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ABHD > SEC Filings for ABHD > Form 10-Q on 14-Nov-2012All Recent SEC Filings

Show all filings for ABTECH HOLDINGS, INC.

Form 10-Q for ABTECH HOLDINGS, INC.


14-Nov-2012

Quarterly Report


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

You should read the following discussion and analysis in conjunction with our financial statements and related notes contained elsewhere in this Quarterly Report on Form 10-Q. This discussion contains forward-looking statements that involve risks, uncertainties, and assumptions. Our actual results and the timing of events may differ materially from those anticipated in these forward-looking statements as a result of a variety of factors, many of which are beyond our control and many of which, with respect to future business decisions, are subject to change.

Overview

ABHD was incorporated in the State of Nevada on February 13, 2007 under the name "Laural Resources, Inc." On February 10, 2011, ABHD consummated the Merger with AbTech Industries, pursuant to the Merger Agreement. Prior to the Merger, ABHD was a development stage company engaged in the business of acquiring and developing mineral properties, and a public reporting "shell company," as defined in Rule 12b-2 under the Securities Exchange Act of 1934, as amended (the "Exchange Act"). As a result of the Merger, ABHD acquired all of the issued and outstanding common stock of AbTech Industries (through a reverse acquisition transaction) in exchange for the stockholders of AbTech Industries acquiring a 78% ownership interest in ABHD, AbTech Industries became ABHD's majority-owned subsidiary, and ABHD acquired the business and operations of AbTech Industries.

This "Management's Discussion and Analysis of Financial Condition and Results of Operations" is based on and relates only to AbTech Industries. Prior to the consummation of the Merger, Abtech Holdings was a "shell company" that did not have an active business and its results of operations are immaterial and are not included in the discussion below. Key factors affecting AbTech Industries' results of operations during the periods covered in this section include revenues, cost of revenues, operating expenses and income.

For accounting purposes, the Merger transaction has been accounted for as a reverse acquisition, with AbTech Industries as the acquirer. The consolidated financial statements of ABHD as of and for the year ended December 31, 2011 represent a continuation of the financial statements of AbTech Industries, with one adjustment, which is to retroactively adjust the legal capital of AbTech Industries to reflect the legal capital of Abtech Holdings. See Note 1 of the Notes to Unaudited Condensed Consolidated Financial Statements included elsewhere in this Quarterly Report on Form 10-Q.

Results of Operations

We generate revenues by selling water filtration products that treat contaminated water so that it can either be discharged or reused. All of our products include some form of Smart Sponge filtration media, which we manufacture. Our products include a variety of designs and sizes to effectively address many applications where water treatment is needed.

Comparison of the nine months ended September 30, 2012 and 2011

Revenues for the first nine months of 2012 increased by 109% compared to revenues in the same period of the prior year. The Company believes that these revenue figures reflect some improvement in the economic factors that affect sales of the Company's products as well as some initial results of expanded business development efforts by the Company. The sales increase for this period was due entirely to the volume of products sold. The Company continues to expect significant sales growth in the fourth quarter of 2012 and into 2013 asnew projects being pursued in stormwater, industrial waste water and produced water markets begin to generate revenues. On June 6, 2012, Waste Management Inc., a distributor of AbTech products, announced a program to provide a total stormwater management offering to U.S. municipalities in the form of public-private partnerships, collaborating with the Company and municipalities to design, build, operate and service stormwater infrastructure. The Company believes that this approach to the stormwater market could have a significant impact on future sales for the Company although the timing of such sales remains difficult to project at this stage.

The Company's gross margin on sales increased from a negative (16)% in the first nine months of 2011 to positive 32% in the same period of 2012. This improvement in gross margins is the direct result of increased levels of production in the first nine months of 2012 that spread fixed overhead cost over a broader base of products, thus allowing the Company to achieve higher gross margins. The Company continues to have excess capacity and expects that gross margins will continue to improve as production increases to satisfy an expected increase in product sales.

Selling, general and administrative expenses increased by approximately $1,178,000 or 56% in the first nine months of 2012 as compared to the same period in 2011. These increases were due primarily to an expanded business development effort that included increased payroll related costs of approximately $225,000 for additional employees, increased travel expenses of approximately $53,000, increased cost for government affairs consultants of $57,000 and increased costs for trade show events of $41,000. The Company is also experiencing the higher costs associated with being a public company. These costs amounted to approximately $788,000 in the first nine months of 2012 versus approximately $488,000 in the same period of 2011. 2012 included increases over costs incurred in the same period of the prior year of approximately $178,000 for investor relations costs, $22,000 for public relations costs, $48,000 for legal fees, $43,000 for liability insurance, and $25,000 for financial printing costs. Selling, general and administrative expenses in the first nine months of 2012 also included an increase of $40,000 for directors' fees, and approximately $194,000 for stock based compensation expense related to stock options vesting during the period. Research and development costs increased approximately 35% for the nine-month period ended September 30, 2012 as compared to the same period of the prior year due to product development activities associated with lab and field testing of products in new applications and testing of new product designs.

Interest expense increased substantially for the nine months ended September 30, 2012 as compared to the same period of 2011 due primarily to the four components of interest expense described in the table below that are related to the convertible promissory notes issued by the Company in 2011 and 2012:

                                                      Nine months ended        Nine months ended
               Interest components                    September 30, 2012       September 30, 2011
1. Interest accrued on the notes outstanding.        $            621,000     $             25,000

2. Amortization of the note discount created by
the bifurcation of the warrant liability at the
time the convertible promissory notes were issued.   $          1,216,000     $             16,000

3. Amortization of the note discount created by
the bifurcation of the beneficial conversion
feature inherent in the convertible promissory
notes issued in February 2012.                       $            972,000     $                  -

4. Amortization of the deferred financing costs
related to the private offerings in which the
convertible promissory notes were sold.              $            859,000     $              8,000

Total interest expense for the nine months ended September 30, 2012 was $3,706,958. Interest expense for the same period of 2011 was $1,711,964, of which, $1,620,955 was attributable to a non-recurring charge for imputed interest on promissory notes that were converted to common stock on beneficial conversion terms during the second quarter of 2011.

For the nine month period ended September 30, 2012, other income includes a loss of ($1,232,291) related to the valuation of the warrant liability. The warrant liability represents the estimated bifurcated value of certain outstanding warrants issued in conjunction with the Secured Notes sold by the Company during 2011 and 2012. The Company revalues this warrant liability (pursuant to ASC 815) at each balance sheet date using the Black-Scholes valuation model. The valuation of the warrant liability is dependent on the market value of the Company's common stock. Because the Company's stock price increased during the nine-month period ended September 30, 2012, the value of the warrant liability also increased resulting in the imputed loss to the Company.

Comparison of the three months ended September 30, 2012 and 2011

While year to date revenues for the nine months ended September 30, 2012 were up 109%, revenues for the three months ended September 30, 2012 were down 35% compared to revenues in the same period of the prior year and down 66% compared to revenues in the second quarter of 2012. The sales decrease for this period was due entirely to the volume of products sold and reflects a combination of the delays experienced by the Company in implementing its market strategies in its primary target markets (stormwater and produced water) and a business development and engineering resource allocation strategy focused on large volume opportunities with strategic distributors and customers. The Company believes that significant revenue growth still lies ahead in each of these markets but it is taking longer to gain market acceptance than previously expected. In the stormwater market, we continue to work with Waste Management, Inc. to establish public private partnerships for municipal stormwater treatment systems. While these efforts are moving ahead, and proposals have been presented to many municipalities, there were no major projects approved in the third quarter of 2012. In the produced water market, the Company has designed multiple systems to treat different flow rates and currently has several proposals outstanding. The next few projects will provide additional field validations in this exciting new application. In treating produced water (water produced in the oil and gas extraction industry including fracking) the Company's Smart Sponge technology is highly effective in removing hydrocarbons but is not a stand-alone treatment solution. The Company is working with many players in the industry, including oil and gas operators, oil field service companies and multiple downstream treatment technologies to provide a treatment-train that effectively solves the variety of contamination issues found in produced water applications.

The Company's gross margin on sales of 15% for the three months ended September 30, 2012 was little changed from the gross margin of 13% in the same period of 2011. However, this represents a decrease from the 36% gross margin achieved in the second quarter of 2012. These low gross margins are the direct result of low levels of production during the three months ended September 30, 2012 that spread fixed overhead cost over a relatively small base of products thus increasing the costs of the individual products manufactured.

Selling, general and administrative expenses increased by approximately $302,000 or 41% for the three months ended September 30, 2012 as compared to the same period in 2011. These increases were due primarily to an expanded business development effort that accounted for increased payroll related costs of approximately $71,000 for additional business development employees, increased travel expenses of approximately $18,000, increased cost for government affairs consultants (at federal, state and local levels) and business development consultants of $23,000 and increased costs for trade show events of $17,000. Selling, general and administrative expenses in the three months ended September 30, 2012 also included increases, compared to the same period in 2011, of $53,000 for non-business development payroll costs, $61,000 for stock based compensation expense related to stock options vesting during period, and approximately $11,000 for directors' fees. Research and development costs decreased by approximately 4% for the three-month period ended September 30, 2012 as compared to the same period of the prior year reflecting a research and development effort that was relatively consistent for the two periods.

Interest expense increased substantially for the three months ended September 30, 2012 as compared to the same period of 2011 due primarily to the four components of interest expense described in the table below that are related to the convertible promissory notes issued by the Company in 2011 and 2012:

                                                      Three months ended       Three months ended
               Interest components                    September 30, 2012       September 30, 2011
1. Interest accrued on the notes outstanding.        $            208,000     $             25,000

2. Amortization of the note discount created by
the bifurcation of the warrant liability at the
time the convertible promissory notes were issued.   $            439,000     $             16,000

3. Amortization of the note discount created by
the bifurcation of the beneficial conversion
feature inherent in the convertible promissory
notes issued in February 2012.                       $            545,000     $                  -

4. Amortization of the deferred financing costs
related to the private offerings in which the
convertible promissory notes were sold.              $            264,000     $              8,000

Total interest expense for the three months ended September 30, 2012 was $1,480,123 compared to $57,127 for the same period of 2011.

For the three-month period ended September 30, 2012, other income (expense) includes a loss of ($553,536) related to the valuation of the warrant liability. The warrant liability represents the estimated bifurcated value of certain outstanding warrants issued in conjunction with the Secured Notes sold by the Company during 2011 and 2012. The Company revalues this warrant liability (pursuant to ASC 815) at each balance sheet date using the Black-Scholes valuation model. The valuation of the warrant liability is dependent on the market value of the Company's common stock. Because the Company's stock price increased during the three-month period ended September 30, 2012, the value of the warrant liability also increased resulting in the imputed loss to the Company.

Liquidity and Capital Resources

Liquidity

To date, the Company has not generated sufficient revenue to cover its operating costs and continues to operate with negative cash flow. While we expect to achieve significant sales growth over the long-term, continued negative cash flow from operations is expected in the short-term. The Company may require additional capital to maintain current operations if sales growth does not occur as anticipated. In addition, rapid growth may require the Company to enter into working capital financing arrangements. The Company currently has no such financing commitments in place.

The Company had a working capital deficiency of approximately $1,165,000 at September 30, 2012 compared to a working capital deficiency of approximately $2,645,000 at December 31, 2011. The Company's cash balance increased from $1,386,502 at December 31, 2011 to $3,577,436 at September 30, 2012. The working capital deficiency is primarily attributable to the short-term convertible promissory notes (the "ST Notes") outstanding which totaled (net of discounts) $4,575,759 at September 30, 2012 and $4,336,763 at December 31, 2011. Accrued interest on the ST Notes increased from $126,232 at December 31, 2011 to $358,507 at September 30, 2012. In September 2012, the Company completed a $3.7 million private offering of common stock and warrants (the "Equity Offering") with the intention of using the proceeds to repay any of the outstanding ST Notes coming due in 2012 that are not converted to common stock. In the nine-months ended September 30, 2012, the Company issued $2.6 million of additional ST Notes and subsequently repaid $275,000 of the ST Notes plus approximately $260,000 of interest due on the ST Notes. During the same period, approximately $2.4 million of the ST Notes were converted to common stock including accrued interest of approximately $128,000. During October 2012, an additional $3.1 million of the ST Notes, including approximately $263,000 of accrued interest, were converted to common stock. As of October 31, 2012, the principal amount of the outstanding ST Notes was $2,045,000. These notes are expected either to be converted prior to the end of 2012 or repaid with the proceeds of the Equity Offering.

The $3.8 million of net cash used in operations during the nine months ended September 30, 2012, was funded primarily by the $2.6 million proceeds from the Secured Notes financing that occurred in February 2012 and the cash available at the beginning of the period of approximately $1.4 million. The Company expects that a significant portion of the Equity Offering completed in September 2012, will be available to fund future operations after all the ST Notes have been settled by conversion or repayment.

Our balance sheet at September 30, 2012 shows an inventory level of approximately $413,000, a relatively large amount compared to net revenues for the nine months ended September 30, 2012 of $561,000. This supply of inventory on hand will mitigate some of the working capital requirements AbTech Industries will encounter in the event it successfully increases sales revenue during upcoming months. At September 30, 2012, AbTech Industries had customer deposits of $41,724 representing prepayments by certain distributors for future product orders. Future sales to these distributors will not generate positive cash flow until the prepayments are depleted.

Comparison of cash flows for the nine months ended September 30, 2012 and 2011

Operating Activities

The Company had negative cash flow from operations for the nine months ended September 30, 2012 of approximately $3.8 million compared to negative cash flows from operations of $2.4 million in the same period of 2011. The increase in negative cash flow from operations is primarily the result of a $1,333,000 increase in operating expenses, a reduction in accounts payable of approximately $141,000 and an increase in accounts receivable of approximately $103,000. The increase in accounts receivable was due to a $146,000 receivable that went beyond its payment terms but was eventually paid in October 2012.

Financing Activities

In February 2012, the Company completed the final closing of a private offering that raised $2.6 million from the sale of the Secured Notes and related warrants. In September 2012, the Company completed the $3.7 million Equity Offering. These financings allowed the Company to increase its cash balance to approximately $3.6 million at September 30, 2012 compared to $1.4 million at December 31, 2011, despite incurring negative cash flows from operations during the period. The cash balance at September 30, 2012 represents approximately 8.3 months of the average monthly operating expenses incurred during the nine-months ended September 30, 2012 and approximately 8.5 months of the average monthly net cash used in operating activities for the same period.

At September 30, 2012, the Company had $4.9 million (principal amount) of ST Notes outstanding that all have original maturity dates in 2012. In October 2012, $2.8 million of these ST Notes converted to common stock leaving approximately $2.1 million outstanding at October 31, 2012. The Company intends to repay in the fourth quarter of 2012, any of these notes, and the accrued interest thereon, that do not convert to common stock.

Investing Activities

The Company had approximately $31,000 of capital expenditures for the nine months ended September 30, 2012. During that period the Company also entered into a three-year capital lease for the purchase of $11,600 of equipment. As of September 30, 2012, the Company had no other commitments for any material future capital expenditures. However, if the Company is successful in achieving significant sales growth in subsequent quarters of 2012 and 2013, it may need to expand its manufacturing capacity or outsource some of its manufacturing. The Company is currently considering both options for expanding manufacturing capacity or outsourcing some of its manufacturing. The Company estimates that it could double its current manufacturing capacity for approximately $250,000 and accommodate an annual sales rate of over $20 million.

Going Concern and Management's Plans

The accompanying condensed consolidated financial statements have been prepared in conformity with generally accepted accounting principles, which contemplate continuation of the Company as a going concern and the realization of assets and satisfaction of liabilities and commitments in the normal course of business. As discussed in Note 4 to the accompanying condensed consolidated financial statements, we have not achieved a sufficient level of revenues to support our business and have suffered substantial recurring losses from operations since our inception. These factors raise substantial doubt about the Company's ability to continue operations as a going concern. As such, the Company's independent registered public accounting firm has expressed an uncertainty about the Company's ability to continue as a going concern in their opinion attached to the Company's audited financial statements for the year ended December 31, 2011. The accompanying condensed consolidated financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or the amount and classification of liabilities or any other adjustment that might be necessary should the Company be unable to continue as a going concern. Management believes that the Company's ability to continue as a going concern will be dependent on its ability to generate significant sales growth in the short term and/or raise additional capital. The Company's ability to achieve these objectives cannot be determined at this time. However, the Company did complete the final closing of its private offering of the Secured Notes and warrants in February 2012, which provided gross proceeds of $2,600,000 to the Company. In addition, the Company completed an Equity Offering in September, 2012, that provided cash proceeds of approximately $3.7 million to the Company. Management's plans in regard to these matters are described in Note 4 to the accompanying condensed consolidated financial statements. If the Company is unable to generate significant sales growth in the near term and/or raise additional capital, there is a risk that the Company could default on debt maturing during 2012, and could be required to significantly reduce the scope of its operations if no other means of financing operations are available.

Off-Balance Sheet Arrangements

The Company does not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future material effect on the Company's financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.

Contractual Obligations

As a smaller reporting company, as defined in Rule 12b-2 of the Exchange Act, we are not required to provide the information required by this item.

Critical Accounting Policies and Estimates

Our discussion and analysis of our financial condition and results of operations, including the discussion on liquidity and capital resources, are based upon our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues, and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, management re-evaluates its estimates and judgments. Management bases the estimates on historical experience and on various other factors that it believes are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. For any given individual estimate or assumption we make, it is possible that other people applying reasonable judgment to the same facts and circumstances could develop different estimates. Actual results may materially differ from these estimates under different assumptions or conditions.

The going concern basis of presentation assumes we will continue in operation throughout the next fiscal year and into the foreseeable future and will be able to realize our assets and discharge our liabilities and commitments in the normal course of business. As discussed above, certain conditions currently exist which raise substantial doubt upon the validity of this assumption. The financial statements do not include any adjustments that might result from the outcome of the uncertainty.

The methods, estimates, interpretations, and judgments we use in applying our most critical accounting policies can have a significant impact on the results that we report in our consolidated financial statements. The SEC considers an entity's most critical accounting policies to be those policies that are both most important to the portrayal of the entity's financial condition and results of operations and those that require the entity's most difficult, subjective, or complex judgments, often as a result of the need to make estimates about matters that are inherently uncertain when estimated.

The following discussion provides supplemental information regarding the significant estimates, judgments and assumptions made in implementing the Company's critical accounting policies.

Fair value of warrant liability and note discount

The warrant liability shown on the Company's balance sheets at September 30, 2012 and December 31, 2011 represents the estimated value of warrants sold with promissory notes that met the characteristics of a derivative and were required to be bifurcated from the debt and reported as a liability at fair value. This bifurcation resulted in the establishment of the estimated value of the warrant liability and a corresponding note discount in the same amount. The warrant liability was originally valued and is revalued at each balance sheet date using the Black-Scholes valuation model because there is no market price available for the warrants. This model uses estimates of volatility, risk free interest rate and the expected term of the warrants, along with the current market price of the Company's common stock, to estimate the value of the outstanding warrants. The value of these warrants can change significantly as the market price of the underlying common stock changes. At each balance sheet date this could result in a gain or loss depending on the change in the market price of the stock, among other factors, from one valuation date to the next. The Company recognized such a gain of $242,052 for the year ended December 31, 2011 and a loss of $(1,232,291) for the nine months ended September 30, 2012.

Inventory valuation

The Company has written-down its inventory to estimate the lesser of cost or market value of inventory in stock at the valuation date due to obsolescence, slow movement or defects. This estimate requires that management make certain judgments about the likelihood that specific inventory items may have minimal or no realizable value in the future. These judgments are based on the current quantity of the item on hand compared to historical sales volumes, potential alternative uses of the products and the age of the inventory item.

Revenue recognition and allowance for doubtful accounts

There are four factors that the Company uses to determine the appropriate timing of the recognition of revenue. Three of these factors (evidence of arrangement exists, delivery occurs and fee is fixed or determinable) are generally factual considerations that are not subject to material estimates or assumptions. The fourth factor involves judgment regarding the collectability of the sales price. The Company only ships product when it has reasonable assurance that it will receive payment from the customer. When such assurance is not available, the . . .

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