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SatCon Technology 10-Q 2009

Documents found in this filing:

  1. 10-Q
  2. Ex-31.1
  3. Ex-32.1
  4. Ex-32.1

Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


 

FORM 10-Q

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the Quarterly Period Ended April 4, 2009

 

Commission File Number 1-11512

 


 

SATCON TECHNOLOGY CORPORATION

(Exact name of registrant as specified in its charter)

 

Delaware
(State or other jurisdiction of
incorporation or organization)

04-2857552
(IRS Employer Identification No.)

 

 

27 Drydock Avenue
Boston, Massachusetts
(Address of principal executive offices)

02210
(Zip Code)

 

(617) 897-2400

(Registrant’s telephone number, including area code)

 


 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x  No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes ¨   No ¨

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company.  See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer o

Accelerated filer x

 

 

Non-accelerated filer o
(Do not check if a smaller reporting company)

Smaller reporting company o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o  No x

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 

Common Stock, $0.01 Par Value,

51,586,893 shares outstanding as of May 1, 2009.

 

 

 



Table of Contents

 

TABLE OF CONTENTS

 

 

Page

 

 

PART I. FINANCIAL INFORMATION

 

Item 1. Financial Statements (Unaudited)

3

Financial Statements of Satcon Technology Corporation

 

Consolidated Balance Sheets

3

Consolidated Statements of Operations

4

Consolidated Statements of Changes in Stockholders’ Deficit

5

Consolidated Statements of Cash Flows

6

Notes to Interim Consolidated Financial Statements

8

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

41

Item 3. Quantitative and Qualitative Disclosures About Market Risk

48

Item 4. Controls and Procedures

48

PART II. OTHER INFORMATION

 

Item 1. Legal Proceedings

49

Item 1A. Risk Factors

49

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

49

Item 3. Defaults Upon Senior Securities

49

Item 4. Submission of Matters to a Vote of Security Holders

49

Item 5. Other Information

49

Item 6. Exhibits

49

Signature

50

Exhibit Index

51

 



Table of Contents

 

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

 

SATCON TECHNOLOGY CORPORATION

CONSOLIDATED BALANCE SHEETS

(Unaudited)

 

 

 

April 4,
2009

 

December 31,
2008

 

ASSETS

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

6,746,429

 

$

9,957,716

 

Restricted cash and cash equivalents

 

84,000

 

84,000

 

Accounts receivable, net of allowance of $173,024 and $168,219 at April 4, 2009 and December 31, 2008, respectively

 

9,348,449

 

11,471,671

 

Unbilled contract costs and fees

 

291,501

 

398,707

 

Inventory

 

7,436,812

 

11,457,532

 

Prepaid expenses and other current assets

 

765,448

 

1,040,441

 

Total current assets

 

$

24,672,639

 

$

34,410,067

 

Property and equipment, net

 

2,350,296

 

1,964,968

 

Goodwill, net

 

123,714

 

123,714

 

Intangibles, net

 

299,954

 

398,526

 

Total assets

 

$

27,446,603

 

$

36,897,275

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS’ DEFICIT

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Line of credit

 

$

4,450,191

 

$

3,000,000

 

Accounts payable

 

6,943,997

 

8,588,313

 

Accrued payroll and payroll related expenses

 

1,461,124

 

2,042,786

 

Other accrued expenses

 

2,898,099

 

2,825,255

 

Accrued contract loss

 

 

1,131,370

 

Accrued restructuring costs

 

456,188

 

602,782

 

Deferred revenue

 

978,360

 

4,214,389

 

Total current liabilities

 

$

17,187,959

 

$

22,404,895

 

 

 

 

 

 

 

Warrant liabilities

 

$

29,819,450

 

$

2,407,438

 

Deferred revenue, net of current portion

 

2,690,860

 

2,512,794

 

Redeemable convertible Series B preferred stock (290 shares issued and outstanding at April 4, 2009 and December 31, 2008, respectively; face value $5,000 per share; liquidation preference $1,450,000, respectively)

 

1,450,000

 

1,450,000

 

Other long-term liabilities

 

50,770

 

58,282

 

Total Liabilities

 

$

51,199,039

 

$

28,833,409

 

Commitments and contingencies (Note H)

 

 

 

 

 

Redeemable convertible Series C preferred stock (25,000 shares issued and outstanding at April 4, 2009 and December 31, 2008, face value $1,000 per share, liquidation preference $26,671,038 and $26,350,000 at April 4, 2009 and December 31, 2008, respectively)

 

$

18,391,125

 

$

17,248,593

 

 

 

 

 

 

 

Stockholders’ deficit:

 

 

 

 

 

Common stock; $0.01 par value, 200,000,000 shares authorized; 51,549,472 and 51,479,822 shares issued and outstanding at April 4, 2009 and December 31, 2008, respectively

 

$

515,495

 

$

514,798

 

Additional paid-in capital

 

171,651,186

 

182,222,762

 

Accumulated deficit

 

(212,539,809

)

(189,962,435

)

Accumulated other comprehensive loss

 

(1,770,433

)

(1,959,852

)

Total stockholders’ deficit

 

$

(42,143,561

)

$

(9,184,727

)

Total liabilities and stockholders’ deficit

 

$

27,446,603

 

$

36,897,275

 

 

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

 

3



Table of Contents

 

SATCON TECHNOLOGY CORPORATION

CONSOLIDATED STATEMENT OF OPERATIONS

(Unaudited)

 

 

 

Three Months Ended

 

 

 

April 4,
2009

 

March 29,
2008

 

Revenue:

 

 

 

 

 

Product revenue

 

$

13,379,849

 

$

10,175,918

 

Funded research and development and other revenue

 

1,481,667

 

1,183,678

 

Total revenue

 

$

14,861,516

 

$

11,359,596

 

 

 

 

 

 

 

Cost of revenue:

 

 

 

 

 

Cost of product revenue

 

$

12,285,038

 

$

9,710,379

 

Cost of funded research and development and other revenue

 

1,116,833

 

1,015,873

 

Total cost of revenue

 

$

13,401,871

 

$

10,726,252

 

 

 

 

 

 

 

Gross margin

 

$

1,459,645

 

$

633,344

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

Research and development

 

$

1,871,262

 

$

868,092

 

Selling, general and administrative

 

4,676,224

 

2,459,109

 

Amortization of intangibles

 

78,573

 

78,572

 

Total operating expenses from continuing operations

 

$

6,626,059

 

$

3,405,773

 

 

 

 

 

 

 

Operating loss from continuing operations

 

$

(5,166,414

)

$

(2,772,429

)

 

 

 

 

 

 

Change in fair value of warrant liabilities

 

$

(5,370,471

)

$

(467,481

)

Other (loss) income, net

 

(138,941

)

258,923

 

Interest income

 

3,731

 

69,385

 

Interest expense

 

(82,361

)

(46,191

)

Net loss from continuing operations

 

$

(10,754,456

)

$

(2,957,793

)

 

 

 

 

 

 

Loss from discontinued operations, net

 

 

$

(443,407

)

Net loss

 

$

(10,754,456

)

$

(3,401,200

)

 

 

 

 

 

 

Deemed dividend and accretion on Series C preferred stock

 

$

(821,494

)

$

(637,991

)

Dividend on Series C preferred stock

 

(321,038

)

(303,962

)

Net loss attributable to common stockholders

 

$

(11,896,988

)

$

(4,343,153

)

 

 

 

 

 

 

Net loss per weighted average share, basic and diluted:

 

 

 

 

 

From loss on continuing operations attributable to common stockholders

 

$

(0.23

)

$

(0.08

)

From loss on discontinued operations

 

 

$

(0.01

)

Net loss attributable to common stockholders per weighted average share, basic and diluted

 

$

(0.23

)

$

(0.09

)

 

 

 

 

 

 

Weighted average number of common shares, basic and diluted

 

51,537,864

 

49,934,919

 

 

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

 

4



Table of Contents

 

SATCON TECHNOLOGY CORPORATION

CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY

For the three months ended April 4, 2009

(Unaudited)

 

 

 

Common
Shares

 

Common
Stock

 

Additional
Paid-in
Capital

 

Accumulated
Deficit

 

Accumulated
Other
Comprehensive
Loss

 

Total Stockholders’ Equity

 

Comprehensive
Loss

 

Balance, December 31, 2008

 

51,479,822

 

$

514,798

 

$

182,222,762

 

$

(189,962,435

)

$

(1,959,852

)

$

(9,184,727

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cumulative effect of a change in accounting principle — January 1, 2009 reclassification of warrants to warrant liabilities

 

 

 

(10,218,623

)

(11,822,918

)

 

(22,041,541

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net loss

 

 

 

 

 

 

 

(10,754,456

)

 

(10,754,456

)

$

(10,754,456

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Issuance of common stock to 401(k) Plan

 

69,650

 

697

 

107,262

 

 

 

107,959

 

 

Accretion of Series C Preferred Stock to its redemption value

 

 

 

(821,494

)

 

 

(821,494

)

 

Dividend on Series C Preferred Stock

 

 

 

(321,038

)

 

 

(321,038

)

 

Employee stock-based compensation

 

 

 

682,317

 

 

 

682,317

 

 

Foreign currency translation adjustment

 

 

 

 

 

189,419

 

189,419

 

189,419

 

Comprehensive loss

 

 

 

 

 

 

 

$

(10,565,037

)

Balance, April 4, 2009

 

51,549,472

 

$

515,495

 

$

171,651,186

 

$

(212,539,809

)

$

(1,770,433

)

$

(42,143,561

)

 

 

 

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

 

5



Table of Contents

 

SATCON TECHNOLOGY CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

 

 

Three Months Ended

 

 

 

April 4,
2009

 

March 29,
2008

 

Cash flows from operating activities:

 

 

 

 

 

Net loss

 

$

(10,754,456

)

$

(3,401,200

)

Net loss from discontinued operations

 

 

443,407

 

Adjustments to reconcile net loss from continuing operations to net cash used in operating activities:

 

 

 

 

 

Depreciation and amortization

 

365,448

 

274,800

 

Provision for uncollectible accounts

 

4,806

 

59,898

 

Non-cash compensation expense related to issuance of stock options and warrants to employees and non-employees and issuance of common stock to 401(k) Plan, including stock based compensation costs of $682,317 and $129,267 for the three months ended April 4, 2009 and March 29, 2008, respectively

 

704,567

 

256,741

 

Change in fair value of warrant liabilities

 

5,370,471

 

467,481

 

Non-cash interest expense

 

29,001

 

33,999

 

Changes in operating assets and liabilities:

 

 

 

 

 

Accounts receivable

 

2,013,159

 

496,356

 

Unbilled contract costs and fees

 

107,206

 

(84,157

)

Prepaid expenses and other assets

 

271,110

 

493

 

Inventory

 

3,915,177

 

(3,741,518

)

Accounts payable

 

(1,586,851

)

(2,048,428

)

Accrued expenses and payroll

 

(438,363

)

377,520

 

Accrued restructuring

 

(146,594

)

 

Accrued contract losses

 

(1,112,412

)

100,459

 

Deferred revenue, current and long portion

 

(2,987,732

)

4,486,859

 

Other current liabilities

 

(7,512

)

(4,810

)

Total adjustments

 

$

6,501,481

 

$

675,693

 

Net cash used in operating activities in continuing operations

 

$

(4,252,975

)

$

(2,282,100

)

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

Purchases of property and equipment

 

$

(660,100

)

$

(101,363

)

Net cash used in investing activities in continuing operations

 

$

(660,100

)

$

(101,363

)

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

Net borrowings under line of credit

 

$

1,450,191

 

$

3,000,000

 

Payments related to warrant holder redemption rights

 

 

(572,250

)

Net proceeds from exercise of options to purchase common stock

 

 

99,385

 

Net cash provided by financing activities in continuing operations

 

$

1,450,191

 

$

2,527,135

 

 

 

 

 

 

 

Cash flows from discontinued operations:

 

 

 

 

 

Net cash used in operating activities of discontinued operations

 

$

 

$

(879,916

)

Net cash used in investing activities of discontinued operations

 

$

 

$

(76,411

)

Net decrease in cash and cash equivalents from discontinued operations

 

$

 

$

(956,327

)

Effects of foreign currency exchange rates on cash and cash equivalents

 

$

251,597

 

$

(102,380

)

Net decrease in cash and cash equivalents

 

$

(3,211,287

)

$

(915,035

)

Cash and cash equivalents at beginning of period

 

$

9,957,716

 

$

12,615,566

 

Cash and cash equivalents at end of period

 

$

6,746,429

 

$

11,700,531

 

 

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

 

6



Table of Contents

 

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION

 

 

 

Three Months Ended

 

Non-cash Investing and Financing Activities:

 

April 4,
2009

 

March 29,
2008

 

Employee stock-based compensation (1)

 

$

682,317

 

$

146,016

 

Common stock issued related to 401(k) contributions

 

$

107,959

 

$

144,511

 

Accretion of redeemable convertible preferred stock discount and dividends

 

$

1,142,532

 

$

637,991

 

Interest and Income Taxes Paid:

 

 

 

 

 

Interest

 

$

53,361

 

$

12,191

 

Income Taxes

 

$

 

$

 

 


(1) Includes $0 and $16,749, related to discontinued operations, for the three month periods ended April 4, 2009 and March 29, 2008, respectively.

 

7



Table of Contents

 

SATCON TECHNOLOGY CORPORATION

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

APRIL4, 2009 (“2009”) AND MARCH 29, 2008 (“2008”)

(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 April 4, 2009 and for the three months ended April 4, 2009 and March 29, 2008 and 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, 2008. Operating results for the three months ended April 4, 2009 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 Company anticipates that its current cash, along with the availability under its credit facility with Silicon Valley Bank, will be sufficient to fund its operations through at least December 31, 2009. The Company has developed a business plan that 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 and allow the Company to remain in compliance with the covenants of the credit facility.  Although the Company believes it has developed a realistic business plan, there is no assurance that it can achieve these objectives.  Accordingly, if the Company is unable to realize its business plan or does not remain in compliance with the covenants of the credit facility, the Company would need to raise additional funds in the near future in order to 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 in the 2007 preferred stock financing.  Such actions would likely require the consent of the investors in that financing (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.

 

Note C. Significant Accounting Policies and Basis of Consolidation

 

There have been no material changes from the Significant Accounting Policies and Basis of Presentation previously disclosed in Part II, Item 8, contained within “Notes to Consolidated Financial Statements” of the Company’s Annual Report on Form 10-K for the fiscal year ending December 31, 2008 except for the adoption of EITF No. 07-05 “Determining Whether an Instrument (or Embedded Feature) Is Indexed to an Entity’s Own Stock” as disclosed below.

 

Basis of Consolidation

 

The consolidated financial statements include the accounts of Satcon and its wholly owned subsidiaries (Satcon Applied Technology, Inc. and Satcon Power Systems Canada, Ltd., and its discontinued operating divisions Satcon Electronics, Inc. and Satcon Power Systems, Inc.). 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 Arrangements 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.

 

8



Table of Contents

 

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 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 April 4, 2009 and December 31, 2008, the Company has accrued approximately $0 and $1.1 million, 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 cost of research and development and other revenue.

 

Deferred revenue consists of payments received from customers in advance of services performed, product shipped or installation completed.  Deferred revenue also consists of cash received for extended product warranties.

 

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 or deferred costs that have not been recognized as revenue or billed to the customer.

 

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 April 4, 2009, the Company had approximately $1.0 million invested in a money market account with a national bank. At April 4, 2009 and December 31, 2008, the Company had restricted cash as indicated in the table below.

 

Restricted Cash

 

April 4, 2009

 

December 31, 2008

 

Security deposits

 

$

34,000

 

$

34,000

 

Certificates of deposit

 

50,000

 

50,000

 

Total restricted cash

 

$

84,000

 

$

84,000

 

 

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.

 

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.

 

9



Table of Contents

 

Foreign Currency Translation

 

The functional currency of the Company’s foreign subsidiary is its local currency. Assets and liabilities of foreign subsidiaries are translated at the rates in effect at the balance sheet date, while stockholders’ equity (deficit) including the long-term portion of intercompany advances 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 income (loss). Foreign currency gains and losses were a charge of approximately $0.1 million for the three months ended April 4, 2009 and income of approximately $0.2 million for the three months ended March 29, 2008.   All foreign currency transaction gains and losses are recorded as a component of other income (expense) and all periods presented have been adjusted to reflect this classification.

 

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, warranty provisions, 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 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 change in the liability for unrecognized tax benefits as a result of the adoption.

 

As of December 31, 2008, the Company had federal and state net operating losses (“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 through 2029. 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 rolling 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

 

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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 has a full valuation allowance against the net operating losses and credits.

 

The tax years 2005 through 2007 remain open to examination by major taxing jurisdictions to which the Company is subject, which are primarily in the United States, as carry forward attributes generated in years past may still be adjusted upon examination by the Internal Revenue Service or state tax authorities if they are or will be used in a future period.  The Company is currently not under examination by the Internal Revenue Service or any other jurisdiction for any tax years.  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, as well as stock options issued outside of such plans as an inducement to engage new executives.  On October 1, 2005, the Company adopted Statement of Financial Accounting Standards 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 consolidated financial statements on a going-forward basis (that is, the prior period results have not been restated).  At the time of adoption the Company had no unvested outstanding options.  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 Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations, which resulted in the accounting for employee share 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 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 shares-based payment arrangements, the classification of compensation expense, non-GAAP financial measures, first-time adoption of SFAS 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 123R, the modification of employee share options prior to adoption of SFAS 123R, and disclosures in Management’s Discussion and Analysis of Financial Condition and Results of Operations subsequent to adoption of SFAS 123R. The Company has accounted for its stock option grants in compliance with SAB 107 and Staff Accounting Bulletin No. 110, Year-End Help for Expensing Employee Stock Option (SAB No. 110).

 

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 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 the additional paid-in capital pool related to the tax effects of employee stock-based compensation, and to determine the subsequent impact to the additional paid-in capital pool 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 uses historical volatility as it believes it is more reflective of market conditions and a better indicator of volatility. The Company uses the simplified calculation of expected life described in SAB No. 107 and SAB No. 110. If the Company determines that another method used to estimate expected volatility is more reasonable than the Company’s current methods, or if another method for calculating these input assumptions is prescribed by authoritative guidance, the fair value calculated for share-based awards could change significantly. Higher volatility and longer expected lives result in an increase to share-based compensation determined at the date of grant.

 

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The Company recognized the full impact of its share-based compensation plans in the consolidated financial statements for the three months ended April 4, 2009 and March 29, 2008 under SFAS 123R and did not capitalize any such costs on the consolidated balance sheets, as such 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

 

 

 

April 4,
2009

 

March 29,
2008

 

Cost of product revenue

 

$

48,628

 

$

20,714

 

Funded research and development and other revenue expense

 

21,058

 

26,795

 

Un-funded research and development and other revenue expenses

 

84,474

 

11,110

 

Selling, general and administrative expenses

 

528,157

 

70,648

 

 

 

 

 

 

 

Share based compensation expense from continuing operations before tax

 

$

682,317

 

$

129,267

 

 

 

 

 

 

 

Share based compensation expense from discontinued operations

 

$

 

$

16,749

 

 

 

 

 

 

 

Total share based compensation expense before tax

 

$

682,317

 

$

146,016

 

 

 

 

 

 

 

Income tax benefit

 

$

 

$

 

 

 

 

 

 

 

Net share-based compensation expense

 

$

682,317

 

$

146,016

 

 

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 weighted average grant date fair value of options granted during the three months ended April 4, 2009 and March 29, 2008 were $1.22 and $1.66, respectively, per 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

 

Assumptions:

 

April 4, 2009

 

March 29, 2008

 

Expected life

 

6.25 years (1)

 

6.25 years (1)

 

Expected volatility ranging from

 

82.14% - 82.81% (2)

 

84.71% - 89.47% (2)

 

Dividends

 

none

 

none

 

Risk-free interest rate

 

2%(3)

 

2.70% to 3.16% (3)

 

Forfeiture Rate (4)

 

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.

 

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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) 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, letters of credit 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 months ended April 4, 2009, there were five customers that were deemed significant with regards to revenue.  For the three months ended April 4, 2009, these customers accounted for approximately 72%, or approximately $10.8 million, of revenue.  At April 4, 2009, there are three customers that were deemed significant with regards to accounts receivable.  At April 4, 2009, these customers accounted for approximately 60%, or approximately $5.7 million, of accounts receivable.

 

Research and Development Costs

 

The Company expenses research and development costs as incurred. Cost of research and development and other revenue includes 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 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 and debt instruments,. The estimated fair values of these financial instruments approximate their carrying values at April 4, 2009 and December 31, 2008. The estimated fair values have been determined through information obtained from market sources and management estimates.  The Company’s warrant liability is recorded at fair value.  See “Fair Value Measurement” section below.

 

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Fair Value Measurements

 

Effective January 1, 2008, the Company adopted SFAS No. 157, “Fair Value Measurements” (“SFAS 157”). In February 2008, the FASB issued FASB Staff Position No. FAS 157-2, “Effective Date of FASB Statement No. 157,” which provides a one year deferral of the effective date of SFAS 157 for non-financial assets and non-financial liabilities, except those that are recognized or disclosed in the financial statements at fair value at least annually. Therefore, the Company has adopted the provisions of SFAS 157 with respect to its financial assets and liabilities only. SFAS 157 defines fair value, establishes a framework for measuring fair value under generally accepted accounting principles and enhances disclosures about fair value measurements. Fair value is defined under SFAS 157 as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Valuation techniques used to measure fair value under SFAS 157 must maximize the use of observable inputs and minimize the use of unobservable inputs. The standard describes a fair value hierarchy based on three levels of inputs, of which the first two are considered observable and the last unobservable, that may be used to measure fair value which are the following:

 

·                  Level 1 - Quoted prices in active markets for identical assets or liabilities.

 

·                  Level 2 - Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

 

·                  Level 3 - Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

 

The adoption of this statement did not have a material impact on the Company’s consolidated results of operations and financial condition.

 

Assets and Liabilities Measured at Fair Value on a Recurring Basis as of April 4, 2009 are as follows:

 

 

 

Fair Value Measurements at Reporting Date Using

 

 

 

 

 

Quoted Prices

 

 

 

 

 

 

 

 

 

in Active

 

Significant

 

 

 

 

 

 

 

Markets for

 

Other

 

Significant

 

 

 

Balance as of

 

Identical

 

Observable

 

Unobservable

 

 

 

April 4,

 

Assets

 

Inputs

 

Inputs

 

Description

 

2009

 

(Level 1)

 

(Level 2)

 

(Level 3)

 

 

 

(Dollars in Thousands)

 

Assets

 

 

 

 

 

 

 

 

 

Money market funds (2)

 

$

1,048,001

 

$

1,048,001

 

$

 

$

 

 

 

 

 

 

 

 

 

 

 

Total Assets

 

$

1,048,001

 

$

1,048,001

 

$

 

$

 

 

 

 

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

 

 

 

 

Long-term warrant liability (1)

 

$

29,819,450

 

$

 

$

29,819,450

 

$

 

 

 

 

 

 

 

 

 

 

 

Total Liabilities

 

$

29,819,450

 

$

 

$

29,819,450

 

$

 

 


(1)

Within the Company’s Level 2 financial assets, which consists of long term investor warrant liabilities comprised of the Warrant As, Warrant Cs, the Series C Preferred Warrants and the placement agent warrants. the Warrant As and Warrant Cs are being fair valued utilizing a binomial lattice model and the placement agent warrants and the Series C Preferred Warrants are being fair valued using the Black-Scholes option pricing model. (see Note J. Warrant Liabilities-Valuation — Methodology and Significant Assumptions and Note K - Redeemable Convertible Series B and Series C Preferred Stock and current liabilities below.).

(2)

Included as a component of cash and cash equivalents on accompanying consolidated balance sheets.

 

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Table of Contents

 

Warrant Liabilities

 

In June 2008, the FASB ratified the consensus reached on Emerging Issues Task Force (“EITF”) Issue No. 07-05, Determining Whether an Instrument (or Embedded Feature) Is Indexed to an Entity’s Own Stock (“EITF No. 07-05”). EITF No. 07-05 clarifies the determination of whether an instrument (or an embedded feature) is indexed to an entity’s own stock, which would qualify as a scope exception under SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. EITF No. 07-05 is effective for financial statements issued for fiscal years beginning after December 15, 2008.

 

Upon the Company’s adoption of EITF No. 07-05 on January 1, 2009, the Company’s evaluation of the Series C Preferred Stock Warrants determined that the 19,899,022 Series C Preferred Stock Warrants did not qualify for a scope exception under SFAS No. 133 as they were determined to not be indexed to the Company’s stock as prescribed by EITF No. 07-05. As a result on the date of adoption the Company reclassified these warrants from additional paid in capital to warrant liabilities through a cumulative effect of a change in accounting principle of $22,041,541.   For the three month period ended April 4, 2009 the Company recorded a charge to change in fair value of warrants of $4,703,493 for the increase in the fair value related to these warrants during the quarter ended April 4, 2009.  The warrants do not qualify for hedge accounting, and as such, all future changes in the fair value of these warrants will be recognized currently in earnings until such time as the warrants are exercised or expire.  These common stock purchase warrants do not trade in an active securities market, and as such, we estimate the fair value of these warrants using the Black-Scholes option pricing model using the following assumptions:

 

Assumptions:

 

January 1, 2009

 

April 4, 2009

 

 

 

 

 

 

 

Expected life

 

5.9 – 6.7 years

 

5.6 – 6.5 years

 

Expected volatility

 

80% - 85%

 

75% - 85%

 

Dividends

 

none

 

none

 

Risk-free interest rate

 

1.69% - 1.83%

 

2.06% - 2.35%

 

 

The Company determined the fair values of the 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 warrants. An increase in the Company’s common stock price would cause the fair values of the warrants to increase, because the exercise price of the warrants is fixed at $1.815 per share 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 warrants to decrease and result in a credit to our statement of operations. See Note J for valuation discussion.

 

Redeemable Convertible Series B Preferred Stock

 

The Company accounts for its Series B Preferred Stock and associated warrants in accordance with EITF 00-27, Application of Issue No. 98-5 to Certain Convertible Instruments, allocating the proceeds received net of transaction costs based on the relative fair value of the redeemable convertible Series B Preferred Stock and the warrants issued to the investors, and then to any beneficial conversion rights contained in the convertible redeemable preferred securities.  The Company determined the initial value of the Series B Preferred Stock and investor warrants using valuation models it considers to be appropriate.  The Series B Preferred Stock is classified within the liability section of the Company’s balance sheet.  To the extent that the Series B Preferred Stock is subject to a remeasurement event under EITF Topic D-98, Classification and Measurement of Redeemable Securities,or is otherwise modified, the Series B Preferred Stock will be reclassified to temporary equity.

 

Redeemable Convertible Preferred Stock

 

The Company accounted for its issuance of Convertible Series C Preferred Stock (the “Series C Preferred Stock”), and associated warrants in accordance with in accordance with EITF 00-27, Application of Issue No. 98-5 to Certain Convertible Instruments, allocating the proceeds received net of transaction costs based on the relative fair value of the redeemable convertible Series C Preferred Stock and the warrants issued to the Investors, and then to any beneficial conversion rights contained in the convertible redeemable preferred securities and in accordance with EITF Topic D-98, classifying the Series C Preferred Stock as temporary equity on the balance sheet between the captions for liabilities and permanent shareholder’s equity.  The Company determined the initial value of the Series C Preferred Stock and investor warrants using valuation models it considers to be appropriate.  The Company is using the effective interest method to accrete the carrying value of the Series C Preferred stock through the earliest possible redemption date (November 8, 2011), at which time the value of the Series C Preferred Stock would be $30.0 million or 120% of its face value.

 

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Table of Contents

 

Reclassifications

 

Certain prior-year balances have been reclassified to conform to current-year presentations.  The Company reclassified the effects of foreign currency translation, of which a portion was previously accounted for in cost of sales, to other income (expense) in its statement of operations for the three months ended March 29, 2008.  The effect of the reclassification was approximately $0.2 million of translation related gains being accounted for in other income for the three month period ended March 29, 2008.

 

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Table of Contents

 

D.  DISCONTINUED OPERATIONS

 

On September 26, 2008, the Company sold its Electronics and Power Systems US business segments to two unrelated companies, for approximately $5.6 million in cash and $0.5 million in non-cash consideration consisting of the accounts receivable balance for the Power Systems US division. Prior to the sale, each of these divisions were reported by the Company as its own operating segment.  Operations associated with these discontinued segments have been classified as loss from discontinued operations in the accompanying consolidated statements of operations, and cash flows associated with these segments are included in cash flows from discontinued operations in the consolidated statements of cash flows.

 

There were no sales and no loss from discontinued operations during the three month period ended April 4, 2009.  Net sales from discontinued operations were $3.5 million for the three months ended March 29, 2008. Loss from discontinued operations was $0.4 million for the three months ended March 29, 2008.   Net sales and net loss from discontinued operations is broken out by division as follows:

 

 

 

Three Months Ended

 

 

 

(amounts in thousands)

 

Division

 

April 4, 2009

 

March 29, 2008

 

 

 

 

 

 

 

Electronics

 

 

 

 

 

Net Sales

 

 

$

2,598

 

Net Loss

 

 

$

(215

)

 

 

 

 

 

 

Power Systems, US

 

 

 

 

 

Net Sales

 

 

$

929

 

Net Loss

 

 

$

(228

)

 

 

 

 

 

 

Discontinued Operations

 

 

 

 

 

Total Net Sales

 

 

$

3,527

 

Total Net Loss

 

 

$

(443

)

 

In accordance with EITF Issue No. 87-24, Allocation of Interest to Discontinued Operations, the Company has not allocated interest to discontinued operations.  The Company has also eliminated all intercompany activity associated with discontinued operations.

 

There were no net assets of the Electronics and Power Systems US divisions at April 4, 2009 and December 31, 2008.

 

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Table of Contents

 

Note E. Loss per Share

 

The following is the reconciliation of the numerators and denominators of the basic and diluted loss per share computations:

 

 

 

Three Months Ended

 

 

 

April 4,
2009

 

March 29,
2008

 

Loss from continuing operations

 

$

(10,754,456

)

$

(2,957,793

)

Loss from discontinued operations

 

$

 

$

(443,407

)

Accretion and dividends and deemed dividends on Series C Preferred Stock

 

$

(1,142,532

)

$

(941,953

)

Net loss attributable to common shareholders

 

$

(11,896,988

)

$

(4,343,153

)

Basic and diluted:

 

 

 

 

 

Common shares outstanding, beginning of period

 

51,479,821

 

49,803,979

 

Weighted average common shares issued during the period

 

58,043

 

130,940

 

Weighted average shares outstanding—basic and diluted

 

51,537,864

 

49,934,919

 

 

 

 

 

 

 

Net loss per weighted average share, basic and diluted:

 

 

 

 

 

From loss on continuing operations attributable to common stockholders

 

$

(0.23

)

$

(0.08

)

From loss on discontinued operations

 

$

 

$

(.01

)

Net loss per weighted average share, basic and diluted

 

$

(0.23

)

$

(0.09

)

 

As of April 4, 2009 and March 29, 2008, 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 Series B Preferred Stock and Series C Preferred Stock were excluded from the diluted weighted average common shares outstanding as their effect would also have been anti-dilutive.   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 attributable 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.

 

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:

 

 

 

Three Months Ended

 

 

 

April 4,
2009

 

March 29,
2008

 

Common Stock issuable upon the exercise of:

 

 

 

 

 

Options

 

10,851,370

 

4,066,454

 

Warrants

 

25,350,932

 

26,572,055

 

Total Options and Warrants excluded

 

36,202,302

 

30,638,509

 

 

 

 

 

 

 

Common Stock issuable upon the conversion of redeemable convertible Series B Preferred Stock

 

935,484

 

1,096,774

 

Common Stock issuable upon the conversion of redeemable convertible Series C Preferred Stock

 

25,553,278

 

24,038,461

 

 

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The table below details out shares of common stock underlying securities for which the securities would have been considered dilutive at April 4, 2009 and March 29, 2008, had the Company not been in a loss position:

 

 

 

# of Underlying Common Shares

 

 

 

April 4,
2009

 

March 29,
2008

 

Employee stock options

 

1,475,700

 

1,944,825

 

Warrants to purchase common stock

 

19,863,054

 

7,742,530

 

Series B Convertible Preferred Stock

 

935,484

 

1,096,774

 

Series C Convertible Preferred Stock

 

25,553,278

 

24,038,461

 

Total

 

47,827,516

 

34,822,590

 

 

Note F. Inventory

 

Inventory components at the end of each period were as follows:

 

 

 

April 4,
2009

 

December 31,
2008

 

Raw material

 

$

4,645,927

 

$

4,920,780

 

Work-in-process

 

2,441,856

 

6,182,835

 

Finished goods

 

349,029

 

353,917

 

 

 

$

7,436,812

 

$

11,457,532

 

 

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 9, 2008, Advanced Energy Industries, Inc. (“AE”) filed a civil action in Colorado state court against the Company and its Chief Executive Officer, Charles S. Rhoades, seeking to enjoin Mr. Rhoades from employment by the Company based upon its claim that Mr. Rhoades was subject to a non-competition agreement with AE. On March 3, 2009, the parties agreed to settle this case.  The settlement of the case will not have a material financial impact on the Company and Mr. Rhoades will be free to continue to serve as the Company’s President and Chief Executive Officer.

 

The Company is not aware of any other 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.

 

Note H. Commitments and Contingencies

 

Operating Leases

 

The Company leases its facilities under various operating leases that expire through October 2011.

 

Future minimum annual rentals under lease agreements at April 4, 2009 are as follows:

 

Fiscal Year

 

 

 

2009

 

$

551,383

 

2010

 

$

344,713

 

2011

 

$

224,712

 

Total

 

$

1,120,808

 

 

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Letters of Credit:

 

The Company utilizes a standby letter of credit to satisfy a security deposit requirement and in some instances to satisfy warranty commitments. Outstanding standby letters of credit as of April 4, 2009 and December 31, 2008 were $34,000.  The Company is required to pledge cash as collateral on these outstanding letters of credit. As of April 4, 2009 and December 31, 2008, 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.

 

Employment Agreements:

 

The Company had employment agreements with certain former employees that provided for severance payments and accelerated vesting of options upon termination of employment under certain circumstances or a change of control, as defined.  During the fourth quarter of 2008, the Company recorded approximately $0.3 million related to the employment contract of the former Chief Executive Officer which represents amounts due subsequent to March 1, 2009.  The former Chief Executive Officer will continue on as a director of the Company.

 

The Company’s employment arrangement with its current Chief Executive Officer provides that if his employment is terminated by the Company without cause or is constructively terminated within one year following a “change of control” transaction, his salary and medical benefits will be continued for one year thereafter subject to his execution of a release agreement with the Company.

 

Line of Credit

 

On February 26, 2008, the Company entered into a Loan and Security Agreement (the “Loan Agreement”) with Silicon Valley Bank (the “Bank”).  Under the terms of the Loan Agreement, the Bank agreed to provide the Company with a credit line up to $10.0 million.  The Company’s obligations under the Loan Agreement are secured by substantially all of the assets of the Company and advances under the Loan Agreement are limited to 80% of eligible receivables and the lesser of 25% of the value of the Company’s eligible inventory, as defined, or $1.0 million.  Interest on outstanding borrowings accrues at a rate per annum equal to the Prime Rate plus one percent (1.0%) per annum, as defined, or the LIBOR Rate plus three and three quarter percent (3.75%) per annum.  The Loan Agreement contains certain financial covenants relating to tangible net worth, as defined, which the Company must satisfy in order to borrow under the agreement.  In addition, the Company agreed to pay to the Bank a collateral monitoring fee of $750 per month and agreed to the following additional terms: (i) $50,000 commitment fee, $25,000 to be paid at signing of the Loan Agreement and $25,000 to be paid on the one year anniversary of the  Loan Agreement; (ii) an unused line fee in the amount of 0.5% per annum of the average unused portion of the revolving line; and (iii) an early termination fee of 0.5% of the total credit line if the Company terminates the Loan Agreement prior to 12 months from the Loan Agreement’s effective date.  The Loan Agreement, if not sooner terminated in accordance with its terms, expires on February 25, 2010.

 

On September 24, 2008, the Company entered into the Second Loan Modification Agreement with the Bank.  The Second Loan Modification modified certain of the financial covenants related to the Loan Agreement.  The Company paid legal fees of approximately $15,000 related to the Second Loan Modification Agreement.  As of April 4, 2009, the Company had $4.5 million outstanding under the Loan Agreement and the Bank’s prime rate was 4.0%.  The rate used was the Bank’s prime rate of 4% plus 1% or (5.0% at April 4, 2009). The Company has certain financial covenants under the Loan Agreement.  As the Company was not in compliance with these covenants as of April 4, 2009, the Company obtained a waiver from the bank with respect to the covenants as of April 4, 2009.  As of April 4, 2009, the Company had availability of $0.9 million under the line of credit.

 

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Table of Contents

 

Note I. Product Warranties

 

In its Renewable Energy Solutions division 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 five for photovoltaic inverter product sales.  The Company reviews its warranty liability quarterly.    The Company’s estimate for product warranties is based on an analysis of actual expenses by specific product line and estimated future costs related to warranty.  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.  To the extent actual experience differs from the Company’s estimate, the provision for product warranties will be adjusted in future periods.  Such differences may be significant.

 

The following is a summary of the Company’s accrued warranty activity for the following periods:

 

 

 

Three Months Ended

 

 

 

April 4,
2009

 

March 29,
2008

 

Balance at beginning of year

 

$

2,175,281

 

$

2,001,757

 

Provision

 

499,308

 

489,305

 

Usage

 

(542,140

)

(187,200

)

Balance at end of year

 

$

2,132,449

 

$

2,303,862

 

 

Note J. 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. until 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. The Warrant Bs were exercised in full on July 17, 2007 for $1.31 per share.  See below for a discussion related to the exercise of the Warrant Bs and the issuance of Warrant Cs to the holders as a result of such exercise.

 

On November 7, 2007, the Convertible Notes were retired by cash redemption.

 

Additionally, with respect to the common stock underlying the Warrant Cs issued in July 2007 upon exercise of the Warrant Bs, the Company was 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 review of such registration statement by the SEC) (which it has satisfied as such registration statement was declared effective on September 11, 2007) 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.

 

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Table of Contents

 

Warrant As

 

The Warrant As originally entitled 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 and December 20, 2007 preferred stock financing, as described in Note K below, the holders were entitled for a limited period of time (45 days after each issuance) to exercise this right.  During the fourth quarter of fiscal 2007, the Company paid approximately $1.4 million to redeem Warrant As representing 1,242,426 shares of common stock.  During the first quarter of fiscal 2008, the Company paid approximately $0.4 million to redeem Warrant As representing 303,031 shares of common stock.  (See table below for assumptions used in valuing the warrants redeemed).  As of April 4, 2009 and December 31, 2008, Warrant As to purchase 2,090,911 shares of common stock were outstanding, respectively.

 

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 satisfied, we may require the holders of the Warrant As to exercise all or any part of the unexercised portions of such warrants.

 

Warrant Bs

 

The Warrant Bs entitled the holders thereof to purchase up to an aggregate of 3,636,368 shares of 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.

 

Warrant Cs

 

As discussed above, upon the exercise of the Warrant Bs, the holders were entitled to receive additional warrants (the “Warrant Cs”).  The Warrant Cs originally 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.

 

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Table of Contents

 

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 November 8, 2007 and December 20, 2007 preferred stock financing, as described in Note K below, the holders were entitled for a limited period of time (45 days after each issuance) to exercise this right.  During the fourth quarter of fiscal 2007, the Company paid approximately $0.7 million to redeem Warrant Cs representing 621,215 shares of common stock.  During the quarter ended March 29, 2008, the Company paid approximately $0.2 million to redeem Warrant Cs representing 151,516 shares of common stock. (See table below for assumptions used in valuing the warrants redeemed).  As of April 4, 2009 and December 31, 2008, Warrant Cs to purchase 1,045,456 shares of common stock were outstanding, respectively.

 

The table below summarizes Black-Scholes option pricing model range of assumptions that were used in valuing the warrants redeemed for both the Warrant As and Warrant Cs during the three month period ended March 29, 2008.

 

Assumptions:

 

Warrant As

 

Warrant Cs

 

Expected life

 

5.5 years

 

6.5 years

 

Expected volatility ranging from

 

83.5%

 

85.6%

 

Dividends

 

none

 

none

 

Risk-free interest rate

 

3.0%

 

3.2%

 

 

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, the Company 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, the Company may require the holders of the Warrant Cs to exercise all or any part of the unexercised portions of such warrants.

 

Placement Agent 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 Warrants

 

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 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 warrant liabilities

 

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Table of Contents

 

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 April 4, 2009 and December 31, 2008, the remaining outstanding Warrants have been marked to fair value resulting in a derivative liability of $3.1 million and $2.4 million, respectively.  The charge to Change in Fair Value of warrant liabilities, for the three months ended April 4, 2009 and March 29, 2008 was $0.7 million and $0.5 million, related to warrant As, Bs and Cs and placement agent warrants, respectively.

 

A summary of the changes in the fair value of the warrant liabilities:

 

 

 

Fair Value
of Warrant
Liabilities

 

 

 

 

 

Balance at December 31, 2007

 

$

3,244,316

 

Fair value adjustment (2)

 

(104,768

)

Change in fair value of redeemed Warrant As and Cs at redemption (1) (2)

 

572,250

 

Warrant Redemptions:

 

 

 

- Cash Paid for Warrant A redemption (1)

 

(387,591

)

- Cash paid for Warrant C redemption (1)

 

(184,659

)

Balance at March 29, 2008

 

$

3,139,548

 

 

Balance at December 31, 2008

 

$

2,407,438

 

Reclassification of Series C Preferred Stock Warrants to liabilities (3)

 

22,041,541

 

Fair value adjustment (2)

 

5,370,471

 

Balance at April 4, 2009

 

$

29,819,450

 

 


(1)   As a result of the Series C Preferred Stock financing, certain holders of both Warrant As (1,242,426) and Warrant Cs (621,215), through December 31, 2007, exercised their right of redemption, resulting in the Company paying to each redeeming warrant holder the Black-Scholes value of these warrants on the date of notification of redemption.  During the three months ended March 29, 2008 holders of both Warrant As (303,031) and Warrant Cs (151,516) exercised their right of redemption, resulting in the Company paying to each redeeming warrant holder the Black-Scholes value of these warrants on the date of notification of redemption.

(2)   Amounts included in change in fair value of warrant liabilities on consolidated statement of operations.

(3)   As a result of adopting EITF 07-05, 19,899,022 of the Company’s issued and outstanding common stock purchase warrants previously treated as equity pursuant to the derivative treatment exemption were no longer afforded equity treatment.  As such, effective January 1, 2009 the Company reclassified the fair value of these common stock purchase warrants, which have exercised price reset features, from equity to liability status as if these warrants were treated as derivative liability since their date of issuance.

 

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Table of Contents

 

Valuation - Methodology 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. (See Note C for valuation related to Series C Preferred Stock Warrants).

 

In estimating the fair value of the Warrants the following methods and significant input assumptions were applied:

 

Methods

 

·                  A binomial lattice model was utilized to estimate the fair value of Warrant As at December 31, 2007, March 29, 2008, December 31, 2008 and April 4, 2009, as well as the fair value of the Placement Agent Warrants at December 31, 2006 and the Warrant Cs at December 31, 2007 and March 29, 2008, December 31, 2008 and April 4, 2009.  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

 

Dec. 31,
2007

 

Mar. 29,
2008

 

Dec. 31,
2008

 

Apr. 4,
2009

 

Quoted Stock Price

 

$

1.650

 

$

1.84

 

$

1.55

 

$

1.88

 

Conversion Price

 

$

1.815

 

$

1.815

 

$

1.815

 

$

1.815

 

Time to Maturity (in years)

 

5.60

 

5.30

 

4.60

 

4.30

 

Stock Volatility

 

83

%

80

%

73

%

75

%

Risk-Free Rate

 

3.53

%

2.57

%

1.44

%

1.69

%

Dividend Rate

 

0

%

0

%

0

%

0

%

Non-Exercise Period

 

N/A

 

N/A

 

N/A

 

N/A

 

 

Warrant Cs (1)

 

 

 

 

 

 

 

 

 

 

 

Input

 

Dec. 31,
2007

 

Mar. 29,
2008

 

Dec. 31,
2008

 

Apr. 4,
2009

 

Quoted Stock Price

 

$

1.650

 

$

1.84

 

$

1.55

 

$

1.88

 

Conversion Price

 

$

1.815

 

$

1.815

 

$

1.815

 

$

1.815

 

Time to Maturity (in years)

 

6.5

 

6.3

 

5.50

 

5.30

 

Stock Volatility

 

85

%

85

%

80

%

75

%

Risk-Free Rate

 

3.64

%

2.77

%

1.63

%

1.97

%

Dividend Rate

 

0

%

0

%

0

%

0

%

Non-Exercise Period

 

Until 1/17/08

 

N/A

 

N/A

 

N/A

 

 


(1) Warrant Cs were issued on July 17, 2007 upon the exercise of the Warrant Bs.

 

·                  A Black-Scholes option pricing model was utilized to estimate the fair value of Placement Agent Warrants after December 31, 2007, March 29, 2008, December 31, 2008 and April 4, 2009. A change in method from the binomial to Black-Scholes was warranted because the warrants’ non-exercise period ended prior to the valuation date and all required inputs were fixed. This model requires the following key inputs with respect to the Company and/or instrument:

 

Input

 

Dec. 31,
2007

 

March 29,
2008

 

Dec. 31,
2008

 

Apr. 4,
2009

 

Quoted Stock Price

 

$

1.65

 

$

1.84

 

$

1.55

 

$

1.88

 

Conversion Price

 

$

1.87

 

$

1.87

 

$

1.87

 

$

1.87

 

Time to Maturity (in years)

 

3.55

 

3.31

 

2.55

 

2.29

 

Stock Volatility

 

70

%

70

%

80

%

75

%

Risk-Free Rate

 

3.175

%

1.91

%

0.89

%

1.08

%

Dividend Rate

 

0

%

0

%

0

%

0

%

Non-Exercise Period

 

N/A

 

N/A

 

N/A

 

N/A

 

 

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Table of Contents

 

Significant Assumptions:

 

·                  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 was 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.

 

Note K. Redeemable Convertible Series B and Series C Preferred Stock

 

Series B Convertible 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 April 4, 2009 and December 31, 2008, the conversion price for the Series B Preferred Stock was $1.55, respectively.  As of April 4, 2009 and December 31, 2008, 290 shares of Series B Preferred Stock were outstanding, respectively.  As of April 4, 2009 and December 31, 2008, the liquidation preference of the remaining 290 shares of Series B Preferred Stock was $1,450,000, respectively, and these were convertible into 935,484 shares of common stock, respectively.

 

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 $1.55 (as of April 4, 2009 and December 31, 2008).  The Company has paid all dividends in shares of common stock, in lieu of cash dividends.

 

As part of the October 2003 Financing Transaction, the Company also issued warrants to purchase up to 1,228,000 shares of its common stock. These warrants were exercisable for a five-year term and had an initial exercise price of $3.32 per share, which represented 110% of the average closing price of the common stock for the five trading days preceding October 31, 2003. The exercise price had been adjusted due to anti-dilution provisions to $2.93 per share.  These warrants were immediately exercisable and expired on October 31, 2008.  As of December 31, 2008, none of these warrants remained outstanding.  During 2008, warrants to purchase an aggregate of 1,116,000 shares of common stock, which were outstanding at March 29, 2008, expired unexercised.

 

Burnham Hill Partners, LLC, a division of Pali Capital, Inc. (“BHP”), served as placement agent for this transaction. As part of its commission BHP, or its assigns, received warrants, with an exercise price of $0.01 per share, to purchase an aggregate of 150,430 shares of common stock. These warrants were immediately exercisable and would expire on October 31, 2008.  The Company valued

 

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these warrants at $435,166, using the Black-Scholes option-pricing model and has treated this as a transaction cost.   As of December 31, 2008, none of these warrants were outstanding as the remaining warrants to purchase an aggregate of 5,182 shares of common stock, which were outstanding as of March 29, 2008, expired unexercised.

 

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 $1.55 (as of April 4, 2009 and December 31, 2008). 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 conversion price will be adjusted downwards using a weighted average calculation.

 

Mandatory Conversion of Series B Preferred Stock

 

If 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 $1.55 (as of April 4, 2009 and December 31, 2008).  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 without restriction pursuant to Rule 144 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 covering the resale of the shares of common stock issuable upon the conversion of the Series B Preferred Stock 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 without restriction pursuant to Rule 144;

 

·                  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 Stock and upon exercise of the warrants issued to the placement agent and its affiliates for the

 

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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 $1.55 (as of April 4, 2009 and December 31, 2008).

 

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 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 $1.55 (as of April 4, 2009 and December 31, 2008).

 

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 without restriction pursuant to Rule 144;

 

·                  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

 

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(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 $1.55 (as of April 4, 2009 and December 31, 2008).

 

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.  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.

 

Accounting for the Series B Preferred Stock and Adjustments to the Conversion Price

 

The Company accounted for the transaction in accordance with EITF 00-27, Application of Issue No. 98-5 to Certain Convertible Instruments, allocating the proceeds received net of transaction costs based on the relative fair value of the redeemable convertible Series B Preferred Stock and the warrants issued to the investors, and then to any beneficial conversion rights contained in the convertible redeemable preferred securities as follows:

 

Security

 

Face
Value

 

Fair
Value

 

Allocation of
Proceeds, Net of
Transaction Costs

 

Beneficial
Conversion
Feature

 

Discount

 

Redeemable convertible Series B Preferred Stock

 

$

7,675,000

 

$

12,398,195

 

$

5,247,393

 

$

3,655,607

 

$

6,083,214

 

Warrants

 

 

$

2,935,558

 

$

1,242,441

 

 

 

 

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 issuance of 850,000 shares of common stock related to the early termination of a lease, conversion of a portion of the Convertible Notes by the note holders, the exercise of the Warrant Bs, the issuance of 749,999 shares of common stock to the note holders as an inducement and the closing of the private placement of Series C Preferred Stock and warrants in the fourth quarter of 2007, the Company adjusted the conversion price on the Series B Preferred Stock as to $1.55.

 

Series C Convertible Preferred Stock

 

On November 8, 2007, the Company entered into a Stock and Warrant Purchase agreement with Rockport Capital Partners II, L.P. and NGP Energy Technology Partners, L.P. (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 $25.0 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 occurred in two closings.  The first closing occurred on November 8, 2007.  At the first closing, the Company issued 10,000 shares of Series C Preferred Stock at $1,000 per share for an aggregate gross purchase price of $10.0 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 are exercisable for a seven-year term and had an initial exercise price of $1.44 per share and may not be exercised until May 8, 2008.  As a result of stockholder approval of the second closing and related matters on December 20, 2007, as described below, the exercise price of these warrants was reduced to $1.25 per share.  The

 

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Company considered this a cancellation and reissuance of new warrants and accounted for the change in the fair value of the warrants in the allocation of net proceeds associated with the second closing and treated it as a deemed dividend to the Series C Preferred Stock holders. (See Accounting for the Series C Preferred Stock below).

 

At the second closing, which occurred on December 20, 2007, following stockholder approval, the Company issued 15,000 shares of Series C Preferred Stock for an aggregate gross purchase price of $15.0 million, of which $10.0 million was paid through the cancellation of the promissory notes previously issued to the Investors on November 7, 2007.  These shares are currently convertible into 14,423,076 shares of common stock.  At this closing, the Company also issued warrants to purchase an aggregate of 4,449,467 shares of common stock at an exercise price of $1.25 per share.  These warrants are exercisable for a seven-year term and are exercisable immediately.

 

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 $1.66 per share (during 2008, prior to the issuance of any such warrants, the warrant holders agreed to change the exercise price to $1.66 per share from $1.25 per share).  During 2008, the Company issued warrants to purchase an aggregate of 87,484 shares of common stock to the Investors as a result of warrant exercises during 2008.  No additional warrants were issued during the quarter ended April 4, 2009.  As of April 4, 2009, if all of the remaining existing warrants are exercised, the Company would need to issue warrants to purchase an additional 2,725,955 shares of common stock to the Investors.

 

Dividends on Series C Preferred Stock

 

The shares of Series C Preferred Stock accrue a cumulative dividend at a rate of 5% per annum of the Stated Liquidation Preference Amount, as defined below.  Dividends on the Series C Preferred Stock shall be cumulative, shall accrue, whether or not declared, and be payable quarterly in cash or, at the Company’s option, added to the Stated Liquidation Preference Amount. So long as any shares of Series C Preferred Stock are outstanding, the Company shall not declare, pay or set apart for payment any dividend or make any distribution on any Series B Preferred Stock (other than dividends or distributions paid on the Series B Preferred Stock in common stock in accordance with the terms of the Series B Preferred Stock) or junior stock (other than dividends or distributions on common stock payable solely in shares of common stock), unless at the time of such dividend or distribution the Company shall have paid all accrued and unpaid dividends on the outstanding shares of Series C Preferred Stock.  In addition, so long as any shares of Series C Preferred Stock are outstanding, the Company shall not declare, pay or set apart for payment any dividend or make any distribution on any common stock (other than dividends or distributions on common stock payable solely in shares of common stock), unless at the time of such dividend or distribution the Company simultaneously pays a dividend or distribution on each outstanding share of Series C Preferred Stock in an amount equal to the product of (i) the dividend or distribution payable on each share of common stock and (ii) the number of shares of common stock issuable upon conversion of a share of Series C Preferred Stock, calculated on the record date for determination of holders entitled to receive such dividend or distribution.

 

Voting Rights

 

The holders of Series C Preferred Stock shall be entitled to notice of all meetings of stockholders in accordance with the Company’s bylaws. On any matter presented to the stockholders of the Company for their action or consideration at any meeting of stockholders of the Company (or by written consent of stockholders in lieu of meeting), each holder of outstanding shares of Series C Preferred Stock shall be entitled to cast the number of votes equal to quotient determined by dividing (i) the Series C Original Issue Price ($1,000 per share) of the shares of Series C Preferred Stock held by such holder as of the record date for determining stockholders entitled to vote on such matter by (ii) $1.44 (as adjusted for any stock dividends, combinations, splits and the like with respect to shares of common stock).  Except as provided by law or as described below, holders of Series C Preferred Stock shall vote together with the holders of common stock as a single class.

 

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The Company is not permitted, without the affirmative vote or written consent of the holders of at least 67% of the outstanding Series C Preferred Stock (50% of the outstanding Series C Preferred Stock with respect to items (4), (5) and (8) below), directly or indirectly, to take any of the following actions or agree to take any of the following actions:

 

(1)           authorize, create or issue any shares of preferred stock or other equity securities ranking senior to or on a parity with the Series C Preferred Stock;

 

(2)           increase or decrease the total number of authorized shares of Series C Preferred Stock;

 

(3)           amend or modify the Company’s certificate of incorporation (including the Certificate of Designation governing the Series C Preferred Stock) or bylaws that would adversely affect the rights, preferences, powers and privileges of the Series C Preferred Stock;

 

(4)           repurchase or redeem any shares of Series B Preferred Stock (except pursuant to the existing terms of the Series B Preferred Stock) or any equity securities ranking junior to the Series C Preferred Stock, subject to certain exceptions;

 

(5)           effect any distribution or declare, pay or set aside any dividend with respect to any equity securities ranking junior to the Series C Preferred Stock;

 

(6)           incur any form of indebtedness for borrowed money in excess of $5,000,000 in the aggregate (other than indebtedness existing at November 8, 2007);

 

(7)           effect a liquidation, consummate a reorganization event or dispose, transfer or license any material assets, technology or intellectual property, other than non-exclusive licenses in connection with sales of the Company’s products in the ordinary course of business;

 

(8)           consummate any transaction that results in the transfer or issuance of securities, or options, warrants or other rights to receive securities of a subsidiary or any other transaction following which a subsidiary no longer remains wholly-owned by the Company or pursuant to which any third party has a right to purchase securities of a subsidiary;

 

(9)           change the size of the Company’s board of directors;

 

(10)         encumber or grant a security interest in all or substantially all or a material part of the Company’s assets except to secure indebtedness permitted above that is approved by the Company’s board of directors;

 

(11)         acquire a material amount of assets of another entity, through a merger, purchase of assets or purchase of capital stock or otherwise; or

 

(12)         enter into any agreement to do or cause to be done any of the foregoing.

 

Liquidation Preference

 

In the event of the liquidation, dissolution or winding up of the affairs of the Company, whether voluntary or involuntary (a “Liquidation”), the holders of shares of the Series C Preferred Stock then outstanding shall be entitled to receive, out of the assets of the Company available for distribution to its stockholders before any payment shall be made to the holders of junior stock by reason of their ownership thereof, an amount per share equal to the greater of:

 

(i) the Series C Original Issue Price ($1,000 per share) plus any dividends accrued but unpaid thereon (the “Stated Liquidation Preference Amount”); or

 

(ii) such amount per share as would have been payable had all shares of Series C Preferred Stock been converted into common stock immediately prior to such Liquidation (the amount payable to the holders of Series C Preferred Stock pursuant to clause (i) or (ii) of this sentence is hereinafter referred to as the “Series C Liquidation Amount”).

 

If upon any such Liquidation, the assets of the Company available for distribution to its stockholders shall be insufficient to pay the holders of shares of Series C Preferred Stock the full amount to which they shall be entitled and the holders of shares of parity stock the full amount to which they shall be entitled pursuant to the terms of such Parity Stock, the holders of shares of Series C Preferred Stock and the holders of shares of parity stock shall share ratably in any distribution of the assets available for distribution in proportion to the

 

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respective amounts which would otherwise be payable in respect of the shares held by them upon such distribution if all amounts payable on or with respect to such shares were paid in full.  The liquidation payment with respect to each outstanding fractional share of Series C Preferred Stock shall be equal to a ratably proportionate amount of the liquidation payment with respect to each outstanding share of Series C Preferred Stock.  All payments shall be in cash, property (valued at its fair market value as determined by an independent appraiser reasonably acceptable to the holders of a majority of the shares of Series C Preferred Stock then outstanding) or a combination thereof; provided, however, that no cash shall be paid to holders of junior stock unless each holder of the outstanding shares of Series C Preferred Stock has been paid in cash the full amount to which such holder shall be entitled.  After payment of the full Series C Liquidation Amount, such holders of shares of Series C Preferred Stock will not be entitled to any further participation as such in any distribution of the assets of the Company.

 

Conversion

 

The holder of Series C Preferred Stock shall have the following conversion rights:

 

Holder’s Right to Convert.

 

At any time the holder of any such shares of Series C Preferred Stock may, at such holder’s option, elect to convert all or any portion of the shares of Series C Preferred Stock held by such person into a number of fully paid and nonassessable shares of common stock equal to the quotient of (i) the Stated Liquidation Preference Amount of the shares of Series C Preferred Stock being converted divided by (ii) the conversion price then in effect as of the date of the delivery by such holder of its notice of election to convert.  The initial conversion price of the Series C Preferred Stock is $1.04 per share.  The Series C Preferred Stock will receive weighted average anti-dilution protection in the event of a dilutive issuance (i.e. stock splits, stock dividends or other issuances deemed to be dilutive to the investor) in accordance with a formula set forth in the Certificate of Designation, subject to certain exceptions.

 

Company’s Right to Convert.

 

At any time on or after November 8, 2009, if the average closing price of the Company’s common stock for any immediately preceding 180-day period exceeds $7.00 (subject to appropriate adjustment in the event of any stock dividend, stock split, combination or other similar recapitalization with respect to the common stock), the Company will have the right, but not the obligation, to convert each outstanding share of Series C Preferred Stock into a number of fully paid and nonassessable shares of common stock equal to the quotient of (i) the Stated Liquidation Preference Amount divided by (ii) the conversion price in effect as of the Company conversion date.

 

Redemption

 

At any time and from time to time on or after November 8, 2011 the holders of at least 66.7% of the then outstanding shares of Series C Preferred Stock may elect to have all or any portion of the outstanding shares of Series C Preferred Stock redeemed.  The Company shall effect the redemption on a redemption date by paying cash or, at the Company’s election, shares of common stock (valued in the manner described below).

 

If such redemption shall be for cash, the Company shall effect the redemption, out of funds legally available therefor, by paying in cash in exchange for each share of Series C Preferred Stock to be redeemed a sum equal to the product of (i) 1.2 multiplied by (ii) the Stated Liquidation Preference Amount.

 

If such redemption shall be for shares of common stock, the Company shall effect the redemption by issuing, in exchange for each share of Series C Preferred Stock to be redeemed, that number of shares of common stock equal to (A) the product of (i) 1.4 multiplied by (ii) the Stated Liquidation Preference Amount divided by (B) the fair market value of the common stock, based on a 10 day volume weighted average, as of the redemption date.

 

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Accounting for the Series C Preferred Stock

 

Initially, based on the accounting guidance available at the closing of the Series C Preferred Stock transaction (see “Change in Accounting Principle” below), the Company accounted for the transaction in accordance with EITF 00-27, Application of Issue No. 98-5 to Certain Convertible Instruments, allocating the proceeds received net of transaction costs based on the relative fair value of the redeemable convertible Series C Preferred Stock and the warrants issued to the Investors, and then to any beneficial conversion rights contained in the convertible redeemable preferred securities as follows:

 

Security

 

Face
Value

 

Fair
Value

 

Allocation of
Proceeds, Net of
Transaction
Costs

 

Beneficial
Conversion
Feature

 

Initial
Carrying
Value

 

Redeemable convertible Series C Preferred Stock