PROPOSAL 1:
APPROVAL OF THE
ISSUANCE OF ADDITIONAL SHARES OF THE CORPORATIONS
COMMON STOCK SUFFICIENT TO ALLOW FOR THE FULL CONVERSION OF THE
CORPORATIONS OUTSTANDING SENIOR SECURED CONVERTIBLE NOTES,
AS WELL AS THE FULL PAYMENT OF INTEREST AND PRINCIPAL ON SUCH
NOTES, ALL IN ACCORDANCE WITH THE TERMS OF SUCH NOTES
Background and
Reasons for Stockholder Approval
On July 19,
2006, the Corporation sold the following securities in a private placement
exempt from the registration requirements of the Securities Act of 1933, as
amended (the Securities Act):
·
$12,000,000
aggregate principal amount of senior secured convertible notes (the Notes),
convertible into shares of the Corporations common stock at a conversion price
of $1.65 per share;
·
Warrant
As to purchase up to an aggregate of 3,636,368 shares of the Corporations
common stock at a price of $1.815 per share (these warrants are set to expire
on July 19, 2013); and
·
Warrant
Bs to purchase up to an aggregate of 3,636,368 shares of the Corporations
common stock at a price of $1.68 per share (these warrants were set to expire
on August 31, 2007, but, as described below, have since been exercised in
full at $1.31 per share).
The Notes contain certain limitations on the
Corporations ability to issue shares of common stock under the Notes,
including that, absent stockholder approval, the Corporation may not issue
shares of common stock under the Notes (and, as described below, the Warrant
Bs) in excess of 19.99% of the Corporations outstanding shares on the closing
date of the private placement (or 7,901,276 shares of common stock). This
provision is meant to ensure compliance with Marketplace Rule 4350(i)(1)(D) (the
20% Rule) of The Nasdaq Stock Market (Nasdaq). The 20% Rule requires a
company whose securities are traded on Nasdaq to obtain stockholder approval
for the issuance of securities other than in a public offering at a price less
than the greater of the book or market value per share of stock, if the
issuance amounts to 20% or more of the companys common stock outstanding prior
to the issuance.
The warrants issued in the private placement were
originally structured such that the shares of common stock underlying such
warrants did not count towards the 20% Rule. However, on July 17, 2007, to
entice the holders of the Warrant Bs to exercise such warrants, the Corporation
reduced the exercise price of the Warrant Bs from $1.68 to $1.31 per share. The
Warrant Bs were then exercised in full and the Corporation received proceeds of
approximately $4.8 million. However, as a result of the reduction of the
Warrant Bs exercise price to $1.31 per share (which was below the market price
of the Corporations common stock at the time of the original private
placement), the shares underlying the Warrant Bs are now required to be counted
towards the 20% Rule. Accordingly, under the terms of the Notes (as revised at
the time of the exercise of the Warrant Bs), the Corporation may not issue
shares of common stock in excess of 19.99% of the Corporations outstanding
shares on the closing date of the private placement upon conversion of the
Notes, as payment of principal or interest on the Notes, or as a result of the
exercise of the Warrant Bs.
As of September 4, 2007, the Corporation had
issued 7,852,052 shares of common stock in connection with the conversion of
certain of the Notes, the payment of principal and interest on the Notes and
the exercise of the Warrant Bs, representing in total approximately 19.87% of
the Corporations outstanding common stock at the time of the private
placement, leaving only 49,224 shares of common stock remaining for future
issuance under the Notes. As of September 4, 2007, the outstanding
principal balance of the Notes was $7,085,052 and they accrue interest at a
rate per annum currently equal to 8.827%. As described below, the conversion
price of the Notes of $1.65 was below the market price of the Corporations
common stock at the time of the closing of the private placement ($1.68). In
addition, the number of shares of
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common stock that the
Corporation issues in connection with principal and interest payments varies
with the price of the Corporations common stock. Based on the current price of
the Corporations common stock, the Corporation expects to use up the remaining
available shares as interest and principal payments during the fourth quarter
of 2007, absent the stockholder approval the Corporation is seeking. This would
mean that the Corporation could no longer honor conversion requests or continue
to make principal and interest payments in shares of common stock without
violating both the terms of the Notes and the 20% Rule.
Accordingly, the Corporation is seeking stockholder
approval that will allow it to issue as many additional shares of common stock
as may be required to allow for full conversion of the Notes and full payment
of principal and interest on the Notes in accordance with the terms of the
Notes. As a result of such approval, the Corporation would be able to issue
shares of common stock under the Notes (taking into account shares previously
issued under the Notes and the Warrant Bs) in excess of 19.99% of the
Corporations outstanding shares on the closing date of the original private
placement and at a per share price below the market price of the Corporations
common stock at the time of the private placement.
At the time the Corporation amended the terms of the
Warrant Bs to reduce the exercise price, the Company agreed to hold a special
meeting of shareholders at the earliest practical date, but in no event later
than December 31, 2007, for the purpose of obtaining stockholder approval
to allow the Corporation to issue additional shares of common stock under the
Notes. Accordingly, the Corporation is required to hold this Special Meeting
before December 31, 2007. However, a default under the Notes may occur at
any time prior to stockholder approval if, due to the conversion of any
principal amount of any Notes, the Corporation would be required to issue
shares in excess of the 20% Rule, or if the Corporation could no longer make
payments of principal or interest (either in cash or shares). If the
Corporation were to issue shares of common stock in violation of the 20% Rule,
such a violation would likely result in the Corporations shares being delisted
from Nasdaq and would also constitute a default under the Notes. Upon a default
under the Notes, the Noteholders would have various rights and remedies,
including the right to foreclose on the assets of the Corporation securing the
Notes.
In addition, if the Corporation
fails to obtain stockholder approval to allow it to issue additional shares of
common stock under the Notes, the Corporation would be required to pay
principal and interest installments under the Notes in cash, which would
require it to dedicate a substantial portion of its cash flows from operations
and other capital resources to these payments. The Company currently
anticipates that its current cash is sufficient to fund operations and make
payments under the Notes only through the end of the year.
Terms of the
Private Placement of the Notes and Warrants
The following sections
describe the material terms of the private placement of the Notes and warrants.
Securities Purchase
Agreement
As noted above, the securities purchase agreement
entered into in connection with the private placement provided for the issuance
and sale to the investors of the Notes, the Warrant As and the Warrant Bs for
an aggregate purchase price of $12,000,000. Other significant provisions of the
securities purchase agreement include:
·
for
so long as the Notes are outstanding, the obligation that the Corporation offer
to the investors the opportunity to participate in subsequent securities
offerings (up to 50% of such offerings), subject to certain exceptions, such as
certain underwritten public offerings and strategic alliances; and
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·
for
so long as the Notes are outstanding, the obligation that the Corporation not
incur any indebtedness that is senior to, or on parity with, the Notes in right
of payment, subject to limited exceptions for purchase money indebtedness and
capital lease obligations.
Under the securities purchase agreement, the
Corporation was also obligated to (i) file a shelf registration statement
covering the resale of the common stock underlying the securities issued in the
private placement (the Registration Statement) with the SEC within 30 days
following the closing of the private placement, which it has satisfied with
respect to the Notes, Warrant As and Warrant Bs issued in the private
placement, (ii) use its best efforts to cause the Registration Statement
to be declared effective within 90 days following the closing of the private
placement, which it has satisfied with respect to the Notes, Warrant As and
Warrant Bs, as the Registration Statement was declared effective on September 27,
2006, and (iii) use its best efforts to keep the Registration Statement
effective until the earlier of (x) the fifth anniversary of the effective
date of the registration statement, (y) the date all of the securities
covered by the Registration Statement have been publicly sold and (z) the date
all of the securities covered by the Registration Statement may be sold without
restriction under SEC Rule 144(k).
Additionally, with respect to the common stock
underlying the Warrant Cs issued in July 2007 upon exercise of the Warrant
Bs, the Corporation was also obligated to (i) file a registration
statement covering the resale of the common stock underlying the Warrant Cs with
the SEC within 30 days following the issuance of the Warrant Cs, which it has
satisfied by filing the registration statement on August 10, 2007, (ii) use
its best efforts to cause such registration statement to be declared effective
within 60 days following the issuance of the Warrant Cs (or 90 days in the
event of a review of such registration statement by the SEC) and (iii) use
its best efforts to keep such registration statement effective until the
earlier of (x) the fifth anniversary of the effective date of the
registration statement, (y) the date all of the securities covered by the
registration statement have been publicly sold and (z) the date all of the
securities covered by the registration statement may be sold without
restriction under SEC Rule 144(k).
If the Corporation fails
to comply with these or certain other provisions, then the Corporation will be
required to pay liquidated damages of 1% of the aggregate purchase price paid
by the investors in the private placement for the initial occurrence of such
failure and 1.5% of such amount for each subsequent 30 day period the failure
continues. The total liquidated damages under this provision are capped at 24%
of the aggregate purchase price paid by the investors in the private placement.
Senior Secured
Convertible Notes
The Notes that are currently outstanding have an
aggregate principal amount of approximately $7.1 million and are
convertible into shares of the Corporations common stock at a conversion price
of $1.65, subject to adjustment for stock splits, stock dividends,
combinations, distributions of assets or evidence of indebtedness, mergers,
consolidations, sales of all or substantially all assets, tender offers,
exchange offers, reclassifications or compulsory share exchanges.
The Notes bear interest at the higher of (i) 7.0%
per annum or (ii) the six-month LIBOR plus 3.5%. Interest is payable
quarterly, beginning on October 31, 2006, and may be made in cash or, at
the Corporations option if certain equity conditions (Equity Conditions) are
satisfied, in shares of the Corporations common stock. If interest is paid in
shares of common stock, the price per share will be at a 10% discount to the
volume weighted average price for the 20 trading days preceding the payment
date. The Equity Conditions include (1) the Corporation has sufficient
authorized shares for a specific issuance of common stock, (2) such shares
are registered for resale or may be sold without volume restrictions pursuant
to Rule 144(k) under the Securities Act, (3) the Corporations
common stock is listed or quoted (and is not suspended from trading) on an
eligible exchange and such shares are approved for listing upon issuance, (4) the
issuance will not cause the holders of the Notes to exceed certain threshold
ownership percentages or violate the rules and regulations of any trading
market, (5) there has been no event of
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bankruptcy by the
Corporation, (6) the Corporation is not in default with respect to any
material obligation under any documents associated with issuance of the Notes
and warrants, and (7) there has been no public announcement of a pending
or proposed change of control that has not been consummated.
Seventy-five percent (75%) of the original principal
amount of the Notes is to be repaid in 18 equal monthly installments
(originally $500,000 per month) beginning on February 28, 2007. Such
principal payments may be made in cash or, at the Corporations option if the Equity
Conditions are satisfied, in shares of the Corporations common stock. If
principal is paid in shares of common stock, the price per share will be the lesser
of (i) the conversion price or (ii) a 10% discount to the volume
weighted average price for the 20 trading days preceding the payment date. At
any time following the 24-month anniversary of the issuance of the Notes,
the holders may elect to require the Corporation to redeem for cash all or any
portion of the outstanding principal on the Notes; provided, however, that on
the 60 month anniversary of the issuance of the Notes, the Corporation will be
required to redeem any remaining outstanding principal and unpaid interest. At
any time following the one year anniversary of the effective date of the
Registration Statement, the Corporation may, under certain circumstances,
including satisfaction of the Equity Conditions with respect to the shares
underlying the Notes, redeem the Notes for cash equal to 120% of the aggregate
outstanding principal amount plus any accrued and unpaid interest. In order to
exercise its right to redeem the Notes for cash, the Corporation must satisfy
the Equity Conditions, which in turn requires that it obtain stockholder
approval for the issuance of common stock upon conversion or payment of
principal and interest of the Notes to satisfy the 20% Rule.
The Notes are convertible at the option of the holders
into shares of the Corporations common stock at any time at the conversion
price. If at any time following the one year anniversary of the effective date
of the Registration Statement, the volume weighted average price per share of
common stock for any 20 consecutive trading days exceeds 175% of the conversion
price, then, if certain conditions are satisfied, including the Equity
Conditions, the Corporation may require the holders of the Notes to convert all
or any part of the outstanding principal into shares of common stock at the
conversion price. The Notes contain certain limitations on optional and
mandatory conversion, including that, absent stockholder approval of the
transaction, the Corporation may not issue shares of common stock under the
Notes or the Warrant Bs, in the aggregate, in excess of 19.99% of the
Corporations outstanding shares on the closing date (or 7,901,276 shares of
common stock).
The Notes contain
certain covenants and restrictions, including, among others, the following (for
so long as any Notes remain outstanding):
·
the
Corporation must maintain aggregate cash and cash equivalents equal to the
greater of (i) $1,000,000 or (ii) $3,000,000 minus 80% of eligible
receivables (as defined in the Notes);
·
if
a change of control of the Corporation occurs, as defined in the Notes, the
holders may elect to require the Corporation to purchase the Notes for 115% of
the outstanding principal amount plus any accrued and unpaid interest; and
·
the
Corporation may not issue any common stock or common stock equivalents at a
price per share less than the conversion price.
Events of default under the Notes include, among
others, payment defaults, cross-defaults, breaches of any representation,
warranty or covenant that is not cured within the proper time periods, failure
to perform certain required activities in a timely manner, the Corporations
common stock is no longer listed on an eligible market, the effectiveness of
the Registration Statement lapses beyond a specified period and certain
bankruptcy-type events involving the Corporation or any significant subsidiary.
Upon an event of default, the holders may elect to require the Corporation to
repurchase all or any portion of the outstanding principal amount of the Notes
for a purchase price equal to the greater of (i) 115% of such
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outstanding principal
amount, plus all accrued but unpaid interest or (ii) 115% of the then
value of the underlying common stock.
In addition, to secure its
obligations to the holders of the Notes, the Corporation has also entered into
a Security Agreement, dated July 19, 2006, with the investors, pursuant to
which the Corporation granted the investors a security interest in all of the
Corporations personal property and other assets, including its ownership
interest in the capital stock of its subsidiaries, as security for the prompt
payment in full of all amounts due and owing under the Notes. Upon an event of
default under the Notes, the holders may elect to exercise their rights and
remedies with respect to the collateral securing the Notes.
Warrant As
The Warrant As entitle the holders thereof to purchase
up to an aggregate of 3,636,368 shares of the Corporations common stock at a
price of $1.815 per share for a period beginning January 19, 2007 and
ending on July 19, 2013.
If either a change of control of the Corporation
occurs or the Corporation issues any common stock or common stock equivalents
at a price per share less than the conversion price of the Notes, the holders
may elect to require the Corporation to purchase the Warrant As for a purchase
price equal to the Black-Scholes value of the remaining unexercised portion of
each Warrant A.
If following January 19,
2007, the volume weighted average price per share of the Corporations common
stock for any 20 consecutive trading days exceeds 200% of the exercise price,
then, if certain conditions are satisfied, including the Equity Conditions, the
Corporation may require the holders of the Warrant As to exercise up to 50% of
the unexercised portions of such warrants. If following July 19, 2008, the
volume weighted average price per share of the Corporations common stock for
any 20 consecutive trading days exceeds 300% of the exercise price, then, if
certain equity conditions are satisfied, the Corporation may require the
holders of the Warrant As to exercise all or any part of the unexercised
portions of such warrants.
Warrant Bs
The Warrant Bs entitled
the holders thereof to purchase up to an aggregate of 3,636,368 shares of the
Corporations common stock at an exercise price of $1.68 per share for a period
of 90 trading days beginning the later of six months from the date of the
issuance of such warrants and the date the SEC declared the Registration
Statement effective. As a result of an amendment, the expiration date of the
Warrant Bs was extended to August 31, 2007. As noted above, on July 17,
2007, the exercise price was reduced to $1.31 per share and the Warrant Bs were
exercised in full.
Warrant Cs
Pursuant to the original
terms of the Warrant Bs, upon exercise of the Warrant Bs, the warrant holders
were entitled to receive additional warrants (Warrant Cs) to purchase a number
of shares of common stock equal to 50% of the number of shares of common stock
purchased upon exercise of the Warrant Bs. As a result of the full exercise of
the Warrant Bs on July 17, 2007, the holders received Warrant Cs to
purchase 1,818,187 shares of common stock at an exercise price of $1.815 per
share for a period beginning January 17, 2008 and ending on July 17,
2014.
Increased Dilution
The number of shares of the Corporations outstanding
common stock would be significantly increased upon the conversion of the
remaining outstanding principal of the Notes, or if shares of common stock were
issued as payment of interest and principal on the Notes at a 10% discount to
market in
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accordance with the terms
of the Notes. In the event of such conversions or interest and principal
payments, there will be substantial dilution to the Corporations current
stockholders.
For example, assuming the Notes were fully converted
on September 4, 2007, the Corporation would have been required to issue
4,581,002 shares of common stock, which would have constituted 9.59% of the
Corporations outstanding common stock as of September 4, 2007. In
addition, the issuance of these shares, together with shares already issued under
the Notes and Warrant Bs, would constitute 31.58% of the Corporations stock that
was outstanding at the time of the private placement.
Further, assuming the
Corporation elects to continue paying accrued interest and principal on the
Notes in shares of common stock at a 10% discount to market (assuming a volume
weighted average price of $1.10 per share throughout the term of the Notes,
resulting in a discounted price per share of $0.99, and an interest rate of
8.827%), the Corporation would issue approximately 9,609,072 shares of common
stock to repay the Notes and accrued interest in full, which would have
constituted 19.7% of the Corporations outstanding common stock as of September 4,
2007. In addition, the issuance of these shares, together with shares already
issued under the Notes and Warrant Bs, would constitute 44.18% of the
Corporations stock that was outstanding at the time of the private placement.
Increased Number of
Shares Available for Public Sale
Similarly, upon conversion
of the Notes, or payment of interest and principal on the Notes, there will be
a greater number of shares of the Corporations common stock eligible for sale
in the public markets. Any such sales, or the anticipation of the possibility
of such sales, represents an overhang on the market and could depress the
market price of the Corporations common stock.
Vote Required and
Board of Directors Recommendation
The proposal to approve the issuance of additional
shares of the Corporations common stock upon conversion of the Notes, or as
payment of interest and principal on the Notes, requires the affirmative vote
of a majority of the shares of the Corporations common stock present in person
or represented by proxy and voting at the Special Meeting. The Board of
Directors recommends a vote FOR this proposal.
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