AMENDMENT TO OUR CERTIFICATE OF INCORPORATION TO RESTRICT CERTAIN ACQUISITIONS OF OUR SECURITIES IN ORDER TO HELP ASSURE THE PRESERVATION OF OUR TAX NET OPERATING LOSS CARRYFORWARDS
INTRODUCTION
For the taxable year beginning April 1, 2003, the Company had available tax operating loss carryforwards ("NOLs") of approximately $122.9 million to offset taxable income recognized by the Company in the future. NOLs benefit the Company by offsetting taxable income dollar-for-dollar by the amount of the NOLs, thereby eliminating (subject to a relatively minor alternative minimum tax) the federal corporate tax on such income. The benefit of the NOLs can be reduced or eliminated if the Company undergoes an "ownership change" (as described below) through transfers of stock by which stockholders or groups of stockholders, each of whom owns at least 5% of the Company's stock, increase their ownership of the Company's stock by more than 50 percentage points within a three year period. The Board of Directors believes the best interests of the Company and its stockholders will be served by adopting provisions (the "Transfer Restrictions") in its Certificate of Incorporation that are designed to restrict direct and indirect transfers of the Company's equity securities if the effect would be to increase the ownership of stock by any person to 4.9% or more of the Company's stock, would increase the percentage of stock owned by a person owning 4.9% or more of the Company's stock or would create a new public group, whose ownership of the Company's stock could give rise to an "ownership change". The Transfer Restrictions will not, however, be applicable to the stock owned by any existing 5-percent stockholder (within the meaning of Section 382 of the Internal Revenue Code of 1986, as amended (the "Code")), other than any direct public group, on the date the Transfer Restrictions become effective, and do not apply to sales of stock in the market by holders of less than 4.9% of the Company's stock to persons who, taking the purchase into account, own less than 4.9% of the Company's stock.
The affirmative vote of a majority of the outstanding shares of Common Stock entitled to vote thereon is required for approval of an amendment to the Company's Certificate of Incorporation. The Transfer Restrictions would be adopted as an amendment to the Certificate of Incorporation of the Company as Article Ninth. STOCKHOLDERS ARE URGED TO READ CAREFULLY THE ACCOMPANYING EXHIBIT A WHICH SETS FORTH THE TRANSFER RESTRICTIONS. The Transfer Restrictions have been approved by the Board. The discussion set forth below is qualified in its entirety by reference to the accompanying Exhibit A.
PURPOSE OF THE TRANSFER RESTRICTIONS
The Transfer Restrictions are designed to restrict direct and indirect transfers of the Company's stock that could result in the imposition of limitations on the use by the Company, for federal income tax purposes, of the NOLs and other tax attributes that are and will be available to the Company, as discussed more fully below.
THE COMPANY'S NOLS AND SECTION 382
For the taxable year beginning April 1, 2003, the Company had available NOLs of approximately $122.9 million to offset taxable income recognized by the Company in the future. NOLs benefit the Company by offsetting taxable income dollar-for-dollar by the amount of the NOLs, thereby eliminating (subject to a relatively minor alternative minimum tax) the federal corporate tax on such income. The maximum federal corporate tax rate is currently 35%.
The benefit of a corporation's NOLs can be reduced or eliminated under Section 382 of the Code if a corporation undergoes an "ownership change," as defined in Section 382. Generally, an ownership change occurs if one or more stockholders, each of whom owns 5% or more in value of a corporation's capital stock, increase their aggregate percentage ownership by more than 50 percentage points over the lowest percentage of stock owned by such stockholders at any time during the preceding three-year period. For this purpose, all holders who each own less than 5% of a corporation's capital stock are generally treated together as one (or, in certain cases, more than one) 5-percent stockholder. Transactions in the public markets among stockholders owning less than 5% of the equity securities generally are not included in the calculation (but can be if a loss corporation has more than one public group). In addition, certain constructive ownership rules, which generally attribute ownership of stock owned by estates, trusts, corporations, partnerships or other entities to the ultimate indirect individual owner thereof, or to related individuals, are applied in determining the level of stock ownership of a particular stockholder. Special rules, described below, can result in the treatment of options (including warrants) or other similar interests as having been exercised if such treatment would result in an ownership change. All percentage determinations are based on the fair market value of a corporation's capital stock, including any preferred stock that is voting stock, is convertible stock or is stock which participates in corporate growth.
If an ownership change of the Company were to occur, the amount of taxable income in any year (or portion of a year) subsequent to the ownership change that could be offset by NOLs or other carryovers prior to such ownership change could not exceed the product obtained by multiplying (i) the aggregate value of the Company's stock immediately prior to the ownership change (with certain adjustments) by (ii) the then applicable federal long-term tax exempt rate (the "Section 382 limitation"). In addition, to the extent the Company is determined to have a net unrealized built-in loss (generally defined as the excess of the tax basis of the Company's assets over their fair market value) which is greater than the lesser of (i) 15 percent of the fair market value of the Company's assets and (ii) $10 million, in the event of an ownership change, any net unrealized built-in losses recognized within the five-year period beginning on the date of the ownership change would be subject to the Section 382 limitation (as if it were a pre-change NOL). The Company believes that it currently has a substantial built-in loss with respect to its assets. Any portion of the annual Section 382 limitation amount not utilized in any year may be carried forward and increase the available Section 382 limitation amount for the succeeding tax year. Thus, the effect of an ownership change could be to reduce significantly the annual utilization of the Company's NOLs and to cause a very substantial portion of the NOLs to expire prior to their use.
if we underwent an ownership change, the NOL carryforward limitations would impose an annual limit on the amount of the taxable income that may be offset by our NOL generated prior to the ownership change. If an ownership change were to occur, we would be unable to use a significant portion of our NOL to offset taxable income. In general, an ownership change occurs when, as of any testing date, the aggregate of the increase in percentage points of the total amount of a corporation's stock owned by "5-percent shareholders" (within the meaning of the NOL carryforward limitations) whose percentage ownership of the stock has increased as of such date over the lowest percentage of the stock owned by each such "5-percent shareholder" at any time during the three-year period preceding such date, is more than 50 percentage points. In general, persons who own 5% or more of a corporation's stock are "5-percent shareholders," and all other persons who own less than 5% of a corporation's stock are treated, together, as a single, public group "5-percent shareholder," regardless of whether they own an aggregate of 5% of a corporation's stock.
The Board of Directors adopted an amendment to the Companys' Shareholders Rights Plan ("Rights Plan") which reduces the triggering of the Rights Plan from 15% of the common stock to 5% of the common stock.
Any transfer restrictions will require any person attempting to acquire a significant interest in the Company to seek the approval of our Board of Directors. This may have an "anti-takeover" effect because our Board of Directors may be able to prevent any future takeover. Similarly, any limits on the amount of capital stock that a stockholder may own could have the effect of making it more difficult for stockholders to replace current management.
PROVISION FOR INCOME TAXES
We account for income taxes in accordance with Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes." Income tax expense consists of foreign income tax withholding on foreign source royalties paid us. As of March 31, 2004, we had net operating loss carryforwards for U.S. federal income tax purposes of approximately $123,000,000 and for U.K. income tax purposes of approximately $3,860,000 and for state income tax purposes of approximately $31,770,000. We also had research and development credit carryforwards for federal income tax purposes of approximately $3,426,000 and for state income tax purposes of approximately $1,506,000. Utilization of our U.S. net operating loss and research credit carryforwards will be subject to annual limitations based on the "change of ownership" provisions of the Tax Reform Act of 1986. These limitations may result in the expiration of net operating loss and research credit carryforwards before utilization.