-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, TKrFV5iIQkK8P+fa9PQK1vnWoWG2yckajoJBJFIOWC7Og7o/8Jyw6eqtJhi8AztG 3jY9/H0KRbEkRXBhlS4N8w== 0000950144-97-007812.txt : 19970716 0000950144-97-007812.hdr.sgml : 19970716 ACCESSION NUMBER: 0000950144-97-007812 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 7 CONFORMED PERIOD OF REPORT: 19970331 FILED AS OF DATE: 19970715 SROS: AMEX FILER: COMPANY DATA: COMPANY CONFORMED NAME: SUBSTANCE ABUSE TECHNOLOGIES INC CENTRAL INDEX KEY: 0000853017 STANDARD INDUSTRIAL CLASSIFICATION: GAMES, TOYS & CHILDREN'S VEHICLES (NO DOLLS & BICYCLES) [3944] IRS NUMBER: 222806310 STATE OF INCORPORATION: DE FISCAL YEAR END: 0331 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 001-10964 FILM NUMBER: 97640385 BUSINESS ADDRESS: STREET 1: 4517 NW 31ST AVENUE CITY: FT. LAUDERDALE STATE: FL ZIP: 33309 BUSINESS PHONE: (954) 739-9600 MAIL ADDRESS: STREET 1: 10410 TRADEMARK ST CITY: RANCHO CUCAMONGA STATE: CA ZIP: 91730 FORMER COMPANY: FORMER CONFORMED NAME: U S ALCOHOL TESTING OF AMERICA INC DATE OF NAME CHANGE: 19930423 10-K 1 SUBSTANCE ABUSE TECHNOLOGIES FORM 10-K 03/31/97 1 ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------------------ FORM 10-K ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED MARCH 31, 1997 COMMISSION FILE NUMBER 0-18938 SUBSTANCE ABUSE TECHNOLOGIES, INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) DELAWARE 22-2806310 (STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
4517 N.W. 31ST AVE. FT. LAUDERDALE, FLORIDA 954-739-9600 (ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES) SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: COMMON STOCK, PAR VALUE $.01, AND PREFERRED "A" STOCK, PAR VALUE $.01 (REGISTERED ON THE AMERICAN STOCK EXCHANGE); PREFERRED "B" STOCK, PAR VALUE $.01 SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT: NONE Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days: YES [X] NO [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] As of July 11, 1997, there were 34,496,036 shares of Common Stock outstanding. THE REGISTRANT HAS ONLY ONE CLASS OF VOTING STOCK OUTSTANDING, THE COMMON STOCK, AND, AS OF JULY 11, 1997, THE AGGREGATE MARKET VALUE OF THE COMMON STOCK HELD BY NON-AFFILIATES WAS $34,496,036 BASED ON THE CLOSING SALE PRICE OF SUCH STOCK ON THAT DATE. ================================================================================ 2 PART I ITEM 1. BUSINESS OF THE COMPANY GENERAL Substance Abuse Technologies, Inc. ("SAT") was incorporated under the laws of Delaware on April 15, 1987 to design, manufacture and market instruments which measure blood alcohol concentration by breath sample and analyzation. SAT, its divisions and its subsidiaries are hereinafter collectively referred to the "Company." Through acquisition and internal development, SAT's management expanded the Company's operations so that, as of March 31, 1997, the Company was conducting the following operations: 1. alcohol testing products through its Alcohol Products Division; 2. human resource provider through its Employer Services Division (the "ESD"); 3. designing policies and programs on substance abuse prevention through its Robert Stutman & Associates Consulting Division (the "RSA Division"); 4. developing drug testing products through its subsidiary U.S. Drug Testing, Inc. ("U.S. Drug"); 5. serving as a clinical laboratory through its Biochemical Toxicology Laboratories ("BioTox") Division. For reasons hereinafter described in the section "Alcohol Products Division" under this caption "Business of the Company," SAT's management made a strategic decision in the fourth quarter of the fiscal year ended March 31, 1997 ("fiscal 1997") to abandon a substantial portion of its alcohol testing products and to concentrate more on the operations of the Employer Services Division. Subsequently, during the quarter ended June 30, 1997, SAT's Board of Directors began to re-evaluate the methods of financing the research and development program of U.S. Drug for the reasons described in the section "U.S. Drug Testing Inc." under this caption "Business of the Company." Percentage of Revenue Derived During Each of the Fiscal Year 1995, 1996 and 1997 from SAT's Products and Services
1995 1996 1997 ---- ---- ---- Alcohol Products........................................ 63% 64% 35% BioTox.................................................. 37% 34% 15% Employer Services....................................... --% 2% 33% Consulting.............................................. --% --% 17% ---- ---- ----
U.S. Drug is a development stage enterprise that has had no sales. EMPLOYMENT SERVICES DIVISION In September 1995, ProActive Synergies, Inc. ("ProActive"), a wholly-owned subsidiary incorporated in June 1995, began to provide single source services to assist corporations in their hiring practices ranging from substance abuse testing and background screening to total program management. On December 31, 1996, ProActive was merged into SAT and its operations are now operated as the Employer Services Division (the "ESD") of SAT. The ESD is a single source service provider, meaning that it is a provider of both substance abuse testing services and background screening services. The ESD's substance abuse testing services include specimen collections, laboratory testing and medical review officer ("MRO") services. Medical review officers review drug test results to verify that chain-of-custody procedures were followed and determine if there is an alternative medical explanation for a positive test result. The ESD's background investigative services include criminal history checks, employment verifications, credit checks, reference checks, driving record checks, workers' compensation history checks, and social security number, educational and professional license verifications. Its total program management services include establishing a substance abuse policy with corporations and conducting program audits to ensure regulatory compliance with such policy. 1 3 Depending on the size of the customers, it may take three to six months for the execution of a contract for the ESD to implement the procedures at the customer's site or sites so as to begin to charge fees for its services. Accordingly, despite the execution of agreements which should result in multi-million dollar revenues (on an annualized basis) from certain customers, revenues from the ESD were not at their full potential in fiscal 1997. SAT management has, accordingly, instituted a new program of seeking acquisitions of third party administrator ("TPA") companies which would bring immediate revenues to the Company. In July 1997, SAT entered into a letter of agreement dated July 3, 1997, a copy of which is filed as an exhibit to this Report and incorporated herein by this reference, with National Medical Review Offices, Inc. ("NMRO") to acquire, for $1,600,000, the TPA operations of the DataMed International Division ("DataMed") of Global Med Technologies, Inc. ("Global Med"). If Global Med's shareholders consent (the shareholders' meeting is scheduled for August 1997), the Company will obtain approximately $8,000,000 in annualized revenues. SAT is managing the DataMed operations from July 1, 1997 under a management agreement. SAT is also entering into an agreement with NMRO for MRO services at reduced charges. There can be no assurance that the acquisition will be consummated or that SAT will effect other acquisitions for the ESD. CONSULTING DIVISION In May 1996, SAT acquired Robert Stutman & Associates, Inc. ("RSA"), a provider of substance abuse testing/background screening policy manuals and a consultant on programs relating to alcohol and drug abuse. Since January 1996, RSA had been designing policies and programs on substance abuse prevention for customers of the ProActive subsidiary. RSA was merged into SAT on December 31, 1996 and its operations are now conducted by the Robert Stutman & Associates Consulting Division of SAT (the "RSA Division"). The RSA Division's services are often packaged with the substance abuse testing and background screening services provided by the ESD. On December 14, 1995, SAT entered into an agreement with RSA and Robert M. Stutman, personally, pursuant to which (1) SAT engaged Mr. Stutman to be their expert spokesman and a consultant with respect to their drug and alcohol testing businesses; (2) SAT agreed to refer customers to RSA for the purpose of RSA providing its services to such customers, including writing drug testing/background screening policy manuals; and (3) RSA agreed to refer customers to SAT. Prior to forming RSA, Mr. Stutman was Special Agent in charge of the New York office of the United States Drug Enforcement Administration (the "DEA"). He also currently serves as special consultant on substance abuse for the CBS News Division. On December 14, 1995, pursuant to the agreement, SAT agreed to issue to each Mr. Stutman and RSA three-year Common Stock purchase warrants to purchase 200,000 shares of SAT's Common Stock, $.01 par value (the "SAT Common Stock"), at $2.00 per share, which was the market price on the date of grant. These warrants were issued on December 14, 1995 and April 1, 1996. The agreement, which had a term of ten years (except the term for the consulting and spokesperson services by Mr. Stutman was three years), provided for payment of fees to SAT based on referrals to RSA and an initial $100,000 payment by SAT and varying monthly fees thereafter to RSA. A copy of the Consulting Agreement dated as of December 14, 1995 by and between SAT and RSA and Mr. Stutman is filed (by incorporation by reference) as an exhibit to this Report and is incorporated herein by this reference. On April 18, 1996, Mr. Stutman was elected as the Chairman of the Board and a director of SAT and designated as its Chief Executive Officer. SAT also agreed in principle to acquire RSA. On May 21, 1996, the Company completed its acquisition of RSA and RSA became a 100% owned subsidiary of SAT. SAT paid $2,100,000 to the RSA stockholders for all of the outstanding shares of RSA (including $1,078,920 paid to Mr. Stutman for his 52.8% of the RSA shares and $721,080 paid to Brian Stutman, son of Mr. Stutman and now Vice President of Sales and Marketing of SAT, for his 35.3% of the RSA shares and issued to the RSA shareholders an aggregate of 500,000 shares of the SAT Common Stock (including 263,750 shares issued to Mr. Stutman and 176,250 shares to Brian Stutman) registered under the Securities Act as Acquisition Shares in SAT's Registration Statement on Form S-1, File No. 33-43337 (the "January 1992 Registration Statement"), and Common Stock purchase warrants expiring May 20, 1999 to purchase an aggregate of 2 4 900,000 shares of the SAT Common Stock (including a warrant to purchase 474,750 shares issued to Mr. Stutman and a warrant to purchase 317,250 shares issued to Brian Stutman). SAT also issued two promissory notes aggregating $400,000 in principal amount (the "RSA Notes"), one to Mr. Stutman who received an RSA Note for $239,760 and the other to Brian Stutman for the balance. The RSA Notes bore interest at the rate of 7.5% per annum and were to become due May 21, 1997. SAT was required to prepay the RSA Notes if the gross proceeds received by SAT from the exercises of the SAT Common Stock purchase warrants after April 17, 1996 exceeded $7,000,000. The RSA Notes were secured by all of SAT's tangible and intangible personal property except the following: (1) SAT's cash and cash equivalents; (2) SAT's securities, including the stock of its subsidiaries; and (3) certain contracts, including the license with the United States Navy. Copies of the Stock Purchase Agreement dated as of May 21, 1996, the Secured Promissory Note dated May 21, 1996, the Security Agreement dated May 21, 1996, the Common Stock purchase warrant expiring May 20, 1999 and Registration Rights Agreement dated as of May 21, 1996, all related to the acquisition of RSA, are filed (by incorporation by reference) as exhibits to this Report and, by this reference, are incorporated herein. As a result of the acquisition of RSA, the Consulting Agreement described in the preceding paragraph terminated; however, the Common Stock purchase warrants described therein remain outstanding, except that the RSA warrant was distributed to its shareholders, including Mr. Stutman who received a warrant to purchase 105,500 shares and Brian Stutman who received a warrant to purchase 70,500 shares. In December 1996, the Board of Directors authorized, in consideration of their having to surrender rights with respect to their secured promissory notes in the aggregate of $400,000 in order for SAT to close its offering of $5,000,000 in principal amount of convertible notes, that the exercise price shall be reduced from $3.125 to $2.125 per share on Robert M. Stutman's Common Stock purchase warrant expiring May 20, 1999 to purchasing 474,750 shares of SAT Common Stock and on Brian Stutman's Common Stock purchase warrant also expiring May 20, 1999 to purchase 317,250 shares of the SAT Common Stock. The $400,000 note due May 21, 1997 was prepaid in December 1996 in connection with the exercise of previously issued Common Stock purchase warrants. See "Certain Relationships and Related Transactions" in this Report. TOXICOLOGY LABORATORIES The Biochemical Toxicology Laboratories ("BioTox") Division provides services to SAT and also provides services to U.S. Drug. The BioTox Division is certified as a Clinical Laboratory by the State of California and possesses a federal license pursuant to the Clinical Laboratory Improvements Act of 1988 ("CLIA 88") promulgated by the United States Department of Health and Human Services. The BioTox Division is engaged in alcohol and drug testing for many area police departments, detoxification centers, coroners departments and corporations and functions within SAT's facilities maintaining state of the art lab testing instrumentation. ALCOHOL PRODUCTS DIVISION SAT through its Alcohol Products Division manufactures, markets and distributes alcohol testing detection equipment directly to law enforcement and correctional facilities, various industrial companies, alcohol treatment centers and emergency rooms. Sales were made directly by SAT's sales representatives. The Alcohol Products Division markets its products at trade shows, conventions and through print advertisements. In February 1994, the United States Department of Transportation (the "DOT") published its final rule implementing the federal act which mandates alcohol testing within the transportation industry. The rule at that time required alcohol testing solely through the use of breath samples. SAT had designed the Alco-Analyzer 2100 to specifically meet these needs. Its marketing strategy had included sales, leases and placements of the instrument with a cost per test charge. Subsequently, the DOT changed the standard resulting in the Model 2100 competing with less specific and less expensive equipment. Additionally the DOT regulations initially were to require pre-employment alcohol and drug testing. The requirement for pre-employment alcohol testing was suspended May 8, 1995 and later eliminated and, largely because of that, the anticipated marketing opportunity for this business failed to materialize. Therefore, management of SAT made a strategic decision to abandon a substantial portion of its alcohol testing equipment manufacturing, sales and service. SAT refurbished the equipment and attempted to market it in the fourth quarter of fiscal 3 5 1997, but to no avail. SAT will continue to package and sell an alcohol breath sampling device (the AlcoProof System). In December 1994, SAT entered into two agreements with major testing laboratories, Quest Diagnostics Inc. ("Quest"), formerly Corning Clinical Laboratories Inc. and Metpath Inc., and Laboratory Corporation of America ("Lab Corp."), formerly National Healthcare Laboratories Incorporated, for placement of approximately 700 units of its Model 2100 at the respective laboratory's collection sites with remuneration to SAT on a per test basis. These two agreements, copies of which agreements are filed (by incorporation by reference) as exhibits to this Report and are incorporated herein by this reference, as well as others with smaller customers, had terms which ranging from three to five years. Subsequently, SAT terminated the agreements. As indicated in the preceding paragraph SAT has discontinued this product and the customers have returned the units to SAT. See Item 7 to this Report for information as to the write-off relating to this product. SAT manufactured in fiscal 1997 a Mobile Alcohol Collection System ("MACS") device used to collect a breath sample for future analysis, the manufacture of which device will now be outsourced. The MACS device contains a silica gel compound within a glass vial accompanied by collection and waste bags which insure the gathering of a proper sample flow through the vial. The vial is then sent to an independent certified laboratory where the alcohol is extracted from the silica gel and analyzed on a gas chromatography to determine the exact blood alcohol content. Management is currently pursuing DOT approval of the MACS device as a collection and transport device. SAT plans to use this product in conjunction with a saliva screening device to be marketed as part of the AlcoProof System. The AlcoProof test system is a product line consisting of an O.E.M. alcohol screening device using saliva as a sample and an alcohol breath testing confirmation device manufactured by SAT and formerly known as MACS. The screening device is a product manufactured by STC Technologies Inc. and marketed as Q.E.D. SAT acquired the rights to co-label and market Q.E.D. as AlcoProof Screen through a recently signed distribution agreement, a copy of which is filed as an exhibit to this Report and is incorporated herein by this reference. The test is a manual, visual read, enzyme based device that is designed for on site use and provides DOT approved results in two minutes. The AlcoProof Confirm test device is used following a positive screening test. A breath sample is collected onto a silica gel compounded in a glass vial. The glass vial is sent to a certified laboratory where the sample is extracted from the silica and test by a gas chromatography method. SAT is currently pursuing DOT approval of AlcoProof confirm as a collection and transport device. SAT intends to pursue the non-regulated market for alcohol testing where approximately 93% of the American work force is employed. Management is of the opinion that the MACS device can increasingly be sold to commercial companies which, recognizing the adverse impact of alcohol abuse on the productivity of their employees, wish to institute on-site testing programs. In order to implement this program, management believes that the MACS device must be reformatted and DOT approval be obtained. Although management believes that the non-regulated market is a market with great potential, there can be no assurance that SAT will derive significant revenues from this market. Revenues for the following products were included in prior fiscal years, but the products were discontinued in fiscal 1997 as a result of the events described in this section. 1. SAT designed and developed a product called an Alco-Analyzer. This product is a gas chromatography alcohol testing device that determines blood alcohol levels by use of breath samples with precision and accuracy to be used as evidence in legal proceedings. SAT's three models had been approved by the DOT as evidential breath alcohol testing instruments. 2. The Alco-Breath Tubes ("ABT") are disposable alcohol breath glass vial testers containing yellow bands comprised of silica gel treated with a reagent solution. Testing begins with breath blown into a balloon which is then attached to the glass vial into which the sample flows. If alcohol is present within the subject's breath, a chemical reaction occurs within the gel changing the yellow bands to green. Measurement results are determined by the extent of color change. SAT manufactured two variations of the Alco-Breath Tubes specifically designed for various 4 6 applications of alcohol breath testing. SAT has sold the assets to a distributor who will now manufacture the product, but will not market or promote the product. 3. The Alcohol Products Division manufactured three devices, the Alco-Simulator, Alco-Simulator 2000 and the Alco-Equilibrator which were used to calibrate and check alcohol testing instruments made by both SAT and its competitors for continued accuracy. The devices were designed to simulate the breath of a person who has been drinking alcohol. The standard alcohol solutions used in these calibration devices were produced by SAT in its own certified laboratory. The Alcohol Products Division purchased the raw materials and parts for its products from various suppliers which delivered them to SAT for assembly, packaging and distribution. These raw materials were primarily glass, plastic containers and certain mechanical parts, all of which were readily available from many suppliers. SAT has decided to out source the manufacture of the MACS device to a single source supplier of these products and discontinue the manufacture of Alco-Breath Tubes. U.S. DRUG TESTING U.S. Drug, of which SAT owned 75.4 % as of May 31, 1997, is a development stage company attempting to develop a saliva based drug and alcohol testing product. In October and November 1993, SAT's then wholly-owned subsidiary U.S. Drug completed an initial public offering of the U.S. Drug Common Stock, $.001 par value (the "U.S. Drug Common Stock"), which security traded on the Pacific Exchange, Inc. (the "Pacific Exchange") through May 12, 1997, at which time trading was suspended because the subsidiary did not comply with the Exchange's net worth maintenance requirement. U.S. Drug has filed an appeal as to such suspension. As of March 31, 1997, SAT owned 3,500,000 of the 5,221,900 outstanding shares of the U.S. Drug Common Stock or 67.0% thereof. At a May 1997 meeting of the Board of Directors, the SAT Board agreed that SAT should purchase 1,768,202 shares of U.S. Drug Common Stock in forgiveness of an inter-company loan in the amount of $2,210,254 (including interest at the rate of 8% per annum) as of April 30, 1997. The additional shares purchased increased SAT ownership to 75.4% of the outstanding shares. The Board of Directors also authorized the purchase of 2,000,000 shares of the U.S. Drug Common Stock for $2,500,000; however such potential investment has been delayed pending additional financing by SAT. At present the SAT Board has agreed to continue to fund U.S. Drug as needed. It is anticipated that these equity purchases will assist U.S. Drug's appeal by demonstrating compliance with the net worth requirement; however, there can be no assurance that the Pacific Exchange will act favorably and, in such event, the U.S. Drug Common Stock will continue to be traded in the over-the-counter market. On January 24, 1992, SAT and the United States Navy ("USN") entered into a ten-year non-assignable agreement (the term of which license was subsequently extended by the USN) granting SAT a partial exclusive patent license to products for drug testing in the United States and certain foreign countries. Effective January 1993, SAT granted a sole and exclusive sublicense to U.S. Drug, then a newly-incorporated wholly-owned subsidiary of SAT, which subsidiary assumed all of SAT's rights and obligations under the foregoing license. However, because the USN refused to grant a novation of the license agreement, the USN looks only to SAT for performance thereunder. During May 1996, SAT filed a Registration Statement on Form S-4, File No. 333-4790 (the "U.S. Drug Registration Statement"), under the Securities Act of 1933, as amended (the "Securities Act"), to register shares of the SAT Common Stock to be issued to the minority stockholders of U.S. Drug upon the consummation of a merger of U.S. Drug with and into U.S. Drug Acquisition Corp., a wholly-owned subsidiary of SAT. The SAT Board of Directors had concluded then that the value of the SAT Common Stock could best be maximized if the Company concentrated its operations on the SAT alcohol testing business, U.S. Drug's drug testing business and the related human resource provider business of the ESD and operated the three as if one corporation. The U.S. Drug Registration Statement is not yet effective and, accordingly, no offer has been made to the minority stockholders of U.S. Drug. As indicated below, in May and June, 1997, the SAT Board began to re-evaluate the means of financing U.S. Drug because of the estimated increased costs and longer period to bring the product to market. In addition, taking into account the Company's limited resources, the SAT Board recognized that the Company would realize a more 5 7 immediate return on the ESD and RSA Division's operations. SAT still intends to take U.S. Drug private, which, as indicated below, will facilitate the possibility of obtaining venture capital investments. There can be no assurance that any or all of these objectives will be achieved and, if achieved, during what time frame. The Company has not received any revenues from U.S. Drug because its products are still in the developmental stage. U.S. Drug is developing proprietary systems that test for alcohol and drug use, specifically the following five commonly used Drugs of Abuse: cocaine, opiates (heroin, morphine and codeine), phencyclidine hydrochloride (PCP), amphetamines (including methamphetamines), and tetrahydrocannabinol (THC, marijuana). Its line of products under development are based on its sub-license from SAT for Drug of Abuse detection utilizing the USN patent for flow immunosensor technology. U.S. Drug is developing its own proprietary "Immunoassay Chemistry" for these five drugs which work with the USN developed technology. U.S. Drug has received six FDA marketing approvals covering its Model 9000 Flow Immunoassay System and the attendant assays for each of the five Drugs of Abuse listed above, using urine as the test medium. However, additional development work would be required before the urine based testing product can be marketed. U.S. Drug, based on its review of these market conditions, decided to complete the assays for a saliva medium testing product first and, as a result, has produced no revenues through March 31, 1997. U.S. Drug has commenced research using saliva as a testing medium in connection with flow immunosensor technology and, assuming success in the remainder of the development program, currently expects to submit its five-panel screening assay to the Food and Drug Administration ("the FDA") in February 1999 at the earliest (compared with the prior estimate of December 1998). U.S. Drug will be able to market it in the United States for non-medical purposes, such as employment screening and screening by correctional and criminal justice agencies, and in Europe where no FDA approval is required, although U.S. Drug will not be able to commence marketing of the product in medical markets until FDA approval is obtained, which marketing should occur approximately five months to a year after that approval. There can be no assurance as to when the submission will be made to the FDA, if at all, as to when FDA approval will be given, if at all, or as to when marketing in either medical or non medical markets will commence. Management recognizes that, although FDA approval is not required for use of drug testing for non-medical purposes, such as described above, FDA approval of the product will assist U.S. Drug's marketing in the United States to such customers. Management anticipates that, assuming successful development of the product and submission to the FDA when currently anticipated product revenues will not be realized until the second quarter of 1999 at the earliest. An independent consulting firm engaged by SAT estimated that it would cost $18,400,000 from April 1, 1997 to complete the development of the saliva based drug testing product. SAT had previously reported the estimated (by U.S. Drug management) additional costs as between $10,000,000 and $12,000,000. Such estimates reflected both product development and manufacturing buildout costs, as well as general and administrative expenses. U.S. Drug will attempt to reduce such estimated costs by leasing rather than purchasing certain items, but there can be no assurance as to the extent, if any, that leasing will be a viable option. The consulting firm also estimated that the launching of the program may not occur until August 1999 at the earliest. However, the consultant's report confirmed U.S. Drug's managements' opinion that the product was developable and had market potential, especially with an added feature of the device also testing for alcohol. During the last six months of fiscal 1997, management sought financing from several investment banking firms or potential investors or a standby commitment from the firms with respect to a rights offering to the U.S. Drug stockholders, but has not received any favorable response, as opposed to an expression of interest by certain of these firms in financing SAT. SAT's management until now believed that the best "partner" for U.S. Drug was SAT, not only because it owned 67.0% (now 75.4%), but because of its related synergistic operations which also would allow the Company to operate while the development program proceeded and because SAT appeared to be the best source for funding. The increase in estimated costs and the further delay in the probable launch date has required SAT's management to re-evaluate the methods of financing and request the U.S. Drug management to seek financing in which SAT's securities are not offered. A probable source of such funding for a development stage company is investments by venture capital investors which would result in a substantial dilution of SAT's ownership percentage in U.S. Drug and, if the U.S. Drug Merger is not consummated, that 6 8 of the U.S. Drug Minority Stockholders' interest. In addition, the SAT's management believes that a venture capital investor would prefer to invest in a privately-owned company with an initial public offering as the investor's exit strategy. Consummation of the U.S. Drug Merger would facilitate that possibility. Current SAT and U.S. Drug management have been of the opinion that use of one of the major pharmaceutical or medical diagnostic companies to assist in the product development as the stage of development risked giving confidential data to potential competitors that would not be fully protected by confidentiality and also could result in marketing rights demands that would later reduce the revenues to the Company assuming successful consummation of the development program. Current management also believed that a potential marketing partner could not be obtained on acceptable terms until there was a working prototype for the instrument and the disposable and certain preliminary clinical data is obtained. Current management does not believe that the prototype will be produced until April 1998 at the earliest and that, at that stage of development, the greater part of the expenses in development and manufacturing build-out expenses would already have been incurred, making it less beneficial to obtain a development partner at that time. Despite these reservations continuing, Management believes that the consulting firm's report may resolve the concerns of these major companies as to there being no prototype currently available and U.S. Drug may have to assume the risks of disclosing confidential data as the lesser evil than not to secure adequate financing. U.S. Drug's management will pursue this potential avenue of funding, but does not currently rate U.S. Drug's chances of succeeding as high as those with venture capital investors or some other equity investor. There can be no assurance that the attempts to obtain venture capital investments or a strategic partner for U.S. Drug will be successfully consummated, in which event a decision would have to be made as to whether SAT would seek the additional funds through sales of its own securities or U.S. Drug will have to suspend its development program until funds become available, as to which there can be no assurance. SAT's new investment bankers, L.H. Friend, Weinress, Frankson & Presson, Inc. and Sutro & Co., Inc., have advised SAT management that it would be difficult to finance both the proposed acquisitions for the ESD and the research and development program of U.S. Drug. To facilitate the possibility of U.S. Drug obtaining financing, SAT's Board has requested that U.S. Drug study the feasibility of terminating certain of the interlocking relationships between SAT and U.S. Drug such as (1) U.S. Drug building up a separate management team (Linda H. Masterson resigned as the President of SAT to become the Chief Executive Officer of U.S. Drug (she was already its President) and (2) seeking independent directors. There can be no assurance that these objectives will be achieved or, if achieved, that they will facilitate financing. U.S. Drug spent approximately $8,998,000 on operating expenses including research and development during the period from Inception, October 1992, through March 31, 1997. The following material contracts relate to the drug testing operations now conducted by the subsidiary: (a) On January 24, 1992, SAT and the USN entered into a ten-year non-assignable agreement granting SAT a partial exclusive patent license to products for drug testing in the United States and certain foreign countries. The license applies to the U.S. Government owned invention described in U.S. Patent Application Serial No. 07486024, "Flow Immunosensor Method and Apparatus" filed February 23, 1990. The technology covered by the patent application is designed to test and detect minute and large amounts of drugs contained in body fluids rapidly and efficiently. In November 1994, the license agreement was revised to provide for minimum annual royalties to be paid to the USN of $375,000 for 1995, $600,000 for 1996 and $1,000,000 for 1997 and thereafter. In June 1995, the license agreement with the USN was re-negotiated and amended to provide for minimum annual royalties to be paid to the USN of $100,000 per year commencing October 1, 1995 and terminating September 30, 2005. Additional royalties will be paid pursuant to a schedule based upon sales of products. By an amendment dated June 16, 1995, the term of the exclusive right under the License Agreement was extended to terminate ten years from June 27, 1995 and SAT has a nonexclusive right to use the technology thereafter for the balance of the patent term, unless the License Agreement is terminated sooner because of SAT's default. By letter dated May 15, 1995, the USN notified SAT that, because the expiration date of the USN patent 7 9 had been extended to February 23, 2010 under the GATT/WTO treaty, the expiration date of the License Agreement was extended to February 23, 2010. (b) On April 16, 1992, SAT entered into a 12-month cooperative development research agreement ("CRDA") with the Naval Research Laboratory section of the USN to further develop the licensing technology of the "Flow Immunosensor". (c) Effective January 1993, SAT granted a sole and exclusive sublicense to U.S. Drug which assumed all of SAT's rights and obligations under the License Agreement. However, the USN refused to grant, as requested, a novation of the License Agreement so that the USN looks to SAT for performance thereunder. In the event of a default by U.S. Drug under its sublicense from SAT, all rights of U.S. Drug under the License Agreement would terminate and SAT as the licensee can continue to exercise all rights, and be subject to all obligations, thereunder without any claim by U.S. Drug. SAT simultaneously assigned to U.S. Drug all of its rights under the CRDA. SAT transferred all of its assets and intellectual property rights related to drug testing operations in exchange for 3,500,000 shares of the U.S. Drug Common Stock. (d) On April 1, 1993, SAT and U.S. Drug entered into a five-year management agreement (the "U.S. Drug Management Agreement") which obligated U.S. Drug to pay SAT $300,000 annually plus ten percent of its product sales in exchange for SAT's administrative management services, including management, administrative, accounting and other financial services and advice. In July 1993, the parties amended the U.S. Drug Management Agreement retroactive to April 1, 1993, changing U.S. Drug's annual management fee obligation to $420,000 plus three percent of its gross revenues. In March of 1997, the Management Agreement was again amended to a percentage of time and services agreement whereby certain SAT employees and facilities are allocated to U.S. Drug based on a percentage of usage. The allocation is estimated to be approximately $1,300,000. As the activity of U.S. Drug is increasing there has been a tremendous increase in time required by SAT employees and expanded use of leased space to satisfy U.S. Drug's needs. This new arrangement in the opinion of management more accurately reflects the current cost to U. S. Drug. Copies of the License Agreement (including all amendments), the cooperative research agreement with CRDA (and the assignment thereof to U. S. Drug), the sublicense (and the USN's consent thereto) and the U.S. Drug Management Agreement (including the amendment thereto) are filed (almost all by incorporation by reference) as exhibits to this Report and are incorporated herein by this reference. U.S. Drug has rights under two patents, in addition to its rights to use the USN patent under its sublicense from SAT. These patents are as follows: 1. U.S. Patent No. 5,183,740, "Flow Immunosensor Method and Apparatus," issued on February 2, 1993. Unless extended, the Company's license under this patent expires on February 23, 2010. The Flow Immunosensor provides a method of detecting drugs of abuse or other target molecules by flowing a solution containing the analyte through the immunosensor. The technology relies on the displacement of fluorescent-labeled antigen from a solid phase immobilized antibody and measuring the released labeled antigen in the immunosensor effluent with a detection apparatus. 2. U.S. Patent No. 5,354,654, "Lyophilized Ligand-Receptor Complexes for Assay and Sensors" issued on October 11, 1994. Unless extended, the Company's license under this patent expires on July 16, 2013. This patented process allows for the freeze-drying of ready-to-use immunoassay chemistry or reagents which is then indefinitely preserved. GOOD IDEAS ENTERPRISES, INC. In June 1988, the predecessor of Good Ideas Enterprises, Inc. ("Good Ideas") began the manufacture and shipment of toys and in December 1992 was merged into Good Ideas. In February and April 1994, Good Ideas completed an initial public offering of Good Ideas Common Stock, which security trades in the over-the-counter market after being delisted from the Pacific Exchange effective January 1, 1997. As of May 31, 1997, SAT owned 2,400,000 of the 3,948,680 outstanding shares of the Good Ideas Common Stock or 60.8% 8 10 thereof. On February 26, 1996, the SAT Board of Directors concluded that, because of the history of losses in Good Ideas and what they perceive to be the problems generally in the toy industry it would be difficult to make Good Ideas' operations profitable. The Board also concluded that the Company's best opportunity for maximizing revenue and securing profitable operations was to focus its resources on its operations which were synergistic with each other. For those reasons, the SAT Board authorized management to seek offers from prospective purchasers of Good Ideas. Subsequently, all operations were discontinued and Good Ideas is being held for sale or liquidation. Good Ideas has been retroactively reported in the Company's financial statements as a discontinued operation since March 31, 1995. At March 31, 1997, Good Ideas has written off all remaining inventory since no offer to purchase the inventory is outstanding and its liquidation value is questionable. Since July 1992, SAT had provided certain management and administrative services to Good Ideas. These services included management and financial advice; maintenance of financial books and records and preparation of financial statements, budgets, forecasts and cash flow projections; services relating to banking relationships; payment of accounts payable and payroll; collection of accounts receivable and credit analysis; order processing; import processing; cash management; and other miscellaneous services and advice. In view of the SAT Board's decision on February 26, 1996 to sell or liquidate Good Ideas (see the preceding paragraph), the Board suspended management fees to SAT retroactive to January 1, 1996. Accordingly, Good Ideas recorded no management fee expense in the last quarter of fiscal 1996 and all of fiscal 1997 and SAT recorded no income from management fees in the same period. SAT filed in April 1996, a Registration Statement on Form S-4, File No. 333-3734 (the "Good Ideas Registration Statement"), under the Securities Act to register shares of the SAT Common Stock to be issued to the minority stockholders of Good Ideas upon the consummation of a merger of Good Ideas with and into Good Ideas Acquisition Corp., a wholly-owned subsidiary of SAT. The Good Ideas Registration Statement is not yet effective and, accordingly, no offer has been made to the minority stockholders of Good Ideas. ALCONET, INC. In March 1995, SAT acquired 100% of the issued and outstanding common stock of Alconet, Inc. ("Alconet") and all the membership interests of Dakotanet, L.L.C. As consideration, SAT issued 782,321 shares of the SAT Common Stock registered under the Securities Act as Acquisition Shares in the January 1992 Registration Statement and valued at $1,564,642. The acquisitions have been accounted for as a purchase in the financial statements of the Company. A copy of the Stock Purchase Agreement relating to the Alconet acquisition is filed (by incorporation by reference) as an exhibit to this Report and is incorporated herein by this reference. In March 1996, SAT settled a dispute with two officers of Alconet for an aggregate payment of $250,000 and the assignment of certain software to one of the officers, both of whom then resigned. Alconet was engaged in the computer software/networking business. SAT has closed the Alconet operation as of March 31, 1997. U.S. RUBBER RECYCLING, INC. In November 1992, SAT purchased all the assets of Adflo International, Inc. for its then newly formed wholly-owned subsidiary, U.S. Rubber Recycling, Inc. ("USRR"), which then began to manufacture floor covering products for office and industrial use from used truck and bus tires. These tires were delivered to USRR's then Rancho Cucamonga plant and to an off-site storage facility, where they were recycled by splitting and cutting the tires and reassembling the recycled parts into finished products. Sales were made nationwide through manufacturer's representatives and distributors. All manufacturing was performed in the Rancho Cucamonga facility. On April 30, 1996, USRR sold substantially all of its assets to an unaffiliated buyer for $450,000, $150,000 of which was paid at the closing and the balance by the delivery of a $300,000 promissory note. The purchaser also paid approximately $80,000 in accounts payable of USRR and assumed certain other liabilities, including USRR's lease. The sale resulted in a loss of approximately $132,000. The promissory note is payable in six annual installments of $50,000, together with interest at a rate of 7% per annum. In addition to the annual installments, the promissory note will be prepaid in an amount equal to 12-1/2% of the buyer's annual gross sales of USRR products in excess of $1,400,000. The promissory note is secured by a first priority 9 11 security interest in all of the buyer's assets. USRR required to agree, however, to subordinate its security interest to up to $1,000,000 of institutional financing for the buyer. USRR has been presented under the caption of "Discontinued Operations" in the accompanying financial statements. See Item 8 to this Report. Copies of the Asset Acquisition Agreement relating to the acquisition of assets by USSR and of the Asset Purchase Agreement relating to the sale of USRR assets are filed (by incorporation by reference) as exhibits to this Report and are incorporated herein by this reference. OTHER SUBSIDIARIES As of May 31, 1997, the only other subsidiaries of SAT were Good Ideas Acquisition Corp. and U.S. Drug Acquisition Corp., both of which are inactive and which were incorporated solely for the purpose of the taking private transactions relating to Good Ideas and U.S. Drug, respectively. COMPETITION (1) Employment Services Division The competition from single source providers which the ESD currently encounters is primarily from smaller local and regional companies. To management's knowledge, currently there is no single source provider on a national level, which is what the ESD hopes to achieve. The ESD has entered into two national contracts as of June 30, 1997 and is actively pursuing others. However, Lab Corp., through Med-Express, is currently offering background screening services to corporations on a limited basis. Although, the ESD has experienced personnel in both the drug testing and investigative arena, there can be no assurance that the ESD will become successful in marketing its services as a single source provider on a national level. In addition, the ESD will face competition from other companies which provide each of these services separately such as the companies mentioned in the succeeding subsections of this section "Competition" under this caption "Business of the Company" as it relates to substance abuse testing providers (including the laboratories which are vendors to the ESD), and local or regional investigative firms or private investigators (including vendors to the ESD) as it relates to background investigative services. Assuming that the combined RSA Division/ESD operations achieve national status as a single source provider, there can be no assurance that existing or new companies will not enter the national marketplace to compete with the combined RSA Division/ESD operations. (2) Alcohol Testing The substance abuse detection equipment industry is highly competitive. SAT competes with small companies which also offer alcohol testing equipment such as CMI Inc., Intoximeters, Inc. and Lifeloc, Inc. Although all of these competitors are believed currently to have greater revenues than SAT from sales of alcohol testing devices, management is of the opinion that only CMI, Inc., which is a subsidiary of MPD Inc., may have greater financial resources than SAT. In addition, several companies, offer an on-site screening saliva based alcohol test. Hoffman-LaRoche, Inc. ("Roche") has, and several of these companies may have, greater revenues and financial resources than the Company. Although SAT believes that its product and service quality, combined with its experienced personnel, will offer it a competitive edge in marketing its products and services, there can be no assurance that SAT will be able to compete successfully with larger companies which have greater financial resources available to them to develop and offer an array of substance abuse detection products, nor is there any assurance that other companies will not enter the marketplace and present additional competition for SAT and its products. (3) Drug Testing The Company has not received any revenues from U.S. Drug because its products are still in the developmental stage. U.S. Drug had previously been developing two products which screen for the presence of drugs of abuse, one which utilizes flow immunosensor technology with urine samples as a medium of testing and another which utilizes flow immunosensor technology with saliva samples as a medium of testing. Only the saliva sampling system is currently being developed. The technology in development will specifically test 10 12 for alcohol and five commonly used drugs of abuse: cocaine, opiates (heroin, morphine and codeine), phencyclidine (PCP), amphetamines (including methamphetamine) and tetrahydrocannabinol (THC, marijuana). When the drug testing product is developed, as to which there can be no assurance, U.S. Drug will compete with many of the companies of varying size that already exist or may be founded in the future which utilize urine samples as a medium of testing. U.S. Drug will face competition from at least eight major companies providing substance abuse screening methods: (1) enzyme-multiplied immunoassay technique (EMIT) manufactured and distributed by Syva, a division of Behring Diagnostics; (2) radioimmunoassay (RIA) manufactured and distributed by Roche and others; (3) thin layer chromatography (TLC) manufactured and distributed by Marion Laboratories, Inc.("Marion"); (4) a fluorescence polarization immunoassay (FPIA) manufactured by Abbott Laboratories, Inc.("Abbott"), and other immunoassay tests provided by (5) Editek, Inc. ("Editek"); (6) Hycor Biomedical, Inc. ("Hycor"); (7) Princeton Biotech, Inc. ("Princeton"), and (8) BioSite, Inc. ("BioSite"). Almost all of these companies (i.e., Syva, Roche, Marion, Abbott, Editek, Hycor, Princeton and BioSite) have substantially greater financial resources available to them than does the Company to develop and to market their products. Management believes that saliva sample testing is unique in that, to management's knowledge, no company is currently offering a drug of abuse detection method using saliva samples as a medium on an "on-site" basis. However, U.S. Drug has been advised that such a product is under development by two or more companies and, accordingly, there can be no assurance that such a product will not be offered by a competitor. In addition, even if no such product is developed, U.S. Drug anticipates, as indicated above, competition from other substance abuse detection methods such as Syva's EMIT, Roche's RIA, Marion's TLC, Abbott's FPIA methods, and other immunoassay tests provided by Editek, Hycor, Princeton and Biosite. U.S. Drug's market research to date has indicated a greater market potential for a saliva sample portable testing instrument for use in detecting drugs of abuse by law enforcement agencies, correctional facilities, hospitals and other medical facilities than a urine sample instrument. However, because of the expected limited life cycle of a saliva specimen, the use of this product in other potential markets may be limited. RESEARCH AND DEVELOPMENT During fiscal 1997 the Company spent approximately $1,787,000 on research and development, including approximately $1,735,000 expended on development of the drug testing technology of U.S. Drug. During the fiscal year ended March 31, 1996 ("fiscal 1996"), the Company spent approximately $1,006,000 on research and development, including $949,000 expended on development of the drug testing technology of U.S. Drug. In the fiscal year ended March 31, 1995 ("fiscal 1995"), the Company spent approximately $1,249,000 on research and development, including $886,000 expended on development of the technology of U.S. Drug. PATENTS AND TRADEMARKS U.S. Drug has rights under two patents, in addition to its rights to use the USN patent under its sublicense from SAT. SAT (including its operating divisions) and its other subsidiaries currently have no patents on the other products of the Company. The term of the USN patent is set forth in the section "U.S. Drug Testing, Inc." under this caption "Business of the Company" and the terms of the U.S. Drug patents are 17 years from the date of issuance as set forth in that section, subject to renewal. Termination of the Licensing Agreement for the USN patent, which would occur only on a default by SAT or an invalidation of the USN patent, would end the Company's rights to develop drug testing products. Termination of the other patents or licenses to use the same would require SAT to make changes to its products which could further delay the development and marketing thereof. The Company has obtained tradenames for its major products. The following are the registered trademarks of the Company and have been published by the U.S. Patent and Trademark Office (the "PTO"): Alco-Equilibrator(TM), Sobriety Checkpoint(TM), ABT(TM), Alco-Analyzer(TM), Final Call(TM), Alco-Equilbrator(TM) and Drug Won't Work Here(TM). On April 12, 1995, the Company abandoned the following trademarks: Mobile Alcohol Collection, MACS, Alco-Report; Alco-Breath Tubes, Alco-Link and Alco-Simulator. The Company also has trademark applications pending with the PTO for AlcoProof(TM) and Substance Abuse Technologies(TM). 11 13 Good Ideas has registered the trademarks Good Ideas(TM) and Big Bill's Bric Builders(TM)and the same are published by the PTO. The Company believes these tradenames afford adequate protection. However, there can be no assurance that infringement claims will not be asserted against the Company in the future. LIABILITY INSURANCE SAT maintains liability insurance of $1,000,000, together with an umbrella policy providing coverage of $3,000,000, to protect the Company against legal actions related to injury resulting from product failure, whether such product is offered by SAT or a subsidiary thereof. EMPLOYEES As of March 31, 1997, the Company had 74 full time employees other than its officers, 17 engaged in, research development of the 10 in sales, and 47 in clerical administrative jobs. The Company has no collective bargaining agreement with its employees. ITEM 2. DESCRIPTION OF PROPERTY Effective August 1, 1996, SAT subleased approximately 8,500 square feet of office space in Fort Lauderdale Florida, under a lease expiring November 30, 2001 which lease grants the tenant a right to renew for an additional five-year term. The space is being used for the RSA Division and the ESD. ProActive occupied approximately 1,640 square feet of office space in Savannah, Georgia under a lease expiring January 2, 1999. ProActive has subleased such office space and remains liable in the event of a default by the sublease. SAT has assumed such liability as a result of the merger of ProActive into SAT. SAT occupies approximately 19,500 square feet of office and factory facilities in Rancho Cucamonga, California under a lease expiring January 31, 2002 (as a result of a renewal). The premises are shared with its subsidiary U.S. Drug. This lease includes an option of extending its terms for another consecutive five-year term. The former Alconet subsidiary occupied approximately 1,200 square feet of office space in Bismarck, North Dakota under a lease which, would have expired March 31, 1997 and has been canceled. Copies of the leases for the Fort Lauderdale and Rancho Cucamonga premises are filed (by incorporation by reference) as exhibits to this Report and are incorporated herein by this reference. In addition to rent, the leases provide for payment of real estate taxes and other occupancy costs. For information as to the aggregate rentals paid during the past three fiscal years and anticipated to be paid in the ensuing five fiscal years, see Note 12 to the Company's Financial Statements elsewhere in this Report. Management is of the opinion that the leased facilities in Fort Lauderdale are not adequate for the Company for its planned expansion of the ESD and acquisition strategy. SAT is, therefore negotiating to sublease approximately 4,000 additional square feet in an adjacent building to its current Fort Lauderdale office. The space in California is adequate for its current use; however, if U.S. Drug successfully completes development of its product, U.S. Drug will require an additional 20,000 square feet of space for manufacturing. ITEM 3. LEGAL MATTERS The Company is not a party to any material litigation and is not aware of any pending litigation that could have a material adverse effect on the Company's business, results of operations or financial condition. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITYHOLDERS Not Applicable. 12 14 PART II ITEM 5. MARKET DATA FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS MARKET DATA Between January 2, 1992 and October 23, 1996, the SAT Common Stock traded on the American Stock Exchange under the symbol "AAA." Effective October 26, 1996, the SAT Common Stock traded under the symbol "SAU." The following table sets forth the high and low sales prices for the shares of the SAT Common Stock during the periods indicated:
HIGH LOW ------- ------- Fiscal 1996 Quarter Ended June 30, 1995............................................. $2.1875 $1.625 September 30, 1995........................................ $2.9375 $1.875 December 31, 1995......................................... $2.25 $1.875 March 31, 1996............................................ $3.375 $1.8125 Fiscal 1997 Quarter Ended June 30, 1996............................................. $3.625 $2.3125 September 30, 1996........................................ $3.00 $1.75 December 31, 1996......................................... $2.3125 $1.375 March 31, 1997............................................ $1.4375 $1.375
On July 11, 1997, the closing sales price of the SAT Common Stock was $1.00 per share. HOLDERS The holders of record of the SAT Common Stock on June 30, 1997 were 982 and SAT estimates, based on the number of proxies mailed in connection with the two Annual Meetings of Stockholders held in February and October 1996, that it has approximately 8,200 stockholders, including holders in street name. EXCHANGE LISTING SAT's stockholders' equity as of March 31, 1997 was a negative $596,484 and it has sustained losses since its incorporation, accordingly not meeting the American Stock Exchange requirements that a listed company have stockholders' equity of not less than $4,000,000 if it has sustained losses from continuing operations in three of its four most recent fiscal years. This is a financial condition that would normally cause the American Stock Exchange to consider delisting a listed company's securities. SAT is seeking equity financing to meet the stockholders' equity requirement and will file a Current Report on Form 8-K with a pro forma balance sheet showing compliance upon consummation of same. However, there can be no assurance that SAT will obtain such equity financing or that it will prevent delisting. If the SAT Common Stock is delisted, it will become subject to Rule 15g-9 promulgated under the Exchange Act, which Rule imposes additional sales practices requirements on a broker-dealer which sells Rule 15g-9 securities to persons other than the broker-dealer's established customers and institutional accredited investors (as such term is defined in Rule 501(a) under the Securities Act). For transactions covered under Rule 15g-9, the broker-dealer must make a suitability determination of the purchaser and receive the purchaser's written agreement to the transaction prior to the sale. In addition, broker-dealers, particularly if they are market makers in the SAT Common Stock, have to comply with the disclosure requirements of Rules 15g-2, 15g-3, 15g-4, 15g-5 and 15g-6 under the Exchange Act unless the transaction is exempt under Rule 15g-1. Consequently, Rule 15g-9 and these other Rules may adversely affect the ability of broker-dealers to sell or to make markets in the SAT Common Stock. 13 15 DIVIDENDS No dividends on the SAT Common Stock have been declared by SAT's Board of Directors through March 31, 1997 and, in view of the Company's cash requirements, its history of operational losses and restrictions in its outstanding Convertible Notes, Convertible Debentures and shares of Preferred Stock, SAT's Board of Directors has no current intention to declare or pay dividends on the SAT Common Stock in the foreseeable future. Dividends on the Class A Preferred Stock are payable semi-annually cumulative from December 17, 1990 and all dividends have been paid timely. Dividends on the Class B Preferred Stock are also payable semi-annually, but they first began to accrue on 62,500 shares on May 8, 1997. ITEM 6. SELECTED FINANCIAL DATA The following selected financial data are derived from the consolidated financial statements of the Company. The selected financial data should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the Company's Consolidated Financial Statements, related notes and other financial information included herein. 14 16 SELECTED CONSOLIDATED STATEMENT OF OPERATIONS DATA:
FISCAL YEAR ENDED MARCH 31, ---------------------------------------------------------------------- 1997 1996 1995 1994 1993 ------------ ------------ ----------- ------------ ----------- Continuing Operations: Net Sales............................ $ 2,723,805 $ 1,165,661 $ 1,695,215 $ 442,728 $ 611,739 Costs and Expenses: Cost of Sales (Exclusive of Depreciation Shown Below).......... 1,993,535 1,208,726 1,397,034 389,830 464,103 Selling, General and Administrative Expenses (Exclusive of Depreciation (Shown below)...................... 9,085,331 5,720,592 5,284,405 3,759,858 4,647,943 Research and Development............. 1,787,213 1,005,832 1,248,962 947,811 1,067,381 Depreciation and Amortization........ 1,166,698 1,017,534 695,367 380,676 191,414 Write off of cost in excess of net assets acquired.................... 714,377 -- -- -- Write off of assets associated with abandonment of breath alcohol and cost per test services............. 1,850,209 -- -- -- Present value of future royalties.... 1,100,000 Loss From Settlement of Class Action Litigation......................... -- -- -- 4,600,000 652,625 Loss From Settlement of Litigation... 416,421 1,137,914 -- 50,000 -- ------------ ------------ ----------- ------------ ----------- Total Costs and Expenses...... 18,113,784 10,090,598 8,625,768 10,128,175 7,023,466 ------------ ------------ ----------- ------------ ----------- Loss From Operations................... (15,389,979) (8,924,937) (6,930,553) (9,685,447) (6,411,727) ------------ ------------ ----------- ------------ ----------- Other (Expense) Income: net............ (306,415) 327,426 (545,206) (474,775) (1,211,888) Loss Before Minority Interest in Net Loss (Income) of Subsidiaries........ (15,696,394) (8,597,511) (7,475,759) (10,160,222) (7,623,615) Minority Interest in Net Loss (Income) of Subsidiaries, Net of Subsidiary Preferred Stock Dividends Paid....... 567,469 541,466 769,632 464,083 (360,477) ------------ ------------ ----------- ------------ ----------- Loss from Continuing Operations........ (15,128,925) (8,056,045) (6,706,127) (9,696,139) (7,623,615) Discontinued Operations: Loss from Operations before Minority Interest........................... (1,545,457) (857,575) (242,451) (173,118) Minority Interest in Net Loss...... 467,183 327,306 (127,445) (200,520) Loss on Disposal, net of Minority Interest of $58,591 in 1997 and 143,671 in 1996.................. (314,889) (1,326,267) -- -- -- ------------ ------------ ----------- ------------ ----------- Loss from Discontinued Operations...... (314,889) (2,404,541) (530,269) (369,896) (373,638) ------------ ------------ ----------- ------------ ----------- Net Loss............................... $(15,443,814) $(10,460,586) $(7,236,396) $(10,066,036) $(7,997,235) ============ ============ =========== ============ =========== Weighted Average Common Shares Outstanding.......................... 35,327,631 29,834,502 25,691,674 22,027,068 12,317,743 Loss Applicable to Common Stock: Net Loss............................. $(15,443,814) $(10,460,586) $(7,236,396) $(10,066,035) $(7,997,253) Preferred Stock Dividend -- Class "A"................................ (28,810) (28,810) (39,179) (26,358) (39,992) Preferred Stock Dividend -- Class "B"................................ -- -- (2,425) (13,826) (331,767) ------------ ------------ ----------- ------------ ----------- Loss Applicable to Common Stock........ $(15,472,624) $(10,489,396) $(7,278,000) $(10,106,219) $(8,369,012) ============ ============ =========== ============ =========== Loss Per Common Share: Loss from Continuing Operations...... $ (.43) $ (.27) $ (.26) $ (.44) $ (.65) Loss from Discontinued Operations.... (.01) (.08) (.02) (.02) (.03) ------------ ------------ ----------- ------------ ----------- Net Loss............................... $ (.44) $ (.35) $ (.28) $ (.46) $ (.68) ============ ============ =========== ============ ===========
15 17 SELECTED CONSOLIDATED BALANCE SHEET DATA:
1997 1996 1995 1994 1993 ----------- ---------- ----------- ----------- ---------- Working Capital (Deficiency)................ $(1,381,892) $1,685,583 $ 4,634,665 $ 7,459,655 $3,172,817 =========== ========== =========== =========== ========== Total Assets................................ $ 8,153,720 $6,535,840 $14,097,548 $16,848,733 $6,300,602 =========== ========== =========== =========== ========== Long-Term Debt Less Current Portion...................... $ 4,144,110 $ 32,935 $ 79,008 $ 81,521 $ 2,886 =========== ========== =========== =========== ========== Minority Interest........................... $ 845,349 $1,478,508 $ 2,723,502 $ 3,705,120 $3,676,068 =========== ========== =========== =========== ========== Stockholders (Deficit) Equity............... $ (596,484) $4,032,330 $ 7,693,942 $ 6,844,375 $1,482,943 =========== ========== =========== =========== ==========
PART III ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS NECESSITY FOR OPERATIONAL CHANGES In February 1996, the SAT Board of Directors reached the conclusion, after months of debate and study, that, in order to make an effort to eliminate the Company's history of declining revenues and increasing operational losses, the Company should concentrate its future operations on three operations which the Board considered to be synergistic: its existing alcohol testing products, its drug testing products which were still in the development stage and its human resource provider business which it had launched in September 1995. To facilitate this change in business focus, the SAT Board initiated a program to sell the Company's unrelated business of manufacturing floor covering products from used bus and truck tires (the assets of USRR were sold in April 1996) and the toy business of Good Ideas. In making its decision to divest these two subsidiaries, the SAT Board recognized that the Company would eliminate operations which had produced 79.9% of the Company's revenues in fiscal 1995 and 67.3% in fiscal 1996, which loss would have to be offset by a growth in the human resource provider and alcohol testing products operations because revenues from drug testing products were then considered to be at least 18 to 24 months off in the future, assuming a successful completion of the product development program, as to which there could be no assurance. In May 1996, SAT acquired RSA, thus adding to the Company's synergistic operations RSA's capabilities as a provider of substance abuse testing/ background screening manuals and a consultant on programs relating to alcohol and drug abuse. The SAT Board also caused the filing of the U.S. Drug and Good Ideas Registration Statements in May 1996 and April 1996, respectively, to take U.S. Drug and Good Ideas private, the first as part of the program to unify the synergistic operations into one corporate entity operating through divisions and the second as part of the program to phase out of non-synergistic operations. In both areas, the SAT Board believed that the minority stockholders of the two public subsidiaries would benefit more by being stockholders of SAT. See the sections "Effect of Merger-U.S. Drug" and "Effect of Merger-Good Ideas" under this caption "Management's Discussion and Analysis of Financial Condition and Results of Operations." In May and June 1997 the SAT Board, delayed in its plans to take the two subsidiaries private, and after consulting with its new investment bankers as to the potential sources of financing available to the Company, the SAT Board felt compelled to review the Company's operational strategy in light of the 15 months which had elapsed since February 1996. The SAT Board also considered the limited resources available to the Company absent new significant financing. First, the human resource provider business of the Employer Services Division (formerly ProActive) seemed, in the opinion of SAT management, to be the most promising operation for potential immediate significant revenues and profitability. This operation had started slowly, but with the changes in management in the Division over the past 15 months, the installation in July of a new computer system to manage more effectively the customer data and the engagement of an effective sales staff and other qualified personnel, this 16 18 Division has begun to produce multi-million dollar (on an annualized basis) contracts. Because it takes three to six months, depending on the size of the customer's requirements, to install at the customer the necessary procedures, there is a gap between contract signing and the customer beginning to pay SAT's charges. Accordingly, revenues from this source have not as yet been reflected in any material amount in the Company's financial statements. Nevertheless, the growth potential of this Division became obvious to SAT's management. Also during this period SAT had to incur the marketing and other build-up expenses to launch the program. The SAT management also ascertained that the growth rate could be accelerated by making acquisitions of appropriate third party administrator ("TPA") companies, the first of which is expected to be consummated in late summer of 1997 adding over $7,000,000 in annualized revenues. See the section "Acquisition Strategy for Human Resource Provider Business" under this caption "Management's Discussion and Analysis of Financial Condition and Results of Operations." In its review of the Robert Stutman & Associates Consulting Division (formerly RSA), the SAT Board concluded that this Division gave added support to the Employer Services Division that made it unique in the industry, as well as being a revenue producer on its own and, now operates on a profitable basis. Depending on future developments with respect to the Alcohol Testing Products Division and U.S. Drug's product development program, this Division can be a potential source of business for these operations. Second, the alcohol testing products business now conducted by the Alcohol Testing Products Division of SAT, which was SAT's original business, did not develop, primarily as a result of a DOT change in alcohol testing requirements, discussed in Part 1, Item 1 "Business of the Company". The contracts with two major testing laboratories entered into by former management with charges based on a per test basis had produced losses as well as collection problems. Although current management has terminated these agreements and collections have improved, the Division has revised its marketing program entirely, the Division abandoned future marketing of the Alcohol-Breath Tubes (the "ABTs") and only the AlcoProof System -- the rights to which were acquired in 1997 -- and an alcohol breath testing confirmation device (formerly known as MACS) remain as the viable products to be marketed in the future. See the section "Results of Operations" under this caption "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the sections "Alcohol Products Division" under the caption "Business of the Company." SAT's management will continue to evaluate the operations of this Division on a periodic basis. The saliva based drug testing product is still in the development stage -- a prototype now is not expected until April 1998 at the earliest and submission to the FDA not expected by U.S. Drug management until, at the earliest, February 1999 U.S. Drug's management had estimated that it would take an additional $10,000,000 to $12,000,000 to bring the product to market, assuming that the development program is successfully completed, as to which there can be no assurance. An independent consulting firm engaged by SAT estimated in June 1997 that the product launch date is August 1999 and not December 1998 as previously announced by SAT and that the cost to produce the product from April 1, 1997 could be approximately $18,400,000. The added delay in the launching of the drug testing product and the increased project costs required the SAT Board to ascertain (1) whether the drug testing product-development program should be continued and (2), if the answer is in the affirmative, whether SAT can continue to fund U.S. Drug. The SAT Board concluded, based on the consultant's review and internal management's recommendation, that the product could be developed and still has the potential for being a major revenue producer, especially with an added alcohol testing capability, provided that the program could be adequately financed. Therefore, the Company has taken the following actions to provide a base for continued development of its products. (1) U.S. Drug management has, been requested to re-explore the possibilities of securing financing for U.S. Drug without SAT being a party thereto (i.e., through sale of SAT securities), with venture capital investments currently appearing to be the most likely source for U.S. Drug to secure financing on a long-term basis. Investments by venture capital investors would likely reduce SAT's ownership to an amount below 50%, which is one of the reasons SAT's Board has not favored considering this approach until now because of the potential benefits to SAT if the drug testing product is successfully developed. SAT management still considers taking U.S. Drug private an appropriate step to take. (2) The Company has agreed to continue to fund U.S. Drug as needed. In addition, SAT will seek funding and use some of the cash raised to purchase U.S. Drug common stock. The Board of Directors also authorized the purchase of 2,000,000 shares of the U.S. 17 19 Drug Common Stock for $2,500,000 however such potential investment has been delayed pending additional financing by SAT. (3) The company purchased 1,768,202 shares of U.S. Drug Common Stock in lieu of payment of debt owed to SAT. (4) To focus management on the Drug research, the SAT Board accepted the resignation of Linda Masterson as President of SAT so she could accept the position of C.E.O. of U.S. Drug Testing. See "Effect of Merger -- U.S. Drug" under this caption "Management's Discussion and Analysis of Financial Condition and Results of Operations." Lastly, the SAT Board has concluded that the revenues of the Biochemical Toxicology Laboratories ("BioTox") Division can be increased if certification is obtained from NIDA and that this Division can be a valuable support to the other operational units of the Company; however, the latter use is still under study. ACQUISITION STRATEGY FOR HUMAN RESOURCE PROVIDER BUSINESS The Employer Services Division provides single source services to assist corporations in their hiring practices ranging from substance abuse testing and background screening to total program management. Until recently this Division has been attempting to build the business only by acquiring major customers through its sales force. The Division has been dependent on the major laboratories for its drug testing services, thereby risking increased costs if these laboratories increased their charges to SAT. Installing the programs at a customer site, depending on the customer's requirements, may take from three to six months and, accordingly, there is a gap between the customer signing and the customer beginning to pay for these services. As a result, the Division's revenues were not significant in fiscal 1997, despite the number of significant new users signed to contracts. The third party administration of testing for substances of abuse as a part of human resources management represents a fragmented industry. SAT's management believes that its management team and unique selling approach will be able to consolidate many of the competitors through acquisition. For the most part, many of the businesses targeted by SAT have evolved into this type of business as an adjunct to another area of expertise. As a result, management believes the TPA business portion of their businesses are not necessarily profitable. Although there can be no assurance, SAT management believes that the Employer Services Division can successfully consolidate these companies and, by using economics of scale, SAT's own resources and unique expertise in this area, coupled with the services of the Robert Stutman & Associates Consulting Division, attain profitability and, as a result, SAT would become a major influence in the area of third party administration of substance abuse testing, background checking and other similar human resource requirements. SAT's two investment bankers have advised SAT management that, to the extent the contemplated acquisition program requires cash as the medium for the purchase prices, as contrasted with use of the SAT Common Stock for the target companies, investors would be interested in financing these acquisitions. They have especially noted the ability of the Company to become profitable at any earlier date as a result of this program without giving effect to the operations of U.S. Drug. There can, of course, be no assurance as to the availability of this financing, as to SAT effecting the acquisitions or as to the profitability of the Company. The contemplated acquisition of the assets of the Datamed International division of Global Med Technologies, Inc. ("Global Med"), assuming Global Med obtains its shareholders' approval in August, will not only bring SAT over $7,000,000 (on an annualized basis) in new revenues, but will also result in an arrangement with National Medical Review Offices, Inc. ("NMRO"), a major provider of medical review officer ("MRO") services This arrangement will result in the Employer Services Division having lower costs for its MRO services, and be a strong incentive for future customers to engage the services of the Employer Service Division. EFFECT OF MERGER -- U.S. DRUG During May 1996, SAT filed the U.S. Drug Registration Statement to solicit the consents of the minority stockholders of U.S. Drug to a merger of U.S. Drug with and into a wholly-owned subsidiary of SAT (the "U.S. Drug Merger") and to register under the Securities Act the shares of the SAT Common Stock to be 18 20 issued to the minority stockholders of U.S. Drug if the U.S. Drug Merger is consummated. Based upon Amendment No. 2 to the U.S. Drug Registration Statement filed on April 21, 1997, SAT would offer 1.62 shares of the SAT Common Stock for each share of the U.S. Drug Common Stock or an aggregate of 2,789,478 shares of the SAT Common Stock for the 1,721,900 shares of the U.S. Drug Common Stock held by the U.S. Drug minority stockholders. SAT delayed filing Amendment No. 3 in order to receive comments from the Staff of the Securities and Exchange Commission as to Amendment No. 2 and to include, because of the delay in receiving comments, the audited financial statements for fiscal 1997 for the Company and U.S. Drug. SAT has been advised that upon such filing the Staff will issue its comments on SAT's filings. The effects of the U.S. Drug Merger are discussed below. The latest estimates, both external and internal, which SAT management has are that, to complete the development of a saliva based drug testing product, will require incremental costs ranging from $15,000,000 to $18,400,000 and that the product is not expected to be launched until some date in the first quarter of 1999 (internal estimate) or August 1999 (external estimate). This contrasts with SAT's previous and publicly announced incremental costs (from April 1, 1997) of $10,000,000 to $12,000,000 and a launch date of December 1998. A consultant's report in June 1997 confirmed U.S. Drug's management's opinion that the product could be developed and had market potential, especially with an added feature of the device also testing for alcohol. SAT's management until now believed that the best "partner" for U.S. Drug was SAT, not only because it owned 67.0% (now 75.4%), but because of its related synergistic operations which also would allow the Company to operate while the development program proceeded and because SAT appeared to be the best source for funding. The increase in estimated costs and the further delay in the probable launch date has required SAT management to re-evaluate the methods of financing and request the U.S. Drug management to seek financing in which SAT securities are not offered. A probable source of such funding for this development stage company is investments by venture capital investors which would result in a substantial dilution of SAT's ownership percentage in U.S. Drug and, if the U.S. Drug Merger is not consummated, that of the U.S. Drug minority stockholders' interests. In addition, SAT management believes that a venture capital investor would prefer to invest in a privately-owned company with an initial public offering as the investor's exit strategy. Consummation of the U.S. Drug Merger would facilitate that possibility. U.S. Drug's management has also been requested to explore the possibility of obtaining a strategic partner for U.S. Drug other than SAT. Current SAT and U.S. Drug management have been of the opinion that obtaining one of the major pharmaceutical or medical companies to assist in the product development at this stage of development risked giving confidential data to potential competitors that would not be fully protected by confidentiality agreements and also could result in marketing rights demands that would later reduce the revenues to the Company assuming successful consummation of the development program. Current management also believed that a potential marketing partner could not be obtained on acceptable terms until there was a working prototype for the instrument and the disposables and certain preliminary clinical data is obtained. Current management does not believe that the prototype will be produced until April 1998 at the earliest and that, at that stage of development, the greater part of the estimated development and manufacturing build-out expenses would already have been incurred, making it less beneficial to obtain a development partner at that time. Despite these reservations continuing, management believes that the consultant's report may resolve the concerns of these major companies as to there being no prototype available and that U.S. Drug may have to assume the risks of disclosing confidential data as the lesser evil than not to secure adequate financing. U.S. Drug's management will pursue this potential avenue of funding, but does not currently rate U.S. Drug's chances of succeeding as high as those with venture capital investors or some other equity investor. There can be no assurance that U.S. Drug will be successful in securing financing, whether through a venture capital investor or otherwise, in which event a decision would have to be made as to whether SAT would seek the additional funds through sales of its own securities or U.S. Drug will have to suspend its development program. If the U.S. Drug Merger is consummated on the currently proposed basis, SAT will record a non-recurring charge to income of approximately $3,800,000 as Incomplete Research and Development cost, representing the excess of the market value of the SAT Common Stock issued in the U.S. Drug Merger over 19 21 the book value of the acquired minority investment in U.S. Drug. Nevertheless, for the reasons which SAT will give in the U.S. Drug Registration Statement, SAT still believes that the U.S. Drug Merger should be approved by the U.S. Drug minority stockholders. SAT may delay the filing of Amendment No. 3 in order to give the Staff of the Commission time to review the audited financial statements and to permit SAT to mail the proxy material for a Special Meeting of Stockholders to approve a proposed increase in the authorized shares of the SAT Common Stock. There can be no assurance as to when the U.S. Drug Registration Statement will be declared effective in view of the past delays. EFFECT OF MERGER -- GOOD IDEAS During April 1996, SAT filed the Good Ideas Registration Statement to solicit the consents of the Good Ideas minority stockholders to a merger of a wholly-owned subsidiary of SAT with and into Good Ideas (the "Good Ideas Merger") and to register shares of the SAT Common Stock to be issued to the Good Ideas minority stockholders if the Good Ideas Merger is consummated. Amendment No. 2 to the Registration Statement filed on April 21, 1997 provided for an exchange offer of .36 of a share of the SAT Common Stock for each share of the Good Ideas Common Stock or an aggregate of 557,524 shares of the SAT Common Stock for the 1,548,680 shares held by the Good Ideas minority stockholders. SAT intends to file Amendment No. 3 to the Registration Statement, including the audited financial statements reported in this Report and in Good Ideas Annual Report, and then to seek to have such Registration Statement declared effective. SAT may delay the filing in order to give the Staff of the Commission time to review the audited financial statements and to permit mailing of proxy material for a Special Meeting of Stockholders to approve the proposed increase in authorized shares of the SAT Common Stock. There can be no assurance as to when the Good Ideas Registration Statement will be declared effective in view of the past delays. Because of problems which management believed were characteristic of the toy industry generally and Good Ideas' declining sales and increasing losses, the SAT Board of Directors concluded on February 26, 1996 that Good Ideas was not likely to reverse the trend of increasing losses during the next 12 months. The Board believed that, whether or not the Good Ideas Merger was consummated, the only way to improve operational results was to secure new toy products, whether through licensing arrangements or otherwise; however, this type of program, even if successful, as to which there could be no assurance, would require substantial cash investments, which was contrary to the Board's conclusion that the Company's best opportunity at maximizing revenues and securing profitability was by concentrating on its alcohol and drug testing and human resource provider operations as its core businesses. Accordingly, on February 26, 1996, the SAT Board authorized seeking a purchaser for Good Ideas. In addition, the SAT Board suspended management fees to SAT retroactive to January 1, 1996. The Company subsequently sold a portion of the Good Ideas assets and has written off the remaining un sold assets.. The SAT Board believes that liquidation of Good Ideas would be preferable than investing substantial additional funds in Good Ideas. As of March 31, 1997, SAT owed Good Ideas $2,032,455. The Good Ideas Merger would terminate SAT's obligation to repay such indebtedness. As indicated in the section "Necessity for Operational Changes" under this caption "Management's Discussion and Analysis of Financial Condition and Results of Operations," the SAT Board still believes that the reasons for the Good Ideas Merger considered in February 1996 are still valid today. LIQUIDITY AND CAPITAL RESOURCES Although the Company has a history of operating losses through March 31, 1997 and the Company has $1,382,000 in negative working capital, compared to a positive working capital in fiscal 1996 of $1,166,000, management believes that the Company will be able to provide cash resources to meet all of its operating requirements for the ensuing 12 months resulting from cost reduction actions as described below and assuming the Company is able to raise additional capital through the sale of common stock or issuance of additional long-term debt. In addition to the change in cash available, the negative working capital is largely attributable to approximately $500,000 additional reserve in accounts receivable, an inventory write off associated with the abandonment of the certain alcohol products and increased current liabilities 20 22 Good Ideas and USRR have produced significant operating losses over the last several years. Both operations have been discontinued. USRR was sold April 30, 1996. Good Ideas' operations have been terminated. Both actions have substantially reduced the Company's cash requirements Management believes that cash flow from operations will increase in fiscal 1998 through the addition of the RSA revenues and by developing the ESD human resource business, both of which experienced significant growth in fiscal 1997. Because of the increasing success in attracting customers to the these divisions, management has decided to focus the majority of it's effort's into this portion of it's business. The company believes this strategy will provide the most effective use of it's resources. (see "Acquisition Strategy for Human Resources Provider" above). The company believes both the ESD and RSA divisions will be cash positive by the end of the fiscal year without acquisitions. With acquisitions the Company believes these divisions can begin to generate enough cash to fuel additional growth. The Company engaged the services of an independent research firm to determine the feasibility as to saliva based testing product by U.S. Drug. The study, completed in June 1997, indicates further development is desirable. The estimated cost to develop the product, from April 1, 1997, is $18,400,000. The Company will seek a joint venture marketing partner to help in the development program, which while reducing current expenditures, would also reduce future revenues to the extent marketing rights are demanded by such "development partner." As described above, the Company has decided to substantially focus on the RSA/ESD business and the acquisition strategy associated with that decision. Additionally, there will be limited cash reserves to both fund SAT operations and a research and development operation. In May 1997, the Company consummated a Convertible Debenture and Preferred Stock Purchase Agreement. The Company issued and sold to an investor a convertible debenture in the principal amount of $750,000 and 62,500 shares of Class "B" preferred stock for $4.00 per share. The aggregate Purchase price for the debentures and the common stock was $1,000,000. On July 3 and July 7, 1997, the Company issued notes totaling $625,000 to a director of the Company. The terms of the notes provided that, in addition to the principal, the Company would pay to the director an additional $175,000 plus issue shares of common stock with a market value of $50,000. Between April 1, 1996 and June 5, 1996, warrants and options were exercised to purchase 2,353,449 shares of the SAT Common Stock generating $4,242,000 in cash. Outstanding unexercised SAT Common Stock purchase warrants as of March 1997 could generate approximately $15,348,000 of new capital to the Company. Outstanding stock options could generate proceeds of approximately $1,040,000 if exercised. SAT will have to update or file registration statements under the Securities Act to make these exercises more attractive to the holders. There can be no assurance that any of the remaining warrants or options will be exercised. In the event that the Company is unable to generate sufficient cash flow from operations or from sources other than those described above, then the Company may have to provide for additional reductions in operating costs, including eliminating funding for U.S. Drug research and development. This will not only result in less cash from operations currently, but also delay future revenue growth. In such event the market price of the SAT Common Stock is likely to drop, not only discouraging the future exercises of the SAT Common Stock purchase warrants and the stock options and possibly discouraging potential new investors, but also increasing the risk that a current investor in SAT may lose the value of their investment. CHANGES IN FINANCIAL CONDITION OPERATING CASH FLOWS Net loss for the Company was $15,444,000 for fiscal year 1997 of which $7,051,000 was the result of non cash items compared to a net loss of $10,461,00 in fiscal 1996 of which $1,300,000 was non cash related. Cash used for operations was $7,376,000 in fiscal 1997 compared to $8,711,000 for fiscal 1996. 21 23 INVESTING CASH FLOWS Cash used in investing activities was $2,321,000 for fiscal 1997 primarily for the cash portion of the acquisition of Robert Stutman Association. In fiscal 1996 investing activities provided $3,376,000 primarily from the sale of marketable securities. FINANCING CASH FLOWS Cash provided from financing activities was $9,092,000 during the fiscal 1997. The proceeds were the result of Warrants exercised amounting to $4,660,000 and sale of convertible debenture for net proceeds of $4,941,000. Cash from financing activities totaled $4,906,000 in fiscal 1996 primarily from the sale of common and preferred stock ($6,788,000) and loans ($1,000,000) offset by loan payments of $2,569,000. Cash resources for fiscal 1998 will be limited unless the Company is successful in raising cash from additional investors. The Company has engaged two investment bankers to help in the process of raising funds and the Company is optimistic that the effort will be successful but there can be no assurances of that success. The drug testing and background screening clients require an initial setup period and therefor each new client can take a number of months before contracted revenues are realized. In management's opinion, to meet the Company's commitments which include lease obligations, royalty obligations and development of products for at least the next 12 months additional investment will be required. The Company expects that ultimately revenue generated from the drug testing business will eventually provide enough working capital for the business. There are currently no unfunded commitments for capital expenditures. RESULTS OF OPERATIONS FISCAL 1997 VS. FISCAL 1996 Revenues from continuing operations for fiscal 1997 were $2,724,000, an increase of $1,558,000 or 134% from revenues of $1,166,000 reported for fiscal 1996. The revenue increase was primarily the result of the continued focus in the human resource provider business. The current fiscal year includes a full year of revenue from ProActive Synergies, Inc. (now referred to as "ESD" division) acquired in September of 1995 and revenue from Robert Stutman & Associates, Inc.,("RSA") acquired in May 1996. There was no revenue from RSA in fiscal 1996. Revenue increase from the Alcohol division contributed, to a lesser degree, to the increase in revenue year over year. The Alcohol division revenue was primarily generated during the first nine months of fiscal tear 1997 as a result of the early stages of the "cost per test" program. In December of 1996 the "cost per test" program was discontinued. (See Item 1 "Business of the Company" for further discussion). Cost of sales for the fiscal 1997 on continuing operations was 73.2% of revenue as compared to 103.7% of revenues for fiscal 1996. The improvement in cost of sales as a percentage of revenue in fiscal 1997 was primarily the result of the Alcohol division's de-emphasizing the costly cost per test business. The cost of sales as a percentage of revenue for products sold was 77.2% and for services was 71.4% in fiscal 1997 compared to 120.7% and 73.1% respectively for 1996. Selling, general and administrative ("S.G.&A") expenses were $9,085,000 for fiscal year ended March 31, 1997 compared to $5,721,000 for fiscal 1996, representing an increase of $3,364,000 or 58.8%. Primarily the increased expense in fiscal 1997 was the result of incurring consulting services in regard to investor relations activities and financial consulting services totaling $1,890,000 which were not incurred in 1996. These services were paid for in Common Stock Warrants. Additionally S.G.&A expenses associated with RSA and ProActive which expenses were not included for a full fiscal year 1996 also contributed to the increase in expenses year over year. Research and development expenses for fiscal year 1997 were $1,787,000 compared to $1,006,000 for fiscal 1996, an increase of $781,000 or 77.7%. Research and development expenses represent the increased activity in the development of the Saliva testing program associated with the subsidiary U.S. Drug. Increased personnel requirements and additional operating expenses to bring Saliva testing to the next stage of development, attributed to the increase. 22 24 Loss from the settlement of litigation for fiscal 1996 included nonrecurring legal and other expenses in the amount of $888,000 which were incurred by SAT in connection with its settlement with the Committee of the consent solicitation litigation. Additionally, a non-recurring settlement of $250,000 was paid to two former owners of Alconet, Inc. relating to a dispute over the terms of their employment contracts. Fiscal 1997 included an accrual for a settlement and legal fees of $416,000 associated with the settlement for one of the Board members associated with a suit arising from actions concerning the results of consent solicitation. (See Note 12 Commitments and Contingencies for further discussion. Depreciation and amortization was $1,167,000 for fiscal year 1997 compared to $1,018,000 for fiscal 1996, representing an increase of $149,000 or 14.7%. The majority of SAT's alcohol testing machines were placed in testing sites in the fourth quarter of 1995, in connection with the cost per test agreements with major laboratories. The depreciation expense in both fiscal 1996 and 1997 associated with this equipment is the primary depreciation expense. In December 1996, the Company discontinued the "cost per test" program and wrote off all of the assets associated with the program. Write off of assets associated with the abandonment of breath alcohol and cost per test services in fiscal 1997 represents the write off of inventory and fixed assets associated with the "cost per test" program. A change in Department of Transportation alcohol testing requirements forced the Company's alcohol testing products to compete with less expensive alternatives. Therefore the anticipated market never materialized causing the write down of assets and inventory related to this market. Combined inventory and assets write off accounted for $1,850,000. The decision to abandon the breath alcohol and cost per test services also resulted in the write-off of costs in excess of net assets associated with Alconet of $714,000. The Company accrued a royalty payment due to the inventor of the Alcohol testing equipment. The amended royalty agreement required the Company to pay a base royalty of $120,000 per year for the life of the inventor. As a result of the Company's decision to cease the "cost per test" business, the royalty agreement has no future value to the company but the payments are required by the royalty agreement. Therefore the Company accrued $1,100,000, in fiscal 1997. The accrual was calculated based on the life expectancy of the inventor. The Company's operating loss of $15,128,000 for fiscal 1997 increased $7,098,000 or 87.8% over the $8,598,000 loss for fiscal 1996. The increased operating loss can be primarily attributed to losses associated with the abandonment of the alcohol testing business, expenses related to consulting services for three consultants, an accrual to cover settlement costs and legal fees associated expenses arising from a suit concerning a consent solicitation and legal fees associated with a settlement, write off of cost in excess of net assets associated with Alconet and lastly expenses included in fiscal 1997 for operations not included in fiscal 1996 Additionally, fiscal 1996 included a net gain of $302,000 on marketable securities and there was no such gain in 1997. U.S. DRUG TESTING, INC. (SUBSTANCE ABUSE TESTING) During fiscal 1997, the Company continued as a development stage enterprise with no revenues. Selling, general and administrative expenses were $185,000 in fiscal 1997 compared to $417,000 in fiscal 1996 or a decrease of $232,000, primarily the result of lower travel, utility and telephone expenses. Research and development expenditures totaled $1,569,000 in fiscal 1997 compared to $851,000 in fiscal 1996 or an increase of $718,000. The increase is primarily the result of expanded personnel requirements and operating expenses to bring the saliva testing to the next phase of development. Costs include engineering and chemist consulting time as well as additional U.S. Drug full time employees. Management fees paid to SAT were $420,000 in both fiscal 1997 and fiscal 1996. For a description of the services rendered under the management agreement relating to these fees, see the section "Subsidiaries -- U.S. Drug Testing, Inc." in Item 1 to this Report. As of March 31, 1997, U.S. Drug did not anticipate generating revenues from product sales during fiscal 1998 and, accordingly, anticipated that operating losses would continue for at least a 12 to 24-month period. Net expenses for fiscal year 1997 were $1,970,000 compared to $1,641,000 for fiscal year 1996. The increase of $329,000 was primarily the result of additional people requirements. The costs include expenses for engineering and chemists consulting time and additional employees. 23 25 DISCONTINUED OPERATIONS GOOD IDEAS ENTERPRISES, INC. (TOY) On February 26, 1996, the SAT Board determined to sell or liquidate Good Ideas, a conclusion concurred with by the Good Ideas Board. As a result of the above decision, the assets of Good Ideas are included in the consolidated balance sheet at management's estimate of liquidation value and the results of operations of Good Ideas are presented on a liquidation basis. As a result there was no Statement of Operations for fiscal 1997. The change in assets (liabilities) held for liquidation included a reserve for $2,032,000 for a note receivable due from SAT leaving a net deficit of $7,000 U.S. RUBBER RECYCLING, INC. (RECYCLED RUBBER PRODUCTS) The SAT Board, on February 26, 1996, concluded that the Company should concentrate on alcohol and drug testing and ESD's human resource provider operations as its core businesses and, accordingly, authorized seeking a purchaser for USRR. A sale of substantially all of the assets of USRR was consummated on April 30, 1996. The net loss for fiscal 1996 included a $88,000 loss on disposal of USRR's assets. FISCAL 1996 VS. FISCAL 1995 Revenues from continuing operations for fiscal 1996 were $1,166,000, a decrease of $529,000 or 31.2% from revenues of $1,695,000 reported for fiscal 1995. Revenues from the sale of alcohol breath analyzing equipment decreased by $750,000, which decrease was attributable to an unusually high volume of alcohol breath analyzing machines sold in the third quarter of the prior year and a reduction in sales effort as the sales force was reassigned to the ESD startup. Sales of the Biotox division decreased $227,000, reflecting the end of a contract performing methadone tests. These decreases were offset by an increase in cost per test revenue from the alcohol breath analyzing equipment of $185,000, miscellaneous sales of supplies of $42,000 and revenues of $203,000 from Alconet, which was acquired March 31, 1995, and the human resource provider business which, while still in a start up mode, produced revenues of $18,000. Cost of sales for the fiscal 1996 on a continuing operations was 100.4% of revenues as compared to 82.4% of revenues for fiscal 1995 as a result of lower sales volumes, increased labor and supply costs relating to the cost per test business and an inventory write-off of $193,000 during fiscal 1996. Selling, general and administrative expenses were $5,721,000 for fiscal 1996, representing an increase of $437,000 or 8.3% from the $5,284,000 of such expenses incurred for the comparable period of the prior year. The expenses for fiscal 1996 included $397,000 of expenses incurred by a newly acquired subsidiary, Alconet, not included in the comparable numbers for the prior year. Research and development expenses were $1,006,000 for fiscal 1996, representing a decrease of $243,000 or 19.5% from the expenses in the prior year. Research and development expenses in connection with SAT's alcohol testing machine decreased by $215,000 during fiscal 1996 from such expenses in the prior year, which decrease was attributable to the fact that the machines were placed in service in the fourth quarter of the prior year. U.S. Drug's research and development expenses decreased $35,000 as compared with such expenses in the prior year. Loss from the settlement of litigation for fiscal 1996 included nonrecurring legal and other expenses in the amount of $888,000 which were incurred by SAT in connection with its settlement with the Committee of the consent solicitation litigation. Additionally, a non-recurring settlement of $250,000 was paid to two former owners of Alconet, Inc. relating to a dispute over the terms of their employment contracts. Depreciation and amortization was $1,018,000 for fiscal 1996, representing an increase of $322,000 or 46.3% over depreciation and amortization in fiscal 1995, which increase was attributable primarily to depreciation on SAT's alcohol testing machines placed in testing sites in connection with the cost per test agreements with major laboratories. The majority of these machines were placed in service in the fourth 24 26 quarter of fiscal 1995. These machines represented an increase in depreciation expense of $514,000 for fiscal 1996 as compared to the expense in the prior year based on a full year's depreciation in fiscal 1996. The Company's operating loss of $9,006,000 for fiscal 1996 increased by $2,029,000 over its operating loss of $6,977,000 for the prior year. The increased operating loss can be attributed to: the lower level of revenues generated from the alcohol testing business attributable to an unusually high volume of alcohol breath analyzing machines sold in the third quarter of the prior year; negative gross margins for fiscal 1996 resulting from higher labor and supply costs necessary to support the start up of the cost per test business; increased selling, general and administrative expenses and nonrecurring losses from settlement of litigation in the amount of $1,138,000, operating losses of $576,000 incurred by Alconet, a newly acquired subsidiary not included in the prior year numbers; and increased depreciation cost relating to the cost per test business. Other income, net of other expenses, for fiscal 1996 was $409,000 as compared to an expense of $499,000 reported for fiscal 1995. The trading securities sold by the Company in fiscal 1996 generated a profit of $302,000 over their carrying value in the March 1995 balance sheet. During fiscal 1995, these securities generated a loss of $155,000 and an unrealized loss of $598,000. Interest income decreased by $134,000 for fiscal 1996 as compared to the interest income in the prior year. Management is of the opinion that it is too speculative to project at this time when the Company will turn profitable because of the Company's history of operational losses, the delay in completing and then marketing its urine sample drug testing product in order to wait until a saliva sample drug testing product is available, the fact that its human resource provider program is in its early marketing stages and the discontinued operations of the toy subsidiary. U.S. DRUG TESTING, INC. (SUBSTANCE ABUSE TESTING) During fiscal 1996, the Company continued as a development stage enterprise with no revenues. Selling, general and administrative expenses were $417,000 in fiscal 1996 as compared with $850,000 in fiscal 1995 or a decrease of $433,000, resulting primarily from a $325,000 reduction in the royalty payments on the SAT license with the USN from $375,000 in fiscal 1995 to $50,000 in fiscal 1996. Other selling, general and administrative expenses for fiscal 1996 were comprised of royalty expenses of $62,000, rent, utilities and telephone charges of $97,000, insurance expenses of $35,000, marketing research expenses of $44,000, legal and auditing services of $33,000, directors' fees of $10,000, travel expenses of $24,000 and other expenses of $112,000. Research and development expenditures totaled $851,000 in fiscal 1996 as compared with $886,000 in fiscal 1995. The 1996 expenditures consisted of payroll and fringe benefits of $593,000, outside consulting services of $184,000 and other costs of $74,000. Depreciation expense decreased $19,000 from $163,000 in fiscal 1995 to $144,000 in fiscal 1996 as some assets became fully depreciated during the year. Management fees paid to SAT were $420,000 in both fiscal 1996 and fiscal 1995. For a description of the services rendered under the management agreement relating to these fees, see the section "Subsidiaries-U.S. Drug Testing, Inc." in Item 1 to this Report. Interest expenses on brokerage loans were $72,000 during fiscal 1996 as compared with $42,000 during fiscal 1995 or an increase of $30,000 resulting from increased borrowings during fiscal 1996. Other income (expense) resulted in net income of $263,000 in fiscal 1996 as compared with net income of $31,000 in the prior year or an increase of $232,000. Fiscal 1996 other income (expense) is comprised of a gain of $76,000 on the sale of REMIC bonds over their earnings value at March 31, 1995, interest income primarily relating to the REMIC bonds of $105,000 and interest income on loans to SAT of $82,000. In fiscal 1995 other income (expense) was comprised of interest income, primarily on the REMIC bond of $245,000, interest income from SAT of $20,000 and an unrealized loss on the market value of the REMIC bonds caused by generally higher interest rates. As of March 31, 1996, U.S. Drug did not anticipate generating revenues from product sales during fiscal 1997 and, accordingly, anticipated that operating losses would continue for at least a 12 to 24-month period. SAT will need to provide the funding necessary to complete the development of the U.S. Drug products and bring them to market. 25 27 DISCONTINUED OPERATIONS GOOD IDEAS ENTERPRISES, INC. (TOY) Net sales for fiscal 1996 were $1,508,000, a decrease of $3,098,000 or 67.3% from the net sales in the prior year. Of this decrease, $1,994,000 or 64.4% was attributable to Toys R Us, the major customer of Good Ideas, not placing orders for Good Ideas' toy products. The customer attributed its reduction in orders to its large inventories and declining sales and customer traffic. Management believes that other manufacturers in the toy industry are currently facing these same problems -- their distributors or retailers to which they sell have large inventories of products and declining sales and customer traffic. In addition, management believes that many retailers are minimizing their number of vendors and reducing the number of items carried in inventory which has the result of squeezing out the smaller companies with their limited product lines. Gross profit for fiscal 1996 was $163,000 or 10.8% of net sales as compared with $1,324,000 or 28.7% of net sales for the prior year. The decrease in gross profit as a percentage of net sales was primarily due to a write-off of inventory in the amount of $192,000. Selling, general and administrative expenses for fiscal 1996 decreased to $1,279,000 from $1,924,000 for the comparable period in fiscal 1995, which decrease was attributable to reductions in payroll and related costs during fiscal 1996. Management fees paid to SAT were $225,000 for fiscal 1996, representing a decrease of $80,000 from the $305,000 of fees paid for fiscal 1995. The decrease resulted from SAT's suspension of the management fee retroactive to January 1, 1996. Good Ideas recognized interest income of $158,000 from its loans to related parties during fiscal 1996, as compared with $68,000 in the prior year due to increased loan balances. Good Ideas also recognized interest income from money market investments of $3,500 and $44,000 during fiscal 1996 and fiscal 1995, respectively. The net loss for Good Ideas was $1,566,000 for fiscal 1996, representing an increase of $768,000 from the net loss of $798,000 reported for fiscal 1995. The increase in the net loss was due to the decreases in sales and gross profit offset by the decreases in selling, general and administrative expenses and management fees, all as described in the preceding paragraphs. The net loss for the current year was also increased by the writedown of assets in the amount of $258,000 and the projected costs through sale or liquidation in the amount of $110,000. Included above but excluded in discontinued operations in the financial statements are intercompany allocations of general corporate overhead of $225,000 and $305,121 in fiscal 1996 and 1995, respectively, and intercompany allocations of interest income of $157,812 and $64,320 in fiscal 1996 and 1995, respectively. Unless Good Ideas were to add new products to its line, as to which there can be no assurance, and there were a stronger demand for toy products in the industry generally, management does not believe that a turnaround in Good Ideas' operations would occur during the next 12 months, if not at a later date. Although management of Good Ideas had in the past considered plans to expand the product line, it was reluctant to implement these plans absent a change in the industry conditions described above. On February 26, 1996, the SAT Board determined to sell or liquidate Good Ideas, a conclusion concurred with by the Good Ideas Board. As a result of the above decision, the assets of Good Ideas are included in the consolidated balance sheet at management's estimate of liquidation value and the results of operations of Good Ideas are presented on a discontinued basis. U.S. RUBBER RECYCLING, INC. (RECYCLED RUBBER PRODUCTS) Net sales of USRR for fiscal 1996 were $892,000, a decrease of $1,244,000 or 58.2% as compared with sales of $2,136,000 in the prior year. This decrease was attributable to the continuing effects of the cancellation of an agreement with a distributor (Matworks, Inc.) by USRR in October 1994 because of significant breaches of the contract by the distributor relating to its use of competitors' flooring products in violation of a contractual requirement to use only USRR's products. SAT does not intend to institute any legal action against the distributor because USRR does not want to incur the protracted legal expenses involved in litigation. 26 28 Gross margin for fiscal 1996 was $419,000 or 47.0% of net sales, up from a gross margin of 41.8% of net sales for fiscal 1995. The increase in gross margin was attributable to an increase in the selling price of USRR's product to its customers. This offset an inventory write off of floor tiles which became non-repairable during the six months ended September 30, 1995. Floor tiles not meeting quality control standards are segregated in the inventory for future repairs to correct the flaws and those not repairable are discarded. During fiscal 1995, USRR worked a double shift to meet the production demand created by the agreement with the distributor. Inexperienced labor resulted in an increase in tiles not initially suitable for shipments. Selling, general and administrative expenses were $605,000 for fiscal 1996, representing a decrease of $214,000 from such expenses in fiscal 1995. Of this amount, $162,000 represented a decrease in commissions and freight related to the decline in sales revenue. Management fees paid to SAT were $89,000 for fiscal 1996, representing a decrease of $124,000 from such fees in the prior year. Depreciation expense was $99,000 for fiscal 1996, representing an increase of $40,000 over such expense in the comparable prior year, which increase was attributable to the commencement of depreciation on additional manufacturing equipment built in contemplation of potential expansion. Interest expense was $123,000 for fiscal 1996 as compared with a $112,000 expense in the comparable period in 1995 as a result of borrowings from affiliates. The operating loss of $492,000 for fiscal 1996 represented a decrease of approximately $131,000 from an operating loss of $623,000 for fiscal 1995. The decrease was primarily attributable to the increased percentage of gross margin and the decrease in selling, general and administrative expenses incurred during fiscal 1996. Included above but excluded in discontinued operations in the financial statements are intercompany allocations of general corporate overhead of $89,193, $213,173 and $119,216 in fiscal 1996, 1995 and 1994, respectively, and intercompany allocations of interest expense (income) of $122,545, $109,575 and $61,034 in fiscal 1996, 1995 and 1994, respectively. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Not Applicable ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA See Item 14 of this Report for an index to the Financial Statements and SUPPLEMENTARY DATA. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Not Applicable ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA See Item 14 of this Report for an index to the Financial Statements and Supplementary Data. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES On November 3, 1995, SAT named Ernst & Young LLP ("E&Y") as SAT's new independent auditors for fiscal 1996 replacing Wolinetz, Gottlieb & Lafazan, P.C. ("Wolinetz"), which firm had served as SAT's independent auditors since SAT's inception. The Board of Directors, which authorized the change on November 1, 1995, indicated that, in making the replacement, the directors were not acting because of any criticism of, or dispute with, Wolinetz, but because they concluded that, at that stage of development for SAT and its subsidiaries, the selection of a national firm like E&Y was in SAT's best interests. The reports of Wolinetz on the financial statements of SAT for fiscal 1994 and fiscal 1995 did not contain an adverse opinion or a disclaimer of opinion, nor was either report qualified as to uncertainty, audit scope or accounting principles. There had been no disagreements between SAT and Wolinetz in fiscal 1994 and fiscal 27 29 1995 and any subsequent interim period preceding the engagement of E&Y as the principal auditors on any matter of accounting principles or practice, financial statement disclosure, auditing scope or procedures. Wolinetz has filed a letter to the Commission stating that it agreed with the above statements. SAT did not consult E&Y, prior to its engagement, regarding the application of accounting principles to a specified transaction, either completed or proposed, or the type of audit opinion that might be rendered on SAT's financial statements, nor was a written report or oral advice provided to SAT that E&Y concluded was an important factor considered by SAT in reaching a decision as to an accounting, auditing or financial reporting issue. 28 30 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS DIRECTORS AND EXECUTIVE OFFICERS The following table contains information concerning the current directors and executive officers of SAT as of June 30, 1997:
NAME AGE POSITION - ---- --- -------- Robert M. Stutman........... 54 Chairman, Chief Executive Officer and a director David L. Dorff.............. 54 President, Chief Operating Officer and a director Linda H. Masterson.......... 46 Director (also President and, since May 23, 1997, Chief Executive Officer of U.S. Drug) Robert Muccini.............. 55 Vice President, Finance, Treasurer, Chief Financial Officer and Chief Accounting Officer Brian Stutman............... 30 Vice President, Sales and Marketing Alan I. Goldman............. 59 Director John C. Lawn................ 60 Director Peter M. Mark............... 51 Director Michael S. McCord........... 53 Director Lee S. Rosen................ 43 Director
A director will be generally elected for a classified term of three years or until his or her successor is elected and shall have qualified, which classification of directors was initiated at the Annual Meeting of Stockholders held on February 7, 1996. Each of the above directors other than Mr. Stutman (who was first elected on April 18, 1996), Mr. Dorff (who was first elected effective May 23, 1997, with the number of authorized directors being simultaneously increased from seven to eight) and Mr. McCord (who was first elected on October 22, 1996) was first elected on September 26, 1995 and was re-elected at the Annual Meeting of Stockholders held on February 7, 1996, with Messrs. Goldman and Mark to serve for a two-year term and Messrs. Lawn and Rosen and Ms. Masterson to serve for a three-year term. Mr. Stutman was elected, and Mr. McCord was initially elected, at the Annual Meeting of Stockholders held on October 22, 1996, each to serve for a three-year term. Mr. Dorff's term will expire at the next Annual Meeting of Stockholders, at which meeting he must be designated to a class and be elected by the stockholders in order to continue to serve as a director. Each officer of SAT is elected by the Board of Directors to serve at the discretion of the directors. For information as to severance arrangements with three executive officers named in the table, see the section "Employment and Severance Agreements" under the caption "Executive Compensation." BUSINESS HISTORY Robert M. Stutman was elected Chairman of the Board and a director of SAT on April 18, 1996 and designated as its Chief Executive Officer. For more than five years prior thereto, he has been serving as the President of RSA, then a provider of corporate "Drug-Free Workplace" programs. Prior to forming RSA, he was Special Agent in charge of the New York office of the DEA. He also currently serves as a special consultant in substance abuse for the CBS News Division. SAT acquired RSA on May 21, 1996. See "Business of the Company -- Consulting Division." On March 24, 1997, the SAT Board of Directors increased the number of directors from seven to eight effective June 1, 1997 and elected David L. Dorff to fill the vacancy. On May 23, 1997, the SAT Board made such increase and election effective that date, elected him as the President of SAT and designated him as its Chief Operating Officer. Mr. Dorff was an executive officer of (1) the Triarc Restaurant Group of Triarc Corporation, a restaurant and beverage company, from June 1995 to February 1997 and (2) the U.S. Shoe Footwear Group of United States Shoe Corp., a shoe and women's clothing manufacturer, from February 29 31 1991 to June 1995, and a consulting partner with the accounting firm of Deloitte & Touche from September 1987 to February, 1991. Linda H. Masterson has had substantial experience in marketing, sales and business development in the medical diagnostics, healthcare and biotechnology fields. On September 26, 1995, she was elected a director of SAT. Effective May 13, 1996, she became the President and Chief Operating Officer of SAT. Effective November 19, 1996, she relinquished her duties as Chief Operating Officer in order to devote more time to supervising the development program of U.S. Drug and the operations of the Alcohol Products and BioTox Divisions of SAT. On May 23, 1997, she resigned as the President of SAT in order to become Chief Executive Officer of U.S. Drug (she was already its President) as part of the program to study the feasibility of separating the interlocking relationships between SAT and U.S. Drug. See "Business of the Company -- U.S. Drug Testing" elsewhere in this Report. Until May 13, 1996, she was employed as the Executive Vice President of Cholestech, Inc., a start-up diagnostic company, for which she developed and restructured the company business strategy. In 1993, Ms. Masterson founded Masterson & Associates, a company of which she was the President and owner until she joined Cholestech, Inc. in May 1994, which was engaged in the business of providing advice to start-up companies, including the preparation of technology and market assessments and the preparation of strategic and five-year business plans for biotech, medical device, pharmaceutical and software applications companies. From 1992 to 1993, Ms. Masterson was employed as the Vice President of Marketing and Sales of BioStar, Inc., a start-up biotech company focused on the commercialization of a new detection technology applicable to both immunoassay and hybridization based systems. From 1989 to 1992, she was employed as Senior Vice President of Marketing, Sales and Business Development by Gen-Probe, Inc., a specialized genetic probe biotechnology company focused on infectious diseases, cancer and therapeutics. Prior to 1989, Ms. Masterson was employed for 12 years in various domestic and international marketing and sales positions at Johnson & Johnson, Inc., Baxter International Inc. and Warner Lambert Co. Ms. Masterson has a BS in Medical Technology from the University of Rhode Island, a MS in Microbiology/Biochemistry from the University of Maryland and attended the Executive Advanced Management Program at the Wharton School of Business at the University of Pennsylvania. Robert Muccini was elected on February 17, 1997 as Vice President, Finance and Treasurer of SAT and designated Chief Financial Officer and Chief Accounting Officer of SAT effective with the then anticipated resignation of Dennis A. Wittman (who had served in such capacities since September 5, 1996) as a result of the then intended relocation of SAT's Finance and Accounting Department from Rancho Cucamonga, California to the corporate headquarters in Fort Lauderdale, Florida, which resignation and, accordingly, Mr. Muccini's election and designation became effective February 25, 1997. In anticipation of such contemplated relocation, he joined SAT on December 16, 1996. From May 1996 until he joined SAT, Mr. Muccini was a consultant on accounting matters to Precision Response Corporation, a provider of telemarketing services. From December 1994 to April 1996, he was Chief Financial Officer of Expert Software, Inc., a developer of consumer software. From November 1991 to July 1994, he was Vice President of Finance of Bird Corporation, a building products manufacturer and environmental services provider. From 1983 to 1990, he was Senior Vice President of Finance of MicroAmerica, Inc. (now Merisel, Inc.), computer distributor. From 1981 to 1983, he was Controller and Chief Financial Officer of Hyde Athletic Industries, an importer and distributor of athletic Footwear. From 1979 to 1981, he was Controller and Treasurer of Stride-Rite Corporation, also an importer and distributor of athletic footwear. From 1967 to 1979, he was an accounting manager in the Construction Products Division of W.R. Grace & Company. Mr. Muccini holds a B.S./B.A. degree in accounting from Northeastern University. Brian Stutman was elected Vice President, Sales and Marketing on December 3, 1996. From September 1993 to December 1996, he was Vice President of Business Development for RSA, which became a subsidiary of SAT on May 21, 1996. From September 1989 to September 1993, Brian Stutman was an account representative for Storage Technology, a north eastern distributor of mainframe computer hardware. Brian Stutman has a B.A. in communications from the University of Massachusetts where he graduated cum laude. Alan I. Goldman has had over 35 years of experience in corporate finance, investment banking, commercial banking and central banking. From February 1985 to the present, Alan I. Goldman has been engaged in investment banking and consulting on financial and management matters, specializing in mergers 30 32 and acquisitions, private placements and business and organization consulting. From October 1986 to July 1990, he was a consultant to Goldmark Partners Ltd., an investment banking firm specializing in mergers and acquisitions. From June 1987 to March 1988, he was also the President of Goldmark Capital, Ltd., a private investment firm. From May 1975 to January 1985, Mr. Goldman held the position of Senior Vice President, Finance and Chief Financial Officer of Management Assistance Inc. ("MAI"), then a $450 million multinational computer manufacturing, marketing and maintenance company listed on the New York Stock Exchange. In January 1985, MAI discontinued its operations when it sold its Sorbus Service Division to a subsidiary of Bell Atlantic Corporation and its Basic Four Computer Division to a corporation now called MAI Systems, Inc. From June 1970 to May 1974, he was Vice President, Finance, Treasurer and Chief Financial Officer of Interway Corporation, then a New York Stock Exchange-listed, $200 million international company engaged in piggy-back trailer and containing leasing and fleet management and now a part of Transamerica Corporation. From 1969 to 1970, he was at Lehman Brothers where he participated in investment banking and corporate finance activities; from 1962 to 1969, he was at Bankers Trust Company, where he managed several offices; and from 1958 to 1962, he served in various positions at the Federal Reserve Bank of New York. Mr. Goldman currently serves as a director of Production Systems Acquisition Corporation, a public company seeking to enter the production systems business by acquisition. From December 8, 1994 to date, John C. Lawn has been serving as the Chairman and Chief Executive Officer of The Century Council ("Century"), which is a national not-for-profit organization dedicated to fighting alcohol abuse which is supported by more than 800 concerned brewers, vintners, distillers and wholesalers. From 1990 to 1994, Mr. Lawn served as Vice President and Chief of Operations of the New York Yankees. From 1985 to 1990 he served as Chief Administrator at the DEA, having previously served as Deputy Administrator from 1982 to 1985, and was awarded the President's Medal, the highest honor for civilian service. Prior to joining the DEA, Mr. Lawn served with the Federal Bureau of Investigation from 1967 to 1982. In December 1994 Peter M. Mark formed Mark Energy Capital Group, Ltd. ("MECG"), a private investment group for which through a wholly-owned corporation he served as the General Partner from December 1994 to the present. The primary interest of MECG is to acquire proven producing oil and gas properties in the United States. In April 1981, he formed Mark Resources Corporation, a private oil and gas company whose operations were primarily located in the Appalachian Basin, and served as its President, its Chief Executive Officer and a director from April 1981 until December 1993 when it was sold to Lomak Petroleum, Inc. ("Lomak"). Mr. Mark then served as a director and the Vice Chairman of Lomak until December 1994 when he formed MECG. Between 1976 and 1991, Mr. Mark organized and managed 30 limited partnerships and numerous joint ventures which explored and developed approximately 700 wells for oil and gas. Michael S. McCord is the owner of McCord Investments, a sole proprietorship formed in 1980 which primarily invests in various capital markets. Mr. McCord is also a stockholder, director and officer of McCord Brothers, Inc. and a partner of McCord Brothers Partnership, a privately-owned company and partnership, respectively, each of which invests in oil, gas and real estate properties. From 1974 to 1980, Mr. McCord served as Financial Vice President of the Wedge Group, a privately held holding company which acquired and held control of international multi-industry (including agricultural, construction, energy, manufacturing and service) companies with aggregate revenues in excess of $1 billion. Mr. McCord was elected as a director of Good Ideas and U.S. Drug on May 31, 1996. From October 12, 1995 to October 22, 1996, he served SAT as a consultant to its Board of Directors. Lee S. Rosen has been a financial consultant with registered broker-dealer firms for the past seven years, as follows: He is currently employed by First Colonial Securities Group, Inc., which firm he joined in October 1996. From July 1995 until October 1996, he was employed by Donald & Co. Securities Inc. From April 1994 until June 1995, he was employed by Kidder Peabody & Co., Incorporated ("Kidder") or, after Kidder was acquired by Paine Webber Incorporated ("PaineWebber") in January 1995, by PaineWebber. Prior to working for Kidder, from April 1993 until April 1994, Mr. Rosen was employed by Shearson, Lehman, Hutton & Co., Inc. ("Shearson") or, after Shearson was acquired by Smith Barney, Inc. ("Smith Barney") in September 1993, by Smith Barney. From September 1991 until April 1993, he was employed by Raymond 31 33 James & Associates, Inc. From February 1989 until September 1991, Mr. Rosen worked for A.G. Edwards, Co., Inc. FAMILY RELATIONSHIPS There are no family relationships among the directors and executive officers of SAT except that Robert M. Stutman and Brian Stutman are father and son, respectively. SECTION 16(A) REPORTING OBLIGATIONS The following officers and directors of SAT filed late reports under Section 16(a) of the Securities Exchange Act of 1934, as amended (the "Exchange Act") during fiscal 1997: (i) John C. Lawn, a director of SAT, filed one late filing relating to one transaction; (ii) Peter M. Mark, a director of SAT, filed one late filing relating to one transaction; and (iii) Robert M. Stutman, Chairman, Chief Executive Officer and a director of SAT, filed one late filing relating to three transactions. There are no known failures to file a required report for any of SAT's reporting persons during such time period. ITEM 11. EXECUTIVE COMPENSATION SUMMARY COMPENSATION TABLE The following table sets forth the cash compensation and certain other components of the compensation of (1) James C. Witham who served as the Chairman of the Board, the President and the Chief Executive Officer of SAT until April 18, 1996; (2) Robert M. Stutman who has been serving as the Chairman of the Board and the Chief Executive Officer of SAT since April 18, 1996; and (3) the three executive officers of SAT who were serving as of March 31, 1997 and who received compensation in excess of $100,000 in fiscal 1997:
LONG TERM COMPENSATION -------------------------- ANNUAL COMPENSATION SECURITIES ALL --------------------------- UNDERLYING OTHER NAME AND PRINCIPAL POSITION YEAR SALARY BONUS OPTIONS COMPENSATION --------------------------- ---- -------- ------- ---------- ------------ James C. Witham(1)................... 1997 $ -- -- -- -- Chairman, President and 1996 $412,500(2) $50,000 -- -- Chief Executive Officer 1995 $301,154 $50,000 150,000(3) -- Robert M. Stutman(4)................. 1997 $260,809 $ -- --(5) -- Chairman and Chief 1996 -- -- -- -- Executive Officer 1995 -- -- -- -- Linda H. Masterson(6)................ 1997 $152,827 $ -- 600,000(7) -- President 1996 -- -- 10,000(7) -- 1995 -- -- -- -- Brian Stutman (8).................... 1997 $152,385 $ -- --(9) -- Vice President, Sales and 1996 -- -- -- -- Marketing 1995 -- -- -- -- Steven J. Kline(10).................. 1997 125,000 -- 50,000 -- Vice President, Research 1996 117,000 -- 10,000 -- and Development 1995 63,231 -- 5,000 --
- --------------- (1) Mr. Witham served in these capacities until April 18, 1996 and as an employee of SAT until May 31, 1996. For information as to his former employment agreement with SAT, see the section "Employment and Severance Agreements" under this caption "Executive Compensation." (2) The amount in the table exceeds the salary amount shown below in the section "Employment and Severance Agreements" as a result of March 1996 company-wide payments of several years of unused vacation accruals, of which $95,192.25 was paid to Mr. Witham. (3) In August 1994, SAT granted non-qualified stock options expiring August 1, 2004 under the 1990 Restricted Stock, Non-Qualified Option and Incentive Stock Option Plan to purchase an aggregate of 32 34 450,000 shares of the SAT Common Stock at $2.375 per share, of which Mr. Witham received a stock option to purchase 100,000 shares of the SAT Common Stock. The option expired unexercised on November 3, 1996. (4) Robert M. Stutman was elected as the Chairman of the Board and designated as Chief Executive Officer of SAT on April 18, 1996. For information as to his severance arrangement with SAT, see the section "Employment and Severance Agreements" under this caption "Executive Compensation." (5) Robert M. Stutman has received various Common Stock purchase warrants from SAT as a result of his having been a consultant to SAT prior to his officership, directorship and employment with SAT and as a result of the acquisition by SAT of RSA. For information as to these non-executive-compensation warrants, see "Business of the Company -- Consulting Division" and "Security Ownership of Certain Beneficial Owners and Management" elsewhere in this Report. (6) Ms. Masterson became President of SAT effective May 13, 1996, having served as a director since September 26, 1995. She resigned as the President effective May 23, 1997 in order to become the Chief Executive Officer of U.S. Drug (she was already its President) as part of the program to study the feasibility of separating the interlocking relationships between SAT and U.S. Drug. (7) For information as to the Common Stock purchase warrant to purchase 600,000 shares of the SAT Common Stock received by Ms. Masterson as an inducement to become the President and an employee of SAT, see the section "Employment and Severance Agreements" under this caption "Executive Compensation" and "Security Ownership of Certain Beneficial Owners and Management." For more information as to her Common Stock purchase warrant to purchase 10,000 shares of the SAT Common Stock received as a director of SAT, see the section "Directors' Compensation" under this caption "Executive Compensation" and "Security Ownership of Certain Beneficial Owners and Management." (8) Brian Stutman was elected as Vice President, Sales and Marketing of SAT on December 3, 1996. From May 21 until December 31, 1996, he served as Vice President of Business Development for RSA. (9) Brian Stutman has received various Common Stock purchase warrants from SAT as a result of the acquisition by SAT of RSA. For information as to these non-executive-compensation warrants, see "Business of the Company -- Consulting Division" and "Security Ownership of Certain Principal Owners and Management." He received his first executive compensation Common Stock purchase warrant on June 24, 1997. For information as to this warrant and his severance agreement, see the section "Employment and Severance Agreements" under this caption "Executive Compensation." (10) Mr. Kline served as Vice President, Research and Development of SAT from March 25, 1997 until May 23, 1997, when he resigned as part of the program to study the feasibility of separating the interlocking relationships between SAT and U.S. Drug. He has served as a Vice President of U.S. Drug since July 1994. OPTION/SAR GRANTS TABLE During fiscal 1997, no stock options were granted by SAT, whether to the individuals named in the Summary Compensation Table or otherwise, and none were outstanding as of March 31, 1997. SAT has never granted any stock appreciation rights. 33 35 The following table sets forth certain information concerning Common Stock purchase warrants granted during fiscal 1997 as executive compensation to the individuals named in the Summary Compensation Table.
INDIVIDUAL GRANTS ----------------------------------------------- POTENTIAL REALIZABLE ALTERNATIVE TO PERCENT VALUE AT ASSUMED (F) AND (G) NUMBER OF OF TOTAL ANNUAL RATES OF GRANT DATE SECURITIES WARRANTS STOCK PRICE VALUE UNDERLYING GRANTED TO EXERCISE APPRECIATION FOR ---------------- WARRANT EMPLOYEES OF BASE OPTION TERM GRANTED IN FISCAL PRICE EXPIRATION ---------------------- GRANT DATE NAME (#) YEAR ($/SH) DATE 5%($) 10%($) PRESENT VALUE($) (A) (B) (C) (D) (E) (F) (G) (H) ---- ---------- ---------- -------- ---------- ------- --------- ---------------- James C. Witham......... -0- N/A N/A N/A N/A N/A N/A Robert M. Stutman....... -0- N/A N/A N/A N/A N/A N/A Linda H. Masterson...... 600,000 57.7% $2.125(1) (3) 894,000 2,142,000 1,338,000 Steven J. Kline......... 50,000 4.8% $2.125(2) (4) 40,500 123,500 100,500 Brian Stutman........... -0- N/A N/A N/A N/A N/A N/A
- --------------- (1) Initially $3.125, but lowered to $2.125 later by SAT's Board of Directors. (2) Initially $3.50, but lowered to $2.125 later by SAT's Board of Directors. (3) The last installment expires May 12, 2003. (4) The last installment expires May 2, 2003. AGGREGATE OPTION EXERCISES IN FISCAL YEAR 1997 AND OPTION VALUES AT MARCH 31, 1997 As of March 31, 1997, there were no stock options outstanding and none had been exercised during fiscal 1997 by the individuals named in the Summary Compensation Table. SAT has never granted any stock appreciation rights. The following table sets forth certain information concerning Common Stock purchase warrants issued as executive compensation to the individuals named in the Summary Compensation Table. No such warrants were exercised in fiscal 1997. The table includes the number of shares covered by such warrants as of March 31, 1997. Also reported are the values for "in-the-money" executive compensation warrants which represent the positive spread between the exercise price of any such existing warrants and the closing market price of the SAT Common Stock at March 31, 1997.
NUMBER OF VALUE OF SECURITIES UNEXERCISED UNDERLYING IN-THE-MONEY UNEXERCISED WARRANTS WARRANTS AT SHARES AT MARCH 31, 1997 MARCH 31, 1997 ACQUIRED ON VALUE -------------------------- -------------------------- NAME EXERCISE REALIZED EXERCISABLE/UNEXERCISABLE EXERCISABLE/UNEXERCISABLE ---- ----------- -------- -------------------------- -------------------------- James C. Witham................. -0- -0- -0- -0- Robert M. Stutman............... -0- -0- -0- -0- Linda H. Masterson.............. -0- -0- 50,000/550,000 Steven J. Kline................. -0- -0- 10,000/ 60,000 Brian Stutman................... -0- -0- -0- -0-
OTHER COMPENSATION SAT currently has no pension plan in effect and has no stock option plan, restricted stock plan, stock appreciation rights nor any other long-term incentive plan under which grants or awards may be made in fiscal 1998 or thereafter. The Board is, however, considering adoption of a stock option plan for directors, officers and key employees of the Company and implemented in fiscal 1997 a 401(k) plan for all employees managed by Automated Data Processing, Inc. 34 36 EMPLOYMENT AND SEVERANCE AGREEMENTS SAT had entered into employment agreements (the "Employment Agreements") with each of James C. Witham, Karen B. Laustsen and Gary S. Wolff providing for a three-year term commencing January 1, 1994 and terminating December 31, 1996. On April 18, 1996, Mr. Witham and Ms. Laustsen resigned their directorships and officerships, but agreed to continue to serve SAT as employees until May 31, 1996. Mr. Wolff resigned as Treasurer, Chief Financial Officer and the Chief Accounting Officer of SAT, Good Ideas and U.S. Drug and as a director of Good Ideas and U.S. Drug on July 3, 1996. The Employment Agreements terminated on May 31, 1996 as to Mr. Witham and Ms. Laustsen and on July 3, 1996 as to Mr. Wolff, except that SAT made a $25,000 severance payment to Mr. Wolff and continued medical benefits for the three former executive officers until December 31, 1996, the original expiration date of the Employment Agreements. Mr. Wolff continued for a few months after July 3, 1996 to assist SAT in its efforts to sell the stock or assets of Good Ideas. Pursuant to his Employment Agreement, Mr. Witham was employed as the President and Chief Executive Officer of SAT at an annual base salary of $330,000. Pursuant to her Employment Agreement, Ms. Laustsen was employed as an Executive Vice President at an annual base salary of $132,000. Pursuant to his Employment Agreement, Mr. Wolff was employed as the Treasurer and Chief Financial Officer at an annual base salary of $176,000 per year. Each of such salaries reflected a 10% increase effective July 1, 1995, which increase was the first in 18 months. Mr. Witham and Ms. Laustsen were each required to devote substantially all of his or her time to the business of SAT, while Mr. Wolff was only required to devote a majority of his time. The Employment Agreements contained standard provisions for participation by the executive in SAT's benefit programs, whether relating to the SAT Common Stock, bonuses or medical, life and disability insurance or otherwise. Mr. Witham and Ms. Laustsen were each provided with a company car, which have been returned to SAT. The Employment Agreements also provided for termination in the event of disability for six or more consecutive months and termination "for cause" which meant conviction for embezzlement, theft or other criminal act constituting a felony or failure to comply with the terms and conditions of the Agreement if such breach was not cured within seven days after written notice was given to the executive by the Board of Directors. Effective April 18, 1996, Robert M. Stutman, the President and a principal shareholder of RSA, became the Chief Executive Officer of SAT (also its Chairman of the Board). From April 18, 1996 to May 20, 1997, Mr. Stutman's annual base salary was $225,000; effective May 21, 1997, it became $350,000. The annual base salary increases to (1) $400,000 upon the Company being profitable for a fiscal year during the term of the Amended and Restated Severance Agreement dated May 21, 1997 (the "Restated Severance Agreement") between Mr. Stutman and SAT, a copy of which is filed as an exhibit to this Report and is incorporated herein by this reference, or any renewal thereof with sales equal to, or greater than, $20,000,000 and (2) $500,000 upon the Company being profitable for a fiscal year during the term of the Restated Severance Agreement or any renewal thereof with sales equal to, or greater than, $40,000,000; provided that, in calculating profitability and sales, the operations of U.S. Drug are excluded. He was eligible to receive a cash bonus of $100,000 if the Company broke even or was profitable in fiscal 1997 and an additional $150,000 if the Company had net earnings of $2,000,040 in fiscal 1997. However, because SAT did not achieve profitability in fiscal 1997, this term of employment became moot. Mr. Stutman received a one-time cash bonus of $50,000 upon ProActive satisfying certain performance standards in fiscal 1996. In subsequent years, commencing with fiscal 1998, Mr. Stutman will receive an aggregate year-end cash bonus (the "Annual Bonus") equal to the bonus percentage (as set forth hereinafter) multiplied by Mr. Stutman's annual base salary as follows: (a) if the Company achieves its financial objectives in such fiscal year, based upon a Board-approved budget, commencing with fiscal year 1998, the bonus percentage shall be 75%; (b) if the Company achieves 100% of its financial objectives and up to 150% of its financial objectives for a fiscal year, then the bonus percentage shall equal the product of 75% and a fraction, the numerator of which shall be the percentage of the financial objectives actually achieved (e.g., 150%), except that any amount in excess of 150% shall be deemed to be 150% for the purposes of this calculation, and the denominator of which shall be 75%; (c) if the Company achieves 80% or more of its financial objectives for a fiscal year up to 100%, Mr. Stutman shall receive an 35 37 Annual Bonus based upon a pro rata amount of the bonus percentage (e.g., if 90% of the financial objectives are achieved, the bonus percentage shall be 37.5%); and (d) if the Company achieves less than 80% of its financial objectives for a fiscal year, Mr. Stutman shall not receive any Annual Bonus. Pursuant to the Restated Severance Agreement, a bonus payment in the amount of $50,000 shall be paid to Mr. Stutman upon the renewal thereof. Mr. Stutman shall be granted a stock option to purchase a minimum of 50,000 shares of SAT Common Stock per year at the end of each year during the term of the Restated Severance Agreement or renewal thereof at an exercise price equal to the closing sale price, as reported on AMEX or such other exchange or national securities association on which the SAT Common Stock may then be regularly quoted or, if not so quoted, as reported in the over-the-counter market at the time of such grant and if such day shall be a day on which the AMEX shall be closed, the preceding day on which the SAT Common Stock is traded (the "Closing Sales Price") and expiring three years from the date of grant. Mr. Stutman shall also be awarded 150,000 shares of the SAT Common Stock for each $.75 increase in the Closing Sales Price of the SAT Common Stock above $1.375, with such increase to be determined by the average of the Closing Sales Prices of the SAT Common Stock during any 90-day period commencing with the fiscal year ending March 31, 1998; provided, however, once the average of the Closing Sales Prices of the SAT Common Stock reaches an award level (e.g., $2.125), no awards will be made again until the average of the Closing Sales Prices of the SAT Common Stock during a 90-day period reaches the next award level (e.g., $2.875 after $2.125). In the event that Mr. Stutman is terminated without cause (as defined in the Restated Severance Agreement) during the first five years (originally three years (i.e., through May 20, 2001 (originally 1999) that he is employed by SAT, he shall receive severance pay in a lump sum amount equal to his annual base salary that would have been paid to him after the date of termination had Mr. Stutman not been terminated and he had been employed by SAT for a period of five (originally three) years. Effective May 13, 1996, Linda H. Masterson, a member of SAT's Board of Directors, was employed as the President and Chief Operating Officer of SAT. On November 19, 1996, Ms. Masterson relinquished her duties as Chief Operating Officer in order to devote more time to supervising the development program of U.S. Drug and the operations of the Alcohol Products and BioTox Divisions of SAT. Effective May 23, 1997, she resigned as the President of SAT in order to become Chief Executive Officer of U.S. Drug (she was already its President) as part of the program to study the feasibility of separating the interlocking relationships between SAT and U.S. Drug. Ms. Masterson's annual base salary is $175,000. Ms. Masterson was granted a Common Stock purchase warrant to purchase 600,000 shares of the SAT Common Stock. If SAT adopts a stock option plan, then the Common Stock purchase warrant will be converted to a stock option subject to such plan. In either case, the option or warrant was to become exercisable over a four-year period as follows: 50,000 shares upon commencement of the term of employment (i.e., May 13, 1996), 100,000 shares at the end of the first year, 150,000 shares at the end of the second year, 150,000 shares at the end of the third year and 150,000 shares at the end of the fourth year. The expiration dates of the stock option will be in accordance with the terms of the stock option plan and the expiration dates of the warrant were four years from the respective dates on which the warrant becomes exercisable. The initial exercise price was $3.125 share. On December 6, 1996, the SAT Board of Directors, while reducing the exercise price of Common Stock purchase warrants granted to other employees from $3.50 to $2.125 per share, made the following adjustments to Ms. Masterson's warrant: (a) the exercise price was also reduced to $2.125 per share for the first 150,000 shares as to which the warrant was currently or became exercisable on May 13, 1997 and (b) the warrant became exercisable on May 13, 1997 at the reduced exercise price with respect to 50,000 of the 150,000 shares as to which the warrant was first to become exercisable in the fourth year. In consideration of her assuming responsibility for U.S. Drug, on May 23, 1997, the SAT Board of Directors reduced the exercise price on the remaining 400,000 shares from $3.125 to $2.125 and agreed that, if, as result of U.S. Drug ceasing to be owned 50% or more by SAT, the restrictions on exercise terminate. A discretionary cash and/or stock bonus may be paid commencing with the fiscal year after the fiscal year in which the Company first has positive earnings. A bonus in the form of stock options pursuant to an employee stock option plan or warrants, if no such plan is adopted, was to be granted in respect of fiscal 1997 as follows: 33,000 shares if the Company broke even in fiscal 1997 and an additional 50,000 shares if the Company had net earnings of $2,000,040 for fiscal 1997. However, as indicated above for Mr. Stutman, this bonus arrangement for fiscal 1997 became moot. In the event that Ms. Masterson is terminated without cause (as defined), she shall be paid, pursuant to a Severance 36 38 Agreement dated June 27, 1996 (the "Masterson Severance Agreement") between Ms. Masterson and SAT, a copy of which is filed as an exhibit to this Report and is incorporated herein by this reference, severance equal to her annual base salary. In view of her acceptance of the position in U.S. Drug, the Compensation Committee is currently working out a new severance arrangement with Ms. Masterson to take effect in U.S. Drug when it is no longer at least a 50%-owned subsidiary of SAT as a result of financings. In the interim the Masterson Severance Agreement remains in effect. Effective May 23, 1997, David L. Dorff was employed as the President and Chief Operating Officer of SAT with an annual base salary of $120,000. The annual base salary increases to (1) $275,000 upon SAT being profitable for two consecutive calendar months during the term of the Severance Agreement dated June , 1997 (the "Dorff Severance Agreement") between Mr. Dorff and SAT, a copy of which is filed as an exhibit to this Report and is incorporated herein by this reference, or any renewal thereof, (2) $325,000 upon SAT being profitable for a fiscal year during the term of the Dorff Severance Agreement or any renewal thereof with sales equal to, or greater than, $20,000,000 and (3) $375,000 upon SAT being profitable for a fiscal year during the term of the Dorff Severance Agreement or any renewal thereof with sales equal to, or greater than $40,000,000; provided that, in calculating profitability and sales, the operations of U.S. Drug are excluded. Mr. Dorff shall receive an Annual Bonus equal to the bonus percentage (as set forth hereinafter) multiplied by his annual base salary as follows: (a) if the Company achieves 100% of its financial objectives in such fiscal year, based upon a Board-approved budget excluding the operations of U.S. Drug, commencing with fiscal 1998, the bonus percentage shall be 75%; (b) if the Company achieves greater than 100% of its financial objectives and up to 150% of its financial objectives for a fiscal year, then the bonus percentage shall equal the product of 75% and a fraction, the numerator of which shall be the percentage of the financial objectives actually achieved (e.g., 150%), except that any amount in excess of 150% shall be deemed to be 150% for the purposes of this calculation, and the denominator of which shall be 75%; (c) if the Company achieves 80% or more of its financial objectives for a fiscal year up to 100%, Mr. Dorff shall receive an Annual Bonus based upon a pro rata amount of the bonus percentage (e.g., if 90% of the financial objectives are achieved, the bonus percentage shall be 37.5%); and (d) if the Company achieves less than 80% of its financial objectives for a fiscal year, Mr. Dorff shall not receive any Annual Bonus. A bonus payment in the amount of $50,000 shall be paid to Mr. Dorff upon each renewal of the Dorff Severance Agreement. Mr. Dorff shall be granted, at the end of each fiscal year during the term of the Dorff Severance Agreement or any renewal thereof, a stock option to purchase a minimum of 50,000 shares of SAT Common Stock at an exercise price equal to the Closing Sale Price on the date of grant and expiring three years from the date of grant. Mr. Dorff shall be awarded 125,000 shares of SAT Common Stock for each $.75 increase in the Closing Sales Price of the SAT Common Stock above $1.375, with such increase to be determined by the average of the Closing Sales Prices of the SAT Common Stock during any 90-day period commencing with fiscal 1998; provided, however, once the average of the Closing Sales Prices of the SAT Common Stock reach an award level (e.g., $2.125), no awards will be made again until the average of the Closing Sales Prices of the SAT Common Stock during a 90-day period reaches the next award level (e.g., $2.875 after $2.125). All shares of the SAT Common Stock awarded shall be vested over a three-year period. In addition, Mr. Dorff was awarded Common Stock purchase warrants upon the execution of the Dorff Severance Agreement to purchase (a) 700,000 shares of the SAT Common Stock at an exercise price of $1.8125 per share, (b) 300,000 shares of the SAT Common Stock at an exercise price of $2.3125 and (c) 300,000 shares of the SAT Common Stock at an exercise price of $2.8125 per share. One-third of each warrant becomes exercisable on June 1998, June 1999 and June 2000, provided that Mr. Dorff is employed by SAT on such dates. The warrants expire five years from the date of the Dorff Severance Agreement. In the event that Mr. Dorff is terminated without cause (as defined) during the first three years of his employment by SAT, he shall receive severance pay in a lump sum amount equal to his annual base salary at the time of his termination for the period from the date of his termination through June 2000. Effective May 21, 1996, when RSA became a subsidiary of SAT, Brian Stutman continued to serve as Vice President of Business Development for RSA. On December 3, 1996, he was elected as Vice President, Sales and Marketing of SAT. Mr. Stutman's annual base salary is $130,000. He was eligible for a bonus of $30,000 for fiscal 1997 if his business plan goals were met and received a one-time bonus of $30,000 upon ProActive satisfying certain performance standards in fiscal 1996. On June 24, 1997, the Compensation 37 39 Committee authorized an increase, effective with the next pay period, in Mr. Stutman's base annual salary to $175,000 and that his bonus for fiscal 1998 would be an amount up to 30% of his annual base salary, one half of which would be based on the financial results of the Company, as compared to a Board-approved budget, and one half of which would be based on his performance with respect to individual goals to be determined by the President of SAT. The Board also granted him a Common Stock purchase warrant to purchase 15,000 shares of the SAT Common Stock at $2.125 per share on the same terms as other employee warrants (i.e., becoming exercisable over a four-year period and each installment expiring three years from the date it becomes exercisable). In the event Mr. Stutman is terminated without cause (as defined) during the first three years (i.e., through May 20, 1999) that he is employed by SAT, then, pursuant to a Severance Agreement dated May 21, 1996 between Mr. Stutman and SAT, a copy of which is filed (by incorporation by reference) as an exhibit to this Report and is incorporated herein by this reference, he shall receive severance pay in an amount equal to the base salary that would have been paid to him after the date of termination had Mr. Stutman not been terminated and had he been employed by SAT for a period of three years. DIRECTORS' COMPENSATION On November 16, 1995, as modified on December 11, 1995 and December 3, 1996, the Board approved the following compensation arrangements for directors who are not employees of the Company: (1) each year the director will receive a SAT Common Stock purchase warrant to purchase 10,000 shares of the SAT Common Stock excercisable at the closing sales price on November 16 or the preceding business day if November 16 is a Saturday, Sunday or holiday (effective October 1, 1997, the date will become October 1) for a three-year period; (2) an annual payment of $10,000 and (3) a quarterly payment of $2,500 provided that the director attends at least 75% of the meetings during the year. The Board also authorized an annual payment of $1,000 for a director serving as the Chairman of a Board committee and $500 for serving as a member of a Board committee. All annual cash payments are to be made as of October 1, commencing October 1, 1996. Pursuant to the foregoing authority, Common Stock purchase warrants were granted for 1995 to five directors (i.e., Alan I. Goldman, John C. Lawn, Peter M. Mark, Linda H. Masterson and Lee S. Rosen) to purchase an aggregate of 50,000 shares at $1.9375, the closing sales price on November 16, 1995 and for 1996 to five directors (i.e., Alan I. Goldman, John C. Lawn, Peter M. Mark, Michael S. McCord and Lee S. Rosen) at $1.8125, the closing sales price on November 15, 1996. The Board approved the following compensation for all directors: the issuance of a SAT Common Stock purchase warrant to purchase 10,000 shares of the SAT Common Stock for each $1.00 rise over the closing sales price of the SAT Common Stock on November 16th (October 1st commencing October 1, 1997) of each year (which would be $1.9375 for November 16, 1995 and $1.8125 for November 15, 1996), the rise to be calculated on the basis of the average of the closing sales prices during the 90-day period preceding the 30th day after the date on which the results of operations for the fiscal year are announced either through a press release or the filing of the Annual Report on Form 10-K under Section 13 of the Exchange Act. The exercise price will be the greater of the average of the closing sales prices during the 90-day period or the closing sales price on October 1 commencing October 1, 1997. Based on the fact that the results of operations for fiscal 1996 were reported in a press release dated June 14, 1996, each of the current directors did not receive a Common Stock purchase warrant in 1996 because the average sales price during the 90-calendar days prior to July 14, 1996 was $2.9308 per share or less than a $1.00 rise over $1.9375 per share. It is also anticipated that the directors will not receive a Common Stock purchase warrant in 1997 because there was no $1.00 rise over $2.9308 per share of the SAT Common Stock. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. The following table sets forth certain information, as of June 30, 1997, with respect to (1) any person who owned beneficially more than 5% of the SAT Common Stock; (2) each director of SAT; (3) the Chief Executive Officer of SAT; (4) each other executive officer of SAT who was paid more than $100,000 in fiscal 1997; and (5) all directors and executive officers as a group. Each beneficial owner has advised SAT that he or she has sole voting and investment power as to the shares of the SAT Common Stock reported in the table, except that the Common Stock purchase warrants described in the notes below do not have any voting power until exercised and may not be sold or otherwise transferred except in compliance with the Securities Act. 38 40
NUMBER OF SHARES NAME AND ADDRESS BENEFICIALLY OWNED PERCENTAGE(1) ---------------- ------------------ ------------- Steven A. Cohen(2)............................... 3,468,300(3) 9.1% 777 Long Ridge Road Stamford, CT 06902 S.A.C. Capital Associates, LLC(2)................ 2,134,400(4) 6.4% 777 Long Ridge Road Stamford, CT 06902 Robert M. Stutman(5)............................. 930,500(6) 2.5% 4517 N.W. 31st Avenue Fort Lauderdale, FL 33309 David L. Dorff(7)................................ 10,000(8) nil 4517 N.W. 31st Avenue Fort Lauderdale, FL 33309 Linda H. Masterson(9)............................ 210,000(10) nil 10410 Trademark Street Rancho Cucamonga, CA 91730 Alan I. Goldman(11).............................. 20,000(12) nil 497 Ridgewood Avenue Glen Ridge, NJ 07028 John C. Lawn(11)................................. 20,000(12) nil c/o The Century Council 550 South Hope Street, Suite 1950 Los Angeles, CA 90071-2604 Peter M. Mark(11)................................ 607,600(12) 1.7% 5531 Sugar Hill Houston, TX 77056 Michael S. McCord(11)............................ 215,455(13) nil Suite 701 2001 Kirby Avenue Houston TX 77019 Lee S. Rosen(11)................................. 1,485,125(14) 4.0% 17332 Saint James Court Boca Raton, FL 33486 Brian Stutman(15)................................ 553,376(16) 1.5% 4517 N.W. 31st Avenue Fort Lauderdale, FL 33309 Steven J. Kline(17).............................. 30,500(18) nil 10410 Trademark Street Rancho Cucamonga, CA 91730 All directors and executive officers as a group 4,315,065(19) 11.2% (ten persons)..................................
- --------------- (1) The percentages computed in this column of the table are based upon 36,030,591 shares of the SAT Common Stock outstanding on June 30, 1997 and effect being given, where appropriate, pursuant to Rule 13d-3(d)(1) under the Exchange Act, to shares issuable upon the exercise of Common Stock purchase warrants which are currently excercisable or excercisable within 60 days of June 30, 1997 and to Convertible Notes which are convertible within 60 days of June 30, 1997. (2) Steven A. Cohen and S.A.C. Capital Associates, LLC filed a Schedule 13D, as amended (the "Cohen Schedule 13D"), because their joint beneficial ownership may constitute ownership by a "group" as such term is defined in Rule 13d-5(b) under the Exchange Act. Based on Amendment No. 4 to the Cohen Schedule 13D and the Company's calculation under the anti-dilution provisions, the group beneficially owned an aggregate of 5,902,700 shares or 14.7% of the outstanding shares at June 30, 1997. (3) The shares reported in the table as being beneficially owned reflect (a) 1,463,300 shares of the SAT Common Stock, (b) 5,000 shares of the SAT Common Stock issuable at $1.8125 per share upon the exercise of a Common Stock purchase warrant expiring November 1, 1999 (the "Lender's Warrant") and (c) 2,000,000 shares of the SAT Common Stock issuable upon the conversion of a Convertible 39 41 Note at $1.25 per share. They do not reflect 2,000,000 shares of the Common Stock issuable at $1.25 per share upon the exercise of a Common Stock purchase warrant expiring June 30, 2000 (the "June 30 Warrant") because the June 30 Warrants are not excercisable so long as, a result of any such exercise, the holders would be the beneficial owners of 10% or more of the outstanding shares of the SAT Common Stock. See Note 2 to the table. (4) The shares reported in the table as being beneficially owned reflect (a) 429,400 shares of the SAT Common Stock, (b) 5,000 shares of the SAT Common Stock issuable at $1.8125 per share upon the exercise of a Lenders Warrant and (c) 2,000,000 shares of the SAT Common Stock issuable upon the conversion of a Convertible Note at $1.25 per share. They do not reflect 2,000,000 shares of the SAT Common Stock issuable at $1.25 per share upon the exercise of a June 30 Warrant because the June 30 Warrants are not excercisable so long as, a result of any such exercise, the holders would be the beneficial owners of 10% or more of the outstanding shares of the SAT Common Stock. See Note 2 to the table. The Cohen Schedule 13D reported that S.A.C. Capital Associates, LLC, an Anguillan limited liability company, acquired the foregoing securities, but, because S.A.C. Capital Advisors, LLC, a Delaware limited liability company, has voting and dispositive power over the securities, the latter was deemed to be the beneficial owner thereof. (5) Robert M. Stutman was elected Chairman of the Board and a director of SAT and designated as its Chief Executive Officer on April 18, 1996. (6) The shares reported in the table include (a) 3,125 shares of the SAT Common Stock issuable upon the exercise at $2.00 per share of a Common Stock purchase warrant expiring December 13, 1998 issued to him for his consulting services, while still an employee of RSA, (b) 105,500 shares of the SAT Common Stock issuable upon the exercise at $2.00 per share of a Common Stock purchase warrant expiring March 31, 1999 issued to him when the Common Stock purchase warrant to purchase 200,000 shares issued to RSA was divided among the RSA shareholders and (c) 474,750 shares of the SAT Common Stock issuable upon the exercise at $2.125 per share of a Common Stock purchase warrant expiring May 20, 1999 issued to him in exchange for his ownership interest in RSA. (7) Mr. Dorff was elected a director of SAT effective May 23, 1997 and, on the same date, was elected as its President and designated as its Chief Operating Officer. (8) The shares reported in the table do not include (a) 700,000 shares of the SAT Common Stock issuable upon the exercise at $1.8125 per share of a Common Stock purchase warrant expiring June 2002; (b) 300,000 shares of the SAT Common Stock issuable upon the exercise at $2.3125 per share of a Common Stock purchase warrant also expiring June 2002; and (c) 300,000 shares of the SAT Common Stock issuable upon the exercise at $2.8125 per share of a Common Stock purchase warrant also expiring June, 2002 because none of the foregoing warrants granted to Mr. Dorff for becoming President and Chief Operating Officer of SAT are currently excercisable or excercisable within 60 days of June 30, 1997. (9) Ms. Masterson, a director of SAT, became its President and Chief Operating Officer effective May 13, 1996. Effective November 19, 1996, Ms. Masterson relinquished her duties as Chief Operating Officer in order to concentrate on certain operations of the Company. Effective May 23, 1997, she resigned as the President of SAT in order to become Chief Executive Officer of U.S. Drug (she was already its President) as part of the program to study the feasibility of separating the interlocking relationships between SAT and U.S. Drug. (10) The shares reported in the table reflect (a) 10,000 shares of the SAT Common Stock issuable upon the exercise at $1.9375 per share of a Common Stock purchase warrant expiring November 15, 1998 issued to her as a director of SAT on the same basis as those described in note (12) to this table and (b) 200,000 shares of the SAT Common Stock issuable upon the exercise at $2.125 per share of a Common Stock purchase warrant, the last installment of which expires May 12, 2003, issued pursuant to Ms. Masterson's terms of employment, which 200,000 shares are the only shares as to which the 40 42 warrant to purchase an aggregate of 600,000 shares is currently excercisable or excercisable within 60 days of May 31, 1997. (11) A director of SAT. (12) The shares reported in this table include or reflect (a) 10,000 shares of the SAT Common Stock issuable upon the exercise at $1.9375 per share of a Common Stock purchase warrant expiring November 15, 1998 and (b) 10,000 shares of the SAT Common Stock issuable upon the exercise at $1.8125 per share of a Common Stock purchase warrant expiring November 15, 1999, both issued to the holder as a director of SAT who is not employed by SAT or any subsidiary thereof. (13) The shares reported in the table include (a) 10,000 shares of the SAT Common Stock issuable upon the exercise at $1.9375 per share of a Common Stock purchase warrant expiring November 15, 1998 issued to Mr. McCord as a consultant to the Board of Directors of SAT and (b) 10,000 shares of the SAT Common Stock issuable upon the exercise at $1.8125 per share of a Common Stock purchase warrant expiring November 15, 1999 issued to him as a director of SAT on the same basis as those described in Note 12 to this table. The shares reported in the table do not include shares of the SAT Common Stock beneficially owned by Mr. McCord's wife, as to which shares he disclaims beneficial ownership. (14) The shares reported in the table include (a) 10,000 shares of the SAT Common Stock issuable upon the exercise at $1.9375 per share of a Common Stock purchase warrant expiring November 15, 1998 issued to Mr. Rosen as a director on the same basis as those described in Note 12 to this table; (b) 10,000 shares of the SAT Common Stock issuable upon the exercise at $1.8125 per share of a Common Stock purchase warrant expiring November 15, 1999 issued to Mr. Rosen as a director on the same basis as those described in Note 12 to this table; (c) 200,000 shares of the SAT Common Stock issuable upon the exercise at $1.9375 per share of a Common Stock purchase warrant expiring November 15, 1998; (d) 150,000 shares of the SAT Common Stock issuable upon the exercise at $3.00 per share of a Common Stock purchase warrant expiring November 15, 2000; (e) 150,000 shares of the SAT Common Stock issuable upon the exercise at $2.00 per share of a Common Stock purchase warrant expiring November 15, 2000; (f) 300,000 shares of the SAT Common Stock issuable upon the exercise at $2.125 per share of a Common Stock purchase warrant expiring April 17, 1999; (g) 200,000 shares of the SAT Common Stock issuable upon the exercise at $2.00 per share of a Common Stock purchase warrant expiring December 2, 1999; and (h) 250,000 shares of the SAT Common Stock issuable upon the exercise at $2.00 per share of a Common Stock purchase warrant expiring December 17, 1999 acquired from his father who purchased the warrant in the Company's private placement consummated in February 1996. The Common Stock purchase warrants described in (c), (d) and (e) were issued to Mr. Rosen as consideration for his services, including those related to the private placement consummated in February 1996. 50,000 of the shares subject to each of the warrants described in (d) and (e) may be forfeited if none of the Common Stock purchase warrants issued to the purchasers in such private placement are exercised and may be reduced in the number of shares which may be exercised pro rata to the exercise of the private placement warrants. (15) Brian Stutman was elected Vice President, Sales and Marketing of SAT on December 3, 1996. (16) The shares reported in the table reflect (a) 176,250 shares of the SAT Common Stock issued to Brian Stutman in exchange for his ownership interest in RSA; (b) 59,876 shares of the SAT Common Stock issuable upon the exercise at $2.00 per share of a Common Stock purchase warrant expiring March 31, 1999 issued to him when the Common Stock purchase warrant to purchase 200,000 shares issued to RSA was divided among the RSA shareholders; and (c) 317,250 shares of the SAT Common Stock issuable upon the exercise at $2.125 per share of a Common Stock purchase warrant expiring May 20, 1999 issued to him in exchange for his ownership interest in RSA. The shares reported in the table exclude 15,000 shares of the SAT Common Stock issuable upon the exercise by Mr. Stutman at $2.125 per share of a Common Stock purchase warrant, the last installment of which expires June 23, 2004, because the warrant is not currently excercisable or excercisable within 60 days of June 30, 1997. 41 43 (17) Mr. Kline served as Vice President, Research and Development of SAT from March 25, 1997 to May 23, 1997, when he resigned as part of the program to study the feasibility of separating the interlocking relationships between SAT and U.S. Drug. (18) The shares reported in the table include (a) 5,000 shares of the SAT Common Stock issuable upon the exercise at $2.125 per share of a Common Stock purchase warrant expiring July 17, 1998; (b) 10,000 shares of the SAT Common Stock issuable upon the exercise at $2.125 per share of a Common Stock purchase warrant expiring July 7, 1999; and (c) 12,500 shares of the SAT Common Stock issuable upon the exercise at $2.125 per share of a Common Stock purchase warrant, the last installment of which expires May 2, 2003, which are the only shares of a total of 50,000 shares subject to that warrant which are currently excercisable or excercisable within 60 days of June 30, 1997. (19) The shares represented in the table reflect the shares of the SAT Common Stock reported elsewhere in the table (see the text relating to Notes 6, 8, 10, 12, 13, 14, 16 and 18) and do not reflect 40,000 shares of the SAT Common Stock issuable upon the exercise by an executive officer of SAT (not named in the table) at $2.125 per share of a Common Stock purchase warrant, the last installment of which expires December 15, 2003, because such Common Stock purchase warrant is not currently excercisable or excercisable within 60 days of June 30, 1997. As indicated elsewhere in this Report (see "Business of the Company -- General"), Good Ideas and U.S. Drug are the only subsidiaries of SAT which are not wholly-owned. As of June 30, 1997, no director or executive officer of SAT owned beneficially any shares of the Good Ideas Common Stock except for Mr. McCord who owned 10,000 shares. No director or officer of SAT owns any of the outstanding Good Ideas Common Stock purchase warrants and there are no outstanding stock options to purchase shares of the Good Ideas Common Stock. SAT itself owns 2,400,000 of the 3,948,600 outstanding shares of the Good Ideas Common Stock or 60.8% thereof. The following table reports, as of June 30, 1997, the number of shares of the U.S. Drug Common Stock beneficially owned by two directors of SAT as of such date. No other director or executive officer of SAT owns any shares of the U.S. Drug Common Stock.
NUMBER OF SHARES NAME BENEFICIALLY OWNED PERCENTAGE(1) ---- ------------------ -------------- Peter M. Mark......................................... 15,500 nil Michael S. McCord..................................... 36,000(2) nil
- --------------- (1) The percentages computed in this column of the table are based upon 6,990,103 shares of the U.S. Drug Common Stock outstanding on June 30, 1997. No effect is given, pursuant to Rule 13d-3(d)(1) under the Exchange Act, to shares issuable upon the exercise of U.S. Drug Common Stock purchase warrants, all of which are currently excercisable, because neither director of SAT owns any such warrant. (2) The shares reported in the table do not reflect an aggregate of 25,300 shares owned by affiliates of Mr. McCord as to which he disclaims beneficial ownership. SAT owns 5,268,203 shares of the 6,990,103 shares of the U.S. Drug Common Stock outstanding as of June 30, 1997 or 75.4% thereof. SAT's Board has authorized the purchase of 2,000,000 additional shares of the U.S. Drug Common Stock for $2,500,000 between May 1 and June 24, 1997, which would result in SAT owning 7,268,203 of the outstanding 8,990,103 shares of the U.S. Drug Common Stock or 80.8%. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS On November 8, 1996, SAT entered into a Convertible Loan and Warrant Agreement (the "Loan Agreement"), a copy of which is filed (by incorporation by reference) as an exhibit to this Report and is incorporated herein by this reference, with Steven A. Cohen and S.A.C. Capital Associates, LLC, an Anguilla limited liability company (collectively the "Lenders"), pursuant to which SAT borrowed $5,000,000 from the Lenders (the "Loan"). Prior thereto, the Lenders beneficially owned an aggregate of 2,342,200 shares of the SAT Common Stock. (For information as to the Lenders' beneficial ownership of shares of the SAT Common 42 44 Stock as of June 30, 1997, see the table under "Security Ownership of Certain Beneficial Owners and Management" elsewhere in this Report.) The Loan is evidenced by promissory notes (the "Convertible Notes") which are due and payable on November 8, 1999 and bear interest at the rate of seven percent per annum, payable quarterly. The Convertible Notes may not be prepaid without the consent of the Lenders and may not be assigned or negotiated without the consent of SAT. The Convertible Notes become convertible into shares of the SAT Common Stock after July 1, 1997 at a conversion price (the "Conversion Price") initially of $2.00 per share. The Conversion Price is subject to a downward adjustment (the "Market Price Adjustment") during the period from May 1, 1997 through May 1, 1998 based on the average market price for shares of the SAT Common Stock over the preceding 65 trading days excluding the date that either Lender sold shares of the SAT Common Stock in an Open Market Transaction (as hereinafter defined) and the trading days that are within 21 days of such date, provided that the Conversion Price will not be reduced below $1.375 as a result of this adjustment. In addition, the Conversion Price is subject to reduction pursuant to certain anti-dilution provisions, if SAT sells shares at less than the Conversion Price, or issues options or convertible securities which can be exercised at a price less than the Conversion Price. As a result of these anti-dilution provisions, the Conversion Price as of June 30, 1997 was $1.25 and the Lenders could acquire upon conversion 4,000,000 shares of the SAT Common Stock. Under the Loan Agreement, as long as any portion of the Convertible Notes are outstanding and thereafter as long as certain conditions are met, the Lenders may designate one person to be nominated by SAT for election to SAT's Board of Directors or may exercise observer rights at meetings of the SAT Board of Directors. The Agreement also imposes certain negative and affirmative covenants on SAT as long as any balance remains outstanding under the Convertible Notes. These covenants, among other matters, restrict SAT's ability to engage in acquisitions (other that the proposed acquisitions of SAT's two majority owned subsidiaries, Good Ideas and U.S. Drug) of companies that are not engaged exclusively in, or engaged in a business directly related to, the business of substance abuse testing, to pay dividends, to incur indebtedness (as defined in the Loan Agreement) senior to the Convertible Notes, to engage in certain related party transactions, to assign the rights in certain intellectual property, to terminate the employment of SAT's chief executive officer, to incur other indebtedness (as defined in the Loan Agreement) in excess of $1,000,000, to sell or otherwise dispose of any subsidiary or division of the corporation (with the exception of Good Ideas), to engage in other transactions with a value in excess of $1,000,000, and to amend SAT's Certificate of Incorporation or Bylaws or enter into any agreement that would adversely affect the rights and priorities of the Lenders. The Lenders also have the right to purchase additional shares of the Common Stock in any capital raising transaction through any public or private sale of shares of the SAT Common Stock effected by SAT and to acquire additional shares under certain other circumstances. In addition, pursuant to the Loan Agreement, the Lenders purchased for $1,000 Common Stock purchase warrants expiring June 30, 2000 (the "June 30 Warrants") to purchase an aggregate of 2,500,000 shares of the SAT Common Stock at an initial exercise price of $2.00 per share. The June 30 Warrants were not excercisable to any extent before July 1, 1997 and thereafter are excercisable only to the extent that, when added together with any other shares beneficially owned by the Lenders, would not result in the Lenders being deemed to be greater than ten percent stockholders subject to Section 16 of the Exchange Act . The number of shares of the SAT Common Stock which may be purchased pursuant to the June 30 Warrants is subject to a downward adjustment, but not less than 2,000,000 shares, in the event that the Conversion Price of the Notes is reduced, such that the number of shares purchasable pursuant to the June 30 Warrants will be reduced at a rate of one share for each 2.2727 additional shares of the SAT Common Stock which may be obtained upon conversion of the Convertible Notes as a result of any Market Price Adjustment. In addition, the exercise price is subject to reduction and the number of shares that may be purchased under the June 30 Warrants is subject to increase pursuant to certain anti-dilution provisions if SAT sells shares at less than the exercise price. As a result of these anti-dilution provisions, the June 30 Warrants were, as of June 30, 1997, excercisable at $1.25 per share into 4,000,000 shares of the SAT Common Stock. The June 30 Warrants are transferable subject to compliance with the Securities Act. 43 45 Under the Loan Agreement, SAT agreed promptly to register under the Securities Act the shares issuable upon the conversion of the Convertible Notes and the exercise of the June 30 Warrants. Registration Statement on Form S-3, File No. 333-19979, was filed to fulfill such commitment, but is not yet effective During times (if any) when SAT has not maintained the registration statement in effect for a specified period or has failed to keep current any prospectus forming a part of such registration statement, SAT must pay the Lenders a cash penalty equal to ten percent of the outstanding principal under the Convertible Notes. Furthermore, the exercise price of the June 30 Warrants may be paid by using shares otherwise issuable thereunder if SAT does not comply with certain registration requirements. SAT and the Lenders entered into a Registration Rights Agreement, a copy of which is filed (by incorporation by reference) as an exhibit to this Report and is incorporated herein by this reference, pursuant to which the Lenders have "piggyback" rights to include shares in any registration statement filed by SAT, and on one occasion to demand registration of shares if the shares issued upon conversion of the Convertible Notes or exercise of the June 30 Warrants are not freely tradable. The right to demand registration may be assigned to a transferee of the securities. The Lenders have, as part of the Loan Agreement, agreed with SAT to certain volume restrictions on Open Market Transactions (as defined below) involving sales of the shares of the SAT Common Stock owned by them as of the date of the Agreement after the first 1,000,000 owned shares sold in Open Market Transactions. After the sale of 1,000,000 such owned shares in Open Market Transaction, the Lenders have agreed that, unless waived by SAT, they will not sell any of the remaining owned shares in Open Market Transactions unless: (i) the sales price for such shares (before any fees or commissions) is equal to or greater than the "Limit Price" (defined in the Loan Agreement as $2.00 per share subject to certain adjustments), (ii) the volume of shares sold by the Lenders on any trading day at a price below the Limit Price (before any fees or commissions) does not exceed 25% of the average daily trading volume of the SAT Common Stock reported for the five trading days immediately preceding the date of such sale, provided that any sales by the Lenders during the immediately preceding five trading days at a price below the Limit Price shall be excluded from the calculation of the average daily trading volume, or (iii) such shares are sold at the best offer price. For purposes of the Loan Agreement, the term "Open Market Transactions" means transactions that are reported on the consolidated quotation system other than block trades (as defined under Exchange Act Rule 10b-18). These volume sales limitations do not extend to any other transactions in the shares of the SAT Common Stock or to any shares of the SAT Common Stock that the Lenders may acquire after November 8, 1996. As a result of the five non-employee directors receiving Common Stock purchase warrants as part of their annual compensation, each of the Lenders received a Common Stock purchase warrant expiring November 15, 1999 (the "Lenders Warrant") to purchase 5,000 shares of the SAT Common Stock at $1.8125 per share. Pursuant to the Loan Agreement, so long as the Convertible Notes are outstanding, whenever the directors receive Common Stock purchase warrants to purchase shares of the Common Stock as compensation for serving in such capacity, each of the Lenders is entitled to receive a Common Stock purchase warrant to purchase one half of the shares of the SAT Common Stock subject to the director's warrant, the other terms and conditions of the Lender Warrant to be similar to those of the director's warrant. As a condition precedent to making its loans, the Lenders required that Robert M. Stutman, the Chairman of the Board, the Chief Executive Officer and a director of SAT, and Brian Stutman, Vice President, Sales and Marketing of SAT since December 3, 1996, surrender their secured position with respect to their promissory notes due May 21, 1997 (the "Promissory Notes") in the principal amount of $239,760 and $160,240, respectively, which they had received on May 21, 1996 as partial payment for their share ownership in RSA, and agree that the Promissory Notes would not be paid prior to the Convertible Notes except through the issuance of shares of the SAT Common Stock. In consideration of this sacrifice, the Board of Directors of SAT authorized on December 3, 1996 that the exercise price of $3.125 per share be reduced to $2.125 per share on Robert Stutman's Common Stock purchase warrant expiring May 20, 1999 to purchase 474,750 shares of the SAT Common Stock and on Brian Stutman's Common Stock purchase warrant also expiring May 20, 1999 to purchase 317,250 shares of the SAT Common Stock. On the same day, the Messrs. Stutman surrendered their Promissory Notes, the principal amount and interest thereon being used to allow Robert Stutman to exercise his Common Stock purchase warrant expiring December 13, 1998 for 127,500 shares as to 124,375 shares and Brian Stutman to exercise his Common Stock purchase warrant also 44 46 expiring December 13, 1998 as to all 72,500 shares subject thereto and his Common Stock purchase warrant expiring March 31, 1999 for 70,500 shares as 10,624 shares, thereby permitting SAT to cancel an aggregate of $415,000 in indebtedness to them ($400,000 in principal and $15,000 in interest). In February 1996, Lee S. Rosen, a director of SAT, received (1) $100,000 and (2)(a) a Common Stock purchase warrant expiring November 15, 1998 to purchase 400,000 shares of the SAT Common Stock at $1.9375 per share, (b) a Common Stock purchase warrant expiring November 15, 2000 to purchase 150,000 shares of the SAT Common Stock at $3.00 per share and (c) a Common Stock purchase warrant to purchase 150,000 shares of the SAT Common Stock at $4.00 per share for services performed in connection with SAT's offering of 2,000,000 shares of the SAT Common Stock pursuant to Regulation D of the Securities Act. The latter two warrants can only be exercised as to 50,000 shares of the SAT Common Stock subject thereto in proportion to the shares issued upon the exercise of December 17 Warrants to purchase 2,000,000 shares of the SAT Common Stock at $2.00 per share issued to the purchasers in such prior placement. During May and June 1996, Mr. Rosen was paid an additional $400,000 for services rendered to SAT in connection with the exercise of outstanding Common Stock purchase warrants to purchase shares of the SAT Common Stock. The payments to Mr. Rosen have been charged to Additional Paid-In Capital. Mr. Rosen also received a Common Stock purchase warrant expiring April 17, 1999 (the "April 17 Warrant") to purchase 300,000 shares of the SAT Common Stock at $3.125 per share. On June 19, 1996, the SAT Board authorized SAT to engage a consultant for whom the consideration was to be 200,000 shares of the SAT Common Stock. Mr. Rosen fulfilled SAT's obligation to such consultant by delivery of his own shares. In consideration thereof, on December 3, 1996, the SAT Board authorized (1) Mr. Rosen's exercise of the Common Stock purchase warrant expiring November 15, 1998 as to 200,000 of the 400,000 shares of the SAT Common Stock, the consideration therefor being the value of the consultant's services (i.e., the product of 200,000 shares and the closing sales price of $2.875 per share on June 19, 1996 or $575,000); (2) the issuance to Mr. Rosen of a Common Stock purchase warrant expiring December 2, 1999 to purchase 200,000 shares of the SAT Common Stock at $2.00 per share; and (3) a reduction in the exercise price of his Common Stock purchase warrant expiring November 15, 2000 from $4.00 to $2.00 per share. On January 23, 1997, in consideration of certain services which Mr. Rosen had performed and certain existing and potential liabilities as to which he had become subject as a result of the 1995 consent solicitation, the SAT Board authorized a reduction in the exercise price of the April 17 Warrant (see the second preceding paragraph) from $3.125 to $2.125 per share. On December 6, 1996, the Board had authorized a similar reduction in exercise price for Common Stock purchase warrants to purchase an aggregate of 259,000 shares of the SAT Common Stock held by employees of the Company. As a result of a consent solicitation against SAT which was settled in September 1995, Mr. Rosen became the defendant in two arbitration proceedings in which a judgment of $170,000 was entered in one proceeding and the other was settled for $221,000. On January 23, 1997, the Board of Directors informally agreed (and on June 24, 1997 formally authorized) payment of these amounts plus Mr. Rosen's legal expenses, the total payments aggregating $416,000 as delayed expenses due to the consent solicitation as to which SAT had agreed to pay all expenses of the member of the dissident Committee (of which Mr. Rosen was a member). 45 47 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K. (a) 1. Financial Statements The Company's financial statements appear in a separate section of this Report commencing on the pages referenced below:
PAGE ---- Report of the Independent Certified Public Accountants...... F-1 Report of the Independent Certified Public Accountants...... F-2 Consolidated Balance Sheets at March 31, 1997 and 1996...... F-3 Consolidated Statements of Operations for the Years Ended March 31, 1997, 1996 and 1995............................. F-4 Consolidated Statements of Stockholders Equity for the Years Ended March 31, 1997, 1996 and 1995....................... F-5 Consolidated Statements of Cash Flows for the Years Ended March 31, 1997, 1996 and 1995............................. F-7 Notes to Consolidated Financial Statements.................. F-9
(a) 2. Financial Statement Schedules The following financial statement schedule of Substance Abuse Technologies, Inc. and subsidiaries are included herein. Schedule II Valuation and qualifying accounts All other schedules are omitted as they are not required, are inapplicable, or the information is included in the financial statements or notes thereto. (a) 3. Exhibits All of the following exhibits designated with a footnote reference are incorporated herein by reference to a prior registration statement filed under the Securities Act of 1933, as amended (the "Securities Act"), or a periodic report filed by SAT, Good Ideas or U.S. Drug pursuant to Section 13 of the Exchange Act. An exhibit marked with an asterisk is filed with this Report.
NUMBER EXHIBITS ------ -------- 2(a) Copy of Exchange of Stock Agreement and Plan of Reorganization dated May 7, 1992 between Good Ideas Enterprises, Inc., a Texas corporation ("Good Ideas Texas"), U.S. Alcohol & Drug Testing International N.V. and David Brooks.(1) 2(b) Copy of Agreement and Plan of Merger dated as of April 12, 1996 by and among SAT, Good Ideas Acquisition Corp. and Good Ideas.(2) 2(b)(1)* Copy of Agreement and Plan of Merger dated as of February 17, 1997 by and among SAT, Good Ideas Acquisition Corp. and Good Ideas. 2(c) Copy of Agreement and Plan of Merger dated as of April 23, 1996 by and among SAT, U.S. Drug Acquisition Corp. and U.S. Drug.(3) 2(c)(1)* Copy of Agreement and Plan of Merger dated as of February 17, 1997 by and among SAT, U.S. Drug Acquisition Corp. and U.S. Drug. 2(d) Copy of the Certificate of Merger of Good Ideas Texas with and into Good Ideas as filed on December 17, 1992.(1) 3(a) Copy of Certificate of Incorporation of SAT as filed in Delaware on April 15, 1987.(4) 3(a)(1) Copy of Amendment to the Certificate of Incorporation as filed in Delaware on July 10, 1989.(4)
46 48
NUMBER EXHIBITS ------ -------- 3(a)(2) Copy of Amendment to the Certificate of Incorporation as filed in Delaware on September 25, 1989.(4) 3(a)(3) Copy of Amendment to the Certificate of Incorporation as filed in Delaware on October 5, 1990.(4) 3(a)(4) Copy of Amendment to the Certificate of Incorporation as filed in Delaware on December 26, 1990.(5) 3(a)(5) Copy of Amendment to the Certificate of Incorporation as filed in Delaware on November 1, 1991.(5) 3(a)(6) Copy of Amendment to the Certificate of Incorporation as filed in Delaware on May 20, 1992.(6) 3(a)(7)* Copy of Amendment to the Certificate of Incorporation as filed in Delaware on October 28, 1996. 3(b) Copy of By-Laws of SAT.(4) 4(a) Specimen of Common Stock certificate of U.S. Alcohol Testing of America, Inc.(4) 4(a)(1)* Specimen of Common Stock certificate of SAT. 4(b) Specimen of Class "A" Cumulative and Convertible Preferred Stock certificate of U.S. Alcohol Testing of America, Inc.(4) 4(b)(1)* Specimen of Class "A" Cumulative and Convertible Preferred Stock certificate of SAT. 4(c) Specimen of Class "B" Non-Voting Preferred Stock certificate of U.S. Alcohol Testing of America, Inc.(7) 4(d) Copy of Convertible Loan and Warrant Agreement dated November 8, 1996 by and between SAT, S.A.C. Capital Associates, LLC and Steven A. Cohen.(13) 4(d)(1) Form of Registration Rights Agreement is Exhibit A to Exhibit 4(d) hereto.(13) 4(d)(2) Form of Convertible Senior Promissory Note due November 8, 1999 is Exhibit B to Exhibit 4(d) hereto.(13) 4(d)(3) Form of Common Stock Purchase Warrant expiring June 30, 2000 is Exhibit C to Exhibit 4(d) hereto.(13) 4(e)* Copy of Convertible Debenture and Preferred Stock Purchase Agreement dated as of May 8, 1997 between SAT and Southbrook International Investments, Ltd. ("Southbrook"). 4(e)(1)* Registration Rights Agreement dated as of May 8, 1996 between SAT and Southbrook. 4(e)(2)* Class B Exchange Agreement dated as of May 8, 1997 between SAT and Southbrook. 4(e)(3)* 14% Convertible Debenture of SAT due May 8, 2000. 4(e)(4)* Form of Common Stock Purchase Warrant expiring May 8, 2000. 10(a) Form of the Company's Indemnification Agreement with Officers and Directors.(4) 10(b) Copy of License Agreement dated January 24, 1992 by and between the United States Department of the Navy and SAT. (Confidential Treatment Requested for Exhibit.)(8) 10(b)(1) Copy of Amendment dated March 15, 1994 to License Agreement filed as Exhibit 10(b) hereto.(3) 10(b)(2) Copy of Amendment dated June 16, 1995 to License Agreement filed as Exhibit 10(b) hereto.(3) 10(b)(3) Copy of Letter dated May 15, 1995 from the USN to SAT.(3) 10(c) Copy of Assignment dated as of January 1, 1993 between SAT and U.S. Drug of the Licensing Agreement filed as Exhibit 10(b) hereto.(8)
47 49
NUMBER EXHIBITS ------ -------- 10(c)(1) Copy of Amended Sublicense Agreement dated September 23, 1993 superseding the Assignment filed as Exhibit 10(b) hereto.(3) 10(c)(2) Copy of Approval dated September 24, 1993 by the USN of Amended Sublicense Agreement filed as Exhibit 10(b) hereto.(3) 10(d) Copy of Cooperative Research Agreement (the "CRDA Agreement") dated April 16, 1992 by and between Naval Research Laboratory Section, United States Department of the Navy, and SAT.(8) 10(d)(1) Copy of Assignment of CRDA Agreement dated as of January 1, 1993 by and between U.S. Drug and SAT.(8) 10(e) Copy of Management Agreement dated April 1, 1993 by and between U.S. Drug and SAT.(8) 10(e)(1) Copy of Amendment dated July 20, 1993 to Management Services Agreement filed as Exhibit 10(e) hereto.(8) 10(f) Copy of Management Services Agreement dated December 29, 1993 by and between Good Ideas and SAT.(2) 10(g) Copy of Equipment, Licensing, Servicing and Maintenance Agreement dated as of December 13, 1994 by and between SAT and METPATH, Inc.(7) 10(h) Copy of Equipment, Licensing, Servicing and Maintenance Agreement dated as of December 22, 1994 by and between SAT and National Health Laboratories Incorporated.(7) 10(i) Copy of Lease dated March 18, 1991 by and between Rancho Cucamonga Business Park (now The Realty Trust) as landlord and SAT as tenant.(7) 10(j)(1) Copy of Lease Modification Agreement to Lease filed as Exhibit 10(o) hereto.(7) 10(j)(2) Copy of Sub-Lease Agreement dated as of January 1, 1993 by and between SAT as sublandlord and U.S. Drug as subtenant.(8) 10(j)(3)* Copy of Third Amendment dated January 2, 1997 to Lease filed as Exhibit 10(j) hereto. 10(k) Copy of Lease dated December 9, 1992 by and between Melvin E. Evans as landlord and Good Ideas as tenant.(1) 10(l) Copy of Lease expiring June 30, 1999 by and between Rancho Cucamonga Business Park as landlord and U.S. Rubber Recycling, Inc. ("USRR") as tenant.(7) 10(m) Copy of Consulting and Royalty Agreement dated June 20, 1988 between Manley Luckey and SAT.(4) 10(m)(1) Copy of Amendment dated August 1990 to Consulting and Royalty Agreement filed as Exhibit 10(m) hereto.(4) 10(n) Form of Warrant Agreement dated December 17, 1990 between J. Gregory & Company Inc. and SAT.(4) 10(n)(1) Form of Underwriter's Warrant expiring December 17, 1997 of SAT.(4) 10(o) Form of Common Stock purchase warrant expiring October 31, 1996 of SAT.(6) 10(p) Form of Common Stock purchase warrant.(5)
48 50
NUMBER EXHIBITS ------ -------- SAT's Common Stock purchase warrants expiring August 28, 1996, September 1, 1996, September 16, 1996, September 30, 1996, October 31, 1996, May 17, 1997, September 16, 1997, November 1, 1997, December 17, 1997, December 31, 1997, February 28, 1998, April 15, 1998, July 17, 1998, August 27, 1998, September 1, 1998, November 1, 1998, November 15, 1998, December 13, 1998, December 20, 1998, December 27, 1998, January 2, 1999, January 31, 1999, February 26, 1999, February 28, 1999, March 31, 1999, April 14, 1999, April 17, 1999, May 12, 1999, July 17, 1999, July 19, 1999, August 11, 1999, December 31, 1999, January 29, 2000, October 19, 2000, December 31, 2000 and December 31, 2001 are substantially identical to the form of Common Stock purchase warrant filed (by incorporation by reference) as Exhibit 10(p) hereto except as to the name of the holder, the expiration date and the exercise price and, accordingly, pursuant to Instruction 2 to Item 601 of Regulation S-K under the Securities Act are not individually filed. 10(q) Restricted Stock, Non-Qualified Option and Incentive Stock Option Plan of SAT.(4) 10(q)(1) Form of Stock Option expiring August 1, 2004 issued pursuant to Exhibit 10(q) hereto.(7) 10(r) Form of Common Stock purchase warrant expiring December 17, 1999.(9) 10(s) Form of Warrant Agreement by and between Good Ideas and Baraban Securities, Incorporated.(1) 10(s)(1) Form of Common Stock purchase warrant expiring February 16, 1999 of Good Ideas.(1) 10(s)(2) Form of Common Stock purchase warrant expiring February 16, 1999 of SAT to be issued in lieu of the Common Stock purchase warrant of Good Ideas filed as Exhibit 10(s)(1) hereto. 10(t) Copy of Agreement made as of December 14, 1995 by and between SAT, ProActive Synergies, Inc., Robert Stutman & Associates, Inc. and Robert Stutman.(10) 10(u) Copy of Asset Purchase Agreement dated April 30, 1996 by and among USRR, SAT and Reclamation Resources Inc.(11) 10(v) Copy of Stock Purchase Agreement dated as of May 21, 1996 by and among SAT, Robert Stutman, Brian Stutman, Sandra DeBow, Michael Rochelle and Kimberly Rochelle.(11) 10(v)(1) Form of Secured Promissory Note dated May 21, 1996 is Exhibit A to Exhibit 10(v) hereto. 10(v)(2) Form of Security Agreement dated May 21, 1996 by and among SAT, Robert Stutman and Brian Stutman is Exhibit C to Exhibit 10(v) hereto. 10(v)(3) Form of SAT Warrant expiring May 20, 1999 is Exhibit B to Exhibit 10(v) hereto. 10(v)(4) Form of Registration Rights Agreement dated as of May 21, 1996 by and between SAT, Robert Stutman, Brian Stutman, Michael Rochelle, Kimberly Rochelle and Sandra DeBow is Exhibit D to Exhibit 10(v) hereto. 10(w) Copy of Severance Agreement dated May 21, 1996 by and between SAT and Robert Stutman.(11) 10(w)(1)* Copy of Amended and Restated Severance Agreement dated May 21, 1997 by and between SAT and Robert Stutman. 10(x) Copy of Severance Agreement dated May 21, 1996 by and between SAT and Brian Stutman.(11) 10(y)* Copy of Severance Agreement dated June 27, 1996 by and between SAT and Linda H. Masterson. 10(z)* Copy of Severance Agreement dated June , 1997 by and between David L. Dorff.
49 51
NUMBER EXHIBITS ------ -------- 10(aa)* Copy of Sublease dated as of June 20, 1996 by and between Lifecare Investments, Inc. ("Lifecare"), Sublessor, and SAT, Sublessee. 10(aa)(1)* Copy of Wingate Commons Business Park Net Lease dated September 27, 1991 by and between Reynolds Metals Development Company, Landlord, and Lifecare, Tenant. 10(aa)(2)* Copy of First Addendum to the Lease filed as Exhibit 10(aa)(1) hereto. 10(aa)(3)* Copy of Second Addendum to the Lease filed as Exhibit 10(aa)(1) hereto. 10(bb) Copy of Demand Promissory Note dated March 31, 1995 executed by SAT in favor of Good Ideas.(12) 10(bb)(1) Copy of Demand Promissory Note dated March 31, 1995 executed by USRR in favor of Good Ideas.(12) 10(cc) Form of Warrant Agreement by and between U.S. Drug and Baraban Securities, Incorporated.(8) 10(cc)(1) Form of Common Stock purchase warrant expiring October 13, 1998 of U.S. Drug.(8). 10(cc)(2)* Form of Common Stock purchase warrant expiring October 13, 1998 of SAT to be issued in lieu of the Common Stock purchase warrant of U.S. Drug filed as Exhibit 10(cc)(1) hereto. 10(dd)* Form of Common Stock purchase warrant expiring November 15, 1999. SAT's Common Stock purchase warrants expiring November 15, 1999, December 2, 1999 and three years from the effective date of a registration statement under the Securities Act are substantially identical to the form of Common Stock purchase warrant filed as Exhibit 10(dd) hereto except as to the name of the holder, the expiration date and the exercise price and, accordingly, pursuant to Instruction 2 to Item 601 of Regulation S-K under the Securities Act are not individually filed. 10(ee)* Form of Common Stock purchase warrant with deferred exercise. SAT's Common Stock purchase warrants expiring three years from the effective date of a registration statement under the Securities Act and those issued or to be issued to employees, of which the currently outstanding warrants expire between September 11, 2000 and June 23, 2004, are substantially identical to the form of Common Stock purchase warrant filed as Exhibit 10(ee) hereto except as to the name of the holder, the expiration date and the exercise price and, accordingly, pursuant to Instruction 2 to Item 601 of Regulation S-K under the Securities Act are not individually filed. 10(ff) Copy of Employment Agreement dated December 31, 1993 between SAT and James C. Witham.(7) 10(gg) Copy of Employment Agreement dated December 13, 1993 between SAT and Karen B. Laustsen.(7) 10(hh) Copy of Employment Agreement dated December 13, 1993 between SAT and Gary S. Wolff.(7) 10(ii) Copy of Employment Agreement dated December 13, 1993 between SAT and Michael J. Witham.(7) 16 Copy of Letter dated November 16, 1995 from Wolinetz, Gottlieb & Lafazan, P.C. to the Securities and Exchange Commission.(14) 21* Subsidiaries of SAT.
- --------------- (1) Filed as an exhibit to Good Ideas' Registration Statement on Form S-1, File No. 33-73494, and incorporated herein by this reference. (2) Filed as an exhibit to Good Ideas' Annual Report on Form 10-K for the fiscal year ended March 31, 1996 and incorporated herein by this reference. 50 52 (3) Filed as an exhibit to U.S. Drug's Annual Report on Form 10-K for the fiscal year ended March 31, 1996 and incorporated herein by this reference. (4) Filed as an exhibit to SAT's Registration Statement on Form S-18, File No. 33-29718, and incorporated herein by this reference. (5) Filed as an exhibit to SAT's Registration Statement on Form S-1, File No. 33-43337, and incorporated herein by this reference. (6) Filed as an exhibit to SAT's Registration Statement on Form S-1, File No. 33-47855, and incorporated herein by this reference. (7) Filed as an exhibit to SAT's Annual Report on Form 10-K for the fiscal year ended March 31, 1995 and incorporated herein by this reference. (8) Filed as an exhibit to U.S. Drug's Registration Statement on Form SB-2, File No. 33-61786, and incorporated herein by this reference. (9) Filed as an exhibit to SAT's Current Report on Form 8-K filed on November 2, 1992 and incorporated herein by this reference. (10) Filed as an exhibit to SAT's Registration Statement on Form S-8 filed on March 5, 1996 and incorporated herein by this reference. (11) Filed as an exhibit to SAT's Current Report on Form 8-K filed on June 5, 1996 and incorporated herein by this reference. (12) Filed as an exhibit to Good Ideas' Annual Report on Form 10-K for the fiscal year ended March 31, 1995 and incorporated herein by this reference. (13) Filed as an exhibit to Amendment 2 to Schedule 13D filed by Steven A. Cohen on November 12, 1996 and incorporated herein by this reference. (14) Filed as an Exhibit to SAT's Current Report on Form 8-K/A filed on November 22, 1995 and incorporated herein by this reference. (b) Reports on Form 8-K There were no reports on Form 8-K filed during the quarter ended March 31, 1997. 51 53 SIGNATURES Pursuant to the requirement of Section 13 or 15(d) of Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on July 14, 1997. SUBSTANCE ABUSE TECHNOLOGIES, INC. (Company) By: /s/ ROBERT M. STUTMAN ------------------------------------ Robert M. Stutman Chairman and Chief Executive Officer Pursuant to the requirement of the Securities Act of 1934, this report has been signed below by the following persons on behalf of the Company and in the capacities indicated on July 14, 1997.
SIGNATURE TITLE --------- ----- /s/ ROBERT M. STUTMAN Principal Executive Officer and Director - ----------------------------------------------------- Robert M. Stutman /s/ ROBERT MUCCINI Principal Financial and Accounting Officer - ----------------------------------------------------- Robert Muccini /s/ ALAN I. GOLDMAN Director - ----------------------------------------------------- Alan I. Goldman /s/ JOHN C. LAWN Director - ----------------------------------------------------- John C. Lawn /s/ PETER M. MARK Director - ----------------------------------------------------- Peter M. Mark /s/ LINDA H. MASTERSON Director - ----------------------------------------------------- Linda H. Masterson /s/ LEE S. ROSEN Director - ----------------------------------------------------- Lee S. Rosen /s/ MICHAEL S. MCCORD Director - ----------------------------------------------------- Michael S. McCord /s/ DAVID L. DORFF Director - ----------------------------------------------------- David L. Dorff
52 54 REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS The Board of Directors Substance Abuse Technologies, Inc. Fort Lauderdale, Florida We have audited the accompanying consolidated balance sheets of Substance Abuse Technologies, Inc. (formerly U.S. Alcohol Testing of America, Inc.) and subsidiaries (the Company) as of March 31, 1997 and 1996, and the related consolidated statements of operations, stockholders' (deficit) equity, and cash flows for the years then ended. Our audits also included the financial statement schedule listed in the Index at Item 14(a). These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Substance Abuse Technologies, Inc. and subsidiaries at March 31, 1997 and 1996, and the consolidated results of their operations and their cash flows for the years then ended in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements as a whole, present fairly in all material respects the information set forth therein. The accompanying financial statements have been prepared assuming that Substance Abuse Technologies, Inc. will continue as a going concern. As more fully described in Note 2, the Company has incurred recurring operating losses and, at March 31, 1997, has a working capital deficiency and a deficiency in stockholders' equity. These conditions raise substantial doubt about the Company's ability to continue as a going concern. Management's plans in regard to these matters are also described in Note 2. The financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the outcome of this uncertainty. ERNST & YOUNG LLP Miami, Florida July 3, 1997, except for Note 13, as to which the date is July 7, 1997 F-1 55 REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS The Board of Directors and Shareholders Substance Abuse Technologies, Inc. Fort Lauderdale, Florida We have audited the accompanying consolidated statements of operations, stockholders' equity and cash flows of Substance Abuse Technologies, Inc. (formerly U.S. Alcohol Testing of America, Inc.) and subsidiaries for the year ended March 31, 1995. These consolidated statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated statements based on our audit. We conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether these statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the consolidated statements referred to above present fairly, in all material respects, the results of operations and cash flows of Substance Abuse Technologies, Inc. and subsidiaries for the year ended March 31, 1995, in conformity with generally accepted accounting principles. WOLINETZ, GOTTLIEB & LAFAZAN, P.C. Rockville Centre, New York May 26, 1995 F-2 56 SUBSTANCE ABUSE TECHNOLOGIES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
MARCH 31, MARCH 31, 1997 1996 ------------ ------------ ASSETS Current assets: Cash and cash equivalents................................. $ 634,429 $ 1,204,646 Accounts receivable (net of allowance for bad debts of $650,000 in 1997 and $112,000 in 1996).................. 473,115 278,874 Inventories............................................... 16,675 681,839 Prepaid expenses and other current assets................. 224,634 255,637 Current portion of note receivable........................ 50,000 -- Current assets of discontinued operations, net............ -- 256,654 ------------ ------------ Total current assets............................... 1,398,853 2,677,650 Property and equipment (net of accumulated depreciation of $1,137,300 in 1997 and $1,469,692 in 1996)................ 1,246,374 2,691,979 Costs in excess of net assets acquired (net of accumulated amortization of $306,300 in 1997 and $93,912 in 1996)..... 4,774,099 797,393 Other assets................................................ 484,394 60,950 Note receivable............................................. 250,000 -- Noncurrent assets of discontinued operations, net........... -- 307,868 ------------ ------------ $ 8,153,720 $ 6,535,840 ============ ============ LIABILITIES AND STOCKHOLDERS' (DEFICIT) EQUITY Current liabilities: Accounts payable.......................................... $ 1,305,484 $ 487,320 Accrued expenses.......................................... 1,389,339 468,150 Current liabilities of discontinued operations, net....... 7,396 -- Current portion of capital lease obligations.............. 71,324 29,395 Preferred stock dividend payable.......................... 7,202 7,202 ------------ ------------ Total current liabilities.......................... 2,780,745 992,067 Convertible debentures, net of unamortized discount of $1,151,161................................................ 3,848,839 -- Long-term portion of capital lease obligations.............. 295,271 32,935 Long-term portion of royalties payable...................... 980,000 -- Commitments and contingencies Minority interest........................................... 845,349 1,478,508 Stockholders' (deficit) equity: Class "A" preferred stock, $.01 par value; 500,000 shares authorized, 41,157 shares issued and outstanding in 1997 and 1996 (liquidation preference of $205,785 in 1997 and 1996)................................................... 412 412 Class "B" preferred stock, $.01 par value; 1,500,000 shares authorized, no shares issued and outstanding..... -- -- Common stock, $.01 par value; 50,000,000 shares authorized, 36,030,591 and 32,480,010 shares issued and outstanding in 1997 and 1996, respectively.............. 360,306 324,800 Additional paid-in capital................................ 55,956,113 45,176,619 Accumulated deficit....................................... (56,913,315) (41,469,501) ------------ ------------ Total stockholders' equity (deficit)............... (596,484) 4,032,330 ------------ ------------ $ 8,153,720 $ 6,535,840 ============ ============
See accompanying notes. F-3 57 SUBSTANCE ABUSE TECHNOLOGIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED MARCH 31 ------------------------------------------- 1997 1996 1995 ------------ ------------ ----------- Continuing operations: Net sales: Alcohol products........................................ $ 952,719 $ 748,793 $ 1,069,498 Services................................................ 1,771,086 416,868 625,717 ------------ ------------ ----------- 2,723,805 1,165,661 1,695,215 Costs and expenses: Cost of alcohol products sales (exclusive of depreciation shown below).............................. 735,498 903,984 936,991 Cost of services provided............................... 1,258,037 304,742 460,043 Selling, general and administrative expenses (exclusive of depreciation shown below) .......................... 9,085,331 5,720,592 5,284,405 Research and development................................ 1,787,213 1,005,832 1,248,962 Depreciation and amortization........................... 1,166,698 1,017,534 695,367 Write-off of costs in excess of net assets acquired..... 714,377 -- -- Write-off of assets associated with abandonment of breath alcohol and cost-per-test services.............. 1,850,209 -- -- Present value of future royalty payments................ 1,100,000 -- -- Loss from settlement of litigation...................... 416,421 1,137,914 -- ------------ ------------ ----------- Total costs and expenses............................ 18,113,784 10,090,598 8,625,768 ------------ ------------ ----------- Loss from operations...................................... (15,389,979) (8,924,937) (6,930,553) Other income (expense): Interest expense........................................ (330,558) (81,450) (46,069) Interest income......................................... 75,065 116,075 250,486 Loss on sale of marketable securities................... -- (1,889,216) (154,707) Unrealized gain (loss) on marketable securities......... -- 2,190,721 (579,991) Loss on disposal of property and equipment.............. (50,922) -- -- Other................................................... -- (8,704) (14,925) ------------ ------------ ----------- Total other (expense) income........................ (306,415) 327,426 (545,206) ------------ ------------ ----------- Loss from continuing operations before minority interest in net loss of subsidiaries............................. (15,696,394) (8,597,511) (7,475,759) Minority interest in net loss of subsidiaries, net of subsidiary preferred stock dividends paid............... 567,469 541,466 769,632 ------------ ------------ ----------- Loss from continuing operations........................... (15,128,925) (8,056,045) (6,706,127) Discontinued operations: Loss from operations before minority interest............. -- (1,545,457) (857,575) Minority interest in net loss............................. -- 467,183 327,306 Loss on disposal, net of minority interest of $58,591 in 1997 and $143,671 in 1996............................... (314,889) (1,326,267) -- ------------ ------------ ----------- Loss from discontinued operations........................... (314,889) (2,404,541) (530,269) ------------ ------------ ----------- Net loss.................................................... $(15,443,814) $(10,460,586) $(7,236,396) ============ ============ =========== Weighted average common shares outstanding.................. 35,327,631 29,834,502 25,691,674 ============ ============ =========== Loss applicable to common stock: Net loss.................................................. $(15,443,814) $(10,460,586) $(7,236,396) Class "A" preferred stock dividend........................ (28,810) (28,810) (39,179) Class "B" preferred stock dividend........................ -- -- (2,425) ------------ ------------ ----------- Loss applicable to common stock............................. $(15,472,624) $(10,489,396) $(7,278,000) ============ ============ =========== Loss per common share: Loss from continuing operations........................... $ (0.43) $ (0.27) $ (0.26) Loss from discontinued operations......................... (0.01) (0.08) (0.02) ------------ ------------ ----------- Net loss per common share................................... $ (0.44) $ (0.35) $ (0.28) ============ ============ ===========
See accompanying notes. F-4 58 SUBSTANCE ABUSE TECHNOLOGIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' (DEFICIT) EQUITY YEARS ENDED MARCH 31, 1997, 1996 AND 1995
CLASS "A" CLASS "B" ADDITIONAL PREFERRED PREFERRED COMMON PAID-IN ACCUMULATED STOCK STOCK STOCK CAPITAL DEFICIT TOTAL ----------- ----------- -------- ----------- ------------ ------------ Balance at April 1, 1994........... $502 $ 88 $240,522 $30,375,782 $(23,772,519) $ 6,844,375 Issuance of 39,375 shares of common stock upon conversion of 8,750 shares of class "B" preferred stock................ -- (88) 394 (306) -- -- Issuance of 40,725 shares of common stock upon conversion of 9,050 shares of class "A" preferred stock................ (90) -- 407 (317) -- -- Issuance of 812,018 shares of common stock upon exercise of warrants....................... -- -- 8,121 1,762,397 -- 1,770,518 Dividend on Class "A" preferred stock.......................... -- -- -- (39,179) -- (39,179) Dividend on Class "B" preferred stock.......................... -- -- -- (2,425) -- (2,425) Issuance of 1,333,333 shares of common stock in connection with settlement of class action litigation..................... -- -- 13,333 2,986,667 -- 3,000,000 Additional paid-in capital arising from additional investment in Good Ideas Enterprises, Inc. by minority interest ...................... -- -- -- 165,977 -- 165,977 Issuance of 931 shares of common stock in payment of class "B" preferred stock dividend....... -- -- 10 2,415 -- 2,425 Issuance of 30,000 shares of common stock to directors for directors' fees................ -- -- 300 54,075 -- 54,375 Issuance of 782,321 shares of common stock in connection with acquisitions................... -- -- 7,823 1,556,819 -- 1,564,642 Issuance of 1,050,000 shares of common stock in connection with a private placement, net of related costs.................. -- -- 10,500 1,584,343 -- 1,594,843 Expenses of warrant exercise..... -- -- -- (25,213) -- (25,213) Other............................ -- -- 1 (1) -- -- Net loss for year ended March 31, 1995........................... -- -- -- -- (7,236,396) (7,236,396) ---- ---- -------- ----------- ------------ ------------ Balance at March 31, 1995.......... 412 -- 281,411 38,421,034 (31,008,915) 7,693,942 Dividend on Class "A" preferred stock.......................... -- -- -- (28,810) -- (28,810) Additional paid-in capital arising from surrender of capital in Good Ideas Enterprises, Inc. by minority shareholder.................... -- -- -- 97,674 -- 97,674 Issuance of 2,152,469 shares of common stock in connection with a private placement to international investors........ -- -- 21,524 3,016,981 -- 3,038,505 Issuance of 116,500 shares of common stock upon exercise of warrants....................... -- -- 1,165 165,440 -- 166,605
F-5 59 SUBSTANCE ABUSE TECHNOLOGIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' (DEFICIT) EQUITY -- (CONTINUED)
CLASS "A" CLASS "B" ADDITIONAL PREFERRED PREFERRED COMMON PAID-IN ACCUMULATED STOCK STOCK STOCK CAPITAL DEFICIT TOTAL ----------- ----------- -------- ----------- ------------ ------------ Issuance of 20,000 shares of common stock to directors for director's fees................ -- -- 200 37,300 -- 37,500 Issuance of 2,000,000 shares of common stock in connection with a private placement under Regulation D................... -- -- 20,000 3,730,000 -- 3,750,000 Expenses of stock offerings and warrant exercises.............. -- -- -- (362,500) -- (362,500) Issuance of 50,000 shares of common stock to consultant for investor relations and financial consulting services....................... -- -- 500 99,500 -- 100,000 Net loss for year ended March 31, 1996........................... -- -- -- -- (10,460,586) (10,460,586) ---- ---- -------- ----------- ------------ ------------ Balance at March 31, 1996.......... 412 -- 324,800 45,176,619 (41,469,501) 4,032,330 Dividend on Class "A" preferred stock.......................... -- -- -- (28,810) -- (28,810) Exercise of warrants by director for 200,000 shares of common stock which were issued, on behalf of the company to a consultant..................... -- -- 2,000 573,000 -- 575,000 Issuance of 2,630,582 shares of common stock upon exercise of warrants, net of expenses...... -- -- 26,306 4,204,316 -- 4,230,622 Issuance of 207,499 shares of common stock upon exercise of warrants by officers in connection with the extinguishment of a $400,000 note payable, plus accrued interest....................... -- -- 2,075 412,925 -- 415,000 Issuance of 500,000 shares of common stock and warrants to purchase 900,000 shares of common stock in connection with an acquisition................. -- -- 5,000 2,757,500 -- 2,762,500 Value of warrants issued to consultants for investor relations and financial consulting services............ -- -- -- 1,317,000 -- 1,317,000 Value of warrants attached to convertible debentures......... -- -- -- 1,300,000 -- 1,300,000 Issuance of 12,500 shares of common stock upon exercise of stock options.................. -- -- 125 29,563 -- 29,688 Change in value of warrants resulting from modification of terms.......................... -- -- -- 214,000 -- 214,000 Net loss for year ended March 31, 1997........................... -- -- -- -- (15,443,814) (15,443,814) ---- ---- -------- ----------- ------------ ------------ Balance at March 31, 1997.......... $412 $ -- $360,306 $55,956,113 $(56,913,315) $ (596,484) ==== ==== ======== =========== ============ ============
See accompanying notes. F-6 60 SUBSTANCE ABUSE TECHNOLOGIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED MARCH 31 -------------------------------------------- 1997 1996 1995 ------------ ------------ ------------ OPERATING ACTIVITIES Net loss................................................... $(15,443,814) $(10,460,586) $ (7,236,396) Adjustments to reconcile net loss to net cash used by operating activities: Provision for bad debts.................................. 582,821 131,551 64,000 Depreciation and amortization............................ 1,166,698 1,311,354 799,858 Write-off of assets associated with abandoned services... 1,850,209 -- -- Write-off of costs in excess of net assets acquired...... 714,377 -- -- Loss on disposal of property and equipment............... 50,922 22,335 40,400 Loss on disposal of discontinued operations.............. 150,940 1,326,267 -- Amortization of debt discount............................ 148,839 -- -- Amortization of deferred financing costs................. 8,133 -- -- Minority interest in net loss of subsidiaries, net of subsidiary preferred stock dividends paid.............. (568,540) (1,008,649) (1,096,938) Value of common stock issued to directors for services... -- 37,500 54,375 Value of common stock issued for consulting services..... 575,000 100,000 -- Value of common stock in subsidiary issued to officer for services............................................... -- 5,000 -- Value of warrants issued for consulting services......... 1,317,000 -- -- Value of warrant modifications, net of deferred amounts................................................ 84,833 -- -- Present value of future royalty payments................. 1,100,000 -- -- Unrealized loss on marketable securities................. -- (2,190,721) 579,991 Realized loss on marketable securities................... -- 1,889,216 154,707 Amortization of discount................................. -- (779) (3,116) Changes in operating assets and liabilities: (Increase) decrease in accounts receivable............. (777,062) 360,682 697,719 (Increase) decrease in inventories..................... (83,585) 1,301,593 (833,681) Decrease (increase) in prepaid expenses and other assets............................................... 1,198 44,185 (79,854) Decrease in restricted funds in escrow................. -- -- 1,578,671 Increase (decrease) in accounts payable................ 828,424 (1,011,022) 135,794 Increase (decrease) in accrued expenses................ 815,538 (4,103) 24,492 Decrease in accrued class action settlement............ -- -- (1,578,671) Decrease (increase) in net assets of discontinued operations........................................... 102,196 (564,522) -- ------------ ------------ ------------ Net cash used by operating activities...................... (7,375,873) (8,710,699) (6,698,649) INVESTING ACTIVITIES Sale of marketable securities.............................. -- 3,609,826 13,320 Purchase of property and equipment......................... (320,205) (269,756) (2,555,133) Purchase of patents and related costs...................... -- -- (9,633) Proceeds from disposals of property and equipment.......... 50,575 59,438 -- Other...................................................... -- (23,221) 1,456 Deferred costs of minority interest consent solicitations............................................ (141,443) -- -- Proceeds from sale of assets of discontinued operations.... 200,000 -- -- Costs of business acquisitions, net of cash acquired of $111,825 in 1997 and $593,261 in 1995.................... (2,075,024) -- 588,141 ------------ ------------ ------------ Net cash (used) provided by investing activities........... (2,286,097) 3,376,287 (1,961,849)
F-7 61
YEARS ENDED MARCH 31 -------------------------------------------- 1997 1996 1995 ------------ ------------ ------------ FINANCING ACTIVITIES Sales and issuance of common and preferred stock........... -- 6,788,505 1,694,063 Proceeds of convertible debentures and warrants, net of issuance costs........................................... 4,941,442 -- -- Proceeds of long-term debt................................. 450,000 -- 81,151 Payments of long-term debt................................. (450,000) -- (93,584) Payments of capital lease obligations...................... (81,189) (88,248) -- Proceeds of brokerage loans payable........................ -- 1,000,000 1,674,683 Payments of brokerage loans payable........................ -- (2,569,592) (105,091) Proceeds from sale of common stock by Good Ideas Enterprises, Inc......................................... -- -- 326,000 Expenses of stock offerings of subsidiaries................ -- -- (44,703) Expenses of stock offering and exercise of warrants........ (400,000) (362,500) (124,433) Payment of dividend on Class "A" preferred stock........... (28,810) (28,810) (31,977) Issuance of common stock upon exercise of warrants and options ................................................. 4,660,310 166,605 1,770,518 ------------ ------------ ------------ Net cash provided by financing activities.................. 9,091,753 4,905,960 5,146,627 ------------ ------------ ------------ Decrease in cash and cash equivalents...................... (570,217) (428,452) (3,513,871) Cash and cash equivalents, beginning of year............... 1,204,646 1,633,098 5,146,969 ------------ ------------ ------------ Cash and cash equivalents, end of year..................... $ 634,429 $ 1,204,646 $ 1,633,098 ============ ============ ============ SUPPLEMENTAL DISCLOSURE OF CASH INFORMATION Cash paid for interest..................................... $ 330,732 $ 81,450 $ 50,139 ============ ============ ============ NONCASH FINANCING ACTIVITIES Preferred stock dividends accrued.......................... $ 7,202 $ 7,202 $ 7,202 ============ ============ ============ Property and equipment acquired under capital leases....... $ 385,454 $ 17,843 $ -- ============ ============ ============ Issuance of common stock upon exercise of warrants in connection with extinguishment of note payable........... $ 415,000 $ -- $ -- ============ ============ ============ Issuance of common stock and warrants in connection with acquisition.............................................. $ 2,762,500 $ -- $ 976,501 ============ ============ ============ Issuance of common stock as payment for Class "B" dividend................................................. $ -- $ -- $ 2,465 ============ ============ ============ Issuance of common stock in connection with settlement of class action litigation.................................. $ -- $ -- $ 3,000,000 ============ ============ ============ Issuance of common stock upon conversion of Class "A" preferred stock.......................................... $ -- $ -- $ 407 ============ ============ ============ Issuance of common stock upon conversion of Class "B" preferred stock.......................................... $ -- $ -- $ 394 ============ ============ ============
See accompanying notes. F-8 62 SUBSTANCE ABUSE TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MARCH 31, 1997 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Organization Effective October 28, 1996, U.S. Alcohol Testing of America, Inc. changed its name to Substance Abuse Technologies, Inc. (the Company). Also during fiscal 1997, the Company made a strategic decision to abandon a substantial portion of its breath and cost-per-test alcohol equipment manufacturing, sales and service and focus on its human resource provider business. Consequently, the Company's major emphasis has become designing and administering drug testing and background checking services for employers as well as developing customized loss prevention programs specifically designed to reduce the negative effect of workplace substance abuse. The Company will continue to operate its forensic laboratory in California and package and sell an alcohol breath sampling device. As a result of the Company's new strategic direction, the Company has decided to initiate a program to have its 67.0% (increased to 75.4% as of May 31, 1997) owned subsidiary, U.S. Drug Testing, Inc. (U.S. Drug) (a developmental stage enterprise) seek its own financing or identify a strategic partner that will fund the future costs to develop U.S. Drug's saliva and urine based on-site drug testing systems. To facilitate that effort, the Company intends to pursue its proposed offer to acquire all of the outstanding shares in U.S. Drug. The Company also owns a 60.8% interest in Good Ideas Enterprises, Inc. (Good Ideas), a toy manufacturer, and all of the outstanding stock of U.S. Rubber Recycling, Inc. (USRR), a manufacturer of floor coverings. The Company discontinued the operations of Good Ideas in February 1996 and sold the assets of USRR in April 1996. Principles of Consolidation The consolidated financial statements include the accounts of Substance Abuse Technologies, Inc. and its wholly and majority owned subsidiaries. All significant intercompany accounts and transactions are eliminated in consolidation. Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. Cash and Cash Equivalents The Company considers all highly liquid cash investments with an original maturity of three months or less when purchased to be cash equivalents. Inventories Inventories are stated at the lower of cost or market. Cost is determined by the first-in, first-out method. Property and Equipment Property and equipment is stated at cost. Depreciation is computed using the straight-line method over the estimated useful lives of the related assets. Amortization of assets under capital leases is included in depreciation expense. F-9 63 SUBSTANCE ABUSE TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Costs in Excess of Net Assets Acquired Costs in excess of net assets acquired are amortized using the straight-line method over 5 to 15 years. Covenants Not to Compete Covenants not to compete are included in other assets and are being amortized using the straight-line method over the life of the agreement, generally five to eight years. The Company continually monitors events and changes in circumstances that could indicate carrying amounts may not be recoverable. When events or changes in circumstances are present that indicate the carrying amount may not be recoverable, the Company assesses the recoverability by determining whether the carrying value will be recovered through undiscounted expected future cash flows after interest charges associated with the business acquired. Costs in excess of net assets acquired relating to the acquisition of Good Ideas in the amount of $1,013,304 was included in the loss on disposal of discontinued operations in fiscal 1996. In fiscal 1997, costs in excess of net assets acquired of $714,377 associated with the acquisition of abandoned services were written off. Impairments would be recognized in operating results if an other than temporary diminution in value were to occur. Impairment of Long-Lived Assets The Company accounts for the impairment of long-lived assets under Statement of Financial Accounting Standards No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of (SFAS 121). SFAS 121 requires impairment losses to be recorded on long-lived assets used in operations when indicators of impairment are present and the undiscounted cash flows estimated to be generated by those assets are less than the assets' carrying amount. Based on current circumstances, the Company does not believe that any impairment indicators are present. Revenue Recognition Service and test revenue are recognized in the period that the service/test is performed. Product sales are recorded when title transfers. Research and Development Costs Research and development costs are expensed as incurred. Income Taxes The Company accounts for income taxes under Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes (SFAS 109). In accordance with SFAS 109, deferred tax assets and liabilities are established for the temporary differences between the financial reporting basis and the tax basis of the Company's assets and liabilities at enacted tax rates expected to be in effect when such amounts are realized or settled. Accounting for Stock Based Compensation The Company grants stock options and warrants for a fixed number of shares to employees with an exercise price equal to the fair value of the shares at the date of grant. The Company accounts for stock option and warrant grants in accordance with Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees, and, accordingly, recognizes no compensation expense for employee stock option and warrant grants. F-10 64 SUBSTANCE ABUSE TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) The Company accounts for common stock, stock options or warrants to purchase common stock issued to nonemployees by recording an expense at the date of issuance based upon the fair market value of the security issued. Concentration of Credit Risks The Company performs ongoing credit evaluations of its customers and generally does not require collateral. The Company maintains reserves for potential credit losses, and such losses have been within management's expectations. No customer accounted for 10% or more of net revenues in the years ended March 31, 1997, 1996 or 1995. Financial instruments that potentially subject the Company to concentration of credit risk consist principally of cash investments and trade receivables. The Company currently invests excess cash in short term commercial paper with strong credit ratings and in money market accounts with commercial banks. Net Loss Per Common Share Loss per common share is based upon the weighted average number of common shares outstanding during the periods reported. Common stock equivalents have not been included in this calculation since their inclusion would be antidilutive. In February 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 128, Earnings per Share (SFAS 128). SFAS 128, which applies to entities with publicly held common stock, simplifies the standards for computing earnings per share previously required in APB Opinion No. 15, Earnings per Share, and makes them comparable to international earnings per share standards. SFAS 128 is effective for financial statements issued for periods ending after December 15, 1997, including interim periods; earlier adoption is not permitted. Management is currently reviewing the provisions of SFAS 128; however, it does not believe that adoption of this new accounting pronouncement will have a material impact on the calculation and presentation of earnings per share. Reclassification Certain prior year balances have been reclassified to conform with the current year's presentation. 2. CONTINUING OPERATIONS The Company has incurred recurring operating losses and at March 31, 1997 has a deficiency in working capital of approximately $1,400,000 and a deficiency in stockholders' equity of approximately $596,000. These conditions raise substantial doubt about the Company's ability to continue as a going concern. The financial statements do not include any adjustments to reflect the possible future effects, if any, on the recoverability and classification of assets or the amounts and classifications of liabilities that may result from this situation. The Company anticipates raising additional capital through the sale of common stock or issuance of additional long-term debt. In addition, management believes the focus on the human resource provider business, elimination of the losses associated with a substantial portion of its breath alcohol and cost per test services as well as identification of a strategic partner to fund the future costs to develop U.S. Drug's saliva and urine based testing systems will substantially enhance future operating results. In management's opinion, these actions will provide the Company the capital necessary for the Company to continue operations. 3. ACQUISITIONS On March 30, 1995, the Company acquired, in transactions accounted for as purchases, 100% of the outstanding capital stock of Alconet, Inc., a privately held North Dakota corporation (Alconet), and 100% of the net equity of Dakotanet, LLC, a privately held North Dakota Limited Liability Company (Dakotanet). F-11 65 SUBSTANCE ABUSE TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) The transactions provided for the issuance of 782,321 shares of the Company's common stock valued at $1,565,000. In connection with the transactions certain of the shares issued by the Company to the selling shareholders of Alconet were used as payment of obligations of Alconet to the Company in the approximate amount of $109,000. The purchase price of the acquisitions exceeded the net book value of the net assets acquired, which included cash of $593,000, by $818,000. This amount has been recorded as costs in excess of net assets acquired. On April 18, 1996, the Company agreed in principle to acquire Robert Stutman & Associates, Inc. (RSA), a provider of corporate "Drug Free Workplace" programs, and elected Robert Stutman as Chairman of the Board, a director of the Company and Chief Executive Officer. On May 21, 1996, the Company completed the acquisition, in a transaction accounted for as a purchase, of all of the common stock of RSA. The purchase price totaled approximately $5,400,000, including approximately $100,000 of costs, and was comprised of $2,100,000 in cash, $400,000 in notes, 500,000 shares of the Company's common stock (valued at $1,562,500) and warrants to purchase 900,000 shares of the Company's common stock at $3.125 per share (valued at $1,200,000). The acquisition resulted in costs in excess of net assets acquired of approximately $5,300,000. The following unaudited pro forma information presents a summary of consolidated results of operations of the Company and RSA as if the acquisition had occurred at the beginning of fiscal 1996, with pro forma adjustments to give effect to amortization of costs in excess of net intangible assets acquired and certain other adjustments, together with related income tax effects:
MARCH 31 MARCH 31 1997 1996 ------------ ------------ Net sales....................................... $ 2,936,778 $ 2,267,260 Loss from continuing operations................. (15,090,698) (8,451,579) Net loss........................................ (15,434,397) (10,856,120) Loss from continuing operations per common share......................................... $ $ (0.43) (0.27) Net loss per common share....................... $ (0.44) $ (0.35)
The Company has filed two Registration Statements on Form S-4, which are not yet effective, in an attempt, through consent solicitations, to acquire the common shares owned by the minority interests of U.S. Drug and Good Ideas. If the Company is successful, it will own 100% of these subsidiaries. There is no assurance that either consent solicitation will be successfully completed. The Company would issue 557,524 shares to acquire the 1,548,689 shares held by the Good Ideas minority stockholders and 2,789,478 shares to acquire the 1,721,900 shares held by the U.S. Drug minority stockholders. The difference between the fair value of the Company's common stock to be issued in the proposed transaction and the book value of the minority interest of U.S. Drug acquired, estimated at $3,800,000 at March 31, 1997, will be treated as incomplete research and development because U.S. Drug is a developmental stage enterprise and recorded in the statement of operations. 4. RESTRUCTURING OF OPERATIONS In December 1996, the Company discontinued its breath alcohol and cost per test program. The equipment being used by the customers was returned to the Company. The Company refurbished the equipment associated with this program and attempted to market it to no avail. Therefore, in the fourth quarter of fiscal 1997, the net book value of this equipment of approximately $1,850,000 was determined to have no value to the Company and was written off. The unamortized costs in excess of net assets acquired of $714,377 associated with the acquisition of Alconet was also written off since the Alconet operations have been closed as a result of the Company's decision. F-12 66 SUBSTANCE ABUSE TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 5. DISCONTINUED OPERATIONS On February 26, 1996, the Board of Directors approved a strategic decision to focus on the Company's core alcohol, drug and human resource provider businesses and to dispose of its non core rubber recycling and toy operations, namely USRR and Good Ideas. These business units are accounted for as discontinued operations and, accordingly, their operations are segregated in the accompanying statements of operations. Sales, operating costs and expenses, other income and expense and applicable minority share of losses for the year ended March 31, 1995 were reclassified for amounts associated with the discontinued units. All operations for USRR and Good Ideas have been classified as Loss from Discontinued Operations in the accompanying statements of operations. Discontinued operations include management's best estimates of the amounts expected to be realized from the sale or liquidation of these operations. The amounts the Company will ultimately realize could differ in the near term from the amounts assumed in arriving at the loss on disposal of the discontinued operations. On April 30, 1996, the Company completed the sale of certain of USRR's assets, net of trade payables of approximately $79,000, to Reclamation Resources, Inc. (RRI), a private California corporation, for $150,000 cash and a $300,000 secured promissory note bearing interest at the rate of 7% per annum, with annual payments of $50,000 plus interest. The note contains a prepayment clause that enables USRR to receive 12 1/2% of product sales in excess of $1,400,000. In the fourth quarter of fiscal 1997, RRI exercised its rights under the agreement to revalue certain assets. The cost of this revaluation amounted to approximately $70,000 thereby eliminating the first year's payment of the note and interest due the Company. The result was a reduction in the loan payment and an adjustment to the charge to discontinued operations. The Company has been unable to finalize an agreement with a potential buyer for Good Ideas or certain of its related assets. Consequently, the Company believes these assets are of questionable value and have written off approximately $147,000 of Good Ideas inventory to discontinued operations in the fourth quarter of fiscal 1997. 6. INVENTORIES Inventories are summarized as follows:
MARCH 31 MARCH 31 1997 1996 --------- --------- Finished goods......................................... $ -- $ 64,437 Work in process........................................ -- 334,699 Raw materials.......................................... 16,675 282,703 ------- -------- $16,675 $681,839 ======= ========
A substantial portion of the inventory at March 31, 1996 related to the breath alcohol and cost per test operations which were abandoned in fiscal 1997. Consequently, this inventory has been written off. F-13 67 SUBSTANCE ABUSE TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 7. PROPERTY AND EQUIPMENT Property and equipment is summarized as follows:
MARCH 31 MARCH 31 1997 1996 ---------- ---------- Furniture and fixtures.............................. $ 174,507 $ 78,286 Equipment........................................... 1,425,423 811,333 Equipment -- network/per test (see Note 4).......... -- 2,327,553 Test equipment...................................... 400,798 476,765 Leasehold improvements.............................. 373,837 343,692 Vehicles............................................ 9,109 124,042 ---------- ---------- 2,383,674 4,161,671 Less: Accumulated depreciation...................... 1,137,300 1,469,692 ---------- ---------- $1,246,374 $2,691,979 ========== ==========
8. CONVERTIBLE DEBENTURES On November 8, 1996, the Company entered into an agreement to borrow $5,000,000 evidenced by two $2.5 million convertible, unsecured senior notes (the Notes). The Notes are due on November 8, 1999, bear interest, payable quarterly commencing December 15, 1996, at 7%, and are convertible at $2.00 per share subject to adjustment. The conversion price of $2.00 is subject to downward adjustment during the period from May 1, 1997 through May 1, 1998 based on the market price of the Company's common stock but will not decrease below a floor of $1.375. In addition, the conversion price contains certain anti-dilution provisions that can reduce the conversion price below the floor. As a result of these provisions, at June 30, 1997, the conversion price was $1.25 per share. As a part of the note agreement, the Company issued, for $1,000, warrants to purchase 2,500,000 shares of common stock at $2.00 per share with an adjustment to the exercise price similar to that of the convertible notes. As a result, at June 30, 1997, the warrants are exercisable at $1.25 per share. Of the $5,001,000 proceeds, $1,300,000 was allocated as the fair value of the warrants (resulting in an effective interest rate of 18.4% on the convertible debentures). This amount is being amortized over the three year life of the Notes. The Notes and warrant agreements contain certain restrictive covenants including a restriction on the payment of dividends, purchase of capital stock, additional borrowings and capital expenditures. As a result of its financial condition, the Company is unable to estimate the fair value for its convertible debentures. In May 1997, the Company consummated a Convertible Debenture and Preferred Stock Purchase Agreement. The Company issued and sold to an investor a convertible debenture in the principal amount of $750,000 and 62,500 shares of Class "B" preferred stock for $4.00 per share. The aggregate Purchase price for the debentures and the common stock was $1,000,000. 9. INCOME TAXES The Company and its majority owned subsidiaries file their corporation income tax returns on an unconsolidated basis and together have net operating loss carryforwards at March 31, 1997 of approximately $51,000,000, expiring from March 31, 2004 to March 31, 2012 if not offset against future federal taxable income. In addition, the company and its majority owned subsidiaries have capital loss carryforwards at March 31, 1997 of approximately $1,890,000 expiring on March 31, 2001, if not offset against future capital gains. Pursuant to Section 382 of the Internal Revenue Code, due to changes in the ownership of the F-14 68 SUBSTANCE ABUSE TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Company and its subsidiaries, the utilization of these loss carryforwards may be subject to an annual limitation. Income tax benefit attributable to net loss differed from the amounts computed by applying the statutory Federal Income tax rate applicable for each period as a result of the following:
FISCAL YEAR ENDED MARCH 31 ----------------------------------------- 1997 1996 1995 ----------- ----------- ----------- Computed "expected" tax benefit............. $ 5,440,000 $ 3,740,000 $ 2,720,000 Decrease in tax benefit resulting from: Net operating loss for which no benefit is currently available.................... (5,440,000) (3,740,000) (2,720,000) ----------- ----------- ----------- $ -- $ -- $ -- =========== =========== ===========
The tax effects of temporary differences that give rise to significant portions of the net deferred tax asset at March 31 are presented below:
MARCH 31 MARCH 31 1997 1996 ----------- ----------- Deferred tax assets: Net operating loss carryforwards........................ $17,367,000 $12,800,000 Capital loss carryforward............................... 642,600 642,600 ----------- ----------- 18,009,600 13,442,600 Less: Valuation allowance under SFAS 109...................... 18,009,600 13,442,600 ----------- ----------- Net deferred tax assets................................... $ -- $ -- =========== ===========
SFAS 109 requires a valuation allowance to reduce the deferred tax assets reported if, based on the weight of evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized. After consideration of all the evidence, both positive and negative, management has determined that a $18,009,600 valuation allowance at March 31, 1997 is necessary to reduce the deferred tax assets to the amount that will more likely than not be realized. The change in the valuation allowance for the current year is $4,567,000. 10. STOCKHOLDERS' EQUITY Shares of the Company's common stock reserved for future issuance at March 31, 1997 are as follows: Preferred stock.......................................... 185,207 Warrants................................................. 9,069,246 Convertible debentures................................... 2,500,000 Good Ideas merger........................................ 631,809 U.S. Drug merger......................................... 3,302,478 ---------- Total.......................................... 15,688,740 ==========
Insufficient Authorized Shares As of March 31, 1997, there were 50,000,000 shares of the Company's common stock authorized, of which 36,030,591 shares were outstanding. The Company's Board of Directors had authorized issuance of an additional 16,108,740 shares, including 631,809 shares to be issued to the Good Ideas minority stockholders F-15 69 SUBSTANCE ABUSE TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) and warrant holders and 3,302,478 shares to be issued to the U.S. Drug minority stockholders and warrant holders assuming that the Good Ideas merger and the U.S. Drug merger are consummated. Were all of such shares to be issued, there would be 51,719,331 shares outstanding, or 2,139,331 shares in excess of the authorized shares. However, as of March 31, 1997, common stock purchase warrants to purchase an aggregate of 3,494,500 shares and the convertible notes as to 2,500,000 shares included in the reserved shares are not currently excercisable or convertible. All of the foregoing amounts as to the shares authorized to be issued do not give effect to anti-dilution or other adjustment provisions in certain common stock purchase warrants and in the convertible notes. Even though there are currently a sufficient number of authorized shares of the Company's common stock to consummate both the Good Ideas and U.S. Drug mergers, the Company has authorized the calling of a Special Meeting of Stockholders for the purpose of increasing the authorized number of shares of the Company's common stock from 50,000,000 to 80,000,000. There can be no assurance that the Company's stockholders will approve this increase, which event would not only adversely impact the issuance of the "excess" shares described above, but also negatively affect the possible financing which the Company intends to initiate to raise funds (see Note 2). Preferred Stock Each share of Class "A" preferred stock is convertible into 4.5 shares of common stock and accrues dividends at the rate of 14% per annum (or $.70 per share) on the liquidation preference of $5 per share. Dividends are payable semi-annually. The holders of the preferred stock have no voting rights. Common Stock In June 1994, the Company authorized the issuance of 30,000 shares of common stock valued at $54,375 as directors' compensation. In September 1995, the Company authorized the issuance of 20,000 shares of common stock valued at $37,500 to two of its directors for directors' fees. The value of these shares were charged to operations in the respective periods. In August 1995, the Company completed a private placement to international investors, who were not related to the Company, in which it sold 2,152,469 shares of common stock resulting in gross proceeds of $3,038,505. In February 1996, the Company completed a private placement realizing gross proceeds of $3,750,000 for 2,000,000 shares of its common stock and warrants expiring December 17, 1999 to purchase 2,000,000 shares of common stock at $2.00 per share warrant. Mr. Lee Rosen, a director of the Company, received $100,000 and warrants to purchase 700,000 shares of common stock for services performed in connection with the Company's offering. These warrants consist of (a) a common stock purchase warrant expiring November 15, 1998 to purchase 400,000 shares of common stock at $1.9375 per share, (b) a common stock purchase warrant expiring November 14, 2000 to purchase 150,000 shares of common stock at $3.00 per share and (c) a common stock purchase warrant to purchase 150,000 shares of common stock at $4.00 per share. The latter two warrants can only be exercised in proportion to the shares issued upon the exercise of the common stock purchase warrants issued to the purchasers in the private placement. On June 19, 1996, the Company engaged a consultant to provide financing related services. The consideration for such services was to be 200,000 shares of the Company's common stock. Mr. Rosen exercised warrants to purchase 200,000 shares of common stock and delivered these shares, with the Board's approval, to the consultant to fulfill the Company's obligation under the consulting arrangement. The Company recorded the cost of the agreement based on the fair market value of the Company's common stock on June 19, 1996. In consideration thereof, the Company authorized the issuance to Mr. Rosen of 200,000 warrants at $2.00 per share and reduced the exercise price of other warrants owned by Mr. Rosen from $4.00 to $2.00 per share. F-16 70 SUBSTANCE ABUSE TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) In May 1997 the Company filed a registration statement under the Securities Act of 1933 in order to register 117,500 shares of its common stock issuable upon the exercise at $2.125 per share of common stock purchase warrants granted to employees of the Company. If all of these warrants are exercised, the Company will receive gross proceeds of $249,688. In addition, the stockholders named in the registration statement are offering 6,422,500 shares of the Company's common stock. The Company would receive gross proceeds of $7,854,063 if all the common stock warrants underlying the shares being registered were exercised. Stock Options The Company had adopted an Employees' Incentive Compensation Plan (the Plan). The Plan provided for the issuance of restricted stock to employees under certain conditions, as well as nonqualified stock options and incentive stock options. During August 1994, stock options to purchase all of the 450,000 shares of common stock reserved for issuance under the Plan were granted to key officers and directors of the Company in recognition for services rendered to the Company. In fiscal 1997, subsequent to the expiration of all outstanding options, the Company terminated the option plan. Warrants During October 1995, the Company issued five-year warrants for the purchase of 100,000 shares of common stock at $2.17 to the placement agents for a private placement. During November 1995, the Board of Directors authorized the issuance of three-year warrants for the purchase of 60,000 shares of common stock at $1.94 to five new directors of the Company and to a consultant to the Board of Directors. During November 1995, the Board of Directors authorized the issuance of three warrants to purchase an aggregate of 700,000 shares of the common stock to Mr. Rosen in connection with his services in a capacity other than as a director, including those related to a private placement. The warrants were issued for three to five-year periods at exercise prices ranging from $1.94 to $4.00 per share. During December 1995, the Board of Directors authorized the issuance of three-year warrants for the purchase of 400,000 shares of common stock at $2.00 pursuant to a consulting agreement. Pursuant to this agreement, a common stock purchase warrant for 200,000 shares was issued on December 14, 1995 to Robert Stutman and a warrant for the remaining 200,000 shares was issued to RSA on April 1, 1996. The Company did not record the value of the 200,000 warrants issued on April 1, 1996 until the fourth quarter of fiscal 1997. During January 1996, the Company issued four-year warrants for the purchase of 150,000 shares of common stock at $2.25 to an individual in connection with the settlement of litigation against the Company. During February 1996, the Board of Directors authorized the issuance of three-year warrants for the purchase of 700,000 shares of common stock at $2.44 per share to a consultant providing financial public relation services to the Company. The agreement with the consultant was terminated in November 1996. The Company did not record the value of these warrants until the fourth quarter of fiscal 1997. During the year ended March 31, 1996, the Company granted three-year warrants to employees to acquire 41,000 shares of common stock at prices ranging from $1.88 to $2.81. From April 1, 1996 through June 5, 1996, the Company received gross proceeds of $4,242,000 from the exercise of warrants and options to purchase 2,353,449 shares of the common stock. In connection with the exercise of these common stock purchase warrants the Company issued Mr. Rosen warrants to purchase 300,000 shares of common stock at $3.125 per share and paid Mr. Rosen $400,000 for services rendered. Since this amount was directly related to raising capital the Company charged this amount to additional paid-in F-17 71 SUBSTANCE ABUSE TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) capital. On January 23, 1997, the exercise price of the warrants issued to Mr. Rosen was reduced from $3.125 to $2.125 per share. Effective May 13, 1996, warrants to purchase 600,000 shares of the Company's common stock were issued to an officer of the Company. The warrants become exercisable as follows: (a) 50,000 upon issuance (b) 100,000 on May 13, 1997 and (c) 150,000 at May 13, 1998, 1999 and 2000. On December 6, 1996, the exercise price for 200,000 shares was reduced from $3.125 to $2.125 per share and 50,000 of the warrants exercisable on May 13, 2000 were modified to become exercisable on May 13, 1997. On May 23, 1997 the exercise price of the remaining 400,000 warrants was reduced from $3.125 to $2.125 per share. On October 31, 1996, 1,172,342 Class B Warrants from a private placement in 1990 expired. On November 4, 1996, 437,500 of the options issued to former officers and directors expired. On December 6, 1996, the exercise price of 792,000 warrants issued to officers of the Company as selling stockholders pursuant to the Company's acquisition of RSA was reduced from $3.125 to $2.125 per share. The reduction in exercise price was in consideration of the warrant holders surrendering their secured position with respect to promissory notes issued to them in connection with the acquisition, and agreeing that the notes could not be repaid except through the issuance of the Company's common stock, in order to permit the Company to execute the placement of the convertible debentures in November 1996. The Company recorded the estimated value of the exercise price reduction of $150,000 as a cost of the convertible debenture financing. Simultaneously, the $400,000 note payable and accrued interest thereon was extinguished upon exercise of warrants to acquire 207,499 shares of common stock. In December 1996, in connection with consulting services, the Company issued four-year warrants to purchase 100,000 shares at $2.00 per share with additional warrants to be issued. The consultant's services were terminated in May 1997 with the issuance of an additional 400,000 four-year warrants with an exercise price of $2.00 per share. In addition to the warrant grants discussed above, during the year ended March 31, 1997, the Company granted three-year warrants to employees and directors to acquire 439,000 shares of common stock at prices ranging from $1.81 to $3.13 per share. In addition to the modifications discussed above, on December 6, 1996, the exercise price of 259,000 warrants previously issued to employees, ranging from $2.38 to $3.50 per share, was reduced to $2.13 per share. F-18 72 SUBSTANCE ABUSE TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Common shares reserved for stock options and for outstanding stock purchase warrants are presented in the following table:
INCENTIVE STOCK OPTIONS NON QUALIFIED OPTIONS WARRANT AGREEMENTS ----------------------- --------------------- ------------------------- NUMBER OF PRICE PER NUMBER OF PRICE PER NUMBER OF PRICE RANGE SHARES SHARE SHARES SHARE SHARES PER SHARE ---------- ---------- --------- --------- ---------- ------------ Outstanding, April 1 1994... -- $ -- -- $ -- 4,188,683 $1.06 - 4.00 Granted..................... 420,000 2.38 30,000 2.38 869,750 1.81 - 2.50 Canceled.................... -- -- -- -- (6,000) 2.19 Exercised................... -- -- -- -- (812,018) 1.33 - 3.00 -------- ----- ------- ----- ---------- Outstanding, March 31, 1995...................... 420,000 2.38 30,000 2.38 4,240,415 1.06 - 4.00 Granted..................... -- -- -- -- 3,951,000 1.88 - 4.00 Exercised................... -- -- -- -- (116,500) 1.06 - 1.87 -------- ----- ------- ----- ---------- Outstanding, March 31, 1996...................... 420,000 2.38 30,000 2.38 8,074,915 1.06 - 4.00 Granted..................... -- -- -- -- 5,249,000 1.81 - 3.13 Cancelled................... (420,000) -- (17,500) 2.38 (1,216,588) 2.22 Exercised................... -- 2.38 (12,500) 2.38 (3,038,081) 1.06 - 2.50 -------- ----- ------- ----- ---------- Outstanding, March 31, 1997...................... -- $ -- -- $ -- 9,069,246 $1.06 - 4.00 ======== ===== ======= ===== ==========
At March 31, 1997, the exercise price of outstanding warrants are as follows:
NUMBER OF RANGE OF WARRANTS EXERCISE PRICE - --------- -------------- 8,281,296................................................. $1.08 to 2.49 787,950................................................. $2.50 to 4.00 - --------- 9,069,246 =========
The weighted-average remaining contractual life of those warrants is approximately 3 years. The weighted average exercise price of outstanding warrants at March 31, 1997 is $2.13. The weighted average fair value of warrants granted to employees during fiscal 1997 was $1.87. Pro forma information regarding net income and earnings per share is required by Statement of Financial Accounting Standards No. 123 for fiscal 1997 and 1996, and has been determined as if the Company had accounted for warrants granted to employees under the fair value method of that Statement. The fair value for these warrants was estimated at the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions for 1997 and 1996, respectively: risk-free interest rates of 6%; dividend yields of 0%; volatility factors of the expected market price of the Company's common stock of 63.8% and 68.7, respectively; and a weighted-average expected life of the warrants of 6.8 and 3.10 years, respectively. The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company's employee stock options and warrants have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options and warrants. F-19 73 SUBSTANCE ABUSE TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) For purposes of pro forma disclosures, the estimated fair value of the options and warrants is amortized to expense over the vesting period. The Company's pro forma information follows:
FOR THE YEARS ENDED MARCH 31 ---------------------------- 1997 1996 ------------ ------------ Pro forma net loss.............................. $(16,270,050) $(10,552,536) Pro forma net loss per share.................... (0.46) (0.35)
11. LITIGATION In September 1995, the Company settled litigation relating to a consent solicitation filed against it by a group of stockholders. Terms of the settlement included the payment of legal costs of the stockholder group. The costs incurred by the Company and the stockholder group for the year ended March 31, 1996 totaled approximately $1,000,000 and are included in the caption "Loss from Settlement of Litigation" in the accompanying statement of operations. In connection with the settlement of the 1995 consent solicitation against the Company, the Company's Board of Directors (the Board) on September 26, 1995 authorized payment of all amounts incurred by the insurgents (which included Mr. Rosen) as a result of the consent solicitation effort. At a January 23, 1997 meeting the Board reaffirmed the Board's earlier authorization to pay Mr. Rosen's legal expenses and settlements. The total cost of these expenses is estimated to be approximately $416,000. The Company has booked a reserve for these expenses and recorded the settlement amount as a "Loss from Settlement of Litigation" in the accompanying statement of operations for the year ended March 31, 1997. Approximately $170,000 of such expenses which qualified for recognition in December 1996 were not recorded by the Company until the fourth quarter of fiscal 1997. In January 1996, the Company settled litigation with a former consultant, Jonathan J. Pallin, with the payment of $175,000 cash and the issuance of warrants to purchase 150,000 shares of the common stock at a price of $2.25 per share though January 30, 2000. Warrants to purchase 200,000 shares of common stock at $2.625 were returned to the Company and canceled as part of the settlement. The cash payment related to this settlement is included in additional paid-in capital. In March 1996, the Company settled litigation with two former officers of Alconet. The settlement resulted in payments by the Company of $250,000. These costs are included in the caption "Loss from Settlement of Litigation" in the accompanying statement of operations for the year ended March 31, 1996. 12. COMMITMENTS AND CONTINGENCIES Royalty Agreements The Company entered into a covenant not to compete with the principal of a company acquired in 1988. As a part of the agreement, the Company was obligated to pay royalties equal to 5% of the first $1,000,000 in sales, 3% of the second $1,000,000 in sales and 2% of sales exceeding $2,000,000, with a maximum guaranteed annual royalty of $120,000. Guaranteed minimum royalties of $30,000 per year were payable at the rate of $2,500 per month, through June 30, 1993. The royalty terms extend for the lifetime of the principal with no minimum guarantee after June 1993, but were limited to $120,000 per year or 3% of gross sales, whichever is less. In September 1994, the Company re-negotiated the terms of the agreement to provide monthly payments of $5,000 for the period from September through December, 1994 and $10,000 per month from January 1, 1995 to the date of the principal's death. The agreement also provides for a CPI adjustment every six months starting June 1, 1995. As a result of abandoning the business from which this royalty agreement arose (see Note 4), a liability for $1,100,000, the entire amount of estimated payments that will be made under the agreement, were accrued in fiscal 1997. The accrual was determined based on the life expectancy of the principal and has been discounted at 7%. F-20 74 SUBSTANCE ABUSE TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) The Company and the Department of the Navy, on January 24, 1992, entered into a ten-year agreement granting the Company a partial exclusive patent license to products for drug testing in the United States and certain foreign countries. In June 1995, the license agreement was re-negotiated and amended to provide for minimum royalties of $100,000 per year commencing October 1, 1995 and terminating September 30, 2005. Additional royalties will be paid pursuant to a schedule based upon sales of products. U.S. Drug is a sub-licensee under this agreement and, accordingly, has an obligation to the Company for the royalty payments required by the License Agreement. Royalties paid by the Company under the License Agreement amounted to $100,000, $50,000 and $375,000 for the years ended March 31, 1997, 1996 and 1995 respectively. Lease Commitments The Company owns certain property and equipment under leases that are classified as capital leases. As of March 31, 1997, future minimum lease payments under capital leases together with the present value of the net minimum lease payments are as follows: Fiscal year ending March 31: 1998................................................... $ 112,962 1999................................................... 109,215 2000................................................... 101,890 2001................................................... 94,831 2002................................................... 57,564 --------- Total minimum lease payments............................. 476,462 Less amount representing interest........................ (109,867) --------- Present value of minimum lease payments (including current portion of $71,324)............................ $ 366,595 =========
The Company has leases for certain of its facilities through June 1999. In addition to rent, the leases provide for payment of real estate taxes and other occupancy costs. Approximate future minimum payments under these leases are summarized as follows as of March 31, 1997: Fiscal year ending March 31: 1998................................................... $ 353,526 1999................................................... 354,773 2000................................................... 339,725 2001................................................... 323,462 2002................................................... 252,492 ---------- $1,623,978 ==========
Rent expense was approximately $308,000, $293,000, and $276,000, for the years ended March 31, 1997, 1996 and 1995, respectively. Although the purchaser of the discontinued USRR business has assumed the lease of the building the business occupied, the landlord did not release USRR from liability on the lease if the purchaser does not perform. Approximate future lease payments, which are not included above, under this lease are $58,418 in fiscal 1997, $60,243 in fiscal 1998, $65,036 in fiscal 1999 and $16,658 in fiscal 2000. F-21 75 SUBSTANCE ABUSE TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 13. SUBSEQUENT EVENTS On July 3 and July 7, 1997, the Company issued notes totaling $625,000 to a director of the Company. The terms of the notes provided that, in addition to the principal, the Company would pay to the director an additional $175,000 plus issue shares of common stock with a market value of $50,000. On July 7, 1997, the Company entered into a letter of intent and made a $600,000 deposit to acquire, for $1,600,000, the assets of the third party administrator business of National Medical Review Offices, Inc (NMRO). The agreement is subject to due diligence by the Company and the acquisition of the entity which contains the assets being acquired by NMRO. 14. FOURTH QUARTER TRANSACTIONS (UNAUDITED) In the fourth quarter of fiscal 1997, the Company recorded adjustments for warrant transactions that occurred in earlier quarters (see Note 10) and for litigation settlement costs which qualified for recognition in an earlier quarter (see Note 11). The Company is amending its previously filed quarterly reports on Form 10-Q for fiscal 1997 to reflect these and certain other transactions in the proper period. As a result, the net losses for the previous quarters will be restated as follows:
PREVIOUSLY QUARTER ENDED REPORTED AS RESTATED - ------------- ---------- ----------- June 30, 1996....................................... $1,389,000 $2,034,300 September 30, 1996.................................. 3,013,200 3,308,500 December 31, 1996................................... 2,605,200 3,238,500
As discussed in Note 4, in the fourth quarter of fiscal 1997, the Company wrote off fixed assets, goodwill and inventory totaling approximately $2,600,000 related to its breath alcohol and cost-per-test products and services that were abandoned in fiscal 1997. Also in the fourth quarter, the Company accrued future royalty payments associated with these products of $1,100,000 (see Note 12). F-22 76 Schedule -- Valuation and Qualifying Accounts Substance Abuse Technologies, Inc. and Subsidiaries Years Ended March 31, 1997, 1996 and 1995
COL. A COL. B COL. C COL. D COL. E ----------- ---------- -------- ---------- ---------- BALANCE AT CHARGED TO CHARGED BALANCE AT BEGINNING COSTS AND TO OTHER END OF FISCAL YEAR ENDING MARCH 31 OF PERIOD EXPENSES ACCOUNTS DEDUCTIONS PERIOD --------------------------- ----------- ---------- -------- ---------- ---------- 1995......................................... $ 61,000 $ 64,000 -- $ -- $125,000 1996......................................... 125,000 131,551 -- 144,551 112,000 1997......................................... 112,000 582,821 -- 44,821 650,000
F-23 EX-4.E 2 CONVERTIBLE DEBENTURE 1 Exhibit 4(e) ================================================================================ CONVERTIBLE DEBENTURE AND PREFERRED STOCK PURCHASE AGREEMENT Between SUBSTANCE ABUSE TECHNOLOGIES, INC., and SOUTHBROOK INTERNATIONAL INVESTMENTS, LTD. ------------------------------ Dated as of May 8, 1997 ------------------------------ ================================================================================ 2 CONVERTIBLE DEBENTURE AND PREFERRED STOCK PURCHASE AGREEMENT, dated as of May 8, 1997 (this "Agreement"), between Substance Abuse Technologies, Inc., a Delaware corporation (the "Company"), and Southbrook International Investments, Ltd., a corporation organized and existing under the laws of the British Virgin Islands (the "Purchaser"). WHEREAS, subject to the terms and conditions set forth in this Agreement, the Company desires to issue and sell to the Purchaser and the Purchaser desires to acquire certain of the Company's 14% Convertible Debentures due May 8, 2000, in the form attached hereto as Exhibit A(1) (the "Convertible Debentures") and shares of the Company Class B Convertible Preferred Stock, $.01 par value per share (the "Preferred Stock"). IN CONSIDERATION of the mutual covenants and agreements set forth herein and for good and valuable consideration, the receipt of which is hereby acknowledged, the parties agree as follows: ARTICLE I CERTAIN DEFINITIONS Section 1.1. Certain Definitions. As used in this Agreement, unless the context requires a different meaning, the following terms have the meanings indicated in this Section 1.1: "Affiliate" means, with respect to any Person, any Person that, directly or indirectly, controls, is controlled by or is under common control with such Person. For the purposes of this definition, "control" (including, with correlative meanings, the terms "controlled by" and "under common control with") shall mean the possession, directly or indirectly, of the power to direct or cause the direction of the management and policies of such Person, whether through the ownership of voting securities or by contract or otherwise. "Agreement" shall have the meaning set forth in the recitals hereto. "Business Day" means any day except Saturday, Sunday and any day which shall be a Federal legal holiday or a day on which banking institutions in the State of New York are authorized or required by law or other government actions to close. "Certificate of Incorporation" means the Company's Certificate of Incorporation, as amended to the date of this Agreement, as filed with the Secretary of State of Delaware and which sets forth certain rights, preferences and privileges of the Preferred Stock. 3 "Class B Exchange Agreement" shall have the meaning set forth in Section 2.1(a). "Closing" shall have the meaning set forth in Section 2.1(b). "Closing Date" shall have the meaning set forth in Section 2.1(b). "Code" means the Internal Revenue Code of 1986, as amended, and the rules and regulations thereunder as in effect on the date hereof. "Commission" means the Securities and Exchange Commission. "Common Stock" means the Company's common stock, par value $.01 per share. "Company" shall have the meaning set forth in the recitals hereto. "Convertible Debentures" shall have the meaning set forth in the recitals hereto. "Conversion Price" shall have the meaning set forth in the Convertible Debentures. "Disclosure Materials" means, collectively, the SEC Documents, the disclosure package delivered to the Purchaser in connection with the offering by the Company of the Convertible Debentures and the Shares and the Schedules to this Agreement furnished by, or on behalf of, the Company pursuant to Section 3.1. "Exchange Act" means the Securities Exchange Act of 1934, as amended. "Exchange Ratio" shall have the meaning set forth in the Class B Exchange Agreement. "Lien" means, with respect to any asset, any mortgage, lien, pledge, right of first refusal, charge, security interest or encumbrance of any kind in or on such asset or the revenues or income thereon or therefrom. "Material Adverse Effect" shall have the meaning set forth in Section 3.1(a). "Original Issue Date" shall have the meaning set forth in the Convertible Debenture or the Class B Exchange Agreement, as applicable. "Per Share Market Value" shall have the meaning set forth in the Convertible Debentures or the Class B Exchange Agreement, as applicable. -2- 4 "Person" means an individual or a corporation, partnership, trust, incorporated or unincorporated association, joint venture, limited liability company, joint stock company, government (or an agency or political subdivision thereof) or other entity of any kind. "Preferred Stock" shall have the meaning set forth in the recitals hereto. "Purchase Price" shall have the meaning set forth in Section 2.1(a). "Purchaser" shall have the meaning set forth in the recitals hereto. "Registration Rights Agreement" means the registration rights agreement, dated as of the date hereof, between the Company and the Purchaser, in the form of Exhibit B, as the same may be amended, supplemented or otherwise modified in accordance with its terms. "Required Approvals" shall have the meaning set forth in Section 3.1(f). "SEC Documents" shall have the meaning set forth in Section 3.1(l). "Securities Act" means the Securities Act of 1933, as amended. "Shares" means the shares of Preferred Stock to be purchased by the Purchaser pursuant to this Agreement. "Stated Value" shall have the meaning set forth in Section 2.1(a). "Subsequent Financing" shall have the meaning set forth in Section 4.9. "Subsequent Financing Notice" shall have the meaning set forth in Section 4.9. "Subsidiaries" shall have the meaning set forth in Section 3.1(a). "Trading Day" shall have the meaning set forth in the Convertible Debentures. "Transaction Documents" shall have the meaning set forth in Section 3.1(b). "Underlying Shares" means the shares of Common Stock issuable upon conversion of Convertible Debentures and Shares in accordance with the terms hereof, the Convertible Debentures and the Certificate of Incorporation and issuable upon exchange of Shares in accordance with the terms of the Class B Exchange Agreement. "Underlying Shares Registration Statement" shall have the meaning set forth in Section 3.1(f). -3- 5 ARTICLE II PURCHASE OF CONVERTIBLE DEBENTURES Section 2.1. Purchase of Convertible Debentures and Shares; Closing. (a) Subject to the terms and conditions set forth in this Agreement, the Company shall issue and sell to the Purchaser, and the Purchaser shall purchase from the Company, on the Closing Date an aggregate principal amount of $750,000 of Convertible Debentures and an aggregate of 62,500 Shares, which shall have the respective rights, privileges and preferences substantially as set forth in the Certificate of Incorporation and a certain agreement between the Company and the Purchaser dated the date hereof (the "Class B Exchange Agreement"), at a price per share of $4 (the "Stated Value"). The aggregate "Purchase Price" for the Debentures and the Shares is $1,000,000. (b) The closing of the purchase and sale of the Convertible Debentures and the Shares (the "Closing") shall take place at the offices of Robinson Silverman Pearce Aronsohn & Berman, LLP, 1290 Avenue of the Americas, New York, New York 10104, immediately following the execution hereof, or at such other time and/or place as the Purchaser and the Company may agree. The date of the Closing is referred to herein as the "Closing Date". (c) At the Closing, the Company shall deliver (i) to the Purchaser, (A) Convertible Debentures in an aggregate principal amount equal to $750,000 and one or more stock certificates representing the 62,500 Shares purchased by it hereunder, registered in the name of the Purchaser, and (B) the legal opinion addressed to it and dated the Closing Date of Gold & Wachtel, LLP, counsel for the Company, substantially in the form of Exhibit C; (ii) to the Company, the Purchase Price, less the fees to Wharton Capital Partners, Ltd. and the legal fees and expenses of the Purchaser's counsel contemplated by Section 5.1 hereof, in United States dollars in immediately available funds by wire transfer to an account designated in writing by the Company prior to the Closing; and (iii) to the party entitled thereto, all documents, instruments and writings required to have been delivered at or prior to Closing by either the Company or the Purchaser pursuant to this Agreement. ARTICLE III REPRESENTATIONS AND WARRANTIES Section 3.1. Representations and Warranties of the Company. The Company hereby represents and warrants to Purchaser as follows: (a) Organization and Qualification. The Company is a corporation, duly incorporated, validly existing and in good standing under the laws of the jurisdiction of its -4- 6 incorporation, with the requisite corporate power and authority to own and use its properties and assets and to carry on its business as currently conducted. The Company has no subsidiaries other than as set forth in the SEC Documents or in Schedule 3.1(a) (collectively, the "Subsidiaries"). Each of the Subsidiaries is a corporation, duly incorporated, validly existing and in good standing under the laws of the jurisdiction of its incorporation, with the requisite corporate power and authority to own and use its properties and assets and to carry on its business as currently conducted. Each of the Company and the Subsidiaries is duly qualified to do business and is in good standing as a foreign corporation in each jurisdiction in which the nature of the business conducted or property owned by it makes such qualification necessary, except where the failure to be so qualified or in good standing, as the case may be, could not, individually or in the aggregate, (x) adversely affect the legality, validity or enforceability of any of the Transaction Documents, (y) have a material adverse effect on the results of operations, assets, prospects, or financial condition of the Company and the Subsidiaries taken as a whole or (z) adversely impair the Company's ability to perform fully on a timely basis its obligations under the Transaction Documents (a "Material Adverse Effect"). (b) Authorization; Enforcement. The Company has the requisite corporate power and authority to enter into and to consummate the transactions contemplated hereby and by the Registration Rights Agreement, the Convertible Debentures and the Class B Exchange Agreement (collectively with this Agreement, the "Transaction Documents") and to otherwise carry out its obligations hereunder and thereunder. The execution and delivery of each of the Transaction Documents by the Company and the consummation by it of the transactions contemplated thereby have been duly authorized by all necessary action on the part of the Company, including, without limitation, approval thereof by the Company's Board of Directors. Each of the Transaction Documents has been duly executed and delivered by the Company and constitutes the legal, valid and binding obligation of the Company enforceable against the Company in accordance with its terms, except as such enforceability may be limited by applicable bankruptcy, insolvency, reorganization, moratorium, liquidation or similar laws relating to, or affecting generally the enforcement of, creditors' rights and remedies or by other equitable principles of general application. Neither the Company nor any Subsidiary is in violation of any of the provisions of its respective certificate of incorporation, bylaws or other charter documents. (c) Capitalization. The authorized, issued and outstanding capital stock of the Company and each of the Subsidiaries is set forth in Schedule 3.1(c). No shares of the Common Stock are entitled to preemptive or similar rights. Except as specifically disclosed in Schedule 3.1(c), there are no outstanding options, warrants, script rights to subscribe to, calls or commitments of any character whatsoever relating to, or, except as a result of the purchase and sale of the Convertible Debentures and Shares hereunder, securities, rights or obligations convertible into, or exchangeable for, or giving any Person any right to subscribe for or acquire, any shares of Common Stock, or contracts, commitments, understandings, or arrangements by which the Company or any Subsidiary is, or may become, bound to issue additional shares of Common Stock, or securities or rights convertible or exchangeable into shares of Common Stock. To the knowledge of the Company, except as specifically disclosed in the SEC Documents or Schedule 3.1(c), no Person beneficially owns (as -5- 7 determined pursuant to Rule 13d-3 promulgated under the Exchange Act) or has the right to acquire by agreement with, or by obligation binding upon, the Company beneficial ownership of in excess of 5% of the Common Stock. (d) Issuance of Convertible Debentures, Shares and Underlying Shares. The Convertible Debentures have been duly and validly authorized for issuance, offer and sale pursuant to this Agreement and, when issued and delivered as provided hereunder against payment therefor, shall be valid and legally binding obligations of the Company enforceable against the Company in accordance with their terms, except as such enforceability may be limited by applicable bankruptcy, insolvency, reorganization, moratorium, liquidation or similar laws relating to, or affecting generally the enforcement of, creditors' rights and remedies or by other equitable principles of general application. The Shares have been duly and validly authorized for offer and sale pursuant to this Agreement and, when issued and delivered as provided hereunder against payment therefor, shall have been duly and validly issued, fully paid and nonassessable, free and clear of any Liens. The Company has and at all times while the Convertible Debentures and Shares are outstanding will maintain a reserve of shares of Common Stock to enable it to perform its conversion and/or exchange, as the case may be, and other obligations under this Agreement, the Convertible Debentures, Certificate of Incorporation, and Class B Exchange Agreement, which reserve shall be no less than the sum of twice the number of shares of Common Stock issuable upon (i) conversion of the aggregate principal balance of all then outstanding and previously unconverted Convertible Debentures into Common Stock pursuant to the terms hereof and the Convertible Debentures and (ii) conversion of Shares into Common Stock pursuant to the terms hereof and the Certificate of Incorporation or exchange of Shares into Common Stock pursuant to the terms hereof and the Class B Exchange Agreement, assuming in the case of clause (i) or (ii) above that such conversion or exchange, as the case may be, occurred on the Original Issue Date. When issued in accordance with the terms hereof, the Convertible Debentures, the Certificate of Incorporation and Class B Exchange Agreement, the Underlying Shares will have been duly authorized, validly issued, fully paid and nonassessable, and free and clear of any Liens. (e) No Conflicts. The execution, delivery and performance of the Transaction Documents by the Company and the consummation by the Company of the transactions contemplated thereby do not and will not (i) conflict with or violate any provision of its Certificate of Incorporation or bylaws (each as amended through the date hereof) or (ii) subject to obtaining the consents specified in Section 3.1(f), conflict with, or constitute a default (or an event which with notice or lapse of time or both would become a default) under, or give to others any rights of termination, amendment, acceleration or cancellation of, any agreement, indenture, loans or credit agreement or other instrument or agreement to which the Company is a party, (iii) subject to obtaining the consents specified in Section 3.1(f), conflict with, or constitute a default (or an event which with notice or lapse of time or both would become a default), under the Convertible Loan and Warrant Agreement, dated as of November 8, 1996, by and between the Company and the Noteholders thereto, pursuant to which the Company issued its Convertible Senior Promissory Notes due November 8, 1999 (the "Senior Notes"), or (iv) result in a violation of any law, rule, regulation, order, judgment, injunction, decree or other restriction of any -6- 8 court or governmental authority to which the Company is subject (including Federal and state securities laws and regulations), or by which any property or asset of the Company is bound or affected, except in the case of each of clauses (ii) and (iv), such conflicts, defaults, terminations, amendments, accelerations, cancellations and violations as could not, individually or in the aggregate, have or result in a Material Adverse Effect. The business of the Company is not being conducted in violation of any law, ordinance or regulation of any governmental authority. (f) Consents and Approvals. Except as specifically set forth in Schedule 3.1(f), neither the Company nor any Subsidiary is required to obtain any consent, waiver, authorization or order of, or make any filing or registration with, any court or other Federal, state, local or other governmental authority or other Person in connection with the execution, delivery and performance by the Company of the Transaction Documents, except for (i) the filing of the registration statement covering, among other things, as specified and limited by the terms of the Registration Rights Agreement, the Underlying Shares (the "Underlying Shares Registration Statement") with the Commission and the making of the applicable blue- sky filings under state securities laws, each as contemplated by the Registration Rights Agreement, and (ii) other than, in all other cases, where the failure to obtain such consent, waiver, authorization or order, or to give or make such notice or filing, could not, individually or in the aggregate, have or would result in a Material Adverse Effect (together with the consents, waivers, authorizations, orders, notices and filings referred to in Schedule 3.1(f), the "Required Approvals"). (g) Litigation; Proceedings. There is no action, suit, notice of violation, proceeding or investigation pending or, to the best knowledge of the Company, threatened against or affecting the Company or any of its Subsidiaries or any of their respective properties before or by any court, governmental or administrative agency or regulatory authority (Federal, state, county, local or foreign) which relates to or challenges the legality, validity or enforceability of the Transaction Documents, Convertible Debentures, Shares, or Underlying Shares or which could, individually or in the aggregate, have or result in a Material Adverse Effect. (h) No Default or Violation. Neither the Company nor any Subsidiary (i) is in default under, or in violation of, any indenture, loan or credit agreement or any other agreement or instrument to which it is a party or by which it or any of its properties is bound, (ii) is in violation of any order of any court, arbitrator or governmental body, or (iii) is in violation of any statute, rule or regulation of any governmental authority, except as could not, in any case of (i) above, individually or in the aggregate, have or result in a Material Adverse Effect. (i) Certain Fees. Except for fees payable by the Company to Wharton Capital Partners, Ltd., no fees or commissions are or will be payable by the Company to any broker, finder, investment banker or bank with respect to the consummation of the transactions contemplated hereby. The Purchaser shall have no obligation with respect to such fees or with respect to any claims made by other Persons for fees of a type contemplated in this Section due in connection with this transaction. -7- 9 (j) Disclosure Materials. The Disclosure Materials (other than the SEC Documents) do not contain any untrue statement of a material fact or omit to state any material fact necessary in order to make the statements made therein, in light of the circumstances under which they were made, not misleading. (k) Private Offering. Neither the Company nor any Person acting on its behalf has taken or will take any action (including, without limitation, any offering of securities of the Company under circumstances which would require the integration of such offering with the offering of the Convertible Debentures, the Shares or the Underlying Shares under the Securities Act) which might subject the offering, issuance or sale of the Convertible Debentures, the Shares or the Underlying Shares to the registration requirements of Section 5 of the Securities Act. (l) SEC Documents. The Company has filed all reports required to be filed by it under the Exchange Act, including pursuant to Section 13(a) or 15(d) thereof, for the period on and after October 1, 1995 (the foregoing materials being collectively referred to herein as the "SEC Documents") on a timely basis, or has received a valid extension of such time of filing (in which case it has made all such filings in the time required by such extension). As of their respective dates, the SEC Documents complied in all material respects with the requirements of the Securities Act and the Exchange Act and the published rules and regulations of the Commission promulgated thereunder, and none of the SEC Documents, when filed, contained any untrue statement of a material fact or omitted to state a material fact required to be stated therein or necessary in order to make the statements therein, in light of the circumstances under which they were made, not misleading. The financial statements of the Company included in the SEC Documents comply in all material respects with applicable accounting requirements and the rules and regulations of the Commission with respect thereto. Such financial statements have been prepared in accordance with generally accepted accounting principles applied on a consistent basis during the periods involved, except as may be otherwise specifically indicated in such financial statements or the notes thereto, and fairly present in all material respects the financial position of the Company and its consolidated subsidiaries as of and for the dates thereof and the results of operations and cash flows for the periods then ended, subject, in the case of unaudited statements, to normal year-end audit adjustments. The date of the Company's last filed audited financial statements with the Commission was July 1, 1996 filed as part of its Form 10-K (the Company filed a Form 10-K/A on September 23, 1996), and the Company has not received any comments from the Commission in respect of such audited financial statements since the filing of the Form 10-K/A. Since the date of the financial statements included in the Company's Quarterly Report on Form 10-Q for the quarterly period ended December 31, 1996, there has been no event, occurrence or development that has had, could have or would result in a Material Adverse Effect which is not specifically disclosed in the Disclosure Materials. (m) Form S-3 Eligibility. The Company is, and at the Closing Date will be, eligible to register securities for resale with the Commission under Form S-3 promulgated under the Securities Act. -8- 10 (n) Investment Company. The Company is not, and is not an Affiliate of, an "investment company" within the meaning of the Investment Company Act of 1940, as amended. (o) Exclusivity. The Company shall not issue and sell the Convertible Debentures or Shares to any Person other than the Purchaser other than with the specific prior written consent of the Purchaser. (p) Listing and Maintenance Requirements Compliance. Other than as specifically listed in Schedule 3.1(p), the Company has not in the two years prior to the date hereof received written notice from any stock exchange or market on which the Common Stock is or has been listed (or on which it is or has been quoted) to the effect that the Company is not in compliance with the listing or maintenance requirements of such exchange or market. The Company has provided to the Purchaser true and complete copies of any notices referenced in Schedule 3.1(p). Purchaser acknowledges that the representations and warranties of the Company in this Section 3.1 are based upon the assumption that the Company's stockholders will approve an increase in the authorized capitalization of the Company to 65,000,000 at a meeting duly called therefor. Section 3.2. Representations and Warranties of the Purchaser. The Purchaser hereby represents and warrants to the Company as follows: (a) Organization; Authority. Purchaser is a corporation duly and validly existing and in good standing under the laws of the jurisdiction of its incorporation. Purchaser has the requisite corporate power and authority to enter into and to consummate the transactions contemplated hereby and by the Class B Exchange Agreement and the Registration Rights Agreement and otherwise to carry out its obligations hereunder and thereunder. The purchase of the Convertible Debentures and Shares by Purchaser hereunder has been duly authorized by all necessary action on the part of Purchaser. Each of this Agreement, the Class B Exchange Agreement and the Registration Rights Agreement has been duly executed and delivered by or on behalf of Purchaser and constitutes the valid and legally binding obligation of Purchaser, enforceable against it in accordance with its terms, except as such enforceability may be limited by applicable bankruptcy, insolvency, reorganization, moratorium, liquidation or similar laws relating to, or affecting generally the enforcement of, creditors' rights and remedies or by other equitable principles of general application. (b) Investment Intent. Purchaser is acquiring the Convertible Debentures, the Shares and the Underlying Shares for its own account (and/or on behalf of managed accounts who are purchasing solely for their own accounts for investment) for investment purposes only and not with a view to or for distributing or reselling such Convertible Debentures, Shares or Underlying Shares or any part thereof or interest therein, without prejudice, however, to Purchaser's right, subject to the provisions of the Transaction Documents, at all times to sell or otherwise dispose of all or any part of such Convertible -9- 11 Debentures, Shares or Underlying Shares under an effective registration statement under the Securities Act and in compliance with applicable State securities laws or under an exemption or exclusion from such registration. (c) Purchaser Status. At the time Purchaser (and any account for which it is purchasing) was offered the Convertible Debentures and the Shares, it (and any managed account for which it is purchasing) was, and at the date hereof, it (and any managed account for which it is purchasing) is, and at the Closing Date, it (and any managed account for which it is purchasing) will be, an "accredited investor" as defined in Rule 501(a) under the Securities Act. (d) Experience of Purchaser. Purchaser, either alone or together with its representatives, has such knowledge, sophistication and experience in business and financial matters so as to be capable of evaluating the merits and risks of the prospective investment in the Convertible Debentures and the Shares, and has so evaluated the merits and risks of such investment. (e) Ability of Purchaser to Bear Risk of Investment. Purchaser is able to bear the economic risk of an investment in the Convertible Debentures and the Shares and, at the present time, is able to afford a complete loss of such investment. (f) Prohibited Transactions. The Convertible Debentures and the Shares are not being acquired, directly or indirectly, with the assets of any "employee benefit plan", within the meaning of Section 3(3) of the Employee Retirement Income Security Act of 1974, as amended. (g) Reliance. Purchaser understands and acknowledges that (i) the Convertible Debentures and the Shares are being offered and sold, and the Underlying Shares are being offered, to it without registration under the Securities Act in a private placement that is exempt from the registration provisions of the Securities Act and (ii) the availability of such exemption depends in part on, and that the Company will rely upon the accuracy and truthfulness of, the foregoing representations and the Purchaser hereby consents to such reliance. The Company acknowledges and agrees that the Purchaser makes no representation or warranty with respect to the transactions contemplated hereby other than those specifically set forth in this Section 3.2. ARTICLE IV OTHER AGREEMENTS OF THE PARTIES Section 4.1. Transfer Restrictions. (a) If the Purchaser should decide to dispose of any portion of the principal amount of the Convertible Debentures or any of the Shares (and upon conversion or exchange thereof, as the case may be, any of the Underlying -10- 12 Shares) held by it, the Purchaser understands and agrees that it may do so only pursuant to an effective registration statement under the Securities Act, to the Company or pursuant to an available exemption from the registration requirements thereof. In connection with any transfer of any portion of the principal amount of the Convertible Debentures, any Shares or any Underlying Shares other than pursuant to an effective registration statement or to the Company, the Company may require the transferor of such Convertible Debentures or Shares to provide to the Company an opinion of counsel experienced in the area of United States securities laws selected by the transferor, the form and substance of which opinion shall be reasonably satisfactory to the Company, to the effect that such transfer does not require registration of such Convertible Debentures, Shares or Underlying Shares under the Securities Act. (b) The Purchaser agrees to the imprinting, so long as is required by this Section 4.1(b), of the following legend on the Convertible Debentures, the Shares or Underlying Shares: [NEITHER THESE SECURITIES NOR THE SECURITIES INTO WHICH THESE SECURITIES ARE [CONVERTIBLE] [EXCHANGEABLE] [THE SECURITIES REPRESENTED HEREBY] HAVE [NOT] BEEN REGISTERED WITH THE SECURITIES AND EXCHANGE COMMISSION OR THE SECURITIES COMMISSION OF ANY STATE IN RELIANCE UPON AN EXEMPTION FROM REGISTRATION UNDER THE SECURITIES ACT OF 1933, AS AMENDED (THE "SECURITIES ACT"), AND, ACCORDINGLY, MAY NOT BE OFFERED OR SOLD EXCEPT PURSUANT TO AN EFFECTIVE REGISTRATION STATEMENT UNDER THE SECURITIES ACT OR PURSUANT TO AN AVAILABLE EXEMPTION FROM, OR IN A TRANSACTION NOT SUBJECT TO, THE REGISTRATION REQUIREMENTS OF THE SECURITIES ACT AND IN ACCORDANCE WITH APPLICABLE STATE SECURITIES LAWS. [FOR CONVERTIBLE DEBENTURES AND SHARES ONLY] THIS [CONVERTIBLE DEBENTURE IS] [THE SHARES REPRESENTED BY THIS CERTIFICATE ARE] SUBJECT TO CERTAIN RESTRICTIONS ON TRANSFER AND [CONVERSION] [EXCHANGE] SET FORTH IN A CONVERTIBLE DEBENTURE AND PREFERRED STOCK PURCHASE AGREEMENT, DATED AS OF MAY 8, 1997, BETWEEN THE COMPANY AND THE ORIGINAL HOLDER HEREOF. A COPY OF THAT AGREEMENT IS ON FILE AT THE PRINCIPAL OFFICE OF SUBSTANCE ABUSE TECHNOLOGIES, INC. The Underlying Shares issuable upon conversion of the Convertible Debentures and Shares or exchange of Shares, as the case may be, shall not contain the legend set forth above if the conversion of the Convertible Debentures, or exchange of Shares, as the case may be, occurs at any time while the Underlying Shares Registration Statement is effective under the Securities Act or in the event there is not an effective Underlying Shares Registration Statement at such time, if in the opinion of counsel to the Company experienced in the area of United States securities laws determines that such legend is not required under applicable requirements of the Securities Act (including judicial -11- 13 interpretations and pronouncements issued by the staff of the Commission). The Convertible Debentures, the Shares and the Underlying Shares shall also bear any other legends required by applicable Federal or state securities laws, which legends shall be removed when not required in accordance with this Section 4.1(b). The Company agrees that it will provide the Purchaser, upon request, with a certificate or certificates representing Underlying Shares, free from such legend at such time as such legend is no longer required hereunder. The Purchaser agrees that, in connection with any transfer of Underlying Shares by it pursuant to an effective registration statement under the Securities Act, it will comply with the prospectus delivery requirements of the Securities Act, Regulation M or any other requirements imposed by the staff of the Commission. Section 4.2. Stop Transfer Instruction. The Company may not make any notation on its records or give instructions to any transfer agent of the Company which enlarge the restrictions of transfer set forth in Section 4.1. Section 4.3. Furnishing of Information. For so long as the Purchaser owns Convertible Debentures, Shares or Underlying Shares, the Company covenants to timely file (or obtain valid extensions in respect thereof) all reports required to be filed by the Company after the date hereof pursuant to Section 13(a) or 15(d) of the Exchange Act and to promptly furnish the Purchaser with true and complete copies of all such filings. If the Company is not at the time required to file reports pursuant to such sections, it will prepare and furnish to the Purchaser annual and quarterly financial statements, together with a discussion and analysis of such financial statements in form and substance substantially similar to those that would otherwise be required to be included in reports required by Section 13(a) or 15(d) of the Exchange Act in the time period that such filings would have been required to have been made under the Exchange Act. Section 4.4. Use of Disclosure Materials. The Company consents to the use of the Disclosure Materials, and any amendments and supplements thereto, by the Purchaser in connection with resales of Underlying Shares other than pursuant to an effective registration statement. Section 4.5. Increase in Authorized Shares. At such time as the Company would be, if a notice of conversion or exchange, as the case may be, were to be delivered on such date, precluded from converting or exchanging, as the case may be, the full outstanding principal amount of Convertible Debentures and all outstanding Shares that remain unconverted or unexchanged, as the case may be, at such date due to the unavailability of authorized but unissued or re-acquired shares of the Common Stock, the Board of Directors of the Company shall promptly (and in any case within 14 Business Days from such date, or such other time period as the Company is permitted to mail pursuant to Section 14 of the Exchange Act and Regulation 14A thereunder) prepare and mail to the stockholders of the Company proxy materials requesting authorization to amend the Company's Certificate of Incorporation to increase the number of shares of Common Stock which the Company is authorized to issue to at least 70,000,000 shares. In connection therewith, the Board of Directors shall (a) adopt proper resolutions authorizing such increase, (b) recommend to and otherwise use its best efforts to promptly and duly obtain stockholder approval to carry out -12- 14 such resolutions (and hold a special meeting of the stockholders no later than the 30th day after delivery of the proxy materials relating to such meeting) and (c) within five Business Days of obtaining such shareholder authorization, file an appropriate amendment to the Company's certificate of incorporation to evidence such increase. Section 4.6. Blue Sky Laws. In accordance with the Registration Rights Agreement, the Company shall qualify the Underlying Shares under the securities or Blue Sky laws of such jurisdictions as the Purchaser may reasonably request and continue such qualification at all times until the Purchaser notifies the Company in writing that it no longer owns Convertible Debentures, Shares or Underlying Shares; provided, however, that neither the Company nor its Subsidiaries shall be required in connection therewith to qualify as a foreign corporation where they are not now so qualified. Section 4.7. Integration. The Company shall not, and shall use its best efforts to ensure that no Affiliate shall, sell, offer for sale or solicit offers to buy or otherwise negotiate in respect of any security (as defined in Section 2 of the Securities Act) that would be integrated with the offer or sale of the Convertible Debentures, the Shares or the Underlying Shares in a manner that would require the registration under the Securities Act of the sale of the Convertible Debentures, the Shares or Underlying Shares to the Purchaser. Section 4.8. Solicitation Materials. The Company shall not (i) distribute any offering materials in connection with the offering and sale of the Convertible Debentures, the Shares or Underlying Shares other than the Disclosure Materials and any amendments and supplements thereto prepared in compliance herewith or (ii) solicit any offer to buy or sell Convertible Debentures, Shares or Underlying Shares by means of any form of general solicitation or advertising. Section 4.9. Right of First Refusal; Subsequent Registrations; Certain Corporate Actions. (a) The Company shall not, directly or indirectly, without the prior written consent of the Purchaser, offer, sell, grant any option to purchase, or otherwise dispose (or announce any offer, sale, grant or any option to purchase or other disposition) of any of its or its Affiliates equity or equity-equivalent securities (which shall include debt instruments convertible into shares of the Common Stock) at a price which is on the face thereof or implied therein, less than either the market price or fair market value for such securities (a "Subsequent Financing") for a period of 180 days after the Closing Date, except (i) the granting of options to employees, officers and directors, and the issuance of shares upon exercise of options granted, under any stock option plan heretofore or hereinafter duly adopted by the Company, (ii) shares issued upon exercise of any currently outstanding warrants and upon conversion of any currently outstanding convertible preferred stock or convertible notes in each case disclosed in Schedule 3.1(c), (iii) shares of the Common Stock issued upon conversion of the Convertible Debentures in accordance herewith and the terms of the Convertible Debentures, (iv) shares of the Common Stock issued upon conversion or exchange, as the case may be, of the Shares in accordance herewith and the terms of the Certificate of Incorporation or the Class B Exchange Agreement, as the case may be, and (v) shares issued in connection with an acquisition by the Company of assets or securities, unless -13- 15 (A) the Company delivers to the Purchaser a written notice (the "Subsequent Financing Notice") of its intention to effect such Subsequent Financing, which Subsequent Financing Notice shall describe in reasonable detail the proposed terms of such Subsequent Financing, the amount of proceeds intended to be raised thereunder, the Person with whom such Subsequent Financing shall be affected, and a term sheet or similar document relating thereto shall be attached to such Subsequent Financing Notice and (B) the Purchaser shall not have notified the Company by 5:00 p.m. (Eastern Time) on the tenth Business Day after its receipt of the Subsequent Financing Notice of its willingness to enter into good faith negotiations to provide (or to cause its sole designee to provide) financing to the Company on substantially the terms set forth in the Subsequent Financing Notice. If Purchaser notifies the Company of its intention to enter into such negotiations within such time period, the Company may effect the Subsequent Financing substantially upon the terms and to the Persons (or Affiliates of such Persons) set forth in the Subsequent Financing Notice; provided, that the Company shall provide the Purchaser with a second Subsequent Financing Notice, and the Purchaser shall again have the right of first refusal set forth above in this paragraph (a), if the Subsequent Financing subject to the initial Subsequent Financing Notice shall not have been consummated for any reason on the terms set forth in such Subsequent Financing Notice within 60 Business Days after the date of the initial Subsequent Financing Notice with the Person (or an Affiliate of such Person) identified in the Subsequent Financing Notice. (b) Other than Underlying Shares and other "Registrable Securities" (as such term is defined in the Registration Rights Agreement) to be registered in accordance with the Registration Rights Agreement and the issuance of shares of Common Stock in connection with the acquisition of the minority ownership interest in U.S. Drug Testing, Inc. and Good Ideas Enterprises, Inc. as previously disclosed to the public, the Company shall not, without the prior written consent of the Purchaser, (i) issue or sell any of its or any of its Affiliates' equity or equity-equivalent securities (which shall include debt instruments convertible into shares of Common Stock) pursuant to Regulation S promulgated under the Securities Act, or (ii) register for resale any securities of the Company for a period of not less than 60 Trading Days after the date that the Underlying Shares Registration Statement is declared effective by the Commission. Any days that Purchaser is unable to sell Underlying Shares under the Underlying Shares Registration Statement shall be added to such 60 Trading Day period for the purposes of (i) and (ii) above. (c) As long as there are Convertible Debentures and Shares outstanding, the Company shall not, and shall cause the Subsidiaries not to, without the consent of the Purchaser, (i) amend its Certificate of Incorporation, bylaws or other charter documents so as to adversely affect any rights of the Purchaser generally or to alter or amend terms relating to the Preferred Stock; (ii) repay, repurchase or offer to repay, repurchase or otherwise acquire shares of its Common Stock or any outstanding Company indebtedness other than as to the Underlying Shares, the Senior Notes or capitalized leases not to exceed an aggregate principal amount of $750,000 outstanding at any time on a consolidated basis; or (iii) enter into any agreement with respect to any of the foregoing. No redemption of the Preferred Stock or repayment of the Convertible Debentures shall affect the terms of this Section 4.9. -14- 16 Section 4.10. Purchaser Ownership of Common Stock. Purchaser may not use its ability to convert or exchange, as the case may be, Convertible Debentures and Shares hereunder or under the terms of the Convertible Debentures, the Certificate of Incorporation and the Class B Exchange Agreement to the extent that such conversion would result in Purchaser beneficially owning (for purposes of Rule 13d-3 under the Exchange Act) more than 4.9% of the outstanding shares of the Common Stock; provided, however, that if ten days shall have elapsed since Purchaser has declared an event of default under any Transaction Document and such event shall not have been cured to Purchaser's satisfaction prior to the expiration of such ten-day period, the provisions of this Section 4.10 shall be null and void ab initio. Section 4.11. Listing of Underlying Shares. The Company shall (a) not later than the fifth Business Day following the Closing Date, prepare and file with the American Stock Exchange (and each other national securities exchange or market on which the Common Stock is then listed) an additional shares listing application covering at least 2,229,501 Underlying Shares, (b) take all steps necessary to cause such shares to be approved for listing on such exchanges and markets as soon as possible thereafter, and (c) provide to the Purchaser evidence of such filing and listing, and the Company shall maintain the listing of its Common Stock on such exchange. Section 4.12. Purchaser's Rights if Trading in Common Stock is Suspended or Delisted. In the event that at any time within the three-year period after the Closing Date trading in the shares of the Common Stock is suspended on (other than as a result of the suspension of trading in securities on such market or exchange generally or temporary suspensions pending the release of material information) or delisted from, the American Stock Exchange, unless immediately therewith the Common Stock is listed for trading in the Nasdaq National Market, the New York Stock Exchange or the Nasdaq SmallCap Market, for more than three Trading Days, at Purchaser's option exercisable by five Business Days prior written notice to the Company, the Company shall repay the entire principal amount of then outstanding Convertible Debentures, redeem all Shares and redeem all then outstanding Underlying Shares then held by Purchaser, at an aggregate purchase price equal to the sum of (I) the aggregate outstanding principal amount of Convertible Debentures then held by Purchaser multiplied by (1) the average Per Share Market Value for the five (5) Trading Days immediately preceding (a) the day of such notice or (b) the date of payment in full of the repurchase price calculated under this Section 4.12, whichever is greater, divided by (2) the Conversion Price on the date of the repurchase notice, (II) the aggregate of all accrued but unpaid interest and other non-principal amounts then payable in respect of all Convertible Debentures to be repaid, (III) the number of Shares then held by the Purchaser multiplied by the product of (1) the average Per Share Market Value for the five (5) Trading Days immediately preceding (a) the day of such notice or (b) the date of payment in full of the redemption price calculated under this Section 4.12, whichever is greater, multiplied by the Exchange Ratio on the date of the redemption notice, (IV) the aggregate of all accrued but unpaid dividends and all other amounts then due and payable on account of all Shares to be redeemed, (V) the number of Underlying Shares then held by Purchaser multiplied by the average Per Share Market Value for the five (5) Trading Days immediately preceding (A) the date of the notice or (B) the date of payment in full by the Company of the repurchase price -15- 17 calculated under this Section 4.12, whichever is greater, and (VI) interest on the amounts set forth in I - V above accruing from the 5th day after such notice until the repurchase price under this Section 4.12 is paid in full at the rate of 15% per annum. Section 4.13. No Violation of Applicable Law. Notwithstanding any provision of this Agreement to the contrary, if any repurchase or redemption of Convertible Debentures, Shares or Underlying Shares otherwise required under the Transaction Documents would be prohibited by the relevant provisions of the Delaware General Corporation Law, such repurchase or redemption shall be effected as soon as it is permitted under such law; provided, however, that, interest payable by the Company with respect to any such repurchase or redemption shall continue to accrue in accordance with Section 4.12 during any such period. Section 4.14. Redemption Restrictions. Notwithstanding any provision of this Agreement to the contrary, if any repurchase of Convertible Debentures or redemption of Shares or Underlying Shares otherwise required under this Agreement would be prohibited in the absence of consent from any lender of the Company or of any Subsidiary, or by the holders of any class of securities of the Company, the Company shall use its best efforts to obtain such consent as promptly as practicable after the redemption is required. Interest payable by the Company with respect to any such repurchase or redemption shall continue to accrue in accordance with Section 4.12 until such consent is obtained. Nothing contained in this Section shall be construed as a waiver by the Purchaser of any rights they may have by virtue of any breach of any representation or warranty of the Company herein as to the absence of any requirement to obtain any such consent. Section 4.15. Notice of Breaches. Each of the Company and the Purchaser shall give prompt written notice to the other of any breach of any representation, warranty or other agreement contained in this Agreement or in the Registration Rights Agreement, as well as any events or occurrences arising after the date hereof and prior to the Closing Date, which could reasonably be likely to cause any representation or warranty or other agreement of such party, as the case may be, contained herein or therein to be incorrect or breached as of such Closing Date. However, no disclosure by any party pursuant to this Section shall be deemed to cure any breach of any representation, warranty or other agreement contained herein or in the Registration Rights Agreement. Neither the Company, any Subsidiary nor the Purchaser will take, or agree to commit to take, any action that is intended to make any representation or warranty of the Company or the Purchaser, as the case may be, contained herein or in the Registration Rights Agreement inaccurate in any respect at the Closing Date. Notwithstanding the generality of the foregoing, the Company shall promptly notify the Purchaser of any notice or claim (written or oral) that it receives from any lender or by any holder of any class of securities of the Company to the effect that the consummation of the transactions contemplated by any of the Transaction Documents violates or would violate any written agreement or understanding between such lender or such holder and the Company, and the Company shall promptly furnish by facsimile to the holders of the Convertible Debentures and holders of Shares a copy of any written statement in support of, or relating to, such claim or notice. -16- 18 Section 4.16. Conversion and Exchange Procedures. Exhibit D attached hereto sets forth the procedures with respect to the conversion and exchange, as the case may be, of the Convertible Debentures and the Shares, including the forms of conversion notice to be provided upon conversion, the form of exchange notice to be provided upon exchange, instructions as to the procedures for conversion and exchange, as the case may be, the form of legal opinion, if necessary, that shall be rendered to the Company's transfer agent and such other information and instructions as may be reasonably necessary to enable the Purchaser to exercise their right of conversion or exchange smoothly and expeditiously. Section 4.17. Conversion Obligations of the Company. The Company covenants to convert Convertible Debentures and Shares and exchange Shares, as the case may be, and to deliver Underlying Shares in accordance with the terms and conditions and time periods set forth in the Convertible Debenture, Certificate of Incorporation and Class B Exchange Agreement. ARTICLE V MISCELLANEOUS Section 5.1. Fees and Expenses. Each party shall pay the fees and expenses of its advisers, counsel, accountants and other experts, if any, and all other expenses incurred by such party incident to the negotiation, preparation, execution, delivery and performance of this Agreement, except as set forth in the Registration Rights Agreement and except that the Company shall reimburse the Purchaser at the Closing for $12,000 for its legal fees and disbursements incurred in connection with the transactions contemplated hereby. The Company shall pay all stamp and other taxes and duties levied in connection with the issuance of the Convertible Debentures and the Shares (and upon conversion or exchange thereof, the Underlying Shares) pursuant hereto. The Purchaser shall be responsible for their own tax liability that may arise as a result of the investment hereunder or the transactions contemplated by this Agreement. Section 5.2. Entire Agreement; Amendments. This Agreement, together with the Exhibits and Schedules hereto, the Convertible Debentures, the Class B Exchange Agreement and the Registration Rights Agreement (together with the respective Exhibits and Schedules thereto), contain the entire understanding of the parties with respect to the subject matter hereof and supersede all prior agreements and understandings, oral or written, with respect to such matters. Section 5.3. Notices. Any and all notices or other communications or deliveries required or permitted to be provided hereunder shall be in writing and shall be deemed given and effective on the earliest of (i) the date of transmission, if such notice or communication is delivered via facsimile at the facsimile telephone number specified in this Section prior to 4:30 p.m. (New York City time) on a Business Day, (ii) the Business Day after the date of transmission, if such notice or communication is delivered via facsimile at the facsimile telephone number specified in the Purchase Agreement later than 4:30 p.m. -17- 19 (New York City time) on any date and earlier than 11:59 p.m. (New York City time) on such date, (iii) the Business Day following the date of mailing, if sent by nationally recognized overnight courier service, or (iv) upon actual receipt by the party to whom such notice is required to be given. If to the Company: Substance Abuse Technologies, Inc. 4517 N.W. 31st Avenue Ft. Lauderdale, FL 33309 Facsimile No.: (954) 714-5049 Attn: Chief Executive Officer With copies to: Gold & Wachtel, LLP 110 East 59th Street New York, New York 10022 Facsimile No.: (212) 909-9455 Attn: Robert W. Berend If to the Purchaser: Southbrook International Investments, Ltd c/o Trippoak Advisors, Inc. 630 Fifth Avenue, Suite 2000 New York, NY 10111 Facsimile No.: (212) 332-3256 Attn: Robert Miller With copies to: Robinson Silverman Pearce Aronsohn & Berman LLP 1290 Avenue of the Americas New York, NY 10104 Facsimile No.: (212) 541-4630 Attn: Eric L. Cohen or such other address as may be designated in writing hereafter, in the same manner, by such Person. Section 5.4. Amendments; Waivers. No provision of this Agreement may be waived or amended except in a written instrument signed, in the case of an amendment, by the Company and the Purchaser, or, in the case of a waiver, by the party against whom enforcement of any such waiver is sought. No waiver of any default with respect to any provision, condition or requirement of this Agreement shall be deemed to be a continuing waiver in the future or a waiver of any other provision, condition or requirement hereof, nor shall any delay or omission of either party to exercise any right hereunder in any manner impair the exercise of any such right accruing to it thereafter. Section 5.5. Headings. The headings herein are for convenience only, do not constitute a part of this Agreement and shall not be deemed to limit or affect any of the provisions hereof. -18- 20 Section 5.6. Successors and Assigns. This Agreement shall be binding upon, and inure to the benefit of, the parties and their successors and permitted assigns. Neither the Company nor Purchaser may assign this Agreement or any rights or obligations hereunder or under the Convertible Debentures, Shares, Registration Rights Agreement or Class B Exchange Agreement without the prior written consent of the other, except that the Purchaser may assign their rights hereunder and under each of such instruments and agreements to an Affiliate thereof or to a managed account of either the Purchaser or such Affiliate, provided, that such assignee demonstrates to the reasonable satisfaction of the Company its satisfaction of the representations and warranties set forth in Section 3.2 herein and does not violate Section 5 of the Securities Act. The assignment by a party of this Agreement or any rights hereunder shall not affect the obligations of such party under this Agreement. Section 5.7. No Third-Party Beneficiaries. This Agreement is intended for the benefit of the parties hereto and their respective permitted successors and assigns and, other than with respect to permitted assignees under Section 5.6, is not for the benefit of, nor may any provision hereof be enforced by, any other person. Section 5.8. Governing Law. This Agreement shall be governed by and construed and enforced in accordance with the internal laws of the State of New York without regard to the principles of conflicts of law thereof. Section 5.9. Survival. The representations and warranties of the Company and the Purchaser contained in Article III and the agreements and covenants of the parties contained in Article IV and this Article V shall survive the Closing (or any earlier termination of this Agreement) and any conversion of Convertible Debentures or Shares and exchange of Shares, as the case may be, hereunder. Section 5.10. Counterpart Signatures. This Agreement may be executed in two or more counterparts, all of which when taken together shall be considered one and the same agreement and shall become effective when counterparts have been signed by each party and delivered to the other party, it being understood that both parties need not sign the same counterpart. In the event that any signature is delivered by facsimile transmission, such signature shall create a valid and binding obligation of the party executing (or on whose behalf such signature is executed) the same with the same force and effect as if such facsimile signature page were an original thereof. Section 5.11. Publicity. The Company and the Purchaser shall consult with each other in issuing any press releases or otherwise making public statements with respect to the transactions contemplated hereby and neither party shall issue any such press release or otherwise make any such public statement without the prior written consent of the other, which consent shall not be unreasonably withheld or delayed, except that no prior consent shall be required if such disclosure is required by law, in which such case the disclosing party shall provide the other party with prior notice of such public statement. -19- 21 Section 5.12. Severability. In case any one or more of the provisions of this Agreement shall be invalid or unenforceable in any respect, the validity and enforceability of the remaining terms and provisions of this Agreement shall not in any way be affecting or impaired thereby and the parties will attempt to agree upon a valid and enforceable provision which shall be a reasonable substitute therefor, and upon so agreeing, shall incorporate such substitute provision in this Agreement. Section 5.13. Remedies. In addition to being entitled to exercise all rights provided herein or granted by law, including recovery of damages, the Purchaser will be entitled to specific performance of the obligations of the Company under this Agreement and the Company will be entitled to specific performance of the obligations of the Purchaser hereunder with respect to the subsequent transfer of Convertible Debentures, Shares and the Underlying Shares. Each of the Company and the Purchaser agree that monetary damages would not be adequate compensation for any loss incurred by reason of any breach of its obligations described in the foregoing sentence and hereby agrees to waive in any action for specific performance of any such obligation the defense that a remedy at law would be adequate. [REMAINDER OF PAGE INTENTIONALLY LEFT BLANK, SIGNATURE PAGE FOLLOWS] -20- 22 IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be duly executed as of the date first indicated above. Company: SUBSTANCE ABUSE TECHNOLOGIES, INC. By:_________________________________ Name: Title: Purchaser: SOUTHBROOK INTERNATIONAL INVESTMENTS, LTD By:_________________________________ Name: Title: 23 Schedule 3.1(a) [To be provided by Company prior to the Closing] 24 Schedule 3.1(c) [To be provided by Company prior to the Closing] 25 Schedule 3.1(f) [To be provided by Company prior to the Closing] EX-4.E.1 3 REGISTRATION RIGHTS AGREEMENT 1 Exhibit 4(e)(1) REGISTRATION RIGHTS AGREEMENT This Registration Rights Agreement (this "Agreement") is made and entered into as of May 8, 1997, between Substance Abuse Technologies, Inc., a Delaware corporation (the "Company") and Southbrook International Investments, Ltd., a corporation organized and existing under the laws of the British Virgin Islands (the "Purchaser"). This Agreement is made pursuant to the Convertible Debenture and Preferred Stock Purchase Agreement, dated as of the date hereof between the Company and the Purchaser (the "Purchase Agreement"). The Company and the Purchaser hereby agree as follows: 1. Definitions Capitalized terms used and not otherwise defined herein shall have the meanings given such terms in the Purchase Agreement. As used in this Agreement, the following terms shall have the following meanings: "Advice" shall have meaning set forth in Section 3(o). "Affiliate" means, with respect to any Person, any other Person that directly or indirectly controls or is controlled by or under common control with such Person. For the purposes of this definition, "control," when used with respect to any Person, means the possession, direct or indirect, of the power to direct or cause the direction of the management and policies of such Person, whether through the ownership of voting securities, by contract or otherwise; and the terms of "affiliated," "controlling" and "controlled" have meanings correlative to the foregoing. "Business Day" means any day except Saturday, Sunday and any day which shall be a legal holiday or a day on which banking institutions in the state of New York generally are authorized or required by law or other government actions to close. "Closing Date" shall have the meaning set forth in the Purchase Agreement. "Commission" means the Securities and Exchange Commission. "Common Stock" means the Company's Common Stock, par value $.01 per share. 2 "Debentures" mean the 14% Convertible Debentures due May 8, 2000 purchased by the Purchaser pursuant to the Purchase Agreement. "Effectiveness Date" means the 120th day following the Closing Date. "Effectiveness Period" shall have the meaning set forth in Section 2(a). "Exchange Act" means the Securities Exchange Act of 1934, as amended. "Filing Date" means July 7, 1997. "Holder" or "Holders" means the holder or holders, as the case may be, from time to time of Registrable Securities. "Indemnified Party" shall have the meaning set forth in Section 5(c). "Indemnifying Party" shall have the meaning set forth in Section 5(c). "Losses" shall have the meaning set forth in Section 5(a). "New York Courts" shall have the meaning set forth in Section 7(h). "Person" means an individual or a corporation, partnership, trust, incorporated or unincorporated association, joint venture, limited liability company, joint stock company, government (or an agency or political subdivision thereof) or other entity of any kind. "Preferred Stock" means the shares of Class B Preferred Stock, par value $.01 per share, of the Company issued to the Purchaser pursuant to the Purchase Agreement. "Proceeding" means an action, claim, suit, investigation or proceeding (including, without limitation, an investigation or partial proceeding, such as a deposition), whether commenced or threatened. "Prospectus" means the prospectus included in the Registration Statement (including, without limitation, a prospectus that includes any information previously omitted from a prospectus filed as part of an effective registration statement in reliance upon Rule 430A promulgated under the Securities Act), as amended or supplemented by any prospectus supplement, with respect to the terms of the offering of any portion of the Registrable Securities covered by the Registration Statement, and all other amendments and supplements to the Prospectus, including post-effective amendments, and all material incorporated by reference or deemed to be incorporated by reference in such Prospectus. "Registrable Securities" means the shares of Common Stock issuable (a) upon conversion of the aggregate outstanding principal amount of Debentures (b) upon payment of -2- 3 interest in respect of the Debentures, (c) upon conversion or exchange, as the case may be, of all shares of Preferred Stock, (d) upon payment of dividends in respect of the Preferred Stock and (e) upon exercise of the Common Stock purchase warrants issued by the Company to Wharton Capital Partners, Ltd. in connection with the transactions contemplated by the Purchase Agreement; provided, however that in order to account for the fact that the number of shares of the Common Stock that are issuable upon conversion of the aggregate outstanding principal amount of the Debentures and conversion or exchange of the Preferred Stock, as the case may be, is determined in part upon the market price of the Common Stock at the time of conversion or exchange, as the case may be, Registrable Securities shall include (but not be limited to) a number of shares of the Common Stock equal to no less than the sum of (1) two times the number of shares of the Common Stock issuable upon (i) conversion in full of the aggregate principal amount of the Debentures and (ii) conversion and exchange, as the case may be, in full of the Preferred Stock, assuming such conversion or exchange, as the case may be, occurred on the Closing Date, (2) the number of shares of the Common Stock issuable upon payment of interest under the Debentures and dividends under the Preferred Stock (assuming all such interest and dividends were paid in shares of the Common Stock) for all such interest and dividends assuming a one-year period and (3) the number of shares of the Common Stock issuable upon conversion in full of warrants described above. Notwithstanding anything herein contained to the contrary, if the actual number of shares of the Common Stock issuable upon conversion in full of the Debentures and conversion or exchange, as the case may be, of the Preferred Stock at any time exceeds twice the number of shares of the Common Stock issuable if such conversion or exchange, as the case may be occurred on the Closing Date, the term "Registrable Securities" shall be deemed to include such additional shares of the Common Stock and the Company shall promptly, but in any case within seven (7) days of notice of such fact, file one or more additional Registration Statements covering such additional shares of the Common Stock. The Company shall use its best efforts to cause such additional Registration Statements to be declared effective as promptly as possible, but in any event within 60 days after the date of the notice triggering such requirement. "Registration Statement" means the registration statement contemplated by Section 2(a) (and any additional Registration Statements contemplated in the definition of Registrable Securities), including (in each case) the Prospectus, amendments and supplements to such registration statement or Prospectus, including pre- and post-effective amendments, all exhibits thereto, and all material incorporated by reference or deemed to be incorporated by reference in such registration statement. "Rule 144" means Rule 144 promulgated by the Commission pursuant to the Securities Act, as such Rule may be amended from time to time, or any similar rule or regulation hereafter adopted by the Commission having substantially the same effect as such Rule. "Rule 158" means Rule 158 promulgated by the Commission pursuant to the Securities Act, as such Rule may be amended from time to time, or any similar rule or -3- 4 regulation hereafter adopted by the Commission having substantially the same effect as such Rule. "Rule 415" means Rule 415 promulgated by the Commission pursuant to the Securities Act, as such Rule may be amended from time to time, or any similar rule or regulation hereafter adopted by the Commission having substantially the same effect as such Rule. "Securities Act" means the Securities Act of 1933, as amended. "Special Counsel" means any special counsel to the Holders, for which the Holders will be reimbursed by the Company pursuant to Section 4. "Underwritten Registration or Underwritten Offering" means a registration in connection with which securities of the Company are sold to an underwriter for reoffering to the public pursuant to an effective registration statement. 2. Shelf Registration (a) On or prior to the Filing Date, the Company shall prepare and file with the Commission a "Shelf" Registration Statement covering all Registrable Securities for an offering to be made on a continuous basis pursuant to Rule 415. The Registration Statement shall be on Form S-3 (except if otherwise directed by the Holders in accordance herewith). The Company shall (i) not permit any securities other than the Registrable Securities to be included in the Registration Statement and (ii) use its best efforts to cause the Registration Statement to be declared effective under the Securities Act as promptly as possible after the filing thereof, but in any event prior to the Effectiveness Date, and to keep such Registration Statement continuously effective under the Securities Act until the date which is three years after the date that such Registration Statement is declared effective by the Commission or such earlier date when all Registrable Securities covered by such Registration Statement have been sold or may be sold without volume restrictions pursuant to Rule 144 as determined by the counsel to the Company pursuant to a written opinion letter, addressed to the Holders to such effect (the "Effectiveness Period"); provided, however, that the Company shall not be deemed to have used its best efforts to keep the Registration Statement effective during the Effectiveness Period if it voluntarily takes any action that would result in the Holders not being able to sell the Registrable Securities covered by such Registration Statement during the Effectiveness Period, unless such action is required under applicable law or the Company has filed a post-effective amendment to the Registration Statement and the Commission has not declared it effective. (b) If the Holders of a majority of the Registrable Securities so elect, an offering of Registrable Securities pursuant to the Registration Statement may be effected in the form of an Underwritten Offering. In such event, and if the managing underwriters advise the Company and such Holders in writing that in their opinion the amount of -4- 5 Registrable Securities proposed to be sold in such Underwritten Offering exceeds the amount of Registrable Securities which can be sold in such Underwritten Offering, there shall be included in such Underwritten Offering the amount of such Registrable Securities which in the opinion of such managing underwriters can be sold, and such amount shall be allocated pro rata among the Holders proposing to sell Registrable Securities in such Underwritten Offering. (c) If any of the Registrable Securities are to be sold in an Underwritten Offering, the investment banker or investment bankers and manager or managers that will administer the offering will be selected by the Holders of a majority of the Registrable Securities included in such offering. No Holder may participate in any Underwritten Offering hereunder unless such Person (i) agrees to sell its Registrable Securities on the basis provided in any underwriting agreements approved by the Persons entitled hereunder to approve such arrangements and (ii) completes and executes all questionnaires, powers of attorney, indemnities, underwriting agreements and other documents required under the terms of such arrangements. 3. Registration Procedures In connection with the Company's registration obligations hereunder, the Company shall: (a) Prepare and file with the Commission on or prior to the Filing Date a Registration Statement on Form S-3 (or such other form if directed by the Holders in connection with an Underwritten Offering hereunder) in accordance with the method or methods of distribution thereof as specified by the Holders (except if otherwise directed by the Holders), and cause the Registration Statement to become effective and remain effective as provided herein; provided, however, that not less than five (5) Business Days prior to the filing of the Registration Statement or any related Prospectus or any amendment or supplement thereto (including any document that would be incorporated or deemed to be incorporated therein by reference), the Company shall (i) furnish to the Holders, their Special Counsel and any managing underwriters, copies of all such documents proposed to be filed, which documents (other than those incorporated or deemed to be incorporated by reference) will be subject to the review of such Holders, their Special Counsel and such managing underwriters, and (ii) cause its officers and directors, counsel and independent certified public accountants to respond to such inquiries as shall be necessary, in the opinion of respective counsel to such Holders and such underwriters, to conduct a reasonable investigation within the meaning of the Securities Act. The Company shall not file the Registration Statement or any such Prospectus or any amendments or supplements thereto to which the Holders of a majority of the Registrable Securities, their Special Counsel, or any managing underwriters, shall reasonably object within five (5) Business Days of their receipt thereof. -5- 6 (b) (i) Prepare and file with the Commission such amendments, including post-effective amendments, to the Registration Statement as may be necessary to keep the Registration Statement continuously effective as to all Registrable Securities for the Effectiveness Period and prepare and file with the Commission such additional Registration Statements in order to register for resale under the Securities Act all of the Registrable Securities; (ii) cause the related Prospectus to be amended or supplemented by any required Prospectus supplement, and as so supplemented or amended to be filed pursuant to Rule 424 (or any similar provisions then in force) promulgated under the Securities Act; (iii) respond as promptly as practicable to any comments received from the Commission with respect to the Registration Statement or any amendment thereto and promptly provide the Holders true and complete copies of all correspondence from and to the Commission relating to the Registration Statement; and (iv) comply with the provisions of the Securities Act and the Exchange Act with respect to the disposition of all Registrable Securities covered by the Registration Statement during the applicable period in accordance with the intended methods of disposition by the Holders thereof set forth in the Registration Statement as so amended or in such Prospectus as so supplemented. (c) Notify the Holders of Registrable Securities to be sold, their Special Counsel and any managing underwriters immediately (and, in the case of (i)(A) below, not less than five (5) days prior to such filing) and (if requested by any such Person) confirm such notice in writing no later than one (1) Business Day following the day (i)(A) when a Prospectus or any Prospectus supplement or post-effective amendment to the Registration Statement is proposed to be filed; (B) when the Commission notifies the Company whether there will be a "review" of such Registration Statement and whenever the Commission comments in writing on such Registration Statement and (C) with respect to the Registration Statement or any post-effective amendment, when the same has become effective; (ii) of any request by the Commission or any other Federal or state governmental authority for amendments or supplements to the Registration Statement or Prospectus or for additional information; (iii) of the issuance by the Commission of any stop order suspending the effectiveness of the Registration Statement covering any or all of the Registrable Securities or the initiation of any Proceedings for that purpose; (iv) if at any time any of the representations and warranties of the Company contained in any agreement (including any underwriting agreement) contemplated hereby ceases to be true and correct in all material respects; (v) of the receipt by the Company of any notification with respect to the suspension of the qualification or exemption from qualification of any of the Registrable Securities for sale in any jurisdiction, or the initiation or threatening of any Proceeding for such purpose; and (vi) of the occurrence of any event that makes any statement made in the Registration Statement or Prospectus or any document incorporated or deemed to be incorporated therein by reference untrue in any material respect or that requires any revisions to the Registration Statement, Prospectus or other documents so that, in the case of the Registration Statement or the Prospectus, as the case may be, it will not contain any untrue statement of a material fact or omit to state any material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances under which they were made, not misleading. -6- 7 (d) Use its best efforts to avoid the issuance of, or, if issued, obtain the withdrawal of (i) any order suspending the effectiveness of the Registration Statement or (ii) any suspension of the qualification (or exemption from qualification) of any of the Registrable Securities for sale in any jurisdiction, at the earliest practicable moment. (e) If requested by any managing underwriter or the Holders of a majority of the Registrable Securities to be sold in connection with an Underwritten Offering, (i) promptly incorporate in a Prospectus supplement or post-effective amendment to the Registration Statement such information as such managing underwriters and such Holders reasonably agree should be included therein and (ii) make all required filings of such Prospectus supplement or such post-effective amendment as soon as practicable after the Company has received notification of the matters to be incorporated in such Prospectus supplement or post-effective amendment; provided, however, that the Company shall not be required to take any action pursuant to this Section 3(e) that would, in the opinion of counsel for the Company, violate applicable law. (f) Furnish to each Holder, their Special Counsel and any managing underwriters, without charge, at least one conformed copy of each Registration Statement and each amendment thereto, including financial statements and schedules, all documents incorporated or deemed to be incorporated therein by reference, and all exhibits to the extent requested by such Person (including those previously furnished or incorporated by reference) promptly after the filing of such documents with the Commission. (g) Promptly deliver to each Holder, their Special Counsel, and any underwriters, without charge, as many copies of the Prospectus or Prospectuses (including each form of prospectus) and each amendment or supplement thereto as such Persons may reasonably request; and the Company hereby consents to the use of such Prospectus and each amendment or supplement thereto by each of the selling Holders and any underwriters in connection with the offering and sale of the Registrable Securities covered by such Prospectus and any amendment or supplement thereto. (h) Prior to any public offering of Registrable Securities, use its best efforts to register or qualify or cooperate with the selling Holders, any underwriters and their Special Counsel in connection with the registration or qualification (or exemption from such registration or qualification) of such Registrable Securities for offer and sale under the securities or Blue Sky laws of such jurisdictions within the United States as any Holder or underwriter requests in writing, to keep each such registration or qualification (or exemption therefrom) effective during the Effectiveness Period and to do any and all other acts or things necessary or advisable to enable the disposition in such jurisdictions of the Registrable Securities covered by a Registration Statement; provided, however, that the Company shall not be required to qualify generally to do business in any jurisdiction where it is not then so qualified or to take any action that would subject it to general service of process in any such jurisdiction where it is not then so subject or subject the Company to any material tax in any such jurisdiction where it is not then so subject. -7- 8 (i) Cooperate with the Holders and any managing underwriters to facilitate the timely preparation and delivery of certificates representing Registrable Securities to be sold, which certificates shall be free of all restrictive legends, and to enable such Registrable Securities to be in such denominations and registered in such names as any such managing underwriters or Holders may request at least two Business Days prior to any sale of Registrable Securities. (j) Upon the occurrence of any event contemplated by Section 3(c)(vi), as promptly as practicable, prepare a supplement or amendment, including a post-effective amendment, to the Registration Statement or a supplement to the related Prospectus or any document incorporated or deemed to be incorporated therein by reference, and file any other required document so that, as thereafter delivered, neither the Registration Statement nor such Prospectus will contain an untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances under which they were made, not misleading. (k) Use its best efforts to cause all Registrable Securities relating to such Registration Statement to be listed on the American Stock Exchange and any other securities exchange, quotation system, market or over-the-counter bulletin board, if any, on which similar securities issued by the Company are then listed as and when required pursuant to the Purchase Agreement. (l) Enter into such agreements (including an underwriting agreement in form, scope and substance as is customary in Underwritten Offerings) and take all such other actions in connection therewith (including those reasonably requested by any managing underwriters and the Holders of a majority of the Registrable Securities being sold) in order to expedite or facilitate the disposition of such Registrable Securities, and whether or not an underwriting agreement is entered into, (i) make such representations and warranties to such Holders and such underwriters as are customarily made by issuers to underwriters in underwritten public offerings, and confirm the same if and when requested; (ii) obtain and deliver copies thereof to each Holder and the managing underwriters, if any, of opinions of counsel to the Company and updates thereof addressed to each selling Holder and each such underwriter, in form, scope and substance reasonably satisfactory to any such managing underwriters and Special Counsel to the selling Holders covering the matters customarily covered in opinions requested in Underwritten Offerings and such other matters as may be reasonably requested by such Special Counsel and underwriters; (iii) immediately prior to the effectiveness of the Registration Statement, and, in the case of an Underwritten Offering, at the time of delivery of any Registrable Securities sold pursuant thereto, obtain and deliver copies to the Holders and the managing underwriters, if any, of "cold comfort" letters and updates thereof from the independent certified public accountants of the Company (and, if necessary, any other independent certified public accountants of any subsidiary of the Company or of any business acquired by the Company for which financial statements and financial data is, or is required to be, included in the Registration Statement), addressed to each selling Holder and each of the underwriters, if any, in form and substance as are -8- 9 customary in connection with Underwritten Offerings; (iv) if an underwriting agreement is entered into, the same shall contain indemnification provisions and procedures no less favorable to the selling Holders and the underwriters, if any, than those set forth in Section 6 (or such other provisions and procedures acceptable to the managing underwriters, if any, and holders of a majority of Registrable Securities participating in such Underwritten Offering; and (v) deliver such documents and certificates as may be reasonably requested by the Holders of a majority of the Registrable Securities being sold, their Special Counsel and any managing underwriters to evidence the continued validity of the representations and warranties made pursuant to clause 3(l)(i) above and to evidence compliance with any customary conditions contained in the underwriting agreement or other agreement entered into by the Company. (m) Make available for inspection by the selling Holders, any representative of such Holders, any underwriter participating in any disposition of Registrable Securities, and any attorney or accountant retained by such selling Holders or underwriters, at the offices where normally kept, during reasonable business hours, all financial and other records, pertinent corporate documents and properties of the Company and its subsidiaries, and cause the officers, directors, agents and employees of the Company and its subsidiaries to supply all information in each case requested by any such Holder, representative, underwriter, attorney or accountant in connection with the Registration Statement; provided, however, that any information that is determined in good faith by the Company in writing to be of a confidential nature at the time of delivery of such information shall be kept confidential by such Persons, unless (i) disclosure of such information is required by court or administrative order or is necessary to respond to inquiries of regulatory authorities; (ii) disclosure of such information, in the opinion of counsel to such Person, is required by law; (iii) such information becomes generally available to the public other than as a result of a disclosure or failure to safeguard by such Person; or (iv) such information becomes available to such Person from a source other than the Company and such source is not known by such Person to be bound by a confidentiality agreement with the Company. (n) Comply with all applicable rules and regulations of the Commission and make generally available to its security holders earning statements satisfying the provisions of Section 11(a) of the Securities Act and Rule 158 not later than 45 days after the end of any 12-month period (or 90 days after the end of any 12-month period if such period is a fiscal year) (i) commencing at the end of any fiscal quarter in which Registrable Securities are sold to underwriters in a firm commitment or best efforts Underwritten Offering and (ii) if not sold to underwriters in such an offering, commencing on the first day of the first fiscal quarter of the Company after the effective date of the Registration Statement, which statement shall cover said 12-month period, or end shorter periods as is consistent with the requirements of Rule 158. The Company may require each selling Holder to furnish to the Company such information regarding the distribution of such Registrable Securities as is required by law to be disclosed in the Registration Statement and the Company may exclude from such -9- 10 registration the Registrable Securities of any such Holder who unreasonably fails to furnish such information within a reasonable time after receiving such request. If the Registration Statement refers to any Holder by name or otherwise as the holder of any securities of the Company, then such Holder shall have the right to require (i) the inclusion therein of language, in form and substance reasonably satisfactory to such Holder, to the effect that the ownership by such Holder of such securities is not to be construed as a recommendation by such Holder of the investment quality of the Company's securities covered thereby and that such ownership does not imply that such Holder will assist in meeting any future financial requirements of the Company, or (ii) if such reference to such Holder by name or otherwise is not required by the Securities Act or any similar Federal statute then in force, the deletion of the reference to such Holder in any amendment or supplement to the Registration Statement filed or prepared subsequent to the time that such reference ceases to be required. The Purchaser covenants and agrees that (i) it will not offer or sell any Registrable Securities under the Registration Statement until it has received copies of the Prospectus as then amended or supplemented as contemplated in Section 3(g) and notice from the Company that such Registration Statement and any post-effective amendments thereto have become effective as contemplated by Section 3(c) and (ii) the Purchaser and its officers, directors or Affiliates, if any, will comply with the prospectus delivery requirements of the Securities Act as applicable to them in connection with sales of Registrable Securities pursuant to the Registration Statement. Each Holder agrees by its acquisition of such Registrable Securities that, upon receipt of a notice from the Company of the occurrence of any event of the kind described in Section 3(c)(ii), 3(c)(iii), 3(c)(iv), 3(c)(v) or 3(c)(vi), such Holder will forthwith discontinue disposition of such Registrable Securities until such Holder's receipt of the copies of the supplemented Prospectus and/or amended Registration Statement contemplated by Section 3(j), or until it is advised in writing (the "Advice") by the Company that the use of the applicable Prospectus may be resumed, and, in either case, has received copies of any additional or supplemental filings that are incorporated or deemed to be incorporated by reference in such Prospectus or Registration Statement. 4. Registration Expenses (a) All fees and expenses incident to the performance of, or compliance with, this Agreement by the Company shall be borne by the Company whether or not the Registration Statement is filed or becomes effective and whether or not any Registrable Securities are sold pursuant to the Registration Statement. The fees and expenses referred to in the foregoing sentence shall include, without limitation, (i) all registration and filing fees (including, without limitation, fees and expenses (A) with respect to filings required to be made with the American Stock Exchange and each other securities exchange or market on which Registrable Securities are required hereunder to be listed and (B) in compliance with -10- 11 state securities or Blue Sky laws (including, without limitation, fees and disbursements of counsel for the underwriters or Holders in connection with Blue Sky qualifications of the Registrable Securities and determination of the eligibility of the Registrable Securities for investment under the laws of such jurisdictions as the managing underwriters, if any, or the Holders of a majority of Registrable Securities may designate)), (ii) printing expenses (including, without limitation, expenses of printing certificates for Registrable Securities and of printing prospectuses if the printing of prospectuses is requested by the managing underwriters, if any, or by the holders of a majority of the Registrable Securities included in the Registration Statement), (iii) messenger, telephone and delivery expenses, (iv) fees and disbursements of counsel for the Company and Special Counsel for the Holders, (v) fees and disbursements of all independent certified public accountants referred to in Section 3(l)(iii) (including, without limitation, the expenses of any special audit and "cold comfort" letters required by or incident to such performance), (vi) Securities Act liability insurance, if the Company so desires such insurance, and (vii) fees and expenses of all other Persons retained by the Company in connection with the consummation of the transactions contemplated by this Agreement. In addition, the Company shall be responsible for all of its internal expenses incurred in connection with the consummation of the transactions contemplated by this Agreement (including, without limitation, all salaries and expenses of its officers and employees performing legal or accounting duties), the expense of any annual audit, the fees and expenses incurred in connection with the listing of the Registrable Securities on any securities exchange as required hereunder. (b) In connection with the Registration Statement, the Company shall reimburse the Holders for the reasonable fees and disbursements of one firm of attorneys chosen by the Holders of a majority of the Registrable Securities. 5. Indemnification (a) Indemnification by the Company. The Company shall, notwithstanding any termination of this Agreement and without limitation as to time, indemnify and hold harmless each Holder, the officers, directors, agents (including any underwriters retained by such Holder in connection with the offer and sale of Registrable Securities), brokers (including brokers who offer and sell Registrable Securities as principal as a result of a pledge or any failure to perform under a margin call of Common Stock), investment advisors and employees of each of them, each Person who controls any such Holder (within the meaning of Section 15 of the Securities Act or Section 20 of the Exchange Act) and the officers, directors, agents and employees of each such controlling Person, to the fullest extent permitted by applicable law, from and against any and all losses, claims, damages, liabilities, costs (including, without limitation, costs of preparation and attorneys' fees) and expenses (collectively, "Losses"), as incurred, arising out of, or relating to, any untrue or alleged untrue statement of a material fact contained in the Registration Statement, any Prospectus or any form of prospectus or in any amendment or supplement thereto or in any preliminary prospectus, or arising out of, or relating to, any omission or alleged omission of a material fact required to be stated therein or necessary to make the statements therein (in the case of -11- 12 any Prospectus or form of prospectus or supplement thereto, in light of the circumstances under which they were made) not misleading, except to the extent, but only to the extent, that such untrue statements or omissions are based solely upon information regarding such Holder furnished in writing to the Company by or on behalf of such Holder expressly for use therein, which information was reasonably relied on by the Company for use therein or to the extent that such information relates to such Holder or such Holder's proposed method of distribution of Registrable Securities and was reviewed and expressly approved in writing by such Holder expressly for use in the Registration Statement, such Prospectus or such form of Prospectus or in any amendment or supplement thereto. The Company shall notify the Holders promptly of the institution, threat or assertion of any Proceeding of which the Company is aware in connection with the transactions contemplated by this Agreement. (b) Indemnification by Holders. Each Holder shall, severally and not jointly, indemnify and hold harmless the Company, the directors, officers, agents and employees, each Person who controls the Company (within the meaning of Section 15 of the Securities Act and Section 20 of the Exchange Act), and the directors, officers, agents or employees of such controlling Persons, to the fullest extent permitted by applicable law, from and against all Losses (as determined by a court of competent jurisdiction in a final judgment not subject to appeal or review) arising solely out of, or based solely upon, any untrue statement of a material fact contained in the Registration Statement, any Prospectus, or any form of prospectus, or arising solely out of, or based solely upon, any omission of a material fact required to be stated therein or necessary to make the statements therein not misleading to the extent, but only to the extent, that such untrue statement or omission is contained in any information so furnished in writing by such Holder to the Company specifically for inclusion in the Registration Statement or such Prospectus and that such information was reasonably relied upon by the Company for use in the Registration Statement, such Prospectus or such form of prospectus or to the extent that such information relates to such Holder or such Holder's proposed method of distribution of Registrable Securities and was reviewed and expressly approved in writing by such Holder expressly for use in the Registration Statement, such Prospectus or such form of Prospectus. In no event shall the liability of any selling Holder hereunder be greater in amount than the dollar amount of the net proceeds received by such Holder upon the sale of the Registrable Securities giving rise to such indemnification obligation. (c) Conduct of Indemnification Proceedings. If any Proceeding shall be brought or asserted against any Person entitled to indemnity hereunder (an "Indemnified Party"), such Indemnified Party promptly shall notify the Person from whom indemnity is sought (the "Indemnifying Party") in writing, and the Indemnifying Party shall assume the defense thereof, including the employment of counsel reasonably satisfactory to the Indemnified Party and the payment of all fees and expenses incurred in connection with defense thereof; provided, that the failure of any Indemnified Party to give such notice shall not relieve the Indemnifying Party of its obligations or liabilities pursuant to this Agreement, except (and only) to the extent that it shall be finally determined by a court of competent -12- 13 jurisdiction (which determination is not subject to appeal or further review) that such failure shall have proximately and materially adversely prejudiced the Indemnifying Party. An Indemnified Party shall have the right to employ separate counsel in any such Proceeding and to participate in the defense thereof, but the fees and expenses of such counsel shall be at the expense of such Indemnified Party or Parties unless: (1) the Indemnifying Party has agreed to pay such fees and expenses; or (2) the Indemnifying Party shall have failed promptly to assume the defense of such Proceeding and to employ counsel reasonably satisfactory to such Indemnified Party in any such Proceeding; or (3) the named parties to any such Proceeding (including any impleaded parties) include both such Indemnified Party and the Indemnifying Party, and such Indemnified Party shall have been advised by counsel that a conflict of interest is likely to exist if the same counsel were to represent such Indemnified Party and the Indemnifying Party (in which case, if such Indemnified Party notifies the Indemnifying Party in writing that it elects to employ separate counsel at the expense of the Indemnifying Party, the Indemnifying Party shall not have the right to assume the defense thereof and such counsel shall be at the expense of the Indemnifying Party). The Indemnifying Party shall not be liable for any settlement of any such Proceeding effected without its written consent, which consent shall not be unreasonably withheld. No Indemnifying Party shall, without the prior written consent of the Indemnified Party, effect any settlement of any pending Proceeding in respect of which any Indemnified Party is a party, unless such settlement includes an unconditional release of such Indemnified Party from all liability on claims that are the subject matter of such Proceeding. All fees and expenses of the Indemnified Party (including reasonable fees and expenses to the extent incurred in connection with investigating or preparing to defend such Proceeding in a manner not inconsistent with this Section) shall be paid to the Indemnified Party, as incurred, within 10 Business Days of written notice thereof to the Indemnifying Party (regardless of whether it is ultimately determined that an Indemnified Party is not entitled to indemnification hereunder; provided, that the Indemnifying Party may require such Indemnified Party to undertake to reimburse all such fees and expenses to the extent it is finally judicially determined that such Indemnified Party is not entitled to indemnification hereunder). (d) Contribution. If a claim for indemnification under Section 5(a) or 5(b) is unavailable to an Indemnified Party because of a failure or refusal of a governmental authority to enforce such indemnification in accordance with its terms (by reason of public policy or otherwise), then each Indemnifying Party, in lieu of indemnifying such Indemnified Party, shall contribute to the amount paid or payable by such Indemnified Party as a result of such Losses, in such proportion as is appropriate to reflect the relative fault of the Indemnifying Party and Indemnified Party in connection with the actions, statements or omissions that resulted in such Losses as well as any other relevant equitable considerations. The relative fault of such Indemnifying Party and Indemnified Party shall be determined by reference to, among other things, whether any action in question, including any untrue or alleged untrue statement of a material fact or omission or alleged omission of a material fact, -13- 14 has been taken or made by, or relates to information supplied by, such Indemnifying Party or Indemnified Party, and the parties' relative intent, knowledge, access to information and opportunity to correct or prevent such action, statement or omission. The amount paid or payable by a party as a result of any Losses shall be deemed to include, subject to the limitations set forth in Section 5(c), any attorneys' or other fees or expenses incurred by such party in connection with any Proceeding to the extent such party would have been indemnified for such fees or expenses if the indemnification provided for in this Section was available to such party in accordance with its terms. The parties hereto agree that it would not be just and equitable if contribution pursuant to this Section 5(d) were determined by pro rata allocation or by any other method of allocation that does not take into account the equitable considerations referred to in the immediately preceding paragraph. Notwithstanding the provisions of this Section 5(d), the Purchaser shall not be required to contribute, in the aggregate, any amount in excess of the amount by which the proceeds actually received by the Purchaser from the sale of the Registrable Securities subject to the Proceeding exceeds the amount of any damages that the Purchaser has otherwise been required to pay by reason of such untrue or alleged untrue statement or omission or alleged omission. No Person guilty of fraudulent misrepresentation (within the meaning of Section 11(f) of the Securities Act) shall be entitled to contribution from any Person who was not guilty of such fraudulent misrepresentation. The indemnity and contribution agreements contained in this Section are in addition to any liability that the Indemnifying Parties may have to the Indemnified Parties. 6. Rule 144 The Company shall file the reports required to be filed by it under the Exchange Act in a timely manner and, if at any time the Company is not required to file such reports, they will, upon the request of any Holder, make publicly available other information so long as necessary to permit sales of its securities pursuant to Rule 144. The Company further covenants that it will take such further action as any Holder may reasonably request, all to the extent required from time to time to enable such Holder to sell Registrable Securities without registration under the Securities Act within the limitation of the exemptions provided by Rule 144. Upon the request of any Holder, the Company shall deliver to such Holder a written certification of a duly authorized officer as to whether it has complied with such requirements. 7. Miscellaneous (a) Remedies. In the event of a breach by the Company or by a Holder, of any of their obligations under this Agreement, each Holder or the Company, as the case may be, in addition to being entitled to exercise all rights granted by law and under this Agreement, including recovery of damages, will be entitled to specific performance of its rights under this Agreement. The Company and each Holder agree that monetary damages -14- 15 would not provide adequate compensation for any losses incurred by reason of a breach by it of any of the provisions of this Agreement and hereby further agrees that, in the event of any action for specific performance in respect of such breach, it shall waive the defense that a remedy at law would be adequate. (b) No Inconsistent Agreements. Except as and to the extent specifically set forth in Schedule 7(b) attached hereto, neither the Company nor any of its subsidiaries has, as of the date hereof, nor shall the Company or any of its subsidiaries, on or after the date of this Agreement, enter into any agreement with respect to its securities that is inconsistent with the rights granted to the Holders in this Agreement or otherwise conflicts with the provisions hereof. Except and to the extent specifically set forth on Schedule 7(b) attached hereto, neither the Company nor any of its subsidiaries has previously entered into any agreement granting any registration rights with respect to any of its securities to any Person. Without limiting the generality of the foregoing, without the written consent of the Holders of a majority of the then outstanding Registrable Securities, the Company shall not grant to any Person the right to request the Company to register any securities of the Company under the Securities Act unless the rights so granted are subject in all respects to the prior rights in full of the Holders set forth herein, and are not otherwise in conflict or inconsistent with the provisions of this Agreement. (c) No Piggyback on Registrations. Neither the Company nor any of its security holders (other than the Holders in such capacity pursuant hereto) may include securities of the Company in the Registration Statement other than the Registrable Securities, and the Company shall not enter into any agreement providing any such right to any of its securityholders. (d) Piggy-Back Registrations. If at any time the Company shall determine to prepare and file with the Commission a registration statement relating to an offering for its own account or the account of others under the Securities Act of any of its equity securities, other than on Form S-4 or Form S-8 (each as promulgated under the Securities Act) or their then equivalents relating to equity securities to be issued solely in connection with any acquisition of any entity or business or equity securities issuable in connection with stock option or other employee benefit plans, the Company shall send to each holder of Registrable Securities written notice of such determination and, if within twenty (20) days after receipt of such notice, any such holder shall so request in writing, the Company shall include in such registration statement all or any part of the Registrable Securities such holder requests to be registered, except that if, in connection with any Underwritten Offering for the account of the Company the managing underwriter(s) thereof shall impose a limitation on the number of shares of Common Stock which may be included in the registration statement because, in such underwriter(s)' judgment, such limitation is necessary to effect an orderly public distribution of securities covered thereby, then the Company shall be obligated to include in such registration statement only such limited portion of the Registrable Securities for to which such holder has requested inclusion hereunder. Any exclusion of Registrable Securities shall be made pro rata among the holders seeking to include Registrable Securities, -15- 16 in proportion to the number of Registrable Securities sought to be included by such holders; provided, however, that the Company shall not exclude any Registrable Securities unless the Company has first excluded all outstanding securities the holders of which are not entitled by right to inclusion of securities in such registration statement; and provided, further, however, that, after giving effect to the immediately preceding proviso, any exclusion of Registrable Securities shall be made pro rata with holders of other securities having the right to include such securities in such registration statement. No right to registration of Registrable Securities under this Section shall be construed to limit any registration otherwise required hereunder. (e) Amendments and Waivers. The provisions of this Agreement, including the provisions of this sentence, may not be amended, modified or supplemented, and waivers or consents to departures from the provisions hereof may not be given, unless the same shall be in writing and signed by the Company and the Holders of at least a majority of the then outstanding Registrable Securities; provided, however, that, for the purposes of this sentence, Registrable Securities that are owned, directly or indirectly, by the Company, or an Affiliate of the Company are not deemed outstanding. Notwithstanding the foregoing, a waiver or consent to depart from the provisions hereof with respect to a matter that relates exclusively to the rights of Holders and that does not directly or indirectly affect the rights of other Holders may be given by Holders of at least a majority of the Registrable Securities to which such waiver or consent relates; provided, however, that the provisions of this sentence may not be amended, modified, or supplemented except in accordance with the provisions of the immediately preceding sentence. (f) Notices. Any and all notices or other communications or deliveries required or permitted to be provided hereunder shall be in writing and shall be deemed given and effective on the earliest of (i) the date of transmission, if such notice or communication is delivered via facsimile at the facsimile telephone number specified in this Section prior to 4:30 p.m. (New York City time) on a Business Day, (ii) the Business Day after the date of transmission, if such notice or communication is delivered via facsimile at the facsimile telephone number specified in the Purchase Agreement later than 4:30 p.m. (New York City time) on any date and earlier than 11:59 p.m. (New York City time) on such date, (iii) the Business Day following the date of mailing, if sent by nationally recognized overnight courier service, or (iv) upon actual receipt by the party to whom such notice is required to be given. If to the Company: Substance Abuse Technologies, Inc. 4517 N.W. 31st Avenue Ft. Lauderdale, FL 33309 Facsimile No.: (954) 714-5049 With copies to: Gold & Wachtel, LLP 110 East 59th Street New York, NY 10022 -16- 17 Facsimile No.: (212) 371-0320 Attention: Robert W. Berend If to Purchaser: Southbrook International Investments, Ltd. c/o Trippoak Advisors, Inc. 630 Fifth Avenue, Suite 2000 New York, NY 10111 Facsimile No.: (212) 332-3256 with copies to: Robinson Silverman Pearce Aronsohn & Berman LLP 1290 Avenue of the Americas New York, NY 10104 Facsimile No.: (212) 541-4630 Attn: Eric L. Cohen If to any other Person who is then the registered Holder: To the address of such Holder as it appears in the stock transfer books or Debenture Register of the Company or such other address as may be designated in writing hereafter, in the same manner, by such Person. (g) Successors and Assigns. This Agreement shall inure to the benefit of, and be binding upon, the successors and permitted assigns of each of the parties and shall inure to the benefit of each Holder. The Company may not assign its rights or obligations hereunder without the prior written consent of each Holder. The Purchaser may assign its rights hereunder in the manner and to the Persons as permitted under the Purchase Agreement. (h) Counterparts. This Agreement may be executed in any number of counterparts, each of which when so executed shall be deemed to be an original and, all of which taken together shall constitute one and the same Agreement. In the event that any signature is delivered by facsimile transmission, such signature shall create a valid binding obligation of the party executing (or on whose behalf such signature is executed) the same with the same force and effect as if such facsimile signature were the original thereof. (i) Governing Law; Submission to Jurisdiction;. This Agreement shall be governed by and construed in accordance with the laws of the State of New York, without regard to principles of conflicts of law. The Company hereby irrevocably submits to the jurisdiction of any New York state court sitting in the Borough of Manhattan in the City of -17- 18 New York or any federal court sitting in the Borough of Manhattan in the City of New York (collectively, the "New York") in respect of any Proceeding arising out of or relating to this Agreement, and irrevocably accepts for itself and in respect of its property, generally and unconditionally, jurisdiction of the New York Courts. The Company irrevocably waives to the fullest extent it may effectively do so under applicable law any objection that it may now or hereafter have to the laying of the venue of any such Proceeding brought in any New York Court and any claim that any such Proceeding brought in any New York Court has been brought in an inconvenient forum. Nothing herein shall affect the right of any Holder to serve process in any manner permitted by law or to commence legal proceedings or otherwise proceed against the company in any other jurisdiction. (j) Cumulative Remedies. The remedies provided herein are cumulative and not exclusive of any remedies provided by law. (k) Severability. If any term, provision, covenant or restriction of this Agreement is held by a court of competent jurisdiction to be invalid, illegal, void or unenforceable, the remainder of the terms, provisions, covenants and restrictions set forth herein shall remain in full force and effect and shall in no way be affected, impaired or invalidated, and the parties hereto shall use their reasonable efforts to find and employ an alternative means to achieve the same or substantially the same result as that contemplated by such term, provision, covenant or restriction. It is hereby stipulated and declared to be the intention of the parties that they would have executed the remaining terms, provisions, covenants and restrictions without including any of such that may be hereafter declared invalid, illegal, void or unenforceable. (l) Headings. The headings in this Agreement are for convenience of reference only and shall not limit or otherwise affect the meaning hereof. (m) Shares Held by The Company and its Affiliates. Whenever the consent or approval of Holders of a specified percentage of Registrable Securities is required hereunder, Registrable Securities held by the Company or its Affiliates (other than the Purchaser or transferees or successors or assigns thereof if such Persons are deemed to be Affiliates solely by reason of their holdings of such Registrable Securities) shall not be counted in determining whether such consent or approval was given by the Holders of such required percentage. [REMAINDER OF PAGE INTENTIONALLY LEFT BLANK. SIGNATURE PAGE FOLLOWS] -18- 19 IN WITNESS WHEREOF, the parties have executed this Agreement as of the date first written above. SUBSTANCE ABUSE TECHNOLOGIES, INC. By: _____________________________ Name: Title: SOUTHBROOK INTERNATIONAL INVESTMENTS, LTD. By: _____________________________ Name: Title: EX-4.E.2 4 CLASS B EXCHANGE AGREEMENT 1 Exhibit 4(e)(2) CLASS B EXCHANGE AGREEMENT This CLASS B EXCHANGE AGREEMENT, dated as of May 8, 1997 (this "Agreement"), is made between Substance Abuse Technologies, Inc., a Delaware corporation (the "Company"), and Southbrook International Investments, Ltd., a corporation organized and existing under the laws of the British Virgin Islands (the "Purchaser"). WHEREAS, concurrently with the execution of this Agreement, the Company and the Purchasers are entering into a Convertible Debenture and Preferred Stock Purchase Agreement (the "Purchase Agreement"), pursuant to which, among other things, the Company will issue and sell to the Purchaser, and the Purchaser will buy, an aggregate principal amount of the Company's 14% Senior Subordinated Convertible Debentures due May 8, 2000 (the "Convertible Debentures") and shares of the Company's Class B Preferred Stock, par value $.01 per share (the "Preferred Stock"); and WHEREAS, the Company and the Purchaser desire to provide the Purchaser with the option to exchange shares of the Preferred Stock into shares of the Company's Common Stock, par value $.01 per share (the "Common Stock"), and to clarify and amplify certain terms of the Preferred Stock; NOW, THEREFORE, for good and value consideration, the receipt and sufficiency of which are hereby acknowledged, the Company and the Purchaser hereby agree as follows: Section 1. Dividends. (a) Holders of the Preferred Stock shall be entitled to receive, when and as declared by the Board of Directors out of funds legally available therefor, and the Company shall pay, cumulative dividends at the rate per share (as a percentage of the Stated Value per share) equal to 14% per annum, payable, in cash or shares of Common Stock at the option of the Company, semi-annually in arrears, but in no event later than the applicable Exchange Date (as hereinafter defined). Dividends on the Preferred Stock shall be calculated on the basis of a 360-day year, shall accrue daily commencing the Original Issue Date (as defined in Section 6), and shall be deemed to accrue on such date whether or not earned or declared and whether or not there are profits, surplus or other funds of the Company legally available for the payment of dividends. The party that holds the Preferred Stock of record on an applicable record date for any dividend payment will be entitled to receive such dividend payment and any other accrued and unpaid dividends which accrued prior to such dividend payment date, without regard to any sale or disposition of such Preferred Stock subsequent to the applicable record date but prior to the applicable dividend payment date. Except as otherwise provided herein, if at any time the Company pays less than the total amount of dividends then accrued on account of the Preferred Stock, such payment shall be distributed ratably among the holders of the Preferred Stock based upon the number of shares held by 2 each holder. Payment of dividends on the Preferred Stock is further subject to the provisions of Section 4(a)(ii). (b) Notwithstanding anything to the contrary contained herein, the Company may not issue shares of Common Stock in payment of dividends (and must deliver cash in respect thereof) on the Preferred Stock if: (i) the number of shares of Common Stock at the time authorized, unissued and unreserved for all purposes, or held as treasury stock, is insufficient to issue such dividends in shares of Common Stock; (ii) such shares of Common Stock are not registered for resale pursuant to an effective registration statement that names the recipient of such dividend as a selling stockholder thereunder and such shares may not be sold without volume restrictions pursuant to Rule 144 as determined by counsel to the Company and set forth in a written opinion letter, addressed to the recipient of such dividend, in form and substance acceptable to such recipient; (iii) such shares of Common Stock are not listed on the American Stock Exchange (or the Nasdaq National Market, Nasdaq SmallCap Market or The New York Stock Exchange) and any other exchange or quotation system on which the Common Stock is then listed for trading; or (iv) the issuance of such shares would result in the recipient thereof beneficially owning, as determined in accordance with Rule 13d-3 promulgated under the Securities Exchange Act of 1934, as amended, more than 4.9% of the issued and outstanding shares of Common Stock. (c) So long as any Preferred Stock shall remain outstanding, neither the Company nor any subsidiary thereof shall redeem, purchase or otherwise acquire, directly or indirectly any Junior Securities (as defined in Section 6), nor shall the Company, directly or indirectly, pay or declare any dividend or make any distribution (other than a dividend or distribution described in Section 4) upon, nor shall any distribution be made in respect of, any Junior Securities, nor shall any monies be set aside for or applied to the purchase or redemption (through a sinking fund or otherwise) of any Junior Securities unless all accrued and unpaid dividends on the Preferred Stock for all past dividend periods shall have been paid. Section 2. Voting Rights. Except as otherwise provided herein and as otherwise required by law, the Preferred Stock shall have no voting rights. However, so long as any shares of Preferred Stock are outstanding, the Company shall not, without the affirmative vote of the holders of at least 80% of the shares of the Preferred Stock then outstanding, (a) alter or change adversely the powers, preferences or rights given to the Preferred Stock, (b) issue any shares of the Company's Class A Preferred Stock, par value -2- 3 $.01 per share, or (c) authorize or create any class of stock ranking as to dividends or distribution of assets upon a Liquidation (as defined in Section 3) senior to, prior to or pari passu with the Preferred Stock. Section 3. Liquidation. Upon any liquidation, dissolution or winding-up of the Company, whether voluntary or involuntary (a "Liquidation"), the holders of Preferred Stock shall be entitled to receive out of the assets of the Company, whether such assets are capital or surplus, for each share of Preferred Stock an amount equal to $4.00 per share (the "Stated Value"), plus all accrued but unpaid dividends per share, whether declared or not, before any distribution or payment shall be made to the holders of any Junior Securities, and if the assets of the Company shall be insufficient to pay in full such amounts, then the entire assets to be distributed to the holders of Preferred Stock shall be distributed among the holders of Preferred Stock ratably in accordance with the respective amounts that would be payable on such shares if all amounts payable thereon were paid in full. A sale, conveyance or disposition of all or substantially all of the assets of the Company or the effectuation by the Company of a transaction or series of related transactions in which more than 50% of the voting power of the Company is disposed of, or a consolidation or merger of the Company with or into any other company or companies shall not be treated as a Liquidation, but instead shall be subject to the provisions of Section 4(b)(vii). The Company shall mail written notice of any such Liquidation, not less than 60 days prior to the payment date stated therein, to each record holder of Preferred Stock. Section 4. Exchange. (a)(i) Each share of Preferred Stock shall be exchangeable into shares of Common Stock (subject to reduction pursuant to Section 4(a)(ii) below and Section 4.10 of the Purchase Agreement) at the option of the holder in whole or in part at any time after the earlier to occur of (A) the 120th day after the Original Issue Date and (B) the date the Securities and Exchange Commission (the "Commission") declares effective under the Securities Act of 1933, as amended (the "Securities Act"), a registration statement (the "Underlying Shares Registration Statement") covering the resale of the shares of Common Stock issuable upon exchange of the Preferred Stock and dividends payable in respect thereof to the extent paid in shares of Common Stock (collectively, the "Underlying Shares"). The holder shall effect exchanges hereunder by surrendering the certificates representing the shares of Preferred Stock to be exchanged to the Company, together with the form of notice attached hereto as Exhibit A (the "Exchange Notice"). Each Exchange Notice shall specify the number of shares of Preferred Stock to be exchanged and the date on which such exchange is to be effected, which date may not be prior to the date the holder delivers such Exchange Notice by facsimile (the "Exchange Date"). If no Exchange Date is specified in an Exchange Notice, the Exchange Date shall be the date that the Exchange Notice is deemed delivered pursuant to Section 7(b). Subject to Sections 4(a)(ii) and 4(b) hereof and Section 4.10 of the Purchase Agreement, each Exchange Notice, once given, shall be irrevocable. If the holder is exchanging less than all of the shares of Preferred Stock represented by the -3- 4 stock certificates tendered by the holder with the Exchange Notice, or if an exchange hereunder cannot be effected in full for any reason, the Company shall honor such exchange to the extent permissible and shall promptly deliver to such holder (in the manner and within the time set forth in Section 4(b)) a new stock certificate representing the shares of Preferred Stock as have not been exchanged. (ii) Certain Regulatory Approval. If on the Exchange Date applicable to any exchange under this Section 4(a), (A) the Common Stock is then listed for trading on the American Stock Exchange or the Nasdaq National Market or, if the rules of the Nasdaq Stock Market are hereafter amended to extend Rule 4460(i) promulgated thereby (or any successor or replacement provision thereof) to the Nasdaq SmallCap Market and the Common Stock is then listed for trading on such market, the Nasdaq SmallCap Market, (B) the Exchange Price then in effect is such that the aggregate number of shares of the Common Stock that would then be issuable upon exchange of all of the then outstanding shares of Preferred Stock, together with any shares of the Common Stock previously issued upon exchange of Preferred Stock and upon conversion of Convertible Debentures and in respect of payment of dividends hereunder and interest on the Convertible Debentures, would equal or exceed 20% of the number of shares of the Common Stock outstanding on the Original Issue Date (the "Issuable Maximum"), and (C) the Company has not previously obtained the Stockholder Approval (as defined below), then the Company shall issue to the holder requesting to exchange shares of Preferred Stock under this Agreement the Issuable Maximum and, with respect to any shares of the Common Stock that otherwise would have been issuable to such holder in respect of the Exchange Notice at issue or in respect of payment of interest hereunder in excess of the Issuable Maximum, the holder shall have the option to require the Company to either (1) as promptly as possible, but in no event later than 90 days after such Exchange Date, convene a meeting of the holders of the Common Stock and use its best efforts to obtain the Stockholder Approval or (2) redeem, from funds legally available therefor at the time of such redemption, the balance of the Preferred Stock subject to such Exchange Notice and all other shares of Preferred Stock then held by the tendering holder at a price per share equal to the sum of (A) the product of (i) the average Per Share Market Value for the five (5) Trading Days immediately preceding (1) the Exchange Date or (2) the date of payment in full by the Company of such redemption price, whichever is greater, and (ii) the Exchange Ratio calculated on the Exchange Date, plus (B) the aggregate of all then accrued but unpaid dividends and all other amounts then due and payable on account of such share; provided, however, that if the holder has requested that the Company obtain Stockholder Approval under paragraph (1) above and the Company fails for any reason to obtain such Stockholder Approval within the time period set forth in (1) above, the Company shall be obligated to redeem the Preferred Stock in accordance with the provisions of paragraph (2) above, and in such case the interest contemplated by the immediately succeeding sentence shall be deemed to accrue from the Exchange Date. If the holder has requested that the Company redeem shares of Preferred Stock pursuant to this Section and the Company fails for any reason to pay the redemption price under (2) above within seven days after the Exchange Date, the Company will pay interest on such redemption price at a rate of 15% per annum to the exchanging holder of Preferred Stock, -4- 5 accruing from the Exchange Date until the redemption price plus any accrued interest thereon is paid in full. The entire redemption price, including interest thereon, shall be paid in cash. "Stockholder Approval" means the approval by a majority of the total votes cast on the proposal, in person or by proxy, at a meeting of the stockholders of the Company held in accordance with the Company's Certificate of Incorporation and by-laws, of the issuance by the Company of shares of the Common Stock exceeding the Issuable Maximum as a consequence of the exchange of shares of Preferred Stock into the Common Stock at a price less than the greater of the book or market value on the Original Issue Date as and to the extent required pursuant to Rule 713 of the American Stock Exchange or Rule 4460(i) of the Nasdaq Stock Market (or any successor or replacement provision thereof), as applicable. (b) Not later than three Trading Days after the Exchange Date, the Company will deliver to the holder (i) a certificate or certificates which shall be free of restrictive legends and trading restrictions (other than those required by Section 4.1(b) of the Purchase Agreement) representing the number of shares of the Common Stock being acquired upon the exchange of shares of Preferred Stock (subject to reduction pursuant to Section 4(a)(ii) hereof and Section 4.10 of the Purchase Agreement), (ii) certificates representing the shares of Preferred Stock tendered for such exchange with the Exchange Notice and not exchanged; (iii) a bank check in the amount of all accrued and unpaid dividends on such shares of Preferred Stock (if the Company has elected to pay accrued dividends in cash), together with all other amounts then due and payable in accordance with the terms hereof, from funds legally available therefor, and (iv) if the Company has elected to pay accrued and unpaid dividends on such shares of Preferred Stock in shares of the Common Stock, certificates, which shall be free of restrictive legends and trading restrictions (other than those required by Section 4.1(b) of the Purchase Agreement), representing such number of shares of the Common Stock as equals such dividends divided by the average Per Share Market Value for the five trading Days immediately preceding the Exchange Date; provided, however, that the Company shall not be obligated to issue certificates evidencing the shares of the Common Stock issuable upon exchange of any shares of Preferred Stock until certificates representing the shares of Preferred Stock to exchanged are either delivered for exchange to the Company or any transfer agent for the Preferred Stock or the Common Stock, or the tendering holder notifies the Company that such certificates have been lost, stolen or destroyed and provides a bond (or other adequate security) reasonably satisfactory to the Company to indemnify the Company from any loss incurred by it in connection therewith. The Company shall, upon request of the holder, use its best efforts to deliver any certificate or certificates required to be delivered by the Company under this Section electronically through the Depository Trust Corporation or another established clearing corporation performing similar functions. If in the case of any Exchange Notice such certificate or certificates, including for purposes hereof, certificates representing shares of the Common Stock to be issued on the Exchange Date on account of accrued but unpaid dividends hereunder, are not delivered to or as directed by the applicable holder by the third Trading Day after the Exchange Date, the holder shall be entitled by written notice to the Company at any time on or before its receipt of any stock certificate or certificates thereafter, to rescind such exchange, in which event the Company shall immediately return -5- 6 the certificates representing the shares of Preferred Stock tendered for exchange. If the Company fails to deliver to the holder such certificate or certificates pursuant to this Section, including for purposes hereof, certificates representing shares of the Common Stock to be issued on the Exchange Date on account of accrued but unpaid dividends hereunder, prior to the fifth Trading Day after the Exchange Date, the Company shall pay to such holder $1,500 in, at the option of the holder, cash or shares of Common Stock equal to $1,500 divided by the average Per Share Market Value for the five trading Days immediately preceding the Exchange Date or the date prior to the date of delivery of such shares (whichever is less), as liquidated damages and not as a penalty, for each day after such fifth Trading Day until such certificates are delivered. If the Company fails to deliver to the holder any stock certificate or certificates pursuant to this Section prior to the 20th day after the Exchange Date, the Company shall, at the holder's option (i) redeem, from funds legally available therefor at the time of such redemption, all of the shares of Preferred Stock then held by the tendering holder (including the shares of Preferred Stock tendered for and not exchanged by the Company hereunder), and (ii) pay all accrued but unpaid dividends on account of the shares of Preferred Stock for which the Company shall have failed to issue the Common Stock certificates hereunder, in cash. The redemption price per share shall be equal to the sum of (A) the product of (i) the average Per Share Market Value for the five (5) Trading Days immediately preceding (1) the Exchange Date or (2) the date of payment in full by the Company of such redemption price, whichever is greater, and (ii) the Exchange Ratio calculated on the Exchange Date, plus (B) the aggregate of all then accrued but unpaid dividends and all other amounts then due and payable on account of such share. If the holder has requested that the Company redeem shares of Preferred Stock pursuant to this Section and the Company fails for any reason to pay the redemption price under (2) above within seven days after such notice is deemed delivered pursuant to Section 7(b), the Company will pay interest on the redemption price at a rate of 15% per annum, in cash to such holder, accruing from such seventh day until the redemption price and any accrued interest thereon is paid in full. (c)(i) The exchange price (the "Exchange Price") in effect on any Exchange Date shall be the lesser of (a) the average Per Share Market Value for the five (5) Trading Days immediately preceding the Original Issue Date (the "Initial Exchange Price") or (b) 85% of the average Per Share Market Value for the five (5) Trading Days immediately preceding the Exchange Date; provided that, (a) if the Underlying Shares Registration Statement is not filed on or prior to July 7, 1997, or (b) the Company fails to file with the Commission a request for acceleration in accordance with Rule 12d1-2 promulgated under the Securities Exchange Act of 1934, as amended, within five (5) days of the date that the Company is notified (orally or in writing, whichever is earlier) by the Commission that an Underlying Shares Registration Statement will not be "reviewed" or is not subject to further review or comment by the Commission, or (c) if the Underlying Shares Registration Statement is not declared effective by the Commission on or prior to the 120th day after the Original Issue Date (which period shall be extended to 150 days after the Original Issued Date in the event that the Commission notifies the Company that the Underlying Shares Registration Statement can not be filed on Form S-3 promulgated under the Securities Act -6- 7 solely because the shares of Preferred Stock are convertible prior to the 180th day after the Original Issue Date), or (d) if such Underlying Shares Registration Statement is filed with and declared effective by the Commission but thereafter ceases to be effective as to all Registrable Securities (as such term is defined in the Registration Rights Agreement) at any time prior to the expiration of the "Effectiveness Period" (as such term as defined in the Registration Rights Agreement), without being succeeded within 10 Business Days by a subsequent Underlying Shares Registration Statement filed with and declared effective by the Commission, or (e) if trading in the Common Stock shall be suspended for any reason for more than three Trading Days, or (f) if the exchange rights of the holders of shares of preferred Stock hereunder are suspended for any reason (any such failure being referred to as an "Event," and for purposes of clauses (a), (c) and (f) the date on which such Event occurs, or for purposes of clause (b) the date on which such five (5) days period is exceeded, or for purposes of clause (d) the date which such 10 Business Day-period is exceeded, or for purposes of clause (e) the date on which such three Trading Day period is exceeded, being referred to as "Event Date"), the Exchange Price shall be decreased by 2.5% each month (i.e., 82.5% as of the Event Date and 80% as of the one month anniversary of the Event Date) until the earlier to occur of the second month anniversary after the Event Date and such time as the applicable Event is cured. Commencing the second month anniversary after the Event Date, at the option of each holder for each applicable monthly period either (a) the Company shall pay to the holders of the Preferred Stock 2.5% of the aggregate Stated Value of the Preferred Stock then held by such holder (each holder being entitled to receive such portion of such amount as equals its pro rata portion of the shares of Preferred Stock then outstanding), in cash or (b) the Exchange Price shall be decreased by 2.5% for each additional such month (to be effective in full on the monthly applicable Event Date) as liquidated damages, and not as a penalty on the first day of each monthly anniversary of the Event Date in either case until such time as the applicable Event is cured. Any decrease in the Exchange Price pursuant to this Section shall remain in effect notwithstanding the fact that the Event causing such decrease has been subsequently cured and further monthly decreases have ceased. The provisions of this Section are not exclusive and shall in no way limit the Company's obligations under the Registration Rights Agreement. Notwithstanding anything to the contrary set forth herein, the Company may not, without the prior written consent of the holders, pay liquidated damages hereunder in cash unless it shall have received the prior written consent of all lenders, debt holders or holders of any class of securities of the Company or its Affiliates that have the right to require such consent or to subordinate any such cash payment, which consent shall provide that the payment by the Company of any such liquidated damages hereunder (and the retention of such sum by the receiving holder) is not subject to any applicable subordination rights of such lender or holders of such class of securities. (ii) If the Company, at any time while any shares of Preferred Stock are outstanding, (a) shall pay a stock dividend or otherwise make a distribution or distributions on shares of its Junior Securities (as defined in Section 7) payable in shares of the Common Stock, (b) subdivide outstanding shares of the Common Stock into a larger number of shares, (c) combine outstanding shares of the Common Stock into a smaller -7- 8 number of shares, or (d) issue by reclassification of shares of the Common Stock any shares of capital stock of the Company, the Initial Exchange Price shall be multiplied by a fraction of which the numerator shall be the number of shares of the Common Stock (excluding treasury shares, if any) outstanding before such event and of which the denominator shall be the number of shares of the Common Stock outstanding after such event. Any adjustment made pursuant to this Section 4(c)(ii) shall become effective immediately after the record date for the determination of stockholders entitled to receive such dividend or distribution and shall become effective immediately after the effective date in the case of a subdivision, combination or re-classification. (iii) If the Company, at any time while any shares of Preferred Stock are outstanding, shall issue rights or warrants to all holders of the Common Stock entitling them to subscribe for or purchase shares of the Common Stock at a price per share less than the Per Share Market Value of the Common Stock at the record date mentioned below, the Initial Exchange Price shall be multiplied by a fraction, of which the denominator shall be the number of shares of the Common Stock (excluding treasury shares, if any) outstanding on the date of issuance of such rights or warrants plus the number of additional shares of the Common Stock offered for subscription or purchase, and of which the numerator shall be the number of shares of the Common Stock (excluding treasury shares, if any) outstanding on the date of issuance of such rights or warrants plus the number of shares which the aggregate offering price of the total number of shares so offered would purchase at such Per Share Market Value. Such adjustment shall be made whenever such rights or warrants are issued, and shall become effective immediately after the record date for the determination of stockholders entitled to receive such rights or warrants. However, upon the expiration of any right or warrant to purchase shares of the Common Stock the issuance of which resulted in an adjustment in the Initial Exchange Price pursuant to this Section 4(c)(iii), if any such right or warrant shall expire and shall not have been exercised, the Initial Exchange Price shall immediately upon such expiration be recomputed and effective immediately upon such expiration be increased to the price which it would have been (but reflecting any other adjustments in the Initial Exchange Price made pursuant to the provisions of this Section 4 after the issuance of such rights or warrants) had the adjustment of the Initial Exchange Price made upon the issuance of such rights or warrants been made on the basis of offering for subscription or purchase only that number of shares of the Common Stock actually purchased upon the exercise of such rights or warrants actually exercised. (iv) If the Company, at any time while any shares of Preferred Stock are outstanding, shall distribute to all holders of the Common Stock (and not to holders of the Preferred Stock) evidences of its indebtedness or assets or rights or warrants to subscribe for or purchase any security (excluding those referred to in Sections 4(c)(ii) and (iii) above), then in each such case the Initial Exchange Price at which shares of Preferred Stock shall thereafter be exchangeable shall be determined by multiplying the Initial Exchange Price in effect immediately prior to the record date fixed for determination of stockholders entitled to receive such distribution by a fraction of which the denominator shall be the Per Share Market Value of the Common Stock determined as of the record date mentioned above, and -8- 9 of which the numerator shall be such Per Share Market Value of the Common Stock on such record date less the then fair market value at such record date of the portion of such assets or evidence of indebtedness so distributed applicable to one outstanding share of the Common Stock as determined by the Board of Directors in good faith; provided, however, that in the event of a distribution exceeding ten percent (10%) of the net assets of the Company, such fair market value shall be determined by a nationally recognized or major regional investment banking firm or firm of independent certified public accountants of recognized standing (which may be the firm that regularly examines the financial statements of the Company) (an "Appraiser") selected in good faith by the holders of a majority in interest of the shares of preferred Stock then outstanding; and provided, further, that the Company, after receipt of the determination by such Appraiser shall have the right to select an additional Appraiser, in good faith, in which case the fair market value shall be equal to the average of the determinations by each such Appraiser. In either case the adjustments shall be described in a statement provided to the holders of the Preferred Stock of the portion of assets or evidences of indebtedness so distributed or such subscription rights applicable to one share of the Common Stock. Such adjustment shall be made whenever any such distribution is made and shall become effective immediately after the record date mentioned above. (v) All calculations under this Section 4 shall be made to the nearest cent or the nearest 1/100th of a share, as the case may be. (vi) Whenever the Initial Exchange Price is adjusted pursuant to Section 4(c)(ii),(iii) or (iv), the Company shall promptly mail to each holder of shares of Preferred Stock, a notice setting forth the Initial Exchange Price after such adjustment and setting forth a brief statement of the facts requiring such adjustment. (vii) In case of any reclassification of the Common Stock, any consolidation or merger of the Company with or into another person pursuant to which the Company will not be the surviving entity, the sale or transfer of all or substantially all of the assets of the Company or any compulsory share exchange pursuant to which the Common Stock is converted into other securities, cash or property, the holders of the Preferred Stock then outstanding shall have the right thereafter to, at their option, (A) exchange such shares only into the shares of stock and other securities, cash and property receivable upon or deemed to be held by holders of the Common Stock following such reclassification, consolidation, merger, sale, transfer or share exchange, and the holders of the Preferred Stock shall be entitled upon such event to receive such amount of securities, cash or property as the shares of the Common Stock of the Company into which such shares of Preferred Stock could have been exchanged immediately prior to such reclassification, consolidation, merger, sale, transfer or share exchange would have been entitled or (B) require the Company to redeem, from funds legally available therefor at the time of such redemption, its shares of Preferred Stock at a price per share equal to the sum of (A) the product of (i) the average Per Share Market Value for the five (5) Trading Days immediately preceding (1) the effective date or the date of the closing, as the case may be, of the reclassification, -9- 10 consolidation, merger, sale, transfer or share exchange the triggering such redemption right or (2) the date of payment in full by the Company of the redemption price hereunder, whichever is greater, and (ii) the Exchange Ratio calculated on the date of the closing or the effective date, as the case may be, of the reclassification, consolidation, merger, sale, transfer or share exchange triggering such redemption right, as the case may be, plus (B) the aggregate of accrued but unpaid dividends and all other amounts due and payable on account of such share. The entire redemption price shall be paid in cash, and the terms of payment of such redemption price shall be subject to the provisions set forth in Section 5(c). The terms of any such consolidation, merger, sale, transfer or share exchange shall include such terms so as to continue to give to the holder of Preferred Stock the right to receive the securities, cash or property set forth in this Section 4(b)(vii) upon any exchange or redemption following such consolidation, merger, sale, transfer or share exchange. This provision shall similarly apply to successive reclassifications, consolidations, mergers, sales, transfers or share exchanges. (viii) If: A. the Company shall declare a dividend (or any other distribution) on its Common Stock; or B. the Company shall declare a special nonrecurring cash dividend on or a redemption of its Common Stock; or C. the Company shall authorize the granting to all holders of the Common Stock rights or warrants to subscribe for or purchase any shares of capital stock of any class or of any rights; or D. the approval of any stockholders of the Company shall be required in connection with any reclassification of the Common Stock of the Company, any consolidation or merger to which the Company is a party, any sale or transfer of all or substantially all of the assets of the Company, of any compulsory share of exchange whereby the Common Stock is converted into other securities, cash or property; or E. the Company shall authorize the voluntary or involuntary dissolution, liquidation or winding up of the affairs of the Company; -10- 11 then the Company shall cause to be filed at each office or agency maintained for the purpose of exchange of the Preferred Stock, and shall cause to be mailed to the holders of shares of Preferred Stock at their last addresses as they shall appear upon the stock books of the Company, at least 30 calendar days prior to the applicable record or effective date hereinafter specified, a notice stating (x) the date on which a record is to be taken for the purpose of such dividend, distribution, redemption, rights or warrants, or if a record is not to be taken, the date as of which the holders of the Common Stock of record to be entitled to such dividend, distributions, redemption, rights or warrants are to be determined or (y) the date on which such reclassification, consolidation, merger, sale, transfer or share exchange is expected to become effective or close, and the date as of which it is expected that holders of the Common Stock of record shall be entitled to exchange their shares of the Common Stock for securities, cash or other property deliverable upon such reclassification, consolidation, merger, sale, transfer or share exchange; provided, however, that the failure to mail such notice or any defect therein or in the mailing thereof shall not affect the validity of the corporate action required to be specified in such notice. Holders are entitled to exchange shares of Preferred Stock during the 30-day period commencing the date of such notice to the effective date of the event triggering such notice. (d) If at any time conditions shall arise by reason of action taken by the Company which in the opinion of the Board of Directors are not adequately covered by the other provisions hereof and which might materially and adversely affect the rights of the holders of the Preferred Stock (different than or distinguished from the effect generally on rights of holders of any class of the Company's capital stock) or if at any time any such conditions are expected to arise by reason of any action contemplated by the Company, the Company shall mail a written notice briefly describing the action contemplated and the material adverse effects of such action on the rights of the holders of the Preferred Stock at least 30 calendar days prior to the effective date of such action, and an Appraiser selected by the holders of majority in interest of the shares of Preferred Stock shall give its opinion as to the adjustment, if any (not inconsistent with the standards established in this Section 4), of the Exchange Price (including, if necessary, any adjustment as to the securities into which shares of Preferred Stock may thereafter be exchangeable) and any distribution which is or would be required to preserve without diluting the rights of the holders of the Preferred Stock; provided, however, that the Company, after receipt of the determination by such Appraiser, shall have the right to select an additional Appraiser, in good faith, in which case the adjustment shall be equal to the average of the adjustments recommended by each such Appraiser. The Board of Directors shall make the adjustment recommended forthwith upon the receipt of such opinion or opinions or the taking of any such action contemplated, as the case may be; provided, however, that no such adjustment of the Exchange Price shall be made which in the opinion of the Appraiser(s) giving the aforesaid opinion or opinions would result in an increase of the Exchange Price to more than the Exchange Price then in effect. (e) Upon an exchange hereunder the Company shall not be required to issue stock certificates representing fractions of shares of Common Stock, but may if otherwise permitted, make a cash payment in respect of any final fraction of a share based on -11- 12 the Per Share Market Value at such time. If the Company elects not, or is unable, to make such a cash payment, the holder shall be entitled to receive, in lieu of the final fraction of a share, one whole share of Common Stock. (f) The issuance of certificates for shares of the Common Stock on exchange of Preferred Stock shall be made without charge to the holders thereof for any documentary stamp or similar taxes that may be payable in respect of the issue or delivery of such certificate, provided that the Company shall not be required to pay any tax that may be payable in respect of any transfer involved in the issuance and delivery of any such certificate upon exchange in a name other than that of the holder of such shares of Preferred Stock so exchanged and the Company shall not be required to issue or deliver such certificates unless or until the person or persons requesting the issuance thereof shall have paid to the Company the amount of such tax or shall have established to the satisfaction of the Company that such tax has been paid. (g) Shares of Preferred Stock exchanged into Common Stock shall be canceled and shall have the status of authorized but unissued shares of Class B Preferred Stock. (h) Any and all notices or other communications or deliveries to be provided by the holders of the Preferred Stock hereunder, including, without limitation, any Exchange Notice, shall be in writing and delivered personally, by facsimile, sent by a nationally recognized overnight courier service or sent by certified or registered mail, postage prepaid, addressed to the attention of the Chief Executive Officer of the Company at the facsimile telephone number or address of the principal place of business of the Company as set forth in the Purchase Agreement. Any and all notices or other communications or deliveries to be provided by the Company hereunder shall be in writing and delivered personally, by facsimile, sent by a nationally recognized overnight courier service or sent by certified or registered mail, postage prepaid, addressed to each holder of Preferred Stock at the facsimile telephone number or address of such holder appearing on the books of the Company, or if no such facsimile telephone number or address appears, at the principal place of business of the holder. Any notice or other communication or deliveries hereunder shall be deemed given and effective on the earliest of (i) the date of transmission, if such notice or communication is delivered via facsimile at the facsimile telephone number specified in this Section prior to 4:30 p.m. (Eastern Time), (ii) the date after the date of transmission, if such notice or communication is delivered via facsimile at the facsimile telephone number specified in this Section later than 4:30 p.m. (Eastern Time) on any date and earlier than 11:59 p.m. (Eastern Time) on such date, (iii) four days after deposit in the United States mails, (iv) the Business Day following the date of mailing, if send by nationally recognized overnight courier service, or (v) upon actual receipt by the party to whom such notice is required to be given. Section 5. Redemption. -12- 13 (a) The Company shall have the right, exercisable at any time upon 20 Trading Days' notice to the holders of the Preferred Stock given at any time after the Original Issue Date to redeem, from funds legally available therefor at the time of such redemption, all or any portion of the shares of Preferred Stock which have not previously been exchanged or redeemed, at a price per share equal to the sum of (A) the product of (i) the average Per Share Market Value for the five (5) Trading Days immediately preceding (1) the date of the redemption notice referenced above or (2) the date of payment in full by the Company of the redemption price hereunder, whichever is greater, and (ii) the Exchange Ratio calculated on the date of such redemption notice, and (B) the aggregate accrued but unpaid dividends and all other amounts due and payable in respect of such share. The entire redemption price shall be paid in cash. Holders of Preferred Stock may exchange any shares of Preferred Stock, including shares subject to a redemption notice given under this Section, during the period from the date of such redemption notice through the 19th Trading Day thereafter. The Company shall honor all such exchanges and all exchanges tendered prior to the date of the Company's redemption notice and shall not be permitted to redeem the shares of Preferred Stock tendered for such exchanges (whether occurring prior to the date of such redemption notice or during such 19 day period). (b) If any portion of the redemption price under Section 5(a) shall not be paid by the Company within seven (7) calendar days after the date due, interest shall accrue thereon at the rate of 15% per annum until the redemption price plus all such interest is paid in full (which amount shall be paid as liquidated damages and not as a penalty). In addition, if any portion of such redemption price remains unpaid for more than 7 calendar days after the date due, the holder of the Preferred Stock subject to such redemption may elect, by written notice to the Company given within 30 days after the date due, to either (i) demand exchange in accordance with the formula and the time frame therefor set forth in Section 4 of all of the shares of Preferred Stock for which such redemption price, plus accrued liquidated damages thereof, has not been paid in full (the "Unpaid Redemption Shares"), in which event the Per Share Market Price for such shares shall be the lower of the Per Share Market Price calculated on the date such redemption price was originally due and the Per Share Market Price as of the holder's written demand for exchange, or (ii) invalidate ab initio such redemption, notwithstanding anything herein contained to the contrary. If the holder elects option (i) above, the Company shall within three (3) Trading Days of its receipt of such election deliver to the holder the shares of Common Stock issuable upon exchange of the Unpaid Redemption Shares subject to such holder exchange demand and otherwise perform its obligations hereunder with respect thereto; or, if the Holder elects option (ii) above, the Company shall promptly, and in any event not later than three (3) Trading Days from receipt of holder's notice of such election, return to the holder all of the Unpaid Redemption Shares. Notwithstanding anything to the contrary contained herein, the Company may not, without the written consent of the holder, redeem shares of Preferred Stock unless both the payment thereof and the retention of such paid cash by the holder is consented to in writing free of any subordination prior thereto by all lenders or holders of any class of securities of the Company who by agreement have the right to consent to or force the subordination of such payment. -13- 14 Section 6. Certain Definitions. As used in this Agreement, unless the context requires a different meaning, the following terms shall have the meanings indicated in this Section 6. "Business Day" means any day except Saturday, Sunday and any day which shall be a legal holiday or a day on which banking institutions in the State of New York are authorized or required by law or other government action to close. "Common Stock" means the Company's common stock, $.01 par value per share, of the Company and stock of any other class into which such shares may hereafter have been reclassified or changed. "Junior Securities" means the Common Stock and all other equity securities of the Company other than the Class A Preferred Stock. "Original Issue Date" shall mean the date of the first issuance of any shares of the Preferred Stock regardless of the number of transfers of any such shares and regardless of the number of certificates which may be issued to evidence such shares. "Per Share Market Value" means on any particular date (a) the closing bid price per share of the Common Stock on such date on the American Stock Exchange or other stock exchange or quotation system on which the Common Stock is then listed or if there is no such price on such date, then the closing bid price on such exchange or quotation system on the date nearest preceding such date, or (b) if the Common Stock is not listed then on the American Stock Exchange or any stock exchange or quotation system, the closing bid price for a share of the Common Stock in the over-the-counter market, as reported by the Nasdaq Stock Market or in the National Quotation Bureau Incorporated or similar organization or agency succeeding to its functions of reporting prices) at the close of business on such date, or (c) if the Common Stock is not then reported by the National Quotation Bureau Incorporated (or similar organization or agency succeeding to its functions of reporting prices), then the average of the "Pink Sheet" quotes for the relevant exchange period, as determined in good faith by the holder, or (d) if the Common Stock is not then publicly traded the fair market value of a share of Common Stock as determined by an Appraiser selected in good faith by the holders of a majority in interest of the share of Preferred Stock; provided, however, that the Company, after receipt of the determination by such Appraiser, shall have the right to select an additional Appraiser, in which case, the fair market value shall be equal to the average of the determinations by each such Appraiser. "Person" means a corporation, an association, a partnership, organization, a business, an individual, a government or political subdivision thereof or a governmental agency. "Registration Rights Agreement" means the Registration Rights Agreement, dated as of the date hereof, between the Company and the Purchaser. -14- 15 "Trading Day" means (a) a day on which the Common Stock is traded on the American Stock Exchange or other stock exchange or market on which the Common Stock has been listed, or (b) if the Common Stock is not listed on the American Stock Exchange or any stock exchange or market, a day on which the Common Stock is traded in the over-the-counter market, as reported by the OTC Bulletin Board, or (c) if the Common Stock is not quoted on the OTC Bulletin Board, a day on which the Common Stock is quoted in the over-the-counter market as reported by the National Quotation Bureau Incorporated (or any similar organization or agency succeeding its functions of reporting prices). Section 7. MISCELLANEOUS (a) This Agreement, together with the Exhibits and Schedules hereto, the Purchase Agreement and the Registration Rights Agreement (together with the respective Exhibits and Schedules thereto), contain the entire understanding of the parties with respect to the subject matter hereof and supersede all prior agreements and understandings, oral or written, with respect to such matters. (b) Any and all notices or other communications or deliveries required or permitted to be provided hereunder shall be in writing and shall be deemed given and effective on the earliest of (i) the date of transmission, if such notice or communication is delivered via facsimile at the facsimile telephone number specified in this Section prior to 4:30 p.m. (New York City time) on a Business Day, (ii) the Business Day after the date of transmission, if such notice or communication is delivered via facsimile at the facsimile telephone number specified in the Purchase Agreement later than 4:30 p.m. (New York City time) on any date and earlier than 11:59 p.m. (New York City time) on such date, (iii) the Business Day following the date of mailing, if sent by nationally recognized overnight courier service, or (iv) upon actual receipt by the party to whom such notice is required to be given. If to the Company: Substance Abuse Technologies, Inc. 4517 N.W. 31st Avenue Ft. Lauderdale, FL 33309 Facsimile No.: (954) 714-5049 Attn: Chief Executive Officer With copies to: Gold & Wachtel, LLP 110 East 59th Street New York, New York 10022 Facsimile No.: (212) 909-9455 Attn: Robert W. Berend If to the Purchaser: Southbrook International Investments, Ltd c/o Trippoak Advisors, Inc. -15- 16 630 Fifth Avenue, Suite 2000 New York, NY 10111 Facsimile No.: (212) 332-3256 Attn: Robert Miller With copies to: Robinson Silverman Pearce Aronsohn & Berman LLP 1290 Avenue of the Americas New York, NY 10104 Facsimile No.: (212) 541-4630 Attn: Eric L. Cohen or such other address as may be designated in writing hereafter, in the same manner, by such Person. (c) No provision of this Agreement may be waived or amended except in a written instrument signed, in the case of an amendment, by the Company and the Purchaser, or, in the case of a waiver, by the party against whom enforcement of any such waiver is sought. No waiver of any default with respect to any provision, condition or requirement of this Agreement shall be deemed to be a continuing waiver in the future or a waiver of any other provision, condition or requirement hereof, nor shall any delay or omission of either party to exercise any right hereunder in any manner impair the exercise of any such right accruing to it thereafter. (d) The headings herein are for convenience only, do not constitute a part of this Agreement and shall not be deemed to limit or affect any of the provisions hereof. (e) This Agreement shall be binding upon, and inure to the benefit of, the parties and their successors and permitted assigns. Neither the Company nor the Purchaser may assign this Agreement or any rights or obligations hereunder without the prior written consent of the other, except that (i) the Purchaser may assign its rights hereunder and under the Registration Rights Agreement to an Affiliate thereof or to a managed account of either the Purchaser or such Affiliate and (ii) any assignment of the Purchaser's rights hereunder shall provide to such assignee the right to assign in accordance with the provisions of clause (i) above. The assignment by a party of this Agreement or any rights hereunder shall not affect the obligations of such party under this Agreement. (f) This Agreement is intended for the benefit of the parties hereto and their respective permitted successors and assigns and, other than with respect to permitted assignees under Section 5.6, is not for the benefit of, nor may any provision hereof be enforced by, any other person. -16- 17 (g) This Agreement shall be governed by and construed and enforced in accordance with the internal laws of the State of Delaware without regard to the principles of conflicts of law thereof. (h) The obligations of the Company and the Purchaser contained in this Agreement shall survive the closing of the transactions contemplated hereby (or any earlier termination of this Agreement) and any exchange of shares of Preferred Stock hereunder. (i) This Agreement may be executed in two or more counterparts, all of which when taken together shall be considered one and the same agreement and shall become effective when counterparts have been signed by each party and delivered to the other party, it being understood that both parties need not sign the same counterpart. In the event that any signature is delivered by facsimile transmission, such signature shall create a valid and binding obligation of the party executing (or on whose behalf such signature is executed) the same with the same force and effect as if such facsimile signature page were an original thereof. (j) The Company and the Purchaser shall consult with each other in issuing any press releases or otherwise making public statements with respect to the transactions contemplated hereby and neither party shall issue any such press release or otherwise make any such public statement without the prior written consent of the other, which consent shall not be unreasonably withheld or delayed, except that no prior consent shall be required if such disclosure is required by law, in which such case the disclosing party shall provide the other party with prior notice of such public statement. (k) In case any one or more of the provisions of this Agreement shall be invalid or unenforceable in any respect, the validity and enforceability of the remaining terms and provisions of this Agreement shall not in any way be affecting or impaired thereby and the parties will attempt to agree upon a valid and enforceable provision which shall be a reasonable substitute therefor, and upon so agreeing, shall incorporate such substitute provision in this Agreement. (l) In addition to being entitled to exercise all rights provided herein or granted by law, including recovery of damages, the Purchaser will be entitled to specific performance of the obligations of the Company under this Agreement and the Company will be entitled to specific performance of the obligations of the Purchaser hereunder with respect to the subsequent transfer of Preferred Stock and Underlying Shares. Each of the Company and the Purchaser agree that monetary damages would not be adequate compensation for any loss incurred by reason of any breach of its obligations described in the foregoing sentence and hereby agrees to waive in any action for specific performance of any such obligation the defense that a remedy at law would be adequate. [REMAINDER OF PAGE INTENTIONALLY LEFT BLANK, SIGNATURE PAGE FOLLOWS] -17- 18 IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be duly executed as of the date first indicated above. Company: SUBSTANCE ABUSE TECHNOLOGIES, INC. By:___________________________________ Name: Title: Purchaser: SOUTHBROOK INTERNATIONAL INVESTMENTS, LTD By:___________________________________ Name: Title: -18- 19 EXHIBIT A NOTICE OF EXCHANGE (To be Executed by the Registered Holder in order to Exchange Shares of Preferred Stock) The undersigned hereby elects to exchange the number of shares of Class B Preferred Stock indicated below, into shares of Common Stock, par value $.01 per share (the "Common Stock"), of Substance Abuse Technologies, Inc. (the "Company") according to the conditions hereof, as of the date written below. If shares are to be issued in the name of a person other than undersigned, the undersigned will pay all transfer taxes payable with respect thereto and is delivering herewith such certificates and opinions as reasonably requested by the Company in accordance therewith. No fee will be charged to the holder for any exchange, except for such transfer taxes, if any. Exchange calculations: ________________________________________________________ Date to Effect Exchange ____________________________________________________ Number of shares of Preferred Stock to be Exchanged ____________________________________________________ Number of shares of Common Stock to be Issued ____________________________________________________ Applicable Exchange Price ____________________________________________________ Signature ____________________________________________________ Name ____________________________________________________ Address The Company undertakes to promptly upon its receipt of this exchange notice (and, in any case prior to the time it effects the exchange requested hereby), notify the exchanging holder by facsimile of the number of shares of Common Stock outstanding on such date and the number of shares of Common Stock which would be issuable to the holder if the exchange requested in this exchange notice were effected in full, whereupon, if the Company determines that such exchange would result in it owning in excess of 4.9% of the outstanding shares of Common Stock on such date, the Company shall exchange up to an amount equal to 4.9% of the outstanding shares of Common Stock and issue to the holder one or more certificates representing shares of Preferred Stock which have not been exchanged as a result of this provision. EX-4.E.3 5 14% CONVERTIBLE DEBENTURE 1 Exhibit 4(e)(3) NEITHER THIS DEBENTURE NOR THE SECURITIES INTO WHICH THIS DEBENTURE IS CONVERTIBLE HAVE BEEN REGISTERED WITH THE SECURITIES AND EXCHANGE COMMISSION OR THE SECURITIES COMMISSION OF ANY STATE IN RELIANCE UPON AN EXEMPTION FROM REGISTRATION UNDER THE SECURITIES ACT OF 1933, AS AMENDED (THE "SECURITIES ACT"), AND, ACCORDINGLY, MAY NOT BE OFFERED OR SOLD EXCEPT PURSUANT TO AN EFFECTIVE REGISTRATION STATEMENT UNDER THE SECURITIES ACT OR PURSUANT TO AN AVAILABLE EXEMPTION FROM, OR IN A TRANSACTION NOT SUBJECT TO, THE REGISTRATION REQUIREMENTS OF THE SECURITIES ACT AND IN ACCORDANCE WITH APPLICABLE STATE SECURITIES LAWS. THIS DEBENTURE IS SUBJECT TO CERTAIN RESTRICTIONS ON TRANSFER AND CONVERSION SET FORTH IN A CONVERTIBLE DEBENTURE AND PREFERRED STOCK PURCHASE AGREEMENT, DATED AS OF MAY 8, 1997, BETWEEN SUBSTANCE ABUSE TECHNOLOGIES, INC. (THE "COMPANY") AND THE ORIGINAL HOLDER HEREOF. A COPY OF THAT AGREEMENT IS ON FILE AT THE PRINCIPAL OFFICE OF THE COMPANY. No. 1 U.S. $50,000.00 SUBSTANCE ABUSE TECHNOLOGIES, INC. 14% CONVERTIBLE DEBENTURE DUE MAY 8, 2000 THIS DEBENTURE is one of a duly authorized issue of debentures of Substance Abuse Technologies, Inc. a Delaware corporation, having a principal place of business at 4517 N.W. 31st Avenue, Ft. Lauderdale, Florida 33309 (the "Company"), designated as its 14% Convertible Debentures, due May 8, 2000 (the "Debentures"), in an aggregate principal amount of up to $750,000. FOR VALUE RECEIVED, the Company promises to pay to Southbrook International Investments, Ltd., or registered assigns (the "Holder"), the principal sum of Fifty Thousand Dollars ($50,000.00), on or prior to May 8, 2000 or such earlier date as the Debentures are required to be repaid as provided hereunder (the "Maturity Date") and to pay interest to the Holder on the principal sum at the rate of 14% per annum, payable upon conversion as provided hereunder, or on the Maturity Date if not earlier converted. Interest shall accrue daily commencing on the Original Issue Date (as defined in Section 7) until payment in full of the principal sum, together with all accrued and unpaid interest and other amounts which may become due hereunder, has been made. Interest shall be calculated on the basis of a 360-day year and for the actual number of days elapsed. Interest hereunder will be paid to the person in whose name this Debenture (or one or more predecessor Debentures) is registered on the records 2 of the Company regarding registration and transfers of the Debentures (the "Debenture Register") on the Conversion Date (as defined below) or the Maturity Date, as the case may be; provided, however, that the Company's obligation to a transferee of this Debenture arises only if such transfer, sale or other disposition is made in accordance with the terms and conditions hereof and of the Convertible Debenture and Preferred Stock Purchase Agreement, dated as of May 8, 1997, as amended from time to time (the "Purchase Agreement"), executed by the original Holder. All overdue, accrued and unpaid interest and other amounts due hereunder shall bear interest at the rate of 15% per annum from the day of conversion hereunder or the Maturity Date or earlier date on which this Debenture is accelerated through and including the date of payment. The principal of, and interest on, this Debenture are payable in such coin or currency of the United States of America as at the time of payment is legal tender for payment of public and private debts, at the address of the Holder last appearing on the Debenture Register, except that interest due hereunder may, at the Company's option, be paid in shares of the Common Stock (as defined in Section 7) calculated based upon the average Per Share Market Value for the five (5) Trading Days immediately preceding the Conversion Date or Maturity Date, as the case may be. All amounts due hereunder other than interest shall be paid in cash. Notwithstanding anything to the contrary contained herein, the Company may not issue shares of the Common Stock in payment of interest on the principal amount if: (i) the number of shares of Common Stock at the time authorized, unissued and unreserved for all purposes, or held as treasury stock, is insufficient to pay interest hereunder in shares of Common Stock; (ii) the shares of Common Stock to be issued in respect of interest hereunder are not registered for resale pursuant to an effective registration statement that names the recipient of such interest shares as a selling stockholder thereunder or may not be sold without volume restrictions pursuant to Rule 144 promulgated under the Securities Act of 1933, as amended (the "Securities Act") as determined by counsel to the Company pursuant to a written opinion letter, addressed to the holder, in form and substance acceptable to the holder; (iii) the shares of Common Stock to be issued in respect of such interest are not listed on the American Stock Exchange (or the Nasdaq National Market, Nasdaq SmallCap Market or The New York Stock Exchange), and any other exchange on which the Common Stock is then listed for trading; or (iv) the issuance of such shares would result in the recipient thereof beneficially owning more than 4.9% of the issued and outstanding shares of Common Stock. A transfer of the right to receive principal and interest under this Debenture shall be transferable only through an appropriate entry in the Debenture Register as provided herein. This Debenture is subject to the following additional provisions: Section 1. The Debentures are issuable in denominations of Fifty Thousand Dollars ($50,000) and integral multiples of Fifty Thousand Dollars ($50,000) in excess thereof. The Debentures are exchangeable for an equal aggregate principal amount of Debentures of different authorized denominations, as requested by the Holder surrendering the same but shall not be issuable in denominations of less than integral multiplies of Fifty Thousand Dollars ($50,000). No service charge will be made for such registration of transfer or exchange. Section 2. [INTENTIONALLY DELETED] -2- 3 Section 3. This Debenture has been issued subject to certain investment representations of the original Holder set forth in the Purchase Agreement and may be transferred or exchanged only in compliance with the Securities Act. Prior to due presentment to the Company for transfer of this Debenture, the Company and any agent of the Company may treat the person in whose name this Debenture is duly registered on the Debenture Register as the owner hereof for the purpose of receiving payment as herein provided and for all other purposes, whether or not this Debenture is overdue, and neither the Company nor any such agent shall be affected by notice to the contrary. Section 4. Events of Default. "Event of Default", wherever used herein, means any one of the following events (whatever the reason and whether it shall be voluntary or involuntary or effected by operation of law or pursuant to any judgment, decree or order of any court, or any order, rule or regulation of any administrative or governmental body): (a) any default in the payment of the principal of or interest on this Debenture as and when the same shall become due and payable on the Conversion Date or the Maturity Date or by acceleration or otherwise; (b) the Company shall fail to observe or perform any other covenant, agreement or warranty contained in, or otherwise commit any breach of, this Debenture, the Purchase Agreement, the Class B Exchange Agreement or the Registration Rights Agreement, dated as of May 8, 1997, between the Company and the original Holder (the "Registration Rights Agreement"), and such failure or breach shall not have been remedied within 30 days after the date on which notice of such failure or breach shall have been given; (c) the Company or any of its subsidiaries shall commence a voluntary case under the United States Bankruptcy Code or insolvency laws as now or hereafter in effect or any successor thereto (the "Bankruptcy Code"); or an involuntary case is commenced against the Company under the Bankruptcy Code and the petition is not controverted within 30 days, or is not dismissed within 60 days, after commencement of such involuntary case; or a "custodian" (as defined in the Bankruptcy Code) is appointed for, or takes charge of, all or any substantial part of the property of the Company or the Company commences any other proceeding under any reorganization, arrangement, adjustment of debt, relief of debtors, dissolution, insolvency or liquidation or similar law of any jurisdiction whether now or hereafter in effect relating to the Company or there is commenced against the Company any such proceeding which remains undismissed for a period of 60 days; or the Company is adjudicated insolvent or bankrupt; or any order of relief or other order approving any such case or proceeding is entered; or the Company suffers any appointment of any custodian or the like for it or any substantial part of its property which continues undischarged or unstayed for a period of 60 days; or the Company makes a general assignment for the benefit of creditors; or the Company -3- 4 shall fail to pay, or shall state that it is unable to pay, or shall be unable to pay, its debts generally as they become due; or the Company shall call a meeting of its creditors with a view to arranging a composition or adjustment of its debts; or the Company shall by any act or failure to act indicate its consent to, approval of or acquiescence in any of the foregoing; or any corporate or other action is taken by the Company for the purpose of effecting any of the foregoing; (d) the Company shall default in any of its obligations under any mortgage, credit agreement or other facility, indenture agreement or other instrument under which there may be issued, or by which there may be secured or evidenced any indebtedness of the Company in an amount exceeding one hundred thousand dollars ($100,000), whether such indebtedness now exists or shall hereafter be created and such default shall result in such indebtedness becoming or being declared due and payable prior to the date on which it would otherwise become due and payable; (e) the Common Stock shall be delisted from the American Stock Exchange or other national securities exchange or market on which such Common Stock is listed for trading or suspended from trading thereon without being relisted or having such suspension lifted, as the case may be, within five days; or (f) the Company shall be a party to any merger or consolidation pursuant to which the Company shall not be the surviving entity or shall dispose of all or substantially all of its assets in one or more transactions, or shall redeem more than 10,000 shares of the Common Stock (other than redemptions of Underlying Shares issued upon conversion of Debentures or exchange of Class B Preferred Stock held by the original Holder at such time). If during the time that any portion of this Debenture remains outstanding, any Event of Default occurs and is continuing, and in every such case, then the Holder may, by notice to the Company, declare the full principal amount of this Debenture, together with all accrued but unpaid interest and other amounts owing hereunder, to the date of acceleration, to be, plus the "Adjustment Amount" (as defined in Section 7) whereupon the same shall become, immediately due and payable in cash (notwithstanding anything herein contained to the contrary) without presentment, demand, protest or other notice of any kind, all of which are waived by the Company, notwithstanding anything herein contained to the contrary, and the Holder may immediately and without expiration of any grace period enforce any and all of its rights and remedies hereunder and all other remedies available to it under applicable law. Such declaration may be rescinded and annulled by Holder at any time prior to payment hereunder. No such rescission or annulment shall affect any subsequent Event of Default or impair any right consequent thereon. -4- 5 Section 5. Conversion. (a) (i) This Debenture shall be convertible into shares of the Common Stock (subject to reduction pursuant to Section 5(a)(ii) below and Section 4.10 of the Purchase Agreement at the option of the Holder in whole or in part at any time and from time to time after the earlier to occur of (A) the 120th day after the Original Issue Date or (B) the date the Securities and Exchange Commission (the "Commission") declares effective under the Securities Act, the registration statement registering the resale of the shares of Common Stock issuable upon conversion of the Debentures and payment of interest hereunder and naming the Holder as a selling stockholder thereunder (the "Underlying Shares Registration Statement") and prior to the close of business on the Maturity Date. The Holder shall effect conversions by surrendering the Debentures (or such portions thereof) to be converted to the Company, together with the form of conversion notice attached hereto as Exhibit A (the "Conversion Notice"). Each Conversion Notice shall specify the principal amount of Debentures to be converted and the date on which such conversion is to be effected, which date may not be prior to the date the Holder delivers such Conversion Notice by facsimile (the "Conversion Date"). If no Conversion Date is specified in a Conversion Notice, the Conversion Date shall be the date that the Conversion Notice is deemed delivered pursuant to Section 5(h). Subject to Sections 5(b) and 5(a)(ii) hereof and Section 4.10 of the Purchase Agreement, each Conversion Notice, once given, shall be irrevocable. If the Holder is converting less than all of the principal amount represented by the Debenture(s) tendered by the Holder with the Conversion Notice, or if a conversion hereunder cannot be effected in full for any reason, the Company shall honor such conversion to the extent permissible hereunder and shall promptly deliver to such Holder (in the manner and within the time set forth in Section 5(b)) a new Debenture for such principal amount as have not been converted. (ii) Certain Regulatory Approval. If on the Conversion Date applicable to any conversion, (A) the Common Stock is then listed for trading on the American Stock Exchange or the Nasdaq National Market or, if the rules of the Nasdaq Stock Market are hereafter amended to extend Rule 4460(i) promulgated thereby (or any successor or replacement provision thereof) to the Nasdaq SmallCap Market and the Common Stock is then listed for trading on the Nasdaq SmallCap Market (B) the Conversion Price then in effect is such that the aggregate number of shares of the Common Stock that would then be issuable upon conversion of the entire outstanding principal amount of Debentures, together with any shares of the Common Stock previously issued upon conversion of Debentures and in respect of payment of interest hereunder, and any shares of Common Stock issued upon exchange of the Class B Preferred Stock and in payment of dividends in respect thereof would equal or exceed 20% of the number of shares of the Common Stock outstanding on the Original Issue Date (the "Issuable Maximum"), and (C) the Company has not previously obtained the Stockholder Approval (as defined below), then the Company shall issue to the Holder requesting such conversion the Issuable Maximum and, with respect to any shares of the Common Stock that otherwise would have been issuable to such holder in respect of the Conversion Notice at issue or in respect of payment of interest hereunder in excess of the Issuable Maximum, the Holder shall have the option to require the Company to either (1) as promptly as possible, but in no event later than -5- 6 90 days after such Conversion Date, convene a meeting of the holders of the Common Stock and use its best efforts to obtain the Stockholder Approval or (2) repay, from funds legally available therefor at the time of such repayment, the balance of the principal amount of the Debentures subject to such Conversion Notice and the remaining aggregate principal amount of Debentures then outstanding and held by such Holder at a price equal to the principal amount of Debentures then outstanding and held by such Holder multiplied by the product of (i) the average Per Share Market Value for the five (5) Trading Days immediately preceding (1) the Conversion Date or (2) the date of payment in full by the Company of such repayment price, whichever is greater, divided by (ii) the Conversion Price calculated on the Conversion Date; provided, however, that if the Holder has requested that the Company obtain Stockholder Approval under paragraph (1) above and the Company fails for any reason to obtain such Stockholder Approval within the time period set forth in (1) above, the Company shall be obligated to repay Debentures in accordance with the provisions of paragraph (2) above, and in such case the interest contemplated by the immediately succeeding sentence shall be deemed to accrue from the Conversion Date. If the Holder has requested that the Company repay Debentures pursuant to this Section and the Company fails for any reason to pay the repayment price under (2) above within seven days after the Conversion Date, the Company will pay interest on such repayment price at a rate of 15% per annum to the converting Holder, accruing from the Conversion Date until the repayment price plus any accrued interest thereon is paid in full. The entire repayment price, including interest thereon, shall be paid in cash. "Stockholder Approval" means the approval by a majority of the total votes cast on the proposal, in person or by proxy, at a meeting of the stockholders of the Company held in accordance with the Company's Certificate of Incorporation and by-laws, of the issuance by the Company of shares of the Common Stock exceeding the Issuable Maximum as a consequence of the conversion of Debentures into the Common Stock at a price less than the greater of the book or market value on the Original Issue Date as and to the extent required pursuant to Rule 713 of the American Stock Exchange or Rule 4460(i) of the Nasdaq Stock Market (or any successor or replacement provision thereof), as applicable. (b) Not later than three Trading Days after the Conversion Date, the Company will deliver to the Holder (i) a certificate or certificates which shall be free of restrictive legends and trading restrictions (other than those required by Section 4.1(b) of the Purchase Agreement) representing the number of shares of the Common Stock being acquired upon the conversion of Debentures (subject to reduction pursuant to Section 5(a)(ii) hereof and Section 4.10 of the Purchase Agreement), (ii) Debentures in a principal amount equal to the principal amount of Debentures not converted; (iii) a bank check in the amount of all accrued and unpaid interest (if the Company has elected to pay accrued interest in cash), together with all other amounts then due and payable in accordance with the terms hereof, in respect of Debentures tendered for conversion and (iv) if the Company has elected to pay accrued interest in shares of the Common Stock, certificates, which shall be free of restrictive legends and trading restrictions (other than those required by law), representing such number of shares of the Common Stock as equals such interest divided by the average Per Share Market Value for the five trading Days immediately preceding the Conversion Date; provided, however, that the Company shall not be obligated to issue certificates evidencing the shares of the Common Stock issuable upon conversion of the principal amount of Debentures, until Debentures are either delivered for conversion to the -6- 7 Company or any transfer agent for the Debentures or the Common Stock, or the Holder notifies the Company that such Debenture has been lost, stolen or destroyed and provides a bond (or other adequate security) reasonably satisfactory to the Company to indemnify the Company from any loss incurred by it in connection therewith. The Company shall, upon request of the Holder, use its best efforts to deliver any certificate or certificates required to be delivered by the Company under this Section electronically through the Depository Trust Corporation or another established clearing corporation performing similar functions. If in the case of any Conversion Notice such certificate or certificates, including for purposes hereof, any shares of the Common Stock to be issued on the Conversion Date on account of accrued but unpaid interest hereunder, are not delivered to or as directed by the applicable Holder by the third Trading Day after the Conversion Date, the Holder shall be entitled by written notice to the Company at any time on or before its receipt of such certificate or certificates thereafter, to rescind such conversion, in which event the Company shall immediately return the Debentures tendered for conversion. If the Company fails to deliver to the Holder such certificate or certificates pursuant to this Section, including for purposes hereof, any shares of the Common Stock to be issued on the Conversion Date on account of accrued but unpaid interest hereunder, prior to the fifth Trading Day after the Conversion Date, the Company shall pay to such Holder, in cash, as liquidated damages and not as a penalty, $1,500 for each day after such fifth Trading Day until such certificates are delivered. If the Company fails to deliver to the Holder such certificate or certificates pursuant to this Section prior to the 20th day after the Conversion Date, the Company shall, at the Holder's option (i) repay, from funds legally available therefor at the time of such repayment, the aggregate of the principal amount of Debentures then held by such Holder, as requested by such Holder, and (ii) pay all accrued but unpaid interest on account of the Debentures for which the Company shall have failed to issue the Common Stock certificates hereunder, in cash. The repayment price shall be equal to the sum of (A) the aggregate of all accrued but unpaid interest and other non-principal amounts then payable in respect of all Debentures to be repaid hereunder and for which repayment hereunder is demanded, plus (B) the aggregate of the principal amount of Debentures then held by such Holder multiplied by (1) the average Per Share Market Value for the five (5) Trading Days immediately preceding (x) the Conversion Date or (y) the date of payment in full by the Company of such repayment price, whichever is greater, divided by, (2) the Conversion Price calculated on the Conversion Date. If the Holder has requested that the Company repay Debentures pursuant to this Section and the Company fails for any reason to pay the repayment price within seven days after such notice is deemed delivered pursuant to Section 5(h), the Company will pay interest on the repayment price at a rate of 15% per annum, in cash to such Holder, accruing from such seventh day until the repayment price and any accrued interest thereon is paid in full. (c) (i) The conversion price (the "Conversion Price") in effect on any Conversion Date shall be the lesser of (a) $1.25 (the "Initial Conversion Price") or (b) 85% of the average Per Share Market Value for the five (5) Trading Days immediately preceding the Conversion Date; provided that, (a) if the Underlying Shares Registration Statement is not filed on or prior to July 7, 1997, or (b) the Company fails to file with the Commission a request for acceleration in accordance with Rule 12d1-2 promulgated under the Securities Exchange Act of 1934, as amended, within five (5) days of the date that the Company is notified (orally or in -7- 8 writing, whichever is earlier) by the Commission that an Underlying Shares Registration Statement will not be "reviewed" or is not subject to further review or comment, or (c) if the Underlying Shares Registration Statement is not declared effective by the Commission on or prior to the 120th day after the Original Issue Date (which period shall be extended to the 150 days after the Original Issue Date in the event that the Commission notifies the Company that the Underlying Shares Registration Statement can not be filed on Form S-3 promulgated under the Securities Act solely because the Debentures are convertible prior to the 180th day after the Original Issue Date), or (d) if such Underlying Shares Registration Statement is filed with and declared effective by the Commission but thereafter ceases to be effective as to all Registrable Securities (as such term is defined in the Registration Rights Agreement) at any time prior to the expiration of the "Effectiveness Period" (as such term as defined in the Registration Rights Agreement), without being succeeded by a subsequent Underlying Shares Registration Statement filed with and declared effective by the Commission within 10 Business Days (as defined in Section 7), or (e) if trading in the Common Stock shall be suspended for any reason for more than three Trading Days, or (f) if the conversion rights of the Holders of Debentures hereunder are suspended for any reason (any such failure being referred to as an "Event," and for purposes of clauses (a), (c) and (f) the date on which such Event occurs, or for purposes of clause (b) the date on which such five (5) days period is exceeded, or for purposes of clause (d) the date which such 10 Business Day-period is exceeded, or for purposes of clause (e) the date on which such three Trading Day period is exceeded, being referred to as "Event Date"), the Conversion Price shall be decreased by 2.5% each month (i.e., 82.5% as of the Event Date and 80% as of the one month anniversary of the Event Date) until the earlier to occur of the second month anniversary after the Event Date and such time as the applicable Event is cured. Commencing the second month anniversary after the Event Date, at the option of each Holder for each applicable monthly period either (a) the Company shall pay to the Holders 2.5% of the product of the principal amount of outstanding Debentures (each Holder being entitled to receive such portion of such amount as equals its pro rata portion of Debentures then outstanding), in cash or (b) the Conversion Price shall be decreased by 2.5% for each additional such month (to be effective in full on the monthly applicable Event Date) as liquidated damages, and not as a penalty on the first day of each monthly anniversary of the Event Date in either case until such time as the applicable Event is cured. Any decrease in the Conversion Price pursuant to this Section shall remain in effect notwithstanding the fact that the Event causing such decrease has been subsequently cured and further monthly decreases have ceased. The provisions of this Section are not exclusive and shall in no way limit the Company's obligations under the Registration Rights Agreement. Notwithstanding anything to the contrary set forth herein, the Company may not, without the prior written consent of the Holders, pay liquidated damages hereunder in cash unless it shall have received the prior written consent of all lenders, debt holders or holders of any class of securities of the Company or its Affiliates that have the right to require such consent or to subordinate any such cash payment, which consent shall provide that the payment by the Company of any such liquidated damages hereunder (and the retention of such sum by the receiving Holder) is not subject to any applicable subordination rights of such lender or holders of such class of securities. -8- 9 (ii) If the Company, at any time while any Debentures are outstanding, (a) shall pay a stock dividend or otherwise make a distribution or distributions on shares of its Junior Securities (as defined in Section 7) payable in shares of the Common Stock, (b) subdivide outstanding shares of the Common Stock into a larger number of shares, (c) combine outstanding shares of the Common Stock into a smaller number of shares, or (d) issue by reclassification of shares of the Common Stock any shares of capital stock of the Company, the Initial Conversion Price shall be multiplied by a fraction of which the numerator shall be the number of shares of the Common Stock (excluding treasury shares, if any) outstanding before such event and of which the denominator shall be the number of shares of the Common Stock outstanding after such event. Any adjustment made pursuant to this Section 5(c)(ii) shall become effective immediately after the record date for the determination of stockholders entitled to receive such dividend or distribution and shall become effective immediately after the effective date in the case of a subdivision, combination or re-classification. (iii) If the Company, at any time while any Debentures are outstanding, shall issue rights or warrants to all holders of the Common Stock (and not to Holders of Debentures) entitling them to subscribe for or purchase shares of the Common Stock at a price per share less than the Per Share Market Value of the Common Stock at the record date mentioned below, the Initial Conversion Price shall be multiplied by a fraction, of which the denominator shall be the number of shares of the Common Stock (excluding treasury shares, if any) outstanding on the date of issuance of such rights or warrants plus the number of additional shares of the Common Stock offered for subscription or purchase, and of which the numerator shall be the number of shares of the Common Stock (excluding treasury shares, if any) outstanding on the date of issuance of such rights or warrants plus the number of shares which the aggregate offering price of the total number of shares so offered would purchase at such Per Share Market Value. Such adjustment shall be made whenever such rights or warrants are issued, and shall become effective immediately after the record date for the determination of stockholders entitled to receive such rights or warrants. However, upon the expiration of any right or warrant to purchase shares of the Common Stock the issuance of which resulted in an adjustment in the Initial Conversion Price pursuant to this Section 5(c)(iii), if any such right or warrant shall expire and shall not have been exercised, the Initial Conversion Price shall immediately upon such expiration be recomputed and effective immediately upon such expiration be increased to the price which it would have been (but reflecting any other adjustments in the Initial Conversion Price made pursuant to the provisions of this Section 5 after the issuance of such rights or warrants) had the adjustment of the Initial Conversion Price made upon the issuance of such rights or warrants been made on the basis of offering for subscription or purchase only that number of shares of the Common Stock actually purchased upon the exercise of such rights or warrants actually exercised. (iv) If the Company, at any time while Debentures are outstanding, shall distribute to all holders of the Common Stock (and not to Holders of Debentures) evidences of its indebtedness or assets or rights or warrants to subscribe for or purchase any security (excluding those referred to in Sections 5(c)(ii) and (iii) above), then in each such case the Initial Conversion Price at which Debentures shall thereafter be convertible shall be determined by -9- 10 multiplying the Initial Conversion Price in effect immediately prior to the record date fixed for determination of stockholders entitled to receive such distribution by a fraction of which the denominator shall be the Per Share Market Value of the Common Stock determined as of the record date mentioned above, and of which the numerator shall be such Per Share Market Value of the Common Stock on such record date less the then fair market value at such record date of the portion of such assets or evidence of indebtedness so distributed applicable to one outstanding share of the Common Stock as determined by the Board of Directors in good faith; provided, however, that in the event of a distribution exceeding ten percent (10%) of the net assets of the Company, such fair market value shall be determined by a nationally recognized or major regional investment banking firm or firm of independent certified public accountants of recognized standing (which may be the firm that regularly examines the financial statements of the Company) (an "Appraiser") selected in good faith by the holders of a majority in interest of Debentures then outstanding; and provided, further, that the Company, after receipt of the determination by such Appraiser shall have the right to select an additional Appraiser, in good faith, in which case the fair market value shall be equal to the average of the determinations by each such Appraiser. In either case the adjustments shall be described in a statement provided to the holders of Debentures of the portion of assets or evidences of indebtedness so distributed or such subscription rights applicable to one share of the Common Stock. Such adjustment shall be made whenever any such distribution is made and shall become effective immediately after the record date mentioned above. (v) All calculations under this Section 5 shall be made to the nearest cent or the nearest 1/100th of a share, as the case may be. (vi) Whenever the Initial Conversion Price is adjusted pursuant to Section 5(c)(ii),(iii) or (iv), the Company shall promptly mail to each holder of Debentures, a notice setting forth the Initial Conversion Price after such adjustment and setting forth a brief statement of the facts requiring such adjustment. (vii) In case of any reclassification of the Common Stock or any compulsory share exchange pursuant to which the Common Stock is converted into other securities, cash or property, the Holder of this Debenture shall have the right thereafter to, at its option, (A) convert the then outstanding principal amount, together with all accrued but unpaid interest and any other amounts then owing hereunder in respect of this Debenture only into the shares of stock and other securities, cash and property receivable upon or deemed to be held by holders of the Common Stock following such reclassification or share exchange, and the Holders of the Debentures shall be entitled upon such event to receive such amount of securities, cash or property as the shares of the Common Stock of the Company into which the then outstanding principal amount, together with all accrued but unpaid interest and any other amounts then owing hereunder in respect of this Debenture could have been converted immediately prior to such reclassification or share exchange would have been entitled or (B) require the Company to repay, from funds legally available therefor at the time of such repayment, all of its Debentures at a price equal to the sum of (i) the aggregate of the principal amount of Debentures then held by the Holder multiplied by (a) the average Per Share Market -10- 11 Value for the five (5) Trading Days immediately preceding (1) the effective date of the reclassification or share exchange triggering such repayment right or (2) the date of payment in full by the Company of the repayment price hereunder, whichever is greater, divided by (b) the Conversion Price calculated on such effective date, plus (ii) the aggregate of all accrued but unpaid interest and other amounts then payable in respect of all Debentures to be repaid hereunder. The entire redemption price shall be paid in cash, and the terms of payment of such redemption price shall be subject to the provisions set forth in Section 6(b). The terms of any such reclassification or share exchange shall include such terms so as to continue to give to the Holder the right to receive the securities, cash or property set forth in this Section 5(c)(vii) upon any conversion following such event. This provision shall similarly apply to successive reclassifications or share exchanges. (viii) If: A. the Company shall declare a dividend (or any other distribution) on its Common Stock; or B. the Company shall declare a special nonrecurring cash dividend on or a redemption of its Common Stock; or C. the Company shall authorize the granting to all holders of the Common Stock rights or warrants to subscribe for or purchase any shares of capital stock of any class or of any rights; or D. the approval of any stockholders of the Company shall be required in connection with any reclassification of the Common Stock of the Company, any consolidation or merger to which the Company is a party, any sale or transfer of all or substantially all of the assets of the Company, of any compulsory share of exchange whereby the Common Stock is converted into other securities, cash or property; or E. the Company shall authorize the voluntary or involuntary dissolution, liquidation or winding up of the affairs of the Company; then the Company shall cause to be filed at each office or agency maintained for the purpose of conversion of the Debentures, and shall cause to be mailed to the Holders of Debentures at their last addresses as they shall appear upon the stock books of the Company, at least 30 calendar days prior to the applicable record or effective date hereinafter specified, a notice stating (x) the date on which a record is to be taken for the purpose of such dividend, distribution, redemption, rights or warrants, or if a record is not to be taken, the date as of which the holders of the -11- 12 Common Stock of record to be entitled to such dividend, distributions, redemption, rights or warrants are to be determined or (y) the date on which such reclassification, consolidation, merger, sale, transfer or share exchange is expected to become effective or close, and the date as of which it is expected that holders of the Common Stock of record shall be entitled to exchange their shares of the Common Stock for securities, cash or other property deliverable upon such reclassification, consolidation, merger, sale, transfer or share exchange; provided, however, that the failure to mail such notice or any defect therein or in the mailing thereof shall not affect the validity of the corporate action required to be specified in such notice. Holders are entitled to convert Debentures during the 30-day period commencing the date of such notice to the effective date of the event triggering such notice. (d) If at any time conditions shall arise by reason of action taken by the Company which in the opinion of the Board of Directors are not adequately covered by the other provisions hereof and which might materially and adversely affect the rights of the Holders (different than or distinguished from the effect generally on rights of holders of any class of the Company's capital stock) or if at any time any such conditions are expected to arise by reason of any action contemplated by the Company, the Company shall mail a written notice briefly describing the action contemplated and the material adverse effects of such action on the rights of the Holders at least 30 calendar days prior to the effective date of such action, and an Appraiser selected by the Holders of majority in interest of the Debentures shall give its opinion as to the adjustment, if any (not inconsistent with the standards established in this Section 5), of the Conversion Price (including, if necessary, any adjustment as to the securities into which Debentures may thereafter be convertible) and any distribution which is or would be required to preserve without diluting the rights of the Holders; provided, however, that the Company, after receipt of the determination by such Appraiser, shall have the right to select an additional Appraiser, in good faith, in which case the adjustment shall be equal to the average of the adjustments recommended by each such Appraiser. The Board of Directors shall make the adjustment recommended forthwith upon the receipt of such opinion or opinions or the taking of any such action contemplated, as the case may be; provided, however, that no such adjustment of the Conversion Price shall be made which in the opinion of the Appraiser(s) giving the aforesaid opinion or opinions would result in an increase of the Conversion Price to more than the Conversion Price then in effect. (e) The Company covenants that it will at all times reserve and keep available out of its authorized and unissued shares of the Common Stock solely for the purpose of issuance upon conversion of the Debentures and payment of interest on the Debentures, each as herein provided, free from preemptive rights or any other actual contingent purchase rights of persons other than the Holders, not less than such number of shares of the Common Stock as shall (subject to any additional requirements of the Company as to reservation of such shares set forth in the Purchase Agreement) be issuable (taking into account the adjustments and restrictions of Section 5(c)) upon the conversion of the outstanding principal amount of the Debentures and payment of interest hereunder. The Company covenants that all shares of the Common Stock that shall be so issuable shall, upon issue, be duly and validly authorized, issued and fully paid, -12- 13 nonassessable and, if the Underlying Shares Registration Statement has been declared effective under the Securities Act, freely tradeable. (f) Upon a conversion hereunder the Company shall not be required to issue stock certificates representing fractions of shares of the Common Stock, but may if otherwise permitted, make a cash payment in respect of any final fraction of a share based on the Per Share Market Value at such time. If the Company elects not, or is unable, to make such a cash payment, the holder shall be entitled to receive, in lieu of the final fraction of a share, one whole share of Common Stock. (g) The issuance of certificates for shares of the Common Stock on conversion of the Debentures shall be made without charge to the Holders thereof for any documentary stamp or similar taxes that may be payable in respect of the issue or delivery of such certificate, provided that the Company shall not be required to pay any tax that may be payable in respect of any transfer involved in the issuance and delivery of any such certificate upon conversion in a name other than that of the Holder of such Debentures so converted and the Company shall not be required to issue or deliver such certificates unless or until the person or persons requesting the issuance thereof shall have paid to the Company the amount of such tax or shall have established to the satisfaction of the Company that such tax has been paid. (h) Any and all notices or other communications or deliveries to be provided by the Holders of the Debentures hereunder, including, without limitation, any Conversion Notice, shall be in writing and delivered personally, by facsimile, sent by a nationally recognized overnight courier service or sent by certified or registered mail, postage prepaid, addressed to the Company, at 4517 N.W. 31st Avenue, Ft. Lauderdale, Florida 33309 (facsimile number (954) 714-5049), attention Chief Executive Officer, or such other address or facsimile number as the Company may specify for such purposes by notice to the Holders delivered in accordance with this Section. Any and all notices or other communications or deliveries to be provided by the Company hereunder shall be in writing and delivered personally, by facsimile, sent by a nationally recognized overnight courier service or sent by certified or registered mail, postage prepaid, addressed to each Holder of the Debentures at the facsimile telephone number or address of such Holder appearing on the books of the Company, or if no such facsimile telephone number or address appears, at the principal place of business of the holder. Any notice or other communication or deliveries hereunder shall be deemed given and effective on the earliest of (i) the date of transmission, if such notice or communication is delivered via facsimile at the facsimile telephone number specified in this Section prior to 4:30 p.m. (Eastern Time), (ii) the date after the date of transmission, if such notice or communication is delivered via facsimile at the facsimile telephone number specified in this Section later than 4:30 p.m. (Eastern Time) on any date and earlier than 11:59 p.m. (Eastern Time) on such date, (iii) four days after deposit in the United States mails, (iv) the Business Day following the date of mailing, if send by nationally recognized overnight courier service, or (v) upon actual receipt by the party to whom such notice is required to be given. -13- 14 Section 6. Repayments. (a) The Company shall have the right, exercisable at any time upon 20 Trading Days notice to the Holders of the Debentures given at any time after the Original Issue Date to repay, from funds legally available therefor at the time of such repayment, all or any portion of the outstanding principal amount of the Debentures which have not previously been converted or repaid, at a price equal to the sum of (A) the aggregate of the principal amount of the Debentures to be repaid multiplied by (i) the average Per Share Market Value for the five (5) Trading Days immediately preceding (1) the date of the repayment notice referenced above or (2) the date of payment in full by the Company of the repayment price hereunder, whichever is greater, divided by (ii) the Conversion Price calculated on the date of such repayment notice and (B) the aggregate of all accrued but unpaid interest and other amounts owing in respect of the Debentures to be repaid. The entire repayment price shall be paid in cash. Holders of the Debentures may convert the Debentures, including the Debentures subject to a repayment notice given under this Section, during the period from the date of such repayment notice through the 19th Trading Day thereafter. (b) If any portion of the applicable repayment price under Sections 6(a) shall not be paid by the Company within seven (7) calendar days after the date due, interest shall accrue thereon at the rate of 15% per annum until the repayment price plus all such interest is paid in full (which amount shall be paid as liquidated damages and not as a penalty). In addition, if any portion of such repayment price remains unpaid for more than 7 calendar days after the date due, the Holder of the Debentures subject to such repayment may elect, by written notice to the Company given within 30 days after the date due, to either (i) demand conversion in accordance with the formula and the time frame therefor set forth in Section 5 of all Debentures for which such repayment price, plus accrued liquidated damages thereof, has not been paid in full (the "Unpaid Repayment Shares"), in which event the Per Share Market Price for such shares shall be the lower of the Per Share Market Price calculated on the date such repayment price was originally due and the Per Share Market Price as of the Holder's written demand for conversion, or (ii) invalidate ab initio such repayment, notwithstanding anything herein contained to the contrary. If the Holder elects option (i) above, the Company shall within three (3) Trading Days of its receipt of such election deliver to the Holder the shares of the Common Stock issuable upon conversion of the Unpaid Repayment Shares subject to such Holder conversion demand and otherwise perform its obligations hereunder with respect thereto; or, if the Holder elects option (ii) above, the Company shall promptly, and in any event not later than three (3) Trading Days from receipt of holder's notice of such election, return to the holder all of the Unpaid Repayment Shares. Notwithstanding anything to the contrary contained herein, the Company may not, without the written consent of the holder, repay Debentures unless both the payment thereof and the retention of such paid cash by the holder is consented to in writing free of any subordination prior thereto by all lenders or holders of any indebtedness or class of securities of the Company who have the right to consent to or force the subordination of such payment. Section 7. Definitions. For the purposes hereof, the following terms shall have the following meanings: -14- 15 "Adjustment Amount" is equal to (i) the aggregate principal amount of Debentures then outstanding multiplied by (A) the average Per Share Market Value for the five Trading Days immediately preceding (1) the applicable Trigger Date or (2) the date of payment of all amounts due as a result of such Event of Default, whichever is greater, divided by (B) the Conversion Price with respect to the aggregate principal amount of Debentures then outstanding calculated on the applicable Trigger Date, MINUS (ii) the aggregate principal amount of Debentures then outstanding, plus all accrued and unpaid interest thereon, and all other amounts due, except for those referred to in (i) above pursuant to the terms hereof. "Business Day" means any day except Saturday, Sunday and any day which shall be a legal holiday or a day on which banking institutions in the State of New York are authorized or required by law or other government action to close. "Class B Exchange Agreement" means the Class B Exchange Agreement, dated May 8, 1997, between the Company and the original Holder relating to the Class B Preferred Stock. "Class B Preferred Stock" means the Company's Class B Preferred Stock, par value $.01 per share. "Common Stock" means the Company's common stock, $.01 par value per share, of the Company and stock of any other class into which such shares may hereafter have been reclassified or changed. "Junior Securities" means the Common Stock and all other equity securities of the Company and all other debt that is subordinated to the Debentures by its terms. "Original Issue Date" shall mean the date of the first issuance of any Debentures regardless of the number of transfers of any Debenture and regardless of the number of instruments which may be issued to evidence such Debenture. "Per Share Market Value" means on any particular date (a) the closing bid price per share of the Common Stock on such date on the American Stock Exchange or other stock exchange or quotation system on which the Common Stock is then listed or if there is no such price on such date, then the closing bid price on such exchange or quotation system on the date nearest preceding such date, or (b) if the Common Stock is not listed then on the American Stock Exchange or any stock exchange or quotation system, the closing bid price for a share of the Common Stock in the over-the-counter market, as reported by the Nasdaq Stock Market or in the National Quotation Bureau Incorporated or similar organization or agency succeeding to its functions of reporting prices) at the close of business on such date, or (c) if the Common Stock is not then reported by the National Quotation Bureau Incorporated (or similar organization or agency succeeding to its functions of reporting prices), then the average of the "Pink Sheet" quotes for the relevant conversion period, as determined in good faith by the holder, or (d) if the Common Stock is not then publicly traded the fair market value of a share -15- 16 of Common Stock as determined by an Appraiser selected in good faith by the holders of a majority in interest of the Debentures; provided, however, that the Company, after receipt of the determination by such Appraiser, shall have the right to select an additional Appraiser, in which case, the fair market value shall be equal to the average of the determinations by each such Appraiser. "Person" means a corporation, an association, a partnership, organization, a business, an individual, a government or political subdivision thereof or a governmental agency. "Registration Rights Agreement" means the Registration Rights Agreement, dated May 8, 1997, between the Company and the original holder of Debentures. "Trading Day" means (a) a day on which the Common Stock is traded on the American Stock Exchange or other stock exchange or market on which the Common Stock has been listed, or (b) if the Common Stock is not listed on the American Stock Exchange or any stock exchange or market, a day on which the Common Stock is traded in the over-the-counter market, as reported by the OTC Bulletin Board, or (c) if the Common Stock is not quoted on the OTC Bulletin Board, a day on which the Common Stock is quoted in the over-the-counter market as reported by the National Quotation Bureau Incorporated (or any similar organization or agency succeeding its functions of reporting prices). "Trigger Date" shall mean, (i) with respect to an Event of Default caused by an event described in Section 4(a), the date the payment of principal or interest at issue was due, (ii) with respect to an Event of Default caused by an event described in Section 4(b), the date specified in any other provision of this Debenture, the Purchase Agreement, the Class B Exchange Agreement or the Registration Rights Agreement that require repayment of the outstanding principal amount of this Debenture as a result of an event so contemplated, if not, the date such event becomes an Event of Default pursuant to Section 4(b), and (iii) with respect to an Event of Default caused by an event described in Section 4(c), (d), (e) and (f), the date such event becomes an Event of Default pursuant to such Sections. "Underlying Shares" means the number of shares of Common Stock into which the Shares are convertible in accordance with the terms hereof and the Purchase Agreement. Section 8. Except as expressly provided herein, no provision of this Debenture shall alter or impair the obligation of the Company, which is absolute and unconditional, to pay the principal of, and interest on, this Debenture at the time, place, and rate, and in the coin or currency, herein prescribed. This Debenture is a direct obligation of the Company. This Debenture ranks pari passu with all other Debentures now or hereafter issued under the terms set forth herein; provided, however, that this Debenture is subordinate in right of payment to the outstanding Convertible Senior Promissory Notes due November 8, 1999 of the Company. The Company may only prepay the outstanding principal amount on the Debentures in accordance with Section 6 hereof. -16- 17 Section 9. This Debenture shall not entitle the Holder to any of the rights of a stockholder of the Company, including without limitation, the right to vote, to receive dividends and other distributions, or to receive any notice of, or to attend, meetings of stockholders or any other proceedings of the Company, unless and to the extent converted into shares of Common Stock in accordance with the terms hereof. Section 10. If this Debenture shall be mutilated, lost, stolen or destroyed, the Company shall execute and deliver, in exchange and substitution for and upon cancellation of a mutilated Debenture, or in lieu of or in substitution for a lost, stolen or destroyed debenture, a new Debenture for the principal amount of this Debenture so mutilated, lost, stolen or destroyed but only upon receipt of evidence of such loss, theft or destruction of such Debenture, and of the ownership hereof, and indemnity, if requested, all reasonably satisfactory to the Company. Section 11. This Debenture shall be governed by and construed in accordance with the laws of the State of New York, without giving effect to conflicts of laws thereof. Section 12. Any waiver by the Company or the Holder of a breach of any provision of this Debenture shall not operate as or be construed to be a waiver of any other breach of such provision or of any breach of any other provision of this Debenture. The failure of the Company or the Holder to insist upon strict adherence to any term of this Debenture on one or more occasions shall not be considered a waiver or deprive that party of the right thereafter to insist upon strict adherence to that term or any other term of this Debenture. Any waiver must be in writing. Section 13. If any provision of this Debenture is invalid, illegal or unenforceable, the balance of this Debenture shall remain in effect, and if any provision is inapplicable to any person or circumstance, it shall nevertheless remain applicable to all other persons and circumstances. Section 14. Whenever any payment or other obligation hereunder shall be due on a day other than a Business Day, such payment shall be made on the next succeeding Business Day (or, if such next succeeding Business Day falls in the next calendar month, the preceding Business Day in the appropriate calendar month). -17- 18 IN WITNESS WHEREOF, the Company has caused this instrument to be duly executed by an officer thereunto duly authorized as of the date first above indicated. SUBSTANCE ABUSE TECHNOLOGIES, INC. By:_______________________________ Name: Title: Attest: By:___________________________ Name: Title: 19 EXHIBIT A NOTICE OF CONVERSION (To be Executed by the Registered Holder in order to Convert the Debenture) The undersigned hereby elects to convert Debenture No. 1 into shares of Common Stock, par value $.01 per share (the "Common Stock"), of Substance Abuse Technologies, Inc. (the "Company") according to the conditions hereof, as of the date written below. If shares are to be issued in the name of a person other than undersigned, the undersigned will pay all transfer taxes payable with respect thereto and is delivering herewith such certificates and opinions as reasonably requested by the Company in accordance therewith. No fee will be charged to the holder for any conversion, except for such transfer taxes, if any. Conversion calculations: ________________________________________________ Date to Effect Conversion ________________________________________________ Principal Amount of Debentures to be Converted ________________________________________________ Number of shares of Common Stock to be Issued ________________________________________________ Applicable Conversion Price ________________________________________________ Signature ________________________________________________ Name ________________________________________________ Address The Company undertakes to promptly upon its receipt of this conversion notice (and, in any case prior to the time it effects the conversion requested hereby), notify the converting holder by facsimile of the number of shares of Common Stock outstanding on such date and the number of shares of Common Stock which would be issuable to the holder if the conversion requested in this conversion notice were effected in full, whereupon, if the Company determines that such conversion would result in it owning in excess of 4.9% of the outstanding shares of Common Stock on such date, the Company shall convert up to an amount equal to 4.9% of the outstanding shares of Common Stock and issue to the holder one or more certificates representing Debentures which have not been converted as a result of this provision. EX-4.E.4 6 WARRANT 1 Exhibit 4(e)(4) NEITHER THESE SECURITIES NOR THE SECURITIES INTO WHICH THESE SECURITIES ARE EXERCISABLE HAVE BEEN REGISTERED WITH THE SECURITIES AND EXCHANGE COMMISSION OR THE SECURITIES COMMISSION OF ANY STATE IN RELIANCE UPON AN EXEMPTION FROM REGISTRATION UNDER SECURITIES ACT OF 1933, AS AMENDED (THE "SECURITIES ACT"), AND, ACCORDINGLY, MAY NOT BE OFFERED OR SOLD EXCEPT PURSUANT TO AN EFFECTIVE REGISTRATION STATEMENT UNDER THE SECURITIES ACT OR PURSUANT TO AN AVAILABLE EXEMPTION FROM THE REGISTRATION REQUIREMENTS THEREUNDER AND IN COMPLIANCE WITH APPLICABLE STATE SECURITIES OR BLUE SKY LAWS. SUBSTANCE ABUSE TECHNOLOGIES, INC. WARRANT Dated May 8, 1997 Substance Abuse Technologies, Inc., a Delaware corporation (the "Company"), hereby certifies that, for value received, Wharton Capital Partners, Ltd., or its registered assigns ("Holder"), is entitled, subject to the terms set forth below, to purchase from the Company up to a total of 75,000 shares of Common Stock, $.01 par value per share (the "Common Stock"), of the Company (each such share, a "Warrant Share" and all such shares, the "Warrant Shares") at an exercise price equal to $2.00 per share (as adjusted from time to time as provided in Section 7, the "Exercise Price"), at any time and from time to time from and after the date hereof and through and including May 8, 2000 (the "Expiration Date"), and subject to the following terms and conditions: 1. Registration of Warrant. The Company shall register this Warrant, upon records to be maintained by the Company for that purpose (the "Warrant Register"), in the name of the record Holder hereof from time to time. The Company may deem and treat the registered Holder of this Warrant as the absolute owner hereof for the purpose of any exercise hereof or any distribution to the Holder, and for all other purposes, and the Company shall not be affected by notice to the contrary. 2. Registration of Transfers and Exchanges. (a) The Company shall register the transfer of any portion of this Warrant in the Warrant Register, upon surrender of this Warrant, with the Form of Assignment attached hereto duly completed and signed, to the Transfer Agent or to the Company at the office specified in or pursuant to Section 3(b). Upon any such registration or transfer, a new 2 warrant to purchase Common Stock, in substantially the form of this Warrant (any such new warrant, a "New Warrant"), evidencing the portion of this Warrant so transferred shall be issued to the transferee and a New Warrant evidencing the remaining portion of this Warrant not so transferred, if any, shall be issued to the transferring Holder. The acceptance of the New Warrant by the transferee thereof shall be deemed the acceptance of such transferee of all of the rights and obligations of a holder of a Warrant. (b) This Warrant is exchangeable, upon the surrender hereof by the Holder to the office of the Company specified in or pursuant to Section 3(b) for one or more New Warrants, evidencing in the aggregate the right to purchase the number of Warrant Shares which may then be purchased hereunder. Any such New Warrant will be dated the date of such exchange. 3. Duration and Exercise of Warrants. (a) This Warrant shall be exercisable by the registered Holder on any business day before 5:30 P.M., New York time, at any time and from time to time on or after the date hereof to and including the Expiration Date. At 5:30 P.M., New York time on the Expiration Date, the portion of this Warrant not exercised prior thereto shall be and become void and of no value. (b) Subject to Sections 2(b), 4 and 8, upon surrender of this Warrant, with the Form of Election to Purchase attached hereto duly completed and signed, to the Company at its office at 4517 N.W. 31st Avenue, Ft. Lauderdale, Florida 33309 Attention: Chief Executive Officer, or at such other address as the Company may specify in writing to the then registered Holder, and upon payment of the Exercise Price multiplied by the number of Warrant Shares that the Holder intends to purchase hereunder, in lawful money of the United States of America, in cash or by certified or official bank check or checks, all as specified by the Holder in the Form of Election to Purchase, the Company shall promptly (but in no event later than 3 business days after the date of exercise) issue or cause to be issued and cause to be delivered to or upon the written order of the Holder and in such name or names as the Holder may designate, a certificate for the Warrant Shares issuable upon such exercise, free of restrictive legends other than as required by applicable law. Any person so designated by the Holder to receive Warrant Shares shall be deemed to have become holder of record of such Warrant Shares as of the Date of Exercise of this Warrant. A "Date of Exercise" means the date on which the Company shall have received (i) this Warrant (or any New Warrant, as applicable), with the Form of Election to Purchase attached hereto (or attached to such New Warrant) appropriately completed and duly signed, and (ii) payment of the Exercise Price for the number of Warrant Shares so indicated by the holder hereof to be purchased. (c) This Warrant shall be exercisable, either in its entirety or, from time to time, for a portion of the number of Warrant Shares. If less than all of the Warrant -2- 3 Shares which may be purchased under this Warrant are exercised at any time, the Company shall issue or cause to be issued, at its expense, a New Warrant evidencing the right to purchase the remaining number of Warrant Shares for which no exercise has been evidenced by this Warrant. 4. Payment of Taxes. The Company will pay all documentary stamp taxes attributable to the issuance of Warrant Shares upon the exercise of this Warrant; provided, however, that the Company shall not be required to pay any tax which may be payable in respect of any transfer involved in the registration of any certificates for Warrant Shares or Warrants in a name other than that of the Holder, and the Company shall not be required to issue or cause to be issued or deliver or cause to be delivered the certificates for Warrant Shares unless or until the person or persons requesting the issuance thereof shall have paid to the Company the amount of such tax or shall have established to the satisfaction of the Company that such tax has been paid. The Holder shall be responsible for all other tax liability that may arise as a result of holding or transferring this Warrant or receiving Warrant Shares upon exercise hereof. 5. Replacement of Warrant. If this Warrant is mutilated, lost, stolen or destroyed, the Company may in its discretion issue or cause to be issued in exchange and substitution for and upon cancellation hereof, or in lieu of and substitution for this Warrant, a New Warrant, but only upon receipt of evidence reasonably satisfactory to the Company of such loss, theft or destruction and indemnity, if requested, satisfactory to it. Applicants for a New Warrant under such circumstances shall also comply with such other reasonable regulations and procedures and pay such other reasonable charges as the Company may prescribe. 6. Reservation of Warrant Shares. The Company covenants that it will at all times reserve and keep available out of the aggregate of its authorized but unissued Common Stock, solely for the purpose of enabling it to issue Warrant Shares upon exercise of this Warrant as herein provided, the number of Warrant Shares which are then issuable and deliverable upon the exercise of this entire Warrant, free from preemptive rights or any other actual contingent purchase rights of persons other than the Holders (taking into account the adjustments and restrictions of Section 7). The Company covenants that all Warrant Shares that shall be so issuable and deliverable shall, upon issuance and the payment of the applicable Exercise Price in accordance with the terms hereof, be duly and validly authorized, issued and fully paid and nonassessable. 7. Certain Adjustments. The Exercise Price and number of Warrant Shares issuable upon exercise of this Warrant are subject to adjustment from time to time as set forth in this Section 7. Upon each such adjustment of the Exercise Price pursuant to this Section 7, the Holder shall thereafter prior to the Expiration Date be entitled to purchase, at the Exercise Price resulting from such adjustment, the number of Warrant Shares obtained by multiplying the Exercise Price in effect immediately prior to such adjustment by the number of Warrant Shares issuable upon exercise of this Warrant immediately prior to such adjustment and dividing the product thereof by the Exercise Price resulting from such adjustment. -3- 4 (a) If the Company, at any time while this Warrant is outstanding, (i) shall pay a stock dividend or otherwise make a distribution or distributions on shares of its Common Stock (as defined below) or on any other class of capital stock and not the Common Stock) payable in shares of the Common Stock, (ii) subdivide outstanding shares of the Common Stock into a larger number of shares, or (iii) combine outstanding shares of the Common Stock into a smaller number of shares, the Exercise Price shall be multiplied by a fraction of which the numerator shall be the number of shares of the Common Stock (excluding treasury shares, if any) outstanding before such event and of which the denominator shall be the number of shares of Common Stock (excluding treasury shares, if any) outstanding after such event. Any adjustment made pursuant to this Section shall become effective immediately after the record date for the determination of stockholders entitled to receive such dividend or distribution and shall become effective immediately after the effective date in the case of a subdivision or combination, and shall apply to successive subdivisions and combinations. (b) In case of any reclassification of the Common Stock, any consolidation or merger of the Company with or into another person, the sale or transfer of all or substantially all of the assets of the Company or any compulsory share exchange pursuant to which the Common Stock is converted into other securities, cash or property, then the Holder shall have the right thereafter to exercise this Warrant only into the shares of stock and other securities and property receivable upon or deemed to be held by holders of the Common Stock following such reclassification, consolidation, merger, sale, transfer or share exchange, and the Holder shall be entitled upon such event to receive such amount of securities or property equal to the amount of securities or property that such Holder would have been entitled to had such Holder exercised this Warrant immediately prior to such reclassification, consolidation, merger, sale, transfer or share exchange, subject to continuing adjustment as set forth herein (except that such adjustment, if any, should be in regard of the new entity or reclassified securities). The terms of any such consolidation, merger, sale, transfer or share exchange shall include such terms so as to continue to give to the Holder the right to receive the securities or property set forth in this Section 7(b) upon any exercise following any such reclassification, consolidation, merger, sale, transfer or share exchange. (c) If the Company, at any time while this Warrant is outstanding, shall distribute to all holders of Common Stock (and not to holders of this Warrant) evidences of its indebtedness or assets or rights or warrants to subscribe for or purchase any security (excluding those referred to in Sections 7(a), (b) and (d)), then in each such case the Exercise Price shall be determined by multiplying the Exercise Price in effect immediately prior to the record date fixed for determination of stockholders entitled to receive such distribution by a fraction of which the denominator shall be the Exercise Price determined as of the record date mentioned above, and of which the numerator shall be such Exercise Price on such record date less the then fair market value at such record date of the portion of such assets or evidence of indebtedness so distributed applicable to one outstanding share of Common Stock as determined by a nationally recognized or major regional investment banking firm or firm of independent certified public accountants of recognized standing (which may be the firm that regularly examines the -4- 5 financial statements of the Company) (an "Appraiser") selected in good faith by the holders of a majority in interest of the Warrants then outstanding. (d) If, at any time while this Warrant is outstanding, the Company shall issue or cause to be issued rights or warrants to acquire or otherwise sell or distribute shares of Common Stock to all holders of Common Stock for a consideration per share less than the Exercise Price then in effect, then, forthwith upon such issue or sale, the Exercise Price shall be reduced to the price (calculated to the nearest cent) determined by dividing (i) an amount equal to the sum of (A) the number of shares of Common Stock outstanding immediately prior to such issue or sale multiplied by the Exercise Price, and (B) the consideration, if any, received or receivable by the Company upon such issue or sale by (ii) the total number of shares of Common Stock outstanding immediately after such issue or sale. (e) For the purposes of this Section 7, the following clauses shall also be applicable: (i) Record Date. In case the Company shall take a record of the holders of its Common Stock for the purpose of entitling them (A) to receive a dividend or other distribution payable in shares of the Common Stock or in Convertible Securities, or (B) to subscribe for or purchase Common Stock or Convertible Securities, then such record date shall be deemed to be the date of the issue or sale of the shares of the Common Stock deemed to have been issued or sold upon the declaration of such dividend or the making of such other distribution or the date of the granting of such right of subscription or purchase, as the case may be. (ii) Treasury Shares. The number of shares of the Common Stock outstanding at any given time shall not include shares owned or held by or for the account of the Company, and the disposition of any such shares shall be considered an issue or sale of the Common Stock. (f) All calculations under this Section 7 shall be made to the nearest cent or the nearest 1/100th of a share, as the case may be. (g) Whenever the Exercise Price is adjusted pursuant to Section 7(c) above, the Company, after receipt of the determination by the Appraiser, shall have the right to select an additional Appraiser, in good faith, in which case the adjustment shall be equal to the average of the adjustments recommended by each Appraiser. The Company shall promptly mail or cause to be mailed to each Holder, a notice setting forth the Exercise Price after such adjustment and setting forth a brief statement of the facts requiring such adjustment. Such adjustment shall become effective immediately after the record date mentioned above. All determinations with respect to adjustments by the Company hereunder shall be made by the Board of Directors in good faith. (h) If: -5- 6 (i) the Company shall declare a dividend (or any other distribution) on its Common Stock; or (ii) the Company shall declare a special nonrecurring cash dividend on or a redemption of its Common Stock; or (iii) the Company shall authorize the granting to all holders of the Common Stock rights or warrants to subscribe for or purchase any shares of capital stock of any class or of any rights; or (iv) the approval of any stockholders of the Company shall be required in connection with any reclassification of the Common Stock of the Company, any consolidation or merger to which the Company is a party, any sale or transfer of all or substantially all of the assets of the Company, or any compulsory share exchange whereby the Common Stock is converted into other securities, cash or property; or (v) the Company shall authorize the voluntary dissolution, liquidation or winding up of the affairs of the Company, then the Company shall cause to be mailed to each Holder at their last addresses as they shall appear upon the Warrant Register, at least 30 calendar days prior to the applicable record or effective date hereinafter specified, a notice stating (x) the date on which a record is to be taken for the purpose of such dividend, distribution, redemption, rights or warrants, or if a record is not to be taken, the date as of which the holders of Common Stock of record to be entitled to such dividend, distributions, redemption, rights or warrants are to be determined or (y) the date on which such reclassification, consolidation, merger, sale, transfer or share exchange is expected to become effective or close, and the date as of which it is expected that holders of Common Stock of record shall be entitled to exchange their shares of Common Stock for securities, cash or other property deliverable upon such reclassification, consolidation, merger, sale, transfer, share exchange, dissolution, liquidation or winding up; provided, however, that the failure to mail such notice or any defect therein or in the mailing thereof shall not affect the validity of the corporate action required to be specified in such notice. -6- 7 8. Fractional Shares. The Company shall not be required to issue or cause to be issued fractional Warrant Shares on the exercise of this Warrant. The number of full Warrant Shares which shall be issuable upon the exercise of this Warrant shall be computed on the basis of the aggregate number of Warrant Shares purchasable on exercise of this Warrant so presented. If any fraction of a Warrant Share would, except for the provisions of this Section 8, be issuable on the exercise of this Warrant, the Company shall pay an amount in cash equal to the Exercise Price multiplied by such fraction. 9. Notices. Any and all notices or other communications or deliveries hereunder shall be in writing and shall be deemed given and effective on the earliest of (i) the date of transmission, if such notice or communication is delivered via facsimile at the facsimile telephone number specified in this Section prior to 4:30 p.m. (Eastern Standard Time) on a business day, (ii) the business day after the date of transmission, if such notice or communication is delivered via facsimile at the facsimile telephone number specified in this Section later than 4:30 p.m. (Eastern Standard Time) on any date and earlier than 11:59 p.m. (Eastern Standard Time) on such date, (iii) the business day following the date of mailing, if sent by nationally recognized overnight courier service, or (iv) upon actual receipt by the party to whom such notice is required to be given. The addresses for such communications shall be: (1) if to the Company, to Substance Abuse Technologies, Inc., 4517 N.W. 31st Avenue, Ft. Lauderdale, Florida 33309, Attention: Chief Executive Officer, or to facsimile no. (954) 714-5049, or (ii) if to the Holder, to the Holder at the address or facsimile number appearing on the Warrant Register or such other address or facsimile number as the Holder may provide to the Company in accordance with this Section 9. 10. Warrant Agent. (a) The Company shall serve as warrant agent under this Warrant. Upon thirty (30) days' notice to the Holder, the Company may appoint a new warrant agent. (b) Any corporation into which the Company or any new warrant agent may be merged or any corporation resulting from any consolidation to which the Company or any new warrant agent shall be a party or any corporation to which the Company or any new warrant agent transfers substantially all of its corporate trust or shareholders services business shall be a successor warrant agent under this Warrant without any further act. Any such successor warrant agent shall promptly cause notice of its succession as warrant agent to be mailed (by first class mail, postage prepaid) to the Holder at the Holder's last address as shown on the Warrant Register. -7- 8 11. Miscellaneous. (a) This Warrant shall be binding on, and inure to the benefit of, the parties hereto and their respective successors and permitted assigns. This Warrant may be amended only in writing signed by the Company and the Holder. (b) Subject to Section 11(a), above, nothing in this Warrant shall be construed to give to any person or corporation other than the Company and the Holder any legal or equitable right, remedy or cause under this Warrant; this Warrant shall be for the sole and exclusive benefit of the Company and the Holder. (c) This Warrant shall be governed by and construed and enforced in accordance with the internal laws of the State of New York without regard to the principles of conflicts of law thereof. (d) The headings herein are for convenience only, do not constitute a part of this Warrant and shall not be deemed to limit or affect any of the provisions hereof. (e) In case any one or more of the provisions of this Warrant shall be invalid or unenforceable in any respect, the validity and enforceability of the remaining terms and provisions of this Warrant shall not in any way be affected or impaired thereby and the parties will attempt in good faith to agree upon a valid and enforceable provision which shall be a commercially reasonable substitute therefor, and upon so agreeing, shall incorporate such substitute provision in this Warrant. -8- 9 IN WITNESS WHEREOF, the Company has caused this Warrant to be duly executed by its authorized officer as of the date first indicated above. SUBSTANCE ABUSE TECHNOLOGIES, INC. By:_______________________________ Name:_____________________________ Title:____________________________ 10 FORM OF ELECTION TO PURCHASE (To be executed by the Holder to exercise the right to purchase shares of Common Stock under the foregoing Warrant) To Substance Abuse Technologies, Inc.: In accordance with the Warrant enclosed with this Form of Election to Purchase, the undersigned hereby irrevocably elects to purchase _____________ shares of Common Stock ("Common Stock"), $.01 par value per share, of Substance Abuse Technologies, Inc. and encloses herewith $________ in cash or certified or official bank check or checks, which sum represents the aggregate Exercise Price (as defined in the Warrant) for the number of shares of Common Stock to which this Form of Election to Purchase relates, together with any applicable taxes payable by the undersigned pursuant to the Warrant. The undersigned requests that certificates for the shares of Common Stock issuable upon this exercise be issued in the name of PLEASE INSERT SOCIAL SECURITY OR TAX IDENTIFICATION NUMBER ________________________________ ________________________________________________________________________________ (Please print name and address) ________________________________________________________________________________ ________________________________________________________________________________ If the number of shares of Common Stock issuable upon this exercise shall not be all of the shares of Common Stock which the undersigned is entitled to purchase in accordance with the enclosed Warrant, the undersigned requests that a New Warrant (as defined in the Warrant) evidencing the right to purchase the shares of Common Stock not issuable pursuant to the exercise evidenced hereby be issued in the name of and delivered to: ________________________________________________________________________________ (Please print name and address) ________________________________________________________________________________ ________________________________________________________________________________ Dated:_______________,_____ Name of Holder: (Print)______________________________________ (By:)________________________________________ (Name:) (Title:) (Signature must conform in all respects to name of holder as specified on the face of the Warrant) 11 [To be completed and signed only upon transfer of Warrant] FOR VALUE RECEIVED, the undersigned hereby sells, assigns and transfers unto ________________________________ the right represented by the within Warrant to purchase ____________ shares of Common Stock of Substance Abuse Technologies, Inc. to which the within Warrant relates and appoints ________________ attorney to transfer said right on the books of Substance Abuse Technologies, Inc. with full power of substitution in the premises. Dated: ______________,_____ ____________________________________________ (Signature must conform in all respects to name of holder as specified on the face of the Warrant) ____________________________________________ Address of Transferee ____________________________________________ ____________________________________________ In the presence of: __________________________ EX-27 7 FINANCIAL DATA SCHEDULE
5 1,000 YEAR MAR-31-1997 APR-01-1996 MAR-31-1997 634 0 1,123 650 17 1,399 2,384 1,137 8,154 2,781 0 0 412 360 (957) 8,154 953 2,724 735 14,033 306 583 331 (15,696) 0 (15,129) (315) 0 0 (15,444) (0.44) (0.44)
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