Note 16 – Convertible Debentures – Related Party
Subsequent to the completion of the September 2008 SPA, transactions between the Company and The Quercus Trust or its trustee, David Gelbaum, are considered related party transactions, due primarily to the significant influence and level of control gained by these parties as a result of the September 2008 SPA transaction. Accordingly, during the quarter ended November 30, 2008, we reclassified convertible debentures with a carrying value of $3,221,000 from convertible debentures to convertible debentures – related party. In addition, amounts presented in the comparative balance sheet herein as convertible debentures – related party as of May 31, 2008, in the amount of $4,781,000, were not previously reported as related party transactions, but have been reclassified to be shown as related party transactions in order to be consistent with the current classification.
The September 2008 SPA amended certain provisions of the Company’s outstanding Series B Convertible Notes held by The Quercus Trust (the” 9/17/2007 Note”) and other holders. Transactions between the Company and The Quercus Trust or its trustee, David Gelbaum, are considered related party transactions. These amendments (1) provided that future interest payments shall be made in the form of warrants in the form of those issued in the September 2008 financing, (2) add additional protective covenants, (3) provide for the granting of voting rights to the holders of the Series B Convertible Notes, subject to the approval by the Company’s stockholders of an amendment to the Company’s articles of incorporation to provide such voting rights.
The issuance of warrants pursuant to the September 2008 SPA caused the reset of the exercise and conversion prices applicable to certain warrants and convertible debentures exercisable for and convertible into shares of the Company’s common stock to $0.087 per share, and an adjustment to the number of shares of the Company’s common stock into which these instruments are exercisable or convertible. As a result of these adjustments, the number of shares into which all affected outstanding debentures are convertible increased from approximately 42,000,000 to 241,379,000 in the aggregate, and the number of shares for which all affected outstanding warrants are exercisable increased from approximately 76,000,000 to 676,509,000 in the aggregate, including warrants issued in lieu of cash interest in October 2008, based on the anti-dilution provision of the respective instruments governing such securities.
In connection with the 9/17/2007 Note and 9/17/2007 Warrant, we originally recorded debt discount in the aggregate amount of $16,910,000 in accordance with EITF 98-05, Accounting for Convertible Securities with Beneficial Conversion Features or Contingently Adjustable Conversion Ratios and EITF 00-27, Application of Issue No. 98-05 to Certain Convertible Instruments. As a result of the debt discounts recorded in connection with the 9/17/2007 Note, the effective interest rate on the date of issuance was estimated to be approximately 64%. As a result of the September 2008 SPA and corresponding reduction in conversion price from $0.50 to $0.087, the Company recorded an additional debt discount of $3,090,000 related to the increase in intrinsic value of the beneficial conversion feature raising the effective interest rate to 106%. Additionally, the Company recognized interest expense of $11,030,000 related to the increase in the fair value of the detachable warrants due to the modification of terms described above.
As of November 30, 2008, the 9/17/2007 Note was convertible into 229,885,000 shares of the Company’s common stock, exclusive of accrued interest of $201,000.
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Redemption of Series B Convertible Notes
Under the terms of the September 2008 SPA we entered into with The Quercus Trust, we are required to amend our articles of incorporation to provide voting rights to the holders of our Series B Convertible Notes (referred to above as the 9/17/2007 Note and the 12/7/2007 Note) by March 12, 2009. At our annual stockholders meeting held in January 2009, we submitted a proposal to our stockholders to approve an amendment to our articles of incorporation to provide for such voting rights. Our stockholders did not approve that proposal. We may seek to obtain such amendment at a later date, but if we are not successful, we may be in default under the terms of the September 2008 SPA and the holders of our Series B Convertible Notes may be entitled to require us to redeem all or any portion of such notes. We may negotiate with the holders of the Series B Convertible Notes and The Quercus Trust to waive the voting right requirement, but we can give no assurance that we will be successful in this regard or that such waiver will be available on favorable terms
