As filed with the U.S. Securities and Exchange Commission on July 22, 2005
Registration No. 333-______
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U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM SB-2
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933
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SMARTIRE SYSTEMS INC.
(Name of small business issuer 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
(Address and telephone number of principal executive offices)
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150-13151 Vanier Place, Richmond, British Columbia, V6V 2J1
(604) 276-9884
(Address of principal place of business or
intended principal place of business)
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Al Kozak
President and Chief Executive Officer
SmarTire Systems Inc.
150-13151 Vanier Place
Richmond, British Columbia, V6V 2J1
(604) 276-9884
(Name, address and telephone number of agent for service)
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Copy to:
Spencer G. Feldman, Esq.
Michael Helsel, Esq.
Greenberg Traurig, LLP
MetLife Building
200 Park Avenue - 14th Floor
New York, New York 10166
Tel: (212) 801-9200; Fax: (212) 801-6400
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Approximate date of commencement of proposed sale to the public: From
time to time after the effective date of this Registration Statement.
If any of the securities being registered on this Form are to be
offered on a delayed or continuous basis pursuant to Rule 415 under the
Securities Act of 1933, check the following box. |X|
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) 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(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, check the following box. |_|
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CALCULATION OF REGISTRATION FEE
================================ ========================== =========================== ======================= ====================
Title of each class of Amount to be Proposed maximum Proposed maximum Amount of
securities registered offering price aggregate offering registration
to be registered(1) per share(2) price Fee(3)
- -------------------------------- -------------------------- --------------------------- ----------------------- --------------------
Common Stock Underlying
Standby Equity Distribution
Agreement 1,000,000,000 shares(4) $0.13 $130,000,000.00 $15,301.00
- -------------------------------- -------------------------- --------------------------- ----------------------- --------------------
Common Stock Underlying 10%
Convertible Debentures 266,666,667 shares(5) $0.13 $34,666,666.71 $4,080.27
- -------------------------------- -------------------------- --------------------------- ----------------------- --------------------
Common Stock Underlying
Warrants issued with 10%
Convertible Debentures 62,500,000 shares(6) $0.13 $8,125,000.00 $956.31
- -------------------------------- -------------------------- --------------------------- ----------------------- --------------------
Common Stock Underlying
Placement Agent Fee in
connection with Standby Equity
Distribution Agreement 75,188 shares(7) $0.13 $9,744.44 $1.15
- -------------------------------- -------------------------- --------------------------- ----------------------- --------------------
Common Stock Underlying 5%
Convertible Debenture 53,571,429 shares(8) $0.13 $6,964,285.77 $819.70
- -------------------------------- -------------------------- --------------------------- ----------------------- --------------------
Common Stock Underlying 5%
Convertible Debentures 5,416,667 shares(9) $0.13 $704,166.71 $82.88
- -------------------------------- -------------------------- --------------------------- ----------------------- --------------------
Common Stock Issued Under
Redemption, Settlement and
Release Agreements 9,112,189 shares(10) $0.13 $1,184,584.57 $139.43
- -------------------------------- -------------------------- --------------------------- ----------------------- --------------------
Common Stock Underlying
Discounted Convertible
Debentures 9,587,893 shares(11) $0.13 $1,246,426.09 $146.70
- -------------------------------- -------------------------- --------------------------- ----------------------- --------------------
Common Stock Underlying Series
A Convertible Preferred Stock 400,000,000 shares(12) $0.13 $52,000,000.00 $6,120.40
- -------------------------------- -------------------------- --------------------------- ----------------------- --------------------
Common Stock Underlying
Warrants issued with investor
relations agreement 250,000 shares(13) $0.13 $32,500.00 $3.83
- -------------------------------- -------------------------- --------------------------- ----------------------- --------------------
Total Registration Fee $27,652.17
- -------------------------------- -------------------------- --------------------------- ----------------------- --------------------
(1) This registration statement will also cover any additional shares of common
stock that will become issuable by reason of any stock dividend, stock split,
recapitalization or other similar transaction effected without receipt of
consideration that results in an increase in the number of outstanding shares of
common stock.
(2) Estimated solely for the purpose of calculating the registration fee
pursuant to Rule 457(c) under the Securities Act of 1933, as amended, based upon
the average of the high and low prices of the registrant's common stock on the
OTC Bulletin Board on July 22, 2005.
(3) 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 July
22, 2005, as quoted on the OTC Bulletin Board.
(4) Represents common stock that may be issued pursuant to the Standby Equity
Distribution Agreement dated June 23, 2005.
(5) Represents common stock that may be issued upon the conversion of principal
under the 10% convertible debentures, dated June 23, 2005 and maturing June 23,
2008.
(6) Represents the common stock issuable upon the exercise of 62,500,000 common
share purchase warrants, dated June 23, 2005 and expiring on June 23, 2010.
(7) Represents common stock issued as a placement agent fee in connection with
the Standby Equity Distribution Agreement.
(8) Represents common stock that may be issued upon the conversion of principal
under the 5% convertible debenture, dated May 20, 2005 and maturing May 20,
2006.
(9) Represents the common stock that may be issued upon the conversion or
redemption of principal under 5% convertible debentures, dated December 15, 2004
and maturing December 15, 2007.
(10) Represents restricted common stock issued to holders of discounted
convertible debentures under redemption, settlement and release agreements dated
various dates in April and May 2005.
(11) Represents common stock that may be issued upon the conversion or
redemption of principal, or restricted stock issued under discounted convertible
debentures, dated December 24, 2003 and maturing April 1, 2006.
(12) Represents the common stock that may be issued upon the conversion of the
series A convertible preferred stock.
(13) Represents the common stock issuable upon the exercise of 250,000 common
share purchase warrants that expire on June 30, 2009.
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THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH 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 OF 1933, AS AMENDED, OR UNTIL THE REGISTRATION STATEMENT SHALL
BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION
8(a), MAY DETERMINE.
The information in this prospectus is not complete and may be changed. Our
selling stockholders may not sell these securities until the 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
offers to buy these securities in any state where the offer or sale is not
permitted.
SUBJECT TO COMPLETION, DATED JULY 22, 2005
1,807,180,033 SHARES OF COMMON STOCK OF
SMARTIRE SYSTEMS INC.
This prospectus relates to the sale by selling stockholders of up to
1,807,180,033 shares of our common stock as follows:
o up to 1,000,000,000 shares of common stock issuable pursuant to a
$160 million Standby Equity Distribution Agreement dated June 23,
2005 between our company and a selling stockholder;
o up to 266,666,667 shares of common stock issuable to selling
stockholders upon the conversion of principal under the 10% convertible
debentures dated June 23, 2005;
o up to 62,500,000 shares of common stock issuable to selling
stockholders assuming the exercise of outstanding common share purchase
warrants, issued June 23, 2005, at an exercise price of $0.16;
o up to 75,188 shares of common stock issued to a selling stockholder as
a placement agent fee in connection with our $160 million Standby
Equity Distribution Agreement;
o up to 53,571,429 shares of common stock issuable to a selling
stockholder upon the conversion of principal under the 5% convertible
debenture dated May 20, 2005;
o up to 5,416,667 shares of common stock issuable to selling stockholders
upon the conversion of principal under our 5% convertible debentures
dated December 15, 2004;
o up to 9,112,189 shares of restricted common stock issued to selling
stockholders under redemption, settlement and release agreements dated
various dates in April and May 2005;
o up to 9,587,893 shares of common stock issuable to selling stockholders
upon the conversion of principal under our discounted convertible
debentures dated December 24, 2003;
o up to 400,000,000 shares of common stock issuable to a selling
stockholder upon the conversion of our series A convertible preferred
stock; and
o up to 250,000 shares of common stock issuable to selling stockholders
assuming the exercise of outstanding common share purchase warrants at
an exercise price of $0.20.
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 pay the
expenses of registering these shares. However, we will receive the proceeds from
any common stock we issue to the selling stockholders upon exercise of all of
the warrants and we will also receive proceeds as we draw down on the equity
line of credit pursuant to the Standby Equity Distribution Agreement we entered
into with one of the selling stockholders. We expect to use the proceeds
received from the exercise of all warrants and the draw down on the equity line
of credit, if any, for general working capital purposes and repayments on our
preferred stock and convertible debentures. 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". The high and low bid prices for shares of our common stock on July 22,
2005, were $0.131 and $0.134 per share, respectively, based upon bids that
represent prices quoted by broker-dealers on the OTC Bulletin Board. These
quotations reflect inter-dealer prices, without retail mark-up, mark-down or
commissions, and may not represent actual transactions.
The selling stockholders and any broker-dealer executing sell orders on
behalf of the selling stockholders may be deemed to be "underwriters" within the
meaning of the Securities Act of 1933. Commissions received by any broker-dealer
may be deemed to be underwriting commissions under the Securities Act of 1933.
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AN INVESTMENT IN THESE SECURITIES INVOLVES A HIGH DEGREE OF RISK.
PLEASE CAREFULLY REVIEW THE SECTION TITLED "RISK FACTORS" BEGINNING ON PAGE 7.
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Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of these securities or passed
upon the adequacy or accuracy of this prospectus. Any representation
to the contrary is a criminal offense.
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The Date of This Prospectus is July 22, 2005
In considering the acquisition of the common stock described in this
prospectus, you should rely only on the information contained in this
prospectus. We have not authorized anyone to provide you with information
different from that contained in this prospectus. This prospectus is not an
offer to sell, or a solicitation of an offer to buy, shares of common stock in
any jurisdiction where offers and sales would be unlawful. The information
contained in this prospectus is complete and accurate only as of the date on the
front cover of this prospectus, regardless of the time of delivery of this
prospectus or of any sale of the shares of common stock.
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TABLE OF CONTENTS
Page
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PROSPECTUS SUMMARY...........................................................1
RISK FACTORS.................................................................4
USE OF PROCEEDS.............................................................24
MARKET FOR OUR COMMON STOCK AND RELATED SECURITYHOLDER MATTERS..............24
SUMMARY FINANCIAL DATA......................................................26
MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION...................27
DESCRIPTION OF BUSINESS.....................................................40
MANAGEMENT..................................................................54
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT..............61
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS..............................63
PRINCIPAL AND SELLING STOCKHOLDERS..........................................64
PLAN OF DISTRIBUTION........................................................68
DESCRIPTION OF SECURITIES...................................................70
LEGAL MATTERS...............................................................84
INTEREST OF NAMED EXPERTS AND COUNSEL.......................................84
EXPERTS ....................................................................84
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE........................................................84
WHERE YOU CAN FIND MORE INFORMATION.........................................85
INDEX TO CONSOLIDATED FINANCIAL INFORMATION................................F-1
PROSPECTUS SUMMARY
You should read the following summary together with the more detailed
information contained elsewhere in this prospectus, including the section titled
"Risk Factors," regarding us and the common stock described in this offering.
Unless the context otherwise requires, "we," "our," "us" and similar phrases
refer to SmarTire Systems Inc. and subsidiaries. All dollar amounts refer to
U.S. dollars unless otherwise indicated.
Our Business
We develop and market technically advanced tire pressure monitoring
systems. These systems are designed to provide improved vehicle safety,
performance, reliability and fuel efficiency for passenger cars, trucks and
motorcycles. We intend to enhance our systems and offer complementary products
for the transportation and automotive industries.
The U.S. government, through the Transportation Recall Enhancement,
Accountability and Documentation Act, has legislated that all new passenger
vehicles must be equipped with tire monitoring systems beginning with a phased
implementation in 2004. The regulation covers all cars and light trucks,
including vans and sport utility vehicles. The government estimates that it will
cost the industry between $800 million and $1.1 billion to phase in the
technology on all new vehicles through 2008. We are striving to capitalize on
the rapidly emerging original equipment manufacturer ("OEM") and aftermarket
opportunities.
We have three wholly-owned subsidiaries: SmarTire Technologies Inc.,
SmarTire USA Inc. and SmarTire Europe Limited. SmarTire Technologies Inc. was
originally incorporated in August, 1987 as Delta Transportation Products Ltd.
and was renamed under the laws of the Province of British Columbia in June 1998,
and was the original developer of our patented technology. SmarTire USA Inc., a
Delaware corporation incorporated in May 1997, is our exclusive marketing agency
for SmarTire in North America. SmarTire Europe Limited, a United Kingdom
corporation incorporated in February 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.
During the fiscal years ended July 31, 2004 and July 31, 2003, we
earned revenues of $1,658,279 and $1,802,596, respectively, primarily from the
sale of tire monitoring systems for passenger cars. For the nine months ended
April 30, 2005, we earned revenue of $1,022,484 and had a net loss of
$11,794,574.
Recent Financing Transactions
On June 30, 2005, we closed a $30 million Securities Purchase Agreement
with Cornell Capital Partners and Highgate House Funds, Ltd. In accordance with
the Securities Purchase Agreement, we issued, for a purchase price of $30
million, (i) a 10% convertible debenture due June 23, 2008, with a principal
balance of $20 million, to Cornell Capital Partners, as trustee for LCC Global
Limited, a corporation organized under the laws of Cyprus, (ii) a 10%
convertible debenture due June 23, 2008, with a principal balance of $8 million,
to Cornell Capital Partners, as trustee for LCC Global Limited, and (iii) a 10%
convertible debenture due June 23, 2008, with a principal balance of $2 million,
to Highgate House Funds, as trustee for LCC Global Limited.
The remaining principal under the convertible debentures may be
converted by Cornell Capital Partners or Highgate House Funds, as applicable, in
whole or in part and from time to time into shares of our common stock at a
conversion price of $0.1125 per share, subject to adjustment as provided for in
the convertible debentures.
On June 23, 2005, we entered into a $160 million Standby Equity
Distribution Agreement with Cornell Capital Partners, LP 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 and replaces our previous $30 million Standby Equity
Distribution Agreement, which was terminated by the parties on June 23, 2005.
We have agreed to pay to Cornell Capital Partners a cash fee of $16
million in connection with the Standby Equity Distribution Agreement, and
Cornell Capital Partners 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.
1
On May 20, 2005, we entered into a Securities Purchase Agreement with
Cornell Capital Partners. In accordance with the Securities Purchase Agreement,
we issued to Cornell Capital Partners, for a purchase price of $1.5 million, a
5% convertible debenture that is convertible, at the option of Cornell Capital
Partners, into shares of our common stock. The convertible debenture matures on
May 20, 2006.
On March 23, 2005, we entered into an Investment Agreement with Cornell
Capital Partners in which we sold an aggregate of $4,000,000 of our series A 5%
convertible preferred stock. The purchase price was $4,000,000, of which
$2,850,000 was previously funded pursuant to certain transaction documents we
entered into with Cornell Capital Partners. These previous transaction documents
were terminated by the parties on March 23, 2005. On March 23, 2005, we received
net proceeds of $1,015,000, after deducting the $2,850,000 that was previously
funded, a $115,000 commitment fee and legal fees in the amount of $20,000.
Due to the uncertainty of our ability to meet our current operating and
capital expenses, in its 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.
Corporate History
We were incorporated under the laws of the Province of British Columbia
as TTC/Truck Tech Corp. in September 1987. We were initially formed to develop
and market remote data sensing, transmission and processing products
incorporating patented technologies to satisfy emerging market requirements in
the transportation industry.
We were 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 Bylaw No. 1, being a bylaw 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 an annual and extraordinary
general meeting held on December 12, 2002. Effective December 10, 2004, we filed
a certificate of amendment with the Yukon Registrar of Corporations to our
Articles of Incorporation to change the number of our authorized shares of
common stock from 300,000,000 shares to an unlimited number of shares and to
authorize the issuance of 100,000 shares of preferred stock. On March 18, 2005,
we filed articles of amendment to our articles of incorporation that set forth
all the rights and preferences of our series A 5% convertible preferred stock.
As of the date hereof, we have issued 25,000 shares of series A 5% convertible
preferred stock to Cornell Capital Partners.
2
In July 1988, we acquired all of the 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 system (which we call 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) in September 1989. In April 1995, we
changed our name to UniComm Signal Inc. In December 1997, we changed our name to
SmarTire Systems Inc. and effected a reverse stock split pursuant to which our
outstanding shares of common stock were consolidated on a 1-for-8 basis. In
December 1998, our common stock commenced trading on the Nasdaq SmallCap Market.
In March 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.
Corporate Information
Our principal executive offices are located at 150-13151 Vanier Place,
Richmond, British Columbia, V6V 2J1, and our telephone number is (604) 276-9884.
Our website is located at www.smartire.com. Our SEC filings are available to the
public from our website. Information on our website is not, and should not be
considered to be, part of this prospectus.
The Offering
This prospectus covers the sale by the selling stockholders named in
this prospectus of up to (i) 1,000,000,000 shares of common stock issuable
pursuant to a Standby Equity Distribution Agreement dated June 23, 2005 between
our company and a selling stockholder; (ii) 266,666,667 shares of common stock
issuable to selling stockholders upon the conversion of principal under the 10%
convertible debentures dated June 23, 2005; (iii) 62,500,000 shares of common
stock issuable to selling stockholders assuming the exercise of outstanding
common share purchase warrants, issued June 23, 2005, at an exercise price of
$0.16; (iv) 75,188 shares of common stock issued to a selling stockholder as a
placement agent fee in connection with our $160 million equity line of credit;
(v) 53,571,429 shares of common stock issuable to a selling stockholder upon the
conversion of principal under the 5% convertible debenture dated May 20, 2005;
(vi) 5,416,667 shares of common stock issuable to selling stockholders upon the
conversion of principal under our 5% convertible debentures dated December 15,
2004; (vii) 9,112,189 shares of restricted common stock issued to selling
stockholders under redemption, settlement and release agreement dated various
dates in April and May 2005; (viii) 9,587,893 shares of common stock issuable to
selling stockholders upon the conversion of principal under our discounted
convertible debentures dated December 24, 2003; (ix) 400,000,000 shares of
common stock issuable to a selling stockholder upon the conversion of our series
A convertible preferred shares; and (x) 250,000 shares of common stock issuable
to selling stockholders assuming the exercise of outstanding common share
purchase warrants at an exercise price of $0.20.
There were 274,595,173 shares of our common stock issued and
outstanding as of June 30, 2005.
Use of Proceeds
We will not receive any of the proceeds from the sale of the shares of
common stock being offered for sale by the selling stockholders. However, upon
any investor's exercise of the warrants we will receive proceeds from such
investor's payment of the exercise price of such warrants, and we will also
receive proceeds as we draw down on the equity line of credit pursuant to the
Standby Equity Distribution Agreement we entered into with one of the selling
stockholders. We expect to use the proceeds received from the exercise of all
warrants and the draw down on the equity line of credit, if any, for general
working capital purposes and monthly repayments on our discounted convertible
debentures. We will incur all costs associated with this registration statement
and prospectus.
Risk Factors
An investment in these securities involves a high degree of risk.
Please carefully review the section titled "Risk Factors" beginning on page 4.
3
RISK FACTORS
An investment in our common stock involves a high degree of risk. You
should carefully consider the following material risks, together with the other
information contained in this prospectus, before you decide to buy our common
stock. If any of the following risks actually occur, our business, results of
operations and financial condition would likely suffer. In these circumstances,
the market price of our common stock could decline, and you may lose all or part
of your investment.
RISKS RELATED TO OUR OUTSTANDING SECURITIES
WE HAVE ISSUED PREFERRED SHARES, CONVERTIBLE DEBENTURES AND SHARE
PURCHASE WARRANTS, AND OUR OBLIGATIONS UNDER THE PREFERRED SHARES, CONVERTIBLE
DEBENTURES AND THE WARRANTS POSE RISKS TO THE PRICE OF OUR COMMON STOCK AND OUR
CONTINUING OPERATIONS.
We have issued $4 million in series A convertible preferred shares
that are currently outstanding and discounted convertible debentures, in the
aggregate principal amount of $3,493,590, maturing on April 1, 2006, of which
amount $306,726 remain outstanding as of June 30, 2005. In addition to the
discounted convertible debentures, we have also issued 10% convertible
debentures, in the aggregate principal amount of $30 million maturing on June
23, 2008, of which the entire balance is outstanding as at June 30, 2005; 8%
convertible debentures in the aggregate principal amount of $1.7 million
maturing July 16, 2006, of which amount $215,000 remain outstanding as at June
30, 2005; and 5% convertible debentures in the aggregate principal amount of
$195,000 maturing on December 15, 2007, of which amount $195,000 remain
outstanding as at June 30, 2005. The preferred shares, discounted, 5%, 8% and
10% convertible debentures provide that in certain circumstances the holder may
convert the (i) shares of preferred stock, (ii) the outstanding principal under
the discounted convertible debentures and (iii) accrued interest under the 5%
and 8% convertible debentures, into shares of our common stock. The purchasers
of the 10% convertible debentures also hold warrants to purchase an aggregate of
62.5 million shares of our common stock.
The terms and conditions of the 5% series A convertible preferred
shares, convertible debentures and the warrants pose unique and special risks to
our continuing operations and the price of our common stock. Some of these 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% SERIES A CONVERTIBLE
PREFERRED SHARES, AND 5%, 8%, 10% AND DISCOUNTED CONVERTIBLE DEBENTURES. SUCH
SHORT SALES MAY IN TURN PLACE ADDITIONAL DOWNWARD PRESSURE ON THE MARKET PRICE
OF OUR COMMON STOCK. IF THE CONVERTIBLE DEBENTURES ARE CONVERTED OR THE WARRANTS
ARE EXERCISED, THERE WILL BE DILUTION OF YOUR SHARES OF COMMON STOCK.
Neither the 5% series A convertible preferred shares, 5%, 8%, 10% nor
discounted convertible debentures, nor our Standby Equity Distribution Agreement
with Cornell Capital Partners, contain any restrictions on short selling.
Accordingly, any significant downward pressure on the price of our common stock
as the debenture holders or Cornell Capital Partners 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 common
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.
As disclosed above in this section outlining certain "Risk Factors,"
the holders of the 5% series A convertible preferred shares, 5%, 8%, 10% and
discounted convertible debentures may ultimately convert the full amount of
their respective securities 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.
4
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.
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 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.
As of June 30, 2005, the aggregate principal amount of $268,461 of
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. As at June 30, 2005, we had issued 52,514,524 shares of
our common stock for monthly payments, conversions and pursuant to release,
redemption and settlement agreements on our discounted convertible debentures.
Holders of 8% convertible debentures had converted a total of $1,521,986 of
principal, and related interest, resulting in the issuance of 13,899,511 shares
of our common stock. The balance of the 8% convertible debentures in the
aggregate amount of $215,000 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, 8% convertible debentures and
advisors to these transactions received warrants to acquire up to an aggregate
of 33,589,131 shares of our common stock. In April 2004, these holders exercised
warrants to purchase 500,000 shares of our common stock. In September 2004,
holders exercised warrants to purchase 18,226,274 shares of common stock, and
during April and May 2005, holders exercised warrants to purchase 14,862,857
shares of our common stock. 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 will be reduced to equal
such effective price.
Holders of our 8% convertible debentures are eligible to sell shares of
our common stock underlying their respective 8% convertible debentures under
Rule 144(k) of the Securities Act of 1933, as amended.
The following table sets forth the number and percentage of shares of
our common stock that would be issuable if the entire principal amount of the
discounted convertible debentures and the 8% convertible debentures of $483,461
is converted or redeemed at the current conversion price of $0.028 as at June
30, 2005:
Discounted and 8% Percentage of
Convertible Class(2)(3)
Debentures(1)
Debentures in the aggregate
principal amount of $483,461 are 17,266,464 5.92%
converted/redeemed at a conversion
price of $0.028.
5
(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.
(2) Based on 274,595,173 common shares issued and outstanding on June 30, 2005.
(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 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:
o 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;
o we fail to comply with any of the other agreements contained in the
convertible debenture after we are given 15 days written notice of such
non-compliance;
o 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 15 days after our receipt of written notice
of such breach;
o we or any of our subsidiaries become bankrupt or insolvent;
o 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 15 days or the breach is waived by the other party
to the debt or credit agreement;
o 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;
o 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
o 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.
6
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.
WE ARE CURRENTLY IN DEFAULT OF THE DISCOUNTED CONVERTIBLE DEBENTURES AS
WE FAILED TO PAY OUR MONTHLY REDEMPTION PAYMENT DUE ON FEBRUARY 1, 2005, MARCH
1, 2005, APRIL 1, 2005 AND WE DID NOT FILE A REGISTRATION STATEMENT AS OF MAY
31, 2005.
In connection with the private placement of our 8% and discounted
convertible debentures, we agreed to make monthly redemption payments to the
holders and file a registration statement registering the shares of common stock
issuable upon conversion of the debentures by January 31, 2005. We are currently
in default of the discounted convertible debentures as we failed to pay our
monthly redemption payment due on February 1, 2005, March 1, 2005 and April 1,
2005 and we did not file a registration statement on or before January 31, 2005.
To resolve all outstanding disputes over the 8% and discounted
convertible debentures, in April and May 2005 we entered into Redemption,
Release and Settlement Agreements with all but one of the holders of our 8% and
discounted convertible debentures. Pursuant to such Redemption, Release and
Settlement Agreements, we redeemed, through the making of $866,066 in cash
payments, an aggregate of $757,011 of the outstanding aggregate principal
balance owed by us under the 8% and discounted convertible debentures. In
addition, we issued to such holders an aggregate of 23,069,042 shares of our
common stock to redeem an additional $272,685 of the outstanding aggregate
principal balance owed by us under the discounted convertible debentures and
exercise of 15,862,857 warrants on a cashless basis. Of the 23,069,942 shares of
common stock issued to the holders of our discounted and 8% convertible
debentures, 14,090,097 were "restricted" shares and 8,979,845 were
"unrestricted" shares.
On April 21, 2005, Bristol Investment Fund, Ltd., a holder of our
discounted debentures in the amount of $91,726, commenced a lawsuit in the
Supreme Court of New York against us, essentially alleging that we wrongfully
refused to honor its request to convert the debt into 9,268,875 shares of our
common stock. The lawsuit seeks an order compelling us to issue the foregoing
shares and for damages and attorneys fees. The Court heard argument on a motion
for preliminary injunction requiring us to issue the shares on May 5, 2005 and
has not yet ruled on the motion. On June 6, 2005, we filed an Answer,
Affirmative Defenses and Counterclaims, denying liability to the debenture
holder and seeking damages from the debenture holder on account of its prior,
wrongful conduct. The parties have not conducted any written discovery or taken
any depositions; however, on June 27, 2005, Bristol Investment Fund filed
Plaintiff's First Request for Documents with the Court, and we must respond to
this request on or before July 31, 2005. In light of the status of the case,
which is in its initial phases and the fact that there has not been any
discovery, we cannot determine the outcome of the legal action. If Bristol
Investment Fund prevails, all outstanding 8% and discounted convertible
debentures will become convertible into shares of our common stock at a
conversion price of $0.01 per share.
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 17,354,382 shares of our common stock, subject to adjustment, upon
conversion of the remaining principal under the convertible debentures.
7
As a result of anti-dilution provisions in the debentures, principal
under the 8% and discounted convertible debentures in the aggregate principal
amount of $483,461 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).
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 them could depress the market price for our common stock.
THE CONTINUOUSLY ADJUSTABLE 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 shares of our common stock that are
issuable upon conversion of our 8% and discounted convertible debentures, based
on the current conversion price of $0.028, and 25%, 50% and 75% below the
current conversion price.
% Below Current Conversion Price Per Share Number of Shares Shares Percentage of
Price Issuable(1) Outstanding(2) Outstanding
Stock(3)
Current conversion price 0.0280 17,266,464 291,861,637 5.92%
25% 0.0210 23,021,952 297,617,125 7.74%
50% 0.0140 34,532,929 309,128,102 11.17%
75% 0.0070 69,065,857 343,661,030 20.10%
(1) Represents the number of shares issuable based on conversion of outstanding
8% and discounted debentures.
(2) Based on 274,595,173 common shares issued and outstanding on June 30, 2005.
(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 ISSUED DECEMBER 15, 2004
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.
8
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 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 trading days preceding the date on which the
notice of conversion is sent to us, subject to adjustment pursuant to the
anti-dilution provisions as set forth in the convertible debentures.
Upon providing three 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 holder 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.
The following is an example of the shares of our common stock that are
issuable, upon conversion of our 5% convertible debentures, based on the 25%,
50% and 75% below the current conversion price:
% Below Current Conversion Price Per Number of Shares Shares Percentage of
Price Share Issuable(1) Outstanding(2) Outstanding Stock(3)
Current conversion price(4) 0.036 5,416,667 280,011,840 1.93%
25% 0.027 7,222,222 281,817,395 2.56%
50% 0.018 10,833,333 285,428,506 3.80%
75% 0.009 21,666,667 296,261,840 7.31%
(1) Represents the number of shares issuable based on conversion of outstanding
5% convertible debentures.
(2) Based on 274,595,173 common shares issued and outstanding on June 30, 2005.
(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.
(4) Calculated based on 120% of the closing price of $0.03 on December 14, 2004.
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.
9
We will be considered in default of the 5% convertible debentures if
any of the following events, among others, occurs:
o 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;
o we fail to comply with any of the other agreements contained in the
convertible debenture after we are given 15 days written notice of such
non-compliance;
o 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 15 days after our receipt of written notice
of such breach;
o we or any of our subsidiaries become bankrupt or insolvent;
o 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;
o 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
o 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.
In addition, under a registration rights agreement executed in
connection with the issuance of the 5% convertible debentures, we agreed to file
a registration statement that includes all the shares of our common stock
underlying such 5% convertible debentures. As a registration statement was not
filed on or before January 9, 2005, the holders of the 5% convertible debentures
may be entitled to receive an amount equal to 1% of the purchase price of the 5%
convertible debentures remaining unconverted for each 30 days or part thereof
pending such non-registration. As of the date hereof, we have not been, nor do
we expect to be, contacted by any holders of 5% convertible debentures with
respect to any rights they may have as a result of this default.
RISKS RELATED TO OUR 5% CONVERTIBLE DEBENTURE ISSUED MAY 20, 2005
The holder of the 5% convertible debenture, dated May 20, 2005, has the
option of converting the convertible debenture into shares of our common stock.
The holder of the convertible debenture may also exercise their common share
purchase warrants. If the convertible debenture is converted, there will be
dilution of your shares of our common stock.
The aggregate principal amount of $1.5 million of the 5% convertible
debenture 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 debenture.
THE 5% CONVERTIBLE DEBENTURE PROVIDES FOR VARIOUS EVENTS OF DEFAULT
THAT WOULD ENTITLE THE HOLDER TO REQUIRE US TO IMMEDIATELY REPAY 100% OF THE
OUTSTANDING PRINCIPAL AMOUNT, PLUS ACCRUED AND UNPAID INTEREST, IN CASH, OR
SHARES OF OUR COMMON STOCK WITH A CONVERSION PRICE REDUCED TO $0.014. 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.
10
We will be considered in default of the 5% convertible debenture if any
of the following events, among others, occurs:
o we fail to pay any amount due under a convertible debenture and such
failure to pay remains uncured for 10 days;
o we fail to observe or perform any other covenant, agreement or warranty
contained in, or otherwise commit any breach or default of any
provision of the 5% convertible debentures;
o we or any of our subsidiaries become bankrupt or insolvent;
o we breach any of our obligations under any other debt or credit
agreements involving an amount exceeding $250,000;
o 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 20 trading days;
o we or any subsidiary experiences a change of control;
o we fail to file a registration statement with the SEC or such
registration statement is not declared effective by the SEC within 120
days after filing;
o if the effectiveness of the registration statement lapses for any
reason or the holder of the convertible debentures is not permitted
to resell the underlying shares of common stock, in either case, for
more than five trading days or an aggregate of eight trading days;
o we fail to deliver common stock certificates to a holder prior to the
fifth trading day after a conversion date or we fail to provide notice
to a holder of our intention not to comply with requests for
conversions of the convertible debentures; or
o we fail to deliver the payment in cash pursuant to a "buy-in" within
three days after notice is claimed delivered.
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 HOLDER OF THE 5% CONVERTIBLE DEBENTURE 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 HOLDER CONVERTS THE 5% CONVERTIBLE DEBENTURE, SUCH HOLDER
WOULD BE ENTITLED TO CONVERT INTO OUR SHARES WHICH MIGHT ENCOURAGE THE HOLDER 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.
11
The holder of the 5% convertible debenture may acquire and resell up to
53,571,429 shares of our common stock, subject to adjustment, upon conversion of
the remaining principal under the convertible debentures.
As a result of anti-dilution provisions in the debentures, principal
under the 5% convertible debenture in the aggregate principal amount of $1.5
million may be converted by the holders 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 5% convertible debenture will result in
dilution to the interests of other holders of our common stock (and securities
convertible into common stock) since the holder of the convertible debenture may
sell all of the resulting shares into the public market.
The resale of common stock by the holder of our 5% convertible
debenture 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 holder of our 5% convertible
debenture will be available for immediate resale, the mere prospect of our sales
to it could depress the market price for our common stock.
The following is an example of the shares of our common stock that are
issuable upon conversion of our 5% convertible debentures, based on the 25%, 50%
and 75% below the current conversion price:
% Below Current Conversion Price Per Number of Shares Shares Percentage of
Price Share Issuable (1) Outstanding(2) Outstanding Stock(3)
Current conversion price 0.028 53,571,429 328,166,602 16.32%
25% 0.021 71,428,571 346,023,744 20.64%
50% 0.014 107,142,857 381,738,030 28.07%
75% 0.007 214,285,714 488,880,887 43.83%
(1) Represents the number of shares issuable based on conversion of outstanding
5% convertible debentures.
(2) Based on 274,595,173 common shares issued and outstanding on June 30, 2005.
(3) Percentage of the total outstanding common stock represented by the shares
issuable on conversion of the 5% convertible debentures issued May 23, 2005
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.
RISKS RELATED TO OUR 10% CONVERTIBLE DEBENTURES
The holders of the 10% convertible debentures have the option of
converting the convertible debentures into 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 issuance of shares of our common stock upon conversion or
redemption of the discounted convertible debentures, and upon the conversion of
the 10% convertible debentures, will result in dilution to the interests of
other holders of our common stock.
12
The aggregate principal amount of $30 million of 10% convertible
debentures may be converted at the option of the holders into shares of our
common stock at a set price of $0.1125 per share, subject to adjustment pursuant
to the anti-dilution provisions as set forth in the convertible debentures.
The purchasers of the 10% convertible debentures received warrants to
acquire up to an aggregate of 62.5 million shares of our common stock. 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 will
be reduced to equal such effective price.
THE 10% CONVERTIBLE DEBENTURES PROVIDE FOR VARIOUS EVENTS OF DEFAULT
THAT WOULD ENTITLE THE HOLDERS TO REQUIRE US TO IMMEDIATELY REPAY 100% OF THE
OUTSTANDING PRINCIPAL AMOUNT, PLUS ACCRUED AND UNPAID INTEREST, IN CASH, OR
SHARES OF OUR COMMON STOCK WITH A CONVERSION PRICE REDUCED TO 20% OF THE VOLUME
WEIGHTED AVERAGE PRICE OF OUR SHARES OF COMMON STOCK ON JUNE 30, 2005. 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 10% convertible debentures if
any of the following events, among others, occurs:
o we fail to pay any amount due under a convertible debenture and such
failure to pay remains uncured for 10 days;
o we fail to observe or perform any other covenant, agreement or warranty
contained in, or otherwise commit any breach or default of any
provision of the 10% convertible debentures;
o we or any of our subsidiaries become bankrupt or insolvent;
o we breach any of our obligations under any other debt or credit
agreements involving an amount exceeding $250,000;
o 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 20 trading days;
o we or any subsidiary experiences a change of control;
o we fail to file a registration statement with the SEC or such
registration statement is not declared effective by the SEC within 120
days after filing;
o if the effectiveness of the registration statement lapses for any
reason or the holder of the convertible debentures is not be permitted
to resell the underlying shares of common stock, in either case, for
more than five trading days or an aggregate of eight trading days;
o we fail to deliver common stock certificates to a holder prior to the
fifth trading day after a conversion date or we fail to provide notice
to a holder of our intention not to comply with requests for
conversions of the convertible debentures; or
o we fail to deliver the payment in cash pursuant to a "buy-in" within
three days after notice is claimed delivered.
13
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 10% 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 10% 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 10% convertible debentures may acquire and resell up to
266,666,667 shares of our common stock, subject to adjustment, upon conversion
of the remaining principal under the convertible debentures.
As a result of anti-dilution provisions in the debentures, principal
under the 10% convertible debentures in the aggregate principal amount of $30
million may be converted by the holders in whole or in part and from time to
time at a conversion price of $0.1125 per share. The issuance of shares of our
common stock upon conversion of the 10% convertible debentures will result in
dilution to the interests of other holders of our common stock (and securities
convertible into common stock).
The resale of common stock by the holders of our 10% 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 10% 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 following is an example of the amount shares of our common stock
that is issuable, upon conversion of our 10% convertible debentures, based on
the 25%, 50% and 75% below the current conversion price:
% Below Current Conversion Price Per Number of Shares Shares Percentage of
Price Share Issuable(1) Outstanding(2) Outstanding Stock(3)
Current conversion price 0.1125 266,666,667 541,261,840 49.27%
25% 0.0844 355,555,556 630,150,729 56.42%
50% 0.0563 533,333,333 807,928,506 66.01%
75% 0.0281 1,066,666,667 1,341,261,840 79.53%
(1) Represents the number of shares issuable based on conversion of outstanding
10% convertible debentures.
(2) Based on 274,595,173 common shares issued and outstanding on June 30, 2005.
(3) Percentage of the total outstanding common stock represented by the shares
issuable on conversion of the 10% 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 10% 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.
14
RISKS RELATED TO OUR 5% SERIES A PREFERRED SHARES
THE HOLDER OF OUR SERIES A PREFERRED SHARES HAS THE OPTION OF
CONVERTING THE PREFERRED SHARES INTO SHARES OF OUR COMMON STOCK, AND WE MAY
ELECT TO REDEEM UP TO 80% OF OUR 5% SERIES A CONVERTIBLE PREFERRED SHARES BY
PAYING CASH EQUAL TO 120% OF FACE VALUE UNDER THE 5% PREFERRED SHARES. IF THE
SERIES A PREFERRED SHARES ARE CONVERTED, THERE WILL BE DILUTION OF YOUR SHARES
OF OUR COMMON STOCK.
The issuance of shares of our common stock upon conversion of the
series A convertible preferred shares will result in dilution to the interests
of other holders of our common stock, since the holders of the preferred shares
may sell all of the resulting shares into the public market.
We issued 25,000 preferred shares to Cornell Capital Partners. Each
preferred share has a stated value of $160 and is convertible at any time after
the date of issuance into such number of shares of our common stock equal to the
quotient of $160 divided by $0.01 per share.
We may redeem up to 80% of the preferred shares by paying to Cornell
Capital Partners cash equal to 120% of the liquidation preference, which is
defined as $160 per share plus all declared and unpaid dividends thereon, for
each share of the preferred shares held by such selling stockholder on the
redemption payment date.
Each preferred share 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 preferred shares, the
conversion price 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 the entire principal amount of the
preferred shares is converted at the current conversion price of $0.01.
Number of Shares Issuable on Shares Percentage of
Description Conversion of Preferred Shares(1) Outstanding(2) Outstanding Stock(3)
Preferred Shares in the aggregate
principal amount of $4 million are
converted at a conversion price of 400 million 674,595,173 59.29%
$0.01
(1) Represents the number of shares issuable if all of the entire outstanding
principal under all of the 5% series A convertible preferred shares were
converted at the current conversion price.
(2) Based on 274,595,173 common shares issued and outstanding on June 30, 2005.
(3) Percentage of the total outstanding common stock represented by the shares
issuable on conversion of the preferred shares 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% series A convertible preferred shares is
subject to adjustment pursuant to anti-dilution provisions contained in the
preferred shares which may or may not be triggered, depending upon factors which
cannot be predicted by us at this time.
SALES OF A SUBSTANTIAL NUMBER OF SHARES OF OUR COMMON STOCK INTO THE
PUBLIC MARKET BY THE HOLDERS OF THE 5% PREFERRED SHARES 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% PREFERRED SHARES, SUCH HOLDERS WOULD
BE ENTITLED TO CONVERT INTO OUR SHARES AT $0.01 PER SHARE, WHICH AT THE CURRENT
PRICE OF OUR SHARES, 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.
15
The 5% preferred shares may be converted by Cornell Capital Partners in
whole or in part and from time to time at a conversion price equal to the
quotient of $160 divided by $0.01 per share. The issuance of shares of our
common stock upon conversion of the preferred shares 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 preferred shares may sell all of the
resulting shares into the public market.
The resale of common stock by the holder of our preferred shares will
increase the number of our publicly traded shares of common stock, 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 Cornell Capital Partners will be
available for immediate resale, the mere prospect of our sales to it could
depress the market price for 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 UNDER OUR $160 MILLION EQUITY LINE
OF CREDIT FACILITY, OF WHICH $160 MILLION 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 WOULD BE ENTITLED TO
PURCHASE SHARES UNDER THE FACILITY AT A 2% DISCOUNT, WHICH MIGHT ENCOURAGE
CORNELL CAPITAL PARTNERS 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 June 23, 2005, we entered into a $160 million Standby Equity
Distribution Agreement with Cornell Capital Partners for the future issuance and
purchase of shares of our common stock.
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 OTC Bulletin Board for the five
trading days immediately following the notice date. This discount may give
Cornell Capital Partners 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
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, since any gains
that Cornell Capital Partners will realize from the sale of the stock will
decrease as the market price approaches the discounted price that Cornell
Capital Partners would have paid for it.
The resale of common stock by Cornell Capital Partners 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 Cornell Capital Partners 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 DRAW DOWN OF $160 MILLION ON OUR $160 MILLION EQUITY
LINE OF CREDIT RESULTING IN THE ISSUANCE OF 1 BILLION SHARES OF OUR COMMON
STOCK PURSUANT TO OUR EQUITY LINE OF CREDIT FACILITY AT AN ISSUE PRICE OF $0.16
PER SHARE, THE EFFECTIVE PRICE PAID FOR EACH SHARE WOULD EXCEED THE NET TANGIBLE
BOOK VALUE OF EACH SHARE AS AT APRIL 30, 2005 BY $0.1231, REPRESENTING A
DILUTION FACTOR OF 23.04%.
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 April 30, 2005.
16
Issue price $0.160(1)
Net tangible book value before the issue of
the common stock(2) $0.0103
Increase in net tangible book value attributable 0.1128
to the issue of the common stock
Net tangible book value after the issue of the
common stock(3) 0.1231
--------
Dilution per share $0.0369
========
Percentage of dilution in relation to the net tangible book 23.04%
value per share prior to the issue of the common stock --------
(1) After taking into account the 2% discount that Cornell Capital Partners is
entitled to receive under the Standby Equity Distribution Agreement. It is
assumed for illustrative purposes that the price of our common stock is $0.16
per share.
(2) As at April 30, 2005 and calculated based on 255,798,467 common shares
outstanding on April 30, 2005.
(3) Represents aggregate proceeds from the issue of the common stock, less the
5% fee paid to Cornell Capital Partners.
ASSUMING THE ISSUANCE OF 1 BILLION 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
dated June 23, 2005 contemplates the potential future issuance and sale of up to
$160 million of our common stock to Cornell Capital Partners 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 $160 million unless the market
price of our common stock increases.
The following is an example of the shares of our common stock that are
issuable upon the entire draw down of $160 million on our equity line based on
a net price of $0.16, and 25%, 50% and 75% below this price:
% Below Market Price Per Number of Shares Shares Percentage of
Share Issuable(1) Outstanding(2) Outstanding
Stock(3)
Estimated price(4) 0.16 1,000,000,000 1,274,595,173 78.46%
25% 0.12 1,333,333,333 1,607,928,506 82.92%
50% 0.08 2,000,000,000 2,274,595,173 87.93%
75% 0.04 4,000,000,000 4,274,595,173 93.58%
(1) Represents the number of shares issuable if all the entire $160 million
under the equity line of credit, was drawn down at the indicated effective
price.
(2) Based on 274,595,173 common shares issued and outstanding on June 30, 2005.
(3) 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.
17
(4) Based on estimated selling price net of 2% discount.
OUR STANDBY EQUITY DISTRIBUTION AGREEMENT WITH CORNELL CAPITAL PARTNERS
LIMITS THE NUMBER OF SHARES OF COMMON STOCK THAT WE CAN REQUIRE CORNELL CAPITAL
PARTNERS 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, L.P. 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. For example, on June 30, 2005, 274,595,173 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 30,170,000 shares to Cornell Capital Partners, at that time. We would have
realized net proceeds from the draw down of approximately $3,931,858 after
accounting for a 2% discount from the share price, a 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 characterized by wide fluctuations in trading prices, Cornell Capital
Partners may have difficulty reselling the shares that it purchases under the
Standby Equity Distribution Agreement. Between January 1, 2005 and June 30, 2005
the average daily trading volume of our common stock on the OTC Bulletin Board
was 7,576,534 shares, and the closing price of one share of our common stock
during this period ranged from $0.022 to $0.241. This volume could decrease and
in turn, may require that draw downs be delayed until Cornell Capital Partners
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.
RISKS RELATED TO OUR BUSINESS AND COMPANY
As discussed under the heading, "Management's Discussion and Analysis -
Liquidity and Capital Resources," we may require additional financing to fund
our operations if holders of our convertible debentures do not convert such
debentures into shares of our common stock or we are unable to draw down on our
$160 million equity line of credit. We are taking the steps necessary to draw
down amounts under the $160 million equity line of credit facility that we
arranged with Cornell Capital Partners. 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.
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.
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 April 30, 2005, we have incurred aggregate
losses of $72,634,863. Our loss from operations for the nine month period ended
April 30, 2005 was $11,794,574; 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, the
level of competition or general economic conditions.
18
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.
The Auditors' Report on our July 31, 2004 consolidated financial
statements includes an additional comment for U.S. readers that states that
there exists substantial doubt about our ability to continue as a going concern.
The financial statements do not include any adjustments as a result of this
uncertainty.
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 U.S. government of 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 TPMS 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 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.
19
THE LOSS OF OUR MAJOR CUSTOMER MAY MATERIALLY AND ADVERSELY AFFECT US.
During the nine months ended April 30, 2005, we earned 38% of our
revenue from Aston Martin, Ford's flagship division. Accordingly, the loss of
this major customer may materially and adversely affect us. The loss of Aston
Martin, or significant reductions by it 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.
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 MAY 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, Al Kozak, our President, Chief
Executive Officer and Chief Operating Officer, Jeff Finkelstein, our Chief
Financial Officer, Erwin Bartz, our Vice President of Product and Business
Development, and Shawn Lammers, our Vice-President, Engineering. Robert Rudman,
our former President and Chief Executive Officer, remains as the Chairman of our
Board of Directors and serves as a consultant to us. 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.
20
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 our 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.
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 SEC 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.
21
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.
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 must 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,
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.
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.
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
Included in this prospectus are "forward-looking" statements, as well
as historical information. Although we believe that the expectations reflected
in these forward-looking statements are reasonable, we can give no assurance
that the expectations reflected in these forward-looking statements will prove
to be correct. Our actual results could differ materially from those anticipated
in forward-looking statements as a result of certain factors, including matters
described in the section titled "Risk Factors." Forward-looking statements
include those that use forward-looking terminology, such as the words
"anticipate," "believe," "estimate," "expect," "intend," "may," "project,"
"plan," "will," "shall," "should," and similar expressions, including when used
in the negative. Although we believe that the expectations reflected in these
forward-looking statements are reasonable and achievable, these statements
involve risks and uncertainties and no assurance can be given that actual
results will be consistent with these forward-looking statements. Important
factors that could cause our actual results, performance or achievements to
differ from these forward-looking statements include the factors described in
the "Risk Factors" section and elsewhere in this prospectus.
All forward-looking statements attributable to us are expressly
qualified in their entirety by these and other factors. We undertake no
obligation to update or revise these forward-looking statements, whether to
reflect events or circumstances after the date initially filed or published, to
reflect the occurrence of unanticipated events or otherwise.
WHERE YOU CAN FIND MORE INFORMATION
We have filed a registration statement with the SEC on Form SB-2 to
register the shares of our common stock being offered by this prospectus. In
addition, we file annual, quarterly and current reports, proxy statements and
other information with the SEC. You may read and copy any reports, statements or
other information that we file at the SEC's public reference facilities at 450
Fifth Street, N.W., Washington, D.C. 20549. Please call the SEC at
1-800-SEC-0330 for further information regarding the public reference
facilities. The SEC maintains a website, http://www.sec.gov, that contains
reports, proxy statements and information statements and other information
regarding registrants that file electronically with the SEC, including us. Our
SEC filings are also available to the public from commercial document retrieval
services. Information contained on our website is not incorporated by reference,
and should not be considered part of, this prospectus. You may also request a
copy of our filings at no cost by writing or telephoning us at:
22
SmarTire Systems Inc.
150-13151 Vanier Place
Richmond, British Columbia, V6V 2J1
Attention: Jeff Finkelstein
Chief Financial Officer
(604) 276-9884
23
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 sales of the common stock by the
selling stockholders. However, we will receive the exercise price of any common
stock we issue to the selling stockholders upon exercise of all of the warrants
and we will also receive proceeds as we draw down on the equity line of credit
pursuant to the $160 million Standby Equity Distribution Agreement we entered
into with Cornell Capital Partners. We expect to use the proceeds received from
the exercise of all warrants and the draw down on the equity line of credit, if
any, for general working capital purposes and we may use the proceeds for
repayments on our series A convertible preferred stock and our convertible
debentures. For more information regarding our series A preferred stock and our
convertible debentures, including the interest rate and maturity, please refer
to "Description of Securities". We will incur all costs associated with this
registration statement and prospectus.
MARKET FOR OUR COMMON STOCK AND RELATED STOCKHOLDER MATTERS
Market Information
On May 29, 2003, our common stock commenced quotation on the OTC
Bulletin Board under the symbol "SMTR".
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
June 30, 2005 $0.184* $0.088
April 30, 2005 $0.241 $0.022
January 31, 2005 $0.037 $0.026
October 31, 2004 $0.094 $0.03
July 31, 2004 $0.015 $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 June 30, 2005.
As of June 30, 2005, we had 274,595,173 shares of common stock
outstanding and approximately 400 stockholders of record.
These bid prices represent prices quoted by broker-dealers on the OTC
Bulletin Board. The quotations reflect inter-dealer prices, without retail
mark-up, mark-down or commissions, and may not represent actual transactions.
24
Dividend Policy
Our Board of Directors is not obligated to declare a dividend. We have
never declared or paid dividends on our common stock, and we do not anticipate
that we will in the foreseeable future. We intend to retain future earnings, if
any, for use in our operations and the expansion of our business. Future
dividends will be subject to the discretion of our Board of Directors and will
depend on, among other things, future earnings, our operating and financial
condition, our capital requirements, general business conditions and other
pertinent factors. It is not anticipated that dividends will be paid in the
foreseeable future.
Equity Compensation Plan Information
We have adopted 10 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") that 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 (i) the awards
may consist of (A) shares of common stock or cash, or a combination of common
stock, 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 (ii) the maximum number of shares of common stock that will be
issuable pursuant to all awards granted under the 2004 US Stock Incentive Plan
will be 3 million.
On December 17, 2004, our Board of Directors approved an additional
formal stock incentive plan (the "2004 Non-US Stock Incentive Plan") that
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 (i) the awards may consist of (A) shares of common stock or cash,
or a combination of shares of common stock, 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 (ii) the maximum number of shares
of common stock that will be issuable pursuant to all awards granted under the
2004 Non-US Stock Incentive Plan will be 50.0 million.
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 our success. These options are not
transferable and are exercisable from the date granted until the earliest of (i)
such number of years (up to 10 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.
25
SUMMARY FINANCIAL DATA
The summary 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, July 31, 2003, July 31, 2002 and our
unaudited consolidated financial statements for the nine-month periods ended
April 30, 2005 and 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 or Plan of Operation".
- -------------------------------------------------------------- ---------------------------- --------------------------
For the 9-Month Period For the 9-Month
Ended Period Ended
April 30, 2005 April 30, 2004
(unaudited) (unaudited)
- -------------------------------------------------------------- ---------------------------- --------------------------
Revenue $1,022,484 $1,259,140
- -------------------------------------------------------------- ---------------------------- --------------------------
Net Loss for the Period $(11,794,574) $(8,118,581)
- -------------------------------------------------------------- ---------------------------- --------------------------
Loss Per Share - basic and diluted $(0.07) $(0.10)
- -------------------------------------------------------------- ---------------------------- --------------------------
- -------------------------------------------------------------- ---------------------------- --------------------------
As at As at
April 30, 2005 April 30, 2004
(unaudited) (unaudited)
- -------------------------------------------------------------- ---------------------------- --------------------------
Working Capital $2,103,240 $1,717,940
- -------------------------------------------------------------- ---------------------------- --------------------------
Total Assets $6,212,784 $7,815,258
- -------------------------------------------------------------- ---------------------------- --------------------------
Total Share Capital $65,627,789 $56,475,822
- -------------------------------------------------------------- ---------------------------- --------------------------
Deficit $(72,634,863) $(56,149,811)
- -------------------------------------------------------------- ---------------------------- --------------------------
Total Stockholders' Equity $3,997,748 $4,904,084
- -------------------------------------------------------------- ---------------------------- --------------------------
- ---------------------------------------- ------------------------- -------------------------- ------------------------
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
- -------------------------------------------------------------- ---------------------------- --------------------------
26
MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
You should read the following description of our financial condition
and results of operations in conjunction with the financial statements and
accompanying notes included in this prospectus beginning on page F-1.
Overview
The following discussion of our financial condition, changes in
financial condition and results of operations for the three and nine months
ended April 30, 2005 and 2004 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.
We carry on business directly and through our three wholly-owned
subsidiaries: SmarTire USA Inc., SmarTire Europe Limited and SmarTire
Technologies Inc.
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 SEC the same reports that a domestic registrant would be required to file
under section 13(a) of the Securities Exchange Act of 1934.
We develop and market technically advanced tire pressure monitoring
systems ("TPMSs") for the transportation and automotive industries. Our TPMSs
are designed for improved vehicle safety, performance, reliability and fuel
efficiency. Although, the majority of our revenues in our first nine months
ended April 30, 2005 were earned from the sale of TPMSs for passenger cars,
sales of our motorcycle TPMSs and recreational vehicle TPMSs increased as a
percentage of our overall revenues. With the re-launch of our motorcycle TPMS in
April 2005 and our June 2004 launch of our high pressure transmitters, we
anticipate that there will be an increase in the percentage of our revenues from
sales of our TPMSs for the motorcycle, recreational, bus and truck markets
during the remainder of fiscal 2005.
Our vision is to become the preeminent provider of wireless sensing and
control systems for the vehicle industry. Our vision may be extended to three
basic types of systems: sensing, control and system applications.
Sensing Applications
Our vision with respect to sensing applications is to commercialize a
wide array of sensors, compatible with our tire monitoring systems for the
vehicle industry. We have developed a receiver module with Vansco Ltd. that
functions as a "wireless gateway". This module can wirelessly receive signals
from up to 256 new sensors in addition to signals from tire pressure sensors.
The data from these sensors can then be placed on the vehicle bus or to a
display module. This ensures that the driver, maintenance group or monitoring
agencies have access to the sensor data as required. In addition to tire
pressure monitoring, customers would have the ability to access far more data on
their vehicles. This translates to a higher value proposition to the customer,
while giving us the ability to sell more products.
Control Applications
A natural evolution of our product family is to use the "wireless
gateway" module to not only receive signals from sensors but to act on the data
received. It can do this by controlling other electronic control units ("ECUs")
or mechanical devices directly in response to sensor data received.
The basic premise is based on using sensors to interpret a condition
and then have the "wireless gateway" module send a control signal to a device to
perform a specified action based on the sensor output. For example, when the
"wireless gateway" module receives data from a tire pressure sensor it could
activate a "horn" to provide an audible warning if the data was outside of
preset limits.
The control applications require feedback from the element being
controlled. In many cases this can be accomplished by one way communication to
the controlled element with the feedback provided by the driver of the vehicle.
An example of this would be the control or positioning of a mirror.
27
In other situations, the feedback may be provided by the element being
controlled. An example of this is a TPMS application in which the wireless
gateway communicates with an engine ECU to limit the speed of the vehicle as air
pressure decreases. For control applications, two way communications may be
required to complete the control loop.
System Applications
System applications are created by utilizing the information obtained
from vehicle sensors to provide a total solution to the owner of a vehicle or
fleet of vehicles. This means that the data generated by the sensors is gathered
by the "wireless gateway" module and integrated with the overall maintenance and
monitoring system utilized by the customer. This integration allows maintenance
staff, purchasing, owners and drivers to access all relevant sensor information
and warnings.
An example of this type of system is a wireless drive-by kiosk that
collects tire pressures from buses returning to a central garage at night. The
tire pressures are sent wirelessly to a kiosk which sends the data to a computer
system that processes the data and creates a work order for the maintenance crew
to correct and check tire pressures only in those vehicles that require
attention. This avoids checking the tire pressures of the whole fleet. Another
advantage of this system is that basic warnings are provided to the driver in
the event that a severe tire condition exists but detailed information is
provided to maintenance so they can schedule corrective action quickly.
Results of Operations
Three months ended April 30, 2005 and April 30, 2004
Revenue
Gross revenue for the three months ended April 30, 2005 decreased to
$330,406 from $401,423 for the three months ended April 30, 2004. The breakdown
of the sources of our gross revenue is as follows:
o Sales of aftermarket passenger car TPMSs decreased to $133,670 for the
three months ended April 30, 2005 from $335,279 for the three months
ended April 30, 2004.
o Sales of OEM passenger car TPMSs increased to $109,631 for the three
months ended April 30, 2005 from $18,096 for the three months ended
April 30, 2004. The increase was primarily due to an increase in sales
to Aston Martin, Ford's flagship division. We anticipate sales to
increase by approximately 100% in the next quarter, mainly as a result
of an increase in sales to Aston Martin.
o Sales of aftermarket motorcycle systems were $34,011 for the three
months ended April 30, 2005 compared to $0 for the three months ended
April 30, 2004. The majority of these sales were in April after the
release of our redesigned sensor that enabled the motorcycle TPMS to
fit most rim designs. 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 decreased to $34,592 for
the three months ended April 30, 2005 from $42,744 for the three months
ended April 30, 2004.
o Sales of OEM recreational vehicle TPMSs increased to $1,166 for the
three months ended April 30, 2005 from $0 for the three months ended
April 30, 2004.
o Sales of aftermarket high pressure TPMSs for use on commercial vehicles
were $6,350 for the three months ended April 30, 2005 compared to $0
for the three months ended April 30, 2004. The majority of these
systems are currently being used for test purposes. Although interest
in this product is high, it is difficult for us to predict what the
volume of sales will be, as this will depend primarily on market
acceptance.
28
o Sales of OEM high pressure TPMS for use on commercial vehicles were
$580 for the three months ended April 30, 2005 compared to $0 for the
three months ended April 30, 2004. The majority of these systems are
currently being used for test purposes. Although interest in this
product is high, 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 TPMS for use on buses were $0 for the three months
ended April 30, 2005 compared to $0 for the three months ended April
30, 2004. Although it is difficult for us to predict what the volume of
sales will be, we anticipate a substantial increase in sales in sales
of OEM TPMSs for use on buses during the next year when we commence
shipping TPMSs to Motorcoach Industries International and New Flyer Bus
for the Chicago Transit Authority.
o Sales of miscellaneous products were $10,406 for the three months ended
April 30, 2005 compared to $5,304 for the three months ended April 30,
2004.
Gross Margin
Gross margin on product sales decreased to 23% for the three months
ended April 30, 2005
from 28% for the three months ended April 30, 2004. The decrease in margin was
mainly a result of the write-down of $30,000 of inventory.
Expenses
Expenses increased to $7,001,729 for the three months ended April 30,
2005 from $1,840,318 for the three months ended April 30, 2004, due to increases
in, marketing, engineering, research and development expenses and depreciation
and amortization expenses. The increase in expenses was primarily due to a
non-cash compensation expense of $5,197,538 which was primarily a result of the
increase in the value of outstanding employee stock options. Excluding the
non-cash compensation expense, expenses were $1,976,779 for the three months
ended April 30, 2005.
Engineering, research and development expenses increased to $2,086,354
for the three months ended April 30, 2005 from $454,715 for the three months
ended April 30, 2004. Excluding the non-cash compensation expense of $1,591,600,
expenses for the three months ended April 30, 2005 were $494,754, or an increase
of $40,039 from the three months ended April 30, 2004. The increase was mainly
due to an increase in engineering employees and engineering-related wages.
Marketing expenses increased to $1,368,330 for the three months ended
April 30, 2005 from $468,312 for the three months ended April 30, 2004.
Excluding the non-cash compensation expense of $962,550, expenses for the three
months ended April 30, 2005 were $405,780, or a decrease of $62,532 from the
three months ended April 30, 2004. The decrease was mainly a result of lower
advertising and promotion expenses and lower travel expenses. This decrease was
partially offset by an increase in marketing-related wages as a result of an
increase in the number of marketing employees.
General and administrative expenses increased to $3,170,568 for the
three months ended April 30, 2005 from $560,871 for the six months ended April
30, 2004. Excluding the non-cash compensation expense of $2,470,800, expenses
for the three months ended April 30, 2005 were $699,768, or an increase of
$138,897 from the three months ended April 30, 2004. The increase was primarily
attributed to higher professional fees and an increase in insurance costs. The
increase was partially offset by a decrease in investor relation fees and travel
costs.
Depreciation and amortization expense increased to $376,477 for the
three months ended April 30, 2005 from $356,420 for the three months ended April
30, 2004.
Interest and finance charges decreased to $188,491 for the three months
ended April 30, 2005 from $1,214,435 for the three months ended April 30, 2005.
Interest and finance charges for the three months ended April 30, 2005 included
non-cash interest of $144,866 compared to non-cash interest of $1,111,447 for
the three months ended April 30, 2004.
29
Interest Income
Interest income of $1,382 was earned for the three months ended April
30, 2005 as compared to $849 for the three months ended April 30, 2004 and was
the result of higher average cash balances during the three months ended April
30, 2005.
Foreign exchange loss
A foreign exchange loss of $14,355 was incurred for the three months
ended April 30, 2005 as compared to a foreign exchange loss of $10,405 for the
three months ended April 30, 2004. Foreign exchange gains or losses are due to
fluctuations in currency exchange rates and are impossible to predict.
Gain on settlement of convertible debt
A gain on settlement of convertible debt was incurred for the three
months ended April 30, 2005 as compared to $0 for the three months ended April
30, 2004.
Nine months ended April 30, 2005 and April 30, 2004
Revenue
Gross revenue for the nine months ended April 30, 2005 decreased to
$1,022,484 from $1,259,140 for the nine months ended April 30, 2004. The
breakdown of the sources of our gross revenue is as follows:
o Sales of aftermarket passenger car systems decreased to $215,832 for
the nine months ended April 30, 2005 from $923,613 for the nine months
ended April 30, 2004.
o Sales of OEM passenger car systems increased to $428,424 for the nine
months ended April 30, 2005 from $117,000 for the nine months ended
April 30, 2004. The increase was primarily due to an increase in sales
to Aston Martin, Ford's flagship division.
o Sales of the aftermarket motorcycle system were $79,053 for the nine
months ended April 30, 2005 compared to $1,555 for the nine months
ended April 30, 2004. 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 were 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 following additional precautionary steps were taken:
1) adding improved warnings and instruction sheets to new
product as well as product in inventory at dealers and
distributors that clarify flat rim drop center well
application only; and
2) removal TPMSs 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 April 2005 were $41,411. We have made a provision
in accounts payable for the additional $25,589 that we anticipate incurring. In
addition, we have developed a solution to enable us to sell our TPMSs on
motorcycles with rims with curved drop center wells. We released this enhanced
product during April 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.
30
o Sales of aftermarket recreational vehicle TPMSs were $156,025 for the
nine months ended April 30, 2005 compared to $58,781 for the nine
months ended April 30, 2004.
o Sales of OEM recreational vehicle systems were $63,218 for the nine
months ended April 30, 2005 compared to $10,682 for the nine months
ended April 30, 2004.
o Sales of aftermarket TPMSs for use on commercial vehicles were $34,799
for the nine months ended April 30, 2005 compared to $1,088 for the
nine months ended April 30, 2004. Although interest in this product is
high, 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 OEM high pressure TPMSs for use on commercial vehicles were
$4,233 for the nine months ended April 30, 2005 compared to $0 for the
nine months ended April 30, 2004. The majority of these systems are
currently being used for test purposes.
o Sales of aftermarket TPMSs for use on buses were $3,252 for the nine
months ended April 30, 2005 compared to $0 for the nine months ended
April 30, 2004. Although it is difficult for us to predict what the
volume of sales will be, we anticipate a substantial increase in sales
of OEM TPMS for use on buses during next year when we commence shipping
TPMS to Motorcoach Industries International and New Flyer Bus for the
Chicago Transit Authority.
o Revenue of $0 was recorded for engineering changes to modify our
products pursuant to the Hyundai Autonet agreement for the nine months
ended April 30, 2005 compared to $96,079 for the nine months ended
April 30, 2004. Revenue from engineering services is recognized on
services as they are rendered and pre-defined milestones are achieved.
o Sales of miscellaneous products were $37,648 for the nine months ended
April 30, 2005 compared to $50,342 for the nine months ended April 30,
2004.
Gross Margin
Gross margin on product sales decreased to 6% for the nine months ended
April 30, 2005 from 18% for the nine months ended April 30, 2004. The decrease
in gross margin for the nine months ended April 30, 2005 was due to an inventory
write-down of $230,000 for slow moving aftermarket passenger car tire pressure
monitoring systems. Without the inventory write-down, the gross margin would
have increased to 25% for the nine months ended April 30, 2005. Factors that
would have resulted in higher margins if not for the inventory write-down are:
o the product mix of systems sold in the nine months ended April 30, 2005
had higher gross margins than the product mix of systems sold in the
nine months ended April 30, 2004; and
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
nine months ended April 30, 2005 were in Pound Sterling.
Expenses
Expenses increased to $11,027,054 for the nine months ended April 30,
2004 from $5,404,057 for the nine months ended April 30, 2004 due to increases
in, marketing, engineering, research and development expenses and depreciation
and amortization expenses. The increase in expenses was primarily due to a
non-cash compensation expense of $5,197,538 which was primarily a result of the
increase in the value of outstanding employee stock options. Excluding the
non-cash compensation expense, expenses were $6,002,104 for the nine months
ended April 30, 2005.
Engineering, research and development expenses increased to $3,083,704
for the nine months ended April 30, 2005 from $1,201,634 for the nine months
ended April 30, 2004. Excluding the non-cash compensation expense of $1,591,600,
expenses for the nine months ended April 30, 2005 were $1,492,104, or an
increase of $290,470 from the nine months ended April 30, 2004. The increase was
primarily attributed to higher prototype development costs, an increase in
product testing on products that we plan to release in the current fiscal year
and an increase in the number of engineering employees and engineering-related
wages. Wages included a non-cash expense of $30,338 related to the issuance of
common stock to senior engineering employees.
31
Marketing expenses increased to $2,275,843 for the nine months ended
April 30, 2005 from $1,329,636 for the nine months ended April 30, 2004.
Excluding the non-cash compensation expense of $962,550, expenses for the nine
months ended April 30, 2005 were $1,313,293 or a decrease of $16,343 from the
nine months ended April 30, 2004. The decrease was primarily a result of lower
advertising and promotion expenses and lower travel expenses. The decrease was
offset by higher marketing-related wages, which increased as a result of an
increase in the number of marketing employees.
General and administrative expenses increased to $4,550,610 for the
nine months ended April 30, 2005 from $1,841,877 for the nine months ended April
30, 2004. Excluding the non-cash compensation expense of $2,470,800, expenses
for the nine months ended April 30, 2005 were $2,079,810 or an increase of
$237,933 from the nine months ended April 30, 2004.The increase was primarily
attributed to higher administration wages, insurance costs and professional
fees. The major increase in administration wages was primarily due to a non-cash
expense related to the issuance of common stock to senior management valued at
$142,251. The increase was partially offset by lower investor relation costs and
lower travel costs.
Depreciation and amortization expense increased to $1,116,897 for the
nine months ended April 30, 2005 from $1,030,910 for the nine months ended April
30, 2004.
Interest and finance charges increased to $2,763,609 for the nine
months ended April 30, 2005 from $2,960,488 for the nine months ended April 30,
2004. Interest and finance charges for the nine months ended April 30, 2005
included $2,607,518 compared to none-cash interest $2,770,481 for the nine
months ended April 30, 3004.
Interest Income
Interest income of $3,173 was earned for the nine months ended April
30, 2005 as compared to $5,416 for the nine months ended April 30, 2004 and was
the result of lower average cash balances during the nine months ended April 30,
2005.
Foreign exchange gain
A foreign exchange gain of $114,634 was incurred for the nine months
ended April 30, 2005 as compared to a gain of $15,931 for the nine months ended
April 30, 2004. Foreign exchange gains or losses are due to fluctuations in
currency exchange rates and are impossible to predict.
Gain on settlement of convertible debt
A gain on settlement of convertible debt was incurred for the three
months ended April 30, 2005 as compared to $0 for the three months ended April
30, 2004.
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 April 30, 2005, we had an accumulated deficit of
$73,369,474. Our net loss for the three months ended April 30, 2005 was
$5,306,734 and for the nine months ended April 30, 2005 was $11,794,574 compared
to $2,950,259 for the three months ended April 30, 2004 and $8,118,581 for the
nine months ended April 30, 2004. As of April 30, 2005, our stockholders' equity
was $3,977,748 and we had a working capital of $2,103,290.
32
Our cash position at April 30, 2005 was $420,270 as compared to
$112,951 at July 31, 2004. This increase was due to the net increase from our
operating, financing and investing activities as described below.
Our net loss of $11,794,574 for our nine months ended April 30, 2005
includes non-cash charges of $1,116,897 for depreciation and amortization,
$5,197,538 for compensation expense, $200,000 for an inventory write-down and
$2,607,518 for interest and finance charges. Decreases in non-cash working
capital during this period amounted to $532,183. Non-cash working capital
changes included increases in inventory and decreases in prepaid
expenses, accounts receivable, accounts payable and accrued liabilities.
During the eleven months ended June 30, 2005, we realized aggregate
gross cash proceeds of $42,953,598 as follows:
On June 23, 2005, we entered into a $160 million Standby Equity
Distribution Agreement and a $30 million Securities Purchase Agreement that
resulted in net proceeds of $11 million to us. We paid Cornell Capital
Partners a cash fee of $16 million in connection with the Standby Equity
Distribution Agreement, and we paid Cornell Capital Partners a cash fee of $3
million, and a cash structuring fee of $50,000 to Yorkville Advisors Management,
in connection with the Securities Purchase Agreement, out of the purchase price
paid by Cornell Capital Partners for the convertible debentures purchased
pursuant to the Securities Purchase Agreement. Refer to "Description of
Securities" for more details regarding the Standby Equity Distribution Agreement
and the Securities Purchase Agreement.
On May 20, 2005, we issued a $1.5 million one year 5% convertible
debenture convertible at the option of the holder at $0.028 per share. Between
April 25 and April 29, 2005, $1,100,000 of the convertible debenture was placed
in escrow with our lawyer. From escrow, $457,999 was paid on April 27, 2005 to
two debenture holders to redeem their convertible debentures.
On March 22, 2005, we issued 5% convertible preferred stock for gross
proceeds of $4,000,000. The proceeds were used to repay the $2,500,000
convertible debenture entered into on December 15, 2004 and a $350,000
promissory note entered into on February 9, 2004. Additional expenses related to
this offering were $20,000.
On February 9, 2005, we received gross proceeds of $350,000 upon the
issuance of an unsecured short-term promissory note to an accredited investor.
The note bears interest at a rate of 10% 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 $35,000.
On December 15, 2004, we received gross proceeds of $2,695,000 upon the
issuance of a three year $2,500,000 5% convertible debenture and five two year
5% convertible debentures aggregating $195,000. Principal under the 5%
convertible debentures 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 (i) $0.035; or
(ii) 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.
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 on the debentures aggregating $195,000 is payable semi-annually
beginning June 15, 2005 and every subsequent six month period that the principal
balance remains unpaid.
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 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.
33
On September 24, 2004, we 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 May 19, 2004, we entered into a Standby Equity Distribution
Agreement with Cornell Capital Partners, an accredited investor, in connection
with a 24-month, $15 million equity line of credit facility. This agreement
was terminated on May 20, 2005 and replaced with a $30 million equity line of
credit facility. On June 23, 2005, our $30 million equity line of credit was
terminated and replaced with a $160 million equity line of credit. We issued
78,867,710 shares of common stock to Cornell Capital Partners LP pursuant to
nine draw downs totaling $2,725,000 from our $15 million equity line of
credit.
We anticipate that we will require between $4.3 million and $11.7
million in financing through the next twelve months 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.
As the continuation of our business is dependent upon the conversion by
certain holders of our outstanding convertible debentures into shares of our
common stock or, if such conversions do not occur or are not sufficient to
significantly decrease our outstanding repayment obligation, our ability to
drawn down on our $160 million equity line of credit, 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.
Fiscal Year Ended July 31, 2004 and Fiscal Year Ended July 31, 2003
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 of July 31, 2004, we had an accumulated deficit of
$59,018,256. Our net loss for fiscal year 2004 was $10,987,026 compared to
$9,914,629 for fiscal year 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 year 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 year 2004, we realized aggregate gross cash proceeds of
$7,170,265 from financing activities as described below.
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 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.
34
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 $0.13 per share and 14,000 were exercised at an exercise price of $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 was reduced to $0.028. 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 (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 our common stock for the 20 days immediately preceding the applicable monthly
redemption date, provided that certain conditions are met, including the
condition that the underlying shares of common stock will 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, we notified the debenture holders that we 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, 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 us 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 outstanding warrants was 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 our 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 us 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 million equity line of credit facility. The
agreement contemplated the potential future issuance and sale of up to $15
million of our common stock to Cornell Capital Partners, subject to certain
restrictions and other obligations. As the underlying shares have been
registered with the SEC, we are able to request advances. As of July 31, 2004,
we had drawn down $750,000. 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. On May 22, 2005, we terminated this standby Equity Distribution
Agreement and replaced it with a new $30 million Standby Equity Distribution
Agreement. On June 23, 2005, we terminated this standby Equity Distribution
Agreement and replaced it with a new $160 million Standby Equity Distribution
Agreement. Refer to "Description of Securities" for additional information
regarding our equity line of credit.
35
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 TPMS for
passenger cars and motorcycles.
We anticipate that we will require between $4.3 million and $11.7
million in financing through April 30, 2006 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 fiscal 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.
The continuation of our business is dependent upon the conversion by
certain holders of our outstanding convertible debentures into shares of our
common stock or, if such conversions do not occur or are not sufficient to
significantly decrease our outstanding repayment obligation, our ability to
draw down on our $160 million equity line of credit, 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.
Future Operation
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.
We project a requirement for a minimum of $4,300,000 and a maximum of
$11,700,000 million to fund our debt repayment, ongoing operating expenses and
working capital requirements through April 30, 2006 as follows:
Marketing $ 1,400,000 $ 1,800,000
Engineering, research and development 1,600,000 2,000,000
General and administrative 2,000,000 2,400,000
Capital Purchases 60,000 200,000
Debt repayment(1) 91,726 5,689,306
General Working Capital (851,726) (389,306)
------------ -----------
TOTAL $ 4,300,000 $11,700,000
============ ===========
36
(1) Assumes that we will not have to make monthly payments to holders of both
the $1.5 million 5% convertible debenture and the 10% $20 million
convertible debenture and that the debenture holders will convert their
debentures to common shares. In addition, we have assumed that we can
settle the outstanding litigation claim for between $91,726 and $110,071.
Our working capital requirements are impacted by our inventory
requirements and any potential loss in litigation above the $110,071 which we
have recorded as a liability. 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.
The continuation of our business depends on the conversion by certain
holders of our outstanding convertible debentures into shares of our common
stock or, if such conversions do not occur or are not sufficient to
significantly decrease our outstanding repayment obligation, our ability to
draw down on our $160 million equity line of credit, 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 becoming a profitable business.
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 April 30, 2006, primarily through the
registration of additional shares of our common stock for issuance upon use of
our $160 million Standby Equity Distribution Agreement entered into on June
23, 2005.
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 April 30, 2005, we had an accumulated deficit of $72,634,863. Our
net loss for the nine months ended April 30, 2005 was $11,794,574 compared to
$8,118,581 for the nine months ended April 30, 2004. As of April 30, 2005, our
stockholders' equity was $3,977,748 and we had working capital of $2,103,240.
During the nine months ended April 30, 2005, we used $5,026,837 cash in
operating activities and $28,918 to purchase capital assets. Accordingly, during
the nine months ended April 30, 2005, we raised gross cash proceeds of
$4,000,000 from the issuance of preferred shares, $3,152,999 from the issuance
of convertible debentures, $2,725,000 from draw downs on our equity line of
credit, $875,000 from the issuance of promissory notes, $153,811 from the
exercise of stock options and $546,788 from the exercise of warrants. In
addition, during May 2005, we raised gross proceeds of $1,500,000 from the
issuance of a convertible debenture. Between April 25 and April 29, 2005, funds
for $1,100,000 of the convertible debenture were placed in escrow with our legal
counsel. From escrow, $457,999 was paid on April 27, 2005 to two debenture
holders to redeem their convertible debentures.
37
Although we have a $160 million Standby Equity Distribution
Agreement, there can be no assurance that we will be able to register 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.
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
We recognize 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. We record 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
nine months ended April 30, 2005 were $0 (nine months ended April 30, 2004 -
$96,079).
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 TPMSs to the OEMs. 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 OEM marketplace, it
is possible that we will not generate cash flow from sales to the OEM
marketplace in excess of net book value, or that we will generate cash flow from
sales to the OEM market in future years after the other assets have been fully
amortized.
38
Off-Balance Sheet Arrangements
We have not entered into any transaction, agreement or other
contractual arrangement with an entity unconsolidated with us under which we
have:
o an obligation under a guarantee contract;
o a retained or contingent interest in assets transferred to the
unconsolidated entity or similar arrangement that serves as credit,
liquidity or market risk support to such entity for such assets;
o an obligation, including a contingent obligation, under a contract that
would be accounted for as a derivative instrument; or
o an obligation, including a contingent obligation, arising out of a
variable interest in an unconsolidated entity that is held by, and
material to, us where such entity provides financing, liquidity, market
risk or credit risk support to, or engages in leasing, hedging, or
research and development services with us.
39
DESCRIPTION OF BUSINESS
Overview
We develop and market technically advanced tire pressure monitoring
systems ("TPMSs") for the transportation and automotive industries. Our TPMSs
are designed for improved vehicle safety, performance, reliability and fuel
efficiency. Although, the majority of our revenues in our first six months ended
January 31, 2005 were earned from the sale of TPMSs for passenger cars, sales of
our motorcycle TPMS and recreational vehicle TPMS increased as a percentage of
our overall revenues. During the fiscal year ended July 31, 2004, we earned
revenues primarily from the sale of tire monitoring systems ("TMSs") for
passenger cars. With the planned re-launch of our motorcycle TPMS in March 2005
and our June 2004 launch of our high pressure transmitters, we anticipate that
there will be an increase in the percentage of our revenues from sales of our
TPMS for the motorcycle, recreational, bus and truck markets during fiscal 2005.
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.
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 SEC the same reports that a domestic registrant would be required to file
under section 13(a) of the Securities Exchange Act of 1934.
Our vision is to become the preeminent provider of wireless sensing and
control systems for the vehicle industry. Our vision may be extended to three
basic types of systems: sensing, control and system applications.
Sensing Applications
Our vision is to commercialize a wide array of sensors, compatible with
our tire monitoring systems for the vehicle industry. We have developed a
receiver module with Vansco that functions as a "wireless gateway". This module
can wirelessly receive signals from up to 256 new sensors in addition to signals
from tire pressure sensors. The data from these sensors can then be placed on
the vehicle bus or on a display module. This ensures that the driver,
maintenance group or monitoring agencies have access to the sensor data as
required. In addition to tire pressure monitoring, customers would have the
ability to access far more data on his vehicle. This translates to a higher
value proposition to the customer, while giving us the ability to sell more
products.
Control Applications
A natural evolution of our product family is to use the "wireless
gateway" module to not only receive signals from sensors but to act on the data
received. It can do this by controlling other electronic control units ("ECUs")
or mechanical devices directly in response to sensor data received.
The basic premise is based on using sensors to interpret a condition
and then have the "wireless gateway" module send a control signal to a device to
perform a specified action based on the sensor output. For example, when the
"wireless gateway" module receives data from a tire pressure sensor it could
activate a "horn" to provide an audible warning if the data was outside of
preset limits.
The control applications require feedback from the element being
controlled. In many cases this can be accomplished by one way communication to
the controlled element with the feedback provided by the driver of the vehicle.
An example of this would be the control or positioning of a mirror.
In other situations, the feedback may be provided by the element being
controlled. An example of this is a TPMS application in which the wireless
gateway communicates with an engine ECU to limit the speed of the vehicle as air
pressure decreases. For control applications, two way communications may be
required to complete the control loop.
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System Applications
These are created by utilizing the information obtained from vehicle
sensors to provide a total solution to the owner of a vehicle or fleet of
vehicles. This means that the data generated by the sensors is gathered by the
"wireless gateway" module and integrated with the overall maintenance and
monitoring system utilized by the customer. This integration allows maintenance
staff, purchasing, owners and drivers to access all relevant sensor information
and warnings.
An example of this type of system is a wireless drive-by kiosk that
collects tire pressures from buses returning to a central garage at night. The
tire pressures are sent wirelessly to a kiosk which sends the data to a computer
system that processes the data and creates a work order for the maintenance crew
to correct and check tire pressures only in those vehicles that require
attention. This avoids checking the tire pressures of the whole fleet. Another
advantage of this system is that basic warnings are provided to the driver in
the event that a severe tire condition exists but detailed information is
provided to maintenance so they can schedule corrective action quickly.
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 initially formed to
develop and market remote data sensing, transmission and processing products
incorporating patented technologies to satisfy emerging market requirements in
the transportation industry.
Our company was continued under the Business Corporations Act (Yukon
Territory) effective February 6, 2003. As a result, our Memorandum and Articles
that 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 Bylaw No. 1, being a bylaw 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. Effective December 10, 2004, we filed
a Certificate of Amendment with the Yukon Registrar of Corporations to our
Articles of Incorporation to increase the number of our authorized shares of
common stock from 300,000,000 shares to an unlimited number of shares. On March
18, 2005, we filed articles of amendment to our articles of incorporation which
set forth all the rights and preferences of the series A 5% convertible
preferred stock.
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 TMSs 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 Technologies 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 Technologies was offered
by Ford Motor Company as an option on Lincoln Continentals until the end of
December 2001 when that particular model was discontinued.
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Our acquisition of EPIC Technologies' Low Tire Pressure Warning
Division accelerated our entry into the passenger car market. Recognizing the
emerging demand for TPMSs in passenger cars and light trucks, we modified the
new car version of the technology that we had acquired from EPIC Technologies
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 OEM products that 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 Motor Company 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 Technologies' Low Tire Pressure Warning
Division also facilitated our entry into the motorsport market. Originally
developed by EPIC Technologies 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.
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 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 TPMSs 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 TPMSs that measure the pressure and temperature of car, truck and
motorcycle tires. The TPMSs 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 recently informed us
that it does not intend to continue to sell our motorcycle TPMS.
In December 2002, we entered into an eight-year supply commitment
letter for TPMSs 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 TPMSs on the V12 Vanquish. In September 2004, Aston Martin
began purchasing TPMSs for installation on its DB9 model that went into
production earlier in 2004.
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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 National Highway
Traffic Safety Administration ("NHTSA") to determine if a Safety Defect and Non
Compliance Report was required and we were advised that it 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. We
took the following additional precautionary steps:
o we added improved warnings and instruction sheets to new product as
well as product in inventory at dealers and distributors that clarify
flat rim drop center well application only; and
o we removed TPMSs 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 April 2005 were $41,411. We have made a provision
in accounts payable for the additional $25,589 that we anticipate incurring. In
addition, we have developed a solution to enable us to sell our TPMSs on
motorcycles with rims with curved drop center wells. We released this enhanced
product during April 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.
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 our
company 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. Currently HACO is in process of product validation testing and is
representing the product to domestic Korean OEM manufacturers. Revenues will
begin to be realized if HACO wins supply agreements from its target customers.
In October 2003, we signed a contract manufacturing services agreement
with HACO. Under the terms of the agreement, HACO will manufacture our
proprietary line of TPMSs 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
TPMSs 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
agreed to purchase over $1.5 million in aftermarket passenger car TPMSs at fixed
intervals during the first year of the agreement.
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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 TPMSs 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.
Beijing Boom Technology did not purchase a significant number of TPMSs during
the nine months ended April 30, 2005, and it is experiencing difficulties
penetrating the Chinese market.
On June 3, 2004, in conjunction with our "master distributor" in China,
Beijing Boom Technology, 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 TPMSs 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. Also, 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 TPMSs in Germany.
We believe that we have all of the necessary governmental approvals for
our current TPMSs 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 NHTSA, develop rules and regulations that require all
new passenger cars, light trucks and multipurpose passenger vans sold after
November 1, 2003 to have TPMSs installed as standard equipment. The TREAD Act
requires that TPMSs 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 that 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:
o 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 wirelessly
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.
o Indirect tire monitoring technologies typically work with the vehicle's
anti-lock brake system. Most indirect TPMSs 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 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 one 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 required 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 was to be equipped with TPMSs. This requirement
increases was to increase 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, are 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 TPMSs 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 TPMSs
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 closely monitor the performance of indirect measurement
TPMSs under the second compliance option. We initially expected the NHTSA to
issue the second part of its final rule on or before March 1, 2005, and, at that
time, to announce whether indirect TPMSs 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%
under-inflation standard contemplated by the second compliance option would
allow automakers to install indirect TPMSs that fail to warn drivers in
approximately half of the instances in which tires are significantly
under-inflated, and that the four-tire, 25% 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 NHTSA issued a Notice of Proposed Rulemaking
("NPRM") document defining their current position. Comments on the proposed
rulemaking were to be received on or before 60 days after date of publication of
the NPRM in the Federal Register. The NHTSA proposed a new Federal Motor Vehicle
Safety Standard requirement for four tire, 25% under-inflation detection. The
rule proposed requirements for covered vehicles manufactured on or after
September 1, 2005.
On April 7, 2005 the NHTSA released their final rule. The NHTSA is
proposing the lead time and phase in schedule described below.
Compliance with the final rule is set to start on October 5, 2005.
Subject to the special provisions discussed below, the phase-in schedule is as
follows:
o 20% of a vehicle manufacturer's light vehicle production is required to
comply with the standard during the period from October 5, 2005, to
August 31, 2006;
o 70% must comply during the period from September 1, 2006 to August 31,
2007; and
o 100% of all light vehicles built on or after September 1, 2007 must
comply.
However, the NHTSA has deferred vehicle manufacturers' compliance with
the new system malfunction indicator light requirements until September 1, 2007.
This requirement is discussed below.
The NHTSA has also decided to encourage early compliance by permitting
carry-forward and carry-back credits. Vehicle manufacturers can earn
carry-forward credits for compliant vehicles produced in excess of the phase-in
requirements that are manufactured between April 8, 2005 and the conclusion of
the phase-in. 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 a dealer to install tires on a
new vehicle that would take the vehicle out of compliance with TPMS standard.
With carry-back credits, manufacturers may defer compliance with a part or all
of the certification requirements under the standard for the first period of the
phase-in, provided they certify a correspondingly increased number of vehicles
during the second period of the phase-in.
Special provisions related to the phase-in include:
o The NHTSA has excluded multi-stage manufacturers and alterers from the
requirements of the phase-in and has extended by one year the time for
compliance by those manufacturers (i.e., until September 1, 2008).
o The final rule also excludes small volume manufacturers (i.e.,
manufacturers producing less than 5,000 vehicles for sale in the U.S.
market in one year) from the phase-in, requiring vehicles produced by
such manufacturers to comply with the standard on September 1, 2007.
Requirements of the final rule are summarized as follows: New Federal
Motor Vehicle Safety Standard 138 requires passenger cars, multi-purpose
passenger vehicles, trucks, and buses with a gross vehicle weight rating of
4,536 kg (10,000 pounds) or less, except those with dual wheels on an axle, to
be equipped with a TPMS to alert the driver when one or more of the vehicle's
tires, up to a total of all four tires, is significantly under-inflated.
Specifically, the TPMS must warn the driver when the pressure in one or more of
the vehicle's tires is 25% or more below the vehicle manufacturer's recommended
cold inflation pressure, or a minimum level of pressure specified in the
standard, whichever pressure is higher. Under the new standard, if any tire
drops below the standard's activation threshold, the TPMS is required to provide
the low tire pressure warning by illuminating a yellow telltale within 20
minutes of additional travel within a speed range of 50-100 km/hr. This telltale
must remain illuminated (and re-illuminate upon subsequent vehicle start-ups)
until the under-inflation condition has been corrected.
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Some additional details of the final rule are as follows:
o The TPMS to be used would be required to include a system malfunction
indicator (provided either by a separate telltale or a combined low
tire pressure/malfunction indicator telltale) that would alert the
driver in situations in which the TPMS is unable to detect low tire
pressure. This malfunction indicator is required to detect incompatible
replacement tires, as well as other system faults. Similar to the low
tire pressure warning, the system is required to trigger a TPMS
malfunction warning telltale within 20 minutes of additional travel
within a speed range of 50-100 km/hr after such a malfunction occurs.
This malfunction indicator light telltale must remain illuminated (and
re-illuminate upon subsequent vehicle start-ups) until the TPMS
malfunction has been corrected.
o 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, would be required to be used.
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.
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.
On June 6, 2005, a lawsuit was filed in the U.S. Court of Appeals for
the District of Columbia by Public Citizen, the Goodyear Tire & Rubber Company,
Bridgestone Firestone North American Tire, Cooper Tire & Rubber Co., Pirelli and
the Tire Industry Association.
The plaintiffs allege that the NHTSA rule, issued in April 2005,
doesn't require tire pressure monitoring systems to operate with replacement
tires and that this is a dangerous omission given that an estimated 61 percent
of passenger and 54 percent of light truck mileage occurs on replacement tires.
Under the rule, a malfunction light will come on to alert motorists that the
system is not working with the tires. The plaintiffs allege that not only would
this undermine public confidence in the systems, but it would likely lead to
consumers ignoring the warning light or having it disabled.
Our direct measurement TPMS generally exceeds 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 OEMs 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 TPMSs 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 TPMSs 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 TPMSs become standard equipment
for new passenger vehicles, demand for TPMSs 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:
Hyundai Autonet Co. Ltd. On February 6, 2003, we signed an agreement
with Hyundai Autonet Company ("HACO"), a leading Korean automotive electronics
supplier, pursuant to which we and HACO 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,
HACO is a subsidiary of the Hyundai Auto Group, a large Korean conglomerate of
companies. HACO has been contracted by its sister company, Hyundai Motor
Corporation, to develop commercial vehicle TPMSs.
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On October 17, 2003, we signed a contract manufacturing services
agreement with HACO. Under the terms of the agreement, HACO will manufacture our
proprietary line of TPMSs for sale and distribution globally by us. 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.
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.
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 currently
supplies us with valve stems that allow the attachment of tire monitoring
sensors inside the tire.
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 ASIS. A receiver
unit and optional display modules mounted in the vehicle provides appropriate
alarm indications with optional graphical readout.
The custom 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 that ensure faster transmission of data when problems occur.
Packaged on a miniaturized circuit board with the 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 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.
We developed 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 OEMs.
We introduced our motorcycle 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" above, 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 shipping TPMSs for
motorcycles that address the issue of rims with curved drop center wells.
48
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 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 TPMSs targeted directly at 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 product has completed design validation testing and has received
regulatory radio approvals in Europe and North America. Production validation
testing has now been completed. Vansco has now begun to manufacture the product
for us. This product will be supplied to both Motor Coach Industries and New
Flyer as lead customers, starting in the fall of 2005.
Our recreational vehicle and bus TPMSs consist of strap mounted
transmitters mounted inside the tires, rugged receivers mounted in the cab or on
the chassis, stand alone graphical displays or warning lights, and antennas
mounted on the chassis. Our system can also be integrated with existing OEM in
vehicle displays.
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 Brake Products. Under the terms of the Co-Marketing and Development
Agreement, we were to engage in a joint development program to integrate our
TPMSs with Haldex's Brake Product's brake systems, with the view to creating a
commercial high pressure TPMS for marketing and resale by Haldex Brake Products.
We anticipated that any new products that result from our collaboration with
Haldex Brake Products would be targeted at both OEMs and aftermarket
applications for trailers. As Haldex requested a hold in the joint development
program until the end of October 2005 due to a lack of technical resources on
their part and the fact that the agreement between our companies has changed
scope considerably since we began this program, we have asked for a release from
the current contract which we believe should be terminated shortly. If in
October 2005 there is a new viable joint venture, we and Haldex will re-visit
the agreement at that time and decide if we will enter into a new joint
development program.
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. It 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 system ("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.
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 TPMSs become standard equipment for
new passenger vehicles in the United States over the next few years, demand for
TPMSs 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 30 different automakers in Europe plus the 12
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 TPMSs than was anticipated prior to introduction of the TREAD Act.
49
Our current marketing strategy is to focus on sales of our TPMSs 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.
While we expect that the greatest demand for TPMSs in the United States
will be at the OEM 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.
Competition
Tire monitoring products can generally be divided between two basic
types: direct technology and indirect monitoring technologies. As described in
the National Highway Traffic Safety Administration's report, and discussed above
under the heading "Description of Business - Government Regulations," direct
tire monitoring technology such as that employed in our products currently
provides 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:
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. Schrader has been in the passenger car TPMS market since 1996 and their
systems have been used by various OEMs. As a transmitter supplier, Schrader has
mainly teamed with separate receiver suppliers to acquire OEM contracts. Current
TPMS business appears to be restricted to the passenger car OEMs.
BorgWarner acquired BERU in February 2005. Beru previously acquired
Doduco and its tire monitoring technology. The company has been supplying TPMSs
primarily as an option to vehicle manufacturers based mainly in Germany. 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 primarily for the OEM market for
passenger car applications. BorgWarner has recently started promoting a
commercial vehicle TPMS.
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 vehicles
manufactured in Asia, some of which are imported into North America. We believe
that Pacific Industrial's products resemble the BorgWarner approach to tire
monitoring with additional antennas and wiring harnesses.
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 some of our current products. During this
period, we and TRW jointly developed a common application specific integrated
sensor chip which we use for some of our existing products.
Siemens Automotive AG is a producer and large supplier of high-tech
automotive electronic systems. Siemens Automotive's product portfolio focuses on
electronic modules and systems including anti-lock brake systems and airbag
electronics. Siemens Automotive has entered the market and offers direct TPMSs
to OEMs.
50
Wabco is a producer of ABS braking products for the commercial vehicle
industry. Wabco jointly developed their IVTM system with Michelin for commercial
vehicles. The system consists of externally mounted wheel-fitted modules which
regularly measure and transmit tire inflation pressure, via an electronic
control unit, to an in-cabin dashboard display monitor. Equipped with visual and
acoustic warning signals, the display can warn drivers of abnormally low tire
pressure, slow leaks and punctures. The advantage of our system is it measures
temperature as well as pressure.
Indirect Competition
For passenger cars, there are several indirect monitoring or anti-lock
brake systems, either available on the market or in prototype stages. To our
knowledge, none of these prototype systems currently meet the proposed
guidelines set out in the September 10, 2004 NHTSA'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 TPMSs
will continue to improve, and they will likely benefit from the fact that they
are the least expensive way of complying with TPMSs standard for vehicles
already equipped with anti-lock braking systems.
For commercial vehicles, 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 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 if the system can provide enough air to the tires to keep them inflated.
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 TPMSs. 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 our early stage development and the early stage development of
the TPMS market in general, we are still dependent on major customers. During
our first nine months of fiscal 2005 we earned 38% of our revenue from Aston
Martin. 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 TPMSs 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:
51
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.
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 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 in December 1996.
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 TRW.
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 TPMS products.
We expect that our annual research and development expenses will approximate the
costs incurred in fiscal 2002 and fiscal 2004 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 for
customers that require application engineering as well as products that are
currently in development.
52
Employees
As of June 30, 2005, we had 48 full-time employees, 13 of whom are in
marketing, 24 of whom are in engineering, research and development and 11 of
whom are administrative and executive personnel and two contract employees in
administration. There is no collective bargaining agreement in place.
Costs and Effects of Compliance with Environmental Laws
There are no material costs or effects of complying with environmental
laws.
Facilities
Our principal executive offices are located at #150 - 13151 Vanier
Place, Richmond, British Columbia, V6V 2J1. On March 23, 2005, we extended the
term of our lease to August 31, 2010 and expanded our 15,364 square foot
facility by approximately 4,000 square feet. The lease modification includes a
CDN$100,000 tenant improvement allowance. We have the right to terminate the
lease on September 1, 2008 provided that we are not in default on our
obligations under the lease and we provide 180 days' prior written notice to our
landlord. 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.
Legal Proceedings
On April 21, 2005, Bristol Investment Fund, Ltd., a holder of our
discounted debentures in the amount of $91,726, commenced a lawsuit in the
Supreme Court of New York against us, essentially alleging that we wrongfully
refused to honor its request to convert the debt into 9,268,875 shares of our
common stock. The lawsuit seeks an order compelling us to issue the foregoing
shares and for damages and attorneys fees. The Court heard argument on a motion
for preliminary injunction requiring us to issue the shares on May 5, 2005 and
has not yet ruled on the motion. On June 6, 2005, we filed an Answer,
Affirmative Defenses and Counterclaims, denying liability to the debenture
holder and seeking damages from the debenture holder on account of its prior,
wrongful conduct. The parties have not conducted any written discovery or taken
any depositions; however, on June 27, 2005, Bristol Investment Fund filed
Plaintiff's First Request for Documents with the Court, and we must respond to
this request on or before July 31, 2005. In light of the status of the case,
which is in its initial phases and the fact that there has not been any
discovery, we cannot determine the outcome of the legal action. If Bristol
Investment Fund prevails, all outstanding 8% and discounted convertible
debentures will become convertible into shares of our common stock at a
conversion price of $0.01 per share.
53
MANAGEMENT
Executive Officers and Directors
The following table shows the positions held by our board of directors
and executive officers, and their ages as of June 30, 2005:
Name Age Position
- ---- --- --------
William Cronin 58 Director
Martin Gannon 53 Director
Johnny Christiansen 50 Director
Robert Rudman 58 Director, Chairman of the Board
Al Kozak 56 Director, President and Chief Executive Officer
Jeff Finkelstein 44 Chief Financial Officer
Erwin Bartz 44 Vice President, Business Development
Shawn Lammers 38 Vice President, Engineering
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 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 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 joined our company as a director on August 14,
2003. Mr. Christiansen resides in Norway and has served as a consultant for
various private companies since 2003. 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.
Robert 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. On June 30, 2005 he resigned as President and Chief Executive
Officer and entered into a consulting agreement with our company. 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.
54
Jeff 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.
Erwin Bartz was appointed Vice President of Business Development in
August 2003. 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.
Al Kozak joined us as Chief Operating Officer on May 1, 2002. He was
subsequently appointed to our Board of Directors on November 20, 2002. On June
30, 2005, Mr. Kozak was appointed as President and Chief Executive Officer. 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.
Shawn Lammers has been with us since our inception in 1987. 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.
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.
Family Relationships
There are no family relationships between any of our 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:
o 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;
o any conviction in a criminal proceeding or being subject to a
pending criminal proceeding (excluding traffic violations and
other minor offences);
o 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
55
o 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.
Audit Committee Financial Expert.
Our Board of Directors has determined that Martin Gannon, a member of
the audit committee, qualifies as an "audit committee financial expert" as such
term is defined by Regulation S-B of the Securities Exchange Act of 1934, as
amended. Our Board of Directors has also determined that Mr. Gannon is
independent as such term is used in Item 7(d)(3)(iv) of Schedule 14A under the
Securities Exchange Act of 1934, as amended.
Section 16(a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Securities Exchange Act of 1934 requires our
officers and directors, and persons who own more than 10% of our common stock,
to file reports of ownership and changes in ownership with the SEC. Officers,
directors and greater than 10% shareholders are required by SEC regulations to
furnish us with copies of all Section 16(a) forms they file.
Based solely on our review of the copies of such forms received by us,
or written representations from certain reporting persons, we believe that
during the year ended July 31, 2004, all filing requirements applicable to our
executive officers and directors and greater than 10% shareholders were complied
with.
Code of Ethics
The Company has a Code of Business Conduct and Ethics Compliance
Program which was approved and adopted by our Board of Directors on October 3,
2003.
Executive Compensation
The following table sets forth, for the years indicated, particulars of
compensation awarded to, earned by or paid to:
o our chief executive officer (the "CEO");
o each of our 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
o any additional individuals for whom disclosure would have been
provided immediately above 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 individuals served as our executive officers 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."
56
Summary Compensation Table
Annual Compensation Long Term Compensation
Awards Payouts
Name and Principal Year Salary Bonus Other Annual Restricted Securities LTIP All Other
Position Compensation(1) Stock Underlying Payouts Compensation
Awards Options/SARs
Granted (#)
- -------------------- -------- ------------ ------------ -------------- ------------ ------------ ----------- ------------
Robert Rudman 2004 $217,478 None None None 1,079,500 None None
President,
Chairman and Chief 2003 $194,543 None None None 232,000 None None
Executive Officer
2002 $185,377 None None None 90,000 None None
- -------------------- -------- ------------ ------------ -------------- ------------ ------------ ----------- ------------
Al Kozak 2004 $164,983 None None None 683,000 None None
Chief Operating
Officer 2003 $147,585 None None None 111,000 None None
- -------------------- -------- ------------ ------------ -------------- ------------ ------------ ----------- ------------
Erwin Bartz 2004 $121,113 None None None 390,000 None None
Vice President,
Business 2003 $108,341 None None None 55,000 None $5,826(2)
Development
- -------------------- -------- ------------ ------------ -------------- ------------ ------------ ----------- ------------
Shawn Lammers 2004 $108,739 None None None 332,600 None None
Vice President,
Engineering 2003 $94,589 None None None 15,100 None None
2002 $86,296 None None None 10,000 None None
- -------------------- -------- ------------ ------------ -------------- ------------ ------------ ----------- ------------
John Taylor-Wilson 2004 $102,576 None None None 450,000 None $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
(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 $5,229 in fiscal 2004.
The following table sets forth for each of the Named Executive Officers
certain information concerning stock options granted to them during fiscal year
2005. We have never issued stock appreciation rights. We grant options that
generally vest immediately at an exercise price equal to the fair market value
of a share of common stock as determined by its closing price on the OTC
Bulletin Board. Until May 28, 2003, the exercise price was determined by its
closing price on the Nasdaq SmallCap Market. The term of each option granted is
generally five years from the date of grant. Options may terminate before their
expiration dates if the optionee's status as an employee is terminated or upon
the optionee's death or disability.
57
Options/SAR Grants in the Last Fiscal Year*
Number of Securities % of Total
Name Underlying Options/SARS Granted Exercise Price Expiration Date
Options/SARS Granted to Employees in ($/share)
(#) Fiscal Year
- ----------------------------------------------------------------------------------------------------------------------
Robert Rudman 5,840,000 14.41% $0.03 December 19, 2009
Al Kozak 4,540,000 11.20% $0.03 December 19, 2009
Erwin Bartz 3,000,000 7.40% $0.03 December 19, 2009
Shawn Lammers 3,000,000 7.40% $0.03 December 19, 2009
Jeff Finkelstein 3,000,000 7.40% $0.03 December 19, 2009
* True as of June 30, 2005. We are on an August 1st to July 31st fiscal year.
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, 2005. 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 June 30, 2005 ($0.142 per
share) and the exercise price of the individual's options. No Named Executive
Officer exercised options during fiscal 2005.
Aggregated Option/SAR Exercises in Last Fiscal Year* and FY-End Option/SAR
Values
Name Shares Value Number of Securities Value of Unexercised
Acquired on Realized Underlying Unexercised In-the-Money Options/SARs at
Exercise (#) ($) Options/SARs at FY-End (#) FY-End* ($)
Exercisable/Unexercisable Exercisable/Unexercisable
- ----------------------------------------------------------------------------------------------------------------------
Robert Rudman None None 3,555,000 654,080
3,555,000 None Exercisable
Exercisable
Al Kozak None None 5,466,000 508,480
5,466,000 None Exercisable
Exercisable
Erwin Bartz None None 3,555,000 336,000
3,555,000 None Exercisable
Exercisable
Shawn Lammers None None 3,392,700 336,000
3,392,700 None Exercisable
Exercisable
Jeff Finkelstein None None 3,417,200 336,000
3,417,200 None Exercisable
Exercisable
* True as of June 30, 2005. We are on an August 1st to July 31st fiscal year.
Employment Contracts and Termination of Employment and Change in Control
Arrangements
On June 30, 2005, Robert Rudman resigned from his position as our
President and Chief Executive Officer. He remains Chairman of our Board of
Directors and has entered into a consulting agreement, dated as of June 30,
2005, with us. Pursuant to the consulting agreement, Mr. Rudman will provide
certain specified consulting services to us for a monthly fee of $20,000. The
consulting agreement will terminate on June 30, 2006 unless renewed by mutual
agreement of the parties.
Effective January 3, 2001, our Board of Directors approved a new
management agreement with Erwin Bartz that 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 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 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. On February 3, 2005, we amended Mr. Bartz's
management agreement whereby in the event that the employment of Mr. Bartz is
terminated within 12 months of an acquisition, hostile takeover or merger, and
the termination is without cause, we, at our option, will either (i) pay upon
termination an amount equal to the salary payable to Mr. Bartz of one year from
the date of termination plus one month for each year of employment up to a
maximum of two years or (ii) pay upon termination an amount equal to the salary
payable on the termination date.
58
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 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. Lammers' salary was increased to CDN$152,000
(approximately $124,000) per annum. Our 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. On
February 3, 2005 we amended Mr. Lammers' management agreement whereby in the
event that the employment of Mr. Lammers is terminated within 12 months of an
acquisition, hostile takeover or merger, and the termination is without cause,
we, at our option, will either (i) pay upon termination an amount equal to the
salary payable to Mr. Lammers of one year from the date of termination plus one
month for each year of employment up to a maximum of two years or (ii) pay upon
termination an amount equal to the salary payable on the termination date.
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 incentive compensation plan. Our
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. On February 3, 2005 we amended Mr. Kozak's
management agreement whereby in the event that the employment of Mr. Kozak is
terminated within 12 months of an acquisition, hostile takeover or merger, and
the termination is without cause, we, at our option, will either (i) pay upon
termination an amount equal to the salary payable to Mr. Kozak of one year from
the date of termination plus one month for each year of employment up to a
maximum of two-and-a-half years or (ii) pay upon termination an amount equal to
the salary payable on the termination date. On June 30, 2005, Mr. Kozak was
elected by our Board of Directors as our new President and Chief Executive
Officer.
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, 2004, 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 equal to the annual salary.
On February 3, 2005 we amended Mr. Finkelstein's management agreement
whereby in the event that the employment of Mr. Finkelstein is terminated within
12 months of an acquisition, hostile takeover or merger, and the termination is
without cause, we, at our option, will either (i) pay upon termination an amount
equal to the salary payable to Mr. Finkelstein of one year from the date of
termination plus one month for each year of employment up to a maximum of
two-and-a-half years or (ii) pay upon termination an amount equal to the salary
payable on the termination date.
Effective March 31, 2003, as a temporary measure to help preserve our
working capital, 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.
59
Effective August 11, 2003, our Board of Directors approved a management
agreement with John Taylor-Wilson that 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. 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. Mr. Taylor-Wilson was terminated on October 14, 2004 and we paid him
severance of CDN$32,308 (approximately $26,000).
Other than as discussed above, we have 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.
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 of Directors or of a committee of the Board of Directors,
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.
Stock Incentive Plans
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. Five 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
five stock incentive plans provide for awards to all other eligible employees of
our company or of any related entity. For more information regarding our stock
incentive plans, please refer to "Market for Our Common Stock and Related
Stockholder Matters - Equity Compensation Plan Information".
60
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth information regarding the number of
shares of our common stock beneficially owned on June 30, 2005 by:
o each person who is known by us to beneficially own 5% or more of
our common stock;
o each of our directors and executive officers; and
o all of our directors and executive officers as a group.
Beneficial ownership is determined in accordance with the rules of the
SEC and generally includes voting or investment power with respect to
securities. Shares of our common stock which may be acquired upon exercise of
stock options or warrants which are currently exercisable or which become
exercisable within 60 days after the date indicated in the table are deemed
beneficially owned by the optionees. Subject to any applicable community
property laws, the persons or entities named in the table above have sole voting
and investment power with respect to all shares indicated as beneficially owned
by them.
Amount and
Name and Address of Nature of
Beneficial Owner Beneficial
Owner Percent of Class
- ------------------------------------------------- ------------------ ----------------------
William Cronin
180 Concord Drive 1,779,746(2) *
Madison, Connecticut, USA 06443
Martin Gannon
1275 Post Road 1,535,000(3) *
Fairfield, Connecticut, USA 06824
Johnny Christiansen
Spurvestien 24 1,150,000(4) *
3189 Horten, Norway
Robert Rudman
4100 North Ocean Drive, Suite 401, Singer 9,687,911(5) 3.34%
Island, West Palm Beach, Florida, USA
33404
Al Kozak
25841 116 Avenue 6,949,181(6) 2.48%
Maple Ridge, BC V4R 1Z6
Jeff Finkelstein
3460 Regent Street 4,434,210(7) 1.59%
Richmond, BC V7E 2N1
Erwin Bartz
21 Arrow-Wood Place 4,566,260(8) 1.64%
Port Moody, BC V3H 4E9
Shawn Lammers
3460 Regent Street 4,405,479(9) 1.58%
Richmond, BC V7E 2N1
Directors and Executive Officers as a Group 34,507,787(10) 11.42%
61
* Represents less than 1% of our outstanding stock
(1) Based on 274,595,173 shares of common stock issued and outstanding as of
June 30, 2005. Beneficial ownership is determined in accordance with the rules
of the SEC 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.
(2) Includes options to acquire up to 1,692,500 shares of common stock
exercisable within 60 days.
(3) Includes options to acquire up to 1,525,100 shares of common stock
exercisable within 60 days.
(4) Includes options to acquire up to 1,150,000 shares of common stock
exercisable within 60 days.
(5) Includes 10,257 shares of common stock 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 shares of common stock exercisable within 60 days.
(6) Consists of options to acquire up to 5,466,000 shares of common stock
exercisable within 60 days.
(7) Includes options to acquire up to 3,417,200 shares of common stock
exercisable within 60 days.
(8) Consists of options to acquire up to 3,555,000 shares of common stock
exercisable within 60 days.
(9) Includes options to acquire up to 3,392,700 shares of common stock
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 our company,
other than the conversion of our outstanding convertible debentures and the
exercise of our outstanding warrants in certain circumstances.
62
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 six months ended January 31, 2005, we incurred
expenses of $60,000 for a research report prepared by Visionaire AS on various
sensor applications.
The promoters of our company are our directors and officers.
63
PRINCIPAL AND SELLING STOCKHOLDERS
The following table sets forth:
o the name and address of each selling stockholder;
o the number of shares of common stock beneficially owned before
this offering by the selling stockholders as of June 30, 2005;
o the percentage of our outstanding common stock beneficially owned
by the selling stockholders before this offering;
o the maximum number of shares of common stock that may be offered
for the account of the selling stockholders under this prospectus;
o the number of shares of common stock being registered in this
offering; and
o the amount and percentage of common stock that would be owned by
the selling stockholders after completion of the offering,
assuming a sale of all of the common stock that may be offered by
this prospectus.
Except as noted below and elsewhere in this prospectus, the selling
stockholders have not, within the past three years, had any position, office or
other material relationship with us. Except as noted below, none of the selling
stockholders are members of the National Association of Securities Dealers, Inc.
Beneficial ownership is determined under the rules of the U.S.
Securities and Exchange Commission. The number of shares beneficially owned by a
person includes shares of common stock underlying warrants, stock options and
other derivative securities to acquire our common stock held by that person that
are currently exercisable or convertible or exercisable within 60 days after
June 30, 2005. The shares issuable under these securities are treated as
outstanding for computing the percentage ownership of the person holding these
securities, but are not treated as outstanding for the purposes of computing the
percentage ownership of any other person.
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, 5%, 8% and 10% convertible debentures, the 5% series A convertible
preferred shares, or upon exercise of the share purchase warrants. Because the
selling stockholders may offer all or only some portion of the 1,807,180,033
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.
Common Shares Percentage of Common Shares Shares Registered Beneficial Ownership
Beneficially Owned Outstanding Issuable in this After this Offering(2)
by Selling Shares Upon Exercise or Offering -----------------------
Stockholder Beneficially Conversion of Number of Percent(3)
Before Owned Before Securities and Shares
Offering(1) Offering Forming Part of
Name of Selling Stockholder this Offering
- ------------------------------------------------------------------------------------------------------------------------------------
Alpha Capital AG
Lettstrasse 32 8,141,670(4) 2.88% None 4,744,234(4) 8,141,670 2.88%
Furstentum 9490
Vaduz, Liechtenstein
Bristol Investment Fund, Ltd.
c/o Bristol Capital Advisors, LLC 3,275,929(5) 1.18% 3,275,929(5) 3,275,929(5) None 0.0%
6363 Sunset Boulevard
Fifth Floor
Hollywood, California 90028 USA
Cornell Capital Partners, L.P.
101 Hudson St-Suite 3606 30,490,000(6) 9.99%(6) 1,760,797,818(6) 1,760,797,818(6) None 0.0%
Jersey City NJ 07302
64
Common Shares Percentage of Common Shares Shares Registered Beneficial Ownership
Beneficially Owned Outstanding Issuable in this After this Offering(2)
by Selling Shares Upon Exercise or Offering -----------------------
Stockholder Beneficially Conversion of Number of Percent(3)
Before Owned Before Securities and Shares
Offering(1) Offering(3) Forming Part of
Name of Selling Stockholder this Offering
- ------------------------------------------------------------------------------------------------------------------------------------
Crescent International Ltd.
84, Avenue 14,425,000(8) 4.99% 6,311,964(8) 9,045,314(7)(8) 7,678,572 2.72%
Louis-Casai
CH 1216 Cointrin, Geneva
Switzerland
Gamma Opportunity Capital
Partners, LP 1,634,605(9) * None 1,634,605(9) None 0.0%
British Colonial Centre of
Commerce
One Bay Street, Suite 401
Nassau (NP), The Bahamas
Hawk Associates, Inc.(10)
204 Ocean Drive 250,000(11) * 250,000(11) 250,000(11) None 0.0%
Tavernier, FL 33070
Highgate House Funds, Ltd.
488 Madison Ave. - 12th Floor 14,150,000(12) 4.9% 21,940,278(12) 21,940,278(12) None 0.0%
New York, NY 10022
Newbridge Securities
Corporation(13) 75,188(14) * None 75,188(14) None 0.0%
1451 Cypress Creek Road, Suite 204
Fort Lauderdale, Florida 33309
Bally, Jr., William A. & Mary C.
39 Hidden Lake Drive 694,444(15) * 694,444(15) 694,444(15) None 0.0%
Burr Ridge, IL 60527
Luca, Minna
5532 Estate Oak Circle 1,388,889(16) * 1,388,889(16) 1,388,889(16) None 0.0%
Fort Lauderdale, FL 33312
Viola, Mary Ellen
294 Lone Hill Drive 2,777,778(17) 1.0% 2,777,778(17) 2,777,778(17) None 0.0%
Short Hills, NJ 07078
Luther, David H.
100 Phlox Creek 277,778(18) * 277,778(18) 277,778(18) None 0.0%
Bristol, TN 37620
Hargiss, Jack
15115 Elk Creek Acres Road 277,778(19) * 277,778(19) 277,778(19) None 0.0%
Pine, CO 80470
* Represents less than 1% of outstanding shares of our common stock.
65
(1) Ownership as of June 30, 2005, for the selling stockholders based on
information provided by the selling stockholders or known to us.
(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, although the selling stockholders are under no obligation known to us
to sell any shares of common stock at this time.
(3) A total of 274,595,173 shares of common stock were issued and outstanding as
of June 30, 2005.
(4) Represents shares of "restricted stock" issued to the named selling
stockholder under the Redemption, Settlement and Release Agreement, May 3, 2005.
3,397,436 shares of this common stock may be sold pursuant to Rule 144(k) of the
Securities Act of 1933, as amended and are not being registered.
(5) Represents all of common stock that potentially may be issued upon the
conversion or redemption of principal of $91,726 under the discounted
convertible debentures maturing April 1, 2006 at a conversion price of $0.028
per share in an aggregate amount of 3,275,929 shares, subject to adjustment in
accordance with their terms. Each of the discounted convertible debentures
contains a contractual restriction on beneficial share ownership limiting
Bristol Investment Fund's beneficial ownership to 4.99% of our outstanding
shares. Beneficial ownership is therefor limited to 4.99% of our outstanding
shares of common stock. See "Description of Securities" for further details on
the terms of the convertible debentures.
(6) Represents (i) all of the common stock that potentially may be issued upon
the draw down of $160 million on our equity line at $0.16 per share in an
aggregate amount of 1.0 billion shares, (ii) all of the common stock that
potentially may be issued upon the conversion of $4 million of 5% series A
convertible preferred shares in an aggregate amount of 400 million shares, (iii)
all of the common stock that potentially may be issued upon the conversion of
$28 million under 10% convertible debentures at a conversion price of $0.1125
per share in an aggregate of 248,888,889 shares, (iv) all of the common stock
that potentially may be issued upon the conversion of $1.5 million under a 5%
convertible debenture at a conversion price of $0.028 per share in an aggregate
of 53,571,429 shares and (v) all of the common stock that potentially may be
issued upon the exercise of 58,337,500 common share purchase warrants issued to
the named selling stockholder and expiring June 23, 2010 at an exercise price of
$0.16 per share , subject to adjustment in accordance with their respective
terms. The Standby Equity Distribution Agreement, the 5% and 10% convertible
debentures and share purchase warrants contain contractual restrictions on
beneficial share ownership limiting Cornell Capital Partner's beneficial
ownership to 4.9%, and in some cases, 9.9% of our outstanding shares. Beneficial
ownership is therefor limited to 9.9% of our outstanding shares of common
stock. See "Description of Securities" for further details on the terms of the
Standby Equity Distribution Agreement and the 5% and 10% convertible debentures.
(7) Represents (i) shares of "restricted stock" issued to the named selling
stockholder under the Redemption, Settlement and Release Agreement, dated May
13, 2005, in the amount of 2,733,350 shares and (ii) all of common stock that
potentially may be issued upon the conversion or redemption of principal of
$215,000 under the 8% convertible debenture in an aggregate amount of 7,678,572
shares plus any shares to be issued on the conversion of interest, at a
conversion price of $0.028 per share subject to adjustment in accordance with
their terms. The shares of common stock described in (ii) may be sold pursuant
to Rule 144(k) of the Securities Act of 1933, as amended and are not being
registered.
(8) Represents all of the common stock that potentially may be issued upon the
conversion or redemption of principal of $176,735 under the discounted
convertible debentures maturing April 1, 2006 at a conversion price of $0.028
per share in an aggregate amount of 6,311,964, subject to adjustment in
accordance with their terms. Each of the discounted convertible debentures and
the share purchase warrants contains a contractual restriction on beneficial
share ownership limiting Crescent International's beneficial ownership to 4.99%
of our outstanding shares. Beneficial ownership is therefor limited to 4.99% of
our outstanding shares of common stock. See "Description of Securities" for
further details on the terms of the convertible debentures.
(9) Represents shares of "restricted stock" issued to the named selling
stockholder under the Redemption, Settlement and Release Agreement, dated April
29, 2005.
(10) 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.
66
(11) Represents all of the common stock that potentially may be issued upon the
exercise of common share purchase warrants issued to the named selling
stockholder and maturing June 30, 2009 at an exercise price of $0.20 per share.
(12) Represents (i) all of the common stock that may be issued upon the
conversion of principal of $2 million under the 10% convertible debentures
maturing June 23, 2008 at a conversion price of $0.1125, subject to adjustment
in accordance with their terms and (ii) all of the common stock that potentially
may be issued upon the exercise of 4,162,500 common share purchase warrants
issued to the named selling stockholder and expiring June 23, 2010 at an
exercise price of $0.16 per share. The 10% convertible debentures and share
purchase warrants contain contractual restrictions on beneficial share ownership
limiting Highgate House Fund's beneficial ownership to 4.9% of our outstanding
shares. Beneficial ownership is therefor limited to 4.9% of our outstanding
shares of common stock. See "Description of Securities" for further details
regarding the 10% convertible debentures and share purchase warrants.
(13) Newbridge Securities Corporation is a placement agent firm that we engaged
to act as the exclusive placement agent in connection with our Standby Equity
Distribution Agreement.
(14) Represents all of the common stock issued to the named selling stockholder
pursuant to the Placement Agent Agreement, dated May 20, 2005, among us, Cornell
Capital Partners and Newbridge Securities Corporation.
(15) Represents all of the common stock that potentially may be issued upon the
conversion of $25,000 of 5% convertible debentures to the named selling
stockholder at a conversion price of $0.036 per share.
(16) Represents all of the common stock that potentially may be issued upon the
conversion of $50,000 of 5% convertible debentures to the named selling
stockholder at a conversion price of $0.036 per share.
(17) Represents all of the common stock that potentially may be issued upon the
conversion of $100,000 of 5% convertible debentures to the named selling
stockholder at a conversion price of $0.036 per share.
(18) Represents all of the common stock that potentially may be issued upon the
conversion of $10,000 of 5% convertible debentures to the named selling
stockholder at a conversion price of $0.036 per share.
(19) Represents all of the common stock that potentially may be issued upon the
conversion of $10,000 of 5% convertible debentures to the named selling
stockholder at a conversion price of $0.036 per share.
67
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:
o 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;
o purchases by broker or dealer as principal and resale by the
broker or dealer for its account pursuant to this prospectus;
o an exchange distribution in accordance with the rules of the
applicable exchange;
o ordinary brokerage transactions and transactions in which the
broker solicits purchasers;
o privately negotiated transactions;
o market sales (both long and short to the extent permitted under
the federal securities laws);
o at the market to or through market makers or into an existing
market for the shares;
o through transactions in options, swaps or other derivatives
(whether exchange listed or otherwise); and
o 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 that 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 fulfill 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.
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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 will 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.
Any shares of common stock covered by this prospectus that 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.
We cannot assure you, however, that any of the selling stockholders
will sell any or all of the shares of common stock they may offer.
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DESCRIPTION OF SECURITIES
Our authorized capital stock consists of an unlimited number of shares
of common stock, no par value, and 100,000 shares of preferred stock, no par
value. Of the preferred stock, 25,000 shares have been designed as series A 5%
convertible preferred stock. As of June 30, 2005, there were issued and
outstanding:
o 274,595,173 shares of common stock;
o 25,000 shares of series A 5% convertible preferred stock,
currently convertible into 400 million shares of common stock;
o stock options to purchase 42,259,802 shares of common stock at an
average weighted per share price of $0.13; and
o warrants to purchase 64,988,141 shares of common stock at an
average per share price of $0.16.
The following summary of the material provisions of our securities,
articles of incorporation and by-law is qualified by reference to the provisions
of our articles of incorporation and by-law and the forms of securities included
as exhibits to the registration statement of which this prospectus is a part.
Common Stock
The holders of our common stock are entitled to one vote per share. The
holders of common stock are entitled to receive dividends, if any, as may be
declared by our board of directors out of legally available funds. Upon a
liquidation, dissolution or winding-up, the holders of common stock are entitled
to share pro rata in any distribution of our assets after payment of
liabilities. The holders of our common stock have no pre-emptive rights. There
are no conversion, redemption, sinking fund or similar provisions regarding our
common stock.
Holders of shares of our common stock are subject to rules adopted by
the SEC that regulate broker-dealer practices in connection with transactions in
"penny stocks". Please refer to "Risk Factors - Risks Related to Our Common
Stock" for more information regarding transactions in "penny stocks".
Series A 5% Convertible Preferred Stock
On March 22, 2005, we entered into an Investment Agreement with Cornell
Capital Partners, L.P. in which we sold an aggregate of $4 million of our
series A 5% convertible preferred stock, no par value (the "Preferred Stock").
$2.85 million of the $4 million had already been funded pursuant to certain
transaction documents we previously entered into with Cornell Capital Partners.
These transaction documents were terminated by the parties on March 23, 2005,
and we received net proceeds of $1,015,000, after deducting the $2.85 million
that had been previously funded, a $115,000 commitment fee and legal fees in the
amount of $20,000. We issued 25,000 shares of the Preferred Stock to Cornell
Capital Partners in a private placement. Each share of Preferred Stock has a
stated value of $160.
Conversion. Holders of the Preferred Stock are entitled, at any time
after the date of issuance, to convert their shares into such number of fully
paid and non-assessable shares of our common stock, no par value, equal to the
quotient of $160 divided by $0.01 per share. The conversion price is adjustable
in the event of any stock split or reverse stock split, stock dividend,
reclassification of common stock, recapitalization, merger or consolidation. In
addition, the conversion price of the Preferred Stock will be adjusted if we
spin off or otherwise divest a material part of our business or operations or
dispose all or a portion of our assets.
Dividends. Holders of the Preferred Stock are entitled to receive
dividends or distributions on a pro rata basis according to their holdings of
the Preferred Stock; when and if declared by our board of directors, in the
amount of 5.0% per year. Dividends will be paid in cash and are cumulative. No
cash dividends or distributions will be declared or paid or set apart for
payment on our common stock in any calendar year unless cash dividends or
distributions on the Preferred Stock for such calendar year are likewise
declared and paid or set apart for payment. No declared and unpaid dividends
will bear or accrue interest.
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Liquidation Preference. Upon our liquidation, dissolution, or
winding-up, whether voluntary or involuntary, before any distribution or payment
is made to any of the holders of our common stock or any series of preferred
stock, holders of the Preferred Stock are entitled to receive out of our assets,
an amount equal to $160 per share of the Preferred Stock plus all declared and
unpaid dividends thereon, for each share of the Preferred Stock held by such
holder.
Redemption. We may redeem up to 80% of the Preferred Stock by paying to
the holder cash equal to 120% of the liquidation preference, which is defined as
$160 per share of the Preferred Stock plus all declared and unpaid dividends
thereon, for each share of the Preferred Stock held by such holder on the
redemption payment date. On December 22, 2006, to the extent Cornell Capital
Partners has not converted in full the Preferred Stock, we must pay to Cornell
Capital Partners the sum of $4 million, together with accrued dividends at the
rate of 12% per year (computed on the basis of a 365-day year and the actual
days elapsed) to redeem its outstanding shares of Preferred Stock.
Registration Rights. In addition, on March 22, 2005, we entered into a
Registration Rights Agreement with Cornell Capital Partners under which we
agreed to file a registration statement within 30 days after the closing date
for the purpose of registering 400,000,000 shares of common stock issuable upon
the conversion of the Preferred Stock. In addition, we are obligated to use our
best efforts to cause such registration statement to be declared effective by
the SEC no later than 120 days after the filing thereof and to insure that the
registration statement remains in effect until all of the shares of common stock
issuable upon conversion of the Preferred Stock have been sold. Cornell Capital
Partners has granted us an extension until July 22, 2005 to file the
registration statement.
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. As of June 30, 2005, $268,461 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.
Conversion Provisions, Conversion Price and Adjustments. As of June 30,
2005 the outstanding aggregate principal amount of $268,461 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, which 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.
Each convertible debenture is subject to anti-dilution protection upon
the occurrence of certain events, as follows:
o 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;
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o 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;
o 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;
o 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;
o 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;
o 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 (i) 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 (ii) 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;
o 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 a 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
o 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 statement 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.
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Monthly redemption payments for February, March, April and May 2004
were made in shares of our common stock, 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 such 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. However, we defaulted as we did not make scheduled payments that were
due on February 1, March 1, and April 1, 2005. To resolve all outstanding
disputes over the 8% and discounted convertible debentures, in April and May
2005 we entered into Redemption, Release and Settlement Agreements with all but
one of the holders of our 8% and discounted convertible debentures. Pursuant to
such Redemption, Release and Settlement Agreements, we redeemed, through the
making of $866,066 in cash payments, an aggregate of $757,011 of the outstanding
aggregate principal balance owed by us under the 8% and discounted convertible
debentures. In addition, we issued to such holders an aggregate of 23,069,042
shares of our common stock to redeem an additional $272,685 of the outstanding
aggregate principal balance owed by us under the discounted convertible
debentures and exercise of 15,862,857 warrants on a cashless basis. Of the
23,069,942 shares of common stock issued to the holders of our discounted and 8%
convertible debentures, 14,090,097 were "restricted" shares and 8,979,845 were
"unrestricted" shares.
Registration Rights. We agreed to file a 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 stale, under the Forbearance and Escrow
Agreement entered into on September 24, 2004, we were obligated to file an
additional registration statement with the SEC 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 certain other debentures
purchased in May and June of 2003 and exercise of the warrants and certain other
warrants purchased in May and June of 2003 assuming for such purposes the
conversion price of the debentures and such previously issued 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 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 the previously
issued debentures and/or exercise in full of the warrants and/or the previously
issued warrants, we must to file an additional registration statement. Due to
anti-dilution provisions in the debentures the conversion price of the
convertible debentures and exercise price of the associated warrants were
reduced to $0.028 per share.
We did not file an additional registration statement on or before
January 31, 2005 as required pursuant to the Forbearance and Escrow Agreement.
Accordingly, we are in default of such registration obligations. There can be no
assurance that the holders of the 8% and discounted convertible debentures will
not commence an action against us relating to our default of our obligation to
file the registration statement by January 31, 2005, or if instituted, that such
action will not be successful. The cost of such potential litigation can be
substantial even if we were to prevail. Further, an unfavorable outcome could
have a material adverse effect on our revenues, profits, results of operations,
financial condition and future prospects.
Events of Default. We will be considered in default of the convertible
debentures if any of the following events, among others, occurs:
o 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;
o 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;
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o 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 15 days after our receipt of written notice
of such breach;
o we or any of our subsidiaries become bankrupt or insolvent;
o 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 15 days and the breach is waived by
the other party to the debt or credit agreement;
o 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;
o 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
o 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:
o 120% of the principal amount of the debenture, plus all accrued
and unpaid amounts outstanding in respect of the debenture; or
o 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 (i) the last reported closing bid price for our common
stock on the date on which the payment is demanded or due or (ii)
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.
5% Convertible Bridge Debentures
On December 15, 2004, we closed a private placement of 5% convertible
debentures to five investors, 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 two 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 (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 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. Due to anti-dilution provisions in the debentures the exercise price of
the convertible debentures was reduced to $0.028 per share on March 23, 2005 as
a result of the issuance of convertible preferred shares.
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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.
Each convertible debenture is subject to anti-dilution protection upon
the occurrence of certain events, as follows:
o 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;
o 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;
o 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;
o 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;
o if we or any of our subsidiaries offers, sells or grants 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;
o 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 (i) 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 (ii) 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;
o 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 a 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
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o 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 that 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, we will not have the redemption right
prior to the effective registration of the shares underlying the convertible
debentures.
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 years from the date of issuance.
Registration Rights. We 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 us 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 statement 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 will 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. We are currently in default as a registration statement was not
effectively filed with the SEC 30 days after our annual general meeting. As of
the date hereof, we have not been, nor do we expect to be, contacted by any
holders of 5% convertible bridge debentures with respect to any rights they may
have as a result of this default.
5% Convertible Debenture
On May 27, 2005, we closed on a $1.5 million Securities Purchase
Agreement with Cornell Capital Partners. In accordance with the Securities
Purchase Agreement, we issued, pursuant to Rule 506 of Regulation D under the
Securities Act, for a purchase price of $1.5 million, a 5% convertible debenture
due May 20, 2006, to Cornell Capital Partners, with principal payments
commencing on October 1, 2005 and interest payments commencing on August 1,
2005. The outstanding principal under the convertible debenture bears interest
at the rate of 5% per annum, calculated on the basis of a 360-day year.
Interest and Maturity. With respect to the convertible debentures issued to
Cornell Capital Partners, principal will be due and payable in 12 equal
installments. The installments of principal will be due and payable commencing
on October 1, 2005 and subsequent installments will be due and payable on the
first day of each calendar month thereafter until the outstanding principal
balance is paid in full. Interest on the outstanding principal balance is due
and payable monthly, in arrears, commencing on August 1, 2005 and will continue
to be payable on the first day of each calendar month thereafter that any
amounts under the convertible debenture remain payable.
Conversion Provisions; Conversion Price and Adjustments. The
remaining principal under the convertible debentures may be converted by Cornell
Capital Partners or Highgate House Funds, as applicable, in whole or in part and
from time to time into shares of our common stock at a conversion price of
$0.028 per share, subject to adjustment as described below.
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In the event of any issuances of shares of common stock or rights,
options, warrants or securities convertible or exercisable into common stock at
a price per share of common stock less than the conversion price of the
convertible debentures, the conversion price of such convertible debentures will
be reduced to the lower purchase price. In addition, the conversion price of the
convertible debentures will be subject to adjustment in connection with any
subdivision, stock split, combination of shares or recapitalization. No
adjustment will be made as a result of issuances and exercises of options to
purchase shares of common stock issued for compensatory purposes pursuant to any
of our stock option or stock purchase plans.
Events of Default. The 5% convertible debenture provides for various
events of default that would entitle the holders to require us to immediately
repay 100% of the outstanding principal amount, plus accrued and unpaid
interest, in cash, or shares of our common stock with a conversion price reduced
to $0.014. 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 debenture if any
of the following events, among others, occurs:
o we fail to pay any amount due under a convertible debenture and
such failure to pay remains uncured for 10 days;
o we fail to observe or perform any other covenant, agreement or
warranty contained in, or otherwise commit any breach or default
of any provision of the 10% convertible debentures;
o we or any of our subsidiaries become bankrupt or insolvent;
o we breach any of our obligations under any other debt or credit
agreements involving an amount exceeding $250,000;
o 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 20 trading days;
o we or any subsidiary experiences a change of control;
o we fail to file a registration statement with the SEC or such
registration statement is not declared effective by the SEC within
120 days after filing;
o if the effectiveness of the registration statement lapses for any
reason or the holder of the convertible debentures is not be
permitted to resell the underlying shares of common stock, in
either case, for more than five trading days or an aggregate of
eight trading days;
o we fail to deliver common stock certificates to a holder prior to
the fifth trading day after a conversion date or we fail to
provide notice to a holder of our intention not to comply with
requests for conversions of the convertible debentures; or
o we fail to deliver the payment in cash pursuant to a "buy-in"
within three days after notice is claimed delivered.
Limitation on Beneficial Ownership. The convertible debenture
contains a contractual restriction on beneficial share ownership. It provides
that Cornell Capital Partners may not convert the 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 Cornell
Capital Partners, together with its respective affiliates, beneficially owning
in excess of 4.9% of our then issued and outstanding shares of common stock.
77
Fees. We paid to Yorkville Advisors Management a cash fee of $150,000,
and a cash structuring fee of $10,000, in connection with the Securities
Purchase Agreement out of the purchase price paid by Cornell Capital Partners
for the convertible debenture.
Registration Rights. In connection with the execution of the Securities
Purchase Agreement, on May 20, 2005, we entered into a Registration Rights
Agreement with Cornell Capital Partners pursuant to which we agreed to prepare
and file, no later than 45 days after the date of the Registration Rights
Agreement, with the SEC a registration statement on Form S-1 or SB-2 (or, if we
are then eligible, on Form S-3) under the Securities Act of 1933, as amended,
for the resale by the investor of 53,571,429 shares of our common stock to be
issued upon conversion of the convertible debenture.
10% Convertible Debentures
On June 30, 2005, we closed on a $30 million Securities Purchase
Agreement with Cornell Capital Partners and Highgate House Funds, Ltd. In
accordance with the Securities Purchase Agreement, we issued, pursuant to Rule
506 of Regulation D under the Securities Act, for a purchase price of $30
million, (i) a 10% convertible debenture due June 23, 2008, with a principal
balance of $20 million, to Cornell Capital Partners, as trustee for LCC Global
Limited, a corporation organized under the laws of Cyprus (ii) a 10% convertible
debenture due June 23, 2008, with a principal balance of $8 million, to Cornell
Capital Partners, as trustee for LCC Global Limited, and (iii) a 10% convertible
debenture due June 23, 2008, with a principal balance of $2 million, to Highgate
House Funds, as trustee for LCC Global Limited. The outstanding principal under
the convertible debentures bears interest at the rate of 10% per annum,
calculated on the basis of a 360-day year.
Interest and Maturity. With respect to the $20 million convertible
debenture issued to Cornell Capital Partners, principal will be due and payable
in 32 equal installments. The installments of principal will be due and payable
commencing on November 1, 2005 and subsequent installments will be due and
payable on the first day of each calendar month thereafter until the outstanding
principal balance is paid in full or the $20 million convertible debenture is
converted in full. Interest on the outstanding principal balance will accrue as
of June 23, 2005 and be due and payable monthly, in arrears, commencing on
November 1, 2005, and will continue to be payable on the first day of each
calendar month thereafter that any amounts under the convertible debenture
remain payable. In lieu of making an interest payment in cash we may elect to
make interest payments in shares of our common stock, the value of which would
be the closing bid price of our common stock on the date the interest payment is
due. Upon any full conversion by Cornell Capital Partners of all of the
principal and interest due under the convertible debenture, all of our payment
obligations will terminate.
With respect to the $8 million convertible debenture issued to Cornell
Capital Partners, as trustee for LCC Global Limited, and the $2 million
convertible debenture issued to Highgate House Funds, as trustee for LCC Global
Limited, principal will be due and payable in five equal installments. The
installments of principal will be due and payable commencing on June 23, 2006
and subsequent installments will be due and payable every six months on the 23rd
day of the calendar month until the outstanding principal balance is paid in
full or the convertible debentures are converted in full. Interest on the
outstanding principal balance will be due and payable monthly, in arrears,
commencing on July 23, 2005, and will continue to be payable on the first day of
each calendar month thereafter that any amounts under the convertible debentures
remain payable. In lieu of making an interest payment in cash we may elect to
make interest payments in shares of our common stock, the value of which would
be the closing bid price of our common stock on the date the interest payment is
due. Upon any full conversion by Cornell Capital Partners or Highgate House
Funds, as applicable, of all of the principal and interest due under the
respective convertible debenture, all of our payment obligations will terminate
with respect to such convertible debenture.
Conversion Provisions; Conversion Price and Adjustments. The remaining
principal under the convertible debentures may be converted by Cornell Capital
Partners or Highgate House Funds, as applicable, in whole or in part and from
time to time into shares of our common stock at a conversion price of $0.1125
per share, subject to adjustment as described below.
78
In the event of any issuances of shares of common stock or rights,
options, warrants or securities convertible or exercisable into common stock at
a price per share of common stock less than the conversion price of the
convertible debentures, the conversion price of such convertible debentures will
be reduced to the lower purchase price. In addition, the conversion price of the
convertible debentures will be subject to adjustment in connection with any
subdivision, stock split, combination of shares or recapitalization. No
adjustment will be made as a result of issuances and exercises of options to
purchase shares of common stock issued for compensatory purposes pursuant to any
of our stock option or stock purchase plans.
Events of Default. The 10% convertible debentures provide for various
events of default that would entitle the holders to require us to immediately
repay 100% of the outstanding principal amount, plus accrued and unpaid
interest, in cash, or shares of our common stock with a conversion price reduced
to 20% of the volume weighted average price of our shares of common stock on
June 30, 2005. 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 10% convertible debentures if
any of the following events, among others, occurs:
o we fail to pay any amount due under a convertible debenture and
such failure to pay remains uncured for 10 days;
o we fail to observe or perform any other covenant, agreement or
warranty contained in, or otherwise commit any breach or default
of any provision of the 10% convertible debentures;
o we or any of our subsidiaries become bankrupt or insolvent;
o we breach any of our obligations under any other debt or credit
agreements involving an amount exceeding $250,000;
o 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 20 trading days;
o we or any subsidiary experiences a change of control;
o we fail to file a registration statement with the SEC or such
registration statement is not declared effective by the SEC within
120 days after filing;
o if the effectiveness of the registration statement lapses for any
reason or the holder of the convertible debentures is not be
permitted to resell the underlying shares of common stock, in
either case, for more than five trading days or an aggregate of
eight trading days;
o we fail to deliver common stock certificates to a holder prior to
the fifth trading day after a conversion date or we fail to
provide notice to a holder of our intention not to comply with
requests for conversions of the convertible debentures; or
o we fail to deliver the payment in cash pursuant to a "buy-in"
within three days after notice is claimed delivered.
Limitation on Beneficial Ownership. The convertible debentures
contain a contractual restriction on beneficial share ownership. They provide
that neither Cornell Capital Partners nor Highgate House Funds may convert the
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 either Cornell Capital Partners or Highgate House Funds,
together with their respective affiliates, beneficially owning in excess of 4.9%
of our then issued and outstanding shares of common stock.
79
Fees. We paid to Cornell Capital Partners a cash fee of $3
million, and a cash structuring fee of $50,000 to Yorkville Advisors Management,
in connection with the Securities Purchase Agreement out of the purchase price
paid by Cornell Capital Partners for the convertible debentures.
Registration Rights. In connection with the execution of the Securities
Purchase Agreement, on June 23, 2005, we entered into a Registration Rights
Agreement with Cornell Capital Partners and Highgate House Funds pursuant to
which we agreed to prepare and file, no later than 60 days after the date of the
Registration Rights Agreement, with the SEC a registration statement on Form S-1
or SB-2 (or, if we are then eligible, on Form S-3) under the Securities Act of
1933, as amended, for the resale by the investors of 266,666,666 shares of our
common stock to be issued upon conversion of the convertible debentures and 62.5
million shares of our common stock to be issued upon exercise of the investors'
warrants.
Warrants
Warrants Issued to Holders of 10% Convertible Debentures. Under the
Securities Purchase Agreement, dated June 23, 2005, we issued (i) to Cornell
Capital Partners, as trustee for LCC Global Limited, two five-year warrants to
purchase an aggregate of 58,337,500 shares of our common stock, at an exercise
price of $0.16 per share and (ii) to Highgate House Funds, as trustee for LCC
Global Limited, a five-year warrant to purchase 4,162,500 shares of our common
stock, at an exercise price of $0.16 per share. Neither Cornell Capital Partners
nor Highgate House Funds will be entitled to exercise the warrants for a number
of shares of our common stock if such exercise would cause the aggregate number
of shares of our common stock beneficially owned by Cornell Capital Partners or
Highgate House Funds, as applicable, and their respective affiliates to exceed
4.99% of the outstanding shares of our common stock following such exercise,
except within 60 days of the expiration date of the warrants. The exercise price
is subject to certain anti-dilution protections as set forth in the respective
warrants.
In connection with the execution of the Securities Purchase Agreement,
on June 23, 2005, we entered into a Registration Rights Agreement with Cornell
Capital Partners and Highgate House Funds pursuant to which we agreed to prepare
and file, no later than 60 days after the date of the Registration Rights
Agreement, with the SEC a registration statement on Form S-1 or SB-2 (or, if we
are then eligible, on Form S-3) under the Securities Act of 1933, as amended,
for the resale by the investors of 266,666,666 shares of our common stock to be
issued upon conversion of the convertible debentures and 62,500,000 shares of
our common stock to be issued upon exercise of the investors' warrants.
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 our 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.
$160 Million Standby Equity Distribution Agreement
On June 23, 2005, we entered into a Standby Equity Distribution
Agreement with Cornell Capital Partners, L.P. 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 and replaces our previous $30 million Standby Equity
Distribution Agreement, which was terminated by the parties on June 23, 2005.
In general, the draw down facility operates like this: Cornell Capital
Partners committed to provide us up to $160 million as we request it over a
24-month period (or a five-year period if we file either an amendment to the
then effective registration statement or a new registration statement is
declared effective after the 24th and 48th month after June 23, 2005), in return
for common stock that we will issue to Cornell Capital Partners. 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 75,188 shares of our common stock. As of July 6,
2005 we have $160 million available under this facility. We may request an
advance every seven trading days. The amount of each advance is subject to a
maximum amount of $3 million every seven trading days. A closing will be held
six trading days after such written notice at which time we will deliver shares
of common stock and Cornell Capital Partners will pay 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 other principal market on which our common stock is traded for
the five days immediately following the notice date.
80
We paid to Cornell Capital Partners a cash fee of $16 million in
connection with the Standby Equity Distribution Agreement, and Cornell Capital
Partners 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 SEC. We may request advances under the equity line of credit once the
underlying shares are registered with the Securities and Exchange Commission. We
may continue to request advances until Cornell Capital Partners has advanced
$160 million or two years (or 5 years if we file either an amendment to the then
effective registration statement or a new registration statement is declared
effective after the 24th and 48th month after June 23, 2005) after the effective
date of the accompanying registration statement, whichever occurs first.
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 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 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
1,000,000,000 shares of common stock in order to raise the maximum amount under
the equity line of credit at a net purchase price of $0.16.
The issuance of shares under the equity line of credit may result in a
change of control. That is, up to 1 billion 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 sold the shares
purchased under the equity line of credit to the same purchaser.
We are under no obligation to request a draw down during any period. In
determining whether we will request a draw down, our management intends to
primarily take into account our working capital requirements, and whether we
have access to other sources of working capital. As described above under the
heading "Risk Factors - Standby Equity Distribution Agreement," 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 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 April 30, 2006 range from $4.3 million to $11.7 million as
of April 30, 2005.
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.
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The amount of the discount that Cornell Capital Partners is entitled to
receive under our Standby Equity Distribution Agreement was determined in arms
length negotiations between us and Cornell Capital Partners. In considering its
acceptability, we 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 a selling stockholder in connection with the draw
down, and the lack of alternative sources of similar financing at the time of
the negotiations.
Necessary Conditions Before Cornell Capital Partners Is Obligated to
Purchase Our Shares. The following conditions must be satisfied before Cornell
Capital Partners 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 Cornell Capital Partners:
o a registration statement for the shares must be declared effective
by the SEC and must remain effective and available as of the draw
down settlement date for making resales of the common shares
purchased by Cornell Capital Partners;
o 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;
o 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;
o trading in our common stock must not have been suspended by the
SEC or by the regulators of the principal market for our common
stock (currently the OTC Bulletin Board); and
o 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.
Limitation on Issuance of Common Stock. During the commitment period,
subject to certain exceptions for issuances resulting from prior commitments, we
cannot, without the prior consent of Cornell Capital Partners:
o issue or sell any common stock or preferred stock with or without
consideration;
o issue or sell any preferred stock, warrant, option, right,
contract, call, or other security or instrument granting the
holder thereof the right to acquire common stock with or without
consideration,
o enter into any security instrument granting the holder a security
interest in any of our assets; or
o file any registration statements on Form S-8.
Provided we give Cornell Capital Partners two days prior written notice, the
foregoing restrictions will exclude options, warrants or other securities
convertible or exchangeable into shares of our common stock that were
outstanding prior to June 23, 2005.
Indemnification of Cornell Capital Partners. Cornell Capital Partners,
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 Cornell Capital
Partners to us for inclusion in the registration statement and prospectus.
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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.
Market Information
Our common stock is quoted on the OTC Bulletin Board under the trading
symbol "SMTR". The high and low bid prices for our common stock at the close of
business on June 30, 2005, as reported by the OTC Bulletin Board, were $0.147
and $0.136 per share, respectively.
Transfer Agent
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.
Indemnification Provisions
Bylaw. Under our Bylaw, subject to the Business Corporations Act (Yukon
Territory) and subject to court approval in certain circumstances, we must
indemnify:
o each of our current or former directors and officers;
o 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
o 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.
Business Corporations Act (Yukon Territory). 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 defense 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 (i) was substantially successful on the merits in his or
her defense of the action or proceeding, (ii) is fairly and reasonably entitled
to indemnity, (iii) acted honestly and in good faith with a view to the best
interests of our company and (iv) 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.
Securities Act. 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 SEC such indemnification is against public
policy as expressed in the Securities Act and is therefore unenforceable.
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LEGAL MATTERS
The validity of the shares of common stock offered by the selling
stockholders will be passed upon for us by our counsel, Greenberg Traurig, LLP,
New York, New York.
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 included herein in reliance
upon the report of KPMG LLP, independent registered public accounting firm,
appearing elsewhere herein, and upon the authority of said 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.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE
We have had no disagreements on any matter of accounting principles or
practices, financial statement disclosure, or auditing scope or procedures with
any of our accountants for the year ended July 31, 2004. We have not had any
changes in nor have we had any disagreements, whether or not resolved, with our
accountants on accounting and financial disclosures during our two recent fiscal
years or any later interim period.
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SMARTIRE SYSTEMS INC.
INDEX TO CONSOLIDATED 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:
Consolidated Balance Sheets at January 31, 2005 (Unaudited) and
Year Ended July 31, 2004 F-1
Consolidated Statements of Operations (Unaudited) - Three and
Nine Months Ended April 30, 2005 and 2004 F-2
Consolidated Statements of Stockholders' Equity and Comprehensive
Loss - Nine Months Ended April 30, 2005 (Unaudited) and Year
Ended July 31, 2004 F-3
Consolidated Statements of Cash Flows (Unaudited) - Three and
Nine Months Ended April 30, 2005 and 2004 F-4
Notes to Consolidated Financial Statements (Unaudited) - Nine
Months Ended April 30, 2005 and 2004 F-6
Auditors' Report including comments for U.S. readers on
Canada-U.S. reporting differences F-21
Consolidated Balance Sheets at July 31, 2004 and July 31, 2003 F-22
Consolidated Statements of Operations - Years Ended July 31,
2004, July 31, 2003 and July 31, 2002 F-23
Consolidated Statements of Stockholders' Equity and
Comprehensive Income (Loss) - Years Ended July 31, 2004, F-24
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-26
Notes to Consolidated Statements - Years Ended July 31, 2004,
July 31, 2003 and July 31, 2002 F-27
SMARTIRE SYSTEMS INC.
Consolidated Balance Sheets
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)
===========================================================================================================================
April 30, July 31,
2005 2004
- ---------------------------------------------------------------------------------------------------------------------------
(Unaudited)
Assets
Current assets:
Cash and cash equivalents $ 420,270 $ 112,951
Receivables, net of allowance for doubtful accounts
of nil (2004 - nil) 245,617 259,508
Inventory 3,285,197 3,245,807
Prepaid expenses 192,190 189,477
- ---------------------------------------------------------------------------------------------------------------------------
4,143,274 3,807,743
Capital assets 721,745 824,616
Deferred financing costs - 157,020
Other assets (note 5) 1,347,765 2,147,749
- ---------------------------------------------------------------------------------------------------------------------------
$ 6,212,784 $ 6,937,128
===========================================================================================================================
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable and accrued liabilities $ 839,030 $ 1,293,251
Deferred revenue 11,389 10,830
Promissory notes payable (note 6) -- 1,500,000
Current portion of convertible debt 1,189,615 271,257
- ---------------------------------------------------------------------------------------------------------------------------
2,040,034 3,075,338
Convertible debt, net of equity portion of $457,998
(July 31, 2004 - $1,955,356) (note 7) 195,001 395,574
Preferred shares, net of equity portion of $3,999,999, 1 --
subject to mandatory redemption (note 8)
Stockholders' equity:
Share capital (note 9):
Preferred shares, par value $1,000 Cdn per share:
100,000 shares authorized
Issued and outstanding: 25,000 series A
Common shares, without par value:
Unlimited shares authorized
255,798,467 shares issued and outstanding at
April 30, 2005 (July 31, 2004 - 103,130,761) 65,627,789 58,368,020
Additional paid-in capital 11,036,386 4,417,323
Deficit (72,634,863) (59,018,256)
Accumulated other comprehensive loss (51,564) (300,871)
- ---------------------------------------------------------------------------------------------------------------------------
3,977,748 3,466,216
- ---------------------------------------------------------------------------------------------------------------------------
$ 6,212,784 $ 6,937,128
===========================================================================================================================
Going concern (note 3)
Subsequent events (note 12)
Contingencies (note 13)
See accompanying notes to financial statements. Approved on behalf of the Board:
"Robert V. Rudman" Director "Bill Cronin" Director
- ------------------- ---------------
F-1
SMARTIRE SYSTEMS INC.
Consolidated Statements of Operations
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)
(Unaudited)
===========================================================================================================================
Three months ended Nine months ended
-------------------------- -------------------------
===========================================================================================================================
April 30, April 30, April 30, April 30,
2005 2004 2005 2004
- ---------------------------------------------------------------------------------------------------------------------------
Revenue $ 330,406 $ 401,423 $ 1,022,484 $ 1,259,140
Cost of goods sold (including in the
nine months ended April 30, 2005
inventory write-down of $230,000) 255,980 287,373 966,235 1,034,523
- ---------------------------------------------------------------------------------------------------------------------------
74,426 114,050 56,249 224,617
Expenses:
Depreciation and amortization 376,477 356,420 1,116,897 1,030,910
Engineering, research and
development 2,086,354 454,715 3,083,704 1,201,634
General and administrative 3,170,568 560,871 4,550,610 1,841,877
Marketing 1,368,330 468,312 2,275,843 1,329,636
- ---------------------------------------------------------------------------------------------------------------------------
7,001,729 1,840,318 11,027,054 5,404,057
- ---------------------------------------------------------------------------------------------------------------------------
Loss from operations (6,927,303) (1,726,268) (10,970,805) (5,179,440)
Other earnings (expenses):
Interest income 1,382 849 3,173 5,416
Net interest and financing
expense (188,491) (1,214,435) (2,763,609) (2,960,488)
Foreign exchange gain (loss) (14,355) (10,405) 114,634 15,931
Gain on settlement of convertible
debt (note 7(a)) 1,822,033 -- 1,822,033 --
- ---------------------------------------------------------------------------------------------------------------------------
1,620,569 (1,223,991) (823,769) (2,939,141)
- ---------------------------------------------------------------------------------------------------------------------------
Loss for the period $ (5,306,734) $ (2,950,259) $ (11,794,574) $ (8,118,581)
===========================================================================================================================
Basic and diluted loss per share $ (0.03) $ (0.04) $ (0.07) $ (0.10)
Weighted average number of common
shares used in the computation of
basic and diluted loss per share 238,545,317 80,450,524 205,742,511 77,461,046
===========================================================================================================================
See accompanying notes to consolidated financial statements.
F-2
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
Nine months ended April 30, 2005 (unaudited) and year ended July 31, 2004
(audited)
====================================================================================================================================
Common shares Additional
------------------------- paid-in
Shares Amount capital Deficit
$ $ $
- ------------------------------------------------------------------------------------------------------------------------------------
Balance at July 31, 2003 55,039,065 48,204,995 6,681,893 (48,031,230)
Exercise of stock options for cash 79,400 15,880 -- --
Intrinsic value of beneficial conversion feature of
convertible debentures plus fair value
of warrants issued -- -- 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) --
Exercise of warrants for cash, net of issuance
costs of $78,370 12,463,231 3,702,985 (1,601,970) --
Issuance of shares and warrants as fees for
services received 200,000 34,800 63,375 --
Fair value of agent's warrants issued on private
placement of convertible debentures -- -- 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) --
Shares issued upon draw downs on equity line of
credit, net of issuance cost of $60,601 10,861,220 689,399 -- --
Loss for the period -- -- -- (10,987,026)
Translation adjustment -- -- -- --
- ------------------------------------------------------------------------------------------------------------------------------------
Balance at July 31, 2004 103,130,761 58,368,020 4,417,323 (59,018,256)
====================================================================================================================================
Exercise of stock options for cash (note 9(c)) 5,127,048 794,692 (640,881) --
Conversion of convertible debentures and accrued
interest to common shares allocated pro-rata between
additional paid-in-capital and common shares (note 7) 37,883,920 1,615,292 (505,528) --
Intrinsic value of beneficial conversion feature of
convertible debt (note 7) -- -- 1,188,845 --
Settlement of convertible debt (note 7(a)) -- -- (677,966) (1,822,033)
Intrinsic value of beneficial conversion feature of
preferred shares (note 8) -- -- 3,999,999 --
Financing cost related to preferred shares (note 8) -- -- (177,325) --
Exercise of warrants for cash, net of issuance costs of
$46,872 (note 9(a)(ii)) 18,226,274 1,517,215 (1,017,299) --
Exercise of warrants on a cashless basis (note 9(a)) 6,789,809 654,216 (654,216) --
Shares issued upon draw downs on equity line, net of
issuance cost of $219,234 (note 9(a)(i)) 78,887,710 2,505,766 78,484 --
Shares issued as compensation for services (note 9(b)) 5,752,945 172,588 -- --
Compensation expense (note 4) -- -- 5,024,950 --
Loss for the period -- -- -- (11,794,574)
Translation adjustment -- -- -- --
- ------------------------------------------------------------------------------------------------------------------------------------
Balance at April 30, 2005 255,798,467 65,627,789 11,036,386 (72,634,863)
====================================================================================================================================
================================================================================================================
Accum. other
comprehensive Stockholders' Comprehensive
loss equity income (loss)
$ $ $
- ----------------------------------------------------------------------------------------------------------------
Balance at July 31, 2003 (568,354) 6,287,304 (9,505,692)
Exercise of stock options for cash -- 15,880 --
Intrinsic value of beneficial conversion feature of
convertible debentures plus fair value
of warrants issued -- 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 -- 2,556,684 --
Exercise of warrants for cash, net of issuance
costs of $78,370 -- 2,101,015 --
Issuance of shares and warrants as fees for
services received -- 98,175 --
Fair value of agent's warrants issued on private
placement of convertible debentures -- 15,699 --
Issuance of shares as fees on equity line of credit -- -- --
Cash cost incurred for equity line -- (35,420) --
Shares issued upon draw downs on equity line of
credit, net of issuance cost of $60,601 -- 689,399 --
Loss for the period -- (10,987,026) (10,987,026)
Translation adjustment 267,483 267,483 267,483
- ----------------------------------------------------------------------------------------------------------------
Balance at July 31, 2004 (300,871) 3,466,216 (10,719,543)
================================================================================================================
Exercise of stock options for cash (note 9(c)) -- 153,811 --
Conversion of convertible debentures and accrued
interest to common shares allocated pro-rata between
additional paid-in-capital and common shares (note 7) -- 1,109,764 --
Intrinsic value of beneficial conversion feature of
convertible debt (note 7) -- 1,188,845 --
Settlement of convertible debt (note 7(a)) -- (2,499,999) --
Intrinsic value of beneficial conversion feature of
preferred shares (note 8) -- 3,999,999 --
Financing cost related to preferred shares (note 8) -- (177,325) --
Exercise of warrants for cash, net of issuance costs of
$46,872 (note 9(a)(ii)) -- 499,916 --
Exercise of warrants on a cashless basis (note 9(a)) -- -- --
Shares issued upon draw downs on equity line, net of
issuance cost of $219,234 (note 9(a)(i)) -- 2,584,250 --
Shares issued as compensation for services (note 9(b)) -- 172,588 --
Compensation expense (note 4) -- 5,024,950 --
Loss for the period -- (11,794,574) (11,794,574)
Translation adjustment 249,307 249,307 249,307
- ----------------------------------------------------------------------------------------------------------
Balance at April 30, 2005 (51,564) 3,977,748 (11,545,267)
==========================================================================================================
See accompanying notes to consolidated financial statements.
F-3
SMARTIRE SYSTEMS INC.
Consolidated Statements of Cash Flows
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)
=================================================================================================================================
Three months ended Nine months ended
------------------ -----------------
April 30, April 30, April 30, April 30,
2005 2004 2005 2004
- ---------------------------------------------------------------------------------------------------------------------------------
Cash provided by (used for):
Operating activities:
Loss for the period $ (5,306,734) $ (2,950,259) $ (11,794,574) $ (8,118,581)
Items not affecting cash:
Depreciation and amortization 376,477 356,420 1,116,897 1,030,910
Stock-compensation expense 5,024,950 -- 5,197,538 --
Non-cash interest, penalties and finance charges 144,866 1,111,447 2,607,518 2,770,483
Inventory write-down -- -- 200,000 --
Issuance of shares and warrants for services -- -- - 82,838
received
Gain on settlement of convertible debt (note 7 (1,822,033) -- (1,822,033) --
(a))
Change in non-cash working capital:
Receivables 28,024 163,076 25,969 86,722
Deferred revenue -- 14,703 -- 15,415
Inventory 98,158 (235,644) (38,681) (1,991,079)
Prepaid expenses 75,205 (92,081) 8,891 (138,511)
Accounts payable and accrued liabilities 54,256 138,090 (528,362) 135,752
- ---------------------------------------------------------------------------------------------------------------------------------
Net cash used in operating activities (1,326,831) (1,494,248) (5,026,837) (6,126,051)
Investing activities:
Purchase of capital assets (3,408) (206,138) (28,918) (441,619)
Financing activities:
Cash received on exercise of stock options 153,811 -- 153,811 15,880
Cash received on exercise of warrants (note 9(a)) -- 52,000 546,788 2,059,385
Proceeds from equity line of credit (note 9 (a)) -- -- 2,725,000 --
Proceeds from convertible debt (note 7) 457,999 -- 3,152,999 2,725,000
Proceeds from preferred shares (note 8) 4,000,000 -- 4,000,000 --
Proceeds from promissory notes (note 6) 350,000 750,000 875,000 750,000
Repayment of convertible debentures (2,957,999) (14,583) (2,957,999) (14,583)
Financing costs (180,000) (27,900) (695,478) (437,696)
Repayment of promissory notes (note 6) (350,000) -- (2,375,000) --
- ---------------------------------------------------------------------------------------------------------------------------------
Net cash used in financing activities 1,473,811 759,517 5,425,121 5,097,986
Effect of exchange rate differences on cash and cash 29,038 (140,717) (62,047) (88,406)
equivalents
- ---------------------------------------------------------------------------------------------------------------------------------
Increase (decrease) in cash and cash equivalents 172,610 (1,081,586) 307,319 (1,558,090)
Cash and cash equivalents beginning of period 247,660 1,367,190 112,951 1,843,694
- ---------------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents, end of period $ 420,270 $ 285,604 $ 420,270 $ 285,604
=================================================================================================================================
F-4
SMARTIRE SYSTEMS INC.
Consolidated Statements of Cash Flows (Continued)
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)
=================================================================================================================================
Three months ended Nine months ended
------------------ -----------------
April 30, April 30, April 30, April 30,
2005 2004 2005 2004
- ---------------------------------------------------------------------------------------------------------------------------------
Supplementary information:
Interest and finance charges paid $ 59,761 $ 114,007 $ 156,091 $190,005
Non-cash investing and financing activities:
Conversion of convertible debentures to common shares 245,444 528,182 1,102,832 2,084,485
Fair value of agents warrants issued in conjunction
with private placements -- -- -- 15,699
Financing costs included in accounts payable -- 45,000 -- 45,000
Shares issued for services -- -- 172,588 --
=================================================================================================================================
See accompanying notes to consolidated financial statements.
F-5
SMARTIRE SYSTEMS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
(Unaudited)
(Prepared in accordance with U.S. generally accepted accounting principles)
Nine months ended April 30, 2005 and 2004
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 included in the Company's
annual report on Form 10-KSB 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 for the automotive
and transportation industries. The Company's primary product is a wireless
tire monitoring system which it currently markets for use on passenger
vehicles, motorcycles, recreational, commercial and industrial vehicles.
All sales of its product are made in these industry segments.
3. Going concern:
The Company requires additional financing to fund its operations. The
Company has incurred recurring operating losses and has a deficit of
$72,634,863 and working capital of $2,103,240 as at April 30, 2005. During
the nine months ended April 30, 2005, the Company used cash of $5,055,755
in operating and investing activities.
The Company is pursuing various alternatives to meet its immediate and
long-term financial requirements. During the nine months ended April 30,
2005, the Company realized net cash proceeds of $5,425,121 from financing
activities to fund its operations. The Company also has an undrawn equity
line of credit of $11,525,000 as at April 30, 2005 to fund future
operations. Subsequent to the period end this equity line was replaced by a
$30 million equity line of credit (note 12(a)). 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.
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. 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.
F-6
SMARTIRE SYSTEMS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
(Unaudited)
(Prepared in accordance with U.S. generally accepted accounting principles)
Nine months ended April 30, 2005 and 2004
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:
===========================================================================================================================
Three months ended Nine months ended
------------------------------- ------------------------------
April 30, April 30, April 30, April 30,
2005 2004 2005 2004
- ---------------------------------------------------------------------------------------------------------------------------
Net loss:
As reported $ (5,306,734) $ (2,950,259) $(11,794,574) $ (8,118,581)
Stock-based compensation
expense (recovery) recognized
using intrinsic value method
(variable award) 5,024,950 -- 5,024,950 --
Stock-based compensation
expense determined under fair
value based method for
all awards (4,507) 111,910 (1,087,519) (1,264,063)
- ---------------------------------------------------------------------------------------------------------------------------
Pro forma $ (286,291) $ (2,838,349) $ (7,857,143) $ (9,382,644)
===========================================================================================================================
Basic and diluted loss per share:
As reported $ (0.03) $ (0.04) $ (0.07) $ (0.10)
Pro forma (0.01) (0.04) (0.05) (0.12)
===========================================================================================================================
The Company recognizes compensation expense on a straight-line basis over
the vesting period beginning on the date the stock option is granted.
F-7
SMARTIRE SYSTEMS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
(Unaudited)
(Prepared in accordance with U.S. generally accepted accounting principles)
Nine months ended April 30, 2005 and 2004
4. Significant accounting policy (continued):
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.
===========================================================================================================================
April 30, April 30,
2005 2004
- ---------------------------------------------------------------------------------------------------------------------------
Expected dividend yield 0% 0%
Expected stock price volatility 140% 135%
Risk-free interest rate 3.74% 4.13%
Expected life of options and warrants 5 Years 2 Years
===========================================================================================================================
Weighted-average fair values of options granted during the period are as
follows:
===========================================================================================================================
April 30, April 30,
2005 2004
- ---------------------------------------------------------------------------------------------------------------------------
Options whose exercise price at date of grant:
Equals the market price of stock $ 0.03 $ --
Exceeds the market price of stock 0.02 0.16
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.
F-8
SMARTIRE SYSTEMS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
(Unaudited)
(Prepared in accordance with U.S. generally accepted accounting principles)
Nine months ended April 30, 2005 and 2004
5. Other assets:
The rights are being amortized over five years on a straight-line basis.
===========================================================================================================================
Accumulated Net book
April 30, 2005 Cost amortization value
- ---------------------------------------------------------------------------------------------------------------------------
OEM - most medium and heavy duty
trucks $ 1,737,500 $ 1,473,491 $ 264,009
OEM - all other vehicles 3,300,000 2,216,244 1,083,756
- ---------------------------------------------------------------------------------------------------------------------------
$ 5,037,500 $ 3,689,735 $ 1,347,765
===========================================================================================================================
Management believes that the net book value of its other assets of
$1,347,765 as at April 30, 2005 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:
(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 bore
interest at a rate of 12% per annum and was 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 bore interest at a rate of 12% per annum
and was repaid on December 30, 2004. As a commitment fee, the holder of
the note received $27,500.
(c) On February 9, 2005, the Company received gross proceeds of $350,000
upon the issuance of an unsecured short-term promissory note to an
accredited investor. The note bore interest at a rate of 10% per annum
and was repaid on March 16, 2005. As a commitment fee, the holder of
the note received $35,000.
(d) During the nine months ended April 30, 2005, the Company repaid
$2,375,000 of principal and $61,462 in interest on its promissory
notes.
F-9
SMARTIRE SYSTEMS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
(Unaudited)
(Prepared in accordance with U.S. generally accepted accounting principles)
Nine months ended April 30, 2005 and 2004
7. Convertible debt:
===========================================================================================================================
Balance to
Redemption Debt be accreted
value 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
Issuance of 5% convertible debenture with
cash finance cost of $ 323,239 (note a) 2,695,000 1,964,153 730,847
Accretion of deemed debt to interest
expense (note d) -- 2,008,237 (2,008,237)
Penalties and premiums accrued for
default on convertible debentures (note d) 128,259 128,259 --
Conversion of $60,000 of 8% and $1,042,832
discounted convertible debentures to
common shares (note b) (1,102,832) (1,102,832) --
Cash payment on discounted convertible
debentures (note b) (381,666) (381,666) --
Premiums paid on repayment of discounted
convertible debentures (note b) (76,333) (76,333) --
Repayment of 5% convertible debentures
(note a) (2,500,000) (1,822,034) (677,966)
Issuance of 5% convertible debenture (note c) 457,999 1 457,998
- ---------------------------------------------------------------------------------------------------------------------------
Balance as at April 30, 2005 1,842,614 1,384,616 457,998
Current portion of convertible debt 1,189,615 1,189,615 --
- ---------------------------------------------------------------------------------------------------------------------------
$ 652,999 $ 195,001 $ 457,998
===========================================================================================================================
F-10
SMARTIRE SYSTEMS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
(Unaudited)
(Prepared in accordance with U.S. generally accepted accounting principles)
Nine months ended April 30, 2005 and 2004
7. Convertible debt (continued):
At April 30, 2005, $215,000 of the 8% convertible debentures issued on July
17, 2003, $974,615 of the convertible debentures issued at a 22% original
discount from the face principal amount on December 24, 2004 and principal
of $195,000 and $457,999 of the two 5% convertible debentures were
outstanding.
(a) On December 15, 2004, the Company closed two private placements of 5%
convertible debentures for gross proceeds of $2,695,000 and net cash
proceeds of $2,394,644. Advisors to the transactions received cash
commissions of $279,250. Additional expenses related to these offerings
were $21,106. The financing cost was recorded as deferred financing
cost and was amortized over the lesser of the life of the convertible
debentures or the date of redemption or conversion into common shares.
Principal under convertible debentures was convertible at the option of
the holder as per the terms of the agreement.
The Company also had the right to redeem the convertible debentures, in
whole or in part, at 120% of the face value of each convertible
debenture and the investor to receive 50,000 redemption warrants for
every $100,000 redeemed.
For accounting purposes the Company calculated the intrinsic value of
the beneficial conversion feature amounting to $730,847 and recorded it
as additional paid-in capital. The remaining value of $1,964,153 is
recorded as a liability and accreted to its face value of $2,695,000
over the maturity period.
The $2,500,000 convertible debenture was due and payable at maturity on
December 15, 2007.
Interest on the remaining outstanding principal under the convertible
debentures that aggregate $195,000 is payable semi-annually beginning
June 15, 2005 and every subsequent six month period that the principal
balance remains unpaid. The maturity date for these convertible
debentures is December 15, 2006.
On March 22, 2005, the Company settled the $2,500,000 convertible debt.
For accounting purposes, the consideration paid was allocated between
equity and liability components based on the intrinsic value of the
beneficial conversion option as equity and the remaining amount as
liability at the date of transaction. The difference between the
carrying value of liability and equity components and fair value of the
consideration paid was charged to income and deficit respectively. This
resulted in a gain on settlement of $1,822,003 being recorded in
statement of operations and a charge to deficit of the same amount.
F-11
SMARTIRE SYSTEMS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
(Unaudited)
(Prepared in accordance with U.S. generally accepted accounting principles)
Nine months ended April 30, 2005 and 2004
7. Convertible debt (continued):
(b) 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 $734,388 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. In addition, the holders of
$308,444 of discounted debentures and $60,000 of 8% debentures
converted these debentures to common shares.
On April 27, 2005, the Company entered into a redemption, release and
settlement agreement with two holders of the Company's discounted
convertible debentures. Pursuant to such redemption, the Company made
cash payments of $457,999. This payment included a 20% premium
amounting to $76,333.
(c) On May 20, 2005, the Company finalized the agreement to issue a
$1,500,000 one year 5% debenture convertible at the option of the
holder at $0.028 per share and matures on May 20, 2006. Between April
25 and April 29, 2005, funds for $1,100,000 of the convertible
debenture were placed in escrow with the Company's legal council. From
escrow, $457,999 was paid on April 27, 2005 to two debenture holders to
redeem their convertible debentures and is recorded as an issuance of
new debt. For accounting purposes, the Company calculated the intrinsic
value of the beneficial conversion feature amounting to $457,998 and
recorded it as additional paid-in capital. The remaining value of $1 is
recorded as a liability and accreted to its face value of $457,999 over
the maturity period.
(d) The Company was in violation of all convertible debenture agreements at
January 31, 2005 and at April 30, 2005 with the exception of new 5%
convertible debentures issued in April 2005 as a registration statement
was not filed with the Securities and Exchange Commission on the date
specified in the agreements. As a result of this violation, the Company
accreted interest to adjust the carrying value of the convertible
debentures to their redemption value. The Company also accrued
penalties and premiums of $128,259.
On April 21, 2005, a holder of discounted debentures in the amount of
$91,726 filed a legal claim against the Company demanding a conversion
of debenture into common shares at $0.01 per share (note 13).
F-12
SMARTIRE SYSTEMS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
(Unaudited)
(Prepared in accordance with U.S. generally accepted accounting principles)
Nine months ended April 30, 2005 and 2004
8. Preferred shares subject to mandatory redemption:
On March 22, 2005, the Company closed a private placement of 5% convertible
Class A preferred shares for gross proceeds of $4,000,000 and net cash
proceeds of $3,865,000. Advisors to the transactions received cash
commission of $115,000. Additional expenses related to this offering were
$20,000. Proceeds of $2,850,000 from this financing were used to settle
$2,500,000 convertible debenture entered into on December 15, 2004 and
$350,000 promissory note entered into on February 9, 2004.
Principal under convertible preferred shares may be converted into common
shares by the holder in whole or in part from time to time at a conversion
price of $0.01. Upon providing 3 business days advance written notice to
holders, during which time the holder may elect to convert up to all of
their convertible preferred stock, the Company may redeem up to 80% of the
convertible preferred stock, in whole or in part, at 120% of the face
value. The $4,000,000 convertible preferred stock is due and payable at
maturity on December 22, 2006.
While the legal form of this financial instrument is that of preferred
shares, due to the mandatory redemption on December 22, 2006, the substance
of the instrument is that of a financial liability. For accounting
purposes, these shares are considered to have both a debt and equity
component. The equity component is related to the intrinsic value of the
beneficial conversion feature at the issuance of the instrument and it
equaled $3,999,999. The equity component value is recorded as additional
paid-in capital. The remaining value of $1 is recorded as a liability. The
carrying value of the liability portion is being accreted to its retraction
value of $4,000,000, over a period from the date of issuance to its
maturity date of December 22, 2006. Total financing costs of $135,000 is
charged to additional paid-in capital as substantially all the value of
preferred shares is treated as equity.
As at April 30, 2005, the Company was in violation of preferred share
agreements as a registration statement was not filed with the Securities
and Exchange Commission on the date specified in the agreement. The Company
has received an extension from the preferred shareholders to file a
registration statement by June 30, 2005 and has received a waiver for any
penalties. If the registration statement is not filed by the Company by
this date, the entire amount of $3,999,999 will be accreted to the income
statement as an interest charge.
F-13
SMARTIRE SYSTEMS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
(Unaudited)
(Prepared in accordance with U.S. generally accepted accounting principles)
Nine months ended April 30, 2005 and 2004
9. Share capital:
(a) During the nine months ended April 30, 2005, 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.
(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. The fair value of these warrants of $1,017,299 initially
recorded as additional paid-in-capital is reclassified to share
capital on exercise of warrants.
(b) On January 19, 2005 the Company issued 5,752,945 shares of common stock
to certain members of senior management of the Company for services
rendered. The fair value of the shares at the date of issuance was
$0.03 per share of $172,588.
(c) A summary of stock option transactions and balances during the period
ended April 30, 2005 is as follows:
===========================================================================================================================
Weighted
average
Options exercise
outstanding price
- ---------------------------------------------------------------------------------------------------------------------------
Balance at July 31, 2004 8,469,800 $ 0.63
Options granted 40,320,000 0.03
Options exercised (5,127,048) 0.03
Options forfeited (920,000) 0.93
- ---------------------------------------------------------------------------------------------------------------------------
Balance at April 30, 2005 42,742,752 $ 0.13
===========================================================================================================================
All options outstanding, with the exception of 200,000 options, as at
April 30, 2005 are fully vested.
Stock compensation expense of $640,881 related to options exercised was
reclassified from additional paid-in capital to share capital.
F-14
SMARTIRE SYSTEMS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
(Unaudited)
(Prepared in accordance with U.S. generally accepted accounting principles)
Nine months ended April 30, 2005 and 2004
9. Share capital (continued):
(d) During April 2005, the Company received notices of a cashless warrant
exercise from holders of the discounted convertible debentures to
exercise 8,386,750 warrants. The exercise price of these warrants was
$0.028. In response, the Company issued 6,789,809 shares of common
stock to the warrant holders.
(e) As at April 30, 2005, warrants outstanding were exercisable for
10,759,861 (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 $0.028 to $2.80 per share that expire on various
dates until June 30, 2009.
10. Related party transactions:
During the nine months ended April 30, 2005, the Company incurred expenses
of $60,000 (2004 - nil) for a research report to a company in which a
director of the Company has significant influence.
11. 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 Nine months ended
------------------------------- ------------------------------
April 30, April 30, April 30, April 30,
2005 2004 2005 2004
- ---------------------------------------------------------------------------------------------------------------------------
United Kingdom $ 157,827 $ 31,027 $ 507,520 $ 153,312
United States 119,533 164,798 372,075 423,334
Korea 4,217 1,350 30,423 93,619
China -- 141,488 15,998 453,877
Germany 21,917 17,244 32,378 33,339
Other 26,912 45,516 64,090 101,659
- ---------------------------------------------------------------------------------------------------------------------------
$ 330,406 $ 401,423 $ 1,022,484 $ 1,259,140
===========================================================================================================================
As at April 30, 2005, 53% (July 31, 2004-53%) of the Company's fixed assets
were in Canada, 18% (July 31, 2004 - 17%) were in Europe and 29% were in
Korea (July 31, 2004 - 30%).
F-15
SMARTIRE SYSTEMS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
(Unaudited)
(Prepared in accordance with U.S. generally accepted accounting principles)
Nine months ended April 30, 2005 and 2004
11. Segmented information (continued):
Major customers, representing 10% or more of total sales, include:
===========================================================================================================================
Three months ended Nine months ended
------------------------------- ------------------------------
April 30, April 30, April 30, April 30,
2005 2004 2005 2004
- ---------------------------------------------------------------------------------------------------------------------------
Customer A $ 103,832 $ 18,907 $ 393,184 $ 98,380
Customer B 50,947 20,542 159,510 33,431
Customer C -- 141,488 15,998 423,945
===========================================================================================================================
12. Subsequent events:
(a) On May 20, 2005, the Company entered into a Standby Equity Distribution
Agreement with Cornell Capital Partners, LP which provides for the
potential issuance and sale of up to $30 million of our common stock
to Cornell Capital. Under this arrangement, the Company, at its sole
discretion, may draw down on this facility, from time to time over a
period of 24 months after the effective date of registration statement
to be filed with Securities and Exchange Commission or until Cornell
Capital purchases $30 million of shares of our common stock,
whichever occurs first. For each share of common stock purchased under
the Standby Equity Distribution Agreement, Cornell Capital will pay 98%
of the lowest closing bid price of our common stock on the OTC Bulletin
Board for the five trading days immediately following the date of the
notice for the draw down. The amount of each advance is subject to a
maximum of $1 million per advance, with a minimum of five trading
days between advances. Cornell Capital intends to sell the shares
purchased under the Standby Equity Distribution Agreement at the then
prevailing market price. In addition, Cornell Capital may deduct the
amount of any fees, expenses and disbursements that we have not paid
from any advance. This Standby Equity Distribution Agreement replaced
the Company's previous $15 million Standby Equity Distribution
Agreement, dated May 19, 2004, with Cornell Capital, which was
terminated by the parties.
(b) On May 20, 2005, the Company also entered into a Securities Purchase
Agreement with Cornell Capital. In accordance with the Securities
Purchase Agreement, we issued to Cornell Capital, for a purchase price
of $1,500,000 million, a 5% convertible debenture that is convertible,
at the option of Cornell Capital, into shares of our common stock at a
price of $0.028 per share and matures on May 20, 2006 (note 7(c)).
F-16
SMARTIRE SYSTEMS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
(Unaudited)
(Prepared in accordance with U.S. generally accepted accounting principles)
Nine months ended April 30, 2005 and 2004
12. Subsequent events (continued):
(c) Between May 2, 2005 and May 23, 2005, the company entered into release,
redemption and settlement agreements whereby it redeemed $863,581 of
discounted convertible debentures. Consideration consisted of $408,067
and the issuance of 9,738,759 shares of common stock which were issued
at an effective conversion price of $0.028 per share.
13. Contingencies:
As described in note 12 (c) the company has settled a series of discounted
convertible debentures with the exception of one with a carrying value of
$91,726. On April 21, 2005, one holder of this discounted debenture in the
amount of $91,726 provided the Company with notice of a summons with the
Supreme Court of the State of New York. The holder is alleging that the
Company wrongfully refused to honor its request to convert this debt into
9,268,875 common shares of the Company. The holder is seeking issuance of
these shares and damages and attorneys fees. It is not possible to
determine whether the debenture holder will be successful in their legal
action. The Company has recorded a liability of $128,259 which includes the
outstanding principal, premium and penalties.
14. Differences between Canadian and United States Generally Accepted 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.
F-17
SMARTIRE SYSTEMS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
(Unaudited)
(Prepared in accordance with U.S. generally accepted accounting principles)
Nine months ended April 30, 2005 and 2004
14. Differences between Canadian and United States Generally Accepted Accounting
Principles and Practices (continued):
(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.
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:
===========================================================================================================================
Three months ended Nine months ended
------------------------------- ------------------------------
April 30, April 30, April 30, April 30,
2005 2004 2005 2004
- ---------------------------------------------------------------------------------------------------------------------------
Net loss:
As reported $ (1,750,749) $ (2,243,554) $ (8,621,025) $ (6,966,770)
Stock-based compensation
expense included in reported
net loss 4,508 7,973 1,089,282 1,125,667
Stock-based compensation
expense determined under
fair value based method
for all awards (4,508) 115,643 (1,087,519) (1,230,338)
- ---------------------------------------------------------------------------------------------------------------------------
Pro forma $ (1,750749) $ (2,119,938) $ (8,619,262) $ (7,071,441)
===========================================================================================================================
Basic and diluted loss per share:
As reported $ (0.01) $ (0.04) $ (0.05) $ (0.10)
Pro forma (0.01) (0.03) (0.04) (0.09)
===========================================================================================================================
F-18
SMARTIRE SYSTEMS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
(Unaudited)
(Prepared in accordance with U.S. generally accepted accounting principles)
Nine months ended April 30, 2005 and 2004
14. Differences between Canadian and United States Generally Accepted 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 expense.
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. Debt issuance cost is
charged to equity.
(e) For US GAAP, on settlement of a debenture, a gain was recorded in the
statement of operations of $1,822,033 and a charge to retained earnings
was recorded for the same amount (note 7(a)). For Canadian GAAP, no
gain arises, since the carrying value of liability and equity component
of the debenture is the same as the allocated fair values between
liability and equity of the consideration paid.
F-19
SMARTIRE SYSTEMS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
(Unaudited)
(Prepared in accordance with U.S. generally accepted accounting principles)
Nine months ended April 30, 2005 and 2004
14. Differences between Canadian and United States Generally Accepted Accounting
Principles and Practices (continued):
===========================================================================================================================
April 30, 2005 July 31, 2004
------------------------------------ ------------------------------
Consolidated Canadian US Canadian US
balance sheets GAAP GAAP GAAP GAAP
- ---------------------------------------------------------------------------------------------------------------------------
Current assets $ 4,143,274 $ 4,143,274 $ 3,807,743 $ 3,807,743
Capital assets 721,745 721,745 824,616 824,616
Deferred financing costs (d) -- -- 443,016 157,020
Other assets 1,347,765 1,347,765 2,147,749 2,147,749
Current liabilities (c) 2,040,034 2,040,034 2,804,081 3,075,338
Long term convertible
debentures (c) 195,001 195,001 1 395,574
Preferred shares subject to
mandatory redemption 1 1 -- --
Stockholders' equity 3,977,748 3,977,748 4,419,042 3,466,216
===========================================================================================================================
===========================================================================================================================
Three months ended Nine months ended
------------------------------- ------------------------------
April 30, April 30, April 30, April 30,
2005 2004 2005 2004
- ---------------------------------------------------------------------------------------------------------------------------
Net loss in accordance with
U.S. GAAP $ (5,306,734) $ (2,950,259) $ (11,794,574) $ (8,118,581)
Effects of differences in accounting for:
Stock based compensation expense
under U.S. GAAP (b) 5,024,950 -- 5,024,950 --
Stock based compensation
recovery under Canadian GAAP (b) (4,508) (7,973) (1,089,282) (1,125,667)
Interest accretion and amortization of
debenture finance costs recorded
under US GAAP (c) (d) 357,576 782,196 2,439,497 2,409,906
Interest accretion and amortization of
debenture finance cost under
Canadian GAAP (d) -- (67,518) (1,379,583) (132,428)
Gain on settlement of convertible
debt (e) (1,822,033) -- (1,822,033) --
- ---------------------------------------------------------------------------------------------------------------------------
Net loss in accordance with Canadian
GAAP (1,750,749) (2,243,554) (8,621,025) (6,966,770)
Beginning deficit in accordance with
Canadian GAAP (59,534,828) (46,486,028) (51,971,322) (41,762,812)
Interest on convertible debentures and
amortization of financing charges (d) (362,543) (646,857) (1,055,763) (646,857)
- ---------------------------------------------------------------------------------------------------------------------------
Ending deficit in accordance with
Canadian GAAP $ (61,648,120) $ (49,376,439) $ (61,648,120) $ (49,376,439)
===========================================================================================================================
Basic and diluted loss per share (in
accordance with Canadian GAAP) $ (0.01) $ (0.04) $ (0.05) $ (0.10)
===========================================================================================================================
15. Comparative figures:
Certain figures have been reclassified to conform to the financial
statement presentation adopted for the current year.
F-20
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 ACCOUNTING 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-21
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-22
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-23
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-24
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-25
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-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
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 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-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):
(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-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
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-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
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-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
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-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
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-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
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-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
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-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:
=============================================================================================================
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-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):
(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-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
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-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
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-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
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-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
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-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):
(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 million and $5 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 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 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 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 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-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
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-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
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-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
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-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
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-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
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-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
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-47
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-48
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-49
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-50
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-51
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.
85
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
(d) 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 SEC 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 $ 27,652.17
Printing and engraving expenses $ 1,000(1)
Accounting fees and expenses $ 10,000(1)
Legal fees and expenses $ 60,000(1)
Transfer agent and registrar fees $ 2,000(1)
Fees and expenses for qualification under state $ 1,000(1)
securities laws
Miscellaneous $ 1,000(1)
Total $ 102,652.17
(1) We have estimated these amounts
86
Item 26 RECENT SALES OF UNREGISTERED SECURITIES
On June 30, 2005, we closed a Securities Purchase Agreement with Cornell Capital
Partners, L.P. and Highgate House Funds, Ltd., both accredited investors, in
which Cornell Capital Partners and Highgate House Funds agreed to lend a
principal amount in the aggregate of $30,000,000 to us in exchange for our 10%
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 June 2, 2005, we issued 75,188 shares of our common stock to Newbridge
Securities Corporation as a placement agent fee on the standby equity
distribution agreement entered into on May 23, 2005.
On May 27, 2005, we closed a Securities Purchase Agreement with Cornell Capital
Partners, L.P., an accredited investor, in which Cornell Capital Partners agreed
to lend a principal amount of $1,500,000 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 notice of a warrant exercise dated May 12, 2005, William Page elected to
exercise 81,327 warrants. In response, we issued 32,889 shares of our common
stock to pursuant to Rule 506 of Regulation D under the Securities Act.
On May 11, 2005, we issued 1,495,195 shares of our common stock pursuant to a
redemption, settlement and release agreement with Goldplate Investment Partners
pursuant to Rule 506 of Regulation D under the Securities Act.
By notice of a warrant exercise dated May 5, 2005, Morval Bank & Trust Cayman,
Ltd, elected to exercise 714,286 warrants. In response, we issued 714,286 shares
of our common stock to pursuant to Regulation S under the Securities Act.
On May 4, 2005, we issued 10,641,670 shares of our common stock pursuant to a
redemption, settlement and release agreement with Alpha Capital
Aktiengesellschaftt pursuant to Rule 506 of Regulation D under the Securities
Act.
On May 2, 2005, we issued 4,143,268 shares of our common stock pursuant to a
redemption, settlement and release agreement with Gamma Opportunity Capital
Partners pursuant to Rule 506 of Regulation D under the Securities Act.
By notice of a cashless warrant exercise dated April 28, 2005, Crescent
International Ltd. elected to exercise 3,846,154 warrants. In response, we
issued 3,205,128 shares of our common stock to Crescent International
Ltd. pursuant to Rule 506 of Regulation D under the Securities Act.
By notice of a cashless warrant exercise dated April 25, 2005, HPC Capital
Management elected to exercise 250,000 warrants. In response, we issued 197,368
shares of our common stock to HPC Capital Management pursuant to Rule 506 of
Regulation D under the Securities Act.
By notice of a cashless warrant exercise dated April 25, 2005, Talisman
Management Limited elected to exercise 1,000,000 warrants. In response, we
issued 789,474 shares of our common stock to Talisman Management Limited
pursuant to Rule 506 of Regulation D under the Securities Act.
87
By notice of a cashless warrant exercise dated April 25, 2005, Palisades Master
Fund, L.P. elected to exercise 3,290,596 warrants. In response, we issued
2,597,839 shares of our common stock to Palisades Master Fund, L.P. pursuant to
Rule 506 of Regulation D under the Securities Act.
By conversion notice dated April 20, 2005, Crescent International Ltd. elected
to convert $59,700 of convertible debentures. In response, we issued 2,132,143
shares of our common stock to Crescent International Ltd. pursuant to Rule 506
of Regulation D under the Securities Act.
By conversion notice dated April 20, 2005, Palisades Master Fund, L.P. elected
to convert $3,864 of convertible debentures. In response, we issued 138,000
shares of our common stock to Palisades Master Fund., L.P. pursuant to Rule 506
of Regulation D under the Securities Act.
By conversion notice dated April 20, 2005, Goldplate Investment Partners elected
to convert $66,080 of convertible debentures. In response, we issued 2,360,000
shares of our common stock to the debenture holder pursuant to Rule 506 of
Regulation D under the Securities Act.
On March 23, 2005, we closed on a transaction pursuant to which we entered into
an Investment Agreement dated as of March 22, 2005 with one accredited investor
in which we sold an aggregate of $4,000,000 of our Series A 5% Convertible
Preferred Stock, no par value per share (the "Preferred Stock"). The purchase
price was $4,000,000, of which $2,850,000 was previously funded pursuant to
certain transaction documents we previously entered into with the investor.
These transaction documents were terminated by the parties on March 23, 2005
(see Item 1.02 below). On March 23, 2005, we received net proceeds of
$1,015,000, after deducting the $2,850,000 which was previously funded, a
$115,000 commitment fee and legal fees in the amount of $20,000. We issued the
Preferred Stock 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 March 21, 2005, a holder of discounted convertible
debentures (described below) elected to convert $65,800 of outstanding under the
convertible debentures under rule 144. In response, we issued 2,350,000 shares
of our common stock to the debenture holder pursuant to Rule 506 of Regulation D
under the Securities Act of 1933, as amended.
By conversion notice dated March 18, 2005, a holder of discounted convertible
debentures (described below) elected to convert $30,000 of outstanding under the
convertible debentures under rule 144. In response, we issued 1,071,429 shares
of our common stock to the debenture holder pursuant to Rule 506 of Regulation D
under the Securities Act of 1933, as amended.
By conversion notice dated March 11, 2005, a holder of discounted convertible
debentures (described below) elected to convert $20,000 of outstanding under the
convertible debentures under rule 144. In response, we issued 714,286 shares of
our common stock to the debenture holder pursuant to Rule 506 of Regulation D
under the Securities Act of 1933, as amended.
By conversion notice dated January 20, 2005, a holder of discounted convertible
debentures (described below) elected to convert $63,000 of outstanding principal
under the convertible debentures under rule 144. In response, we issued
2,250,000 shares of our common stock to the debenture holder pursuant to Rule
506 of Regulation D under the Securities Act of 1933, as amended.
By conversion notice dated January 3, 2005, a holder of 8% convertible
debentures (described below) elected to convert $30,000 of principal and $3,573
in accrued interest outstanding under the convertible debentures under rule 144.
In response, we issued 1,200,337 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 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.
88
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 under rule 144.
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 draw down 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 draw down 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 5, 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 draw down 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 draw down 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 draw down 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 draw down 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 draw down on the equity line of credit and 58,824 shares of common
stock 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.
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 draw down 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 draw down 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.
89
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 draw down 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 draw down 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 $.09 per share, in payment
of a $250,000 draw down 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 $0.104 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 $0.104 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 $15 million equity line of credit.
On May 19, 2004, we entered into a $15 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.
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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.
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.
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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.
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
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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.
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 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
93
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 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 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.
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.
94
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.
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
95
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.
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.
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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 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 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.
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 a 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
97
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.
On November 21, 2002, we entered into a $5 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
million equity line of credit facility as described above.
On December 4, 2002, we issued 446,154 shares of our common stock to Cornell
Capital Partners 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.
98
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 a 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 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.
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. The
warrants expired on March 26, 2005.
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. The warrants expired on February 13, 2005.
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. The warrants expired on January 18, 2005.
99
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 December 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)
100
EXHIBIT
NUMBER DESCRIPTION
- ------- ---------------------------------------------------------------------
3.17 Certificate of Amendment to Articles of Incorporation of SmarTire
Systems Inc.(28)
3.18 Articles of Amendment to the Articles of Incorporation of SmarTire
Systems Inc. with respect to the series A convertible stock (29)
5.1 Opinion of Greenberg Traurig, LLP regarding the legality
of the securities being registered**
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)
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)
101
EXHIBIT
NUMBER DESCRIPTION
- ------- ---------------------------------------------------------------------
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)
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)
102
EXHIBIT
NUMBER DESCRIPTION
- ------- ---------------------------------------------------------------------
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)
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)
103
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)
104
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 dated as of September 24, 2004.(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)
10.77 Amendment Agreement dated February 3, 2005 between SmarTire Systems
Inc. and Robert Rudman.(29)
105
EXHIBIT
NUMBER DESCRIPTION
- ------- ---------------------------------------------------------------------
10.78 Amendment Agreement dated February 3, 2005 between SmarTire Systems
Inc. and Allan Kozak.(29)
10.79 Amendment Agreement dated February 3, 2005 between SmarTire Systems
Inc. and Jeff Finkelstein.(29)
10.80 Amendment Agreement dated February 3, 2005 between SmarTire Systems
Inc. and Erwin Bartz.(29)
10.81 Amendment Agreement dated February 3, 2005 between SmarTire Systems
Inc. and Shawn Lammers.(29)
10.82 Amendment Agreement dated February 3, 2005 between SmarTire Systems
Inc. and William Cronin.(29)
10.83 Amendment Agreement dated February 3, 2005 between SmarTire Systems
Inc. and Martin Gannon.(29)
10.84 Amendment Agreement dated February 3, 2005 between SmarTire Systems
Inc. and Johnny Christiansen.(29)
10.85 Registration Rights Agreement dated as of March 22, 2005 by and
between SmarTire Systems, Inc. and Cornell Capital Partners,
L.P.(30)
10.86 Investment Agreement dated as of March 22, 2005 by and between
SmarTire Systems, Inc. and Cornell Capital Partners, L.P.(30)(31)
10.87 Termination Agreement dated as of March 22, 2005 by and between
SmarTire Systems, Inc. and Cornell Capital Partners, L.P.(30)
10.88 Redemption, settlement and release agreement dated April 27, 2005 by
and between SmarTire Systems Inc. and Palisades Master Fund, L.P. and
PEF Advisors, Ltd.(32)
10.89 Redemption, settlement and release agreement dated May 2, 2005 by and
between SmarTire Systems Inc. and Gamma Opportunity Partners. (32)
10.90 Redemption, settlement and release agreement dated May 4, 2005 by and
between SmarTire Systems Inc. and Alpha Capital Aktiengesellschaftt,
L.P.(32)
10.91 Redemption, settlement and release agreement dated May 13, 2005 by
and between SmarTire Systems Inc. and Crescent International
Ltd.(32)
10.92 Redemption, settlement and release agreement dated May 23, 2005 by
and between SmarTire Systems Inc. and Goldplate Investment
Partners.(32)
10.93 Registration Rights Agreement dated as of May 22, 2005 by and between
SmarTire Systems Inc. and Cornell Capital Partners.(32)
106
EXHIBIT
NUMBER DESCRIPTION
- ------- ---------------------------------------------------------------------
10.94 Standby Equity Distribution Agreement dated as of May 22, 2005 by and
between SmarTire Systems Inc. and Cornell Capital Partners LP.(32)
10.95 Investor Registration Rights Agreement dated as of May 22, 2005 by
and between SmarTire Systems Inc. and Cornell Capital Partners LP.
(32)
10.96 Amended and Restated Convertible Debenture dated as of June 10, 2005
by and between SmarTire Systems Inc. and Cornell Capital
Partners LP.(32)
10.97 Securities Purchase Agreement dated as of May 22, 2005 by and between
SmarTire Systems Inc. and Cornell Capital Partners LP.(32)
10.98 Standby Equity Distribution Agreement, dated as of June 23, 2005,
between SmarTire Systems Inc. and Cornell Capital Partners, LP.(33)
10.99 Securities Purchase Agreement, dated as of June 23, 2005, among
SmarTire Systems Inc., Cornell Capital Partners, LP and Highgate
House Funds, Ltd.(33)
10.100 Securities Purchase Agreement, dated as of June 23, 2005, among
SmarTire Systems Inc., Cornell Capital Partners, LP and Highgate
House Funds, Ltd.(33)
10.101 Convertible Debenture, dated as of June 23, 2005, with a principal
balance of $20 million, issued by SmarTire Systems Inc. to Cornell
Capital Partners, LP as trustee for LCC Global Ltd.(33)
10.102 Amended and Restated Convertible Debenture, dated as of July 21,
2005, with a principal balance of $8 million, issued by SmarTire
Systems Inc. to Cornell Capital Partners, LP.**
10.103 Amended and Restated Convertible Debenture, dated as of July 21,
2005, with a principal balance of $2 million, issued by SmarTire
Systems Inc. to Highgate House Funds, Ltd.**
10.104 Amended and Restated Warrant to purchase 41,668,750 shares of common
stock, dated as of July 21, 2005 issued by SmarTire Systems Inc. to
Cornell Capital Partners LP.**
10.105 Amended and Restated Warrant to purchase 16,668,750 shares of common
stock, dated as of July 21, 2005 issued by SmarTire Systems Inc. to
Cornell Capital Partners LP.**
10.106 Amended and Restated Warrant to purchase 4,162,500 shares of common
stock, dated as of July 21, 2005 issued by SmarTire Systems Inc. to
Highgate House Funds, Ltd.**
10.107 Registration Rights Agreement, dated as of June 23, 2005, between
SmarTire Systems Inc. and Cornell Capital Partners, LP.(33)
10.108 Investor Registration Rights Agreement, dated as of June 23, 2005,
among SmarTire Systems Inc., Cornell Capital Partners, LP and
Highgate House Funds, Ltd.(33)
14.1 Code of Business Conduct and Ethics Compliance Program.(16)
107
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.
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(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.
(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.
(29) Incorporated by reference to SmarTire Systems Inc.'s 8-K filed with the
Securities Exchange Commission on February 9, 2005.
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(30) Incorporated by reference to SmarTire Systems Inc.'s 8-K filed with the
Securities Exchange Commission on March 29, 2005.
(31) Incorporated by reference to SmarTire Systems Inc.'s 8-K filed with the
Securities Exchange Commission on April 1, 2005, as amended.
(32) Incorporated by reference to SmarTire Systems Inc.'s Form 10-QSB filed with
the Securities and Exchange Commission on June 14, 2004.
(33) Incorporated by reference to SmarTire Systems Inc.'s 8-K filed with the
Securities Exchange Commission on June 30, 2005.
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.
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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 July 22, 2005.
SMARTIRE SYSTEMS INC.
/s/ Al Kozak
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By: Al Kozak, President and Chief Executive Officer
/s/ Jeff Finkelstein
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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
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Robert Rudman, Chairman and Director
July 22, 2005
/s/ Al Kozak
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Al Kozak, President and Chief Executive Officer, Director
July 22, 2005
/s/ William Cronin
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William Cronin, Director
July 22, 2005
/s/ Johnny Christiansen
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Johnny Christiansen, Director
July 22, 2005
/s/ Martin Gannon
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Martin Gannon, Director
July 22, 2005
111