NAME:_______________________
COPY NO.:___________________
CONFIDENTIAL TERM SHEET
COMPLIANCE SYSTEMS CORPORATION
UP TO 2,500,000 SHARES OF CLASS B COMMON STOCK
THIS CONFIDENTIAL TERM SHEET (THIS "TERM SHEET") RELATES TO THE OFFERING
("OFFERING") OF UP TO AN AGGREGATE OF 2,500,000 SHARES OF NON-VOTING CLASS B
COMMON STOCK, $.001 PAR VALUE PER SHARE ("CLASS B COMMON STOCK"), BY COMPLIANCE
SYSTEMS CORPORATION A DELAWARE COMPANY, AT A PURCHASE PRICE EQUAL TO $1.00 PER
SHARE. THIS OFFERING IS BEING EFFECTED AS PART OF A DEBT RESTRUCTURING PROGRAM
IN CONNECTION WITH WHICH THE COMPANY WILL (i) AFFORD CERTAIN HOLDERS OF 9%
SECURED PROMISSORY NOTES IN THE AGGREGATE PRINCIPAL AMOUNT OF $1.5 MILLION ("9%
SECURED NOTES") THE OPPORTUNITY TO CONVERT SUCH INDEBTEDNESS INTO SHARES OF
NON-VOTING CLASS B COMMON STOCK, $.001 PAR VALUE PER SHARE ("CLASS B COMMON
STOCK"), AT A PURCHASE PRICE OF $1.00 PER SHARE, ON THE TERMS AND CONDITIONS
MORE SPECIFICALLY SET FORTH HEREIN ("DEBT CONVERSION") AND (ii) DURING THE TERM
OF THIS OFFERING, REDUCE TO $1.00 THE EXERCISE PRICE OF WARRANTS CURRENTLY
EXERCISABLE TO PURCHASE AN AGGREGATE OF 1,500,000 OF SHARES OF CLASS B COMMON
STOCK.
IN 2002, THE COMPANY EFFECTED A CORPORATE REORGANIZATION PURSUANT TO WHICH IT
BECAME THE HOLDING COMPANY FOR FOUR OF ITS WHOLLY-OWNED SUBSIDIARIES: CALL
COMPLIANCE.COM, INC., A DELAWARE CORPORATION, AND CALL COMPLIANCE, INC., AMS
NETWORK INC. AND JASMIN COMMUNICATIONS, INC., EACH A NEW YORK CORPORATION. THE
COMPANY ALSO WHOLLY-OWNS TELEPHONE BLOCKING SERVICES CORP. ("SERVICES"), A
COMPANY FORMED UNDER THE LAWS OF NEW YORK, AND IN 2004 ENTERED INTO A JOINT
VENTURE PURSUANT TO WHICH IT OWNS A 50% INTEREST IN COMPLIANCE TESTING &
SOLUTIONS, LLC ("CTS"), A LIMITED LIABIITY COMPANY FORMED UNDER THE LAWS OF
DELAWARE. HEREINAFTER THE COMPANY, EACH OF ITS FIVE WHOLLY-OWNED SUBSIDIARIES
DESCRIBED ABOVE ("SUBSIDIARIES") AND ITS JOINT VENTURE INTEREST IN CTS SHALL
COLLECTIVELY BE REFERRED TO AS THE "COMPANY."
THE COMPANY WILL RECEIVE NO CASH PROCEEDS IN CONNECTION WITH THE DEBT
CONVERSION. THERE CAN BE NO ASSURANCE AS TO THE AMOUNT OF SHARES OF CLASS B
COMMON STOCK ULTIMATELY SUBSCRIBED FOR AND ISSUED IN CONNECTION WITH SUCH
INITIATIVE.
ALL PROCEEDS FROM THE EXERCISE OF WARRANTS WILL BE PAID OVER DIRECTLY TO THE
COMPANY AS AND WHEN RECEIVED. THERE CAN BE NO ASSURANCE AS TO THE NUMBER OF
WARRANT EXERCISED, IF ANY AT ALL.
TO DATE, THE COMPANY HAS PRIMARILY BEEN INVOLVED IN START-UP AND DEVELOPMENT
ACTIVITIES AND HAS NOT GENERATED SUFFICIENT REVENUES TO SATISFY ONGOING
OPERATING EXPENSES AND DEBT SERVICE OBLIGATIONS. AT DECEMBER 31, 2004, THE
COMPANY HAD AN ACCUMULATED DEFICIT OF $5,273,418 AND FOR EACH OF THE YEARS ENDED
DECEMBER 31, 2002, 2003 AND 2004, THE COMPANY HAD CONSOLIDATED NET LOSSES FROM
OPERATING ACTIVITIES OF $2,099,141, $1,880,508 AND $1,293,769, RESPECTIVELY.
THERE CAN BE NO ASSURANCE THAT ANY REVENUES GENERATED BY OUR BUSINESS WILL BE
SUFFICIENT TO SUPPORT THE COMPANY'S PLANNED DEVELOPMENT AND GROWTH ACTIVITIES
AND DEBT SERVICE OBLIGATIONS OR THAT THE COMPANY WILL EVER OPERATE ON A
PROFITABLE BASIS.
IN ADDITION TO ANY PROCEEDS RECEIVED FROM THE EXERCISE OF THE WARRANTS, OF WHICH
THERE CAN BE NO ASSURANCE, THE COMPANY MUST RAISE ADDITIONAL SIGNIFICANT CAPITAL
IN ORDER TO SUSTAIN OPERATIONS AND MEET ITS OTHER OBLIGATIONS. IN FURTHERANCE OF
THIS OBJECTIVE, IN FEBRUARY 2005, THE COMPANY ENTERED INTO TWO NON-BINDING TERM
SHEETS AND A NON-BINDING LETTER OF INTENT (COLLECTIVELY, "THE TRANSACTION
DOCUMENTS") CONTEMPLATING A BRIDGE FINANCING, LINE OF CREDIT AND MERGER WITH A
PUBLIC SHELL ("MERGER"), RESPECTIVELY. THE COMPANY IS IN THE PROCESS OF
NEGOTIATING DEFINITIVE AGREEMENTS REFLECTING THE BRIDGE FINANCING AND LINE OF
CREDIT. THE COMPANY WAS RECENTLY ADVISED THAT THE MERGER CANDIDATE WITH WHICH IT
ENTERED INTO THE LETTER OF INTENT IS NO LONGER AVAILABLE FOR SUCH TRANSACTION,
ACCORDINGLY THE COMPANY IS IN THE PROCESS OF LOCATING A
THE DATE OF THIS CONFIDENTIAL TERM SHEET IS JUNE 20, 2005
NEW MERGER CANDIDATE. THE CONSUMMATION OF THE BRIDGE FINANCING, WHICH IS THE
FIRST OF SUCH TRANSACTIONS TO OCCUR, IS CONDITIONED UPON THE COMPANY ENTERING
INTO DEFINITIVE DOCUMENTS WITH RESPECT TO THE MERGER AND LINE OF CREDIT. THERE
CAN BE NO ASSURANCE THAT THE COMPANY WILL FIND A SUITABLE MERGER CANDIDATE, OR
THAT THE BRIDGE FINANCING, LINE OF CREDIT AND MERGER TRANSACTIONS WILL BE
CONSUMMATED ON THE TERMS SET FORTH IN THE TRANSACTION DOCUMENTS, IF AT ALL. "SEE
PLANNED CAPITAL FINANCING TRANSACTION."
THE COMPANY HAS NOT YET PAID ITS REQUIRED INTEREST PAYMENT ON THE 9% SECURED
NOTES FOR THE QUARTER ENDED MARCH 31, 2005 AGGREGATING $33,750 WHICH WAS DUE
APRIL 1, 2005 ("FIRST QUARTERLY INTEREST OBLIGATION"). IT COULD CONSTITUTE AN
EVENT OF DEFAULT, AS DEFINED IN THE 9% SECURED NOTES, IF THE COMPANY DOES NOT
PAY THE FIRST QUARTERLY INTEREST OBLIGATION BY JULY 1, 2005. IN CONNECTION WITH
THIS OFFERING, SUBSCRIBERS PARTICIPATING IN THE DEBT CONVERSION WILL BE
REQUIRED, AS PART OF THEIR AGREEMENT TO CONVERT PRINCIPAL INDEBTEDNESS AND
SUBSCRIBE FOR SHARES OF CLASS B COMMON STOCK, TO PERMANENTLY AND IRREVOCABLY
WAIVE PAYMENT OF THE FIRST QUARTERLY INTEREST OBLIGATION AND ADDITIONAL INTEREST
ACCRUING ON THE NOTES THROUGH THE TERMINATION OF THE OFFERING PERIOD AND WAIVE
ANY DEFAULT UNDER THE 9% SECURED NOTES TO THE EXTENT ONE MAY HAVE EXISTED OR
EXISTS ("WAIVER"). TO THE EXTENT ANY HOLDERS OF THE 9% SECURED NOTES DO NOT
PARTICIPATE IN THE DEBT CONVERSION, AND ACCORDINGLY DELIVER A WAIVER, THE
COMPANY WILL CONTINUE TO BE OBLIGATED TO PAY SUCH NOTEHOLDERS' RESPECTIVE FIRST
QUARTERLY INTEREST OBLIGATION BY JULY 1, 2005 AND FOR SUBSEQUENT QUARTERS. THERE
CAN BE NO ASSURANCE THAT THE COMPANY WILL RAISE SUFFICIENT PROCEEDS FROM THE
EXERCISE OF THE WARRANTS TO PAY THE FIRST QUARTERLY INTEREST OBLIGATION TO
NON-COVERTING HOLDERS OF THE 9% SECURED NOTES BY JULY 1, 2005. IN THE EVENT THE
COMPANY DOES NOT HAVE THE NECESSARY FUNDS TO MAKE SUCH PAYMENT(S) BY JULY 1,
2005, OR ANY OTHER QUARTERLY PAYMENTS ON A TIMELY BASIS, AN EVENT OF DEFAULT
WOULD BE TRIGGERED UNDER THE 9% SECURED NOTES, AND SUCH NOTEHOLDERS COULD ELECT
TO EXERCISE THEIR RIGHTS UNDER THE 9% SECURED NOTES AND UNDER THE RELATED
SECURITY AGREEMENT PROVIDING THEM WITH A SECURITY INTEREST IN CERTAIN OF THE
COMPANY'S INTELLECTUAL PROPERTY.
THE COMPANY IS ALSO CURRENTLY IN ARREARS WITH ITS JANUARY THROUGH MAY MONTHLY
PAYMENT OBLIGATIONS UNDER FOUR PROMISSORY NOTES IN THE AGGREGATE PRINCIPAL
AMOUNT OF $1,210,000 ("ENTITY NOTES") AND IS REQUIRED TO MAKE ITS JUNE PAYMENT
ON JUNE 30, 2005. SUCH NOTEHOLDERS HAVE EACH ENTERED INTO DEBT RESTRUCTURING
AGREEMENTS WITH THE COMPANY AGREEING (i) ON A RETROACTIVE AND PROSPECTIVE BASIS
TO RESTRUCTURE THE FORM, ORDER AND TIMING OF PAYMENTS DUE UNDER THE ENTITY NOTES
FOR CALENDAR YEAR 2005 AND (ii) TO ACCEPT CERTAIN PAST AND FUTURE DUE PAYMENTS
UNDER THE ENTITY NOTES IN-KIND, IN SHARES OF CLASS B COMMON STOCK
("RESTRUCTURING"). THE HOLDERS OF THE ENTITY NOTES HAVE ALSO AGREED TO WAIVE,
SUBJECT TO THE COMPANY REMAINING IN FULL COMPLIANCE WITH THE RESTRUCTURING
PAYMENT OBLIGATIONS, ANY DEFAULT UNDER THE ENTITY NOTES THAT MAY HAVE RESULTED
FROM THE COMPANY NOT PAYING ON A TIMELY BASIS THE MONTHLY PAYMENTS DURING THE
PERIOD JANUARY THROUGH MAY 2005 AND, ANY DEFAULT THAT MAY BE DEEMED TO OCCUR AS
A RESULT OF THE RESTRUCTURING. IN CONNECTION WITH THE RESTRUCTURING, THE COMPANY
IS OBLIGATED TO MAKE A PAYMENT OF $31,500 TO THE ENTITIES ON JUNE 30, 2005. THE
COMPANY IS DEPENDANT ON THE PROCEEDS FROM THE EXERCISE OF THE WARRANTS TO MAKE
SUCH PAYMENT. THERE CAN BE NO ASSURANCE THAT THE COMPANY WILL RAISE SUFFICIENT
PROCEEDS FROM THE EXERCISE OF THE WARRANTS TO EFFECT SUCH PAYMENT ON JUNE 30,
2005. IN THE EVENT THE COMPANY DOES NOT HAVE THE NECESSARY FUNDS TO MAKE SUCH
JUNE 30, 2005 PAYMENT TO ANY OF THE ENTITIES, THE COMPANY WOULD BE IN DEFAULT
UNDER THE CORRESPONDING ENTITY NOTE AND THE HOLDER THEREOF COULD ELECT TO
EXERCISE ITS RIGHTS UNDER SUCH ENTITY NOTE.
THERE IS NO CURRENT PUBLIC MARKET FOR ANY OF THE SECURITIES OF THE COMPANY.
ASSUMING THE CONSUMMATION OF THE TRANSACTIONS CONTEMPLATED IN THE TRANSACTION
DOCUMENTS, OF WHICH THERE CAN BE NO ASSURANCE, THE COMPANY, OR ITS SUCCESSOR IN
THE MERGER (DEPENDING ON THE FORM OF THE TRANSACTION), MAY BE A REPORTING
COMPANY UNDER THE SECURIIES EXCHANGE ACT OF 1934 WITH ITS COMMON STOCK LISTED
FOR QUOTATION ON THE PINK SHEETS. NOTWITHSTANDING THE CONSUMMATION OF SUCH
TRANSACTIONS, THERE CAN BE NO ASSURANCE THAT A REGULAR TRADING MARKET WILL
DEVELOP FOR THE COMPANY'S SECURITIES IN THE FORSEEABLE FUTURE, IF AT ALL.
MOREOVER, THE CLASS B COMMON STOCK IS BEING OFFERED AND SOLD IN THIS PRIVATE
PLACEMENT PURSUANT TO REGULATION D PROMULGATED UNDER THE SECURITIES ACT OF 1933,
AS AMENDED (THE "SECURITIES ACT"), AND HAS NOT BEEN REGISTERED UNDER THE ACT OR
UNDER THE SECURITIES LAWS OF ANY STATE OR OTHER JURISDICTION, NOR DOES THE
COMPANY HAVE AN OBLIGATION TO DO SO. AS SUCH, THE SHARES OF CLASS B COMMON STOCK
(HEREINAFTER, COLLECTIVELY, THE "SECURITIES") MAY NOT BE TRANSFERRED OR RESOLD
EXCEPT AS PERMITTED UNDER THE SECURITIES ACT AND/OR SUCH STATE LAWS PURSUANT TO
REGISTRATION THEREUNDER OR EXEMPTION THEREFROM.
AN INVESTMENT IN THE SHARES OFFERED HEREBY IS SPECULATIVE, AND INVOLVES A HIGH
DEGREE OF RISK. INVESTORS MUST BE PREPARED TO BEAR THE ECONOMIC RISK OF THEIR
INVESTMENT FOR AN INDEFINITE PERIOD AND BE ABLE TO WITHSTAND A TOTAL LOSS OF
THEIR INVESTMENT.
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THE COMPANY HAS ELECTED TO BE TREATED AS AN "S" CORPORATION UNDER THE INTERNAL
REVENUE CODE OF 1986, AS AMENDED, AND HAS FILED SUCH ELECTION IN THOSE
JURISDICTIONS IN WHICH IT DOES BUSINESS, AS MAY BE PERMITTED. AS LONG AS THE
COMPANY CONTINUES TO MAINTAIN ITS "S" CORPORATION STATUS, ANY TRANSFER OF ANY
ONE OF THE COMPANY'S SECURITIES REQUIRES THE COMPANY'S PRIOR WRITTEN CONSENT.
THE COMPANY ANTICIPATES THAT, AS A RESULT OF THE MERGER, OF WHICH THERE CAN BE
NO ASSURANCE, THE COMPANY'S "S" CORPORATION STATUS COULD BE TERMINATED.
INVESTORS SHOULD UNDERSTAND AND BE ADVISED WITH RESPECT TO THE TAX CONSEQUENCES
OF A PURCHASE OF THE SHARES.
THIS TERM SHEET CONSTITUTES AN OFFER ONLY TO THE PERSON NAMED ON THE COVER PAGE,
AND ONLY IF SAID PERSON MEETS THE SUITABILITY STANDARDS SET FORTH IN THIS
CONFIDENTIAL TERM SHEET. SEE "INVESTOR SUITABILITY STANDARDS."
NEITHER THIS TERM SHEET NOR THE SECURITIES OFFERED HEREBY HAS BEEN APPROVED OR
DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES
COMMISSION, NOR HAS THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE
SECURITIES COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS TERM SHEET.
ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
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THE RECIPIENT AGREES BY ACCEPTING THIS TERM SHEET THAT ALL INFORMATION
REGARDING THIS OFFERING AND THE INFORMATION CONTAINED HEREIN AND IN ALL RELATED
AND ANCILLARY DOCUMENTS ARE NOT TO BE USED FOR ANY PURPOSE OTHER THAN IN
CONNECTION WITH ITS CONSIDERATION OF A PURCHASE OF THE SHARES OF CLASS B COMMON
STOCK, THAT SUCH INFORMATION IS OF A CONFIDENTIAL NATURE, THAT THE RECIPIENT
WILL TREAT IT IN A CONFIDENTIAL MANNER, AND THAT IT WILL NOT, DIRECTLY OR
INDIRECTLY, DISCLOSE OR PERMIT ITS AFFILIATES OR REPRESENTATIVES TO DISCLOSE ANY
OF SUCH INFORMATION TO ANY OTHER PERSON OR REPRODUCE THIS CONFIDENTIAL TERM
SHEET, IN WHOLE OR IN PART, WITHOUT THE PRIOR WRITTEN CONSENT OF THE COMPANY.
IN CONNECTION WITH THE OFFERING, NO PERSON HAS BEEN AUTHORIZED TO
PROVIDE ANY INFORMATION WITH RESPECT TO THE COMPANY OR THE SECURITIES, EXCEPT
THE INFORMATION CONTAINED HEREIN. PROSPECTIVE INVESTORS SHOULD NOT RELY ON ANY
INFORMATION NOT CONTAINED IN THIS TERM SHEET. THIS TERM SHEET PRESENTS
INFORMATION WITH RESPECT TO THE COMPANY AS OF THE DATE HEREOF. THE COMPANY DOES
NOT INTEND TO UPDATE OR OTHERWISE REVISE THIS TERM SHEET FOLLOWING ITS
DISTRIBUTION, AND RECIPIENTS OF THIS TERM SHEET SHOULD NOT EXPECT THE COMPANY TO
DO SO. PROSPECTIVE INVESTORS ARE URGED TO CONDUCT AN INDEPENDENT INVESTIGATION
AND EVALUATION OF THE COMPANY.
THE SECURITIES DESCRIBED HEREIN ARE BEING OFFERED TO A LIMITED NUMBER
OF ACCREDITED INVESTORS, AS DEFINED UNDER THE SECURITIES ACT. AN OFFEREE MAY NOT
SOLICIT, DIRECTLY OR INDIRECTLY (WHETHER THROUGH AN AGENT OR OTHERWISE), THE
PARTICIPATION OF ANY OTHER PERSON OR ENTITY IN THIS OFFERING WITHOUT THE PRIOR
WRITTEN APPROVAL OF THE COMPANY.
THIS TERM SHEET DOES NOT CONSTITUTE AN OFFER OR SOLICITATION IN ANY
STATE OR OTHER JURISDICTION IN WHICH SUCH AN OFFER OR SOLICITATION IS NOT
AUTHORIZED.
PROSPECTIVE INVESTORS ARE NOT TO CONSTRUE THE CONTENTS OF THIS TERM
SHEET AS LEGAL OR TAX ADVICE. EACH PROSPECTIVE INVESTOR SHOULD CONSULT AND RELY
UPON ITS OWN COUNSEL, ACCOUNTANT OR BUSINESS ADVISOR AS TO LEGAL, TAX AND
RELATED MATTERS CONCERNING ITS INVESTMENT.
THE COMPANY WILL MAKE AVAILABLE, PRIOR TO THE CONSUMMATION OF THE
OFFERING, TO EACH PROSPECTIVE INVESTOR, ITS PURCHASER REPRESENTATIVE(S), OR
BOTH, THE OPPORTUNITY TO ASK QUESTIONS OF, AND RECEIVE ANSWERS FROM, THE COMPANY
OR A PERSON ACTING ON ITS BEHALF CONCERNING THE TERMS AND CONDITIONS OF THIS
OFFERING, THE COMPANY OR ANY OTHER RELEVANT MATTERS, AND TO OBTAIN ANY
ADDITIONAL INFORMATION, TO THE EXTENT THAT THE COMPANY POSSESSES SUCH
INFORMATION OR CAN ACQUIRE IT WITHOUT UNREASONABLE EFFORT OR EXPENSE, NECESSARY
TO VERIFY THE ACCURACY OF THE INFORMATION SET FORTH HEREIN.
THIS OFFER CAN BE WITHDRAWN AT ANY TIME AND IS SPECIFICALLY MADE
SUBJECT TO THE TERMS DESCRIBED IN THIS TERM SHEET. THE COMPANY RESERVES THE
RIGHT TO REJECT ANY SUBSCRIPTION IN WHOLE OR IN PART OR TO ALLOT TO ANY
PROSPECTIVE INVESTOR LESS THAN THE AMOUNT OF SECURITIES SUBSCRIBED FOR BY SUCH
INVESTOR.
THIS OFFERING IS BEING MADE IN RELIANCE UPON AN EXEMPTION FROM
REGISTRATION UNDER THE SECURITIES ACT FOR AN OFFER AND SALE OF SECURITIES WHICH
DOES NOT INVOLVE A PUBLIC OFFERING. EACH PURCHASER OF THE SECURITIES OFFERED
HEREBY, IN MAKING ITS PURCHASE, WILL BE DEEMED TO HAVE MADE CERTAIN
ACKNOWLEDGMENTS, REPRESENTATIONS AND AGREEMENTS AS SET FORTH UNDER "TRANSFER
RESTRICTIONS."
THIS TERM SHEET HAS BEEN PREPARED BY THE COMPANY SOLELY FOR THE BENEFIT
OF INVESTORS INTERESTED IN THE PROPOSED PRIVATE PLACEMENT OF THE SECURITIES AND
CONSTITUTES AN OFFER ONLY IF THE ACCOMPANYING SUBSCRIPTION PURCHASE AGREEMENT IS
DULY EXECUTED AND RETURNED TO THE COMPANY BY THE OFFEREE. DISTRIBUTION OF THIS
TERM SHEET TO ANY PERSON OTHER THAN SUCH OFFEREE AND THOSE PERSONS RETAINED TO
ADVISE SUCH PERSONS WITH RESPECT THERETO IS UNAUTHORIZED, AND ANY REPRODUCTION
OF THIS TERM SHEET, IN WHOLE OR IN PART, OR THE DIVULGENCE OF ANY OF ITS
CONTENTS, WITHOUT THE PRIOR WRITTEN CONSENT OF THE COMPANY, IS PROHIBITED.
EACH OFFEREE, BY ACCEPTING DELIVERY OF THIS TERM SHEET, AGREES TO
RETURN IT AND ALL RELATED EXHIBITS AND OTHER DOCUMENTS TO THE COMPANY IF: (i)
THE OFFEREE DOES NOT INTEND TO SUBSCRIBE FOR THE PURCHASE OF UNITS OFFERED
HEREBY; (ii) THE OFFEREE"S SUBSCRIPTION IS NOT ACCEPTED, OR (iii) THE OFFERING
IS TERMINATED.
NASAA UNIFORM LEGEND
IN MAKING AN INVESTMENT DECISION INVESTORS MUST RELY ON THEIR OWN
EXAMINATION OF THE ISSUER AND THE TERMS OF THE OFFERING, INCLUDING THE MERITS
AND RISKS INVOLVED. THESE SECURITIES HAVE NOT BEEN RECOMMENDED BY ANY FEDERAL OR
STATE SECURITIES COMMISSION OR REGULATORY AUTHORITY. FURTHERMORE, THE FOREGOING
AUTHORITIES HAVE NOT CONFIRMED THE ACCURACY OR DETERMINED THE ADEQUACY OF THIS
DOCUMENT. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. THESE
SECURITIES ARE SUBJECT TO RESTRICTIONS ON TRANSFERABILITY AND RESALE AND MAY NOT
BE TRANSFERRED OR RESOLD EXCEPT AS PERMITTED UNDER THE SECURITIES ACT OF 1993,
AS AMENDED, AND APPLICABLE STATE SECURITIES LAWS, PURSUANT TO REGISTRATION OR
EXEMPTION THEREFROM. INVESTORS SHOULD BE AWARE THAT THEY WILL BE REQUIRED TO
BEAR THE FINANCIAL RISKS OF THEIR INVESTMENT FOR AN INDEFINITE PERIOD OF TIME.
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DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS
This Term Sheet includes "forward-looking statements" within
the meaning of various provisions of the Securities Act of 1993, as amended (the
"Securities Act"), and the Securities Exchange Act of 1934, as amended (the
"Exchange Act"). All statements, other than statements of historical facts,
included in this Term Sheet that address future activities, events or
developments, including such things as future revenues, product development,
market acceptance, responses from competitors, capital expenditures (including
the amount and nature thereof), business strategy and measures to implement
strategy, competitive strengths, goals, expansion and growth of our business and
operations, plans, references to future success and other such matters, are
forward-looking statements. These statements are based on certain assumptions
and analyses made by us in light of our experience and our assessment of
historical trends, current conditions and expected future developments as well
as other factors We believe are appropriate in the circumstances. However,
whether actual results will conform to our expectations and predictions is
subject to a number of risks and uncertainties that may cause actual results to
differ materially, including the risks and uncertainties discussed in this Term
Sheet; general economic, market or business conditions; the opportunities (or
lack thereof) that may be presented to and pursued by us; competitive actions by
other companies; changes in laws or regulations; and other factors, many of
which are beyond our control. Consequently, all of the forward-looking
statements made in this Term Sheet are qualified by these cautionary statements
and there can be no assurance that the actual results anticipated by us will be
realized or, even if substantially realized, that they will have the expected
consequences to or effects on us or our business or operations.
PRIVATE PLACEMENT PROCEDURES
We undertake to make available to every investor, during the
course of the transaction and prior to sale, the opportunity to ask questions of
and receive answers from us concerning the terms and conditions of the Offering
and to obtain any appropriate additional information (i) necessary to verify the
accuracy of the information contained in this Term Sheet or any other document
given, or to any statement made by us or any person acting on our behalf, to any
prospective investor or (ii) for any other purpose relevant to a prospective
investment in the securities offered hereby, to the extent We possess such
information or can acquire it without unreasonable effort or expense.
All communications or inquires relating to these materials or
to a possible transaction with us should be directed to:
Compliance Systems Corporation
90 Pratt Oval
Glen Cove, New York 11542
Attn: Dean Garfinkel, Chairman
Telephone: (888) 674-6774
Fax: (516) 676-2420
e-mail: dean@callcompliance.com
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THE OFFERING
THE COMPANY:........................
Compliance Systems Corporation ("We" or the
"Company") is a corporation formed in
November 2002 under the laws of the State of
Delaware. In 2002, we effected a corporate
reorganization ("Reorganization") pursuant
to which we became the holding Company for
four wholly-owned subsidiaries: Call
Compliance, Inc. ("CCI"), a corporation
formed under the laws of New York; Call
Compliance.com, Inc. ("CCC"), a corporation
formed under the laws of Delaware; AMS
Network Inc. ("AMS"), a corporation formed
under the laws of New York; and Jasmin
Communications, Inc. ("Jasmin"), a
corporation formed under the laws of New
York. We have an additional wholly-owned
subsidiary, Telephone Blocking Services
Corp. ("Services"), a Company organized
under the laws of New York and in 2004,
entered into a joint venture pursuant to
which we own a fifty percent (50%) interest
in Compliance Testing & Solutions, LLC
("CTS"), a limited liability company formed
under the laws of Delaware. The term
"Company" shall include all operations and
assets of all five subsidiaries identified
above ("Subsidiaries") and our joint venture
interest in CTS.
SUMMARY OF THE OFFERING:...
o DEBT CONVERSION
History of 9% Secured Notes. In December
2003, we concluded a private placement of
Units, each unit consisting of (i) $30,000
principal amount of 9% Secured Notes, due
September 30, 2008 ("9% Secured Notes") and
(ii) Warrants to purchase an aggregate of
20,000 shares of Class B Common Stock
("Warrants"). The 9% Secured Notes are
secured by a first priority security
interest in certain of the Company's
intellectual property. Each Warrant has an
exercise price equal to $1.50 per share,
subject to adjustment in certain instances.
As described below under "Reduction of
Exercise Price of Warrants During Offering
Period," as part of this Offering, the
Company will reduce the exercise price of
the Warrants to $1.00 per share, but only
if, and to the extent, they are exercised
during the Offering Period (as defined
below).
Conversion of 9% Secured Notes. We are
offering the holders of the 9% Secured Notes
the opportunity to convert the principal
thereof into shares of Class B Common Stock
at a purchase price of $1.00 a share ("Debt
Conversion").
Waiver of Interest Obligation From January
1, 2005 through the Termination of the
Offering Period. The Company has not yet
paid its required interest payments on the
9% Secured Notes aggregating $33,750, which
were due April 1, 2005 ("First Quarterly
Interest Obligation"). It could constitute
an event of default, as defined under the 9%
Secured Notes if the Company does not pay
the First Quarterly Interest Obligation by
July 1, 2005.
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Subscribers participating in the Debt
Conversion will be required, as part of the
subscription terms, to permanently and
irrevocably waive in the entirety all rights
to payment of the First Quarterly Interest
Obligation in addition to any additional
interest that accrues through the
termination of the Offering Period ($67,500
in total, through June 30, 2005), and any
default under the 9% Secured Notes, to the
extent one may have existed or exists
("Waiver"). See Paragraph 1.3 of
Subscription Agreement.
o REDUCTION OF EXERCISE PRICE OF WARRANTS
DURING OFFERING PERIOD
The Company has agreed to reduce the
exercise price of the Warrants from $1.50 to
$1.00, but only if they are exercised during
the Offering Period. Warrantholders may
exercise the Warrants in whole or in part.
AGGREGATE AMOUNT OF THE OFFERING;
SECURITIES OFFERED:..............
Up to an aggregate of 2,500,000 shares of
Class B Common Stock, each such share
issuable at a purchase price of $1.00 per
share, as follows:
o DEBT CONVERSION
Up to 1.5 million shares of Class B
Common Stock upon conversion of the 9%
Secured Promissory Notes.
o REDUCTION OF EXERCISE PRICE OF WARRANTS
Up to 1 million shares of Class B
Common Stock upon exercise of the Warrants.
SECURITIES OUTSTANDING PRIOR
TO THE OFFERING..................6,875,003 shares of Class A Common Stock((1))
4,200,000 shares of Class B Common Stock.((2))(4)
SECURITIES OUTSTANDING AFTER THE
OFFERING.......................6,875,003 shares of Class A Common Stock.((1))
6,700,000 shares of Class B Common Stock.((3))((4))
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(1) Gives effect to the sale of 1,250,000 shares of Class A Common Stock to the
Company by Alison Garfinkel and the cancellation thereof.
(2) Gives effect to the issuance of 300,00 shares of Class B Common Stock in
connection with the 2005 Debt Restructuring and Payment In-Kind Program, as
hereinafter defined. See "Restructuring of the Entity Notes." Does not
include up to 1 million shares of Class B Common Stock underlying the
Warrants.
(3) Assumes (i) conversion of all of the 9% Secured Promissory Notes and (ii)
exercise of all the Warrants.
(4) Gives effect to the (i) issuance of 300,000 shares of Class B Common Stock
in connection with the 2005 Debt Restructuring and Payment In-Kind Program
and (ii) issuance of 100,000 shares of Class B Common Stock in connection
with 2004 Payment In-Kind Program Downward Adjustment (as hereinafter
defined) See "Restructuring of the Entity Notes. "
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DESCRIPTION OF CLASS A AND
CLASS B COMMON STOCK;
VOTING CONTROL:....................
Authorized Shares. The Company is authorized
to issue 40,000,000 shares of Common Stock,
$.001 par value per share ("Common Stock"),
consisting of 15 million shares designated
as Class A Common Stock ("Class A Common
Stock") and 25 million shares designated as
Class B Common .
Voting Rights. Only shares of Class A Common
Stock have voting rights. Shares of Class B
Common Stock have no voting rights.
Before and after this Offering, on a
collective basis, at least 92% of the
outstanding Class A Common Stock will be
owned by Dean Garfinkel and Barry Brookstein
(officers, directors and the principal
stockholders of the Company) and Alison
Garfinkel, an officer and director of the
Company who has entered into an agreement in
principal with the Company, pursuant to
which she will resign from such positions,
effective as of May 31, 2005 (hereinafter,
collectively, the "Principal Stockholders").
Accordingly, the Principal Stockholders
have, and following this Offering will
continue to have, effective control over the
Company and the power to control the outcome
of all matters submitted to the vote of the
Company's stockholders, including the power
to elect the full Board of Directors,
increase the authorized capital, dissolve,
merge or sell the assets of the Company.
Dividends. Holders of Class A Common Stock
and Class B Common Stock shall participate
equally per share in any dividend
distribution, to the extent there are any,
without distinction between classes. The
Company has no current intention to make any
dividend distributions in the foreseeable
future. See "Dividend Policy."
Liquidation. In the event of any
liquidation, dissolution or winding up of
the Company, the holders of Class A Common
Stock and Class B Common Stock shall
participate equally per share in any
distribution to stockholders without
distinction between classes.
The Company anticipates that as a result of
the Merger, of which there can be no
assurance, all outstanding shares of Class A
and Class B Common Stock will be exchanged
equally at a certain ratio, which has not
yet been determined, for shares of one class
of voting common stock of the company that
survives the Merger. See "Planned Capital of
Finance Transaction".
8
MINIMUM SUBSCRIPTION:.......................
o DEBT CONVERSION
9% Secured Notes in whole, not part, may be
converted into Class B Common Stock in
connection with the Debt Conversion.
o REDUCTION OF EXERCISE PRICE OF WARRANTS
The Warrants may be exercised in whole or in
part
SUBSCRIPTION PROCEDURE;
PAYMENT:.................................
In order to purchase the shares of Class B
Common Stock offered hereby, each purchaser
must complete and execute the Subscription
Agreement attached hereto as Exhibit "A",
including an Investor Questionnaire which
contains, among other things, investors'
representations regarding their
qualification to purchase the shares of
Class B Common Stock, as summarized in the
"Investor Suitability Standards" section
below, in addition to the following
documents, as applicable:
o DEBT CONVERSION
If subscribers are subscribing for shares of
Class B Common Stock in connection with the
Debt Conversion, each Subscription Agreement
must be accompanied by the original 9%
Secured Promissory Note, which will then be
cancelled.
o EXERCISE OF WARRANTS
If subscribers are exercising Warrants, each
subscription agreement must be accompanied
by the original Warrant and a check made out
to "Compliance Systems Corporation" in the
amount of the aggregate exercise price,
based on an adjusted exercise price of $1.00
per share. To the extent Warrants are only
being exercised in part, warrantholders
will, following the termination of this
Offering, receive replacement warrants
exercisable to purchase a number of shares
of Class B Common Stock equal to the
difference between (i) the number of shares
originally underlying the Warrant and (ii)
the number of shares to be issued upon the
exercise of the Warrant in connection with
this Offering. THE REPLACEMENT WARRANT WILL
CONTINUE TO HAVE AN EXERCISE PRICE OF $1.50.
OFFERING PERIOD:....................
The offering period during which the Company
will accept subscriptions to purchase the
shares of Class B Common Stock (the
"Offering Period") shall commence on the
date of this Term Sheet and shall continue
until the earlier to occur of (i) June 30,
2005 or (ii) conversion of all the 9%
Secured Notes and exercise of all the
Warrants, subject to a thirty day extension,
in the Company's sole discretion.
9
PAYMENTS FOR SUBSCRIPTIONS;
CANCELLATION OR TERMINATION OF
OFFERING; REJECTION OF
SUBSCRIPTIONS:...................
All funds delivered to the Company in
connection with the exercise as Warrants
will be deposited into the working capital
of account of the Company, as and when
received.
This Offering is subject to withdrawal,
cancellation or modification by us, at any
time, without notice. In the event of the
cancellation or termination of this
Offering, all subscriptions (and payments
therefor) received subsequent to such
cancellation or termination will be promptly
returned to investors, without interest.
We also reserve the right to reject any
subscription, in whole or in part, if in our
reasonable judgment We deem such action to
be in our best interest. If any prospective
investor's subscription is rejected, the
funds received on account of such
subscription, or the portion thereof
rejected, shall promptly be returned to such
prospective investor, without interest.
REPRESENTATIONS AND
WARRANTIES:......................
The Subscription Agreement contains a number
of representations and warranties that each
purchaser of shares of Class B Common Stock
will be required to make to us including,
without limitation, representations and
warranties relating to a purchaser's status
as an "accredited investor," the investor's
investment intent regarding the purchase of
the shares of Class B Common Stock offered
hereby and the purchaser's legal authority
to execute the Subscription Agreement.
USE OF PROCEEDS:....................
We plan to apply the proceeds from the
exercise of the Warrants, to the extent
there are sufficient proceeds, in the
following manner, set forth in the order of
application: (i) to pay the First Quarterly
Interest Obligation aggregating $33,750 to
the extent any holders of the 9% Secured
Notes do not participate in the Debt
Conversion (ii) to pay to the holders of the
Entity Notes deferred interest that accrued
or will accrue during the period January 1,
2005 through June 30, 1995 amounting to
$31,500, (iii) in connection with the
purchase of shares of Common Stock from
Alison Garfinkel for an aggregate of
$225,000 ($33,333 which has already been
paid and $66,667 which is due by June 30,
2005, (iv) to repay certain bank
indebtedness in the principal amount of
$350,000, which has been personally
guaranteed by Barry Brookstein, an officer,
director and principal stockholder and (v)
for all operating expenses, including but
not limited to, ongoing debt service
obligations, payment of equipment lease
obligations, salaries and other employee and
executive compensation, consulting fees and
rent. See "Alison Garfinkel Buyout and
Resignation," "Use of Proceeds" and
"Restructuring of Entity Notes."
10
SUBCHAPTER "S" STATUS OF COMPANY:...
The Company has elected to be treated as an
"S" corporation under the Internal Revenue
Code of 1986, as amended ("Code"), and has
filed elections in those jurisdictions in
which it does business, as permitted. In
order to preserve such "S" election, certain
types of entities are precluded from being
stockholders of an "S" corporation.
Accordingly, prospective investors will not
be permitted to transfer the shares of Class
B Common Stock without the Company's prior
written consent as long as the Company
continues to be as "S" corporation. This is
in addition to restrictions on
transferability imposed by applicable
Federal and state securities laws. See
"Transfer Restrictions." In addition, there
are certain tax consequences of being a
stockholder of an "S" corporation. See
"Dividend Policy" and "Income Tax
Considerations." The Company anticipates
that as a result of the Merger, of which
there can be no assurance, the Company's "S"
corporation status could be terminated.
11
BUSINESS
Through the Subsidiaries, we (the "Company") have developed a
compliance technology called the TeleBlock(R) Call Blocking System
("TeleBlock(R)") which is a product that automatically screens and blocks
outbound calls against federal, state, and in-house "do not call" lists. In
December 2001, the technology and process underlying TeleBlock(R) was granted a
patent from the United States Patent and Trademark Office.
Telemarketing companies that subscribe to TeleBlock(R) access it via a
national SS7/IP platform managed by our alliance partner, VeriSign, Inc.
("VeriSign"). This SS7/IP based deployment enables TeleBlock(R) to be offered to
subscribers via standard telephone company offerings, including, but not limited
to, analog telephone lines, T1s and PRIs. TeleBlock(R) was first deployed
through VeriSign in November 2002; since that time, we have been working closely
with VeriSign in its efforts to enter into contracts with telephone carriers to
provide their customers with TeleBlock(R) on a commercial basis. To date, more
than forty (40) telephone carriers and resellers, including Qwest, MCI, XO, and
Paetec have licensed TeleBlock(R) and offer it to their customers who
telemarket. The TeleBlock service is currently being utilized by many Fortune
500 companies, including Cendant, Marriott, and John Hancock.
TeleBlock(R) is also offered, via a Virtual Private Network (VPN)
connection, by predictive dialer companies such as Stratasoft, Marketel, and
TeleDirect, as well as by application service providers such as Sales Lead
Management and VanillaSoft. We believe that delivering TeleBlock(R) in this
manner (via IP) makes TeleBlock(R) available in virtually unlimited
circumstances, and enables overseas telemarketers calling into the U.S. to
seamlessly integrate TeleBlock(R) into their calling operations. In addition, we
are in talks with many other industry leaders such as SER, Noble, Amcat, and
Datatel, to offer this IP version of TeleBlock(R).
The Company continues to seek out additional avenues for enhancing the
value of TeleBlock(R) in the teleservices arena. In 2002, in anticipation of
changes to federal telemarketing rules, the Company filed a provisional patent
application entitled "Caller Id Insertion Process." This TeleBlock(R) add-on
service enables a telemarketer to insert in the SS7 Caller ID packet a calling
number when Caller ID is not available from its equipment or telephone carrier.
Alternatively, this service allows a telemarketer to insert a return number
different from the calling number in the caller packet. The new federal rule
requiring transmission of Caller ID went into effect in January of 2004, and the
new functionality was available shortly thereafter. In 2005, we applied for
patent protection in Greece for a modified version of the TeleBlock(R) system;
this patent, once granted, will apply throughout the European Union. We believe
that having this patent protection in place will enable the Company to deploy
TeleBlock(R) technology world-wide, as the EU countries move to implement Do Not
Call programs similar to those in the United States.
In 2003, we signed agreements with the American Teleservices
Association (ATA) and the American Resort and Development Association (ARDA) to
produce and distribute a co-branded electronic newsletter and an online
co-branded Regulatory Guide(SM) to their members. These publications provide
up-to-the-minute information about developments in the continually changing
legal landscape regarding telemarketing. The Regulatory Guide(SM) boasts
hundreds of subscribers, and has truly become the industry "bible" for
telemarketing related laws and regulations. (The Regulatory Guide(SM) has also
been branded by the Newspaper Association of America and TMCnet, a leading
publisher serving the teleservices industry.) In 2005, we also entered into an
agreement with the ATA to provide to its members an online system designed to
assist telemarketers to easily fill out voluminous state commercial registration
forms (the "Registration Station"). This online service is currently in
development, and we believe will be ready for the teleservices market by the end
of the second quarter of 2005.
We intend that 2005 will also witness our entry into the emerging world
of Voice-Over IP (or "VoIP") communications. In order to accomplish this, we
formed a division called Citadel Telephone Company ("Citadel"). Citadel has
entered into a wholesale reseller agreement by which it will able to sell
TeleBlock(R)-enabled dial tone, via VoIP, across the United States. The launch
date for this additional product offering is scheduled for late June of 2005.
The Citadel TeleBlock(R) service provides the Company yet another avenue by
which TeleBlock(R) can be offered to the teleservices industry.
12
We have also partnered with TPG Telemanagement, Inc. ("TPG"), the
quality control management industry leader for many Fortune 500 clients,
including Discover and Chase, to form an audit/consulting service called
Compliance Testing & Solutions, LLC ("CTS"). CTS offers a complete review and
analysis of a company's calling operations, incorporating all telemarketing
regulations at the state and federal levels. By leveraging the respective
strengths of the Company and TPG, we believe that CTS will be able to meet the
growing needs of teleservices companies to establish the efficacy of their
compliance policies and procedures.
RISK FACTORS
Prospective purchasers of shares should carefully consider the risk
factors contained in this Term Sheet and Section III of the Subscription
Agreement.
MANAGEMENT
DIRECTORS AND EXECUTIVE OFFICERS
The directors and executive officers of the Company, and each of our
Subsidiaries, their positions and ages are as follows:
NAME POSITION AGE
---- -------- ---
Dean Garfinkel Chairman of the Board of 47
Directors and Secretary
Alison Garfinkel President and Director 39
Barry Brookstein Chief Financial Officer, 63
Treasurer and Director
----------------------------------
All directors and officers hold office until the next annual meeting of
holders of shares of Class A Common Stock or until their successors are duly
elected and qualify, with the exception of Alison Garfinkel whose resignation
was effective as of May 31, 2005. Each of the Principal Stockholders and three
minority stockholders of the Company (one which is an employee of the Company)
are the only holders of shares of Class A Common Stock, and accordingly
control the right to elect all of the Company's Directors. Officers are
elected annually by, and serve at the discretion of, the Board of Directors.
There are no familial relationships between or among any officers or directors
of the Company except Dean Garfinkel and Alison Garfinkel who are husband and
wife.
Set forth below are brief descriptions of the recent employment and
business experience of our officers and directors:
DEAN GARFINKEL, 47, has served as Chairman of the Board of Directors
and Secretary of the Company and each of the Subsidiaries since each such entity
was founded. Mr. Garfinkel served as Chief Executive Officer and Director of ASN
Voice & Data Corp. ("ASN"), a telecommunications Company he founded in 1991,
which specialized in providing telephone systems for securities brokerage firms.
In the last calendar quarter of 2001, ASN sold its material assets, none of
which had any relation to the Tele Block System, to a third party ("ASN Sale").
Mr. Garfinkel has served as a communications consultant to fortune 500 companies
and other businesses for over 20 years.
13
ALISON GARFINKEL, 39, has served as President and Director of the
Company and each of the Subsidiaries since each such entity was founded. Ms.
Garfinkel served as Vice President, Secretary and Director of ASN from 1991
until the ASN Sale. On May 18, 2005, the Company entered into an agreement in
principal providing for the resignation of Ms. Garfinkel from all executive
positions with the Company, and as a director, and the Company's purchase from
her of 1,250,000 shares of Class A Common Stock. Subsequent to the consummation
of such transaction, she would be retained as a consultant to the Company. The
Company is in the process of finalizing the definitive documentation. Once
finalized, her resignation would be effective as of May 31, 2005. See below
"Alison Garfinkel Stock Buyout and Resignation" for a more complete description.
BARRY BROOKSTEIN, 63, has served as Chief Financial Officer, Treasurer
and Director of the Company and each of the Subsidiaries (other than AMS)
since each such entity was founded. Since 1962, Mr. Brookstein has been in the
private accounting practice.
EMPLOYMENT AGREEMENTS AND EXECUTIVE COMPENSATION
CCC entered into a five-year employment agreements, effective
as of December 1, 2001, with each of Mr. Garfinkel, Ms. Garfinkel and Mr.
Brookstein, pursuant to which Mr. Garfinkel serves as Chairman of the Board of
Directors and Secretary, Ms. Garfinkel serves as President, and Mr. Brookstein
serves as Chief Financial Officer and Treasurer, in each case, of the Company
and each of the Subsidiaries. Under the terms of the respective employment
agreements, Mr. Garfinkel and Ms. Garfinkel each receive a base salary of
$240,000 per year and Mr. Brookstein received a base salary of $120,000 per
year until July 1, 2003, at which time his base salary was increased to
$240,000 per year (each a "Base Salary"). Each officer is entitled to an
annual bonus from the Bonus Pool (as hereinafter defined), the amount to be
determined in the sole discretion of the Company's Board of Directors, and an
allowance for an automobile of up to $1,000 per month, also to be determined
in the sole discretion of the Company's Board of Directors. Each employment
agreement provides for health insurance and other standard benefits and
contains certain non-competition prohibitions which require that each officer
not engage in any business activities which directly compete with the business
of the Company while he or she is employed by, or a principal stockholder of,
the Company. Commencing in December 2001, each officer agreed to temporarily
defer a portion of his/her annual Base Salary until such date as shall be
determined by the Company's Board of Directors, in its sole discretion, but in
no event later than January 1, 2004. In January 2004, each officer agreed to
continue to defer a portion of his/her Base Salary, along with all past and
future deferred amounts, until such date as to be determined by the Company's
Board of Directors, in its sole discretion, but in no event later than January
1, 2005. In January 2005, each officer agreed to defer his salary on the same
terms for another year. All deferred amounts shall be paid to each executive
in 12 equal monthly payments, commencing on a date to be determined by the
Company's Board of Directors, in its sole discretion; however, all deferred
amounts shall become automatically due and be immediately paid by the Company
to each executive in one lump sum payment upon complete repayment of the
Entity Notes and the Brookstein Loan (as hereinafter defined). See "Prior
Transactions." Each of Mr. and Ms. Garfinkel's respective employment
agreements provide for each of them to devote their full business time to the
activities of the Company. Mr. Brookstein's employment agreement provides that
he devote a portion of his business time to the activities of the Company, as
is required from time to time.
As described above, each Mr. and Ms. Garfinkel's and Mr. Brookstein's
respective employment agreements provide for an annual bonus from the "Bonus
Pool," with the amount of each bonus to be determined in the sole discretion
of the Company's Board of Directors. The Bonus Pool shall be equal to a
percentage of the Company's pre-tax profits after the service of any debt
("Pretax Earnings") on a calendar year basis, starting with 25% of the first
$10 million in Pretax Earnings, and 10% of any Pretax Earnings in excess of
$10 million.
Each of Mr. and Mrs. Garfinkel's and Mr. Brookstein's respective
employment agreements with the Company is guaranteed by the Company.
14
As disclosed under "Alison Garfinkel stock Buyout and Resignation,"
Alison Garfinkel has agreed in principal to resign as an officer and director of
the Company, effective as of May 31, 2005. As of such date, she will be a
consultant to the Company.
ALISON GARFINKEL STOCK BUYOUT AND RESIGNATION
On May 18, 2005, the Company entered into an agreement in principal with
Alison Garfinkel pursuant to which she would sell to the Company at a purchase
price of $.18 per share ($225,000 in the aggregate) 1,250,000 shares of Class
A Common owned by her, and in connection therewith resign as an officer and
director of the Company ("Alison Garfinkel Buyout"). The first $33,333 of the
purchase price was paid on May 18, 2005 and an additional $66,667 is required
to be paid by June 30, 2005. The balance ($125,000) would be payable in the
amount of $7,500 per month from June 2005 through June 2006 and then in the
amount of $2,500 per month from July 2006 through May 2007. Ms. Garfinkel
would also receive five-year warrants to purchase an aggregate of 250,000
shares of Class B Common Stock, exercisable at $1.00 per share, and would be
retained as a consultant to the Company for a twenty-two month period
commencing as of June 1, 2005 at a rate of $2,500 per month. Ms. Garfinkel
will be waiving all Deferred Salary and bonus, agree to the termination of her
Employment Agreement, provide the Company with a general release and agree to
certain non-compete and confidentiality provisions. The Company and Ms.
Garfinkel are in the process of finalizing the documentation with respect to
her stock buyout and resignation, which once finalized, will be effective as
of May 31, 2005.
STOCK OPTION PLAN
We plan to adopt a stock option or other similar stock-based
compensation plan for our officers, directors, employees and consultants in
the future ("Future Plan").
PERSONAL LIABILITY OF DIRECTORS - INDEMNIFICATION OF OFFICERS AND DIRECTORS
The Certificate of Incorporation, of the Company, eliminates the
personal liability of our directors to the Company or to our stockholders for
monetary damages for breach of a fiduciary duty as a director. However, such
personal liability is not eliminated in the event a director breaches his/her
fiduciary duty of loyalty to any Company or to its stockholders, when a
director has not acted in good faith, and in certain other events described in
paragraph 7 of subsection (b) of Section 102 of the Delaware Business General
Corporation Law.
The Certificate of Incorporation, of the Company also allows us to
indemnify our officers and directors, to the fullest extent permitted by the
provisions of Section 145 of the Delaware General Corporation Law, from and
against any and all expenses, liabilities, or other matters referred to in or
covered by said Section, if the officer or director acted in good faith and in
a manner he/she reasonably believed to be in or not opposed to the best
interests of the Company.
Insofar as indemnification for liabilities arising under the Securities
Act, the Securities and Exchange Commission is of the opinion that such
indemnification is against public policy as expressed in the Securities Act
and is therefore unenforceable.
CONFLICTS OF INTEREST
From time-to time, the Principal Stockholders have entered into
transactions with the Company. None of such transactions have, and in the
future will, require the consent of any independent party.
15
SECURITY OWNERSHIP OF CERTAIN
BENEFICIAL OWNERS AND NAMED MANAGEMENT
The following table sets forth the information as of the date hereof
regarding beneficial ownership and voting rights with respect to the Common
Stock of the Company by (i) each person (or group of affiliated persons) who
is known by us to beneficially own more than 5% of the outstanding shares of
Common Stock, (ii) each of our directors, (iii) each of our executive
officers, and (iv) all of our executive officers and directors as a group.
OWNERSHIP VOTING
OWNERSHIP PERCENTAGE PERCENTAGE
SHARES OF COMMON PERCENTAGE AFTER (BEFORE VOTING
NAME OF STOCK BEFORE OFFERING OFFERING) PERCENTAGE
BENEFICIAL OWNER BENEFICIALLY OWNED OFFERING (4) (4)(5) (4)(5)(6) (AFTER OFFERING)
- ------------------------ ------------------------ ------------ ------------ ------------ ----------------
Dean Garfinkel (1) 3,033,751 27.4 22.3 43.6 43.6
- ------------------------ ------------------------ ------------ ------------ ------------ ----------------
Alison Garfinkel (2)(4) 1,488,751 13.4 11.0 21.1 21.1
- ------------------------ ------------------------ ------------ ------------ ------------ ----------------
Barry Brookstein (3) 3,384,376 30.6 24.9 27.7 27.7
- ------------------------ ------------------------ ------------ ------------ ------------ ----------------
All officers and
directors as a group
[3](1)(2)(3) 7,906,878 71.4 58.2 92.4 92.4
- ------------------------ ------------------------ ------------ ------------ ------------ ----------------
Of the 7,906,878 shares of Common Stock owned beneficially by the
Principal Stockholders, 6,355,003 are shares of Class A Common Stock and have
voting rights. There are an additional 250,000 shares of Class A Common Stock
owned by an employee of the Company and a total of 270,000 shares of Class A
Common Stock owned by two other minority stockholders. All other shares of
currently outstanding Common Stock, and shares of Common Stock to be issued
upon exercise of the Warrants, is Class B Common Stock and has no voting
rights. Accordingly, the Principal Stockholders have and will continue to have
effective control over the Company and the power to control the outcome of all
matters submitted to a vote of the Company's stockholders; they have and will
continue to have the power to elect the full Board of Directors of the
Company, increase the authorized capital, dissolve, merge or sell the assets
of the Company, giving them the right to direct the future of the Company. In
addition, the Founders and Principal Stockholders have been granted the First
Repurchase Option and Offering Repurchase Option, respectively, by certain
holders of Class B Common Stock. See "Repurchase Options."
- ---------------------
Footnotes on following page.
16
- -----------Footnotes for table on prior page.------------
(1) Consists of (i) 3,000,001 shares of Class A Common Stock, (ii) 38,750
shares of Class B Common Stock held jointly by Mr. Garfinkel and Ms.
Garfinkel as custodian for their minor children and owned directly by
one of their children. Does not include (i) shares of Class A Common
Stock owned by Mr. Garfinkel's wife, Alison Garfinkel (see footnote 2
below), as to which Mr. Garfinkel disclaims beneficial ownership, (ii)
(a) up to 500,000 shares of Class B Common Stock underlying the First
Repurchase Option that Mr. Garfinkel has the option to purchase (b) up
to 100,000 shares of Class B Common Stock underlying the Offering
Repurchase Option that Mr. Garfinkel has the option to purchase or
(iii) 20,000 shares of Class A Common Stock owned by Mr. Garfinkel's
mother.
(2) Consists of (i) 1,450,001 shares of Class A Common Stock and (ii)
38,750 shares of Class B Common Stock held jointly by Ms. Garfinkel and
Mr. Garfinkel as custodian for their minor children and owned directly
by one of their children. Does not include (i) shares of Class A Common
Stock owned by Ms. Garfinkel's husband, Dean Garfinkel, (see footnote 1
above), as to which Ms. Garfinkel disclaims beneficial ownership or (b)
up to 100,000 shares of Class B Common Stock underlying the Offering
Repurchase Option that Ms. Garfinkel has the Option to purchase. Gives
effect to Alison Garfinkel Buyout.
(3) Consists of (i) 1,905,001 shares of Class A Common Stock and 1,460,000
shares of Class B Common Stock beneficially owned by Mr. Brookstein and
(ii) 19,375 shares of Class B Common Stock owned by Mr. Brookstein as
custodian for his minor children. Does not include (i) Up to 375,000
shares of Class B Common Stock underlying the First Repurchase Option
that Mr. Brookstein has the option to purchase, (ii) up to 100,000
shares of Class B Common Stock that Mr. Brookstein has the option to
purchase underlying the Offering Repurchase Option or (iii) [16,875]
shares of Class B Common Stock held by Mr. Brookstein's adult children.
(4) Based on aggregate of 11,075,003 shares of Common Stock outstanding,
giving effect to (i) the Alison Garfinkel Buyout and cancellation of
1,250,000 share of Class A Common Stock and (ii) the issuance of
100,000 and 300,000 shares of Class B Common Stock in connection with
the 2004 In-Kind Downward Adjustment and 2005 Debt Restructuring and
Payment In-Kind Program, respectively. Does not give effect to the
issuance of up to 1,000,000 shares of Class B Common Stock upon
exercise of the Warrants or any shares of Common Stock that may be
reserved for issuance under any Future Plan.
(5) Assumes (i) conversion of all the 9% Secured Promissory Notes and (ii)
exercise of all the Warrants.
(6) Based on aggregate of 6,875,003 shares of voting Class A Common Stock
outstanding prior to and after this Offering.
17
USE OF PROCEEDS
The Company will receive no proceeds in connection with the Debt
Conversion.
We plan to apply the proceeds from the exercise of the Warrants, to the
extent there are sufficient proceeds, in the following manner, set forth in the
order of application: (i) to pay the First Quarterly Interest Obligation
aggregating $33,750 to the extent any holders of the 9% Secured Notes do not
participate in the Debt Conversion, (ii) to pay the holders of the Entity Notes
deferred interest which accrued or will accrue during the period January 1, 2005
through June 30, 2005 amounting to $31,500, (iii) in connection with the
purchase of shares of Common Stock from Alison Garfinkel for an aggregate of
$225,000 ($ 33,333 of which has already been paid and $66,667 which is due by
June 30, 2005), (iv) to repay certain bank indebtedness in the principal amount
of $350,000, which has been personally guaranteed by Barry Brookstein, an
officer, director and principal stockholder of the Company and (v) for all
operating expenses, including but not limited to, ongoing debt service
obligations, payment of equipment lease obligations, salaries and other employee
and executive compensation, consulting fees and rent. See "Prior Transactions."
In addition to the cash proceeds the Company receives from the exercise
of the Warrants, the Company is required to raise significant additional
capital. See "Planned Capital Finance Transaction".
The foregoing represents our present intentions based upon our present
plans and business conditions. The occurrence of unforeseen events or changed
business conditions, however, could result in the application of the proceeds
of the Offering in a manner other than as described above.
DIVIDEND POLICY
The Company does not have a dividend policy at the present since it
does not intend to distribute any funds in the foreseeable future based on
current results of operations. The Company is currently operating at a loss,
by not generating sufficient revenues to cover operating expenses and its debt
service obligations. Any possible future distributions will depend on the
financial condition and revenues of the Company. The Company will attempt to
make distributions to approximate taxes attributable to stockholders from
subchapter S allocations; however, there is no guaranty that the Company will
have the cash available to do so. The Company anticipates that as a result of
the Merger (as hereinafter defined), of which there can be no assurance, the
Company's "S" corporation status could be terminated.
PRIOR TRANSACTIONS
We were formed on November 7, 2002 under the laws of the State of
Delaware in anticipation of the Reorganization pursuant to which we became the
holding Company for the Subsidiaries. In connection with the Reorganization, the
shareholders of each of CCI, CCC, AMS and Jasmin became shareholders of the
Company.
Development activities with respect to the Tele Block System originally
began prior to 1996 through certain predecessor entities controlled by the
Founders ("Predecessor Entities"). The Founders, directly and through the
Predecessor Entities, have transferred and assigned all rights related to the
Tele Block System and associated telecommunications services and assets to the
Company.
18
During the period July 1996 to December 1999, in order to fund
development activities, one of the Predecessor Entities, borrowed an aggregate
of $700,000 from three lenders ("First Lenders") in return for granting the
First Lenders a portion of the revenues generated under certain
telecommunication contracts owned by certain of the Predecessor Entities,
including certain agreements relating to the Tele Block System. Mr. Brookstein,
an officer, director and principal stockholder of the Company is an officer,
director and principal stockholder of one of the First Lenders which lent the
Company an aggregate of $300,000. In addition, Mr. Brookstein, as custodian for
his minor children, Mr. Brookstein's adult children and Mr. and Ms. Garfinkel,
as custodians for their minor children, are stockholders of one of the First
Lenders which lent the Company an aggregate of $25,000. Such loans were secured
by promissory notes ("Lender's Notes") issued by the Predecessor Entity in the
amount of each loan, and various corporate and individual guarantees, including
that of the Founders ("Prior Guarantees"). In December 2001, the contracts and
related revenue rights were assigned to CCI, one of the Subsidiaries, in return
for CCI assuming the obligations under the Lender's Notes. At such time, the
Lender's Notes were restructured, with self amortizing principal and 18%
interest per annum payable over five years. Also in December 2001, CCI borrowed
an additional $300,000 from an additional party ("Additional Lender") on the
same terms (hereinafter, the First Lenders and Additional Lender collectively
referred to as the "Lenders"). In connection with such loans in the aggregate
principal amount of $1 million ("Lender Loans"), the stockholders of each of the
Lenders (the "Lender Stockholders") (including Mr. Brookstein on his own behalf
and as custodian for his minor children, Mr. Brookstein's adult children and Mr.
and Ms. Garfinkel, as custodian for their minor children), were given the right
to purchase for nominal consideration 26.9% of the outstanding Common Stock of
each of the Subsidiaries then existing, as well as any other companies
subsequently formed in connection with the Tele Block System, as in the case of
Jasmin, which was formed in August 2002 ("Lenders' Subsidiary Stock").
From December 2001 through November 2002 ("Note Deferment Period"), CCI
did not make any payments to the Lenders in connection with the Lender Loans. As
of December 1, 2002, the Lender Loans were further restructured into the Entity
Notes which are due June 1, 2008 ("Entity Notes") in the aggregate principal
amount of $ 1 million, plus unpaid interest during the Note Deferment Period in
the amount of $210,000 ("Deferred Interest"). The interest rate on the Lender
Loans during the Note Deferment Period was increased from 18% to 21% as
compensation to the Lenders for deferring payment of the interest and principal
during such period. Principal on the Entity Notes were to bear interest at the
rate of 21% per annum from December 1, 2002 through May 30, 2003, and thereafter
through May 30, 2008 at the rate of 18% per annum. The New Notes are self
amortizing with Deferred Interest, principal and interest payments payable over
the five-year term commencing June 1, 2003. The New Notes are guaranteed by the
Company and CCC. The Company has not made its monthly payments under the Entity
Notes for the months of January through May 2005. See "Restructuring of Entity
Notes."
In April 2002, in three separate transactions, one of the Predecessor
Entities sold certain fixtures and equipment which have been, and continue to be
used by the Company, to a leasing company for an aggregate of $200,000 with such
equipment to be leased to CCI pursuant to three lease agreements. Because CCI
was a newly formed Company, one of the First Lenders entered into the lease
agreements on behalf of CCI. CCI makes the monthly payments under the lease
agreements directly to the Leasor. CCI and the First Lender have entered into an
agreement assigning to CCI the buy-back provisions contained in the leases. Mr.
Brookstein is an officer, director and principal stockholder of such First
Lender.
In June 2002, one of the First Lenders lent an additional $75,000 to
CCI as evidenced by a self liquidating promissory note due April 2006, with
principal and interest (at the rate of 24% per annum) payable monthly. Mr.
Brookstein is an officer, director and principal stockholder of such First
Lender. This promissory note is guaranteed by the Company and CCC.
In July 2002, CCI borrowed an aggregate of $500,000 from Mr. Brookstein
("Brookstein Loan"). The Brookstein Loan bears interest at 12% per annum,
payable monthly, and was originally due on July 1, 2004, with the maturity date
extended to July 1, 2006. Payments under the Brookstein Loan are current. The
Brookstein Loan is guaranteed by the Company and CCC.
In connection with the Reorganization, all of the Prior Guarantees,
including that of the Founders', were released.
19
The Company occupies facilities originally leased to an unaffiliated
entity controlled by the Founders. The lease subsequently was assigned to the
Company at the same rental price paid by such entity.
RECENT FINANCINGS AND LOANS
In December 2002, the Company concluded a private placement of 600,000
shares of Class B Common Stock at a purchase price of $1.25 per share, raising
an aggregate of $750,000 in gross proceeds ("2002 Offering"). See "Outstanding
Repurchase Options."
In December 2003, the Company concluded a private placement of 50
Units, consisting of the 9% Secured Notes and Warrants, raising an aggregate of
$1.5 million ("2003 Offering"). Such investors were granted a first security
interest in the patent and patent applications and any divisionals and
continuations with respect to certain intellectual property relating to our Tele
Block Systems.
During the period March 2003 to December 2004, from time-to-time the
Principal Stockholders (including, in one case a company controlled by a
Principal Stockholder) have loaned funds to the Company in order to finance
operating activities and debt service obligations. As of the date of this
Confidential Term Sheet, loans from principal stockholders in the aggregate
amount of $1,125,000 are outstanding. Such loans bear interest at the rate of
12% per annum and are due on demand.
In April 2005, the Company obtained a line of credit in the amount of
$250,000 from a bank. Such line of credit was increased to $350,000 in May 2005.
To date, the Company has drawn down the full $350,000 under the line of credit.
Such loan bears interest at the prime rate (as adjusted on a monthly basis).
Barry Brookstein, an officer, director and principal stockholders has personally
guaranteed such loan and pledged certain of his property as collateral. To the
extent the Company raises sufficient proceeds it plans to repay such loan from
the proceeds from the exercise of the Warrants. See "Use of Proceeds."
RESTRUCTURING OF THE ENTITY NOTES
CCI is the obligor and the Company is a guarantor under four separate
promissory notes, each dated December 1, 2002 ("Entity Notes"), which contain
identical terms, but name different payees ("Entities") and reflect different
amounts due thereunder. The Entity Notes were originally issued in the
aggregate principal amount of $1,210,000, $210,000 reflecting deferred
interest for the period December 2001 through November 2002 ("Deferred
Interest") on prior notes in the original aggregate principal amount of $1
million ("Original Principal"), which the Entity Notes replaced in connection
with the restructuring of such indebtedness. See "Prior Transactions" for more
information relating to the Entity Notes and their history.
Pursuant to the Entity Notes, effective as June 1, 2003, the Company is
required to make monthly payments ("Monthly Payments") consisting of the
following allocation (i) amortization of Deferred Interest, (ii) amortization
of interest that accrued at the rate of 21% per annum on the Original
Principal during the period December 1, 2002 through May 31, 2003 ("21%
Accrued Interest"), (iii) amortization of the Original Principal (iv) payment
of interest at the rate of 18% per annum on the Original Principal, as
amortized ("Ongoing 18% Interest Obligation").
All Monthly Payments through December 31, 2003 were made in accordance
with the Entity Notes.
2004 PAYMENT IN-KIND PROGRAM. In an effort to reduce its operating
expenses with respect to certain of its debt service obligations, the Company
and CCI entered into a series of agreements in 2004 pursuant to which the four
holders of the Entity Notes agreed and their respective stockholders ("Entity
Stockholders") received, a portion of their monthly payments of principal and
interest in a combination of cash and in-kind, in shares of Class B Common
Stock ("2004 Payment In-kind Program"). The shares of Class B Common Stock
were issued at a valuation of $1.50 ("Valuation Price"). As a result of the
2004 Payment In-Kind Program, the Company reduced its cash obligations under
the Entity Notes by $300,000 during calendar year 2004 and issued 200,000
shares of Class B Common Stock to the Entity Stockholders. The agreements
governing the 2004 Payment In-Kind Program contained, among other things, a
provision providing for a retroactive adjustment in the Valuation Price in the
event the Company issues during the period ending July 15, 2005 Common Stock
or Common Stock equivalents at an effective purchase price less than $1.50. In
such event, the original purchase price of $1.50 would be adjusted downward to
such adjusted price. As a result of the 2005 Debt Restructuring and Payment
In-Kind Program the Valuation Price will be adjusted downward to $1.00 per
share, resulting in the issuance of an additional 100,000 shares of Class B
Common Stock to the respective Entity Stockholders ("2004 Payment In-Kind
Downward Adjustment").
20
As of December 31, 2004, the Deferred Interest and Original Principal
had been amortized to $143,500 and $773,456, respectively.
2005 DEBT RESTRUCTURING AND PAYMENT IN-KIND PROGRAM. The Company has
not made its Monthly Payments for the months of January through May 2005
("Nonpayment Period") amounting to $153,217 ("Entity Note Arrears") and on
June 20, 2005 entered into an agreement with each of the Entities
("Restructuring Agreements") providing for the restructuring, on a retroactive
and prospective basis for all of calendar year 2005 ("2005"), of the form,
order and timing of its 2005 payment obligations under the Entity Notes
("Restructuring of Entity Notes").
The Restructuring of Entity Notes as provided in each of the
Restructuring Agreements contemplates the issuance by the Company of an
aggregate of 300,000 shares of Class B Common Stock, at an effective purchase
price of $1.00 a share ("In-Kind Shares"), reflecting the in-kind payment of
certain past and future payments under the Entity Notes, as restructured. In
connection with the Restructuring of the Entity Notes, the In-Kind Shares
would be allocated as follows: (i) 71,130 shares would be issued to satisfy,
on a retroactive and prospective basis, the Company's Ongoing 18% Interest
Obligation for the period January 1, 2005 through June 30, 2005 (the
termination date of this Offering) and (ii) 228,870 shares of Class B Common
Stock would be issued to prepay the Original Principal ("Partial Prepayment of
Principal"), so that, giving effect to such prepayment, the balance of the
Original Principal would be $544,586.
Each of the Entities has requested the Company to deliver directly to
the shareholders of each of the Entities their pro-rata share the In-Kind
Shares.
In addition to the issuance of the In-Kind Shares, the Entity Notes
would be further restructured as follows: (i) to defer payment of the 21%
Accrued Interest and Deferred Interest that accrued during the Nonpayment
Period (amounting to $31,500 in the aggregate) until the closing of this
Offering, at which time it will be paid in cash ("Closing Date Payment") and
(ii) to defer payment of all Ongoing 18% Interest Obligations for the period
July 1, 2005 through December 31, 2005, so that they will be accrued and added
to the Original Principal at December 31, 2005. Monthly Payment obligations
with respect to the amortization of Deferred Interest and the 21% Accrued
Interest will continue as of July 1, 2005 pursuant to the original terms of
the Entity Notes.
Pursuant to each of the Restructuring Agreements, at January 1, 2006,
the Company will have complied and be up-to-date with all of its payment
obligations under the Entity Notes and commencing as of such date through May
31, 2008 (the maturity date of the Entity Notes) revert back to the Monthly
Payment schedule, as originally set forth in the Entity Notes.
Pursuant to each of the Restructuring Agreements, each Entity has
agreed to waive, subject to the Company and CCI remaining in full compliance
with the terms of the Restructuring of the Entity Notes, (i) any default that
may have existed with respect to the Entity Notes as a result of the Company
not paying on a timely basis any Monthly Payments during the Non-Payment
Period, and any default that may be deemed to occur as a result of the
Restructuring of the Entity Notes and (ii) any right to late charges that may
have been triggered as a result of the rescheduling of the timing and order of
payments under the Entity Notes. In addition, each entity consented to the
restructured 2005 payment schedule described above, including the prepayment
of a portion of the Original Principal prior to the prepayment of the Deferred
Interest and other interest obligations, the order of payment required in the
Entity Notes.
21
Any failure of the Company to comply with the terms of any of the
Restructuring Agreements would constitute a default under the corresponding
Entity Note, in which case the holder shall have full right and power to
exercise its rights thereunder.
The Company is dependant on the proceeds generated from the exercise of
the Warrants to make the Closing Date Payment aggregating $31,500 to the
Entities. Failure to make such payment on such date to any of the Entities
would be a default under the corresponding Entity Note.
OUTSTANDING REPURCHASE OPTIONS
Each of the Dean and Alison Garfinkel (the "Founders") was originally
granted an option exercisable through December 31, 2007 to purchase from certain
holders of Class B Common Stock an aggregate of One Million shares of Class B
Common Stock at a purchase price of $.67 per share ("First Repurchase Option")
(500,000 shares for each Founder, or 1 million shares in the aggregate), with
the exception of stock held by Mr. Brookstein, individually, in which case the
option was for 125,000 shares of Class B Common Stock in the aggregate. In June
2003, Alison Garfinkel sold her portion of the First Repurchase Option to Barry
Brookstein. Because Ms. Garfinkel's options included options to purchase 125,000
shares of Class B Common Stock owned by Barry Brookstein, giving effect to such
transaction, Mr. Brookstein holds options to purchase 375,000 shares of Class B
Common Stock and Dean Garfinkel holds options to purchase 500,000 shares of
Class B Common Stock from such stockholders.
Dean Garfinkel, Alison Garfinkel and Barry Brookstein (the "Principal
Stockholders") have been granted an option exercisable through December 31,
2007, to purchase from investors who participated in the 2002 Offering an
aggregate of 300,000 shares of Class B Common Stock at a purchase price of $2.50
per share ("Offering Repurchase Option").
Each of the First Repurchase Option and Offering Repurchase Option
(hereinafter, any one being referred to as an "Option," or both as the
"Options") may be exercised an unlimited number of times, at any time, in whole
or in part until December 31, 2007 ("Option Term"); however, neither Option may
be exercised until repayment of the Entity Notes and Brookstein Loan and neither
Option may be exercised on any one occasion to purchase less than 10,000 shares,
or all shares owned by a stockholder, if less than 10,000. The Options are
transferable, in whole or in part, to any third party by each of the Founders in
the case of the First Repurchase Option, and each of the Principal Stockholders,
in the case of the Offering Repurchase Option, but only upon the prior written
consent of the Company's Board of Directors (hereinafter, each Founder,
Principal Stockholder and transferee, as the case may be, referred to as an
"Option Holder" and one or more of such parties as the "Option Holders").
In the event that during the Option Term, to the extent that any part
of either of the Options remains unexercised, the Company effects any stock
dividend, stock split, combination of shares, reclassification, recapitalization
or other similar event affecting its outstanding Class B Common Stock, then the
number and type of securities subject to both Options, and the exercise price
per share, shall be appropriately adjusted so that the Options shall each
thereafter represent the right to purchase, at the same aggregate exercise
price, such number of shares of Class B Common Stock or other securities as have
actually been received by the Option Holder in exchange for or in respect of the
underlying shares of Class B Common Stock.
If any holder of Class B Common Stock sells, assigns, hypothecates or
otherwise transfers any Class B Common Stock, to the extent permitted, the
transferee shall be required, as a condition precedent to agree to the terms of
the applicable Option. Share certificates for Class B Common Stock underlying
such options shall bear a legend with respect to the applicable Option.
22
If on the date during the Option Term which is 90 days prior to the
expiration of the Options ("90-day Date"), any Option has not been exercised in
full by the Holder thereof ("Non-Exercising Option Holder"), then during the
immediately succeeding 15-day period, each of the remaining Option Holder(s)
("Remaining Holder(s)") shall have the right to provide notice to the
Non-Exercising Option Holder(s) of its intent to exercise any Options remaining
unexercised as of the 90-day Date ("Unexercised Options") on the terms thereof
("Notice"). In the event that a Non-Exercising Option Holder does not exercise
all of the Unexercised Options within 30 days of receipt of the Notice ("Final
Exercise Period"), then the Remaining Holder(s) shall have the automatic and
irrevocable right to exercise any Unexercised Options commencing on the
termination of the Final Exercise Period up through the expiration of the
Options. If there is more than one Remaining Holder, then each Remaining Holder
shall be entitled to exercise one-half of the Unexercised Options, unless
otherwise agreed to between the parties; however, each Remaining Holder must
exercise his share of Unexercised Options during the period ending no later than
the close of business on the fifteenth day immediately following the Final
Exercise Period, but in no event later than 5 business days prior to the
expiration of the Options ("Final Shared Exercise Date"). In such case, if one
of the Remaining Holders does not exercise all of his/her interest in the
Remaining Options prior to the Final Shared Exercise Date, then the one
Remaining Holder shall have the automatic and irrevocable right to exercise any
Unexercised Options until the expiration of the Options.
23
PLANNED CAPITAL FINANCE TRANSACTION
As part of a plan to raise significant additional capital, in February
2005, the Company entered into a series of non-binding documents.
The Promissory Note Term Sheet contemplates a bridge loan in the
principal amount of $1 million ("Bridge Loan"), to be extended in two stages.
The first amount of $600,000 would be extended upon completion of execution and
delivery of definitive documents ("Bridge Closing Date"), including the final
documents with respect to the Merger and Line of Credit (both described below).
The balance would be extended two days prior to the filing of the Registration
Statement with the United States Securities and Exchange Commission (as defined
below). The loan would be evidenced in the form of a twelve-month promissory
note bearing interest at the rate of 2% per month, payable monthly, commencing
immediately. The Company would amortize the principal of the note to the extent
of $50,000 per month commencing on the seventh through and including the ninth
month of the note and thereafter would pay $100,000 per month until the note has
been fully satisfied, plus interest in both instances. The promissory note would
be secured by a first security interest in the Company's assets (assuming
conversion of all the 9% Secured Notes in connection with the Debt Conversion).
In addition the Company would pledge a to-be-determined number of shares of
Common Stock which would be issued to the lender upon the conversion of the note
in the event of default, if any. The applicable conversion price would be the
lower of (a) 120% of the closing bid price on the Bridge Closing Date or (b) 70%
of the average of the 3 value lowest closing bid prices for the previous 30
days, assuming there is a public market for the Company's securities, of which
there can be no assurance. The Company has the right to prepay all or any amount
due under the note at face value, plus accrued interest, with a 20% prepayment
premium with 3 days advance notice.
The Company also entered into a letter of intent contemplating the
merger of the Company with a public company that is quoted on the pink sheets
("Merger"). The Company was recently advised that the Merger candidate with
which it entered into the letter of intent is no longer available. Accordingly,
the Company is in the process of locating a new merger candidate.
The final document, the "Standby Equity Distribution Term Sheet"
outlines the material terms of a line of credit ("Line of Credit") pursuant to
which a third party ("Investor") would commit to purchase (subject to certain
terms and conditions) up to $25 million of Common Stock of the Company (or its
successor in the Merger) over a 24 month period at a purchase price equal to 98%
of the lowest daily volume weighted average price of the Common Stock during the
five consecutive trading days after an advance notice ("SEDA"). Each such
advance would be, in the Company's discretion, in an amount up to $1 million
(hereinafter, an "Advance"). The Company would be obligated to file a
Registration Statement covering such Common Stock with the United States
Securities and Exchange Commission within 45 days from the Bridge Closing Date
("Registration Statement"), and have it declared effective within 150 days from
the Bridge Closing Date. The Company would be subject to penalties in the event
such deadlines are not met, or for other named reasons, sales of Common Stock
cannot be made pursuant to the Registration Statement. The Company will pay the
Investor a restructuring fee of $25,000 and on the Bridge Closing Date is
obligated to issue the Investor a debenture in the amount of $325,000, on terms
to be mutually agreed upon. In addition, the Company would be obligated to issue
to the Investor an additional debenture in the amount of $325,000 on similar
terms after it has drawn down advances under the SEDA totaling $12,500,000, and
pay the Investor $100,000, of which $60,000 is due on the Bridge Closing Date
and $40,000 due upon filing of the Registration Statement. Under the SEDA, upon
each Advance, the Investor would receive directly from escrow, cash compensation
a equal to 4% of the gross proceeds of the Advance.
24
The Company is in the process of negotiating the terms of each of the
definitive documents reflecting the Bridge Loan and Line of Credit. The Company
was recently advised that the merger candidate with which it entered the letter
of intent is no longer available for such transaction, and accordingly, the
Company is in the process of locating a new merger candidate. The consummation
of the Bridge Financing, which is the first scheduled to occur of such
transactions, is conditioned upon the Company entering into definitive documents
with respect to the Merger and Line of Credit. There can be no assurance that
the Company will find a suitable merger candidate, or that the Bridge Financing,
Line of Credit and Merger will be consummated in conformance with the above
described terms, if at all.
In August 2004, the Company entered into a consulting agreement with an
individual who is entitled to certain compensation in cash and Common Stock upon
the consummation of the above described transactions and upon the consummation
of certain other applicable transactions described in the consulting agreement.
25
TRANSFER RESTRICTIONS
OFFERS AND SALES OF
SECURITIES ....................
None of such securities may be offered or
sold in the United States by a purchaser in
this Offering except pursuant to an
effective registration statement or in
accordance with an exemption from the
registration requirements of the Securities
Act, as set forth below.
INVESTOR REPRESENTATIONS AND
RESTRICTIONS ON RESALE.........
Each purchaser of the shares hereby will be
deemed to have represented and agreed as
follows:
(1) he or she is acquiring the
shares for his or her own account or for an
account with respect to which he or she
exercises sole investment discretion, and
that he or she is an accredited investor;
(2) he or she understands that the
shares are being offered only in a
transaction not involving any public
offering within the meaning of the
Securities Act, and that if, after the date
of original issuance of the shares he or she
decides to resell, pledge or otherwise
transfer the shares, such shares may be
resold, pledged or transferred only :
(A) pursuant to an
exemption from
registration under
the Securities Act;
or
(B) pursuant to an
effective
registration
statement under the
Securities Act, in
each case in
accordance with any
applicable
securities laws of
any state of the
United States, and
(C) upon the prior
consent of the
Company, as long as
it is a subchapter
"S" corporation.
(D) the purchaser will,
and each subsequent
holder is required
to, notify any
purchaser of such
securities from him
or her of the resale
restrictions
referred to above,
if then applicable;
and
(3) he or she understands that the
following legend will be placed on any
certificate representing the Securities:
"THE SECURITES REPRESENTED BY THIS
CERTIFICATE HAVE NOT BEEN REGISTERED UNDER
THE SECURITIES ACT OF 1933, AS AMENDED (THE
"ACT"), AND MAY NOT BE SOLD, OFFERED FOR
SALE, TRANSFERRED, PLEDGED OR OTHERWISE
DISPOSED OF IN THE ABSENCE OF (A) THE PRIOR
WRITTEN CONSENT OF THE COMPANY, AS LONG AS
THE COMPANY IS A SUBCHAPTER "S" CORPORATION
AND (B) AN EFFECTIVE REGISTRATION STATEMENT
UNDER THE ACT OR AN OPINION OF COUNSEL FOR
THE CORPORATION THAT REGISTRATION THEREOF IS
NOT REQUIRED UNDER THE ACT."
26
INVESTOR SUITABILITY REQUIREMENTS
GENERAL...........................
An investment in the securities offered
hereby involves significant risks and is
suitable only for persons of adequate
financial means who have no need for
liquidity with respect to this investment
and who can bear the economic risk of a
complete loss of their investment. This
Offering is made in reliance on exemptions
from the registration requirements of the
Securities Act, and applicable state
securities laws or regulations.
The suitability standards discussed below
represent minimum suitability standards for
prospective investors. The satisfaction of
such standards by a prospective investor
does not necessarily mean that the
securities are a suitable investment for
such prospective investor. Prospective
investors are encouraged to consult their
personal financial advisors to determine
whether an investment in the securities is
appropriate. We may reject subscriptions for
the securities, in whole or in part, in our
absolute discretion.
We will require each investor to represent
in writing, among other things, that (i) by
reason of the investor's business or
financial experience, or that of the
investor's professional advisor, the
investor is capable of evaluating the merits
and risks of an investment in the securities
and of protecting its own interest in
connection with the Offering, (ii) the
investor is acquiring the securities for its
own account, for investment only and not
with a view toward the resale or
distribution thereof, (iii) the investor is
aware that the shares have not been
registered under the Securities Act or any
state securities laws and that transfer
thereof is restricted by the Securities Act,
applicable state securities laws, and the
subscription agreement to be entered into in
connection with the purchase of the
securities, and the investor is aware of the
absence of a market for the securities,
other securities to be received upon
conversion and (iv) such investor meets the
suitability requirements set forth below.
SUITABILITY
REQUIREMENTS...................
Unless otherwise approved by the Company,
each investor must represent in writing that
it qualifies as an "accredited investor," as
such term is defined in Rule 501(a) of
Regulation D promulgates under the
Securities Act, and must demonstrate the
basis for such qualification. To be an
accredited investor, an investor must fall
within any of the following categories at
the time of the sale of securities to that
investor:
(1) A bank as defined in Section
3(a)(2) of the Securities Act, or a savings
and loan association or other institution as
defined in Section 3(a)(5)(A) of the
Securities Act, whether acting in its
individual or fiduciary capacity; a broker
or dealer registered pursuant to Section 15
of the Exchange Act; an insurance company as
defined in Section 2(13) of the Securities
Act; an investment company registered under
the Investment Company Act of 1940 or a
business development company as defined in
Section 2(a)(48) of that act; a Small
Business Investment Company licensed by the
U.S. Small Business Administration under
Section 301(c) or (d) of the Small Business
Investment Act to 1958; a plan established
and maintained by a state or its political
subdivisions, and maintained by a state, its
political subdivisions, or any agency or
instrumentality of a state or its political
subdivisions, for the benefit of its
employees, if such plan has total assets in
excess of $5,000,000; an employee benefit
plan within the meaning of the Employee
Retirement Income Security Act of 1974, if
the investment decision is made by a plan
fiduciary, as defined in Section 3(21) of
that act, which is either a bank, savings
and loan association, insurance company, or
registered investment advisor, or if the
employee benefit plan has total assets in
excess of $5,000,000, or, if a self-directed
plan, with investment decisions made solely
by persons that are accredited investors;
27
(2) A private business development
company as defined in Section 202(a)(22) of
the Investment Advisors Act of 1940;
(3) An organization described in
Section 501(c)(3) of the Internal Revenue
Code, a corporation, a Massachusetts or
similar business trust, or a partnership,
not formed for the specific purpose of
acquiring the securities, with total assets
in excess of $5,000,000;
(4) A director or executive officer
of the Company;
(5) A natural person whose
individual net worth, or joint net worth
with that person's spouse, at the time of
such person's purchase of the securities
exceeds $1,000,000;
(6) A natural person who has an
individual income in excess of $200,000 in
each of the two most recent years or joint
income with that person's spouse in excess
of $300,000 in each of those years and has a
reasonable expectation of reaching the same
income level in the current year;
(7) A trust, with total assets in
excess of $5,000,000, not formed for the
specific purpose of acquiring the
securities, whose purchase is directed by a
sophisticated person as described in Rule
506(b)(2)(ii) of Regulation D; and
(8) An entity in which all of the
equity owners are accredited investors (as
defined above).
28
As used in this Term Sheet, the term "net
worth" means the excess of total assets over
total liabilities. In computing net worth
for the purpose of (5) above, the principal
residence of the investor must be valued at
cost, including costs of improvements, or at
recently appraised value by an institutional
lender making a secured loan, net of
encumbrances. In determining income, an
investor should add to the investor's
adjusted gross income any amounts
attributable to tax exempt income received,
losses claimed as a limited partner in any
limited partnership, deductions claimed for
depletion, contributions to an IRA or Keogh
retirement plan, alimony payments, and any
amount by which income for long-term capital
gains has been reduced in arriving at
adjusted gross income.
In order to meet the conditions for
exemption from the registration requirements
under the securities laws of certain
jurisdictions, investors who are residents
of such jurisdictions may be required to
meet additional suitability requirements.
In addition to the suitability standards set
forth above, the Company will assess each
prospective investor to ascertain that such
purchaser's subscription will not impair the
Company's plan to file a sub "S" election.
INCOME TAX CONSIDERATIONS
THIS CONFIDENTIAL TERM SHEET DOES NOT CONSTITUTE INVESTMENT, LEGAL OR
TAX ADVICE WITH RESPECT TO THE SUBSCRIPTION FOR CLASS B COMMON STOCK OFFERED
HEREBY. EACH PROSPECTIVE PURCHASER SHOULD CONSULT HIS OR HER OWN TAX ADVISOR
WITH RESPECT TO THE INCOME TAX ISSUES AND CONSEQUENCES CONCERNING PURCHASING,
HOLDING AND DISPOSING OF THE SHARES OFFERED HEREBY, IN EACH CASE, AS THEY MAY
PERTAIN TO THE PURCHASER'S OWN PERSONAL SITUATION.
29
EXHIBIT A
SUBSCRIPTION AGREEMENT
See below page 33
EXHIBIT B
AUDITED FINANCIAL STATEMENTS
FOR THE YEARS ENDED
DECEMBER 31, 2003 AND 2004
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COMPLIANCE SYSTEMS CORPORATION
SUBSCRIPTION AGREEMENT made as of the acceptance date indicated on the
signature page hereof between COMPLIANCE SYSTEMS CORPORATION, a Delaware
corporation, with its principal offices at 90 Pratt Oval, Glen Cove, New York
11542 (the "Company") and the undersigned (the "Subscriber").
WHEREAS, in December 2002 the Company concluded a private placement of
50 units, raising aggregate gross proceeds of $1.5 million ("Units"), each Unit
consisting of (i) a 9% secured Promissory Note in the principal amount of
$30,000 ("9% Secured Notes"), and (ii) warrants ("Warrants") to purchase an
aggregate of 20,000 shares of non-voting Class B Common Stock, par value $.001
per share ("Class B Common Stock).
WHEREAS, the Company is in arrears with respect to certain payments due
under the 9% Secured Notes.
WHEREAS, the Company wishes to reduce its debt and ongoing interest
obligations as well as raise additional capital and accordingly, pursuant to a
Confidential Term Sheet dated June 20, 2005 ("CTS") the Company is offering
("Offering") (i) the holders of the 9% Secured Notes the opportunity to convert
the principal indebtedness into shares of Class B Common Stock at a purchase
price of $1.00 per share ("Debt Conversion") and (ii) holders of the Warrants
the opportunity to exercise the Warrants at a reduced exercise price of $1.00
per share (reduced from $1.50), but only to the extent that they are exercised
during the Offering, which is scheduled to terminate the earlier of (i) June 30,
2005 or (ii) conversion of all the 9% Secured Notes and exercise of all the
Warrants, subject to a thirty day extension, in the Company's sole discretion
("Offering Period").
WHEREAS, the Company is offering the shares of Class B Common Stock in
connection with the Debt Conversion and exercise of the Warrants pursuant to
Rule 506 of Regulation D promulgated under the Securities Act of 1933, as
amended (the "Act"), to "accredited investors" only, as such term is defined in
Rule 501(a) of said Regulation D.
DEBT CONVERSION - 9% SECURED NOTES. IN DECEMBER 2003
WHEREAS, the Company has not yet paid its required interest payments on
the 9% Secured Notes aggregating $33,750, for the period January through March
2005 which were due April 1, 2005 ("First Quarterly Interest Obligation"). It
could constitute an event of default, as defined under the 9% Secured Notes, if
the Company does not pay the First Quarterly Interest Obligation by July 1,
2005.
WHEREAS, subscribers participating in the Debt Conversion will be
required, as part of the subscription terms, to permanently and irrevocably
waive in the entirety (i) all rights to payment of the First Quarterly Interest
Obligation and any other interest that is to accrue under the 9% Secured Notes
during the period of April through the termination of the Offering Period ("Full
Interest Obligation") and (ii) any default under the 9% Secured Notes, to the
extent one may have existed or exists ("Waiver").
WHEREAS, the 9% Secured Notes may be converted in, whole, not in part.
REDUCTION OF EXERCISE PRICE OF WARRANTS.
WHEREAS, in an effort to raise additional capital, the Company has
agreed to reduce the exercise price of the Warrants from $1.50 to $1.00, but
only if they are exercised during the Offering Period. Warrantholders may
exercise the Warrants in whole or in part.
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NOW, THEREFORE, for and in consideration of the premises and
the mutual covenants hereinafter set forth, the parties hereto do hereby agree
as follows:
I. CONVERSION OF 9% SECURED NOTES; WAIVER OF INTEREST AND DEFAULT
1.1 Subject to the terms and conditions hereinafter set forth, the
subscriber(s) hereby agrees to convert the outstanding principal on the 9%
Secured Note held by him, in whole, into shares of Class B Common Stock, at an
effective purchase price of $1.00 per share, resulting in the issuance by the
Company of that number of shares of Class B Common Stock set forth on the Debt
Conversion Signature Page (Page 8 of this Agreement) ("Conversion Shares").
1.2 In connection with the subscription hereunder, the Subscriber
understands that he will be receiving one share of Class B Common Stock, for
every dollar of principal indebtedness currently outstanding under the 9%
Secured Note, and upon the delivery of the 9% Secured Note to the Company
accompanied by this Subscription Agreement, and the issuance of the Conversion
Shares, the 9% Note will be cancelled and have no force and/or effect.
1.3 Subscriber agrees to (i) permanently and irrevocably waive all
rights to payment of the Full Interest Obligation and (ii) waive any default
that may have existed at any point during the term of the 9% Secured Note, or
exists as of the date hereof, under the 9% Secured Note.
1.4 The Subscriber understands that there can be no assurance that all
(or any other) holders of the 9% Secured Notes will agree to convert the related
outstanding principal indebtedness in connection with the Debt Conversion.
II. EXERCISE OF WARRANTS.
2.1 Subject to the terms and conditions hereinafter set forth, the
Subscriber hereby agrees to exercise the Warrant in his name to purchase that
number of shares of Class B Common Stock for the aggregate purchase price
("Aggregate Purchase Price"), both as set forth on the Warrant Exercise
Signature Page of this Agreement (Page 9). The Warrant may be exercised in
whole, or in part.
2.2 Subscriber understands that the Company has agreed to reduce the
exercise price of the Warrant to $1.00 (from $1.50), only if it is exercised
prior to June 30, 2005, the termination of the Offering Period.
2.3 Subscriber understands that in the event he does not exercise the
Warrant during the Offering Period, the exercise price shall continue to be
$1.50 during the remainder of the term of the Warrant, until September 30, 2008.
2.4 Subscriber understands that if he exercises the Warrant in part,
following the Offering Period, he will receive a replacement Warrant exercisable
to purchase a number of shares of Class B Common Stock equal to the difference
between (i) the number of shares originally underlying the Warrant and (ii) the
number of shares the subscriber is purchasing pursuant to this Agreement
("Replacement Warrant").
2.5 Subscriber understands that the Replacement Warrant will be
identical in all respects to the original warrant, including reflecting an
exercise price of $1.50.
2.6 Upon exercise of the Warrant subscriber hereby delivers to the
Company, accompanied by this Agreement (i) the original Warrant and (ii) a check
made payable to "Compliance Systems Corporation" for the Aggregate Purchase
Price. If Subscriber is exercising the Warrant in whole, the Warrant will be
cancelled, and have no further force and/or effect.
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III. REPRESENTATIONS BY AND COVENANTS OF SUBSCRIBER.
3.1 Subscriber understands that the Company will receive no proceeds in
connection with the Debt Conversion and there can be no assurance as to the
amount of proceeds generated in connection with the Warrants. All funds
delivered to the Company in connection with the exercise of Warrants will be
deposited into the working capital account of the Company, as and when received.
Should only a small portion of the Warrants be exercised, the Company may be
unable to adequately accomplish the goals set forth in "Use of Proceeds" of the
CTS.
3.2 The Subscriber recognizes that the subscription for the shares of
Class B Common Stock involves a high degree of risk and that, among other
things, to date, the Company has primarily been involved in start-up and
development activities and has not generated sufficient revenues to satisfy
ongoing operating expenses and debt service obligations. At December 31, 2004,
the Company had an accumulated deficit of $5,273,418 and for each of the years
ended December 31, 2002, 2003 and 2004, the Company had consolidated net losses
from operating activities of $2,099,141, $1,880,508 and $1,293,769,
respectively. There can be no assurance that any revenues generated by the
Company's business will be sufficient to support the Company's planned
development and growth activities and debt service obligations or that the
Company will ever operate on a profitable basis.
3.3 The Subscriber understands that the Class B Common Stock has no
voting rights and, accordingly, a subscriber will not be afforded any right to
vote on any matter as it relates to the Company, its management or future
operations. Subscriber further understands that an aggregate of approximately
92% of the Company's Class A Common Stock, which is the only Common Stock of the
Company with voting rights, is owned by Dean Garfinkel, Alison Garfinkel, and
Barry Brookstein (collectively the "Principal Stockholders"), giving such
individuals the right to direct the future of the Company by giving them the
power to control the outcome of all matters submitted to the vote of the
Company's stockholders, including the right to elect the Board of Directors,
increase the authorized capital and dissolve, merge or sell the assets of the
Company. The Subscriber acknowledges that is aware that Alison Garfinkel has
entered into an agreement in principal providing, among other things, for her
resignation from her executive position with the Company and as a director, as
disclosed in the CTS. Messrs. Garfinkel and Brookstein are officers and
directors of the Company.
3.4 The Subscriber represents that he is an "accredited investor" as
such term is defined in Rule 501(a) of Regulation D promulgated under the Act,
as indicated by his responses to the investor questionnaire attached hereto as
Schedule "A" delivered herewith by the Subscriber ("Investor Questionnaire"),
and that he is able to bear the economic risk of an investment in the Units.
3.5 The Subscriber acknowledges that he has prior investment
experience, including investment in non-listed and non-registered securities, or
he has employed the services of an investment advisor, attorney or accountant to
read all of the documents furnished or made available by the Company both to him
and to all other prospective investors and to evaluate the merits and risks of
such an investment on his behalf, and that he recognizes the highly speculative
nature of this investment.
3.6 The Subscriber hereby represents that he has received and reviewed
the CTS and that he has been furnished by the Company during the course of this
transaction with all information regarding the Company which he has requested or
desired to know; that all documents which could be reasonably provided have been
made available for his inspection and review; and that he has been afforded the
opportunity to ask questions of and receive answers from duly authorized
officers or other representatives of the Company concerning the business and
other aspects of the Company.
3.7 The Subscriber acknowledges that the Company has filed an election
as an "S" corporation under the Internal Revenue Code of 1986, as amended
("Code"), and has filed in other jurisdictions where it does business, as
permitted ("Jurisdiction"). Subscriber agrees to execute upon request by the
Company, any and all documentation as may be required for the Company to make a
sub "S" election under any such Jurisdiction. As long as the Company remains a
"S" corporation, the Subscriber agrees not to transfer the Securities without
the Company's prior written consent. The Subscriber acknowledges and understands
that the Company is currently seeking to raise additional capital, as disclosed
in the CTS, which may involve its merger with a public shell corporation. The
Company anticipates that as a result of such merger, of which there can be no
assurance, the Company's "S" corporation status could be terminated. See CTS
Section "Planned Capital Finance Transaction" for more details regarding the
Company's plans in this regard
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3.8 The Subscriber acknowledges that by virtue of the Company's "S"
election and otherwise, the Offering as well as his status as a stockholder of
an "S" corporation may involve tax consequences and that the Company has not
provided him with any tax advice or information. The Subscriber acknowledges
that he must retain his own professional advisors to evaluate the tax and other
consequences of an investment in the Units.
3.9 The Subscriber acknowledges that the Offering has not been reviewed
by the United States Securities and Exchange Commission ("SEC") because of the
Company's representations that this is intended to be a nonpublic offering
pursuant to Sections 4(2) or 3(b) of the Act. The Subscriber represents that the
Securities are being purchased for his own account, for investment and not for
distribution or resale to others. The Subscriber agrees that he will not sell,
assign, hypothecate or otherwise transfer such securities unless they are
registered under the Act or unless an exemption from such registration is
available.
3.10 The Subscriber understands that the Securities have not been
registered under the Act by reason of a claimed exemption under the provisions
of the Act which depends, in part, upon his investment intention. In this
connection, the Subscriber understands that it is the position of the SEC that
the statutory basis for such exemption would not be present if his
representation merely meant that his present intention was to hold such
securities for a short period, such as the capital gains period of tax statutes,
for a deferred sale, for a market rise, assuming that a market develops, or for
any other fixed period. The Subscriber realizes that, in the view of the SEC, a
purchase now with an intent to resell would represent a purchase with an intent
inconsistent with his representation to the Company, and the SEC might regard
such a sale or disposition as a deferred sale to which such exemptions are not
available.
3.11 The Subscriber understands that there is no public market for any
of the securities of the Company. The Subscriber understands that even if a
public market develops for any of the Company's securities, Rule 144 (the
"Rule") promulgated under the Act requires, among other conditions, a one year
holding period prior to the resale (in limited amounts) of securities acquired
in a non-public offering without having to satisfy the registration requirements
under the Act. The Subscriber understands that the Company makes no
representation or warranty regarding its fulfillment in the future of any
reporting requirements under the Securities Exchange Act of 1934, as amended, or
its dissemination to the public of any current financial or other information
concerning the Company, as is required by the Rule as one of the conditions of
its availability. The Subscriber understands and hereby acknowledges that the
Company is under no obligation to register any of the Securities under the Act.
The Subscriber consents that in addition to the prior written consent of the
Company, as set forth in Section 3.7 and other conditions and limitations
regarding transferability as contained herein and in the CTS, the Company will
permit the transfer of the Securities out of his name only when his request for
transfer is accompanied by an opinion of counsel reasonably satisfactory to the
Company that neither the sale nor the proposed transfer results in a violation
of the Act or any applicable state "blue sky" laws (collectively "Securities
Laws"). The Subscriber agrees to hold the Company and its directors, officers
and controlling persons and their respective heirs, representatives, successors
and assigns harmless and to indemnify them against all liabilities, costs and
expenses incurred by them as a result of any misrepresentation made by him
contained herein or in the Investor Questionnaire, or any sale or distribution
by the undersigned Subscriber in violation of any Securities Laws.
3.12 The Subscriber consents to the placement of a legend on any
certificate or other document evidencing the Securities stating that they have
not been registered under the Act and setting forth or referring to the
restrictions on transferability and sale thereof set forth in Sections 3.7, 3.9
and 3.11 above.
3.13 The Subscriber understands that the success of the Company will be
dependent, to a significant extent, upon its ability to attract and retain
additional qualified personnel and upon the continued services of Dean
Garfinkel. As of December 1, 2002, the Company entered into five-year Employment
Agreements with Dean Garfinkel. Should Mr. Garfinkel become incapacitated or
leave the Company's employ, the Company might not be able to find a suitable
replacement. See Section 3.3 with respect to Alison Garfinkel resignation and
related disclosure in the CTS.
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3.14 The Subscriber understands that the Company's success will depend
on, among other things, its ability to enforce patent protection for its
technologies, both in the United States and other countries. There can be no
assurance that the Company's patents will protect the Company against
competitors. Any failure by the Company to enforce patent protection could have
an adverse effect on the Company's business, operating results and financial
condition. With regard to provisional and final patent applications, there is no
assurance that they will issue as patents. In addition, no assurance can be
given that any patent issued to the Company will not be challenged, invalidated
or circumvented or that the rights granted thereunder will provide adequate
protection to the Company's products.
3.15 The Subscriber understands that the Company will review and rely
on this Subscription Agreement and the Investor Questionnaire delivered
herewith. The Company reserves the unrestricted right to reject or limit any
subscription and to close the offer at any time.
3.16 The Subscriber hereby represents that the address of the
Subscriber furnished by him at the end of this Subscription Agreement is the
undersigned's principal residence if he is an individual or its principal
business address if it is a corporation or other entity.
3.17 The Subscriber acknowledges that if he is a Registered
Representative of a National Association of Securities Dealers, Inc. ("NASD")
member firm, he must give such firm the notice required by the NASD Conduct
Rules, or any applicable successor rules of the NASD receipt of which must be
acknowledged by such firm on the signature page hereof.
3.18 The Subscriber hereby represents that, except as set forth in this
Subscription Agreement and in the CTS, no representations or warranties have
been made to the Subscriber by the Company or any agent, employee or affiliate
of the Company and, in entering into this transaction, the Subscriber is not
relying on any information, other than as set forth above or that resulting from
any independent investigation by the Subscriber.
3.19 The Subscriber acknowledges that at such time, if ever, as any of
the Securities are registered, sales of such securities will be subject to state
securities laws, including those of New Jersey which require any securities sold
in New Jersey to be sold through a registered broker-dealer or in reliance upon
an exemption from registration.
IV. TERMS OF SUBSCRIPTION.
4.1 The subscription period will begin as of the date hereof and will
terminate the earlier of (i) at 11:59 PM June 30, 2005 or (ii) conversion of all
the 9% Secured Notes and exercise of all the Warrants, unless extended by the
Company, in its sole discretion, for up to an additional 30 days (the
"Termination Date").
4.2 The Subscriber hereby authorizes and directs the Company to deliver
the Securities to be issued to such Subscriber pursuant to this Subscription
Agreement to the residential or business address indicated in the Investor
Questionnaire.
4.3 The Subscriber hereby authorizes and directs the Company to return
any funds for unaccepted subscriptions to the same account from which the funds
were drawn.
4.4 If the Subscriber is not a United States person, such Subscriber
hereby represents that it has satisfied itself as to the full observance of the
laws of its jurisdiction in connection with any invitation to subscribe for the
Units or any use of this Agreement, including (i) the legal requirements within
its jurisdiction for the purchase of the Securities, (ii) any foreign exchange
restrictions applicable to such purchase, (iii) any governmental or other
consents that may need to be obtained, and (iv) the income tax and other tax
consequences, if any, that may be relevant to the purchase, holding, redemption,
sale or transfer of the Securities. Such Subscriber's subscription and payment
for, and his or her continued beneficial ownership of the Securities, will not
violate any applicable securities or other laws of the Subscriber's
jurisdiction.
V. MISCELLANEOUS.
5.1 Any notice or other communication given hereunder shall be deemed
sufficient if in writing and sent by registered or certified mail, return
receipt requested, addressed to the Company, at its registered office, 90 Pratt
Oval, Glen Cove, New York 11542, Attention: Chairman and, to the Subscriber at
his address indicated on the last page of this Subscription Agreement. Notices
shall be deemed to have been given on the date of mailing, except notices of
change of address, which shall be deemed to have been given when received.
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5.2 This Subscription Agreement shall not be changed, modified or
amended except by a writing signed by the parties to be charged, and this
Subscription Agreement may not be discharged except by performance in accordance
with its terms or by a writing signed by the party to be charged.
5.3 This Subscription Agreement shall be binding upon and inure to the
benefit of the parties hereto and to their respective heirs, legal
representatives, successors and assigns. This Subscription Agreement sets forth
the entire agreement and understanding between the parties as to the subject
matter thereof and merges and supersedes all prior discussions, agreements and
understandings of any and every nature among them.
5.4 Notwithstanding the place where this Subscription Agreement may be
executed by any of the parties hereto, the parties expressly agree that all the
terms and provisions hereof shall be construed in accordance with and governed
by the laws of the State of New York, without regard to conflicts of law
principles. The parties hereby agree that any dispute which may arise between
them arising out of or in connection with this Subscription Agreement shall be
adjudicated before a court located in New York City and they hereby submit to
the exclusive jurisdiction of the courts of the State of New York located in New
York, New York and of the federal courts in the Southern District of New York
with respect to any action or legal proceeding commenced by any party, and
irrevocably waive any objection they now or hereafter may have respecting the
venue of any such action or proceeding brought in such a court or respecting the
fact that such court is an inconvenient forum, relating to or arising out of
this Subscription Agreement or any acts or omissions relating to the sale of the
securities hereunder, and consent to the service of process in any such action
or legal proceeding by means of registered or certified mail, return receipt
requested, in care of the address set forth below or such other address as the
undersigned shall furnish in writing to the other.
5.5 This Subscription Agreement may be executed in counterparts. Upon
the execution and delivery of this Subscription Agreement by the Subscriber,
this Subscription Agreement shall become a binding obligation of the Subscriber
with respect to the purchase of Class B Common Stock as herein provided;
subject, however, to the right hereby reserved to the Company to enter into the
same agreements with other subscribers and to add and/or to delete other persons
as subscribers.
5.6 The holding of any provision of this Subscription Agreement to be
invalid or unenforceable by a court of competent jurisdiction shall not affect
any other provision of this Subscription Agreement, which shall remain in full
force and effect.
5.7 It is agreed that a waiver by either party of a breach of any
provision of this Subscription Agreement shall not operate, or be construed, as
a waiver of any subsequent breach by that same party.
5.8 The parties agree to execute and deliver all such further
documents, agreements and instruments and take such other and further action as
may be necessary or appropriate to carry out the purposes and intent of this
Subscription Agreement.
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DEBT CONVERSION SIGNATURE PAGE
IN WITNESS WHEREOF, the parties have executed this Subscription Agreement as of
the acceptance date by the Company indicated below.
- ------------------------------------- ------------------------------------
Signature of Subscriber Signature of Co-Subscriber
- ------------------------------------- ------------------------------------
Name of Subscriber Name of Co-Subscriber
[please print]
- ------------------------------------- ------------------------------------
Address of Subscriber Address of Co-Subscriber
- ------------------------------------- ------------------------------------
Social Security or Taxpayer Social Security or Taxpayer
Identification Number of Subscriber. Identification Number of
Co-Subscriber
- ---------------------------------------------------------------
OUTSTANDING PRINCIPAL OF 9% SECURED NOTES:
_____________________________________ Subscription Accepted:
NUMBER OF SHARES OF CLASS B COMMON STOCK COMPLIANCE SYSTEMS CORPORATION
ISSUED
BY:________________________________
Title: ______________________
DATE:________________________
*IF SUBSCRIBER IS A REGISTERED REPRESENTATIVE
WITH AN NASD MEMBER FIRM, HAVE THE FOLLOWING
ACKNOWLEDGEMENT SIGNED BY THE APPROPRIATE PARTY:
The undersigned NASD member firm acknowledges receipt of the notice required by
Rule 3050 of the NASD Conduct Rules.
- ------------------------------
Name of NASD Member Firm
By:___________________________
Authorized Officer
THE ORIGINAL 9% NOTE MUST ACCOMPANY A SIGNED SUBSCRIPTION AGREEMENT.
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WARRANT EXERCISE SIGNATURE PAGE
IN WITNESS WHEREOF, the parties have executed this Subscription Agreement as of
the acceptance date by the Company indicated below.
- ------------------------------ ------------------------------------
Signature of Subscriber Signature of Co-Subscriber
- ------------------------------ ------------------------------------
Name of Subscriber Name of Co-Subscriber
[please print]
- ------------------------------ ------------------------------------
Address of Subscriber Address of Co-Subscriber
- ------------------------------ ------------------------------------
Social Security or Taxpayer Social Security or Taxpayer
Identification Number of Subscriber Identification Number of
Co-Subscriber
______________________________ Subscription Accepted:
NUMBER OF SHARES OF CLASS B COMPLIANCE SYSTEMS CORPORATION
COMMON STOCK TO BE ISSUED UPON
EXERCISE OF WARRANT BY:___________________________
$ __________________________________________ Title: __________________
AGGREGATE EXERCISE PRICE
DATE:____________________
*IF SUBSCRIBER IS A REGISTERED REPRESENTATIVE
WITH AN NASD MEMBER FIRM, HAVE THE FOLLOWING
ACKNOWLEDGEMENT SIGNED BY THE APPROPRIATE PARTY:
The undersigned NASD member firm acknowledges receipt of the notice required by
Rule 3050 of the NASD Conduct Rules.
- ------------------------------
Name of NASD Member Firm
By:___________________________
Authorized Officer
THE ORIGINAL WARRANT AND AGGREGATE PURCHASE PRICE MUST ACCOMPANY A SIGNED
SUBSCRIPTION AGREEMENT.
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SCHEDULE A
ACCREDITED INVESTOR CERTIFICATION
INITIAL OR CHECK THE APPROPRIATE ITEM(S)
THE UNDERSIGNED FURTHER REPRESENTS AND WARRANTS AS INDICATED BELOW BY THE
UNDERSIGNED'S INITIALS:
Individual investors: (Please initial one or more of the following four
statements)
1. I certify that I am an accredited investor because I have had individual
---income (exclusive of any income earned by my spouse) of more than $200,000
in each of the most recent two years and I reasonably expect to have an
individual income in excess of $200,000 for the current year.
2. I certify that I am an accredited investor because I have had joint income
---with my spouse in excess of $300,000 in each of the most recent two years
and reasonably expect to have joint income with my spouse in excess of
$300,000 for the current year.
3. I certify that I am an accredited investor because I have an individual net
---worth, or my spouse and I have a joint net worth, in excess of $1,000,000.
4. I am a director or executive officer of Compliance Systems Corporation.
---
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