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John Petersen is the executive vice president and chief financial officer of ePower Engine Systems, Inc., a Kentucky-based enterprise that has developed, built and demonstrated an engine-dominant diesel-electric hybrid drivetrain for long-haul heavy trucks that promises fuel savings of 30 to 40... More
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  • Current Update From EPower Engine Systems

    Since many stockholders of Axion Power International (OTCQB:AXPW) are following the progress of our development work at ePower Engine Systems and it's been a month and a half since I offered any detail, I thought a lightly edited version Jay Bowman's most recent shareholder update would be worthwhile.

    We have completed all of the modifications to the Peterbilt 387 sleeper as of last Friday. Over the course of the last month we have.

    • Changed the transmission valve body to drop the shifting points to 1950 rpm because we wanted to bring the drive motor's speed within its maximum torque band (1800 rpm).
    • Reduced the rear end gear ratio on the truck from 4:63 to 3:55 because we wanted to reduce the drive motor speed and keep it closer to its optimal torque curve.
    • Removed the forward drive axle and replaced it with a liftable tag axle to reduce weight.
    • Reworked the air system for the air ride suspension and brakes to ensure legal operation of the tag axle and controls.
    • Replaced the rear dual wheels with aluminum wheels and super single tires to reduce weight.
    • Removed four PbC batteries from the battery pack because we wanted to find out if the batteries could operate at a higher state of charge, which would eliminate the need for further work on our charge optimization software and save about 230 pounds.
    • Collected data for the Marathon engineers in an effort to improve our system's Power Factor and improve efficiency.
    • Moved the electric drive motor and transmission assembly 30 inches towards the rear of the tractor to shift weight off the front steering axle.

    As you can see, thses were some major modifications. I'm happy to report that we saved 1,022 lbs. and brought the tractor closer to the goals R&L gave me last year. The front axle weight is well within DOT limits and the transmission is more accessible for maintenance. Our drive motor is now operating at 1860 rpm at 65 mph, rather than 2800 rpm at 65 mph. We spent most of last week working with the Marathon engineers collecting data while we tuned the truck for our upcoming fuel and performance testing. With Marathon's help we have been able to correct several problems with our digital voltage regulator (DVR) and raised our power factor from the 0.62 we were seeing last month into the 0.92 to 0.94 range. We also increased peak generator output from 115KW to 135KW and reduced the drop in rpm on the diesel engine during high power requirements.

    We made one test run on the truck each day last week logging a total of 330 miles. We had some problems with the air system that prevented us from doing additional testing. The truck's air dryer was releasing air pressure to the brake system and the brakes would not function properly. Temporary repairs have been made so that we can continue testing and we have ordered a new air dryer that should be delivered by end of next week. Most of the testing last week focused on collecting data Marathon. We will begin serious fuel economy testing on Monday and should have a good idea of what our numbers are by the end of the week. With the generator and DVR working properly and a 52 PbC battery pack we saw a solid 11.0 MPG on our test course with a bob-tail tractor.

    (click to enlarge)

    As you can see our test course contains many elevation changes, rather than the flat and level testing courses typically used for MPG testing. Elevation is in blue graduated on the right axis, with speed in red on the left axis. We have four stopping points on this course as indicated by a zero mph. The truck is operated in cruise control mode and holds its speed very flat during the testing. I am certain that when tested under typical course conditions our numbers will be higher.

    Our experiment with removing four PbC's from the battery pack caused several problems and had a negative impact on fuel mileage and performance. The idea was to have the batteries operate at a higher state of charge thereby supplying the same amount of boost power to our system. Both I and the Axion engineers thought this was worth a try to see how they would perform. We knew that the PbC battery has a U shaped curve as far as internal resistance of the battery and that attempting to run at a higher SOC may have us fighting the resistance curve. This has proven to be the case. By raising the internal resistance of our battery pack we have upset the balance of power distribution in the system. The electric drive motor now has a lower internal resistance than our battery pack; this makes it more difficult to charge our batteries, as the power path to the electric motor has less resistance than the batteries. We will be reinstalling the four additional batteries and associated wiring on Monday morning to return the pack to a 56-battery configuration. We have also bought Cummins' "INSITE Service Tool" and expect to receive our copy of the software on Monday. We integrate the INSITE software into our data collection system immediately. The upgrade will give us printed documentation of real time fuel usage and information to share with the Cummins engineers.

    (click to enlarge)

    Our heaviest test last week was at a GVW of 45,200 lbs. on Friday afternoon. We had to abandon that test when an accident backed-up freeway traffic. The truck performed well from a power point of view. We did notice a significant decrease in acceleration under load but once up to speed the truck maintained speed through the course.

    As you know our US Patent application was allowed by the US patent Office. I have instructed our Patent attorneys to complete the granting process. This will provide patent protection as of today in the US and Mexico. Our applications in Canada, Europe, China and Honk Kong are still pending. Our attorney was pleased that the body of our patent was approved and remained intact by the examiners. They will be requesting expedited reviews from the EU and Canada at my request now that we have the US patent in hand.

    Disclosure: I am long AXPW.

    Tags: AXPW
    Jun 08 4:43 PM | Link | 45 Comments
  • Axion Power International's History And Future

    I have a love-hate relationship with publicly held research and development companies because outside the biotech space, very few investors understand them. To make matters worse you can't know what a particular innovation will be worth until the money's all been spent and a cruel and heartless end-user market casts the only vote that counts. The entire process is like having sex with a gorilla. Once you start down the path you can't stop until the market is satisfied with your innovation or it decides to kill you. Most of the signals and clues are subtle and very difficult to interpret. Success is incredibly gratifying and rewarding. Failure is not.

    Most of my readers are familiar with the Hype Cycle. While I typically use the following graph to caution stockholders of companies that are approaching the peak of inflated expectations, it can be very helpful for other investors who want to understand how the future is likely to unfold.

    The critical requirement if you want to use the hype cycle as an investment tool is to understand where a particular company is situated on the curve at a particular moment in time.

    (click to enlarge)

    I always get a kick out of the Hype Cycle graph because it shows R&D as a discrete point in the lower left-hand corner without offering any insight into the complexity of the R&D process. While experts have written volumes on the innovation and product development process, the three essential stages every innovation must navigate and traverse in sequential order are:

    • Developing a comprehensive understanding of an innovation;
    • Learning how to build devices that make the innovation useful; and
    • Refining production methods and developing products for specific markets.

    Each of these stages involves years of work and huge amounts of capital. There are no short-cuts or certain outcomes, and the only thing an R&D investor can do is monitor progress toward the ultimate goal of a product that end-users will buy in sufficient volumes to justify the time, effort and expense. Until the process is completed, R&D companies simply don't have anything they can sell in meaningful volume. They can generate lumpy bits of revenue by selling prototypes and services to potential end-users, but predictable revenue and meaningful growth can't happen until a company exits the R&D stage and begins commercialization.

    In my experience, the most important character traits for managers of R&D companies are conviction that their project is worth pursuing, confidence that the multitude of challenges can be overcome, and a dogged determination to see the project through to a bitter or brilliant end. Failures are far more common than successes, but the payoff of successful innovation makes the entire game worthwhile, and more than a little addictive.

    I've been involved with Axion Power International (OTCQB:AXPW) since 2004 because a public shell I controlled was used in the reverse merger that made Axion a public company. I served as a director of Axion for three years and as legal counsel for four. Since early 2008 I've only been a stockholder, but lawyers who work in my field develop deep bonds of friendship with former clients and tend to follow their evolution closely for years after the attorney-client relationship comes to an end, particularly if they're still stockholders.

    The following graph shows my assessment of the research, development and commercialization phases Axion has successfully traversed over the last ten years. It also shows the 10-year growth in Axion's share count, the 10-year growth in its trading volume and the 10-year evolution of its market capitalization. The discussions after the graph add more detail on the challenges Axion faced and overcame during each of the principal development stages.

    (click to enlarge)

    The First Three Years

    The first three years of Axion's existence (2004 through 2006) were a period that I've come to think of as the basic scientific research and technology litigation years. Axion's main focus was developing a better understanding of the how the PbC electrochemistry worked, discovering its strengths and weaknesses and finding ways to improve the performance, charge acceptance and cycle-life of single cell laboratory prototypes that bore only a passing resemblance to a battery. The rest of its time was spent with lawyers who fought long and hard to eliminate the clouds on Axion's title to the core patents and intellectual property. From inception through September 2006, Axion raised and spent a total of $9.9 million in cash.

    Axion won the critical lawsuits in the fall of 2006 and those victories set the stage for its first big financing, an $8.1 million placement of convertible preferred stock that closed in Q4-06. With that funding in hand, Axion was ready to move into the second phase of R&D work on the PbC technology, figuring out how to build a multi-cell battery that had the charge-acceptance, cycle life and other performance attributes the scientific staff demonstrated during the scientific research and technology litigation years.

    The Second Three Years

    The second three years of Axion's existence (2007 through 2009) were a period that I've come to think of as the basic product design and process development years. We knew from the outset that the easiest and most effective development path for the PbC technology would be to find a way to integrate our carbon electrode assemblies with the manufacturing equipment and methods used by every lead-acid battery manufacturer in the world. If we could make carbon electrodes in a form factor that could be used in existing battery plants, the path forward would be far easier than one that would the construction of new battery plants. The challenge was developing an electrode assembly that could work as a drop-in replacement for conventional electrodes without requiring major changes in established battery manufacturing equipment and methods.

    Exiting the scientific research stage was a frightening time because the first prototypes built by the scientific staff required lateral compression that was an order of magnitude higher than we could get with standard battery cases and manufacturing technology. We knew how we wanted the electrode assemblies to work and had a sensible path forward with a concept for laminated electrode assemblies, but that path required Axion to develop new methods for processing activated carbon and binding powdered carbon into uniform electrode sheets with appropriate structural integrity, electrical conductivity and other physical characteristics. Then we had to develop new methods for bonding corrosion barriers to current collectors, bonding electrode surfaces to corrosion barriers and sealing everything tightly enough to survive years in a sulfuric acid bath. The challenge of minimizing internal resistance between the electrode assembly layers was particularly daunting.

    The second three years would have been impossible without the New Castle battery plant that Axion bought for a song in early 2006. As battery plants go it was old and not heavily automated, which would have made it hard to make money producing conventional lead-acid batteries. While New Castle wasn't a great manufacturing facility, it was the perfect prototyping facility because it had the same equipment as every lead-acid battery plant in the world. That meant the scientific team could make electrode prototypes in the lab and then immediately build battery prototypes using company-owned facilities that didn't have to be scheduled weeks or months ahead of time. While most battery technology developers have to rely on third parties to build prototypes, Axion had a unique ability to do everything in house at a lower cost and with better security for its rapidly evolving intellectual property estate.

    The second three years was an expensive time. By the end of 2007, Axion had spent most of the $8.1 million in proceeds from the 2006 offering and it needed additional capital to design and build an automated fabrication line for the carbon electrode assemblies the scientific team had previously built by hand. In January 2008, Axion closed the first $4 million tranche of an $18 million investment from the Quercus Trust. The two remaining tranches came in April and July of 2008, which was a darned good thing given the market meltdown that hit in the fall of 2008.

    By the end of 2009, Axion had finished its work on a first generation automated electrode assembly fabrication line. The carbon sheeting for electrode surfaces was still being made with a labor-intensive manual process, but the lamination and sealing of the electrode assemblies was fully automated and Axion was beginning to get favorable reviews from potential customers who were impressed with the performance of its pre-commercial prototypes.

    The successful development of a basic manufacturing process for PbC batteries set the stage for Axion's largest financing ever, a $26 milion placement of common stock that closed in Q4-09. With that funding in place, Axion was ready to move into the third phase of its development work on the PbC technology, finding ways to refine its manufacturing methods and begin the difficult and costly process of proving product performance developing battery products for specific applications.

    The Third Three Years

    The third three years of Axion's existence (2010 through 2012) were a period that I've come to think of as the process refinement and application development years. Axion quickly learned that its first generation automated electrode assembly line wasn't good enough to satisfy first tier customers. It also needed a less labor-intensive process for manufacturing carbon sheeting.

    The first prong of the manufacturing process refinement was simple. Axion hired a respected industrial engineering firm to redesign the electrode fabrication line, significantly augment the robotics and add better quality control throughout. That upgrade took about a year.

    The second prong was more challenging because there was a delicate balance between the amount of binder used in an electrode sheet and the electrical performance of the finished sheet. The basic problem was that gluing small particles together blocked pores in the carbon and reduced the accessible surface area while increasing internal resistance. In the original carbon sheeting process particles were mixed with binder and the carbon dough was passed through rollers, folded over and passed trough the rollers again. The rolling and folding was repeated over and over again until the desired structural integrity was achieved. The closest analog was a French bakery making croissants. It was a mind-numbing repetitive process that left a lot of room for variability, but it used a very low binder to carbon ratio and resulted in electrode surfaces that performed well in pre-commercial prototypes.

    While Axion usually maintains tight control over information, word that they'd found an automated solution for the carbon sheeting spread quickly through the grapevine in 2011. It took another 18 months, however, to prove that the automated sheeting process would work at scale. The big advantage of automated sheeting was that it stripped 80% to 90% of the labor cost out of a PbC battery.

    When I first heard about the automated sheeting process, a nagging concern in the back of my mind was that increasing the binder to carbon ratio would impair electrode performance. I was pleasantly surprised when Axion announced that it had commissioned an automated sheeting line and the new sheets performed better than the originals. While I haven't been able to confirm my suspicions, I think the reason the new electrode sheets perform better is that repeatedly rolling, folding and re-rolling the carbon resulted in a stratification or layering like you see in a fine French pastry while a single pass process doesn't.

    The Last Year

    With the successful commissioning of the automated carbon sheeting line in 2013, Axion finally arrived at the lower left-hand corner of the Hype Cycle graph. The PbC had survived the R&D process without significant performance degradation and it was time for the battery market to consider the question of whether the PbC technology was worth the ten years of effort.

    The early results are encouraging. Until November of last year, Axion had never sold a PbC to a customer that planned to use the battery in a commercial activity. There were lumpy sales to outfits like BMW, Norfolk Southern, the DC Naval Yard and ePower who planned to test the PbC to find out whether it would serve their needs, but all those purchases were experimental in nature and non-recurring by definition.

    Last November's PowerCube sale was very different. It was a sale of 600 batteries that the buyer is interconnecting with a solar panel array and using for frequency regulation, renewables integration, demand charge management and emergency power backup at a commercial business facility. The customer didn't buy the batteries with the intention of testing them. It bought the batteries for the express purpose of putting them to work in a day-to-day commercial activity. The recent follow-on order from the same customer for four more systems is confirmation that Axion has its first commercial battery customer. These are working batteries, not testing batteries.

    In my view, these recent sales mark the beginning of Axion's journey up the Hype Cycle.

    While most of us are looking forward to the launch of the second generation NS 999 and the expansion of ePower's demonstration fleet, these activities are still experimental. NS won't know whether an electric switcher will satisfy its needs until the locomotive has been put to work moving boxcars around a rail yard. Likewise, ePower won't know whether its engine dominant series hybrid drivetrain will meet the needs of the trucking industry until it builds a small fleet of tractors, puts them to work hauling freight and accumulates several million miles of experience with industry partners who will make their own decisions on the value of ePower's drivetrain. The same is true for ongoing testing by automakers and other developers of systems that need the PbC's charge acceptance and cycle life. While there's no doubt in my mind that some of these experimental projects will fall by the wayside, it's increasingly clear to me that some are likely to succeed and add impetus to the PbC's success in stationary applications.

    What The Hell Happened in the Stock Market?

    At this point I'd like to revisit my development stages graph. For the first six years of its existence Axion's market capitalization trend was moderately positive, which is exactly what I'd expect from an early stage R&D company that still faced huge challenges of developing a product, refining the product and introducing the product to potential customers. Axion's spending during each phase ramped slowly but steadily and each investment resulted in a proportional added value that was reflected in Axion's market capitalization.

    Beginning in 2010 there was an extraordinary breakdown in the market capitalization trend. Axion's value adding activities accelerated rapidly but its market capitalization started as steady downward trend. The only explanation that makes sense to me is that a handful of very large investors who had no business selling their shares did so anyway, and they did so in the most savage manner possible. For better or worse, nano-cap markets are like babies. If you try to feed them too much at a sitting or try to force-feed them when they're feeling finicky, they'll puke all over your shirt. That's exactly what happened with Axion's stock price.

    I believe the Axion that exists today is far more valuable than the Axion that existed in early 2010. The old Axion didn't have

    • Fully developed products;
    • Cost effective manufacturing processes:
    • Identifiable potential customers;
    • Successful testing by potential customers; or
    • Expectations that anyone would buy PbC batteries for use in a commercial activity.

    Axion may not have had any of those things in 2010, but it has them all today.

    The PbC is a fine but expensive battery that's certain to get cheaper as Axion builds scale and progresses along the learning curve that impacts every manufacturing business.

    While Axion is little more than an asteroid in the universe of public companies, several planet-sized giants have fallen into orbit around Axion and a pair of them publicly embraced the PbC technology before there was a product. I can't remember another nano-cap that had disclosed relationships with two first-tier companies and discovered relationships with several more. That fact alone tells me the PbC is every bit as valuable as Axion's founders hoped it would be.

    It makes me crazy when I read criticisms that Axion's sales haven't ramped quickly enough. The simple fact is Axion didn't have anything to sell during the first six years and all it could offer from 2010 through 2013 was pre-commercial prototypes that were suitable for testing and demonstration but were not suitable for use in a commercial activity and couldn't be produced in sufficient volume to support a commercial activity.

    Over the last few months that business dynamic has changed. Last November a customer bought a PowerCube for use in a commercial activity. It recently ordered four more comparable systems and Management has told the stockholders that several additional PowerCube projects are in the sales funnel and expected to mature into purchase orders later this year.

    In addition to the commercial sales for stationary applications, several experimental applications of the PbC including the NS 999 and ePower's series hybrid tractor are approaching transition points where we'll get the first clear indication of the PbC's value in rail and heavy trucking applications. Only the gods know when we'll hear from the automakers While there are still no guarantees, there are many good reasons to be optimistic that these additional markets will develop in due course.

    The PIPE investors have just left the stage and for the first time in four years Axion doesn't have several huge investors pushing and shoving at the pay window trying to force their shares into the market ahead of the other guy. In fact the only possible sellers at this point are the old guard and the retail investors who did all the buying over the last four years. I have a hard time imagining a better dynamic for investors.

    Disclosure: I am long AXPW.

    Tags: AXPW
    May 19 7:58 AM | Link | 15 Comments
  • Understanding The Details Of Axion's Reverse Split Proposal

    On Wednesday afternoon Axion Power International (OTCQB:AXPW) filed a preliminary "Notice of Consent Solicitation" with the Securities and Exchange Commission that describes a plan to ask its stockholders to authorize the board of directors to implement a reverse split in a range of not less than 1 for 20 and not more than 1 for 50 at any time prior to December 31, 2014 without further stockholder action. Since this is an important proposal, emotions are running high, fears are running deep and the entire process is a mystery to most investors, I prepared this discussion to highlight the issues and offer a back-stage view of a very complex process that's an essential element in the maturation of every public company; a process that I think is long overdue.

    The proposal described in the preliminary Notice of Consent Solicitation will:

    1. Authorize the board of directors to implement a reverse split of not less than 1 for 20 and not more than 1 for 50 without further stockholder approval; and
    2. Leave Axion's authorized capital stock unchanged at 350 million shares of common stock and 12.5 million shares of preferred stock.

    The stated goals of the proposal are to:

    1. Facilitate the negotiation and closing of a financing transaction that will be required before year end; and
    2. Facilitate an upgrade of Axion's trading market from the OTC Bulletin Board to the Nasdaq Stock Market.

    It's an ambitious plan with a lot of moving pieces that stockholders need to understand before making a decision.

    Preliminary disclosure

    Readers should understand that in the fall of 2003, a partner and I controlled a public shell that ultimately merged with Axion Power Corporation to form Axion Power International. When I negotiated the reverse merger my most important concern was the market where the combined companies would trade. While I knew the combined companies would have to start trading on the OTCBB because of the transaction structure, my primary goal was to get Axion off the OTCBB and onto a national exchange as quickly as possible. The reason is simple. The OTC market is a financial ghetto where nasty characters lurk in every back alley and shadow. It's a great place to learn street smarts, but life in the national market suburbs is far more comfortable, safe and secure.

    The process should have been completed in 2004, but litigation that was filed within a couple months after the reverse merger disrupted certain soft third party financing commitments that were at the heart of the original plan. Since there was no way to unscramble the eggs, my only options were to walk away from a busted deal or go to work and do it the hard way. I chose the more difficult path, but the greatest frustration of my career is that the decisions stockholders are facing today should have been resolved a decade ago and baseless litigation from dishonest characters we couldn't control screwed up our carefully conceived plans.

    My view of dilution

    The first topic I want to touch on is the dreaded D word - dilution. I've spent my whole career working with entrepreneurs who have great potential but don't have enough money to realize that potential. The entrepreneurs, quite rationally, want to keep as much of the upside as possible. Their prospective investors, on the other hand, know that the business potential can't be realized unless they step up new cash and if things go badly they'll eat the lion's share of the loss. Those two differing and entirely rational perspectives create incredible tension. Bringing the parties to a reasonable middle ground where the entrepreneurs and the investors both get a fair share of the unrealized value is the heart of the deal, the region where I've always earned a living.

    A harsh reality that most public company stockholders never understand is that they became members of the entrepreneur class when they bought their first share of stock. From that point forward, their interests were diametrically opposed to the interests of the investor class; the people who need to write new checks to help their enterprise realize its potential.

    Over the years I've gotten pretty jaded on the topic of dilution. An entrepreneur starts with a collection of bricks, sticks, mortar and widgets that have an ascertainable value, and a far fuzzier "unrealized business potential" that can be quite high if things go well and quite low if things go poorly. In the context of a public company like Axion, the spread between the equity that appears on the balance sheet (~$10 million) and the market capitalization (~$30 million) is the market's best current estimate of the intrinsic value of that unrealized business potential.

    When an investor comes along and invests $10 million in a company, his new cash increases the aggregate value of the bricks, sticks, mortar and widgets by $10 million. It also increases the intrinsic value of the unrealized business potential because the entrepreneur has $10 million more that can be used to turn ambition into reality. The increase in the value of the unrealized business potential isn't always proportional, but it's usually pretty darned close.

    Stockholders tend to think in terms of a pie and assume that selling a piece of their pie to a new investor somehow decreases their retained value. The reality is the cash paid by the new investor usually makes the pie bigger. It increases the value of the bricks, sticks, mortar and widgets by an amount equal to the new cash. It also increases the value of the unrealized business potential by providing new resources that allow the entrepreneur to move closer to his goal.

    The entrepreneur class always gives up a slice of the pie when new money comes to the table, but the total weight of the pie usually increases by an amount that's equal to or greater than the weight the new investor brought to the table. In the business world a big pie has a greater chance of success than a small one. Given a choice between owning 100% of a 3 pound pie and owning 50% of a 6 pound pie, I'll take the half pie every time because my chances of success are better.

    I frequently quip that every bartender knows you don't dilute a beer by adding a shot of whisky. As long as the new investors increase the intrinsic value of the business the entrepreneur class benefits from new financing transactions. It does not suffer dilution.

    How credible investors think

    In the preliminary disclosure I spoke of the OTC markets as a financial ghetto. While that may strike some as an exaggeration it really isn't. The SEC is extremely wary of small companies that trade on the OTC markets because it knows that dishonest promoters are more common in the ghetto than they are in the suburbs. It also knows that shady characters who lurk in alleyways and shadows are more than happy to victimize the honest residents.

    While the suburbs are filled with financial institutions that have open airy lobbies and friendly personal bankers, the only financial institutions you'll find in the ghetto are heavily fortified check-cashing joints, pawnshops and loan sharks. When you live in the ghetto convincing a credible investor that he wants to do business with you is a long hard uphill battle. If you want to be taken seriously by the boys in mid-town and the suburbs, moving to a better neighborhood must be part of your overall plan, and the sooner the better.

    How funds are organized

    Investment funds come in two basic flavors. The mainstream investment funds are a lot like mainstream bankers who want to do business in mid-town and the suburbs. They're incredibly risk-averse and usually have strict provisions in their bylaws and other corporate documents that prohibit investments in the ghetto. The rest are the "special situations" funds that run the check-cashing joints, pawnshops and loan sharks. It's not unusual for a major fund family to have a combination of mainstream and special situations funds, but the funds that are organized to do business in the ghetto are much tougher beasts than the mainstream funds.

    Most funds that aren't specifically organized for special situations investing have ironclad rules against buying shares of companies that aren't listed in a national exchange. In addition to their ironclad rules, many have detailed policies that are almost as inflexible. It's not at all unusual for a fund to have a minimum price requirement of $5, $10 or even $20. Unfortunately, the most stable and reliable funds, the guys you really want as investors, are the hardest to please.

    Over the last thirty years I've attended more financial pitch presentations than I can count. The easiest presentations are ones where a company that's listed on a national exchange wants to raise more money. The second easiest presentations are the ones where a privately held company wants to raise money from investors who are willing to do a deep due diligence dive into their business fundamentals and deal terms. The hardest presentations in the world are the ones for public companies that still live in the ghetto. If your business card shows that you live in the wrong neighborhood the meetings are hard to come by and if you do make it past the reception desk the first question on everybody's lips is "How and when are you going to move out of that crappy and dangerous neighborhood?"

    What it takes to get a NASDAQ listing

    NASDAQ has two market tiers that are potential fits for Axion - the Capital Market and the more prestigious Global Market. It's third tier, the Global Select Market, is reserved for very large issuers and will be out of Axion's reach for at least a few years. While NASDAQ publishes a detailed list of initial listing requirements for each market tier, the key financial requirements for Axion's proposed application are as follows:







    Stockholders equity - or -

    $30 million

    $5 million

    Market capitalization

    $75 million

    $50 million



    Minimum bid price - or -



    Minimum closing price



    While the NASDAQ will consider planned financing transactions when determining whether a company meets the stockholders equity and market capitalization standards, the major hook is a requirement that a company like Axion that wants to upgrade from the OTCBB <edit> in reliance on the Market capitalization standards <edit> must meet the Market capitalization and Minimum price requirements for 90 consecutive trading days before filing an application. Since there are 20 to 22 trading days in the average month we're currently on the cusp of the price evaluation period for a September market upgrade.

    NASDAQ will consider trading prior to a reverse split as solid evidence that the price will hold, but they also tend to like some headroom because they worry about post reverse price declines like everybody else. So its not unusual for a stock that's been trading at $.20 before a reverse split to use a larger ratio than 1 for 20 to give everybody confidence that the price will hold.

    Authorized capital

    The concept of authorized capital is the bane of every securities lawyer because it's a throwback to another time when corporations had a handful of shareholders who actively participated in the business. It makes a world of sense in closely held companies where individual stockholders participate in management decisions and day-to-day operations but it makes no sense in the context of a public company where the biggest holders own 2% or 3% of the outstanding stock.

    Every time a company goes to its stockholders to request an increase in the authorized capital the knee-jerk response is the same. Holders who own an insignificant stake suddenly find themselves overcome by paranoia that the people who manage the business will change established behavior patterns and begin to carelessly issue new shares or greedily line their own pockets.

    I've never seen that happen in real life because managers know they'll be sued for that kind of behavior and they'll almost certainly lose. There are occasional abuses in closely held companies and even companies that trade on the OTC markets, but once a company graduates to a national exchange like the NASDAQ the potential for the kind of malfeasance stockholders fear most effectively disappears.

    If we consider Axion's current capital structure, there are 350 million authorized shares and 221 million shares outstanding in mid-April. By the time you reserve about 30 million shares for future issuance under warrants, stock options and convertible securities that only leaves 100 million shares of wiggle room for the board.

    I don't have the foggiest idea of the amount Axion will need to raise in this next round or what the use of proceeds might be. My fondest hope is that it will need a good deal more than $10 million of survival money. Since I can't begin to estimate the amount of cash that might be needed I can't have any firm conviction that 100 million pre-split shares will be enough to get the company where it needs to be. I've never had a good outcome when I tried to empower with one hand and hobble with the other.

    Corporate governance

    In order for a public company to upgrade its market listing from the OTC to the NASDAQ it must:

    1. Make its annual and interim reports available to shareholders, either by mail or electronically through the company's website;
    2. Have a majority of independent directors;
    3. Have an audit committee consisting solely of independent directors who also satisfy the requirements of SEC Rule 10A-3 and who can read and understand fundamental financial statements. The audit committee must have at least three members. One member of the audit committee must have experience that results in the individual's financial sophistication;
    4. Have a compensation committee consisting solely of independent directors and having at least two members. In addition, Rule 5605(d)(2)(A) includes an additional independence test for compensation committee members. The compensation committee must determine, or recommend to the full board for determination, the compensation of the chief executive officer and all other executive officers;
    5. Adopt a code of conduct applicable to all directors, officers and employees.
    6. Hold an annual meeting of shareholders no later than one year after the end of its fiscal year;
    7. Solicit proxies for all shareholder meetings;
    8. Provide for a quorum of not less than 33 1/3% of the outstanding shares of it voting stock for any meeting of the holders of its common stock;
    9. Conduct appropriate review and oversight of all related party transactions for potential conflict of interest situations; and
    10. Obtain shareholder approval of certain issuances of securities, including:
    • Acquisitions where the issuance equals 20% or more of the pre-transaction outstanding shares …
    • Issuances resulting in a change of control
    • Equity compensation
    • Private placements where the issuance equals 20% or more of the pre-transaction outstanding shares at a price less than the greater of book or market value.

    Axion already complies with most of these rules because they're just good corporate governance. But without the protections the NASDAQ requirements provide for stockholders, it's easy for a management team to get mugged or worse by a special situations investor that says, "Take it or leave it."

    Offering price discounts

    Institutional investors usually expect a discount from the quoted market price of a security because their risk profile is very different from the street investor who can typically sell his entire position in within a few days if he changes his mind. Responsible large investors know that they can't account for more than 5% to 10% of sell-side volume without distorting the market. There's also a strong theoretical basis for the position that a new investor who writes a check to a company to is creating new value for the company and its existing stockholders while an investor who buys shares in the open market creates no new value.

    In general the magnitude of the discount demanded by prospective investors is directly related to the market where the underlying stock trades. Investors fear stocks that trade in the OTC ghetto and they demand deeper discounts when buying shares. As companies move up the market tiers through the NASDAQ Capital Market and Global Market, the discount demands get less severe. By the time a company makes it to the NASDAQ Global Select Market, it can usually sell shares without any discounts.

    The recent follow-on offerings by Capstone Turbine (CPST), Plug Power (PLUG) and ZBB Energy (ZBB) are all fairly typical. The companies took haircuts of 15% to 20% in connection with the deals, but it was nowhere near the 40% to 60% discounts you see when OTC companies sell shares to special situations investors.

    What it takes to bring it all together

    In the final analysis an outfit like Axion has to negotiate with NASDAQ to find out what it will take to satisfy their staff and then negotiate with the investors to find out what it will take to satisfy them. Until you know the answers to those questions, pulling a reverse split number out of thin air and implementing it is a great way to find out that somebody you were depending on is shaking his head and saying "not good enough."

    The Notice of Consent Solicitation talks about a range of 1 for 20 to 1 for 50 because that's what management needs to find a clean path through the negotiations. It could act unilaterally, but that would be a very foolish thing to do.

    Disclosure: I am long AXPW.

    Tags: AXPW
    May 03 3:01 PM | Link | 86 Comments
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