INFOCROSSING, INC. [LOGO]
2 CHRISTIE HEIGHTS STREET
LEONIA, NJ 07605
August 14, 2006
Fax No. 202.772.9211
VIA FACSIMILE AND
EDGAR TRANSMISSION
Securities and Exchange Commission
Division of Corporation Finance
Mail Stop 4561
100 F Street, N.E.
Washington, DC 20549
Attention: Brad Skinner
Accounting Branch Chief
Re: Infocrossing, Inc.
Form 10-K for the Fiscal Year Ended December 31, 2005
Filed March 15, 2006
File No. 000-20824
Ladies and Gentlemen:
Infocrossing, Inc. (the "Company") filed its Form 10-K for the fiscal
year ended December 31, 2005 with the Securities and Exchange Commission (the
"Commission") on March 15, 2006. The undersigned received a letter from the
Commission's Staff (the "Staff") dated July 17, 2006 containing the Staff's
comments on the Form 10-K (the "Comment Letter"). A copy of the Comment Letter
is attached hereto as Exhibit A. The Company has the following responses to the
Comment Letter. The following responses are numbered to correspond to the
numbered paragraphs in the Comment Letter.
FORM 10-K FOR THE FISCAL YEAR ENDED DECEMBER 31, 2005
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS, PAGE 22
1. WE NOTE THAT YOU DISCUSS GROSS MARGIN PERCENTAGES AND IT APPEARS THAT THESE
MEASURES ARE CALCULATED USING COSTS OF REVENUES ON THE FACE OF YOUR INCOME
STATEMENT THAT EXCLUDE DEPRECIATION. REVISE YOUR PRESENTATION TO INCLUDE
DEPRECIATION IN YOUR CALCULATION OF GROSS MARGIN. ALTERNATIVELY, EXPLAIN WHY YOU
DO NOT CONSIDER THESE COSTS TO BE COSTS OF REVENUE. THIS COMMENT ALSO APPLIES TO
YOUR DISCUSSIONS OF GROSS MARGIN IN YOUR QUARTERLY EARNINGS RELEASES.
With respect to the Staff's comment related to the exclusion of depreciation
from cost of revenue and discussion of gross margin in the Company's
Management's Discussion and Analysis of Financial Condition and Results of
Operations and quarterly earnings releases:
o The Company's presentation of costs of revenues in its income statement
clearly states that it excludes depreciation and this presentation is
consistent with our presentation in prior periods.
o The exclusion of depreciation from costs of revenues is consistent with the
Company's internal financial statements used for management reporting and
analysis.
o The exclusion of depreciation from costs of revenues is not uncommon for
service providers.
o Regulation S-X Rule 5-03 does not require reporting of gross margin.
o The Company acknowledges that while its presentation and discussion of
costs of revenues clearly states that it excludes depreciation, its
reference to gross margin is not appropriate. In the future, the Company
will modify its discussion of costs of revenues and will not make reference
to gross margin or gross margin percentage since the costs of revenues, as
presented, does not include depreciation.
o In a letter from Barbara C. Jacobs, Assistant Director, dated December 5,
2003, the Staff instructed the Company to revise its consolidated
statements of operations to state the cost of revenue separately from
operating expenses. Rule 5-03(2) of Regulation S-X was cited as the basis
for the comment. The Company responded to this comment on December 24, 2003
as follows:
The Company has changed the caption [on its Consolidated
Statements of Operation] of "Operating costs" to read "Costs
of revenues, excluding depreciation shown below." The
"Operating costs" line is solely comprised of expenses that
are directly related to the generation of revenue for the
Company. The types of costs included are (a) salaries and
benefits for personnel providing client services, (b) services
obtained from other vendors provided as part of our complete
customer service package, such as disaster recovery and
off-site data storage, (c) software license and maintenance
fees paid for the operating systems used to support clients,
(d) operating lease and maintenance costs for equipment and
operating facilities, (e) telecommunications charges for data
circuits and (f) other expenses. The Company has included the
additional phrase in the caption to disclose that there is no
depreciation or amortization included in the "Costs of
revenues" in accordance with SAB Topic 11.B. "Depreciation and
Depletion Excluded From Cost of Sales." In addition,
facilities costs related to "Costs of revenues" were
reclassified from "General and administrative expense."
Since the Staff made no further comments to the Company's response, the
Company continued to apply such policy.
NOTES TO CONSOLIDATED FINANCIAL STATEMENT
NOTE 7. NOTES PAYABLE, CONVERTIBLE DEBT, AND CAPITALIZED LEASE OBLIGATIONS
CONVERTIBLE DEBT, PAGE F-19
2. PLEASE TELL US HOW YOU HAVE CONSIDERED THE GUIDANCE IN EITF 00-19 IN
EVALUATING WHETHER THE CONVERSION, CALL AND PUT FEATURES OF THE SENIOR
CONVERTIBLE NOTES ARE EMBEDDED DERIVATIVES THAT REQUIRE BIFURCATION FROM THE
DEBT HOST AND ACCOUNTED FOR AT FAIR VALUE UNDER SFAS 133. SPECIFICALLY, TELL US
HOW YOU CONSIDERED THE CRITERIA IN PARAGRAPH 12 OF SFAS 133 AND THE SCOPE
EXCEPTION OF PARAGRAPH 11(A) OF SFAS 133 IN YOUR ANALYSIS. REFER ALSO TO
PARAGRAPH 68 OF EITF 00-19. IN ADDITION, PROVIDE US WITH YOUR ANALYSIS USING THE
CONDITIONS OUTLINED IN PARAGRAPHS 12-32 OF EITF 00-19 REGARDING WHETHER YOU MEET
THE SCOPE EXCEPTION OF SFAS 133. AS PART OF YOUR RESPONSE, PLEASE TELL US
WHETHER THE HOST INSTRUMENT MEETS THE DEFINITION OF CONVENTIONAL CONVERTIBLE
DEBT IN PARAGRAPH 4 OF EITF ISSUE 00-19. IN THIS REGARD, WE NOTE THAT THERE
APPEAR TO BE ANTI-DILUTION AND OTHER PROVISIONS THAT COULD RESULT IN THE
CONVERSION RATIO NOT BEING FIXED AND THEREFORE WOULD PRECLUDE THE CONVERTIBLE
DEBT FROM QUALIFYING AS CONVENTIONAL CONVERTIBLE.
FOR ADDITIONAL INFORMATION, REFER TO STAFF GUIDANCE ON THIS TOPIC IN SECTION
II.B. OF CURRENT ACCOUNTING AND DISCLOSURE ISSUES IN THE DIVISION OF CORPORATION
FINANCE, AVAILABLE ON OUR WEBSITE AT
http://www.sec.gov/divisions/corpfin/acctdis120105.pdf,
With respect to the Staff's inquiry as to how the Company considered the
guidance in EITF 00-19 in evaluating whether the conversion, call and put
features of the senior convertible notes are embedded derivatives that require
bifurcation from the debt host and accounted for at fair value under SFAS 133:
o We have included our analysis of the potential derivative features in
Exhibit B.
With respect to specific questions raised by the Staff:
1. We reviewed the scope exception of paragraph 11(a) of SFAS 133 and
determined that it was applicable to the notes. Our analysis, including the
conditions outlined in paragraphs 12-32 of EITF 00-19, is set forth in
Exhibit B as it relates to the conversion feature.
2. We reviewed the criteria in paragraph 12 of SFAS 133 as it relates to the
conversion, call and put features of the senior convertible notes. Our
analysis of the criteria as it relates to each feature is included in
Exhibit B.
3. We reviewed paragraph 4 of EITF Issue 00-19 and concluded that the senior
convertible notes do not qualify as conventional convertible debt. However,
as discussed in Exhibit B, the embedded conversion feature in the notes
meets the scope exception of SFAS 133 and therefore is not bifurcated.
We will continue to monitor the conversion, call and put features of the notes
in the event that a change in circumstances necessitates the bifurcation of any
embedded derivatives.
NOTES TO CONSOLIDATED FINANCIAL STATEMENT
NOTE 12. QUARTERLY FINANCIAL INFORMATION (UNAUDITED), PAGE F-31
3. WE NOTE THAT YOUR QUARTERLY INFORMATION INCLUDES ONLY REVENUES AND NET
INCOME. PLEASE EXPLAIN TO US HOW THIS PRESENTATION COMPLIES WITH ITEM 302(A) OF
REGULATION S-K.
With respect to the Staff inquiry regarding the Company's disclosure and
compliance with Item 302(a) of Regulation S-K:
o The Company disclosed revenues and net income for the periods required
under Item 302(a) of Regulation S-K.
o The Company did not have any extraordinary or cumulative effect of a change
in accounting to report for any of the periods required for presentation
which is why the Company presented net income.
o As noted in the response to question 1, the Company presents costs of
revenues, excluding depreciation in its financial statements and does not
report gross profit. The disclosure in Note 12 is consistent with this
presentation.
The Company is available at any time to discuss any questions the Staff may
have or to provide materials the Staff may request.
Please call the undersigned at (201) 840-4732 or Nicholas J. Letizia, the
Company's general counsel, at (201) 840-4717, if you have any questions with
respect to the foregoing.
Very truly yours,
/s/ WILLIAM J. McHALE
William J. McHale
Chief Financial Officer
cc: Nicholas J. Letizia
EXHIBIT A
LETTER FROM THE SECURITIES AND EXCHANGE COMMISSION DATED JULY 17, 2006
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
SEAL
DIVISION OF
CORPORATION FINANCE
Room 4561
July 17, 2006
Mr. William McHale
Chief Financial Officer
Infocrossing, Inc.
2 Christie Heights Street
Leonia, NJ 07605
Re: Infocrossing, Inc.
Form 10-K for the Fiscal Year Ended December 31, 2005
Filed March 15, 2006
File No. 000-20824
Dear Mr. McHale:
We have reviewed the above referenced filing and have the following
comments. Please note that we have limited our review to the matters addressed
in the comments below. We may ask you to provide us with supplemental
information so we may better understand your disclosure. Please be as detailed
as necessary in your explanation. After reviewing this information, we may raise
additional comments.
Please understand that the purpose of our review process is to assist you
in your compliance with the applicable disclosure requirements and to enhance
the overall disclosure in your filing. We look forward to working with you in
these respects. We welcome any questions you may have about our comments or any
other aspect of our review. Feel free to call us at the telephone numbers listed
at the end of this letter.
Form 10-K for the Fiscal Year Ended December 31, 2005
- -----------------------------------------------------
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations, page 22
- --------------------------------------------------------------------------------
1. We note that you discuss gross margin percentages and it appears that these
measures are calculated using costs of revenues on the face of your income
statement that exclude depreciation. Revise your presentation to include
depreciation in your calculation of gross margin. Alternatively, explain
why you
Mr. William McHale
Infocrossing, Inc.
July 17, 2006
Page 2
do not consider these costs to be costs of revenue. This comment also
applies to your discussions of gross margin in your quarterly earnings
releases.
Notes to Consolidated Financial Statement
- -----------------------------------------
Note 7. Notes Payable, Convertible Debt, and Capitalized Lease Obligations
- --------------------------------------------------------------------------
Convertible Debt, page F-19
- ---------------------------
2. Please tell us how you have considered the guidance in EITF 00-19 in
evaluating whether the conversion, call and put features of the senior
convertible notes are embedded derivatives that require bifurcation from
the debt host and accounted for at fair value under SFAS 133. Specifically,
tell us how you considered the criteria in paragraph 12 of SFAS 133 and the
scope exception of paragraph 11(a) of SFAS 133 in your analysis. Refer also
to paragraph 68 of EITF 00-19. In addition, provide us with your analysis
using the conditions outlined in paragraphs 12-32 of EITF 00-19 regarding
whether you meet the scope exception of SFAS 133. As part of your response,
please tell us whether the host instrument meets the definition of
conventional convertible debt in paragraph 4 of EITF Issue 00-19. In this
regard, we note that there appear to be anti-dilution and other provisions
that could result in the conversion ratio not being fixed and therefore
would preclude the convertible debt from qualifying as conventional
convertible.
For additional information, refer to Staff Guidance on this topic in
Section II.B. of Current Accounting and Disclosure Issues in the Division
of Corporation Finance, available on our website at
http://www.sec.gov/divisions/corpfin/acctdis120105.pdf,
Note 12. Quarterly Financial Information (Unaudited), page F-31
- ---------------------------------------------------------------
3. We note that your quarterly information includes only revenues and net
income. Please explain to us how this presentation complies with Item
302(a) of Regulation S-K.
As appropriate, please amend your filing and respond to these comments
within 10 business days or tell us when you will provide us with a response.
Please submit all correspondence and supplemental materials on EDGAR as required
by Rule 101 of Regulation S-T. You may wish to provide us with marked copies of
any amendment to expedite our review. Please furnish a cover letter with any
amendment that keys your responses to our comments and provides any requested
information. Detailed cover letters greatly facilitate our review. Please
understand that we may have additional comments after reviewing any amendment
and your responses to our comments.
Mr. William McHale
Infocrossing, Inc.
July 17, 2006
Page 3
We urge all persons who are responsible for the accuracy and adequacy of
the disclosure in the filing reviewed by the staff to be certain that they have
provided all information investors require for an informed decision. Since the
company and its management are in possession of all facts relating to a copy's
disclosure, they are responsible for the accuracy and adequacy of the
disclosures they have made.
In connection with responding to our comments, please provide, in writing,
a statement from the company acknowledging that:
o the company is responsible for the adequacy and accuracy of the disclosure
in the filing;
o staff comments or changes to disclosure in response to staff comments do
not foreclose the Commission from taking any action with respect to the
filing; and
o the company may not assert staff comments as a defense in any proceeding
initiated by the Commission or any person under the federal securities laws
of the United States.
In addition, please be advised that the Division of Enforcement has access
to all information you provide to the staff of the Division of Corporation
Finance in our review of your filing or in response to our comments on your
filing.
You may contact Christine Davis, Staff Accountant at (202) 551-3408 or Mark
Kronforst, Assistant Chief Account, at (202) 551-3451 or me at (202) 551-3489 if
you have questions regarding these comments.
Sincerely,
/s/ Brad Skinner
Brad Skinner
Accounting Branch Chief
EXHIBIT B
ANALYSIS OF DERIVATIVE ASPECTS OF CONVERTIBLE NOTES
CONVERSION FEATURE
We analyzed the conversion feature of the notes to determine if it is an
embedded derivative and needed to be separated from the host contract and
accounted for under SFAS 133. Paragraph 12 of SFAS 133 states that contracts
that do not in their entirety meet the definition of a derivative instrument
such as bonds, insurance policies or leases may contain embedded derivative
instruments. An embedded derivative instrument should be separated from the host
contract and accounted for as a derivative instrument pursuant to paragraph
12(a)-(c) of SFAS 133 if the following criteria are met:
a. The economic characteristics and risks of the embedded derivative
instrument are not clearly and closely related to the economic
characteristics and risks of the host contract.
ANALYSIS: Because the conversion feature is indexed to the stock of the
Company and the host is a debt host, the conversion feature is not clearly
and closely related to the host contract.
b. The contract that embodies both the embedded derivative instrument and the
host contract is not remeasured at fair value with changes in fair value
reported in earnings as they occur.
ANALYSIS: Since the host contract is a debt instrument, it is not measured
at fair value with changes in fair value being reported in earnings.
c. A separate instrument with the same terms as the embedded derivative
instrument would, pursuant to paragraphs 6 to 11, be a derivative
instrument subject to the requirements of SFAS 133.
ANALYSIS: SFAS 133 does not require the Company to bifurcate the stock
conversion feature from the convertible notes since that feature on a
standalone basis would be classified as an equity instrument. Paragraph
11(a) of SFAS 133 indicates that certain contracts will not be considered
derivative instruments for the purpose of bifurcating embedded derivatives
from host contracts. These contracts include "contracts issued or held by
that reporting entity that are both (1) indexed to its own stock and (2)
classified in stockholders' equity in its statement of financial position."
EITF 01-6 states that an instrument is considered indexed to a company's
own stock within the meaning of EITF 00-19 provided that the contingency
provisions are not based on an observable market, other than the market for
the issuer's stock, or an observable index, other than those calculated or
measured solely by reference to the issuer's own operations, and once the
contingent events have occurred, the instrument's settlement amount is
based solely on the issuer's stock. Based on the guidance within EITF 01-6,
the instrument meets the definition of "indexed to a company's stock" since
the instrument's settlement value is indexed to the Company's stock.
The notes have three contingent features which trigger conversion and are
evaluated below to determine whether they are considered indexed to the
Company's own stock.
------------------------------------------------- -----------------------------------------------------
1. CONVERSION UPON SATISFACTION OF SALE This provision is based upon the trading price of
PRICE CONDITIONS: The notes may be the Company's common stock. As such, the provision
converted during any fiscal quarter if is considered indexed to the Company's own stock.
the market price per share of the
Company's common stock for a period of
at least 20 consecutive trading days
during the 30 consecutive trading day
period ending on the last day of the
preceding fiscal quarter is more than
130% of the conversion price in effect
on that 30th day or during the 5
business-day period following any 10
consecutive trading-day period in which
the trading price of the notes was less
than 98% of the conversion value;
------------------------------------------------- -----------------------------------------------------
2. CONVERSION UPON NOTICE OF REDEMPTION: The conversion is not based on an index, but is
If the notes have been called for based on the Company's ability to call the notes
redemption; or for redemption. Therefore the feature does not
violate EITF 01-6.
------------------------------------------------- -----------------------------------------------------
3. CONVERSION UPON SPECIFIED CORPORATE The conversion is not based on an index. The
TRANSACTIONS: The specified transactions purpose of these provisions is to protect the
include: (1) certain distributions to the interests of the holders to assure that their
Company's common stockholders of rights economic interests are not subordinate to the
to acquire shares of the Company's common common shareholders. (Note that the make whole
stock at a discount (2) certain feature is evaluated as a separate feature below.)
distributions to the Company's common
stockholders when the distribution has a
per share value in excess of 5% of the
market price of the Company's common stock;
and (3) a consolidation, merger or binding
share exchange pursuant to which the
Company's common stock will be converted
into cash, securities or other property.
Upon a "change of control," as defined in
the indenture, the holders can require us
to repurchase all or part of the notes for
cash equal to 100% of principal plus
accrued interest. A consolidation, merger,
or binding exchange also may constitute a
"change of control" in certain instances.
If the "change of control" occurred prior
to July 15, 2009, in certain instances,
the Company may be required to pay a
"make whole premium" when repurchasing
the notes. The amount of the "make whole
premium" is based on the trading price of
the Company's stock.
------------------------------------------------- -----------------------------------------------------
The conversion price of the Company's notes will be adjusted to reflect stock
dividends, stock splits, issuances of rights to purchase shares of common stock
pursuant to a rights plan, distributions to common shareholders, and certain
tender offers made by the Company or its subsidiaries with respect to shares of
the Company's common stock. In addition, if after the effective date of shelf
registration statement filed by the Company with respect to the notes and the
common shares issuable upon conversion of the notes (August 17, 2004) and prior
to the 18th month thereafter, the market price of the Company's common stock is
less than 68.23% of the conversion price then in effect for at least 20 trading
days during any 30 consecutive trading day period, the conversion price shall
immediately be reduced by 17.38%; provided that there shall be no more than one
such reduction of the conversion price during the term of the notes (the "Reset
Adjustment"). The maximum number of shares issuable after the Reset Adjustment
was fixed and determinable on the issuance date. The Reset Adjustment will shall
only apply to the notes that have been sold or otherwise distributed pursuant to
the shelf registration statement referred to above.
EITF 00-19 and EITF 05-2 discuss conventional convertible debt instruments. The
notes are a "modified" Instrument B type convertible under EITF 90-19 (which may
be settled, at the Company's option in cash or shares or a combination thereof).
The Company believes that the notes are not conventional convertible debt
instruments since (1) settlement may be in a combination of cash and shares and
(2) the fact that not all of the anti-dilution provisions would be considered
equity restructuring events as defined in SFAS 123(R) and as required by EITF
05-2 (although we would note that EITF 05-2 was not effective at the time of the
issuance of the instrument). Thus, the conversion feature of the notes is
analyzed under paragraphs 12-32 of EITF 00-19 (discussed below).
Paragraph 8 of EITF 00-19 provides that contracts that require physical
settlement or net-share settlement, or contracts that give the issuer a choice
of net-cash settlement be classified as equity provided that the criteria of
paragraphs 12 through 32 of EITF 00-19 are also met. The conversion feature in
the notes can only be settled, at the Company's option, in cash or with shares
of the Company's common stock or a combination of the foregoing.
The requirements of paragraphs 12 through 32 of EITF 00-19 are considered below
in order to determine if the embedded derivative should be classified as a
component of stockholders' equity.
------------------------------------------------- -----------------------------------------------------
1. The contract permits the company to The Company may settle the conversion with
settle in unregistered shares. unregistered shares. The Company has certain
registration obligations described in "Liquidated
Damages Provision," below. There are no
penalties associated with one settlement option
versus another settlement option. (Note the
registration rights agreement is further
analyzed below.)
------------------------------------------------- -----------------------------------------------------
2. The company has sufficient authorized At the time of issuance, the Company was authorized
and unissued shares available to settle to issue 50,000,000 shares of common stock, of
the contract after considering all other which approximately 18,326,990 shares were
commitments that may require the outstanding.
issuance of stock during the maximum
period the derivative contract could As of the time of issuance, the maximum number of
remain outstanding. shares issuable upon conversion, after the increase
for the Reset Adjustment, was 5,673,759. As of the
time of issuance, the Company had outstanding
warrants and options on 6,482,398 shares.
The Company had no other instruments at the time
of issuance that would have required issuance of
additional shares.
This clearly demonstrates that the number of
authorized and available common shares exceeds the
number of shares needed to satisfy all existing
commitments.
------------------------------------------------- -----------------------------------------------------
3. The contract contains an explicit limit The maximum number of shares that could be issued
on the number of shares to be delivered to satisfy the conversion of the notes based on the
in a share settlement. initial conversion price was 4,687,500. Following
the Reset Adjustment, the maximum number increased
to 5,673,759. All of the anti-dilution triggers
are controlled by the Company, and there is a
cap on the number of shares until such time
the Company chooses to effect a triggering
event.
------------------------------------------------- -----------------------------------------------------
4. There are no required cash payments to Although there is a liquidated damages provision,
the counterparty in the event the this provision does not represent a net cash
company fails to make timely filings settlement feature since the investor will
receive with the SEC. damages as well as the shares or cash due under the
arrangement. For further discussion related to
this provision, see "Liquidated Damages
Provision," below.
------------------------------------------------- -----------------------------------------------------
5. There are no required cash payments to There are no such provisions.
the counterparty if the shares initially
delivered upon settlement are
subsequently sold by the counterparty
and the sales proceeds are insufficient
to provide the counterparty with full
return of the amount due (that is, there
are no cash settled "top-off" or
"make-whole" provisions).
------------------------------------------------- -----------------------------------------------------
6. The contract only requires net-cash There is no such requirement.
settlement only in specific circumstances
in which holders of shares underlying the
contract also would receive cash in exchange
for their shares.
------------------------------------------------- -----------------------------------------------------
7. There are no provisions in the contract There are no such provisions.
that indicate that the counterparty has
rights that rank higher than those of a
shareholder of the stock underlying the
contract.
------------------------------------------------- -----------------------------------------------------
8. There is no requirement in the contract There is no collateral requirement.
to post collateral at any point or for
any reason.
------------------------------------------------- -----------------------------------------------------
Under EITF 00-19, the stock conversion feature meets the definition of an equity
instrument since the Company has met the eight conditions within paragraphs 12
through 32. We reviewed these requirements each quarter subsequent to the
issuance of the notes and all eight conditions continue to be met. We will
continue this review each quarter.
In summary, the conversion feature is both (1) indexed to the Company's own
stock because it meets the provisions of EITF 01-06 and (2) classified in
stockholders' equity in its statement of financial position because it meets the
provisions of EITF 00-19. Therefore, the stock conversion feature is not within
the scope of SFAS 133 according to paragraph 11(a), and is not required to be
bifurcated and separately accounted for as a derivative instrument. Rather it is
considered part of the notes and the instrument is one instrument - convertible
debt.
We reviewed the anti-dilution provisions to the conversion ratio in the event of
an equity restructuring transaction. The glossary of SFAS 123(R) defines an
equity restructuring as "a nonreciprocal transaction between an entity and its
shareholders that causes the per-share fair value of the shares underlying the
option or similar award to change, such as a stock dividend, stock split,
spinoff, rights offering, or recapitalization through a large, nonrecurring cash
dividend." The following table analyzes the conversion rate adjustments with
respect to the notes agreement and compares those to the model established in
SFAS 123R and whether they are within the control of the Company:
------------------------------------------------- -----------------------------------------------------
Conversion Rate Adjustments: Analysis:
------------------------------------------------- -----------------------------------------------------
1. Issuance of shares of common stock as a This adjustment is within the SFAS 123(R) definition
dividend or distribution on shares of as being a stock split or stock dividend, and is
common stock or effect a share split or within control of the Company.
share combination.
------------------------------------------------- -----------------------------------------------------
2. Certain subdivisions, combinations, or This adjustment is within the SFAS 123(R) definition
reclassifications of the Company's common as being a stock split or stock dividend, and is
stock. within control of the Company.
------------------------------------------------- -----------------------------------------------------
3. Issuance to holders of common stock any This adjustment is within the SFAS 123(R) definition
rights or warrants entitling them to as being a stock split or stock dividend, and is
purchase common stock at a discount. within control of the Company.
------------------------------------------------- -----------------------------------------------------
4. Distributions of capital stock, other This adjustment is within the SFAS 123(R) definition
assets or property to holders of common as being a spin-off or similar transaction of
stock (except 1 through 3 above). providing a dividend to the holders, and is within
control of the Company.
------------------------------------------------- -----------------------------------------------------
5. Cash dividend or distribution. While this adjustment is not within the SFAS 123(R)
definition as being a dividend, it is within the
control of the Company. This adjustment disqualifies
the notes from being conventional convertible
instruments.
------------------------------------------------- -----------------------------------------------------
6. Purchases of the Company's common stock The anti-dilution provision is formula driven and
pursuant to tender offers by the Company within the control of the Company. However, it does
or any of its subsidiaries in excess of not represent a non-reciprocal transaction with
5% of the Company's market capitalization shareholders. Accordingly, it does disqualify the
as of the expiration of such offer (the debt from being conventional convertible. The number
consideration paid will be aggregated of shares that can be issued upon the change in the
with any tender or exchange offers for conversion are limited as the conversion factor is
the Company's stock made by the Company within the control of the Company.
or any of its subsidiaries during the 12
month period preceding the tender offer
for which no adjustment has been made).
------------------------------------------------- -----------------------------------------------------
The Company believes that the anti-dilution provisions of the notes do not give
rise to embedded derivatives.
PUT AND CALL FEATURES
The put and call features of the notes allow the holder to "put" the notes back
to the Company or the Company to "call" the notes. The notes contain the
following put and call features:
1) Put Option by Holder: The holders of the notes have the right to require
the Company to repurchase for cash any or all of the notes on July 15,
2009, 2014 and 2019. The purchase price payable will be equal to 100% of
the principal amount of the notes to be purchased plus any accrued and
unpaid interest.
2) Redemption at Option of Issuer: The notes may be redeemed by the Company at
any time on or after July 15, 2007; provided, however that the Company may
only redeem the notes prior to July 15, 2009 if (a) the market price of the
Company's common stock has been at least 150% of the conversion price then
in effect for at least 20 trading days during any 30 consecutive trading
day period; and (b) the shelf registration statement covering re-sales of
the notes and the shares of common stock issuable upon conversion is
effective and available for use and is expected to remain effective and
available for use for the 30 days following the redemption date. The notes
will be redeemed at 100% of the principal amount of the notes redeemed plus
any accrued and unpaid interest.
If the Company redeems the notes prior to July 15, 2009, the Company will
also make an additional interest payment on the redemption date with
respect to the notes called for redemption, such payment to be made in an
amount equal to $173.83 per $1,000 principal amount for the notes, less the
amount of any interest actually paid on such notes prior to the redemption
date. If redemption were to occur on the earliest possible date under this
feature - July 15, 2007 - the additional interest payable would not cause
the holders to double their initial rate of return.
3) Put Option by Holder Upon a Change of Control: If a change of control
occurs, holders of the notes may require the Company to repurchase for cash
all or a portion of the notes at a repurchase price equal to 100% of the
principal amount of the notes, plus any accrued and unpaid interest, plus a
make whole premium under certain circumstances. The provisions of the make
whole premium are discussed in greater detail below.
We analyzed the put and call features under SFAS 133. SFAS 133 does not require
put and call options that are clearly and closely related to the host contract
to be bifurcated from the host contract and accounted for separately. Paragraph
61(d) of SFAS 133 indicates that call and put options in debt that require the
prepayment of principal are considered to be clearly and closely related to the
debt instrument unless both (1) the debt involves a substantial premium or
discount and (2) the put or call option is only contingently exercisable and
meets the requirements of paragraph 13 of SFAS 133.
Paragraph 13(a) of SFAS 133 questions whether a hybrid instrument could
contractually be settled in such a way that the investor (holder) would not
recover substantially all of its initial recorded investment. In this case, the
holder of the notes will recover substantially all of its initial investment
because it will always receive the principal amount of the notes plus any
accrued and unpaid interest.
Paragraph 13(b) of SFAS 133 questions:
1) Is there a possible future interest rate scenario under which the embedded
derivative would at least double the investor's initial rate of return on
the host contract and
2) For each of the possible interest rate scenarios under which the investor's
initial rate of return on the host contract would be doubled, would the
embedded derivative at the same time result in a rate of return that is at
least twice what otherwise would be the then-current market return?
Neither the embedded put nor call feature in items 1 and 2 involve a substantial
premium or discount. Accordingly, each feature is considered to be clearly and
closely related to the debt host since they meet the requirements of paragraph
13 of SFAS 133.
The put discussed in item 3 contains a make whole provision in the event of
certain transactions involving a change of control. The make whole is analyzed
as a separate feature. The amount of the make whole premium that may be payable
even under remote instances always will be based on the value of the Company's
stock. In addition, the make whole premium will be payable in the same form of
consideration into which the Company's common stock has been exchanged or
converted, on the repurchase date for the notes after the change of control,
both for notes tendered for repurchase and for notes converted in connection
with the change of control. In other words, the make whole premium will be
payable in the same form as payment to other Company shareholders in the event
of a change of control, which is outside the control of the Company.
This feature represents an embedded derivative that would require bifurcation.
Since we believe any value associated with this feature would be de minimis, no
value was assigned at the time of issuance or in the subsequent periods. This
embedded derivative was not bifurcated. The Company continually monitors this
matter to ensure such derivative remains immaterial. If the value of this
derivitave should become materila in the future, the Company will report it at
such time.
MAKE WHOLE PREMIUM
On or prior to July 15, 2009, upon the occurrence of a change of control, under
certain circumstances, the Company will pay, in addition to the repurchase
price, a make whole premium on notes converted in connection with, or tendered
for repurchase upon, the change of control. The make whole premium will be
payable in the same form of consideration into which the Company's common stock
has been exchanged or converted, on the repurchase date for the notes after the
change of control, both for notes tendered for repurchase and for notes
converted in connection with the change of control.
The amount of the make whole premium, if any, will be based on the price of the
Company's common stock on the effective date of the change of control. The
amount of the make whole premium will be determined pursuant to a table set
forth in the indenture.
No make whole premium will be paid if the stock price is less than or equal to
82.62% of the conversion price or if the stock price is equal to or exceeds
227.86% of the conversion price. The make whole premium ranges from zero to
12.56% of the principal amount of the notes. The applicable percentage of
premium declines over time. The amount of the premium can be determined with the
following table:
Additional Premium Upon Change in Control
(expressed as a percentage of principal amount)
Stock price (expressed as a percentage of the conversion price)
Effective Date 82.62% 89.13% 100.00% 123.70% 149.74% 182.29% 227.86%
June 30, 2004............ 0.00% 4.52% 12.56% 7.95% 4.55% 1.87% 0.00%
July 15, 2004............ 0.00 4.47 12.50 7.90 4.51 1.84 0.00
January 15, 2005......... 0.00 4.00 11.99 7.39 4.10 1.58 0.00
July 15, 2005............ 0.00 3.64 11.56 6.93 3.72 1.34 0.00
January 15, 2006......... 0.00 3.36 11.16 6.47 3.33 1.11 0.00
July 15, 2006............ 0.00 3.11 10.76 5.98 2.93 0.88 0.00
January 15, 2007 0.00 2.82 10.26 5.37 2.46 0.63 0.00
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The exact stock price and effective date may not be set forth on the table. In
such event:
o If the stock price is between two stock prices on the table or the
effective date is between two dates on the table, the additional
premium will be determined by straight-line interpolation between
additional premium amounts set forth for the higher and lower stock
prices and the two dates, as applicable, based on a 365 day year.
o If the stock price (expressed as a percentage of the conversion price)
is equal to or in excess of 227.86%, no additional premium will be
paid.
If the stock price (expressed as a percentage of the conversion price) is less
than or equal to than 82.62%, no additional premium will be paid.
RESET ADJUSTMENT
As discussed above, the notes contain a Reset Adjustment that increases the
number of shares into which the notes can be converted if the trading price of
the Company's stock declines to a certain level over a specified period within
the eighteen months after the effective date of the a shelf registration
statement with respect to the resale of the notes and the common stock issuable
upon conversion of the notes.
As noted above, there is a limit on the additional shares that can be issued
under the Reset Adjustment. Also, as discussed previously, management has
concluded that the Company has sufficient authorized shares available to satisfy
all existing commitments to issue common stock including the maximum number of
shares that could be issued following the Reset Adjustment. Since the Reset
Adjustment is indexed to the share price and potentially settled in shares
of the Company, the Reset Adjustment is not required to be bifurcated from the
debt host contract and separately accounted for under paragraph 11(a) of SFAS
133.
SFAS 150 paragraph 12(c) requires that unconditional obligations, or conditional
obligations, to issue a variable number of shares be classified as liabilities
if the monetary value of the obligation is inversely based on the changes in
fair value of the underlying equity shares. Although the Company would have to
issue more shares as a result of the Reset Adjustment, the Reset Adjustment is
not required to be accounted for as a liability under SFAS 150 because the scope
of SFAS 150 applies to freestanding instruments, and not embedded instruments
(such as the Reset Adjustment).
LIQUIDATED DAMAGES PROVISION
The notes have a liquidated damages provision which must be analyzed to
determine whether or not it is a derivative instrument. The Company was required
to file a shelf registration statement with respect to the resale of the notes
and the common stock issuable upon conversion of the notes within 15 days after
the original issuance of the notes and to use commercially reasonable efforts to
cause such shelf registration statement to become effective as promptly as
practicable, but in no event later than 120 days after the original issuance of
the notes. The Company also agreed to keep the registration statement effective
until the earlier of the second anniversary of the effective date of the shelf
registration statement and the date when all of the securities covered by the
registration statement have been sold by holders who had delivered the selling
securityholder notice and questionnaire. If the Company had failed to meet its
registration obligations, it will be required to pay additional interest of
0.25% of the principal for the first 90 days after the occurrence of the event;
an additional 1.00% of the principal amount from and after the 91st day to the
second anniversary of the first issuance of the notes; an additional 3.00% of
the principal amount from and after the second anniversary of the first issuance
of the notes to the third anniversary of such issuance; and thereafter, an
additional 2.00% on each anniversary of the first issuance of the notes. The
interest representing liquidated damages will be paid along with regular
interest on scheduled payment.
The Company filed a shelf registration statement with respect to the resale of
the notes and the common stock issuable upon conversion of the notes on July 13,
2004, and the registration statement was declared effective on August 17, 2004.
The second anniversary of the effective date of the registration statement will
be on August 17, 2006. The Company believes that if it had incurred any penalty
interest during the two year period, any such amount would be no more than, and
likely less than, a reasonable discount between registered and unregistered
securities, and thus not an issue if the liquidated damages provision must be
considered in light of paragraph 16 of EITF 00-19.
The Company believes that the liquidated damages provision is a contingent
liability which under SFAS No. 5, would not require financial statement
recognition unless it is becomes both probable and quantifiable. The Company
does not believe either requirement has been met. Once the Company satisfies its
registration requirements on August 17, 2006, it will no longer be necessary to
continue to analyze this feature under SFAS No. 5. The Company does not believe
that the liquidated damages provision is an embedded derivative because a
less-liquid debt security would bear a higher interest rate, and this feature
would be clearly and closely related to the host instrument.