5. The 2010 Notes

6 Months Ended

Jun. 30, 2011

Debt Disclosure [Text Block]

5. The 2010 Notes

The following summarizes other terms of the 2010 notes are as follows:

Term.  The 2010 notes are due and payable on July 2, 2014.

Interest.  Interest accrues at a rate equal to the prime rate as published in The Wall Street Journal as of the first business day of each interest period plus 4.75% per annum and is payable at the end of each month, with the first payment due on July 31, 2010.  Through June 30, 2011, the Company had the option to defer the monthly interest payments otherwise due and have the amount of interest deferred added to the principal balance of the 2010 notes.

Principal Payment.  In July 2011 and continuing for the 11 months thereafter, principal payments of $200,000 per month are due on the last day of each month.  Thereafter, the Company is required to pay principal in a monthly amount equal to the sum of (a) $316,667 and (b) the quotient determined by dividing the (i) aggregate amount of interest added to the principal amount by (ii) 24.  Any remaining principal amount, if not paid earlier, is due and payable on July 2, 2014.

Early Redemption.  As discussed in more detail below under the heading entitled, "Rights Offering," the Company has the right to redeem up to $3 million of the 2010 notes prior to maturity.  In August 2011, the Company and Hale amended the Hale Securities Purchase Agreement to (1) cancel the Company's obligation to conduct the rights offering, and (2) cancel Hale's obligation to convert up to $3.0 million of the 2010 notes into common stock.  As a result of the amendment, the principal amount of the 2010 notes outstanding remained at approximately $10.5 million, plus interest that was accrued to principal through July 31, 2011.  The Company's scheduled payment obligations under the 2010 notes will be approximately $250,000 per month through June 30, 2012 and average approximately $415,000 per month for the remaining 24 months until maturity.

See "Rights Offering," below.

No Conversion Rights.  The 2010 notes are not convertible other than in connection with the rights offering.  See "Rights Offering," below.

Security.  The 2010 notes are secured by all of the Company's assets under the terms of a pledge and security agreement that the Company and its subsidiaries entered into with Hale.  Each of the Company's subsidiaries also entered into guarantees in favor of Hale, pursuant to which each subsidiary guaranteed the complete payment and performance by the Company of its obligations under the 2010 notes and related agreements.

Covenants.  The 2010 notes impose certain covenants on the Company, including: restrictions against incurring additional indebtedness, creating any liens on its property, entering into a change in control transaction, redeeming or paying dividends on shares of its outstanding common stock, entering into certain related party transactions, changing the nature of its business, making or investing in a joint venture, disposing of any of its assets outside of the ordinary course of business, effecting any subsequent offering of debt or equity, amending its articles of incorporation or bylaws, limiting its ability to enter into lease arrangements.

Events of Default.  The 2010 notes define certain events of default, including: failure to make a payment obligation under the 2010 notes, failure to pay other indebtedness when due if the amount exceeds $250,000, bankruptcy, entry of a judgment against the Company in excess of $250,000 which are not discharged or covered by insurance,  failure to observe other covenants of the 2010 notes or related agreements (subject to applicable cure periods), breach of representation or warranty, failure of Hale's security documents to be binding and enforceable, and casualty loss of any of the Company's assets that would have a material adverse effect on its business, and failure to meet 80% of quarterly financial targets from its annual operating budget, including cash, revenues and EBITDA.  In the event of default, additional default interest of 4% will accrue on the outstanding balance.  In addition, in the event of default, the Company may be required to redeem all or any portion of the 2010 notes at a price equal to 125% of the sum of the principal amount that such holder requests that it redeems plus accrued but unpaid interest on such principal amount plus any accrued and unpaid late charges with respect to such principal and interest.  The Company was not in default for the three and six months ending June 30, 2011.

Change of Control.  The Company is required to obtain the consent of the holders of the 2010 notes representing at least a majority of the aggregate principal amount of the 2010 notes then outstanding in order to enter into a change of control transaction.  If such consent is obtained, the holders of the 2010 notes may require the Company to redeem all or any portion of such notes at a price equal to 125% of the sum of the principal amount that such holder requests that it redeems plus accrued but unpaid interest on such principal amount plus any accrued and unpaid late charges with respect to such principal and interest.

            Rights Offering, Under the terms of the Hale Securities Purchase Agreement, the Company agreed to conduct a rights offering pursuant to which it would distribute at no charge to holders of its common stock non-transferable subscription rights to purchase up to an aggregate of 1,038,414 shares of common stock at a subscription price of $2.889 per share. Under the terms of the 2010 notes, the Company agreed to use the gross proceeds of the rights offering to redeem an aggregate of up to $3 million of principal amount of such notes. To the extent the gross proceeds of the rights offering are less than $3 million, the Company and Hale agreed that Hale would exchange the principal amount to be redeemed (up to $3 million) for shares of our common stock at an exchange price equal to the subscription price of the subscription rights.  The Company paid Hale an aggregate of $60,000 in consideration of the foregoing. In addition, the Company agreed to pay Hale upon completion of the rights offering an amount of cash equal to the accrued and unpaid interest in respect of the principal amount of the senior secured notes redeemed or exchanged for shares of common stock in connection with the rights offering.  

In August 2011, the independent directors of the Company approved, and the Company and Hale entered into a settlement agreement, pursuant to which (1) Hale released the Company from any obligation to conduct the rights offering, and (2) the Company released Hale from its "backstop" obligation to convert up to $3.0 million of the 2010 notes into common stock.  As a result of the amendment, the principal amount of the 2010 notes outstanding remained at approximately $10.5 million, plus interest that was accrued to principal through June 30, 2011.  In addition, under the settlement agreement, Hale granted the Company the right to defer cash payment of the interest on up to $ 3 million of principal (plus associated “PIK Interest”) through July 31, 2012 and have the amounts added to principal.  The Company's scheduled payment obligations under the 2010 notes, assuming that it pays all of the interest current, will be approximately $250,000 per month through June 30, 2012 and will average approximately $415,000 per month for the remaining 24 months until maturity.

The following table summarizes information relative to the 2010 Notes at June 30, 2011:

	June 30, 2011
Face value of debt	$	10,500,000
Plus: accreted interest		871,495
Less: unamortized debt discounts		(3,424,184	)
2010 Notes, net of discounts		7,947,311
Less current portion		(2,400,000	)
2010 Notes, long term portion	$	5,547,311

Aggregate annual principal payments of long-term debt for the periods ending December 31st are stated below:

2011	$	1,200,000
2012	$	3,502,213
2013	$	4,604,426
2014	$	2,064,856
Total	$	11,371,495

The value assigned to the debt and related discount and equity associated with issuance of the Recapitalization were calculated by an independent valuation using relative fair values.