphere, subject to upward adjustment based on certain anti-dilution protections, in consideration for 100% of the outstanding units of TerraSphere, which represents 84.6% of our voting shares prior to the issuance and would represent 45.7% of our voting shares following the issuance, assuming the maximum number of shares are issued in the transaction, based on our outstanding capital stock at July 6, 2010. Our issuance of the shares will result in substantial percentage dilution of our existing stockholders’ ownership interests. Our issuance of the shares may also have an adverse impact on our net income per share in fiscal periods that include or follow the closing of the TerraSphere acquisition.

 

If we are unable to realize sufficient strategic and financial benefits from the TerraSphere acquisition, our stockholders will have experienced substantial dilution of their ownership interest without receiving commensurate benefit.

 

The actual value of the consideration we will pay to the TerraSphere members may exceed the value allocated to it at the time we entered into the purchase agreement.

 

Under the purchase agreement, the number of shares of common stock we will issue as consideration at closing or upon the achievement of milestones is fixed, and there will be no adjustment for changes in the market price of our common stock. The per share value of the shares issued to the TerraSphere members was based on the closing price of our common stock during the 15-day period preceding the date of the execution of the purchase agreement, or $0.756. Neither we nor the TerraSphere members are permitted to abandon or terminate the transaction solely because of changes in the market price of our common stock between the signing of the purchase agreement and the closing. Our common stock has historically experienced significant volatility. Stock price changes may result from a variety of factors that are beyond our control, including changes in our business, operations and prospects, regulatory considerations and general market and economic conditions. The value of the shares we issue to acquire TerraSphere may be significantly higher at the closing or upon the achievement of milestones than when we entered into the purchase agreement.

 

If the conditions to the closing of the purchase agreement are not met, the TerraSphere acquisition will not occur, which could adversely impact the market price of our common stock as well as our business, financial condition and results of operations.

 

The purchase agreement is subject to closing conditions that must be satisfied or waived before the TerraSphere acquisition can be completed, including, without limitation, obtaining the requisite approval of our stockholders with respect to our proposed issuance of common stock in the acquisition. These conditions are summarized in the section in this proxy statement entitled “The Purchase Agreement — Conditions to Closing” beginning on page 39 and are described in detail in the purchase agreement attached to this proxy statement at Annex A. We cannot assure you that each of the conditions will be satisfied.

 

If the conditions are not satisfied or waived in a timely manner and the TerraSphere acquisition is delayed, we may lose some or all of the intended or perceived benefits of the transaction which could cause our stock price to decline and harm our business. If the acquisition is not completed for any reason, our stock price may decline to the extent that the current market price reflects a market assumption that the acquisition will be completed.

 

In addition, we will be required to pay our costs related to the acquisition even if the acquisition is not completed, such as amounts payable to legal and financial advisors and independent accountants, and such costs are significant. All of these costs will be incurred whether or not the transaction is completed.

 

We may be required to issue additional shares of common stock to certain of the TerraSphere members if we issue shares of our common stock at a price less than the price per share at which we valued the shares issued to the TerraSphere members.

 

The TerraSphere members are required to lock-up the shares they will receive in the acquisition for a period of either six or eighteen months. During the applicable lock-up period, we have agreed to provide the TerraSphere members anti-dilution rights. The rights provide that if we issue shares of our common stock for cash consideration in connection with a financing transaction at a price less than $0.756 per share, then the TerraSphere members shall receive additional shares of our common stock based on a weighted average dilution formula. See the section entitled “The TerraSphere Acquisition — Description of the TerraSphere Acquisition — Anti-Dilution Protection” for details about the formula. Messrs. Edward Gildea and William Gildea have not been provided this anti-dilution protection.

 

The market price of our common stock may decline as a result of the issuance of shares in connection with the TerraSphere acquisition.

 

The market price of our common stock may decline as a result of the TerraSphere acquisition for a number of reasons including if:

 

 

As shares of our common stock issued in the TerraSphere acquisition become eligible for resale, the sale of those shares could adversely impact our stock price.

 

All of the shares of our common stock issued to the TerraSphere members in the acquisition will be restricted securities and may not be sold absent registration under the Securities Act or pursuant to Rule 144 or another available exemption from registration. Additionally, TerraSphere members entitled to an aggregate of 8,611,111 shares of common stock are required to lock-up the shares they will receive in the acquisition for a period of six months and TerraSphere members entitled to an aggregate of up to 25,555,556 shares of common stock (assuming all milestones are achieved by TerraSphere) are required to lock-up the shares they will receive in the acquisition for a period of eighteen months.

 

Accordingly, a substantial number of shares of our common stock will become eligible for resale six months after the closing date, with an additional substantial number of shares of our common stock becoming eligible for resale eighteen months after the closing date. Our stock price may suffer a significant decline as a result of the sudden increase in the number of shares sold in the public market or market perception that the increased number of shares available for sale will exceed the demand for our common stock.

 

We may face challenges in integrating our business with TerraSphere’s and, as a result, we may not realize the expected benefits of the proposed acquisition.

 

We will be required to integrate the operations and personnel of both our company and TerraSphere, which will require a significant investment of our management’s time and effort as well as the investment of capital. The successful integration of the two companies will require, among other things, coordination of sales and marketing operations and the integration of TerraSphere’s operations into our organization. The diversion of the attention of our senior management and any difficulties encountered in the process of combining the companies could cause the disruption of, or a loss of momentum in, the activities of the combined business.

 

The inability to successfully integrate the operations and personnel of the two companies, or any significant delay in achieving integration, could have a material adverse effect on the combined business after the completion of the acquisition, and, as a result, on our cash flows, results of operations and financial position.

 

The combined business will continue to require significant capital, and financing may not be available to us on reasonable terms, if at all.

 

Our current operations are not cash flow positive and have required us to raise significant external financing. The combined business will continue to require significant working capital for the manufacturing and marketing activities as well as the expansion and integration of TerraSphere’s operations. Our existing resources will be insufficient to satisfy our liquidity requirements, and we will need to sell additional equity or debt securities to finance these operations. Any sale of additional equity or debt securities may result in additional dilution to our stockholders, and we cannot be certain that we will be able to obtain additional public or private financing in amounts, or on terms, acceptable to us, or at all.

 

The financial projections in this proxy statement are only estimates of future results and there is no assurance that we will achieve the results shown in the financial projections.

 

The financial projections included elsewhere in this proxy statement are only estimates of possible future operating results and not guarantees of future performance. The future operating results of the combined business will be affected by numerous factors, including those discussed in this “Risk Factors” section of this proxy statement. TerraSphere prepared the financial projections in good faith based upon assumptions. Although such assumptions are believed to be reasonable, no assurance can be given regarding the attainability of the projections or the reliability of the assumptions on which they are based. The projections are subject to the uncertainties inherent in any attempt to predict the results of operations for a business, especially where new products are involved. Certain of the assumptions used will inevitably not materialize and unanticipated events will occur. Therefore, the actual results of operations are likely to vary from the projections and such variations may be material and adverse to us. We will conduct our business in a manner different from that set forth in the assumptions as changing circumstances may require.

 

TerraSphere has a limited operating history, and its prospects are difficult to evaluate.

 

TerraSphere is an early stage company and its activities have been limited primarily to developing its technology, and consequently there is limited historical financial information related to operations available upon which you may base your evaluation of TerraSphere’s business and prospects. The revenue and income potential of TerraSphere’s business is unproven. If TerraSphere is unable to develop its business, it will not achieve its goals and could suffer economic loss or collapse, which may have a material negative effect on our financial performance.

 

TerraSphere’s licensees are generally early stage companies and the failure of such licensees to be successful may adversely effect TerraSphere’s future revenues.

 

TerraSphere principally generates revenue from its licensing activities. TerraSphere generates revenues from its licensee partners initially from license fees payable from such partners, followed by such partners purchasing equipment from TerraSphere and finally from royalties from product sales. Many of TerraSphere’s licensees are early stage companies that may be under capitalized. If these licensees are not successful they may not be in a position to pay TerraSphere any future license fees, or to purchase equipment or pay royalties in the future. The failure of TerraSphere’s licensees may have a material adverse effect on TerraSphere’s future revenues.

 

TerraSphere is dependent on a small number of major customers for its revenues.

 

To date, TerraSphere has relied on a few major customers for a majority of its revenues. During the three month period ended March 31, 2010, 100% of TerraSphere’s revenues were from two customers. The loss of any of TerraSphere’s major customers could adversely effect its results of operations.

 

This proxy statement contains forward-looking statements that involve substantial risks and uncertainties. All statements, other than statements of historical facts, included in this proxy statement regarding strategy, future operations, future financial position, future revenues, projected costs, prospects, plans and objectives of management are forward-looking statements. The words “anticipate,” “believe,” “estimate,” “expect,” “intend,” “may,” “plan,” “predict,” “project,” “will,” “would” and similar expressions are intended to identify forward-looking statements, although not all forward-looking statements contain these identifying words.

 

The parties may not actually achieve the plans, intentions or expectations disclosed in the forward-looking statements, and you should not place undue reliance on the forward-looking statements. Actual results or events could differ materially from the plans, intentions and expectations disclosed in the forward-looking statements made by the parties. The parties to this proxy statement have included important factors in the cautionary statements included in this proxy statement, particularly in the “Risk Factors” section, that the parties believe could cause actual results or events to differ materially from the forward-looking statements made by the parties, including, among others:

 

 

 

Further, the forward-looking statements do not reflect the potential impact of any future acquisitions, mergers, dispositions, joint ventures, collaborations, dividends or investments made by the parties.

 

You should read this proxy statement, including all annexes to this proxy statement, completely and with the understanding that actual future results may be materially different from what the parties expect. Neither we nor TerraSphere assume any obligation to update any forward-looking statements.

 

The following tables summarize TerraSphere consolidated financial and other data. The consolidated statements of operations data for the years ended December 31, 2009 and 2008 and the consolidated balance sheet data as of December 31, 2009 and 2008 have been derived from TerraSphere’s audited consolidated financial statements included elsewhere in this proxy statement. The consolidated statement of operations data for the three months ended March 31, 2010 and 2009, and the consolidated balance sheet data as of March 31, 2010, have been derived from TerraSphere’s unaudited consolidated financial statements included elsewhere in this proxy statement. The unaudited consolidated financial statements have been prepared on a basis consistent with TerraSphere’s audited financial statements and include, in the opinion of management, all adjustments that management considers necessary for the fair statement of the financial information set forth in those consolidated financial statements. The following financial data should be read in conjunction with, and is qualified by reference to, TerraSphere’s consolidated financial statements and related notes and schedules included elsewhere in this proxy statement and the information under “TerraSphere’s Management’s Discussion and Analysis of Financial Condition and Results of Operations” below. Historical results are not necessarily indicative of the results to be expected in any future period.

 

 

 

 

The following tables summarize selected unaudited pro forma consolidated condensed financial data. The unaudited pro forma consolidated balance sheet data as of March 31, 2010 gives effect to the acquisition of TerraSphere, on the balance sheet of Converted Organics Inc., as if it had occurred on March 31, 2010, and the unaudited pro forma consolidated statements of operations data for the year ended December 31, 2009 and for the three month period ended March 31, 2010 give effect to the acquisition, on the statements of operations of Converted Organics Inc., as if it had occurred on January 1, 2009. The pro forma financial statements are based upon available information and certain assumptions that we believe are reasonable. The unaudited pro forma consolidated financial statements do not purport to represent what our financial condition or results of operations would actually have been had these transactions in fact occurred as of the dates indicated above or to project our results of operations for the period indicated or for any other period. The following pro forma financial data should be read in conjunction with our Form 8-K dated July 6, 2010 and filed on July 7, 2010, the historical financial statements and the related notes of Converted Organics Inc., which are included in our Annual Report on Form 10-K for the year ended December 31, 2009, the quarterly financial statements and the related notes of Converted Organics Inc., which are included in our Form 8-K as of March 31, 2010, and the TerraSphere Systems, LLC financial statements and the unaudited pro forma consolidated financial statements included elsewhere in this proxy.

 

 

 

 

Our common stock has been listed on the NASDAQ Capital Market under the symbol “COIN” since March 16, 2007. Prior to March 16, 2007, there was no public market for our common stock. The following table sets forth the range of high and low closing prices per share as reported on NASDAQ for the periods indicated.

 

 

 

 

Holders

 

As of July 2, 2010, there were approximately 7,000 beneficial holders of our common stock.

 

Dividends

 

Beginning with the first quarter of 2007, at the end of each calendar quarter, holders of record of our common stock received a 5% common stock dividend until the Woodbridge facility commenced commercial

operations on June 30, 2008. We did not issue fractional shares as a part of the dividend program nor did we issue shares with respect to the calendar quarter in which we commenced commercial operations. We also issued a special 15% common stock dividend, payable on December 1, 2008, for all holders of record of our common stock on November 17, 2008. During 2008, we issued 1,232,552 shares as stock dividends.

 

We have not declared or paid any cash dividends and do not intend to pay any cash dividends in the foreseeable future. We intend to retain any future earnings for use in the operation and expansion of our business. Any future decision to pay cash dividends on common stock will be at the discretion of our Board of Directors and will depend upon our financial condition, results of operation, capital requirements and other factors our Board of Directors may deem relevant.

 

TerraSphere securities are not publicly traded.

 

We are furnishing this proxy statement to our stockholders as part of the solicitation of proxies by our board of directors for use at the special meeting in connection with the proposed acquisition of TerraSphere. This document provides you with the information you need to know to be able to vote or instruct your vote to be cast at the special meeting.

 

Date, Time and Place.  We will hold the special meeting at 9:30 a.m., Eastern time, on August 31, 2010, at Renaissance Boston Waterfront Hotel, 606 Congress Street, Boston, MA 02210.

 

Purpose.  At the special meeting, holders of our common stock will be asked to approve the issuance of at least 34,166,667 shares of our common stock to the members of TerraSphere in exchange for 100% of the units of TerraSphere, subject to upward adjustment based on certain anti-dilution protections described in this proxy statement.

 

The Acquisition Committee of our board of directors unanimously determined that the terms of the TerraSphere acquisition are advisable, fair to, and in the best interests of our stockholders. Upon the Acquisition Committee’s unanimous recommendation, our board of directors then unanimously (with Mr. Gildea abstaining) determined that the terms of the TerraSphere acquisition are advisable, fair to, and in the best interests of, our stockholders.

 

The special meeting has been called only to consider approval of the TerraSphere Proposal and the Adjournment Proposal. Under Delaware law and our bylaws, no other business may be transacted at the special meeting.

 

Record Date; Who Is Entitled to Vote.  The “record date” for the special meeting is July 21, 2010. Record holders of our common stock at the close of business on the record date are entitled to vote or have their votes cast at the special meeting. On the record date, there were 42,359,041 outstanding shares of our common stock. Each share of common stock is entitled to one vote at the special meeting.

 

Vote Required.  Approval of TerraSphere Proposal and the Adjournment Proposal requires the affirmative vote of the holders of a majority of the shares of common stock present in person at the meeting or represented by a proxy and entitled to vote thereon.

 

Abstentions; Broker Non-Votes.  Abstaining from voting or not voting on the proposal, either in person or by proxy or voting instruction, will have the effect of voting against the TerraSphere Proposal and the Adjournment Proposal.

 

A broker non-vote occurs when a broker submits a proxy card with respect to shares held in a fiduciary capacity (typically referred to as being held in “street name”) but declines to vote on a particular matter because the broker has not received voting instructions from the beneficial owner and does not have discretionary authority to vote on the proposal. Under the rules that govern brokers who are voting with respect to shares held in street name, brokers have the discretion to vote such shares on routine matters, but

not on non-routine matters. The matters currently planned to be considered by the stockholders are not routine matters. As a result, brokers can only vote the common stock if they have instructions to do so. Broker non-votes will not be counted in determining whether the proposal to be considered at the meeting is approved.

 

Voting Your Shares.  Each share of common stock that you own in your name entitles you to one vote per proposal.

 

There are three ways for holders of record to have their shares represented and voted at the special meeting:

 

By signing and returning the enclosed proxy card.  If you duly sign and return a proxy card, your “proxy,” whose names are listed on the proxy card, will vote your shares as you instruct on the card. If you sign and return the proxy card, but do not give instructions on how to vote your shares, your shares will be voted as recommended by our board of directors, which is “FOR” approval of the TerraSphere Proposal and the Adjournment Proposal.

 

By telephone or on the internet.  You can submit a proxy to vote your shares by following the telephone or internet voting instructions included with your proxy card. If you do, you should not return the proxy card.

 

You can attend the special meeting and vote in person.  We will give you a ballot when you arrive. However, if your shares are held in the “street name” of your broker, bank or another nominee, you must get a proxy from the broker, bank or other nominee. That is the only way we can be sure that the broker, bank or nominee has not already voted your shares.

 

Questions About Voting.  If you have any questions about how to vote or direct a vote in respect of your shares, you may call Phoenix Advisory Partners, LLC at (866) 351-1539. You may also want to consult your financial and other advisors about the vote.

 

Revoking Your Proxy and Changing Your Vote.  If you give a proxy, you may revoke it or change your voting instructions at any time before it is exercised by:

 

 

If your shares are held in “street name,” consult your broker for instructions on how to revoke your proxy or change your vote.

 

Solicitation Costs.  We will pay for all costs incurred in connection with the solicitation of proxies from our stockholders on behalf of our board of directors, including assembly, printing and mailing of this document, its related attachments, and the proxy card. Our directors, officers and employees may solicit proxies by telephone, email, facsimile and in person, without additional compensation. Upon request, we will reimburse brokerage houses and other custodians, nominees and fiduciaries for their reasonable out-of-pocket expenses for distributing proxy materials. We have agreed to pay Phoenix Advisory Partners, LLC a fee of $7,500, plus expenses, for its services in connection with the special meeting.

 

Approval of the TerraSphere acquisition and the issuance of the shares in connection with the acquisition.

 

At the special meeting and any adjournment or postponement thereof, our stockholders will be asked to consider and vote upon a proposal to approve the issuance of at least 34,166,667 shares of our common stock to the members of TerraSphere in exchange for 100% of the units of TerraSphere, subject to upward adjustment based on certain anti-dilution protections described in this proxy statement.

 

Further information with respect to the issuance of the shares, the TerraSphere acquisition, TerraSphere, the purchase agreement and TerraSphere’s members is contained elsewhere in this proxy statement.

 

The Acquisition Committee unanimously recommends a vote “FOR” the TerraSphere acquisition and the issuance of the shares in connection with the acquisition.

 

Upon the unanimous recommendation of the Acquisition Committee, our board of directors unanimously (with Mr. Gildea abstaining) recommends a vote “FOR” the TerraSphere acquisition and the issuance of the shares in connection with the acquisition.

 

This proposal allows our board of directors to submit a proposal to adjourn the special meeting to a later date or dates, if necessary, to permit further solicitation of proxies in the event there are not sufficient votes at the time of the special meeting to approve the TerraSphere Proposal. If this proposal is not approved by our stockholders, our board of directors may not be able to adjourn the special meeting to a later date in the event there are not sufficient votes at the time of the special meeting to approve the TerraSphere Proposal.

 

After careful consideration of all relevant factors, our board of directors determined that the Adjournment Proposal of the special meeting for the purpose of soliciting additional proxies is in our best interests and in the best interest of our stockholders. The board of directors has approved and declared the Adjournment Proposal advisable and recommends that you vote or give instructions to vote “FOR” the proposal.

 

The following is a description of the material aspects of the TerraSphere acquisition, including the purchase agreement. While we believe that the following description covers the material terms of the acquisition, the description may not contain all of the information that is important to you. We encourage you to carefully read this entire proxy statement, including the purchase agreement attached to this proxy statement at Annex A, for a more complete understanding of the acquisition.

 

General

 

On July 6, 2010, we entered into a purchase agreement with TerraSphere Inc., our wholly owned subsidiary, TerraSphere and the members of TerraSphere. Pursuant to the purchase agreement, the maximum total purchase price for TerraSphere will be $25,830,000, which includes earn-out payments of up to $11,040,000, payable solely in shares of common stock valued at $0.756 per share. We will issue up to 34,166,667 shares of our common stock, subject to upward adjustment based on certain anti-dilution protections, in consideration for 100% of the outstanding units of TerraSphere, which represents 84.6% of our voting shares prior to the issuance and would represent 45.7% of our voting shares following the issuance. Upon completion of the proposed acquisition, TerraSphere would become our wholly-owned subsidiary.

Pursuant to the terms of the purchase agreement, each TerraSphere member was given the option to receive either:

 

 

The earn-out payment is structured such that the TerraSphere members electing to receive Option Two Shares will be paid their respective pro rata portion of our common stock, valued at the Closing Price Per Share, in accordance with the following schedule:

 

(1) on the date of the closing, $12,000,000 of our common stock;

 

(2) $5,000,000 of our common stock, if, and only if, between the date of the purchase agreement and the earlier of the 90th day following the closing or the 180th day following the date of the purchase agreement, for a period of five consecutive trading days, our Market Capitalization (as defined below) exceeds the sum of: (1) our Initial Market Capitalization (as defined below) on the date of the purchase agreement plus (2) the Closing Price Per Share multiplied by the number of shares of our common stock to be issued to TerraSphere members electing Option One Shares, the number of shares of our common stock to be issued pursuant to paragraph 1 above and, if such calculation is being made prior to the closing, the number of shares of our common stock to be issued pursuant to this paragraph 2. Notwithstanding the foregoing, if between the date of the purchase agreement and the earlier of the 90th day following the closing or the 180th day following the date of the purchase agreement, we complete a debt or equity financing with a third party other than project financing, unless such project financing is completed for TerraSphere (referred to as a “Financing”), the cash received from the Financing during such period shall be added to the Market Capitalization. In addition, if between the closing and December 31, 2011, we sell equity of either the TerraSphere or any of TerraSphere’s subsidiaries, any cash received from such equity sales during such period shall be added to the Market Capitalization.

 

(3) $2,000,000 of our common stock, if, and only if, $2,000,000 of TerraSphere’s accounts receivable as of the date of the purchase agreement are received prior to February 28, 2011;

 

(4) $5,000,000 of our common stock, or the Milestone Three Payment, if TerraSphere generates Gross Margin (as defined below) of $6,000,000 from its operations during the period from the date of the purchase agreement through December 31, 2011; provided that, if TerraSphere generates Gross Margin of at least $4,200,000, or the Milestone Three Gross Margin Threshold, from its operations during such period, the TerraSphere members will be entitled to a pro rata portion of the common stock; and

 

(5) $4,000,000 of our common stock, or the Milestone Four Payment, if, and only if, TerraSphere generates Gross Margin of $4,000,000, or the Milestone Four Gross Margin Target, from its operations during any six-month period commencing on the date of the purchase agreement and ending on December 31, 2012; provided that, if TerraSphere achieves the Milestone Three Gross Margin Threshold, but does not achieve the Milestone Three Gross Margin Target, 83.3% of the difference between the Milestone Three Gross Margin Target and the actual Gross Margins achieved pursuant to paragraph 4 above may be added by the TerraSphere members to the Milestone Four Payment and the Milestone Four Gross Margin Target.

For the purposes of the above milestone calculations we agreed upon the following definitions for “Market Capitalization,” “Initial Market Capitalization,” and “Gross Margin”:

 

 

 

Lock-Up of Shares

 

With limited exceptions, the shares to be issued to the TerraSphere members are subject to the following sale restrictions absent our approval:

 

 

The above restrictions will not apply to the following transfers; provided the transfers do not involve a disposition for value and provided that we receive a lock-up agreement for the balance of the lock-up period discussed above from each donee, trustee, distributee, or transferee, as the case may be:

 

 

Anti-Dilution Protection

 

During the applicable lock-up period described above, we have agreed to provide the TerraSphere members anti-dilution rights. The rights provide that if we issue shares of our common stock for cash consideration in connection with a financing transaction at a price less than the Closing Price Per Share, or $0.756 per share, then the TerraSphere members shall receive additional shares of our common stock based on the following formula:

 

New shares to be issued = [(A*B) / [B*(C/D)]] — A

 

 

 

Messrs. Edward Gildea and William Gildea have not been provided this anti-dilution protection.

 

During March 2010, our Chief Financial Officer, Mr. David Allen, contacted Atlas Advisors, LLC, or Atlas, a consulting firm that was assisting us with business development to discuss potential new acquisitions and new lines of business. As part of the discussion, Mr. Allen suggested that Atlas contact Mr. William Gildea and look into whether TerraSphere would be a good acquisition candidate. Atlas met with Mr. William Gildea to discuss TerraSphere and after their meeting Atlas suggested that they believed we should conduct some preliminary analysis as to whether TerraSphere would be a good fit for us.

 

On March 12, 2010, Mr. Edward Gildea introduced the topic of holding discussions with TerraSphere with our board of directors. Due to Mr. Gildea’s relationship with TerraSphere, our board decided to create an Acquisition Committee comprised of the three independent and disinterested directors, Messrs. Robert Cell, John DeVillars and Edward Stoltenberg, to review and evaluate a possible transaction with TerraSphere. Mr. Cell was made chairman of the committee. Mr. Allen was instructed by the Acquisition Committee to prepare an initial presentation for the committee regarding TerraSphere and to begin discussions with Atlas regarding a possible acquisition of TerraSphere.

 

On March 16, 2010, Mr. Allen and Atlas received correspondence from Mr. William Gildea containing TerraSphere’s valuation model with an enterprise value of $83 million.

 

Between March 22-29, 2010, we and TerraSphere discussed possible deal structures, and we continued performing due diligence on TerraSphere.

 

On March 30, 2010, the Acquisition Committee met with Mr. Allen and Atlas to discuss the TerraSphere opportunity. At the meeting, Atlas indicated that based on its review of TerraSphere, it believed a $40 million valuation was fair from a financial point of view for TerraSphere. Between March 30-31, 2010, we continued to receive additional due diligence items from TerraSphere.

 

On April 2, 2010, the Acquisition Committee met again to discuss the transaction. The Acquisition Committee determined that although it believed a TerraSphere acquisition had merit, it do not feel it could proceed at the proposed valuation. The Acquisition Committee instructed Mr. Cell (the chairman of the committee) to continue to review the transaction.

 

Between April 2-9, 2010, we and the Acquisition Committee continued to review a possible TerraSphere acquisition. During this period, we authorized our outside legal counsel, Cozen O’Connor, to begin preparation of the purchase agreement.

 

On April 9, 2010, our board of directors held a previously schedule meeting, at which the board continued to discuss a possible transaction with TerraSphere.

 

On April 13-14, 2010, Mr. Cell met Messrs. William Gildea and Mr. Edward Gildea in Chicago to discuss the TerraSphere transaction and TerraSphere’s valuation assumptions.

 

On April 23, 2010, the Acquisition Committee met to discuss Mr. Cell’s meeting with TerraSphere. After discussion at the meeting, the Acquisition Committee instructed Mr. Allen to contact Mr. William Gildea and

to continue negotiations at an enterprise valuation of $20 million and to attempt to purchase 100% of TerraSphere.

 

On April 23, 2010, Mr. Allen and Mr. William Gildea discussed the revised proposed valuation and deal structure.

 

On April 24, 2010, Mr. William Gildea delivered a counterproposal to Mr. Allen that provided that we acquire 51% of TerraSphere with options to acquire the remaining interest over a one year period. In addition, the proposal required us to commit to certain funding requirements during such period, if needed by TerraSphere. Further, the proposal asked for price protection on the shares of our common stock being issued such that if we issued shares in the future for financings, the TerraSphere members would receive additional shares of common stock.

 

On April 25, 2010, Mr. Allen contacted Mr. William Gildea and proposed that the option for us to acquire the remaining 49% of TerraSphere be exercisable by us on a more expedited basis and that we were not willing to provide price protection for Messrs. William Gildea or Edward Gildea. On April 26, 2010, Mr. Allen met with Mr. William Gildea at our offices to further discuss the parameters of the price protection.

 

On April 27, 2010, Mr. Allen provided TerraSphere with an initial draft of the purchase agreement prepared by Cozen O’Connor. On May 3, 2010, Clark, Balboni & Gildea, or CBG, legal counsel to TerraSphere provided its initial comments to the purchase agreement.

 

On May 4, 2010, TerraSphere notified us that based on certain tax advice received it wished to structure the acquisition as a 100% acquisition of the members interest. After notifying the chairman of the Acquisition Committee, Mr. Allen informed TerraSphere that he believed a 100% acquisition would be in our best interest as well.

 

On May 5, 2010, Cozen O’Connor sent a revised draft of the purchase agreement to CBG with the revisions agreed to on May 4, 2010. On May 7, 2010, CBG provided its comments to the revised purchase agreement.

 

On May 11, 2010, the Acquisition Committee engaged Duff & Phelps, LLC, or Duff & Phelps, to provide the Acquisition Committee with an opinion as to the fairness, from a financial point of view, to us and our stockholders (other than our stockholders who are also TerraSphere members) of the proposed consideration to be paid by us in the TerraSphere transaction.

 

On May 12, 2010, the Acquisition Committee met to discuss the status of the TerraSphere transaction.

 

On May 17, 2010, Cozen O’Connor sent a revised draft of the purchase agreement. On May 18, 2010, CBG provided its comments to the revised purchase agreement. On May 18, 2010, Cozen O’Connor responded to CBG comments on the purchase agreement.

 

On May 20, 2010, Mr. Allen distributed draft TerraSphere financial statements to the Acquisition Committee. On May 21, 2010, the Acquisition Committee met to discuss the transaction with Mr. Allen, Duff & Phelps and Cozen O’Connor. At the meeting, Duff & Phelps informed the Acquisition Committee that it would not be able to arrive at a favorable opinion as to the fairness of the consideration to be paid by the Company in the TerraSphere acquisition. However, Duff & Phelps suggested that the parties consider restructuring the TerraSphere acquisition to include an earn-out feature that would permit the Company to pay a portion of the total consideration contingent upon TerraSphere’s achievement of specified milestones and, as a result, less up-front consideration. Based on Duff & Phelps’ suggestion, the Acquisition Committee instructed Mr. Allen, Mr. Cell and Mr. Allen to prepare alternative transaction structures that required less consideration to be paid at closing with additional consideration to be paid on the achievement of milestones by TerraSphere.

 

On May 30, 2010, Mr. Allen sent a revised transaction structure to Mr. William Gildea, which structure provided for less consideration to be paid at closing with additional consideration to be paid on the achievement of milestones by TerraSphere. On May 31, 2010, Mr. William Gildea informed Mr. Allen that the proposal sent by Mr. Allen on May 30 would not be acceptable to the TerraSphere members.

On June 2, 2010, the Acquisition Committee met to discuss the status of the transaction. Mr. William Gildea attended a portion of the meeting. At the meeting, the Acquisition Committee informed Mr. William Gildea that it believed a structured transaction with less consideration to be paid at closing with additional consideration to be paid on the achievement of milestones by TerraSphere was required due to the early stage nature of TerraSphere’s operations. At the meeting, Mr. William Gildea informed the Acquisition Committee that TerraSphere was willing to continue a dialogue of a structured transaction.

 

Between June 3-8, 2010, Mr. Allen and Mr. William Gildea negotiated a structured payout transaction with less consideration to be paid at closing with additional consideration to be paid on the achievement of milestones by TerraSphere. On June 8, 2010, Mr. William Gildea reported that he had come to an impasse with TerraSphere members and they would not accept a structured transaction.

 

Between June 9-21, 2010, the parties continued to negotiate. During this negotiation, the parties acknowledged that certain of the TerraSphere members, particularly the smaller equity holders, did not want to enter into a structured transaction, but wanted to receive their consideration in full at closing. In order to accommodate these members, the parties agreed to provide the TerraSphere members with two options: (1) an option to receive the $21 million valuation as previously discussed with all consideration being paid at closing; and (2) an option to receive an increased valuation of $28 million with a portion of such consideration being paid only upon the achievement of certain milestones. In negotiating such two-tiered offer, Mr. Allen informed Mr. William Gildea that such offer was contingent on a majority of TerraSphere members accepting the second option in order to keep the up-front consideration as low as possible. On June 21, 2010, the final transaction was agreed to by the parties.

 

On June 28, 2010, the Acquisition Committee met to discuss the transaction. At the meeting, Duff & Phelps made a presentation regarding the fairness to us, from a financial point of view, of the consideration to be paid by us pursuant to the purchase agreement. Duff & Phelps detailed for the Acquisition Committee the analysis performed and made a presentation concerning how it arrived at its opinion. Duff & Phelps discussed at length with the Acquisition Committee the different analyses used to determine whether the consideration to be paid by us was fair from a financial point of view to our stockholders (excluding the TerraSphere members that are our stockholders). After considerable review and discussion, the purchase agreement was unanimously approved and the board of directors (with Mr. Gildea abstaining) unanimously approved the purchase agreement. For a more detailed description of the Duff & Phelps fairness opinion, see the section entitled “The TerraSphere Acquisition — Opinion of the Acquisition Committee’s Financial Advisor Regarding the TerraSphere Acquisition.”

 

On July 6, 2010, the purchase agreement was executed by us, TerraSphere Inc., our wholly owned subsidiary, TerraSphere and the TerraSphere members.

 

On July 19, 2010, we issued Atlas 1,623,333 shares of common stock and a five-year warrant to acquire 1,623,333 shares of common stock with an exercise price of $0.54 per share. The issuance to Atlas was made pursuant to a Business Development Agreement dated January 29, 2010 between us and Atlas. Under the Business Development Agreement, we had agreed to compensate Atlas in the event of any mergers and/or acquisitions that were a result of the services provided by Atlas, such payment to have included both cash payments and equity payments. Pursuant to the agreement reached between us, in exchange for the equity consideration described above, Atlas agreed that no further consideration be paid to it in connection with our proposed acquisition of TerraSphere. The all stock payment was made to Atlas at a share price of $0.54, which was the closing price of our common stock on the date of execution of the TerraSphere purchase agreement.

 

In the course of reaching its unanimous decision to recommend that our board of directors approve the TerraSphere acquisition and the purchase agreement and to recommend that our stockholders vote to approve the acquisition pursuant to the purchase agreement, the Acquisition Committee consulted with our senior

management and with its own independent financial advisors, and considered a number of potentially positive factors in its deliberations, including, but not limited to, the following:

 

 

The Acquisition Committee also considered potential negative factors relating to the TerraSphere acquisition, including:

 

 

After careful consideration of a variety of factors, including the positive and negative factors described under the heading “The TerraSphere Acquisition — Our Reasons for the TerraSphere Acquisition,” on June 28, 2010, the Acquisition Committee unanimously recommended that our board of directors and stockholders approve the acquisition, including the issuance of the shares in connection with the acquisition. In particular, the Acquisition Committee unanimously:

 

 

The Acquisition Committee unanimously recommends that you vote “FOR” the TerraSphere acquisition and the issuance of the shares in connection with the acquisition.

 

Having received the recommendation of the Acquisition Committee, for reasons including those described above under the heading “The TerraSphere Acquisition — Our Reasons for the TerraSphere Acquisition,” on June 28, 2010, based solely on the recommendation of the Acquisition Committee, our board of directors unanimously (with Mr. Gildea abstaining) approved the TerraSphere acquisition and related transactions and

the issuance of the shares in connection with the acquisition, and recommends such matters to our stockholders. In particular, the board of directors unanimously (with Mr. Gildea abstaining):

 

 

Based solely on the recommendation of the Acquisition Committee, our board of directors unanimously (with Mr. Gildea abstaining) recommends that you vote “FOR” the TerraSphere acquisition and the issuance of the shares in connection with the acquisition.

 

The Company engaged Duff & Phelps to serve as the financial advisor to the Acquisition Committee and to provide an opinion as to the fairness, from a financial point of view, to the Company, and, accordingly, to the holders of the Company’s common stock, other than those holders who also own units of TerraSphere, of the consideration to be paid by the Company in the TerraSphere acquisition. Duff & Phelps is a leading independent financial advisory firm, offering a broad range of valuation, investment banking services and consulting services, including fairness and solvency opinions, mergers and acquisitions advisory, mergers and acquisitions due diligence services, financial reporting and tax valuation, fixed asset and real estate consulting, ESOP and ERISA advisory services, legal business solutions, and dispute consulting. Duff & Phelps is regularly engaged in the valuation of businesses and securities and the preparation of fairness opinions in connection with mergers, acquisitions and other strategic transactions.

 

On June 28, 2010, Duff & Phelps rendered its oral opinion to the Acquisition Committee, which opinion was subsequently confirmed in a written opinion dated July 6, 2010, to the effect that, subject to the limitations, exceptions, assumptions and qualifications set forth therein, as of July 6, 2010, the consideration to be paid by the Company in the TerraSphere acquisition was fair, from a financial point of view, to the Company and, accordingly, to the holders of the Company’s common stock, other than those holders who also own units of TerraSphere.

 

The full text of the written opinion of Duff & Phelps, which sets forth, among other things, the assumptions made, procedures followed, matters considered and qualifications and limitations of the review undertaken in rendering the opinion, is attached as Annex B to this proxy statement. This summary of the Duff & Phelps opinion set forth below is qualified in its entirety by reference to the full text of the Duff & Phelps opinion. The Company encourages its stockholders to read the full text of the Duff & Phelps opinion carefully and in its entirety.

 

In connection with its opinion, Duff & Phelps made such reviews, analyses and inquiries as Duff & Phelps deemed necessary and appropriate under the circumstances. Duff & Phelps also took into account its assessment of general economic, market and financial conditions, as well as its experience in securities and business valuation, in general, and with respect to similar transactions, in particular. Duff & Phelps’ procedures, investigations, and financial analysis with respect to the preparation of its opinion included, but were not limited to, the items summarized below:

 

 

 

In performing its analyses and rendering its opinion with respect to the TerraSphere acquisition, Duff & Phelps, with the Company’s consent:

 

 

The Duff & Phelps opinion noted that the management of the Company directed Duff & Phelps to assume that TerraSphere members owning 69% of the units of TerraSphere will elect to receive Option Two

Shares. The Duff & Phelps opinion further noted that the number of shares of the Company’s common stock to be issued in connection with the TerraSphere acquisition is subject to certain potential anti-dilution adjustments after the closing as to which Duff & Phelps expressed no opinion.

 

Duff & Phelps did not make any independent evaluation, appraisal or physical inspection of the Company’s solvency or of any specific assets or liabilities (contingent or otherwise). The Duff & Phelps opinion should not be construed as a valuation opinion, credit rating, solvency opinion, an analysis of the Company’s credit worthiness, as tax advice, or as accounting advice. Duff & Phelps was not requested to, and did not, (a) initiate any discussions with, or solicit any indications of interest from, third parties with respect to the TerraSphere acquisition, the assets, businesses or operations of the Company, or any alternatives to the TerraSphere acquisition, (b) negotiate the terms of the TerraSphere acquisition, and therefore, Duff & Phelps assumed that such terms are the most beneficial terms, from the Company’s perspective, that could, under the circumstances, be negotiated among the parties to the purchase agreement and the TerraSphere acquisition, or (c) advise the Acquisition Committee, the Company’s board of directors or any other party with respect to alternatives to the TerraSphere acquisition. In addition, Duff & Phelps did not express any opinion as to the market price or value of the Company’s common stock after announcement of the TerraSphere acquisition. Duff & Phelps did not make, and assumed no responsibility to make, any representation, or render any opinion, as to any legal matter.

 

In rendering its opinion, Duff & Phelps did not express any opinion with respect to the amount or nature of any compensation to any of the Company’s officers, directors, or employees, or any class of such persons, relative to the consideration to be received by any other party, or with respect to the fairness of any such compensation. Duff & Phelps also expressed no opinion with respect to the impact of the TerraSphere acquisition on any particular holder of the Company’s common stock other than in its capacity as such.

 

The basis and methodology for the Duff & Phelps opinion were designed specifically for the express purposes of the Acquisition Committee and may not translate to any other purposes. The Duff & Phelps opinion:

 

 

Instead, the Duff & Phelps opinion merely states whether the consideration in the TerraSphere acquisition is within a range suggested by certain financial analyses. The decision as to whether to proceed with the TerraSphere acquisition or any related transaction may depend on an assessment of factors unrelated to the financial analysis on which the Duff & Phelps opinion is based. The Duff & Phelps opinion should not be construed as creating any fiduciary duty on the part of Duff & Phelps to any party.

 

Duff & Phelps prepared the opinion effective as of July 6, 2010. The Duff & Phelps opinion is necessarily based upon market, economic, financial and other conditions as they exist and can be evaluated as of July 6, 2010, and Duff & Phelps disclaims any undertaking or obligation to advise any person of any change in any fact or matter affecting the opinion which may come or be brought to the attention of Duff & Phelps after July 6, 2010.

 

The following is a summary of the material analyses performed by Duff & Phelps in connection with rendering its opinion. Duff & Phelps noted that the basis and methodology for its opinion have been designed specifically for this purpose and may not translate to any other purposes. While this summary describes the material information in Duff & Phelps’ opinion, the material analyses performed and the material factors considered by Duff & Phelps, it does not purport to be a comprehensive description of all analyses and factors considered by Duff & Phelps. The Duff & Phelps opinion is based on the comprehensive consideration of the various analyses performed.

In performing its analyses, Duff & Phelps considered general business, economic, industry and market conditions, financial and otherwise, and other matters as they existed on, and could be evaluated as of, the date of its written opinion. No company, transaction or business used in Duff & Phelps’s analyses for comparative purposes is identical to the Company, TerraSphere or the TerraSphere acquisition. Duff & Phelps made judgments and assumptions with regard to industry performance, general business, economic, regulatory, market and financial conditions and other matters, many of which are beyond the control of the Company, such as the impact of competition on the business of the Company, TerraSphere and on the industry generally, industry growth and the absence of any adverse material change in the financial condition and prospects of the Company, TerraSphere or the industry or in the markets generally. Duff & Phelps believes that mathematical analyses (such as determining average and median) are not by themselves meaningful methods of using selected company data and must be considered together with qualities, judgments and informed assumptions to arrive at sound conclusions. While the results of each analysis were taken into account in reaching its overall conclusion with respect to fairness, Duff & Phelps did not make separate or quantifiable judgments regarding individual analyses. The implied reference range values indicated by Duff & Phelps’s analyses are illustrative and not necessarily indicative of actual values or predictive of future results or values, which may be significantly more or less favorable than those suggested by the analyses. In addition, any analyses relating to the value of assets, businesses or securities do not purport to be appraisals or to reflect the prices at which businesses or securities actually may be sold, which may depend on a variety of factors, many of which are beyond the control of the Company and Duff & Phelps. Much of the information used in, and accordingly the results of, Duff & Phelps’s analyses are inherently subject to substantial uncertainty.

 

In arriving at its opinion, Duff & Phelps did not attribute any particular weight to any particular analysis or factor considered by it, but rather made qualitative judgments as to the significance and relevance of each analysis and factor. Several analytical methodologies were employed by Duff & Phelps in its analyses, and no one single method of analysis should be regarded as critical to the overall conclusion reached by Duff & Phelps. Each analytical technique has inherent strengths and weaknesses, and the nature of the available information may further affect the value of particular techniques. Accordingly, Duff & Phelps believes that its analyses must be considered as a whole and that selecting portions of its analyses and of the factors considered by it, without considering all analyses and factors in their entirety, could create a misleading or incomplete view of the evaluation process underlying its opinion. The conclusion reached by Duff & Phelps, therefore, is based on the application of Duff & Phelps’ own experience and judgment to all analyses and factors considered by Duff & Phelps, taken as a whole.

 

The Duff & Phelps opinion was provided to the Acquisition Committee in connection with its consideration of the TerraSphere acquisition and was only one of many factors considered by the Acquisition Committee in evaluating the TerraSphere acquisition. Neither the Duff & Phelps opinion nor its analyses were determinative of the consideration to be paid by the Company in the TerraSphere acquisition or of the views of the Acquisition Committee or the management of the Company with respect to the TerraSphere acquisition.

 

The following is a summary of the material financial analyses prepared in connection with the Duff & Phelps opinion to the Acquisition Committee. The order of the analyses does not represent relative importance or weight given to those analyses by Duff & Phelps. The fact that any specific analysis has been referred to in the summary below is not meant to indicate that such analysis was given greater weight than any other analysis. The financial analyses summarized below include information presented in tabular format. In order to fully understand the financial analyses used by Duff & Phelps, the tables must be read together with the text of each summary. The tables alone do not constitute a complete description of the financial analyses. Rather, the analyses listed in the tables and described below must be considered as a whole; considering any portion of such analyses and of the factors considered, without considering all analyses and factors, could create a misleading or incomplete view of the process underlying Duff & Phelps’ opinion.

 

Transaction Overview

 

The Company directed Duff & Phelps to assume that holders of 69% of TerraSphere’s outstanding units would elect to receive Option Two Shares, resulting in 57.3% of the aggregate consideration to be paid by the Company in connection with the TerraSphere acquisition being paid at the closing of the TerraSphere

acquisition and the balance being contingent and paid upon TerraSphere’s achievement of the four milestones contemplated by the purchase agreement. Based on the average closing price per share of the Company’s common stock during the 15-day period ending July 2, 2010, the aggregate implied value of the shares to be delivered upon closing of the TerraSphere acquisition was approximately $14.8 million. To estimate the range of potential values of the aggregate consideration to be paid in connection with the TerraSphere acquisition, including the shares paid at closing and pursuant to the milestone payments, Duff & Phelps applied probability percentages of 70%, 85% and 100% to the achievement of such milestones and the value of the resulting milestone payments, which, when added to the implied value of the shares to be paid at closing of $14.8 million, resulted in implied aggregate consideration values of approximately $22.5 million, $24.2 million and $25.8 million, respectively, or a range of implied aggregate consideration values of approximately $22.5 million to $25.8 million.

 

Company Analysis

 

Duff & Phelps reviewed the share price trading history for the Company’s common stock for the period commencing March 16, 2007 and ending July 2, 2010. Duff & Phelps also reviewed the volume weighted average price of the Company’s common stock for the 30-day, 60-day, 90-day, 6-month and 1-year periods ending July 2, 2010. This analysis showed the following:

 

 

In addition, based on approximately 40.5 million shares of the Company’s common stock outstanding as of July 2, 2010, the closing price of the Company’s common stock on July 2, 2010 and the 15-day average of the closing prices of the Company’s common stock, Duff & Phelps derived a range of equity values for the Company of approximately $24.3 million to $30.6 million. Duff & Phelps then added approximately $18.5 million, the book value of the net debt of the Company as of March 31, 2010, to derive a range of enterprise values for the Company of approximately $43 million to $49 million.

 

TerraSphere Analysis

 

PharmaSphere Analysis

 

Based on information provided by TerraSphere management, Duff & Phelps noted that in February 2010, a private equity group offered to purchase 52.9% of newly issued units of PharmaSphere for an aggregate purchase price of $6.7 million, and that such offer remained outstanding as of July 6, 2010. After applying an assumed 20% illiquidity discount, this aggregate offer price implied an equity value for PharmaSphere of approximately $4.8 million.

 

Discounted Cash Flow Analyses

 

 

Duff & Phelps performed a discounted cash flow analysis to estimate the present value of the free cash flows of TerraSphere (excluding cash flows from PharmaSphere) through the calendar year ending December 31, 2029 (which takes into consideration the life of the existing patents) based on TerraSphere management’s financial projections and estimates as to the minimum milestones needed to achieve full earnout payments under the purchase agreement, and discount rates ranging from 30.0% to 50.0%. This analysis indicated a range of enterprise values for TerraSphere of approximately $15.6 million to $30.7 million, compared to a range of implied aggregate transaction consideration values of approximately $22.5 million to $25.8 million.

 

Duff & Phelps also performed a discounted cash flow analysis to estimate the present value of the free cash flows of existing licensees of TerraSphere through the calendar year ending December 31, 2029 based on TerraSphere management’s financial projections and discount rates ranging from 25.0% to 35.0%. To estimate the value of the existing licensees of TerraSphere products, Duff & Phelps projected the revenues from the existing licensees through 2029 (which takes into consideration the life of the existing patents) and assumed TerraSphere would not obtain any new licensees. This analysis indicated a range of enterprise values for TerraSphere of approximately $9.2 million to $12.8 million.

 

Using the ranges of enterprise values for TerraSphere of approximately $15.6 million to $30.7 million calculated using the discounted cash flow analysis summarized above, Duff & Phelps then adjusted for cash and debt and added the implied equity value of $4.8 million for PharmaSphere and derived a range of implied equity values for TerraSphere of approximately $20.3 million to $35.4 million, compared to a range of implied aggregate transaction consideration values of approximately $22.5 million to $25.8 million.

 

Contribution Analysis

 

Duff & Phelps analyzed the expected contribution percentages of each of the Company and TerraSphere to the post-transaction combined equity value as implied by the estimated equity value ranges for TerraSphere calculated as summarized above, as compared to the Company’s market capitalization, excluding any possible synergies that the combined company may realize following the consummation of the TerraSphere acquisition. Duff & Phelps noted that the TerraSphere acquisition could result in holders of the Company’s common stock owning approximately 67.4% of the combined company if no milestones payments are paid by the Company and approximately 54.2% if all the milestone payments are paid by the Company, compared to the relative contribution by the Company to the combined company of earnings before interest, taxes, depreciation and amortization, or “EBITDA”, excluding EBITDA from PharmaSphere, based upon forecasts prepared by Company management and TerraSphere management, of 25.6% in 2011, 36.7% in 2012 and 45.7% in 2013.

 

Other Items

 

The Duff & Phelps engagement letter and amendment with the Company, dated May 11, 2010, and June 23, 2010, respectively, provided that, for its services, Duff & Phelps is entitled to receive from the Company a fee of $250,000, which was due and payable as follows: $100,000 non-refundable retainer payable upon execution of the engagement letter, and $150,000 payable upon Duff & Phelps informing the Acquisition Committee that Duff & Phelps is prepared to deliver its opinion. The engagement letter also provided that Duff & Phelps would be paid additional fees at its standard hourly rates for any time incurred should Duff & Phelps be called upon to support its findings subsequent to the delivery of the opinion. In addition, the Company agreed to reimburse Duff & Phelps for its reasonable out-of-pocket expenses and to indemnify Duff & Phelps and certain related persons against liabilities arising out of Duff & Phelps’ service as a financial advisor to the Acquisition Committee. Other than this engagement, during the two years preceding the date of its opinion, Duff & Phelps performed financial advisory services to a subsidiary of TerraSphere for which Duff & Phelps received customary fees and indemnification. Other than such services, during the two years preceding the date of Duff & Phelps’ opinion, Duff & Phelps did not have any material relationship with any party to the TerraSphere acquisition for which compensation was received or is intended to be received, nor is any such material relationship or related compensation mutually understood to be contemplated.

 

When you consider the unanimous (with Mr. Gildea abstaining) recommendation of our board of directors in favor of the TerraSphere acquisition you should note that our Chairman and Chief Executive Officer, Mr. Edward Gildea, has an interest in 8.75% of the units of TerraSphere. In addition, relatives of Mr. Gildea hold an additional 30.75% of the units of TerraSphere. If the acquisition is completed, and assuming all milestones are achieved, Mr. Gildea would receive 3,240,741 shares of our common stock in exchange for his

TerraSphere units and his relatives would receive an additional 10,775,463 of our common stock in exchange for their TerraSphere units.

 

Furthermore, Mark C. Gildea, the brother of Edward J. Gildea, is the President and Chief Executive Officer of TerraSphere, and William A. Gildea, also the brother of Edward J. Gildea, is an independent contractor of TerraSphere.

 

Effective April 2, 2010, Mark C. Gildea entered into an employment agreement with TerraSphere, pursuant to which TerraSphere employed Mr. Gildea as its President and Chief Executive Officer for a term of five years. Mr. Gildea’s annual salary is $180,000, subject to discretionary annual increases at the discretion of the board of directors, and Mr. Gildea is entitled to an annual bonus of at least $20,000. In the event Mr. Gildea is terminated without cause and in connection with a change of control of TerraSphere, he shall be entitled to severance, payable in a single lump sum, equal to thirty-six months base salary and all options or equity interests previously granted shall immediately vest. Our acquisition of TerraSphere constitutes a change of control as such term is defined in Mr. Gildea’s employment agreement, such that if Mr. Gildea is terminated in connection with the change of control transaction, he shall be entitled to the foregoing severance benefits.

 

Effective April 2, 2010, William A. Gildea entered into an engagement agreement with TerraSphere, pursuant to which TerraSphere engaged Mr. Gildea as an independent contractor for a term of three years. Mr. Gildea’s compensation for such independent contracting services is a flat monthly fee of $16,667 per month, and Mr. Gildea will be entitled to an annual bonus equal to that which is paid to senior management employees if TerraSphere develops a companywide bonus plan. In the event Mr. Gildea’s engagement is terminated without cause during the first two years of the engagement, he will be entitled to receive one-half of such annual compensation (or $100,000) subject to his execution of a non-competition agreement and release.

 

Because of Mr. Edward Gildea’s relationship with TerraSphere, our board of directors formed the Acquisition Committee to evaluate and, if appropriate, negotiate the proposed TerraSphere acquisition. The Acquisition Committee obtained valuation advice and a fairness opinion from an independent investment bank, and negotiated the terms of the TerraSphere acquisition with the TerraSphere management. Mr. Gildea did not participate in the negotiations.

 

No gain or loss will be recognized by us or by holders of shares of our common stock as a result of the TerraSphere acquisition.

 

We are not aware of any governmental or regulatory approval required for completion of the TerraSphere acquisition, other than compliance with applicable corporate laws of Delaware, compliance with securities laws and filing with the NASDAQ Stock Market, with respect to the shares of our common stock to be issued to the TerraSphere stockholders pursuant to the purchase agreement. If any other governmental approvals or actions are required, we intend to try to obtain them. We cannot assure you, however, that we will be able to obtain any such approvals or actions.

 

The discussion in this proxy statement of the TerraSphere acquisition and the principal terms of the purchase agreement described below are qualified in their entirety by reference to the copy of the purchase agreement attached as Annex A hereto, and incorporated herein by reference. The following description summarizes the material provisions of the purchase agreement, which agreement we urge you to read carefully because it is the principal legal document that governs the TerraSphere acquisition.

 

The representations and warranties described below and included in the purchase agreement were made by us and TerraSphere as of specific dates. The assertions embodied in these representations and warranties

may be subject to important qualifications and limitations agreed to by us and TerraSphere in connection with negotiating the purchase agreement. The representations and warranties may also be subject to a contractual standard of materiality that may be different from what may be viewed as material to stockholders, or may have been used for the purpose of allocating risk among us and TerraSphere, rather than establishing matters as facts. The purchase agreement is described in this proxy statement and included as Annex A only to provide you with information regarding its terms and conditions at the time it was entered into by the parties. Accordingly, you should read the representations and warranties in the purchase agreement not in isolation but rather in conjunction with the other information contained in this document.

 

Pursuant to the purchase agreement, we agreed to acquire 100% of the units of TerraSphere. We will make the acquisition by issuing up to 34,166,667 shares of our common stock to the TerraSphere members, subject to upward adjustment based on certain anti-dilution protections, in exchange for 100% of the units of TerraSphere. Upon completion of the proposed acquisition, TerraSphere would become our wholly-owned subsidiary. For a more detailed description of the share issuance to be made pursuant to the purchase agreement, please see the section “The TerraSphere Acquisition — Description of the TerraSphere Acquisition — General.”

 

With limited exceptions, the shares to be issued to the TerraSphere members are subject to the following sale restrictions absent our approval:

 

 

During the applicable lock-up period described above, we have agreed to provide the TerraSphere members anti-dilution rights. The rights provide that if we issue shares of our common stock for cash consideration in connection with a financing transaction at a price less than $0.756 per share, then the TerraSphere members shall receive additional shares of our common stock based on a weighted average dilution formula. See the section entitled “The TerraSphere Acquisition — Description of the TerraSphere Acquisition — Anti-Dilution Protection” for details about the formula. Messrs. Edward Gildea and William Gildea have not been provided this anti-dilution protection.

 

In the purchase agreement, TerraSphere’s controlling members, consisting of Messrs. William Gildea, Edward Gildea and Nick Brusatore make certain representations and warranties (subject to certain exceptions) relating to, among other things:

 

 

 

In the purchase agreement, we make certain representations and warranties (subject to certain exceptions) relating to, among other things:

 

 

Until the closing of the acquisition, TerraSphere agreed, among other items:

 

 

In addition, until the closing of the acquisition, TerraSphere agreed not to, without our prior written consent, among other things:

 

 

 

The purchase agreement also contains restrictive covenants of the parties, including covenants providing for:

 

 

Converted Organics Closing Conditions

 

Our obligation to consummate the purchase agreement is conditioned upon certain closing conditions, including:

 

 

TerraSphere Closing Conditions

 

The obligation of TerraSphere and its members to consummate the purchase agreement is conditioned upon certain closing conditions, including:

 

 

The parties may waive any inaccuracies in the representations and warranties made to such party contained in the purchase agreement and waive compliance with any agreements or conditions for the benefit of itself or such party contained in the purchase agreement. We cannot assure you that all of the conditions will be satisfied or waived.

 

Indemnification by the Controlling Members of TerraSphere

 

The controlling members of TerraSphere, which consist of Messrs. William Gildea, Edward Gildea and Nick Brusatore, have agreed, on a joint and several basis, to indemnify us from any damages arising from: (a) any misrepresentation, breach of representation or warranty or any non-fulfillment of any covenant or agreement made by or to be performed by TerraSphere or any controlling members; or (b) any and all actions, suits, proceedings, demands, assessments, judgments, reasonable attorneys’ fees, costs and expenses incident to any of the foregoing.

 

With certain exceptions, the controlling members will have no obligation to indemnify us with respect to misrepresentations or breaches of warranties until the aggregate amount of all damages incurred or suffered exceeds $100,000 in the aggregate, in which event we will be entitled to indemnification for the amount of damages arising under such indemnification in excess of such amount.

 

With certain exceptions, the maximum aggregate amount of damages subject to indemnification claims by us is the total purchase price received by the controlling members (and any assignees of such members’ interest), or $13,580,000 worth of our common stock valued at $0.756 per share, assuming all milestones are achieved. As all the controlling members selected the Option Two Shares, if the milestones are not achieved by TerraSphere, such members will receive fewer shares, which will reduce their indemnification obligations.

 

Any claims for damages with respect to breaches of representations and warranties by the controlling member shall be satisfied by either cash, or to the extent the members hold sufficient shares of our common stock, such member may return of the appropriate number of shares of our common stock to us, with the shares to be valued at the average closing price of the our common stock for the five days prior to the date when the subject claim accrued.

 

Indemnification by Converted Organics

 

We have agreed to indemnify the TerraSphere members from any damages arising from: (a) any misrepresentation, breach of representation or warranty or any non-fulfillment of any covenant or agreement made by or to be performed by the buyer of TerraSphere; or (b) any and all actions, suits, proceedings, demands, assessments, judgments, reasonable attorneys’ fees, costs and expenses incident to any of the foregoing.

 

With certain exceptions, we will have no obligation to indemnify the TerraSphere members with respect to misrepresentations or breaches of warranties until the aggregate amount of all damages incurred or suffered exceeds $100,000 in the aggregate, in which event the TerraSphere members will be entitled to indemnification for the amount of damages arising under such indemnification in excess of such amount.

 

With certain exceptions, the maximum aggregate amount of damages subject to indemnification claims by the TerraSphere members is the total purchase price received by the controlling members as set forth above.

 

The purchase agreement may be terminated and/or abandoned at any time prior to the closing by:

 

 

 

In the event of termination and abandonment by either party, all further obligations of the parties shall terminate, no party shall have any right against the other party, and each party shall bear its own costs and expenses.

 

The purchase agreement may be amended by the parties thereto at any time by execution of an instrument in writing signed by us and the controlling members. At any time prior to the closing, the parties, to the extent allowed by applicable law, may extend the time for the performance of the obligations under the purchase agreement, waive any inaccuracies in representations and warranties made to the other party and waive compliance with any of the agreements or conditions for the benefit of the other party.

 

To the extent a waiver by any party renders the statements in this proxy statement materially misleading, we intend to supplement this proxy statement and resolicit proxies from our stockholders to the extent required by law.

 

General

 

TerraSphere Systems, LLC, or TerraSphere, designs and builds highly efficient systems that grow an abundance of crops in compact, safe, pollutant-free facilities. TerraSphere’s technology is fully contained, which means crops can be grown year-round in any location using precise combinations of light, water, and nutrients to maximize production. TerraSphere’s technology is patented in the United States, with several international patents pending. TerraSphere’s wholly owned subsidiary, PharmaSphere, LLC, or PharmaSphere, is a pre-revenue company that will use the TerraSphere technology to grow plants and herbs that express high value compounds that are used as pharmaceutical ingredients.

 

TerraSphere’s units consist of vertically stacked modules housing rows of plants that are placed perpendicular to an interior light source (the “TerraSphere System” or “Technology”). The modules produce an abundance of crops with strong, compact, multi-directional growth. TerraSphere believes the Technology’s greatest advantage over traditional growth methods is its ability to generate higher yields per square foot of land than traditional growing methods. The contained nature of the TerraSphere System also provides many benefits related to year-round production, cost control, food safety and environmental concerns.

 

In 2008, TerraSphere completed its system design and testing, built a demonstration plant in Michigan under a joint venture agreement, and sold its first license for the rights to utilize the technology in the Province of British Columbia. In 2009, TerraSphere began construction of the foregoing plant in Vancouver.

 

TerraSphere has eight full-time employees. TerraSphere operates out of its research and manufacturing facility in Vancouver and its corporate office in Boston, Massachusetts. TerraSphere began generating revenue in 2007.

 

TerraSphere believes its Technology has several key benefits over competing growth methods. These include:

 

 

 

TerraSphere uses its Technology to generate revenue in two ways:

 

 

Overview of the Technology

 

TerraSphere believes its Technology has a competitive advantage over traditional growth methods, the most important of which is its ability to generate significantly larger yields per square foot of floor space. The Technology consists of collapsible trays that contain rows of plants placed perpendicular to a light source. The TerraSphere Technology has adjustable lighting. As the plants mature, the lights can be adjusted for maximum growth. The high pressure watering tanks and lines will ensure even distribution of water and nutrition to vegetation. The result is an abundance of plants with strong, compact, even growth. The Technology can be used to grow numerous different types of crops, from lettuce to tree seedlings to rare medicinal herbs. The following is a brief overview of how the Technology works and its advantages over other growth technologies.

 

Flat Trays

 

The trays that make up the TerraSphere System allow for efficient loading and unloading of the crops. The plastic trays rest on an aluminum frame which then clamp on four galvanized chains. These trays can be adjusted in height to accommodate any type of plant. The fertilizer is fed at one end and drained at the other by gravity, ensuring that each plant receives the proper nutrition for maximum growth. A UV Protected food grade ABS material is used for its light weight and cost savings.

 

The flat trays in which the crops are grown are a reusable plastic injection molded unit which allows the addition of water directly into each growing unit. The mechanical medium can be reused for several years and does not require the use of non-biodegradable rock wool, which is used by most traditional hydroponic facilities and is known to pose environmental challenges.

 

Collapsible Flat Tray

 

Each steel frame structure can hold many different configurations depending on the crop and the ceiling height of the building.

 

The taller the ceiling the more tiers that can be added. The trays extend and collapse by using a winch pulley system. When the plants are being loaded the trays are completely collapsed. When the top tray is filled with plants the winch moves up. The next tray is filled and the cycle continues until all the trays are filled. Unloading is the opposite. The collapsible trays are made of stainless steel, anodized aluminum, and various other common materials.

 

Facilities

 

Depending on the ceiling height of the building and the square footage of the space, the TerraSphere System has the ability to be scaled accordingly. A typical facility is 75% growing space and 25% office and

storage space. TerraSphere can design any size facility, depending on what a customer wants to grow and in what volumes.

 

PharmaSphere

 

Overview

 

PharmaSphere is a pre-revenue wholly owned subsidiary of TerraSphere. PharmaSphere’s business plan is to utilize the TerraSphere System for the production of high value biocompounds sourced from plants and used as active pharmaceutical ingredients, and for the production of transgenic plants (genetically engineered plants) for the biotechnology market.

 

PharmaSphere will install TerraSphere Systems in retrofitted warehouses, and extract and purify the compounds using environmentally friendly technologies. Additional environmental benefits include less water and fertilizer use by metered dispensing, less waste water or fertilizer discharge due to plant uptake, no chemical pesticides, no fuel and oil use by agricultural machinery, and no transportation of bulk plant materials to distant processing facilities.

 

PharmaSphere will cultivate “native” or “wild” plants that naturally express biocompounds, called “natural products or extracts.” Depending on obtaining partners and financing, PharmaSphere would cultivate “transgenic” plants, namely plants that have been genetically altered by the insertion of foreign DNA encoding the expression of a specific compound.

 

The model for PharmaSphere’s natural product business is to cultivate plants expressing biocompounds with well-established pharmaceutical, nutraceutical and cosmeceutical uses, and extract and purify the compounds for sale to customers for use in their products as “active ingredients” or chemical synthesis “starting material.” Unless there are a number of potential buyers for the compound in question, PharmaSphere will not grow the plant source without a partner or a long-term purchase agreement.

 

A major concern of sellers of natural product drugs, nutraceuticals and cosmeceuticals is the unreliable supply of top quality active ingredients because the cultivation of source plants in the field is erratic and the quality of extracts is uneven. With the TerraSphere system and state-of-the art extraction, purification and quality control technologies, PharmaSphere believes it can provide its customers a reliable supply of consistently high quality plant compounds.

 

By isolating the plants from the environment, the TerraSphere system allows each plant species’ growth parameters to be optimized for maximum compound expression by the precise control of light, temperature, water, carbon dioxide and fertilizer. The benefits are:

 

 

PharmaSphere’s transgenic plant business model is to form development partnerships with pharmaceutical and biotechnology companies having product pipelines that include recombinant biopharmaceutical compounds (antibodies and other therapeutic proteins and vaccines). A typical partnership would first determine the feasibility of efficient expression of the compound of interest in the TerraSphere system, and then scale up production to the desired quantities. PharmaSphere would receive upfront and milestone payments and royalties. PharmaSphere does not intend to cultivate transgenic plants without partners, and there is no assurance that PharmaSphere will be able to find such partners.

PharmaSphere Plant Growth System

 

PharmaSphere believes the TerraSphere system is ideal for growing both native plants and transgenic plants as it permits full environmental containment and controlled growth conditions. The expression of natural compounds from native plants grown in the system is greatly enhanced by the absence of field-growth hazards such as weather, soil conditions, pests and disease.

 

A typical PharmaSphere commercial-scale biopharmaceutical production facility will contain hundreds of structures and extraction and purification areas in one single-story industrial building, and will comply with U.S. Food and Drug Administration (“FDA”) current Good Manufacturing Practices (cGMPs). The planting, harvest and storage areas of the building will provide containment at the BL-2 level for transgenic plant cultivation. USDA licensure for cultivating transgenic plants is not necessary, as transgenic plants growing in the trays will not be considered to be growing in the field, or in a greenhouse with inadequate containment. USDA licensure is not required in any event to grow native plants expressing natural compounds. A facility for cultivating native plants to produce natural products will comply with BL-2 to provide a flexible facility that could also be used to grow transgenic plants.

 

Other Applications

 

TerraSphere believes another potential application is the growth of plants that naturally express various biocompounds and substances that are used as nutrition supplements, cosmetic ingredients or herbal remedies. They are not regulated as “drugs” if health claims do not accompany their marketing. PharmaSphere believes it can economically grow large amounts of these plants using the TerraSphere System and can increase the expressed quantities of the biocompounds by optimizing and controlling growth conditions.

 

Market Demand

 

TerraSphere

 

The U.S. organic produce market has grown significantly in recent years. TerraSphere believes that a decrease in farmland near urban areas coupled with the increase in demand for organic foods creates a compelling opportunity to grow whole, organic foods locally for urban consumers (businesses, food markets, restaurants). Organic and natural foods are traditionally grown on smaller farms across the country and in hydroponic facilities on large farms in the western United States. The long distance between western suppliers and east coast markets increases both the economic cost and the environmental impacts of the produce. Seasonal constraints make it impossible to stock locally-grown, organic produce in northern cities year round. TerraSphere offers the ability to deliver fresh, local produce to whole foods markets, restaurants and other buyers, without seasonal interruption. This is true not only in the United States, but in cities throughout the world.

 

Food security is also a growing concern, which TerraSphere believes creates demand for the Technology since it grows produce in contained, secure facilities that are not dependent on environmental conditions.

 

PharmaSphere

 

Natural Biocompounds (therapeutic biocompounds native to a plant species): PharmaSphere intends to cultivate plants expressing natural biocompounds, and to extract, purify and market these compounds. As determined by customer requirements, either crude extracts or purified compounds will be sold as “active pharmaceutical ingredients” or as “starting material” for chemical synthesis. Potential customers are pharmaceutical companies with generic products, as well as patented products, and those biotechnology companies that add value to generic compounds with proprietary formulations for safer and more effective delivery. Unless the biocompound in question has a number of potential buyers, PharmaSphere will not grow the plant source without a partner or a long-term supply agreement. PharmaSphere expects revenues from this market will not be achieved until approximately 12 months after completion of its first facility.

 

Transgenic or Recombinant Biopharmaceuticals (therapeutic biocompounds from foreign DNA inserted in a plant host): In this category, working with partners, PharmaSphere would produce high value recombinant

antibodies and other therapeutic proteins and subunit vaccines. PharmaSphere believes plants offer the prospect of inexpensive biopharmaceutical production without sacrificing product quality or safety. PharmaSphere believes the use of transgenic plants for pharmaceutical production has important safety and economic advantages, including the absence of animal contaminants such as viruses which are toxic to humans, less complex purification requirements, quicker conduct of feasibility studies and more rapid production implementation and scale-up due to shorter periods of time required for plant transformation and cultivation of the needed quantities of transformed plants. Transforming animals and building up transgenic herds require substantially more time.

 

Competitive Advantages

 

TerraSphere competes with both traditional field agriculture and greenhouses. TerraSphere believes its Technology has several advantages over both types of competitors, which include:

 

 

Government Regulation

 

In order to assure pharmaceutical product safety, quality and consistency, PharmaSphere is required to produce “active pharmaceutical ingredients” and chemical synthesis “starting material” in compliance with “current Good Manufacturing Practices” (or cGMPs) promulgated by the FDA. If PharmaSphere were to produce finished, end-use drugs, it would also be required to comply with cGMPs. In general, cGMPs entail process and equipment validation, maintenance of rigorous quality control procedures and extensive documentation. PharmaSphere facilities will be inspected by the FDA, including those located abroad that manufacture product to be sold in the United States. Similar regulation exists in Canada and other countries.

PharmaSphere’s plant cultivation system, in addition to its extraction and purification operations, must comply with cGMPs. If PharmaSphere intends to cultivate, extract and purify controlled substances, it will be required to register with the U.S. Drug Enforcement Administration (“DEA”) as a controlled substance bulk manufacturer. Registration entails the DEA’s inspecting and testing PharmaSphere’s physical security systems, verifying its compliance with state and local laws, and reviewing its background and history.

 

The field cultivation, interstate movement and importation of transgenic plants in the United States is regulated by the U.S. Department of Agriculture (“USDA”) under the Plant Protection Act. A separate permit is required for each activity, the most important and complex of which is the field-growing permit. Biopharmaceuticals, which are regulated by the FDA, are also subject to the USDA regulatory framework if produced by transgenic plants.

 

If PharmaSphere cultivates transgenic plants within the TerraSphere System, a field-growing permit from the USDA under the Plant Protection Act would not be necessary. If PharmaSphere were to transport transgenic plant materials such as seeds, seedlings or leaves across state lines or import them from abroad, it would be required to obtain a movement or importation permit from the USDA. PharmaSphere anticipates engaging in such transportation and importation from time to time. A development partner might require harvested transgenic plants or plant materials to be transported across state lines to its own facilities for processing. If so, PharmaSphere will be required to obtain a USDA movement permit.

 

PharmaSphere will submit to the FDA and maintain a “Drug Master File” for each native plant compound it sells to customers in the United States as an “active pharmaceutical ingredient” or chemical synthesis “starting material.” If other countries where it solicits customers have similar systems, it will make filings as required.

 

Should PharmaSphere sell products as finished, end-use drugs in the United States, it will be required to obtain premarket approval for each such drug product and its intended use from the FDA under the Federal Food, Drug, and Cosmetic Act. In general, if a drug is novel, it cannot be sold unless covered by an approved New Drug Application (“NDA”) after the completion of lengthy and expensive three-phase clinical trials. Similar regulation exists in foreign countries. PharmaSphere does not intend to sell finished drugs requiring NDA approval without a partner to fund the clinical trials and regulatory submissions.

 

A nutraceutical, cosmeceutical, or herbal product if marketed without specific health claims and labeling is not a “drug,” but may be a “dietary supplement,” a “food,” or a “cosmetic” as defined and regulated under the FDA laws. PharmaSphere could produce such products on its own or with partners.

 

PharmaSphere’s facilities in the United States will be subject to federal, state and local laws and regulations regarding the use, storage, handling and disposal of hazardous materials, including materials routinely used in life science research laboratories and for bioprocessing activities such as compound extraction and purification. Foreign countries generally have comparable laws and regulations.

 

The following discussion should be read in conjunction with the consolidated year-end and unaudited interim financial statements and related notes to the consolidated year-end and interim unaudited financial statements included elsewhere in this report. This discussion contains forward-looking statements that relate to future events or TerraSphere’s future financial performance. These statements involve known and unknown risks, uncertainties and other factors that may cause TerraSphere’s actual results, levels of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievement expressed or implied by these forward-looking statements. These forward-looking statements are based largely on TerraSphere’s current expectations and are subject to a number of uncertainties and risks. Actual results could differ materially from these forward-looking statements.

 

TerraSphere Overview

 

TerraSphere Systems LLC, located in Boston, Massachusetts designs and builds highly efficient systems for growing organic fruits and vegetables in a controlled, indoor environment. TerraSphere partners with private businesses and public institutions to create solutions for food production challenges. TerraSphere derives its revenues from licensing fees and royalties, the sale of equipment and expects future revenue from operating facilities using the TerraSphere System. The TerraSphere System uses technology to operate automated, software driven plant growth systems that can be used to grow a variety of crops, from lettuce to tree seedlings to rare medicinal herbs.

 

PharmaSphere, LLC, located in Boston, Massachusetts, is a wholly-owned subsidiary of TerraSphere. PharmaSphere’s business plan is to utilize the TerraSphere System for the production of high value biocompounds sourced from plants and used as active pharmaceutical ingredients and for the production of transgenic plants (genetically engineered plants) for the biotechnology market. PharmaSphere has a wholly-owned subsidiary PharmaSphere Worcester, LLC, which was formed to build a facility in Worcester, Massachusetts utilizing PharmaSphere’s business plan. The building of the facility has not commenced. PharmaSphere has no revenue to date.

 

TerraSphere Systems Canada, Inc., or TerraSphere Canada, located in Vancouver, British Columbia, operates the research and manufacturing facility for TerraSphere and is 85% owned by TerraSphere.

 

Future Development

 

TerraSphere plans on entering into partnerships to own and operate TerraSphere facilities. TerraSphere will seek qualified local partners to build and operate TerraSphere facilities. Under the joint-venture model, both parties contribute to the capital costs of the project and split the associated risks by selling TerraSphere systems and equipment to licensees and project partners. TerraSphere will also continue to market its exclusive licensing agreements to interested third parties throughout North America, Asia and Europe.

 

Trends and Uncertainties Affecting Operations

 

TerraSphere is subject to a number of factors that may affect its operations and financial performance. These factors include, but are not limited to, the ability of entering into partnerships to own and operate TerraSphere facilities, the ability to market its exclusive licensing agreements to interested third parties and market acceptance of TerraSphere patented technology. Furthermore, TerraSphere’s plans call for raising debt and/or equity financing to expand its operations. Currently there has been a slowdown in lending in both the equity and bond markets which may hinder its ability to raise the required funds.

 

Results of Operations for the Three Months Ended March 31, 2010 and 2009

 

For the three month period ended March 31, 2010, TerraSphere had revenue of approximately $1,684,000 compared to $9,000 for the same period in 2009. The $1,675,000 increase is comprised of equipment sales of $675,000 and granting a licensing fee for approximately $1,000,000.

For the three month period ended March 31, 2010, TerraSphere had cost of goods sold of approximately $703,000 compared to no cost of goods sold for the same period in 2009. The increase in cost of goods sold is related to the equipment sales of $675,000 as well as additional work on previous equipment sold in prior years.

 

TerraSphere had general and administrative expenses of approximately $437,000 and $227,000 for the three month periods ended March 31, 2010 and 2009, respectively. The approximately $210,000 increase in general and administrative expenses from 2010 to 2009 is composed of increases in legal and professional fees related to the future construction of the Worcester PharmaSphere facility.

 

Provision for income taxes totaling $388,000 was recorded for the three month period ended March 31, 2010 as TerraSphere elected to be treated as a taxable association effective February 22, 2010 for United States federal and state tax purposes.

 

Net income after tax for the three month period ended March 31, 2010 was $158,000 compared to a loss of $225,000 for the three month period ended March 31, 2009. The increase in net income of $383,000 is made up of equipment sales of $675,000 and granting a licensing fee for approximately $1,000,000.

 

Results of Operations for the Years Ended December 31, 2009 and 2008

 

For the year ended December 31, 2009, TerraSphere had revenues of approximately $37,000 compared to $1,459,000 for the same period in 2008. The decrease was due to no new licensing fees or equipment sales being consummated in 2009.

 

For the year ended December 31, 2009, TerraSphere had no cost of goods sold. Cost of goods sold for the year ended December 31, 2008 totaling $730,000 were related to equipment sales of $622,000 and licensing fees of $800,000.

 

TerraSphere had general and administrative expenses of approximately $1,292,000 and $674,000 for the years ended December 31, 2009 and 2008, respectively. The approximately $618,000 increase in general and administrative expenses from 2009 to 2008 is composed of increases in legal and professional fees related to the future construction of the Worcester PharmaSphere facility.

 

Net loss for the year ended December 31, 2009 was $1,216,000 compared to a net income of $93,000 for the year ended December 31, 2008. The decrease in net income is the result of no new licensing fees or equipment sales being consummated in 2009 to offset the increase in general and administrative expenses.

 

Results of Operations for the Years Ended December 31, 2008 and 2007

 

For the year ended December 31, 2008, TerraSphere had revenues of approximately $1,459,000 compared to $21,000 for the same period in 2007. The increase is due to equipment sales of $622,000 and licensing fees of $800,000 in 2008. There were no equipment sales or licensing fees consummated in 2007.

 

For the year ended December 31, 2008, TerraSphere had cost of goods sold of approximately $730,000 compared to $405,000 for the same period in 2007. Cost of goods sold increase in 2008 is related to equipment sales of $622,000 and licensing fees of $800,000.

 

TerraSphere had general and administrative expenses of approximately $674,000 and $346,000 for the years ended December 31, 2008 and 2007, respectively. The approximately $327,000 increase in general and administrative expenses from 2008 to 2007 is composed of increases in legal and professional fees related to the future construction of the Worcester PharmaSphere facility.

 

Net income for the year ended December 31, 2008 was $93,000 compared to a net loss of $625,000 for the year ended December 31, 2007. The increase in net income is the result of equipment sales of $622,000 and licensing fees of $800,000 in 2008.

Changes in Balance Sheet

 

As of March 31, 2010, TerraSphere had current assets of approximately $1.2 million compared to $289,000 as of December 31, 2009. TerraSphere’s total assets were approximately $1.6 million as of March 31, 2010 compared to approximately $592,000 as of December 31, 2009. The majority of the increase in assets from December 31, 2009 to March 31, 2010 is due to an increase in accounts receivable arising from the granting of an exclusive licensing agreement.

 

As of March 31, 2010, TerraSphere had current liabilities of approximately $2.4 million compared to $1.6 million at December 31, 2009. This increase is due largely to legal and professional fees incurred and the recording of a deferred tax liability.

 

As of December 31, 2009, TerraSphere had current assets of approximately $289,000 compared to $527,000 as of December 31, 2008. TerraSphere’s total assets were approximately $592,000 as of December 31, 2009 compared to approximately $630,000 as of December 31, 2008, a decrease in total assets of $38,000.

 

As of December 31, 2009, TerraSphere had current liabilities of approximately $1.6 million compared to $390,000 at December 31, 2008. This increase is due largely to legal and professional fees incurred.

 

Liquidity and Capital Resources

 

As of March 31, 2010 and December 31, 2009, TerraSphere had $106,000 and $197,000, respectively, in cash on hand. The major uses of cash during the three months ended March 31, 2010 were approximately $119,000 for operating activities and $97,000 for investing activities offset by an increase in cash of approximately $162,000 from financing activities.

 

Subsequent to March 31, 2010, TerraSphere entered into exclusive licensing agreements totaling $3.8 million. Based on the terms of these agreements, TerraSphere will receive installment payments throughout the year with the final installment payment being received in March 2011.

 

Off-Balance Sheet Transactions

 

TerraSphere does not engage in material off-balance sheet transactions.

 

Critical Accounting Policies

 

Use of Estimates

 

The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect reported amounts and disclosures in the consolidated financial statements. Actual results could differ from those estimates.

 

Foreign Operations

 

The accounting records of TerraSphere Canada are maintained in Canadian dollars, its functional currency. Revenue and expense transactions are translated to U.S. dollars using the average exchange rate of the month in which the transaction took place. Assets and liabilities are translated to U.S. dollars using the exchange rate in effect as of the balance sheet date. Equity transactions are translated to U.S. dollars using the exchange rate in effect as of the date of the equity transaction. Translation gains and losses are reported as a component of accumulated other comprehensive income or loss. Gains and losses resulting from transactions which are denominated in other than the functional currencies are reported as foreign currency exchanges gain (loss) in the statements of operations and comprehensive income (loss) in the period the gain or loss occurred.

Patent and Patent Costs, Net

 

TerraSphere accounts for its patent and patent related costs in accordance with ASC 250, which requires that intangible assets with finite lives, such as TerraSphere’s, specifically identifiable costs for patent and patent applications, be capitalized and amortized over their respective estimated lives and reviewed for impairment whenever events or other changes in circumstances indicate that the carrying amount may not be recoverable.

 

Pre-Construction Costs

 

Pre-construction costs include architectural and engineering services related to the building of the PharmaSphere facility.

 

Revenue Recognition

 

Revenue is recognized when all of the following criteria are met: persuasive evidence of a sales arrangement exists; delivery of the product has occurred; the sales price is fixed or determinable; and, collectability is reasonably assured.

 

In those cases where all four criteria are not met, TerraSphere defers recognition of revenue until the period these criteria are satisfied. Revenue is generally recognized upon shipment or upon completed performance on exclusive technology licenses where the term is equal to the life of the associated intellectual property.

 

TerraSphere recognizes deferred revenue when payment has been received for product sales but the revenue recognition criteria has not been met. In addition, TerraSphere defers revenue when payment has been received for future services to be provided.

 

Income Taxes

 

TerraSphere elected to be treated as a taxable association effective February 22, 2010 for United States federal and state tax purposes. TerraSphere accounts for income taxes following the asset and liability method in accordance with ASC 740. Under such method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years that the asset is expected to be recovered or the liability settled.

 

Management performs an evaluation of TerraSphere’s tax positions, ensuring that these tax return positions meet the “more likely than not” recognition threshold and can be measured with sufficient precision. These evaluations provide management with a comprehensive model for how TerraSphere should recognize, measure, present and disclose in its financial statements certain tax positions that TerraSphere has taken or expects to take on income tax returns.

 

Set forth below is information regarding the beneficial ownership of our common stock, as of July 7, 2010, by:

 

 

We believe that, except as otherwise noted below, each named beneficial owner has sole voting and investment power with respect to the shares listed. Unless otherwise indicated herein, beneficial ownership is determined in accordance with the rules of the Securities and Exchange Commission, and includes voting or investment power with respect to shares beneficially owned. Shares of common stock to be received upon conversion of preferred stock, or subject to options or warrants currently exercisable or exercisable on or within 60 days of the date of this report, are deemed outstanding for computing the percentage ownership of the person holding such options or warrants, but are not deemed outstanding for computing the percentage ownership of any other person.

 

 

 

 

 

Should a stockholder desire to include in next year’s annual meeting proxy statement a proposal other than those made by the Board, such proposal must be sent to the Corporate Secretary of the Company at 137A Lewis Wharf, Boston, MA 02110. Stockholder proposals must be received at our principal executive offices no later than 120 days prior to the first anniversary of the date our fiscal 2010 annual meeting proxy statement was mailed to stockholders, which was May 19, 2010. All stockholder proposals received after this date will be considered untimely and will not be included in the proxy statement for the fiscal 2011 annual meeting. The deadline for submission of shareholder proposals that are not intended to be included in our proxy statement is 45 days prior to the first anniversary of the date our fiscal 2010 annual meeting proxy statement was mailed to stockholders, which was May 19, 2010.

 

Pursuant to the rules of the SEC, we and our agents that deliver communications to our stockholders are permitted to deliver to two or more stockholders sharing the same address a single copy of our proxy statement. Upon written or oral request, we will deliver a separate copy of the proxy statement to any stockholder at a shared address who wishes to receive separate copies of such documents in the future. Stockholders receiving multiple copies of such documents may likewise request that we deliver single copies of such documents in the future. Stockholders may notify us of their requests by calling or writing us at our principal executive offices at 137A Lewis Wharf, Boston, MA 02110, and our phone number is (617) 624-0111.

 

We file reports, proxy statements and other information with the SEC. You may read and copy reports, proxy statements and other information filed by us with the SEC at its public reference room located at 100 F Street, N.E., Washington, D.C. 20549-1004. You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. You may also obtain copies of the materials described above at prescribed rates by writing to the SEC, Public Reference Section, 100 F Street, N.E., Washington, D.C. 20549-1004. We files our reports, proxy statements and other information electronically with the SEC. You may access information on us at the SEC web site containing reports, proxy statements and other information at http://www.sec.gov.

 

 

TERRASPHERE SYSTEMS LLC

CONSOLIDATED FINANCIAL STATEMENTS

AS OF DECEMBER 31, 2009 AND 2008
AND FOR THE YEARS ENDED
DECEMBER 31, 2009, 2008 AND 2007

WITH REPORT OF INDEPENDENT REGISTERED
PUBLIC ACCOUNTING FIRM

 

 

To the Members of

  TerraSphere Systems LLC

 

We have audited the accompanying consolidated balance sheets of TerraSphere Systems LLC (the “Company”) as of December 31, 2009 and 2008, and the related consolidated statements of operations and comprehensive income (loss), changes in members’ equity (deficit) and cash flows for the years ended December 31, 2009, 2008 and 2007. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements, 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 consolidated financial statements referred to above present fairly, in all material respects, the financial position of TerraSphere Systems LLC as of December 31, 2009 and 2008, and the results of their operations and their cash flows for the years ended December 31, 2009, 2008 and 2007 in conformity with accounting principles generally accepted in the United States of America.

 

/s/ CCR LLP

 

Glastonbury, Connecticut

June 3, 2010

TERRASPHERE SYSTEMS LLC

 

CONSOLIDATED BALANCE SHEETS

DECEMBER 31, 2009 AND 2008

 

 

The accompanying notes are an integral part of these consolidated financial statements.

TERRASPHERE SYSTEMS LLC

 

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)

FOR THE YEARS ENDED DECEMBER 31, 2009, 2008 AND 2007

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

TERRASPHERE SYSTEMS LLC

CONSOLIDATED STATEMENTS OF CHANGES IN MEMBERS’ EQUITY (DEFICIT)
FOR THE YEARS ENDED DECEMBER 31, 2009, 2008 AND 2007

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

TERRASPHERE SYSTEMS LLC

CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2009, 2008 AND 2007