AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON DECEMBER 30, 2004
REGISTRATION NO. 333-
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM SB-2
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933
SMARTIRE SYSTEMS INC.
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
YUKON TERRITORY 3714 NOT APPLICABLE
- ----------------------------- ---------------------------- -------------------
State or jurisdiction of (Primary Standard Industrial (I.R.S. Employer
incorporation or organization Classification Code Number) Identification No.)
150-13151 Vanier Place, Richmond, British Columbia, V6V 2J1
(604) 276-9884
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(Address and telephone number of registrant's principal executive offices)
Robert Rudman, President and CEO
150-13151 Vanier Place, Richmond, British Columbia, V6V 2J1
(604) 276-9884
- --------------------------------------------------------------------------------
(Name, address and telephone number of agent for service)
Copy of communications to:
Darrin M. Ocasio, Esq.
Sichenzia Ross Friedman Ference LLP
1065 Avenue of Americas
New York, NY 10018
Telephone: 212-930-9700
Facsimile: 212-930-9725
Approximate date of proposed sale to the public: From time to time after the
effective date of this Registration Statement.
If this Form is filed to register additional securities for an offering pursuant
to Rule 462(b) under the Securities Act, please check the following box and list
the Securities Act registration statement number of the earlier effective
registration statement for the same offering. [ ]
If this Form is a post-effective amendment filed pursuant to Rule 462(c) under
the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ]
If this Form is a post-effective amendment filed pursuant to Rule 462(d) under
the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ]
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. [ ]
CALCULATION OF REGISTRATION FEE
- ---------------------------- ------------------- ----------------------- ---------------------- ----------------------
Title of each class Proposed maximum
of securities to be Amount to be Proposed maximum aggregate offering Amount of
registered(1) registered offering price per share price registration fee(2)
- ---------------------------- ------------------- ----------------------- ---------------------- ----------------------
Common stock to be 132,699,858(3) $0.029 $3,848,295.88 $452.94
offered for resale by the
selling stockholder
upon conversion of
convertible debentures
- ---------------------------- ------------------- ----------------------- ---------------------- ----------------------
Common stock to be 269,500,000(4) $0.029 $7,815,500.00 $919.88
offered for resale by the
selling stockholder
upon conversion of
convertible debentures
- ---------------------------- ------------------- ----------------------- ---------------------- ----------------------
Common stock to be offered 29,225,714(5) $0.029 $847,545.71 $99.76
for resale by holders of
warrants assuming the
exercise of such warrants
- ---------------------------- ------------------- ----------------------- ---------------------- ----------------------
Common stock to be offered 1,500,000(6) $0.029 $43,500.00 $5.12
for resale by holders of
warrants assuming the
exercise of such warrants
- ---------------------------- ------------------- ----------------------- ---------------------- ----------------------
Common stock offered for 411,607,143(7) $0.029 $11,936,607.14 $1,404.94
resale pursuant to Standby
Equity Distribution
Agreement
- ---------------------------- ------------------- ----------------------- ---------------------- ----------------------
Total Registration Fee $2,882.64
- ---------------------------- ------------------- ----------------------- ---------------------- ----------------------
(1) In the event of a stock split, stock dividend, or similar transactions
involving our common stock, the number of shares registered shall automatically
be increased to cover the additional shares of common stock issuable pursuant to
Rule 416 under the Securities Act of 1933, as amended.
(2) Fee calculated in accordance with Rule 457(c) of the Securities Act.
Estimated for the sole purpose of calculating the registration fee and based
upon the average quotation of the high and low price of our common stock on
December 29, 2004, as reported on the OTC Bulletin Board.
(3) Represents 200% of the common stock that may be issued upon the conversion
of principal under the 8% convertible debentures, maturing July 16, 2006 and
200% of the common stock that may be issued upon the conversion or redemption of
principal under the discounted convertible debentures, maturing December 24,
2006.
(4) Represents the common stock that was agreed to be registered and may be
issued upon the conversion or redemption of principal under the 5% convertible
debentures and redemption warrants, maturing December 15, 2007.
(5) Represents 200% of the common stock that may be issued upon the exercise of
common share purchase warrants, maturing between July 16, 2006 and November 10,
2008.
2
(6) Represents the common stock that may be issued upon the exercise of common
share purchase warrants, of which 1,250,000 common share purchase warrants
mature on July 22, 2006 and 250,000 common share purchase warrants mature on
June 30, 2009.
(7) Represents common stock that may be issued pursuant to the Standby Equity
Distribution Agreement dated May 19, 2004.
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON THE DATE OR DATES AS
MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL FILE A
FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION STATEMENT
SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF THE
SECURITIES ACT OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME EFFECTIVE ON THE
DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(A), MAY DETERMINE.
3
PROSPECTUS
SUBJECT TO COMPLETION
DECEMBER 30, 2004
SMARTIRE SYSTEMS INC.
A YUKON CORPORATION
844,532,715 SHARES OF COMMON STOCK OF SMARTIRE SYSTEMS INC.
---------------------------------
This prospectus relates to the resale by certain selling stockholders
of up to 844,532,715 shares of common stock of SmarTire Systems Inc. issuable to
the selling stockholders:
- up to 132,699,858 shares of common stock issuable to certain selling
stockholders upon the conversion of principal and interest, or in
payment of interest, under 8% convertible debentures and discounted
convertible debentures;
- up to 269,500,000 shares of common stock issuable to certain selling
stockholders upon the conversion of principal and redemption of
warrants under 5% convertible debentures;
- up to 29,225,714 shares of common stock issuable to certain selling
stockholders assuming the exercise of outstanding common share purchase
warrants issued in connection with the private placement of the 8%
convertible debentures and discounted convertible debentures;;
- up to 1,500,000 shares of common stock issuable to certain selling
stockholders assuming the exercise of outstanding common share purchase
warrants;
- up to 411,607,143 shares of common stock issuable pursuant to a
Standby Equity Distribution Agreement dated May 19, 2004 between our
company and a certain selling stockholder.
The selling stockholders may offer to sell the shares of common stock
being offered in this prospectus at fixed prices, at prevailing market prices at
the time of sale, at varying prices or at negotiated prices. We will not receive
any proceeds from the resale of shares of our common stock by the selling
stockholders.
Our common stock is quoted on the OTC Bulletin Board under the symbol
"SMTR". On December 30, 2004 the closing bid price for one share of our
common stock was $0.029. We do not have any securities that are currently traded
on any other exchange or quotation system.
OUR BUSINESS IS SUBJECT TO MANY RISKS AND AN INVESTMENT IN OUR COMMON
STOCK WILL ALSO INVOLVE A HIGH DEGREE OF RISK. YOU SHOULD INVEST IN OUR COMMON
STOCK ONLY IF YOU CAN AFFORD TO LOSE YOUR ENTIRE INVESTMENT. YOU SHOULD
CAREFULLY CONSIDER THE VARIOUS RISK FACTORS DESCRIBED BEGINNING ON PAGE 12
BEFORE INVESTING IN OUR COMMON STOCK.
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES
COMMISSION HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR DETERMINED IF THIS
PROSPECTUS IS TRUTHFUL OR COMPLETE. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
The information in this prospectus is not complete and may be changed.
The selling stockholder may not sell or offer these securities until this
registration statement filed with the Securities and Exchange Commission is
effective. This prospectus is not an offer to sell these securities and it is
not soliciting an offer to buy these securities in any state where the offer or
sale is not permitted.
The date of this prospectus is December ____, 2004.
4
The following table of contents has been designed to help you find important
information contained in this prospectus. We encourage you to read the entire
prospectus.
TABLE OF CONTENTS
PAGE NUMBER
PROSPECTUS SUMMARY 10
RISK FACTORS 12
RISKS RELATED TO SOME OF OUR OUTSTANDING SECURITIES 12
We have issued convertible debentures and share purchase warrants, and our obligations under 12
the convertible debentures and the warrants pose risks to the price of our common stock and
our continuing operations.
Any significant downward pressure on the price of our common stock could encourage short 12
sales by the holders of the 5%, 8% and discounted convertible debentures. Such short sales
may in turn place additional downward pressure on the market price of our common stock.
Assuming the issuance of 411,607,143 shares of our common stock pursuant to our equity line 12
of credit facility, and assuming that the holders of the convertible debentures and certain
warrant holders convert their convertible debentures or exercise their warrants, there will
be substantial dilution of your shares of our common stock.
RISKS RELATED TO OUR 8% AND DISCOUNTED CONVERTIBLE DEBENTURES 12
The holders of the discounted and 8% convertible debentures have the option of converting 12
the convertible debentures into shares of our common stock, and we may elect to make the
monthly redemption payments under the discounted convertible debentures in shares of our
common stock. The holders of the convertible debentures may also exercise their common
share purchase warrants. If the convertible debentures are converted or the warrants are
exercised, there will be dilution of your shares of our common stock.
The 8% and discounted convertible debentures provide for various events of default that 14
would entitle the holders to require us to immediately repay 120% of the outstanding
principal amount, plus accrued and unpaid interest, in cash. If an event of default occurs,
we may be unable to immediately repay the amount owed, and any repayment may leave us with
little or no working capital in our business.
Sales of a substantial number of shares of our common stock into the public market by the 15
holders of the 8% and discounted convertible debentures may result in a significant downward
pressure on the price of our common stock and could affect the ability of our stockholders
to realize the current trading price of our common stock. If the holders convert the 8% and
discounted convertible debentures, such holders might immediately sell such shares. In
addition, the mere prospect of sales of such a substantial number of shares of our common
stock could depress the market price for our common stock.
The continuously adjustable conversion price feature of our 8% and discounted convertible 15
notes could require us to issue a substantially greater number of shares, which will cause
dilution to our existing stockholders.
RISKS RELATED TO OUR 5% CONVERTIBLE DEBENTURES 16
The holders of the 5% convertible debentures have the option of converting the convertible 16
debentures into shares of our common stock, and we may elect to redeem all or a portion of
the convertible debentures by paying cash and issuing warrants, under the 5% convertible
debentures. The holders of the convertible debentures may also exercise their redemption
warrants, if any. If the convertible debentures are converted or the warrants are exercised,
there will be dilution of your shares of our common stock.
5
PAGE NUMBER
The 5% convertible debentures provide for various events of default that would entitle the 17
holders to require us to immediately accelerate full repayment of all debentures thereon
or, notwithstanding any limitations contain in the debentures and/or the Securities
Purchase Agreement, to convert all debentures outstanding and accrued interest thereon into
shares of our common stock. If an event of default occurs, we may be unable to immediately
repay the amount owed, and any repayment may leave us with little or no working capital in
our business.
Sales of a substantial number of shares of our common stock into the public market by the 18
holders of the 5% convertible debentures may result in a significant downward pressure on
the price of our common stock and could affect the ability of our stockholders to realize
the current trading price of our common stock. If the holders convert the 5% convertible
debentures, such holders would be entitled to convert into our shares at a 20% discount,
which might encourage the holders to immediately sell such shares. In addition, the mere
prospect of sales of such a substantial number of shares of our common stock could depress
the market price for our common stock.
The continuously adjustable conversion price feature of our 5% convertible notes 18
could require us to issue a substantially greater number of shares, which will cause
dilution to our existing stockholders.
RISKS RELATED TO OUR STANDBY EQUITY DISTRIBUTION AGREEMENT 19
Sales of a substantial number of shares of our common stock into the public market by 19
Cornell Capital Partners, LP under our remaining $11,525,000 of our $15 million equity line
of credit facility, may result in a significant downward pressure on the price of our common
stock and could affect the ability of our stockholders to realize the current trading price
of our common stock. If we are able and elect to draw down any amount under the equity line
of credit facility, Cornell Capital Partners, LP would be entitled to purchase shares under
the facility at a 2% discount, which might encourage Cornell Capital Partners, LP to
immediately sell such shares. In addition, the mere prospect of sales of such a substantial
number of shares of our common stock could depress the market price for our common stock.
Assuming the drawdown of $11,525,000 on our $15 million equity line of credit resulting in 19
the issuance of 411,607,143 shares of our common stock pursuant to our equity line of
credit facility at an issue price of $0.028 per share, the effective price paid for each
share would exceed the net tangible book value of each share as at October 31, 2004 by $0.014,
representing a dilution factor of 21.4%.
Assuring the issuance of 411,607,143 shares of our common stock pursuant to our equity line of 20
credit facility, there will be a substantial dilution of your shares of common stock.
6
PAGE NUMBER
Our Standby Equity Distribution Agreement with Cornell Capital Partners, LP limits the 21
number of shares of common stock that we can require Cornell Capital Partners, LP to
purchase to not more than 9.99% of our then issued and outstanding shares of common stock in
connection with each draw down, which may further limit our ability to draw down amounts
that we request and which may cause us to significantly curtail the scope of our operations
and alter our business plan.
RISKS RELATED TO OUR BUSINESS AND COMPANY 22
We require additional financing in order to continue in business as a going concern, the 22
availability of which is uncertain. We may be forced by business and economic conditions to
accept financing terms which will require us to issue our securities at a discount, which
could result in further dilution to our existing stockholders.
We have a history of operating losses and fluctuating operating results, which raise 22
substantial doubt about our ability to continue as a going concern
We may experience significant and rapid growth if we are able to capitalize on the expansion 23
of the tire monitoring market. If we are unable to hire and train staff to handle sales and
marketing of our products and manage our operations, such growth could materially and
adversely affect us.
Technological changes in our industry could render our products non-competitive 23
or obsolete 23 and consequently affect our ability to generate revenues.
We do carry a reasonable amount of product liability insurance. However there can be no 23
assurance that our existing insurance coverage would be adequate in term and scope to
protect us against material financial effects in the event of a successful claim.
Substantially all of our assets and a majority of our directors and officers are outside the 23
United States, with the result that it may be difficult for investors to enforce within the
United States any judgments obtained against us or any of our directors or officers.
The loss of our major customer may materially and adversely affect us. 23
We may experience difficulty in obtaining components and raw materials, and we could be 24
materially and adversely affected as a result.
The loss of any of our contract manufacturers would materially and adversely affect us. 24
We depend to a significant extent on certain key personnel, the loss of any of whom may 24
materially and adversely affect our company.
RISKS RELATED TO OUR COMMON STOCK 24
Future sales of our common stock may cause our stock price to decline. 24
Our stock price can be extremely volatile. 24
Trading on the OTC Bulletin Board may be sporadic because it is not a stock exchange, and 24
stockholders may have difficulty reselling their shares.
We do not expect to pay dividends. 25
If we fail to remain current on our reporting requirements, we could be removed from the OTC 25
Bulletin Board which would limit the ability of broker-dealers to sell our securities and
the ability of stockholders to sell their securities in the secondary market.
Our common stock is subject to the "penny stock" rules of the SEC and the trading market in 25
our securities is limited, which makes transactions in our stock cumbersome and may reduce
the value of an investment in our stock.
7
PAGE NUMBER
FORWARD-LOOKING STATEMENTS 27
SECURITIES AND EXCHANGE COMMISSION'S PUBLIC REFERENCE 27
THE OFFERING 27
USE OF PROCEEDS 28
SELLING STOCKHOLDERS 29
PLAN OF DISTRIBUTION 32
8% CONVERTIBLE DEBENTURES 34
DISCOUNTED CONVERTIBLE DEBENTURES 37
5% CONVERTIBLE DEBENTURES TO CORNELL CAPITAL PARTNERS, LP 41
5% CONVERTIBLE BRIDGE DEBENTURES 44
WARRANTS 46
STANDBY EQUITY DISTRIBUTION AGREEMENT 48
LEGAL PROCEEDINGS 50
DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS 51
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT 54
DESCRIPTION OF COMMON STOCK 55
LEGAL MATTERS 56
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE 56
INTEREST OF NAMED EXPERTS AND COUNSEL 56
EXPERTS 56
DISCLOSURE OF SEC POSITION OF INDEMNIFICATION FOR SECURITIES ACT LIABILITIES 56
DESCRIPTION OF BUSINESS 57
MANAGEMENT'S DISCUSSION AND ANALYSIS 71
RESULTS OF OPERATIONS 76
LIQUIDITY AND CAPITAL RESOURCES 83
FUTURE OPERATIONS 88
APPLICATION OF CRITICAL ACCOUNTING POLICIES 90
DESCRIPTION OF PROPERTY 91
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS 91
MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS 92
DIVIDEND POLICY 93
EXECUTIVE COMPENSATION 93
COMPENSATION OF DIRECTORS AND EXECUTIVE OFFICERS 97
FINANCIAL STATEMENTS F-1-F-47
WHERE YOU CAN FIND MORE INFORMATION 99
INDEMNIFICATION OF DIRECTORS AND OFFICERS 100
8
PAGE NUMBER
OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION 100
RECENT SALES OF UNREGISTRED SECURITIES 101
EXHIBITS 113
SIGNATURES 123
As used in this prospectus, the terms "we", "us", "our", and "SmarTire"
mean SmarTire Systems Inc. and its subsidiaries, unless otherwise indicated.
All dollar amounts refer to US dollars unless otherwise indicated.
9
PROSPECTUS SUMMARY
OUR BUSINESS
We (together with our subsidiaries) are engaged in the development and
marketing of tire monitoring systems designed for improved vehicle safety,
performance, reliability and fuel efficiency. We were formed to develop and
market remote data sensing, transmission and processing products incorporating
patented technologies to satisfy emerging market requirements in the
transportation industry. Currently we are focused on developing and marketing
technically advanced tire pressure monitoring systems (TPMS) for the
transportation and automotive industries. During the fiscal years ended July 31,
2004 and July 31, 2003, we earned revenues primarily from the sale of tire
monitoring systems for passenger cars. Our principal executive offices are
located at #150 - 13151 Vanier Place, Richmond, British Columbia, Canada, V6V
2J1. We were incorporated under the laws of the Province of British Columbia on
September 8, 1987, and were continued under the laws of the Yukon Territory to
become a Yukon corporation effective February 6, 2003. Our telephone number is
(604) 276-9884.
We have three wholly-owned subsidiaries: SmarTire Technologies Inc.,
SmarTire USA Inc. and SmarTire Europe Limited. SmarTire Technologies Inc. was
incorporated on June 3, 1988 under the laws of the Province of British Columbia,
and was the original developer of our patented technology. SmarTire USA Inc., a
Delaware corporation incorporated on May 16, 1997, is our exclusive marketing
agency for SmarTire in North America. SmarTire Europe Limited, a United Kingdom
corporation incorporated on February 25, 1998, is our exclusive sales and
distribution operation for Europe. SmarTire Europe's head office is located at
Park 34, Southmead Industrial Park, Didcot, Oxfordshire, England, OX11 7WB.
NUMBER OF SHARES BEING OFFERED
This prospectus covers the resale by the selling stockholders named in
this prospectus of up to 402,199,858 shares of our common stock which may be
issued to certain selling stockholders upon the conversion of principal and
interest, or in payment of interest, under 8% convertible debentures, 5%
convertible debentures and discounted convertible debentures, up to 30,725,714
shares of common stock which may be issued to certain selling stockholders upon
the exercise of certain outstanding common share purchase warrants issued
primarily in connection with the private placement of the convertible debentures
and the resale by Cornell Capital Partners, LP of up to 411,607,143 shares of
common stock issuable pursuant to a Standby Equity Distribution Agreement dated
May 19, 2004 between our company and Cornell Capital Partners, LP. The Standby
Equity Distribution Agreement contemplated the potential future issuance and
sale of up to $15.0 million, of which $11,525,000 remains available to us of our
common stock to Cornell Capital Partners, LP, subject to restrictions and other
obligations that are described throughout this prospectus. Under this
arrangement, we, at our sole discretion, may draw down on this facility,
sometimes termed an equity line, from time to time over a period of twenty-four
months after the effective date of this registration statement or until Cornell
Capital Partners, LP purchases $15.0 million worth of shares of our common
stock, whichever comes first. For each share of common stock purchased under the
Standby Equity Distribution Agreement, Cornell Capital Partners will pay 98% of
the lowest closing bid price of our common stock on the Over-The-Counter
Bulletin Board for the five trading days immediately following the notice date.
The amount of each advance is subject to a maximum of $500,000 per advance, with
a minimum of seven trading days between advances. Cornell Capital Partners
intends to sell any shares purchased under the Standby Equity Distribution
Agreement at the then prevailing market price. In addition, Cornell Capital
Partners will retain 5% of each advance under the Standby Equity Distribution
Agreement. The selling stockholders may sell the shares of common stock in the
public market or through privately negotiated transactions or otherwise. The
selling stockholders may sell these shares of common stock through ordinary
brokerage transactions, directly to market makers or through any other means
described in the section entitled "Plan of Distribution".
NUMBER OF SHARES OUTSTANDING
There were 225,912,470 shares of our common stock issued and
outstanding as at December 30, 2004.
USE OF PROCEEDS
10
We will not receive any of the proceeds from the sale of the shares of
common stock being offered for sale by the selling stockholder. We will,
however, incur all costs associated with this registration statement and
prospectus.
SUMMARY OF FINANCIAL DATA
The summarized financial data presented below is derived from and
should be read in conjunction with our audited consolidated financial statements
for the years ended July 31, 2004 and July 31, 2003, and our unaudited
consolidated financial statements for the three-month period ended October 31,
2004, (in each case including the notes to those financial statements) which are
included elsewhere in this prospectus along with the section entitled
"Management's Discussion and Analysis" beginning on page 71 of this prospectus.
- -------------------------------------------------- ------------------------ -------------------------
FOR THE 3-MONTH FOR THE 3-MONTH
PERIOD ENDED PERIOD ENDED
OCTOBER 31, 2004 OCTOBER 31, 2003
(UNAUDITED) (UNAUDITED)
- -------------------------------------------------- ------------------------ -------------------------
Revenue $301,169 $427,526
- -------------------------------------------------- ------------------------ -------------------------
Net Loss for the Period $(2,383,900) $(3,263,143)
- -------------------------------------------------- ------------------------ -------------------------
Loss Per Share - basic and diluted $(0.02) $(0.06)
- -------------------------------------------------- ------------------------ -------------------------
AS AT AS AT
OCTOBER 31, 2004 OCTOBER 31, 2003
(UNAUDITED) (UNAUDITED)
- -------------------------------------------------- ------------------------ -------------------------
Working Capital $2,494,264 $1,662,348
- -------------------------------------------------- ------------------------ -------------------------
Total Assets $7,410,823 $7,143,750
- -------------------------------------------------- ------------------------ -------------------------
Total Share Capital $63,553,832 $50,149,585
- -------------------------------------------------- ------------------------ -------------------------
Deficit $(61,402,156) $(51,294,373)
- -------------------------------------------------- ------------------------ -------------------------
Total Stockholders' Equity $5,341,326 $5,605,947
- -------------------------------------------------- ------------------------ -------------------------
- --------------------------------------- ------------------------ ------------------------ --------------------------
FOR THE YEAR ENDED FOR THE YEAR ENDED FOR THE YEAR ENDED
JULY 31, 2004 JULY 31, 2003 JULY 31, 2002
- --------------------------------------- ------------------------ ------------------------ --------------------------
Revenue $1,658,279 $1,802,596 $1,012,344
- --------------------------------------- ------------------------ ------------------------ --------------------------
Net Loss for the Period $(10,987,026) $(9,914,629) $(6,829,176)
- --------------------------------------- ------------------------ ------------------------ --------------------------
Loss Per Share - basic and diluted $(0.13) $(0.37) $(0.41)
- --------------------------------------- ------------------------ ------------------------ --------------------------
- --------------------------------------------------- ----------------------- -------------------------
AS AT AS AT
JULY 31, 2004 JULY 31, 2003
- --------------------------------------------------- ----------------------- -------------------------
Working Capital $732,405 $2,423,932
- --------------------------------------------------- ----------------------- -------------------------
Total Assets $6,937,128 $7,085,592
- --------------------------------------------------- ----------------------- -------------------------
Total Share Capital $58,368,020 $48,204,995
- --------------------------------------------------- ----------------------- -------------------------
Deficit $(59,018,256) $(48,031,230)
- --------------------------------------------------- ----------------------- -------------------------
Total Stockholders' Equity $3,466,216 $6,287,304
- --------------------------------------------------- ----------------------- -------------------------
11
RISK FACTORS
An investment in our common stock involves a number of very significant
risks. You should carefully consider the following risks and uncertainties in
addition to other information in this prospectus in evaluating our company and
our business before purchasing shares of common stock. Our business, operating
results and financial condition could be seriously harmed due to any of the
following risks. The risks described below are not the only ones facing our
company. Additional risks not presently known to us may also impair our business
operations. You could lose all or part of your investment due to any of these
risks.
RISKS RELATED TO SOME OF OUR OUTSTANDING SECURITIES
WE HAVE ISSUED CONVERTIBLE DEBENTURES AND SHARE PURCHASE WARRANTS, AND OUR
OBLIGATIONS UNDER THE CONVERTIBLE DEBENTURES AND THE WARRANTS POSE RISKS TO THE
PRICE OF OUR COMMON STOCK AND OUR CONTINUING OPERATIONS.
We have issued discounted convertible debentures, in the aggregate
principal amount of $3,493,590, maturing on April 1, 2006 of which amount
$1,612,798 remain outstanding as at December 30, 2004. In addition to the
discounted convertible debentures, we have also issued 8% convertible debentures
in the aggregate principal amount of $1,700,000 maturing July 16, 2006, of which
amount $245,000 remain outstanding as at December 27, 2004 and 5% convertible
debentures in the aggregate principal amount of $2,695,000 maturing December 15,
2007. The discounted, 5% and 8% convertible debentures provide that in certain
circumstances the holder of the debentures may convert the outstanding principal
and, in the case of the 5% and 8% convertible debentures, accrued interest, into
shares of our common stock. The purchasers of the discounted convertible
debentures and 8% convertible debentures also hold an aggregate of 14,612,857
warrants.
The terms and conditions of the convertible debentures and the warrants
pose unique and special risks to our continuing operations and the price of our
common stock. Some of those risks are outlined below.
ANY SIGNIFICANT DOWNWARD PRESSURE ON THE PRICE OF OUR COMMON STOCK COULD
ENCOURAGE SHORT SALES BY THE HOLDERS OF THE 5%, 8% AND DISCOUNTED CONVERTIBLE
DEBENTURES. SUCH SHORT SALES MAY IN TURN PLACE ADDITIONAL DOWNWARD PRESSURE ON
THE MARKET PRICE OF OUR COMMON STOCK.
Neither the 5%, 8% or discounted convertible debentures nor our Standby
Equity Distribution Agreement with Cornell Capital Partners, LP contain any
restrictions on short selling. Accordingly, any significant downward pressure on
the price of our common stock as the debenture holders and Cornell Capital
Partners, LP sell shares of our common stock could encourage short sales by them
or others, subject to applicable securities laws. In turn, sales of a
substantial number of shares of our common stock by way of short sales could
further depress the market price of our stock.
In an ordinary or "uncovered" short sale, a selling stockholder causes
his or her executing broker to borrow the shares to be delivered at the
completion of the sale from another broker, subject to an agreement to return
them upon request, thereby avoiding the need to deliver any shares actually
owned by the selling stockholder on the settlement date for the sale. Since the
selling stockholder does not own the shares that are sold, the selling
stockholder must subsequently purchase an equivalent number of shares in the
market to complete or "cover" the transaction. The selling stockholder will
realize a profit if the market price of the shares declines after the time of
the short sale, but will incur a loss if the market price rises and he or she is
forced to buy the replacement shares at a higher price. Accordingly, a declining
trend in the market price of our common stock may stimulate short sales.
ASSUMING THE ISSUANCE OF 411,607,143 SHARES OF OUR COMMON STOCK PURSUANT TO OUR
EQUITY LINE OF CREDIT FACILITY, AND ASSUMING THAT THE HOLDERS OF THE CONVERTIBLE
DEBENTURES AND CERTAIN WARRANT HOLDERS CONVERT THEIR CONVERTIBLE DEBENTURES OR
EXERCISE THEIR WARRANTS, THERE WILL BE SUBSTANTIAL DILUTION OF YOUR SHARES OF
OUR COMMON STOCK.
Our Standby Equity Distribution Agreement with Cornell Capital
Partners, LP dated May 19, 2004 contemplated the potential future issuance and
sale of up to $15.0 million of our common stock to Cornell Capital Partners, LP,
subject to certain restrictions and other obligations. Given our company's
current capital needs and the market price of our common stock, we presently
have no intention of drawing down the entire amount available of $11,525,000
unless the market price of our common stock increases. Accordingly, our
company's good faith estimate of the number of shares that we will issue
pursuant to the equity line in addition to the 89,748,929 shares previously
issued is 411,607,143 shares. Of this amount, 251,071 shares are registered.
As disclosed above in this section outlining certain "Risk Factors,"
the holders of the discounted convertible debentures may ultimately convert the
full amount of the convertible debentures and exercise all of their outstanding
warrants. They may then sell all of the resulting shares into the public market.
This will result in dilution to the interests of other holders of our common
stock.
RISKS RELATED TO OUR 8% AND DISCOUNTED CONVERTIBLE DEBENTURES
THE HOLDERS OF THE DISCOUNTED AND 8% CONVERTIBLE DEBENTURES HAVE THE OPTION OF
CONVERTING THE CONVERTIBLE DEBENTURES INTO SHARES OF OUR COMMON STOCK, AND WE
MAY ELECT TO MAKE THE MONTHLY REDEMPTION PAYMENTS UNDER THE DISCOUNTED
CONVERTIBLE DEBENTURES IN SHARES OF OUR COMMON STOCK. THE HOLDERS OF THE
CONVERTIBLE DEBENTURES MAY ALSO EXERCISE THEIR COMMON SHARE PURCHASE WARRANTS.
IF THE CONVERTIBLE DEBENTURES ARE CONVERTED OR THE WARRANTS ARE EXERCISED, THERE
WILL BE DILUTION OF YOUR SHARES OF OUR COMMON STOCK.
12
The issuance of shares of our common stock upon conversion or
redemption of the discounted convertible debentures, and upon the conversion of
the 8% convertible debentures, will result in dilution to the interests of other
holders of our common stock, since the holders of the convertible debentures may
sell all of the resulting shares into the public market.
The principal amount of the discounted convertible debentures may be
converted at the option of the holders into shares of our common stock at a set
price of $0.028 per share, subject to adjustment pursuant to the anti-dilution
provisions as set forth in the convertible debentures. In addition, we may elect
to make the monthly redemption payments in shares of our common stock at a
conversion price equal to the lesser of (a) the set price of $0.028 per share
(subject to adjustment pursuant to the anti-dilution provisions contained in the
debentures), and (b) 85% of the average of the 20 closing prices of our common
stock. As at December 30, 2004, we had issued 31,759,908 shares of our common
stock for monthly payments on our discounted convertible debenture and holders
of 8% convertible debentures had converted a total of $1,488,413 of principal,
and related interest, resulting in the issuance of 12,699,174 shares of our
common stock. The balance of the 8% convertible debentures in the aggregate
amount of $245,000 may be converted at a conversion price of $0.028 per share,
subject to adjustment as set forth in the convertible debentures. Accrued
interest on any principal amount that is so converted will be converted into
shares of our common stock at a conversion price equal to 90% of the 20-day
average closing bid price.
The purchasers of the discounted convertible debentures received
warrants to acquire up to an aggregate of 7,939,978 shares of our common stock,
exercisable for a period of two years. These warrants were exercised during
September 2004.
The purchasers of the 8% convertible debentures received warrants to
acquire up to an aggregate of 13,076,922 shares of our common stock, exercisable
for a period of three years. As 555,558 of these warrants have been exercised,
12,521,364 remain exercisable. They also hold additional warrants to acquire up
to an aggregate of 2,091,493 shares of our common stock, exercisable for a
period of five years.
Each convertible debenture and each warrant is subject to anti-dilution
protection upon the occurrence of certain events. If, among other things, we or
any of our subsidiaries offers, sells or otherwise disposes of or issues any of
our common stock (or any equity, debt or other instrument that is at any time
over its life convertible into or exchangeable for our common stock) at an
effective price per share that is less than the conversion price of the
convertible debenture or the exercise price of the warrant, the conversion price
or the exercise price of the warrant will be reduced to equal such effective
price.
The following table sets forth the number and percentage of shares of
our common stock that would be issuable if:
- entire principal amount of the discounted convertible debentures and
the 8% convertible debentures of $1,857,798 is converted or redeemed at
the current conversion price of $.028
- --------------------------------------------- -------------------- ---------------------- ----------------- ----------------
NUMBER OF SHARES
ISSUABLE
ON CONVERSION/
REDEMPTION OF
DISCOUNTED AND 8% SHARES ISSUED OR
CONVERTIBLE ISSUABLE ON EXERCISE PERCENTAGE OF
DESCRIPTION DEBENTURES(1) OF WARRANTS TOTAL SHARES CLASS(2)(3)
- --------------------------------------------- -------------------- ---------------------- ----------------- ----------------
DEBENTURES IN THE AGGREGATE PRINCIPAL
AMOUNT OF $1,857,798 ARE CONVERTED/REDEEMED
AT A CONVERSION PRICE OF $0.028. 66,349,929 14,612,857 80,962,786 26.38%
- --------------------------------------------- -------------------- ---------------------- ----------------- ----------------
(1) Represents the number of shares issuable if all of the outstanding principal
under all of the discounted convertible debentures and the 8% convertible
debentures were converted/redeemed at the indicated conversion price. For ease
of reference, any shares of common stock that may be issued upon conversion of
interest under the 8% convertible debentures have been excluded. The outstanding
principal under the 8% convertible debentures bears interest at the rate of 8%
per annum, calculated on the basis of a 360-day year.
13
(2) Based on 225,912,470 common shares issued and outstanding on December 30,
2004.
(3) Percentage of the total outstanding common stock represented by the shares
issuable on conversion/redemption of the discounted convertible debentures and
the 8% convertible debentures, and upon exercise of the warrants, without regard
to any contractual or other restriction on the number of securities the selling
stockholders may own at any point in time. The actual number of shares of common
stock issued or issuable upon the conversion/redemption of the discounted
convertible debentures is subject to adjustment pursuant to anti-dilution
provisions contained in the debentures which may or may not be triggered,
depending upon factors which cannot be predicted by us at this time.
THE 8% AND DISCOUNTED CONVERTIBLE DEBENTURES PROVIDE FOR VARIOUS EVENTS OF
DEFAULT THAT WOULD ENTITLE THE HOLDERS TO REQUIRE US TO IMMEDIATELY REPAY 120%
OF THE OUTSTANDING PRINCIPAL AMOUNT, PLUS ACCRUED AND UNPAID INTEREST, IN CASH.
IF AN EVENT OF DEFAULT OCCURS, WE MAY BE UNABLE TO IMMEDIATELY REPAY THE AMOUNT
OWED, AND ANY REPAYMENT MAY LEAVE US WITH LITTLE OR NO WORKING CAPITAL IN OUR
BUSINESS.
We will be considered in default of the discounted convertible
debentures and the 8% convertible debentures if any of the following events,
among others, occurs:
(a) we fail to pay any amount due under a convertible debenture within
five days of any notice sent to us by the holder of the convertible
debenture that we are in default of our obligation to pay the amount;
(b) we fail to comply with any of the other agreements contained in the
convertible debenture after we are given fifteen days written notice of
such non-compliance;
(c) we breach any of our obligations under the related securities
purchase agreement or the related registration rights agreement and the
breach is not cured by us within fifteen days after our receipt of
written notice of such breach;
(d) we or any of our subsidiaries become bankrupt or insolvent;
(e) we breach any of our obligations under any other debt or credit
agreements involving an amount exceeding $150,000, unless the breach is
cured by us within fifteen days or the breach is waived by the other
party to the debt or credit agreement;
(f) our common stock ceases to be eligible for quotation on the
principal market for our common stock (currently the OTC Bulletin
Board), and fails to be quoted or listed for trading on another
principal market (defined to mean the OTC Bulletin Board, the New York
Stock Exchange, American Stock Exchange, the NASDAQ Small-Cap Market or
the NASDAQ National Market) within five trading days;
(g) we agree to sell or dispose of more than 33% of our assets in one
or more transactions, or we agree to redeem or repurchase more than an
insignificant number of shares of our outstanding common stock or any
other equity securities of our company; or
(h) we fail to issue shares of our common stock to the holder within
five trading days of the conversion date specified in any conversion
notice delivered in respect of a convertible debenture by the holder.
If an event of default occurs, the holder of a convertible debenture
can elect to require us to pay a mandatory prepayment amount generally equal to
120% of the outstanding principal amount, plus all other accrued and unpaid
amounts under the convertible debenture.
14
Some of the events of default include matters over which we may have
some, little or no control. If a default occurs and we cannot pay the amounts
payable under the convertible debentures in cash (including any interest on such
amounts and any applicable late fees under the convertible debentures), the
holders of the debentures may protect and enforce their rights or remedies
either by suit in equity or by action at law, or both, whether for the specific
performance of any covenant, agreement or other provision contained in the
convertible debentures, in the related securities purchase agreement or in any
document or instrument delivered in connection with or pursuant to the
convertible debentures, or to enforce the payment of the outstanding convertible
debentures or any other legal or equitable right or remedy. In addition, any
repayment that we are required to make may leave us with little or no working
capital in our business. This would have an adverse effect on our continuing
operations.
SALES OF A SUBSTANTIAL NUMBER OF SHARES OF OUR COMMON STOCK INTO THE PUBLIC
MARKET BY THE HOLDERS OF THE 8% AND DISCOUNTED CONVERTIBLE DEBENTURES MAY RESULT
IN A SIGNIFICANT DOWNWARD PRESSURE ON THE PRICE OF OUR COMMON STOCK AND COULD
AFFECT THE ABILITY OF OUR STOCKHOLDERS TO REALIZE THE CURRENT TRADING PRICE OF
OUR COMMON STOCK. IF THE HOLDERS CONVERT THE 8% AND DISCOUNTED CONVERTIBLE
DEBENTURES, SUCH HOLDERS WOULD BE ENTITLED TO CONVERT INTO OUR SHARES , WHICH
MIGHT ENCOURAGE THE HOLDERS TO IMMEDIATELY SELL SUCH SHARES. IN ADDITION, THE
MERE PROSPECT OF SALES OF SUCH A SUBSTANTIAL NUMBER OF SHARES OF OUR COMMON
STOCK COULD DEPRESS THE MARKET PRICE FOR OUR COMMON STOCK.
Holders of the 8% and discounted convertible debentures may acquire and
resell up to 66,349,929 shares of our common stock, subject to adjustment, upon
conversion of the remaining principal under the convertible debentures, and up
to an additional 14,612,857 shares of our common stock, subject to adjustment,
upon exercise of certain outstanding common share purchase warrants.
As a result of anti-dilution provisions in the debentures, principal
under the 8% and discounted convertible debentures in the aggregate principal
amount of $1,857,798 may be converted by the holder in whole or in part and from
time to time at a conversion price of $0.028 per share The issuance of shares of
our common stock upon conversion of the 8% and discounted convertible debentures
will result in dilution to the interests of other holders of our common stock
(and securities convertible into common stock) since the holders of the
convertible debentures may sell all of the resulting shares into the public
market.
The resale of common stock by the holders of our 8% and discounted
convertible debentures will increase the number of our publicly traded shares,
which could depress the market price of our common stock, and thereby affect the
ability of our stockholders to realize the current trading price of our common
stock. Moreover, as all the shares we issue to the holders of our 8% convertible
debentures will be available for immediate resale, the mere prospect of our
sales to it could depress the market price for our common stock.
THE CONTINUOUSLY ADJUSTABLE CONVERSION PRICE FEATURE OF OUR 8% AND DISCOUNTED
CONVERTIBLE NOTES COULD REQUIRE US TO ISSUE A SUBSTANTIALLY GREATER NUMBER OF
SHARES, WHICH WILL CAUSE DILUTION TO OUR EXISTING STOCKHOLDERS.
Our obligation to issue shares upon conversion of our 8% and discounted
convertible debentures is essentially limitless. As sequential conversions and
sales take place, the price of our securities may decline and if so, if other
securities are issued at a price lower than the current conversion price our
convertible debenture holders would be entitled to receive an increasing number
of shares, which could then be sold, triggering further price declines and
conversions for even larger numbers of shares, to the detriment of the investors
in this offering. The sale of these shares may adversely affect the market price
of our common stock.
The following is an example of the number of shares of our common stock
that is issuable, upon conversion of our convertible debentures, based on the
current conversion price of $0.028, and 25%, 50% and 75% below the current
conversion price.
15
Number of Percentage
% Below Price shares Shares of Outstanding
Current conversion price per share issuable(1) Outstanding(2) Stock(3)
- ----------------------------- ----------- -------------- --------------- -----------------
Current conversion price 0.0280 66,349,929 292,262,399 22.70%
25% 0.0210 88,466,571 314,379,041 28.14%
50% 0.0140 132,699,857 358,612,327 37.00%
75% 0.0070 265,399,714 491,312,184 54.02%
(1) Based on current conversion price of $0.028 on December 30, 2004.
(2) Based on 225,912,470 common shares issued and outstanding on December 30,
2004.
(3) Percentage of the total outstanding common stock represented by the shares
issuable on conversion of the 8% and discounted convertible debentures, without
regard to any contractual or other restriction on the number of securities the
selling stockholders may own at any point in time. The actual number of shares
of common stock issued or issuable upon the conversion of the 8% and discounted
convertible debentures is subject to adjustment pursuant to anti-dilution
provisions contained in the debentures which may or may not be triggered,
depending upon factors which cannot be predicted by us at this time.
(4) For ease of reference, any shares of common stock that may be issued upon
conversion of interest under the 8% convertible debentures have been excluded.
The outstanding principal under the 8% convertible debentures bears interest at
the rate of 8% per annum, calculated on the basis of a 360-day year.
RISKS RELATED TO OUR 5% CONVERTIBLE DEBENTURES
THE HOLDERS OF THE 5% CONVERTIBLE DEBENTURES HAVE THE OPTION OF CONVERTING THE
CONVERTIBLE DEBENTURES INTO SHARES OF OUR COMMON STOCK, AND WE MAY ELECT TO
REDEEM ALL OR A PORTION OF THE CONVERTIBLE DEBENTURES BY PAYING CASH AND ISSUING
WARRANTS, UNDER THE 5% CONVERTIBLE DEBENTURES. THE HOLDERS OF THE CONVERTIBLE
DEBENTURES MAY ALSO EXERCISE THEIR REDEMPTION WARRANTS, IF ANY. IF THE
CONVERTIBLE DEBENTURES ARE CONVERTED OR THE WARRANTS ARE EXERCISED, THERE WILL
BE DILUTION OF YOUR SHARES OF OUR COMMON STOCK.
The issuance of shares of our common stock upon conversion of the 5%
convertible debentures will result in dilution to the interests of other holders
of our common stock, since the holders of the convertible debentures may sell
all of the resulting shares into the public market.
The principal amount of the 5% convertible debentures may be converted
at the option of the holders into shares of our common stock at at a conversion
price equal to the lesser of (i) 120% of the closing bid price of the common
stock as reported by Bloomberg, L.P. as of December 15, 2004, or (ii) 80% of the
lowest closing prices for the five (5) trading days preceding the date on which
the notice of conversion is sent via facsimile to us, subject to adjustment
pursuant to the anti-dilution provisions as set forth in the convertible
debentures.
Upon providing 3 business days advance written notice to holders,
during which time they may elect to convert up to all of their convertible
debentures, we may redeem the convertible debentures, in whole or part, at 120%
of the face value of each convertible debenture and the investor shall receive
50,000 redemption warrants for every $100,000 redeemed. The redemption warrants
are exercisable at 120% of the closing bid price on our common stock as reported
by Bloomberg, L.P. for the trading day immediately preceding the Closing Date.
The Redemption Warrants will be exercisable until 2 years from the date of
issuance.
Each convertible debenture and redemption warrant is subject to
anti-dilution protection upon the occurrence of certain events. If, among other
things, we or any of our subsidiaries offers, sells or otherwise disposes of or
issues any of our common stock (or any equity, debt or other instrument that is
at any time over its life convertible into or exchangeable for our common stock)
at an effective price per share that is less than the conversion price of the
convertible debenture or the exercise price of the warrant, the conversion price
or the exercise price of the warrant will be reduced to equal such effective
price.
16
The following is an example of the amount shares of our common stock
that is issuable, upon conversion of our 5% convertible debentures, based on the
25%, 50% and 75% below the current conversion price:
% Below Price Number of Percentage
per shares Shares of Outstanding
Current conversion price share(1) issuable Outstanding(2) Stock(3)
- -------------------------------- -------- ----------------- ----------------- ---------------
Current conversion price (1) 0.0228 118,201,754 344,114,224 34.35%
25% 0.0171 157,602,339 383,514,809 41.09%
50% 0.0114 236,403,509 462,315,979 51.13%
75% 0.0057 472,807,018 698,719,488 67.67%
(1) Based on 80% of the closing bid price of $0.0285 on December 29, 2004.
(2) Based on 225,912,470 common shares issued and outstanding on December 30,
2004.
(3) Percentage of the total outstanding common stock represented by the shares
issuable on conversion of the 5% convertible debentures, without regard to any
contractual or other restriction on the number of securities the selling
stockholders may own at any point in time. The actual number of shares of common
stock issued or issuable upon the conversion of the 5% convertible debentures is
subject to adjustment pursuant to anti-dilution provisions contained in the
debentures which may or may not be triggered, depending upon factors which
cannot be predicted by us at this time.
THE 5% CONVERTIBLE DEBENTURES PROVIDE FOR VARIOUS EVENTS OF DEFAULT THAT WOULD
ENTITLE THE HOLDERS TO REQUIRE US TO IMMEDIATELY ACCELERATE FULL REPAYMENT OF
ALL DEBENTURES OUTSTANDING AND ACCRUED INTEREST THEREON OR, NOTWITHSTANDING ANY
LIMITATIONS CONTAINED IN THE DEBENTURES AND/OR THE SECURITIES PURCHASE
AGREEMENT, TO CONVERT ALL DEBENTURES OUTSTANDING AND ACCRUED INTEREST THEREON
INTO SHARES OF OUR COMMON STOCK. IF AN EVENT OF DEFAULT OCCURS, WE MAY BE UNABLE
TO IMMEDIATELY REPAY THE AMOUNT OWED AND ANY REPAYMENT MAY LEAVE US WITH LITTLE
OR NO WORKING CAPITAL IN OUR BUSINESS.
We will be considered in default of the 5% convertible debentures if
any of the following events, among others, occurs:
(a) we fail to pay any amount due under a convertible debenture within
five days of any notice sent to us by the holder of the convertible
debenture that we are in default of our obligation to pay the amount;
(b) we fail to comply with any of the other agreements contained in the
convertible debenture after we are given fifteen days written notice of
such non-compliance;
(c) we breach any of our obligations under the related securities
purchase agreement or the related registration rights agreement and the
breach is not cured by us within fifteen days after our receipt of
written notice of such breach;
(d) we or any of our subsidiaries become bankrupt or insolvent;
(e) we fail to issue shares of our common stock to the holder within
five trading days of the conversion date specified in any conversion
notice delivered in respect of a convertible debenture by the holder.
17
(g) we agree to sell or dispose of more than 33% of our assets in one
or more transactions, or we agree to redeem or repurchase more than an
insignificant number of shares of our outstanding common stock or any
other equity securities of our company; or
(h) we fail to issue shares of our common stock to the holder within
five trading days of the conversion date specified in any conversion
notice delivered in respect of a convertible debenture by the holder.
If an event of default occurs, the holder of a convertible debenture
can elect to require us to pay a mandatory prepayment amount generally equal to
120% of the outstanding principal amount, plus all other accrued and unpaid
amounts under the convertible debenture.
Some of the events of default include matters over which we may have
some, little or no control. If a default occurs and we cannot pay the amounts
payable under the convertible debentures in cash (including any interest on such
amounts and any applicable late fees under the convertible debentures), the
holders of the debentures may protect and enforce their rights or remedies
either by suit in equity or by action at law, or both, whether for the specific
performance of any covenant, agreement or other provision contained in the
convertible debentures, in the related securities purchase agreement or in any
document or instrument delivered in connection with or pursuant to the
convertible debentures, or to enforce the payment of the outstanding convertible
debentures or any other legal or equitable right or remedy. In addition, any
repayment that we are required to make may leave us with little or no working
capital in our business. This would have an adverse effect on our continuing
operations.
SALES OF A SUBSTANTIAL NUMBER OF SHARES OF OUR COMMON STOCK INTO THE PUBLIC
MARKET BY THE HOLDERS OF THE 5% CONVERTIBLE DEBENTURES MAY RESULT IN A
SIGNIFICANT DOWNWARD PRESSURE ON THE PRICE OF OUR COMMON STOCK AND COULD AFFECT
THE ABILITY OF OUR STOCKHOLDERS TO REALIZE THE CURRENT TRADING PRICE OF OUR
COMMON STOCK. IF THE HOLDERS CONVERT THE 5% CONVERTIBLE DEBENTURES, SUCH HOLDERS
WOULD BE ENTITLED TO CONVERT INTO OUR SHARES AT A 20% DISCOUNT, WHICH MIGHT
ENCOURAGE THE HOLDERS TO IMMEDIATELY SELL SUCH SHARES. IN ADDITION, THE MERE
PROSPECT OF SALES OF SUCH A SUBSTANTIAL NUMBER OF SHARES OF OUR COMMON STOCK
COULD DEPRESS THE MARKET PRICE FOR OUR COMMON STOCK.
Principal under convertible debentures in the aggregate principal
amount of $195,000 and $2,500,000 may be converted by the holder in whole or in
part and from time to time at a conversion price equal to the lesser of (a) 120%
of the closing bid price of the common stock as reported by Bloomberg, L.P. for
the trading day immediately preceding the date that the holder's funds
representing the net amount due to us from the purchase price is transmitted by
wire transfer or otherwise to or for the benefit of us, or (ii) 80% of the
lowest closing prices for the 5 trading days preceding the date on which the
notice of conversion is sent via facsimile to us (the latter being at a 20%
discount). This discount may give the holders an incentive to immediately resell
any stock that it acquires from us, in order to realize a gain equal to the
difference between the market price of the stock (being the price at which
holders would sell) and the discounted price which it would have paid for the
stock. Any decreasing trend in the market price of our stock could potentially
result in an acceleration of sales of the stock by the holders, since any gains
that such holders will realize from the sale of the stock will decrease as the
market price approaches the discounted price that the holders would have paid
for it.
The resale of common stock by the holders of our 5% convertible
debentures will increase the number of our publicly traded shares, which could
depress the market price of our common stock, and thereby affect the ability of
our stockholders to realize the current trading price of our common stock.
Moreover, as all the shares we issue to the holders of our 5% convertible
debentures will be available for immediate resale, the mere prospect of our
sales to it could depress the market price for our common stock.
THE CONTINUOUSLY ADJUSTABLE CONVERSION PRICE FEATURE OF OUR 5% CONVERTIBLE NOTES
COULD REQUIRE US TO ISSUE A SUBSTANTIALLY GREATER NUMBER OF SHARES, WHICH WILL
CAUSE DILUTION TO OUR EXISTING STOCKHOLDERS.
18
Our obligation to issue shares upon conversion of our 5% convertible
debentures is essentially limitless. As sequential conversions and sales take
place, the price of our securities may decline and if so, our convertible
debenture holders would be entitled to receive an increasing number of shares,
which could then be sold, triggering further price declines and conversions for
even larger numbers of shares, to the detriment of the investors in this
offering. The sale of these shares may adversely affect the market price of our
common stock.
RISKS RELATED TO OUR STANDBY EQUITY DISTRIBUTION AGREEMENT
SALES OF A SUBSTANTIAL NUMBER OF SHARES OF OUR COMMON STOCK INTO THE PUBLIC
MARKET BY CORNELL CAPITAL PARTNERS, LP UNDER OUR $15,000,000 EQUITY LINE OF
CREDIT FACILITY, OF WHICH $11,525,000 HAS NOT BEEN DRAWN UPON MAY RESULT IN A
SIGNIFICANT DOWNWARD PRESSURE ON THE PRICE OF OUR COMMON STOCK AND COULD AFFECT
THE ABILITY OF OUR STOCKHOLDERS TO REALIZE THE CURRENT TRADING PRICE OF OUR
COMMON STOCK. IF WE ARE ABLE AND ELECT TO DRAW DOWN ANY AMOUNT UNDER THE EQUITY
LINE OF CREDIT FACILITY, CORNELL CAPITAL PARTNERS, LP WOULD BE ENTITLED TO
PURCHASE SHARES UNDER THE FACILITY AT A 2% DISCOUNT, WHICH MIGHT ENCOURAGE
CORNELL CAPITAL PARTNERS, LP TO IMMEDIATELY SELL SUCH SHARES. IN ADDITION, THE
MERE PROSPECT OF SALES OF SUCH A SUBSTANTIAL NUMBER OF SHARES OF OUR COMMON
STOCK COULD DEPRESS THE MARKET PRICE FOR OUR COMMON STOCK.
On May 19, 2004, we entered into our Standby Equity Distribution
Agreement with Cornell Capital Partners, LP, an accredited investor, in
connection with the 24-month, $15.0 million equity line of credit facility. The
agreement contemplated the potential future issuance and sale of up to $15.0
million of our common stock to Cornell Capital Partners, LP, subject to
restrictions and other obligations (including the requirement that the
underlying shares of common stock issuable to the investor under the facility
shall have been registered on an appropriate registration form under the
Securities Act of 1933). To date we have sold $3,475,000 of our common stock. As
such, $11,525,000 is available for us to use under our equity line of credit
facility provided that we have available registered shares. Currently, only
251,070 shares are registered out of the 90,000,000 shares that were registered
on June 1, 2004.
For each share of common stock purchased under the Standby Equity
Distribution Agreement, Cornell Capital Partners will pay 98% of the lowest
closing bid price of our common stock on the Over-The-Counter Bulletin Board for
the five trading days immediately following the notice date. This discount may
give Cornell Capital Partners, LP an incentive to immediately resell any stock
that it acquires from us, in order to realize a gain equal to the difference
between the market price of the stock (being the price at which Cornell Capital
Partners, LP would sell) and the discounted price which it would have paid for
the stock. Any decreasing trend in the market price of our stock could
potentially result in an acceleration of sales of the stock by Cornell Capital
Partners, LP, since any gains that Cornell Capital Partners, LP will realize
from the sale of the stock will decrease as the market price approaches the
discounted price that Cornell Capital Partners, LP would have paid for it.
The resale of common stock by the holders of our discounted convertible
debentures, and by Cornell Capital Partners, LP, will increase the number of our
publicly traded shares, which could depress the market price of our common
stock, and thereby affect the ability of our stockholders to realize the current
trading price of our common stock. Moreover, as all the shares we issue to the
holders of our discounted convertible debentures or to Cornell Capital Partners,
LP will be available for immediate resale, the mere prospect of our sales to it
could depress the market price for our common stock.
ASSUMING THE DRAWDOWN OF $11,525,000 ON OUR $15 MILLION EQUITY LINE OF CREDIT
RESULTING IN THE ISSUANCE OF 411,607,143 SHARES OF OUR COMMON STOCK PURSUANT TO
OUR EQUITY LINE OF CREDIT FACILITY AT AN ISSUE PRICE OF $0.028 PER SHARE, THE
EFFECTIVE PRICE PAID FOR EACH SHARE WOULD EXCEED THE NET TANGIBLE BOOK VALUE OF
EACH SHARE AS AT OCTOBER 31, 2004 BY $0.014, REPRESENTING A DILUTION FACTOR OF
21.4%.
Assuming the issuance of 411,607,143 shares of our common stock
pursuant to our equity line of credit facility with Cornell Capital Partners, LP
at a discounted issue price of $0.028 per share, the effective price paid for
each share would exceed the net tangible book value of each share as at October
31, 2004 by $0.014, representing a dilution factor of 21.4%. The following table
sets forth the dilution for the common stock that will be issuable based upon
the net tangible book value attributable to each share of our common stock as at
October 31, 2004.
19
Issue price $0.028(1)
Net tangible book value before the issue of the common stock(2) $0.014
Increase in net tangible book value attributable to the issue of the common stock 0.008
Net tangible book value after the issue of the common stock(3) 0.022
-----
Dilution per share $0.006
======
Percentage of dilution in relation to the net tangible book value per share prior
to the issue of the common stock 21.4%
(1) After taking into account the 2% discount that Cornell Capital Partners, LP
is entitled to receive under the Standby Equity Distribution Agreement. It is
assumed for illustrative purposes that the price of our common stock is $0.028
per share.
(2) As at October 31, 2004.
(3) Represents aggregate proceeds from the issue of the common stock, less the
5% fee paid to Cornell Capital Partners, LP.
ASSUMING THE ISSUANCE OF 411,607,143 SHARES OF OUR COMMON STOCK PURSUANT TO OUR
EQUITY LINE OF CREDIT FACILITY, THERE WILL BE SUBSTANTIAL DILUTION OF YOUR
SHARES OF OUR COMMON STOCK.
Our Standby Equity Distribution Agreement with Cornell Capital
Partners, LP dated May 19, 2004 contemplated the potential future issuance and
sale of up to $15.0 million of our common stock to Cornell Capital Partners, LP,
subject to certain restrictions and other obligations. Given our company's
current capital needs and the market price of our common stock, we presently
have no intention of drawing down the entire amount available of $11,525,000
unless the market price of our common stock increases. Accordingly, our
company's good faith estimate of the number of shares that we will issue
pursuant to the equity line in addition to the 89,748,929 shares previously
issued is 411,607,143 shares. Of this amount, 251,071 shares are registered.
The following is an example of the amount shares of our common stock
that is issuable, upon the entire drawdown of $11,525,000 on our equity line
based on the price of $0.028, and 25%, 50% and 75% below the this price:
Number of Percentage
% Below Price shares Shares of Outstanding
Market per share issuable(1) Outstanding(2) Stock(4)
- ----------------------------- ----------- ----------------- ------------------ --------------
Current price(3) 0.0280 411,607,143 637,519,613 64.56%
25% 0.0210 548,809,524 774,721,984 70.84%
50% 0.0140 823,214,286 1,049,126,756 78.47%
75% 0.0070 1,646,428,571 1,872,341,041 87.93%
20
(1) Represents the number of shares issuable if all the remaining $11,525,000
remaining under the equity line of credit, was drawn down at the indicated
effective price.
(2) Based on 225,912,470 common shares issued and outstanding on December 30,
2004.
(3) Based on 98% of the closing bid price of $0.0285 on December 29, 2004.
(4) Percentage of the total outstanding common stock represented by the shares
issuable on draw down on the equity line of credit without regard to any
contractual or other restriction on the number of securities the selling
stockholders may own at any point in time.
OUR STANDBY EQUITY DISTRIBUTION AGREEMENT WITH CORNELL CAPITAL PARTNERS, LP
LIMITS THE NUMBER OF SHARES OF COMMON STOCK THAT WE CAN REQUIRE CORNELL CAPITAL
PARTNERS, LP TO PURCHASE TO NOT MORE THAN 9.99% OF OUR THEN ISSUED AND
OUTSTANDING SHARES OF COMMON STOCK IN CONNECTION WITH EACH DRAW DOWN, WHICH MAY
FURTHER LIMIT OUR ABILITY TO DRAW DOWN AMOUNTS THAT WE REQUEST AND WHICH MAY
CAUSE US TO SIGNIFICANTLY CURTAIL THE SCOPE OF OUR OPERATIONS AND ALTER OUR
BUSINESS PLAN.
Our Standby Equity Distribution Agreement with Cornell Capital
Partners, LP provides that we may not sell shares of our common stock pursuant
to our draw down right under the agreement if the draw down would result in the
issuance of more than 9.99% of our then issued and outstanding common stock to
Cornell Capital Partners, LP. For example, on December 30, 2004, 225,912,470
shares of our common stock were issued and outstanding. Assuming that we would
have otherwise been in a position to effect a draw down under the equity line of
credit facility, the 9.99% restriction would have prevented us from selling more
than 25,074,000 shares to Cornell Capital Partners, LP at that time. We would
have realized net proceeds from the draw down of approximately $666,468, after
deduction of a 2% discount, 5% fee payable to Cornell Capital and a $500 escrow
fee payable to the escrow agent.
Since trading in stock quoted on the OTC Bulletin Board is often thin
and characterised by wide fluctuations in trading prices, Cornell Capital
Partners, LP may have difficulty reselling the shares that it purchases under
the Standby Equity Distribution Agreement. Between September 1, 2004 and
December 29, 2004 the average daily trading volume of our common stock on the
OTC Bulletin Board was 4,352,808 shares, and the closing price of one share of
our common stock during this period ranged from $0.0285 to $0.094. This volume
could decrease and in turn, may require that draw downs be delayed until Cornell
Capital Partners, LP has sold a sufficient number of shares to stay within the
9.99% restriction. We may have to significantly curtail the scope of our
operations and alter our business plan if, at the time of any draw down under
the equity line, this 9.99% restriction results in our inability to draw down
some or all of the amounts requested in any draw down notice.
21
RISKS RELATED TO OUR BUSINESS AND COMPANY
WE REQUIRE ADDITIONAL FINANCING IN ORDER TO CONTINUE IN BUSINESS AS A GOING
CONCERN, THE AVAILABILITY OF WHICH IS UNCERTAIN. WE MAY BE FORCED BY BUSINESS
AND ECONOMIC CONDITIONS TO ACCEPT FINANCING TERMS WHICH WILL REQUIRE US TO ISSUE
OUR SECURITIES AT A DISCOUNT, WHICH COULD RESULT IN FURTHER DILUTION TO OUR
EXISTING STOCKHOLDERS.
As discussed under the heading, "Management's Discussion and Analysis -
Liquidity and Capital Resources," we require additional financing to fund our
operations. We are taking the steps necessary to draw down amounts under the
remaining $11,525,000 from our $15,000,000 equity line of credit facility that
we arranged with Cornell Capital Partners, LP. However, business and economic
conditions may make it unfeasible or undesirable for us to draw down amounts
under the equity line of credit at every opportunity,
In conjunction with our investment advisors, Cornell Capital Partners,
LP, we are pursuing various financing alternatives to meet our immediate and
long-term financial requirements. There can be no assurance that additional
financing will be available to us when needed or, if available, that it can be
obtained on commercially reasonable terms. In addition, any additional equity
financing may involve substantial dilution to our stockholders. If we fail to
raise sufficient financing to meet our immediate cash needs, we will be forced
to scale down or perhaps even cease the operation of our business, which may
result in the loss of some or all of your investment in our common stock.
In addition, in seeking debt or equity private placement financing, we
may be forced by business and economic conditions to accept terms which will
require us to issue our securities at a discount from the prevailing market
price or face amount, which could result in further dilution to our existing
stockholders.
WE HAVE A HISTORY OF OPERATING LOSSES AND FLUCTUATING OPERATING RESULTS, WHICH
RAISE SUBSTANTIAL DOUBT ABOUT OUR ABILITY TO CONTINUE AS A GOING CONCERN.
Since inception through October 31, 2004, we have incurred aggregate
losses of $61,402,156. Our loss from operations for the three month period ended
October 31, 2004 was $1,857,007; our loss from operations for the fiscal years
ended July 31, 2004 and July 31, 2003 were, respectively, $6,973,571 and
$6,387,160. There is no assurance that we will operate profitably or will
generate positive cash flow in the future. In addition, our operating results in
the future may be subject to significant fluctuations due to many factors not
within our control, such as the unpredictability of when customers will order
products, the size of customers' orders, the demand for our products, and the
level of competition and general economic conditions.
Although we are confident that revenues will increase, we also expect
an increase in development costs and operating costs. Consequently, we expect to
incur operating losses and negative cash flow until our products gain market
acceptance sufficient to generate a commercially viable and sustainable level of
sales, and/or additional products are developed and commercially released and
sales of such products made so that we are operating in a profitable manner.
22
WE MAY EXPERIENCE SIGNIFICANT AND RAPID GROWTH IF WE ARE ABLE TO CAPITALIZE ON
THE EXPANSION OF THE TIRE MONITORING MARKET. IF WE ARE UNABLE TO HIRE AND TRAIN
STAFF TO HANDLE SALES AND MARKETING OF OUR PRODUCTS AND MANAGE OUR OPERATIONS,
SUCH GROWTH COULD MATERIALLY AND ADVERSELY AFFECT US.
We intend to proceed with initiatives intended to capitalize on the
expansion of the tire monitoring market that is occurring as a result of the
enactment by the TREAD Act. This could potentially lead to significant and rapid
growth in the scope and complexity of our business. Any inability on our part to
manage such growth effectively will have a material adverse effect on our
product development, business, financial condition and results of operations.
Our ability to manage and sustain growth effectively will depend, in part, on
the ability of our management to implement appropriate management, operational
and financial systems and controls, and the ability of our management to
successfully hire, train, motivate and manage employees.
TECHNOLOGICAL CHANGES IN OUR INDUSTRY COULD RENDER OUR PRODUCTS NON-COMPETITIVE
OR OBSOLETE AND CONSEQUENTLY AFFECT OUR ABILITY TO GENERATE REVENUES.
The markets in which we operate are subject to technological change,
evolving industry standards and changes in customer demands. The introduction of
products embodying new technologies and the emergence of new industry standards
can render existing products obsolete and unmarketable, including ours. Although
we are confident that our tire monitoring systems (TMS) technology and products
are technologically advanced and currently competitive, we believe that our
long-term success will depend upon our ability to continuously develop new
products and to enhance our current products and introduce them promptly into
the market. If we are not able to develop and introduce new products, our
business, financial condition and results of operations could be adversely
affected.
WE DO CARRY A REASONABLE AMOUNT OF PRODUCT LIABILITY INSURANCE. HOWEVER THERE
CAN BE NO ASSURANCE THAT OUR EXISTING INSURANCE COVERAGE WOULD BE ADEQUATE IN
TERM AND SCOPE TO PROTECT US AGAINST MATERIAL FINANCIAL EFFECTS IN THE EVENT OF
A SUCCESSFUL CLAIM.
We could be subject to claims in connection with the products that we
sell. There can be no assurance that we would have sufficient resources to
satisfy any liability resulting from any such claim, or that we would be able to
have our customers indemnify or insure us against any such liability. Although
we have product and directors and officers liability insurance, there can be no
assurance that our insurance coverage would be adequate in term and scope to
protect us against material financial effects in the event of a successful
claim. We currently do not carry commercial general liability insurance
providing comprehensive product liability coverage in all instances. We may in
the future obtain such insurance provided it can be obtained at reasonable
prices. However, there can be no assurance that such coverage, if obtained,
would be adequate in term and scope to protect us.
SUBSTANTIALLY ALL OF OUR ASSETS AND A MAJORITY OF OUR DIRECTORS AND OFFICERS ARE
OUTSIDE THE UNITED STATES, WITH THE RESULT THAT IT MAY BE DIFFICULT FOR
INVESTORS TO ENFORCE WITHIN THE UNITED STATES ANY JUDGMENTS OBTAINED AGAINST US
OR ANY OF OUR DIRECTORS OR OFFICERS.
Substantially all of our assets are located outside the United States
and we do not currently maintain a permanent place of business within the United
States. In addition, a majority of our directors and officers are nationals
and/or residents of countries other than the United States, and all or a
substantial portion of such persons' assets are located outside the United
States. As a result, it may be difficult for investors to enforce within the
United States any judgments obtained against us or our officers or directors,
including judgments predicated upon the civil liability provisions of the
securities laws of the United States or any state thereof.
THE LOSS OF OUR MAJOR CUSTOMER MAY MATERIALLY AND ADVERSELY AFFECT US.
During fiscal 2004, we earned 29% of our revenue from one major
customer. Accordingly, the loss of this major customer may materially and
adversely affect us. The loss of this major customer, or significant reductions
by them in buying our products, or any inability on our part to collect accounts
receivable from them may adversely affect our business and results of
operations.
23
WE MAY EXPERIENCE DIFFICULTY IN OBTAINING COMPONENTS AND RAW MATERIALS, AND WE
COULD BE MATERIALLY AND ADVERSELY AFFECTED AS A RESULT.
Our current products, and the products that we may provide in the
future, embody new technologies. Certain of the components and raw materials
used in our products are difficult to obtain and/or require purchase commitments
to be made by us far in advance of the manufacturing date. The inability to
obtain sufficient quantities of components or raw materials, or the inability to
forecast purchase requirements accurately, could adversely affect our business
and results of operations. Similarly, commitments to purchase components and raw
materials in excess of customer demand for our products could materially and
adversely affect our results of operations.
THE LOSS OF ANY OF OUR CONTRACT MANUFACTURERS WOULD MATERIALLY AND ADVERSELY
AFFECT US.
We contract the manufacture of our products to third parties. In
certain cases, we do not have an alternative source of manufacturing, and a
suitable replacement would be time-consuming and expensive to obtain. If, for
any reason, one of our third party manufacturers is unable or refuses to produce
our products, our business, financial condition and results of operations would
be materially and adversely affected.
WE DEPEND TO A SIGNIFICANT EXTENT ON CERTAIN KEY PERSONNEL, THE LOSS OF ANY OF
WHOM MAY MATERIALLY AND ADVERSELY AFFECT OUR COMPANY.
Our success depends to a significant extent on the continued service of
certain key management personnel, including Robert Rudman, our President and
Chief Executive Officer, Al Kozak, our Chief Operating Officer, Jeff
Finkelstein, our Chief Financial Officer, Erwin Bartz, our Vice President of
Business Development, and Shawn Lammers, our Vice-President, Engineering. The
loss or interruption of services from one or more of these personnel, for
whatever reason, could have a material adverse effect on us. In the event of the
loss of services of such personnel, no assurances can be given that we will be
able to obtain the services of adequate replacement personnel. We do not
maintain key person insurance on the lives of any of our officers or employees.
RISKS RELATED TO OUR COMMON STOCK
FUTURE SALES OF OUR COMMON STOCK MAY CAUSE OUR STOCK PRICE TO DECLINE.
Our stock price may decline by future sales of our shares or the
perception that such sales may occur. If we issue additional shares of common
stock in private financings under an exemption from the registration laws, then
those shares will constitute "restricted shares" as defined in Rule 144 under
the Securities Act. The restricted shares may only be sold if they are
registered under the Securities Act, or sold under Rule 144, or another
exemption from registration under the Securities Act.
Some of our outstanding restricted shares of common stock are either
eligible for sale pursuant to Rule 144 or have been registered under the
Securities Act for resale by the holders. We are unable to estimate the amount,
timing, or nature of future sales of outstanding common stock. Sales of
substantial amounts of our common stock in the public market may cause the
stock's market price to decline. See "Description of Securities."
OUR STOCK PRICE CAN BE EXTREMELY VOLATILE.
Our common stock is traded on the OTC Bulletin Board. There can be no
assurance that an active public market will continue for the common stock, or
that the market price for the common stock will not decline below its current
price. Such price may be influenced by many factors, including, but not limited
to, investor perception of us and our industry and general economic and market
conditions. The trading price of the common stock could be subject to wide
fluctuations in response to announcements of our business developments or our
competitors, quarterly variations in operating results, and other events or
factors. In addition, stock markets have experienced extreme price volatility in
recent years. This volatility has had a substantial effect on the market prices
of companies, at times for reasons unrelated to their operating performance.
Such broad market fluctuations may adversely affect the price of our common
stock.
TRADING ON THE OTC BULLETIN BOARD MAY BE SPORADIC BECAUSE IT IS NOT A STOCK
EXCHANGE, AND STOCKHOLDERS MAY HAVE DIFFICULTY RESELLING THEIR SHARES.
Our common stock is quoted on the OTC Bulletin Board. Trading in stock
quoted on the OTC Bulletin Board is often thin and characterized by wide
fluctuations in trading prices, due to many factors that may have little to do
with the company's operations or business prospects. Moreover, the OTC Bulletin
Board is not a stock exchange, and trading of securities on the OTC Bulletin
Board is often more sporadic than the trading of securities listed on the Nasdaq
SmallCap. Accordingly, you may have difficulty reselling any of the shares you
purchase from the selling stockholders. In addition, since our common stock was
traded on the Nasdaq SmallCap Market until May 28, 2003, past trading activity
in our common stock should not be relied upon as necessarily being indicative of
future trading activity in our common stock.
24
WE DO NOT EXPECT TO PAY DIVIDENDS.
We have not paid dividends since inception on our common stock, and we
do not contemplate paying dividends in the foreseeable future on our common
stock in order to use all of our earnings, if any, to finance expansion of our
business plans.
IF WE FAIL TO REMAIN CURRENT ON OUR REPORTING REQUIREMENTS, WE COULD BE REMOVED
FROM THE OTC BULLETIN BOARD WHICH WOULD LIMIT THE ABILITY OF BROKER-DEALERS TO
SELL OUR SECURITIES AND THE ABILITY OF STOCKHOLDERS TO SELL THEIR SECURITIES IN
THE SECONDARY MARKET.
Companies trading on the OTC Bulletin Board, such as us, must be
reporting issuers under Section 12 of the Securities Exchange Act of 1934, as
amended, and must be current in their reports under Section 13, in order to
maintain price quotation privileges on the OTC Bulletin Board. If we fail to
remain current on our reporting requirements, we could be removed from the OTC
Bulletin Board. As a result, the market liquidity for our securities could be
severely adversely affected by limiting the ability of broker-dealers to sell
our securities and the ability of stockholders to sell their securities in the
secondary market.
OUR COMMON STOCK IS SUBJECT TO THE "PENNY STOCK" RULES OF THE SEC AND THE
TRADING MARKET IN OUR SECURITIES IS LIMITED, WHICH MAKES TRANSACTIONS IN OUR
STOCK CUMBERSOME AND MAY REDUCE THE VALUE OF AN INVESTMENT IN OUR STOCK.
The Securities and Exchange Commission has adopted Rule 15g-9 which
establishes the definition of a "penny stock," for the purposes relevant to us,
as any equity security that has a market price of less than $5.00 per share or
with an exercise price of less than $5.00 per share, subject to certain
exceptions. For any transaction involving a penny stock, unless exempt, the
rules require:
o that a broker or dealer approve a person's account for
transactions in penny stocks; and
o the broker or dealer receive from the investor a written
agreement to the transaction, setting forth the identity and
quantity of the penny stock to be purchased.
In order to approve a person's account for transactions in penny
stocks, the broker or dealer must:
o obtain financial information and investment experience
objectives of the person; and
o make a reasonable determination that the transactions in penny
stocks are suitable for that person and the person has
sufficient knowledge and experience in financial matters to be
capable of evaluating the risks of transactions in penny
stocks.
The broker or dealer must also deliver, prior to any transaction in a
penny stock, a disclosure schedule prescribed by the Commission relating to the
penny stock market, which, in highlight form:
o sets forth the basis on which the broker or dealer made the
suitability determination; and
o that the broker or dealer received a signed, written agreement
from the investor prior to the transaction.
Generally, brokers may be less willing to execute transactions in
securities subject to the "penny stock" rules. This may make it more difficult
for investors to dispose of our common stock and cause a decline in the market
value of our stock.
Disclosure also has to be made about the risks of investing in penny
stocks in both public offerings and in secondary trading and about the
commissions payable to both the broker-dealer and the registered representative,
25
current quotations for the securities and the rights and remedies available to
an investor in cases of fraud in penny stock transactions. Finally, monthly
statements have to be sent disclosing recent price information for the penny
stock held in the account and information on the limited market in penny stocks.
26
Please read this prospectus carefully. You should rely only on the information
contained in this prospectus. We have not authorized anyone to provide you with
different information. You should not assume that the information provided by
the prospectus is accurate as of any date other than the date on the front of
this prospectus.
FORWARD-LOOKING STATEMENTS
This prospectus contains forward-looking statements which relate to
future events or our future financial performance. In some cases, you can
identify forward-looking statements by terminology such as "may", "will",
"should", "expects", "plans", "anticipates", "believes", "estimates",
"predicts", "potential" or "continue" or the negative of these terms or other
comparable terminology. These statements are only predictions and involve known
and unknown risks, uncertainties and other factors, including the risks in the
section entitled "Risk Factors" on pages 12 to 27, that may cause our or our
industry's actual results, levels of activity, performance or achievements to be
materially different from any future results, levels of activity, performance or
achievements expressed or implied by these forward-looking statements.
While these forward-looking statements, and any assumptions upon which
they are based, are made in good faith and reflect our current judgment
regarding the direction of our business, actual results will almost always vary,
sometimes materially, from any estimates, predictions, projections, assumptions
or other future performance suggested herein. Except as required by applicable
law, including the securities laws of the United States, we do not intend to
update any of the forward-looking statements to conform these statements to
actual results. The safe harbor for forward-looking statements provided in the
Private Securities Litigation Reform Act of 1995 does not apply to the offering
made in this prospectus.
SECURITIES AND EXCHANGE COMMISSION'S PUBLIC REFERENCE
Any member of the public may read and copy any materials filed by us
with the Securities and Exchange Commission at the SEC's Public Reference Room
at 450 Fifth Street, N.W., Washington, D.C. 20549. Information on the operation
of the Public Reference Room may be obtained by calling the SEC at
1-800-SEC-0330. The SEC maintains an Internet web site (http://www.sec.gov) that
contains reports, proxy and information statements, and other information
regarding issuers that file electronically with the SEC.
THE OFFERING
This prospectus covers the resale by the selling stockholders named in
this prospectus by the selling stockholders named in this prospectus of:
- up to 132,699,858 shares of common stock issuable to certain selling
stockholders upon the conversion of principal and interest, or in
payment of interest, under 8% convertible debentures and upon the
conversion of principal under the discounted convertible debentures;
- up to 269,500,000 shares of common stock issuable to certain selling
stockholders upon the conversion of principal under 5% convertible
debentures;
- up to 29,225,714 shares of common stock issuable to certain selling
stockholders assuming the exercise of outstanding common share purchase
warrants issued in connection with the private placement of the 8%
convertible debentures, discounted convertible debentures and other
warrants;
27
- up to 1,500,000 shares of common stock issuable to certain selling
stockholders assuming the exercise of outstanding common share purchase
warrants;
- up to 411,607,143 shares of common stock issuable pursuant to a
Standby Equity Distribution Agreement dated May 19, 2004 between our
company and a certain selling stockholder.
USE OF PROCEEDS
The shares of common stock offered hereby are being registered for the
account of the selling stockholders named in this prospectus. As a result, all
proceeds from the sales of the common stock will go to the selling stockholders
and we will not receive any proceeds from the resale of the common stock by the
selling stockholders. We will, however, incur all costs associated with this
registration statement and prospectus.
28
SELLING STOCKHOLDERS
Overview
The selling stockholders may offer and sell, from time to time, any or
all of the common stock issued to them upon conversion or redemption of the
discounted, 8% and 5% convertible debentures, upon exercise of the share
purchase warrants or upon draw down under its Standby Equity Distribution
Agreement with Cornell Capital Partners, LP. Because the selling stockholders
may offer all or only some portion of the 844,532,715 shares of common stock to
be registered, no estimate can be given as to the amount or percentage of these
shares of common stock that will be held by the selling stockholders upon
termination of the offering.
The following table sets forth certain information regarding the
beneficial ownership of shares of common stock by the selling stockholders as of
December 30, 2004, and the number of shares of common stock covered by this
prospectus. The numbers of shares in the table represents an estimate of the
number of shares of common stock to be offered by each selling stockholder.
- ------------------------------- ------------------ ------------------- ----------------- -----------------------------
NUMBER OF
SHARES
COMMON ISSUABLE
NAME OF SELLING SHARES OWNED BY UPON EXERCISE OF NUMBER OF SHARES OWNED
STOCKHOLDER AND POSITION, THE SELLING CONVERSION OR BY SELLING STOCKHOLDER AFTER
OFFICE OR MATERIAL STOCKHOLDER NOT PURCHASE RIGHTS OFFERING AND PERCENT OF
RELATIONSHIP WITH SMARTIRE PART OF THIS AND FORMING PART TOTAL SHARES TOTAL
SYSTEMS INC. OFFERING(1) OF THIS OFFERING REGISTERED ISSUED AND OUTSTANDING(2)(3)
- ------------------------------- ------------------ ------------------- ----------------- ----------------- -----------
# OF % OF
SHARES CLASS
- ------------------------------- ------------------ ------------------- ----------------- ----------------- -----------
Palisades Master Fund, L.P.
Citco Building Nil 36,808,798(4)(7) 36,808,798(4)(7) Nil 0%
Wickhams Cay
P.O. Box 662 Road Town Tortola
- ------------------------------- ------------------ ------------------- ----------------- ----------------- -----------
Alpha Capital AG
Lettstrasse 32 Nil 30,289,340(4)(6) 30,289,340(4)(6) Nil 0%
Furstentum 9490
Vaduz, Liechtenstein
- ------------------------------- ------------------ ------------------- ----------------- ----------------- -----------
Crescent International Ltd.
84, Avenue Louis-Casai 6,210,768 52,893,028(4)(5)(7) 52,893,028(4)(5)(7) 6,210,768 2.75%
CH 1216 Cointrin, Geneva
Switzerland
- ------------------------------- ------------------ ------------------- ----------------- ----------------- -----------
Goldplate Investment Partners
515 Ave I Nil 8,617,068(4)(7) 8,617,068(4)(7) Nil 0%
Brooklyn NY 11219
- ------------------------------- ------------------ ------------------- ----------------- ----------------- -----------
29
- ------------------------------- ------------------ ------------------- ----------------- -----------------------------
NUMBER OF
SHARES
COMMON ISSUABLE
NAME OF SELLING SHARES OWNED BY UPON EXERCISE OF NUMBER OF SHARES OWNED
STOCKHOLDER AND POSITION, THE SELLING CONVERSION OR BY SELLING STOCKHOLDER AFTER
OFFICE OR MATERIAL STOCKHOLDER NOT PURCHASE RIGHTS OFFERING AND PERCENT OF
RELATIONSHIP WITH SMARTIRE PART OF THIS AND FORMING PART TOTAL SHARES TOTAL
SYSTEMS INC. OFFERING(1) OF THIS OFFERING REGISTERED ISSUED AND OUTSTANDING(2)(3)
- ------------------------------- ------------------ ------------------- ----------------- ----------------- -----------
# OF % OF
SHARES CLASS
- ------------------------------- ------------------ ------------------- ----------------- ----------------- -----------
Bristol Investment Fund, Ltd.
c/o Bristol Capital Advisors, 759,997 10,192,054(4) 10,192,054 (4) 759,997 *
LLC
6363 Sunset Boulevard, Fifth
Floor
Hollywood, California 90028
USA
- ------------------------------- ------------------ ------------------- ----------------- ----------------- -----------
Gamma Opportunity Capital
Partners, LP Nil 16,573,084(4) 16,573,084(4) Nil 0%
British Colonial Centre of
Commerce
One Bay Street, Suite 401
Nassau (NP), The Bahamas
- ------------------------------- ------------------ ------------------- ----------------- ----------------- -----------
PEF Advisors, Ltd.
C/O Beacon Fund Advisors Nil 6,552,200(4) 6,552,200(4) Nil 0%
Harbour House
Waterfront Drive
Road Town, Tortola
British Virgin Islands
- ------------------------------- ------------------ ------------------- ----------------- ----------------- -----------
Talisman Management Limited
PO Box 175 Nil 1,000,000(7) 1,000,000(7) Nil 0%
12-14 Finch Road, Douglas
Isle of Man IM99 ITT
- ------------------------------- ------------------ ------------------- ----------------- ----------------- -----------
HPC Capital Advisors(14)
200 Mansell Court East
Suite 550
Roswell, GA 30076 Nil 250,000(7) 250,000(7) Nil 0%
- ------------------------------- ------------------ ------------------- ----------------- ----------------- -----------
Hawk Associates, Inc.(15)
204 Ocean Drive Nil 250,000(8) 250,000(8) Nil 0%
Tavernier, FL 33070
- ------------------------------- ------------------ ------------------- ----------------- ----------------- -----------
Cornell Capital Partners, L.P.
101 Hudson St-Suite 10,983,584 661,607,143(9) 661,607,143(9) Nil 3.09%
3606
Jersey City NJ 07302
- ------------------------------- ------------------ ------------------- ----------------- ----------------- -----------
Ballay, Jr., William A. &
Mary C. Nil 2,500,000(10) 2,500,000(10) Nil 0%
39 Hidden Lake Drive
Burr Ridge, IL 60527
- ------------------------------- ------------------ ------------------- ----------------- ----------------- -----------
30
- ------------------------------- ------------------ ------------------- ----------------- -----------------------------
NUMBER OF
SHARES
COMMON ISSUABLE
NAME OF SELLING SHARES OWNED BY UPON EXERCISE OF NUMBER OF SHARES OWNED
STOCKHOLDER AND POSITION, THE SELLING CONVERSION OR BY SELLING STOCKHOLDER AFTER
OFFICE OR MATERIAL STOCKHOLDER NOT PURCHASE RIGHTS OFFERING AND PERCENT OF
RELATIONSHIP WITH SMARTIRE PART OF THIS AND FORMING PART TOTAL SHARES TOTAL
SYSTEMS INC. OFFERING(1) OF THIS OFFERING REGISTERED ISSUED AND OUTSTANDING(2)(3)
- ------------------------------- ------------------ ------------------- ----------------- ----------------- -----------
# OF % OF
SHARES CLASS
- ------------------------------- ------------------ ------------------- ----------------- ----------------- -----------
Luca, Minna
5532 Estate Oak Circle Nil 5,000,000(11) 5,000,000 (11) Nil 0%
Fort Lauderdale, Florida
33312
USA
- ------------------------------- ------------------ ------------------- ----------------- ----------------- -----------
Viola, Mary Ellen
294 Lone Hill Drive Nil 10,000,000(12) 10,000,000 (12) Nil 0%
Short Hills, N.J. 07078
USA
- ------------------------------- ------------------ ------------------- ----------------- ----------------- -----------
Luther, David H.
100 Phlox Creek Nil 1,000,000 (13) 1,000,000 (13) Nil 0%
Bristol, TN 37620
USA
- ------------------------------- ------------------ ------------------- ----------------- ----------------- -----------
Hargiss, Jack
15115 Elk Creek Acres Road, Nil 1,000,000(13) 1,000,000 (13) Nil 0%
Pine CO 80470
USA
- ------------------------------- ------------------ ------------------- ----------------- ----------------- -----------
* Denotes a percentage of our issued and outstanding common stock that is
greater than zero but less than one percent.
(1) For these purposes, beneficial ownership is to be determined in accordance
with Section 13(d) of the Securities Exchange Act of 1934, as amended, and the
rules promulgated thereunder. Beneficial ownership includes shares over which
the named stockholder exercises voting control or investment power. Shares of
common stock subject to options or warrants that are currently exercisable or
will become exercisable within sixty days from December 30, 2004 are deemed
outstanding for purposes of the ownership of the person holding the option or
warrant, but are not deemed outstanding for purposes of computing the ownership
percentage of any other person.
(2) Because the selling stockholders may offer all or only some portion of the
shares of common stock to be registered, no estimate can be given as to the
amount or percentage of these shares of common stock that will be held by the
selling shareholder upon termination of the offering. Accordingly, it is assumed
that all of the shares of common stock offered pursuant to this prospectus will
be sold.
(3) A total of 225,912,470 shares of common stock were issued and outstanding as
of December 30, 2004.
(4) Represents common stock that potentially may be issued upon the conversion
or redemption of principal under the discounted convertible debentures maturing
April 1, 2006 at a conversion price of $0.028 per share subject to adjustment in
accordance with their terms. Each of the discounted convertible debentures and
the share purchase warrants (see (6) and (7))contains a contractual restriction
on beneficial share ownership. It provides that the holder may not convert the
discounted convertible debenture, receive shares of our common stock upon a
redemption of the debenture, or exercise the warrant, to the extent that the
conversion of the debenture, the redemption of the debenture for stock, or the
exercise of the warrants, as the case may be, would result in the holder,
together with its affiliates, beneficially owning in excess of 4.99% of our then
issued and outstanding shares of common stock. Pursuant to a registration rights
agreement, we have agreed to register under the Securities Act of 1933, as
amended, 200% of the shares of our common stock issuable upon conversion of
principal under the discounted convertible debentures, and 200% of the shares of
our common stock issuable upon exercise of the related warrants. See
"Description of Securities to be Registered" for further details on the terms of
the convertible debentures and warrants.
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(5) Represents common stock that potentially may be issued upon the conversion
of principal under the 8% convertible debentures maturing July 16, 2006 at an
exercise price of $0.28 per share. subject to adjustment in accordance with
their terms. For purposes of this table, the number of shares to be issued on
the conversion of interest has been excluded. The remaining principal of
$245,000 under the 8% convertible debentures and the share purchase warrants
(see (6) and (7)) contains a contractual restriction on beneficial share
ownership. It provides that the holder may not convert the convertible
debenture, receive shares of our common stock as payment of interest under the
convertible debenture, or exercise the warrant, to the extent that the
conversion of the debenture, the receipt of the interest payment or the exercise
of the warrants, as the case may be, would result in the holder, together with
its affiliates, beneficially owning in excess of 4.99% of our then issued and
outstanding shares of common stock. Pursuant to a registration rights agreement,
we have agreed to register under the Securities Act of 1933, as amended, 200% of
the shares of our common stock issuable upon conversion of principal under the
8% convertible debentures at the applicable base conversion price, and 200% of
the shares of our common stock issuable upon exercise of the warrants at the
base exercise price. See "Description of Securities to be Registered" for
further details on the terms of the 8% convertible debentures and warrants.
(6) Represents common stock that potentially may be issued upon the exercise of
common share purchase warrants issued to the named selling stockholder as a
purchaser of discounted convertible debentures, and exercisable between July 16,
2006 and November 10, 2008 at an exercise price of $0.028 per share.
(7) Represents common stock that potentially may be issued upon the exercise of
common share purchase warrants issued to the named selling stockholder and
exercisable by July 22, 2006 at an exercise price of $0.028 per share.
(8) Represents common stock that potentially may be issued upon the exercise of
common share purchase warrants issued to the named selling stockholder and
exercisable by June 30, 2009 at an exercise price of $0.20 per share.
(9) Represents common stock that potentially may be issued upon the drawdown of
$11,525,000 on our equity line at 0.028 per share and the conversion of
$2,500,000 of 5% convertible debentures.
(10) Represents common stock that potentially may be issued upon the conversion
of $25,000 of 5% convertible debentures to the named selling stockholder.
(11) Represents common stock that potentially may be issued upon the conversion
of $50,000 of 5% convertible debentures to the named selling stockholder.
(12) Represents common stock that potentially may be issued upon the conversion
of $100,000 of 5% convertible debentures to the named selling stockholder.
(13) Represents common stock that potentially may be issued upon the conversion
of $10,000 of 5% convertible debentures to the named selling stockholder.
(14) HPC Capital Advisors is a broker dealer registered pursuant to section 15
of
the Securities Exchange Act of 1934, as amended. We engaged HPC Capital
Management as our non-exclusive investment banker, financial advisor and
consultant pursuant to an engagement letter agreement dated March 19, 2003,
which was superseded and replaced by an engagement letter agreement dated August
12, 2003.
(15) Hawk Associates, Inc is a Florida investor relations firm that we engaged
on July 1, 2004 to provide investor relations, financial media relations and
other appropriate consulting and advisory services.
PLAN OF DISTRIBUTION
The selling stockholders may, from time to time, sell all or a portion
of the shares of common stock on any market upon which the common stock may be
quoted (currently the OTC Bulletin Board), in privately negotiated transactions
or otherwise. Such sales may be at fixed prices prevailing at the time of sale,
at prices related to the market prices or at negotiated prices. The shares of
common stock being offered by this prospectus may be sold by the selling
stockholders by one or more of the following methods, without limitation:
(a) block trades in which the broker or dealer so engaged will attempt
to sell the shares of common stock as agent but may position and resell
a portion of the block as principal to facilitate the transaction;
(b) purchases by broker or dealer as principal and resale by the broker
or dealer for its account pursuant to this prospectus;
(c) an exchange distribution in accordance with the rules of the
applicable exchange;
(d) ordinary brokerage transactions and transactions in which the
broker solicits purchasers;
(e) privately negotiated transactions;
(f) market sales (both long and short to the extent permitted under the
federal securities laws);
(g) at the market to or through market makers or into an existing
market for the shares;
32
(h) through transactions in options, swaps or other derivatives
(whether exchange listed or otherwise); and
(i) a combination of any aforementioned methods of sale.
In the event of the transfer by the selling stockholder of its shares
to any pledgee, donee or other transferee, we will amend this prospectus and the
registration statement of which this prospectus forms a part by the filing of a
post-effective amendment in order to have the pledgee, donee or other transferee
in place of the selling stockholder who has transferred his or her shares.
In effecting sales, brokers and dealers engaged by a selling
stockholder may arrange for other brokers or dealers to participate. Brokers or
dealers may receive commissions or discounts from the selling stockholder or, if
any of the broker-dealers act as an agent for the purchaser of such shares, from
the purchaser in amounts to be negotiated which are not expected to exceed those
customary in the types of transactions involved. Broker-dealers may agree with a
selling stockholder to sell a specified number of the shares of common stock at
a stipulated price per share. Such an agreement may also require the
broker-dealer to purchase as principal any unsold shares of common stock at the
price required to fulfil the broker-dealer commitment to the selling stockholder
if such broker-dealer is unable to sell the shares on behalf of the selling
stockholder. Broker-dealers who acquire shares of common stock as principal may
thereafter resell the shares of common stock from time to time in transactions
which may involve block transactions and sales to and through other
broker-dealers, including transactions of the nature described above. Such sales
by a broker-dealer could be at prices and on terms then prevailing at the time
of sale, at prices related to the then-current market price or in negotiated
transactions. In connection with such resales, the broker-dealer may pay to or
receive from the purchasers of the shares commissions as described above.
A selling stockholder and any broker-dealers or agents that participate
with that selling stockholder in the sale of the shares of common stock may be
deemed to be "underwriters" within the meaning of the Securities Act of 1933, as
amended, in connection with these sales. In that event, any commissions received
by the broker-dealers or agents and any profit on the resale of the shares of
common stock purchased by them may be deemed to be underwriting commissions or
discounts under the Securities Act of 1933, as amended.
From time to time, a selling stockholder may pledge its shares of
common stock pursuant to the margin provisions of its customer agreements with
its brokers. Upon a default by a selling stockholder, the broker may offer and
sell the pledged shares of common stock from time to time. Upon a sale of the
shares of common stock, the selling stockholders intend to comply with the
prospectus delivery requirements under the Securities Act of 1933 by delivering
a prospectus to each purchaser in the transaction. We intend to file any
amendments or other necessary documents in compliance with the Securities Act of
1933 which may be required in the event a selling stockholder defaults under any
customer agreement with brokers.
To the extent required under the Securities Act of 1933, a post
effective amendment to this registration statement will be filed, disclosing the
name of any broker-dealers, the number of shares of common stock involved, the
price at which the common stock is to be sold, the commissions paid or discounts
or concessions allowed to such broker-dealers, where applicable, that such
broker-dealers did not conduct any investigation to verify the information set
out or incorporated by reference in this prospectus and other facts material to
the transaction.
We and the selling stockholders will be subject to applicable
provisions of the Securities Exchange Act of 1934, as amended, and the rules and
regulations under it, including, without limitation, Rule 10b-5 and, insofar as
a selling stockholder is a distribution participant and we, under certain
circumstances, may be a distribution participant, under Regulation M. All of the
foregoing may affect the marketability of the common stock.
All expenses of the registration statement including, but not limited
to, legal, accounting, printing and mailing fees are and will be borne by us.
Any commissions, discounts or other fees payable to brokers or dealers in
connection with any sale of the shares of common stock will be borne by the
selling stockholder, the purchasers participating in such transaction, or both.
33
Any shares of common stock covered by this prospectus which qualify for
sale pursuant to Rule 144 under the Securities Act of 1933, as amended, may be
sold under Rule 144 rather than pursuant to this prospectus.
8% CONVERTIBLE DEBENTURES
On July 17, 2003, we closed a private placement of 8% convertible
debentures to four of the selling stockholders pursuant to Rule 506 of
Regulation D under the Securities Act of 1933, for gross proceeds of $1,700,000.
As of December 30, 2004 $245,000 remains outstanding form this private
placement.
Interest and Maturity
The outstanding principal under the convertible debentures bears
interest at the rate of 8% per annum, calculated on the basis of a 360-day year.
Interest is payable quarterly on March 1, June 1, September 1 and December 1,
and at maturity, in cash or, at our option, in shares of our common stock at an
interest conversion price equal to 90% of the lesser of the average closing bid
price during the 20 trading days immediately preceding the interest payment
date, or the average closing bid price during the 20 trading days immediately
preceding the date on which the shares are issued if such shares are issued and
delivered after the interest payment date.
Our right to elect to pay accrued interest in shares of our common
stock is subject to certain conditions, including the requirement that there
shall be an effective registration statement qualifying the resale of the common
stock to be issued to the holders of the convertible debentures in lieu of a
cash interest payment.
All overdue accrued and unpaid interest under the convertible
debentures will be subject to a late fee at the rate of 18% per annum.
All principal, and all accrued and unpaid interest, under the
convertible debentures will be due and payable at maturity on July 16, 2006.
Conversion Provisions, Conversion Price and Adjustments
The remaining principal as of December 30, 2004 under convertible
debentures in the aggregate principal amount of $245,000 may be converted by the
holder in whole or in part and from time to time at a conversion price of $0.028
per share, subject to adjustment as provided for in the debentures.
Accrued and unpaid interest on any principal amount that is converted
under the debentures will be converted into shares of our common stock at a
conversion price equal to 90% of the lesser of the average closing bid price
during the 20 trading days immediately preceding the conversion date, or the
average closing bid price during the 20 trading days immediately preceding the
date on which the shares are issued if such shares are issued and delivered
after the conversion date.
Each of the convertible debentures contains a contractual restriction
on beneficial share ownership. It provides that the holder may not convert
convertible debentures, or receive shares of our common stock as payment of
interest, to the extent that the conversion or the receipt of the interest
payment would result in the holder, together with its affiliates, beneficially
owning in excess of 4.99% of our then issued and outstanding shares of common
stock. For these purposes, beneficial ownership is to be determined in
accordance with Section 13(d) of the Securities Exchange Act of 1934, as
amended, and the rules promulgated thereunder.
Each convertible debenture is subject to anti-dilution protection upon
the occurrence of certain events, as follows:
(a) the conversion price will be reduced proportionately if we increase
the number of our outstanding shares of common stock as a result of: a
stock dividend or any other distribution on, or payable in, shares of
our common stock; a subdivision of our common stock; or a combination
or reclassification of our common stock;
34
(b) the conversion price will be reduced proportionately if we issue
rights, options or warrants to all holders of our common stock (but not
to holders of the convertible debentures) entitling them to purchase
shares of our common stock (or any equity, debt or other instrument
that is at any time over its life convertible into or exchangeable for
our common stock) at a price per share that is less than the closing
bid price for our common stock on the record date established for the
purposes of determining our stockholders who would be entitled to
receive such rights, options or warrants;
(c) if we or any of our subsidiaries offers, sells or otherwise
disposes of or issues any of our common stock (or any equity, debt or
other instrument that is at any time over its life convertible into or
exchangeable for our common stock) at an effective price per share that
is less than the conversion price, the conversion price will be reduced
to equal such effective price;
(d) if we or any of our subsidiaries grants any option entitling the
holder of the option to purchase any of our common stock (or any
equity, debt or other instrument that is at any time over its life
convertible into or exchangeable for our common stock) at an effective
price pr share that is less than the conversion price, the conversion
price will be reduced to equal such effective price;
(e) if we or any of our subsidiaries offer, sell or grant any right to
reprice outstanding securities at an effective price per share that is
less than the conversion price, the conversion price will be reduced to
equal such effective price;
(f) if we reclassify our outstanding shares of common stock, or if we
participate in any compulsory share exchange transaction pursuant to
which all of our outstanding shares of common stock will be converted
into other securities, cash or property, then each holder of a
convertible debenture will have the right, at its option, to: (a)
convert the then outstanding principal amount of the convertible
debenture, together with accrued but unpaid interest and any other
amounts then owing in respect of the convertible debenture, into the
shares of stock or other securities, cash and property that would have
been receivable by the holder as a result of such reclassification or
share exchange transaction if the holder had converted the convertible
debenture immediately prior to the reclassification or share exchange
transaction; or (b) to require us to pay to the holder of the
convertible debenture the mandatory prepayment amount equal to 120% of
the outstanding principal amount, plus all accrued and unpaid interest
and any other amounts then owing in respect of the convertible
debenture;
(g) if we consolidate or merge with another company or other entity, or
if we sell or transfer all or substantially all of our assets, then
upon the subsequent conversion of an convertible debenture, the
debenture holder will have the right to receive, for each share of our
common stock that would have been issuable to the debenture holder upon
such conversion absent such consolidation, merger or asset transaction,
the same kind and amount of securities, cash or property as the
debenture holder would have been entitled to receive if the debenture
holder had been the holder of one share of our common stock immediately
prior to the consolidation, merger or asset transaction; and
(h) if we or any other person, association, partnership or entity
completes any tender offer or exchange offer whereby the holders of our
common stock are permitted to tender or exchange their common stock for
other securities, cash or property, the debenture holder will have the
right to receive, for each share of our common stock that would have
been issuable to the debenture holder upon such conversion absent such
tender offer or exchange offer, the same kind and amount of securities,
cash or property as the debenture holder would have been entitled to
receive if the debenture holder had been the holder of one share of our
common stock immediately prior to the tender offer or exchange offer.
No Right of Prepayment
We may not prepay any portion of the principal amount on any
convertible debenture without the prior written consent of the holder of the
debenture.
35
Registration Rights
In connection with the offering of the convertible debentures and the
associated common share purchase warrants, on August 18, 2003 we filed a
registration statement for the purpose of registering at least 200% of the
shares of common stock potentially issuable upon the conversion of principal and
interest, or in payment of interest, under the 8% convertible debentures at the
base conversion price, and at least 200% of the shares of common stock
potentially issuable upon exercise of the warrants at the base exercise price.
This registration statement was declared effective on August 27, 2003. Although
this registration statement is now staledated, under the Forbearance and Escrow
Agreement entered into on September 24, 2003 we are obligated to file an
additional registration statement with the Commission on or before January 1,
2005, to the extent necessary to have registered at least 100% of the shares of
Common Stock issuable upon conversion of the Debentures and Prior Debenture and
exercise of the Warrants and Prior Warrants assuming for such purposes the
conversion price of the Debentures and Prior Debentures is the lower of $.028
(subject to adjustment for reverse and forward stock splits and the like and
subject to adjustments for dilutive events in the Debentures and Warrants) and
the then applicable Monthly Conversion Price pursuant to Section 5(a) of the
Debentures. If, at any time, the number of shares registered for resale is less
than 100% of the shares issuable upon conversion in full of the Debentures and
Prior Debentures and/or exercise in full of the Warrants and/or Prior Warrants,
the Company shall be obligated to file an additional registration statement
pursuant to Section 3(c) of the applicable Registration Rights Agreement.
If we default on our obligations under the registration rights
agreement, or to file a request for acceleration in accordance with Rule 461
under the Securities Act of 1933 within five trading days of the date that we
are notified by the Securities and Exchange Commission that the registration
statement will not be "reviewed" or will not subject to further review, we are
required pay to each debenture holder, as liquidated damages and not as a
penalty, for each month that the registration statement has not been filed or
declared effective, as the case may be, a cash amount equal to 1.5% of: (a) the
aggregate purchase price of the holder's debentures; and (b) if the market price
for our common stock then exceeds the exercise price of the warrants issued to
the holder in connection with the private placement of the convertible
debentures, the value of such warrants. For these purposes, the value of the
warrants are to be calculated by multiplying the number of shares into which the
warrants are exercisable into by the difference between the average closing bid
price of our common stock during the applicable month and the exercise price of
the warrants. Further, if we fail to pay any liquidated damages under the
registration rights agreement, we will be required to pay interest on the amount
of such damages at a rate of 18% per annum.
Events of Default
We will be considered in default of the convertible debentures if any
of the following events, among others, occurs:
(a) we fail to pay any amount due under a convertible debenture within
five days of any notice sent to us by the holder of the convertible
debenture that we are in default of our obligation to pay the amount;
(b) we fail to comply with any of the other agreements contained in the
convertible debenture after we are given fifteen days written notice of
such non-compliance;
(c) we breach any of our obligations under the Securities Purchase
Agreement or the Registration Rights Agreement and the breach is not
cured by us within fifteen days after our receipt of written notice of
such breach;
(d) we or any of our subsidiaries become bankrupt or insolvent;
(e) we breach any of our obligations under any other debt or credit
agreements involving an amount exceeding $150,000, unless the breach is
cured by us within fifteen days and the breach is waived by the other
party to the debt or credit agreement;
36
(f) we agree to sell or dispose of more than 33% of our assets in one
or more transactions, or we agree to redeem or repurchase more than an
insignificant number of shares of our outstanding common stock or any
other equity securities of our company; or
(g) we fail to issue shares of our common stock to the holder within
five trading days of the conversion date specified in any conversion
notice delivered in respect of a convertible debenture by the holder.
If an event of default occurs, the holder of a convertible debenture
can elect to require us to immediately repay a mandatory prepayment
amount equal to the greater of:
(i) 120% of the principal amount of the debenture, plus all accrued and
unpaid interest and any other amounts outstanding in respect of the
debenture; or
(ii) the principal amount of the debenture, plus all accrued and unpaid
interest and any other amounts outstanding in respect of the debenture,
divided by the conversion price of the debenture on the date on which
the payment is demanded or due (or if less, the conversion price on the
date on which the payment is actually paid), and multiplied by the
greater of (A) the last reported closing bid price for our common stock
on the date on which the payment is demanded or due or (B) the last
reported closing bid price for our common stock on the date on which
the payment actually paid.
DISCOUNTED CONVERTIBLE DEBENTURES
On December 24, 2003, we closed a private placement of discounted
unsecured convertible debentures in the aggregate principal amount of $3,493,590
to seven of the selling stockholders pursuant to Rule 506 of Regulation D under
the Securities Act of 1933. As of December 30, 2004 $1,612,798 of the discounted
convertible debentures were outstanding.
Interest and Maturity
We issued the convertible debentures at a 22% original issue discount
from the face principal amount (based on a notional interest rate of 11% per
annum for each year of the two-year term of the debentures), resulting in gross
proceeds of $2,725,000, before the deduction of a $218,000 cash placement fee
subsequently paid to HPC Capital Management and other expenses of the offering.
The discounted convertible debentures do not otherwise bear interest, and will
mature on April 1, 2006.
37
Conversion Provisions, Conversion Price and Adjustments
As of December 30, 2004 the outstanding aggregate principal amount of
$1,612,798 of the debentures may be converted at any time into shares of our
common stock, in whole or in part, at the option of the holder of the debenture
at a set price of $0.028 per share.
Each of the convertible debentures contains a contractual restriction
on beneficial share ownership. It provides that the holder may not convert
convertible debentures, or receive shares of our common stock as payment of
interest, to the extent that the conversion or the receipt of the interest
payment would result in the holder, together with its affiliates, beneficially
owning in excess of 4.99% of our then issued and outstanding shares of common
stock. For these purposes, beneficial ownership is to be determined in
accordance with Section 13(d) of the Securities Exchange Act of 1934, as
amended, and the rules promulgated thereunder.
Each convertible debenture is subject to anti-dilution protection upon
the occurrence of certain events, as follows:
(a) the conversion price will be reduced proportionately if we increase
the number of our outstanding shares of common stock as a result of: a
stock dividend or any other distribution on, or payable in, shares of
our common stock; a subdivision of our common stock; or a combination
or reclassification of our common stock;
(b) the conversion price will be reduced proportionately if we issue
rights, options or warrants to all holders of our common stock (but not
to holders of the convertible debentures) entitling them to purchase
shares of our common stock (or any equity, debt or other instrument
that is at any time over its life convertible into or exchangeable for
our common stock) at a price per share that is less than the closing
bid price for our common stock on the record date established for the
purposes of determining our stockholders who would be entitled to
receive such rights, options or warrants;
(c) if we or any of our subsidiaries offers, sells or otherwise
disposes of or issues any of our common stock (or any equity, debt or
other instrument that is at any time over its life convertible into or
exchangeable for our common stock) at an effective price per share that
is less than the conversion price, the conversion price will be reduced
to equal such effective price;
(d) if we or any of our subsidiaries grants any option entitling the
holder of the option to purchase any of our common stock (or any
equity, debt or other instrument that is at any time over its life
convertible into or exchangeable for our common stock) at an effective
price per share that is less than the conversion price, the conversion
price will be reduced to equal such effective price;
(e) if we or any of our subsidiaries offer, sell or grant any right to
reprice outstanding securities at an effective price per share that is
less than the conversion price, the conversion price will be reduced to
equal such effective price;
(f) if we reclassify our outstanding shares of common stock, or if we
participate in any compulsory share exchange transaction pursuant to
which all of our outstanding shares of common stock will be converted
into other securities, cash or property, then each holder of a
convertible debenture will have the right, at its option, to: (a)
convert the then outstanding principal amount of the convertible
debenture, together with any other amounts then owing in respect of the
convertible debenture, into the shares of stock or other securities,
cash and property that would have been receivable by the holder as a
result of such reclassification or share exchange transaction if the
holder had converted the convertible debenture immediately prior to the
reclassification or share exchange transaction; or (b) to require us to
pay to the holder of the convertible debenture the mandatory prepayment
amount equal to 120% of the outstanding principal amount, plus any
other amounts then owing in respect of the convertible debenture;
38
(g) if we consolidate or merge with another company or other entity, or
if we sell or transfer all or substantially all of our assets, then
upon the subsequent conversion of an convertible debenture, the
debenture holder will have the right to receive, for each share of our
common stock that would have been issuable to the debenture holder upon
such conversion absent such consolidation, merger or asset transaction,
the same kind and amount of securities, cash or property as the
debenture holder would have been entitled to receive if the debenture
holder had been the holder of one share of our common stock immediately
prior to the consolidation, merger or asset transaction; and
(h) if we or any other person, association, partnership or entity
completes any tender offer or exchange offer whereby the holders of our
common stock are permitted to tender or exchange their common stock for
other securities, cash or property, the debenture holder will have the
right to receive, for each share of our common stock that would have
been issuable to the debenture holder upon such conversion absent such
tender offer or exchange offer, the same kind and amount of securities,
cash or property as the debenture holder would have been entitled to
receive if the debenture holder had been the holder of one share of our
common stock immediately prior to the tender offer or exchange offer.
Mandatory Redemption Provisions
The discounted convertible debentures are subject to mandatory
redemption in equal monthly payments, with the first redemption payment to occur
on the earlier of the first day of the month next following that date that is
three months after the closing date and the date the registration registering
these convertible debentures is effective. As the registration statement to
register these convertible debentures was declared effective on January 30,
2004, the first monthly redemption date was February 1, 2004.
Monthly redemption payments for February, March, April and May 2004
were made in shares of the Company, except for one cash payment of $14,583.
Aggregate monthly redemption payments of $145,566 for each of June and July
were made in cash.
During August 2004, we defaulted on payments to holders of our
discounted debentures. In response to the default, certain debenture holders
filed legal actions against us. On September 24, 2004 we signed an agreement
with the debenture holders which provided for withdrawal of legal action; an
immediate exercise of warrants at $0.03 for gross proceeds to as of $546,788;
conversion of $734,389 (face value) of discounted debentures into 24,479,630
common shares and the next monthly redemption payment would be due on February
1, 2004.
We may elect to make the monthly redemption payments in cash
or shares of our common stock at a conversion price equal to the lesser of (a)
the set price of $0.22 per share (subject to adjustment pursuant to the
anti-dilution provisions contained in the debentures), and (b) 85% of the
average of the 20 closing prices of our common stock immediately preceding the
applicable monthly redemption date, provided that certain conditions are met,
including the condition that the underlying shares of common stock shall have
been registered under the Securities Act of 1933, as amended. Due to
anti-dilution provisions in the debentures, the conversion price has been
reduced to $0.028. As of December 30, 2004 we have advised the debenture holders
that we will make our monthly redemption payments in cash.
Registration Rights
In connection with the offering of the convertible debentures and the
associated common share purchase warrants, we agreed to file the registration
statement for the purpose of registering at least 200% of the shares of common
stock potentially issuable upon the conversion of principal under the discounted
convertible debentures at the set conversion price of $0.22 per share, subject
to anti-dilution and at least 200% of the shares of common stock potentially
issuable upon exercise of the related warrants. This registration statement was
filed on January 15, 2004 and declared effective on January 30, 2004. Although
this registration statement is now staledated, under the Forbearance and Escrow
Agreement entered into on September 24, 2003 we are obligated to file an
additional registration statement with the Commission on or before January 1,
2005, to the extent necessary to have registered at least 100% of the shares of
Common Stock issuable upon conversion of the Debentures and Prior Debenture and
exercise of the Warrants and Prior Warrants assuming for such purposes the
conversion price of the Debentures and Prior Debentures is the lower of $0.03
(subject to adjustment for reverse and forward stock splits and the like and
subject to adjustments for dilutive events in the Debentures and Warrants) and
the then applicable Monthly Conversion Price pursuant to Section 5(a) of the
Debentures. If, at any time, the number of shares registered for resale is less
than 100% of the shares issuable upon conversion in full of the Debentures and
Prior Debentures and/or exercise in full of the Warrants and/or Prior Warrants,
the Company shall be obligated to file an additional registration statement
pursuant to Section 3(c) of the applicable Registration Rights Agreement.
39
If we default on our obligations under the registration rights
agreement, or to file a request for acceleration in accordance with Rule 461
under the Securities Act of 1933 within five trading days of the date that we
are notified by the Securities and Exchange Commission that the registration
statement will not be "reviewed" or will not subject to further review, we are
required pay to each debenture holder, as liquidated damages and not as a
penalty, for each month that the registration statement has not been filed or
declared effective, as the case may be, a cash amount equal to 1.5% of: (a) the
aggregate purchase price of the holder's debentures; and (b) if the market price
for our common stock then exceeds the exercise price of the warrants issued to
the holder in connection with the private placement of the convertible
debentures, the value of such warrants. For these purposes, the value of the
warrants are to be calculated by multiplying the number of shares into which the
warrants are exercisable into by the difference between the average closing bid
price of our common stock during the applicable month and the exercise price of
the warrants. Further, if we fail to pay any liquidated damages under the
registration rights agreement, we will be required to pay interest on the amount
of such damages at a rate of 18% per annum.
Events of Default
We will be considered in default of the convertible debentures if any
of the following events, among others, occurs:
(a) we fail to pay any amount due under a convertible debenture within
five days of any notice sent to us by the holder of the convertible
debenture that we are in default of our obligation to pay the amount;
(b) we fail to comply with any of the other agreements contained in the
convertible debenture after we are given fifteen days written notice of
such non-compliance;
(c) we breach any of our obligations under the Securities Purchase
Agreement or the Registration Rights Agreement and the breach is not
cured by us within fifteen days after our receipt of written notice of
such breach;
(d) we or any of our subsidiaries become bankrupt or insolvent;
(e) we breach any of our obligations under any other debt or credit
agreements involving an amount exceeding $150,000, unless the breach is
cured by us within fifteen days and the breach is waived by the other
party to the debt or credit agreement;
(f) our common stock ceases to be eligible for quotation on the
principal market for our common stock (currently the OTC Bulletin
Board), and fails to be quoted or listed for trading on another
principal market (defined to mean the OTC Bulletin Board, the New York
Stock Exchange, American Stock Exchange, the NASDAQ Small-Cap Market or
the NASDAQ National Market) within five trading days;
(g) we agree to sell or dispose of more than 33% of our assets in one
or more transactions, or we agree to redeem or repurchase more than an
insignificant number of shares of our outstanding common stock or any
other equity securities of our company; or
(h) we fail to issue shares of our common stock to the holder within
five trading days of the conversion date specified in any conversion
notice delivered in respect of a convertible debenture by the holder.
(i) If an event of default occurs, the holder of a convertible
debenture can elect to require us to immediately repay a mandatory
prepayment amount equal to the greater of:
(i) 120% of the principal amount of the debenture, plus all
accrued and unpaid amounts outstanding in respect of the debenture; or
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(ii) the principal amount of the debenture, plus all accrued
and unpaid amounts outstanding in respect of the debenture, divided by
the conversion price of the debenture on the date on which the payment
is demanded or due (or if less, the conversion price on the date on
which the payment is actually paid), and multiplied by the greater of
(A) the last reported closing bid price for our common stock on the
date on which the payment is demanded or due or (B) the last reported
closing bid price for our common stock on the date on which the payment
actually paid.
Interest will accrue daily on any mandatory prepayment amount from the
fifth day after it becomes due through and including the date on which the
mandatory prepayment amount is paid, at the rate of 18% per annum.
Limitation on Future Financings and Rights of First Refusal
Our securities purchase agreement dated December 19, 2003 with the
holders of the discounted convertible debentures prohibits us from issuing for a
period of 120 days following effective date of the registration statement filed
in connection with this prospectus: (a) any shares of common stock, or of any
other class of shares having the right to participate in a distribution of
earnings or assets of our company; and (b) any security, right or obligation
that is convertible into or exchangeable for, or that give the holder any direct
or indirect right to purchase any shares of our common stock, or shares any
other class having the right to participate in a distribution of earnings or
assets of our company. The 120 day period during which we cannot effect any such
equity financing transactions will be extended for the number of trading days,
if any, during which trading in our common stock is suspended, or during which
the purchasers of the discounted convertible debentures are prevented from
reselling any registered securities pursuant to this prospectus. This
prohibition is subject to limited exemptions that will permit us to issue common
stock to, for example, our employees, officers and directors pursuant to a
qualifying stock option plan, and to issue common stock pursuant to convertible
securities, options or warrants that were issued and outstanding at closing on
December 24, 2003.
In addition, we have granted to the purchasers of the discounted
convertible debentures a right of first refusal to participate in any equity
financing transaction that we may effect, until that date that is 12 months
after the effective date of the registration statement filed. As the effective
date of the registration statement to register these discounted debentures was
January 30, 2004, the right of first refusal expires on January 30, 2005.
5% CONVERTIBLE DEBENTURES TO CORNELL CAPITAL PARTNERS, L.P.
On December 15, 2004, we closed a private placement of 5% convertible
debentures to Cornell Capital Partners, L.P. pursuant to Rule 506 of Regulation
D under the Securities Act of 1933, for gross proceeds of $2,500,000.
41
Interest and Maturity
The outstanding principal under the convertible debentures bears
interest at the rate of 5% per annum, calculated on the basis of a 360-day year.
Interest is payable quarterly on March 1, June 1, September 1 and December 1,
and at maturity, in cash or, at our option, in shares of our common stock. If
interest is to be paid in the form of common stock, the amount of stock to be
issued will be calculated as follows: the value of the stock shall be the
closing bid price of our common stock on: (i) the date the interest payment is
due; or (ii) if the interest payment is not made when due, the date the interest
payment is made. A number of shares of common stock with a value equal to the
amount of interest due shall be issued. No fractional shares will be issued;
therefore, in the event that the value of the common stock per share does not
equal the total interest due, the Company will pay the balance in cash.
All principal, and all accrued and unpaid interest, under the
convertible debentures will be due and payable at maturity on December 15, 2007.
Conversion Provisions, Conversion Price and Adjustments
Principal under convertible debentures in the aggregate principal
amount of $2,500,000 may be converted by the holder in whole or in part and from
time to time at a conversion price equal to the lesser of (a) $0.035 or (b) an
amount equal to 80% of the lowest closing bid price of our common stock, as
quoted on Bloomberg, L.P., for the 5 trading days immediately preceding the
conversion date, subject to adjustment as provided for in the debentures.
Each of the convertible debentures contains a contractual restriction
on beneficial share ownership. It provides that the holder may not convert
convertible debentures, or receive shares of our common stock as payment of
interest, to the extent that the conversion or the receipt of the interest
payment would result in the holder, together with its affiliates, beneficially
owning in excess of 4.99% of our then issued and outstanding shares of common
stock. For these purposes, beneficial ownership is to be determined in
accordance with Section 13(d) of the Securities Exchange Act of 1934, as
amended, and the rules promulgated thereunder.
Each convertible debenture is subject to anti-dilution protection upon
the occurrence of certain events, as follows:
(a) the conversion price will be reduced proportionately if we increase
the number of our outstanding shares of common stock as a result of: a
stock dividend or any other distribution on, or payable in, shares of
our common stock; a subdivision of our common stock; or a combination
or reclassification of our common stock;
(b) the conversion price will be reduced proportionately if we issue
rights, options or warrants to all holders of our common stock (but not
to holders of the convertible debentures) entitling them to purchase
shares of our common stock (or any equity, debt or other instrument
that is at any time over its life convertible into or exchangeable for
our common stock) at a price per share that is less than the closing
bid price for our common stock on the record date established for the
purposes of determining our stockholders who would be entitled to
receive such rights, options or warrants;
(c) if we or any of our subsidiaries offers, sells or otherwise
disposes of or issues any of our common stock (or any equity, debt or
other instrument that is at any time over its life convertible into or
exchangeable for our common stock) at an effective price per share that
is less than the conversion price, the conversion price will be reduced
to equal such effective price;
(d) if we or any of our subsidiaries grants any option entitling the
holder of the option to purchase any of our common stock (or any
equity, debt or other instrument that is at any time over its life
convertible into or exchangeable for our common stock) at an effective
price pr share that is less than the conversion price, the conversion
price will be reduced to equal such effective price;
42
(e) if we or any of our subsidiaries offer, sell or grant any right to
reprice outstanding securities at an effective price per share that is
less than the conversion price, the conversion price will be reduced to
equal such effective price;
(f) if we reclassify our outstanding shares of common stock, or if we
participate in any compulsory share exchange transaction pursuant to
which all of our outstanding shares of common stock will be converted
into other securities, cash or property, then each holder of a
convertible debenture will have the right, at its option, to: (a)
convert the then outstanding principal amount of the convertible
debenture, together with accrued but unpaid interest and any other
amounts then owing in respect of the convertible debenture, into the
shares of stock or other securities, cash and property that would have
been receivable by the holder as a result of such reclassification or
share exchange transaction if the holder had converted the convertible
debenture immediately prior to the reclassification or share exchange
transaction; or (b) to require us to pay to the holder of the
convertible debenture the mandatory prepayment amount equal to 120% of
the outstanding principal amount, plus all accrued and unpaid interest
and any other amounts then owing in respect of the convertible
debenture;
(g) if we consolidate or merge with another company or other entity, or
if we sell or transfer all or substantially all of our assets, then
upon the subsequent conversion of an convertible debenture, the
debenture holder will have the right to receive, for each share of our
common stock that would have been issuable to the debenture holder upon
such conversion absent such consolidation, merger or asset transaction,
the same kind and amount of securities, cash or property as the
debenture holder would have been entitled to receive if the debenture
holder had been the holder of one share of our common stock immediately
prior to the consolidation, merger or asset transaction; and
(h) if we or any other person, association, partnership or entity
completes any tender offer or exchange offer whereby the holders of our
common stock are permitted to tender or exchange their common stock for
other securities, cash or property, the debenture holder will have the
right to receive, for each share of our common stock that would have
been issuable to the debenture holder upon such conversion absent such
tender offer or exchange offer, the same kind and amount of securities,
cash or property as the debenture holder would have been entitled to
receive if the debenture holder had been the holder of one share of our
common stock immediately prior to the tender offer or exchange offer.
Right of Redemption and Redemption Warrants
Upon providing 3 business days advance written notice to holders,
during which time they may elect to convert up to all of their convertible
debentures, we may redeem the convertible debentures, in whole or part, at 120%
of the face value of each convertible debenture and the investor shall receive
50,000 redemption warrants for every $100,000 redeemed (the "Redemption
Warrants"). The Redemption Warrants are exercisable at 120% of the closing bid
price on our common stock as reported by Bloomberg, L.P. for the trading day
immediately preceding the Closing Date. The Redemption Warrants will be
exercisable until 2 years from the date of issuance.
Registration Rights
In connection with the offering of the convertible debentures and the
associated common share purchase warrants, we have agreed to file this
registration statement for the purpose of registering 250,000,000 shares of
common stock potentially issuable upon the conversion of principal and interest,
or in payment of interest, under the 5% convertible debentures at the base
conversion price.
If we default on our obligations under the Registration Rights
Agreement, including our agreement to file the registration statement with the
Securities and Exchange Commission no later than 30 days after December 15, 2004
(or to file a request for acceleration in accordance with Rule 461 under the
Securities Act of 1933 within five trading days of the date that we are notified
by the Securities and Exchange Commission that the registration statement will
not be "reviewed" or will not subject to further review), or if the registration
statement is not declared effective by 90 days after December 15, 2004, we are
required pay to each debenture holder, as liquidated damages and not as a
penalty, for each month that the registration statement has not been filed or
declared effective, as the case may be, either a cash amount or shares of our
common stock within three (3) business days, after demand therefore, equal to 2%
of the liquidated value of the convertible debentures outstanding.
43
Events of Default
We will be considered in default of the convertible debentures if any
of the following events, among others, occurs:
(a) we fail to pay any amount due under a convertible debenture within
five days of any notice sent to us by the holder of the convertible
debenture that we are in default of our obligation to pay the amount;
(b) we fail to comply with any of the other agreements contained in the
convertible debenture after we are given ten days written notice of
such non-compliance;
(c) we breach any of our obligations under the Securities Purchase
Agreement or the Registration Rights Agreement and the breach is not
cured by us within ten days after our receipt of written notice of such
breach;
(d) we or any of our subsidiaries become bankrupt or insolvent;
(e) we fail to issue shares of our common stock to the holder within
five trading days of the conversion date specified in any conversion
notice delivered in respect of a convertible debenture by the holder.
If an event of default occurs, the holder of the convertible debenture
entitle the holder to accelerate full repayment of all debentures outstanding
and accrued interest thereon or, notwithstanding any limitations contained in
the debentures and/or the Securities Purchase Agreement, to convert all
debentures outstanding and accrued interest thereon into shares of our common
stock
Upon providing 3 business days advance written notice to holders,
during which time they may elect to convert up to all of their convertible
debentures, we may redeem the convertible debentures, in whole or part, at 120%
of the face value of each convertible debenture and the investor shall receive
50,000 redemption warrants for every $100,000 redeemed (the "Redemption
Warrants"). The Redemption Warrants are exercisable at 120% of the closing bid
price on our common stock as reported by Bloomberg, L.P. for the trading day
immediately preceding the Closing Date. The Redemption Warrants will be
exercisable until 2 years from the date of issuance.
5% CONVERTIBLE BRIDGE DEBENTURES
On December 15, 2004, we closed a private placement of 5% convertible
debentures to five accredited investors pursuant to Rule 506 of Regulation D
under the Securities Act of 1933, for gross proceeds of $195,000.
Interest and Maturity
The outstanding principal under the convertible debentures bears
interest at the rate of 5% per annum, payable in cash semi-annually beginning
six months from the date of the last closing of the offering in arrears.
All principal, and all accrued and unpaid interest, under the
convertible debentures will be due and payable at maturity 2 years from the date
in which the selling stockholder's funds are disbursed to us.
Conversion Provisions, Conversion Price and Adjustments
Principal under convertible debentures in the aggregate principal
amount of $195,000 may be converted by the holder in whole or in part and from
time to time at a conversion price equal to the lesser of (a) 120% of the
closing bid price of the common stock as reported by Bloomberg, L.P. for the
trading day immediately preceding the date that the holder's funds representing
the net amount due to us from the purchase price is transmitted by wire transfer
or otherwise to or for the benefit of us, or (ii) 80% of the lowest closing
prices for the 5 trading days preceding the date on which the notice of
conversion is sent via facsimile to us.
44
Each of the convertible debentures contains a contractual restriction
on beneficial share ownership. It provides that the holder may not convert
convertible debentures, or receive shares of our common stock as payment of
interest, to the extent that the conversion or the receipt of the interest
payment would result in the holder, together with its affiliates, beneficially
owning in excess of 4.99% of our then issued and outstanding shares of common
stock. For these purposes, beneficial ownership is to be determined in
accordance with Section 13(d) of the Securities Exchange Act of 1934, as
amended, and the rules promulgated thereunder.
Each convertible debenture is subject to anti-dilution protection upon
the occurrence of certain events, as follows:
(a) the conversion price will be reduced proportionately if we increase
the number of our outstanding shares of common stock as a result of: a
stock dividend or any other distribution on, or payable in, shares of
our common stock; a subdivision of our common stock; or a combination
or reclassification of our common stock;
(b) the conversion price will be reduced proportionately if we issue
rights, options or warrants to all holders of our common stock (but not
to holders of the convertible debentures) entitling them to purchase
shares of our common stock (or any equity, debt or other instrument
that is at any time over its life convertible into or exchangeable for
our common stock) at a price per share that is less than the closing
bid price for our common stock on the record date established for the
purposes of determining our stockholders who would be entitled to
receive such rights, options or warrants;
(c) if we or any of our subsidiaries offers, sells or otherwise
disposes of or issues any of our common stock (or any equity, debt or
other instrument that is at any time over its life convertible into or
exchangeable for our common stock) at an effective price per share that
is less than the conversion price, the conversion price will be reduced
to equal such effective price;
(d) if we or any of our subsidiaries grants any option entitling the
holder of the option to purchase any of our common stock (or any
equity, debt or other instrument that is at any time over its life
convertible into or exchangeable for our common stock) at an effective
price pr share that is less than the conversion price, the conversion
price will be reduced to equal such effective price;
(e) if we or any of our subsidiaries offer, sell or grant any right to
reprice outstanding securities at an effective price per share that is
less than the conversion price, the conversion price will be reduced to
equal such effective price;
(f) if we reclassify our outstanding shares of common stock, or if we
participate in any compulsory share exchange transaction pursuant to
which all of our outstanding shares of common stock will be converted
into other securities, cash or property, then each holder of a
convertible debenture will have the right, at its option, to: (a)
convert the then outstanding principal amount of the convertible
debenture, together with accrued but unpaid interest and any other
amounts then owing in respect of the convertible debenture, into the
shares of stock or other securities, cash and property that would have
been receivable by the holder as a result of such reclassification or
share exchange transaction if the holder had converted the convertible
debenture immediately prior to the reclassification or share exchange
transaction; or (b) to require us to pay to the holder of the
convertible debenture the mandatory prepayment amount equal to 120% of
the outstanding principal amount, plus all accrued and unpaid interest
and any other amounts then owing in respect of the convertible
debenture;
(g) if we consolidate or merge with another company or other entity, or
if we sell or transfer all or substantially all of our assets, then
upon the subsequent conversion of an convertible debenture, the
debenture holder will have the right to receive, for each share of our
common stock that would have been issuable to the debenture holder upon
such conversion absent such consolidation, merger or asset transaction,
the same kind and amount of securities, cash or property as the
debenture holder would have been entitled to receive if the debenture
holder had been the holder of one share of our common stock immediately
prior to the consolidation, merger or asset transaction; and
45
(h) if we or any other person, association, partnership or entity
completes any tender offer or exchange offer whereby the holders of our
common stock are permitted to tender or exchange their common stock for
other securities, cash or property, the debenture holder will have the
right to receive, for each share of our common stock that would have
been issuable to the debenture holder upon such conversion absent such
tender offer or exchange offer, the same kind and amount of securities,
cash or property as the debenture holder would have been entitled to
receive if the debenture holder had been the holder of one share of our
common stock immediately prior to the tender offer or exchange offer.
Right of Redemption and Redemption Warrants
At our option, we shall have the right to redeem, with 3 business days
advance written notice to the holders, during which time they may elect to
convert up to all of their convertible debentures, in whole or part, at 120% of
the face value of each convertible debenture and the holder shall receive 50,000
redemption warrants for every $100,000 redeemed. However, in no event shall we
have the redemption right prior to the shares underlying the convertible
debentures have been registered and such registration declared effective by the
SEC.
The redemption warrants are exercisable at 120% of the closing bid
price on our common stock as reported by Bloomberg, L.P. for the trading day
immediately preceding the closing date. The redemption warrants will be
exercisable until two (2) years from the date of issuance.
Registration Rights
We have agreed to file a registration statement that includes all the
shares of our common stock underlying the convertible debentures. If a
registration statement is not (i) filed within 30 days from our 2004 Annual
Meeting of Shareholders (ii) declared effective within 120 days of filing or
(iii) within 3 business days of receipt by the Company of written or oral
communication from the SEC that the registration statement will not be reviewed
or that the SEC has no further comments, or (iv) the registration stated is
filed and effective but thereafter ceases to be effective (without being
effected within 15 business days with a replacement or amendment thereto), then
the Debenture holders shall receive an amount equal to 1% for the first 30 days
or part thereof pending such non-registration event and 2% for each 30 days or
part thereof, of the purchase price of the Debenture remaining unconverted and
purchase price of shares issued upon conversion of the Debenture owned by such
holder.
WARRANTS
Warrants Issued to Holders of the Convertible Debentures
On May 15, 2003, we issued warrants to purchase an aggregate of
10,769,231 shares of our common stock to the four purchasers of our 7%
convertible debentures pursuant to Rule 506 of Regulation D under the Securities
Act of 1933. As issued, each warrant was exercisable at any time during the
five-year period ending on May 15, 2008, at an exercise price of $0.2645 per
share (being equal to 115% of $0.23 per share, the last reported closing bid
price of our common stock on May 14, 2003).
On October 27, 2003, in order to encourage early exercise of the
warrants by the warrant holders, we offered to reduce the exercise price of the
warrants from $0.2645 per share to $0.20 per share. The offer was open for
acceptance by the warrant holders until November 4, 2003. All other terms of the
warrants, including their expiry date, were to remain the same. In consideration
of the warrant holders' agreement to immediately exercise their respective
warrants, we offered to issue to the participating warrant holders one
additional warrant for each warrant that is exercised. The additional warrants
were to be exercisable for a period of five years at an exercise price of $0.20
per share.
One of the warrant holders, Palisades Master Fund, L.P. accepted our
offer and exercised a total of 3,290,596 outstanding warrants at the reduced
exercise price of $0.20 per share. On October 27, 2003, we issued a total of
3,290,596 five-year warrants to Palisades Master Fund, exercisable at an
exercise price of $0.20 per share.
On November 6, 2003, in order to encourage early exercise of the
warrants by the remaining three warrant holders, we offered to reduce the
exercise price of the remaining 7,478,635 warrants from $0.2645 per share to
$0.1771 per share. The offer was open for acceptance by the warrant holders
until November 19, 2003. All other terms of the warrants, including their expiry
date, remain the same. In consideration of the warrant holders' agreement to
immediately exercise their respective warrants, we offered to issue to the
participating warrant holders one additional warrant for each warrant that is
exercised.
46
On November 10, 2003, all of the remaining warrant holders, Crescent
International Ltd., Alpha Capital AG and Goldplate Investment Partners, accepted
our offer and exercised a total of 7,478,635 outstanding warrants at the reduced
exercise price of $0.1771 per share. We issued to the warrant holders the
following numbers of five-year warrants set forth opposite their respective
names, each exercisable at an exercise price of $0.1771 per share:
Crescent International Ltd. 1,794,873 warrants
Alpha Capital AG 4,487,181 warrants
Goldplate Investment Partners 1,196,581 warrants
In light of the reduced exercise price of the additional warrants
issued to the remaining warrant holders, we agreed to reduce the exercise price
of the 3,290,596 warrants previously issued to Palisades Master Fund from
US$0.20 to $0.1771 per share. All other terms of the warrants, including their
expiry date, remain the same. In addition, we paid $75,354.65 to Palisades
Master Fund as an early participation bonus, being an amount equal to the
difference between the aggregate exercise price that Palisades Master Fund paid
upon the exercise of its 3,290,596 outstanding warrants at $0.20 per share and
the aggregate exercise price that Palisades Master Fund would have paid if it
had had the benefit of the reduced exercise price of $0.1771 per share. On
September 24, 2004 all warrants with the exception of 2,091,493 warrants held by
Alpha Capital AG were exercised at an effective price of $0.03 per share. This
reduced price was due to the anti-dilution provisions in the warrants.
The warrants contain customary anti-dilution provisions that provide
for, among other things, certain adjustments to the number and kind of
securities purchasable upon exercise of the warrants, and to the exercise price,
upon the occurrence of certain events such as a reclassification, split or
reverse split (consolidation) or other reorganisation of our share capital, or
the declaration of a stock dividend. The anti-dilution provisions include an
automatic adjustment to the exercise price of the warrants if we offer, sell or
otherwise dispose of or issue any of our common stock (or any equity, debt or
other instrument that is at any time over its life convertible into or
exchangeable for our common stock) at an effective price per share that is less
than the exercise price, whereby the conversion price will be reduced to equal
such effective price.
Each warrant contains a contractual restriction on beneficial share
ownership. It provides that the holder may not exercise the warrant to the
extent that such exercise would result in the holder, together with its
affiliates, beneficially owning in excess of 4.99% of our then issued and
outstanding shares of common stock. For these purposes, beneficial ownership is
to be determined in accordance with Section 13(d) of the Securities Exchange Act
of 1934, as amended, and the rules promulgated thereunder.
On July 17, 2003, we issued warrants to the four purchasers of the 8%
convertible debentures pursuant to Rule 506 of Regulation D under the Securities
Act of 1933. Under the Securities Purchase Agreement, each purchaser of
convertible debentures received a warrant to purchase that number of shares of
our common stock equal to 100% of the aggregate principal amount of all
convertible debentures issued to such purchaser divided by $0.13. Warrants to
purchase an aggregate of 13,076,922 shares of our common stock have been issued
to the purchasers of the convertible debentures. As of December 30, 2004
12,521,364 of these warrants remain unexercised.
Each warrant is exercisable at any time during the five-year period
ending on July 17, 2008, at an exercise price of $0.028 per share due to
anti-dilution provisions in the warrant.
The warrants contain customary anti-dilution provisions that provide
for, among other things, certain adjustments to the number and kind of
securities purchasable upon exercise of the warrants, and to the exercise price,
upon the occurrence of certain events such as a reclassification, split or
reverse split (consolidation) or other reorganisation of our share capital, or
the declaration of a stock dividend.
47
Each warrant contains a contractual restriction on beneficial share
ownership. It provides that the holder may not exercise the warrant to the
extent that such exercise would result in the holder, together with its
affiliates, beneficially owning in excess of 4.99% of our then issued and
outstanding shares of common stock. For these purposes, beneficial ownership is
to be determined in accordance with Section 13(d) of the Securities Exchange Act
of 1934, as amended, and the rules promulgated thereunder.
Warrants Issued to Talisman Management Limited
On July 23, 2003, we issued to Talisman Management Limited, an
accredited investor, a warrant to purchase up to 1,000,000 shares of our common
stock, exercisable at any time during the three-year period ending on July 23,
2006, at an exercise price of $0.1955 per share. Due to anti-dilution provisions
in the warrant, the exercise price has been reduced to $.028. We issued these
warrants pursuant to Rule 506 of Regulation D under the Securities Act of 1933,
in partial payment of a commitment fee in connection with a 36-month, 15,000,000
equity line of credit facility. We do not plan to use this equity line of
credit.
The warrant contains customary anti-dilution provisions that provide
for, among other things, certain adjustments to the number and kind of
securities purchasable upon exercise of the warrant, and to the exercise price,
upon the occurrence of certain events such as a reclassification, split or
reverse split (consolidation) or other reorganisation of our share capital, or
the declaration of a stock dividend.
The warrant contains a contractual restriction on beneficial share
ownership. It provides that the holder may not exercise the warrant to the
extent that such exercise would result in the holder, together with its
affiliates, beneficially owning in excess of 4.99% of our then issued and
outstanding shares of common stock. For these purposes, beneficial ownership is
to be determined in accordance with Section 13(d) of the Securities Exchange Act
of 1934, as amended, and the rules promulgated thereunder.
Warrants Issued to HPC Capital Management as a Placement Fee
HPC Capital Management was instrumental in arranging for the $15.0
million equity line of credit facility provided by Talisman Management. HPC
Capital Management verbally agreed accept 250,000 warrants, which were issued on
July 23, 2003. These warrants were exercisable at any time until July 23, 2006
at an exercise price of $0.1955 per share subject to anti-dilution. Due to
anti-dilution provisions in the warrant, the exercise price has been reduced to
$0.028.
Warrants Issued to Hawk Associates, Inc. as partial consideration for investor
relations services
Hawk Associates, Inc. were granted five-year warrants on 250,000 shares
of the Company's common stock priced at US$0.20 with full piggyback rights and
were to be registered with the company's next registration statement after July
1, 2004. The warrants will expire at midnight June 30, 2009.
STANDBY EQUITY DISTRIBUTION AGREEMENT
On May 19, 2004, we entered into a Standby Equity Distribution
Agreement with selling stockholder, a Delaware limited partnership, for the
future issuance and purchase of shares of our common stock. This Standby Equity
Distribution Agreement establishes what is sometimes termed an equity line of
credit or an equity draw down facility.
In general, the draw down facility operates like this: the investor and
the selling stockholder committed to provide us up to $15.0 million as we
request it over a 24-month period, in return for common stock that we will issue
to selling stockholder. In addition, we engaged Newbridge Securities
Corporation, a registered broker-dealer, to advise us in connection with the
equity line of credit. For its services, Newbridge Securities Corporation
received 96,154 shares of our common stock. As of December 27, 2004 we have
$11,525,000 available under this facility.
We are under no obligation to request a draw down during any period. In
determining whether we will request a draw down, our company's management
intends to primarily take into account our company's working capital
requirements, and whether we have access to other sources of working capital. As
described above under the heading "Risk Factors," our existing stockholders may
face substantial dilution if we are compelled by circumstances to draw down
amounts under the equity line of credit facility. Further, as described below
and elsewhere in this prospectus, the number of shares that we will be required
to issue under the equity line of credit will increase if the stock price
decreases during the pricing period in respect of a draw down. Accordingly, if
at all possible, our company's management would like to avoid effecting any draw
downs under the equity line of credit, and particularly if our stock price is
low. However, there can be no assurances in this regard, since our capital
requirements may change dramatically.
As discussed under the heading, "Management's Discussion and Analysis -
Future Operations," our working capital requirements are impacted by our
inventory requirements. Therefore, any increase in sales of our products will be
accompanied not only by an increase in revenues, but also by an increase in our
working capital requirements. Since our inventory needs will be dictated in part
by market acceptance of our new products, which is extremely difficult to
predict, our debt repayments, budgeted operating expenses and working capital
requirements through July 31, 2005 range from $3,500,000 to $4,200,000.
48
As of December 30, 2004, pursuant to the equity line of credit, we may,
at our discretion, periodically sell to Cornell Capital Partners, L.P. shares of
common stock for a total purchase price of up to $11,500,000. We may request an
advance every 7 trading days. A closing will be held 6 trading days after such
written notice at which time we will deliver shares of common stock and Cornell
Capital Partners, L.P. will pay the advance amount. For each share of common
stock purchased under the equity line of credit, Cornell Capital Partners, L.P.
will pay 98% of the lowest closing bid price on the Over-the-Counter Bulletin
Board or other principal market on which our common stock is traded for the 5
days immediately following the notice date. Cornell Capital Partners, L.P. is a
private limited partnership whose business operations are conducted through its
general partner, Yorkville Advisors, LLC. Further, Cornell Capital Partners,
L.P. will retain 5% of each advance under the equity line of credit. The
issuance of these shares is conditioned upon us registering these shares with
the Securities and Exchange Commission. We may request advances under the equity
line of credit once the underlying shares are registered with the Securities and
Exchange Commission. Thereafter, we may continue to request advances until
Cornell Capital Partners, L.P. has advanced $15,000,000 or two years after the
effective date of the accompanying registration statement, whichever occurs
first.
We may periodically sell shares of common stock to Cornell Capital
Partners, L.P. to raise capital to fund our working capital needs. The periodic
sale of shares is known as an advance or drawdown.
The amount of each advance is subject to a maximum amount of $500,000
every 7 Trading days. The amount of capital available under the equity line of
credit is not dependent on the price or volume of our common stock. Cornell
Capital Partners, L.P. may not own more than 9.9% of our outstanding common
stock at any time. Because Cornell Capital Partners, L.P. can repeatedly acquire
and sell shares, this limitation does not limit the potential dilutive effect or
the total number of shares that Cornell Capital Partners, L.P. may receive under
the equity line of credit.
We cannot predict the actual number of shares of common stock that will
be issued pursuant to the equity line of credit, in part, because the purchase
price of the shares will fluctuate based on prevailing market conditions and we
have not determined the total amount of advances we intend to draw. Nonetheless,
we can estimate the number of shares of our common stock that will be issued
using certain assumptions. For example, we would need to issue 411,607,143
shares of common stock in order to raise the maximum amount remaining under the
equity line of credit at a purchase price of $.028.
The issuance of shares under the equity line of credit may result in a
change of control. That is, up to 411,607,143 shares of common stock could be
issued under the equity line of credit (i.e., the maximum number of shares being
registered in the accompanying registration statement for the equity line of
credit). If all or a significant block of these shares are held by one or more
stockholders working together, then such stockholder or stockholders would have
enough shares to assume control of us by electing its or their own directors.
This could happen, for example, if Cornell Capital Partners, L.P. sold the
shares purchased under the equity line of credit to the same purchaser.
Proceeds used under the equity line of credit will be used in the
manner set forth in the "Use of Proceeds" section of this prospectus. We cannot
predict the total amount of proceeds to be raised in this transaction because we
have not determined the total amount of the advances we intend to draw.
The amount of the discount that Selling stockholder is entitled to
receive under our Standby Equity Distribution Agreement was determined in arms
length negotiations between our company and Selling stockholder. In considering
its acceptability, our management took into account, among other things, our
negotiated right to designate a threshold price in our draw down notice as the
lowest price at which we will sell the shares to Selling stockholder in
connection with the draw down, and the lack of alternative sources of similar
financing at the time of the negotiations.
49
Our Standby Equity Distribution Agreement with Selling stockholder
provides that we may not sell shares of our common stock pursuant to our draw
down right under the agreement if the draw down would result in the issuance of
more than 9.99% of our then issued and outstanding common stock. In such cases,
we will not be permitted to issue the shares otherwise issuable pursuant to the
draw down and Selling stockholder will not be obligated to purchase those
shares.
Necessary Conditions Before Selling stockholder Is Obligated to Purchase Our
Shares
The following conditions must be satisfied before Selling stockholder
is obligated to purchase any common shares under any draw down notice that we
may deliver from time to time under our Standby Equity Distribution Agreement
with Selling stockholder:
(a) a registration statement for the shares must be declared effective
by the Securities and Exchange Commission and must remain effective and
available as of the draw down settlement date for making resales of the common
shares purchased by Selling stockholder;
(b) there must be no statute, rule, regulation, executive order,
decree, ruling or injunction which would prohibit the consummation of any of the
transactions contemplated by the Standby Equity Distribution Agreement;
(c) there must be no material action, suit or proceeding before any
arbitrator or any governmental authority against us or any of our subsidiaries,
or against any of the officers, directors or affiliates of our company or any of
our subsidiaries, in respect of the Standby Equity Distribution Agreement or in
respect of the transactions contemplated by the agreement;
(d) trading in our common stock must not have been suspended by the
Securities and Exchange Commission or by the regulators of the principal market
for our common stock (currently the OTC Bulletin Board); and
(e) the principal market for our common stock must not have instituted,
or otherwise been made subject to, a general suspension or limitation on the
trading of securities through its facilities at any time prior to delivery of
our draw down notice.
Indemnification of Selling stockholder
Selling stockholder, and each of directors, officers, shareholders,
partners, employees and agents, is entitled to customary indemnification from us
for any losses or liabilities suffered by any such person based upon material
misstatements or omissions from the Standby Equity Distribution Agreement,
registration statement and the prospectus, except as they relate to information
supplied by Selling stockholder to us for inclusion in the registration
statement and prospectus.
Governing Law of the Standby Equity Distribution Agreement
The Standby Equity Distribution Agreement, and the related transaction
documents, are governed by the internal laws of the State of New Jersey and all
legal proceedings in connection with the Standby Equity Distribution Agreement
must be commenced exclusively in the state and federal courts sitting in the
City of Newark. Thus, all questions concerning the validity, enforcement and
interpretation of the Standby Equity Distribution Agreement and the related
transaction documents, will be determined by reference to New Jersey law.
LEGAL PROCEEDINGS
During August 2004, the Company defaulted on payments to holders of its
discounted convertible debentures. As disclosed in our 8-K's filed between
September 13 and October 1, 2004, in response to the default, certain debenture
holders filed legal actions against the Company. On September 24, 2004, the
Company and holders of the discounted convertible debentures signed an agreement
which provided for: withdrawal of legal action; an immediate exercise of
18,226,274 warrants at $0.03 for gross proceeds of $546,788; conversion of
$734,389 of debentures into 24,479,630 common shares; a lock-up provision that
establishes a daily limit on the number of shares that can be traded by the
debenture holders.
50
DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS
- ------------------------------ ---------------------------------------- ------- ------------------------------------
DATE FIRST
NAME POSITION HELD WITH THE COMPANY AGE ELECTED OR APPOINTED
- ------------------------------ ---------------------------------------- ------- ------------------------------------
William Cronin Director 57 Director since June 7, 2001.
- ------------------------------ ---------------------------------------- ------- ------------------------------------
Martin Gannon Director 52 Director since February 3, 2003.
- ------------------------------ ---------------------------------------- ------- ------------------------------------
Johnny Christiansen Director 49 Director since August 14, 2003.
- ------------------------------ ---------------------------------------- ------- ------------------------------------
Robert Rudman Director, President, CEO and Chairman 57 Director since September 22, 1993,
President and CEO since January
19, 1996, and Chairman since June
4, 1999.
- ------------------------------ ---------------------------------------- ------- ------------------------------------
Al Kozak Director, Chief Operating Officer 55 Director since November 20, 2002,
and Chief Operating Officer since
May 1, 2002.
- ------------------------------ ---------------------------------------- ------- ------------------------------------
Jeff Finkelstein Chief Financial Officer 43 Chief Financial Officer since
October 23, 2002.
- ------------------------------ ---------------------------------------- ------- ------------------------------------
Erwin Bartz Vice President, Business Development 43 Vice President of Business
Development since January 3, 2001.
- ------------------------------ ---------------------------------------- ------- ------------------------------------
Shawn Lammers Vice President, Engineering 37 Vice President, Engineering since
January 1, 1997.
- ------------------------------ ---------------------------------------- ------- ------------------------------------
The directors of our Company are elected at each annual general meeting and hold
office until the next annual general meeting or until their successors are
appointed.
Business Experience
The following is a brief account of the education and business
experience during at least the past five years of each director, executive
officer and key employee, indicating the principal occupation during that
period, and the name and principal business of the organization in which such
occupation and employment were carried out.
William Cronin:
Mr. Cronin has been a director since June, 2001 and previously served
as a director from November 17, 1995 to April 25, 1998. Since 1986, Mr. Cronin
has been the owner of Madison Financial Services, a registered investment
adviser firm located in Madison, Connecticut, specializing in tax, pension
investing planning strategies and portfolio management.
Martin Gannon
Mr. Gannon joined our company as a director on February 3, 2003. Mr.
Gannon has been a Certified Public Accountant since 1973. He has been a partner
and the vice president of the accounting firm of Barron Gannon & Co., P.C. since
1982. In his advisory role to his clientele, he has assisted companies from
their inception to maturity.
Johnny Christiansen
Mr. Christiansen joined our company as a director on August 14, 2003.
Mr. Christiansen resides in Norway. He has a strong knowledge of our business
and industry as he served as the President of SensoNor asa from 1999-2002.
SensoNor is a Norwegian company and a leading provider of tire monitoring,
airbag and rollover sensors for the automotive industry. During Mr.
Christiansen's tenure as its President, SensoNor raised more than $100 million
in financing and signed contracts for more than $400 million. Before 1999, Mr.
Christiansen served as a director of various companies, including Davis AS,
Kongsberg Norcontrol Systems, Norcontrol Training AS and Norcontrol Automation
AS.
51
Robert Rudman:
Mr. Rudman has been a director since September, 1993. Mr. Rudman joined
our company in March, 1993 as the Chief Financial Officer after serving as an
independent financial consultant for several months. He was appointed Chief
Executive Officer of our company on January 19, 1996, and served as President
from January 19, 1996 to June 4, 1999, when he was appointed Chairman of the
Board. Mr. Rudman was reappointed President of our company effective April 1,
2000. He is a Chartered Accountant with 15 years of experience assisting public
companies listed primarily on the Vancouver Stock Exchange (now the TSX Venture
Exchange). Prior to joining our company, Mr. Rudman was manager of a
California-based sales contract financing firm. Previously, he was a partner in
a consulting firm providing professional assistance to publicly traded
companies. Mr. Rudman became a Chartered Accountant in 1974 and worked with
Laventhol & Horwath and Price Waterhouse & Co. in Winnipeg, Manitoba.
Jeff Finkelstein
Mr. Finkelstein was formally appointed as our Chief Financial Officer
in October 2002. He is a Chartered Accountant and is responsible for all
financial and related functions for our company, including finance, treasury,
accounting, taxation, legal, management information systems and administration.
Mr. Finkelstein was promoted to Acting Chief Financial Officer of our company in
May 2002, and served as our controller since February 22, 1999. From 1996 to
1999, he served as controller of Golden Knight Resources Inc., a Toronto Stock
Exchange listed public company, and Silver Standard Resources, a Nasdaq listed
public company. From 1993 to 1995, he served as controller of a private
distribution company after eight years as a public accountant.
Erwin Bartz
Mr. Bartz has recently been appointed Vice President of Business
Development. He has overall responsibility for defining product strategies and
roadmaps as well as developing strategic alliances. He was formerly our
Director, Technical Operations since January 2001 with responsibility for
overall technical operations including engineering and manufacturing. Mr. Bartz
is a Professional Engineer with 19 years of engineering experience. Prior to
joining our company, Mr. Bartz spent ten years as Manager of Engineering and
Manufacturing at Finning (Canada), the Caterpillar dealer for British Columbia,
Alberta, United Kingdom and Chile, with corporate responsibility for
engineering, product review, heavy manufacturing and new equipment preparation.
Previously, he held the Engineering Manager role at Weldco Beales, a custom
attachment manufacturer for the mobile equipment market, and also worked as a
design engineer for the Chapman Industries, a Hitachi distributor and general
manufacturer of purpose-built machinery and equipment.
Al Kozak:
Mr. Kozak joined us as Chief Operating Officer on May 1, 2002. He was
subsequently appointed to our board of directors on November 20, 2002. Mr. Kozak
is a seasoned executive with strong operational management and business
development experience in fast-paced, high growth, technology companies. From
May 2000 to April 2001, Mr. Kozak was the President and founder of Siwash
Ventures where he assembled an advisory board of senior executives from the
Vancouver area to analyze and recommend investment and business development
strategies to technology companies. From 1992 to 1998 he held the position of
President with Digital Courier International, Inc., an industry extranet that
networked over 7,000 radio stations, 1500 advertising and 400 production
facilities. Following the sale by Digital Courier International of its assets
and technology to Digital Generations Systems Inc. in 1998, Mr. Kozak was
appointed by Digital Generations Systems as its VP, Marketing and Business
Development and served in that capacity for two years.
52
Shawn Lammers:
Mr. Lammers has been with us since our inception. He currently serves
as the Vice President Engineering and is responsible for the development of the
patented remote sensing technology utilized in SmarTire's products. He has been
the chief engineer in respect to the design, development and production of our
passenger car tire monitoring system, the commercial vehicle tire monitoring
system and the industrial equipment tire monitoring systems. He has developed
software for MS-DOS, Windows, UNIX Workstations and Amiga platforms.
Family Relationships
There are no family relationships between any of our company's
directors or executive officers.
Involvement In Certain Legal Proceedings
None of our directors, executive officers, promoters or control persons
have been involved in any of the following events during the past five years:
1. any bankruptcy petition filed by or against any business of which
such person was a general partner or executive officer either at the
time of the bankruptcy or within two years prior to that time;
2. any conviction in a criminal proceeding or being subject to a
pending criminal proceeding (excluding traffic violations and other
minor offences);
3. being subject to any order, judgment, or decree, not subsequently
reversed, suspended or vacated, of any court of competent jurisdiction,
permanently or temporarily enjoining, barring, suspending or otherwise
limiting his involvement in any type of business, securities or banking
activities; or
4. being found by a court of competent jurisdiction (in a civil
action), the Commission or the Commodity Futures Trading Commission to
have violated a federal or state securities or commodities law, and the
judgment has not been reversed, suspended, or vacated.
53
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Principal Stockholders
The following table sets forth, as of December 30, 2004, certain
information with respect to the beneficial ownership of our common stock by each
stockholder known by us to be the beneficial owner of more than 5% of our common
stock and by each of our current directors and executive officers. Each person
has sole voting and investment power with respect to the shares of common stock,
except as otherwise indicated. Beneficial ownership consists of a direct
interest in the shares of common stock, except as otherwise indicated.
- ------------------------------------------------- --------------------------------- --------------------------------
AMOUNT AND NATURE OF PERCENTAGE
NAME AND ADDRESS OF BENEFICIAL OWNER BENEFICIAL OWNERSHIP OF CLASS(1)
- ------------------------------------------------- --------------------------------- --------------------------------
William Cronin 1,779,746(2) *
180 Concord Drive
Madison, Connecticut, USA 06443
- ------------------------------------------------- --------------------------------- --------------------------------
Martin Gannon 1,535,000(3) *
1275 Post Road
Fairfield, Connecticut, USA 06824
- ------------------------------------------------- --------------------------------- --------------------------------
Johnny Christiansen 1,150,000(4) *
Spurvestien 24
3189 Horten, Norway
- ------------------------------------------------- --------------------------------- --------------------------------
Robert Rudman 7,440,667(5) 3.19%
#40 - 5740 Garrison Road
Richmond, BC V7C 5E7
- ------------------------------------------------- --------------------------------- --------------------------------
Al Kozak 5,466,000(6) 2.36%
25841 116 Avenue
Maple Ridge, BC V4R 1Z6
- ------------------------------------------------- --------------------------------- --------------------------------
Jeff Finkelstein 3,422,950(7) 1.49%
3460 Regent Street
Richmond, BC V7E 2N1
- ------------------------------------------------- --------------------------------- --------------------------------
Erwin Bartz 3,555,0008) 1.55%
21 Arrow-Wood Place
Port Moody, BC V3H 4E9
- ------------------------------------------------- --------------------------------- --------------------------------
Shawn Lammers 3,394,219(9) 1.48%
3460 Regent Street
Richmond, BC V7E 2N1
- ------------------------------------------------- --------------------------------- --------------------------------
DIRECTORS AND EXECUTIVE OFFICERS AS A GROUP 27,743,582 COMMON SHARES(10) 10.94%
- ------------------------------------------------- --------------------------------- --------------------------------
* Represents less than 1% of our company's outstanding stock
(1) Based on 225,912,470 shares of common stock issued and outstanding as of
December 30, 2004. Beneficial ownership is determined in accordance with the
rules of the Securities and Exchange Commission and generally includes voting or
investment power with respect to securities. Except as otherwise indicated, we
believe that the beneficial owners of the common stock listed above, based on
information furnished by such owners, have sole investment and voting power with
respect to such shares, subject to community property laws where applicable.
54
(2) Includes options to acquire up to 1, 692,500 Common Shares, exercisable
within sixty days.
(3) Includes options to acquire up to 1,525,100 Common Shares, exercisable
within sixty days.
(4) Includes options to acquire up to 1,150,000 Common Shares, exercisable
within sixty days.
(5) Includes 10,257 Common Shares owned by Mr. Rudman's wife. Mr. Rudman has
sole voting and dispositive power over such shares. Includes options to acquire
up to 7,409,000 Common Shares, exercisable within sixty days.
(6) Consists of options to acquire up to 5,466,000 Common Shares, exercisable
within 60 days.
(7) Includes options to acquire up to 3,417,200 Common Shares, exercisable
within 60 days.
(8) Consists of options to acquire up to 3,555,000 Common Shares, exercisable
within 60 days.
(9) Includes options to acquire up to 3,392,700 Common Shares, exercisable
within 60 days.
(10) Includes options to acquire up to 27,607,500 Common Shares, exercisable
within 60 days.
Changes in Control
We are unaware of any contract or other arrangement the operation of
which may at a subsequent date result in a change of control of SmarTire, other
than the conversion of our outstanding convertible debentures and the exercise
of our outstanding warrants in certain circumstances.
DESCRIPTION OF COMMON STOCK
Our authorized capital stock consists of an unlimited number of shares
of common stock without par value, and 100,000 shares of preferred stock with a
par value of CDN$1,000 per share. As of December 30, 2004, there are 225,912,470
shares of our common stock issued and outstanding. Each stockholder is entitled
to one vote for each share of common stock held on all matters submitted to a
vote of stockholders, including the election of directors.
Each stockholder is entitled to receive the dividends as may be
declared by our board of directors out of funds legally available for dividends
and, in the event of liquidation, to share pro rata in any distribution of our
assets after payment of liabilities. Our board of directors is not obligated to
declare a dividend. Any future dividends will be subject to the discretion of
our board of directors and will depend upon, among other things, future
earnings, the operating and financial condition of SmarTire, its capital
requirements, general business conditions and other pertinent factors. It is not
anticipated that dividends will be paid in the foreseeable future.
Stockholders do not have pre-emptive rights to subscribe for additional
shares of common stock if issued by us. There is no conversion, redemption,
sinking fund or similar provisions regarding the common stock.
Shares of our common stock are subject to rules adopted by the
Securities and Exchange Commission that regulate broker-dealer practices in
connection with transactions in "penny stocks". "Penny stock" is defined to be
any equity security that has a market price (as defined) less than $5.00 per
share or an exercise price of less than $5.00 per share, subject to certain
exceptions. For the foreseeable future, our common stock will most likely
continue to be covered by the penny stock rules, which impose additional sales
practice requirements on broker-dealers who sell to persons other than
established customers and "accredited investors." The term "accredited investor"
refers generally to institutions with assets in excess of $5,000,000 or
individuals with a net worth in excess of $1,000,000 or annual income exceeding
$200,000 or $300,000 jointly with their spouse.
55
The penny stock rules require a broker-dealer, prior to a transaction
in a penny stock not otherwise exempt from the rules, to deliver a standarized
risk disclosure document in a form prepared by the Securities and Exchange
Commission which provides information about penny stocks and the nature and
level of risks in the penny stock market. The broker-dealer also must provide
the customer with current bid and offer quotations for the penny stock, the
compensation of the broker-dealer and its salesperson in the transaction and
monthly account statements showing the market value of each penny stock held in
the customer's account. The bid and offer quotations, and the broker-dealer and
salesperson compensation information, must be given to the customer orally or in
writing prior to effecting the transaction and must be given to the customer in
writing before or with the customer's confirmation. In addition, the penny stock
rules require that prior to a transaction in a penny stock not otherwise exempt
from these rules, the broker-dealer must make a special written determination
that the penny stock is a suitable investment for the purchaser and receive the
purchaser's written agreement to the transaction. These disclosure requirements
may have the effect of reducing the level of trading activity in the secondary
market for the stock that is subject to these penny stock rules. Consequently,
these penny stock rules may affect the ability of broker-dealers to trade our
securities.
LEGAL MATTERS
The validity of the shares of common stock offered by the selling
stockholders was passed upon by the law firm of Sichenzia Ross Friedman Ference
LLP.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
INTEREST OF NAMED EXPERTS AND COUNSEL
No expert or counsel named in this prospectus as having prepared or
certified any part of this prospectus or having given an opinion upon the
validity of the securities being registered or upon other legal matters in
connection with the registration or offering of the common stock was employed on
a contingency basis or had, or is to receive, in connection with the offering, a
substantial interest, directly or indirectly, in the registrant or any of its
parents or subsidiaries. Nor was any such person connected with the registrant
or any of its parents, subsidiaries as a promoter, managing or principal
underwriter, voting trustee, director, officer or employee.
EXPERTS
Our consolidated financial statements as at July 31, 2004 and 2003, and
for each of the years in the three-year period ended July 31, 2004, filed with
this prospectus and registration statement have been audited by KPMG LLP,
independent chartered accountants, as set forth in their report accompanying the
consolidated financial statements and are included herein in reliance upon the
report, and upon the authority of the firm as experts in accounting and
auditing. The audit report covering the July 31, 2004 consolidated financial
statements includes additional comments for United States readers that states
that conditions and events exist that cast substantial doubt about our ability
to continue as a going concern. The consolidated financial statements do not
include any adjustments that might result from the outcome of that uncertainty.
DISCLOSURE OF SEC POSITION OF
INDEMNIFICATION FOR SECURITIES ACT LIABILITIES
Under our Bylaw, subject to the Business Corporations Act (Yukon
Territory) and subject to court approval in certain circumstances, we must
indemnify:
(a) each of our current or former directors and officers,
(b) any person who acts or has acted at our request as a director or
officer of a corporation of which we are or were a shareholder or
creditor, and
56
(c) any such indemnified person's heirs and legal representatives,
against all costs, charges and expenses, including any amount paid to settle an
action or satisfy a judgment, reasonably incurred by him or her in respect of
any civil, criminal or administrative action or proceeding to which he or she is
made a party by reason of serving or having served as a director or officer of
our company or such corporation, if: (i) he or she acted honestly and in good
faith with a view to the best interests of our company; and (ii) in the case of
a criminal or administrative action or proceeding that is enforced by a monetary
penalty, he or she had reasonable grounds for believing his or her conduct was
lawful.
Section 126 of the Business Corporations Act (Yukon Territory) provides
that, in any event, any of the foregoing persons is entitled to be indemnified
by us in respect of all costs, charges and expenses reasonably incurred by him
or her in connection with the defence of any civil, criminal or administrative
action or proceeding to which he or she is made a party by reason of being or
having been a director or officer of our company or a corporation of which we
are or were a shareholder or creditor, if he or she: (a) was substantially
successful on the merits in his or her defence of the action or proceeding; (b)
is fairly and reasonably entitled to indemnity, (c) acted honestly and in good
faith with a view to the best interests of our company; and (b) in the case of a
criminal or administrative action or proceeding that is enforced by a monetary
penalty, he or she had reasonable grounds for believing his or her conduct was
lawful.
Insofar as indemnification for liabilities arising under the Securities
Act might be permitted to directors, officers or persons controlling our company
under the provisions described above, we have been informed that in the opinion
of the Securities and Exchange Commission such indemnification is against public
policy as expressed in the Securities Act and is therefore unenforceable.
DESCRIPTION OF BUSINESS
General Overview
We (together with our subsidiaries) are engaged in the development and
marketing of tire pressure monitoring systems (TPMS) designed for improved
vehicle safety, performance, reliability and fuel efficiency. During the fiscal
year ended July 31, 2004, we earned revenues primarily from the sale of tire
monitoring systems (TMS) for passenger cars. Our principal executive offices are
located at #150 - 13151 Vanier Place, Richmond, British Columbia, Canada, V6V
2J1. We were incorporated under the laws of the Province of British Columbia on
September 8, 1987, and were continued under the laws of the Yukon Territory to
become a Yukon corporation effective February 6, 2003. Our telephone number is
(604) 276-9884.
We have three wholly owned subsidiaries: SmarTire Technologies Inc.,
SmarTire USA Inc. and SmarTire Europe Limited. SmarTire Technologies Inc. was
incorporated on June 3, 1988 under the laws of the Province of British Columbia,
and was the original developer of our patented technology. SmarTire USA Inc., a
Delaware corporation incorporated on May 16, 1997, is our exclusive marketing
agency for SmarTire in North America. SmarTire Europe Limited, a United Kingdom
corporation incorporated on February 25, 1998, is our exclusive sales and
distribution operation for Europe. SmarTire Europe's head office is located at
Park 34, Southmead Industrial Park, Didcot, Oxfordshire, England, OX11 7WB.
We are a "foreign private issuer", as such term is defined in Rule 3b-4
under the Securities Exchange Act of 1934. However, we have elected to file with
the Securities and Exchange Commission the same reports that a domestic
registrant would be required to file under section 13(a) of the Securities
Exchange Act of 1934.
Corporate History
We were incorporated under the laws of the Province of British Columbia
as TTC/Truck Tech Corp. on September 8, 1987. We were formed to develop and
market remote data sensing, transmission and processing products incorporating
patented technologies to satisfy emerging market requirements in the
transportation industry.
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Our company was continued under the Business Corporations Act (Yukon
Territory) effective February 6, 2003. As a result, our Memorandum and Articles
which constituted our constitutional documents while we were a British Columbia
company have been superseded and replaced by Articles of Continuance filed with
the Yukon Registrar of Corporations under section 190 of the Business
Corporations Act (Yukon Territory) and By-law No. 1, being a by-law adopted by
our board of directors relating generally to the transaction of the business and
affairs of our company. Our continuance as a Yukon corporation was approved by
special resolution adopted by our shareholders at the annual and extraordinary
general meeting held on December 12, 2002.
On July 29, 1988, we acquired all of the issued and outstanding shares
of Delta Transportation Products Ltd., and subsequently caused it to change its
name to SmarTire Technologies Inc. effective June 3, 1998. Our initial product,
based on technology developed by Delta Transportation Products Ltd., consisted
of a wireless tire monitoring systems (TMS) designed for large ore hauling
trucks and wheeled loaders that are utilized in the mining industry.
We completed our initial public offering on the Vancouver Stock
Exchange (now the TSX Venture Exchange) on September 11, 1989. On April 13,
1995, we changed our name to UniComm Signal Inc. On December 24, 1997, we
changed our name to SmarTire Systems Inc. and effected a reverse stock split
pursuant to which our common stock was consolidated on a 1 for 8 basis. On
December 16, 1998, our common stock commenced trading on the Nasdaq SmallCap
Market. On March 12, 1999, we voluntarily delisted our common stock from trading
on the Vancouver Stock Exchange. On May 28, 2003, our common stock ceased
trading on the Nasdaq SmallCap Market and is now quoted on the OTC Bulletin
Board.
On December 6, 1996, we acquired the Low Tire Pressure Warning Division
of EPIC Technologies, Inc. of Norwalk, Ohio. The assets that we acquired from
EPIC included specialized testing equipment, patents and certain contractual
rights, including the rights under a production program that EPIC had
established with Ford Motor Company. Under that production program, the Low Tire
Pressure Warning System that we acquired from EPIC was offered by Ford as an
option on Lincoln Continentals until the end of December 2001 when that
particular model was discontinued.
Our acquisition of EPIC's Low Tire Pressure Warning Division
accelerated our entry into the passenger car market. Recognizing the emerging
demand for tire pressure monitoring systems (TPMS) in passenger cars and light
trucks, we modified the new car version of the technology that we had acquired
from EPIC for use in existing vehicles. This product was launched into the
automotive aftermarket in June 1997 to support the market introduction of
run-flat tires. Automotive aftermarket products are sold as optional add-on
products for automobiles and are produced by third-party suppliers such as our
company. The aftermarket consists of retailers including tire retailers,
automotive electronic stores and accessory shops, which sell products directly
to consumers. Aftermarket products are distinguishable from original equipment
manufacturers - or so-called "OEM" - products which are sold as options offered
directly by or through the manufacturer of the automobile. OEM products may be
produced by third party suppliers as well, but are sold to automobile
manufacturers rather than to end-users. The TPMS that we supplied to Ford for
use on Lincoln Continentals is an example of an OEM product.
During 1997, Goodyear, Michelin and Bridgestone/Firestone approved our
company's first generation TPMS for sale with run-flat or extended mobility
tires. Run-flat tires allow drivers to drive up to 50 miles on a tire that has
lost all of its air pressure. These tires perform so well without any air
pressure that an approved TPMS is required with the purchase of each set.
Otherwise the operator may unknowingly drive on the tire until it fails or is no
longer repairable. TPMS for both run-flat and conventional tires are distributed
as aftermarket products, primarily through independent tire dealers and
distributors and automobile service centers.
Our acquisition of EPIC's Low Tire Pressure Warning Division also
facilitated our entry into the motorsport market. Originally developed by EPIC
and Penske Racing, our motorsport TPMS was distributed exclusively by Pi
Research of Cambridge, England. It is widely used by Indy racing teams. We do
not anticipate further sales of our motorsport TPMS to Pi Research as they now
manufacture and market their own system.
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On April 20, 1998, we established a strategic alliance with TRW Inc., a
large U.S.-based automotive parts supplier. The strategic alliance was founded
on four agreements between the parties: an Equity Agreement, a Cooperation
Engineering Agreement, an Original Equipment Manufacturer License Agreement and
a Manufacturing Agreement. The agreements provided for joint engineering and
development activities between the parties, and TRW was granted exclusive
marketing and distribution rights for some of our company's products. In
addition, TRW had exclusive rights in the original equipment market for any tire
monitoring products that it developed jointly with us and we had exclusive
rights in the automotive aftermarket.
Effective August 31, 2001, we restructured our strategic alliance with
TRW. As a result of the restructuring, most of the agreements that we had
entered into with TRW in 1998 were cancelled. However, TRW retained its equity
position in our company. By ending our collaboration with TRW in product
development and by providing that neither we nor TRW will have exclusive rights
to any products, the restructuring effectively provided us with immediate access
to all levels of the global automotive and transportation industries.
During May 2002 we entered into a non-binding Memorandum of
Understanding with Visteon Corporation, a global supplier of products to the
automotive industry, to develop and market tire monitoring solutions for the OEM
market. Our Memorandum of Understanding matured into a formal agreement dated
December 10, 2002 which contemplated collaboration between our company and
Visteon to develop and market more advanced tire pressure monitoring systems
(TPMS) systems for passenger vehicles and light trucks, and to jointly explore
other opportunities for tire monitoring products such as the commercial vehicle
market. Under the agreement, we also granted Visteon rights to manufacture some
of our products. On July 16, 2003, we formally ended our relationship with
Visteon Corporation.
On September 24, 2002, we and Pirelli Pneumatici signed a Supply
Agreement for TPMS that measure the pressure and temperature of car, truck and
motorcycle tires. The tire pressure monitoring systems (TPMS) are produced and
tested by our company, and marketed and sold by Pirelli under the name
X-PressureTM. The systems went on sale by the end of 2002 through Pirelli's tire
distribution channels in Italy, Germany, United Kingdom, Spain and Switzerland.
During October 2002, we made our first shipment to Pirelli under the Supply
Agreement. Pirelli is currently testing our second generation motorcycle system.
In December 2002, we entered into an eight-year supply commitment
letter for TPMS to be offered as part of the OEM package on certain vehicles
produced by Aston Martin. We are committed to supply the systems in response to
purchase orders submitted by Aston Martin from time to time. Aston Martin
initially installed TPS on the V12 Vanquish. In September 2004, it began to
purchasing TMS for installation on its DB9 model that went into production
earlier in 2004.
We completed the development and launch of our second generation TPMS for the
passenger car and light truck market during the fiscal year ended July 31, 2001.
We introduced our motorcycle TPMS for sale into the aftermarket in September
2002. In February 2004, we introduced a substantially improved second generation
motorcycle TPMS. During May 2004 this product became commercially available and
we began shipping it to our customers. In August 2004, we discovered that the
sensor/transmitter may break during installation on the subset of motorcycle
rims with curved rim surfaces when the strap is torqued to its required value.
On September 14, 2004 we contacted the NHTSA to determine if a Safety Defect and
Non Compliance Report was required and was advised that this was necessary. Our
remedy for the defect was to recall 100% of affected sensor/transmitter items
from the field and replace both recalled and inventory sensor/transmitters with
sensor/transmitters previously manufactured by a different supplier that have
been tested and known to use plastics that provide the required mechanical
properties. Additionally we wish to ensure that transmitters are used only on
rims with flat drop center wells (as originally designed for) and not curved.
The additional precautionary steps were taken:
o Adding improved warnings and instruction sheet to new product
as well as product in inventory at dealers and distributors
that clarify flat rim drop center well application only
o Removal of TPMS on motorcycles with rims with curved drop
center wells
We anticipate the cost of this recall will be approximately $67,000.
Recall costs incurred to the end of October were $19,211. In addition, we are
currently working on a solution to enable us to sell our TPMS on motorcycles
with rims with curved drop center wells. We anticipate this solution will be
available for sale by March 2005.
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In February 2003, we signed a manufacturing, co-marketing and development
agreement with Hyundai Autonet Company, Ltd., (HACO) an established Korean
automotive electronics supplier. Under this agreement, HACO and we will
co-develop, manufacture and distribute tire monitoring products to HACO original
equipment vehicle manufacturers and the automotive aftermarket in Korea. The
agreement provides for the payment to us by HACO of a total of $300,000 in fees,
to cover the cost to develop a receiver and transmitter that can be used in the
Korean and Japanese markets. Initial payments totaling $165,000 were made by
HACO upon execution of our agreement, and the balance of $135,000 is payable
upon the attainment of certain milestones including the completion of validation
testing of these products and the launch of these products in South Korea. In
November 2004, we received $67,500, reducing the balance due from HACO to
$67,500. We originally expected to receive an ongoing revenue stream through the
sales of proprietary components to HACO beginning in early 2004. However due to
delays in attaining these milestones, we now expect revenue from the sale of
these components to commence in early 2005.
In October 2003, we signed a contract manufacturing services agreement
with Hyundai Autonet Company (HACO). Under the terms of the agreement, HACO will
manufacture the Company's proprietary line of tire pressure monitoring systems
(TPMS) for sale and distribution globally by SmarTire. HACO's tier one
manufacturing status provides SmarTire the opportunity to compete on a worldwide
basis with higher quality products, an increased volume capability and a more
flexible cost structure.
On September 8, 2003, we entered into an agreement in principle
appointing Beijing Boom Technology Co. Ltd. as the Master Distributor of our
TPMS in mainland China. The agreement in principle led to a formal Master
Distributor Agreement between us and Beijing Boom Technology dated October 17,
2003, which provides for an initial two year term ending on October 9, 2005 and
automatic renewal for successive one-year terms subject to termination by either
party on giving 90 days' advance notice in writing. Beijing Boom Technology has
agreed to purchase over $1.5 million in aftermarket passenger car TPMS at fixed
intervals during the first year of the agreement. Beijing Boom Technology must
submit purchase orders to us for these products in accordance with a fixed
delivery schedule covering the first year of the agreement, and must pay for
each shipment before the products are shipped until March 2004. Beijing Boom
Technology may return products to us, but any products which are returned
without our prior written consent are subject to a charge equal to 50% of the
invoiced value of such products. Although Beijing Boom Technology has not placed
orders in accordance with the fixed delivery schedule, we have continued to
require them to make an advance payment to us on prior to each shipment of
orders in excess of $25,000.
In order to maintain its status as our Master Distributor in China,
Beijing Boom Technology must also purchase approximately $3.9 million in
additional aftermarket passenger car tire pressure monitoring systems (TPMS)
during the second year of the agreement. Per our agreement, Beijing Boom
Technology was to also establish a network of certified dealers in all provinces
of China by May 1, 2004. Although several dealers have been established, the
milestone has not been reached. However, in June 2004 we verbally agreed with
Beijing Boom Technology that the milestone be changed towards establishing a
network of certified dealers in all major cities in China. Subject to Beijing
Boom Technology meeting these milestones, we have agreed not to appoint any
other master distributor for mainland China during the initial two-year term of
the Master Distributor Agreement. Although Beijing Boom Technology continues to
make progress, they did not purchase any TPMS during the three months ended
October 31, 2004 as they had sufficient inventory from their purchases in fiscal
2004.
On September 12, 2003 we entered into a development agreement with
Vansco Ltd. This agreement provides for the merging of Vansco's vehicle
communication expertise with our proven radio frequency (RF) technology to
create a high sensitivity, weatherproof, J1939 controller area network (CAN),
chassis-mounted receiver. The J1939 CAN is the most widely used communication
standard in commercial vehicles today, allowing for multiplexing, receiving and
transmitting of signals from various sources. When CAN technology is combined
with our high pressure sensors, we anticipate that this joint development effort
will result in a new TPMS targeted directly at original equipment manufacturers
(OEMs) of commercial trucks, buses, agricultural, construction and recreational
vehicles. In November, 2004, design validation testing and the initial pilot
build of 300 units was completed. The 300 units will be utilized to validate the
reliability of the production line and to satisfy early test and validation
demands from our existing and potential OEM customers. Vansco will manufacture
the CAN, chassis-mounted receiver for us.
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On October 10, 2003 we entered into a Co-Marketing and Development
agreement with Haldex Brake Products Ltd., and a related Supply Agreement with
Haldex. Under the terms of this agreement, we will engage in a joint development
program to integrate our TPMS with Haldex's brake systems, with the view to
creating a commercial high pressure tire pressure monitoring system (TPMS) for
marketing and resale by Haldex. We anticipate that any new products that result
from our collaboration with Haldex will be targeted at both OEM and aftermarket
applications for trailers. Once development is complete, we plan to execute on
the Supply Agreement with Haldex. As part of this program, both organizations
have commenced work on understanding the requirements of the market and their
existing customers prior to completion of development.
On June 3, 2004, in conjunction with its Master Distributor in China,
Beijing Boom Technology Co. Ltd., we finalized a major sales order with its
exclusive dealer in Taiwan, Chu Chang International Ltd. ("CCIL").The order was
valued at approximately $5 million and was to be secured by an irrevocable
letter of credit. To date, we have not shipped any product to CCIL as they have
not provided us with an irrevocable letter of credit.
GOVERNMENT REGULATIONS
Our products are subject to regulation by the government agencies
responsible for radio frequencies in each country that our TPMS will be sold.
For example, in the United States approval must be received from the Federal
Communications Commission for each product. Some countries require additional
governmental approvals in certain circumstances. For example, in the United
Kingdom, all electronic equipment to be installed in emergency and police
vehicles must be approved by the Vehicle Installation Development Group, a
governmental body. And, as a practical matter, certain non-governmental
approvals may be necessary for market acceptance of our products in certain
countries. For example, the approval of TUV (an independent testing company) is
considered necessary to market our TPMS in Germany.
We believe that we have all of the necessary governmental approvals for
our current TPMS in our intended market countries. As each new TPMS is
introduced to the market, we intend to apply for the necessary approvals.
During our fiscal year ended July 31, 2001, the United States
Government enacted the Transportation Recall Enhancement, Accountability, and
Documentation Act of 2000, commonly known as the TREAD Act. This new legislation
was implemented to address perceived safety concerns resulting from poor tire
maintenance, tread separation and tire blowouts. The TREAD Act, among other
things, requires that the National Highway Traffic Safety Administration,
commonly referred to by its acronym (NHTSA) develop rules and regulations which
require all new passenger cars, light trucks and multipurpose passenger vans
sold after November 1, 2003 to have TPMS installed as standard equipment. The
TREAD Act requires that TPMS must be capable of warning drivers if a tire is
significantly under-inflated. The mandated rules and regulations were scheduled
to be finalized in November 2001 for implementation in 2003.
In July 2001, NHTSA published and circulated a Notice of Proposed Rule
Making which included provisions related to the tire monitoring requirements of
the TREAD Act. The Notice of Proposed Rule Making outlined the parameters of
systems that the NHTSA would consider compliant with the legislation and the
proposed periods for complying with the regulations. Two forms of tire
monitoring technologies were to be considered:
1) Direct tire monitoring technologies are based on dedicated sensor /
transmitters located within the cavity of the tire that are usually mounted on
the wheel. The transmitter monitors and measures contained air pressure and
temperature within each tire and transmits this information to a receiver
located in or around the instrument panel of the vehicle. Our products are an
example of a direct system.
2) Indirect tire monitoring technologies typically work with the vehicle's
anti-lock brake system. Most indirect TPMS compare each wheel's rotational speed
with the rotational speed of other wheels. If one tire becomes significantly
under-inflated while the others remain at proper pressure, the indirect system
eventually detects the problem because that wheel's rotational speed is on
average slightly higher than that of other wheels.
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In the Notice of Proposed Rule Making, the National Highway Traffic Safety
Administration (NHTSA) concluded that direct measurement systems have major
advantages over indirect systems as they:
o actually measure the pressure in each tire and can detect when
any tire or combination of tires is under-inflated, including
when all tires are under-inflated;
o operate while the vehicle is stationary;
o are highly accurate and can detect small pressure losses, some
even as low as 1 pound per square inch;
o provide full time monitoring even when the vehicle is driven
on bumpy roads, has mismatched tires or has a tire out of
balance or alignment;
o do not need substantial time to calibrate the system and
reduce the very real possibility for human error; and
o can tell the operator which tire is under-inflated.
On May 31, 2002, the NHTSA issued part one of a two-part final rule. Part
one established a new Federal Motor Vehicle Safety Standard that requires that a
TPMS be installed in passenger vehicles and light trucks to warn the driver when
a tire is below specified pressure levels. During the first year of the
implementation schedule, beginning November 1, 2003, at least 10% of each auto
manufacturer's total production must be equipped with tire pressure monitoring
system (TPMS). This requirement increases to 35% during the second year, 65% by
the third and 100% after October 31, 2006.
Part one of the NHTSA final rule contemplated two compliance options during
the period from November 1, 2003 to October 31, 2006. Under the first compliance
option, a vehicle's TPMS must alert the driver if one or more tires, up to four
tires, is 25% or more under-inflated. Under the second compliance option, a
vehicle's TPMS must alert the driver if any of the vehicle's tires is 30% or
more under-inflated. The second compliance option was adopted by the NHTSA
because indirect TPMS are currently not capable of meeting the stricter
four-tire, 25% requirement under the first compliance option, and it was deemed
appropriate to permit manufacturers to continue to use current indirect TPMS
while they work to improve those systems.
At the time that it issued the first part of its final rule, the NHTSA
announced that it would be closely monitoring the performance of indirect
measurement TPMS under the second compliance option. We initially expected that
the NHTSA would issue the second part of its final rule on or before March 1,
2005, and that it would, at that time, announce whether indirect TPMS based on
anti-lock brake systems would be a permissible compliance option under the TREAD
Act after October 31, 2006. However, due to a Court of Appeals ruling discussed
below, we no longer hold these expectations as to the timing and content of the
second part of the final rule.
Three not-for-profit advocacy organizations, Public Citizen, Inc., New York
Public Interest Research Group and The Center for Auto Safety filed a petition
in United States Court of Appeals for the Second Circuit seeking review of the
NHTSA's final rule. The Secretary of Transportation was named as the respondent
in the matter, and Alliance of Automobile Manufacturers was an intervener. On
August 6, 2003, the United States Court of Appeals, Second Circuit, granted the
petition for review, vacated the NHTSA's final rule, and remanded the matter to
the NHTSA for further rulemaking proceedings in a manner consistent with the
court decision.
The court stated that the NHTSA decision to adopt the second compliance
option was both contrary to law and arbitrary, but that the adoption of the
first compliance option was appropriate. In coming to this conclusion, the court
found that, according to the rule-making record, the one-tire, 30 percent
under-inflation standard contemplated by the second compliance option would
allow automakers to install indirect TPMS that fail to warn drivers in
approximately half of the instances in which tires are significantly
under-inflated, and that the four-tire, 25 percent under-inflation standard
contemplated by the first compliance option would prevent more injuries, save
more lives and be more cost-effective.
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On September 10, 2004 the National Highway Traffic Safety Administration
(NHTSA) issued a Notice of Proposed Rulemaking (NPRM) document defining their
current position. Comments on the proposed Rulemaking must be received on or
before 60 days after date of publication (of the NRPM) in the Federal Register.
The NHTSA is proposing a new Federal Motor Vehicle Safety Standard (FMVSS)
requirement for four tire, 25-percent under-inflation detection. The rule
proposes requirements for covered vehicles manufactured on or after September 1,
2005. The NHTSA is proposing the following phase in schedule:
o 50 percent of a vehicle manufacturer's light vehicles would be
required to comply with the standard during the first year (September
1, 2005 to August 31, 2006);
o 90 percent during the second year (September 1, 2006 to August 31,
2007);
o all light vehicles thereafter.
The NHTSA is also proposing the following:
o to require vehicle manufacturers to assure compliance with Federal
Motor Vehicle Safety Standard 138 (FMVSS) with the tires installed on
the vehicle at the time of the initial sale;
o to require the tire pressure monitoring system (TPMS) to be equipped
with a telltale that would alert the driver of a tire pressure
monitoring malfunction. The malfunction warning be provided either
through a separate, dedicated telltale or through a distinctive
warning delivered by the low pressure telltale;
o the use of a specific test course (i.e., the Southern loop of the
tread wear test course, San Angelo, Texas) which is both objective and
representative of a range of driving conditions;
o the TPMS would be required to warn the driver when the tire pressure
in one or more of the vehicle's tires, up to a total of four tires, is
25 percent or more below the vehicle manufacturer's recommended cold
inflation pressure for the tire, or a minimum level of pressure
specified in the standard, whichever pressure is higher;
o vehicle manufacturers would be required to certify vehicle compliance
under the standard with the tires installed on the vehicle at the time
of the initial vehicle sale;
o the TPMS would be required to include a low tire pressure warning
telltale (Yellow) that must remain illuminated as long as any of the
vehicle's tires remains significantly under inflated and the vehicle's
ignition locking system is in the "On" ("Run") position. The telltale
must be extinguished when all of the vehicle's tires cease to be
significantly under inflated. The TPMS low tire pressure warning
telltale would be required to perform a bulb-check at vehicle startup;
o the TPMS also would be required to include a malfunction indicator to
alert the driver when the system is non-operational, and thus unable
to provide the required low pressure warning. The NHTSA is proposing
that the malfunction would be indicated by either:
1) separate dedicated telltale (Yellow) or;
2) designing the low pressure telltale so that it flashes for one
minute when a malfunction is detected after which the telltale
will remain illuminated as long as the ignition locking system
is in the "On" ("Run") position. This flashing and
illumination sequence would be repeated upon each subsequent
vehicle start up until the situation has been corrected
o the TPMS would not be required to monitor the spare tire (if provided)
either when it is stowed or when it is installed on the vehicle;
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o For vehicle's certified under the standard, vehicle manufacturers
would be required to provide in the owners manual an explanation of
the purpose of the low tire pressure warning telltale, the potential
consequences of significantly under-inflated tires, the meaning of the
telltale when it is illuminated, and what action the driver should
take when the telltale is illuminated.
To encourage early compliance, the National Highway Traffic Safety
Administration's (NHTSA) is proposing to permit carry-forward credits for
vehicles that are certified as complying with the standard and that are
manufactured on or after the effective date of the final rule. However,
beginning September 1, 2007 all covered vehicles would be required to comply
with the standard, without regard to any earlier carry forward credits. It will
not be permissible for dealer to install tires on a new vehicle that would take
the vehicle out of compliance with TPMS standard. The NHTSA is proposing to
permit vehicle manufactures to incorporate a second, red light to accompany the
continuously illuminated yellow TPMS telltale, which would be illuminated when
pressure in one or more tires becomes dangerously under-inflated, as determined
by the manufacturer. It will be permissible to incorporate the TPMS telltale as
part of a reconfigurable display, provided that the illumination of the yellow
telltale is continuous while one or more tires are under-inflated. The NHTSA
will retain their discretion regarding how they will structure phase in
requirements for small volume manufacturers (5,000 vehicles or less for the
North American market) and will make such determination on a case by case basis.
Original equipment manufacturers' (OEM's) are free to select a low pressure
alert level at a higher level than the 25 percent below placard.
Our direct measurement tire pressure monitoring system (TPMS) meet the
standard for tire pressure monitoring established by the NHTSA. Accordingly, we
believe the auto manufacturers must accelerate their implementation plans in
order to meet these new NHTSA regulations, which will create additional
opportunities to market our products to OEM's in the automobile industry. In
addition, although the TREAD Act only applies to passenger automobiles, we
believe that other motor vehicles, including medium and heavy trucks, buses and
motorcycles will be impacted by this legislation in subsequent years. We also
believe that compliance with the TREAD Act by European, Japanese, Chinese and
other automakers will accelerate the adoption of TPMS globally.
It is difficult to predict the magnitude of the expected sales increase
or the exact timing of the increase since our products will continue to face
competition from other TPMS manufactured by our competitors, and the timing of
additional legislative initiatives on tire safety, if any, in the United States
and abroad remains uncertain. We expect that as TPMS becomes standard equipment
for new passenger vehicles, demand for TPMS as dealer installed options and
aftermarket products will gradually decline.
Strategic Relationships
Our strategy includes the establishment of alliances to assist in the
development and marketing of our products and technologies. Key strategic
alliances include:
(a) Hyundai Autonet Co. Ltd.
On February 6, 2003, we signed an agreement with Hyundai Autonet,
pursuant to which we and Hyundai Autonet have agreed to co-develop, manufacture
and distribute TPMS products to the OEM market and the automotive aftermarket in
Korea. Originally founded in 1985 as Hyundai Automotive Electronics Division,
Hyundai Autonet is a subsidiary of the Hyundai Auto Group, a large Korean
conglomerate of companies. Hyundai Autonet has been contracted by its sister
company, Hyundai Motor Corporation, to develop commercial vehicle TPMS.
On October 17, 2003, we signed a contract manufacturing services
agreement with Hyundai Autonet Company (HACO), a leading Korean automotive
electronics supplier and a subsidiary of Hyundai Group. Under the terms of the
agreement, HACO will manufacture the Company's proprietary line of TPMS for sale
and distribution globally by SmarTire. HACO's tier one manufacturing status will
provide SmarTire the opportunity to compete on a worldwide basis with higher
quality products, an increased volume capability and a more flexible cost
structure.
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(b) SensoNor ASA
In 1998, TRW, SensoNor and our Company developed an application
specific integrated sensor (ASIS) for use in tire monitoring systems (TMS). On
December 15, 1999, we entered into a development and supply agreement with
SensoNor, relating in part to the development of an application specific
integrated sensor (ASIS) for commercial vehicle tire monitoring systems (TMS).
SensoNor, based in Horten, Norway, is a producer of sensors for automotive
applications.
SensoNor and our Company subsequently entered into an Application
Specific Integrated Sensor (ASIS) Purchase and Supply Contract dated November 1,
2001, pursuant to which we paid SensoNor a fee of $500,000. The SensoNor low
pressure ASIS is used in our low pressure transmitters.
(c) GE Nova Sensor
In 2004, our ASIS procurement strategy was refined to begin procuring
the high pressure ASIS from GE Novasensor. Low pressure ASIS's would be
purchased from both GE Nova Sensor and SensoNor.
(d) Alligator Ventilfabrik GmbH
On December 10, 1999, we entered into an agreement to develop valve
stem designs and tire monitoring electronic packaging for new market
applications and new tire monitoring technologies with Alligator Ventilfabrik
GmbH ("Alligator"). Based in Giengen, Germany, Alligator is currently supplies
us with valve stems that allow the attachment of tire monitoring sensors inside
the tire.
(e) Transense Technologies plc
On December 2, 1999, we entered into a licensing agreement with Transense
Technologies of Oxfordshire, England, pursuant to which we were granted a
non-exclusive, worldwide right to develop and market Transense's Surface
Acoustic Wave technology for use in tire monitoring. Transense researches,
develops and markets the use of its patented technology in the automotive
industry. To date, we have not used Transense's Surface Acoustic Wave technology
for use in our tire monitoring applications.
Product Development
Our technology provides drivers with real time information regarding
tire pressure and temperature changes. This information provides the consumer
and commercial markets with improved vehicle safety, performance and fuel
economy. Our products have been engineered and designed for universal
application. The sensor / transmitter can be installed on virtually any tire and
wheel combination. Each sensor / transmitter contains a custom application
specific integrated sensor (ASIS). A receiver unit mounted in the vehicle
provides appropriate alarm indications with optional digital readout.
The custom application specific integrated sensor (ASIS) is a single
micro-electronic package containing pressure and temperature sensing elements
and a digital logic state machine that functions as the brains of the
sensor/transmitter. This chip is robust in design, optimizes battery life and
provides various modes of sensing and communicating which ensure faster
transmission of data when problems occur. Packaged on a miniaturized circuit
board with the application specific integrated sensor (ASIS) are various
components and our radio frequency technology. Using this wireless radio
frequency technology, the data is transmitted through the tire to a remote
receiver.
Our company's products feature transmitter options providing different
installation choices for various automotive applications. A strap-mounted
transmitter attached to the wheel offers the most universal installation for a
wide range of tire and wheel assemblies. A valve-mounted transmitter attached to
the base of the valve offers an adjustable, secure in-tire installation for
specific wheel / rim profiles. Once installed, the sensor / transmitters do not
require ongoing maintenance. The sensor / transmitters communicate to remote
receivers and the data is displayed inside the vehicle. We have developed three
display options for the aftermarket (basic, integrated full function and remote
full function) as well as telltale lights, switch blanks and digital displays
for OEM and port of entry applications.
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We have recently developed original equipment manufacturer (OEM)
passenger car solutions to support the level of demand that our management
anticipates from potential customers in this market sector. The OEM transmitter
features a 50% size and weight reduction over our current generation
transmitter, as well as innovative new mounting options including bonding
directly to the wheel as well as a more innovative valve mount approach. We are
currently marketing our existing products to small and medium sized original
equipment manufacturers.
We introduced our motorcycle tire pressure monitoring system (TPMS) for
sale into the aftermarket in September 2002. We introduced a substantially
improved second generation motorcycle TPMS at the Indy Motorcycle Dealers Show,
held in Indianapolis, Indiana in mid-February 2004. During May, 2004 this
product became commercially available and we began shipping it to our customers.
As discussed under "corporate history", we encountered a component defect issue
as well as an application issue with curved rims and initiated a recall in
September 2004. We have corrected the component defect issue and are currently
working on a solution to supply TPMS to motorcycles with curved rims.
On September 12, 2003 we entered into a development agreement with
Vansco Ltd. This agreement provides for the merging of Vansco's vehicle
communication expertise with our proven radio frequency (RF) technology to
create a high sensitivity, weatherproof, J1939 controller area network (CAN),
chassis-mounted receiver. The J1939 CAN is the most widely used communication
standard in commercial vehicles today, allowing for multiplexing, receiving and
transmitting of signals from various sources. When CAN technology is combined
with our high pressure sensors, we anticipate that this joint development effort
will result in a new TPMS targeted directly at original equipment manufacturers
(OEMs) of commercial trucks, buses, agricultural, construction and recreational
vehicles. In November, 2004, design validation testing and the initial pilot
build of 300 units was completed. The 300 units will be utilized to validate the
reliability of the production line and to satisfy early test and validation
demands from our existing and potential OEM customers. Vansco will manufacture
the CAN, chassis-mounted receiver for us.
On October 10, 2003 we entered into a Co-Marketing and Development
agreement with Haldex Brake Products Ltd., and a related Supply Agreement with
Haldex. Under the terms of this agreement, we will engage in a joint development
program to integrate our TPMS with Haldex's brake systems, with the view to
creating a commercial high pressure TPMS for marketing and resale by Haldex. We
anticipate that any new products that result from our collaboration with Haldex
will be targeted at both OEM and aftermarket applications for trailers. Once
development is complete, we plan to execute on the Supply Agreement with Haldex.
As part of this program, both organizations have commenced work on understanding
the requirements of the market and their existing customers prior to completion
of development.
During July 2004, we successfully completed the initial prototype test
phase of a new battery-less tire pressure and temperature monitoring system.
With the automotive industry in search of a tire monitoring technology that does
not rely on batteries, we believe that our next generation of tire monitoring
systems could set a new standard.
Current tire monitoring systems use battery power to transmit pressure
and temperature information from sensors inside the tires to a receiver located
within the vehicle. Our new technology involves a passive sensor inside each
tire that is energized by an antenna located within each wheel arch.
We are continuing to advance our battery-less system, that offers
significant improvements over current battery powered tire monitoring
technologies. Elimination of the battery in the sensor greatly reduces its
weight, size and cost. Sensor life and reliability are increased and battery
disposal issues are eliminated, creating an environmentally "green" solution.
This new approach to tire monitoring allows tires to be rotated or changed
without re-programming the system. It also tracks tire revolutions, a critical
variable in predicting tire life.
Marketing
Our subsidiaries, SmarTire USA and SmarTire Europe, were established to
market our tire monitoring systems (TMS) products. SmarTire USA and SmarTire
Europe were mandated to establish a distribution network for the automotive
aftermarket including the supporting sales and support infrastructure and to
create OEM opportunities with automotive manufacturers.
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As a result of the enactment of the TREAD Act and the restructuring of
our strategic alliance with TRW, we have substantially changed our marketing
strategy to take advantage of OEM business for vehicles manufactured or imported
into the United States. We expect that, as tire pressure monitoring systems
(TPMS) become standard equipment for new passenger vehicles in the United States
over the next few years, demand for TPMS will increase on a worldwide basis.
With the implementation of the TREAD Act, we expect that demand for
tire monitoring technology will be initiated by the big three United States
automakers: General Motors, DaimlerChrysler and Ford. Some European automotive
groups have already used tire monitoring as a means to add value and
differentiate models. Due to the large volume of import vehicles to the United
States, it is expected that the thirty different automakers in Europe plus the
twelve from Asia will meet the TREAD Act requirements for North America. Adding
tire monitoring to domestic European and Asian vehicles would trigger a much
larger demand for tire pressure monitoring systems (TPMS) than was anticipated
prior to introduction of the TREAD Act.
Our Company's current marketing strategy is to focus on sales of our
TPMS for OEM applications in all market sectors: passenger cars, light trucks,
motorcycles, recreational vehicles, commercial and industrial applications. In
approaching the OEM market, we expect to position ourselves as a complete system
and associated technology provider. Our strategy is to provide high quality
products to the OEM market which incorporate the highest level of technology
possible, at a competitive price. Our strategy requires that, among other
things, we minimize our manufacturing costs.
We intend to achieve this in conjunction with Hyundai Autonet a Tier
One supplier of automotive parts in Korea. Tier One suppliers produce systems
and subsystems for original equipment manufacturers. We believe that Hyundai
Autonet possesses competitive world-class manufacturing capabilities which will
directly complement our specialized technical know-how, and thereby help to give
us an improved industry presence. We also hope to work closely together with
Hyundai Autonet to secure Asian contracts with certain automobile manufacturers,
for the supply of fully-integrated tire monitoring solutions for selected
automobile platforms.
While we expect that the greatest demand for TPMS in the United States
will be at the original equipment manufacturer level for passenger vehicles and
commercial vehicles, we will continue to market our products through
installation at either the new car dealer or port-of-entry level. We refer to
this opportunity as car accessory programs and motorcycle accessory programs.
These programs may be used to provide an OEM quality product that is not
installed at the factory. Car and motorcycle accessory programs opportunities
also exist in Europe due to the number and diversity of automakers.
We completed the development and launch of our second generation TPMS
for the passenger car and light truck market during the fiscal year ended July
31, 2001. We introduced our TPMS for sale into the aftermarket in September
2002. We recently introduced a substantially improved second generation
motorcycle TPMS at the Indy Motorcycle Dealers Show, held in Indianapolis,
Indiana in mid-February 2004. During May 2004 this product became commercially
available and we began shipping it to our customers. In August 2004, we
discovered that the sensor/transmitter may break during installation on the
subset of motorcycle rims with curved rim surfaces when the strap is torqued to
its required value. On September 14, 2004 we contacted the National Highway
Transportation Safety Administration (NHTSA) to determine if a Safety Defect and
Non Compliance Report was required and was advised that this was necessary.
SmarTire's remedy for the defect was to recall 100% of affected
sensor/transmitter items from the field and replace both recalled and inventory
sensor/transmitters with sensor/transmitters previously manufactured by a
different supplier that have been tested and known to use plastics that provide
the required mechanical properties. Additionally SmarTire wishes to ensure that
transmitters are used only on rims with flat drop center wells (as originally
designed for) and not curved. The additional precautionary steps were taken:
o Adding improved warnings and instruction sheet to new product
as well as product in inventory at dealers and distributors
that clarify flat rim drop center well application only
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o Removal of tire pressure monitoring system (TPMS) on
motorcycles with rims with curved drop center wells
We anticipate the cost of this recall will be approximately $US 67,000.
In addition, we are currently working on a solution to enable us to sell TPMS on
motorcycles with rims with curved drop center wells.
The aftermarket opportunity currently consists of a niche market in the
enthusiast and high performance segment. To access this niche, we have worked to
establish a wholesale distribution network in Europe, while in North America we
have sought to work directly with major retail distributors.
In June 2004, we released TPMS for high pressure tires. These high
pressure systems are designed for use by buses, recreational and commercial
vehicles. Maintaining proper tire inflation on large vehicles is important to
maximizing fuel economy, tire life and the safety of the driver and cargo. We
believe this market segment provides us with our largest sales opportunities and
our products are being tested by many of the worlds premier RV, Truck and Bus
manufacturers.
Competition
As a whole, the TPMS industry is still in its early stages. There have
been very few products available in the market. Tire monitoring products can
generally be divided among two basic types, direct technology and indirect
monitoring technologies. As described in the NHTSA's (National Highway Traffic
Safety Administration) report, and discussed above under the heading "Business
of our company - Government Regulations," direct tire monitoring technology such
as that employed in our company's products currently provide substantial
advantages over indirect monitoring technology. However, several of our
competitors and potential competitors have long and established relationships
with automobile OEMs and suppliers, which may make it difficult for us to
compete in the OEM market. Additionally, automobile manufacturers may elect to
develop their own TPMS to comply with the TREAD Act.
Our main competitors with respect to direct TPMS include the following:
o Schrader Bridgeport, claims to be the world's largest producer
of tire valves and tire-pressure measurement equipment with
over $140 million in annual sales. The TPMS developed by
Schrader has been used on Chevrolet Corvettes since 1996. The
Schrader tire monitoring systems TPMSwas also used on the
Plymouth Prowler during its five-year production run from 1997
to 2002. The product is being aggressively marketed at the OEM
level. As a transmitter supplier, Schrader has teamed with
receiver suppliers to recently win OEM contracts. In the
aftermarket, Schrader has joined with Johnson Controls in the
launch of their PSI-branded product.
o German based BERU has acquired Doduco and its tire monitoring
technology. That company is presently working with and
approved by a consortium of five German vehicle manufacturers.
To our knowledge, the system requires the use of transmitters
attached to the valve stem (inside the tire / wheel assembly),
receiving antennas at each of the wheel wells, wiring harness
for conveying data to the receiver and some form of in-dash
display. This system has been developed for the OEM market
only.
o Pacific Industrial Co. Ltd., a Japanese company, has developed
a product that measures the air pressure in each tire and
sends the data to a receiver mounted inside a vehicle. The
products are available on a few Asian vehicles and, to date,
are not commercially available in North America. We believe
that the Pacific products resemble the BERU approach to tire
monitoring with additional antennas and wiring harnesses. o
TRW Automotive U.S. LLC is a producer of safety and security
systems for the global automotive market. It supplies advanced
technology products and services to the automotive markets.
From December 1998 to August 2001, we and TRW jointly
developed advanced tire monitoring technology and each has
access to this technology, which encompasses our current
products. During this period, we and TRW jointly developed a
common application specific integrated sensor (ASIS) chip for
existing products.
o Siemens Automotive merged with Atecs Mannesmann AG to create
Siemens Automotive AG, a large supplier of high-tech
automotive electronic systems. The combined company's product
portfolio focuses on electronic modules and systems including
anti-lock brake system and airbag electronics. Siemens
Automotive has entered the market, and offers direct tire
pressure monitoring systems (TPMS)to OEMs.
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There are several indirect monitoring or anti-lock brake systems,
either available on the market or in prototype stages. To the knowledge of our
company's management, none of these prototype systems currently meet the
proposed guidelines set out in the September 10, 2004 National Highway Traffic
Safety Administration's Notice of Proposed Rule Making. Given the substantial
advantages of direct monitoring technology, we do not believe that indirect
monitoring technology will be a significant competitor in the short term.
However, it is likely that the performance of indirect TPMS will continue to
improve, and they will likely benefit from the fact that they are the least
expensive way of complying with TPMS standard for vehicles already equipped with
anti-lock braking systems.
With respect to commercial vehicle TPMS, the major tire companies have
been developing medium truck tires incorporating electronic chips in the
sidewall to provide tire tracking information possibly including pressure,
temperature and identification. Their disadvantage is the inability to provide
real-time, dynamic values to the driver, which eliminates any early warning
capability while operating the vehicle. Further, it seems that currently there
are no additional functions that can be programmed into these static systems,
limiting their integration into other fleet management programs.
There are a number of companies that are marketing tire inflation
systems into the commercial trailer market. While these systems do not provide
tire monitoring systems (TMS) information to the driver, they utilize the air
lines in the trailer to supply air pressure to a tire that is experiencing an
air loss. This allows the driver to continue to operate the vehicle. This system
is not available on the tractor or truck unit itself.
One potential future development that could affect the market for both
passenger car and commercial vehicle tire monitoring is the development of a
"smart chip". This is a computer chip that could transmit data and would be
manufactured into tires. We believe that Goodyear and Bridgestone / Firestone
have both completed some development of such a computer chip.
Raw Materials and Principal Suppliers
We contract the manufacture of our products to third parties. These
manufacturers normally provide turnkey operations whereby the manufacturer is
responsible for purchasing the component parts for our TPMS. Presently, we
purchase component parts and deliver them to our contract manufacturer. We also
purchase component parts on our own account for engineering and prototype
development purposes. Certain of the components and raw materials used in our
products are difficult to obtain and/or require purchase commitments far in
advance of the manufacturing date. At present, our relationships with our
current suppliers are generally good and we expect that the suppliers will be
able to meet the anticipated demand for our products through fiscal year 2005.
Dependence on Certain Customers
Due to the early stage development of the TPMS market in general and
for our Company's, we are still dependent on major customers. During fiscal 2004
we earned 29% of our revenue from one major customer. We expect that this
dependence will be reduced as we start to realize sales through our
relationships with new customers and through our strategic alliances, including
our alliance with Hyundai Autonet.
Proprietary Protection
Our intellectual property is important to protecting our competitive
advantage and expanding our tire pressure monitoring systems (TPMS) market
share. We rely on a combination of patents, trade secret laws, confidentiality
procedures and contractual provisions to protect our intellectual property.
We hold several patents for our current technologies, which are listed
below:
o United States Patent 5,231,872 addresses the technology in our
tire monitoring product. It was issued on August 3, 1993 and
expires August 3, 2010.
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o United States Patent 5,285,189 addresses the technology in our
abnormal tire condition warning system. It was issued on
February 8, 1994 and expires February 8, 2011. We purchased
this patent from EPIC Technologies, Inc. in December 1996.
o United States Patent 5,335,540 addresses the technology in our
tire monitoring product. It was issued on August 9, 1994 and
expires August 9, 2011.
o United States Patent 5,559,484 addresses certain technology in
our data logging tire monitor with condition predictive
capabilities and integrity checking. It was issued on
September 24, 1996 and expires September 24, 2013. We
purchased this patent from EPIC Technologies, Inc. in December
1996.
o United States Patent 5,945,908 addresses certain other
technology in our data logging tire monitor with condition
predictive capabilities and integrity checking. It was issued
on August 31, 1999 and expires on August 31, 2016. We
purchased this patent from EPIC Technologies, Inc. in December
1996.
o United States Patent 4,653,445 addresses the technology in an
Engine Protection System product. It was issued on March 31,
1987 and expired in March 31, 2004.
o United States Patent 6,357,883 addresses the technology for a
wheel component with a cavity for mounting a housing for
measurement apparatus. It was issued on March 19, 2002 and
expires March 19, 2019.
o United States Patent 6,805,000 addresses the technology for a
wheel component with a cavity for mounting a housing for
measurement apparatus. It was issued on October 25, 2004 and
expires October 25, 2021.
In addition to our patents, we also have access to a number of other
patents under our license agreements with Transense and TRW.
We entered into a license agreement on September 30, 1999 with
Transense based in Oxfordshire, United Kingdom. Transense researches, develops
and exploits the use of its patented Surface Acoustic Wave technology in the
automotive industry. The license agreement grants SmarTire a non-exclusive,
worldwide right to develop and market Transense's Surface Acoustic Wave
technology for use in tire monitoring systems (TMS).
We restructured our strategic alliance with TRW effective August 31,
2001. As part of the restructuring, we received a royalty-free license from TRW
to utilize technology developed during the term of the Cooperative Engineering
Agreement that is patented, now or in the future, by TRW. We have granted a
parallel royalty-free license to TRW.
Research and Development
We spent the following amounts on engineering, research and development
activities during the fiscal years ended July 31, 2004, 2003 and 2002:
2004 - $1,654,690
2003 - $1,177,935
2002 - $1,727,606
These expenses were incurred in the development of our second
generation tire monitoring systems (TMS). We expect that our annual research and
development expenses will continue to increase as we work to integrate our
current products into automobile platforms of various OEMs seeking to satisfy
the TREAD Act requirements, and as we complete work on other products that are
currently in development.
Number of Total Employees and Number of Full-time Employees
70
At December 27, 2004, we had 48 full-time employees, 15 of whom are in
marketing, 22 of whom are in engineering, research and development and 11 of
whom are administrative and executive personnel. There is no collective
bargaining agreement in place.
MANAGEMENT'S DISCUSSION AND ANALYSIS
The following discussion of our financial condition, changes in
financial condition and results of operations for the three months ended October
31, 2004 and 2003 should be read in conjunction with our most recent audited
annual financial statements for the financial year ended July 31, 2004, the
unaudited interim financial statements included herein, and, in each case, the
related notes.
Our consolidated financial statements are stated in United States
Dollars and are prepared in accordance with United States Generally Accepted
Accounting Principles.
We carry on business directly and through our three wholly-owned
subsidiaries: SmarTire USA Inc., SmarTire Europe Limited and SmarTire
Technologies Inc. SmarTire Technologies Inc.
We are engaged in developing and marketing technically advanced tire
pressure monitoring systems (TPMS) designed for improved vehicle safety,
performance, reliability and fuel efficiency for the transportation and
automotive industries. Although, the majority of our revenues in our first three
months ended October 31, 2004 were earned from the sale of tire pressure
monitoring systems (TPMS) for passenger cars, sales of our motorcycle TPMS and
recreational vehicle TPMS increased as a percentage of our overall revenues.
With the launch of our high pressure transmitter in June 2004, we anticipate
that there will be an increase in the percentage of our revenues from sales of
our TPMS for the recreational, bus and truck markets during fiscal 2005.
GOVERNMENT REGULATIONS
Our products are subject to regulation by the government agencies
responsible for radio frequencies in each country that our TPMS will be sold.
For example, in the United States approval must be received from the Federal
Communications Commission for each product. Some countries require additional
governmental approvals in certain circumstances. For example, in the United
Kingdom, all electronic equipment to be installed in emergency and police
vehicles must be approved by the Vehicle Installation Development Group, a
governmental body. And, as a practical matter, certain non-governmental
approvals may be necessary for market acceptance of our products in certain
countries. For example, the approval of TUV (an independent testing company) is
considered necessary to market our TPMS in Germany.
We believe that we have all of the necessary governmental approvals for
our current TPMS in our intended market countries. As each new TPMS is
introduced to the market, we intend to apply for the necessary approvals.
During our fiscal year ended July 31, 2001, the United States
Government enacted the Transportation Recall Enhancement, Accountability, and
Documentation Act of 2000, commonly known as the TREAD Act. This new legislation
was implemented to address perceived safety concerns resulting from poor tire
maintenance, tread separation and tire blowouts. The TREAD Act, among other
things, requires that the National Highway Traffic Safety Administration,
commonly referred to by its acronym, NHTSA, develop rules and regulations which
require all new passenger cars, light trucks and multipurpose passenger vans
sold after November 1, 2003 to have TPMS installed as standard equipment. The
TREAD Act requires that TPMS must be capable of warning drivers if a tire is
significantly under-inflated. The mandated rules and regulations were scheduled
to be finalized in November 2001 for implementation in 2003.
In July 2001, the National Highway Traffic Safety Administration
(NHTSA) published and circulated a Notice of Proposed Rule Making which included
provisions related to the tire monitoring requirements of the TREAD Act. The
Notice of Proposed Rule Making outlined the parameters of systems that the
National Highway Traffic Safety Administration (NHTSA) would consider compliant
with the legislation and the proposed periods for complying with the
regulations. Two forms of tire monitoring technologies were to be considered:
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1) Direct tire monitoring technologies are based on dedicated sensor /
transmitters located within the cavity of the tire that are usually mounted on
the wheel. The transmitter monitors and measures contained air pressure and
temperature within each tire and transmits this information to a receiver
located in or around the instrument panel of the vehicle. Our products are an
example of a direct system.
2) Indirect tire monitoring technologies typically work with the vehicle's
anti-lock brake system. Most indirect tire pressure monitoring systems (TPMS)
compare each wheel's rotational speed with the rotational speed of other wheels.
If one tire becomes significantly under-inflated while the others remain at
proper pressure, the indirect system eventually detects the problem because that
wheel's rotational speed is on average slightly higher than that of other
wheels.
In the Notice of Proposed Rule Making, the NHTSA concluded that direct
measurement systems have major advantages over indirect systems as they:
o actually measure the pressure in each tire and can detect when
any tire or combination of tires is under-inflated, including
when all tires are under-inflated;
o operate while the vehicle is stationary;
o are highly accurate and can detect small pressure losses, some
even as low as 1 pound per square inch;
o provide full time monitoring even when the vehicle is driven
on bumpy roads, has mismatched tires or has a tire out of
balance or alignment;
o do not need substantial time to calibrate the system and
reduce the very real possibility for human error; and
o can tell the operator which tire is under-inflated.
On May 31, 2002, the NHTSA issued part one of a two-part final rule. Part
one established a new Federal Motor Vehicle Safety Standard that requires that
TPMS be installed in passenger vehicles and light trucks to warn the driver when
a tire is below specified pressure levels. During the first year of the
implementation schedule, beginning November 1, 2003, at least 10% of each auto
manufacturer's total production must be equipped with TPMS. This requirement
increases to 35% during the second year, 65% by the third and 100% after October
31, 2006.
Part one of the NHTSA final rule contemplated two compliance options during
the period from November 1, 2003 to October 31, 2006. Under the first compliance
option, a vehicle's TPMS must alert the driver if one or more tires, up to four
tires, is 25% or more under-inflated. Under the second compliance option, a
vehicle's TPMS must alert the driver if any of the vehicle's tires is 30% or
more under-inflated. The second compliance option was adopted by the NHTSA
because indirect TPMS are currently not capable of meeting the stricter
four-tire, 25% requirement under the first compliance option, and it was deemed
appropriate to permit manufacturers to continue to use current indirect TPMS
while they work to improve those systems.
At the time that it issued the first part of its final rule, the NHTSA
announced that it would be closely monitoring the performance of indirect
measurement TPMS under the second compliance option. We initially expected that
the NHTSA would issue the second part of its final rule on or before March 1,
2005, and that it would, at that time, announce whether indirect TPMS based on
anti-lock brake systems would be a permissible compliance option under the TREAD
Act after October 31, 2006. However, due to a Court of Appeals ruling discussed
below, we no longer hold these expectations as to the timing and content of the
second part of the final rule.
Three not-for-profit advocacy organizations, Public Citizen, Inc., New York
Public Interest Research Group and The Center for Auto Safety filed a petition
in United States Court of Appeals for the Second Circuit seeking review of the
National Highway Traffic Safety Administration's (NHTSA) final rule. The
Secretary of Transportation was named as the respondent in the matter, and
Alliance of Automobile Manufacturers was an intervener. On August 6, 2003, the
United States Court of Appeals, Second Circuit, granted the petition for review,
vacated the NHTSA's final rule, and remanded the matter to the NHTSA for further
rulemaking proceedings in a manner consistent with the court decision.
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The court stated that the NHTSA decision to adopt the second compliance
option was both contrary to law and arbitrary, but that the adoption of the
first compliance option was appropriate. In coming to this conclusion, the court
found that, according to the rule-making record, the one-tire, 30 percent
under-inflation standard contemplated by the second compliance option would
allow automakers to install indirect tire pressure monitoring systems (TPMS)
that fail to warn drivers in approximately half of the instances in which tires
are significantly under-inflated, and that the four-tire, 25 percent
under-inflation standard contemplated by the first compliance option would
prevent more injuries, save more lives and be more cost-effective.
On September 10, 2004 the NHTSA issued a Notice of Proposed Rulemaking
(NPRM) document defining their current position. Comments on the proposed
Rulemaking must be received on or before 60 days after date of publication (of
the NRPM) in the Federal Register. The NHTSA is proposing a new Federal Motor
Vehicle Safety Standard (FMVSS) requirement for four tire, 25-percent
under-inflation detection. The rule proposes requirements for covered vehicles
manufactured on or after September 1, 2005. The NHTSA is proposing the following
phase in schedule:
o 50 percent of a vehicle manufacturer's light vehicles would be
required to comply with the standard during the first year (September
1, 2005 to August 31, 2006);
o 90 percent during the second year (September 1, 2006 to August 31,
2007);
o all light vehicles thereafter.
The NHTSA is also proposing the following:
o to require vehicle manufacturers to assure compliance with Federal
Motor Vehicle Safety Standard 138 (FMVSS) with the tires installed on
the vehicle at the time of the initial sale;
o to require the TPMS to be equipped with a telltale that would alert
the driver of a tire pressure monitoring malfunction. The malfunction
warning be provided either through a separate, dedicated telltale or
through a distinctive warning delivered by the low pressure telltale;
o the use of a specific test course (i.e., the Southern loop of the
tread wear test course, San Angelo, Texas) which is both objective and
representative of a range of driving conditions;
o the TPMS would be required to warn the driver when the tire pressure
in one or more of the vehicle's tires, up to a total of four tires, is
25 percent or more below the vehicle manufacturer's recommended cold
inflation pressure for the tire, or a minimum level of pressure
specified in the standard, whichever pressure is higher;
o vehicle manufacturers would be required to certify vehicle compliance
under the standard with the tires installed on the vehicle at the time
of the initial vehicle sale;
o the TPMS would be required to include a low tire pressure warning
telltale (Yellow) that must remain illuminated as long as any of the
vehicle's tires remains significantly under inflated and the vehicle's
ignition locking system is in the "On" ("Run") position. The telltale
must be extinguished when all of the vehicle's tires cease to be
significantly under inflated. The TPMS low tire pressure warning
telltale would be required to perform a bulb-check at vehicle startup;
o the TPMS also would be required to include a malfunction indicator to
alert the driver when the system is non-operational, and thus unable
to provide the required low pressure warning. The NHTSA is proposing
that the malfunction would be indicated by either:
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1) separate dedicated telltale (Yellow) or;
2) designing the low pressure telltale so that it flashes for one
minute when a malfunction is detected after which the telltale
will remain illuminated as long as the ignition locking system
is in the "On" ("Run") position. This flashing and
illumination sequence would be repeated upon each subsequent
vehicle start up until the situation has been corrected
o the tire pressure monitoring systems (TPMS) would not be required to
monitor the spare tire (if provided) either when it is stowed or when
it is installed on the vehicle;
o For vehicle's certified under the standard, vehicle manufacturers
would be required to provide in the owners manual an explanation of
the purpose of the low tire pressure warning telltale, the potential
consequences of significantly under-inflated tires, the meaning of the
telltale when it is illuminated, and what action the driver should
take when the telltale is illuminated.
To encourage early compliance, the National Highway Traffic Safety
Administration's (NHTSA) is proposing to permit carry-forward credits for
vehicles that are certified as complying with the standard and that are
manufactured on or after the effective date of the final rule. However,
beginning September 1, 2007 all covered vehicles would be required to comply
with the standard, without regard to any earlier carry forward credits. It will
not be permissible for dealer to install tires on a new vehicle that would take
the vehicle out of compliance with TPMS standard. The NHTSA is proposing to
permit vehicle manufactures to incorporate a second, red light to accompany the
continuously illuminated yellow TPMS telltale, which would be illuminated when
pressure in one or more tires becomes dangerously under-inflated, as determined
by the manufacturer. It will be permissible to incorporate the TPMS telltale as
part of a reconfigurable display, provided that the illumination of the yellow
telltale is continuous while one or more tires are under-inflated. The NHTSA
will retain their discretion regarding how they will structure phase in
requirements for small volume manufacturers (5,000 vehicles or less for the
North American market) and will make such determination on a case by case basis.
Original equipment manufacturers' (OEM's) are free to select a low pressure
alert level at a higher level than the 25 percent below placard.
Our direct measurement TPMS meet the standard for tire pressure monitoring
established by the NHTSA. Accordingly, we believe the auto manufacturers must
accelerate their implementation plans in order to meet these new NHTSA
regulations, which will create additional opportunities to market our products
to OEM's in the automobile industry. In addition, although the TREAD Act only
applies to passenger automobiles, we believe that other motor vehicles,
including medium and heavy trucks, buses and motorcycles will be impacted by
this legislation in subsequent years. We also believe that compliance with the
TREAD Act by European, Japanese, Chinese and other automakers will accelerate
the adoption of TPMS globally.
It is difficult to predict the magnitude of the expected sales increase
or the exact timing of the increase since our products will continue to face
competition from other TPMS manufactured by our competitors, and the timing of
additional legislative initiatives on tire safety, if any, in the United States
and abroad remains uncertain. We expect that as TPMS becomes standard equipment
for new passenger vehicles, demand for TPMS as dealer installed options and
aftermarket products will gradually decline.
Our current marketing strategy is to focus on sales of TPMS for OEM
applications in all market sectors that include passenger cars, light trucks,
motorcycles, recreational vehicles, commercial (buses and trucks) and industrial
applications. In approaching the OEM market, we expect to position ourselves as
a complete system and associated technology provider. Our strategy is to provide
high quality products to the OEM market which incorporate the highest level of
technology possible, at a competitive price. Our strategy requires that, among
other things, we minimize our manufacturing costs.
We completed the development and launch of our second generation TPMS
for the passenger car and light truck market during the fiscal year ended July
31, 2001. We introduced our motorcycle TPMS for sale into the aftermarket in
September 2002. In February 2004, we introduced a substantially improved second
generation motorcycle TPMS. During May 2004 this product became commercially
available and we began shipping it to our customers. In August 2004, we
discovered that the sensor/transmitter may break during installation on the
subset of motorcycle rims with curved rim surfaces when the strap is torqued to
its required value. On September 14, 2004 we contacted the NHTSA to determine if
a Safety Defect and Non Compliance Report was required and was advised that this
was necessary. Our remedy for the defect was to recall 100% of affected
sensor/transmitter items from the field and replace both recalled and inventory
sensor/transmitters with sensor/transmitters previously manufactured by a
different supplier that have been tested and known to use plastics that provide
the required mechanical properties. Additionally we wish to ensure that
transmitters are used only on rims with flat drop center wells (as originally
designed for) and not curved. The additional precautionary steps were taken:
74
o Adding improved warnings and instruction sheet to new product
as well as product in inventory at dealers and distributors
that clarify flat rim drop center well application only
o Removal of TPMS on motorcycles with rims with curved drop
center wells
We anticipate the cost of this recall will be approximately $67,000.
Recall costs incurred to the end of October were $19,211. In addition, we are
currently working on a solution to enable us to sell our TPMS on motorcycles
with rims with curved drop center wells. We anticipate this solution will be
available for sale by March 2005.
The aftermarket opportunity currently consists of a niche market in the
enthusiast and high performance segment. To access this niche, we have worked to
establish a wholesale distribution network in Europe, while in North America we
have sought to work directly with major retail distributors.
In June 2004, we released a TPMS for commercial vehicles. These high
pressure systems are designed for use by buses, trucks, monorails, recreational,
industrial and other specialty vehicles. Maintaining proper tire inflation on
large vehicles is important to maximizing fuel economy, tire life and the safety
of the driver and cargo. We believe this market segment provides us with our
largest sales opportunities and our products are being tested by many of the
world's premier recreational, truck and bus manufacturers. In addition, during
October 2004 we signed a new distributor that plans to sell this product and our
passenger car product.
In February 2003, we signed a manufacturing, co-marketing and
development agreement with Hyundai Autonet Company, Ltd., (HACO) an established
Korean automotive electronics supplier. Under this agreement, HACO and we will
co-develop, manufacture and distribute tire monitoring products to HACO original
equipment vehicle manufacturers and the automotive aftermarket in Korea. The
agreement provides for the payment to us by HACO of a total of $300,000 in fees,
to cover the cost to develop a receiver and transmitter that can be used in the
Korean and Japanese markets. Initial payments totaling $165,000 were made by
HACO upon execution of our agreement, and the balance of $135,000 is payable
upon the attainment of certain milestones including the completion of validation
testing of these products and the launch of these products in South Korea. In
November 2004, we received $67,500, reducing the balance due from HACO to
$67,500. We originally expected to receive an ongoing revenue stream through the
sales of proprietary components to HACO beginning in early 2004. However due to
delays in attaining these milestones, we now expect revenue from the sale of
these components to commence in early 2005.
In October 2003, we signed a contract manufacturing services agreement
with Hyundai Autonet Company (HACO). Under the terms of the agreement, HACO will
manufacture the Company's proprietary line of tire pressure monitoring systems
(TPMS) for sale and distribution globally by SmarTire. HACO's tier one
manufacturing status provides SmarTire the opportunity to compete on a worldwide
basis with higher quality products, an increased volume capability and a more
flexible cost structure.
On September 8, 2003, we entered into an agreement in principle
appointing Beijing Boom Technology Co. Ltd. as the Master Distributor of our
TPMS in mainland China. The agreement in principle led to a formal Master
Distributor Agreement between us and Beijing Boom Technology dated October 17,
2003, which provides for an initial two year term ending on October 9, 2005 and
automatic renewal for successive one-year terms subject to termination by either
party on giving 90 days' advance notice in writing. Beijing Boom Technology has
agreed to purchase over $1.5 million in aftermarket passenger car TPMS at fixed
intervals during the first year of the agreement. Beijing Boom Technology must
submit purchase orders to us for these products in accordance with a fixed
delivery schedule covering the first year of the agreement, and must pay for
each shipment before the products are shipped until March 2004. Beijing Boom
Technology may return products to us, but any products which are returned
without our prior written consent are subject to a charge equal to 50% of the
invoiced value of such products. Although Beijing Boom Technology has not placed
orders in accordance with the fixed delivery schedule, we have continued to
require them to make an advance payment to us on prior to each shipment of
orders in excess of $25,000.
75
In order to maintain its status as our Master Distributor in China,
Beijing Boom Technology must also purchase approximately $3.9 million in
additional aftermarket passenger car tire pressure monitoring systems (TPMS)
during the second year of the agreement. Per our agreement, Beijing Boom
Technology was to also establish a network of certified dealers in all provinces
of China by May 1, 2004. Although several dealers have been established, the
milestone has not been reached. However, in June 2004 we verbally agreed with
Beijing Boom Technology that the milestone be changed towards establishing a
network of certified dealers in all major cities in China. Subject to Beijing
Boom Technology meeting these milestones, we have agreed not to appoint any
other master distributor for mainland China during the initial two-year term of
the Master Distributor Agreement. Although Beijing Boom Technology continues to
make progress, they did not purchase any TPMS during the three months ended
October 31, 2004 as they had sufficient inventory from their purchases in fiscal
2004.
On September 12, 2003 we entered into a development agreement with
Vansco Ltd. This agreement provides for the merging of Vansco's vehicle
communication expertise with our proven radio frequency (RF) technology to
create a high sensitivity, weatherproof, J1939 controller area network (CAN),
chassis-mounted receiver. The J1939 CAN is the most widely used communication
standard in commercial vehicles today, allowing for multiplexing, receiving and
transmitting of signals from various sources. When CAN technology is combined
with our high pressure sensors, we anticipate that this joint development effort
will result in a new TPMS targeted directly at original equipment manufacturers
(OEMs) of commercial trucks, buses, agricultural, construction and recreational
vehicles. In November, 2004, design validation testing and the initial pilot
build of 300 units was completed. The 300 units will be utilized to validate the
reliability of the production line and to satisfy early test and validation
demands from our existing and potential OEM customers. Vansco will manufacture
the CAN, chassis-mounted receiver for us.
On October 10, 2003 we entered into a Co-Marketing and Development
agreement with Haldex Brake Products Ltd., and a related Supply Agreement with
Haldex. Under the terms of this agreement, we will engage in a joint development
program to integrate our TPMS with Haldex's brake systems, with the view to
creating a commercial high pressure TPMS for marketing and resale by Haldex. We
anticipate that any new products that result from our collaboration with Haldex
will be targeted at both OEM and aftermarket applications for trailers. Once
development is complete, we plan to execute on the Supply Agreement with Haldex.
As part of this program, both organizations have commenced work on understanding
the requirements of the market and their existing customers prior to completion
of development.
On June 3, 2004, in conjunction with its Master Distributor in China,
Beijing Boom Technology Co. Ltd., we finalized a major sales order with its
exclusive dealer in Taiwan, Chu Chang International Ltd. ("CCIL").The order was
valued at approximately $5 million and was to be secured by an irrevocable
letter of credit. To date, we have not shipped any product to CCIL as they have
not provided us with an irrevocable letter of credit.
RESULTS OF OPERATIONS
THREE MONTHS ENDED OCTOBER 31, 2004 AND OCTOBER 31, 2003
Revenue
Gross revenue for the three months ended October 31, 2004 decreased to
$301,169 from $427,526 for the three months ended October 31, 2003. The
breakdown of the sources of our gross revenue is as follows:
o Sales of aftermarket passenger car tire pressure monitoring
systems (TPMS) decreased to $47,001 for the three months ended
October 31, 2004 from $276,164 for the three months ended
76
October 31, 2003. The decrease in sales during the quarter is
mainly due to having no sales into China during the three
months ended October 31, 2004 compared to sales of $188,523
during the three months ended October 31, 2003. Although it is
difficult for us to predict what the volume of sales will be,
we anticipate an increase in sales of aftermarket passenger
TPMS during the remainder of fiscal 2005.
o Sales of OEM passenger car TPMS increased to $147,262 for the
three months ended October 31, 2004 from $36,648 for the three
months ended October 31, 2003. The increase was primarily due
to an increase in sales to Aston Martin, Ford's flagship
division. We anticipate the sale of these systems to increase
during the remainder of fiscal 2005.
o Sales of aftermarket motorcycle systems were $16,734 for the
three months ended October 31, 2004 compared to $nil for the
three months ended October 31, 2003. In August 2004, we
discovered that the sensor/transmitter may break during
installation on the subset of motorcycle rims with curved rim
surfaces when the strap is torqued to its required value. On
September 14, 2004 we contacted the National Highway
Transportation Safety Administration (NHTSA) to determine if a
Safety Defect and Non Compliance Report was required and was
advised that this was necessary. Our remedy for the defect was
to recall 100% of affected sensor/transmitter items from the
field and replace both recalled and inventory
sensor/transmitters with sensor/transmitters previously
manufactured by a different supplier that have been tested and
known to use plastics that provide the required mechanical
properties. Additionally to ensure that transmitters are used
only on rims with flat drop center wells (as originally
designed for) and not curved, the additional precautionary
steps were taken:
1) Adding improved warnings and instruction sheet to new
product as well as product in inventory at dealers
and distributors that clarify flat rim drop center
well application only
2) Removal of tire pressure monitoring systems (TPMS) on
motorcycles with rims with curved drop center wells
We anticipate the cost of this recall will be approximately $67,000.
Recall costs incurred to the end of October were $19,211. In addition;
we are currently working on a solution to enable us to sell our TPMS on
motorcycles with rims with curved drop center wells. We anticipate this
solution will be available for sale by March 2005. To date, the
response to the recall by our customers has been very positive.
Although interest in the motorcycle product by existing and potential
customers remains positive, it is difficult for us to predict what the
volume of sales will be, as this will depend primarily on market
acceptance.
o Sales of aftermarket recreational vehicle TPMS increased to $51,669 for
the three months ended October 31, 2004 compared to $10,337 for the
three months ended October 31, 2003.
o Sales of OEM recreational vehicle TPMS increased to $25,222 for the
three months ended October 31, 2004 from $10,682 for the three months
ended October 31, 2003.
o Sales of aftermarket high pressure TPMS for use on commercial vehicles
were $10,789 for the three months ended October 31, 2004 compared to
$nil for the three months ended October 31, 2003. The majority of these
systems are currently being used for test purposes. Although it is
difficult for us to predict what the volume of sales will be, we
anticipate a substantial increase in sales during the remainder of our
year.
o Revenue of $nil was recorded for engineering changes to modify our
products pursuant to the Hyundai Autonet (HACO) agreement for the three
months ended October 31, 2004 compared to $58,800 for the three months
ended October 31, 2003. Revenue from engineering services is recognized
on services as they are rendered and pre-defined milestones are
achieved. Presently, we do not anticipate future revenue from HACO for
engineering changes.
77
o Sales of miscellaneous products were $2,492 for the three months ended
October 31, 2004 compared to $34,895 for the three months ended October
31, 2003.
The miscellaneous products that accounted for $33,807 of our revenue
during the three months ended October 31, 2003 consisted primarily of
dataloggers, which are used to facilitate testing by our OEM customers.
Gross Margin
Gross margin on product sales increased to 26.8% for the three months
ended October 31, 2004 from 13.4% for the three months ended October
31, 2003. The higher margins are mainly due to:
o the product mix of systems sold in the three months ended
October 31, 2004 had higher gross margins than the product mix
of systems sold in the three months ended October 31, 2003;
o the decrease in the value of the $US against the Pound
Sterling increased our margins as a higher proportion of our
sales during the three months ended October 31, 2004 were in
Pound Sterling.
Expenses
Expenses increased to $1,937,740 for the three months ended October 31,
2004 from $1,854,326 for the three months ended October 31, 2003, as increases
in marketing, engineering, research and development expenses and depreciation
and amortization expenses were partially offset by lower general and
administration expenses.
Engineering, research and development expenses increased to $501,685
for the three months ended October 31, 2004 from $386,566 for the three months
ended October 31, 2003. The increase was primarily attributed to higher
prototype development costs. The expenses were mainly incurred to advance the
development of our new controller area network (CAN) receiver and to participate
in a research study on the application of sensors for markets other than tire
pressure monitoring.
Marketing expenses increased to $496,787 for the three months ended
October 31, 2004 from $442,961 for the three months ended October 31, 2003. The
increase was mainly a result of higher tradeshow expenditures and increased
travel. Trade show expenses in the three months ended October 31, 2004 included
the cost of attending the Automechanika show, which is held in Europe every two
years. Expenses for the three months ended October 31, 2003 expenses would have
been $414,990 as a non-cash compensation charge in the amount of $27,971 was
recorded as we recognize compensation expense as the majority of our employee
stock options are accounted for as variable awards as the employee stock options
are granted in US dollars, yet the majority of our employees are paid in
Canadian dollars and Pounds Sterling.
General and administrative expenses decreased to $579,131 for the three
months ended October 31, 2004 from $709,847 for the three months ended October
31, 2003. The decrease was primarily attributed to lower investor relation
costs, administration wages and professional fees. Administrative wages
decreased as during the three months ended October 31, 2003 and as explained
above, a non-cash compensation charge in the amount of $66,152 was recorded. The
decrease was partially offset by an increase in insurance costs.
Depreciation and amortization expense increased to $360,137 for the
three months ended October 31, 2004 from $314,952 for the three months ended
October 31, 2003.
Interest and finance charges decreased to $585,021 for the three months
ended October 31, 2004 from $1,430,444 for the three months ended October 31,
2004. Interest and finance charges for the three months ended October 31, 2004
included $552,416 on our 8% and discounted convertible debentures and $23,267 on
our promissory notes. Interest and finance charges for the three months ended
October 31, 2003 included $1,350,445 in interest and finance charges on our 7%
and 8% convertible debentures, plus an accrual for a payment in November 2003 of
$75,355 to Palisades Master Fund, L.P. as an early participation bonus.
78
Interest Income
Interest income of $484 was earned for the three months ended October
31, 2004 as compared to $2,740 for the three months ended October 31, 2003 and
was the result of lower average cash balances during the three months ended
October 31, 2004.
Foreign exchange gain
A foreign exchange gain of $57,644 was incurred for the three months
ended October 31, 2004 as compared to a loss of $38,235 for the three months
ended October 31, 2003. Foreign exchange gains or losses are due to fluctuations
in currency exchange rates and are impossible to predict.
FISCAL YEAR ENDED JULY 31, 2004 VS. FISCAL YEAR ENDED JULY 31, 2003
REVENUE
Gross revenue for the fiscal year ended July 31, 2004 decreased to
$1,658,279 from $1,802,596 for our fiscal year ended July 31, 2003. This
decrease in revenue was a result of the following:
o Sales of aftermarket passenger car tire monitoring systems
(TMS) decreased to $1,087,395 for fiscal 2004 from $1,141,210
for fiscal 2003.
o Sales of original equipment manufacturer ("OEM") passenger car
systems decreased to $166,202 for fiscal 2004 from $174,880
for fiscal 2003.
o Sales of aftermarket motorcycle systems decreased to $37,744
for fiscal 2004 compared to $183,589 for fiscal 2003. We
recently introduced a substantially improved second generation
motorcycle tire pressure monitoring system (TPMS) at the Indy
Motorcycle Dealers Show, held in Indianapolis, Indiana in
mid-February 2004. During May 2004 this product became
commercially available and we began shipping it to our
customers. In August 2004, we discovered that the
sensor/transmitter may break during installation on the subset
of motorcycle rims with curved rim surfaces when the strap is
torqued to its required value. On September 14, 2004 we
contacted the National Highway Transportation Safety
Administration (NHTSA) to determine if a Safety Defect and Non
Compliance Report was required and was advised that this was
necessary. Our remedy for the defect was to recall 100% of
affected sensor/transmitter items from the field and replace
both recalled and inventory sensor/transmitters with
sensor/transmitters previously manufactured by a different
supplier that have been tested and known to use plastics that
provide the required mechanical properties. Additionally to
ensure that transmitters are used only on rims with flat drop
center wells (as originally designed for) and not curved, the
additional precautionary steps were taken:
o Adding improved warnings and instruction sheet to new product
as well as product in inventory at dealers and distributors
that clarify flat rim drop center well application only
o Removal of tire pressure monitoring system (TPMS) on
motorcycles with rims with curved drop center wells
We anticipate the cost of this recall will be approximately $US 67,000.
In addition, we are currently working on a solution to enable us to sell our
tire pressure monitoring system (TPMS) on motorcycles with rims with curved drop
center wells. To date, the response to the recall by our customers has been very
positive. Although interest in the motorcycle product by existing and potential
customers remains positive, it is difficult for us to predict what the volume of
sales will be, as this will depend primarily on market acceptance.
o Sales of aftermarket recreational vehicle systems were
$118,357 for fiscal 2004 compared to $26,383 for fiscal 2003.
These sales include sales of our high pressure transmitters
that were released in our fourth quarter and sales of low
pressure sensors to monitor the wheels of a towed vehicle or
trailer that was introduced during our first quarter ended
October 31, 2003.
79
o Sales of OEM recreational vehicle systems were $64,454 for
fiscal 2004. The majority of these sales occurred in the
fourth quarter after the release our high pressure
transmitters. Although it is difficult for us to predict what
the volume of sales will be, we anticipate a substantial
increase in sales during the next fiscal year.
o Sales of aftermarket high pressure monitoring systems for use
on buses were $42,406 for fiscal 2004. All of these sales
occurred in our fourth quarter after the release our high
pressure transmitters. Although it is difficult for us to
predict what the volume of sales will be, we anticipate a
substantial increase in sales during the next fiscal year.
o Sales of aftermarket high pressure monitoring systems for use
on commercial vehicles were $22,733 for fiscal 2004. Our
customers purchased these systems in the fourth quarter after
the release our high pressure transmitters. The majority of
these systems are currently being used for test purposes.
Although it is difficult for us to predict what the volume of
sales will be, we anticipate a substantial increase in sales
during the next fiscal year.
o Sales of off-the-road (OTR) tire monitoring systems were
$1,088 for fiscal 2004 compared to $58,395 for fiscal 2003.
Our off-the-road (OTR) tire pressure monitoring system (TPMS)
utilizes a high-pressure transmitter and is designed primarily
for off-the-road (OTR) heavy industrial applications and
commercial applications. The system may potentially be used
not only on large mining trucks, but also heavy mobile
equipment (such as tractors, wheeled loaders, graders and the
like). Sales of our off-the-road (OTR) tire monitoring systems
to date have been limited to those systems which are designed
for use on large mining trucks. We anticipate that an increase
in sales of this product in fiscal 2005 now that we have
successfully completed commercializing the wireless gateway
receiver that has been developed with Vansco.
o Revenue of $94,800 was recorded for engineering changes to
modify our products pursuant to our Manufacturing,
Co-Marketing and Development Agreement with Hyundai Autonet
Co. Ltd. for fiscal 2004 compared to $173,400 for the fiscal
2003. Revenue is determined by the percentage of completion
method.
o Sales of the motorsport tire monitoring systems (TMS)
decreased to $nil for fiscal 2004 from $44,739 for fiscal
2003. As indicated above, we do not anticipate further sales
of our motorsport tire monitoring systems (TMS) as our
exclusive motorsport distributor, Pi Research of Cambridge,
England, now manufactures and markets their own system.
Accordingly, we have discontinued production of our motorsport
tire monitoring systems (TMS).
o Sales of miscellaneous products were $23,100 for fiscal 2004
compared to $nil for fiscal 2003.
The miscellaneous products that accounted for $23,100 during fiscal
2004 consisted primarily of dataloggers, which are used to facilitate testing by
our OEM customers.
Gross Margin
Gross margin on product sales decreased to 12.8% for fiscal 2004 from 23% for
fiscal 2003. The decrease occurred due to the following factors:
1) our product mix of systems sold in the fiscal 2004 had lower gross
margins than the product mix of systems sold in the fiscal 2003;
2) our provision for our motorcycle recall (discussed above) in the
amount of $66,801 decreased our fiscal 2004 margin by 4%;
During our third quarter, we shifted the majority of our production to
Hyundai Autonet, and as we expected, our gross margin increased in our third and
fourth quarters, after excluding the cost of the motorcycle recall. Although we
expect that our gross margin will continue to increase in fiscal 2005, this is
dependent on the cost of components and the sales contracts that we enter into.
Expenses
80
Expenses increased to $7,186,287 for fiscal 2004 from $6,802,391 for
fiscal 2003, as increases in marketing, engineering, research and development
expenses and depreciation and amortization were partially offset by a decrease
in general and administration expenses.
Engineering, research and development expenses increased to $1,654,690
for fiscal 2004 from $1,177,935 for fiscal 2003. This increase was primarily
attributed to an increase in prototype development expenses, an increase in
product testing on products that we have released in the current fiscal year, an
increase in the number of patents and approval applications, and an increase in
the number of engineering employees and engineering-related wages.
Marketing expenses increased to $1,821,122 for fiscal 2004 from
$1,448,326 for fiscal 2003. The increase was primarily a result of an increase
in travel and higher marketing-related wages, which increased as a result of the
recruitment of a V.P. of Sales and Marketing. This increase was partially offset
by lower tradeshow expenditures. Trade show expenses in fiscal 2003 included the
cost of attending the Automechanika show, which is held in Europe every two
years. Fiscal 2003 also included expenses of $130,000 in connection with the
termination of a management agreement; 50% of this amount or $65,000 was booked
as marketing expenses and 50% was booked as general and administrative expenses.
General and administrative expenses decreased to $2,338,758 for fiscal
2004 from $2,939,260 for fiscal 2003. The decrease was primarily attributed to
lower professional fees, investor relation costs and administration wages.
Professional fees for fiscal 2003 included an expense of $315,044 to settle
certain potential unquantified claims threatened by certain offshore investors
against our Company. Administrative wages decreased as there were less
administrative employees during fiscal 2004 and as explained above, our general
and administrative expenses for year ended July 31, 2003 include $65,000 that
was incurred in connection with the termination of a management contract. The
decrease was partially offset by an increase in insurance costs.
Depreciation and amortization expense increased to $1,371,717 for
fiscal 2004 from $1,236,870 for fiscal 2003. Depreciation and amortization
expense is expected to remain at approximately its current level for the
foreseeable future.
Interest and finance charges increased to $4,031,820 for fiscal 2004
from $3,722,505 for fiscal 2003. The charges for fiscal 2004 included $3,302,272
in interest and finance charges on our 7% and 8% convertible debentures, and our
discounted convertible debentures, $262,965 related to the issuance of our $15M
equity line of credit with Talisman Management Limited which we do not plan to
use, $179,917 related to the issuance of promissory notes totaling $1,500,000,
plus a payment in November 2003 of $75,355 paid to Palisades Master Fund, L.P.
as an early participation bonus. As discussed below under the heading "Liquidity
and Capital Resources," on October 27, 2003, in order to encourage early
exercise of certain outstanding warrants by Palisades Master Fund and three
additional warrant holders, we offered to reduce the exercise price of a total
of 10,769,231 outstanding warrants from $0.2645 per share to $0.20 per share.
Palisades Master Fund elected to accept our offer, but on November 6, 2003, in
order to encourage early exercise of the warrants by the remaining three warrant
holders, we offered to reduce the exercise price of the remaining 7,478,635
warrants from $0.2645 per share to $0.1771 per share. As a result, we agreed to
pay the $75,355 early participation bonus to Palisades Master Fund, being an
amount equal to the difference between the aggregate exercise price that
Palisades Master Fund paid upon the exercise of 3,290,596 outstanding warrants
at $0.20 per share and the aggregate exercise price that Palisades Master Fund
would have paid if it had the benefit of the reduced exercise price of $0.1771
per share. The fair value of the early participation bonus is included in
interest expense.
Interest and finance charges of $3,722,505 were incurred during fiscal
2003, including $3,720,250 in interest and finance charges on 10%, 5%, 7% and 8%
redeemable convertible debentures, a 12% promissory note and a $5 million equity
line of credit issued during fiscal 2003. The $5 million equity line of credit
was terminated on July 22, 2004.
Interest Income
Interest income of $5,873 was earned for fiscal 2004 as compared to
$2,835 for fiscal 2003. This increase was due to slightly higher average cash
balances maintained during fiscal 2004.
81
Foreign exchange gain
A foreign exchange gain of $12,492 was earned for fiscal 2004 as
compared to $192,201 for fiscal 2003. Foreign exchange gains or losses are due
to fluctuations in currency exchange rates and are impossible to predict.
LIQUIDITY AND CAPITAL RESOURCES
CURRENT POSITION
We have continued to finance our activities primarily through the
issuance and sale of securities. We have incurred losses from operations in each
year since inception. As at October 31, 2004, we had an accumulated deficit of
$61,402,156. Our net loss for the three months ended October 31, 2004 was
$2,383,900 compared to $3,263,143 for our three months ended October 31, 2003.
As of October 31, 2004, our stockholders' equity was $5,341,326 and we had a
working capital of $2,494,264.
Our cash position at October 31, 2004 was $231,950 as compared to
$112,951 at July 31, 2004. This decrease was due to the net decrease from our
operating, financing and investing activities as described below.
83
Our net loss of $2,383,900 for our three months ended October 31, 2004
includes non-cash charges of $360,137 for depreciation and amortization and
$557,962 for interest and finance charges. Decreases in non-cash working capital
during this period amounted to $501,139. Non-cash working capital changes
included increases in prepaid expenses, and accounts receivable and a decrease
in inventory and accounts payable and accrued liabilities.
During the three months ended October 31, 2004, we realized aggregate
gross cash proceeds of $3,271,788 as follows:
We issued 78,887,710 shares of common stock to Cornell Capital Partners
L.P. pursuant to nine draw downs totaling $2,725,000 from our $15 Million equity
line of credit.
On May 19, 2004, we entered into a Standby Equity Distribution
Agreement with Cornell Capital Partners, LP, (Cornell) an accredited investor,
in connection with a 24-month, $15.0 million equity line of credit facility. The
agreement contemplates the potential future issuance and sale of up to $15.0
million of our common stock to Cornell Capital Partners, LP, subject to certain
restrictions and other obligations.
Pursuant to the equity line of credit, we may, at our discretion,
periodically sell to Cornell during the effectiveness of the related
registration statement, shares of common stock for a total purchase price of up
to $15.0 million. Each such periodic sale of shares is known as an advance or
drawdown. We may request an advance every 7 trading days. The maximum amount of
each advance is $500,000. Each advance will close 6 trading days after we give
written notice of such advance, at which time we will deliver the appropriate
number of shares of our common stock to Cornell against payment of the advance
amount. For each share of common stock purchased under the equity line of
credit, Cornell will pay 98% of the lowest closing bid price on the OTC Bulletin
Board, or such other principal market on which our common stock may then be
traded, for the 5 days immediately following the notice date. Further, Cornell
will retain 5% of each advance as a fee.
The amount of capital available under the equity line of credit will
not be dependent on the price or volume of our common stock. Cornell may not own
more than 9.9% of our outstanding common stock at any time. Because Cornell can
repeatedly acquire and sell shares, this limitation does not limit the potential
dilutive effect or the total number of shares that Cornell Capital Partners L.P.
(Cornell) may receive under the equity line of credit.
We currently have $11,525,000 available to us from our equity line of
credit, but only 251,071 registered shares. As such, we plan to file a new
registration statement to register additional shares.
On September 24, 2004, the Company and holders of the discounted
convertible debentures signed an agreement which provided for an immediate
exercise of 18,226,274 warrants at $0.03 for gross proceeds of $546,788.
On November 16, 2004 we received gross proceeds of $250,000 upon the
issuance of an unsecured short-term promissory note to an accredited investor.
The note bears interest at a rate of 12% per annum and is repayable within 30
days of issuance with accrued interest.
On November 30, 2004 we received gross proceeds of $275,000 upon the
issuance of an unsecured short-term promissory note to an accredited investor.
The note bears interest at a rate of 12% per annum and is repayable within 30
days of issuance with accrued interest. As a commitment fee to loan the Company
money, the holder of the note received $27,500.
On December 15, 2004, we closed on a transaction pursuant to which we
entered into a Subscription Agreement with several accredited investors in which
the investors agreed to lend a principal amount of $195,000 to us in exchange
for our 5% convertible debentures. We issued the convertible debentures to the
investors pursuant to Rule 506 of Regulation D as promulgated under the
Securities Act of 1933, as amended (the "Act"), and/or Section 4(2) of the Act.
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The convertible debentures shall pay 5% per annum simple interest in
cash semi-annually beginning six months from the date of the last closing of the
offering in arrears. They will mature 24 months from the date the investor's
funds were disbursed to us. The holders may convert, at their sole discretion at
any time, the principal amount of some or all of their convertible debentures
into shares of our common stock, no par value, at a conversion price equal to
the lesser of (i) 120% of the closing bid price of the common stock as reported
by Bloomberg, L.P. for the trading day immediately preceding the date that the
holder's funds representing the net amount due to the Company from the purchase
price of the offering is transmitted by wire transfer or otherwise to or for the
benefit of the Company, or (ii) 80% of the lowest closing prices for the 5
trading days preceding the date on which the notice of conversion is sent via
facsimile to us.
Upon providing 3 business days advance written notice to holders,
during which time they may elect to convert up to all of their convertible
debentures, we may redeem the convertible debentures, in whole or part, at 120%
of the face value of each convertible debenture and the investor shall receive
50,000 redemption warrants for every $100,000 redeemed (the "Redemption
Warrants"). The Redemption Warrants are exercisable at 120% of the closing bid
price on our common stock as reported by Bloomberg, L.P. for the trading day
immediately preceding the Closing Date. The Redemption Warrants will be
exercisable until 2 years from the date of issuance.
On December 15, 2004, we entered into a Securities Purchase Agreement
with Cornell Capital Partners, L.P., an accredited investor (the "Investor"), in
which the Investor agreed to lend a principal amount of $2,500,000 to us in
exchange for the Company's 5% convertible debenture. We issued the convertible
debenture to the Investor pursuant to Rule 506 of Regulation D as promulgated
under the Securities Act of 1933, as amended (the "Act"), and/or Section 4(2) of
the Act.
The convertible debentures shall pay interest at 5% per annum (computed
on the basis of a 365-day year and the actual days elapsed) from the date of
this convertible debenture until paid in full. The convertible debenture will
mature on December 15, 2007. The holders may convert, at their sole discretion
at any time, the principal amount of some or all of their convertible debentures
into shares of our common stock, no par value, at a conversion price equal to
the lesser of (i) 120% of the closing bid price of the common stock as reported
by Bloomberg, L.P. as of December 15, 2004, or (ii) 80% of the lowest closing
prices for the five (5) trading days preceding the date on which the notice of
conversion is sent via facsimile to us.
Upon providing 3 business days advance written notice to holders,
during which time they may elect to convert up to all of their convertible
debentures, we may redeem the convertible debentures, in whole or part, at 120%
of the face value of each convertible debenture and the investor shall receive
50,000 redemption warrants for every $100,000 redeemed (the "Redemption
Warrants"). The Redemption Warrants are exercisable at 120% of the closing bid
price on our common stock as reported by Bloomberg, L.P. for the trading day
immediately preceding the Closing Date. The Redemption Warrants will be
exercisable until 2 years from the date of issuance.
We have an unlimited number of authorized shares of our common stock,
without par value. Accordingly, we have sufficient authorized common stock to
fully draw down on the remaining $11,525,000 of our $15.0 million standby equity
line. However, although we have successfully registered the $15.0 million
standby equity distribution agreement, which, as discussed elsewhere in this
report, we only have 251,070 registered shares remaining under the agreement and
there can be no assurance that we will be able to register additional shares.
If the equity line of credit facility will not be accessible to us,
when needed, we anticipate that we will require between $3.5 million and $4.2
million in financing through July 31, 2005 in order to continue in business as a
going concern, the availability of which is uncertain.
Due to the uncertainty of our ability to meet our current operating and
capital expenses, in their report on the annual consolidated financial
statements for the year ended July 31, 2004, our independent auditors included
additional comments in their Auditors' report indicating concerns about our
ability to continue as a going concern. Our consolidated financial statements
contain additional note disclosures describing the circumstances that led to
this disclosure by our independent auditors. The consolidated financial
statements do not include any adjustments that might result from the outcome of
this uncertainty.
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As the continuation of our business is dependent upon obtaining further
financing, successful and sufficient market acceptance of our current products
and any new products that we may introduce, the continuing successful
development of our products and related technologies, and, finally, achieving a
profitable level of operations. The issuance of additional equity securities by
us could result in a significant dilution in the equity interests of our current
stockholders. Obtaining commercial loans, assuming those loans would be
available, will increase our liabilities and future cash commitments.
We plan to raise any additional capital required to meet the balance of
our estimated funding requirements for the next nine months, primarily through
the private placement of our securities. We are presently working with Cornell
on a plan to meet our financial capital requirements.
YEAR ENDED JULY 31, 2004
We have continued to finance our activities primarily through the
issuance and sale of securities. We have incurred losses from operations in each
year since inception. As at July 31, 2004, we had an accumulated deficit of
$59,018,256. Our net loss for fiscal 2004 was $10,987,026 compared to $9,914,629
for fiscal 2003. As of July 31, 2004, our stockholders' equity was $3,466,216
and we had working capital of $732,405.
Our cash position at July 31, 2004 was $112,951 as compared to
$1,843,694 at July 31, 2003. This decrease was due to the net decrease from our
operating, financing and investing activities as described below.
Our net loss of $10,987,026 for fiscal 2004 includes non-cash charges
of $1,371,717 for depreciation and amortization, $3,842,107 for interest and
finance expense and $98,175 for shares and warrants issued for services
received. Decreases in non-cash working capital during this period amounted to
$1,860,812. Non-cash working capital changes included increases in inventory,
prepaid expenses and accounts payable and accrued liabilities and a decrease in
receivables.. An increase in inventory of $2,391,749 accounted for the most
significant use of cash for working capital. This increase was primarily due to
the procurement of components for production builds at Hyundai Autonet.
During fiscal 2004, we realized aggregate gross cash proceeds of
$7,170,265 from financing activities as follows:
On October 27, 2003, in order to encourage early exercise of a total of
10,769,231 warrants issued to the purchasers of our 7% convertible debentures,
we offered to reduce the exercise price of the warrants from $0.2645 per share
to $0.20 per share. The offer was open for acceptance by the warrant holders
until November 4, 2003. In consideration of the warrant holders' agreement to
immediately exercise their respective warrants, we offered to issue to the
participating warrant holders one additional warrant for each warrant that was
exercised. One of the warrant holders, Palisades Master Fund, L.P. accepted our
offer and exercised a total of 3,290,596 outstanding warrants at the reduced
exercise price of $0.20 per share. On October 27, 2003, we issued a total of
3,290,596 five-year warrants to Palisades Master Fund, exercisable at an
exercise price of $0.20 per share, resulting in gross proceeds of $658,119. The
additional warrants were to be exercisable for a period of five years at an
exercise price of $0.20 per share.
On October 27, 2003, our former investment banker HPC Capital
Management, also agreed to immediately exercise 194,000 outstanding common stock
purchase warrants dated May 16, 2003, in consideration of receiving one
additional five-year warrant with an exercise price of $0.20 per share for each
warrant so exercised. Of the 194,000 warrants exercised by HPC Capital
Management under this arrangement, 180,000 were exercised at an exercise price
of US$0.13 per share and 14,000 were exercised at an exercise price of US$0.10
per share, resulting in gross proceeds of $24,800.
On November 6, 2003, in order to encourage early exercise of the
warrants by the remaining three warrant holders, we offered to reduce the
exercise price of the remaining 7,478,635 warrants from $0.2645 per share to
$0.1771 per share.
On December 24, 2003, we closed a private placement of discounted
unsecured convertible debentures in the aggregate principal amount of
$3,493,590. We issued the convertible debentures at a 22% original issue
discount from the face principal amount (based on a notional interest rate of
11% per annum for each year of the two-year term of the debentures), resulting
in gross proceeds of $2,725,000, before the deduction of a $218,000 cash
placement fee subsequently paid to HPC Capital Management and other expenses of
the offering. The discounted convertible debentures do not otherwise bear
interest, and will mature on April 1, 2006. The outstanding principal amount of
each debenture may be converted at any time into shares of our common stock, in
whole or in part, at the option of the holder of the debenture at an original
set price of $0.22 per share. As a result of anti-dilution provisions, the
conversion price is $0.028 at December 27, 2004. The discounted convertible
debentures are subject to mandatory redemption in equal monthly payments,
payable in cash. We may elect to make the monthly redemption payments in shares
of our common stock at a conversion price equal to the lesser of:
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(a) the set price of $0.22 per share (subject to adjustment pursuant to
the anti-dilution provisions contained in the debentures), and
(b) 85% of the average of the closing prices of the Company's common
stock for twenty days immediately preceding the applicable monthly redemption
date, provided that certain conditions are met, including the condition that the
underlying shares of common stock shall have been registered under the
Securities Act of 1933, as amended.
On February 5, 2004, we notified the holders of the discounted
convertible debentures that we had elected to effect the first monthly
redemption payment in shares, and that the election should continue for
subsequent redemption periods until revised. One of the holders of the
discounted convertible debentures exercised its right to receive its first
monthly redemption payment, in the amount of $14,583, in cash.
On April 28, 2004, the Company irrevocably notified the debenture
holders that it would make the monthly redemption payments in cash commencing
June 1, 2004 until otherwise notified.
On October 14, 2003, an employee exercised 79,400 employee stock
options at $0.20 per stock option.
On April 15, 2004, the Company received gross proceeds of $750,000 upon
the issuance of an unsecured short-term promissory note to an accredited
investor. The note bears interest at a rate of 8% per annum and is repayable
within 120 days of issuance with accrued interest. As a commitment fee to loan
the Company money, the holder of the note received $75,000.
On April 30, 2004, 500,000 warrants were exercised at $0.104. Pursuant
to the anti-dilution provisions contained in certain warrants, the exercise
price of 25,290,153 warrants outstanding were reduced to $0.104 per share, which
was the deemed price per share of the common stock that was issued to effect the
April 1, 2004 redemption payment of the Company's discounted convertible
debentures maturing April 1, 2006.
On May 19, 2004, we received gross proceeds of $750,000 upon the
issuance of an unsecured short-term promissory note to an accredited investor.
The note bears interest at a rate of 8% per annum and is repayable within 120
days of issuance with accrued interest. As a commitment fee to loan the Company
money, the holder of the note received $75,000.
On May 19, 2004, we entered into a Standby Equity Distribution
Agreement with Cornell Capital Partners, LP, an accredited investor, in
connection with a 24-month, $15.0 million equity line of credit facility. The
agreement contemplates the potential future issuance and sale of up to $15.0
million of our common stock to Cornell Capital Partners, LP, subject to certain
restrictions and other obligations. As the the underlying shares have been
registered with the Securities and Exchange Commission, we are able to request
advances. To July 31, 2004, we have drawn down $750,000. We may continue to
request advances until Cornell Capital Partners has advanced $15,000,000 or two
years after the effective date of the registration statement, whichever occurs
first. Cornell Capital Partners is a private limited partnership whose business
operations are conducted through its general partner, Yorkville Advisors, LLC.
Pursuant to the equity line of credit, we may, at our discretion,
periodically sell to Cornell Capital Partners during the effectiveness of the
related registration statement, shares of common stock for a total purchase
price of up to $15.0 million. Each such periodic sale of shares is known as an
advance or drawdown. We may request an advance every 7 trading days. The maximum
amount of each advance is $500,000. Each advance will close 6 trading days after
we give written notice of such advance, at which time we will deliver the
appropriate number of shares of our common stock to Cornell Capital Partners,
L.P. against payment of the advance amount. For each share of common stock
purchased under the equity line of credit, Cornell Capital Partners will pay 98%
of the lowest closing bid price on the OTC Bulletin Board, or such other
principal market on which our common stock may then be traded, for the 5 days
immediately following the notice date. Further, Cornell Capital Partners will
retain 5% of each advance as a fee.
87
The amount of capital available under the equity line of credit will
not be dependent on the price or volume of our common stock. Cornell Capital
Partners may not own more than 9.9% of our outstanding common stock at any time.
Because Cornell Capital Partners can repeatedly acquire and sell shares, this
limitation does not limit the potential dilutive effect or the total number of
shares that Cornell Capital Partners may receive under the equity line of
credit.
We have issued to Cornell Capital Partners 14,370,835 shares of common
stock of which 10,861,220 were pursuant to three draw downs of $250,000 and
3,509,615 shares of common stock as a commitment fee under the equity line of
credit. In addition, we have also issued, as a placement fee, 96,154 shares of
our common stock to Newbridge Securities Corporation.
The net proceeds realized or to be realized by us from these
transactions have and are to be used for debt repayment, working capital and the
purchase of capital assets.
During fiscal 2004, we also purchased certain capital assets at an
aggregate cost of $446,780. The majority of these capital assets were sent to
Hyundai Autonet in Korea to facilitate production of our aftermarket tire
pressure monitoring systems (TPMS) for passenger cars and motorcycles.
Our management projects that we will require a minimum of $3.5-$4.2
million to fund our debt repayment, ongoing operating expenses and working
capital requirements through July 31, 2005.
Between August 1, 2004 and October 15, 2004, the Company realized gross
cash proceeds of $2,746,788 from draw downs totalling $2.2 Million from our $15
Million equity line of credit and $546,788 from the exercise of warrants.
However, due to the uncertainty of our ability to meet our current
operating and capital expenses, in their report on the annual consolidated
financial statements for fiscal 2004, our independent auditors included
additional comments in their Auditors' report indicating concerns about our
ability to continue as a going concern. Our consolidated financial statements
contain additional note disclosures describing the circumstances that led to
this disclosure by our independent auditors. The consolidated financial
statements do not include any adjustments that might result from the outcome of
this uncertainty.
As the continuation of our business is dependent upon obtaining further
financing, successful and sufficient market acceptance of our current products
and any new products that we may introduce, the continuing successful
development of our products and related technologies, and, finally, achieving a
profitable level of operations. The issuance of additional equity securities by
us could result in a significant dilution in the equity interests of our current
stockholders. Obtaining commercial loans, assuming those loans would be
available, will increase our liabilities and future cash commitments.
We plan to raise any additional capital required to meet the balance of
our estimated funding requirements for the next twelve months, primarily through
the private placement of our securities (including shares issuable under our
$15.0 Million standby equity distribution agreement with Cornell Capital,
assuming that we will meet all conditions to effect drawdowns under equity line
of credit facility). We may also realize cash proceeds upon the exercise of our
outstanding warrants, which cannot be assured.
FUTURE OPERATIONS
Presently, our revenues are not sufficient to meet operating and capital
expenses. We have incurred operating losses since inception, and this is likely
to continue for the foreseeable future.
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We project a requirement for a minimum of $3.5-$4.2 million to fund our debt
repayment, ongoing operating expenses and working capital requirements through
July 31, 2005 as follows:
Marketing $ 1,050,000 $ 1,200,000
Engineering, research and development 900,000 1,200,000
General and administrative 1,300,000 1,400,000
Capital Purchases 50,000 175,000
Debt repayment(1) 727,830 727,830
General Working Capital (527,830) (502,830)
----------- -----------
TOTAL $ 3,500,000 $ 4,200,000
=========== ===========
(1) Assumes monthly repayments on the discounted convertible debentures of
$145,566 in cash commencing February 1, 2005. The amount of cash used to redeem
the discounted convertible debentures may be less than the October 31, 2004
balance outstanding of $1,612,798 as per the forbearance and escrow agreement
dated September 24, 2004, the debenture holders have the option, after December
31, 2004, of converting the convertible debenture in whole or in part into
shares of our common our common stock at $0.028 per share (subject to adjustment
pursuant to the anti-dilution provisions contained in the debentures). The cash
required to repay the debenture holders will be less if the debenture holder
converts all or a portion of its outstanding debenture into our common stock.
The Company has advised the debenture holders that it plans to make the monthly
payment in cash although it has the option of making this payment in shares.
Our working capital requirements are impacted by our inventory requirements.
Therefore, any increase in sales of our products will be accompanied not only by
an increase in revenues, but also by an increase in our working capital
requirements. Our new products, the market acceptance of which will impact on
our inventory needs and therefore will impact on our working capital
requirements, include the following:
o Our motorcycle tire pressure monitoring system (TPMS) was
introduced for sale into the aftermarket in September 2002. We
introduced a substantially improved second generation
motorcycle tire pressure monitoring system (TPMS) in
mid-February, 2004 and began delivery of this system to our
distributors in May 2004. We had a recall in September and are
currently working on a solution for curved rims that we plan
will be available for sale by March 2005.
o During our fiscal 2004 year, we introduced low pressure tire
monitoring systems (TPMS) for the recreational vehicle market.
Marketed as "RoadVoiceTM" and "TrailerVoiceTM", they represent
the first tire monitoring systems targeted specifically at the
recreational vehicle, towed vehicle and trailer markets.
o During our 2004 fiscal year, we introduced high pressure tire
monitoring systems (TPMS) for the recreational vehicle market,
bus and commercial market.
o In November, 2004, design validation testing and the initial
pilot build of 300 weatherproof, J1939 controller area network
(CAN), chassis-mounted receivers was completed. The 300 units
will be utilized to validate the reliability of the production
line and to satisfy early test and validation demands from our
existing and potential OEM customers. Vansco will manufacture
the CAN, chassis-mounted receiver for us. As such, we
anticipate the manufacture of CAN receivers for commercial
vehicles.
The continuation of our business is dependent upon obtaining further financing,
market acceptance of our current products and any new products that we may
introduce, the continuing successful development of our products and related
technologies, and, finally, achieving a profitable level of operations.
As discussed above under the heading "Liquidity and Capital Resources,
we plan to raise any additional capital required to meet the balance of our
estimated funding requirements through July 31, 2005, primarily through the
private placement of our securities (including the registration of additional
shares of our common stock for issuance upon use of our $15M standby equity
distribution agreement entered into on May 19, 2004).
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The issuance of additional equity securities by us could result in a
significant dilution in the equity interests of our current stockholders.
Obtaining commercial loans, assuming those loans would be available, will
increase our liabilities and future cash commitments.
APPLICATION OF CRITICAL ACCOUNTING POLICIES
Our consolidated financial statements and accompanying notes are prepared in
accordance with generally accepted accounting principles in the United States.
Preparing financial statements requires management to make estimates and
assumptions that affect the reported amounts of assets, liabilities, revenue,
and expenses. These estimates and assumptions are affected by management's
application of accounting policies. We believe that understanding the basis and
nature of the estimates and assumptions involved with the following aspects of
our consolidated financial statements is critical to an understanding of our
financials.
GOING CONCERN
As at October 31, 2004, we had an accumulated deficit of $61,402,156. Our net
loss for the three months ended October 31, 2004 was $2,383,900 compared to
$3,263,143 for the three months ended October 31, 2003. As of October 31, 2004,
our stockholders' equity was $5,341,326 and we had working capital of
$2,494,264.
We require additional financing to fund our operations. During the three months
ended October 31 2004, we used $1,966,940 cash in operating activities and
$15,157 to purchase capital assets. Accordingly, during the three months ended
October 31, 2004, we raised gross cash proceeds of $546,788 from the exercise of
warrants and $2,725,000 from draw downs on our equity line of credit. In
addition, during November and December 2004, we raised gross proceeds of
$2,695,000 from the issuance of convertible debentures, and $525,000 from the
issuance of two promissory notes. Out of these proceeds, we paid an aggregate
amount of $1,100,462.24 to Cornell Capital Partners, LP in payment of certain
promissory notes previously issued by SmarTire to Cornell Capital Partners, LP.
Although we have successfully registered our $15.0 million standby equity
distribution agreement, which, as discussed elsewhere in this registration
statement, we only have 251,070 registered shares and $11,525,000 remaining
under the agreement and there can be no assurance that we will be able to
register additional shares. Our consolidated financial statements have been
prepared on the going concern basis, which assumes that adequate sources of
financing will be obtained as required and that our assets will be realized, and
liabilities settled in the ordinary course of business. Accordingly, our
consolidated financial statements do not include any adjustments related to the
recoverability of assets and classification of assets and liabilities that might
be necessary should we be unable to continue as a going concern.
INVENTORY
Inventory is carried at the lower of cost, determined on a weighted average cost
method, and net realizable value. The determination of net realizable value is
based on several assumptions and estimates. We provide an allowance that we
consider to be reasonable for non-moving or slow moving inventory items and for
items with expected future realizable value lower than cost. These assumptions
and estimates may be inaccurate and may be revised.
The markets in which we compete are rapidly changing due to technological
developments and increasing focus on automotive safety. Other companies offer
products similar to those offered by us, and target the same customers as we do.
Many of these companies have substantially greater financial, marketing and
technical resources. We also anticipate that the competition within these
markets will increase as demand for the products escalates. It is possible that
new competitors or alliances among existing competitors may emerge and such
competitors may rapidly acquire significant market share and make it difficult
for us to sell our current inventory. All of these elements could reduce the net
realizable value of our inventory.
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WARRANTY OBLIGATIONS
On an ongoing basis, we record our best estimate of our warranty obligations and
product returns related to products sold. These estimates are made after the
consideration of contractual warranty obligations and historical experience.
Unforeseen events, including increased technological difficulties with products,
could occur that have not been anticipated in estimating the warranty provision.
Additional costs or estimates will be recognized as determined.
REVENUE RECOGNITION
Our Company recognizes revenue when there is persuasive evidence of an
arrangement, goods are shipped and title passes, collection is probable, and the
fee is fixed or determinable. Customer acceptance is used as the criterion for
revenue recognition when the product sold does not have an established sales
history to allow management to reasonably estimate returns and future
provisions. Provisions are established for estimated product returns and
warranty costs at the time the revenue is recognized. Our Company records
deferred revenue when cash is received in advance of the revenue recognition
criteria being met. Revenue from engineering services is recognized on services
as they are rendered and pre-defined milestones are achieved. Engineering
services revenue for the three months ended October 31, 2004 were $nil (three
months ended October 31, 2003-$58,800).
OTHER ASSETS
Other assets are recorded at cost and are being amortized over five years on a
straight-line basis. Other assets are comprised of licenses to manufacture and
sell tire pressure monitoring systems (TPMS) to the original equipment
manufacturers. On an ongoing basis, management assesses whether the expected net
recoverable amount of the licenses exceeds the book value of the licenses. The
net recoverable amount is determined on a projected cash flow basis, discounted
at an appropriate rate. In making our cash flow estimates, we consider recent
market trends and transactions, as well as reasonable estimates of future events
based on current economic characteristics. Although we expect to generate cash
flow from sales to the original equipment manufacturer market place, it is
possible that we will not generate cash flow from sales to the original
equipment manufacturer marketplace in excess of net book value, or that we will
generate cash flow from sales to the original equipment manufacturer market in
future years after the other assets have been fully amortized.
DESCRIPTION OF PROPERTY
Our principal executive offices are located at #150 - 13151 Vanier
Place, Richmond, British Columbia, V6V 2J1. We leased this 15,364 square foot
facility for a five-year term ending August 31, 2005. This facility consists of
an office and administration area, an engineering department, a prototype
production facility and a warehouse.
Our subsidiary, SmarTire Europe Limited, leases a 9,069 square foot
facility at Park 34, Didcot, Oxfordshire, United Kingdom OX11 7WB for a 15 year
term ending February 20, 2016. This facility consists of an office and
administration area and a warehousing area.
We expect that our current facilities will be sufficient for the
foreseeable future. To the extent that we require additional space in the near
future, we believe that we will be able to secure additional leased facilities
at commercially reasonable rates.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Other than as listed below, we have not been a party to any
transaction, proposed transaction, or series of transactions in which the amount
involved exceeds or equals $60,000, and in which, to our knowledge, any of our
directors, officers, five percent beneficial security holders, or any member of
the immediate family of the foregoing persons has had or will have a direct or
indirect material interest.
Mr. Christiansen, a director of our Company is a principal in
Visionaire AS. During the three months ended October 31, 2004, we incurred
expenses of $60,000 for a research report prepared by Visionaire AS on various
sensor applications.
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Mr. Becerra, a director of our Company until his resignation on March
17, 2003, is a principal of West Sussex Trading Inc. During the fiscal year
ended July 31, 2003, we paid West Sussex Trading Inc. $215,108 for consulting
and financial advisory services and have issued 621,143 share purchase warrants
(224,000 at an exercise price of $0.10, 160,000 at an exercise price of $0.50,
60,000 at an exercise price of $0.67, 80,000 at an exercise price of $0.70,
57,143 at an exercise price of $0.35, and 40,000 at an exercise price of $0.10),
which will expire on various dates between December 20, 2007 and July 24, 2008.
During fiscal 2002, we paid West Sussex Trading Inc. $115,900 for consulting and
financial advisory services and issued 46,900 share purchase warrants at an
exercise price of $1.70, expiring on January 18, 2005. During fiscal 2001, we
paid West Sussex Trading Inc. $78,510 for consulting and financial advisory
services. Our Advisory Agreement with West Sussex Trading Inc. dated September
4, 2002 (filed with the Securities and Exchange Commission on October 25, 2002
as an exhibit to our annual report on Form 10-KSB for fiscal 2002) has been
terminated effective March 17, 2003.
Bernard Pinsky, a director of our company until July 11, 2002, is a
partner in the law firm of Clark, Wilson and during the years ended July 31,
2002 and 2001, we paid to Clark, Wilson $98,752 and $79,858, respectively, for
legal services.
The promoters of our company are our directors and officers.
MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
On May 29, 2003, our common stock commenced quotation on the OTC
Bulletin Board under the symbol "SMTR.OB".
Until May 28, 2003, our common stock was quoted on the Nasdaq SmallCap
Market under the symbol "SMTR". The following quotations obtained from Canada
Stockwatch reflect the high and low bids for our common stock based on
inter-dealer prices, without retail mark-up, mark-down or commission and may not
represent actual transactions. The high and low bid prices of our common stock
for the periods indicated below are as follows:
-----------------------------------------------------------------------
QUARTER ENDED HIGH LOW
-----------------------------------------------------------------------
January 31, 2005* $0.036 $0.0285
-----------------------------------------------------------------------
October 31, 2004 $0.094 $0.03
-----------------------------------------------------------------------
July 31, 2004 $0.15 $0.07
-----------------------------------------------------------------------
April 30, 2004 $0.193 $0.10
-----------------------------------------------------------------------
January 31, 2004 $0.243 $0.165
-----------------------------------------------------------------------
October 31, 2003 $0.28 $0.135
-----------------------------------------------------------------------
July 31, 2003 $0.39 $0.135
-----------------------------------------------------------------------
April 30, 2003 $0.48 $0.07
-----------------------------------------------------------------------
January 31, 2003 $0.83 $0.31
-----------------------------------------------------------------------
October 31, 2002 $1.27 $0.42
-----------------------------------------------------------------------
July 31, 2002 $2.16 $0.88
-----------------------------------------------------------------------
April 30, 2002 $2.05 $1.75
-----------------------------------------------------------------------
* As of December 30, 2004.
Our common shares are issued in registered form. Pacific Corporate
Trust Company (10th Floor, 625 Howe Street, Vancouver, British Columbia, V6C 3B8
(telephone: (604) 689-9853, facsimile (604) 689-8144) is the registrar and
transfer agent for our common shares.
As of December 30, 2004, we had 225,912,470 shares of common stock
outstanding and approximately 400 stockholders of record.
92
DIVIDEND POLICY
We have never declared or paid dividends on our common stock, and we do
not anticipate that we will do so in the foreseeable future. We intend to retain
future earnings, if any, for use in our operations and the expansion of our
business.
EXECUTIVE COMPENSATION
Particulars of compensation awarded to, earned by or paid to:
(a) our Company's chief executive officer (the "CEO");
(b) each of our Company's four most highly compensated executive
officers who were serving as executive officers at the end of the most recently
completed fiscal year and whose total salary and bonus exceeds $100,000 per
year; and
(c) any additional individuals for whom disclosure would have been
provided under (b) but for the fact that the individual was not serving as an
executive officer of our Company at the end of the most recently completed
fiscal year; (the "Named Executive Officers") are set out in the summary
compensation table below.
During fiscal 2004, six (6) individuals served as executive officers of
the Company at various times: Robert Rudman, Al Kozak, Jeff Finkelstein, Erwin
Bartz, Shawn Lammers, and John Taylor-Wilson. Mr. Finkelstein earned less than
$100,000 in total salary and bonuses during fiscal 2004, and, therefore, is not
considered a "Named Executive Officer."
================================================================================================================================
SUMMARY COMPENSATION TABLE
- --------------------------------------------------------------------------------------------------------------------------------
Annual Compensation Long Term Compensation
- --------------------------------------------------------------------------------------------------------------------------------
Awards Payouts
- --------------------------------------------------------------------------------------------------------------------------------
Name and Principal Year Salary Bonus Other Annual Securities Restricted LTIP Payouts All Other
Position Compen-sation(1)Underlying Shares or Compen-sation
Options/SARs Restricted
Granted (#) Share Units
- --------------------------------------------------------------------------------------------------------------------------------
Robert Rudman 2004 $217,478 Nil Nil 1,079,500 Nil Nil Nil
President, Chairman 2003 $194,543 Nil Nil 232,000 Nil Nil Nil
and Chief Executive
Officer 2002 $185,377 Nil Nil 90,000 Nil Nil Nil
- --------------------------------------------------------------------------------------------------------------------------------
Al Kozak 2004 $164,983 Nil Nil 683,000 Nil Nil Nil
Chief Operating 2003 $147,585 Nil Nil 111,000 Nil Nil Nil
Officer
- --------------------------------------------------------------------------------------------------------------------------------
Erwin Bartz 2004 $121,113 Nil Nil 390,000 Nil Nil Nil
Vice-President, 2003 $108,341 Nil Nil 55,000 Nil Nil $5,826(2)
Business Development
- --------------------------------------------------------------------------------------------------------------------------------
Shawn Lammers 2004 $108,739 Nil Nil 332,600 Nil Nil Nil
Vice-President, 2003 $94,589 Nil Nil 15,100 Nil Nil Nil
Engineering 2002 $86,296 Nil Nil 10,000 Nil Nil Nil
- --------------------------------------------------------------------------------------------------------------------------------
John Taylor-Wilson 2004 $102,576 Nil Nil 450,000 Nil Nil $5,229(3)
================================================================================================================================
* The average of the closing foreign exchange rates for fiscal 2004, as
calculated by using the reported daily rates posted by the Federal Reserve Bank
of New York, was CDN$1.3386 to every US$1.00. For the purposes of this table,
executive compensation paid in Canadian currency to the Named Executive Officers
has been converted into United States currency at the rate of CDN$1.3386 to
every US$1.00
93
(1) The value of perquisites and other personal benefits, securities and
property for the Named Executive Officers that do not exceed the lesser of
$50,000 or 10% of the total of the annual salary and bonus is not reported
herein.
(2) Mr. Bartz earned sales commissions of $5,826 in fiscal 2003.
(3) Mr. Taylor-Wilson earned sales commissions of $5,229 in fiscal 2004.
The following table sets forth for each of the Named Executive Officers
certain information concerning stock options granted to them during fiscal 2004.
Our Company has never issued stock appreciation rights. Our Company grants
options that generally vest immediately at an exercise price equal to the fair
market value of a share of common stock as determined by its closing price on
the OTC Bulletin Board. Until May 28, 2003, the exercise price was determined by
its closing price on the Nasdaq SmallCap Market. The term of each option granted
is generally five years from the date of grant. Options may terminate before
their expiration dates if the optionee's status as an employee is terminated or
upon the optionee's death or disability.
OPTION/SAR GRANTS IN THE LAST FISCAL YEAR
=================================================================================================
NUMBER OF % OF TOTAL
SECURITIES OPTIONS/ SARS
UNDERLYING GRANTED TO
OPTIONS/ SARS EMPLOYEES IN EXERCISE PRICE
NAME GRANTED (#) FISCAL YEAR ($/SHARE) EXPIRATION DATE
=================================================================================================
Robert Rudman 1,669,500 18.2% $0.20 August 12, 2008
- -------------------------------------------------------------------------------------------------
Al Kozak 1,123,000 12.2% $0.20 August 12, 2008
- -------------------------------------------------------------------------------------------------
Erwin Bartz 615,000 6.7% $0.20 August 12, 2008
- -------------------------------------------------------------------------------------------------
Shawn Lammers 557,600 6.1% $0.20 August 12, 2008
- -------------------------------------------------------------------------------------------------
John Taylor-Wilson 450,000 4.9% $0.20 August 12, 2008
=================================================================================================
The following table sets forth for each Named Executive Officer certain
information concerning the number of shares subject to both exercisable and
unexercisable stock options as of July 31, 2004. The values for "in-the-money"
options are calculated by determining the difference between the fair market
value of the securities underlying the options as of July 31, 2004 ($0.055 per
share) and the exercise price of the individual's options. No Named Executive
Officer exercised options during fiscal 2004.
AGGREGATED OPTION/SAR EXERCISES IN LAST FISCAL YEAR AND FY-END OPTION/SAR VALUES
====================================================================================================================================
AGGREGAGE NUMBER OF SECURITIES UNDERLYING VALUE OF UNEXERCISED IN-THE-MONEY
SHARES ACQUIRED VALUE REALIZED UNEXERCISED OPTIONS/SARS AT FY-END (#) OPTIONS/SARS AT FY-END ($)
NAME ON EXERCISE (#) ($) EXERCISABLE / UNEXERCISABLE EXERCISABLE / UNEXERCISABLE
- ------------------------------------------------------------------------------------------------------------------------------------
Robert Rudman Nil Nil 1,501,000 68,000 Nil Nil
Al Kozak Nil Nil 926,000 24,000 Nil Nil
Erwin Bartz Nil Nil 536,666 18,334 Nil Nil
Shawn Lammers Nil Nil 435,166 5,034 Nil Nil
John Taylor-Wilson Nil Nil 450,000 Nil Nil Nil
====================================================================================================================================
94
EMPLOYMENT CONTRACTS AND TERMINATION OF EMPLOYMENT AND CHANGE IN CONTROL
ARRANGEMENTS
Effective August 1, 1999, our Board of Directors approved a new
management agreement with Robert Rudman, which calls for payment of a base
salary of CDN$273,000 (approximately $222,000 at current exchange rates) per
annum subject to increase from time to time plus incentive compensation as
determined by our company's incentive compensation plan. Effective August 1,
2000, Mr. Rudman's salary was increased to CDN$290,000 (approximately $236,000)
per annum. Our company's incentive compensation plan expired on July 31, 2002.
The agreement with Mr. Rudman requires us to pay a termination allowance in the
event of the termination of Mr. Rudman's employment other than for just cause.
The termination allowance is equal to the annual salary.
Effective January 3, 2001, our Board of Directors approved a new
management agreement with Erwin Bartz, which calls for payment of a base salary
of CDN$150,000 (approximately $122,000) per annum subject to increase from time
to time plus incentive compensation as determined by our company's incentive
compensation plan. Effective August 1, 2001, Mr. Bartz's salary was increased to
CDN$155,000 (approximately $126,000) per annum. Effective August 1, 2002, Mr.
Bartz's salary was increased to CDN$161,500 (approximately $131,000) per annum
plus a commission based on sales to and margins in the passenger car vehicle
market. Our company's incentive compensation plan expired on July 31, 2002. The
agreement with Mr. Bartz requires us to pay a termination allowance in the event
of the termination of Mr. Bartz' employment other than for just cause. The
termination allowance is equal to the annual salary.
Effective August 1, 1999, our Board of Directors approved a new
management agreement with Shawn Lammers, which calls for payment of a base
salary of CDN$120,000 (approximately $98,000) per annum subject to increase from
time to time plus incentive compensation as determined by our company's
incentive compensation plan. Effective August 1, 2000, Mr. Lammers' salary was
increased to CDN$127,200 (approximately $103,000) per annum. Effective August 1,
2001, Mr. Lammers' salary was increased to CDN$135,000 (approximately $110,000)
per annum. Effective August 1, 2002, Mr. Lammers' salary was increased to
CDN$141,000 (approximately $115,000) per annum. Effective August 1, 2003, Mr.
Lammers' salary was increased to CDN$145,000 (approximately $118,000) per annum.
Effective December 6, 2003, Mr. Lammer's salary was increased to CDN$152,000
(approximately $124,000) per annum Our company's incentive compensation plan
expired on July 31, 2002. The agreement with Mr. Lammers requires us to pay a
termination allowance in the event of the termination of Mr. Lammers' employment
other than for just cause. The termination allowance is equal to the annual
salary.
Effective May 1, 2002, our Board of Directors approved a new management
agreement with Al Kozak, which calls for payment of a base salary of CDN$220,000
(approximately $179,000) per annum subject to increase from time to time plus
incentive compensation as determined by our company's incentive compensation
plan. Our company's incentive compensation plan expired on July 31, 2002. The
agreement with Mr. Kozak requires us to pay a termination allowance in the event
of the termination of Mr. Kozak's employment except for just cause. The
termination allowance is equal to the annual salary.
Effective October 23, 2002, our Board of Directors approved a
management agreement with Jeff Finkelstein, which calls for the payment of a
base salary of CDN$120,000 (approximately $98,000) per annum subject to increase
from time to time. Effective August 1, 2003, Mr. Finkelstein's salary was
increased to CDN$130,000 (approximately $106,000) per annum. Effective December
6, 2003, Mr. Finkelstein's salary was increased to CDN$170,000 (approximately
$138,000) per annum. This agreement with Mr. Finkelstein requires us to pay a
termination allowance in the event of the termination of Mr. Finkelstein other
than for just cause. The termination allowance is as follows:
95
o three months salary if terminated before April 23, 2003,
o six months salary if terminated between April 23, 2003 and
October 23, 2003,
o nine months salary if terminated between October 23, 2003 and
October 23, 2004, and twelve months salary if terminated after
October 23, 2004.
Effective March 31, 2003, as a temporary measure to help preserve
working capital for our company, each of the Named Executive Officers verbally
agreed to a 20% reduction in the cash that he may receive as his base salary
under his management agreement. We agreed to periodically issue shares of our
common stock to each of the Named Executive Officers to make up the balance of
the base salary that he would otherwise be entitled to receive in cash. On July
18, 2003, the 20% in salary that we had withheld since March 31, 2003 was paid
in cash to the Named Executive Officers and the 20% reduction in cash was
cancelled.
Effective August 11, 2003, our Board of Directors approved a management
agreement with John Taylor-Wilson, which calls for payment of a base salary of
CDN$140,000 (approximately $103,000) per annum plus quarterly commissions
ranging from 5% to 100% of the base salary amount if certain predetermined
performance criteria in connection with his duties as Vice President Sales and
Marketing are met. Mr. Taylor-Wilson may, with the approval of our compensation
committee, elect to receive his salary, commission and termination allowance, if
any, in such number of shares of our common stock as will be determined based on
the five day average closing price for our common stock. Pursuant to the
agreement, we also issued to Mr. Taylor-Wilson a total of 450,000 stock options
pursuant to our 2002 Stock Incentive Plan (Non-U.S.), exercisable for five years
at an exercise price equal to 115% of the 10 day average closing price for our
common stock as at August 13, 2003. The agreement is subject to the following
termination provisions:
o if we terminate the agreement for any reason other than for
just cause within three months, we will have no further
obligations to Mr. Taylor-Wilson;
o if we terminate the agreement for any reason other than for
just cause after three months and within six months, we will
be required to either continue to pay Mr. Taylor-Wilson his
salary and to provide him with benefits for a period of three
months from the date of termination or, at our option, to pay
him three months' salary in lieu of notice;
o if we terminate the agreement for any reason other than for
just cause after six months and within twelve months, we will
be required to either continue to pay Mr. Taylor-Wilson his
salary and to provide him with benefits for a period of six
months from the date of termination or, at our option, to pay
him six months' salary in lieu of notice;
o if we terminate the agreement for any reason other than for
just cause after twelve months and within twenty-four months,
we will be required to either continue to pay Mr.
Taylor-Wilson his salary and to provide him with benefits for
a period of nine months from the date of termination or, at
our option, to pay him nine months' salary in lieu of notice;
and
o if we terminate the agreement for any reason other than for
just cause after twenty-four months, we will be required to
either continue to pay Mr. Taylor-Wilson his salary and to
provide him with benefits for a period of twelve months from
the date of termination or, at our option, to pay him twelve
months' salary in lieu of notice.
We agreed to pay Mr. Taylor-Wilson's severance of CDN $32,308 (approximately
$26,000) over three months.
Other than as discussed above, our Company has no plans or arrangements in
respect of remuneration received or that may be received by Named Executive
Officers of our company in fiscal 2004 to compensate such officers in the event
of termination of employment (as a result of resignation, retirement, change of
control) or a change of responsibilities following a change of control, where
the value of such compensation exceeds $100,000 per Named Executive Officer.
96
COMPENSATION OF DIRECTORS AND EXECUTIVE OFFICERS
Directors and executive officers receive, on an annual basis, incentive
stock options to purchase shares of our common stock as awarded by our Board of
Directors in consultation with the compensation committee.
Effective January 30, 2003, we instituted a formal directors'
compensation policy whereby directors are compensated for all meetings that they
attend in person at the rate of $1,000 per day, and for all meetings that they
participate by teleconference or other electronic means at the rate of $500 per
day. Directors who participate in a meeting of any committee of the Board of
Directors are entitled to compensation at the rate of $500 per day for
attendance in person, and at the rate of $300 per day for participation by
teleconference or other electronic means. Such fees are payable only if the
meeting of the Board or of a committee of the Board, as the case may be, is more
than one-half hour in duration. Directors are also entitled to reimbursement for
reasonable travel and other out-of-pocket expenses incurred in connection with
attendance at meetings of our Board of Directors, as well as a per diem travel
time allowance of $500 per day.
Effective November 2, 2004, we amended our directors' compensation
policy whereby directors are compensated for all meetings that they attend in
person at the rate of $1,500 per day including travel days.
Our Board of Directors may award special remuneration to any director
undertaking any special services on our behalf other than services ordinarily
required of a director. Other than indicated herein, no director received and/or
accrued any compensation for his services as a director, including committee
participation and/or special assignments.
There are no arrangements or plans in which we provide pension,
retirement or similar benefits for directors or executive officers.
We have adopted ten formal stock incentive plans, two of which were
approved by our shareholders at our 1998 Annual General Meeting, two of which
were approved at our 2000 Annual General Meeting, two of which were adopted at
our 2002 Annual General Meeting, two of which were adopted by our board of
directors on August 11, 2003, one which was adopted by our board of directors on
December 17, 2004 and one of which was approved by our shareholders at our 2004
Annual General Meeting. Four of the stock incentive plans provide for awards to
eligible employees of our company or of any related entity who are resident in
the United States and/or subject to taxation in the United States; the other
four stock incentive plans provide for awards to all other eligible employees of
our company or of any related entity.
On December 10, 2004, our shareholders approved an additional formal
stock incentive plan (the "2004 US Stock Incentive Plan") which provides for the
granting to eligible employees such incentive awards as the board of directors
or a committee of the board of directors appointed to administer the 2004 US
Stock Incentive Plan may from time to time approve, provided that:
1. The awards may consist of:
(a) Common Shares or cash, or a combination of Common Shares, cash
or other securities, earned in whole or in part upon the
attainment of performance criteria that may from time to time
be established by the Board of Directors or by a committee of
the Board of Directors, or
(b) Stock options, stock appreciation rights, restricted stock
and/or certain other rights and benefits; and
2. The maximum number of Common Shares of the Company that will be
issuable pursuant to all awards granted under the 2004 US Stock
Incentive Plan will be 3,000,000.
On December 17, 2004, our board of directors approved an additional
formal stock incentive plan (the "2004 Non-US Stock Incentive Plan") which
provides for the granting to eligible employees such incentive awards as the
board of directors or a committee of the board of directors appointed to
administer the 2004 US Stock Incentive Plan may from time to time approve,
provided that:
97
1. The awards may consist of:
(a) Common Shares or cash, or a combination of Common Shares, cash
or other securities, earned in whole or in part upon the
attainment of performance criteria that may from time to time
be established by the Board of Directors or by a committee of
the Board of Directors, or
(b) Stock options, stock appreciation rights, restricted stock
and/or certain other rights and benefits; and
2. The maximum number of Common Shares of the Company that will be
issuable pursuant to all awards granted under the 2004 Non-US Stock
Incentive Plan will be 50,000,000.
To date, we have granted to directors, officers, employees and
consultants incentive stock options to purchase shares of our common stock
subject to and in accordance with the prevailing policies of the stock exchange
on which our shares were then listed. Options are granted based on the
assessment by our Board of Directors and/or compensation committee of the
optionee's past and present contribution to the success of our company. These
options are not transferable and are exercisable from the date granted until the
earliest of (i) such number of years (up to ten years) from the date of the
grant, or (ii) such number of days following the death of the optionee as is
specified in each optionee's option agreement.
Other than the management agreements, the advisory agreements and the
stock incentive plans discussed herein, we presently have no material bonus or
profit sharing plans pursuant to which cash or non-cash compensation is or may
be paid to our directors or executive officers.
98
FINANCIAL STATEMENTS
Our consolidated financial statements are stated in United States
Dollars (US$) and are prepared in conformity with generally accepted accounting
principles of the United States of America.
The following financial statements pertaining to SmarTire are filed as
part of this prospectus:
NAME PAGE
Consolidated Balance Sheets at October 31, 2004 (Unaudited) and Year Ended July 31, 2004 F-2
Consolidated Statements of Operations (Unaudited) - Three Months Ended October 31, 2004 and 2003 F-3
Consolidated Statements of Stockholders' Equity and Comprehensive Loss - Three Months Ended October 31, F-4
2004 (Unaudited) and Year Ended July 31, 2004
Consolidated Statements of Cash Flows (Unaudited) - Three Months Ended October 31, 2004 and 2003 F-5
Notes to Consolidated Financial Statements (Unaudited) - Three Months Ended October 31, 2004 and 2003 F-6-F-16
Auditors' Report F-17
Consolidated Balance Sheets at July 31, 2004 and July 31, 2003 F-18
Consolidated Statements of Operations - Years Ended July 31, 2004, July 31, 2003 and July 31, 2002 F-19
Consolidated Statements of Stockholders' Equity and Comprehensive Income (Loss) - Years Ended July 31, F-20
2004, July 31, 2003 and July 31, 2002
Consolidated Statements of Cash Flows - Years Ended July 31, 2004, July 31, 2003 and July 31, 2002 F-22
Notes to Consolidated Statements - Years Ended July 31, 2004, July 31, 2003 and July 31, 2002 F-23-F-47
SMARTIRE SYSTEMS INC.
PERIODS ENDED OCTOBER 31, 2004 AND 2003
SMARTIRE SYSTEMS INC.
CONSOLIDATED BALANCE SHEETS
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)
OCTOBER 31, 2004 AND JULY 31, 2004
October 31, 2004
(Unaudited) July 31, 2004
------------ ------------
Assets
Current assets:
Cash and cash equivalents $ 231,950 $ 112,951
Receivables, net of allowance
for doubtful accounts of nil (2004 - nil) 285,580 259,508
Inventory 3,508,997 3,245,807
Prepaid expenses 400,383 189,477
------------ ------------
4,426,910 3,807,743
Capital assets 852,592 824,616
Deferred financing costs 109,544 157,020
Other assets (note 5) 2,021,777 2,147,749
------------ ------------
$ 7,410,823 $ 6,937,128
============ ============
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable and accrued liabilities $ 1,056,505 $ 1,293,251
Deferred revenue 10,926 10,830
Promissory notes payable (note 6) 564,683 1,500,000
Current portion of convertible debentures 300,532 271,257
------------ ------------
1,932,646 3,075,338
Convertible debentures, net of equity portion
of $1,450,415 (July 31, 2004 - $1,955,356 (note 7) 136,851 395,574
Stockholders' equity:
Share capital (note 8):
Preferred shares, par value $1,000 Cdn per share:
100,000 shares authorized
Issued and outstanding; none
Common shares, without par value:
300,000,000 shares authorized
224,724,375 shares issued and outstanding at
October 31, 2004 (July 31, 2004 -103,130,761) 63,553,832 58,368,020
Additional paid-in capital 3,050,065 4,417,323
Deficit (61,402,156) (59,018,256)
Accumulated other comprehensive income (loss) 139,585 (300,871)
------------ ------------
5,341,326 3,466,216
------------ ------------
$ 7,410,823 $ 6,937,128
============ ============
Going concern (note 3)
Subsequent events (note 11)
See accompanying notes to consolidated financial statements.
Approved on behalf of the Board
/s/ Robert V. Rudman Director /s/ Bill Cronin Director
Robert V. Rudman Bill Cronin
F-2
SMARTIRE SYSTEMS INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally Accepted Accounting Principles)
THREE MONTHS ENDED OCTOBER 31, 2004 AND 2003
(Unaudited)
2004 2003
------------- -------------
Revenue $ 301,169 $ 427,526
Cost of goods sold 220,436 370,404
------------- -------------
80,733 57,122
Expenses:
Depreciation and amortization 360,137 314,952
Engineering, research and development 501,685 386,566
General and administrative 579,131 709,847
Marketing 496,787 442,961
------------- -------------
1,937,740 1,854,326
------------- -------------
Loss from operations (1,857,007) (1,797,204)
Other earnings (expenses):
Interest income 484 2,740
Net interest and financing expenses (585,021) (1,430,444)
Foreign exchange gain (loss) 57,644 (38,235)
------------- -------------
(526,893) (1,465,939)
------------- -------------
Loss for the period (2,383,900) (3,263,143)
Deficit, beginning of period (59,018,256) (48,031,230)
------------- -------------
Deficit, end of period $ (61,402,156) $ (51,294,373)
============= =============
Basic and diluted loss per share $ (0.02) $ (0.06)
Weighted average number of common shares used in the computation of
basic and diluted loss per share 152,905,430 59,185,880
============= =============
See accompanying notes to consolidated financial statements.
F-3
SMARTIRE SYSTEMS INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY AND COMPREHENSIVE LOSS
(Expressed in United States dollars)
Prepared in accordance with U. S. generally accepted accounting principles
Three months ended October 31, 2004
(unaudited) and year ended July 31, 2004
(audited)
Accumulated
Additional other
Common shares paid-in comprehensive Stockholders' Comprehensive
Shares Amount capital Deficit loss equity income (loss)
$ $ $ $ $ $
----------- ----------- ----------- ----------- ----------- ----------- -----------
Balance at July 31, 2003 55,039,065 48,204,995 6,681,893 (48,031,230) (568,354) 6,287,304 (9,505,692)
=========== =========== =========== =========== =========== =========== ===========
Exercise of stock
options for cash 79,400 15,880 -- -- -- 15,880 --
Intrinsic value of
beneficial conversion
feature of convertible
debentures plus fair
value of warrants issued -- -- 2,457,023 -- -- 2,457,023 --
Conversion of convertible
debentures and accrued
interest to common shares
allocated pro-rata between
additional paid-in-capital
and common shares, net of
issuance costs of $156,133 20,882,076 5,344,961 (2,788,277) -- -- 2,556,684 --
Exercise of warrants for
cash, net of issuance
costs of $78,370 12,463,231 3,702,985 (1,601,970) -- -- 2,101,015 --
Issuance of shares and warrants
as fees for services received 200,000 34,800 63,375 -- -- 98,175 --
Fair value of agent's warrants
issued on private placement
of convertible debentures -- -- 15,699 -- -- 15,699 --
Issuance of shares as fees
on equity line of credit 3,605,769 375,000 (375,000) -- -- -- --
Cash cost incurred
for equity line -- -- (35,420) -- -- (35,420) --
Shares issued upon
draw downs on equity line
of credit, net of issuance
cost of $60,601 10,861,220 689,399 -- -- -- 689,399
Loss for the period -- -- -- (10,987,026) -- (10,987,026) (10,987,026)
Translation adjustment -- -- -- -- 267,483 267,483 267,483
Balance at July 31, 2004 103,130,761 58,368,020 4,417,323 (59,018,256) (300,871) 3,466,216 (10,719,543)
=========== =========== =========== =========== =========== =========== ===========
Conversion of convertible
debentures and accrued
interest to common shares
allocated pro-rata between
additional paid-in-capital
and common shares, net of
issuance costs
of $335,427 (note 7) 24,479,630 1,069,815 (335,427) -- -- 734,388 --
Exercise of warrants
for cash, net of issuance
costs of $46,872 (note 8(a)) 18,226,274 1,610,231 (1,110,315) -- -- 499,916 --
Shares issued upon draw downs
on equity line, net of
issuance cost of
$219,234 (note 8) 78,887,710 2,505,766 78,484 -- -- 2,584,250 --
Loss for the period -- -- -- (2,383,900) -- (2,383,900) (2,383,900)
Translation adjustment -- -- -- -- 440,456 440,456 440,456
Balance at October 31, 2004 224,724,375 63,553,832 3,050,065 (61,402,156) 139,585 5,341,326 (1,943,444)
=========== =========== =========== =========== =========== =========== ===========
See accompanying notes to consolidated financial statements.
F-4
SMARTIRE SYSTEMS INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)
(Unaudited)
Three months ended October 31, 2004 and 2003
2004 2003
----------- -----------
Cash provided by (used for):
Operating activities:
Loss for the period $(2,383,900) $(3,263,143)
Items not affecting cash:
Depreciation and amortization 360,137 314,952
Stock based compensation expense -- 120,882
Non-cash interest and finance charges 557,962 1,350,445
Issuance of shares and warrants for services received -- 46,810
Change in non-cash working capital:
Receivables (2,824) (9,603)
Deferred revenue -- (124)
Inventory 24,549 (809,144)
Prepaid expenses (184,673) (133,103)
Accounts payable and accrued liabilities (338,191) 666,416
----------- -----------
Net cash used in operating activities (1,966,940) (1,715,612)
Investing activities:
Purchase of capital assets (15,157) (85,265)
----------- -----------
Net cash used in investing activities (15,157) (85,265)
Financing activities:
Cash received on exercise of stock options -- 15,880
Cash received on exercise of warrants (note 8(a)) 546,788 682,919
Proceeds from equity line of credit (note 8(a)) 2,725,000 --
Financing costs (not 8(a)) (187,622) (85,480)
Repayment of promissory notes (note 6) (935,317) --
----------- -----------
Net cash provided by financing activities 2,148,849 613,319
Effect of exchange rate differences on cash
and cash equivalents (47,753) 93,168
----------- -----------
Net decrease in cash and cash equivalents 118,999 (1,094,390)
Cash and cash equivalents, beginning of period 112,951 1,843,694
----------- -----------
Cash and cash equivalents, end of period $ 231,950 $ 749,304
=========== ===========
Supplementary information:
Interest and finance charges paid $ 54,475 $ 4,644
Non-cash investing and financing activities:
Conversion of convertible debentures to common shares 734,388 1,333,511
=========== ===========
See accompanying notes to consolidated financial statements.
F-5
SMARTIRE SYSTEMS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)
(Unaudited)
Three months ended October 31, 2004 and 2003
1. BASIS OF PRESENTATION:
These interim consolidated financial statements have been prepared using United
States generally accepted accounting principles. The interim financial
statements include all adjustments, consisting solely of normal recurring
adjustments, which in management's opinion are necessary for a fair presentation
of the financial results for the interim periods presented.
The disclosures in these statements do not conform in all respects to the
requirements of generally accepted accounting principles for annual financial
statements. These statements follow the same accounting policies and methods of
their application as the most recent annual financial statements. These
statements should be read in conjunction with the significant accounting
policies and other information in the Company's most recent annual financial
statements which are for the year ended July 31, 2004.
2. OPERATIONS
The Company and its subsidiaries develop and market products incorporating
wireless data transmission and processing technologies, primarily for the
automotive markets. The Company's primary product is a wireless tire monitoring
system which it currently markets for use on passenger vehicles, motorcycles,
recreational vehicles, trucks, buses and other pneumatic tire applications. All
sales of its product are made in this industry segment.
3. GOING CONCERN
The Company requires additional financing to fund its operations. The Company
has incurred recurring operating losses and has a deficit of $61,402,156 and
working capital of $2,494,264 as at October 31, 2004. During the three months
ended October 31, 2004, the Company used cash of $1,982,097 in operating and
investing activities.
The Company is pursuing various alternatives to meet its immediate and long-term
financial requirements. During the three months ended October 31, 2004, the
Company realized gross cash proceeds of $3,271,788 from financing activities to
fund its operations. The Company also has undrawn equity line of credit of
$11,525,000 as at October 31, 2004 to future operations. There can be no
assurance that the Company can draw down amounts under the equity line of credit
when required and that additional financing will be available to the Company
when needed or, if available, that it can be obtained on commercially reasonable
terms. These consolidated financial statements have been prepared on the going
concern basis which assumes that adequate sources of financing will be obtained
as required and that the Company's assets will be realized and liabilities
settled in the ordinary course of business. Accordingly, these consolidated
financial statements do not include any adjustments related to the
recoverability of assets and classification of assets and liabilities that might
be necessary should the Company be unable to continue as a going concern.
F-6
SMARTIRE SYSTEMS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)
(Unaudited)
Three months ended October 31, 2004 and 2003
4. SIGNIFICANT ACCOUNTING POLICY
Stock-based compensation:
The Company has elected under FAS 123, Accounting For Stock-based Compensation,
to account for employee stock options using the intrinsic value method. This
method is described in Accounting Principles Board ("APB") Opinion No. 25,
Accounting For Stock Issued To Employees, and related interpretations. As the
Company grants stock options with an exercise price not less than the market
value of the underlying common shares on the date of grant, no compensation
expense is required to be recognized under APB 25. FAS 123 uses the fair value
method of calculating the cost of stock option grants. Had compensation cost for
employee stock options been determined by this method, net loss and net loss per
share would have been as follows:
OCTOBER 31, OCTOBER 31,
2004 2003
------------ -----------
Net loss:
As reported $(2,383,900) $(3,263,143)
Stock-based compensation expense
recognized using intrinsic value method -- 120,882
Stock-based compensation expense
determined under fair value based
method for all awards (6,377) (1,239,597)
------------ -----------
Pro forma $(2,390,277) $(4,381,858)
=========== ===========
Basic and diluted loss per share:
As reported (0.02) (0.06)
Pro forma (0.02) (0.07)
The Company recognizes compensation expense on a straight-line basis over the
vesting period beginning on the date the stock option is granted.
The fair value of each option and warrant granted is estimated on the date of
grant using the Black-Scholes option valuation model with the following weighted
average assumptions.
October 31, October 31,
2004 2003
------------ -----------
Expected dividend yield 0% 0%
Expected stock price volatility 137% 152%
Risk-free interest rate 4.11% 3.99%
Expected life of options and warrants 5 Years 5 Years
F-7
SMARTIRE SYSTEMS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)
(Unaudited)
Three months ended October 31, 2004 and 2003
4. STOCK-BASED COMPENSATION (continued):
Weighted-average fair values of options granted during the period are as
follows:
October 31, October 31,
2004 2003
-------- -------
Options whose exercise price at date of grant:
Equals the market price of stock $ 0.04 $ --
Exceeds the market price of stock -- --
Is less than the market price of stock -- 0.16
======== =======
The Company recognizes compensation expense for stock options, common stock and
other instruments issued to non-employees for services received based upon the
fair value of the equity instruments issued as the services are performed and
the instrument is earned.
If the exercise price of employee stock option award is not fixed in the
functional currency of the company or in the currency the employee is paid, the
award is accounted for as a variable award until the award is exercised,
forfeited, or expires unexercised. The Company measures compensation as the
amount by which the quoted market value of the common shares of the Company's
stock covered by the grant exceeds the option price, with changes in the market
price included in the measurement of loss.
5. OTHER ASSETS:
The rights are being amortized over five years on a straight-line basis.
Accumulated Net book
OCTOBER 31, 2004 Cost amortization Value
---------- ---------- ----------
OEM - most medium and heavy duty trucks $1,737,500 $1,249,704 $ 487,796
OEM - all other vehicles 3,300,000 1,766,019 1,533,981
---------- ---------- ----------
$5,037,500 $3,015,723 $2,021,777
---------- ---------- ----------
F-8
SMARTIRE SYSTEMS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)
(Unaudited)
Three months ended October 31, 2004 and 2003
5. OTHER ASSETS (continued):
Management believes that the net book value of its other assets of $2,021,777 as
at October 31, 2004 is recoverable based on expectations of future cash flows
from the Company's future sales of tire monitoring systems. Management's belief
is based on an undiscounted cash flow analysis of Management's current best
estimate of projected annual sales to the passenger vehicle and light truck OEM
market plus Management's projected sales to the heavy truck OEM market.
6. PROMISSORY NOTES:
During the three months ended October 31, 2004, the Company repaid $ 935,317 of
principal and $ 50,683 in interest on its promissory notes. The Company obtained
a further extension to December 31, 2004 to repay the balance.
7. CONVERTIBLE DEBENTURES:
Balance to
Face value Debt be accreted
of debt component to operations
----------- ----------- -----------
Balance as at July 31, 2003 $ 1,966,667 $ 3 $ 1,966,664
Issuance of 11% discounted convertible
debenture with cash finance cost of $264,894
and discount of $768,590 3,493,590 1,036,567 2,457,023
Accretion of deemed debt discount to interest
expense -- 3,236,921 (3,236,921)
Discount in convertible debentures -- (768,590) 768,590
Conversion of 7%, 8% and $840,681 of
discounted convertible debentures to common
shares (2,532,355) (2,532,355) --
Cash payment on discounted convertible
debentures (305,715) (305,715) --
----------- ----------- -----------
Balance as at July 31, 2004 2,622,187 666,831 1,955,356
Accretion of deemed debt discount to interest
expense -- 504,941 (504,941)
Conversion of $734,389 of discounted
convertible debentures to common shares (734,389) (734,389) --
----------- ----------- -----------
Balance as at October 31, 2004 1,887,798 437,383 1,450,415
Less: Current portion of convertible debentures 1,449,102 300,532 1,148,570
----------- ----------- -----------
$ 438,696 $ 136,851 $ 301,845
=========== =========== ===========
F-9
SMARTIRE SYSTEMS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)
(Unaudited)
Three months ended October 31, 2004 and 2003
7. CONVERTIBLE DEBENTURES (continued):
At October 31, 2004, $275,000 of the 8% convertible debentures issued on July
17, 2003 and $1,612,798 of the convertible debentures issued at a 22% original
discount from the face principal amount on December 24, 2003 were outstanding.
During August 2004, the Company defaulted on payments to holders of its
discounted convertible debentures. In response to the default, certain debenture
holders filed legal actions against the Company. On September 24, 2004, the
Company and holders of the discounted convertible debentures signed an agreement
which provided for: withdrawal of legal action; an immediate exercise of
18,226,274 warrants at $0.03 for gross proceeds to the Company of $546,788;
conversion of $734,389 (face value) of discounted debentures into 24,479,630
common shares; a lock-up provision that establishes a daily limit on the number
of shares that can be traded by the debenture holders. The conversion of the
convertible debentures into common shares resulted in interest accretion of
$374,895 and was charged to the statement of operations as net interest and
financing expenses.
8. SHARE CAPITAL
(a) During the three months ended October 31, 2004, the Company realized gross
cash proceeds of $3,271,788 and net cash proceeds of $3,084,166 as follows:
(i) The Company issued 78,887,710 shares at effective prices ranging from $0.028
to $0.05 per share pursuant to the Standby Equity Distribution Agreement for
gross proceeds of $2,725,000 and net proceeds of $2,584,250. In addition,
$78,484 was reclassified from additional paid-in capital to share financing
expense to record the proportionate share of costs on the equity line against
the gross amount of draw downs. The issuance of these shares reduced the set
price that the holders of the convertible debentures can convert the convertible
debentures into common stock and the exercise price of 14,612,907 warrants
outstanding to $0.028. In addition the Company has $11,525,000 that has not been
drawn down under its standby Equity Distribution Agreement and has 251,070
registered shares remaining that can be drawn down against the equity line. The
Company plans to file a new registration statement to register additional
shares.
(ii) As described in note 7, on September 24, 2004, the holders of the
discounted convertible debentures exercised 18,226,274 warrants at $0.03 for
gross proceeds of $546,788, and net proceeds of $499,916.
F-10
SMARTIRE SYSTEMS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)
(Unaudited)
Three months ended October 31, 2004 and 2003
8. SHARE CAPITAL (continued):
(B) A summary of stock option transactions and balances during the period ended
October 31, 2004 is as follows:
WEIGHTED
AVERAGE
OPTIONS EXERCISE
OUTSTANDING PRICE
--------- ---------
BALANCE AT JULY 31, 2004 8,469,800 $ 0.63
OPTIONS GRANTED 90,000 0.04
OPTIONS EXERCISED - -
OPTIONS FORFEITED - -
--------- ---------
BALANCE AT OCTOBER 31, 2004 8,559,800 $ 0.62
--------- ---------
(C) As at October 31, 2004, warrants outstanding were exercisable for 19,257,211
(July 31, 2004-37,483,485) common shares of the Company. The warrants entitle
the holders to purchase common shares of the Company at prices ranging from
$.028 to $2.80 per share that expire on various dates until June 30, 2009.
9. RELATED PARTY TRANSACTIONS:
During the three months ended October 31, 2004, the Company incurred expenses of
$60,000 (2003 - $nil) for a research report to a company in which a director of
the Company has significant influence.
F-11
SMARTIRE SYSTEMS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)
(Unaudited)
Three months ended October 31, 2004 and 2003
10. SEGMENTED INFORMATION:
The Company operates in the wireless tire monitoring technology industry.
Management of the Company makes decisions about allocating resources based on
this one operating segment. Geographic information is as follows:
REVENUE FROM EXTERNAL CUSTOMERS
Three months ended
October 31, October 31,
2004 2003
-------- --------
CHINA $ -- $188,523
UNITED STATES 113,355 82,163
KOREA 2,117 58,800
UNITED KINGDOM 158,439 58,389
OTHER 27,258 39,651
-------- --------
$301,169 $427,526
======== ========
As at October 31, 2004, 52% (July 31, 2004-53%) of the Company's fixed assets
were in Canada, 17% (July 31, 2004 - 17%) were in Europe and 31% were in Korea
(July 31, 2004 - 30%).
MAJOR CUSTOMERS, REPRESENTING 10% OR MORE OF TOTAL SALES, INCLUDE:
Three months ended
October 31, October 31,
2004 2003
--------- ---------
Customer A $ 134,427 $ 26,849
Customer B 52,828 12,639
Customer C 2,117 58,800
Customer D - 176,986
========= =========
11. SUBSEQUENT EVENTS:
(a) On November 16, 2004, the Company received gross proceeds of $250,000 upon
the issuance of an unsecured short-term promissory note to an accredited
investor. There were no fees on the note. The note bears interest at a rate of
12% per annum and is repayable on December 15, 2004.
(b) On November 30, 2004, the Company received gross proceeds of $275,000 upon
the issuance of an unsecured short-term promissory note to an accredited
investor. The note bears interest at a rate of 12% per annum and is repayable on
December 30, 2004. As a commitment fee, the holder of the note received $27,500.
F-12
SMARTIRE SYSTEMS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)
(Unaudited)
Three months ended October 31, 2004 and 2003
12. DIFFERENCES BETWEEN CANADIAN AND UNITED STATES ACCOUNTING PRINCIPLES AND
PRACTICES
These consolidated financial statements have been prepared in accordance with
accounting principles and practices generally accepted in the United States ("US
GAAP") which differ in certain respects from those principles and practices that
the Company would have followed had its consolidated financial statements been
prepared in accordance with accounting principles and practices generally
accepted in Canada ("Canadian GAAP").
(a) Under U.S. GAAP, the adoption of U.S. dollar in 2001 as reporting currency
was implemented retroactively, such that prior period financial statements were
translated under the current rate method using foreign exchange rates in effect
on those dates. Under Canadian GAAP, a change in reporting currency is
implemented by translating all prior year financial statement amounts at the
foreign exchange rate on the date of change in reporting currency, which was
July 31, 2001. As a result, there is a difference in share capital, deficit and
cumulative translation adjustment amount under Canadian GAAP as compared to US
GAAP.
(b) Under U.S. GAAP, the Company has elected to continue to apply the guidance
set out in Accounting Principles Board Opinion No. 25, "Accounting for Stock
Issued to Employees" ("APB 25") and related interpretation in accounting for its
employee stock option. As the Company grants options with an exercise price not
less than the market value of the underlying common shares on the date of grant,
no compensation expense is required to be recognized under APB 25. If the
exercise price of employee stock option award is not fixed in the functional
currency of the Company or in the currency the employee is paid, the award is
accounted for as variable award until the award is exercised, forfeited, or
expires unexercised. The Company measures compensation expense as the amount by
which the quoted market value of the common shares of the Company's common stock
covered by the grant exceeds the option price, with changes in the market price
included in the measurement of loss.
F-13
SMARTIRE SYSTEMS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)
(Unaudited)
Three months ended October 31, 2004 and 2003
12. DIFFERENCES BETWEEN CANADIAN AND UNITED STATES ACCOUNTING PRINCIPLES AND
PRACTICES (continued)
(b) Prior to 2003, under Canadian GAAP, no compensation was recorded for
employee options. Subsequent to August 1, 2003, the Company elected to use the
fair-value based method under Canadian GAAP, on a prospective basis, to record
compensation expense for options. Had the Company determined compensation
expense for option grants made to employees after July 31, 2002 based on the
fair values at grant dates of the stock options consistent with the fair value
method, the Company's loss and loss per share would have been as follows:
OCTOBER 31, OCTOBER 31,
2004 2003
----------- -----------
NET LOSS:
AS REPORTED $(1,972,007) $(3,051,365)
STOCK-BASED COMPENSATION EXPENSE
INCLUDED IN REPORTED NET LOSS 9,788 1,200,771
STOCK-BASED COMPENSATION EXPENSE
DETERMINED UNDER FAIR VALUE BASED METHOD
FOR ALL AWARDS (6,377) (1,223,299)
----------- -----------
$(1,968,596) $(3,073,893)
=========== ===========
BASIC AND DILUTED LOSS PER SHARE:
AS REPORTED (0.01) (0.05)
PRO FORMA (0.01) (0.05)
=========== ===========
F-14
SMARTIRE SYSTEMS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)
(Unaudited)
Three months ended October 31, 2004 and 2003
12. DIFFERENCES BETWEEN CANADIAN AND UNITED STATES ACCOUNTING PRINCIPLES AND
PRACTICES (continued)
(c) Under U.S. GAAP, the proceeds from the issuance of convertible debentures
with detachable warrants are allocated to the fair value of warrants issued and
intrinsic value of beneficial conversion feature. The remaining proceeds are
allocated to debt which is being accreted to the redemption value of the
convertible debentures over the maturity period. On the date of conversion of
debt to equity, the difference between the carrying amount and redemption amount
is charged to statement of operations as interest expenses.
Under Canadian GAAP, the proceeds from the issuance of convertible debentures
with detachable warrants are allocated to the warrants issued and the beneficial
conversion feature based on their fair values. The remaining proceeds are
allocated to debt which is then being accreted to the redemption value of the
convertible debentures over the maturity period. On the date of conversion of
debt to equity, the carrying value of debt is reclassified to equity with no
additional interest accretion. When the Company has the option of repaying the
convertible debentures in cash or its common shares, the entire principal amount
of is recorded as equity. The principal equity is accreted to the redemption
value of the convertible debentures over the maturity period and is charged to
deficit.
(d) Under US GAAP, the discount on convertible debt is netted against the value
of debenture, and debt issuance cost is recorded as deferred financing cost and
is amortized over the maturity period. Under Canadian GAAP, the discount is
recorded as deferred financing cost and is being amortized over the maturity
period, as the value allocated to debt is only a $1. Debt issuance cost is
charged to equity.
October 31, 2004 July 31, 2004
CONSOLIDATED BALANCE SHEETS Canadian GAAP US GAAP Canadian GAAP US GAAP
-------------- -------------- -------------- --------------
Current assets $ 4,426,910 $ 4,426,910 $ 3,807,743 $ 3,807,743
Capital assets 852,592 852,592 824,616 824,616
Deferred financing costs (d) 312,279 109,544 443,016 157,020
Other assets 2,021,777 2,021,777 2,147,749 2,147,749
Current liabilities (c) 1,632,114 1,932,646 2,804,081 3,075,338
Convertible debentures (c) 1 136,851 1 395,574
Stockholders' equity 5,981,443 5,341,326 4,419,042 3,466,216
-------------- -------------- -------------- --------------
F-15
SMARTIRE SYSTEMS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)
(Unaudited)
Three months ended October 31, 2004 and 2003
12. CANADIAN ACCOUNTING PRINCIPLES (continued):
Three months ended
Consolidated statement of operations and deficit October 31, October 31,
2004 2003
------------ ------------
Net loss in accordance with U.S. GAAP $ (2,383,900) $ (3,263,143)
Effects of differences in accounting for:
Stock based compensation expense under U.S. GAAP (b) -- 120,882
Stock based compensation expense under
Canadian GAAP (b) (9,788) (1,200,771)
Interest accretion recorded under US GAAP (c) 374,895 1,327,667
Amortization of debenture finance costs under U.S. GAAP (d) 177,521 --
Amortization of debenture finance costs under Canadian GAAP (d) (130,737) --
------------ ------------
Net loss in accordance with Canadian GAAP (1,972,009) (3,015,365)
Beginning deficit in accordance with Canadian GAAP (51,971,332) (41,762,812)
Interest on convertible debentures and
amortization of financing charges (d) (393,907) --
------------ ------------
Ending deficit in accordance with Canadian GAAP $(54,337,248) $(44,778,177)
Basic and diluted loss per share (Canadian GAAP) $ (0.01) $ (0.05)
============ ============
13. COMPARATIVE FIGURES:
Certain figures have been reclassified to conform to the financial statement
presentation adopted for the current year.
F-16
CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)
SMARTIRE SYSTEMS INC.
YEARS ENDED JULY 31, 2004, 2003 AND 2002
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUTING FIRM
TO THE SHAREHOLDERS OF SMARTIRE SYSTEMS INC.
We have audited the consolidated balance sheets of SmarTire Systems Inc. as at
July 31, 2004 and 2003 and the consolidated statements of operations,
stockholders' equity and comprehensive income (loss) and cash flows for each of
the years in the three year period ended July 31, 2004. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with Canadian generally accepted auditing
standards and the standards of the Public Company Accounting Oversight Board
(United States). Those standards require that we plan and perform an audit to
obtain reasonable assurance whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of the Company as at
July 31, 2004 and 2003 and the results of its operations and its cash flows for
each of the years in the three year period ended July 31, 2004 in accordance
with U.S. generally accepted accounting principles.
On September 10, 2004, except for note 16 which is as of October 5, 2004, we
reported separately to the shareholders of the Company on the consolidated
balance sheets as at July 31, 2004 and 2003 and the consolidated statements of
operations and deficit and cash flows for the years then ended, which
consolidated financial statements were prepared in accordance with Canadian
generally accepted accounting principles.
/s/KPMG LLP
Chartered Accountants
Vancouver, Canada
September 10, 2004, except for note 16
which is as of October 5, 2004
COMMENTS BY AUDITOR FOR U.S. READERS ON CANADA - U.S. REPORTING DIFFERENCE
In the United States, reporting standards for auditors require the addition of
an explanatory paragraph (following the opinion paragraph) when the financial
statements are affected by conditions and events that cast substantial doubt on
the Company's ability to continue as a going concern, such as those described in
note 2 to the financial statements. Our report to the shareholders dated
September 10, 2004, except for note 16 which is as of October 5, 2004, is
expressed in accordance with Canadian reporting standards which do not permit a
reference to such events and conditions in the report of independent registered
public accounting firm when these are adequately disclosed in the financial
statements.
/s/KPMG LLP
Chartered Accountants
Vancouver, Canada
September 10, 2004, except for note 16
which is as of October 5, 2004
F-17
SMARTIRE SYSTEMS INC.
Consolidated Balance Sheets
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)
July 31, 2004 and 2003
- -----------------------------------------------------------------------------------------------------------------------------
2004 2003
- -----------------------------------------------------------------------------------------------------------------------------
Assets
Current assets:
Cash and cash equivalents $ 112,951 $ 1,843,694
Receivables, net of allowance for doubtful accounts
of nil (2003 - nil) 259,508 405,885
Inventory (note 4) 3,245,807 806,846
Prepaid expenses 189,477 165,792
- -----------------------------------------------------------------------------------------------------------------------------
3,807,743 3,222,217
Capital assets (note 5) 824,616 550,458
Deferred financing costs (note 10) 157,020 183,259
Other assets (note 6) 2,147,749 3,129,658
- -----------------------------------------------------------------------------------------------------------------------------
$ 6,937,128 $ 7,085,592
=============================================================================================================================
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable and accrued liabilities $ 1,293,251 $ 788,267
Deferred revenue 10,830 10,018
Promissory notes payable (note 7) 1,500,000 --
Current portion of convertible debentures 271,257 --
- -----------------------------------------------------------------------------------------------------------------------------
3,075,338 798,285
Convertible debentures, net of equity portion of $1,955,356
(2003 - $1,966,664) (note 8) 395,574 3
Stockholders' equity:
Share capital (note 9):
Preferred shares, par value $1,000 Cdn per share:
100,000 shares authorized
Issued and outstanding: none
Common shares, without par value:
300,000,000 shares authorized (July 31, 2003-200,000,000)
103,130,761 shares issued and outstanding at
July 31, 2004 (July 31, 2003 -55,039,065) 58,368,020 48,204,995
Additional paid-in capital 4,417,323 6,681,893
Deficit (59,018,256) (48,031,230)
Accumulated other comprehensive loss (300,871) (568,354)
- -----------------------------------------------------------------------------------------------------------------------------
3,466,216 6,287,304
- -----------------------------------------------------------------------------------------------------------------------------
$ 6,937,128 $ 7,085,592
=============================================================================================================================
Going concern (note 2)
Commitments and contingencies (note 14)
Subsequent events (note 16)
See accompanying notes to consolidated financial statements.
Approved on behalf of the Board
/s/ Robert V. Rudman Director /s/ Bill Cronin Director
- ------------------------- ------------------------
Robert V. Rudman Bill Cronin
F-18
SMARTIRE SYSTEMS INC.
Consolidated Statements of Operations
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)
Years ended July 31, 2004, 2003 and 2002
- ----------------------------------------------------------------------------------------------------------------------------
2004 2003 2002
- ----------------------------------------------------------------------------------------------------------------------------
Revenue $ 1,658,279 $ 1,802,596 $ 1,012,344
Cost of goods sold 1,445,563 1,387,365 699,955
- ----------------------------------------------------------------------------------------------------------------------------
212,716 415,231 312,389
Expenses:
Depreciation and amortization 1,371,717 1,236,870 1,152,378
Engineering, research and development 1,654,690 1,177,935 1,727,606
General and administrative 2,338,758 2,939,260 2,631,215
Marketing 1,821,122 1,448,326 1,527,644
- ----------------------------------------------------------------------------------------------------------------------------
7,186,287 6,802,391 7,038,843
- ----------------------------------------------------------------------------------------------------------------------------
Loss from operations (6,973,571) (6,387,160) (6,726,454)
Other earnings (expenses):
Interest income 5,873 2,835 18,735
Net interest and financing expenses (4,031,820) (3,722,505) (145,472)
Foreign exchange gain 12,492 192,201 24,015
- ----------------------------------------------------------------------------------------------------------------------------
(4,013,455) (3,527,469) (102,722)
- ----------------------------------------------------------------------------------------------------------------------------
Loss for the year $(10,987,026) $ (9,914,629) $ (6,829,176)
============================================================================================================================
Basic and diluted loss per share $ (0.13) $ (0.37) $ (0.41)
Weighted average number of common
shares used in the computation of basic
and diluted loss per share (note 13) 83,356,095 26,771,427 16,743,977
============================================================================================================================
See accompanying notes to consolidated financial statements.
F-19
SMARTIRE SYSTEMS INC.
Consolidated Statements of Stockholders' Equity and Comprehensive Income (Loss)
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)
====================================================================================================================================
Years ended July 31, 2004, 2003 and 2002
Accumulated
Common shares Additional Deferred other
---------------------- paid-in stock comprehensive Stockholders'Comprehensive
Shares Amount capital compensation Deficit loss equity income (loss)
- ------------------------------------------------------------------------------------------------------------------------------------
$ $ $ $ $ $ $
Balance at July 31, 2001 15,159,369 37,566,083 683,462 (40,773) (31,287,425) (806,198) 6,115,149 (5,779,943)
====================================================================================================================================
Issuance of common
shares for cash
upon private
placements, net
of issuance costs
of $551,569 3,352,000 4,650,289 -- -- -- -- 4,650,289 --
Exercise of warrants
for cash, net of
issuance costs
of $10,890 200,000 298,110 -- -- -- -- 298,110 --
Fair value of
warrants issued
on private placement -- -- 206,340 -- -- -- 206,340 --
Forfeiture of
stock options -- -- (4,341) 4,341 -- -- -- --
Compensation
expense -- -- -- 19,427 -- -- 19,427 --
Loss for the
period -- -- -- -- (6,829,176) -- (6,829,176) (6,829,176)
Translation
adjustment -- -- -- -- -- (171,093) (171,093) (171,093)
- ------------------------------------------------------------------------------------------------------------------------------------
Balance at July
31, 2002 18,711,369 42,514,482 885,461 (17,005) (38,116,601) (977,291) 4,289,046 (7,000,269)
====================================================================================================================================
Issuance of common
shares for cash
upon private
placements, net
of issuance costs
of $289,172
(note 9(a)) 6,964,286 1,810,828 -- -- -- -- 1,810,828 --
Intrinsic value of
beneficial
conversion feature
of convertible
debentures plus
fair value of
warrants issued
(note 8) -- -- 5,157,521 -- -- -- 5,157,521 --
Conversion of
convertible
debenture and
accrued interest
to common shares
net of issuance
costs of $628,526
(note 8) 24,381,133 3,024,395 -- -- -- -- 3,024,395 --
Exercise of warrants
for cash, net of
issuance costs
of $61,060 (note 9(b)) 3,300,000 298,940 -- -- -- -- 298,940 --
Issuance of shares
as fees on equity
line of credit
(note 9(c)) 478,412 300,000 -- -- -- -- 300,000 --
- ------------------------------------------------------------------------------------------------------------------------------------
Balance carried forward 53,835,200 47,948,645 6,042,982 (17,005) (38,116,601) (977,291) 14,880,730 --
F-20
SMARTIRE SYSTEMS INC.
Consolidated Statements of Stockholders' Equity and Comprehensive Income (Loss)
(Continued)
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)
Years ended July 31, 2004, 2003 and 2002
====================================================================================================================================
Accumulated
Common shares Additional Deferred other
---------------------- paid-in stock comprehensive Stockholders'Comprehensive
Shares Amount capital compensation Deficit loss equity income (loss)
- ------------------------------------------------------------------------------------------------------------------------------------
$ $ $ $ $ $ $
Balance brought forward 53,835,200 47,948,645 6,042,982 (17,005) (38,116,601) (977,291) 14,880,730 --
Fair value of agent's
warrants issued on
private placements and
convertible debentures
(notes 8 and 9) -- -- 502,367 -- -- -- 502,367 --
Debt settlement through
issuance of common
shares (note 9(d)) 353,865 77,850 -- -- -- -- 77,850 --
Issuance of shares and
repricing of warrants
to settle a potential
claim (note 9(e)) 850,000 178,500 136,544 -- -- -- 315,044 --
Compensation expense -- -- -- 17,005 -- -- 17,005 --
Loss for the period -- -- -- -- (9,914,629) -- (9,914,629) (9,914,629)
Translation adjustment -- -- -- -- -- 408,937 408,937 408,937
- ------------------------------------------------------------------------------------------------------------------------------------
Balance at July 31, 2003 55,039,065 48,204,995 6,681,893 -- (48,031,230) (568,354) 6,287,304 (9,505,692)
====================================================================================================================================
Exercise of stock options
for cash (note 9 (j)) 79,400 15,880 -- -- -- -- 15,880 --
Intrinsic value of
beneficial conversion
feature of convertible
debentures plus fair
value of warrants
issued (note 8) -- -- 2,457,023 -- -- -- 2,457,023 --
Conversion of convertible
debentures and accrued
interest to common shares
allocated pro-rata between
additional paid-in-capital
and common shares, net
of issuance costs of
$156,133 (note 8) 20,882,076 5,344,961 (2,788,277) -- -- -- 2,556,684 --
Exercise of warrants for
cash, net of issuance
costs of $78,370
(note 9(f)) 12,463,231 3,702,985 (1,601,970) -- -- -- 2,101,015 --
Issuance of shares and
warrants as fees for
services
received (note 9(g)) 200,000 34,800 63,375 -- -- -- 98,175 --
Fair value of agent's
warrants issued on
private placement of
convertible debentures
(note 8(d)) -- -- 15,699 -- -- -- 15,699 --
Issuance of shares as
fees on equity line of
credit (note 9(h)) 3,605,769 375,000 (375,000) -- -- -- -- --
Cash cost incurred for
equity line (note 9(h)) -- -- (35,420) -- -- -- (35,420) --
Shares issued upon draw
downs on equity line
of credit, net of
issuance cost of
$60,601 (note 9(h)) 10,861,220 689,399 -- -- -- -- 689,399
Loss for the period -- -- -- -- (10,987,026) (10,987,026) (10,987,026)
Translation adjustment -- -- -- -- -- 267,483 267,483 267,483
- ------------------------------------------------------------------------------------------------------------------------------------
Balance at July 31, 2004 103,130,761 58,368,020 4,417,323 -- (59,018,256) (300,871) 3,466,216 (10,719,543)
====================================================================================================================================
See accompanying notes to consolidated financial statements.
F-21
SMARTIRE SYSTEMS INC.
Consolidated Statements of Cash Flows
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)
Years ended July 31, 2004, 2003 and 2002
===============================================================================================================================
2004 2003 2002
- -------------------------------------------------------------------------------------------------------------------------------
Cash provided by (used for):
Operating activities:
Loss for the year $(10,987,026) $ (9,914,629) $ (6,829,176)
Items not affecting cash:
Depreciation and amortization 1,371,717 1,236,870 1,152,378
Stock-based compensation -- 17,005 19,427
Non-cash interest and finance charges 3,842,107 3,694,914 --
Issuance of shares and warrants for services received 98,175 -- --
Issuance of shares and repricing of warrants to settle a
potential claim (note 9(c)) -- 315,044 --
Changes in non-cash working capital:
Receivables 170,127 (182,366) (5,266)
Deferred revenue -- 9,423 --
Deferred financing expense -- (5,000) --
Inventory (2,391,749) 594,333 151,249
Prepaid expenses (13,984) 240,861 (294,769)
Accounts payable and accrued liabilities 374,794 (434,556) 346,652
- -------------------------------------------------------------------------------------------------------------------------------
Net cash used in operating activities (7,535,839) (4,428,101) (5,459,505)
Investing activities:
Purchase of capital assets (446,780) (62,978) (164,886)
Purchase of other asset -- -- (500,000)
- -------------------------------------------------------------------------------------------------------------------------------
Net cash used in investing activities (446,780) (62,978) (664,886)
Financing activities:
Cash received on exercise of stock options 15,880 -- --
Issuance of common shares -- 2,100,000 5,173,500
Cash received on exercise of warrants (note 9 (f)) 2,179,385 360,000 309,000
Proceeds from convertible debentures (note 8) 2,725,000 5,618,000 --
Proceeds from promissory note (note 7) 1,500,000 250,000 --
Proceeds from equity line of credit (note 9) 750,000 -- --
Financing costs (626,696) (886,799) (316,871)
Repayment of promissory notes (notes 6 and 7) (305,715) (1,600,000) (1,450,000)
- -------------------------------------------------------------------------------------------------------------------------------
Net cash provided by financing activities 6,237,854 5,841,201 3,715,629
Effect of exchange rate differences on cash
and cash equivalents 14,022 (32,396) 4,473
- -------------------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents (1,730,743) 1,317,726 (2,404,289)
Cash and cash equivalents, beginning of year 1,843,694 525,968 2,930,257
- -------------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents, end of year $ 112,951 $ 1,843,694 $ 525,968
===============================================================================================================================
Supplementary information:
Interest and finance charges paid $ 189,713 $ 27,591 $ 92,093
Non-cash investing and financing activities:
Purchase of other asset through issuance of promissory note -- -- 2,800,000
Fair value of agents warrants issued in conjunction with
financings 15,699 502,367 206,340
Shares issued for financing services on private placement -- -- 28,358
Settlement of debt through issuance of common shares
(note 9(d)) -- 77,850 --
Conversion of convertible debentures to common shares 2,556,684 3,024,395 --
Issuance of shares as consideration for equity line of credit 375,000 300,000 --
Financing costs included in accounts payable 52,859 30,000 --
===============================================================================================================================
See accompanying notes to consolidated financial statements.
F-22
SMARTIRE SYSTEMS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)
YEARS ENDED JULY 31, 2004, 2003 AND 2002
1. OPERATIONS:
The Company and its subsidiaries develop and market products incorporating
wireless data transmission and processing technologies, primarily for the
automotive markets. The Company's primary product is a wireless tire monitoring
system which it currently markets for use on passenger vehicles, motorcycles,
recreational vehicles, trucks, buses and other pneumatic tire applications. All
sales of its product are made in this industry segment.
2. GOING CONCERN:
The Company requires additional financing to fund its operations. The Company
has incurred recurring operating losses and has a deficit of $59,018,256 and
working capital of $732,405 as at July 31, 2004. During the year ended July 31,
2004, the Company used cash of $7,982,619 in operating and investing activities.
The Company is pursuing various alternatives to meet its immediate and long-term
financial requirements. During fiscal 2004, the Company realized gross cash
proceeds of $7,170,265 from financing activities (2003-$8,328,000) and arranged
a $15.0 million equity line of credit (note 9(h)) to fund its operations.
Subsequent to the year-end, the Company raised gross proceeds of $2,746,788
(note 16). There can be no assurance that the Company can draw down amounts
under the equity line of credit when required and that additional financing will
be available to the Company when needed or, if available, that it can be
obtained on commercially reasonable terms. These consolidated financial
statements have been prepared on the going concern basis which assumes that
adequate sources of financing will be obtained as required and that the
Company's assets will be realized and liabilities settled in the ordinary course
of business. Accordingly, these consolidated financial statements do not include
any adjustments related to the recoverability of assets and classification of
assets and liabilities that might be necessary should the Company be unable to
continue as a going concern.
3. SIGNIFICANT ACCOUNTING POLICIES:
(a) Basis of presentation:
These consolidated financial statements include the accounts of the Company and
its wholly-owned subsidiaries, SmarTire USA Inc., SmarTire Europe Limited, and
SmarTire Technologies Inc. All intercompany balances and transactions have been
eliminated.
(b) Research and development costs:
Research and development costs are expensed as incurred. Equipment used in
research and development is capitalized only if it has an alternative future
use.
(c) Cash and cash equivalents:
Cash and cash equivalents includes investments in short-term investments with a
term to maturity when acquired of 90 days or less.
F-23
SMARTIRE SYSTEMS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)
YEARS ENDED JULY 31, 2004, 2003 AND 2002
3. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED):
(d) Inventory:
Inventory of raw materials are recorded at the lower of cost, determined on a
first-in, first-out basis, and net realizable value. Inventory of finished goods
and work-in progress are recorded at the lower of average cost and net
realizable value. Average cost is determined using the weighted-average method
and includes invoice cost, duties and freight where applicable plus direct
labour applied to the product and an applicable share of manufacturing overhead.
A provision for obsolescence for slow moving inventory items is estimated by
management based on historical and expected future sales and is included in cost
of goods sold.
(e) Capital assets:
Capital assets are recorded at cost. Depreciation of computer hardware and
software and office and shop equipment is provided for on the declining balance
basis at 30% per annum. Leasehold improvements are depreciated over the lesser
of their useful lives or the term of the lease.
(f) Other assets:
Other assets include the license to manufacture and sell tire monitoring systems
to the original equipment vehicle manufacturers (note 6). Other assets are
recorded at cost and are being amortized over five years on a straight-line
basis.
(g) Impairment of long-lived assets:
The Company monitors the recoverability of long-lived assets, based on estimates
using factors such as expected future asset utilization, business climate and
future undiscounted cash flows expected to result from the use of the related
assets or to be realized on sale. The Company recognizes an impairment loss if
the projected undiscounted future cash flows is less than the carrying amount.
The amount of the impairment charge, if any, is measured equal to the excess of
the carrying value over the expected future cash flows discounted using the
Company's average cost of funds.
(h) Revenue recognition:
The Company recognizes revenue when there is persuasive evidence of an
arrangement, goods are shipped and title passes, collection is probable, and the
fee is fixed or determinable. Customer acceptance is used as the criterion for
revenue recognition when the product sold does not have an established sales
history to allow management to reasonably estimate returns and future
provisions. Provisions are established for estimated product returns and
warranty costs at the time the revenue is recognized. The Company records
deferred revenue when cash is received in advance of the revenue recognition
criteria being met. Revenue from engineering services is recognized on services
as they are rendered and pre-defined milestones are achieved. Engineering
services revenue for the year were $94,800 (2003-$173,400 and 2002 - nil).
F-24
SMARTIRE SYSTEMS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)
YEARS ENDED JULY 31, 2004, 2003 AND 2002
3. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED):
(i) Loss per share:
Basic loss per share computations are based on the weighted average number of
shares outstanding during the year. If in a period the Company has outstanding
dilutive stock options and warrants, diluted loss per share is calculated using
the treasury stock method.
(j) Income taxes:
The Company accounts for income taxes in accordance with the asset and liability
method. Under this method, deferred income taxes are recognized for the future
income tax consequences attributable to differences between the financial
statement carrying amounts and their respective income tax bases and for loss
and tax credit carryforwards. Deferred tax assets and liabilities are measured
using enacted tax rates expected to apply to taxable income in the years in
which temporary differences are expected to be recovered or settled. The effect
on deferred income tax assets and liabilities of a change in tax rates is
recognized in income in the period of enactment. Deferred income tax assets are
evaluated and if their realization is not considered to be "more likely than
not", a valuation allowance is provided.
(k) Warranty costs:
The Company accrues warranty costs upon the recognition of related revenue,
based on its best estimates, with reference to past experience. See note 14(c).
(l) Foreign currency translation:
The Company's functional or primary operating currency is the Canadian dollar.
The Company's financial statements are prepared in Canadian dollars before
translation to the US dollar reporting currency. The Company translates
transactions in currencies other than the Canadian dollar at the exchange rate
in effect on the transaction date. Monetary assets and liabilities denominated
in a currency other than the Canadian dollar are translated at the exchange
rates in effect at the balance sheet date. The resulting exchange gains and
losses are recognized in earnings. Amounts reported in Canadian dollars have
been translated into US dollars as follows: assets and liabilities are
translated into US dollars at the rate of exchange in effect at the balance
sheet date and revenue and expense items are translated at the average rates for
the period. Unrealized gains and losses resulting from the translation into the
reporting currency are accumulated in accumulated other comprehensive loss, a
separate component of stockholders' equity.
F-25
SMARTIRE SYSTEMS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)
YEARS ENDED JULY 31, 2004, 2003 AND 2002
3. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED):
(m) Use of estimates:
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management at the
date of the financial statements 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 to revenues and expenses during the reporting period. Significant areas
requiring the use of estimates include estimating the net realizable value of
inventory, the future cash flows for assessing the net recoverable amount of
long-lived assets and warranty reserve. Actual results may differ from those
estimates.
(n) Stock-based compensation:
The Company has elected under FAS 123, Accounting for Stock-based Compensation,
to account for employee stock options using the intrinsic value method. This
method is described in Accounting Principles Board ("APB") Opinion No. 25,
Accounting for Stock Issued to Employees, and related interpretations. As the
Company grants stock options with an exercise price not less than the market
value of the underlying common shares on the date of grant, no compensation
expense is required to be recognized under APB 25. FAS 123 uses the fair value
method of calculating the cost of stock option grants. Had compensation cost for
employee stock options been determined by this method, net loss and net loss per
share would have been as follows:
===================================================================================================================
2004 2003 2002
- -------------------------------------------------------------------------------------------------------------------
Net loss:
As reported $(10,987,026) $ (9,914,629) $ (6,829,176)
Stock-based compensation expense
recognized using intrinsic value method -- 17,005 19,427
Stock-based compensation expense
determined under fair value based
method for all awards (1,291,736) (738,339) (1,076,749)
- -------------------------------------------------------------------------------------------------------------------
Pro forma $(12,278,762) $(10,635,963) $ (7,886,498)
===================================================================================================================
Basic and diluted loss per share:
As reported (0.13) (0.37) (0.41)
Pro forma (0.15) (0.40) (0.47)
===================================================================================================================
F-26
SMARTIRE SYSTEMS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)
YEARS ENDED JULY 31, 2004, 2003 AND 2002
3. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED):
(n) Stock-based compensation (continued):
The Company recognizes compensation expense on a straight-line basis over the
vesting period beginning on the date the stock option is granted.
The fair value of each option and warrant granted is estimated on the date of
grant using the Black-Scholes option valuation model with the following range of
weighted average assumptions.
===================================================================================================================
2004 2003 2002
- -------------------------------------------------------------------------------------------------------------------
Expected dividend yield 0% 0% 0%
Expected stock price volatility 139-152% 128-155% 129%
Risk-free interest rate 3.28-4.08% 3.6-4.3% 4.35%
Expected life of options and warrants 3-5 years 2-5 years 1-2 years
- -------------------------------------------------------------------------------------------------------------------
Weighted-average fair values of options granted during the year are as follows:
===================================================================================================================
2004 2003 2002
- -------------------------------------------------------------------------------------------------------------------
Options whose exercise price at date of grant:
Equals the market price of stock $ 0.07 $ 0.72 $ --
Exceeds the market price of stock 0.16 0.94 2.07
Is less than the market price of stock -- -- --
===================================================================================================================
The Company recognizes compensation expense for stock options, common stock and
other instruments issued to non-employees for services received based upon the
fair value of the equity instruments issued as the services are performed and
the instrument is earned.
If the exercise price of employee stock option award is not fixed in the
functional currency of the Company or in the currency the employee is paid, the
award is accounted for as a variable award until the award is exercised,
forfeited, or expires unexercised. The Company measures compensation as the
amount by which the quoted market value of the common shares of the Company's
stock covered by the grant exceeds the option price, with changes in the market
price included in the measurement of loss.
(o) Comprehensive income:
Under SFAS 130, Reporting Comprehensive Income, the Company is required to
report comprehensive income, which includes net loss as well as changes in
equity from non-owner sources. The other changes in equity included in
comprehensive income for the periods presented comprise the foreign currency
cumulative translation adjustments. Accumulated other comprehensive loss is
presented in the consolidated statements of stockholders' equity and
comprehensive income (loss).
F-27
SMARTIRE SYSTEMS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)
YEARS ENDED JULY 31, 2004, 2003 AND 2002
3. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED):
(p) Recent accounting pronouncements:
In December 2003, the FASB issued FASB Interpretation No. 46 (revised December
2003), Consolidation of Variable Interest Entities, which addresses how a
business enterprise should evaluate whether it has a controlling financial
interest in an entity through means other than voting rights and accordingly
should consolidate the entity. FIN 46R replaces FASB Interpretation No. 46,
Consolidation of Variable Interest Entities, which was issued in January 2003.
The Company will be required to apply FIN 46R to variable interest in VIEs
created after December 31, 2003. For variable interests in VIEs created before
January 1, 2004, the Interpretation will be applied beginning on July 31, 2004.
For any VIEs that must be consolidated under FIN 46R that were created before
January 1, 2004, the assets, liabilities and noncontrolling interests of the VIE
initially would be measured at their carrying amounts with any difference
between the net amount added to the balance sheet and any previously recognized
interest being recognized as the cumulative effect of an accounting charge. If
determining the carrying amounts is not practicable, fair value at the date FIN
46R first applies may be used to measure the assets, liabilities and
noncontrolling interest of the VIE. The Company currently has no variable
interest entities, hence there is no impact of FIN 46R on these consolidated
financial statements.
In April 2003, the FASB issued FAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities" ("FAS No. 149"), which amends and
clarifies financial accounting and reporting for derivative instruments,
including certain derivative instruments embedded in other contracts, and for
hedging activities under FAS No. 133. FAS No. 149 is to be applied prospectively
for certain contracts entered into or modified after June 30, 2003. The Company
has adopted FAS No. 149, which had no effect on our consolidated financial
statements.
FASB Statement No. 150, Accounting for Certain Financial Instruments with
Characteristics of both Liabilities and Equity, was issued in May 2003. This
Statement establishes standards for the classification and measurement of
certain financial instruments with characteristics of both liabilities and
equity. The Statement also includes required disclosures for financial
instruments within its scope. For the Company, the Statement was effective for
instruments entered into or modified after May 31, 2003 and otherwise will be
effective as of August 1, 2004, except for mandatorily redeemable financial
instruments. For certain mandatorily redeemable financial instruments, the
Statement will be effective for the Company on August 1, 2005. The effective
date has been deferred indefinitely for certain other types of mandatorily
redeemable financial instruments. The Company has adopted FAS No. 150, which had
no impact on these consolidated financial statements.
F-28
SMARTIRE SYSTEMS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)
YEARS ENDED JULY 31, 2004, 2003 AND 2002
4. Inventory:
=============================================================================================================
2004 2003
-------------------------------------------------------------------------------------------------------------
Raw materials $ 1,515,438 $ 318,512
Work in progress 554,421 59,599
Finished goods 1,175,948 428,735
-------------------------------------------------------------------------------------------------------------
$ 3,245,807 $ 806,846
=============================================================================================================
5. CAPITAL ASSETS:
=============================================================================================================
Accumulated Net book
2004 Cost amortization Value
-------------------------------------------------------------------------------------------------------------
Computer hardware and software $ 697,178 $ 509,980 $ 187,198
Office and shop equipment 1,336,068 786,049 550,019
Leasehold improvements 207,327 119,928 87,399
-------------------------------------------------------------------------------------------------------------
$ 2,240,573 $ 1,415,957 $ 824,616
=============================================================================================================
=============================================================================================================
Accumulated Net book
2003 Cost amortization Value
-------------------------------------------------------------------------------------------------------------
Computer hardware and software $ 600,781 $ 415,801 $ 184,980
Office and shop equipment 886,748 609,095 277,653
Leasehold improvements 192,515 104,690 87,825
-------------------------------------------------------------------------------------------------------------
$ 1,680,044 $ 1,129,586 $ 550,458
=============================================================================================================
6. OTHER ASSETS:
On December 13, 2000, the Company entered into an Assignment and Amendment
Agreement with TRW Inc. ("TRW") that transferred to the Company the license to
manufacture and sell tire monitoring systems to the original equipment vehicle
manufacturers of most medium and heavy duty trucks. Consideration consisted of
490,072 shares of common stock valued at $1,337,500, based on the market value
of the Company's stock at the date of purchase, plus cash of $400,000.
On August 31, 2001, the Company and TRW entered into an agreement to restructure
their strategic alliance. Under the terms of restructuring, the Company and TRW
agreed to terminate a number of agreements. The Company has the right to
manufacture and sell tire monitoring systems to the original equipment vehicle
manufacturers market ("OEM"). Consideration consisted of a promissory note of
$2.8 million, carrying an interest rate of 6% per annum plus cash of $500,000.
The balance of principal in the amount of $1,350,000 owed at July 31, 2002 was
repaid during fiscal 2003 and interest of $97,542 on this balance was forgiven
by TRW.
F-29
SMARTIRE SYSTEMS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)
YEARS ENDED JULY 31, 2004, 2003 AND 2002
6. OTHER ASSETS (CONTINUED):
The rights are being amortized over five years on a straight-line basis.
=============================================================================================================
Accumulated Net book
2004 Cost amortization Value
- -------------------------------------------------------------------------------------------------------------
OEM - most medium and heavy duty trucks $ 1,737,500 $ 1,190,402 $ 547,098
OEM - all other vehicles 3,300,000 1,699,349 1,600,651
- -------------------------------------------------------------------------------------------------------------
$ 5,037,500 $ 2,889,751 $ 2,147,749
=============================================================================================================
=============================================================================================================
Accumulated Net book
2003 Cost amortization Value
- -------------------------------------------------------------------------------------------------------------
OEM - most medium and heavy duty Trucks $ 1,737,500 $ 845,850 $ 891,650
OEM - all other vehicles 3,300,000 1,061,992 2,238,008
- -------------------------------------------------------------------------------------------------------------
$ 5,037,500 $ 1,907,842 $ 3,129,658
=============================================================================================================
Management believes that the net book value of its other assets of $2,147,749 as
at July 31, 2004 is recoverable based on expectations of future cash flows from
the Company's future sales of tire monitoring systems. Management's belief is
based on an undiscounted cash flow analysis of management's current best
estimate of projected annual sales to the passenger vehicle and light truck OEM
market plus management's projected sales to the heavy truck OEM market.
7. PROMISSORY NOTES:
During the year, the Company received total gross proceeds of $1,500,000 upon
the issuance of two unsecured short-term promissory notes of $750,000 each, to
an accredited investor. Each note bears interest at a rate of 8% per annum and
was repayable on August 13, 2004 and September 16, 2004 respectively (see note
16 for subsequent events). As a commitment fee, the holder of the notes received
a total of $150,000.
F-30
SMARTIRE SYSTEMS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)
YEARS ENDED JULY 31, 2004, 2003 AND 2002
8. Convertible debentures:
=============================================================================================================
Balance to
Face value Debt be accreted
of debt component to operations
- -------------------------------------------------------------------------------------------------------------
Balance as at July 31, 2002 $ -- $ -- $ --
10% redeemable convertible debentures
with cash financing cost of $76,177 (a) 750,000 66,000 684,000
5% redeemable convertible debentures
with cash financing cost of $94,000 and
discount of $32,000 (b) 400,000 257,143 142,857
7% and 8% convertible debentures with
cash financing cost of $483,022 (c) 4,500,000 3 4,499,997
- -------------------------------------------------------------------------------------------------------------
Initial allocation 5,650,000 323,146 5,326,854
Accretion of deemed debt discount to
interest -- 3,329,778 (3,329,778)
Conversion of 10%, 5% and $2,533,333 of
7% convertible debentures to common
shares (a, b, c) (3,683,333) (3,652,921) (30,412)
- -------------------------------------------------------------------------------------------------------------
Balance as at July 31, 2003 1,966,667 3 1,966,664
Issuance of 11% discounted convertible debenture
with cash finance cost of $264,894 and discount
of $768,590(d) 3,493,590 1,036,567 2,457,023
Accretion of deemed debt discount to interest
expense -- 3,236,921 (3,236,921)
Discount in convertible debentures (d) -- (768,590) 768,590
Conversion of 7%, 8% and $840,681 of discounted
convertible debentures to common shares (c, d)
(2,532,355) (2,532,355) --
Cash payment on discounted convertible
debentures (d) (305,715) (305,715) --
- -------------------------------------------------------------------------------------------------------------
Balance as at July 31, 2004 2,622,187 666,831 1,955,356
Less: current portion of convertible debentures
1,714,284 271,257 1,443,027
- -------------------------------------------------------------------------------------------------------------
$ 907,903 $ 395,574 $ 512,329
=============================================================================================================
F-31
SMARTIRE SYSTEMS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)
YEARS ENDED JULY 31, 2004, 2003 AND 2002
8. CONVERTIBLE DEBENTURES (CONTINUED):
(a) In the first private placement during the year ended July 31, 2003, the
Company realized gross cash proceeds of $500,000 and $250,000, respectively,
from the issuance of 10% redeemable convertible notes of the Company plus
150,000 share purchase warrants on the completion of a private placement
effected pursuant to Regulation S under the Securities Act of 1933. The
agreements were signed on September 20, 2002 and the notes were to mature on
December 20, 2002.
On November 4, 2002, the holders converted these convertible notes into
1,500,000 units. Each unit consisted of one common share and one share purchase
warrant. Each warrant entitles the holder to purchase one additional common
share at an exercise price of $0.50 per share until November 4, 2005. On
conversion of these senior convertible notes, the carrying value of debt and
accrued interest was reclassified to common shares included in stockholders'
equity. Interest accretion of $684,000 was charged to the statement of
operations as interest expense during the year ended July 31, 2003.
Each warrant initially entitled the holder to purchase one of the Company's
common shares and is exercisable at a price of $1.25 on or before September 20,
2005, on which date the warrant will expire. These warrants were subsequently
repriced to $0.10 on May 6, 2003 as described in note 9(e).
For accounting purposes, the Company calculated the fair value of warrants
issued using the Black-Scholes model using the weighted average assumptions as
disclosed in note 3(n) and the intrinsic value of the beneficial conversion
feature, which in aggregate totals $684,000, and initially recorded these values
as additional paid-in capital. The intrinsic value is the amount by which the
fair value of the underlying common shares at the date of the agreement exceeds
the conversion price.
Advisors to the private placement received a cash commission of $60,000 or 8% on
the face value of the notes and 120,000 share purchase warrants exercisable at a
price equal to the lesser of conversion price of the convertible notes into
common shares or $0.50. The Company also incurred an additional cash cost of
$16,177 to secure the funding. The warrants are exercisable over five years and
expire on November 4, 2007. The fair value of these warrants at the date of
grant was $51,393. The fair value of the warrants was estimated on the date of
issuance using the Black-Scholes option valuation model.
(b) In the second private placement during fiscal 2003, the Company issued
senior subordinated redeemable convertible debentures to a private investment
company bearing interest at 5% per annum. The Company closed the first tranche
on November 21, 2002 and the second tranche on January 31, 2003. In each
tranche, the Company received proceeds of $184,000 for the issuance of a
debenture in the principal amount of $200,000. Total net cash proceeds after
finance charges were $274,000. Each debenture was issued at an 8% discount from
the face principal amount. Advisors to the placement received a cash commission
of $64,000 and 68,325 warrants. Additional expenses of $30,000 were incurred for
this transaction. The fair value of these warrants at the date of grant was
estimated at $15,626. The fair value of these warrants was estimated on the date
of issuance using the Black-Scholes option valuation model.
F-32
SMARTIRE SYSTEMS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)
YEARS ENDED JULY 31, 2004, 2003 AND 2002
8. CONVERTIBLE DEBENTURES (CONTINUED):
(b) Continued:
For accounting purposes, the Company calculated the intrinsic value of the
beneficial conversion feature which amounted to $142,857 and initially recorded
its value as additional paid-in capital. The remaining balance of $257,143 was
recorded as liability.
The commission and fair value of the warrant were recorded as financing costs.
These debentures were converted to common shares between February 10, 2003 and
May 16, 2003 at conversion prices ranging from $0.064 to $0.28. Interest
accretion of $142,857 was charged to the statement of operations as interest
expense during the year ended July 31, 2003.
(c) On June 17, 2003, the Company closed a private placement of 7% convertible
debentures in three tranches pursuant to (c) Rule 506 of Regulation D under the
Securities Act of 1933, for gross proceeds of $2,800,000. On July 17, 2003, the
Company closed another private placement of 8% convertible debentures pursuant
to Rule 506 of Regulation D under the Securities Act of 1933, for gross proceeds
of $1,700,000. Net cash proceeds from the convertible debentures were
$4,016,978.
In connection with the offering of the convertible debentures, the Company
issued 23,846,153 common share purchase warrants which expire between July 17,
2008 and November 10, 2008. Advisors to the transactions received a cash
commission of $360,000 and 180,000 share purchase warrants: 112,000 share
purchase warrants for a period of five years, and 68,000 share purchase warrants
for a period of three years. At July 31, 2004 the warrants entitle the holders
to purchase common shares of the Company at $0.059 per share (subject to
adjustment pursuant to the anti-dilution provisions contained in the warrants).
The fair value of these warrants at the date of grant was estimated at $77,640
using the Black-Scholes option valuation model using weighted average
assumptions as disclosed in note 3(n). Additional expenses related to this
offering were $123,022 plus 100,000 share purchase warrants exercisable at a
price of $0.135 per share for a period of five years. The financing cost will be
amortized over the lesser of the life of the convertible debentures or the date
of redemption or conversion into common shares.
Interest on the debentures is payable quarterly on March 1, June 1, September 1
and December 1, and at maturity, in cash or, at the Company's option, in shares
of the Company's common stock at an interest conversion price equal to 90% of
the lesser of the average closing bid price during the 20 trading days
immediately preceding the interest payment date, or the average closing bid
price during the 20 trading days immediately preceding the date on which the
shares are issued if such shares are issued and delivered after the interest
payment date. The Company's right to elect to pay accrued interest in shares of
its common stock is subject to certain conditions, including the requirement
that there shall be an effective registration statement qualifying the resale of
the common stock to be issued to the holders of the convertible debentures in
lieu of a cash interest payment. All overdue accrued and unpaid interest under
the convertible debentures will be subject to a late fee at the rate of 18% per
annum.
F-33
SMARTIRE SYSTEMS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)
YEARS ENDED JULY 31, 2004, 2003 AND 2002
8. CONVERTIBLE DEBENTURES (CONTINUED):
(c) Continued:
The Company may not prepay any portion of the principal amount on any
convertible debenture without the prior written consent of the holder of the
debenture.
The Company will be considered in default of the convertible debentures if
certain events occur. Once an event of default occurs, the holder of a
convertible debenture can elect the Company to immediately repay a mandatory
prepayment amount as outlined in the agreement.
If an event of default occurs, the holder of a convertible debenture can elect
to require the Company to immediately repay a mandatory prepayment amount equal
to the greater of:
(i) 120% of the principal amount of the debenture, plus all accrued and unpaid
interest and any other amounts outstanding in respect of the debenture; or
(ii) 120% of the principal amount of the debenture, plus all accrued and unpaid
interest and any other amounts outstanding in respect of the debenture, divided
by the conversion price of the debenture, and multiplied by the greater of:
A. the last reported closing bid price for our common stock on the date on which
the payment is due, or
B. the last reported closing bid price for our common stock on the date on which
the payment actually paid.
For accounting purposes, the proceeds from the issuance of these convertible
debentures were primarily allocated to fair value of warrants issued and the
intrinsic value of the beneficial conversion feature, which amounts to
$2,799,997 and $1,700,000 respectively. The fair value of the warrants was
calculated using the Black Scholes option model using assumptions as disclosed
in note 3(n). The remaining value of the proceeds of $3 was allocated to debt
and is being accreted to the redemption value of the convertible debentures over
the period from the date of issuance to the initial maturity dates of May 19,
2005 and July 16, 2006.
During the year ended July 31, 2003, $2,533,333 of principal and $12,846 of
interest were converted into common shares resulting in the issuance of
19,564,102 common shares. Interest accretion of $2,533,322 was charged to the
statement of operations as interest expense upon conversion of convertible
debentures.
F-34
SMARTIRE SYSTEMS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)
YEARS ENDED JULY 31, 2004, 2003 AND 2002
8. CONVERTIBLE DEBENTURES (CONTINUED):
(c) Continued:
During the year ended July 31, 2004, $1,691,667 of principal and $41,270 of
interest were converted into common shares resulting in the issuance of
13,601,799 common shares. Interest accretion of $1,732,935 was charged in the
statement of operations as interest expense upon conversion of convertible
debentures.
As at July 31, 2004, $275,000 of the convertible debenture remained outstanding.
(d) On December 24, 2003, the Company closed a private placement of discounted
unsecured convertible debentures in the aggregate principal amount of
$3,493,590. The Company also issued 7,939,978 warrants exercisable at $0.25
(subject to adjustment pursuant to the anti-dilution provisions contained in the
warrants) with an expiry period of 5 years. The Company issued the convertible
debentures at a 22% original issue discount from the face principal amount
(based on a notional interest rate of 11% per annum for each year of the
two-year term of the debentures), resulting in gross proceeds of $2,725,000. The
discount of $768,590 has been netted against the face value of debentures and is
being amortized over the maturity period. Advisors to the transaction received a
cash commission of $218,000 and 109,000 three year share purchase warrants
exercisable at a price of $0.25 each (subject to adjustment pursuant to the
anti-dilution provisions contained in the warrants). The fair value of these
warrants at the date of grant was estimated at $15,699. The fair value of these
warrants was estimated on the date of issuance using the Black-Scholes option
valuation model using the volatility 141%, risk free interest rate 3.28%,
expected life of warrants 3 years. In addition, expenses of $46,894 for
professional fees related to this transaction were incurred. The discounted
convertible debentures do not otherwise bear interest, and will mature on April
1, 2006. The outstanding principal amount of each debenture may be converted at
any time into shares of the Company's common stock, in whole or in part, at the
option of the holder of the debenture at a set price of $0.22 per share (subject
to adjustment pursuant to the anti-dilution provisions contained in the
debentures). The Company will make the monthly redemption payments of $145,566
over two years in cash unless during the twenty trading day prior notice period
immediately prior to the applicable monthly redemption date the Company
irrevocably notifies the holder that it will issue underlying shares in lieu of
cash at a conversion price equal to the lesser of:
(i) the set price of $0.22 per share (subject to adjustment pursuant to the
anti-dilution provisions contained in the debentures), and
(ii) 85% of the average of the closing prices of the Company's common stock for
twenty days immediately preceding the applicable monthly redemption date,
provided that certain conditions are met, including the condition that the
underlying shares of common stock shall have been registered under the
Securities Act of 1933, as amended.
F-35
SMARTIRE SYSTEMS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)
YEARS ENDED JULY 31, 2004, 2003 AND 2002
8. CONVERTIBLE DEBENTURES (CONTINUED):
(d) Continued:
For accounting purposes, the proceeds from the issuance of these convertible
debentures were allocated to the fair value of the warrants issued and the
intrinsic value of the beneficial conversion feature which amounts to $861,351
and $1,595,672, respectively. The fair value of the warrants was calculated
using the Black-Scholes option valuation model using assumptions consistent with
those disclosed in note 3(n). The remaining proceeds of $1,036,567 was allocated
to debt and is being accreted to the redemption value of the convertible
debentures over the maturity period. Monthly redemption payments for February,
March, April and May 2004 were made in shares of the Company, except for one
cash payment of $14,583. Monthly redemption payments of $145,566 for each of
June and July were made in cash. During the year, holders of discounted
convertible debentures also converted $273,000 of convertible debentures into
common shares. This resulted in additional interest accretion of $240,085.
During the year ended July 31, 2004, interest accretion of $1,206,762 was
charged to the statement of operations as interest expense.
9. SHARE CAPITAL:
(a) During the year ended July 31, 2003, the Company issued 6,964,286 units in
five separate private placements for gross cash proceeds of $2,100,000, each
effected pursuant to Regulation S under the Securities Act of 1933. 6,964,286
units consist of 6,964,286 common shares and 5,714,286 share purchase warrants.
Each warrant entitles the holder to purchase one additional common share at an
exercise price ranging from $0.10 to $0.85. Warrants begin to expire in November
4, 2005. These warrants were repriced to have an exercise price of $0.10 per
share on May 6, 2003 (note 9(e)). Advisors to the private placement were paid a
commission of $168,000 and were issued 291,143 share purchase warrants
exercisable at a price ranging from $0.10 to $0.85. The fair value of these
warrants at the date of grant was estimated at $121,172. The fair value of these
warrants is estimated on the date of issuance using the Black-Scholes option
valuation model using the weighted average assumptions as disclosed in note
3(n). The fair value of the warrants issued to the advisors and commission paid
is recorded as share issue cost.
F-36
SMARTIRE SYSTEMS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)
YEARS ENDED JULY 31, 2004, 2003 AND 2002
9. SHARE CAPITAL (CONTINUED):
(b) The Company also realized gross cash proceeds of $360,000 and net cash
proceeds of $334,400 from the exercise of 3,300,000 warrants. Advisors to the
transactions received a cash commission of $25,600 and 224,000 share purchase
warrants exercisable at a price of $0.10. The fair value of these warrants at
the date of grant was estimated at $35,460 by the Black-Scholes option valuation
using the weighted average assumptions as disclosed in note 3(n). The fair value
of the warrants were recorded as share issue costs.
(c) The Company also arranged a $15.0 million and $5.0 million equity line of
credit facilities from separate private investment companies during 2003.
Neither facility has been used nor registered with the Securities and Exchange
Commission. The $5.0 million equity line of credit facility was cancelled on
July 22, 2004. During the year ended July 31, 2004, the Company decided not to
use the $15.0 million equity line of credit facility as it entered into a new
equity line of credit facility (note 9(h).
(i) The Company issued 1,250,000 warrants exercisable at a price of $0.1955 per
share for three years as consideration for the $15.0 million equity line of
credit. The fair value of these warrants at the date of grant is estimated at
$178,259 using the Black-Scholes option valuation using the weighted average
assumptions as disclosed in note 3(n). The fair value of the warrant was
expensed as an interest and finance cost during fiscal 2004.
(ii) On the date of execution of the $5.0 million equity line of credit
facility, the Company issued shares worth $290,000 based on the trading price of
the stock of the Company on that day. Shares worth $10,000 were issued to the
placement agent on February 26, 2003. The Company has recorded the fair value of
the common shares as an interest and financing expense.
(d) On April 3, 2003, the Company issued to the former managing director of
SmarTire Europe Limited a total of 353,865 common shares at a deemed price of
$0.22 per share, in partial payment and settlement of the Company's obligation
to pay him a termination allowance in connection with the termination of his
management agreement, without cause, on October 15, 2002.
F-37
SMARTIRE SYSTEMS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)
YEARS ENDED JULY 31, 2004, 2003 AND 2002
9. SHARE CAPITAL (CONTINUED):
(e) On May 6, 2003, the Company issued 850,000 shares at a deemed price of $0.21
per share to an accredited investor and repriced 1,000,000 warrants previously
issued to the investor on December 20, 2002, thereby reducing the exercise price
of the warrant from $0.70 per share to $0.10 per share. An aggregate of
3,614,286 additional warrants previously issued to other investors were also
repriced to an exercise price of $0.10 per share. These transactions were all
effected pursuant to Regulation S under the Securities Act of 1933, and were
effected in consideration of certain releases provided by the investors to the
Company in respect of certain potential unquantified claims threatened by the
investors against the Company. The fair value of the shares is $178,500 based on
the deemed price of $0.21 and the incremental fair value of the warrants is
$136,544. The fair value of the warrant is estimated on the date of issuance by
the Black-Scholes option valuation model using the weighted average assumptions
as disclosed in note 3(n). The incremental fair value of these warrants and the
value of shares issued were recorded as an administrative expense.
(f) For the year ended July 31, 2004, the Company realized gross cash proceeds
of $2,179,385 and net cash proceeds of $2,101,015 from the exercise of warrants
as follows:
(i) On April 30, 2004, 500,000 warrants were exercised at $0.104 resulting in
gross cash proceeds of $52,000 and net cash proceeds of $49,920.
(ii) On October 27, 2003, the Company offered warrant holders who were issued
warrants with an exercise price of $0.2645 on May 15, 2003 in connection with
the convertible debenture a reduction in their exercise price to $0.20 plus one
additional warrant at $0.20 if they exercised their warrants. A total of
3,290,596 warrants were exercised. In addition, the Company granted 194,000
additional warrants exercisable at a price of $0.20 per share for five years to
a shareholder who also exercised their warrants. On November 6, 2003, the
exercise price of the 7,478,635 warrants initially granted at $0.2645 were
reduced to $0.1771 and were exercised for gross proceeds of $1,324,466.
During October and November 2003, the fair value of the 10,963,231 warrants of
$1,601,970 initially recorded as additional paid in capital was reclassified to
share capital on exercise of the warrants.
(iii) On May 20, 2004, the Company realized gross cash proceeds of $120,000 from
the exercise of 1,000,000 warrants at an exercise price of $0.12 per share.
F-38
SMARTIRE SYSTEMS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)
YEARS ENDED JULY 31, 2004, 2003 AND 2002
9. Share capital (continued):
(g) During the year ended July 31, 2004, 200,000 common shares with a fair
market value of $0.174 per share, 300,000 share purchase warrants with an
exercise price of $0.17 per share and 250,000 share purchase warrants with an
exercise price of $0.20 per share were issued for services received. The fair
value of these warrants at the date of grant was estimated at $63,375. The fair
value of these warrants was estimated on the date of issuance using the
Black-Scholes option valuation model using the weighted average assumptions
consistent with those as described in note 3(n). Fair value of common shares and
warrants of $98,175 has been exercised.
(h) On May 19, 2004, the Company arranged a $15 million Standby Equity
Distribution Agreement from a private investment company. The Company may, at
its discretion, draw down $500,000 every seven business days, subject to an
effective registration statement. In consideration for each draw down, the
Company will sell shares of common stock at a 2% discount to the lowest closing
bid prices for the 5 trading days after an advance notice is given by the
Company. In addition, 5% of each advance will be retained by the private
investment company as a commission.
On June 1, 2004, the Company filed a registration statement with the Securities
and Exchange Commission to register the $15 million equity line of credit that
was declared effective on June 14, 2004. On June 1, 2004, the Company issued
3,605,769 shares at an effective price of $0.104 per share as payment for the
$365,000 commitment fee and $10,000 placement agency fee related to the Standby
Equity Distribution Agreement. The Company also incurred additional costs of
$35,420 in fees to prepare and file the registration statement. During the year
ended July 31, 2004, the Company effected three draw downs of $250,000 each at
prices of $.090, $.065 and $.059, which resulted in the issuance of 10,861,220
common shares and net proceeds of $689,399. In addition, the Company incurred an
additional $60,000 as a financing expense to advisors of the Standby Equity
Distribution Agreement of which $30,000 is payable as at July 31, 2004.
(i) On December 15, 2003, the Company's authorized common share capital was
increased to 300,000,000 pursuant to a special resolution of the shareholders
adopted at the annual and special annual meeting of the Company held on December
11, 2003.
F-39
SMARTIRE SYSTEMS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)
YEARS ENDED JULY 31, 2004, 2003 AND 2002
9. SHARE CAPITAL (CONTINUED):
(j) Stock-based compensation plans:
At July 31, 2004, the Company had eight stock-based compensation plans that are
described below:
(i) Under the "1998 US Stock Incentive Plan" the Company may grant options to
its employees for up to 300,000 common shares.
Under the "1998 Stock Incentive Plan" the Company may grant options to its
employees for up to 600,000 common shares.
(ii) Under the "2000 US Stock Incentive Plan" the Company may grant options to
its employees for up to 200,000 common shares.
Under the "2000 Stock Incentive Plan" the Company may grant options to its
employees for up to 800,000 common shares.
(iii) Under the "2002 US Stock Incentive Plan" the Company may grant options to
its employees for up to 100,000 common shares.
Under the "2002 Stock Incentive Plan" the Company may grant options to its
employees for up to 900,000 common shares.
(iv) Under the "2003 US Stock Incentive Plan" the Company may grant options to
its employees for up to 2,000,000 common shares.
Under the "2003 Stock Incentive Plan" the Company may grant options to its
employees for up to 8,000,000 common shares.
The options currently outstanding under the "2003 US Stock Incentive Plan" and
the "2003 Stock Incentive Plan" vest immediately. The options currently
outstanding under the "1998 US Stock Incentive Plan" and the "2000 and 2002
Stock Incentive Plan" generally vest from two to four years, with the first 20%
to 33% vesting at the date of grant and the balance vesting annually at each
anniversary date of the grant thereafter. The exercise price of each option is
based on the fair value of the common stock at the date of grant. These options
have a five year term.
================================================================================================================================
2004 2003 2002
---------------------------- --------------------------- --------------------------
Weighted Weighted Weighted
average average average
exercise exercise exercise
Shares price Shares price Shares price
- --------------------------------------------------------------------------------------------------------------------------------
Outstanding, beginning of year 1,714,400 $ 2.54 1,677,250 $ 3.08 1,458,750 $ 3.20
Options granted 9,169,600 0.20 778,300 1.42 484,700 2.88
Options exercised (79,400) (0.20) -- -- -- (2.00)
Options forfeited (2,334,800) (0.38) (741,150) (2.80) (266,200) (3.40)
- --------------------------------------------------------------------------------------------------------------------------------
Outstanding, end of year 8,469,800 $ 0.63 1,714,400 $ 2.54 1,677,250 $ 3.08
================================================================================================================================
F-40
SMARTIRE SYSTEMS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)
YEARS ENDED JULY 31, 2004, 2003 AND 2002
9. SHARE CAPITAL (CONTINUED):
(j) Stock-based compensation plans (continued):
=====================================================================================================================
Options outstanding Options exercisable
------------------------------------------------- --------------------------------------------
Weighted
average Weighted Weighted
remaining average average
Range of Number contractual exercise Number exercise
exercise prices of shares life price exercisable price
- ---------------------------------------------------------------------------------------------------------------------
$0.085 -0.20 6,900,200 4.07 $0.20 6,900,200 $0.20
$0.37 -1.00 136,134 3.46 0.52 136,134 0.52
$1.16 - 6.76 1,433,466 2.07 2.71 1,222,337 2.78
- ---------------------------------------------------------------------------------------------------------------------
$0.85 - 6.76 8,469,800 3.72 $0.63 8,258,671 $0.59
=====================================================================================================================
The Company normally issues options to directors at fixed exercise prices.
75,000 options issued to directors and outstanding as at July 31, 2004 (2002 -
75,000) vested immediately, but if not exercised each year, there is an annual
20% increase in the exercise price until the options expire. For accounting
purposes these options are considered to be variable in nature and compensation
expense is recorded to the extent of increases in the market value of the
underlying common shares as compared to the exercise price at each reporting
period.
Where options issued after January 18, 2001 have an exercise price in a currency
that is not either the (a) functional currency of the Company, or (b) the
currency in which the employee is paid, the options are to be accounted for as
variable plan options and compensation expense will be recorded equal to changes
in the market value of the underlying common shares at each reporting period.
The Company normally grants options in U.S. dollars when the functional currency
of the Company is the Canadian dollar. Most employees of the Company are paid in
either Canadian dollars or British pounds sterling. Accordingly, these employee
options are considered to be variable options.
The compensation expense for these variable options for the year ended July 31,
2004 is nil (2003 - nil). In addition, compensation expense is recognized to the
extent that options are granted having an exercise price less than the market
price of the underlying common stock on the date of grant.
(k) Warrants:
As at July 31, 2004, warrants outstanding were exercisable for 37,483,485 (2003
- - 32,154,507) common shares of the Company. The warrants entitle the holders to
purchase common shares of the Company at prices ranging from $0.059 to $2.80 per
share and expire on various dates until June 30, 2009.
The exercise price of warrants issued were not less than the market price of the
Company's common shares at the date of issuance.
F-41
SMARTIRE SYSTEMS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)
YEARS ENDED JULY 31, 2004, 2003 AND 2002
10. DEFERRED FINANCING COSTS:
=======================================================================================================================
2004 2003
- -----------------------------------------------------------------------------------------------------------------------
Equity line of credit
Fair value of agents warrants (note 9(c)) $ -- $ 178,259
Professional fees -- 5,000
- -----------------------------------------------------------------------------------------------------------------------
-- 183,259
Convertible debenture (note 8)
Commission 218,000 --
Fair value of agents warrants 15,699 --
Professional fees 46,894 --
- -----------------------------------------------------------------------------------------------------------------------
280,593 --
Amortization (123,573) --
- -----------------------------------------------------------------------------------------------------------------------
157,020 --
- -----------------------------------------------------------------------------------------------------------------------
$ 157,020 $ 183,259
=======================================================================================================================
The deferred charges related to the discounted convertible debenture are
being amortized over the maturity period. During the year, $123,573 was
amortized and charged to interest expense.
11. FINANCIAL INSTRUMENTS:
(a) Fair value of financial instruments:
The carrying values of cash and cash equivalents, receivables,
accounts payable and accrued liabilities, promissory notes payable
and convertible debentures approximate their fair values due to
being in a ready cash form or the short-term maturity of these
instruments.
(b) Credit risk:
The majority of the Company's activities are concentrated in the
automotive industry and sales are primarily to a few major customers
(note 15). To reduce credit risk, management performs ongoing credit
evaluations of its customers' financial condition. The Company
maintains reserves for potential credit losses based on a risk
assessment of its customers.
(c) Foreign currency risk:
The Company operates internationally which gives rise to the risk
that cash flows may be adversely impacted by exchange rate
fluctuations. To July 31, 2004, the Company has not entered into
derivatives or other hedging instruments to mitigate its foreign
exchange risk.
F-42
SMARTIRE SYSTEMS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)
Years ended July 31, 2004, 2003 and 2002
================================================================================
12. INCOME TAXES:
(a) Effective tax rate:
The effective income tax rates differ from the Canadian statutory
rates for the following reasons:
===================================================================================================================
2004 2003 2002
- -------------------------------------------------------------------------------------------------------------------
Canadian statutory tax rate 36.4% 38.5% 41.7%
Computed tax expense $ (3,999,277) $ (3,817,132) $ (2,847,766)
Foreign losses tax affected at lower rates 5,162 192,027 128,066
Reduction in effective tax rates (339,481) -- 483,059
Permanent and other differences 1,352,012 387,870 975,676
Change in valuation allowance 2,981,584 3,237,235 1,260,965
- -------------------------------------------------------------------------------------------------------------------
$ -- $ -- $ --
===================================================================================================================
(b) Deferred tax assets and liabilities:
===================================================================================================================
2004 2003 2002
- -------------------------------------------------------------------------------------------------------------------
Deferred tax assets:
Fixed and other assets, accounting
depreciation in excess of tax $ 1,220,775 861,607 $ 519,987
Loss carryforwards 16,534,418 14,148,423 11,472,671
Scientific research and development
expenses 382,971 359,733 319,525
Share issue costs 549,499 373,523 192,718
Others 37,207 -- 1,150
- -------------------------------------------------------------------------------------------------------------------
Total gross deferred tax assets 18,724,870 15,743,286 12,506,051
Valuation allowance (18,724,870) (15,743,286) (12,506,051)
- -------------------------------------------------------------------------------------------------------------------
Net deferred tax assets $ -- $ -- $ -
===================================================================================================================
F-43
SMARTIRE SYSTEMS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)
YEARS ENDED JULY 31, 2004, 2003 AND 2002
12. INCOME TAXES (CONTINUED):
(b) Deferred tax assets and liabilities (continued):
In assessing the realizability of future tax assets, Management considers
whether it is more likely than not that some portion or all of the future tax
assets will be realized. The ultimate realization of the future tax assets is
dependent upon the generation of future taxable income during the periods in
which those temporary differences become deductible.
For Canadian tax purposes, the Company has approximately $31,500,000 of
non-capital losses for income tax purposes available at July 31, 2004 to reduce
taxable income of future years. These losses will expire as follows:
====================================================================
2005 $ 3,200,000
2006 7,600,000
2007 200,000
2008 4,400,000
2009 5,600,000
2010 4,900,000
2011 5,600,000
- --------------------------------------------------------------------
$ 31,500,000
====================================================================
Additionally, for Canadian tax purposes, the Company has scientific research and
development expenditures of $1,080,000 available to reduce future taxable income
indefinitely.
For United States tax purposes, the Company has approximately $6,100,000 of net
operating losses for income tax purposes available at July 31, 2004 to reduce
taxable income of future years. These losses will expire as follows:
====================================================================
2012 $ 100,000
2013 1,000,000
2019 1,800,000
2020 1,300,000
2021 400,000
2022 800,000
2023 300,000
2024 400,000
- --------------------------------------------------------------------
$ 6,100,000
====================================================================
For United Kingdom tax purposes, the Company has approximately $9,600,000 of
non-capital losses for income tax purposes available at July 31, 2004 to reduce
taxable income of future years. These losses may be carried forward
indefinitely.
F-44
SMARTIRE SYSTEMS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)
YEARS ENDED JULY 31, 2004, 2003 AND 2002
13. EARNINGS (LOSS) PER SHARE:
The weighted average number of shares outstanding used in the computation of
earnings (loss) per share were as follows:
===============================================================================================
2004 2003 2002
- -----------------------------------------------------------------------------------------------
Weighted-average shares used in computation
of basic earnings (loss) per share 83,356,095 26,771,427 16,743,977
Weighted average shares from assumed
conversion of dilutive warrants and options -- -- --
- -----------------------------------------------------------------------------------------------
Fully diluted weighted average number
of common shares 83,356,095 26,771,427 16,743,977
===============================================================================================
14. COMMITMENTS AND CONTINGENCIES:
(a) The Company is committed to the following payments under operating leases,
and service agreements for premises and certain equipment and consultants:
====================================================================
2005 $ 1,372,953
2006 218,325
2007 182,176
2008 143,303
2009 142,570
2010 139,907
====================================================================
(b) Cash and short-term investments are used to secure credit card advances in
the amount of $15,000 (2003 - $25,000).
(c) Product warranties:
The Company provides for estimated warranty costs at the time of product sale.
Warranty expense accruals are based on best estimate with reference to
historical claims experience. As warranty estimates are based on forecasts,
actual claim costs may differ from amounts provided. An analysis of changes in
liability for product warranties follows:
===================================================================
Balance, August 1, 2002 $ 9,114
Provision increase 29,946
Expenditures (18,622)
- --------------------------------------------------------------------
Balance, July 31, 2003 20,438
Provision increase 85,934
Expenditures (16,512)
- --------------------------------------------------------------------
Balance, July 31, 2004 $ 89,860
====================================================================
F-45
SMARTIRE SYSTEMS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)
YEARS ENDED JULY 31, 2004, 2003 AND 2002
15. SEGMENTED INFORMATION:
The Company operates in the wireless tire monitoring technology industry.
Management of the Company makes decisions about allocating resources based on
this one operating segment. Geographic information is as follows:
Revenue from external customers:
=============================================================================================
Revenue from
external customers
------------------------------------------------------------------
2004 2003 2002
- ---------------------------------------------------------------------------------------------
United States $ 651,089 $ 509,228 $ 524,516
United Kingdom 225,517 261,905 266,638
Italy -- 391,169 12,629
China 514,365 243,866 --
Other 267,308 396,428 208,561
- ---------------------------------------------------------------------------------------------
$ 1,658,279 $ 1,802,596 $ 1,012,344
=============================================================================================
As at July 31, 2004, 53% (July 31, 2003-73%) of the Company's fixed assets were
in Canada, 17% (July 31, 2003-27%) were in Europe and 30% were in Korea (July
31, 2003-nil). Major customers, representing 10% or more of total sales,
include:
=============================================================================================
2004 2003 2002
- ---------------------------------------------------------------------------------------------
Customer A $ 484,433 $ -- $ --
Customer B -- 391,169 12,629
Customer C 28,472 125,413 143,487
Customer D 113,888 109,270 187,314
=============================================================================================
16. SUBSEQUENT EVENTS:
(a) Between August 9, 2004 and October 5, 2004, the Company issued 60,673,423
shares at effective prices ranging from $0.03 to $0.05 per share pursuant to the
Standby Equity Distribution Agreement for gross proceeds of $2,200,000 and net
proceeds of $2,086,500. The issuance of these shares reduced the set price that
the holders of the convertible debentures can convert the convertible debentures
into common stock and the exercise price of 14,612,907 warrants outstanding to
$0.037.
(b) Subsequent to year end, the Company defaulted on payments to holders of its
discounted convertible debentures. In response to the default, certain debenture
holders filed legal actions against the Company. On September 24, 2004, the
Company and holders of the discounted convertible debentures signed an agreement
which provided for: withdrawal of legal action; an immediate exercise of
18,226,274 warrants at $0.03 for gross proceeds of $546,788 and conversion of
$734,389 of debentures into 24,479,630 common shares and a lock-up provision
that establishes a daily limit on the number of shares that can be traded by the
debenture holders.
F-46
SMARTIRE SYSTEMS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)
YEARS ENDED JULY 31, 2004, 2003 AND 2002
16. SUBSEQUENT EVENTS (CONTINUED):
(c) Between August 1, 2004 and October 5, 2004, the Company repaid $651,837 of
principal and $49,663 in accrued interest on its promissory notes. The Company
obtained an extension to November 30, 2004 to repay the balance due on the
promissory notes.
17. COMPARATIVE FIGURES:
Certain figures have been reclassified to conform to the financial statement
presentation adopted for the current year.
F-47
WHERE YOU CAN FIND MORE INFORMATION
We are required to file annual, quarterly and current reports, proxy
statements and other information with the Securities and Exchange Commission.
Our Securities and Exchange Commission filings are available to the public over
the Internet at the SEC's website at http://www.sec.gov.
You may also read and copy any materials we file with the Securities
and Exchange Commission at the SEC's public reference room at 450 Fifth Street
N.W., Washington, D.C. 20549. Please call the SEC at 1-800-SEC-0330 for further
information on the operation of the public reference rooms.
We have filed with the Securities and Exchange Commission a
registration statement on Form SB-2, under the Securities Act with respect to
the securities offered under this prospectus. This prospectus, which forms a
part of that registration statement, does not contain all information included
in the registration statement. Certain information is omitted and you should
refer to the registration statement and its exhibits. With respect to references
made in this prospectus to any contract or other document of SmarTire, the
references are not necessarily complete and you should refer to the exhibits
attached to the registration statement for copies of the actual contract or
document. You may review a copy of the registration statement at the SEC's
public reference room. Please call the SEC at 1-800-SEC-0330 for further
information on the operation of the public reference rooms. Our filings and the
registration statement can also be reviewed by accessing the SEC's website at
http://www.sec.gov.
NO FINDER, DEALER, SALES PERSON OR OTHER PERSON HAS BEEN AUTHORIZED TO
GIVE ANY INFORMATION OR TO MAKE ANY REPRESENTATION IN CONNECTION WITH THIS
OFFERING OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS AND, IF GIVEN OR MADE,
SUCH INFORMATION OR REPRESENTATION MUST NOT BE RELIED UPON AS HAVING BEEN
AUTHORIZED BY SMARTIRE SYSTEMS INC. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER
TO SELL OR A SOLICITATION OF AN OFFER TO BUY ANY OF THE SECURITIES OFFERED
HEREBY BY ANYONE IN ANY JURISDICTION IN WHICH SUCH OFFER OR SOLICITATION IS NOT
AUTHORIZED OR IN WHICH THE PERSON MAKING SUCH OFFER OR SOLICITATION IS NOT
QUALIFIED TO DO SO OR TO ANY PERSON TO WHOM IT IS UNLAWFUL TO MAKE SUCH OFFER OR
SOLICITATION. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE
HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE ANY IMPLICATION THAT THE
INFORMATION CONTAINED HEREIN IS CORRECT AS OF ANY TIME SUBSEQUENT TO THE DATE OF
THIS PROSPECTUS.
99
PART II - INFORMATION NOT REQUIRED IN PROSPECTUS
Item 24 INDEMNIFICATION OF DIRECTORS AND OFFICERS
Under our Bylaw, subject to the Business Corporations Act (Yukon
Territory) and subject to court approval in certain circumstances, we must
indemnify each of our current or former directors and officers, and any a person
who acts or has acted at our request as a director or officer of a corporation
of which we are or were a shareholder or creditor, and any such indemnified
person's heirs and legal representatives, against all costs, charges and
expenses, including any amount paid to settle an action or satisfy a judgment,
reasonably incurred by him or her in respect of any civil, criminal or
administrative action or proceeding to which he or she is made a party by reason
of serving or having served as a director or officer of our company or such
corporation, if: (a) he or she acted honestly and in good faith with a view to
the best interests of our company; and (b) in the case of a criminal or
administrative action or proceeding that is enforced by a monetary penalty, he
or she had reasonable grounds for believing his or her conduct was lawful.
Under section 126 of the Business Corporations Act (Yukon Territory),
court approval is required for us to indemnify any of the foregoing persons in
respect of an action by or on behalf of our company, or by or on behalf of any
corporation of which we are or were a shareholder or creditor, to procure a
judgment in our or its favor, as the case may be. Court approval may be granted
for us to indemnify any such person against all costs, charges and expenses
reasonably incurred by him or her in connection with the action only if: (a) he
or she acted honestly and in good faith with a view to the best interests of our
company; and (b) in the case of a criminal or administrative action or
proceeding that is enforced by a monetary penalty, he or she had reasonable
grounds for believing that his or her conduct was lawful.
Section 126 of the Business Corporations Act (Yukon Territory) goes on
to provide that, in any event, any of the foregoing persons is entitled to be
indemnified by us in respect of all costs, charges and expenses reasonably
incurred by him or her in connection with the defence of any civil, criminal or
administrative action or proceeding to which he or she is made a party by reason
of being or having been a director or officer of our company or a corporation of
which we are or were a shareholder or creditor, if he or she: (a) was
substantially successful on the merits in his or her defence of the action or
proceeding; (b) is fairly and reasonably entitled to indemnity, (c) acted
honestly and in good faith with a view to the best interests of our company; and
(b) in the case of a criminal or administrative action or proceeding that is
enforced by a monetary penalty, he or she had reasonable grounds for believing
his or her conduct was lawful.
Insofar as indemnification for liabilities arising under the Securities
Act might be permitted to directors, officers or persons controlling our company
under the provisions described above, we have been informed that in the opinion
of the Securities and Exchange Commission such indemnification is against public
policy as expressed in the Securities Act and is therefore unenforceable.
Item 25 OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION
The following table sets forth the costs and expenses payable by us in
connection with the issuance and distribution of the securities being registered
hereunder. No expenses shall be borne by the selling stockholder. All of the
amounts shown are estimates, except for the SEC Registration Fees.
SEC registration fees $2,882.64
Printing and engraving expenses $1,000(1)
Accounting fees and expenses $10,000(1)
Legal fees and expenses $30,000(1)
Transfer agent and registrar fees $2,000(1)
Fees and expenses for qualification under state $1,000
securities laws
Miscellaneous $1,000(1)
Total $47,882.64
100
(1) We have estimated these amounts
Item 26 RECENT SALES OF UNREGISTERED SECURITIES
On December 15, 2004, we closed on a transaction pursuant to which the
Company entered into a Subscription Agreement with several accredited investors
in which the investors agreed to lend a principal amount of $195,000 to us in
exchange for our 5% convertible debentures. We issued the convertible debentures
to the investors pursuant to Rule 506 of Regulation D as promulgated under the
Securities Act of 1933, as amended (the "Act"), and/or Section 4(2) of the Act.
On December 15, 2004 we entered into a Securities Purchase Agreement
with Cornell Capital Partners, L.P., an accredited investor, in which the
investor agreed to lend a principal amount of $2,500,000 to us in exchange for
our 5% convertible debenture. We issued the convertible debenture to the
investor pursuant to Rule 506 of Regulation D as promulgated under the
Securities Act of 1933, as amended (the "Act"), and/or Section 4(2) of the Act.
By conversion notice dated December 2, 2004, a holder of 8% convertible
debentures (described below) elected to convert $30,000 of principal and $3,359
in accrued interest outstanding under the convertible debentures. In response,
we issued 1,188,095 shares of our common stock to the debenture holder pursuant
to Rule 506 of Regulation D under the Securities Act of 1933, as amended.
On October 25, 2004, we issued 7,500,000 shares of our common stock to
the purchaser in a standby equity facility at a price of $0.03 per share, in
payment of a $225,000 drawdown on the equity line of credit. We relied on Rule
506 of Regulation D and/or Section 4(2) of the Securities Act of 1933 to effect
this issuance.
On October 14, 2004, we issued 10,714,286 shares of our common stock to
the purchaser in a standby equity facility at a price of $0.028 per share, in
payment of a $300,000 drawdown on the equity line of credit. We relied on Rule
506 of Regulation D and/or Section 4(2) of the Securities Act of 1933 to effect
this issuance.
On October 05, 2004, we issued 12,500,000 shares of our common stock to the
purchaser in a standby equity facility at a price of $0.032 per share, in
payment of a $400,000 drawdown on the equity line of credit. We relied on Rule
506 of Regulation D and/or Section 4(2) of the Securities Act of 1933 to effect
this issuance.
On September 27, 2004, we issued 12,500,000 shares of our common stock
to the purchaser in a standby equity facility at a price of $0.04 per share, in
payment of a $500,000 drawdown on the equity line of credit. We relied on Rule
506 of Regulation D and/or Section 4(2) of the Securities Act of 1933 to effect
this issuance.
Between September 22, 2004 and October 4, 2004, we issued 56,833,691
shares to the escrow agent of the holders of the discounted convertible
debentures of which 14,127,787 shares were returned to treasury. 18,226,274 of
these shares were issued pursuant to the exercise of warrants at a price of
$0.03 per share and 24,479,630 were issued at an effective price of $0.03 per
share to repay a portion of the discounted convertible debenture. We relied on
section 3(a)(9) and/or section 4(2) of the Securities Act of 1933 in issuing
these shares.
Between September 17, 2004 and September 22, 2004, we issued 16,667,667
shares of our common stock to the purchaser in a standby equity facility at a
price of $0.03 per share, in payment of a $500,000 drawdown on the equity line
of credit. We relied on Rule 506 of Regulation D and/or Section 4(2) of the
Securities Act of 1933 to effect this issuance.
On September 8, 2004, we issued 6,756,757 shares of our common stock to
the purchaser in a standby equity facility at a price of $0.037 per share, in
payment of a $250,000 drawdown on the equity line of credit. We relied on Rule
506 of Regulation D and/or Section 4(2) of the Securities Act of 1933 to effect
this issuance.
On August 30, 2004, we issued 6,250,000 shares of our common stock to
the purchaser in a standby equity facility at a price of $0.04 per share, in
payment of a $250,000 drawdown on the equity line of credit and 58,824 as a
result of a miscalculation of shares necessary to close the Advance Notice dated
August 13, 2004. We relied on Rule 506 of Regulation D and/or Section 4(2) of
the Securities Act of 1933 to effect this issuance.
101
On August 20, 2004, we issued 2,941,176 shares of our common stock to
the purchaser in a standby equity facility at a price of $.051 per share, in
payment of a $150,000 drawdown on the equity line of credit. We relied on Rule
506 of Regulation D and/or Section 4(2) of the Securities Act of 1933 to effect
this issuance.
On August 9, 2004, we issued 3,000,000 shares of our common stock to
the purchaser in a standby equity facility at a price of $.050 per share, in
payment of a $150,000 drawdown on the equity line of credit. We relied on Rule
506 of Regulation D and/or Section 4(2) of the Securities Act of 1933 to effect
this issuance.
On July 21, 2004, we issued 4,237,288 shares of our common stock to the
purchaser in a standby equity facility at a price of $.059 per share, in payment
of a $250,000 drawdown on the equity line of credit. We relied on Rule 506 of
Regulation D and/or Section 4(2) of the Securities Act of 1933 to effect this
issuance.
On July 12, 2004, we issued 3,846,154 shares of our common stock to the
purchaser in a standby equity facility at a price of $.065 per share, in payment
of a $250,000 drawdown on the equity line of credit. We relied on Rule 506 of
Regulation D and/or Section 4(2) of the Securities Act of 1933 to effect this
issuance.
On July 1, 2004, we issued to Hawk Associates, Inc., a warrant to
purchase up to 250,000 shares of our common stock, exercisable at any time
during the five-year period ending on June 30, 2009, at an exercise price of
$0.20 per share. We issued these warrants pursuant to Rule 506 and/or section
4(2) of the Securities Act of 1933, in partial payment of an engagement fee.
On June 22, 2004, we issued 2,777,778 shares of our common stock to the
purchaser in a standby equity facility at a price of $.090 per share, in payment
of a $250,000 drawdown on the equity line of credit. We relied on Rule 506 of
Regulation D and/or Section 4(2) of the Securities Act of 1933 to effect this
issuance.
On June 1, 2004, we issued a total of 1,399,676 shares of our common
stock, at a deemed issue price of $0.1040 per share, to the holders of the
discounted convertible debentures (described below), upon exercise of our right
to effect payment of the first monthly redemption amount due under the
discounted convertible debentures in shares of our common stock. We relied on
section 3(a)(9) and/or section 4(2) of the Securities Act of 1933 in issuing
these shares.
On May 25, 2004, we issued 3,509,615 shares of our common stock to the
purchaser in standby equity facility at a deemed price of $.104 per share, in
payment of a commitment fee and 96,154 shares of our common stock as a placement
fee. We relied on Rule 506 of Regulation D and/or Section 4(2) of the Securities
Act of 1933 to effect this issuance.
By conversion notice effective June 17, 2004, a holder of discounted
convertible debentures elected to convert $50,000 outstanding under the
convertible debentures. In response, we issued 480,769 shares of our common
stock to the debenture holder relying on section 3(a)(9) of the Securities Act
of 1933.
By conversion notice effective June 14, 2004, holders of discounted
convertible debentures elected to convert $208,000 outstanding under the
convertible debentures. In response, we issued 2,000,000 shares of our common
stock to the debentures holder relying on section 3(a)(9) of the Securities Act
of 1933.
By conversion notice effective June 8, 2004, a holder of 8% convertible
debentures (described below) elected to convert $50,000 of principal and $3,633
in accrued interest outstanding under the convertible debentures. In response,
we issued 521,444 shares of our common stock to the debenture holder relying on
section 3(a)(9) of the Securities Act of 1933. We also issued 192,307 shares of
our common stock to the debenture holder relying on section 3(a)(9) of the
Securities Act of 1933 that were owed from the April 15, 2004 conversion notice
(described below).
On May 25, 2004, 3,509,615 shares of our common stock were issued as a
commitment fee ($365,000) and 96,154 shares of our common stock were issued as a
placement fee ($10,000) to arrange a $15M equity line of credit
102
On May 19, 2004, we entered into a $15.0 million standby equity
distribution agreement with selling stockholder relying on Rule 506 of
Regulation D and/or Section 4(2) of the Securities Act of 1933. We may draw down
the facility at its discretion provided that each draw down is at least seven
trading days apart, and the maximum amount that may be drawn down at any one
time is limited to $500,000 and advance notice is required. The term of the
equity line of credit is 24 months. At the time of draw down against the line of
credit we will issue common shares equal to that amount advanced divided by 98%
of the lowest bid price on the five consecutive days after the date of notice.
On each date of advance of funds, we are to pay 5% placement fee. We may draw
down the facility at its discretion upon effectiveness of the registration
statement to be filed in the appropriate form under the Securities Act of 1933
for the purpose of registering the shares issuable upon the draw down of the
credit facility.
On April 30, 2004, 500,000 warrants were exercised at an exercise price
of $0.104 per share to a non-U.S. person upon exercise of warrants previously
granted to it. The shares were issued in an offshore transaction relying on
Regulation S under the Securities Act of 1933.
By conversion notice effective April 15, 2004, a holder of 8%
convertible debentures (described below) elected to convert $100,000 of
principal and $6,067 in accrued interest outstanding under the convertible
debentures. In response, we issued 823,680 shares of our common stock to the
debenture holder relying on section 3(a)(9) of the Securities Act of 1933.
On April 2, 2004, we issued a total of 1,399,676 shares of our common
stock, at a deemed issue price of $0.1040 per share, to the holders of the
discounted convertible debentures (described below), upon exercise of our right
to effect payment of the first monthly redemption amount due under the
discounted convertible debentures in shares of our common stock. We relied on
section 3(a)(9) and/or section 4(2) of the Securities Act of 1933 in issuing
these shares.
On March 2, 2004, we issued a total of 1,033,851 shares of our common
stock, at a deemed issue price of $0.1408 per share, to the holders of the
discounted convertible debentures (described below), upon exercise of our right
to effect payment of the first monthly redemption amount due under the
discounted convertible debentures in shares of our common stock. We relied on
section 3(a)(9) and/or section 4(2) of the Securities Act of 1933 in issuing
these shares.
On February 3, 2004, we issued a total of 812,045 shares of our common
stock, at a deemed issue price of $0.1613 per share, to six of the holders of
the discounted convertible debentures (described below), upon exercise of our
right to effect payment of the first monthly redemption amount due under the
discounted convertible debentures in shares of our common stock. We relied on
section 3(a)(9) and/or section 4(2) of the Securities Act of 1933 in issuing
these shares.
By conversion notice effective January 27, 2004, a holder of 8%
convertible debentures (described below) elected to convert $84,000 of principal
and $3,621 in accrued interest outstanding under the convertible debentures. In
response, we issued 667,331 shares of our common stock to the debenture holder
relying on section 3(a)(9) of the Securities Act of 1933.
By conversion notice dated January 12, 2004, a holder of 8% convertible
debentures (described below) elected to convert $130,000 of principal and $5,171
in accrued interest outstanding under the convertible debentures. In response,
we issued 1,030,965 shares of our common stock to the debenture holder relying
on section 3(a)(9) of the Securities Act of 1933.
On December 24, 2003, we closed a private placement of discounted
convertible debentures in the aggregate principal amount of $3,493,590, maturing
April 1, 2006, to seven accredited investors pursuant to Rule 506 and/or section
4(2) of the Securities Act of 1933, for gross proceeds of $2,725,000. Principal
under each discounted convertible debenture may be converted by the holder in
whole or in part and from time to time at a conversion price of $0.22 per share,
subject to adjustment as set forth in the convertible debentures. The discounted
convertible debentures are subject to mandatory redemption in equal monthly
payments. We may elect to make the monthly redemption payments in shares of our
common stock at a conversion price equal to the lesser of (a) the set price of
$0.22 per share (subject to adjustment pursuant to the anti-dilution provisions
contained in the debentures), and (b) 85% of the average of the 20 closing
prices of our common stock immediately preceding the applicable monthly
redemption date, provided that certain conditions are met. In connection with
this private placement, each purchaser of discounted convertible debentures also
received a warrant to purchase that number of shares of our common stock equal
to 50% the principal amount of such purchaser's convertible debentures divided
by the set conversion price of $0.22 per share. Warrants to purchase an
aggregate total of 7,939,978 shares of our common stock were issued, and are
exercisable until December 24, 2006 at an exercise price of $0.25 per share.
103
On December 24, 2003, we issued to HPC Capital Management, a broker
dealer registered pursuant to section 15 of the Securities Exchange Act of 1934,
a warrant to purchase up to 109,000 shares of our common stock, exercisable
until December 24, 2006, at an exercise price of $0.25 per share. We issued
these warrants pursuant to Rule 506 and/or section 4(2) of the Securities Act of
1933, in partial payment of placement fee in connection with the private
placement of the discounted convertible debentures.
On November 10, 2003, in consideration for their agreement to
immediately exercise a total of 7,478,635 outstanding warrants at a reduced
exercise price of $0.1771 per share, we issued to three of the four purchasers
of our 7% convertible debentures (described below), a total of 7,478,635
additional warrants exercisable for a period of five years at an exercise price
of $0.1771 per share. The outstanding warrants that were exercised were
originally issued with an exercise price of $0.2645 per share. We issued a total
of 7,478,635 shares of our common stock upon the exercise of the outstanding
warrants for gross proceeds of $1,324,466, and the 7,478,635 additional
warrants, pursuant to Rule 506 and/or section 4(2) of the Securities Act of
1933. Each of the purchasers represented that it is an "accredited investor" as
defined in Rule 501 of the Securities Act of 1933.
On October 27, 2003, in consideration for its agreement to immediately
exercise a total of 3,290,596 outstanding warrants at a reduced exercise price
of $0.20 per share, we issued to one of the four purchasers of the 7%
convertible debentures, Palisades Master Fund, a total of 3,290,596 additional
warrants exercisable for a period of five years at an exercise price of $0.20
per share. The outstanding warrants that were exercised were originally issued
with an exercise price of $0.2645 per share. We issued a total of 3,290,596
shares of our common stock upon the exercise of the outstanding warrants for
gross proceeds of $658,119, and the 3,290,596 additional warrants, pursuant to
Rule 506 and/or section 4(2) of the Securities Act of 1933. The purchaser
represented that it is an "accredited investor" as defined in Rule 501 of the
Securities Act of 1933. In light of the reduced exercise price of the additional
warrants issued to the other three warrant holders, we subsequently agreed to
reduce the exercise price of the 3,290,596 additional warrants issued to
Palisades Master Fund, and the exercise price of 194,000 warrants previously
issued to HPC Capital Management, from $0.20 to $0.1771 per share. All other
terms of the warrants, including their expiry date, remain the same. In
addition, we paid $75,354.65 to Palisades Master Fund as an early participation
bonus, being an amount equal to the difference between the aggregate exercise
price that Palisades Master Fund paid upon the exercise of its 3,290,596
outstanding warrants at $0.20 per share and the aggregate exercise price that
Palisades Master Fund would have paid if it had had the benefit of the reduced
exercise price of $0.1771 per share.
On October 27, 2003, in consideration of its agreement to immediately
exercise a total of 194,000 outstanding warrants, we issued to HPC Capital
Management, a broker dealer registered pursuant to section 15 of the Securities
Exchange Act of 1934, a total of 194,000 additional warrants, exercisable for a
period of five years at an exercise price of $0.20 per share. We issued these
warrants pursuant to Rule 506 and/or section 4(2) of the Securities Act of 1933.
HPC Capital Management represented that it is an "accredited investor" as
defined in Rule 501 of the Securities Act of 1933.
By conversion notice dated October 21, 2003, a holder of 8% convertible
debentures (described below) elected to convert $75,000 of principal and $1,600
in accrued interest outstanding under the convertible debentures. In response,
we issued 585,525 shares of our common stock to the debenture holder relying on
section 3(a)(9) of the Securities Act of 1933.
By conversion notice dated October 10, 2003, a holder of 7% convertible
debentures (described below) elected to convert $66,667 of principal and $1,503
in accrued interest outstanding under the convertible debentures. In response,
we issued 522,626 shares of our common stock to the debenture holder relying on
section 3(a)(9) of the Securities Act of 1933.
104
By conversion notice dated October 9, 2003, a holder of 8% convertible
debentures (described below) elected to convert $300,000 of principal and $5,333
in accrued interest outstanding under the convertible debentures. In response,
we issued 2,343,858 shares of our common stock to the debenture holder relying
on section 3(a)(9) of the Securities Act of 1933.
By conversion notice dated October 6, 2003, a holder of 8% convertible
debentures (described below) elected to convert $156,000 of principal and $2,808
in accrued interest outstanding under the convertible debentures. In response,
we issued 1,219,366 shares of our common stock to the debenture holder relying
on section 3(a)(9) of the Securities Act of 1933.
By conversion notice dated October 3, 2003, a holder of 7% convertible
debentures (described below) elected to convert $100,000 of principal and $2,119
in accrued interest outstanding under the convertible debentures. In response,
we issued 784,164 shares of our common stock to the debenture holder relying on
section 3(a)(9) of the Securities Act of 1933
By conversion notice dated October 1, 2003, a holder of 8% convertible
debentures (described below) elected to convert $200,000 of principal and $3,778
in accrued interest outstanding under the convertible debentures. In response,
we issued 1,562,763 shares of our common stock to the debenture holder relying
on section 3(a)(9) of the Securities Act of 1933.
By conversion notice dated September 24, 2003, a holder of 8%
convertible debentures (described below) elected to convert $100,000 of
principal and $2,061 in accrued interest outstanding under the convertible
debentures. In response, we issued 783,930 shares of our common stock to the
debenture holder relying on section 3(a)(9) of the Securities Act of 1933.
By conversion notice dated September 10, 2003, a holder of 7%
convertible debentures (described below) elected to convert $130,000 of
principal and $1,560 in accrued interest outstanding under the convertible
debentures. In response, we issued 1,010,612 shares of our common stock to the
debenture holder relying on section 3(a)(9) of the Securities Act of 1933.
By conversion notices dated September 9, 2003 and September 10, 2003, a
holder of 7% convertible debentures (described below) elected to convert $70,000
and $50,000 of principal and $840 and $611 in accrued interest outstanding under
the convertible debentures. In response, we issued 932,769 shares of our common
stock to the debenture holder relying on section 3(a)(9) of the Securities Act
of 1933.
By conversion notice dated August 27, 2003, a holder of 7% convertible
debentures (described below) elected to convert $80,000 of principal and $764 in
accrued interest outstanding under the convertible debentures. In response, we
issued 620,694 shares of our common stock to the debenture holder relying on
section 3(a)(9) of the Securities Act of 1933.
On August 15, 2003, we issued to Epoch Financial Group, Inc., an
accredited investor, a warrant to purchase up to 300,000 shares of our common
stock, exercisable at any time during the five-year period ending on August 15,
2008, at an exercise price of $0.17 per share. We issued these warrants pursuant
to Rule 506 and/or section 4(2) of the Securities Act of 1933, in partial
payment of an engagement fee.
On August 14, 2003, we issued to HPC Capital Management, a broker
dealer registered pursuant to section 15 of the Securities Exchange Act of 1934,
a total of 200,000 fully-paid and non-assessable shares of our common stock at a
deemed price of $0.17 per share. We issued these shares pursuant to Rule 506
and/or section 4(2) of the Securities Act of 1933, in partial payment of an
engagement fee.
By conversion notice dated July 30, 2003, a holder of 7% convertible
debentures (described below) elected to convert $50,000 of principal and $486 in
accrued interest outstanding under the convertible debentures. In response, we
issued 391,674 shares of our common stock to the debenture holder relying on
Rule 506 of Regulation D and/or Section 4(2) of the Securities Act of 1933.
105
By conversion notice dated July 28, 2003, a holder of 7% convertible
debentures (described below) elected to convert $300,000 of principal and $2,392
in accrued interest outstanding under the convertible debentures. In response,
we issued 2,323,648 shares of our common stock to the debenture holder relying
on Rule 506 of Regulation D and/or Section 4(2) of the Securities Act of 1933.
On July 25, 2003, we issued at the direction of West Sussex Trading,
Inc. a total of 224,000 warrants to three accredited investors in partial
payment of placement fees, relying on Rule 506 of Regulation D, Section 4(2) of
the Securities Act of 1933 and/or Regulation S under the Securities Act of 1933.
Each warrant is exercisable until July 25, 2008 at an exercise price of $0.10
per share.
On July 23, 2003, we entered into a $15.0 million equity line of credit
facility with an accredited investor relying on Rule 506 of Regulation D and/or
Section 4(2) of the Securities Act of 1933. We may, in our discretion, draw down
amounts under the facility from time to time, subject to various conditions and
certain limitations. We will receive the proceeds of each draw down under the
equity line of credit facility in payment for shares of our common stock, to be
issued to the investor in two tranches for each draw down. The number of shares
of our common stock so issuable will be determined with reference to a draw down
pricing period of 20 consecutive trading days, as specified in the draw down
notice, subject to a threshold price to be designated by us in connection with
the draw down as the lowest price at which we will sell shares of common stock
to the investor. Each draw down will be limited to the greater of: (a) $300,000
and (b) 12.5% of the average of the daily volume weighted average prices of our
common stock during the 30-day period preceding the draw down notice, multiplied
by the total aggregate trading volume of our common stock during such 30-day
period; subject to a minimum draw down amount of $300,000. Only one draw down is
permitted under the equity line during each draw down pricing period of 20
consecutive trading days, and there must be at least six trading days between
each draw down pricing period. We may not draw down the facility unless the
shares issuable upon the draw down of the credit facility have been registered
on an effective registration statement filed in the appropriate form under the
Securities Act of 1933.
On July 22, 2003, relying on Rule 506 of Regulation D and/or Section
4(2) of the Securities Act of 1933, we issued to the investor under the $15.0
million equity line of credit, as a commitment fee, a warrant to purchase up to
1,000,000 shares of our common stock, exercisable until July 23, 2006 at an
exercise price of $0.1955 per share.
On July 22, 2003, we issued to HPC Capital Management, a broker dealer
registered pursuant to section 15 of the Securities Exchange Act of 1934, a
warrant to purchase up to 250,000 shares of our common stock, exercisable until
July 23, 2006, at an exercise price of $0.1955 per share. We issued these
warrants pursuant to Rule 506 and/or section 4(2) of the Securities Act of 1933,
in partial payment of placement fee in connection with the $15.0 million equity
line of credit.
On July 17, 2003, we closed a private placement of 8% convertible
debentures to four accredited investors pursuant to Rule 506 and/or section 4(2)
of the Securities Act of 1933, for gross proceeds of $1,700,000. Principal under
the convertible debentures in the aggregate principal amount of $1,700,000 may
be converted by the holder in whole or in part and from time to time at a
conversion price of $0.13 per share, and interest may be converted at a price
per share equal to 90% of the average closing bid price of our common stock
during the 20 trading days immediately preceding the conversion date, in each
case subject to adjustment as set forth in the convertible debentures. In
connection with this private placement, each of the purchasers of the 8%
convertible debentures also received warrants to purchase that number of shares
of our common stock determined by dividing the principal amount of such
purchaser's convertible debentures by the base conversion price of $0.13 per
share, for an aggregate total of 13,076,922 warrants exercisable until July 17,
2008 at $0.1771 per share.
On July 17, 2003, we issued to HPC Capital Management, a broker dealer
registered pursuant to section 15 of the Securities Exchange Act of 1934, a
warrant to purchase up to 68,000 shares of our common stock, exercisable until
July 17, 2008, at an exercise price of $0.1771 per share. We issued these
warrants pursuant to Rule 506 and/or section 4(2) of the Securities Act of 1933,
in partial payment of placement fee in connection with the private placement of
8% convertible debentures.
By conversion notice dated July 14, 2003, a holder of 7% convertible
debentures (described below) elected to convert $200,000 of principal and $1,180
in accrued interest outstanding under the convertible debentures. In response,
we issued 1,540,205 shares of our common stock to the debenture holder relying
on Rule 506 of Regulation D and/or Section 4(2) of the Securities Act of 1933.
106
By conversion notice dated July 11, 2003, a holder of 7% convertible
debentures (described below) elected to convert $305,555 of principal and $2,258
in accrued interest outstanding under the convertible debentures. In response,
we issued 2,366,124 shares of our common stock to the debenture holder relying
on Rule 506 of Regulation D and/or Section 4(2) of the Securities Act of 1933.
By conversion notice dated July 10, 2003, a holder of 7% convertible
debentures (described below) elected to convert $279,167 of principal and $1,628
in accrued interest outstanding under the convertible debentures. In response,
we issued 2,166,062 shares of our common stock to the debenture holder relying
on Rule 506 of Regulation D and/or Section 4(2) of the Securities Act of 1933.
By conversion notice dated June 30, 2003, a holder of 7% convertible
debentures (described below) elected to convert $200,000 of principal and $1,580
in accrued interest outstanding under the convertible debentures. In response,
we issued 1,543,469 shares of our common stock to the debenture holder relying
on Rule 506 of Regulation D and/or Section 4(2) of the Securities Act of 1933.
By conversion notices dated June 17, 2003, three holders of 7%
convertible debentures (described below) elected to convert a total of $356,111
of principal and $957 in accrued interest outstanding under the convertible
debentures. In response, we issued a total of 2,729,486 shares of our common
stock to the debenture holders relying on Rule 506 of Regulation D and/or
Section 4(2) of the Securities Act of 1933.
By conversion notice dated June 12, 2003, a holder of 7% convertible
debentures (described below) elected to convert $260,000 of principal and $358
in accrued interest outstanding under the convertible debentures. In response,
we issued 2,008,821 shares of our common stock to the debenture holder relying
on Rule 506 of Regulation D and/or Section 4(2) of the Securities Act of 1933.
By conversion notices dated June 11, 2003, two holders of 7%
convertible debentures (described below) elected to convert a total of $387,500
of principal and $1,249 in accrued interest outstanding under the convertible
debentures. In response, we issued a total of 2,988,859 shares of our common
stock to the debenture holders relying on Rule 506 of Regulation D and/or
Section 4(2) of the Securities Act of 1933.
By conversion notice dated June 9, 2003, a holder of 7% convertible
debentures (described below) elected to convert $195,000 of principal and $758
in accrued interest outstanding under the convertible debentures. In response,
we issued 1,505,754 shares of our common stock to the debenture holder relying
on Rule 506 of Regulation D and/or Section 4(2) of the Securities Act of 1933.
On May 27, 2003, we issued 1,050,000 shares of common stock to a
non-U.S. person upon exercise of warrants previously granted to it. The shares
were issued in an offshore transaction relying on Regulation S under the
Securities Act of 1933.
On May 27, 2003, we issued to Impact Capital Partners Limited, a broker
dealer registered pursuant to section 15 of the Securities Exchange Act of 1934,
warrants to purchase up to an aggregate of 168,325 shares of our common stock,
exercisable at any time during the five-year period ending on May 27, 2008, at
exercise prices of: (a) with respect to 23,881 warrants, $0.74 per share; (b)
with respect to 44,444 warrants, $0.40 per share; and (c) with respect to
100,000 warrants, $0.22 per share. We issued these warrants pursuant to Rule 506
and/or section 4(2) under the Securities Act of 1933, in partial payment of a
placement fee in connection with the private placement of certain convertible
debentures and the issuance of a short-term secured promissory note to Selling
stockholder.
On May 15, 2003, June 11, 2003 and June 17, 2003, we closed the
constituent tranches of a three-tranche private placement of 7% convertible
debentures to four accredited investors pursuant to Rule 506 and/or section 4(2)
of the Securities Act of 1933, for gross proceeds of $2,800,000. Principal under
the convertible debentures in the aggregate principal amount of $2,800,000 may
be converted by the holder in whole or in part and from time to time at a
conversion price of $0.13 per share, and interest may be converted at a price
per share equal to 90% of the average closing bid price of our common stock
during the 20 trading days immediately preceding the conversion date, in each
case subject to adjustment as set forth in the convertible debentures. In
connection with this private placement, each of the purchasers of the 7%
convertible debentures also received warrants to purchase that number of shares
of our common stock determined by dividing 50% of the principal amount of such
purchaser's convertible debentures by the base conversion price of $0.13 per
share, for an aggregate total of 10,769,231 warrants exercisable until May 19,
2008 at $0.2645 per share.
107
By conversion notice dated May 16, 2003, Cornell Capital Partners
elected to convert $100,000 of principal and $5,854.02 in accrued interest
outstanding under certain convertible debentures (described below) that were
issued on November 21, 2002 and January 31, 2003. The conversion price was
$0.20. In response, we issued 529,270 shares to Cornell Capital Partners relying
on Section 4(2) of the Securities Act of 1933.
On May 15, 2003, we issued to HPC Capital Management, a broker dealer
registered pursuant to section 15 of the Securities Exchange Act of 1934, a
warrant to purchase up to 112,000 shares of our common stock, exercisable at any
time during the five-year period ending on May 15, 2008, at an exercise price of
$0.13 per share. We also issued to HPC Capital Management a warrant to purchase
up to 14,000 shares of our common stock exercisable at any time until May 15,
2008 at an exercise price of $0.10 per share. We issued these warrants pursuant
to Rule 506 and/or section 4(2) of the Securities Act of 1933, in partial
payment of placement fees: (a) with reference to the warrant to purchase up to
112,000 shares of common stock, in connection with the private placement of the
7% convertible debentures; and (b) with reference to the warrant to purchase up
to 14,000 shares of our common stock, in connection with a private placement of
3,500,000 units (each consisting of one common share and one-half of a
non-transferable share purchase warrant), issued on March 31, 2003 at a price of
$0.10 per unit in an offshore transaction pursuant to Regulation S under the
Securities Act of 1933.
On May 15, 2003, we issued to Dunwoody Brokerage Services, Inc., a
broker dealer registered pursuant to section 15 of the Securities Exchange Act
of 1934, a warrant to purchase up to 100,000 shares of our common stock,
exercisable at any time during the five-year period ending on May 15, 2008, at
an exercise price of $0.135 per share. We issued these warrants pursuant to Rule
506 and/or section 4(2) under the Securities Act of 1933, in partial payment of
a placement fee in connection with the private placement of the 7% convertible
debentures.
By conversion notice dated May 14, 2003, Cornell Capital Partners
elected to convert $125,000 of principal outstanding under certain convertible
debentures (described below) that were issued on November 21, 2002 and January
31, 2003. The conversion price was $0.20. In response, we issued 625,000 shares
to Cornell Capital Partners relying on Section 4(2) of the Securities Act of
1933.
On May 7, 2003, we issued at the direction of West Sussex Trading, Inc.
a total of 40,000 warrants to three accredited investors in partial payment of
placement fees in connection with the private placement of 500,000 units on May
5, 2003 described below, relying on Rule 506 of Regulation D, Section 4(2) of
the Securities Act of 1933 and/or Regulation S under the Securities Act of 1933.
Each warrant is exercisable until May 7, 2008 at an exercise price of $0.10 per
share.
On May 7, 2003, we issued at the direction of West Sussex Trading, Inc.
a total of 57,143 warrants to four accredited investors in partial payment of
placement fees, relying on Rule 506 of Regulation D, Section 4(2) of the
Securities Act of 1933 and/or Regulation S under the Securities Act of 1933.
Each warrant is exercisable until May 7, 2008 at an exercise price of $0.35 per
share.
On May 5, 2003, we issued 500,000 units at a price of $0.10 per unit in
an offshore transaction pursuant to Regulation S under the Securities Act of
1933. We realized gross cash proceeds of $50,000 from this private placement.
Each unit consists of one share of our common stock and two non-transferable
share purchase warrants. Each whole warrant entitles the holder to purchase an
additional share of our common stock at a price of $0.12 per share until April
30, 2004. In connection with this private placement, we have paid placement and
advisory fees of $4,000.
On May 6, 2003, we issued 850,000 shares at a deemed price of $0.21 per
share to an accredited investor and, as disclosed below, we repriced 1,000,000
warrants previously issued to the investor on December 20, 2002, thereby
reducing the exercise price of the warrant from $0.70 per share to $0.10 per
share. An aggregate of 3,614,286 additional warrants previously issued to four
other investors in connection with the offshore private placements effected by
us on November 4, 2002, December 20, 2002 and February 14, 2003 (each of which
are discussed below), were also repriced to have an exercise price of $0.10 per
share. These transactions were all effected pursuant to Regulation S under the
Securities Act of 1933, and were effected in consideration of certain releases
provided by the investors to our company in respect of certain potential
unquantified claims threatened by the investors against our company.
108
On March 31, 2003, we issued 3,500,000 units at a price of $0.10 per
unit in an offshore transaction pursuant to Regulation S under the Securities
Act of 1933. Each unit consists of one common share and one-half of a
non-transferable share purchase warrant. Each whole warrant entitles the holder
to purchase an additional share of our common stock at a price of US$0.16 per
share until March 31, 2005. We have paid a placement fee of $28,000 in
connection with this private placement.
By conversion notice dated March 14, 2003, Cornell Capital Partners
elected to convert $125,000 of principal outstanding under the convertible
debentures that were issued on November 21, 2002. The conversion price was
$0.064, which is equal to 80% of the lowest closing bid price for the five day
period prior to March 14, 2003. On March 20, 2003, we issued 1,953,125 shares to
Cornell Capital Partners relying on Section 4(2) of the Securities Act of 1933.
On April 3, 2003, we issued to Ian Bateman a total of 353,865 shares of
our common stock at a deemed price of $0.17 per share, in partial payment and
settlement of our obligation to pay him a termination allowance in connection
with the termination of his management agreement, without cause, on October 15,
2002. We issued these shares to Mr. Bateman in an offshore transaction pursuant
to Regulation S under the Securities Act of 1933.
On February 24, 2003, we issued 32,258 shares of our common stock to
the placement agent that we have engaged in connection with the $5.0 million
equity line of credit facility described below, as a commitment fee in
consideration of the placement agent's agreement to act in such capacity. We
issued the shares to the placement agent, an accredited investor, at a deemed
price of $0.31 per share relying on Rule 506 and/or Section 4(2) of the
Securities Act of 1933.
On February 19, 2003, we entered into a $5.0 million equity line of
credit facility with an accredited investor relying on Rule 506 of Regulation D
and/or Section 4(2) of the Securities Act of 1933. This replaces and supersedes
the equity line of credit facility we entered into on November 21, 2002. We may
draw down the facility at its discretion provided that each draw down is at
least seven trading days apart, and the maximum amount that may be drawn down at
any one time is limited to $70,000 and advance notice is required. The term of
the equity line of credit is 24 months. At the time of draw down against the
line of credit we will issue common shares equal to that amount advanced divided
by 99% of the stock price on the five consecutive days after the date of notice.
On each date of advance of funds, we are to pay 1.5% of the advanced fund as a
commission. On the date of the execution of the contract, we issued shares worth
$300,000 based on the trading price of our stock on that day. We may draw down
the facility at its discretion upon effectiveness of the registration statement
to be filed in the appropriate form under the Securities Act of 1933 for the
purpose of registering the shares issuable upon the draw down of the credit
facility.
On February 14, 2003, we issued 714,286 units at a price of $0.35 per
unit in an offshore transaction pursuant to Regulation S under the Securities
Act of 1933. Each unit consists of one common share and one share purchase
warrant. Each warrant entitles the holder to purchase one additional common
share at an exercise price of $0.42 per share until February 13, 2006. Effective
May 6, 2003, these warrants were repriced at $0.10 per share. Advisors to the
private placement are entitled to a commission of $20,000 plus 57,143 purchase
warrants exercisable at $0.35 per share until February 13, 2008. Of the 57,143
share purchase warrants, 9,524 were issued pursuant to one accredited person
pursuant to Regulation D, Section 4(6) and/or Section 4(2) of the Securities Act
of 1933 and 47,619 were issued to three persons in an offshore transaction
pursuant to Regulation S of the Securities Act of 1933.
On February 12, 2003, Cornell Capital Partners elected to convert
$40,000 of principal outstanding under the convertible debentures that were
issued on November 21, 2002. The conversion price was $0.256, which is equal to
80% of the lowest closing bid price for the five day period prior to February
12, 2003. We issued 156,250 shares to Cornell Capital Partners relying on Rule
506 and/or Section 4(2) of the Securities Act of 1933.
109
On February 10, 2003, Cornell Capital Partners elected to convert
$10,000 of principal outstanding under the convertible debentures that were
issued on November 21, 2002. The conversion price was $0.28, which is equal to
80% of the lowest closing bid price for the five day period prior to February
10, 2003. We issued 35,714 shares to Cornell Capital Partners relying on Rule
506 and/or Section 4(2) of the Securities Act of 1933.
On February 3, 2003, we granted stock options to purchase an aggregate
of up to 26,300 shares of our common stock at $0.37 per share. The options have
a five year term and were granted to two of our directors in reliance upon Rule
506 of Regulation D and/or Section 4(2) of the Securities Act of 1933.
On January 31, 2003, we issued a convertible debenture to Selling
stockholder, an accredited investor, relying on Rule 506 of Regulation D and/or
Section 4(2) of the Securities Act of 1933. This constituted the second and
final tranche of a $400,000 private placement effected by us pursuant to a
Securities Purchase Agreement dated November 21, 2002. We issued a single
convertible debenture maturing November 21, 2004 and having a face principal
amount of $200,000. The convertible debenture was issued at an 8% discount, for
gross proceeds of $184,000. Our obligations under the convertible debentures
were secured against all of our present and after-acquired personal property,
assets and undertaking. Such security interest was subordinated to the security
interest previously granted by us to TRW Inc. in all of our present and
after-acquired personal property, assets and undertaking.
On January 30, 2003, we granted stock options to purchase an aggregate
of up to 118,000 shares of our common stock. 114,000 options vest immediately
and if exercised before January 30, 2004 the exercise price is $0.36, if
exercised after January 30, 2004 but before January 30, 2005 the exercise price
is $0.43 and if exercised after January 30, 2005, the exercise price is $0.52.
Of the other 4,000 options, 1,334 vest immediately at an exercise price of
$0.36, 1,333 vest on January 2, 2004 at an exercise price of $0.43 and 1,333
vest on January 2, 2005 at an exercise price of $0.52. The options have a five
year term and were granted to five of our directors, officers and/or employees
in reliance upon either Regulation S or Rule 506 of Regulation D and/or Section
4(2) of the Securities Act of 1933.
On January 15, 2003, we issued 300,000 share purchase warrants in
payment of a placement fee related to the private placement of units on November
4, 2002 and December 20, 2002. We issued 236,667 warrants in an offshore
transaction to three non-U.S. persons in reliance upon Regulation S of the
Securities Act of 1933. We issued 63,333 warrants to one accredited person
pursuant to Regulation D, Section 4(6) and/or Section 4(2) of the Securities Act
of 1933. 160,000 of the warrants are exercisable at $0.50 per share until
November 4, 2007, 60,000 of the warrants are exercisable at $0.67 until December
15, 2007 and 80,000 of the warrants are exercisable at $0.70 per share until
December 15, 2007.
On January 2, 2003, we granted stock options to acquire an aggregate of
up to 18,000 shares of our common stock. 6,000 of the options are exercisable at
$1.00 per share, 6,000 vest on January 2, 2004 and are exercisable at $1.20 per
share and 6,000 vest on January 2, 2005 and are exercisable at $1.44 per share.
The options have a five year term and were granted to an employee in reliance on
Regulation S and/or Section 4(2) of the Securities Act of 1933.
On December 20, 2002, we issued 750,000 units at a price of $0.67 per
unit in an offshore transaction pursuant to Regulation S under the Securities
Act of 1933. Each unit consists of one common share and one share purchase
warrant. Each warrant entitles the holder to purchase one additional common
share at an exercise price of $0.85 per share until December 15, 2005. Effective
May 6, 2003, these warrants were repriced at $0.10 per share. Advisors to the
private placement were paid placement and advisory fees of $40,000.
On December 20, 2002, we issued 1,000,000 units at a price of $0.70 per
unit in an offshore transaction pursuant to Regulation S under the Securities
Act of 1933. Each unit consists of one common share and one share purchase
warrant. Each warrant entitles the holder to purchase one additional common
share at an exercise price of $0.70 per share until December 15, 2005. Effective
May 6, 2003, these warrants were repriced at $0.10 per share. Advisors to the
private placement were paid placement and advisory fees of $56,000.
110
On November 21, 2002, we entered into a $5.0 million equity line of
credit facility with Selling stockholder relying on Rule 506 of Regulation D
and/or Section 4(2) of the Securities Act of 1933. We may draw down the facility
at its discretion provided that each draw down is at least seven trading days
apart, and the maximum amount that may be drawn down at any one time is limited
to $70,000 and advance notice is required. The term of the equity line of credit
is 24 months. At the time of draw down against the line of credit we will issue
common shares equal to that amount advanced divided by 99% of the stock price on
the five consecutive days after the date of notice. On each date of advance of
funds, we are to pay 1.5% of the advanced fund as a commission. On the date of
the execution of the contract, we issued shares worth $300,000 based on the
trading price of our stock on that day. We may draw down the facility at its
discretion upon effectiveness of the registration statement to be filed in the
appropriate form under the Securities Act of 1933 for the purpose of registering
the shares issuable upon the draw down of the credit facility. We subsequently
terminated this equity line of credit facility and entered into a new $5.0
million equity line of credit facility as described above.
On December 4, 2002, we issued 446,154 shares of our common stock to
the lender under the equity line of credit at a deemed price of $0.65 per share,
in payment of a commitment fee. We relied on Rule 506 of Regulation D and/or
Section 4(2) of the Securities Act of 1933 to effect this issuance.
On November 21, 2002, we entered into a Securities Purchase Agreement
whereby we agreed to issue up to $400,000 in convertible debentures, issuable in
two tranches of $200,000 each to Selling stockholder relying on Rule 506 of
Regulation D and/or Section 4(2) of the Securities Act of 1933. Upon closing of
the first tranche of the private placement on November 21, 2002, we issued a
single convertible debenture maturing November 21, 2004 and having a face
principal amount of $200,000. The convertible debenture was issued at an 8%
discount, for gross proceeds of $184,000. Our obligations under the convertible
debentures were secured against all of our present and after-acquired personal
property, assets and undertaking. Such security interest was subordinated to the
security interest previously granted by us to TRW Inc. in all of our present and
after-acquired personal property, assets and undertaking.
On November 4, 2002, we issued, in an offshore transaction pursuant to
Regulation S under the Securities Act of 1933, two million units at a price of
$0.50 per unit. We realized gross cash proceeds of $250,000 from the private
placement; the balance of the aggregate purchase price for the units was paid
for by the application of $750,000 of principal under the senior convertible
notes issued on September 20, 2002 (described below). Each unit consists of one
common shares and one share purchase warrant. Each warrant entitled the holder
to purchase one additional common share at an exercise price of $0.50 per share
until November 4, 2005. Effective May 6, 2003, these warrants were repriced at
$0.10 per share. An additional 17,672 common shares were issued as a payment of
accrued interest at a deemed price of $0.50 per share. Advisors to the private
placement were paid placement and advisory fees of $80,000 and issued 160,000
share purchase warrants exercisable at $0.50 per share for a period of five
years pursuant to Rule 506, Section 4(2) under the Securities Act of 1933 and/or
Regulation S.
On September 20, 2002, we realized gross cash proceeds of $750,000 from
the issuance of 10% redeemable convertible notes plus 150,000 share purchase
warrants from the completion of a private placement effected in an off-shore
transaction to a non-U.S. person, pursuant to Regulation S under the Securities
Act of 1933. Interest on these notes is payable when the notes are fully
converted or redeemed.
On July 17, 2002, we issued 750,000 shares of common stock to a
non-U.S. person in an offshore transaction pursuant to Regulation S at a price
of $1.00 per share. In connection with such private placement, on July 31, 2002,
we issued 22,000 shares of common stock to a different non-U.S. person in an
offshore transaction pursuant to Regulation S at a price of $1.29 per share, as
a placement fee.
On June 27, 2002, we issued 30,000 common share purchase warrants to a
non-U.S. person in an offshore transaction pursuant to Regulation S under the
Securities Act of 1933. Each warrant entitles the holder to purchase one common
share in the capital of the issuer at an exercise price of $2.80 per share until
June 27, 2005, on which date the warrant will expire.
On June 26, 2002, we issued 60,000 shares of common stock to a non-U.S.
person upon exercise of warrants previously granted to it. We received total
consideration of $99,000. The shares were issued in an offshore transaction
relying on Regulation S under the Securities Act of 1933.
111
On May 14, 2002, we issued 140,000 shares of common stock to a non U.S
person upon exercise of warrants previously granted to it. We received total
consideration of $210,000. The shares were issued in an offshore transaction
relying on Regulation S under the Securities Act of 1933.
On March 26, 2002, we issued 750,000 common shares at a price of $1.75
to a non-U.S. person in an offshore transaction pursuant to Regulation S. We
also issued warrants for the purchase of 52,500 common shares to a non-U.S.
person in an offshore transaction pursuant to Regulation S. The warrants were
issued in payment of a placement fee related to the sale of the common shares.
Each warrant entitles the holder to purchase one common share at an exercise
price of $1.75 until March 26, 2005, on which date the warrant will expire.
On February 13, 2002, we issued warrants for the purchase of 11,200
common shares to a non-U.S. person in an offshore transaction pursuant to an
exemption from registration as provided by Regulation S under the Securities Act
of 1933. The warrants were issued in payment of a placement fee related to the
sale of units described below. Each warrant entitles the holder to purchase one
common share of the Company at an exercise price of $1.70 until February 13,
2005, on which date the warrant will expire.
On January 18, 2002, we issued 46,900 share purchase warrants to an
accredited investor pursuant to Rule 506 of Regulation D of the Securities Act
of 1933 . This warrant was issued in payment of a placement fee related to the
sale of units described below. Each warrant entitles the holder to purchase one
common share in the capital of the issuer at an exercise price of $1.70 until
January 18, 2005, on which date the warrant will expire.
112
Item 27 EXHIBITS
EXHIBIT
NUMBER DESCRIPTION
- ------- ---------------------------------------------------------------------
3.1 Certificate of Incorporation of TTC/Truck Tech Corp. dated September
8, 1987 (1)
3.2 Memorandum and Articles of TTC/Truck Tech Corp. (1)
3.3 Memorandum of TTC/Truck Tech Corp. dated September 2, 1987 (1)
3.4 Altered Memorandum of TTC/Truck Tech Corp. dated October 25, 1991 (1)
3.5 Certificate of Change of Name from TTC/Truck Tech Corp. to UniComm
Signal Inc. dated April 13, 1994.(1)
3.6 Certificate of Change of Name from UniComm Signal Inc. to SmarTire
Systems Inc. dated December 24, 1997.(1)
3.7 Special Resolution and Altered Memorandum of UniComm Signal Inc.
dated October 28, 1994.(1)
3.8 Special Resolution and Altered Memorandum of UniComm Signal Inc.
dated January 17, 1997.(1)
3.9 Special Resolution and Altered Memorandum of SmarTire Systems Inc.
dated November 17, 1995.(1)
3.10 Special Resolution and Altered Memorandum of SmarTire Systems Inc.
dated January 16, 1998.(1)
3.11 Special Resolution and Altered Memorandum of SmarTire Systems Inc.
dated December 5, 2000.(4)
3.12 Substituted Articles of SmarTire Systems Inc. adopted December 5,
2000.(4)
3.13 Articles of Continuance, dated January 29, 2003 and effective
February 6, 2003.(9)
3.14 Certificate of amendment issued to SmarTire Systems Inc. by the Yukon
Registrar of Corporations effective December 15, 2003 and attached
Articles of Amendment of SmarTire Systems Inc. dated Decmeber 11,
2003.(21)
3.15 Certificate of Registration of Restated Articles issued to SmarTire
Systems Inc. by the Yukon Registrar of Corporations effective
December 15, 2003, and attached Restated Articles of Incorporation of
SmarTire Systems Inc. dated December 11, 2003.(21)
3.16 By-Law No. 1, dated February 6, 2003.(9)
3.17 Certificate of Amendment to Articles of Incorporation of SmarTire
Systems Inc.(28)
5.1 Opinion of Sichenzia Ross Friedman Ference LLP regarding the legality
of the securities being registered**
113
EXHIBIT
NUMBER DESCRIPTION
- ------- ---------------------------------------------------------------------
10.1 Product Licensing Agreement dated May 5, 1998 between our Company and
Advantage Enterprises Inc.(2)(3)
10.2 Management Agreement between our Company and Shawn Lammers dated as
of August 1, 1999.(3)
10.3 Management Agreement between our Company and Robert Rudman dated as
of August 1, 1999.(3)
10.4 Management Agreement between SmarTire Europe Limited and Ian Bateman
dated as of December 9, 1999.(3)
10.5 License Agreement dated September 20, 1999 between our Company and
Transense Technologies plc.(3)(2)
10.6 Management agreement between our Company and Erwin Bartz dated as of
January 3, 2001.(5)
114
EXHIBIT
NUMBER DESCRIPTION
- ------- ---------------------------------------------------------------------
10.7 License agreement dated August 31, 2001 between our Company and TRW
Inc.(6)(2)
10.8 License agreement dated August 31, 2001 between TRW Inc. and our
Company.(6)(2)
10.9 Management agreement between our Company and Al Kozak dated as of May
1, 2002.(7)
10.10 Advisory agreement between our Company and Impact Capital Limited
dated October 25, 2002.(8)
10.11 Management agreement between our Company and Jeff Finkelstein dated
as of October 25, 2002.(8)
10.12 Supply agreement between our Company and Pirelli Pneumatici dated
September 24, 2002.(8)(2)
10.13 Manufacturing, Co-Marketing and Development Agreement, dated February
6, 2003, between SmarTire Systems Inc. and Hyundai Autonet Co.
Ltd.(12)
10.14 Warrant Certificate dated May 16, 2003 registered in the name of
Dunwoody Brokerage Services, Inc.(12)
10.15 Stock Purchase Warrant dated May 16, 2003 registered in the name of
HPC Capital Management.(12)
10.16 Form of Stock Purchase Warrant for Impact Capital Partners
Limited.(12)
10.17 Securities Purchase Agreement, dated as of July 17, 2003, among
SmarTire Systems Inc. and Palisades Master Fund, L.P., Alpha Capital
AG, Crescent International Ltd., and Goldplate Investment
Partners.(13)
10.18 Registration Rights Agreement, dated as of July 17, 2003, among
SmarTire Systems Inc. and Palisades Master Fund, L.P., Alpha Capital
AG, Crescent International Ltd., and Goldplate Investment
Partners.(13)
10.19 Escrow Agreement, dated as of July 17, 2003, among SmarTire Systems
Inc. and Palisades Master Fund, L.P., Alpha Capital AG, Crescent
International Ltd., Goldplate Investment Partners and Feldman
Weinstein, LLP, as escrow agent.(13)
10.20 Form of 8% Convertible Debenture.(13)
10.21 Form of Stock Purchase Warrant.(13)
115
EXHIBIT
NUMBER DESCRIPTION
- ------- ---------------------------------------------------------------------
10.22 Stock Purchase Warrant, dated as of July 17, 2003, registered in the
name of HPC Capital Management.(13)
10.23 Common Stock Purchase Agreement, dated as of July 23, 2003, between
SmarTire Systems Inc. and Talisman Management Limited.(13)
10.24 Registration Rights Agreement, dated as of July 23, 2003, between
SmarTire Systems Inc. and Talisman Management Limited.(13)
10.25 Escrow Agreement, dated as of July 23, 2003, among SmarTire Systems
Inc., Talisman Management Limited and Feldman Weinstein, LLP, as
escrow agent.(13)
10.26 Stock Purchase Warrant, dated as of July 23, 2003, registered in the
name of Talisman Management Limited.(13)
10.27 Stock Purchase Warrant, dated as of July 23, 2003, registered in the
name of HPC Capital Management.(13)
10.28 Management Agreement between our Company and John Taylor-Wilson,
dated as of August 1, 2003.(13)
10.29 Engagement Letter between our Company and HPC Capital Management,
dated August 12, 2003.(13)
10.30 Stock Purchase Warrant, dated August 15, 2003, registered in the name
of Epoch Financial Group, Inc.(13)
10.31 Agreement in Principle between our Company and Beijing Boom
Technology Limited dated September 8, 2003(14)(2)
10.32 Master Distribution Agreement between SmarTire Systems and Beijing
Boom Technology Co. Ltd. dated October 17, 2003 (14)(2)
10.33 Contract Manufacturing Services Agreement between SmarTire Systems
Inc. and Hyundai Autonet Company dated October 17, 2003.(16)(2)
10.34 Letter Agreement dated October 27, 2003 between SmarTire Systems Inc.
and HPC Capital Management.(18)
10.35 Stock Purchase Warrant, dated October 27, 2003, registered in the
name of HPC Capital Management.(18)
10.36 Letter Agreement dated October 27, 2003 between SmarTire Systems Inc.
and Palisades Master Fund, L.P.(18)
10.37 Stock Purchase Warrant, dated October 27, 2003, registered in the
name of Palisades Master Fund, L.P.(18)
116
EXHIBIT
NUMBER DESCRIPTION
- ------- ---------------------------------------------------------------------
10.38 Letter Agreement dated November 6, 2003 between SmarTire Systems Inc.
and Crescent International Ltd.(19)
10.39 Stock Purchase Warrant, dated November 10, 2003, registered in the
name of Crescent International Ltd. (19)
10.40 Letter Agreement dated November 6, 2003 between SmarTire Systems Inc.
and Alpha Capital AG(19)
10.41 Stock Purchase Warrant, November 10, 2003, registered in the name of
Alpha Capital AG(19)
10.42 Letter Agreement dated November 6, 2003 between SmarTire Systems Inc.
and Goldplate Investment Partners(19)
10.43 Stock Purchase Warrant, dated November 10, 2003, registered in the
name of Goldplate Investment Partners(19)
117
EXHIBIT
NUMBER DESCRIPTION
- ------- ---------------------------------------------------------------------
10.44 Amending Letter Agreement dated November 10, 2003 between SmarTire
Systems Inc. and HPC Capital Management(19)
10.45 Amended Stock Purchase Warrant, dated as of October 27, 2003,
registered in the name of HPC Capital Management(19)
10.46 Amending Letter Agreement dated November 10, 2003 between SmarTire
Systems Inc. and Palisades Master Fund, L.P.(19)
10.47 Amended Stock Purchase Warrant, dated as of October 27, 2003,
registered in the name of Palisades Master Fund, L.P.(19)
10.48 Development Agreement dated September 12, 2003 between SmarTire
Systems Inc. and Vansco Ltd.(20)
10.49 Co-Marketing and Development Agreement dated October 10, 2003 between
Haldex Brake Products Ltd. and SmarTire Systems Inc.(20)
10.50 Supply Agreement dated October 10, 2003 between SmarTire Systems Inc.
and Haldex Brake Products Ltd.(20)
10.51 Securities Purchase Agreement, dated as of December 19, 2003, among
SmarTire Systems Inc. and Palisades Master Fund, L.P., Alpha Capital
AG, Crescent International Ltd., Goldplate Investment Partners, Gamma
Opportunity Capital Partners, LP, PEF Advisors Ltd. and Bristol
Investment Fund, Ltd.(22)
10.52 Registration Rights Agreement, dated as of December 24, 2003, among
SmarTire Systems Inc. and Palisades Master Fund, L.P., Alpha Capital
AG, Crescent International Ltd., Goldplate Investment Partners, Gamma
Opportunity Capital Partners, LP, PEF Advisors Ltd. and Bristol
Investment Fund, Ltd. (22)
10.53 Escrow Agreement, dated as of December 24, 2003, among SmarTire
Systems Master Fund, L.P., Alpha Capital AG, Crescent International
Ltd., Goldplate Investment Partners, Gamma Opportunity Capital
Partners, LP, PEF Advisors Ltd., Bristol Investment Fund, Ltd. and
Feldman Weinstein, LLP, as escrow agent(22)
10.54 Form of Discounted Convertible Debenture(22)
10.55 Form of Addendum to Discounted Convertible Debenture(22)
10.56 Form of Stock Purchase Warrant(22)
10.57 Placement Fee Payment and Subscription Agreement, dated as of
December 24, 2003, between SmarTire Systems Inc. and HPC Capital
Management(22)
10.58 Stock Purchase Warrant, dated as of December 24, 2003, registered in
the name of HPC Capital Management(22)
118
EXHIBIT
NUMBER DESCRIPTION
- ------- ---------------------------------------------------------------------
10.59 Amendment Agreement between SmarTire Systems Inc. and Talisman
Management Limited dated January 21, 2004, amending the Common Stock
Purchase Agreement between the parties dated as of July 23, 2003(22)
10.60 Amendment Agreement between SmarTire Systems Inc. and Talisman
Management Limited dated January 21, 2004, amending the Registration
Rights Agreement between the parties dated as of July 23, 2003(22)
10.61 Form of Promissory note issued to Cornell Capital Partners, LP(23)
10.62 Standby Equity Distribution Agreement dated May 19, 2004(24)
10.63 Registration Rights Agreement dated May 19, 2004(24)
10.64 Escrow Agreement with Cornell Capital Partners, LP(24)
10.65 Dealer and Supply Agreement between SmarTire Systems Inc, Chu Chang
International Ltd, Beijing Boom Technology Co. Ltd. dated as of June
3, 2004(25)
10.66 Forbearance and Escrow Agreement(26)
10.67 Promissory note dated as of November 16, 2004 with Cornell Capital
Partners, LP(27)
10.68 Promissory note dated as of November 16, 2004 with Cornell Capital
Partners, LP(27)
10.69 Form of Subscription Agreement and Prospective Purchaser
Questionnaire of SmarTire Systems Inc.(28)
10.70 Form of 5% Convertible Debenture SmarTire Systems Inc.(28)
10.71 Form of Redemption Warrant of SmarTire Systems Inc. (28)
10.72 Securities Purchase Agreement dated December 15, 2004 by and between
SmarTire Systems, Inc. and Cornell Capital Partners, L.P. (28)
10.73 Registration Rights Agreement dated December 15, 2004 by and between
SmarTire Systems, Inc. and Cornell Capital Partners, L.P. (28)
10.74 Form of 5% Convertible Debenture SmarTire Systems, Inc. (28)
10.75 Form of Common Stock Purchase Warrant of SmarTire Systems, Inc. (28)
10.76 2004 Non-US US Stock Incentive Plan of SmarTire Systems, Inc. (28)
14.1 Code of Business Conduct and Ethics Compliance Program (16)
119
EXHIBIT
NUMBER DESCRIPTION
- ------- ---------------------------------------------------------------------
21.1 SmarTire Technologies Inc.
21.2 SmarTire USA Inc.
21.3 SmarTire Europe Limited
23.1 Consent of KPMG LLP**
23.2 Consent of legal counsel (see Exhibit 5.1)**
24.1 Power of Attorney (contained on the signature pages of this
registration statement)
** Filed herewith.
(1) Incorporated by reference to SmarTire Systems Inc.'s Form 10-KSB
filed with the Securities and Exchange Commission on August 18, 1998.
(2) Portions of the Exhibit have been omitted pursuant to an order
granting confidential treatment under the Securities Exchange Act of
1934.
(3) Incorporated by reference to SmarTire Systems Inc.'s Form 10-QSB
filed with the Securities and Exchange Commission on March 16, 2000.
(4) Incorporated by reference to SmarTire Systems Inc.'s definitive
Proxy Statement and Information Circular on Schedule 14A filed with the
Securities and Exchange Commission on October 31, 2000.
(5) Incorporated by reference to SmarTire Systems Inc.'s Form 10-KSB
filed with the Securities and Exchange Commission on October 26, 2001.
(6) Incorporated by reference to SmarTire Systems Inc.'s Form 10-KSB/A
filed with the Securities and Exchange Commission on August 19, 2002.
(7) Incorporated by reference to SmarTire Systems Inc.'s Form 10-KSB
filed with the Securities and Exchange Commission on October 25, 2002.
(8) Incorporated by reference to SmarTire Systems Inc.'s Form 10-QSB
filed with the Securities and Exchange Commission on December 13, 2002.
(9) Incorporated by reference to SmarTire Systems Inc.'s Form SB-2
filed with the Securities and Exchange Commission on January 23, 2003.
(10) Incorporated by reference to Post-Effective Amendment No. 1 to
SmarTire Systems Inc.'s Form SB-2 filed with the Securities and
Exchange Commission on March 14, 2003.
(11) Incorporated by reference to Post-Effective Amendment No. 3 to
SmarTire Systems Inc.'s Form SB-2 filed with the Securities and
Exchange Commission on May 2, 2003.
(12) Incorporated by reference to SmarTire Systems Inc.'s Form SB-2
filed with the Securities and Exchange Commission on June 4, 2003.
(13) Incorporated by reference to SmarTire Systems Inc.'s Form SB-2
filed with the Securities and Exchange Commission on August 18, 2003.
(14) Incorporated by reference to SmarTire Systems Inc.'s Form 8-K
filed with the Securities and Exchange Commission on September 10,
2003.
(15) Incorporated by reference to SmarTire Systems Inc.'s Form 10-KSB
filed with the Securities and Exchange Commission on October 25, 2003.
120
(16) Incorporated by reference to SmarTire Systems Inc.'s Form 8-K/A
filed with the Securities and Exchange Commission on January 7, 2004.
(17) Incorporated by reference to SmarTire Systems Inc.'s Form 8-K
filed with the Securities and Exchange Commission on October 24, 2003.
(18) Incorporated by reference to Pre-Effective Amendment No. 1 to
SmarTire Systems Inc.'s registration statement on Form SB-2/A filed
with the Securities Exchange Commission on November 4, 2003.
(19) Incorporated by reference to SmarTire Systems Inc.'s Form 8-K
filed with the Securities and Exchange Commission on November 13, 2003.
(20) Incorporated by reference to SmarTire Systems Inc.'s Form 10-QSB
filed with the Securities and Exchange Commission on December 12, 2003.
(21) Incorporated by reference to SmarTire Systems Inc.'s Form 8-K
filed with the Securities and Exchange Commission on December 23, 2003.
(22) Incorporated by reference to SmarTire Systems Inc.'s Form SB-2
filed with the Securities Exchange Commission on January 15, 2004.
(23) Incorporated by reference to SmarTire Systems Inc.'s 8-K filed
with the Securities Exchange Commission on April 28, 2004.
(24) Incorporated by reference to SmarTire Systems Inc.'s Form SB-2
filed with the Securities Exchange Commission on June 2, 2004.
(25) Incorporated by reference to SmarTire Systems Inc.'s 8-K filed
with the Securities Exchange Commission on June 15, 2004.
(26) Incorporated by reference to SmarTire Systems Inc.'s 8-K filed
with the Securities Exchange Commission on October 1, 2004.
(27) Incorporated by reference to SmarTire Systems Inc.'s Form 10-QSB
filed with the Securities and Exchange Commission on December 14, 2004.
(28) Incorporated by reference to SmarTire Systems Inc.'s 8-K filed
with the Securities Exchange Commission on December 21, 2004.
121
Item 28 UNDERTAKINGS
The undersigned Company hereby undertakes that it will:
(1) file, during any period in which offers or sales are being made, a
post-effective amendment to this registration statement to include:
(a) any prospectus required by Section 10(a)(3) of the Securities Act;
(b) reflect in the prospectus any facts or events which, individually
or together, represent a fundamental change in the information in the
registration statement. Notwithstanding the foregoing, any increase or
decrease in volume of securities offered (if the total dollar value of
securities offered would not exceed that which was registered) and any
deviation from the low or high end of the estimated maximum offering
range may be reflected in the form of prospectus filed with the
Commission pursuant to Rule 424(b) if, in the aggregate, the changes in
volume and price represent no more than a 20% change in the aggregate
offering price set forth in the "Calculation of Registration Fee" table
in the effective registration statement; and
(c) any additional or changed material information with respect to the
plan of distribution not previously disclosed in the registration
statement;
(2) for the purpose of determining any liability under the Securities Act, each
of the post-effective amendment shall be deemed to be a new registration
statement relating to the securities offered therein, and the offering of the
securities at that time shall be deemed to be the initial bona fide offering
thereof; and
(3) remove from registration by means of a post-effective amendment any of the
securities being registered which remain unsold at the termination of the
offering.
Insofar as indemnification for liabilities arising under the Securities
Act may be permitted to directors, officers and controlling persons of SmarTire
pursuant to the foregoing provisions, or otherwise, SmarTire has been advised
that in the opinion of the Commission that type of indemnification is against
public policy as expressed in the Securities Act and is, therefore,
unenforceable. In the event that a claim for indemnification against said
liabilities (other than the payment by SmarTire of expenses incurred or paid by
a director, officer or controlling person of SmarTire in the successful defense
of any action, suit or proceeding) is asserted by the director, officer or
controlling person in connection with the securities being registered, SmarTire
will, unless in the opinion of our counsel the matter has been settled by
controlling precedent, submit to a court of appropriate jurisdiction the
question whether such indemnification by it is against public policy as
expressed in the Securities Act and will be governed by the final adjudication
of the issue.
For purposes of determining any liability under the Securities Act, the
information omitted from the form of prospectus filed as part of this
registration statement in reliance upon Rule 430A and contained in a form of
prospectus filed by the registrant pursuant to Rule 424(b)(1) or (4) or 497(h)
under the Securities Act shall be deemed to be part of this registration
statement as of the time it was declared effective.
122
SIGNATURES
In accordance with the requirements of the Securities Act, the
registrant certifies that it has reasonable grounds to believe that it meets all
of the requirements of filing on Form SB-2 and authorized this registration
statement to be signed on its behalf by the undersigned, in the City of
Richmond, British Columbia on December 30, 2004.
SMARTIRE SYSTEMS INC.
/s/Robert Rudman
- ------------------------------------------------------------------
By: Robert Rudman, President, Chief Executive Officer and Chairman
/s/Jeff Finkelstein
- ------------------------------------------------------------------
By: Jeff Finkelstein, Chief Financial Officer,
Principal Financial Officer and Principal Accounting Officer
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person who signature
appears below constitutes and appoints Robert Rudman as his true and lawful
attorney-in-fact and agent, with full power of substitution and re-substitution,
for him and in his name, place and stead, in any and all capacities, to sign any
and all amendments (including post-effective amendments) to this registration
statement, and to file the same, with all exhibits thereto, and other documents
in connection therewith, with the Securities and Exchange Commission, granting
unto said attorney-in-fact and agent, full power and authority to do and perform
each and every act and thing requisite and necessary to be done in connection
therewith, as fully to all intents and purposes as he might or could do in
person, hereby ratifying and confirming all that said attorney-in-fact and agent
or any of them, or of their substitute or substitutes, may lawfully do or cause
to be done by virtue hereof.
Pursuant to the requirements of the Securities Act, this registration
statement has been signed by the following persons in the capacities and on the
dates stated.
SIGNATURES
/s/Robert Rudman
- ------------------------------------------------------------------
Robert Rudman, President, CEO, Chairman and Director
December 30, 2004
/s/Al Kozak
- ------------------------------------------------------------------
Al Kozak, Chief Operating Officer and Director
December 30, 2004
/s/William Cronin
- ------------------------------------------------------------------
William Cronin, Director
December 30, 2004
/s/Johnny Christiansen
- ------------------------------------------------------------------
Johnny Christiansen, Director
December 30, 2004
/s/Martin Gannon
- ------------------------------------------------------------------
Martin Gannon, Director
December 30, 2004
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