SATCON TECHNOLOGY CORPORATION
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
September 29, 2007 ("2007") AND September 30, 2006 ("2006")
(Unaudited)
Note A. Basis of Presentation
The accompanying unaudited consolidated financial statements include the accounts of SatCon Technology Corporation and its wholly-owned subsidiaries
(collectively, the "Company") as of September 29, 2007 and for the three and nine months then ended have been prepared by the Company in accordance with accounting principles generally accepted
in the United States of America for interim financial reporting and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X.
Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. All intercompany accounts and transactions
have been eliminated. These unaudited consolidated financial statements, which, in the opinion of management, reflect all adjustments (including normal recurring adjustments) necessary for a fair
presentation, should be read in conjunction with the financial statements and notes thereto included in the Company's Annual Report on Form 10-K for the year ended
December 31, 2006. Operating results for the three and nine months ended September 29, 2007 are not necessarily indicative of the results that may be expected for any future interim
period or for the entire fiscal year.
Note B. Realization of Assets and Liquidity
The accompanying unaudited consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States
of America, which contemplates continuation of the Company as a going concern. However, the Company has sustained substantial losses from operations in recent years. In addition, the Company has used,
rather than provided, cash in its operations.
On
October 19, 2007, the Company entered into an Offer to Sell Notes with all of the holders of the Company's senior secured convertible notes (the "Convertible Notes"). Under the
terms of the offer, at anytime prior to November 9, 2007, the Company had the right to purchase the Convertible Notes for an amount equal to 120% of the aggregate outstanding principal amount
of the Convertible Notes plus accrued and unpaid interest thereon. In exchange for the holders' agreement to keep the offer open until November 9, 2007, the Company issued an aggregate of
749,999 shares of the Company's common stock to the holders. The Company will record a charge to operations of approximately $0.9 million in its fourth quarter ending on December 31,
2007 related to such issuance.
On
October 19, 2007, the Company entered into a Note Purchase Agreement with Rockport Capital Partners II, L.P. and NGP Energy Technology Partners, L.P. (the "Investors") to lend
the Company up to $10.0 million to provide funds to repurchase the Convertible Notes, among other things. Pursuant to the Note Purchase Agreement, on November 7, 2007, the Investors
purchased from the Company promissory notes (the "New Notes") in an aggregate principal amount of $10.0 million. The New Notes bear interest at 17% per annum. All unpaid principal, together
with accrued but unpaid interest, is due and payable in full on February 19, 2008.
On
November 7, 2007, the Company used approximately $8.5 million of the proceeds from the sale of the New Notes to retire the Convertible Notes, which represented 120% of
the then outstanding amount due under the Convertible Notes. The Company will record a charge to operations in its fourth quarter ending December 31, 2007 of approximately $1.4 million,
which represents the 20% prepayment penalty under the Convertible Notes. In addition, the Company will record an additional
8
amount
related to the change in fair value of the Convertible Notes on the date such notes were paid off. Upon the retirement of the Convertible Notes, the New Notes became immediately secured by all
of the Company's assets, including the Company's ownership interest in the capital stock of its subsidiaries.
On
November 8, 2007, the Company entered into a Stock and Warrant Purchase agreement with the Investors. Under this purchase agreement, the Investors agreed to purchase in a
private placement up
to 25,000 shares of the Company's newly created Series C convertible preferred stock (the "Series C Preferred Stock") and warrants to purchase up to 19,711,539 shares of common stock,
for an aggregate gross purchase price of $25 million. Each share of Series C Preferred Stock initially converts into common stock at a price equal to $1.04 per share, subject to
adjustment.
This
private placement will occur in two closings. The first closing occurred on November 8, 2007. The Company issued 10,000 shares of Series C Preferred Stock at $1,000
per share for an aggregate gross purchase price of $10 million. These shares are currently convertible into 9,615,384 shares of common stock. The Company also issued warrants to purchase an
aggregate of 15,262,072 shares of common stock. These warrants have an initial exercise price of $1.44 per share and may not be exercised until May 8, 2008. The initial exercise price of these
warrants is subject to adjustment as discussed below.
At
the second closing, which is subject to stockholder approval, as well as other customary closing conditions, the Company will issue 15,000 shares of Series C Preferred Stock
for an aggregate gross purchase price of $15 million, of which $10 million will paid through the cancellation of the New Notes. These shares will be initially convertible into 14,423,076
shares of common stock. At this closing, the Company will also issue warrants to purchase an aggregate of 4,449,467 shares of common stock at an exercise price of $1.25 per share. These warrants will
be exercisable immediately. This second closing is to take place not later than January 31, 2008.
In
the purchase agreement, the Company agreed to reprice the exercise price of the warrants issued at the first closing, subject to stockholder approval. The exercise price of these
warrants is initially $1.44, which equaled the closing bid price of the common stock immediately prior to signing the purchase agreement. If the Company's stockholders approve the second closing, the
exercise price of these warrants will be reduced to $1.25 per share.
In
the purchase agreement, the Company also agreed to issue the Investors additional warrants in the event that the holders of certain existing warrants (none of whom are affiliated with
the Investors) exercise those warrants in the future. Upon such exercises, the Company will issue to the Investors additional warrants to purchase common stock equal to one-half of the
number of shares of common stock issued upon exercise of these existing warrants. The exercise price of these warrants will be $1.25 per share. If all of these existing warrants are exercised, the
Company would need to issue warrants to purchase an additional 4,639,564 shares of common stock to the Investors.
On
July 17, 2007, the holders of the Company's Warrant Bs exercised such warrants in full, acquiring 3,636,638 shares of common stock at $1.31 per share. The Company received
proceeds of approximately $4.8 million. To entice the holders of the Warrant Bs to exercise such warrants the
9
Company
reduced the exercise price from $1.68 to $1.31 per share. As a result of reducing the exercise price the Company recorded a charge to operations in its fiscal third quarter ending
September 29, 2007 related to the warrant modification of approximately $0.9 million. 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, 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 six months from the date of such warrants and ending on the seventh anniversary of the date of such warrants.
The
Company has incurred significant costs to develop its technologies and products. These costs have exceeded total revenue. As a result, the Company has incurred losses in each of the
past ten years. As of September 29, 2007, it had an accumulated deficit of $168.8 million. During the three and nine months ended September 29, 2007, the Company incurred a loss
from operations of approximately $1.1 million and $7.7 million, respectively, while using net cash from operations of approximately $8.0 million for the nine month period ended
September 29, 2007. The Company's restricted cash balances at September 29, 2007 and December 31, 2006 were $1,084,000.
In
view of the matters described in the preceding paragraph, recoverability of a major portion of the recorded asset amounts shown in the accompanying consolidated balance sheet is
dependent upon the continued operations of the Company. The consolidated financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts
or amounts and classification of liabilities that might be necessary should the Company be unable to continue its existence.
The
Company anticipates that its current cash, including proceeds from the exercise of the Warrant Bs, the proceeds from the sale of the New Notes and from the sale of Series C
Preferred Stock and warrants in the preferred stock financing, of which the first closing has occurred and of which the second closing is subject to stockholder approval, will be sufficient to fund
its operations over the next year, subject to the assumptions that follow. First, this assumes the Company achieves its business plan. The business plan envisions a significant increase in revenue and
significant reductions in the cost structure and the cash burn rate from the results experienced in the recent past. Second, this assumes that stockholders approve the second closing and the Company
is able to consummate the second closing of the preferred stock financing with the Investors. Accordingly, if the Company is unable to realize its business plan or is unable consummate the second
closing of the preferred stock financing with the Investors, the Company would not be able to retire the $10 million of New Notes, which mature on February 19, 2008, and the Company
would need to raise additional funds in the near future in order to pay-off the New Notes and sustain operations by selling equity or taking other actions to conserve its cash position,
which could include selling of certain assets and incurring additional indebtedness, subject to the restrictions contemplated in the both the note and preferred stock financing with the Investors.
Such actions would likely require the consent of the Investors, and there can be no assurance that such consent would be given. Furthermore, there can be no assurance that the Company will be able to
raise such funds if they are required. Finally, if the second closing does not occur and the Company were to obtain alternative financing from a source other than the Investors
10
prior
to July 19, 2008, then, at the election of the Investors, the Company would either be required to use its best efforts to include the Investors in that financing or be required to pay the
Investors an alternative transaction fee equal to $1.5 million in cash or, at the Company's option, $2 million of the Company's common stock.
It
should also be noted that, as a result of the preferred stock financing, the holders of certain outstanding warrants have the right to seek redemption of those warrants at their
Black-Scholes value. If the holders of those warrants exercise this redemption right, the Company's liquidity position would be adversely impacted.
Note C. Significant Accounting Policies and Basis of Presentation
Basis of Consolidation
The consolidated financial statements include the accounts of SatCon Technology Corporation and its wholly-owned subsidiaries (SatCon Applied Technology, SatCon
Electronics and SatCon Power Systems). All intercompany accounts and transactions have been eliminated in consolidation.
Revenue Recognition
The Company recognizes revenue from product sales in accordance with Staff Accounting Bulletin ("SAB") No. 104,
Revenue
Recognition
. Product revenue is recognized when there is persuasive evidence of an arrangement, the fee is fixed or determinable, delivery of the product to the customer has
occurred and the Company has determined that collection of the fee is probable. Title to the product passes upon shipment of the product, as the products are typically shipped FOB shipping point,
except for certain foreign shipments. If the product requires installation to be performed by the Company, all revenue related to the product is deferred and recognized upon the completion of the
installation. If the product requires specific customer acceptance, revenue is deferred until customer acceptance occurs or the acceptance provisions lapse, unless the Company can objectively and
reliably demonstrate that the criteria specified in the acceptance provisions are satisfied. When appropriate the Company provides for a warranty reserve at the time the product revenue is recognized.
If a contract involves the provisions of multiple elements and the elements qualify for separation under EITF 00-21,
Revenue Agreements with Multiple
Deliverables
, total estimated contact revenue is allocated to each element based on the relative fair value of each element provided. The amount of revenue allocated to each
element is limited to the amount that is not contingent upon the delivery of another element in the future. Revenue is recognized on each element as described above.
The
Company performs funded research and development and product development for commercial companies and government agencies under both cost reimbursement and fixed-price contracts.
Product development revenue is included in product revenue. Cost reimbursement contracts provide for the reimbursement of allowable costs and, in some situations, the payment of a fee. These contracts
may contain incentive clauses providing for increases or decreases in the fees depending on how costs compare with a budget. On fixed-price contracts, revenue is generally recognized on the percentage
of completion method based upon the proportion of costs incurred to the total estimated costs for the contract. Revenue from reimbursement contracts is recognized as the services are
11
performed.
In each type of contract, the Company receives periodic progress payments or payments upon reaching interim milestones. All payments to the Company for work performed on contracts with
agencies of the U.S. government are subject to audit and adjustment by the Defense Contract Audit Agency. Adjustments are recognized in the period made. When the current estimates of total contract
revenue for commercial product development contracts indicate a loss, a provision for the entire loss on the contract is recorded. As of September 29, 2007 and December 31, 2006, the
Company had approximately $0.8 million and $0, respectively for anticipated contract losses on commercial contracts.
Cost
of product revenue includes materials, labor and overhead. Costs incurred in connection with funded research and development and other revenue arrangements are included in research
and development and other revenue expenses.
Deferred
revenue consists of payments received from customers in advance of services performed, product shipped or installation completed.
Cash and Cash Equivalents
Cash and cash equivalents include demand deposits, overnight repurchase agreements with Silicon Valley Bank (the "Bank") and highly liquid investments with
maturities of three months or less when acquired. Cash equivalents are stated at cost, which approximates market value. At September 29, 2007, the Company had approximately $2.5 million
invested in a money market account with a national bank. At September 29, 2007 and December 31, 2006, the Company had restricted cash as indicated in the table below. In addition, at
September 29, 2007 and December 31, 2006, the Company had overnight repurchase agreements with the Bank of $1,483,453 and $296,844, respectively.
Restricted Cash
|
|
September 29, 2007
|
|
December 31, 2006
|
Convertible Notes
|
|
$
|
1,000,000
|
|
$
|
1,000,000
|
Security deposits
|
|
|
34,000
|
|
|
34,000
|
Certificates of Deposit
|
|
|
50,000
|
|
|
50,000
|
|
|
|
|
|
Total restricted Cash
|
|
$
|
1,084,000
|
|
$
|
1,084,000
|
|
|
|
|
|
Under
the terms of the Convertible Notes, the Company was required, for so long as any Convertible Notes were outstanding, to maintain aggregate cash and cash equivalents equal to the
greater of (i) $1.0 million or (ii) $3.0 million minus 80% of eligible receivables (as defined therein). Based on the level of eligible receivables, the Company was
required to maintain aggregate cash and cash equivalents of $1.0 million. The Company was in compliance with this requirement as of September 29, 2007.
Under
the terms of the New Notes, for so long as any New Notes are outstanding, the Company is required to maintain aggregate cash and cash equivalents of at least $1.0 million.
12
Accounts Receivable
Accounts receivable are reduced by an allowance for amounts that may become uncollectible in the future. The estimated allowance for uncollectible amounts is
based primarily on a specific analysis of accounts in the receivable portfolio and historical write-off experience. While
management believes the allowance to be adequate, if the financial condition of our customers were to deteriorate, resulting in impairment of their ability to make payments, additional allowances may
be required.
Unbilled Contract Costs and Fees and Funded Research and Development Costs in Excess Of Billings
Unbilled contract costs and fees represent revenue recognized in excess of amounts billed due to contractual provisions.
Inventory
Inventory is stated at the lower of cost or market and costs are determined based on the first-in, first-out method of accounting and
include material, labor and manufacturing overhead costs. The Company periodically reviews quantities of inventory on hand and compares these amounts to expected usage of each particular product or
product line. The Company records, as a charge to cost of sales, any amounts required to reduce the carrying value to net realizable value.
Property and Equipment
Property and equipment are stated at cost. Depreciation and amortization is computed using the straight-line method over the asset's estimated useful
life. The estimated useful lives of property and equipment are as follows:
|
|
Estimated Lives
|
Machinery and equipment
|
|
3-10 years
|
Furniture and fixtures
|
|
7-10 years
|
Computer software
|
|
3 years
|
Leasehold improvements
|
|
Lesser of the remaining life of the lease or the useful life of the improvement
|
When
assets are retired or otherwise disposed of, the cost and related depreciation and amortization are eliminated from the accounts and any resulting gain or loss is reflected in
operating expenses.
Goodwill and Intangible Assets
Purchase accounting requires extensive use of accounting estimates and judgments to allocate the purchase price to the fair market value of the assets purchased
and liabilities assumed. The Company has accounted for its acquisitions using the purchase method of accounting. Values were assigned to goodwill and intangible assets based on third-party independent
valuations, as well as management's
13
forecasts
and projections that include assumptions related to future revenue and cash flows generated from the acquired assets.
The
Company applies the provisions of Statement of Financial Accounting Standards ("SFAS") No. 142,
Goodwill and Other Intangible
Assets
. This statement affects the Company's treatment of goodwill and other intangible assets. The statement requires that goodwill existing at the date of adoption be
reviewed for possible impairment and that impairment tests be periodically repeated, with impaired assets written down to fair value. Additionally, existing goodwill and intangible assets must be
assessed and classified within the statement's criteria. Intangible assets with finite useful lives will continue to be amortized over those periods.
The
Company annually performs a goodwill impairment test as of the beginning of its fourth quarter, as required by SFAS No. 142. The Company determines the fair value of each of
the reporting units based on a discounted cash flow income approach. The income approach indicates the fair value of a business enterprise based on the discounted value of the cash flows that the
business can be expected to generate in the future. This analysis is largely based upon projections prepared by the Company and data from sources of publicly available information available at the
time of preparation. These projections are based on management's best estimate of future results. In making these projections, the Company considers the markets it is addressing, the competitive
environment and its advantages. There will usually be differences between estimated and actual results as events and circumstances frequently do not occur as expected, and those differences may be
material. In addition, the Company performs a
macro assessment of the overall likelihood that the Company would achieve the projected cash flows and performed sensitivity analysis using historical data as the basis for projected cash flows.
Long-lived Assets
The Company applies the provisions of SFAS No. 144,
Accounting for the Impairment or Disposal of Long-Lived
Assets
, which supersedes SFAS No. 121,
Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be
Disposed Of
, and the accounting and reporting provisions of the Accounting Principles Board ("APB") Opinion No. 30. SFAS No. 144 addresses financial accounting
and reporting for the impairment or disposal of long-lived assets. The statement requires that long-lived assets be reviewed for possible impairment, if certain conditions
exist, with impaired assets written down to fair value.
The
Company determines the fair value of certain of the long-lived assets based on a discounted cash flow income approach. The income approach indicates the fair value of a
long-lived asset based on the discounted value of the cash flows that the long-lived asset can be expected to generate in the future over the life of the long-lived
asset. This analysis is based upon projections prepared by the Company. These projections represent management's best estimate of future results. In making these projections, the Company considers the
markets it is addressing, the competitive environment and its advantages. There will usually be differences between estimated and actual results as events and circumstances frequently do not occur as
expected, and those differences may be material. In addition, the Company performs a macro assessment of the overall likelihood that we would achieve the
14
projected
cash flows and performed sensitivity analysis using historical data as the basis for projected cash flows.
Foreign Currency Translation
The functional currency of the Company's foreign subsidiary is the local currency. Assets and liabilities of foreign subsidiaries are translated at the rates in
effect at the balance sheet date, while stockholders' equity (deficit) is translated at historical rates. Statements of operations and cash flow amounts are translated at the average rate for the
period. Translation adjustments are included as a component of accumulated other comprehensive loss. Foreign currency gains and losses arising from transactions are reflected in the loss from
operations and were $0.2 million, $0.6 million, during the three and nine months ended September 29, 2007, respectively and $0 and 0.1 million for the three and nine months
ended September 30, 2006, respectively.
Use of Estimates
The preparation of financial statements, in conformity with accounting principles generally accepted in the United States of America, requires management to make
estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported
amounts of revenue and expenses during the period reported. Management believes the most significant estimates include the net realizable value of accounts receivable and inventory, the recoverability
of long-lived assets and intangible assets, the accrued contract losses on fixed-price contracts, the recoverability of deferred tax assets and the fair value of equity and financial
instruments. Actual results could differ from these estimates.
Income Taxes
The Company accounts for income taxes in accordance with SFAS No. 109,
Accounting for Income Taxes
, which
is the asset and liability method for accounting and reporting for income taxes. Under SFAS No. 109, deferred tax assets and deferred tax liabilities are recognized based on temporary
differences between the financial reporting and income tax basis of assets and liabilities using statutory rates. In addition, SFAS No. 109 requires a valuation allowance against net deferred
tax assets if, based upon the available evidence, it is more likely than not that some or all of the deferred tax assets will not be realized.
In
June 2006, the FASB issued Interpretation No. 48, "
Accounting for Uncertainty in Income Taxes, an Interpretation of FASB Statement
No. 109"
("FIN 48"). FIN 48 requires companies to recognize the tax benefits of uncertain tax positions only where the position is "more likely than not"
to be sustained assuming examination by tax authorities. The amount recognized is the amount that represents the largest amount of tax benefit that is greater than 50% likely of being ultimately
realized. A liability is recognized for any benefit claimed, or expected to be claimed, in a tax return in excess of the benefit recorded in the financial statements, along with any interest and
penalties (if applicable) on that excess. FIN 48 requires a tabular reconciliation of the change in the aggregate unrecognized tax benefits
15
claimed,
or expected to be claimed, in tax returns and disclosure relating to the accrued interest and penalties for unrecognized tax benefits. Discussion is also required for those uncertain tax
positions where it is reasonably possible that the estimate of the tax benefit will change significantly in the next twelve months.
The
Company adopted the provisions of FIN 48 on January 1, 2007. The Company did not recognize any decrease in the liability for unrecognized tax benefits as a result of
the adoption.
As
of December 31, 2006, the Company had federal and state NOL carry forwards and federal and state R&D credit carry forwards, which may be available to offset future federal and
state income tax liabilities which expire at various dates starting in 2007 and going through 2026. Utilization of the NOL and R&D credit carry forwards may be subject to a substantial annual
limitation due to ownership change limitations that have occurred previously or that could occur in the future provided by Section 382 of the Internal Revenue Code of 1986, as well as similar
state and foreign provisions. These ownership changes may limit the amount of NOL and R&D credit carry forwards that can be utilized annually to offset future taxable income and tax, respectively. In
general, an ownership change, as defined by Section 382, results from transactions increasing the ownership of certain shareholders or public groups in the stock of a corporation by more than
50 percentage points over a three-year period. Since the Company's formation, the Company has raised capital through the issuance of capital stock on several occasions (both pre and
post initial public offering) which, combined with the purchasing shareholders' subsequent disposition of those shares, may have resulted in a change of control, as defined by Section 382, or
could result in a change of control in the future upon subsequent disposition. The Company has not currently completed a study to assess whether a change of control has occurred or whether there have
been multiple changes of control since the Company's formation due to the significant complexity and cost associated with such study and that there could be additional changes in control in the
future. If the Company has experienced a change of control at any time since Company formation, utilization of its NOL or R&D credit carry forwards would be subject to an annual limitation under
Section 382 which is determined by first multiplying the value of our stock at the time of the ownership change by the applicable long-term tax-exempt rate, and then
could be subject to additional adjustments, as required. Any limitation may result in expiration of a portion of the NOL or R&D credit carry forwards before utilization. Further, until a study is
completed and any limitation known, no amounts are being presented as an uncertain tax position under FIN 48. The Company does not expect to have any taxable income for the foreseeable future.
The
Company did not recognize any interest and penalties associated with unrecognized tax benefits in the accompanying financial statements. The Company would record any such interest
and penalties as a component of interest expense. The Company does not expect any material changes to the unrecognized benefits within 12 months of the reporting date.
Accounting for Stock-based Compensation
The Company has several stock-based employee compensation plans. On October 1, 2005, the Company adopted SFAS No. 123R ("SFAS 123R")
Accounting for
Stock-based Compensation
, using the modified prospective method, which results in the provisions of SFAS 123R only being applied
to the
16
consolidated
financial statements on a going-forward basis (that is, the prior period results have not been restated). At the time of adoption all outstanding options of the Company had vested. Under
the fair value recognition provisions of SFAS 123R, stock-based compensation cost is measured at the grant date based on the value of the award and is recognized as expense over the service
period. Previously, the Company had followed APB Opinion No. 25,
Accounting for Stock Issued to Employees
, and related interpretations, which
resulted in the accounting for employee stock options at their intrinsic value in the consolidated financial statements.
On
March 29, 2005, the SEC issued SAB 107 which expresses the view of the SEC regarding the interaction between SFAS No. 123R and certain SEC rules and regulations
concerning the valuation of share-based payment arrangements for public companies. In particular, SAB 107 provides guidance related to share-based payment transactions with non-employees,
the transition from nonpublic to public entity status, valuation methods (including assumptions such as expected volatility and expected term), the accounting for certain redeemable financial
instrument issues under share-based payment arrangements, the classification of compensation expense, non-GAAP financial measures, first-time adoption of SFAS No. 123R
in an interim period, capitalization of compensation costs related to share-based payment arrangements, the accounting for income tax effects of share-based payment arrangements, the accounting for
income tax effects of share-based payment arrangements upon adoption of SFAS No. 123R, the modification of employee stock options prior to adoption of SFAS No. 123R, and disclosures in
Management's Discussion and Analysis of Financial Condition and Results of Operations subsequent to adoption of SFAS No. 123R. The Company has accounted for its stock option grants in
compliance with SAB 107.
On
November 10, 2005, the Financial Accounting Standards Board ("FASB") issued FASB Staff Position SFAS 123R-3 "
Transition Election
Related to Accounting for Tax Effects of Share-Based Payment Awards."
The Company has elected to adopt the alternative transition method provided in the FASB Staff Position for
calculating the tax effects (if any) of stock-based compensation expense pursuant to SFAS 123R. The alternative transition method includes simplified methods to establish the beginning balance
of additional paid-in capital related to the tax effects of employee stock-based compensation, and to determine the subsequent impact to additional paid-in capital and the
consolidated statements of operations and cash flows of the tax effects of employee stock-based compensation awards that are outstanding upon adoption of SFAS 123R.
The
Company recognized the full impact of its share-based compensation plans in the consolidated financial statements for the three and nine months ended September 29, 2007 and
September 30, 2006 under SFAS 123R and did not capitalize any such costs on the consolidated balance sheets, as such
17
costs
that qualified for capitalization were not material. The following table presents share-based compensation expense included in the Company's consolidated statement of operations:
|
|
Three Months Ended
|
|
Nine Months Ended
|
|
|
September 29,
2007
|
|
September 30,
2006
|
|
September 29,
2007
|
|
September 30,
2006
|
Cost of product revenue
|
|
$
|
76,755
|
|
$
|
14,286
|
|
$
|
101,686
|
|
$
|
83,965
|
Funded research and development and other revenue expense
|
|
|
100,054
|
|
|
22,924
|
|
|
149,690
|
|
|
124,554
|
Selling, general and administrative expenses
|
|
|
134,933
|
|
|
94,880
|
|
|
397,260
|
|
|
612,986
|
|
|
|
|
|
|
|
|
|
Share based compensation expense before tax
|
|
$
|
311,742
|
|
$
|
132,090
|
|
$
|
648,636
|
|
$
|
821,505
|
Income tax benefit
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net compensation expense
|
|
$
|
311,742
|
|
$
|
132,090
|
|
$
|
648,636
|
|
$
|
821,505
|
|
|
|
|
|
|
|
|
|
Compensation
expense associated with the granting of stock options to employees is being recognized on a straight-line basis over the service period of the option. In
instances where the actual compensation expense would be greater than that calculated using the straight-line method, the actual compensation expense is recorded in that period.
The
Company had previously adopted the provisions of SFAS No. 123,
Accounting for Stock-Based Compensation,
as amended by SFAS
No. 148,
Accounting for Stock-Based CompensationTransition and Disclosure
, through disclosure only. SFAS No. 123,
Accounting for Stock-Based
Compensation
, requires the measurement of the fair value of stock options or warrants granted to employees to be included in
the statement of operations or, alternatively, disclosed in the notes to consolidated financial statements. The Company previously accounted for stock based compensation of employees under the
intrinsic value method of APB Opinion No. 25,
Accounting for Stock Issued to Employees
, and had elected the disclosure-only
alternative under SFAS No. 123. The Company records the fair value of stock options and warrants granted to non-employees in exchange for services in accordance with Emerging Issues
Task Force ("EITF") No. 96-18,
Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods
or Services
, as determined using the Black- Scholes option-pricing model, and amortizes the amount ratably over the period the service is performed in the consolidated
statement of operations.
The
weighted average grant date fair value of options granted during the three and nine months ended September 29, 2007 and September 30, 2006 were $1.49, $1.67, $1.42 and
$2.69, respectively, per
18
option.
The fair value of each stock option is estimated on the date of the grant using the Black-Scholes option-pricing model with the following range of assumptions:
|
|
Three Months Ended
|
|
Nine Months Ended
|
Assumptions:
|
|
September 29, 2007
|
|
September 30, 2006
|
|
September 29, 2007
|
|
September 30, 2006
|
Expected life(1)
|
|
6.0 years
|
|
6.25 years
|
|
5.0 years - 6.25
years
|
|
5.0 years to 6.25
years
|
Expected volatility range(2)
|
|
85.64% - 86.24%
|
|
90.6% - 93.0%
|
|
84.7% - 89.9%
|
|
89.8% - 96.5%
|
Dividends
|
|
none
|
|
none
|
|
none
|
|
none
|
Risk-free interest rate(3)
|
|
4.3%
|
|
4.74%
|
|
4.3% - 4.8%
|
|
4.29% to 5.3%
|
Forfeiture Rate(4)
|
|
6.25%
|
|
6.25%
|
|
6.25%
|
|
6.25%
|
-
(1)
-
The
option life was determined using the simplified method for estimating expected option life, which qualify as "plain-vanilla" options.
-
(2)
-
The
stock volatility for each grant is measured using the weighted average of historical daily price changes of the Company's common stock over the most recent period equal to the
expected option life of the grant, the historical short-term trend of the option and other factors, such as expected changes in volatility arising from planned changes in the Company's business
operations.
-
(3)
-
The
risk-free interest rate for each grant is equal to the U.S. Treasury yield curve in effect at the time of grant for instruments with a similar expected life.
-
(4)
-
The
estimated forfeiture rate for each option grant is 6.25%. At the time SFAS 123R was adopted, all outstanding stock options were vested. The company periodically reviews the
estimated forfeiture rate, in light of actual experience.
In December 2005, the Company granted 50,000 shares of restricted common stock to a senior executive as permitted under the 2005 Stock
Incentive Compensation Plan. This grant vested 12,500 shares per quarter over four quarters. 12,500 and 37,500 of these restricted shares vested during the three and nine month period ended
September 30, 2006. Compensation expense for the number of shares issued is recognized over the service period and is recorded in the consolidated statement of operations as a component of
selling, general and administrative expense. For the three and nine month period ended September 30, 2006, compensation expense of $17,750 and $53,250 has been recognized related to this
restricted stock award. This amount is included in the table above that presents share-based compensation expense included in the Company's consolidated statement of operations. The entire grant was
vested as of December 31, 2006.
Net Loss per Basic and Diluted Common Share
The Company reports net loss per basic and diluted common share in accordance with SFAS No. 128,
Earnings Per
Share
, which establishes standards for computing and presenting earnings per share. Basic earnings per share excludes dilution and is computed by dividing income available to
common stockholders by the weighted average number of common shares outstanding for the period. Diluted earnings per share reflects the potential dilution that could occur if securities or other
contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the Company, except when the effect would
be anti-dilutive.
19
Concentration of Credit Risk
Financial instruments that subject the Company to concentrations of credit risk principally consist of cash equivalents, trade accounts receivable, unbilled
contract costs and deposits in bank accounts. The Company deposits its cash and invests in short-term investments primarily through a national commercial bank. Deposits in excess of
amounts insured by the Federal Deposit Insurance Corporation (FDIC) of $100,000 are exposed to loss in the event of nonperformance by the institution. The Company has had cash deposits in excess of
the FDIC insurance coverage.
The
Company's trade accounts receivable and unbilled contract costs and fees are primarily from sales to U.S. government agencies and commercial customers. The Company does not require
collateral and has not historically experienced significant credit losses related to receivables or unbilled contract costs and fees from individual customers or groups of customers in any particular
industry or geographic area.
Significant
customers are defined as those customers that account for 10% or more of total net revenue in a fiscal year or 10% or more of accounts receivable and unbilled contract costs
and fees at the end of a fiscal period. For the three and nine month period ended September 29, 2007, there was one customer that was deemed significant with regards to revenue. For the three
and nine month period ended September 29, 2007, this customer accounted for 27% or $5.7 million and 14% or $5.7 million, respectively, of revenue. At September 29, 2007,
one customer had a balance equal to 10% or $0.9 million of our outstanding gross receivables.
Research and Development Costs
The Company expenses research and development costs as incurred. Research and development and other revenue expenses include costs incurred in connection with
both funded research and development and other revenue arrangements and unfunded research and development activities.
Comprehensive Income (Loss)
Comprehensive income (loss) includes net loss, change in unrealized gains and losses on marketable securities and foreign currency translation adjustments.
Fair Value of Financial Instruments
The Company's financial instruments consist of cash equivalents, accounts receivable, unbilled contract costs and fees, warrants to purchase shares of common
stock, accounts payable, debt instruments, convertible notes and Series B preferred stock. The estimated fair values of these financial instruments approximate their carrying values at
September 29, 2007 and December 31, 2006. The estimated fair values have been determined through information obtained from market sources and management estimates.
20
Convertible Debt Instruments and Warrant Liabilities
The Company accounts for its senior secured convertible notes (the "Convertible Notes"), which were paid off on November 7, 2007, and associated warrants
in accordance with SFAS 155,
Accounting for Certain Hybrid Financial Instruments
an amendment of FASB
Statements No. 133 and 140
, and SFAS No. 133,
Accounting for Derivative Instruments and Hedging Activities.
The
Convertible Notes included features that qualify as embedded derivatives, such as (i) the holders' conversion option, (ii) the Company's option to settle the Convertible Notes at the
scheduled dates in cash or shares of its common stock, and (iii) premiums and penalties the Company would be liable to pay in the event of default. As permitted under SFAS 155, the
Company has irrevocably elected, as of January 1, 2007, to
measure the Convertible Notes and embedded derivatives in their entirety at fair value with changes in fair value recognized as either gain or loss.
The
Company records interest expense under the Convertible Notes based on the greater of (i) 7% or (ii) the six-month LIBOR in effect at the time plus 350 basis
points, as well as the amortization of the debt discount, which the Company computes using the effective interest method. The debt discount represents the difference between the Company's gross
proceeds from the sale of the Convertible Notes in July 2006 of $12.0 million and the fair value of the convertible debt upon issuance, after separately valuing the investor warrants,
the placement agent warrants and the Convertible Notes on a relative fair value basis. By amortizing the debt discount to interest expense, rather than recognizing it as a change in fair value of the
convertible debt instrument and warrants, which is a separate line item in our statement of operations, the Company believes its interest expense line item more appropriately reflects the cost of the
debt associated with the Convertible Notes.
The
Company determined the fair values of the Convertible Notes, investor warrants and placement agent warrants using valuation models it considers to be appropriate. The Company's stock
price has the most significant influence on the fair value of its Convertible Notes and related warrants. An increase in the Company's common stock price would cause the fair values of both the
Convertible Notes and warrants to increase, because the conversion and exercise prices, respectively, of such instruments are fixed at $1.65 and $1.68 per share, respectively, and result in a charge
to our statement of operations. A decrease in the Company's stock price would likewise cause the fair value of the convertible Notes and the warrants to decrease and result in a credit to our
statement of operations. If the price of the Company's common stock were to decline significantly, however, the decrease in the fair value of the Convertible Notes would be limited by the instrument's
debt characteristics. Under such circumstances, the Company's estimated cost of capital would become another significant variable affecting the fair value of the Convertible Notes.
Redeemable convertible Series B Preferred Stock
The Company is currently evaluating the impact of the recent changes to EITF Topic D-98 as it relates to the classification of its redeemable
convertible Series B preferred stock. The comments made by the Securities and Exchange Commission at the June 14, 2007 Emerging Issues Task Force meeting will be applied prospectively
for the first quarter beginning after September 15, 2007.
21
Note D. Loss per Share
The following is the reconciliation of the numerators and denominators of the basic and diluted per share computations of net loss:
|
|
Three Months Ended
|
|
Nine Months Ended
|
|
|
|
September 29,
2007
|
|
September 30,
2006
|
|
September 29,
2007
|
|
September 30,
2006
|
|
Net loss
|
|
$
|
(2,643,859
|
)
|
$
|
(7,583,169
|
)
|
$
|
(9,764,886
|
)
|
$
|
(14,303,477
|
)
|
|
|
|
|
|
|
|
|
|
|
Basic and diluted:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Common shares outstanding, beginning of period
|
|
|
43,967,441
|
|
|
39,439,047
|
|
|
40,105,073
|
|
|
38,382,707
|
|
Weighted average common shares issued during the period
|
|
|
3,873,932
|
|
|
80,329
|
|
|
3,930,096
|
|
|
670,127
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average shares outstandingbasic and diluted
|
|
|
47,841,373
|
|
|
39,519,376
|
|
|
44,035,169
|
|
|
39,052,834
|
|
|
|
|
|
|
|
|
|
|
|
Net loss per weighted average share, basic and diluted
|
|
$
|
(0.06
|
)
|
$
|
(0.19
|
)
|
$
|
(0.22
|
)
|
$
|
(0.37
|
)
|
|
|
|
|
|
|
|
|
|
|
As
of September 29, 2007 and September 30, 2006, shares of common stock issuable upon the exercise of options and warrants were excluded from the diluted average common
shares outstanding, as their effect would have been antidilutive. In addition, shares of common stock issuable upon the conversion of redeemable convertible preferred stock and the Convertible Notes
were excluded from the diluted weighted average common shares outstanding as their effect would also have been antidilutive. The table below summarizes the option and warrants and convertible
preferred stock that were excluded from the calculation above due to their effect being antidilutive:
|
|
September 29,
2007
|
|
September 30,
2006
|
Common Stock issuable upon the exercise of:
|
|
|
|
|
|
Options
|
|
4,893,329
|
|
4,365,253
|
|
Warrants
|
|
9,279,127
|
|
11,097,308
|
|
|
|
|
|
Total Options and Warrants excluded
|
|
14,172,456
|
|
15,462,561
|
|
|
|
|
|
Common stock issuable upon the conversion of the Convertible Notes, at conversion price of $1.65 per share
|
|
4,581,002
|
|
7,272,727
|
Common Stock issuable upon the conversion of redeemable convertible Series B Preferred Stock
|
|
898,438
|
|
833,333
|
22
Note E. Inventory
Inventory components at the end of each period were as follows:
|
|
September 29,
2007
|
|
December 31, 2006
|
Raw material
|
|
$
|
5,140,385
|
|
$
|
3,042,286
|
Work-in-process
|
|
|
6,809,955
|
|
|
2,554,871
|
Finished goods
|
|
|
2,010,991
|
|
|
2,348,717
|
|
|
|
|
|
|
|
$
|
13,961,331
|
|
$
|
7,945,874
|
|
|
|
|
|
Note F. Segment Disclosures
The Company's organizational structure is based on strategic business units that perform services and offer various products to the principal markets in which the
Company's products are sold. These business units equate to four reportable segments: Applied Technology, Power Systems, US, Power Systems, Canada and Electronics.
SatCon
Applied Technology, Inc. performs research and development services in collaboration with third parties. SatCon Power Systems, Canada, ltd. specializes in the
engineering and manufacturing of power systems. Satcon Power Systems, US specializes in the engineering and manufacturing of electric motors and hybrid electric automobile systems. SatCon
Electronics, Inc. designs and manufactures electronic products. The Company's principal operations and markets are located in the United States. In
previous years the Company has shown SatCon Power Systems US and Canada as one segment; the table below has been adjusted to show the Power Systems divisions as separate segments.
The
accounting policies of each of the segments are the same as those described in the summary of significant accounting policies. The Company evaluates performance based on revenue and
profit and loss from operations, including amortization of intangibles. Common costs not directly attributable to a particular segment are included in the corporate segment. These costs include
corporate costs such as executive officer compensation, facility costs, legal, audit and tax and other professional fees.
23
The
following is a summary of the Company's operations by operating segment for the three and nine months ended September 29, 2007 and September 30, 2006:
|
|
Three Months Ended
|
|
Nine Months Ended
|
|
|
|
September 29,
2007
|
|
September 30,
2006
|
|
September 29,
2007
|
|
September 30,
2006
|
|
Applied Technology:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Funded research and development and other revenue
|
|
|
2,724,819
|
|
$
|
1,259,301
|
|
$
|
6,284,664
|
|
$
|
3,456,073
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) from operations, including amortization of intangibles of $78,573 and $235,717 for the three and nine months ended September 29, 2007, respectively, and $66,545 and $227,387 for the three and nine month
period ended September 30, 2006, respectively
|
|
$
|
10,497
|
|
$
|
(364,076
|
)
|
$
|
(365,870
|
)
|
$
|
(1,518,286
|
)
|
|
|
|
|
|
|
|
|
|
|
Power Systems, US
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Product revenue
|
|
$
|
1,039,115
|
|
$
|
843,393
|
|
$
|
3,811,966
|
|
$
|
3,483,349
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss from operations, including restructuring costs of $262,000 for the three and nine months ended September 30, 2006
|
|
$
|
(160,401
|
)
|
$
|
(1,738,866
|
)
|
$
|
(571,812
|
)
|
$
|
(3,448,619
|
)
|
|
|
|
|
|
|
|
|
|
|
Power Systems, Canada:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Product revenue
|
|
$
|
14,698,799
|
|
$
|
4,120,196
|
|
$
|
23,547,007
|
|
$
|
9,726,439
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss from operations
|
|
$
|
(265,683
|
)
|
$
|
(214,852
|
)
|
$
|
(4,423,502
|
)
|
$
|
(1,551,973
|
)
|
|
|
|
|
|
|
|
|
|
|
Electronics:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Product revenue
|
|
$
|
2,528,453
|
|
$
|
2,268,521
|
|
$
|
7,359,466
|
|
$
|
7,535,545
|
|
|
|
|
|
|
|
|
|
|
|
Loss from operations, including amortization of intangibles of $0 and $36,450 for the three and nine months ended September 29, 2007 and $31,249, respectively, and $93,749 for the three and nine month period ended
September 30, 2006, respectively
|
|
$
|
(136,507
|
)
|
$
|
(254,610
|
)
|
$
|
(465,922
|
)
|
$
|
(659,396
|
)
|
|
|
|
|
|
|
|
|
|
|
Corporate:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss from operations
|
|
$
|
(579,788
|
)
|
$
|
(895,087
|
)
|
$
|
(1,831,477
|
)
|
$
|
(3,037,562
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
24
Consolidated:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Product revenue
|
|
$
|
18,266,367
|
|
$
|
7,232,110
|
|
$
|
34,718,439
|
|
$
|
20,745,333
|
|
|
Funded research and development and other revenue
|
|
$
|
2,724,819
|
|
|
1,259,301
|
|
$
|
6,284,664
|
|
|
3,456,073
|
|
|
|
|
|
|
|
|
|
|
|
|
Total revenue
|
|
$
|
20,991,186
|
|
$
|
8,491,411
|
|
$
|
41,003,103
|
|
$
|
24,201,406
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating loss
|
|
$
|
(1,131,882
|
)
|
$
|
(3,467,491
|
)
|
$
|
(7,658,583
|
)
|
$
|
(10,215,836
|
)
|
|
Change in fair value of Convertible Notes and Warrants
|
|
|
(1,008,163
|
)
|
|
(3,573,229
|
)
|
|
(423,535
|
)
|
|
(3,573,229
|
)
|
|
Other (loss) income
|
|
|
(64,370
|
)
|
|
(20,965
|
)
|
|
(129,849
|
)
|
|
42,406
|
|
|
Interest income
|
|
|
56,804
|
|
|
121,976
|
|
|
179,035
|
|
|
274,758
|
|
|
Interest expense
|
|
|
(496,248
|
)
|
|
(643,460
|
)
|
|
(1,731,954
|
)
|
|
(831,576
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Net loss
|
|
$
|
(2,643,859
|
)
|
$
|
(7,583,169
|
)
|
$
|
(9,764,886
|
)
|
$
|
(14,303,477
|
)
|
|
|
|
|
|
|
|
|
|
|
Common
assets not directly attributable to a particular segment are included in the Corporate segment. These assets include cash and cash equivalents, prepaid and other corporate assets.
The following is a summary of the Company's assets by operating segment:
|
|
September 29,
2007
|
|
December 31,
2006
|
Applied Technology:
|
|
|
|
|
|
|
|
Segment assets
|
|
$
|
4,390,011
|
|
$
|
2,995,181
|
Power Systems, US:
|
|
|
|
|
|
|
|
Segment assets
|
|
|
3,078,993
|
|
|
4,196,821
|
Power Systems, Canada
|
|
|
|
|
|
|
|
Segment assets
|
|
|
16,073,170
|
|
|
8,594,046
|
Electronics:
|
|
|
|
|
|
|
|
Segment assets
|
|
|
6,422,265
|
|
|
5,883,674
|
Corporate:
|
|
|
|
|
|
|
|
Segment assets
|
|
|
4,763,321
|
|
|
8,907,565
|
|
|
|
|
|
Total assets
|
|
$
|
34,727,760
|
|
$
|
30,577,287
|
|
|
|
|
|
25
The
Company operates and markets its services and products on a worldwide basis with its principal markets as follows:
|
|
Three Months Ended
|
|
Nine Months Ended
|
|
|
September 29,
2007
|
|
September 30,
2006
|
|
September 29,
2007
|
|
September 30,
2006
|
Revenue by geographic region based on location of customer:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
United States
|
|
$
|
14,349,018
|
|
$
|
7,882,223
|
|
$
|
32,334,076
|
|
$
|
21,500,313
|
|
Rest of world
|
|
|
6,642,168
|
|
|
609,188
|
|
|
8,669,027
|
|
|
2,701,093
|
|
|
|
|
|
|
|
|
|
|
Total revenue
|
|
$
|
20,991,186
|
|
$
|
8,491,411
|
|
$
|
41,003,103
|
|
$
|
24,201,406
|
|
|
|
|
|
|
|
|
|
|
|
September 29,
2007
|
|
December 31,
2006
|
Long-lived assets (including goodwill and intangible assets) by geographic region based on location of operations:
|
|
|
|
|
|
|
|
United States
|
|
$
|
3,487,918
|
|
$
|
4,406,166
|
|
Rest of world
|
|
|
1,031,645
|
|
|
306,584
|
|
|
|
|
|
|
Total long-lived assets (including goodwill and intangible assets)
|
|
$
|
4,519,563
|
|
$
|
4,712,750
|
|
|
|
|
|
Note G. Legal Matters
From time to time, the Company is a party to routine litigation and proceedings in the ordinary course of business. On May 19, 2006, the Company filed a
suit in the U.S. District Court, District of Massachusetts, against one of its customers. The suit demanded full payment of all outstanding amounts due to the Company from its customer. The customer
filed a counterclaim that the Company believed was without merit. The suit was settled on March 9, 2007. The settlement did not have a material effect on the Company's financial position or
operations.
The
Company is not aware of any current or pending litigation in which the Company is or may be a party that it believes could materially adversely affect the results of operations or
financial condition or net cash flows.
Note H. Commitments and Contingencies
Operating Leases
The Company leases its facilities under various operating leases that expire through October 2011.
26
Future
minimum annual rentals under lease agreements at September 29, 2007 are as follows:
Fiscal Year
|
|
|
2007
|
|
$
|
352,919
|
2008
|
|
$
|
1,265,984
|
2009
|
|
$
|
970,609
|
2010
|
|
$
|
523,797
|
2011
|
|
$
|
159,408
|
Thereafter
|
|
$
|
|
|
|
|
Total
|
|
$
|
3,272,717
|
|
|
|
Letters of Credit:
The Company utilizes a standby letter of credit to satisfy a security deposit requirement. Outstanding standby letters of credit as of September 29, 2007
and December 31, 2006 were $34,000. The Company is required to pledge cash as collateral on these outstanding letters of credit. As of September 29, 2007 and December 31, 2006,
the cash pledged as collateral for these letters of credit was $34,000 and is included in restricted cash and cash equivalents on the balance sheet.
Purchase Commitments:
In the ordinary course of business the Company enters into agreements with vendors for the purchase of goods and services through the issuance of purchase orders.
In general the majority of these purchases do not represent commitments of the Company until the goods or services are received. In the third quarter of fiscal 2003 the Company provided for
approximately $0.9 million of outstanding purchase commitments related to its Shaker and UPS product lines. As of September 29, 2007 and
December 31, 2006 the balance outstanding on these purchase commitments was $237,150. These amounts are included in other accrued expenses in the Company's consolidated balance sheet.
Employment Agreements:
The Company has employment agreements with certain employees that provide severance payments and accelerated vesting of options upon termination of employment
under certain circumstances or a change of control, as defined in the employment agreements. As of September 29, 2007 and December 31, 2006, the Company's potential obligation to these
employees was approximately $500,000 and $300,000 in total, respectively. During the year ended December 31, 2006, the Company terminated the employment of an employee that had an employment
agreement that provided for severance payments upon termination. The Company recorded a charge to operations of approximately $250,000 related to this severance agreement as selling, general and
administrative expense in its results of operations for the year ended December 31, 2006. At September 29, 2007 and December 31, 2006, approximately $0 and $0.2 million
were accrued, respectively.
27
Line of Credit:
As a condition precedent to the Convertible Note financing (see Note K), the Company was required to repay any amounts outstanding under the credit
facility and cancel the agreement with Silicon Valley Bank (the "Bank"). The Company no longer has a credit facility with the Bank. Under the terms of the credit facility, the Bank agreed to provide
the Company with a credit line of up to $7.0 million. The credit facility was secured by most of the assets of the Company and advances under the credit facility were limited to 80% of eligible
receivables and up to $1.0 million based on the levels of eligible inventory. Interest on outstanding borrowings accrued at the Bank's prime rate of interest plus 1.5% per annum. In addition,
the credit facility provided the ability to borrow up to $3,000,000 on a revolver basis paying only interest provided that the Company remained in compliance with all financial covenants, as defined.
Note I. Restructuring Costs
On September 19, 2006, the Board of Directors approved a plan to close the Company's Worcester, Massachusetts manufacturing facility by approximately
December 31, 2006 in furtherance of the Company's continuing efforts to streamline operations and reduce its operating costs.
As
of December 31, 2006, approximately $1.6 million had been incurred by the Company related to the restructuring. This charge represents approximately $42,000 related to
employee severance, $45,000 related to employee retention payments and $0.2 million in impairment charges related to property, plant and equipment. In addition, on December 22, 2006, the
Company came to an agreement with the landlord of the Worcester facility whereby the Company would issue 850,000 shares of common stock in exchange for allowing the Company to terminate the lease
early. The stock was issued to the landlord on January 3, 2007. The Company recorded a restructuring charge in the period ended December 31, 2006 in the amount of $1.1 million
related to this agreement and approximately $0.2 million related to the revaluation of investor warrants. The Company paid all remaining amounts related to the restructuring during the quarter
ended March 31, 2007 and did not incur any additional costs during the period associated with the restructuring.
The
following is a summary of the Company's accrued restructuring costs at September 29, 2007 and December 31, 2006:
|
|
September 29, 2007
|
|
December 31, 2006
|
Severance costs and payroll-related costs
|
|
$
|
|
|
$
|
78,326
|
Facility costs
|
|
$
|
|
|
$
|
1,122,000
|
|
|
|
|
|
Accrued restructuring costs
|
|
$
|
|
|
$
|
1,200,326
|
|
|
|
|
|
Note J. Product Warranties
In its Power Systems Divisions the Company provides a warranty to its customers for most of its products sold. In general the Company's warranties are for one
year after the sale of the product, and in some instances five years for photovoltaic inverters. The Company reviews its warranty liability quarterly. Factors taken into consideration when evaluating
the Company's warranty reserve are (i) historical claims for each product, (ii) the development stage of the product, (iii) volume increases, (iv) life of warranty and
(v) other factors.
28
The following is a summary of the Company's accrued warranty activity for the following periods:
|
|
Three Months Ended
|
|
Nine Months Ended
|
|
|
|
September 29,
2007
|
|
September 30,
2006
|
|
September 29,
2007
|
|
September 30,
2006
|
|
Balance at beginning of period
|
|
$
|
922,111
|
|
$
|
374,745
|
|
$
|
679,747
|
|
$
|
556,314
|
|
|
Provision
|
|
|
717,157
|
|
|
103,180
|
|
|
1,220,745
|
|
|
199,180
|
|
|
Usage
|
|
|
(76,107
|
)
|
|
(29,362
|
)
|
|
(337,331
|
)
|
|
(306,931
|
)
|
|
|
|
|
|
|
|
|
|
|
Balance at end of period
|
|
$
|
1,563,161
|
|
$
|
448,563
|
|
$
|
1,563,161
|
|
$
|
448,563
|
|
|
|
|
|
|
|
|
|
|
|
Note K. Convertible Debt Instruments and Warrant Liabilities
Features of the Convertible Notes and Warrants
On July 19, 2006, the Company entered into a Securities Purchase Agreement (the "Purchase Agreement") with the purchasers named therein (the "Purchasers")
in connection with the private placement (the "Private Placement") of:
-
-
$12,000,000
aggregate principal amount of senior secured convertible notes (the "Convertible Notes"), convertible into shares of the Company's 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 Company's common stock at a price of $1.815 per share for a period beginning six months from the date of
such warrants and ending on the seventh anniversary of the date of such warrants; and
-
-
Warrant
Bs to purchase up to an aggregate of 3,636,368 shares of the Company's common stock at a price of $1.68 per share for a period of 90 trading days beginning the later
of six months from the date of such warrants and the date the Securities and Exchange Commission (the "SEC") declares effective a shelf registration statement covering the resale of the common stock
underlying the securities issued in the Private Placement (the "Registration Statement"); to the extent the Warrant Bs are exercised, the Purchasers were entitled to receive additional warrants (the
Warrant Cs), as described below. Because the registration statement was declared effective on September 27, 2006, these warrants were originally exercisable for the 90 trading day period
beginning six months from the date of such warrants (i.e. May 30, 2007). On December 20, 2006 the Warrant Bs were amended to extend the expiration date of the Warrant Bs issued in the
Private Placement from May 30, 2007 to August 31, 2007. In addition, this amendment amended the definition of "Excluded Stock" set forth in the Purchase Agreement to enable the Company
to issue up to 1.1 million shares of the Company's common stock in connection with the early termination of the lease for the Company's facility located in Worcester, Massachusetts, without
such shares being subject to the Purchasers' right of participation set forth in the Purchase Agreement and certain prohibitions set forth in the Convertible Notes and related warrants (as discussed
in Note I above, the Company ultimately settled the lease for 850,000 shares).
29
In
connection with the Private Placement, the Company also entered into a Security Agreement, dated July 19, 2006, with the Purchasers, pursuant to which the Company granted the
Purchasers a security interest in all of its right, title and interest in, to and under all of the Company's 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 Convertible Notes. The following is a summary of the material provisions of the Purchase
Agreement, the Notes, the Warrant As, the Warrant Bs, And the Warrant Cs.
As noted above, the Purchase Agreement provided for the issuance and sale to the Purchasers of the Convertible Notes, the Warrant As and the Warrant Bs for an
aggregate purchase price of $12,000,000. Other significant provisions of the Purchase Agreement include:
-
-
the
requirement that the Company pay off all amounts outstanding under our credit facility with Silicon Valley Bank (see Note H);
-
-
for
so long as the Convertible Notes were outstanding, the obligation that the Company offer to the Purchasers the opportunity to participate in subsequent securities
offerings (up to 50% of such offerings), subject to certain exceptions for, among other things, certain underwritten public offerings and strategic alliances;
-
-
for
so long as the Convertible Notes were outstanding, the obligation that the Company not incur any indebtedness that is senior to, or on parity with, the Convertible Notes
in right of payment, subject to limited exceptions for purchase money indebtedness and capital lease obligations.
On
November 7, 2007, the Convertible Notes were retired using approximately $8.5 million of the proceeds from the sale of the New Notes. See Note B above and
Note N below.
Under
the Purchase Agreement, the Company was also obligated to (i) file the Registration Statement with the SEC within 30 days following the closing of the Private
Placement (which it has satisfied with respect to the securities issued in July 2006), (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 securities issued in July 2006, 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 Company is also obligated to
(i) file a registration statement covering the resale of such common stock with the SEC within 30 days following the issuance of the Warrant Cs(which it has satisfied),
(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
30
review
of such registration statement by the SEC) (which it has satisfied) 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 Company fails to comply with these or certain other provisions, then the Company will be required to pay liquidated damages of 1% of the aggregate purchase price paid by the
Purchasers 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 Purchasers in the Private Placement.
The Convertible Notes originally had an aggregate principal amount of $12 million and were convertible into shares of the Company's 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
Convertible Notes bore interest at the higher of (i) 7.0% per annum or (ii) the six-month LIBOR plus 3.5% (the "Stated Rate 6-Month LIBOR
Condition"). Interest was payable quarterly, beginning on October 31, 2006, and could be made in cash or, at the Company's option if certain equity conditions ("Equity Conditions") were
satisfied, in shares of the Company's common stock. If interest wa paid in shares of common stock, the price per share was at a 10% discount to the volume weighted average price for the 20 trading
days preceding the payment date. The Equity Conditions included (1) the Company had sufficient authorized shares for issuance, (2) such shares were registered for resale or may be sold
without volume restrictions pursuant to Rule 144(k) under the Securities Act, (3) the common stock was listed or quoted (and was not suspended from trading) on an eligible exchange and
such shares were approved for listing upon issuance, (4) the issuance did not violate Section 6(c) of the Convertible Note or the rules and regulations of any trading market,
(5) there had been no event of bankruptcy by the Company, (6) the Company was not in default with respect to any material obligation under any documents associated with issuance of the
Convertible Notes and Warrants, and (7) there had 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 Convertible Notes were to be repaid in 18 equal monthly installments ($500,000 per month) beginning on
February 28, 2007. Such principal payments could be made in cash or, at the Company's option if certain equity conditions were satisfied, in shares of common stock. If principal was paid in
shares of common stock, the price per share was 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 had the right to elect to require the Company to redeem for cash all or any portion
of the outstanding principal on the Convertible Notes; provided,
31
however,
that on the 60 month anniversary of the issuance of the Convertible Notes, the Company would have been required to redeem any remaining outstanding principal and unpaid interest.
Notwithstanding the foregoing, at any time following the one year anniversary of the effective date of the Registration Statement, the Company had the right, under certain circumstances, including
satisfaction of the Equity Conditions with respect to the underlying shares, redeem the Convertible Notes for cash equal to 120% of the aggregate outstanding principal amount plus any accrued and
unpaid interest.
The
Convertible Notes were convertible at the option of the holders into shares of the Company's 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 exceeded 175% of the conversion price,
then, if certain conditions were satisfied, including the Equity Conditions, the Company could require the holders of the Convertible Notes to convert all or any part of the outstanding principal into
shares of common stock at the conversion price. The Convertible Notes contained certain limitations on optional and mandatory conversion, including that, absent stockholder approval of the
transaction, the Company could not issue shares of common stock under the Convertible Notes or the Warrant Bs, in the aggregate, in excess of 19.99% of our outstanding shares on the closing date (or
7,901,276 shares of common stock). As of September 29, 2007, there were no shares of common stock remaining for issuance upon conversion of, or as principal and interest payments on, the
Convertible Notes, of which approximately $7.6 million was outstanding as of September 29, 2007. On October 19, 2007, the Company received stockholder approval
allowing for the issuance of additional shares of the Company's common stock sufficient to allow for the full conversion of the Company's outstanding Convertible Notes, as well as the full payment of
interest and principal on such notes, all in accordance with the terms of such notes.
The
Convertible Notes contained certain covenants and restrictions, including, among others, the following (for so long as any Convertible Notes remained outstanding):
-
-
the
Company was required to 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 Convertible
Notes);
-
-
if
a change of control of the Company occurred, as defined in the Convertible Notes, the holders may elect to require the Company to purchase the Notes for 115% of the
outstanding principal amount plus any accrued and unpaid interest; and
-
-
the
Company could not issue any common stock or common stock equivalents at a price per share less than the $1.65 conversion price.
Events
of default under the Convertible Notes included, among others, payment defaults, cross-defaults, breaches of any representation, warranty or covenant that was not cured within the
proper time periods, failure to perform certain required activities in a timely manner, the Company's common stock was no longer listed on an eligible market, the effectiveness of the Registration
Statement lapsed beyond a specified period and certain bankruptcy-type events involving us or any significant subsidiary.
32
Upon
an event of default, the holders could elect to require us to repurchase all or any portion of the outstanding principal amount of the Convertible Notes for a purchase price equal to the greater
of (i) 115% of such outstanding principal amount, plus all accrued but unpaid interest or (ii) 115% of the then value of the underlying common stock.
In
July 2007, $533,895 of the Convertible Notes and accrued interest were converted into shares of common stock. The Convertible Notes and accrued interest converted at $1.65 per
share. The Company issued 318,182 shares of common stock related to the conversion of the principal on the Convertible Notes and 5,391 shares of common stock related to the accrued
interest due through the date of conversion as a result of the Convertible Note holders' conversions. As a result of such conversions, the monthly installment payments on the Convertible Notes
decreased to $472,115 per month.
On
November 7, 2007, the Convertible Notes were retired using approximately $8.5 million of the proceeds from the sale of the New Notes. See Note B above and
Note N below.
The Warrant As entitle the holders thereof to purchase up to an aggregate of 3,636,368 shares of the Company's common stock at a price of $1.815 per share for a
period beginning six months from the date of such warrants and ending on the seventh anniversary of the date of such warrants. The period prior to six months from the date of the warrants is
hereinafter referred to as the "non-exercise period." The exercise price and the number of shares underlying these warrants are 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.
If
a change of control of the Company occurs, as defined, the holders may elect to require us to purchase the Warrant As for a purchase price equal to the Black-Scholes value of the
remaining unexercised portion of each Warrant A.
For
so long as any Warrant As remain outstanding, we may not issue any common stock or common stock equivalents at a price per share less than $1.65. In the event of a breach of this
provision, the holders may elect to require us to purchase the Warrant As for a purchase price equal to the Black-Scholes value of the remaining unexercised portion of each Warrant A. As a result of
the November 8, 2007 preferred stock financing, as described in Note B above, the holders may exercise this right.
If
following the later of (i) the effective date of the Registration Statement and (ii) the six month anniversary of the issuance date, the volume weighted average price
per share of our common stock for any 20 consecutive trading days exceeds 200% of the exercise price, then, if certain conditions are satisfied, including the Equity Conditions, we may require the
holders of the Warrant As to exercise up to 50% of the unexercised portions of such warrants. If following the 24 month anniversary of the issuance date, the volume weighted average price per
share of our common stock for any 20 consecutive trading days exceeds 300% of the exercise price, then, if certain equity conditions are
33
satisfied,
we may require the holders of the Warrant As to exercise all or any part of the unexercised portions of such warrants.
The Warrant Bs entitled the holders thereof to purchase up to an aggregate of 3,636,368 shares of our common stock at a price of $1.68 per share for a period of
90 trading days beginning the later of six months from the date of such warrants and the date the SEC declares effective the Registration Statement. As noted above, as a result of an amendment, the
expiration date of the Warrant Bs was extended to August 31, 2007.
On
July 17, 2007, the holders of the Warrant Bs exercised such warrants in full, acquiring 3,636,638 shares of common stock at $1.31 per share. The Company received proceeds of
approximately $4.8 million. To entice the holders of the Warrant Bs to exercise such warrants the Company reduced the exercise price from $1.68 to $1.31 per share. As a result of reducing the
exercise price the Company recorded a charge to operations in its fiscal third quarter ending September 29, 2007 related to the warrant modification of approximately $0.9 million to
change in fair value of the Convertible Notes and warrants on the accompanying statement of operations. 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, 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 six months from the date of such warrants and ending on the seventh anniversary of the date of such warrants.
As discussed above, upon the exercise of the Warrant Bs, the holders were entitled to receive additional warrants (The "Warrant Cs"). The Warrant Cs entitled the
holders thereof to purchase up to an aggregate of 1,818,187 shares of our common stock at a price of $1.815 per share for a period beginning six months from the date of such warrants and ending on the
seventh anniversary of the date of such warrants. The period prior to six months from the date of the warrants is hereinafter referred to as the "non-exercise period." The exercise price
and the number of shares underlying these warrants are 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.
If
a change of control of the Company occurs, as defined, the holders may elect to require us to purchase the Warrant Cs for a purchase price equal to the Black-Scholes value of the
remaining unexercised portion of each Warrant C.
For
so long as any Warrant Cs remain outstanding, the Company may not issue any common stock or common stock equivalents at a price per share less $1.65. In the event of a breach of this
provision, the holders may elect to require the Company to purchase the Warrant Cs for a purchase price equal to the Black-Scholes value of the remaining unexercised portion of each Warrant C. As a
result of the
34
November 8,
2007 preferred stock financing, as described in Note B above, the holders may exercise this right.
If
following the later of (i) the effective date of the Registration Statement and (ii) the six month anniversary of the issuance date, the volume weighted average price
per share of our common stock for any 20 consecutive trading days exceeds 200% of the exercise price, then, if certain conditions are satisfied, including the Equity Conditions, we may require the
holders of the Warrant Cs to exercise up to 50% of the unexercised portions of such warrants. If following the 24 month anniversary of the issuance date, the volume weighted average price per
share of our common stock for any 20 consecutive trading days exceeds 300% of the exercise price, then, if certain equity conditions are satisfied, we may require the holders of the Warrant Cs to
exercise all or any part of the unexercised portions of such warrants.
First Albany Capital ("FAC") acted as placement agent in connection with the Private Placement. In addition to a cash transaction fee, FAC or its designees were
entitled to receive five-year warrants to purchase 218,182 shares of the Company's common stock at an exercise price of $1.87 per share. These warrants will be callable after the second
anniversary of the closing of the Private Placement if the 20-day volume weighted average price per share of the Company's common stock exceeds 175% of the exercise price. At the direction
of FAC, these warrants were issued to First Albany Companies Inc., the parent of FAC.
Accounting for the Convertible Debt Instrument and Warrants
The Company has determined that the Convertible Notes constituted a hybrid instrument that has the characteristics of a debt host contract containing several
embedded derivative features that would require bifurcation and separate accounting as a derivative instrument pursuant to the provisions of SFAS 133,
Accounting for
Derivative Instruments and Hedging Activities
(SFAS 133). The Company has identified all of the derivatives associated with the July 19, 2006 financing, and
concluded that two of the derivatives cannot be reliably measured nor reliably associated with another derivative that can be reliably measured. As such, the Company has appropriately valued these
derivatives as a single hybrid
contract together with the Convertible Notes. The contract was remeasured at each period at the fair value with the changes in fair value recognized in the statement of operations until settlement of
the Convertible Notes. As permitted under SFAS 155, the Company has irrevocably elected, as of January 1, 2007, to continue to measure the Convertible Notes and embedded derivatives in
their entirety at fair value with changes in fair value recognized as either gain or loss. The Company has determined that this election had no impact on the accounting for the Convertible Notes.
Upon
issuance, the Warrant As, Warrant Bs and Warrant Cs, along with the Placement Agent Warrants (together the "Warrants"), did not meet the requirements for equity classification set
forth in EITF Issue 00-19,
Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in a Company's Own Stock
,
because such warrants (a) must be settled in registered shares, (b) are subject to substantial liquidated damages if the Company is unable to maintain the effectiveness of the resale
35
registration
of the shares and (c) there is a cash-out election using a Black-Scholes valuation under various circumstances. Therefore these Warrants are required to be accounted
for as freestanding derivative instruments pursuant to the provisions of SFAS 133. Changes in fair value are recognized as either a gain or loss in the statement of operations under the caption
"change in fair value of Notes and warrants". In addition, prior to their exercise by the holders', the Warrant Bs had been classified as a current liability on the balance sheet as they are
outstanding for less than one year.
Upon
issuance of the Convertible Notes and Warrants, the Company allocated the proceeds received from the Convertible Notes and Warrants on a relative fair value basis. As a result of
such allocation, the Company determined the initial carrying value of the Convertible Notes to be $9.4 million. The Convertible Notes were immediately marked to fair value, resulting in a
derivative liability in the amount of $16.3 million. As of December 31, 2006, the Convertible Notes have been marked to fair value resulting in a derivative liability of
$12.7 million. As of September 29, 2007, the Convertible Notes have been marked to fair value resulting in a derivative liability of $7.7 million. The net credit to Change in Fair
Value of Convertible Notes and Warrants, related to the Convertible Notes, for the three months ended September 29, 2007 was $0.8 million. The net credit to Change in Fair Value of
Convertible Notes and Warrants for the nine months ended September 29, 2007 was $1.0 million. For the three and nine months ended September 30, 2006, the charge to Change in Fair
Value of Convertible Notes and Warrants, related to the Convertible Notes, was $3.5 million.
Upon
issuance, the Company allocated $2.7 million of the initial proceeds to the Warrants and immediately marked them to fair value resulting in a derivative liability of
$4.9 million and a charge to other expense of $2.2 million. As of December 31, 2006, the Warrants have been marked to fair value resulting in a derivative liability of
$2.9 million. As of September 29, 2007, the Warrants have been marked to fair value resulting in a derivative liability of $3.5 million. The charge to Change in Fair Value of
Convertible Notes and Warrants, related to the Warrants, for the three and nine months ended September 29, 2007 was $0.9 million and $0.6 million ($1.8 million and
$(0.9) million, including warrant modification, discussed above), respectively. The transaction costs were immediately expensed as part of the fair value adjustment. For the three and nine
months ended September 30, 2006, the
charge to Change in Fair Value of the Convertible Notes and Warrants, related to the Warrants, was $0.1 million.
The
debt discount in the amount of $2.6 million (resulting from the allocation of proceeds) is being amortized to interest expense using the effective interest method over the
expected term of the Convertible Notes. The Company amortized approximately $0.2 million and $0.8 million for the three and nine months ended September 29, 2007, respectively,
which is a component of interest expense. The Company amortized approximately $0.2 million related to the debt discount for the three and nine months ended September 30, 2006.
36
A summary of the changes in the fair value of the Convertible Notes and the Warrants:
|
|
Fair Value
of Notes
|
|
Fair Value
of Warrant
Liabilities
|
|
Total
|
|
Allocation of initial proceeds
|
|
$
|
9,351,084
|
|
$
|
2,648,916
|
|
$
|
12,000,000
|
|
Transaction costs
|
|
|
(1,064,207
|
)
|
|
|
|
|
(1,064,207
|
)
|
Initial fair value adjustment
|
|
|
8,002,518
|
|
|
2,204,950
|
|
|
10,207,468
|
|
|
|
|
|
|
|
|
|
|
at July 19, 2006
|
|
$
|
16,289,395
|
|
$
|
4,853,866
|
|
$
|
21,143,261
|
|
Amortization of debt discount
|
|
|
236,022
|
|
|
|
|
|
236,022
|
|
Fair value adjustment
|
|
|
(4,507,777
|
)
|
|
(2,126,462
|
)
|
|
(6,634,239
|
)
|
|
|
|
|
|
|
|
|
Balance September 30, 2006
|
|
$
|
12,017,640
|
|
$
|
2,727,404
|
|
$
|
14,745,044
|
|
Amortization of debt discount
|
|
|
297,452
|
|
|
|
|
|
297,452
|
|
Restructuring charge fair value adjustment
|
|
|
|
|
|
193,117
|
|
|
193,117
|
|
Fair value adjustment
|
|
|
425,390
|
|
|
32
|
|
|
425,422
|
|
|
|
|
|
|
|
|
|
Balance December 31, 2006
|
|
$
|
12,740,482
|
|
$
|
2,920,553
|
|
$
|
15,661,035
|
|
Amortization of debt discount
|
|
|
286,810
|
|
|
|
|
|
286,810
|
|
Redemptions:
|
|
|
|
|
|
|
|
|
|
|
|
Stock(1)
|
|
|
(1,026,440
|
)
|
|
|
|
|
(1,026,440
|
)
|
Fair value adjustment
|
|
|
(417,430
|
)
|
|
217,837
|
|
|
(199,593
|
)
|
|
|
|
|
|
|
|
|
Balance March 31, 2007
|
|
$
|
11,583,422
|
|
$
|
3,138,390
|
|
$
|
14,721,812
|
|
Amortization of debt discount
|
|
|
257,442
|
|
|
|
|
|
257,442
|
|
Redemptions:
|
|
|
|
|
|
|
|
|
|
|
|
Cash
|
|
|
(500,000
|
)
|
|
|
|
|
(500,000
|
)
|
|
Stock(2)
|
|
|
(1,792,284
|
)
|
|
|
|
|
(1,792,284
|
)
|
Fair value adjustment
|
|
|
210,866
|
|
|
(595,901
|
)
|
|
(385,035
|
)
|
|
|
|
|
|
|
|
|
Balance June 30, 2007
|
|
$
|
9,759,446
|
|
$
|
2,542,489
|
|
$
|
12,301,935
|
|
Amortization of debt discount
|
|
|
224,344
|
|
|
|
|
|
224,344
|
|
Note holder conversion @ $1.65 per share
|
|
|
(525,000
|
)
|
|
|
|
|
(525,000
|
)
|
Redemptions:
|
|
|
|
|
|
|
|
|
|
|
|
Stock(3)
|
|
|
(990,723
|
)
|
|
|
|
|
(990,723
|
)
|
Modification charge of Warrant Bs
|
|
|
|
|
|
872,728
|
|
|
872,728
|
|
Exercise of Warrant Bs and reclassification to equity
|
|
|
|
|
|
(872,728
|
)
|
|
(872,728
|
)
|
Charge related to the initial issuance of Warrant Cs
|
|
|
|
|
|
1,775,666
|
|
|
1,775,666
|
|
Fair value adjustment
|
|
|
(792,747
|
)
|
|
(847,484
|
)
|
|
(1,640,231
|
)
|
|
|
|
|
|
|
|
|
Balance September 29, 2007
|
|
$
|
7,675,320
|
|
$
|
3,470,671
|
|
$
|
11,145,991
|
|
|
|
|
|
|
|
|
|
-
(1)
-
Includes
a fair value adjustment of $26,440.
37
-
(2)
-
Includes
a fair value adjustment of $292,284.
-
(3)
-
Includes
a fair value adjustment of $46,493.
Under
the provisions of the Convertible Notes, the Company could elect to make principal and interest payments in shares of its common stock if the Equity Conditions were satisfied.
In
addition, the Company elected to pay the April 30, 2007 and July 31, 2007 interest payments in shares of its common stock. As a result the Company recorded the following
charges as it relates to the interest payment on the Convertible Notes (interest on the Convertible Notes is due quarterly on the last day of January, April, July and October, respectively):
Due Date
|
|
Shares
|
|
$ Value
|
|
Fair Value
|
|
Additional
Expense Recorded
|
April 30, 2007
|
|
226,746
|
|
$
|
252,824
|
|
$
|
303,941
|
|
$
|
51,117
|
July 31, 2007
|
|
164,385
|
|
$
|
214,858
|
|
$
|
216,069
|
|
$
|
1,211
|
ValuationMethodology and Significant Assumptions
The valuation of derivative instruments utilizes certain estimates and judgments that affect the fair value of the instruments. Fair values for the Company's
derivatives are estimated by utilizing valuation models that consider current and expected stock prices, volatility, dividends, forward yield curves and discount rates. Such amounts and the
recognition of such amounts are subject to significant estimates which may change in the future.
In
estimating the fair value of the Convertible Notes and Warrants the following methods and significant input assumptions were applied:
Methods
-
-
A
binomial model was utilized to estimate the fair value of the Convertible Notes at their inception (July 19, 2006), December 31, 2006, March 31, 2007,
June 30, 2007 and September 29, 2007. A binomial model represents finite possible paths of the underlying instruments price over the life of the instrument and is most practical in
valuations involving variable inputs or when the option/conversion feature is both exercisable and exercise prior to maturity is favorable (
i.e.
, an
American option). The binomial model considers the key features of the Convertible Notes, and is subject to the significant assumptions discussed below. First, a discrete simulation of the Company's
stock price was conducted at each monthly step (node) throughout the expected life of the instrument. Second, an analysis of all future debt repayments was conducted using an appropriate discount
rate, while considering the 10% discount in the event repayments are settled with shares rather than with cash, to estimate the fair value of the debt at each monthly date. The Stated Rate
6-Month LIBOR Condition was estimated by utilizing a 6-month LIBOR forward yield curve based on LIBOR rates and interest rate swaps. Third, an analysis of the higher of the
fair value of debt or conversion/redemption value was conducted relative to each node. Fourth, an analysis of the higher of a holding position (
i.e
.,
fair value of a future node value discounted using an applicable discount rate) or the fair value result of the second step
38
Input
|
|
July 19,
2006
|
|
December 31,
2006
|
|
March 31,
2007
|
|
June 30,
2007
|
|
September 29.
2007
|
|
Quoted Stock Price
|
|
$
|
1.68
|
|
$
|
1.14
|
|
$
|
1.30
|
|
$
|
1.22
|
|
$
|
1.14
|
|
Conversion Price
|
|
$
|
1.65
|
|
$
|
1.65
|
|
$
|
1.65
|
|
$
|
1.65
|
|
$
|
1.65
|
|
Time to Maturity (in years)
|
|
|
5.00
|
|
|
4.55
|
|
|
4.30
|
|
|
4.05
|
|
|
3.80
|
|
Stock Volatility
|
|
|
90
|
%
|
|
90
|
%
|
|
84
|
%
|
|
82
|
%
|
|
70
|
%
|
Risk-Free Rate
|
|
|
5.02
|
%
|
|
4.71
|
%
|
|
4.54
|
%
|
|
4.91
|
%
|
|
4.11
|
%
|
Dividend Rate
|
|
|
0
|
%
|
|
0
|
%
|
|
0
|
%
|
|
0
|
%
|
|
0
|
%
|
-
-
A
binomial lattice model was utilized to estimate the fair value of Warrant As at their inception (July 19, 2006), December 31, 2006, March 31, 2007,
June 30, 2007 and September 29, 2007, as well as the fair value of the Placement Agent Warrants at their inception and December 31, 2006 and the Warrant Cs at their issuance
(July 17, 2007) and of September 29, 2007. A binomial lattice model was utilized to estimate the fair value of the Warrant Bs at their inception (July 19, 2006),
December 31, 2006, March 31, 2007, June 30, 2007 and July 17, 2007 (their date of modification and exercise). The binomial model considers the key features of the Warrants,
and is subject to the significant assumptions discussed below. First, a discrete simulation of the Company's stock price was conducted at each node and throughout the expected life of the instrument.
Second, an analysis of the higher of a holding position (
i.e
., fair value of a future node value discounted using an applicable discount rate) or
exercise position was conducted relative to each node, which considers the non-exercise period, until a final fair value of the instrument is concluded at the node representing the
valuation date. This model requires the following key inputs with respect to the Company and/or instrument:
Warrant As
|
|
Input
|
|
July 19,
2006
|
|
December 31,
2006
|
|
March 31,
2007
|
|
June 30,
2007
|
|
September 29,
2007
|
|
Quoted Stock Price
|
|
$ 1.68
|
|
$ 1.14
|
|
$
|
1.30
|
|
$
|
1.22
|
|
$
|
1.14
|
|
Conversion Price
|
|
$1.815
|
|
$1.815
|
|
$
|
1.815
|
|
$
|
1.815
|
|
$
|
1.815
|
|
Time to Maturity (in years)
|
|
7.01
|
|
6.55
|
|
|
6.31
|
|
|
6.06
|
|
|
5.80
|
|
Stock Volatility
|
|
93
|
%
|
91
|
%
|
|
88
|
%
|
|
86
|
%
|
|
85
|
%
|
Risk-Free Rate
|
|
5.02
|
%
|
4.70
|
%
|
|
4.57
|
%
|
|
4.94
|
%
|
|
4.29
|
%
|
Dividend Rate
|
|
0
|
%
|
0
|
%
|
|
0
|
%
|
|
0
|
%
|
|
0
|
%
|
Non-Exercise Period
|
|
Until 1/19/2007
|
|
Until 1/19/2007
|
|
|
N/A
|
|
|
N/A
|
|
|
N/A
|
|
39
Warrant Bs
|
|
Input
|
|
July 19,
2006
|
|
December 31,
2006
|
|
March 31,
2007
|
|
June 30,
2007
|
|
July 17,
2007
|
|
Quoted Stock Price
|
|
$1.68
|
|
$1.14
|
|
$
|
1.30
|
|
$
|
1.22
|
|
$
|
1.55
|
|
Conversion Price
|
|
$1.68
|
|
$1.68
|
|
$
|
1.68
|
|
$
|
1.68
|
|
$
|
1.68
|
|
Time to Maturity (in years)
|
|
0.75
|
|
0.67
|
|
|
0.42
|
|
|
0.17
|
|
|
0.17
|
|
Stock Volatility
|
|
72
|
%
|
72
|
%
|
|
68
|
%
|
|
40
|
%
|
|
40
|
%
|
Risk-Free Rate
|
|
5.25
|
%
|
5.06
|
%
|
|
5.04
|
%
|
|
4.56
|
|
|
5.02
|
%
|
Dividend Rate
|
|
0
|
%
|
0
|
%
|
|
0
|
%
|
|
0
|
%
|
|
0
|
%
|
Non-Exercise Period
|
|
Until 1/19/2007
|
|
Until 1/19/2007
|
|
|
N/A
|
|
|
N/A
|
|
|
N/A
|
|
Warrant Cs(1)
|
|
Input
|
|
July 17, 2007
|
|
September 29, 2007
|
|
Quoted Stock Price
|
|
$ 1.55
|
|
$ 1.14
|
|
Conversion Price
|
|
$1.815
|
|
$1.815
|
|
Time to Maturity (in years)
|
|
7.0
|
|
6.8
|
|
Stock Volatility
|
|
90
|
%
|
87
|
%
|
Risk-Free Rate
|
|
5.02
|
%
|
4.37
|
%
|
Dividend Rate
|
|
0
|
%
|
0
|
%
|
Non-Exercise Period
|
|
Until 1/17/08
|
|
Until 1/17/08
|
|
(1) Warrant
Cs were issued on July 17, 2007 upon the exercise of the Warrant Bs.
Placement Agent Warrants
|
|
Input
|
|
July 19, 2006
|
|
December 31, 2006
|
|
Quoted Stock Price
|
|
$1.68
|
|
$1.14
|
|
Conversion Price
|
|
$1.87
|
|
$1.87
|
|
Time to Maturity (in years)
|
|
5.00
|
|
4.55
|
|
Stock Volatility
|
|
89
|
%
|
86
|
%
|
Risk-Free Rate
|
|
5.02
|
%
|
4.71
|
%
|
Dividend Rate
|
|
0
|
%
|
0
|
%
|
Non-Exercise Period
|
|
Until 1/19/2007
|
|
Until 1/19/2007
|
|
-
-
A
Black-Scholes option pricing model was utilized to estimate the fair value of Placement Agent Warrants at March 31, 2007, June 30, 2007 and
September 29, 2007. A change in method from the binomial to Black-Scholes was warranted because the warrants' non-exercise period ended
40
Input
|
|
March 31,
2007
|
|
June 30,
2007
|
|
September 29,
2007
|
|
Quoted Stock Price
|
|
$
|
1.30
|
|
$
|
1.22
|
|
$
|
1.14
|
|
Conversion Price
|
|
$
|
1.87
|
|
$
|
1.87
|
|
$
|
1.87
|
|
Time to Maturity (in years)
|
|
|
4.30
|
|
|
4.05
|
|
|
3.80
|
|
Stock Volatility
|
|
|
84
|
%
|
|
82
|
%
|
|
70
|
%
|
Risk-Free Rate
|
|
|
4.54
|
%
|
|
4.91
|
%
|
|
4.11
|
%
|
Dividend Rate
|
|
|
0
|
%
|
|
0
|
%
|
|
0
|
%
|
Non-Exercise Period
|
|
|
N/A
|
|
|
N/A
|
|
|
N/A
|
|
-
-
Penalties
upon an event of default and liquidated damages are fully reflected in the fair values of the Convertible Notes. These features are typical protective features in
similar convertible instruments and accordingly are fully considered in our market based inputs for volatility, interest rates, and appropriate discount rates;
-
-
The
Convertible Notes' Equity Conditions are assumed to have been met throughout the life of the instrument;
-
-
The
Company expects to settle the required future principal redemptions and interest payments, under the terms of the Convertible Notes, with shares of common stock rather
than with cash;
-
-
Stock
volatility was estimated by annualizing the daily volatility of the Company's stock price during the historical period preceding the respective valuation dates and
measured over a period corresponding to the remaining life of the instruments. Historic stock prices were used to estimate volatility as the Company did not have traded options as of the valuation
dates;
-
-
The
volume weighted average price for the 20 trading days preceding a payment date is reasonably approximated by the average of the simulated stock price at each respective
node of the binomial model;
-
-
Based
on the Company's historical operations and management expectations for the near future, the Company's stock was assumed to be a non-dividend-paying stock;
-
-
The
quoted market price of the Company's stock was utilized in the valuations because SFAS 133 requires the use of quoted market prices without considerations of
blockage discounts. Because the stock is thinly traded, the quoted market price may not reflect the market value of a large block of stock; and
-
-
The
quoted market price of the Company's stock as of measurement dates and expected future stock prices were assumed to reflect the effect of dilution upon conversion of the
instruments to shares of common stock.
41
Note L. Redeemable Convertible Series B Preferred Stock
On October 31, 2003, the Company completed a $7.7 million equity transaction involving the issuance of 1,535 shares of its Series B
Convertible Preferred Stock, $0.01 par value per share (the "Series B Preferred Stock"), and warrants to purchase up to 1,228,000 shares of the Company's common stock, to accredited investors
(the "October 2003 Financing Transaction"). In connection with the October 2003 Financing Transaction, the Company issued shares of Series B Preferred Stock for $5,000 per share.
The Series B Preferred Stock is convertible into a number of shares of common stock equal to $5,000 divided by the conversion price of the Series B Preferred Stock, which was initially
$2.50. As of
September 29, 2007 and December 31, 2006, 345 shares of Series B Preferred Stock were outstanding. On October 5, 2007, 5 shares of Series B Preferred Stock were
converted into 13,020 shares of common stock at $1.92 per share.
Dividends on Series B Preferred Stock
The shares of Series B Preferred Stock initially bore a cumulative dividend at a rate of 6% per annum; pursuant to its terms, this was increased to a rate
of rate of 8% per annum on October 1, 2005. Dividends on the Series B Preferred Stock are payable semi-annually and, except in certain limited circumstances, may be paid by
the Company, at its option, either through the issuance of shares of common stock or in cash. If the Company elects to pay the dividend in shares of common stock, the Company will issue a number of
shares of common stock equal to the quotient of the dividend payment divided by the greater of 80% of the average closing bid and ask price of the common stock on the Nasdaq Stock Market for the 15
trading days ending on the 11th trading day prior to the date the dividend is required to be paid, and the conversion price, which was initially $2.50, but which has since been adjusted in accordance
with the terms of the Series B Preferred Stock to $1.92 (as of September 29, 2007).
Liquidation Preference on Series B Preferred Stock
In the event of a liquidation of the Company, the holders of shares of the Series B Preferred Stock are entitled to receive a liquidation payment prior to
the payment of any amount with respect to the shares of the common stock. The amount of this preferential liquidation payment is $5,000 per share of Series B Preferred Stock, plus the amount of
any accrued but unpaid dividends on those shares. After payment of the full liquidation preference amount, the holders of the Series B Preferred Stock will not be entitled to any further
participation as such in any distribution of the Company's assets.
Optional Conversion of Series B Preferred Stock
The Series B Preferred Stock is convertible into common stock at any time at the option of the holder. Each outstanding share of Series B Preferred
Stock is convertible into a number of shares of common stock equal to $5,000 divided by the conversion price of the Series B Preferred Stock, which was initially $2.50, but which has since been
adjusted in accordance with the terms of the Series B Preferred Stock to $1.92 (as of September 29, 2007). The Series B Preferred Stock has anti-dilution protections
which adjust the conversion price, in the event of the issuance of shares of common stock at a price less than the conversion price then in effect. If the Company issues equity securities for a per
share price less than the conversion price of the Series B Preferred Stock, which was initially $2.50, the
42
conversion
price will be adjusted downwards using a weighted average calculation. As noted above, as a result of subsequent issuances of equity securities, the conversion price has been adjusted to
$1.92 (as of September 29, 2007).
Mandatory Conversion of Series B Preferred Stock
Beginning the first date following the effective date of the registration statement which registers all of the common stock issuable upon the conversion of the
Series B Preferred Stock, and provided that certain conditions described below are met, each share of Series B Preferred Stock will be automatically converted into a number of shares of
common stock equal to $5,000 divided by the conversion price of the Series B Preferred Stock, which was initially $2.50, but which has since been adjusted in accordance with the terms of the
Series B Preferred Stock to $1.92 (as of September 29, 2007). Mandatory conversion may only occur if the average of the closing bid and ask price of the common stock on the Nasdaq Stock
Market exceeds $5.00 (as adjusted for stock splits, stock dividends, combinations and similar transactions) for 20 consecutive trading days and either the registration statement governing the
underlying shares of common stock is effective or the shares of common stock issuable upon conversion of the Series B Preferred Stock can be sold pursuant to Rule 144(k) of the
Securities Act of 1933. The mandatory conversion date will be extended for so long as the following events have occurred and are continuing:
-
-
the
effectiveness of the registration statement lapses for 20 consecutive trading days (other than as a result of factors solely in control of the holders of the
Series B Preferred Stock) and the shares of Common Stock into which the shares of Series B Preferred Stock are convertible cannot be sold pursuant to Rule 144(k);
-
-
the
common stock is suspended from listing without subsequent listing on any one of, or is not listed on at least one of, the Nasdaq Global Market, the Nasdaq Capital
Market, the OTC Bulletin Board, the New York Stock Exchange, Inc. or the American Stock Exchange, Inc. for five consecutive trading days;
-
-
the
Company provides notice to the holders of Series B Preferred Stock that it will not or cannot comply with a proper conversion notice; or
-
-
the
Company fails to comply with a proper conversion notice within 10 business days of receipt of that notice.
If,
however, on the mandatory conversion date, a holder is prohibited from converting all of its shares of Series B Preferred Stock as a result of the restrictions described below
under "Conversion Restrictions," such shares of Series B Preferred Stock will not be converted, will remain outstanding and will not accrue any dividends.
Conversion Restrictions
Unless the Company seeks and obtains stockholder approval, the number of shares of common stock the Company may issue upon the conversion of the shares of
Series B Preferred Stock (when aggregated with the number of shares of common stock issued as dividends on the Series B Preferred
43
Stock
and upon exercise of the warrants issued to the placement agent and its affiliates for the Series B Preferred Stock financing) is limited to 4,947,352 shares (representing 19.999% of the
Company's total outstanding common stock as of October 31, 2003 immediately prior to the issuance of the Series B Preferred Stock). In addition, no holder may convert shares of
Series B Preferred Stock if conversion of those shares would result in the holder owning more than 4.99% of the common stock then outstanding or would result in the holder beneficially owning
more than 9.999% of the common stock then outstanding, unless the holder waives this limitation at least 61 days prior to the proposed conversion.
Failure to Convert
If for any reason upon an optional or mandatory conversion the Company cannot issue shares of common stock which have been registered for resale pursuant to an
effective registration statement, then the Company will be obligated to issue as many shares of common stock as its is able to issue. If the Company does not have enough shares of common stock to
cover the conversion of all outstanding shares of Series B Preferred Stock, then with respect to the unconverted shares of Series B Preferred Stock (other than unconverted
Series B Preferred Stock resulting from the restrictions described above under "Conversion Restrictions"), the holder will have the right to (i) void its conversion notice,
(ii) require the Company to redeem the unconverted shares of Series B Preferred Stock at a price per share equal to $6,250 plus liquidated damages and any accrued but unpaid dividends or
(iii) require the Company to issue shares of common stock that have not been registered pursuant to the Securities Act. If the holder elects redemption, the Company may pay the redemption price
either in cash or in shares of common stock based on the quotient of the redemption price divided by the greater of 80% of the average of the closing bid and ask price of the common stock on the
Nasdaq Stock Market for the 15 trading days ending on the 11th trading day prior to the redemption date and the conversion price, which was initially $2.50, but which has since been adjusted in
accordance with the terms of the Series B Preferred Stock to $1.92 (as of September 29, 2007).
Redemption of Series B Preferred Stock
The holders of Series B Preferred Stock are entitled to redeem their shares of Series B Preferred Stock immediately prior to the consolidation,
merger or business combination of the Company with another entity (other than pursuant to a migratory merger effected solely for the purpose of changing the jurisdiction of incorporation of the
Company or a consolidation, merger or other business combination in which holders of the Company's voting power immediately prior to the transaction continue after the transaction to hold, directly or
indirectly, the voting power of the surviving entity or entities necessary to elect a majority of the members of the board of directors (or their equivalent if other than a corporation) of such entity
or entities), the sale or transfer of more than 50% of the Company's assets (other than inventory in the ordinary course of business) or the closing of a purchase, tender or exchange offer made to the
holders of more than 50% of the outstanding common stock. In such an event, the redemption price per share will equal $6,250 plus any accrued but unpaid dividends and liquidated damages. The Company
may pay the redemption price in either cash or shares of common stock based on the quotient of the redemption price divided by the greater of 80% of the
44
average
of the closing bid and ask price of the common stock on the Nasdaq Stock Market for the 15 trading days ending on the 11th trading day prior to the redemption date and the conversion price,
which was initially $2.50, but which has since been adjusted in accordance with the terms of the Series B Preferred Stock to $1.92 (as of September 29, 2007).
In
addition, the holders of Series B Preferred Stock are entitled to redeem their shares of Series B Preferred Stock if the following events occur:
-
-
the
effectiveness of the registration statement lapses for 20 consecutive trading days (other than as a result of factors solely in control of the holders of the
Series B Preferred Stock) and the shares of common stock into which the Series B Preferred Stock are convertible cannot be sold pursuant to Rule 144(k);
-
-
the
common stock is suspended from listing without subsequent listing on any one of, or is not listed on at least one of, the Nasdaq Global Market, the Nasdaq Capital
Market, the OTC Bulletin Board, the New York Stock Exchange, Inc. or the American Stock Exchange, Inc. for five consecutive trading days;
-
-
the
Company provides notice to the holders of Series B Preferred Stock that it will not or cannot comply with a conversion notice that was properly executed and
delivered; or
-
-
the
Company fails to comply with a proper conversion notice within 10 business days of receipt of that notice (other than as a result of the restrictions described above
under "Conversion Restrictions").
With
respect to the events set forth in the first three bullet points above, the redemption price per share will equal $6,000 plus liquidated damages and any accrued but unpaid
dividends. With respect to the event described in the fourth bullet point above, the redemption price per share will be the greater of (i) $6,000 plus liquidated damages and any accrued but
unpaid dividends and (ii) the product of the number of shares of common stock issuable upon the relevant shares of Series B Preferred Stock multiplied by the highest closing price for
the common stock during the period beginning on the date of first occurrence of the event and ending one day prior to the date of payment of the redemption price. If the effectiveness of the
registration statement lapses, listing is suspended or the holders receive a notice that the Company will not or cannot comply with a conversion notice, the Company may choose to pay the redemption
price in shares of common stock based on the quotient of the redemption price divided by the greater of 80% of the average of the closing bid and ask price of the common stock on the Nasdaq Stock
Market for the 15 trading days ending on the 11th trading day prior to the redemption date and the conversion price, which was initially $2.50, but which has since been adjusted in accordance with the
terms of the Series B Preferred Stock to $1.92 (as of September 29, 2007).
Commencing
October 31, 2006 (and so long as a registration statement covering the resale of the shares of common stock underlying the Series B Preferred Stock and related
warrants is effective and none of the events listed in the four bullet points above has occurred and is continuing), the Company may redeem all or any portion of the outstanding Series B
Preferred Stock upon five days prior written notice at a price per share of $7,500, plus liquidated damages and any accrued but unpaid dividends.
45
However,
if a holder has delivered a conversion notice to the Company within three trading days of receipt of the Company's redemption notice for all or a portion of the shares of Series B
Preferred Stock, such shares of Series B Preferred Shares which the Company has designated for redemption may be converted by the holder. In addition, if during the period between the date of
the Company's redemption notice and the redemption date a holder becomes entitled to redeem the Series B Preferred Stock as a result of a consolidation, merger or business combination of the
Company with another entity, the sale or transfer of more than 50% of the Company's assets (other than inventory in the ordinary course of business) or the closing of a purchase, tender or exchange
offer made to the holders of more than 50% of the common stock, the right of the holder with respect to the conversion will take precedence over the Company's redemption notice. If a holder delivers a
conversion notice but is prohibited from converting all of its shares of Series B Preferred Stock as a result of the restrictions described above under "Conversion Restrictions," such shares of
Series B Preferred Stock will not be converted, will remain outstanding and will not accrue any dividends.
As
a result of the issuance of 850,000 shares of common stock to the Worcester landlord on January 3, 2007, the Company was required to adjust the conversion price of the
remaining 345 shares of Series B Preferred Stock outstanding at that time in accordance with the anti-dilution provisions of the Series B Preferred Stock. These shares of
Series B Preferred Stock have a liquidation preference of $5,000 per share and are convertible into a number of shares of common stock equal to $5,000 divided by the conversion price of the
Series B Preferred Stock, which, as a result of the issuance to the landlord, was adjusted from $2.07 per share to $2.04 per share. As of January 3, 2007, the liquidation preference of
the remaining 345 shares of Series B Preferred Stock was $1,725,000, and the shares of Series B Preferred Stock were convertible into 845,588 shares of common stock, after adjustment.
The issuance of common stock to the landlord resulted in an additional adjustment of $16,912, which was recorded as interest expense for the quarter ended March 31, 2007 (see Note I.
Restructuring Costs).
As
a result of the issuance of shares of Common Stock to the landlord, the Company recorded the following non-cash charges as interest expense in its Statement of Operations
during the nine months ended September 29, 2007:
Security
|
|
Conversion/
Exercise Price
|
|
Adjusted Conversion/
Exercise Price
|
|
Interest
Expense
|
Redeemable Convertible Series B Preferred Stock
|
|
$
|
2.07
|
|
$
|
2.04
|
|
$
|
16,912
|
As
a result of the issuance of shares of common stock in lieu of cash for principal payments on the Notes, due February 28, 2007, the Company was required to adjust the conversion
price of the remaining 345 shares of Series B Preferred Stock outstanding at that time in accordance with the anti-dilution provisions of the Series B Preferred Stock. These
shares of Series B Preferred Stock have a liquidation preference of $5,000 per share and are convertible into a number of shares of common stock equal to $5,000 divided by the conversion price
of the Series B Preferred Stock, which, as a result of the issuance in lieu of cash for the principal payments due, the table below details out the adjustments to the conversion price of the
Series B Preferred Stock after issuances of stock in lieu of cash for interest and principal payments on the Notes. As of, February 28, 2007, the liquidation
46
preference
of the remaining 345 shares of Series B Preferred Stock was $1,725,000, and the shares of Series B Preferred Stock were convertible into 849,754 shares of common stock, after
all adjustments. Resulting adjustments are recorded as interest expense for the three and nine month period ended September 29, 2007 (see Note K. Convertible Debt Instruments and Warrant
Liabilities).
As
a result of the issuance of shares of common stock in lieu of cash for the principal and interest payments due on the Convertible Notes, the Company recorded the following
non-cash charges as interest expense in its Statement of Operations during the three and nine months ended September 29, 2007:
Date
|
|
Type of Payment
|
|
Conversion/
Exercise
Price
|
|
Adjusted
Conversion/
Exercise
Price(1)
|
|
Interest
Expense
|
2/28/07
|
|
Principal payment issuing 445,899 shares
|
|
$
|
2.04
|
|
$
|
2.03
|
|
$
|
8,498
|
4/30/07
|
|
Interest payment issuing 226,746 shares
|
|
$
|
2.03
|
|
$
|
2.03
|
|
|
|
5/1/07
|
|
Principal payment issuing 444,361 shares
|
|
$
|
2.03
|
|
$
|
2.02
|
|
$
|
8,112
|
6/1/07
|
|
Principal payment issuing 452,343 shares
|
|
$
|
2.02
|
|
$
|
2.01
|
|
$
|
8,208
|
7/1/07
|
|
Principal payment issuing 480,753 shares
|
|
$
|
2.01
|
|
$
|
2.00
|
|
$
|
9,296
|
7/10/07
|
|
Conversion of Notes and accrued interest at $1.65 per shares, issuing 323,573 shares
|
|
$
|
2.00
|
|
$
|
2.00
|
|
$
|
2,232
|
7/17/07
|
|
Warrant Exercise issuing 3,636,368 shares
|
|
$
|
2.00
|
|
$
|
1.94
|
|
$
|
46,774
|
7/31/07
|
|
Interest payment issuing 174,662 shares
|
|
$
|
1.94
|
|
$
|
1.94
|
|
$
|
2,281
|
08/01/07
|
|
Principal payment issuing 379,716 shares
|
|
$
|
1.94
|
|
$
|
1.94
|
|
$
|
4,870
|
9/01/07
|
|
Principal payment issuing 381,220 shares
|
|
$
|
1.94
|
|
$
|
1.93
|
|
$
|
8,938
|
9/28/2007
|
|
Principal Payment issuing 492,559 shares
|
|
$
|
1.93
|
|
$
|
1.92
|
|
$
|
8,984
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest expense for the three months ended September 29, 2007
|
|
$
|
83,375
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest expense for the nine months ended September 29, 2007
|
|
$
|
108,193
|
|
|
|
|
|
|
|
|
|
|
|
-
(1)
-
After
the adjustments made to the conversion price in the period ended September 29, 2007, the 345 outstanding shares of Series B Preferred Stock are convertible into
898,438 shares of common stock.
47
Note M. Stock Option Plans
Under the Company's 1992, 1994, 1996, 1998, 1999, 2000, 2002 and 2005 Stock Option Plans (collectively, the "Plans"), both qualified and non-qualified
stock options may be granted to certain officers, employees, directors and consultants to purchase up to a total of 9,250,000 shares of the Company's common stock. At September 29, 2007,
4,893,329 of the 9,250,000 shares available for grant under the Plans have been granted.
The
Plans are subject to the following provisions:
-
-
The
aggregate fair market value (determined as of the date the option is granted) of the Company's common stock that any employee may purchase in any calendar year pursuant
to the exercise of qualified options may not exceed $100,000. No person who owns, directly or indirectly, at the time of grant of a qualified option to him or her, more than 10% of the total combined
voting power of all classes of stock of the Company shall be eligible to receive any qualified options under the Plans unless the exercise price is at least 110% of the fair market value of the
Company's common stock subject to the option, determined on the date of grant. Non-qualified options are not subject to this limitation.
-
-
Qualified
options are issued only to employees of the Company, while non-qualified options may be issued to non-employee directors,
consultants and others, as well as to employees of the Company. Options granted under the Plans may not be granted with an exercise price less than 100% of fair value of the Company's common stock, as
determined by the Board of Directors on the grant date.
-
-
Options
under the Plans must be granted within 10 years from the effective date of the Plan. Qualified options granted under the Plans cannot be exercised more than
10 years from the date of grant, except that qualified options issued to 10% or greater stockholders are limited to five-year terms.
-
-
Generally,
the options vest and become exercisable ratably over a four-year period.
-
-
The
Plans contain antidilutive provisions authorizing appropriate adjustments in certain circumstances.
-
-
Shares
of the Company's common stock subject to options that expire without being exercised or that are canceled as a result of the cessation of employment are available for
future grants.
48
The
following table summarizes activity of the Company's stock plans since December 31, 2005: