June
7,
2006
Mr.
Daniel Gordon
Branch
Chief
United
States Securities and Exchange Commission
100
F St.
Street, NE
Washington,
D.C. 20549
Dear
Mr.
Gordon:
The
following are responses to your letter of May 18, 2006.
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1.
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Please
tell us how you have applied the guidance in EITF 00-19 in evaluating
whether the warrants issued in May 2004 in connection with the sale
of six
million share of you common stock should be accounted for as liabilities.
We note that you filed a registration statement on July 21, 2004
for the
shares underlying these warrants that currently remains effective,
however
your registration rights agreement requires you to keep the registration
statement continuously effective for a two year period, or else you
are
required to pay a liquidated damages payment equal to 2.5% or the
purchase
price per month until the event is cured, with no cap on the maximum
penalty that could be incurred. The EITF recently deliberated the
impact
of these liquidated damages clauses and the effect on the accounting
and
classification of instruments subject to the scope of EITF 00-19
in EITF
05-4. The EITF has not reached a consensus on this issue and has
deferred
deliberation until the FASB addresses certain questions which could
impact
a conclusion on this issue. However, in the meantime, please tell
us how
you considered the guidance in EITF 05-4 and the difference views
on this
issue as outlined in Issue Summary No. 1 of EITF 05-4 in analyzing
the
registration rights agreement and in considering whether you are
required
to account for the warrants as liabilities.
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We
evaluated the warrants issued in May 2004 under the guidance in effect at the
time of the transaction. This guidance included FAS 150, Accounting
for Certain Financial Instruments with Characteristics of both Liabilities
and
Equity, and
EITF 00-19, Accounting
for Derivative Financial Instruments Indexed to, and Potentially Settled in,
a
Company’s Own Stock.
The
warrants issued could not be “put” back to us, and, in no circumstances, would
we ever be required to pay cash or transfer other assets to satisfy the
outstanding warrants. Because of these factors, we concluded that permanent
equity classification was appropriate, and FAS 150 did not apply. Based on
this
conclusion, the question of whether the
warrants
met the definition
of a derivative under FAS 133, Accounting
for Derivative Instruments and Hedging Activities, was
not considered necessary. This is due to the FAS 133 ¶11(a) scope exception for
instruments classified as equity.
The
warrants provide for physical share settlement, and, in certain circumstances,
net share settlement. There is no provision for net cash settlement. Based
on
these factors, equity treatment is appropriate under the provisions of EITF
00-19.
We
are aware that in June 2005 the EITF discussed Issue No. 05-4, and no consensus
was reached. We also considered the discussion in Issue Summary No. 1 of EITF
05-4. We would consider the registration rights agreement as a separate
freestanding contract, to be accounted for separately. This is the approach
set
forth in “View C” of EITF 05-4. The warrants would therefore also be considered
a separate financial instrument, and accounted for as permanent equity, as
described in the previous paragraph.
The
registration rights agreement meets the definition of a derivative under FAS
133, and would be recorded as a liability at fair value at inception. Subsequent
changes in fair value would be recognized in earnings. We consider the fair
value of the registration rights agreement to be immaterial. In considering
fair
value, several factors were analyzed. We had 30 days to file the registration
statement, which was done in the allowable timeframe. We had 120 days for the
registration statement to be declared effective. This was achieved on July
27,
2004, which was before the filing of our first financial statements subsequent
to the transaction, the June 30, 2004 quarterly report on Form 10-QSB.
Therefore, we knew that no penalties were due related to initial effectiveness
provision of the registration rights agreement. Penalties would then only become
due if the registration statement did not remain effective for two years after
the signing of the agreement, or May 18, 2006. We believed that events causing
the suspension of the effectiveness of the registration statement were not
likely to occur. At each balance sheet date, should a penalty have been
determined to be probable, it would have been accrued in accordance with FAS
5, Accounting
for Contingencies.
We
do
note that the registration statement continues to remain effective as of the
date of this letter, and the 2-year period in which penalties could apply lapsed
on May 18, 2006.
We
acknowledge that the Company is responsible for the adequacy and accuracy of
the
disclosure in the filing; staff comments or changes to disclosure in response
to
staff comments do not foreclose the Commission from taking any action with
respect to the filings; and the Company may not assert staff comments as a
defense in any proceeding initiated by the Commission or any person under the
federal securities laws of the United States.
Sincerely
yours,
Marc
Sherman
Chief
Executive Officer