January 30, 2006
BY EDGAR
Securities and Exchange Commission
Division of Corporate Finance
450 Fifth Street, N.W.
Washington, D.C. 20549
Attn: David R. Humphrey, Branch Chief
RE: | Coach Industries Group, Inc. | |
Form 10-KSB for the year ended December 31, 2004 | ||
Form 10-QSB for the quarter ended March 31, 2005 | ||
Commission File Number 000-19471 |
Dear Mr. Humphrey:
We hereby transmit by EDGAR pursuant to Rule 101(a) of Regulation S-T, our responses to the Commission’s letter, dated January 24, 2005, in connection with the Commission’s review of the Company’s Form 10-KSB for the year ended December 31, 2004 and Form 10-QSB for the quarterly period ended March 31, 2005 (the “Annual Report” and “Quarterly Report,” respectively). For the convenience of the staff, each comment is repeated verbatim with the Company’s response immediately following.
Debt
Laurus Master Fund Note
1. Refer to our previous comment 6, 7, and 8. We note from your response to our previous comment 6 that the $300,000 draw occurring on November 3, 2004 was drawn under an amended conversion rate. However, your table in Schedule C still appears to indicate the original conversion rate. However, your table in Schedule C still appears to indicate the original conversion rate of $0.97. Your current use of $0.97 yields an original benefit on conversion of approximately $50,000 and you have taken an additional $282,000 on conversion on the date of draw. Please note that the benefit on conversion taken cannot exceed the amount of debt drawn. Also, as the conversion rate was amended to $0.50 per share, it is unclear why you continue to present the November 3 draw at $0.97 in your table. Please revise your table and calculation accordingly.
Response: We have adjusted the schedule to reflect the $300,000 draw as $0.50 and have recognized a loss of the full amount of $300,000 and have adjusted the discount of $50,000. We have adjusted the attachments accordingly.
David R. Humphrey
Securities and Exchange Commission
January 30, 2006
Page 2
2. We note you have included the unfunded restricted portion of the Laurus note as a liability and a corresponding amount in cash equivalents. We also note that you do not pay interest on the undrawn portion, and to obtain the additional funds available under the credit facility you must meet certain criteria. Supplementally explain to us why you consider the restricted portion of the Laurus note a liability and an unrestricted asset given that you do not have full legal right to these funds. We may have further comment on your response.
Response: We considered the restricted account as cash and cash equivalents at year end as the restriction was lifted between 30 and 60 days of year-end prior to the issuance of our Form 10-KSB. Based on our understanding of the disclosure requirements for cash and cash equivalents, the funds were reclassified to a cash and cash equivalent. As disclosed in Note 15, included in Schedule C, the funds in the restricted account earned income to the Company and required that we accrue interest on the undrawn portion. The Company considers the restricted portion of the Laurus convertible note as a liability because upon payment of the funds held in the restricted account, the Company would pay Laurus a 5% penalty plus interest accrued from the date Laurus funded the restricted account.
3. We note that the table as presented in Schedule C includes one column entitled “initial adjustments” that appears to include the adjustments to correctly apply EITF 00-19 and EITF 00-27 to the Laurus transaction, the adjustment related to the error in valuation of the Laurus warrants, and the adjustment related to the Elm Street conversion. Please consider presenting each of these adjustments in separate columns so that the effect of each adjustment can be readily identified. Specifically, you should show the effect of the accounting policy change prior to the effect of the warrant valuation change. Also, each adjustment should be footnoted and explained so the value presented in the table can be recalculated and easily understood.
Response:See attached Schedule C, as revised.
4. Refer to the table presented in Schedule C of your response letter. We note that you have assessed the impact of the adjustments presented in each column as not material, citing your internal quantitative threshold, lack of effect on your loan covenants, and your opinion of how a reasonable person and the market might view this information. It is unclear whether you considered these adjustments on both an annual and quarterly basis or whether you conducted the qualitative and quantitative analysis on these adjustments in the aggregate as required by SAB Topic (1)(M)(1). Given that the aggregate effect of these adjustments reduces stockholders’ equity by 8.8% at December 31, 2004 and reduces net income by 6% for 2004, we disagree with the conclusion that these adjustments would not impact the fair presentation of your financial statements. In addition the adjustments significantly alter and, in some cases create balance sheet and income statement line items. As such, please file an amended Form 10-KSB restating your financial statements for all the adjustments outlined in your Schedule C, as revised in accordance with our comment 4, above. This amended Form 10-KSB should include an explanatory note similar in form and content to the tabular and footnote presentation of your revised Schedule C. Please respond to this letter with a revision of Schedule C prior to filing your amended Form 10-KSB.
Response: See attached Schedule C, as revised. We will revise our Annual Report on Form 10-KSB for the period ended December 31, 2004.
David R. Humphrey
Securities and Exchange Commission
January 30, 2006
Page 3
* * * *
If you have any questions or further comments, please do not hesitate to contact the undersigned or Mark Y. Abdou at (310) 208-1182 or via fax at (310) 208-1154.
Very truly yours, | ||
COACH INDUSTRIES GROUP, INC. | ||
By: | /s/ SUSAN WEISMAN | |
Susan Weisman, | ||
Chief Financial Officer |
cc: | Amy Geddes, Esq. | |
Mr. Francis J. O’Donnell, Chief Executive Officer | ||
Mark Y. Abdou, Esq. |
Schedule A
(Response No. 1)
December 31, 2004
Date | Face Value | Warrants Liability | Debt | APIC | Amortization War | Amortization Beneficial Conversion Feature | Charge for Conversion | |||||||||||
9/29/2004 | 1,600,000 | 313,000 | 821,798 | 465,202 | 26,083 | 38,767 | ||||||||||||
11/3/2004 | 300,000 | — | 300,000 | — | — | |||||||||||||
10/22/2004 | 100,000 | — | 86,570 | 13,430 | — | 767 | ||||||||||||
10/22/2004 | 300,000 | — | — | 300,000 | — | |||||||||||||
11/3/2004 | (300,000 | ) | — | (300,000 | ) | — | 300,000 | |||||||||||
10/22/2004 | 78,588 | — | 78,588 | — | — | |||||||||||||
11/10/2004 | 105,517 | — | 105,517 | — | — | |||||||||||||
11/16/2004 | 683,910 | — | 683,910 | — | — | |||||||||||||
Total Conversion 12/31/04 | 2,868,015 | 313,000 | 2,026,209 | 478,632 | 26,083 | 39,534 | 300,000 | |||||||||||
1/13/2005 | 1,500,000 | — | 1,500,000 | — | ||||||||||||||
1/14/2005 | 240,000 | — | 235,119 | 4,881 | — | — | ||||||||||||
2/17/2005 | 1,091,985 | — | 1,091,985 | — | ||||||||||||||
4/22/2005 | (200,000 | ) | (200,000 | ) | — | |||||||||||||
Total Conversions 2005 | 2,631,985 | — | 2,627,104 | 4,881 | — | — | — | |||||||||||
Total Debt Funded from Restricted | 5,500,000 | 313,000 | 4,653,313 | 483,513 | 26,083 | 39,534 | 300,000 | |||||||||||
365,617 | ||||||||||||||||||
Warrant Liability 9/29/04 | (313,000 | ) | ||||||||||||||||
Warrant Liability 12/31/04 | 168,080 | |||||||||||||||||
Adjustment at 12/31/04 | (144,920 | ) | ||||||||||||||||
Recorded Warrants Amort | 35,625 | |||||||||||||||||
Recorded BCF Amort | 14,286 | |||||||||||||||||
Recorded Conversion | — | |||||||||||||||||
Recorded 12/31/04 | 49,911 | |||||||||||||||||
Total Impact to 12/31/04 | 170,786 | |||||||||||||||||
ELM Street | 169,500 | |||||||||||||||||
340,286 | ||||||||||||||||||
Schedule B (cont.)
COACH INDUSTRIES GROUP, INC.
CONSOLIDATED BALANCE SHEETS DECEMBER 31,
2004 - Originally Presented | (1) Warrant Adjustment | (2) BCF Adjustment | (3) Laurus Conversion | (4) ELM Street Conversion | (5) Market Valuation | (6) Amortization | (7) Reclasses 12/31/04 | 2004 - As Proposed | ||||||||||||||||||||||
ASSETS | ||||||||||||||||||||||||||||||
CURRENT ASSETS: | ||||||||||||||||||||||||||||||
Cash and cash equivalents | $ | 3,545,995 | $ | — | $ | 3,545,995 | ||||||||||||||||||||||||
Restricted cash | 500,000 | — | 500,000 | |||||||||||||||||||||||||||
Accounts receivable, net | 1,094,196 | — | 1,094,196 | |||||||||||||||||||||||||||
Unbilled revenues | 298,290 | — | 298,290 | |||||||||||||||||||||||||||
Supply inventory | 1,836,535 | — | 1,836,535 | |||||||||||||||||||||||||||
Due from related party | 188,862 | — | 188,862 | |||||||||||||||||||||||||||
Prepaid expenses and other current assets | 247,922 | — | 247,922 | |||||||||||||||||||||||||||
Total current assets | 7,711,800 | — | — | — | — | — | — | — | 7,711,800 | |||||||||||||||||||||
PROPERTY AND EQUIPMENT, net | 1,968,927 | — | 1,968,927 | |||||||||||||||||||||||||||
LEASE RECEIVABLES, NET | 2,202,788 | — | 2,202,788 | |||||||||||||||||||||||||||
DEFERRED LOAN COSTS, net | 270,728 | — | 270,728 | |||||||||||||||||||||||||||
INTANGIBLE- CUSTOMER LIST, net | 1,160,000 | — | 1,160,000 | |||||||||||||||||||||||||||
GOODWILL | 6,207,581 | — | 6,207,581 | |||||||||||||||||||||||||||
$ | 19,521,824 | $ | — | — | — | — | — | — | $ | 19,521,824 | ||||||||||||||||||||
LIABILITIES AND SHAREHOLDERS’ EQUITY | ||||||||||||||||||||||||||||||
CURRENT LIABILITIES: | ||||||||||||||||||||||||||||||
Accounts payable and accrued expenses | $ | 2,294,354 | $ | — | $ | 2,294,354 | ||||||||||||||||||||||||
Accrued interest payable | 90,682 | — | 90,682 | |||||||||||||||||||||||||||
Related party payable | 95,450 | — | 95,450 | |||||||||||||||||||||||||||
Accrued contract settlement | 294,561 | — | 294,561 | |||||||||||||||||||||||||||
Current portion of long-term debt – funded | 1,784,776 | — | (801,827 | ) | 982,949 | |||||||||||||||||||||||||
Current portion of long-term debt – restricted | — | — | 653,451 | 653,451 | ||||||||||||||||||||||||||
Warrant liability | — | 313,000 | (144,920 | ) | 168,080 | |||||||||||||||||||||||||
Deferred rent | — | — | — | |||||||||||||||||||||||||||
Warranty reserve | 148,755 | — | 148,755 | |||||||||||||||||||||||||||
Customer deposits | 233,345 | 233,345 | ||||||||||||||||||||||||||||
Accrued wages | 427,205 | 427,205 | ||||||||||||||||||||||||||||
Note payable – related parties | 900,000 | 900,000 | ||||||||||||||||||||||||||||
Lines of credit | 1,054,909 | 1,054,909 | ||||||||||||||||||||||||||||
Total current liabilities | 7,322,038 | 313,000 | — | — | — | (144,920 | ) | — | (148,376 | ) | 7,341,731 | |||||||||||||||||||
OTHER LIABILITIES: | ||||||||||||||||||||||||||||||
Convertible notes payable- long term - funded | 2,592,833 | 659,300 | (78,632 | ) | 15,706 | (2,030,158 | ) | 1,159,049 | ||||||||||||||||||||||
Convertible notes payable – long term – restricted | — | — | 2,178,534 | 2,178,534 | ||||||||||||||||||||||||||
Lease financing obligation | 884,851 | — | 884,851 | |||||||||||||||||||||||||||
COMMITMENTS AND CONTINGENCIES | — | |||||||||||||||||||||||||||||
SHAREHOLDERS’ EQUITY: | — | |||||||||||||||||||||||||||||
Common stock $0.001 par value; 50,000,000 shares authorized; 18,982,785 and 9,785,531 shares issued and outstanding, respectively | 18,982 | — | 18,982 | |||||||||||||||||||||||||||
— | ||||||||||||||||||||||||||||||
Additional paid-in capital | 17,159,784 | (972,300 | ) | 78,632 | 300,000 | 169,500 | 16,735,616 | |||||||||||||||||||||||
Restricted stock – unearned compensation | (550,842 | ) | (550,842 | ) | ||||||||||||||||||||||||||
Accumulated deficit | (7,905,822 | ) | (300,000 | ) | (169,500 | ) | 144,920 | (15,706 | ) | (8,246,108 | ) | |||||||||||||||||||
Treasury stock, 1,176,471 shares at cost | — | — | ||||||||||||||||||||||||||||
Total shareholders’ equity | 8,722,102 | (972,300 | ) | 78,632 | — | — | 144,920 | (15,706 | ) | — | 7,957,657 | |||||||||||||||||||
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY | $ | 19,521,824 | — | — | — | — | — | — | — | 19,521,824 | ||||||||||||||||||||
CONSOLIDATED STATEMENTS OF OPERATIONS
For the year ended December 31, 2004
For the Year Ended 31-Dec-04 | (3) Laurus Conversion | (4) ELM Street Conversion | (5) Market Valuation | (6) Amortization | As Proposed 31-Dec-04 | |||||||||||||||||||
REVENUES | $ | 83,595,584 | $ | — | $ | — | $ | — | $ | — | $ | 83,595,584 | ||||||||||||
COST OF GOODS SOLD | 80,016,021 | — | — | — | — | 80,016,021 | ||||||||||||||||||
GROSS PROFIT (LOSS) | 3,579,563 | — | — | — | — | 3,579,563 | ||||||||||||||||||
OPERATING EXPENSES: | ||||||||||||||||||||||||
General and Administrative | 4,990,340 | — | — | — | — | 4,990,340 | ||||||||||||||||||
Provision for lease losses and uncollectible accounts receivables | 55,263 | — | — | — | — | 55,263 | ||||||||||||||||||
Interest expense | 354,774 | 300,000 | 169,500 | (144,920 | ) | 15,706 | 695,060 | |||||||||||||||||
Interest income | (14,496 | ) | — | — | — | — | (14,496 | ) | ||||||||||||||||
Research and development | 829,840 | — | — | — | — | 829,840 | ||||||||||||||||||
Sales and marketing | 549,317 | — | — | — | — | 549,317 | ||||||||||||||||||
Rent | 232,954 | — | — | — | — | 232,954 | ||||||||||||||||||
Amortization of intangible assets | 106,667 | — | — | — | — | 106,667 | ||||||||||||||||||
Other | — | — | — | — | — | — | ||||||||||||||||||
Loss on relocation of CTMC | 1,328,436 | — | — | — | — | 1,328,436 | ||||||||||||||||||
Amortization of deferred Compensation | 1,309,000 | — | — | — | — | 1,309,000 | ||||||||||||||||||
Total operating expenses | 9,742,095 | 300,000 | 169,500 | (144,920 | ) | 15,706 | 10,082,381 | |||||||||||||||||
Loss before income taxes | (6,162,532 | ) | (300,000 | ) | (169,500 | ) | 144,920 | (15,706 | ) | (6,502,818 | ) | |||||||||||||
Income taxes | — | |||||||||||||||||||||||
NET LOSS | $ | (6,162,532 | ) | $ | (300,000 | ) | $ | (169,500 | ) | $ | 144,920 | $ | (15,706 | ) | $ | (6,502,818 | ) | |||||||
Basic and diluted net income (loss) per share : | ||||||||||||||||||||||||
Net loss per share | $ | (0.39 | ) | $ | (0.02 | ) | $ | (0.01 | ) | $ | 0.01 | $ | (0.00 | ) | $ | (0.41 | ) | |||||||
Basic and diluted weighted average common shares outstanding | 15,877,662 | 15,877,662 | 15,877,662 | 15,877,662 | 15,877,662 | 15,877,662 | ||||||||||||||||||
(1) Warrant Adjustment | |||
Reclassification of Warrants | |||
APIC | (972,300 | ) | |
Convertible Notes | 972,300 | ||
Reclassification of Warrant Liability | |||
Convertible Notes | (313,000 | ) | |
Warrant Liability | 313,000 | ||
(2) BCF Adjustment | |||
Beneficial Conversion Feature | |||
Convertible Notes | (78,632 | ) | |
APIC | 78,632 | ||
(3) Laurus Conversion | |||
Converison of Laurus convertible notes | |||
APIC | 300,000 | ||
Loss on conversion | (300,000 | ) | |
(4) ELM Street Conversion | |||
Conversion of ELM street warrants | |||
APIC | 169,500 | ||
Loss on conversion | (169,500 | ) | |
(5) Market Valuation | |||
Mark to Market Warrant Liability | |||
Warrant Liability | (144,920 | ) | |
Gain on Market Valuation - Warrant Liability | 144,920 | ||
(6) Amortization | |||
BCF - Amortization | |||
Interest Expense - Amortization | (15,706 | ) | |
Convertible Notes | 15,706 | ||
(7) Reclasses 12/31/04 | |||
Reclassification - LT- ST |
This is based on the 5 year debt schedule in the notes, broken down between funded versus restricted.
Schedule C
(Response No. 3)
Beneficial Conversion Feature Analysis
Allocated Debt Amount | Shares at Conversion Shares | Effective Conversion Price | Intrinsic Value Based on Effective Rate | BCF | ||||||
1,287,000 | 1,649,485 | 0.7802438 | 0.2820290 | 465,202 | ||||||
300,000 | 600,000 | 0.5000000 | 0.6322273 | 300,000 | ||||||
(300,000) | 600,000 | 0.5000000 | (0.0000000 | ) | (300,000 | ) | ||||
100,000 | 103,093 | 0.9700000 | 0.1302727 | 13,430 | ||||||
300,000 | 247,934 | 1.2100000 | (0.1097273 | ) | NA | |||||
78,588 | 64,949 | 1.2100000 | (0.1097273 | ) | NA | |||||
105,517 | 87,204 | 1.2100000 | (0.1226818 | ) | NA | |||||
683,910 | 565,215 | 1.2100000 | (0.1028182 | ) | NA | |||||
478,362 | ||||||||||
1,500,000 | 1,376,147 | 1.0900000 | (0.0881818 | ) | NA | |||||
240,000 | 247,423 | 0.9700000 | 0.0197273 | 4,881 | ||||||
1,091,985 | 949,552 | 1.1500000 | (0.1766818 | ) | NA | |||||
4,881 | ||||||||||
483,513 | ||||||||||
(200,000.00) | 400,000.00 | 0.97 | (0.47 | ) |
Schedule C (cont.)
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Beneficial Conversion Feature in Debentures
In accordance with EITF Issue 98-5, as amended by EITF 00-27, we must evaluate the potential effect of any beneficial conversion terms related to convertible instruments such as convertible debt or convertible preferred stock. The Company has issued several debentures and a beneficial conversion may exist if the holder, upon conversion, may receive instruments that exceed the value of the convertible instrument. Valuation of the benefit is determined based upon various factors including the valuation of equity instruments, such as warrants, that may have been issued with the convertible instruments, conversion terms, value of the instruments to which the convertible instrument is convertible, etc. Accordingly, the ultimate value of the beneficial feature is considered an estimate due to the partially subjective nature of valuation techniques.
NOTE 15 - Convertible Debentures
The Laurus Master Fund, LLC Obligation outstanding as of December 31, 2004 was as follows:
Conversion Rate | Amount Outstanding | Number of Shares Issuable Upon Conversion | |||
$0.97 | $ | 2,000,000 | 2,061.856 | ||
$1.21 | 868,015 | 717,368 | |||
Total Unrestricted Balance as of December 31, 2004 of Convertible Debentures: | 2,868,015 | 2,779,224 | |||
Restricted Balance as of December 31, 2004: | |||||
$0.97 | 240,000 | 247,243 | |||
$1.09 | 1,500,000 | 1,376,147 | |||
$1.33 | 1,091,985 | 821,041 | |||
Total Restricted Cash | 2,831,985 | 2,444,431 | |||
Total Convertible Notes | $ | 5,700,000 | 5,223,655 | ||
The repayment of the Laurus Transaction over the next five years ended December 31, are as follows:
For the year ended December 31, | Funded Balance | Restricted Cash Released in 2005 | Total Convertible Notes | ||||||
2005 | $ | 982,949 | $ | 653,451 | $ | 1,636,400 | |||
2006 | 1,042,915 | 1,029,813 | 2,072,728 | ||||||
2007 | 842,151 | 1,148,721 | 1,990,872 | ||||||
Total | $ | 2,868,015 | $ | 2,831,985 | $ | 5,700,000 | |||
The Company issued to Laurus warrants to purchase shares of common stock in connection with the above Convertible Notes. The Company issued the following warrants with the value of the warrants:
Number of Warrants | Exercise Price | Value of Warrants | ||||
495,867 | $ | 1.51 | $ | 103,400 | ||
495,867 | $ | 1.82 | 104,400 | |||
495,867 | $ | 2.12 | 105,200 | |||
1,487,601 | $ | 313,000 |
The Laurus transaction provided for 1.5 million warrants valued as freestanding instruments that meet the definition of a derivative under SFAS 133. We measured and recognized the warrants as a liability at their fair value, as determined using the Black-Scholes option pricing model, prior to the registration of shares underlying the warrants. We subsequently valued the warrants at December 31, 2004 for an adjustment to the market value to $168,000, and a gain of $145,000. The warrants will be valued quarterly, and upon registration of the underlying common stock through an effective Registration Statement. We allocated the $1.6 million of proceeds received from the first borrowing as: a $313,000 liability for the warrants (at fair value), $465,000 of additional paid-in capital for the benefit on conversion, and $822,000 liability for the convertible debt (net of debt discount). The $465,000 of additional paid-in capital reflects the value of Laurus’ option to convert the initial $1.6 million of debt at prices beneficial to Laurus as compared to the market price of our common stock (the beneficial conversion option). The beneficial conversion option on the initial $1.6 million of debt was determined by comparing the $1.3 million of proceeds not allocated to the detached warrants to the 1,649,485 shares into which the $1.6 million of debt was convertible. Effectively, the initial debt was convertible to common stock at $0.78 per share, which was less than $1.06 market price of our stock on the date off issuance, resulting in $465,000 value for the beneficial conversion option. The proceeds of subsequent borrowings under the agreement were allocated between additional paid-in capital (for beneficial conversion options present on the date of borrowing, if any) and a liability for the debt (discounted to the extent value was assigned to a beneficial conversion option). We accreted the recorded debt balances up to its face amounts over the term of the borrowings using the effective interest method, which results in additional interest expense and effective interest rates on the borrowings greater than the stated interest rates and at the time of conversion additional interest expense is recorded for the unamortized discount on such debt.
Our effective interest rates, debt, conversion prices and beneficial conversion on the various tranches of borrowings for the Laurus transaction are at December 31, 2004:
Date of Draw | Debt | Warrants | Additional Paid in Capital | Total Draw | Effective Interest Rate | |||||||||||||
9/29/04 | $ | 821,798 | $ | 313,000 | $ | 465,202 | $ | 1,600,000 | 49 | % | ||||||||
10/22/04 | 465,158 | — | 13,430 | 478,588 | 11 | % | ||||||||||||
11/3/04 | — | — | 300,000 | 300,000 | NA | |||||||||||||
11/10/04 | 105,517 | — | — | 105,517 | 10 | % | ||||||||||||
11/16/04 | 683,910 | — | — | 683,910 | 10 | % | ||||||||||||
2,076,383 | 313,000 | 778,632 | 3,168,015 | |||||||||||||||
Conversion | — | — | (300,000 | ) | (300,000 | ) | ||||||||||||
Accretion | 65,617 | (26,083 | ) | (39,534 | ) | — | ||||||||||||
Total | $ | 2,142,000 | $ | 286,917 | $ | 439,098 | $ | 2,868,015 | 114 | % | ||||||||
Allocated to Restricted | $ | 2,831,985 | 0 | 0 | 2,831,985 | 9 | % | |||||||||||
Total | $ | 4,973,985 | $ | 286,917 | $ | 439,098 | $ | 5,700,000 | ||||||||||
The Company holds the balance at December 31, 2004 under the Note of $2,831,985 in a restricted account controlled by Laurus. The amounts included in the restricted account are considered as a cash and cash equivalent, as the Company has drawn those funds from the restricted account in the first quarter of 2005.
Interest Rate Adjustment
The interest rate may be adjusted on the last business day of each month if: (i) the -shares underlying the conversion of the Note and the warrant are registered for resale under the Securities Exchange Act of 1933, as amended (the “Securities Act”), (ii) our common stock is listed on the NasdaqSC Market, NasdaqNM System, or the American Stock Exchange and (iii) the average market price of our common stock for the five (5) consecutive trading days immediately preceding an adjustment date exceeds the then applicable conversion price by at least twenty five percent (25%), the interest rate for each day of the succeeding calendar month shall automatically be reduced by 2.0% for each incremental increase in the market price of the Common Stock by 25% above the applicable conversion price. The interest rate may be adjusted on the last business day of adjustment date exceeds the then applicable conversion price by at least twenty five percent (25%), the interest rate for each day of the succeeding calendar month shall automatically be reduced by 1.0% for each incremental increase in the market price of the Common Stock by 25% above the applicable conversion price. Notwithstanding the foregoing (and anything to the contrary contained in herein), in no event shall the Interest Rate be less than zero percent (0%).
Interest and Principal Payments
The Company is required to make monthly interest payments to Laurus on the Unrestricted Funds, commencing November 1, 2004, and on the first day of each consecutive calendar month thereafter and on the Maturity Date. Accrued interest on the Restricted Funds is payable only on the Maturity Date or, in the event of the redemption or conversion, on such date. The Company shall commence making payments toward the principal amount of Unrestricted Funds on January 1, 2004. If and when Laurus transfers funds from the Restricted Account to the Company (Unrestricted Funds), the Company will commence making principal payments on such Unrestricted Funds 90 days following any such transfer.
Upon the Company registering the shares underlying the conversion of the Note and the warrant for resale under the Securities Act and subject to the 4.99% limitation and other limitations, Laurus shall convert the principal and interest payments for the Unrestricted Funds into common stock according to the following guidelines: (i) the average closing price of the common stock for the five (5) consecutive trading days immediately preceding such proposed conversion date is greater than or equal to 110% of the applicable conversion price and (ii) the amount to be paid in shares of Common Stock does not exceed twenty five percent (25%) of the aggregate dollar trading volume of the Common Stock for the immediately preceding ten (10) day trading period. If the conversion criteria are not met, Laurus will convert only such amounts as meets the conversion criteria and the remaining amounts will be paid by the Company in cash at the rate of 102% of the amount due.
Release of Restricted Funds
Upon the Company registering the shares underlying the conversion of the Note and the warrant for resale under the Securities Act, Laurus may release at its discretion, the Restricted Funds to the Company upon satisfaction of the following conditions: (i) as principal under the Convertible Note is converted into common stock, or (ii) upon Laurus securing a first priority lien on tangible, unencumbered assets to secure such Unrestricted Funds.
Redemption of Principal Amount
The Company may prepay the outstanding balance under the Convertible note by paying Laurus 125% of the Unrestricted Funds, together with accrued interest, and 105% of Restricted Funds, together with accrued interest.
Limitations on Conversion
Laurus may not convert debt under the Convertible Note if the amount that would be convertible into that number of shares of common stock would exceed the difference between 4.99% of our outstanding common stock and the number of shares of common stock beneficially owned by Laurus or issuable upon exercise in full of its Warrants. However, Laurus may void the 4.99% limitation upon 75 days prior notice to the Company or without any notice requirement upon an event of default under
the terms of the Convertible Note. In addition, this 4.99% limitation does not prevent Laurus from converting debt into shares of our common stock and then reselling those shares at times when neither Laurus nor its affiliates beneficially own shares in excess of the 4.99% limitation. Therefore, by periodically selling our common shares into the market, avoiding the limitations imposed by the 4.99% limitation.
Events of Default
Upon the occurrence and continuance of an event of default under the Convertible Note, Laurus may demand immediate payment of 125% of the outstanding principal amount under the Convertible Note, plus accrued interest. In addition, the interest rate on the Convertible Note will increase to two percent (2%) per month, and all outstanding obligations under the Note, including unpaid interest at the higher interest will accrue from the date of default until the date the default is cured or waived. The following events will constitute an event of default under the Convertible Note:
• | failure to pay interest and principal payments when due; |
• | a breach by us of any material covenant, representation, term or condition of the note or in any related agreement; |
• | an assignment for the benefit of our creditors is made by us, or a receiver or trustee is appointed for us; |
• | any money judgment or similar final process filed against us for more than $50,000, which remains unvacated, unbonded or unstayed for a period of 30 days; |
• | any form of bankruptcy or insolvency proceeding is instituted by or against us, which is not vacated within 45 days; |
• | our common stock is suspended for five consecutive days or five days during any ten consecutive days from our principal trading market; |
• | our failure to timely deliver shares of our common stock when due upon conversion of the note; |
• | the occurrence and continuance of an event of default under any related agreement or the default under any other agreement of indebtedness; and |
• | any change in the controlling ownership of us. |
Costs in connection with Debt Financing
The Company paid Laurus Capital Management, LLC., the manager of Laurus, a closing payment of $240,000. In addition, the Company paid Laurus $39,500, as reimbursement for its expenses incurred in connection with the preparation and negotiation of the Purchase Agreement, Convertible Note and other agreements executed in connection therewith and expenses incurred in connection with their due diligence review of the Company and our subsidiaries.
Warrants
In connection with the Purchase Agreement, we issued to Laurus warrants, exercisable for a period of seven years, to purchase up to (i) 495,867 shares of common stock at $1.51 per share, (ii) 495,867 shares of common stock at $1.82 per share, and (iii) 495,867 shares of common stock at $2.12 per share.
Restrictions on Future Financings
The Company has agreed not to issue any securities with a continuously variable or floating conversion feature, which are or could be (by conversion or registration) free-trading securities prior to the full repayment or conversion of the Convertible Note.
No Short-Selling by Laurus
Laurus has represented to the Company that neither it nor its affiliates or investment partners will engage in “short sales” of our common Stock during the term of the Convertible Note.
Right of First Opportunity
The Company granted Laurus a right of first opportunity to provide any additional financing to the Company or its subsidiaries on terms and conditions no less favorable than offered to a third party, other than with respect to certain indebtedness or equity financing (as specified in the Purchase Agreement, such as, (i) trade debt and debt incurred to finance the purchase of equipment (not in excess of five percent (5%) of the fair market value of the our assets) whether secured or unsecured other than unsecured indebtedness not to exceed an aggregate principal amount outstanding of $200,000, indebtedness existing prior to the entering into the Purchase Agreement, and debt incurred in connection with the purchase of assets or equipment in the ordinary course of business, or any refinancings or replacements thereof on terms no less favorable to the Purchaser than the indebtedness being refinanced or replaced or (ii) equity issued as consideration for the purchase of assets or property, a business or another entity or other than issuances or sales to employees, officers, directors or consultants.
Registration Rights Granted to Laurus
The Company agreed to file a registration statement to register the resale of the shares issued to Laurus upon conversion of the debt under the Convertible Note and shares issuable upon exercise of the warrants issued pursuant to the Purchase Agreement.