-----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, V2ae4xqhctE7SFam/cEtkxJ+V2HZhl7djISHLJAov20yhPJGHY7tuYfYqqmuIBCY Ujc3f5sQZfram0lFZE21Zg== 0001005477-02-001437.txt : 20020415 0001005477-02-001437.hdr.sgml : 20020415 ACCESSION NUMBER: 0001005477-02-001437 CONFORMED SUBMISSION TYPE: 10KSB PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 20011231 FILED AS OF DATE: 20020329 FILER: COMPANY DATA: COMPANY CONFORMED NAME: INFINITE GROUP INC CENTRAL INDEX KEY: 0000884650 STANDARD INDUSTRIAL CLASSIFICATION: MISCELLANEOUS ELECTRICAL MACHINERY, EQUIPMENT & SUPPLIES [3690] IRS NUMBER: 521490422 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10KSB SEC ACT: 1934 Act SEC FILE NUMBER: 000-21816 FILM NUMBER: 02593779 BUSINESS ADDRESS: STREET 1: 2364 POST RD STREET 2: 923 INCLINE WAY 8 CITY: WARWICK STATE: RI ZIP: 02886 BUSINESS PHONE: 4017385777 MAIL ADDRESS: STREET 1: 2364 POST ROAD STREET 2: 923 INCLINE WAY 8 CITY: WARWICK STATE: RI ZIP: 02886 FORMER COMPANY: FORMER CONFORMED NAME: INFINITE MACHINE CORP DATE OF NAME CHANGE: 19971015 10KSB 1 d02-36881.txt FORM 10-K FORM 10-KSB SECURITIES AND EXCHANGE COMMISSION Washington D.C. 20549 (Mark One) |X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Fiscal Year Ended December 31, 2001 OR |_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission File Number 0-21816 INFINITE GROUP, INC. -------------------- (Exact name of registrant as specified in its charter) Delaware 52-1490422 - ----------------------------------- ------------------------------------- (State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.) 2364 Post Road, Warwick, RI 02886 - ----------------------------------- ------------------------------------- (Address of principal executive offices) (Zip Code) Issuer's telephone number (401) 738-5777 Securities registered under Section 12(b) of the Exchange Act: Name of each exchange on which Title of each class registered - ----------------------------------- ------------------------------------- None None Securities registered under Section 12(g) of the Exchange Act: Common Stock, $.001 par value (Title of class) 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-B is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-KSB or any amendment to this Form 10-KSB. |_| The registrant's revenues for the year ended December 31, 2001 were $8,507,648. As of March 27, 2002, there were 5,577,086 outstanding shares of common stock, par value $0.001 per share. The aggregate market value of the voting stock of the registrant held by non-affiliates of the registrant on March 27, 2002, based on the average bid and asked price on such date was $11,711,881. DOCUMENTS INCORPORATED BY REFERENCE: None. Transitional Small Business Disclosure Format: Yes |_| No |X| INFINITE GROUP, INC. Form 10-KSB TABLE OF CONTENTS Page ---- PART I Item 1.Business 3 Item 2.Properties 16 Item 3.Legal Proceedings. 16 Item 4.Submission of Matters to a Vote of Security Holders 16 PART II Item 5. Market for Common Equity and Related Stockholder Matters 17 Item 6. Management's Discussion and Analysis of Financial Condition and Results of Operations 18 Item 7. Financial Statements 25 Item 8. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure 25 PART III Item 9. Directors and Executive Officers 26 Item 10. Executive Compensation 29 Item 11. Security Ownership of Certain Beneficial Owners and Management 33 Item 12. Certain Relationships and Related Transactions 35 Item 13. Exhibits, and Reports on Form 8-K 36 PART IV Item 14. Financial Statements F-1 FORWARD LOOKING STATEMENT INFORMATION Various statements made in this Annual Report on Form 10-KSB are "forward-looking statements" (within the meaning of the Private Securities Litigation Reform Act of 1995) regarding the plans and objectives of management for future operations. These statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by these "forward-looking statements." The "forward-looking statements" included in this report are based on current expectations that involve numerous risks and uncertainties. Our plans and objectives are based, in part, on assumptions involving judgments about, among other things, future economic, competitive and market conditions and future business decisions, all of which are difficult or impossible to predict accurately and many of which are beyond our control. Although we believe that our assumptions underlying the forward-looking statements are reasonable, any of these assumptions could prove inaccurate and, therefore, we cannot assure you that the forward-looking statements included in this report will prove to be accurate. In light of the significant uncertainties inherent in the forward-looking statements included in this report, the inclusion of these statements should not be interpreted by anyone that our objectives and plans will be achieved. Factors that could cause actual results to differ materially from those expressed or implied by forward-looking statements include, but are not limited to, the factors set forth elsewhere in this Report under the headings "Business," "Factors That May Affect Future Growth," and Management's Discussion and Analysis of Financial Condition and Results of Operations." 2 PART I BUSINESS We operate through two business segments, our Laser Group and our Photonics Group. Our Laser Group provides comprehensive laser-based materials and processing services. Our Photonics Group develops and markets diodes for source and pump lasers and semiconductor optical amplifiers. During 2001, we also had a Plastics Group, which consisted of two subsidiaries, Express Pattern, Inc. (EP) and Osley & Whitney, Inc. (O&W). Our Plastics Group provided rapid prototyping services and proprietary mold building services. In November 2001 and December 2001, our board of directors determined to dispose of O&W and EP. Our plan consisted of shutting down the operations of O&W and selling the assets of EP. The sale of EP was consummated on March 14, 2002 and we are in the process of selling off the remaining assets of O&W. The Laser Group Our Laser Group provides laser-based manufacturing services (cutting, welding, drilling and assembly) to industrial customers. It uses 26 multi-axis laser workstations to process parts ranging in size from very large (jet engine or gas turbine parts) to very small medical products, such as stents (stents are medical implants used to open veins for better blood flow). We use lasers to fabricate components for customers in the aerospace, defense, medical, telecommunications and sensing industries. We have developed proprietary manufacturing techniques that, we believe, have established us as a valued supplier of engineered components. Substantially all of our laser workstations employ multi-axis lasers, commonly used for industrial component fabrication. One of our laser workstations uses a new system developed with and licensed from Sandia National Laboratories (Sandia). This workstation uses a process called Laser Engineered Net Shaping (LENS(R)), which was developed cooperatively at Sandia by Sandia and a consortium that included our Laser Group, Ford, Motorola, Lockheed Martin and others. The LENS(R) workstation is used to make parts or resurface parts directly in metal by introducing powdered metals through a feeder system, melting the airborne powdered metals as they pass through a small tube with a laser beam, and depositing the metal on to a surface. This process is computer controlled and the systems deposit metals based on information provided from three-dimensional engineering files, such as AutoCad(R). LENS(R) workstations are useful for the overhaul and repair of expensive aerospace parts that would otherwise be discarded, and for depositing rare metals, such as titanium, in complex structures used in medical devices. Lockheed Martin, Barnes Aerospace, United States Government military overhaul depots and Triton Systems are our primary customers to date for these services. The United States Federal Aviation Administration (FAA) has licensed us to perform overhaul and repair of jet engine and aerospace parts and the United States Food and Drug Administration (FDA) has licensed us as a contract manufacturer of medical devices. Our customers are responsible for obtaining all regulatory approvals of their products or components; we solely manufacture these components to our customers' specifications. We cut, weld, drill and / or 3 assemble parts for over 100 industrial companies, including: General Electric Jet Engine and Gas Turbine divisions; United Technologies' Jet and Aerospace; Barnes Aerospace; Johnson & Johnson; Mitek, Smith & Nephew; Dey Laboratories; and Stryker Medical. Our Laser Group also provides laser-related contract research and development. We are both a prime contractor and subcontractor on several projects sponsored by the Defense Advanced Research Projects Agency (DARPA). We are a subcontractor on all four of DARPA's Mesoscopic Integrated Conformal Electronics (or MICE) programs. Mesoscopic refers to "handheld", and MICE programs are aimed at providing a series of sophisticated handheld devices for military, industrial and consumer use based on very small electronic components, many of which may be manufactured using lasers. Other research and development projects include acoustic bandgap research for the United States Naval Underwater Warfare Center and the Electric Boat division of General Dynamics, as well as photonic bandgap and high temperature superconductor research for the United States Air Force Research Laboratory (AFRL). The Laser Group employs 68 full-time technical and engineering personnel in Smithfield and Narragansett, RI in 16,800 square feet of facilities that we own and 8,326 square feet of facilities that we lease. The Photonics Group Photonics is the science of generating and harnessing light to do useful work. Lasers and fiber optics are the best-known expressions of photonics technology. We believe photonics technology will be as important to the 21st century as electronics was to the 20th century. The basic unit of light is the photon, while in electronics it is the electron. Because photons are massless and travel faster than electrons, photonic devices can be smaller and significantly faster than electronic devices. For example, replacing electronics (copper wire) with photonics (fiber optic cable) boosts the capacity of telecommunications transmission lines by a factor of 10,000. Photonic components are the "enabling technology" in many familiar consumer products including CD-ROM players, digital cameras, displays on laptop computers and calculators, fiber optic cable for telephones, cable television and networked computer systems. In industry, photonic "eyes" enable robots to "see." Photonics is also found in semiconductor manufacturing as well as analytical and process-monitoring applications. In medicine, photonics is at the core of diagnostic instrumentation, laser microsurgery, and filmless real-time imaging. In April 2001, we organized Infinite Photonics, Inc. to develop and market laser diodes based on our proprietary, patented and patent pending grating coupled surface emitting lasers (GCSEL) diode technology platform developed by our Laser Group's research and development unit over the last four years. In addition to our staff researchers, we also engaged researchers at the Photonics Research Center at the University of Connecticut, the Ioffe Institute in St. Petersburg, Russia and the Center for Research and Education in Optics and Lasers at the University of Central Florida in Orlando to develop applications of our GCSEL's. To date we have obtained one patent (expiring in 2018), have ten patents pending and an additional ten patents are under 4 development for GCSEL and related technologies. We own the intellectual property, which in addition to patents and patent applications, includes the trade secrets and processing techniques used to manufacture these diodes. Our diode lasers are produced from two to four inch semiconductor wafer material, usually indium phosphide (InP), gallium arsenide (GaAs), or gallium nitride (GaN). The semiconductor wafer material chosen determines the wavelength of the laser beam, such as 980 nanometers for GaAs, 1550 nanometers for InP, and 1480 nanometers for GaN. A nanometer is one billionth of a meter. The semiconductor diode wafers we currently use in the manufacture of GCSEL's are processed at Industrial Microphotonics Company (a TRW subsidiary). We are currently qualifying a second wafer-manufacturing source, as required by most larger telecommunications equipment manufacturers. A three-inch semiconductor wafer has the potential to produce substantially more than 2,000 individual diode lasers as small as a millimeter by one and one-half millimeters. Each diode can emit laser energy (lase) with continuous power of greater than one watt. Each individual diode has two sections, active and passive. The passive area of each diode on the wafer is etched with one of a variety of grating patterns. It is through this grating on the surface of the diode that the laser beam emits, hence the name, Grating Coupled Surface Emitting Laser. At the opposite end of the diode from the grating, a contact is placed on the diode to provide electrical power, and a thermo-electric cooler or heat sink may be used to cool the diode during operation. When electrical power is applied to the contact, lasing begins in the semiconductor material, and laser energy is emitted through the grating. The device is packaged to protect the diode, along with a very small focusing lens, and that lens is used to focus the laser beam into the end of the fiber optic cable. Our competitors produce diode lasers that can either emit from the edge of the wafer material, such as processes known as Fabry-Perot or Distributed Feedback diode lasers, or through the surface, such as through a surface emitting technology different from ours, known as Vertically Coupled Surface Emitting Lasers. Each technology has different characteristics in terms of cost, power output and laser beam quality. We believe that our GCSEL diodes produce the best overall combination of cost, power and beam quality of emitted light. Because the beam comes out of the grating in a cylindrical shape (low beam spreading), our diodes require lower cost focusing optics. Emitting the beam from the wide surface of the wafer (as opposed to the narrow edge of the wafer) allows our diodes to be tested on the wafer, which provides lower test, burn-in and packaging costs. Finally, the very narrow line width of the beam allows for tunability over a greater number of available channels. The qualities of our diode lasers in comparison to competitive diodes include: o Power of up to eight watts compared to currently commercially available power of under one watt; o Beam spreading of less than one degree as compared to 12 to 30 degrees for edge emitted laser energy (which reduces the cost and complexity of the optics needed to focus to the fiber); and o Relatively narrow line width of emitted laser energy (which allows for more than 50 communication channels on a single fiber optic cable). 5 We have many of the same disadvantages of most emerging technology start-ups, which includes among others: market acceptance of a new technology; customer commitment to engineer or re-engineer their products to incorporate our technology; the need to expand rapidly and attract talented personnel; and the need to raise capital to fund that expansion. On January 23, 2002, Infinite Photonics, Inc. signed and commenced a $12.0 million research and development contract with DARPA, which is scheduled to conclude by the end of 2003. The purpose of the contract is to provide DARPA with pump and source laser diodes and grating coupled semiconductor optical amplifiers with powers much higher than the current industry standard of about 0.3 watts (more than one watt with a goal as high as ten watts), high repetition rates (up to 20,000 laser pulses per second), and high beam quality (minimum beam spreading of the laser). We will own the intellectual property developed under the contract. In March 2002, we signed a one-year lease with the Central Florida Research Park in Orlando, Florida for a 6,750 square foot laboratory and manufacturing facility. This facility replaces laboratory and office space we were leasing on a short-term basis from the University of Central Florida. Depending on market acceptance of our products once we achieve full production, we may require more space in the foreseeable future. Our Photonics Group employs ten full-time personnel. We expect to grow our Photonics Group staff to approximately 30 to 40 full-time employees by the end of 2002. We currently have subcontractors producing raw material (semiconductor wafers), electrical drivers, power supplies and devices to control the heat produced by our diodes (thermal management). The proprietary grating patterns etched into the semiconductor wafers for different applications are accomplished at our current facilities in Orlando, FL and in St. Petersburg, Russia at the Ioffe Institute. We expect to acquire a minimum of approximately $1.2 million in capital equipment over the next year through equipment operating leases that will be negotiated under terms available at the time of acquisition. Additionally, we currently have semiconductor steppers and other relatively high cost equipment available to us on a per hour basis from the University of Central Florida, as well as from other commercial facilities. We estimate that this equipment will support up to $10.0 million in annual revenue capacity. Our Florida facility is certified for exemption by the Governor's Office from sales and use taxes under Florida's Semiconductor, Defense and Space Technology Facilities Program. We intend to continue to use a combination of direct sales to customers, contract research and development for new and existing customer applications and early stage prototype assistance to foster our Photonics Group's growth. We were incorporated under the laws of the state of Delaware on October 14, 1986. On January 7, 1998, we changed our name from Infinite Machines Corp. to Infinite Group, Inc. Our principal executive offices are located at 2364 Post Road, Warwick, RI 02886 and our facsimile number is (401) 738-6180. Our subsidiaries are located in Rhode Island and Florida. We maintain sites on the World Wide Web at www.infinite-group.com, www.laserfare.com, and 6 www.infinitephotonics.com. Information contained on any of our websites do not constitute a part of this Report on Form 10-KSB. Factors that may affect future growth. In addition to the other information provided in our reports, you should consider the following factors carefully in evaluating our business and us. Additional risks and uncertainties not presently known to us, that we currently deem immaterial or that are similar to those faced by other companies in our industry or business in general, such as competitive conditions, may also impair our business operations. If any of the following risks occur, our business, financial condition, or results of operations could be materially adversely affected. We have experienced losses in the current and prior years and we anticipate that we will continue to generate operating losses for at least the first quarter of 2002. Our operations to date have not been profitable. As of December 31, 2001 we had an accumulated deficit of approximately $23.5 million. We expect to continue operating at a loss during the first quarter of 2002. The majority of the operating losses during 2001 were primarily attributable to discontinued injection molding operations at our former Osley & Whitney, Inc. subsidiary and start up costs at our Infinite Photonics, Inc. subsidiary. Other factors that could adversely affect our operating results in the future include: o the cost of manufacturing scale-up and production at our Photonics Group; o introduction of new products and product enhancements by us or our competitors; o changes in applied photonics technologies; and o changes in general economic conditions. We cannot assure you that our revenues will increase sufficiently to offset our operating costs or that, even if they do, that our operations will ever be profitable. We are highly leveraged, which increases our operating deficit and makes it difficult for us to grow. At December 31, 2001 we had current liabilities, including trade payables, of $6.2 million, and long-term liabilities of $2.6 million and a working capital deficit of $1.7 million. We continue to experience working capital shortages that impair our business operations and growth strategy. If we continue to incur operating losses and experience working capital limitations, our business, operations and financial condition will be materially adversely affected. We may require additional financing in the future, which may not be available on acceptable terms. Depending on the amount of money we raise under our existing credit facilities, we may require additional funds to expand our production capability, continue to develop new applications for our diode technology and for working capital and general corporate purposes. At this time, we cannot assure you that cash flow from product sales will reach the level required to sustain our 7 operations and growth plans in the near term. Further, we cannot assure you that adequate additional financing will be available or, if available, will be offered on acceptable terms. Our existing credit facilities limit our ability to raise capital through the sale of our securities. Accordingly, if we need additional capital but are unable to access it under our existing facilities, our access to capital may be limited. In addition, any additional equity financing may be dilutive to stockholders, and debt financings, if available, may involve restrictive covenants that further limit our ability to make decisions that we believe will be in our best interests. In the event we cannot obtain additional financing on terms acceptable to us when required, our operations will be materially adversely affected and we may have to cease or substantially reduce operations. Some of our products and services are at an early stage of development and may not achieve market acceptance. Our primary focus is to develop new commercial applications for our diode laser and laser-driven technologies. Many of the benefits of our diode laser and laser technologies are not widely known. Therefore, we anticipate that we will need to educate our target markets to generate demand for our products and services and, as a result of market feedback, we may be required to further refine these services. In order to persuade potential customers to purchase our services, we will need to overcome industry resistance to, and suspicion of, new technologies. In addition, developing new applications for these technologies and other new technologies may require significant further research, development, testing and marketing prior to commercialization. We cannot assure you that commercial applications of these technologies can be successfully developed, marketed or produced. Some of our current products and services have not been commercially successful. Our laser materials processing services have not generated a significant amount of revenue, even though they have been available for some time. In addition, since the number of jet engine, aerospace and medical device manufacturers is relatively small, most of our revenue from these businesses is generated from a limited number of customers. We cannot assure you that these customers will continue to purchase these products and services or that we will be able to expand the market for these products and services. Therefore, any material delay, retooling, cancellation or reduction in orders from the customers who purchase these products and services could have a material adverse affect on our business, operations and financial condition. We have limited marketing and sales capabilities and must make sales in fragmented markets. Our future success depends, to a great extent, on our ability to successfully market our products and services. We currently have limited sales and marketing capabilities and experience at our Photonics Group (generally limited to technical trade conferences, technical publications, and direct customer inquiry) and we will need to hire qualified sales and marketing personnel, develop additional sales and marketing programs and establish sales distribution channels in order to achieve and sustain commercial sales of our products. In addition, our ability to successfully market our products and services is further complicated by the fact that our principal markets, laser photonics, telecommunications, aerospace and medical components, are highly fragmented. Consequently, we will need to identify and successfully target particular market 8 segments in which we believe we will have the most success. These efforts will require a substantial amount of effort and resources. We cannot assure you that any marketing and sales efforts undertaken by us will be successful or will result in any significant product sales. We depend on the aerospace, laser photonic, telecommunications and medical device industries, which continually produce technologically advanced products. A majority of our sales in our Laser Group are to companies in the aerospace, laser photonic, telecommunications and medical device industries, which are subject to rapid technological change and product obsolescence. If our customers are unable to create products that keep pace with the changing technological environment and market demand, their products could become obsolete and the demand for our services could decline significantly. If we are unable to offer cost-effective, quick-response manufacturing services to customers, demand for our services will also decline. This would have a material adverse affect on our business, operations and financial condition. We depend on government research and development contracts to support our Photonics Group. Substantially all of our Photonics Group revenue has been derived from governmental research programs. Any reduction in spending on these programs would have a material adverse affect on our business, operations and financial condition. Our industry is intensely competitive, which may adversely affect our operations and financial results. All our markets are intensely competitive and numerous companies offer conventional and laser driven products and services that compete with our products and services. We anticipate that competition for our products and services will continue to increase. Most of our competitors have substantially greater capital resources, research and development staffs, manufacturing capabilities, sales and marketing resources, facilities and experience. These companies, or others, could undertake extensive research and development in laser technology and related fields that could result in technological changes. Many of these companies also are primary customers for various components, and therefore have significant control over certain markets that we have targeted. In addition, we may not be able to offer prices as low as some of our competitors because those competitors may have lower cost structures. Our inability to provide comparable or better products and services at a lower cost than our competitors could adversely effect demand for our products and services. We cannot assure you that our competitors will not succeed in developing technologies in these fields which will enable them to offer laser services more advanced and less costly than those we offer or which could render our technologies obsolete. 9 Our products and services are subject to industry standards, which increases their cost and could delay or bar their commercial acceptance. Since some of our products and services in development are used in the telecommunications industry, they must comply with the Bellcore Testing standards for traditional equipment and/or Bluetooth standards for wireless devices. These standards govern the design, manufacture and marketing of these items. If we fail to comply with these standards, we will not be able to sell our products. We may encounter significant delays or incur additional costs in our efforts to comply with these industry standards. We depend on our relationship with third parties to develop and commercialize new products. Our strategy for research and development and for the commercialization of our products contemplates a continuing relationship with various publicly and privately funded consortia and our existing relationships will continue with strategic partners, original equipment manufacturers (OEMs), potential licensees and others. We depend on these associations and relationships not only to underwrite our research and development efforts, but also for product testing and to create markets for our products and services. The majority of our product research has been funded by customers or potential customers. We cannot assure you that our existing relationships will continue or the extent to which the parties to such arrangements will continue to allocate time of resources to these strategic alliances. Similarly, we cannot assure you that we will be able to enter into new arrangements in the future. In addition, we cannot assure you that any agreement will progress to a production phase or, if production commences, that we will receive significant revenues as a result of these relationships. The majority of our relationships for product development or contract research is for one to two years in duration, and is generally cancelable based on attaining or not attaining the customers' milestones. We have only limited manufacturing capabilities and our inability to continuously manufacture products on a cost-effective basis would harm our business. We have limited production facilities and limited experience in manufacturing our product offerings. To the extent any of our existing or future products must be produced in commercially reasonable quantities, we will have to either develop that expertise quickly or outsource that function. Developing manufacturing capability is an expensive and time-consuming endeavor and we do not have the resources that are required for a full-scale manufacturing capability. Therefore, in all likelihood we will have to engage a third party to manufacture our products for us. In that event, we will depend on the manufacturer to produce high-quality products based on our specifications, on time and within budget. If we are unable to manufacture products in sufficient quantities and in a timely manner to meet customer demand ourselves or by others, our business, financial condition and results of operations will be materially adversely affected. We depend on our intellectual property rights to provide us with a competitive advantage. Our ability to compete successfully depends, in part, on our ability to protect our products and technologies under United States and foreign patent laws, to preserve trade secrets and other proprietary information and technologies, and to operate without infringing the proprietary rights 10 of others. We cannot assure you that patent applications relating to our products or potential products will result in patents being issued, that any issued patents will afford adequate protection or not be challenged, invalidated, infringed or circumvented, or that any rights granted will give us a competitive advantage. Furthermore, we cannot assure you that others have not independently developed, or will not independently develop, similar products and/or technologies, duplicate any of our product or technologies, or, if patents are issued to, or licensed by, us, design around those patents. We cannot assure you that patents owned or licensed and issued in one jurisdiction will also be issued in any other jurisdiction. In addition, we cannot assure you that we can adequately protect our proprietary technology and processes that we maintain as trade secrets. If we are unable to develop and adequately protect our proprietary technology and other assets, our business, financial condition and results of operations will be materially adversely affected. We depend on the continued services of our key personnel. Our future success depends, in part, on the continuing efforts of our senior executive officers, Clifford G. Brockmyre II, Thomas Mueller, Bruce J. Garreau, and Jeff Bullington who conceived our strategic plan and who are responsible for executing that plan. The loss of any of these key employees may adversely affect our business. At this time we do not have any term "key man" insurance on any of these executives other than a $1.7 million policy on Clifford G. Brockmyre II. If we lose the services of any of these senior executives, our business, operations and financial condition could be materially adversely affected. We may have difficulties in managing our growth. Our future growth depends, in part, on our ability to implement and expand our financial control systems and to expand, train and manage our employee base and provide support to an expanded customer base. If we cannot manage growth effectively, it could have material adverse effect on our results of operations, business and financial condition. Acquisitions and expansion involve substantial infrastructure and working capital costs. We cannot assure you that we will be able to integrate our acquisitions and expansions efficiently. Similarly, we cannot assure you that we will continue to expand or that any expansion will enhance our profitability. If we do not achieve sufficient revenue growth to offset increased expenses associated with our expansion, our results will be adversely affected. We must attract, hire and retain qualified personnel. As we continue to develop new products and as our business grows, significant demands will be placed on our managerial, technical, financial and other resources. One of the keys to our future success will be our ability to attract, hire and retain highly qualified scientific, engineering, marketing, sales and administrative personnel. Competition for qualified personnel in these areas is intense and we will be competing for their services with companies that have substantially greater resources than we do. We cannot assure you that we will be able to identify, attract and retain employees with skills and experience necessary and relevant to the future operations of our business. Our inability to retain or attract qualified personnel in these areas could have a material adverse effect on our business and results of operations. 11 We face potential product liability claims. The sale of our telecommunications, aerospace and medical products and services will involve the inherent risk of product liability claims by others. We maintain product liability insurance coverage. However, we cannot assure that the amount and scope of our existing coverage is adequate to protect us in the event that a product liability claim is successfully asserted. Moreover, we cannot assure you that we will continue to maintain the coverage we currently have. Product liability insurance is expensive, subject to various coverage exclusions and may not always be obtainable on terms acceptable to us. Our stock price is volatile and could be further affected by events not within our control. The trading price of our common stock has been volatile and will continue to be subject to: o volatility in the trading markets generally; o significant fluctuations in our quarterly operating results; o announcements regarding our business or the business of our competitors; o changes in prices of our or our competitors' products and services; o changes in product mix; and o changes in revenue and revenue growth rates for us as a whole or for geographic areas, and other events or factors. Statements or changes in opinions, ratings or earnings estimates made by brokerage firms or industry analysts relating to the markets in which we operate or expect to operate could also have an adverse effect on the market price of our common stock. In addition, the stock market as a whole has from time to time experienced extreme price and volume fluctuations which have particularly affected the market price for the securities of many small cap companies and which often have been unrelated to the operating performance of these companies. The price of our common stock may be adversely affected by the possible issuance of shares under our credit facilities and as a result of the exercise of outstanding warrants and options. In addition to the shares that may be issuable under our credit facilities, as of December 31, 2001 we have granted options covering 1,036,037 shares of our common stock under our stock option plans. In addition, we have issued warrants covering 1,083,375 shares of common stock. As a result of the actual or potential sale of these shares into the market, our common stock price may decrease. Concentration of ownership As of March 27, 2002, our chief executive officer, Clifford G. Brockmyre II, is our largest stockholder, owning approximately 24% of the issued and outstanding shares of our common stock. Mr. Brockmyre, as a result, effectively controls all our affairs, including the election of directors and any proposals regarding a sale of the Company or its assets or a merger. 12 Some provisions in our charter documents and bylaws may have anti-takeover effects. Our certificate of incorporation and bylaws contain provisions that may make it more difficult for a third party to acquire us, with the result that it may deter potential suitors. For example, our board of directors is authorized, without action of the stockholders, to issue authorized but unissued common stock and preferred stock. The existence of undesignated preferred stock and authorized but unissued common stock enables us to discourage or to make it more difficult to obtain control of us by means of a merger, tender offer, proxy contest or otherwise. Absence of dividends to shareholders. We have never declared a dividend on our common stock. We do not anticipate paying dividends on the common stock in the foreseeable future. We anticipate that earnings, if any, will be reinvested in the expansion of our business and debt reduction. We have agreed to limitations on the potential liability of our directors. Our certificate of incorporation provides that, in general, directors will not be personally liable for monetary damages to the company or our stockholders for a breach of fiduciary duty. Although this limitation of liability does not affect the availability of equitable remedies such as injunctive relief or rescission, the presence of these provisions in the certificate of incorporation could prevent us from recovering monetary damages. We must maintain compliance with certain criteria in order to maintain listing of our shares on the Nasdaq market. Our common stock is traded on the Nasdaq SmallCap Market. In order to maintain this listing, we are required to meet certain requirements relating to our stock price and net tangible assets of $2.0 million (stockholders' equity, less unamortized goodwill). If we fail to meet these requirements, our stock could be delisted. If our stock is delisted, it will trade on the OTC Bulletin Board or in the "pink sheets" maintained by the National Quotation Bureau Incorporated. As a consequence of such delisting, an investor could find it more difficult to dispose of or to obtain accurate quotations as to the market value of our securities. Among other consequences, delisting from Nasdaq may cause a decline in our stock price and difficulty in obtaining future financing. The liquidity of our stock could be severely reduced if it becomes classified as "penny stock". The Securities and Exchange Commission has adopted regulations which generally define a "penny stock" to be any non-Nasdaq equity security that has a market price (as therein defined) of less than $5.00 per share or with an exercise price of less than $5.00 per share. If our securities were subject to the existing rules on penny stocks, the market liquidity for our securities could be severely adversely affected. For any transaction involving a penny stock, unless exempt, the rules require substantial additional disclosure obligations and sales practice obligations on broker-dealers where the sale is to persons other than established customers and accredited investors (generally, those persons with assets in excess of $1,000,000 or annual income 13 exceeding $200,000, or $300,000 together with their spouse). For transactions covered by these rules, the broker-dealer must make a special suitability determination for the purchase of the common stock and have received the purchaser's written consent to the transaction prior to the purchase. Additionally, for any transaction involving a penny stock, unless exempt, the rules require the delivery, prior to the transaction, of a risk disclosure document mandated by the Commission relating to the penny stock market. The broker-dealer also must disclose the commissions payable to both the broker-dealer and the registered representative, current quotations for the securities and, if the broker-dealer is the sole market maker, the broker-dealer must disclose this fact and the broker-dealer's presumed control over the market. Finally, monthly statements must be sent disclosing recent price information for the penny stock held in the account and information on the limited market in penny stocks. Consequently, the "penny stock" rules may restrict the ability of broker-dealers to sell the common stock and accordingly the market for our common stock. Customer concentration Both our Laser Group and our Photonics Group have experienced significant customer concentration. The Laser Group sells laser services to over 100 customers for jet engine and aerospace parts including: General Electric; United Technologies; Rolls Royce Allison; Barnes Aerospace; and Orenta. Medical laser services are sold to over 20 customers, including Dey Laboratories (a Merck Germany unit), Stryker Medical, and Johnson & Johnson. In our Photonics Group, over 90% of our revenues are derived from sales to the United States Government, including DARPA and AFRL. Due to the concentration of revenues in both groups, loss of any of these customers could have a significant detrimental effect on that group's business and financial results. Government regulation To meet aerospace and medical device customer needs, our Laser Fare subsidiary is certified for overhaul and repair by the FAA, and as a Contract Manufacturer by the FDA. We maintain the overhaul and repair license in order to perform laser material processing services on jet engine parts (cutting, welding, drilling) and to use the LENS process to repair or deposit titanium or other metals to aerospace components. Additionally, we maintain the license with the FDA as a contract manufacturer of medical devices to produce such products as asthma testing devices for Dey Laboratories (in which some of the components are cut using laser workstations). However, customers are responsible for the sale and distribution of their products and devices and we do not believe we have liability to end users. As we perform government defense contracts in both our Laser and Photonics Groups, a number of our employees have received National Security Clearance by the appropriate agencies, and we are responsible for compliance with Federal Acquisition Regulations, or "FAR's." In addition, we are audited by the Defense Contract Audit Agency (DCAA), who must periodically approve our hourly billing rates for direct labor charged to our federal contracts. 14 Patents and intellectual property Our patents and patent applications relate to diode grating structure, design and processes to produce the diode; thermal management devices to control the heat of the diode and other manufacturing processes; titanium processes for the LENS application, and other manufacturable product discovered or acquired in the course of our research. The majority of our intellectual property is employed directly in the development and manufacture of laser diodes, products using the LENS process or processes used to provide laser processing services. For intellectual property that we discover or develop that is not related to our core businesses, we intend to seek to license or sell this technology to unaffiliated third parties. Competition Our Laser Group's materials processing business competes with laser and traditional job shops. We principally compete with universities and large corporations for some of our laser research services. Our proprietary technology allows us to compete in these markets. Our Photonics Group competes in the estimated $6.0 billion laser diode market. Laser diodes are produced for a large number of consumer, industrial and government purposes. We are focused on three of the larger components of those markets: telecommunications; materials processing; and medical products. We compete against a large global market of component manufacturers, and against many large, well-funded diode manufacturers including industry leaders, such as JDS Uniphase, Nortel, Coherent and Novalux. Much of the industry addresses low to mid-range power applications under 0.5 watts, such as edge emitting diode and vertically coupled surface emitting laser manufacturers. Our product development program is concentrated on applications requiring mid to high power (greater than 1.0 watts), relatively high beam quality (beam spreading less than 1%), and narrow line width (for greater than 50 channel applications). We believe that such applications are and will be important to current and future telecommunications requirements for optical amplification (Raman and EDFA); materials processing applications for ablation (low heat affected zone), and medical applications (low heat affected zone). We compete with different manufacturers, depending on the type of service or product we provide and the geographic locale of our different operations. Most of our competitors have greater manufacturing, financial, research and development and/or marketing resources than we have. In addition, we may not be able to offer prices as low as some of our competitors because those competitors may have lower cost structures as a result of their geographic location, economies of scale, or the services they provide. Our inability to provide comparable or better manufacturing services at a lower cost than our competitors could cause our net sales to decline. Employees As of March 29, 2002, we had 78 full-time employees including 38 production personnel, 26 engineering and research personnel, three sales personnel and 11 general and administrative personnel. Our ability to develop, manufacture and market our products and service, and to establish and maintain a competitive position in our businesses will depend, in large part, upon our ability to attract and retain qualified technical, marketing and managerial personnel, of which 15 there can be no assurance. We believe that our relations with our employees are good. None of our employees are covered by a collective bargaining agreement. Properties The table below lists our manufacturing and administrative office locations and square feet owned or leased. The Orlando, Florida rent includes electric power, water and high speed internet.
Square feet ---------------------------- Location Owned Leased Annual Rent Termination Date - --------------------- ----------- ------------- -------------- ------------------- Warwick, RI -- 2,223 $ 35,568 2002 Smithfield, RI 16,800 8,000 $ 28,800 Month to Month Narragansett, RI -- 326 $ 6,850 2002 Orlando, FL -- 6,750 $ 104,123 2003
We anticipate the need for additional manufacturing facilities in the foreseeable future that we believe will be available on commercially reasonable terms. We believe all properties are in good operating condition. We do not expect to renew the leases for our Warwick and Narragansett facilities in our continuing effort to reduce general and administrative costs, and to further consolidate functions and personnel either in Smithfield, RI or Orlando, FL. Legal proceedings We are a defendant in an action commenced in the Circuit Court for the Sixteenth Judicial Circuit, Kane County, Illinois, by Craftsman Tool & Mold Co. in which the plaintiff alleges that we guaranteed an obligation of O&W in the approximate amount of $130,000. We intend to vigorously defend this action, and believe the plaintiff's position is without merit. We are the plaintiff in a lawsuit filed in the Rhode Island Superior Court on August 13, 1999 captioned Infinite Group, Inc. vs. Spectra Science Corporation and Nabil Lawandy. In the action we assert that by fraud and in breach of fiduciary duties owed, Spectra and its president Nabil Lawandy, caused us to sell to Spectra shares of Spectra's Series A Preferred Stock at a substantial discount to fair market value. We allege that in entering into the transaction we relied on various representations made by Spectra and Mr. Lawandy, which were untrue at the time they were made. In the action we seek compensatory damages in the amount of $500,000 plus punitive damages as well as an award of attorney's fees and costs. In its response to the complaint, Spectra has asserted counterclaims against us which we believe are without merit. Other than the foregoing proceeding, we are not a party to any material legal proceeding. Submission of matters to a vote of security holders None. 16 PART II Market for common equity and related stockholder matters Our common stock is quoted on the Nasdaq SmallCap Market System ("Nasdaq") under the symbol "IMCI". The following table sets forth the high and low bid prices of the common stock for the past two fiscal years by quarter as reported by Nasdaq. Quotations represent interdealer prices without an adjustment for retail markups, markdowns or commissions and may not represent actual transactions. Period High Low ------ ---- --- 2001 First Quarter $4.234 $1.500 Second Quarter 3.990 1.688 Third Quarter 3.320 1.600 Fourth Quarter 4.170 1.500 2000 First Quarter $18.375 $ 1.063 Second Quarter 4.938 1.531 Third Quarter 6.125 2.000 Fourth Quarter 4.000 1.375 As of March 27, 2002, we believe that we had approximately 1,650 beneficial stockholders. Dividend policy We do not expect to declare or pay any dividends in the foreseeable future. Instead, we intend to retain all earnings, if any, in order to expand our operations. The payment of dividends, if any, in the future is within the discretion of our board of directors and will depend upon our earnings, if any, our capital requirements and financial condition and other relevant factors. Under the terms of our credit facilities, we are prohibited from paying dividends or making other cash distributions. 17 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Cautionary statement identifying important factors that could cause our actual results to differ from those projected in forward-looking statements. Pursuant to the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995, readers of this report are advised that this document contains both statements of historical facts and forward-looking statements. Forward-looking statements are subject to certain risks and uncertainties, which could cause actual results to differ materially from those indicated by the forward-looking statements. Examples of forward looking statements include, but are not limited to (i) projections of revenues, income or loss, earnings per share, capital expenditures, dividends, capital structure and other financial items, (ii) statements of our plans and objectives, including product enhancements, or estimates or predictions of actions by customers, suppliers, competitors or regulatory authorities, (iii) statements of future economic performance, and (iv) statements of assumptions underlying other statements and statements about is and our business. This report also identifies important factors, which could cause our actual results to differ materially from those indicated by the forward-looking statements. These risks and uncertainties include the factors discussed under the heading "Factors that may affect future growth" beginning at page 7 of this report. The following Management's Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with our consolidated financial statements and the notes thereto appearing elsewhere in this report. Overview Our business has two segments; our Laser Group and our Photonics Group. During 2001, we sold or discontinued operations of our Plastics Group. Our Laser Group, comprised of Laser Fare, Inc. (LF -Smithfield, RI) and Mound Laser & Photonics Center, Inc. (MLPC- Miamisburg, OH) provides comprehensive laser-based materials processing services to leading manufacturers. Our Photonics Group, which includes Infinite Photonics, Inc., (Orlando, FL) and the Advanced Technology Group (Narragansett, RI), manufactures and markets our proprietary grating coupled surface emitting laser (GCSEL) diodes. MetaTek, Inc. of Albuquerque, NM was merged into Infinite Photonics, Inc. Our Plastics Group, which had been comprised of Osley & Whitney, Inc. (Westfield, MA), Materials & Manufacturing Technologies, Inc. (West Kingston, RI) and Express Pattern, Inc. (Buffalo Grove, IL), provided rapid prototyping services and proprietary mold building services, which were discontinued or sold. During 2001, we continued to experience operating losses, due primarily to losses in the discontinued Plastics Group attributed to falling demand for our injection molds, and start-up costs for our Photonics Group. These losses resulted in reductions in cash flow and a negative 18 working capital position. We are currently focused on our two primary lines of business and we are actively pursuing additional capital through the equity line of credit agreement, private equity sources, strategic alliances, venture capital and investment banking sources. Our financial statements included in this report have been prepared in conformity with accounting principles generally accepted in the United States. During 2001, there were a number of new accounting standards issued by the Financial Accounting Standards Board, which we have determined, did not have any effect on our financial statements in 2001 and we anticipate they will not have a material effect on our financial statements in 2002. We believe that our operations, as currently structured, together with our current financial resources, will result in improved financial performance in fiscal 2002. Forward looking strategy Our business plan for 2002 includes the completion of our plan to dispose of the Plastics Group commenced in November 2001 and the ramp up of research, engineering, manufacturing, marketing and administrative capability for our Photonics Group. In cooperation with O&W's secured lender, the majority of O&W's equipment and furnishings were sold at public auction on March 12, 2002, and accounts receivable are being remitted to the secured lender as paid. We expect to sell the O&W real estate during 2002 and satisfy the remaining mortgage. On March 14, 2002 we closed on the sale of the assets of Express Pattern, Inc. for $575,000 in cash (of which $300,000 was paid to O&W's secured lender) and a five year 8% subordinated $100,000 note, due upon maturity with quarterly interest payments. Our Photonics Group is completing leasehold improvements to its semiconductor laser diode manufacturing facilities in Orlando, Florida, which will be completed during the second quarter of 2002. We have hired or transferred ten research and administrative personnel who are working on the DARPA contract and we are actively interviewing for additional engineering, quality control, manufacturing and administrative personnel. Equipment has started arriving at the facility, and we expect to complete about $1.2 million in capital equipment expansion by the end of 2002, primarily funded through operating leases. As a result of these steps, we expect that our Photonics Group will have approximately $10.0 million in revenue capacity by year-end. In addition, we closed on a $1.0 convertible note with Laurus Master Fund, which has been used to fund salaries and other costs billable under our DARPA contract. We have completed the first technical review with DARPA and believe we are on schedule to meet their timetable for completion of that contract by the end of 2003. Our Photonics Group is actively engaged in discussions with a number of potential commercial customers to incorporate our technology in their next major product updates planned for late 2002 or early 2003. Our marketing efforts are aimed at customer education and in that regard our staff members have recently presented papers at technical trade shows, such as the recent Photonics West and Optical Fiber conferences, which are attended by representatives of leading companies using diode devices. Additionally, we are actively exploring financing alternatives for our Photonics Group, including through venture capital firms with, in many cases, portfolio companies that could be end users of our products. 19 Finally, we are completing steps to further reduce corporate overhead including facilities consolidation and other cost reduction measures. We believe that the successful implementation of this plan will result in profitable operations during 2002. Liquidity and capital resources We have financed our product development activities and operations through a series of private placements of debt and equity securities. As of December 31, 2001, we had cash and cash equivalents of approximately $130,242 available for our working capital needs and planned capital asset expenditures. In addition, in February, 2002, we closed on a $1.0 million, two year convertible note (see below). While the majority of the revenues realized as of December 31, 2001 were attributed to our Laser Group operations, we anticipate improved revenue from our Photonics Group and positive results from additional expense containment measures that have been implemented. We anticipate that our existing credit facilities, together with our other strategies for raising additional working capital through debt and/or equity transactions will provide adequate liquidity to fund our operations. Subsequent to year-end, additional private placements of our common stock yielded gross proceeds of $150,000. At December 31, 2001 we had a working capital deficit of approximately $1.7 million, ($1.3 million after eliminating the assets and liabilities of our discontinued operations). In conjunction with our on-going business expansion program, we are pursuing alternative sources of funding. We have put several agreements in place to potentially provide future liquidity and are exploring several additional arrangements including private placements, direct investment by strategic alliance partners, and venture capital sources. To date we have arranged an equity line of credit (that will be available for use if the trading volume in our common stock reaches certain levels), and an asset based convertible note that is available to fund sales volume increases and working capital needs at our Photonics Group. Our equity line of credit agreement On November 20, 2000 we entered into an equity line of credit agreement with Cockfield Holdings Limited (Cockfield). The purpose of the equity line of credit is to provide us with a source of funding for our current activities and for the development of our current and planned products. The equity line of credit agreement establishes what is sometimes referred to as an equity drawdown facility. Under the equity line of credit agreement, we have the right to sell and Cockfield has agreed to purchase up to 3,000,000 shares of our common stock during a 36-month period. During this period, we may request a drawdown under the equity line of credit by selling shares of our common stock to Cockfield, and Cockfield is obligated to purchase the shares we put to them. The minimum amount we can draw down at any one time is $200,000. The maximum amount we can draw down at any one time will be determined at the time of the drawdown request under a formula contained in the equity line of credit agreement, but cannot be more than $5,000,000. 20 We may request a drawdown once every 20 trading days, although we are under no obligation to request any drawdowns. In order to exercise our drawdown rights, we must have an effective registration statement on file with the SEC registering the resale of the shares of our common stock that may be sold to Cockfield. We must also give at least 20 business days advance notice to Cockfield of the date on which we intend to exercise a particular put right and we must indicate the maximum number of shares of our common stock that we intend to sell to Cockfield. At our option, we may also designate a maximum dollar amount of our common stock that we will sell under the put and/or a minimum purchase price per share at which Cockfield may purchase shares under the put. The maximum amount may not to exceed the lesser of a) $5,000,000 or b) fifteen percent (15%) of the weighted average price of our common stock during the 20 trading days immediately prior to the put date, multiplied by the total trading volume of our common stock during the 20 trading days immediately prior to that date. During the 20 trading days following a drawdown request, we will calculate the number of shares we will sell to Cockfield and the price per share. The purchase price per share of common stock will be at a discount to the daily volume weighted average price of our common stock during the 20 trading days immediately following the drawdown date. On each of the 20 trading days during the calculation period, the number of shares to be purchased by Cockfield will be determined by dividing 1/20th of the drawdown amount by the purchase price on each trading day. If we designate a minimum purchase price in our drawdown request and the daily volume weighted average price for our common stock on any trading day during the 20 trading day calculation period is below the minimum threshold price, and Cockfield elects not to purchase shares at the minimum threshold price, then the drawdown amount will be reduced by 1/20th. For each share of our common stock, Cockfield will pay us 87.5% of the volume weighted market price for a share of our common stock during the 20-day trading period following the exercise of a put. The percentage will increase to 90% if we move our principal market to the Nasdaq National Market or to 91% if we move our principal market to the New York Stock Exchange. It will decrease to 84% if our common stock is delisted from the Nasdaq SmallCap Market. Market price is defined as the volume weighted average price for our common stock (as reported by Bloomberg Financial LP using its VAP function) on its principal market during the pricing period. The pricing period is defined as the 20 day trading period immediately prior to the day we exercise our put right. Cockfield will pay for the shares on the 22nd trading day following the drawdown request. We will receive the purchase price less a brokerage fee payable to Jesup & Lamont ranging between 4.25% and 4.75% of the aggregate purchase price, depending on the dollar volume of the transaction. Jesup & Lamont is the placement agent that introduced Cockfield to us and is a registered broker-dealer. At the closing of each drawdown, we will also grant Cockfield warrants to purchase a number of shares of our common stock equal to 33% of the number of shares purchased by Cockfield at the closing of the drawdown. These unit warrants will expire one day after they are granted and will have an exercise price equal to the weighted average of the purchase price of a share of our 21 common stock purchased at the closing of each drawdown. The 3,000,000 shares available under the equity line of credit will be reduced by the number of shares issued as a result of the exercise of these unit warrants. The equity line of credit agreement prevents us from drawing down funds and issuing the corresponding shares of common stock to Cockfield if the issuance would result in Cockfield beneficially owning more than 9.9% of our then outstanding shares of common stock. In addition, the listing requirements of the Nasdaq SmallCap Market prohibit us from issuing 20% or more of our issued and outstanding shares of common stock in a single transaction at a price less than the greater of market value or book value unless we get stockholder approval. At our annual meeting held on March 22, 2001, our stockholders approved the issuance of the shares of our common stock contemplated by the equity line of credit agreement. As consideration for establishing the equity line of credit, we granted Cockfield warrants to purchase up to 200,000 shares of our common stock. As consideration for the services rendered by Jesup & Lamont as placement agent in connection with the equity line of credit, we granted Jesup & Lamont warrants to purchase up to 100,000 shares of our common stock. These warrants, covering 300,000 shares of our common stock, are exercisable at any time prior to November 20, 2003, for $3.135 per share. On February 8, 2001, we issued a drawdown notice to Cockfield. This notice offered to sell up to $250,000 of our common stock to Cockfield based on the formula in the stock purchase agreement, during the 20 trading day period beginning on February 9, 2001 and ending on March 9, 2001, but at not less than $3.00 per share. During this period, Cockfield purchased a total of 21,737 shares of our common stock at an average net purchase price of $2.8753 per share. These purchases resulted in aggregate proceeds of $62,500 being paid and released from escrow to us by Cockfield. Jesup & Lamont Securities Corporation received $2,969 as a placement fee in connection with this draw down. Because of relatively low trading volume in our stock, weakness in the general price level of the Nasdaq Stock Market, and a relatively low market price per share of our common stock, we have not been able to meet the minimum put price of $200,000 under that agreement. We expect that as market conditions continue to improve we may be able to meet those minimums in the future. Our asset based convertible note On February 8, 2002, we completed a transaction with Laurus Master Fund, Ltd., a New York based hedge fund, (Laurus) for $1.0 million in cash in exchange for a $1,000,000 two-year note bearing interest at 15%, with interest payable quarterly. If we allow Laurus to convert the Note into shares of common stock at $2.25 per share, we will receive an interest rebate from Laurus equal to one percent per $100,000 converted. The Note is secured by a deposit account and by the accounts receivable of our Infinite Photonics subsidiary. Our use of the proceeds of this note is limited to funding expenses under our DARPA contract, and the growth of accounts receivable with commercial customers. 22 In connection with the transaction, we issued five-year warrants to Laurus to purchase 50,000 shares of common stock at $2.65 per share, paid a $50,000 loan origination fee at closing and paid legal and closing expenses of $37,500. There is no assurance, that our current resources will be adequate to fund our current operations and business expansion or that we will be successful in raising additional working capital. Our failure to raise necessary working capital could force us to curtail operations, which would have a material adverse effect on our financial condition and results of operations. Results of operations Laser Group Revenues from our Laser Group for the years ended December 31, 2001 and 2000 were $7,305,574 and $6,285,882, respectively, with a net operating loss of $140,742 and $239,704, respectively. The increase in revenue was due to increased sales to gas turbine and medical device manufacturers. The reduced operating loss resulted from economies of scale. Photonics Group Revenues from our Photonics Group for the years ended December 31, 2001 and 2000 were $1,202,074 and $341,688, respectively. Net operating loss for the 2001 period was $332,245 as compared to net income of $84,727 for the 2000 period. The 2001 operating loss was due to start-up costs at Infinite Photonics. The increased revenue in 2001 was attributable to the DARPA contract performed during the period. Plastics Group The loss from our discontinued Plastics Group for the year ended December 31, 2001 was $994,045 compared to a loss of $383,665 for the year ended December 31, 2000. The increased loss during 2001 was attributable to a general reduction in revenues at O&W primarily attributable to loss of business from key customers and a $622,000 loss on the disposal of assets divested in connection with these discontinued operations. Comparison of the years ended December 31, 2001 and 2000 In 2001, consolidated revenues were $8,507,648 on cost of goods sold of $5,897,511 resulting in a gross profit of $2,610,137 from continuing operations for the year. Consolidated revenues from continuing operations in 2000 were $6,627,570 on cost of sales of $ 4,720,649, resulting in a gross profit of $1,906,921. The increase of $ 1,880,078 or 28.4% in consolidated revenues for the year ended December 31, 2001 compared to the year ended December 31, 2000 was primarily due to a $1.3 Million DARPA contract in 2001 awarded to our Photonics Group, and increases in sales in our Laser Group to GE Gas Turbine Division for power generation equipment and to medical device manufacturers. Gross profit margin increased in 2001 to 30.7% from 28.8% in 2000. This increase was due to slightly higher margins in both gas turbine and medical devices. We signed a large $12.0 million DARPA contract on January 23, 2002 where 23 net margins are limited to approximately 6.7% for government research which historically has been approximately eight percent. As a result, we expect revenues to increase significantly in 2002, but at lower net margins. Research and development expenses were $94,665 for the year ended December 31, 2001. Because we are in the contract research and development business and mark up our services to reflect an anticipated profit on such services, the majority of our research revenues and related costs are reflected in sales and cost of goods sold, respectively. Research and development reflects internal costs associated with new product development efforts. We anticipate that internal research and development expenses will increase in 2002, based on expected GCSEL product development efforts in our Photonics Group based upon customer demand and discretionary cash flows. General and administrative expenses were $2,735,782 for the year ended December 31, 2001 as compared to $1,775,596 for the year ended December 31, 2000. The increase of $960,186, or 54.1%, is primarily due to Infinite Photonics start-up expenses, the hiring of our new chief operating officer in 2001, reinstatement in 2001 of a 20% salary reduction taken in the previous eighteen months by our executives, and increased legal, investment banking and other fees related to our capital raising activities. Selling expenses were $307,030 for the year ended December 31, 2001 as compared to $433,845 for the year ended December 31, 2000. The decrease of $126,815, or 29.2%, was primarily attributed to decreased sales salaries and commissions in our Laser Group due to better utilization of cross selling to existing customers, and other efficiencies. Depreciation and amortization expense totaled $775,924 for the year ended December 31, 2001 as compared to $755,052 for the year ended December 31, 2000. The increase was primarily due to depreciation expense for new lasers acquired for stent production at our Laser Group. Interest expense was $456,179 during 2001 as compared to $580,239 during 2000. The decrease of $124,060, or 21.4%, was due to a reduction of interest paid on the debt obligations related to the acquisition of O&W, a reduction in short term borrowings in our Laser Group and conversions of debt to equity. Interest income for the year ended December 31, 2001 was $18,508 as compared to $21,003 for the year ended December 31, 2000 due to comparatively lower interest rates in 2001. We had a consolidated net loss from continuing operations of $1,788,459 for the year ended December 31, 2001 as compared to $1,710,582 in 2000. The loss from discontinued operations was $994,055 for the year ended December 31, 2001 as compared to $383,665 for the period ended December 31, 2000. Disappointing results, offshore Asian competition in the mold business, and a weak market after the tragedies of September 11, 2001 lead to the discontinuance of our Plastics Group. 24 Effect of new accounting pronouncements In June 2001, the FASB issued SFAS No. 141, "Business Combinations," and SFAS No. 142, "Goodwill and Other Intangible Assets." Under these new standards, all acquisitions subsequent to June 30, 2001 must be accounted for under the purchase method of accounting, and purchased goodwill is no longer amortized over its useful life. Rather, goodwill will be subject to a periodic impairment test based upon its fair value. In August 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement Obligations" ("SFAS 143"). SFAS 143 establishes accounting standards for recognition and measurement of a liability for the costs of asset retirement obligations. Under SFAS 143, the costs of retiring an asset will be recorded as a liability when the retirement obligation arises, and will be amortized to expense over the life of the asset. In October 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" ("SFAS 144"). SFAS 144 addresses financial accounting and reporting for the impairment or disposal of long-lived assets and discontinued operations. We are currently evaluating the impact of these pronouncements to determine the effect, if any, they may have on the consolidated financial position and results of operations. We are required to adopt these statements effective January 1, 2002. Financial statements Reference is made to the financial statements, the report thereon and notes thereto, beginning on page F-1 of this report. Changes in and disagreements with accountants on accounting and financial disclosure During the third quarter of 2001 we filed a current report on Form 8-K regarding a change in our certified public accountants. On August 2, 2001, we were notified that the firm of Freed Maxick Sachs & Murphy, PC, which had previously merged with McGladrey & Pullen, LLP on November 1, 2000, elected to demerge from McGladrey & Pullen, LLP effective August 1, 2001 and that McGladrey & Pullen, LLP would no longer be our auditors. The demerged firm, which is newly named Freed Maxick & Battaglia, CPAs, PC, was appointed as our new auditors by our board of directors. We had no disagreements with McGladrey & Pullen, LLP on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure. 25 PART III DIRECTORS AND EXECUTIVE OFFICERS Set forth below are the names, ages and positions of the our directors and executive officers.
Affiliated Name Age Position Since ---- --- -------- ----- Clifford G. Brockmyre II(1) 60 Chairman of the board, 1994 president and chief executive officer Thomas J. Mueller 50 Chief operating officer 2000 Bruce J. Garreau 51 Chief financial and accounting 1999 officer Daniel T. Landi 59 Corporate controller and 1994 secretary J. Terence Feeley 51 Director 1994 Michael S. Smith (2) 47 Director 1995 Brian C. Corridan (2) 53 Director 2000
- ---------- (1) This person may be deemed a parent and/or promoter as those terms are defined in the Rules and Regulations promulgated under the Securities Act of 1933, as amended. (2) Member of the audit and compensation committees. Each director is elected for a period of one year and serves until his successor is duly elected by our stockholders. Officers are elected by and serve at the will of our board of directors. Background The principal occupation of each of our directors and executive officers for at least the past five years is as follows: Clifford G. Brockmyre II has been a director since October 1994, our president since October 1995 and our chief executive officer since January 1998. For over 27 years, Mr. Brockmyre has been involved in the tooling, machining and manufacturing industries and was the 1992 chairman of the 3000+ corporation member National Tooling and Machining Association. He developed the laser manufacturing liaison to the National Laboratories at Los Alamos, Sandia and Oak Ridge for Laser Fare. The Department of Energy has set up Laser Fare as a model for technology transfer under its Small Business Initiative. Mr. Brockmyre serves on the Rhode Island State Economic Advisory Council, a position he was appointed to by the Governor of Rhode Island. 26 Thomas J. Mueller became our Chief Operating Officer in December 2000. He joined us in April 1999 as founder and president of our Express Pattern, an Infinite Group subsidiary. He has a long history in rapid prototyping, previously founding Prototype Express, an early rapid prototyping service bureau. Mr. Mueller held engineering and management positions at Baxter Healthcare and Caterpillar. He received BS and MS degrees in mechanical engineering from the University of Illinois and an MS in Management from the Sloan School of Management at MIT. Bruce J. Garreau became our chief financial officer in July 1999. Prior thereto, he served as a consulting principal with the Corporate Financial Group (CFG), which provided financial, merger and acquisition, planning and strategy services to venture capital funded technology and other start-ups, as well as product and other development services to larger companies. Prior to CFG he was executive vice president and controller of Northeast Savings, FA, Hartford, CT, then the largest publicly traded thrift institution in New England (subsequently acquired by Fleet Bank). He served nine years as senior manager and senior computer specialist at KPMG. Mr. Garreau received a BS in public accountancy from State University of new York at Albany and is a certified public accountant in New York and Connecticut. Daniel T. Landi is our corporate controller and secretary and was our chief financial officer from August 1994 to July 1999. Prior thereto, from January 1993 to June 1994 he was the chief financial officer of a privately held aerospace research and development company. From June 1991 through 1992, Mr. Landi was a principal of Focused Management Consulting Group, a firm concentrating on acquisitions, mergers, joint ventures and start-up operations, including private placements and initial public offerings. Mr. Landi has extensive domestic and international experience in finance, accounting and information systems with his twenty-six years of progressive growth in overall business and senior financial management with IBM. Mr. Landi received a BS in Finance and an MBA from the University of Connecticut. J. Terence Feeley has been the president of the Laser Fare -- Advanced Technology Group since 1994. He became a director in March 1999. He was the co-founder, president and chief executive officer of Laser Fare prior to its acquisition by us. Mr. Feeley is the past President of the Laser Institute of America, the author of over 50 papers on laser technology and the co-editor of three books in the area of laser based rapid manufacturing. Mr. Feeley received a BA from the University of Rhode Island. Michael S. Smith became a director in 1995 and is a member of our audit and compensation committees. He is the president and chief executive officer of Micropub Systems International Inc., a brewery system manufacturer. From October 1992 through January 1997, Mr. Smith was the managing director of corporate finance of H.J. Meyers & Co., an investment-banking firm and was general counsel of that firm from May 1991 through May 1995. Mr. Smith was associated with the law firm of Harter, Secrest & Emery from 1987 until 1991. Mr. Smith received a BA from Cornell University and a JD from Cornell University School of Law. Brian Q. Corridan became a director in November 2000 and is a member of our audit and compensation committees. Since 1994, he has been president of Corridan & Co. after founding the privately owned full service investment firm registered with the SEC, NYSE and NASD. He has served as a Registered Representative with Prudential Securities, Tucker Anthony-R.L., Day, 27 and Kidder Peabody & Co. Mr. Corridan received a BA from Stonehill College, and is a graduate of the Naval Officers Candidate School in Newport, RI. Also, he is a director of Health New England, serves on the Finance Committee of Baystate Health System, and as a Trustee for several civic and educational organizations, including Our Lady of Elms College and Springfield Technical Community College Assistance Corporation. Our board of directors has an audit committee and a compensation committee. The audit committee reviews the scope and results of the audit and other services provided by our independent accountants and our internal controls. The compensation committee is responsible for the approval of compensation arrangements for our officers and the review of our compensation plans and policies. Section 16(a) beneficial ownership reporting compliance Section 16(a) of the Securities Exchange Act of 1934 requires our officers and directors, and persons who own more than ten percent of a registered class of our equity securities, to file reports of ownership and changes in ownership with the Securities and Exchange Commission ("SEC"). Officers, directors and greater than ten-percent shareholders are required by SEC regulation to furnish us with copies of all Section 16(a) forms they file. Based solely on review of the copies of such forms furnished to us, or written representations that no Forms 5 were required, we believe that all Section 16(a) filing requirements applicable to its officers and directors were complied with except as follows: Thomas J. Mueller - Form 4 two transactions; J. Terence Feeley -- Form 4 two transactions; Bruce J. Garreau - Form 4 one transaction; Clifford G. Brockmyre - Form 4 one transaction. Directors' compensation Our directors do not receive any cash consideration for serving as directors. All directors are reimbursed for out-of-pocket expenses incurred in connection with their attendance at board meetings. In addition, pursuant to our non-discretionary, non-employee directors' stock option plan, each non-employee director is granted options to purchase 7,500 shares of common stock upon becoming a director and an additional 5,000 shares at the end of each fiscal year during which he served as a director. Limitation of directors' liability and indemnification The Delaware General Corporation Law (DGCL) authorizes corporations to limit or eliminate the personal liability of directors to corporations and their shareholders for monetary damages for breach of directors' fiduciary duty of care. Our certificate of incorporation limits the liability of our directors to the company or its shareholders to the fullest extent permitted by Delaware law. Our certificate of incorporation provides mandatory indemnification rights to any officer or director who, by reason of the fact that he or she is an officer or director, is involved in a legal proceeding of any nature. Such indemnification rights include reimbursement for expenses incurred by such officer or director in advance of the final disposition of such proceeding in accordance with the applicable provisions of the DGCL. Insofar as indemnification for liabilities 28 under the Securities Act may be provided to officers and directors or persons controlling the company, we have been informed that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Securities Act and is, therefore, unenforceable. There is no pending litigation or proceeding involving any of our directors, officers, employees or agents in which indemnification by us will be required or permitted. We are not aware of any threatened litigation or proceeding that may result in a claim for such indemnification. Executive compensation Summary Compensation. The following table sets forth certain information concerning compensation for services in all capacities awarded to, earned by or paid to our chief executive officer and the other four most highly compensated executive officers ("Named Executives") during 2001, 2000 and 1999 whose aggregate compensation exceeded $100,000.
Annual compensation Long-term compensation -------------------------------------- -------------------------------------- Shares of common Other Restricted stock All Name and annual stock underlying other principal position Salary Bonus compensation* awards options compensation - ------------------- --------- ------- ------------ ---------- ---------- ------------ Clifford G. Brockmyre President and chief executive officer 2001........... $ 99,836 $ -- $ -- -- -- -- 2000........... 132,966 -- -- -- 11,000 -- 1999........... 163,096 -- -- -- 60,019 -- Thomas J. Mueller Chief operating officer 2001........... 156,651 -- 10,500 -- 50,000 -- 2000........... 125,643 -- -- -- 131,250 -- 1999........... 71,876 -- -- -- -- -- J. Terrence Feeley President-- Advanced Technology Group 2001........... 139,861 -- 10,298 -- 125,000 -- 2000........... 140,297 -- 9,288 -- 240,000 -- 1999........... 151,603 -- 9,652 -- 1,731 -- Bruce J. Garreau Chief financial officer 2001........... 158,277 -- 6,750 -- -- -- 2000........... 124,868 -- 8,308 -- 108,500 -- 1999........... 51,714 -- -- -- 75,000 -- Daniel T. Landi Corporate controller and secretary 2001........... 75,944 -- -- -- 6,500 -- 2000........... 87,966 -- -- -- 1,270 -- 1999........... 101,539 -- -- -- -- --
- ---------- *Reflects executive's contribution to our 401k plan. 29 Employment Agreements We have an employment agreement with Clifford G. Brockmyre II, our president and chief executive officer, for a term expiring on June 30, 2003, which provides for an annual salary of $175,000 and various benefits. In addition to the compensation provided under the agreement, Mr. Brockmyre is eligible to participate in our bonus plan and is eligible for other bonuses as determined in the sole direction of the board of directors. The agreement also provides, among other things, that, if Mr. Brockmyre is terminated other than for cause (which is defined to include conviction of a crime involving moral turpitude, engaging in activities competitive with us, divulging confidential information, dishonesty or misconduct detrimental to us or breach of a material term of the agreement), we will pay to him a lump sum payment equal to the product of the sum of (i) the highest annual rate of salary paid to Mr. Brockmyre, and (ii) the highest annual bonus paid to or accrued to the benefit of Mr. Brockmyre during the employment term multiplied by 2.99. The agreement also provides for payments to Mr. Brockmyre, or his estate, in the event of his death or permanent disability. We have an employment agreement with J. Terence Feeley, president of the Advanced Technology Group, for a term expiring on July 1, 2002, which provides for an annual salary of $150,000 and various benefits. In addition to the compensation provided under the agreement, Mr. Feeley is eligible to participate in our bonus plan and is eligible for other bonuses as determined in the sole direction of the board of directors. This agreement also provides, among other things, that, if Mr. Feeley is terminated other than for Cause, we will pay to him a lump sum payment equal to the product of the sum of (i) the highest annual rate of salary paid to Mr. Feeley, and (ii) the highest annual bonus paid to or accrued to the benefit of Mr. Feeley during the employment term multiplied by two. The agreement also provided for payments to Mr. Feeley, or his estate, in the event of his death or permanent disability. We have an employment agreement with Bruce J. Garreau, our chief financial and accounting officer, for a term expiring on October 1, 2002, which provides for an annual salary of $135,000 and various benefits including the grant of 10,000 shares of our common stock and 75,000 stock options exercisable at $1.00 per share. The 10,000 shares had a value of $7,312 upon issuance. The options vest in three equal installments of 25,000 shares over an eighteen-month period. In addition to the compensation provided under the agreement, Mr. Garreau is eligible to participate in our bonus plan and is eligible for other bonuses as determined in the sole direction of the board of directors. The agreement also provides, among other things, that if Mr. Garreau is terminated other than for Cause, we will pay to him a lump sum payment equal to the product of the sum of (i) the highest annual rate of salary paid to Mr. Garreau and (ii) the highest annual bonus paid to or accrued to the benefit of Mr. Garreau during the employment term multiplied by two. The agreement also provides for payments to Mr. Garreau, or his estate, in the event of his death or permanent disability. 30 Stock options Option grants The following table sets forth certain information regarding options granted by us in 2001 to each of the Named Executives.
Option Grants in Last Fiscal Year ------------------------------------------------------------------------------------ Individual Grants ------------------------------------------------------ Potential Percent Realizable Value of Total at Assumed Options Annual Rates of Number of Granted Stock Price Shares to Appreciation for Underlying Employees Exercise Option Term(1) Options in Fiscal Price Expiration ------------------------- Name Granted Year ($/share) Date 5% 10% ---------- --------- --------- ---------- --------- -------- Clifford G Brockmyre ................... -- -- -- -- -- -- Thomas J. Mueller ...................... 50,000 28.6 $ 2.04 8/30/06 $28,181 $ 62,272 J. Terrence Feeley ..................... 125,000 71.4 2.01 9/15/06 69,416 153,391 Bruce J. Garreau ....................... -- -- -- -- -- -- Daniel T. Landi ........................ -- -- -- -- -- --
- ---------- (1) Potential realizable values are net of exercise price but before taxes, and are based on the assumption that our common stock appreciates at the annual rate shown (compounded annually) from the date of grant until the expiration date of the options. These numbers are calculated based on Securities and Exchange Commission requirements and do not reflect our projection or estimate of future stock price growth. Actual gains, if any, on stock option exercises are dependent on our future financial performance, overall market conditions and the option holder's continued employment through the besting period. This table does not take into account any appreciation in the price of the common stock from the date of grant to the date of this Form 10KSB. Option exercises and year-end option values The following table provides information with respect to options exercised by the Named Executives during 2001 and the number and value of unexercised options held by the Named Executives as of December 31, 2001. Aggregated option exercises in last fiscal year and year-end option values
Number of Shares Underlying Value of Unexercised Unexercised Options at In-the-Money Options At Shares Fiscal Year-End Fiscal Year-End(2) Acquired on Value ----------------------------- ------------------------- Name Exercise (#) Realized(1) Exercisable Unexercisable 5% 10% ---- ------------ ----------- ----------- ------------- -- --- Clifford G. Brockmyre .................. -- -- 7,337 -- $7,557 -- Thomas J. Mueller ...................... 21,550 $22,197 22,200 137,500 $22,866 $114,625 J. Terrence Feeley ..................... -- 184,953 278,333 $85,549 $222,933 Bruce J. Garreau ....................... 59,300 58,845 4,733 66,667 $4,875 $68,667 Daniel T. Landi ........................ 3,438 4,607 13,284 -- $4,732 --
- ---------- (1) For the purposes of this calculation, value is based upon the difference between the exercise price of the options and the stock price at date of exercise. (2) For the purpose of this calculation value is based upon the difference between the exercise price of the exercisable and unexercisable options and the stock price at December 31, 2001 of $2.53 per share 31 Stock Option Plans We have stock option plans, which were adopted by our board and approved by our shareholders covering an aggregate of 2,077,014 unexercised shares of our common stock, consisting of both incentive stock options within the meaning of Section 422 of the United States Internal Revenue Code of 1986 (the "Code") and non-qualified options. The option plans are intended to qualify under Rule 16b-3 of the Securities Exchange Act of 1934. incentive stock options are issuable only to our employees, while non-qualified options may be issued to non-employees, consultants, and others, as well as to employees. The option plans are administered by the compensation committee of the board of directors, which determines those individuals who shall receive options, the time period during which the options may be partially or fully exercised, the number of share of common stock that may be purchased under each option, and the option price. The per share exercise price of an incentive or non-qualified stock option may not be less than the fair market value of the common stock on the date the option is granted. The aggregate fair market value (determined as of the date the option is granted) of the shares of common stock for which incentive stock options are first exercisable by any individual during any calendar year may not exceed $100,000. No person who owns, directly or indirectly, at the time of the granting of an incentive stock option to him or her, more than 10% of the total combined voting power of all classes of stock of the company shall be eligible to receive any incentive stock option under the option plans unless the option price is at least $110% of the fair market value of our common stock subject to the option, determined on the date of grant. Non-qualified options are not subject to this limitation. An optionee may not transfer an incentive stock option, other than by will or the laws of descent and distribution, and during the lifetime of an optionee, the option will be exercisable only by him or her. In the event of termination of employment other than by death or disability, the optionee will have three months after such termination during which to exercise the option. Upon termination of employment of an optionee by reason of death or permanent total disability, the option remains exercisable for one year thereafter to the extent it was exercisable on the date of such termination. No similar limitation applies to non-qualified options. Pursuant to our option plans, each new non-employee director is automatically granted, upon becoming a director, an option to purchase 7,500 shares of our common stock at the fair market value of such shares on the grant date. In addition, each non-employee director is automatically granted an option to purchase 5,000 shares at the fair market value of such shares on the date of grant, at the end of each fiscal year during which he served as a director. These options vest 1/3 upon grant and 1/3 at the end of each subsequent year of service. Options under the option plans must be granted within 10 years from the effective date of each respective plan. Incentive stock options granted under the plan cannot be exercised more than 10 years from the date of grant, except that incentive stock options issued to greater than 10% stockholders are limited to four-year terms. All options granted under the plans provide for the payment of the exercise price in cash or by delivery of shares of common stock already owned 32 by the optionee having a fair market value equal to the exercise price of the options being exercised, or by a combination of such methods of payment. Therefore, an optionee may be able to tender shares of common stock to purchase additional shares of common stock and may theoretically exercise all of his stock options without making any additional cash investment. Any unexercised options that expire or that terminate upon an optionee's ceasing to be affiliated with the company become available once again for issuance. As of January 31, 2002, we had outstanding stock options to purchase 1,161,037 shares under our option plans, including 22,000 shares to Michael S. Smith and 12,500 shares to Brian Q. Corridan under the our non-employee directors' plan. These options are exercisable at prices ranging from $1.375 to $9.40 per share. Compensation committee interlocks and insider participation in compensation decisions None of the directors serving on the compensation committee of our board of directors is employed by us. In addition, none of our directors or executive officers is a director or executive officer of any other corporation that has a director or executive officer who is also a member of our board of directors. Security ownership of certain beneficial owners and management The following table sets forth information regarding the beneficial ownership of our common stock as of February 28, 2001 by: o each person known to us to be the beneficial owner of more than 5% of our outstanding shares; o each of our directors; o each executive officer named in the Summary Compensation Table above; o all of our directors and executive officers as a group. Except as otherwise indicated, the persons listed below have sole voting and investment power with respect to all shares of common stock owned by them. All information with respect to beneficial ownership has been furnished to us by the respective stockholder. 33 Name of Shares of Common Stock Percentage Beneficial Owner (1) Beneficially Owned (2) of Class (3) -------------------- ---------------------- ------------ Directors and Executive Officers Clifford G. Brockmyre II 1,899,703(4) 33.38% J. Terence Feeley 199,454(5) 3.76% Bruce J. Garreau 130,333(6) 2.54% Thomas J. Mueller 49,250(7) * Daniel T. Landi 13,180(8) * Brian Q. Corridan 4,157(9) * Michael S. Smith 10,002(10) * All executive officers and directors as a group (7 persons) 2,307,065(12) 38.89% 5% Stockholders Northeast Hampton Holdings, LLC (11) 497,106 8.85% Estate of Ralph P. Lazarra 379,253 6.90% - ----------------- * less than 1% (1) The address of Mr. Brockmyre is c/o Infinite Group, Inc. 2364 Post Road, Warwick, RI 02886. The address of Northeast Hamptons Holding, LLC is P. O. Box 146, Boca Raton, FL 33429. The address for the Estate of Ralph P. Lazarra is % Gary A. Martinelli, Esq., 1500 Main Street, Suite 912, Tower Square, PO Box 15407, Springfield, MA 0115. (2) Pursuant to the rules of the Securities and Exchange Commission, shares of common stock which an individual or group has a right to acquire within 60 days pursuant to the exercise of options or warrants or upon the conversion of securities are deemed to be outstanding for the purpose of computing the percent of ownership of such individual or group, but are not deemed to be outstanding for the purpose of computing the percentage ownership of any other person shown in the table. (3) Assumes that all currently exercisable options or warrants or convertible notes owned by the individual have been exercised. (4) Includes 20,000 shares owned by Mr. Brockmyre's wife as to which shares Mr. Brockmyre disclaims beneficial ownership, 7,337 shares subject to currently exercisable options and 544,900 shares subject to currently exercisable warrants. (5) Includes 184,953 shares subject to currently exercisable options (6) Includes 4,733 shares subject to currently exercisable options. (7) Includes 22,200 shares subject to currently exercisable options. (8) Includes 13,180 shares subject to currently exercisable options. (9) Includes 4,157 shares subject to currently exercisable options. (10) Includes 10,002 shares subject to currently exercisable options. (11) The information with respect to this stockholder was derived from the stockholders Schedule 13D. (12) Assumes that all currently exercisable options or warrants owned by members of the group have been exercised. 34 Certain relationships and related transactions During 2000 and 2001, our president and chief executive officer loaned us an aggregate of $1,124,000, which bore interest at various interest rates ranging from 10% to 11%. In consideration for these loans, our president was issued warrants to purchase 152,900 shares of common stock at exercise prices ranging from $1.03125 to $3.42 per share. As of December 31, 2001, $50,000 of the loans remained outstanding and $1,074,000 had been converted into 584,599 shares of common stock. In addition, $ 628,579 (including $8,998 of accrued interest) of long-term debt which was outstanding at December 31, 1999 was converted during 2001 into 248,450 shares of common stock. Additionally, during 2000 and 2001, respectively, $168,830 and $117,796 of interest was paid to our president and chief executive officer. The following table summarizes these transactions: Loan/Maturity Date Amount Purpose Status ------------------ ------ ------- ------ 2000 2/1/00-5/1/00 $30,000.00 Working capital Converted to stock 2/16/00-5/16/00 $30,000.00 Working capital Converted to stock 3/15/00-6/15/00 $180,000.00 Working capital Converted to stock 3/30/00-6/30/00 $15,000.00 Working capital Converted to stock 4/11/00-7/11/00 $20,000.00 Working capital Converted to stock 4/25/00-7/25/00 $5,000.00 Working capital Converted to stock 4/25/00-7/25/00 $4,000.00 Working capital Converted to stock 5/3/00-8/03/00 $35,000.00 Working capital Converted to stock 5/10/00-8/10/00 $40,000.00 Working capital Converted to stock 6/6/00-9/6/00 $325,000.00 Working capital Converted to stock 10/11/00-1/11/01 $290,000.00 Working capital Converted to stock Sub-total 2000 $974,000.00 - -------------- ----------- 2001 01/24/01-3/25/01 $10,000.00 Working capital Converted to stock 9/10/01-10/10/01 $51,000.00 Working capital Converted to stock 9/17/01-10/17/01 $12,000.00 Working capital Converted to stock 10/26/01-10/26/01 $21,000.00 Working capital Converted to stock 10/02/01-11/02/01 $2,000.00 Working capital Converted to stock 35 10/09/01-11/09/01 $23,000.00 Working capital $19,000 outstanding, $4,000 converted to stock 10/18/01-11/18/01 $12,000.00 Working capital Outstanding 10/25/01-11/25/01 $19,000.00 Working capital Outstanding Sub-total 2001 $150,000.00 - -------------- ----------- Total $1,124,000 =========== During the quarter ended June 30, 2001, we were released from a capital lease due to our president relating a laser workstation for stent manufacture and related accrued interest aggregating $448,830. Our president contributed this equipment, which had been purchased in April 2000 for approximately $412,000, to us in exchange for 225,000 shares of our common stock valued at $1.995 per share. The workstation was purchased by our president at a point in time that we did not have the resources to acquire the equipment, which was necessary for our operations. We believe that the foregoing transactions were on terms no less favorable to us than could have been obtained from third parties. As a matter of policy, in order to reduce the risks of self-dealing or a breach of the duty of loyalty to the company, all transactions between the company and any of its officers, directors or principal stockholders are for bona fide purposes and are approved by a majority of the disinterested members of our Board. Exhibits and Reports on Form 8-K Exhibits The Exhibits listed below are filed as part of this Report. 3.1 Restated Certificate of Incorporation of the Company. (1) 3.2 Certificate of Amendment of Certificate of Incorporation dated January 7, 1998. (8) 3.3 Certificate of Amendment of Certificate of Incorporation dated February 16, 1999.(9) 3.4 By-Laws of the Company. (1) 4.1 Specimen Stock Certificate. (1) 10.1 Form of Stock Option Plan. (3) 10.2 Form of Stock Option Agreement. (1) 10.3 Lease Agreement between Rhode Island Industrial Facilities Corporation and HGG Laser Fare, Inc. for certain equipment and operating facility in Smithfield, Rhode Island. (4) 10.4 Loan Agreement between HGG Laser Fare, Inc. and First National Bank of New England and dated December 21, 1995.(5) 10.5 Employment Agreement between Clifford G. Brockmyre II and the Company. (12) 10.6 Supply Agreement between Laser Fare, Inc. and Dey Laboratories, L.P. dated October 20, 1997. (8) 10.7 Form of Loan Agreements and Warrant between the Company and Clifford G. Brockmyre. (9) 36 10.8 Employment Agreement between J. Terence Feeley and the Company dated July 1, 1999. (11) 10.9 Employment Agreement between Bruce J. Garreau and the Company dated October 1, 1999.(11) 10.10 Employment Agreement between Thomas M. O'Connor and the Company dated November 15, 1999. (11) 10.11 Stock Acquisition Agreement between Infinite Group, Inc. and Osley & Whitney, Inc. dated April 16, 1999. (10) 10.12 Stock Acquisition Agreement between Infinite Group, Inc. and Materials & Manufacturing Technologies, Inc. dated March 24, 1999. (11) 10.13 Equity Line of Credit Agreement dated November 20, 2000, between Registrant and Cockfield Holdings Limited. (12) 10.14 Registration Rights Agreement dated November 20, 2000, between Registrant and Cockfield Holdings Limited. (12) 10.15 Escrow Agreement dated as of November 20, 2000, among Registrant, Cockfield Holdings Limited and Epstein Becker & Green, P.C. (12) 10.16 Form of Stock Purchase Warrant dated November 20, 2000, issued to each of Cockfield Holdings Limited and Jesup & Lamont Securities Corporation. (12) 10.17 Securities Purchase Agreement dates as of February 5, 2002 between the Company and Laurus Master Fund, Ltd.* 21 Subsidiaries of the Company.(13) 23 Consent of Freed Maxick Sachs & Murphy, PC* --------------------------- * Filed herewith. (1) Previously filed as on Exhibit to the Company's Registration Statement on Form S-1 (File #33-61856). This Exhibit is incorporated herein by reference. (2) Incorporated by reference to Report on Form 8-K, dated July 1, 1994. (3) Incorporated by reference to 1993 Preliminary Proxy Statement. (4) Incorporated by reference to Annual Report on Form 10-KSB for the fiscal year ended December 31, 1994. (5) Incorporated by reference to Annual Report on Form 10-KSB for the fiscal year ended December 31, 1995. (6) Incorporated by reference to Annual Report on Form 10-KSB for the fiscal year ended December 31, 1996. (7) Incorporated by reference to Report on Form 8-K dated August 26, 1996. (8) Incorporated by reference to Annual Report on Form 10-KSB for the fiscal year ended December 31, 1997. (9) Incorporated by reference to Annual Report on Form 10-KSB for the fiscal year ended December, 31, 1998. (10) Incorporated by reference to report on Form 8-K dated April 16, 1999. (11) Incorporated by reference to Annual Report on Form 10-KSB for the fiscal year ended December, 31, 1999. (12) Previously filed as on Exhibit to the Company's Registration Statement on Form S-2 (File #333-51768). This Exhibit is incorporated herein by reference. (13) Incorporated by reference to Annual Report on Form 10-KSB for the fiscal year ended December 31, 2000. 37 Reports on Form 8-K Date Item/Description - ----------------- ---------------------------------------------------- November 29, 2001 #5 / Press Release : Closure of Osley & Whitney, Inc. December 12, 2001 #5 / Press Release : DARPA Contract Grant 38 SIGNATURES Pursuant to the requirements of Section 13 or 15(d), the Securities Exchange Act of 1934, the company has duly caused this Report to be signed on March 29, 2002 on its behalf by the undersigned, thereunto duly authorized. INFINITE GROUP, INC. By: /s/ Clifford G. Brockmyre II ----------------------------- Clifford G. Brockmyre II, President Pursuant to the requirements 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. SIGNATURE TITLE DATE - --------- ----- ---- /s/ Clifford G. Brockmyre II Director, President and - ---------------------------- Chief Executive Officer March 29, 2002 Clifford G. Brockmyre II /s/ Bruce J. Garreau Chief Financial and March 29, 2002 - ---------------------------- Accounting Officer Bruce J. Garreau /s/ J. Terence Feeley Director March 29, 2002 - ---------------------------- J. Terence Feeley /s/ Michael S. Smith Director March 29, 2002 - ---------------------------- /s/ Brian Q. Corridan Director March 29, 2002 - ---------------------------- Brian Q. Corridan 39 CONSOLIDATED FINANCIAL STATEMENTS INFINITE GROUP, INC. ================================================================================ DECEMBER 31, 2001 with INDEPENDENT AUDITOR'S REPORTS INFINITE GROUP, INC. CONTENTS ================================================================================ Page ---- Independent Auditor's Report ........................................... 1 Consolidated Financial Statements: Balance Sheets ................................................... 2 Statements of Operations ......................................... 3 Statements of Stockholders' Equity ............................... 4 - 5 Statements of Cash Flows ......................................... 6 - 7 Notes to Consolidated Financial Statements ............................. 8 - 36 INDEPENDENT AUDITOR'S REPORT Board of Directors and Stockholders Infinite Group, Inc. We have audited the accompanying consolidated balance sheets of Infinite Group, Inc. as of December 31, 2001 and 2000, and the related consolidated statements of operations, stockholders' equity and cash flows for the years then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. 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 consolidated financial statements referred to above present fairly, in all material respects, the financial position of Infinite Group, Inc. as of December 31, 2001 and 2000, and the consolidated results of their operations and their cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America. Buffalo, New York March 15, 2002 INFINITE GROUP, INC. CONSOLIDATED BALANCE SHEETS ================================================================================ December 31, ------------------------- ASSETS 2001 2000 ----------- ----------- Current assets: Cash and cash equivalents $ 130,242 $ 185,901 Restricted funds 86,318 85,735 Accounts receivable, net of allowance 1,498,463 1,827,275 Inventories 129,824 482,585 Other current assets 112,728 104,003 Assets of discontinued operations 2,566,674 -- Advance - stockholder -- 50,249 ----------- ----------- Total current assets 4,524,249 2,735,748 Property and equipment, net 4,463,122 7,169,794 Other assets: Prepaid pension cost 904,673 726,326 Intangible assets, net 1,045,959 416,002 Preferred stock investment -- 295,000 Cash surrender value of officer life insurance -- 30,464 ----------- ----------- 1,950,632 1,467,792 ----------- ----------- $10,938,003 $11,373,334 =========== =========== 1
December 31, ---------------------------- LIABILITIES AND STOCKHOLDERS' EQUITY 2001 2000 ------------ ------------ Current liabilities: Notes payable: Bank $ 282,206 $ 945,695 Stockholders/officers 124,906 48,946 Accounts payable 1,146,016 1,429,906 Accrued expenses 708,762 1,045,947 Current maturities of long-term obligations 841,878 2,917,365 Current maturities of long-term obligations - stockholders 120,000 175,911 Liabilities of discontinued operations 2,986,904 -- ------------ ------------ Total current liabilities 6,210,672 6,563,770 Long-term obligations 2,586,696 2,014,934 Long-term obligations - stockholders -- 907,514 Commitments and contingencies (see Notes 16 and 20) Stockholders' equity Common stock, $.001 par value, 20,000,000 shares authorized; 5,119,047 and 3,542,049 shares issued; 5,119,047 and 3,450,113 outstanding; 93,750 subscribed in 2000 5,119 3,636 Additional paid-in capital 25,585,864 22,653,410 Accumulated deficit (23,450,348) (20,352,590) ------------ ------------ 2,140,635 2,304,456 Less: Treasury stock, at cost -- (229,840) Common stock subscription receivable -- (187,500) ------------ ------------ Total stockholders' equity 2,140,635 1,887,116 ------------ ------------ $ 10,938,003 $ 11,373,334 ============ ============
See notes to consolidated financial statements. 2 INFINITE GROUP, INC. CONSOLIDATED STATEMENTS OF OPERATIONS ================================================================================ Years Ended December 31, -------------------------- 2001 2000 ----------- ----------- (As Restated) Sales $ 8,507,648 $ 6,627,570 Cost of goods sold 5,897,511 4,720,649 ----------- ----------- Gross profit 2,610,137 1,906,921 Costs and expenses: General and administrative 2,735,782 1,775,596 Depreciation and amortization 775,924 755,052 Selling 307,030 433,845 Research and development 94,665 -- ----------- ----------- Total costs and expenses 3,913,401 2,964,493 ----------- ----------- Operating loss (1,303,264) (1,057,572) Other income (expense): Interest expense: Stockholders (128,567) (173,694) Other (327,612) (406,545) Loss on dispositions of assets (11,856) (60,587) Other (21,135) (4,427) Interest income 18,508 21,003 ----------- ----------- Total other expense (470,662) (624,250) ----------- ----------- Loss from continuing operations before income tax expense (1,773,926) (1,681,822) Income tax expense (14,533) (28,760) ----------- ----------- Loss from continuing operations (1,788,459) (1,710,582) Loss from discontinued operations, including $622,000 loss on disposal (Note 4) (994,055) (383,665) ----------- ----------- Loss before extraordinary loss (2,782,514) (2,094,247) Extraordinary loss (Note 15) (273,813) -- ----------- ----------- Net loss $(3,056,327) $(2,094,247) =========== =========== Loss per share - basic and diluted: Continuing operations $ (.43) $ (.59) Loss from discontinued operations (.24) (.13) Extraordinary loss (.07) -- ----------- ----------- Net loss $ (.74) $ (.72) =========== =========== Weighted average number of common shares outstanding - basic and diluted 4,132,724 2,911,217 =========== =========== See notes to consolidated financial statements. 3 INFINITE GROUP, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY Years Ended December 31, 2001 and 2000 ================================================================================
Common Stock Additional --------------------------- Paid-in Accumulated Shares Amount Capital Deficit ------------ ------------ ------------ ------------ Balance - December 31, 1999 2,918,604 $ 2,918 $ 21,235,597 $(17,985,172) Issuance of common stock in connection with conversion of stockholder notes payable 97,700 98 346,402 (82,844) Issuance of common stock in connection with conversion of debentures 74,176 74 134,926 -- Issuance of common stock under subscription agreement, 93,750 shares subscribed, net of fees 250,000 250 484,269 -- Issuance of common stock in connection with the exercise of stock options 121,784 122 210,246 (37,672) Issuance of common stock in connection with the exercise of stock warrants 153,000 153 172,597 -- Issuance of common stock in connection with the satisfaction of a liability 20,535 21 22,678 -- Issuance of common stock, from treasury -- -- -- (152,655) Stock options issued in exchange for services rendered -- -- 46,695 -- Net loss -- -- -- (2,094,247) ------------ ------------ ------------ ------------ Balance - December 31, 2000 3,635,799 $ 3,636 $ 22,653,410 $(20,352,590) Common Treasury Stock Stock ---------------------------- Subscription Shares Amount Receivable Total ------------ ------------ ------------ ------------ Balance - December 31, 1999 (550,075) $ (1,375,187) $ -- $ 1,878,156 Issuance of common stock in connection with conversion of stockholder notes payable 294,649 736,622 -- 1,000,278 Issuance of common stock in connection with conversion of debentures -- -- -- 135,000 Issuance of common stock under subscription agreement, 93,750 shares subscribed, net of fees -- -- (187,500) 297,019 Issuance of common stock in connection with the exercise of stock options 45,290 113,225 -- 285,921 Issuance of common stock in connection with the exercise of stock warrants -- -- -- 172,750 Issuance of common stock in connection with the satisfaction of a liability -- -- -- 22,699 Issuance of common stock, from treasury 118,200 295,500 -- 142,845 Stock options issued in exchange for services rendered -- -- -- 46,695 Net loss -- -- -- (2,094,247) ------------ ------------ ------------ ------------ Balance - December 31, 2000 (91,936) $ (229,840) $ (187,500) $ 1,887,116
See notes to consolidated financial statements. 4 INFINITE GROUP, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY - CONTINUED ================================================================================
Common Stock Additional --------------------------- Paid-in Accumulated Shares Amount Capital Deficit ------------ ------------ ------------ ------------ Issuance of common stock in connection with conversion of stockholder notes payable 415,256 415 973,930 -- Issuance of common stock in connection with conversion of capital lease 225,000 225 448,605 -- Issuance of common stock in connection with the pension plan contribution 100,000 100 269,900 -- Issuance of common stock, from treasury, in connection with a draw on the equity line of credit, net of fees -- -- -- (3,869) Issuance of common stock, net of fees 637,974 638 1,089,616 (35,109) Issuance of common stock in connection with services rendered 3,750 4 7,496 -- Issuance of common stock in connection with the exercise of stock options 101,268 101 142,907 (2,453) Cash payment received under common stock subscription agreement -- -- -- -- Net loss -- -- -- (3,056,327) ------------ ------------ ------------ ------------ Balance - December 31, 2001 5,119,047 $ 5,119 $ 25,585,864 $(23,450,348) ============ ============ ============ ============ Common Treasury Stock Stock ---------------------------- Subscription Shares Amount Receivable Total ------------ ------------ ------------ ------------ Issuance of common stock in connection with conversion of stockholder notes payable -- -- -- 974,345 Issuance of common stock in connection with conversion of capital lease -- -- -- 448,830 Issuance of common stock in connection with the pension plan contribution -- -- -- 270,000 Issuance of common stock, from treasury, in connection with a draw on the equity li of credit, net of fees 21,737 54,343 -- 50,474 Issuance of common stock, net of fees 65,554 163,884 -- 1,219,029 Issuance of common stock in connection with services rendered -- -- -- 7,500 Issuance of common stock in connection with the exercise of stock options 4,645 11,613 -- 152,168 Cash payment received under common stock subscription agreement -- -- 187,500 187,500 Net loss -- -- -- (3,056,327) ------------ ------------ ------------ ------------ Balance - December 31, 2001 -- $ -- $ -- $ 2,140,635 ============ ============ ============ ============
See notes to consolidated financial statements. 5 INFINITE GROUP, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS ================================================================================
Years Ended December 31, -------------------------- 2001 2000 ----------- ----------- (As Restated) Operating activities: Net loss $(3,056,327) $(2,094,247) Adjustments to reconcile net loss to net cash used in operating activities of continuing operations: Loss from discontinued operations 994,055 383,665 Extraordinary loss 273,813 -- Depreciation and amortization 775,924 755,052 Amortization of discount on note payable 34,044 36,104 Expenses satisfied via issuance of debt or equity instruments 169,459 143,297 Loss on dispositions of assets 11,856 60,587 (Increase) decrease in assets: Accounts receivable (684,406) (84,034) Inventories 23,510 57,062 Other current assets (74,692) 99,876 Prepaid pension cost 91,653 42,775 Note receivable allowance -- 6,652 Increase in liabilities: Accounts payable and accrued expenses 581,023 168,329 ----------- ----------- Net cash used in operating activities of continuing operations (860,088) (424,882) Investing activities: Increase in restricted funds, net (583) (6,500) Purchase of property and equipment (392,384) (731,211) Proceeds from sale of property and equipment 9,500 134,860 Investment in preferred stock -- (45,000) Purchase of intangible assets (372,664) (12,670) ----------- ----------- Net cash used in investing activities of continuing operations (756,131) (660,521)
See notes to consolidated financial statements. 6 INFINITE GROUP, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS - CONTINUED ================================================================================
Years Ended December 31, -------------------------- 2001 2000 ----------- ----------- (As Restated) Financing activities: Net (repayments) borrowings of bank notes payable (241,551) 90,000 Proceeds from notes payable - stockholders/officers 270,000 1,004,000 Repayments of long-term obligations (269,478) (594,803) Repayment of long-term obligations - stockholders (13,245) (13,652) Proceeds from issuances of common stock, net of expenses 1,476,535 447,943 Cash paid for deferred financing costs (33,168) (87,418) ----------- ----------- Net cash provided by financing activities of continuing operations 1,189,093 846,070 Net cash provided by discontinued operations 371,467 97,140 ----------- ----------- Net decrease in cash and cash equivalents (55,659) (142,193) Cash and cash equivalents - beginning of year 185,901 328,094 ----------- ----------- Cash and cash equivalents - end of year $ 130,242 $ 185,901 =========== =========== Supplemental cash flow disclosures: Cash paid for: Interest $ 358,399 $ 669,411 =========== =========== Income taxes $ 15,591 $ 32,060 =========== ===========
See notes to consolidated financial statements. 7 INFINITE GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ================================================================================ NOTE 1. - PRINCIPLES OF CONSOLIDATION AND BUSINESS The accompanying consolidated financial statements include the financial statements of Infinite Group, Inc. (IGI), each of its wholly owned subsidiaries: Infinite Photonics, Inc. (IP), Laser Fare, Inc. (LF), and LF's wholly-owned subsidiary, Mound Laser and Photonics Center, Inc. (MLPC); Osley and Whitney, Inc. (O&W); Express Tool, Inc. (ET); Materials and Manufacturing Technologies, Inc. (MMT); Express Pattern (EP) and MetaTek, Inc. (MT) (collectively "the Company"). The Company operated in three segments: the Laser Group (LF, MLPC, ET and MMT) the Photonics Group (IP and MT) and the Plastics Group (O&W and EP). All significant intercompany accounts and transactions have been eliminated. The Company's continuing operations consist of contracted research and development for government and commercial customers in applied photonics and advanced laser technologies, as well as traditional laser services, which include welding, machining, drilling and engraving manufacturing services. The Company's Plastics Group previously provided proprietary mold building and rapid prototyping services. During the year ended December 31, 2001, the operations of the Plastics Group were discontinued (see Note 4). NOTE 2. - MANAGEMENT PLANS The Company continued experiencing operating losses in 2001. Improved sales levels at the Laser Group and Company wide cost containment measures improved gross profit levels, which were offset by start-up costs at the Company's Infinite Photonics subsidiary. These operating losses resulted in the Company experiencing negative operating cash flow for the year ended December 31, 2001. The infusion of funds in the form of sales of the Company's common stock during 2001 were sufficient enough to fund these losses and the Company's other investing and financing requirements. The Company's business plan for 2002 and beyond is to focus on its two primary remaining business segments, the Laser and Photonics Groups. This will include the ramp up of research, engineering, manufacturing, marketing and administrative capability for the Photonics Group and concentrating on expanding its sales volume in the Laser Group through the acquisition of new customers with limited increases in operating costs. This business plan also includes the completion of the plan to dispose of the Plastics business segment, which historically experienced operating losses. The Company is in the process of liquidating the remaining assets at Osley & Whitney through auction and anticipates that the proceeds should be sufficient to repay the secured bank debt, which the Company has guaranteed. The Company completed the sale of its subsidiary Express Pattern, which resulted in the infusion of $575,000 in cash that will be used also to repay the O&W debt and for working capital purposes (see Note 4). Finally, the Company is completing steps to further reduce corporate overhead including facilities consolidated and other cost reduction measures. 8 INFINITE GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ================================================================================ NOTE 2. - MANAGEMENT PLANS - CONTINUED The Company is also actively pursuing additional capital through strategic alliances, venture capital, private equity and investment banking sources. Subsequent to year end the Company raised $1 million through the issuance of convertible debt, the proceeds of which will be utilized to fund the working capital needs of the Photonics Group for 2002 (see Note 19). The Company believes, but can offer no assurances, that its operations, as restructured, coupled with its capital raising efforts will provide sufficient working capital to fund its operations for 2002 and the near future. NOTE 3. - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Cash Equivalents - For purposes of reporting cash flows, the Company considers all highly liquid instruments purchased with original maturities of 90 days or less to be cash equivalents. Cash equivalents at December 31, 2001 and 2000 consist primarily of money market funds. Restricted Funds - Restricted funds represent escrow funds set aside to meet scheduled payments pursuant to a capital lease financing arrangement. These funds are held in cash deposit and treasury trust accounts. Inventories - Inventories are stated at the lower of cost (first-in, first-out) or market. Inventories at EP and O&W are included in the December 31, 2000 amounts, however, at December 31, 2001 they are included in assets of discontinued operations in the accompanying balance sheet (see Note 4). Inventories consist of the following: December 31, --------------------------------------- 2001 2000 ------------- ------------- Raw materials $60,805 $235,153 Work-in-process 69,019 247,432 ------------- ------------- $129,824 $482,585 ============= ============= Property and Equipment - Additions to property and equipment are recorded at cost and are depreciated over their estimated useful lives utilizing both accelerated and straight-line methods. The cost of improvements to leased properties are amortized over the shorter of the lease term or the life of the improvement. Maintenance and repairs are charged to expenses as incurred while improvements are capitalized. Intangible Assets - Intangible assets consist of goodwill, deferred financing costs and patents. Goodwill represents the excess of the purchase price over the fair value of net assets of acquired businesses and is amortized using the straight-line method over ten years. Deferred financing costs are amortized using the straight-line method over the terms of the related financing instruments, which range from two to fifteen years. The Company capitalizes certain costs for internally developed patents related to legal fees, patent filing fees, consulting and internal payroll costs related to patent applications, models and drawings. Patents are being amortized on the straight-line method over their estimated useful lives, commencing with the date of issuance. 9 INFINITE GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ================================================================================ NOTE 3. - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - CONTINUED The Company periodically reviews the recoverability of the carrying value of its intangible assets. In determining whether there is an impairment, the Company compares the sum of the expected future net cash flows (undiscounted and without interest charges) to the carrying amount of the asset. In addition, the Company will consider other significant events or changes in the economic and competitive environments that may indicate that the remaining estimated useful lives of its intangibles may warrant revision. At December 31, 2001 and 2000, the Company believed that no impairment of intangibles existed. In July 2001, the Financial Accounting Standards Board issued No. 142 (SFAS 142), "Goodwill and Other Intangible Assets", which becomes effective January 1, 2002. This standard specifies, among other things, that goodwill no longer be amortized. The standard requires goodwill to be periodically tested for impairment and written down to fair value if considered impaired. The Company does not expect the adoption of this standard to have a material impact on its financial statements. Preferred Stock Investment - As of December 31, 2000, the Company owned 7% and 5%, respectively, of the outstanding Preferred Series A and B Stock of Tensegra, Inc., which was recorded at cost. During the year ended December 31, 2001, the Company disposed of this investment as part of a non-monetary exchange transaction, accounted for in accordance with APB 29. As consideration for the purchase of certain intellectual property owned by Tensegra, the Company transferred its investment in Tensegra, recorded at $295,000, and discharged certain accounts receivable from Tensegra, amounting to $58,512. The intellectual property received was recorded at the carrying value of the assets surrendered in the aggregate amount of $353,512. The intellectual property received will be utilized in its Laser Group. This asset is included in other intangible assets (see Note 7). Revenue Recognition - Revenues are primarily recognized after the services are performed and the units are shipped. Consulting revenues are recognized as the consulting services are provided. Customer deposits received in advance are recorded as liabilities until associated services are completed. Revenue from research contracts is recognized over the life of the contract as costs are incurred. Revenues from mold manufacturing contracts are recognized using the completed contract method of accounting, which does not vary significantly from the percentage completion method. Accordingly, revenue and related costs are included in operations upon substantial completion of the contract. Research and Development Costs - All costs related to internal research and development are expensed as incurred. Research and development expense was $94,665 for the year ended December 31, 2001 and consists primarily of salaries. There was no research and development expense during the year ended December 31, 2000. Contracted research and development conducted for others is classified as cost of sales. Research and development costs for which the Company has subcontracted out is recognized as cost of sales as incurred. Advertising - The Company expenses advertising costs as incurred. Advertising expense was approximately $33,000 and $40,000 for the years ended December 31, 2001 and 2000, respectively. 10 INFINITE GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ================================================================================ NOTE 3. - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - CONTINUED Income Taxes - The Company and its wholly owned subsidiaries file consolidated federal income tax returns. Deferred taxes are provided on an asset and liability method whereby deferred tax assets are recognized for deductible temporary differences and operating loss and tax credit carryforwards and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax bases. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment. Concentration of Credit Risk - Credit is granted to substantially all customers throughout the United States. The Company maintains adequate reserves for potential credit losses and such losses have been minimal and within management's estimates. The allowance for doubtful accounts of continuing operations was approximately $40,000 and $46,000 at December 31, 2001 and 2000, respectively. During the year ended December 31, 2001 sales to one customer accounted for 12% of total revenues from continuing operations and 33% of accounts receivable at December 31, 2001. During the year ended December 31, 2000, sales to a different customer accounted for 12% of total revenues and 4% of accounts receivable from continuing operations at December 31, 2000. Net Loss Per Common Share - Net loss per common share is based upon the weighted average number of common shares outstanding during the periods presented. As of December 31, 2001 and 2000, all outstanding stock options, warrants and convertible obligations have not been considered common stock equivalents because their assumed exercise would be anti-dilutive. Reclassifications - Certain amounts for 2000 have been reclassified to conform to the 2001 presentation. Use of Estimates - The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Fair Value of Financial Instruments - The carrying amounts of cash and cash equivalents, accounts receivable and accounts payable and accrued expenses are reasonable estimates of their fair value due to their short maturity. Based on the borrowing rates currently available to the Company for loans similar to its term debt and notes payable, the fair value approximates its carrying amount. Accounting for Stock Issued to Employees - The Company accounts for its stock option plans under APB Opinion No. 25, "Accounting for Stock Issued to Employees." Accordingly, compensation expense is recognized for the excess of the fair market value of the Company's common stock over the exercise price. In accordance with Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation," (SFAS No. 123) the Company 11 INFINITE GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ================================================================================ discloses the summary of proforma effects to reported net loss and loss per share for 2001 and 2000, as if the Company had elected to recognize compensation costs based on the fair value of the options granted at grant date (see Note 12). NOTE 4. - DISCONTINUED OPERATIONS On March 29, 1999, the Company acquired 100% of the common stock of O&W, a mold building Company. The aggregate consideration paid for the stock was $1.5 million ($300,000 in cash and $1,200,000 in promissory notes, See Note 10). The O&W acquisition was accounted for under the purchase method of accounting. In April 1999 the Company formed EP, to compliment it's O&W subsidiary. EP was formed to allow customers' design engineers to produce rapid prototype parts. In November 2001 and December 2001, the Company's Board of Directors resolved to dispose of O&W and EP, respectively. The formal plan consisted of shutting down the operations of the O&W subsidiary and selling the net assets of the EP subsidiary. Effective November 30, 2001, the Company shut down the operations of O&W and terminated all of the employees. The Company is in the process of liquidating all of the assets of O&W. The proceeds from the sale of these assets will be used to repay the outstanding bank obligations, which are secured by the assets. As of December 31, 2001 the amounts outstanding under these bank obligations amounted to approximately $1,550,000. These obligations are guaranteed by IGI. Any bank obligation remaining after the sale of assets will be assumed by IGI and will be payable based on a seven year amortization with a balloon payment due after 18 months. The loss on disposal of discontinued operations in the amount of $622,000 for the year ending December 31, 2001, represents the writedown of property, plant and equipment, inventory and accounts receivable at O&W to their net realizable value. On March 14, 2002, the Company consummated the sale of the net assets of EP to certain officers/employees of the Company. The purchase price amounted to $675,000, plus the assumption of liabilities, of which $575,000 was received in cash. The remaining $100,000 is in the form of a subordinated note which bears interest at the rate of 8% and is payable in March 2005. In accordance with Statement of Financial Accounting Standards Board No. 144, the disposal of the Plastics Group has been accounted for as a disposal of a business segment and accordingly, the assets and liabilities for O&W and EP have been segregated from continuing operations in the accompanying consolidated balance sheet as of December 31, 2001 and classified as assets/liabilities of discontinued operations. The operating results are segregated and reported as discontinued operations in the accompanying consolidated statements of operations and cash flows. The accompanying statement of operations and cash flows for the year ended December 31, 2000 have been restated to present separately the operating results and cash flows of these discontinued operations. The 2000 balance sheet has not been restated. 12 INFINITE GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ================================================================================ NOTE 4. - DISCONTINUED OPERATIONS - CONTINUED The following is a summary of financial position and results of operations for the years ended December 31, 2001 and 2000 for the disposed Plastics segment (O&W and EP): December 31, Financial Position 2001 ------------ Current assets $ 580,799 Property and equipment, net 1,985,875 ---------- Assets of discontinued operations $2,566,674 ========== Secured bank obligations $1,550,038 Accounts payable and accrued expenses 963,646 Capital lease obligations 473,220 ---------- Liabilities of discontinued operations $2,986,904 ========== Years Ended December 31, ------------------------------ Results of Operations 2001 2000 ---------- ---------- Revenue $5,389,327 $6,538,169 ========== ========== Net loss $ 994,055 $ 383,665 ========== ========== NOTE 5. - NOTES RECEIVABLE Long term promissory notes in the amount of $318,452, receivable from two stockholders, mature through December 2004 and accrue interest at 6%, which is payable quarterly. Shares of the Company's common stock held by the stockholders collateralize the notes. As of December 31, 2001 and 2000 the notes have been fully offset by a valuation allowance based on management's estimate of the net realizable value of the notes. 13 INFINITE GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ================================================================================ NOTE 6. - PROPERTY AND EQUIPMENT Property and equipment and related accumulated depreciation and amortization at EP and O&W are included in the December 31, 2000 amounts below, however, amounts at December 31, 2001 are included in assets of discontinued operations (see Note 4). Property and equipment consists of:
December 31, Depreciable ---------------------------------- Lives 2001 2000 --------------------------- --------- ---------- Land N/A $ 100,000 $ 143,625 Building and leaseholds 18 - 40 years 1,007,145 1,853,346 Machinery and equipment 5 - 10 years 6,487,227 7,536,898 Furniture and fixtures 5 - 7 years 694,988 856,038 ---------- ---------- 8,289,360 10,389,907 Accumulated depreciation and amortization (3,826,238) (3,776,637) ---------- ---------- 4,463,122 6,613,270 Contracts in progress - 556,524 ---------- ---------- $4,463,122 $7,169,794 ========== ==========
Included above is the following property and equipment held under capital leases.
December 31, ----------------------------------- 2001 2000 --------- ---------- Land $ 100,000 $ 100,000 Building and leaseholds 725,762 725,762 Machinery and equipment 878,052 1,539,369 --------- ---------- 1,703,814 2,365,131 Accumulated depreciation and amortization (917,255) (898,374) --------- ---------- $ 786,559 $1,466,757 ========= ==========
Depreciation charges for assets under capital leases are included in depreciation and amortization expense and amounted to $101,348 and $190,697 in 2001 and 2000, respectively. During the year ended December 31, 2000, the Company entered into an agreement to provide certain consulting services in exchange for equipment to be utilized in its Laser Group. The transaction was accounted for as a non-monetary exchange, whereby the Company is recording the fair value of the services rendered. The fair value of services rendered approximated the fair value of the equipment received, which amounted to $796,000. The services and asset exchange were completed in July 2001. Amounts capitalized relating to this agreement as of December 31, 2000 amounted to $556,524 and were recorded as contracts in progress. 14 INFINITE GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ================================================================================ NOTE 7. - INTANGIBLE ASSETS Intangible assets consists of the following: December 31, -------------------------------- 2001 2000 ----------- ----------- Goodwill $ 249,227 $ 249,227 Deferred financing costs 257,958 296,419 Patents 796,985 69,749 ----------- ----------- 1,304,170 615,395 Accumulated amortization (258,211) (199,393) ----------- ----------- $ 1,045,959 $ 416,002 =========== =========== NOTE 8. - NOTES PAYABLE Notes payable consists of the following: December 31, -------------------------------- 2001 2000 ----------- ----------- Bank (a) $ 282,206 $ 945,695 Stockholders/officers (b) 124,906 48,946 ----------- ----------- $ 407,112 $ 994,641 =========== =========== (a) Bank revolving demand notes - LF maintained a line of credit with a financial institution that provided for borrowings of up to $525,000 with interest at the bank's prime rate plus .50%. As of December 31, 2000 there was $523,757 outstanding under this line. During November 2001, LF refinanced the outstanding balance on the line of credit, which amounted to approximately $285,000, into a demand note. The bank demand note requires monthly principal and interest payments amounting to approximately $5,800 through November 2002, at which point the remaining unpaid balance is due. The outstanding balance as of December 31, 2001 amounted to $282,206 and bears interest at the bank's prime rate (4.75% at December 31, 2001) plus 3%. All the assets of LF and the guarantee of the Company secure the note. O&W maintains a bank demand note that provides for borrowings of up to $500,000 with interest at the bank's prime rate (4.75% at December 31, 2001) plus 0.50%. As of December 31, 2001, there was $497,554 ($421,938 - 2000) outstanding under this line. Substantially all of O&W's assets and the guarantee of IGI secure the line. This demand note is included in liabilities of discontinued operations on the accompanying balance sheet at December 31, 2001 (see Note 4). 15 INFINITE GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ================================================================================ NOTE 8. - NOTES PAYABLE - CONTINUED (b) Notes payable, stockholders/officers - During the year ended December 31, 2001, the Company issued various unsecured short-term notes payable to the president/principal stockholder amounting to $150,000 of which $100,000 was subsequently applied to the purchase of 39,526 shares of common stock of the Company (see Note 11). The remaining outstanding balance of $50,000 bears interest at 10%. During the year ended December 31, 2001, the Company issued unsecured short-term notes payable to various employees/stockholders, amounting to an aggregate of $120,000 of which $50,000 was subsequently applied to the purchase of 25,486 shares of common stock of the Company (see Note 11). The remaining outstanding balance of $70,000 bears interest at 10%. During the year ended December 31, 2000, the Company issued unsecured short-term notes payable to three employees/stockholders, amounting to $42,500 as consideration for unpaid compensation. During the year ended December 31, 2001, approximately $14,000 ($24,000 - 2000) of this amount was applied to the exercise of options for 8,104 shares of common stock of the Company (see Note 11). The remaining outstanding balance of $4,906 ($18,946 - 2000) bears interest at 8% per annum. During the year ended December 31, 2000, the Company issued two unsecured short-term notes payable to an employee/stockholder, amounting to $30,000 which were outstanding at December 31, 2000. During the year ended December 31, 2001 the outstanding balance of $30,000 along with accrued interest of $2,536 was applied to the purchase of 16,268 shares of common stock of the Company (see Note 11). During the year ended December 31, 2000, the Company issued various unsecured short-term notes payable to the president/principal stockholder amounting to $974,000. Also during 2000, this amount, along with $40,000 previously outstanding notes payable and $12,000 of related accrued interest was applied to the exercise of 153,000 stock warrants ($172,750), 96,758 options ($199,472) and the purchase of 294,649 shares of common stock of the Company ($653,778). 16 INFINITE GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ================================================================================ NOTE 9. - LONG-TERM OBLIGATIONS Long-term obligations consists of the following: 2001 2000 ----------- ----------- Term notes (a) $ 2,768,574 $ 3,990,385 Capital lease obligations (b) 660,000 941,914 ----------- ----------- 3,428,574 4,932,299 Less current maturities and classifications 841,878 2,917,365 ----------- ----------- Total long-term obligations $ 2,586,696 $ 2,014,934 =========== =========== (a) Term notes - A $1,250,000 bank term promissory note that requires monthly principal and interest payments amounting to approximately $13,000 through February 2011. The outstanding balance as of December 31, 2001 amounted to $957,882 ($1,023,297 - 2000) and bears interest at the bank's prime rate (4.75% at December 31, 2001) plus 1.0%. All the assets of LF and the guarantee of the Company secure the note. The note includes certain financial covenants that require the Company to, among other things, maintain certain working capital, current and debt to net worth ratios. The Company was in violation of certain of its covenants for the year ended December 31, 2001, however, these violations have been waived by the bank. Certain of these covenants had been violated as of December 31, 2000, which were not waived by the bank. Accordingly, the entire outstanding portion of the note was classified as current as of December 31, 2000. A $1,260,000 bank term promissory note that requires monthly principal and interest payments amounting to approximately $13,000 through December 2014. The outstanding balance as of December 31, 2001 amounted to $1,178,766 ($1,227,064 - 2000) and bears interest at the bank's prime rate (4.75% at December 31, 2001) plus 0.75%. The Company was in violation of certain of its covenants for the year ended December 31, 2001, however, these violations have been waived by the bank. Certain of these covenants had been violated as of December 31, 2000, which were not waived by the bank. Accordingly, the entire outstanding portion of the note was classified as current as of December 31, 2000. A $125,000 bank term promissory note which requires monthly principal and interest payments amounting to approximately $1,800 through July 2006. The outstanding balance as of December 31, 2001 amounted to $79,926 ($96,078 - 2000) and bears interest at the bank's prime rate (4.75% at December 31, 2001) plus 1.0%. All the assets of the LF and the guarantee of the Company secure the loan. The Company was in violation of certain of its covenants for the year ended December 31, 2001, however, these violations have been waived by the bank. Certain of these covenants had been violated as of December 31, 2000, which were not waived by the bank. Accordingly, the entire outstanding portion of the note was classified as current as of December 31, 2000. 17 INFINITE GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ================================================================================ NOTE 9. - LONG-TERM OBLIGATIONS - CONTINUED An $828,000 note payable to a former shareholder of O&W, due in three equal annual installments of $276,000, with interest at 8.0%, beginning in April 2000. The outstanding balance as of December 31, 2001 and 2000 amounted to $552,000. Subsequent to December 31, 2001, the Company entered into an agreement with the holder to convert the entire outstanding balance along with accrued interest into common stock of the Company based upon certain conditions (see Note 19). Two unsecured term promissory notes aggregating $30,100 were payable to the former shareholders of MLPC, payable in monthly installments of $971, including interest at the rate of 10.0%. The aggregate outstanding balance as of December 31, 2000 amounted to $1,919. These noted were repaid in full during 2001. An installment loan, payable in monthly installments of $391, including interest at the rate of 10% per annum, through September 2001. The outstanding balance as of December 31, 2000 amounted to $2,694. This note was repaid in full during 2001. A $700,000 mortgage loan, payable in monthly installments of $5,746 including interest at 7.75% through April 2006, at which time a balloon payment of approximately $565,000 is due. The outstanding balance as of December 31, 2001 amounted to $670,155 ($676,932 - 2000). Substantially all the assets of O&W and the guarantee of IGI secure the loan. This mortgage loan is included in liabilities of discontinued operations on the accompanying balance sheet at December 31, 2001 (see Note 4). The outstanding balance at December 31, 2000 is included in long-term obligations. A $500,000 bank term loan, payable in monthly installments of $7,731, including interest at 7.75%, through April 2006. The outstanding balance as of December 31, 2001 amounted to $379,998 ($410,401 - 2000). Substantially all the assets of O&W and the guarantee of IGI secure the loan. This bank term loan is included in liabilities of discontinued operations on the accompanying balance sheet at December 31, 2001 (see Note 4). The outstanding balance at December 31, 2000 is included in long-term obligations. (b) Capital lease obligations - The Company is obligated under a capital lease for an operating facility. The lease provides for monthly payments to an escrow account in amounts sufficient to allow for the repayment of the principal of the underlying tax-exempt bonds together with interest at rates ranging from 6.0% to 7.25%. The outstanding balance as of December 31, 2001 amounted to $660,000 ($795,000 - 2000). Combined payments of principal and interest are approximately $9,600 per month through June 2002 and $4,600 per month thereafter through June 2012. Under the terms of this credit facility, the Company is prohibited from paying dividends or making other cash distributions. 18 INFINITE GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ================================================================================ NOTE 9. - LONG-TERM OBLIGATIONS - CONTINUED The Company is also the lessee of certain machinery and equipment under a capital lease that expires in 2002. The outstanding balance as of December 31, 2001 amounted to $74,508 ($146,914 - 2000). The monthly payments under this lease amount to approximately $7,200, including interest at the rate of 10.47%. The Company entered into another capital lease for certain machinery and equipment during the year ended December 31, 2001. The monthly payments under this lease amounted to approximately $8,700, including interest at 5.42% through June 2005, at which time a balloon payment of approximately $66,000 is due. The outstanding balance as of December 31, 2001 amounted to $398,712. These capital leases are included in liabilities of discontinued operations on the accompanying balance sheet at December 31, 2001 (see Note 4). The outstanding balance at December 31, 2000 is included in long-term obligations. Minimum future annual payments of long-term obligations as of December 31, 2001 are as follows: 2002 $ 884,198 2003 196,277 2004 205,478 2005 215,214 2006 212,756 Thereafter 2,115,121 ---------- Total minimum payments 3,829,044 Less amount representing interest 400,470 ---------- 3,428,574 Less current maturities 841,878 ---------- Total long-term obligations $2,586,696 ========== NOTE 10. - LONG-TERM OBLIGATIONS - STOCKHOLDERS Long-term obligations - stockholders consists of the following: 2001 2000 ----------- ----------- Term notes (a) $ 120,000 $ 664,507 Capital lease obligation (b) -- 418,918 ----------- ----------- 120,000 1,083,425 Less current maturities - stockholders 120,000 175,911 ----------- ----------- Total long-term obligations - stockholders $ -- $ 907,514 =========== =========== 19 INFINITE GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ================================================================================ NOTE 10. - LONG-TERM OBLIGATIONS - STOCKHOLDER - CONTINUED (a) Term Notes - Convertible notes payable to former shareholders of O&W, aggregating $372,000, due in three equal annual aggregate installments of $124,000, with interest at 8.0%, beginning in April 2000. The outstanding balance as of December 31, 2001 amounted to $120,000 ($240,000 - 2000). The Company has the option to pay interest by delivery of shares of the Company's common stock. The former shareholders have the option to convert 50% of the principal balance due into common stock of the Company on each payment date based on the fair value of the stock one-year preceding the payment date. During the years ended December 31, 2001 and December 31, 2000, a portion of these notes were satisfied through the issuance of 85,526 and 97,700 shares common stock, respectively (see Note 11). A ten-year term note to the Company's current president/principal stockholder in the original amount of $1,150,000, with interest at the one year Treasury Bill rate plus 3.5%, adjusted annually. The balance as of December 31, 2000 amounted to $683,076 and was being repaid in monthly installments of approximately $6,000 including interest. The note matured in June 2008 when the remaining unpaid principal of approximately $525,000 was due. In December 2001, the entire outstanding balance of $619,582, along with accrued interest at $8,998 was applied to the purchase of 248,450 shares of common stock (see Note 11). Detachable warrants to purchase 536,000 shares of common stock at a price of $5.60 were issued with this note. The warrants expire five years from the date of issuance. A portion of the proceeds of the note, in the amount of $551,716 was allocated to the warrants as they became exercisable and was reflected as additional paid-in capital. The note payable balance had been shown net of the discount allocated to the warrants. This discount was being amortized to interest expense over the term of the note, which amortization amounted to $34,044 and $36,104 for 2001 and 2000. As a result of the conversion of the note during 2001, the unamortized discount, amounting to $224,525, was written off (see Note 15). The unamortized discount at December 31, 2000 was $258,569. (b) Capital Lease Obligation - During the year ended December 31, 2000, the Company entered into a capital lease agreement for equipment with its president/principal stockholder. The lease provided for monthly payments of approximately $5,650 through April 2010, including interest at the prime rate plus 1%. As of December 31, 2000, the Company was in arrears on the required payments. The outstanding balance as of December 31, 2000 amounted to $418,918, plus accrued interest of $26,912. In April 2001, the Company's president and principal stockholder contributed the assets under this lease to the Company in exchange for 225,000 shares of common stock (see Note 11) and released the Company from all obligations, amounting to $448,830, under the lease. NOTE 11. - STOCKHOLDERS' EQUITY A. Preferred Stock The certificate of incorporation authorizes the Board of Directors to issue up to 1,000,000 shares of Preferred Stock. The stock is issuable in series that may vary as to certain rights and preferences, as determined upon issuance, and has a par value of $.01 per share. As of December 31, 2001 and 2000, there were no preferred shares issued or outstanding. 20 INFINITE GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ================================================================================ NOTE 11. - STOCKHOLDERS' EQUITY - CONTINUED B. Common Stock During the year ended December 31, 2001, the following common stock transactions took place: o Stockholder notes payable in the amount of $180,000 and $3,508 of related accrued interest (see Note 8) were converted into 81,280 shares of common stock. The fair market value of the shares issued equaled the amount of the recorded liability. o Stockholder term notes in the amount of $739,582 and $42,455 of related accrued interest (see Note 10), as well as accrued employee related expenses of $8,800 were converted into 333,976 shares of common stock. The fair market value of the shares issued equaled the amount of the recorded liability. o The Company issued 225,000 shares of common stock as satisfaction for a capital lease obligation and related accrued interest, amounting to $448,830 due to the Company's president and principal stockholder (see Note 10). The fair market value of the shares issued equaled the amount of the outstanding liability. o The Company issued 100,000 shares of its common stock at a price of $2.70 per share as a contribution to the defined benefit pension plan (see Note 14). The total common stock contribution amounted to $270,000. The fair value of the shares issued equaled the recorded contribution. o In connection with a drawdown on the equity line of credit, (Note 11c), the Company issued 21,737 shares of common stock from treasury, resulting in proceeds of $50,474, net of expenses of $12,206. o In private placement transactions with accredited investors, the Company entered into agreements to sell common stock at prices ranging from $1.25 to $2.25 per share, resulting in the issuance of 703,528 shares of its common stock, of which 65,554 shares were issued from treasury. Total consideration resulting from these agreements amounted to $1,219,029, net of fees of $133,371. In connection with these transactions, the Company granted warrants to the investors to purchase, in aggregate, 24,000 shares of common stock with exercise prices ranging from $3.00 to $4.00 per share. The Company also granted 49,400 warrants to the placement agents with exercise prices ranging from $3.00 to $4.00 per share. The Company issued 3,750 shares of common stock, valued at $7,500, to a placement agent in exchange for services provided in connection with the private placement transactions. The fair market value of the shares issued equaled the amount of the services provided. 21 INFINITE GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ================================================================================ NOTE 11. - STOCKHOLDERS' EQUITY - CONTINUED B. Common Stock (continued) o Various employees exercised stock options with exercise prices ranging from $1.00 to $2.50 per share, resulting in the issuance of 105,913 shares of common stock, of which, 4,645 were issued from treasury. Total consideration resulting from these exercised options amounted to $152,168. In lieu of cash payments, $14,040 related to the satisfaction of outstanding notes payable (see Note 8) and $126,094 reduced outstanding employee related expenses. o The unpaid portion of $187,500 related to a private placement transaction in 2000, which was recorded as a stock subscription receivable, was received, at which time 93,750 shares were issued. During the year ended December 31, 2000, the following common stock transactions took place: o Stockholder notes payable due to the Company's president/ principal stockholder in the amount of $641,778 and $12,000 of related accrued interest (see Note 8) were converted into 294,649 shares of common stock, issued from treasury. In connection with these transactions, the Company granted warrants to purchase 33,900 shares of common stock at prices ranging from $1.63 to $3.42. These warrants vested immediately. o Stockholder term notes payable in the amount of $132,000 and $14,500 of related accrued interest associated with the loans (see Note 10) were converted into 97,700 shares of common stock. o Convertible debentures in the amount of $100,000 and $35,000 of related accrued interest were converted into 74,176 shares of common stock. o In a private placement transaction with an accredited investor, the Company entered into an agreement to sell 250,000 shares of its common stock at a price of $2.00 per share, resulting in expected proceeds of $500,000. As of December 31, 2000, $312,500 of this amount was received and 156,250 shares were issued. The unpaid portion of $187,500 was recorded as a stock subscription receivable, which was received in 2001, at which time the remaining 93,750 shares were issued. The receivable is shown as a reduction to stockholders' equity in the accompanying balance sheet. In connection with this transaction, the Company granted a warrant to the investor to purchase 50,000 shares of common stock at a price of $1.63 per share. The Company also granted the purchaser's designee, for services rendered in connection with the financing, a warrant to purchase 100,000 common shares at a price of $2.00 per share. Both warrants are exercisable for a four-year period commencing May 31, 2001. 22 INFINITE GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ================================================================================ NOTE 11. - STOCKHOLDERS' EQUITY - CONTINUED o Various employees exercised stock options with exercise prices ranging from $1.00 to $2.50 per share, resulting in the issuance of 167,074 shares of common stock, of which, 45,290 were issued from treasury. Total consideration resulting from these exercised options amounted to $285,921. In lieu of cash payments, $199,472 related to the satisfaction of outstanding notes payable to the president/principal stockholder (see Note 8), $24,170 related to the satisfaction of notes payable to other stockholders (see Note 8) and $54,200 reduced an outstanding employee related liability due to an officer. o The Company's president/principal stockholder exercised 153,000 common stock warrants with exercise prices ranging from $1.03 to $1.63 per share resulting in consideration of $172,750. In lieu of cash payments, outstanding notes payable to the president/principal stockholder were satisfied for this amount (see Note 8). o The Company issued 20,535 shares of common stock as satisfaction of outstanding liabilities amounting to $22,699. The fair market value of the shares issued equaled the amount of the recorded liability. o In other transactions, the Company issued from treasury 118,200 shares of common stock to various accredited investors resulting in proceeds of $120,000. In connection with these transactions, the Company granted warrants to purchase 4,200 shares of common stock at an exercise price of $3.95. These warrants vest immediately and expire in October 2003. C. Equity Line of Credit On November 20, 2000, the Company entered into an equity line of credit agreement with an accredited investor to purchase up to 3,000,000 shares of common stock of the Company over a three-year period beginning February 9, 2001. During this three-year period the Company may request a drawdown under the equity line of credit by selling shares of the Company's common stock to the investor. The price per share will be determined using a formula based on 87.5% of the Company's closing share price 20 days immediately following the drawdown date. The minimum amount, which can be raised from each drawdown, is $200,000. The maximum amount is determined as the lower of a) $5,000,000 or b) 15% of the weighted average share price over the 20 days immediately prior to the drawdown multiplied by the total trading volume during those days. Further, the shares issued as the result of a drawdown cannot cause the investor's ownership in the Company to exceed 9.9% of the outstanding shares. 23 INFINITE GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ================================================================================ NOTE 11. - STOCKHOLDERS' EQUITY - CONTINUED In conjunction with the establishment of the equity line of credit, the Company issued warrants to this investor to purchase 200,000 shares of the Company's common stock for an exercise price of $3.135, which expire November 30, 2003. In addition, at the close of each drawdown the Company will issue the investors additional warrants to purchase a number of shares of the Company's common stock equal to 33% of the number of shares purchased by the investor at the close of the drawdown. These warrants will expire one day after they are granted and will be exercisable for a price equal to the weighted average fair value of a share of the Company's common stock purchased at the closing of each drawdown. If any of these warrants are exercised, the shares available for future drawdowns will be reduced so that the aggregate may not exceed 3,000,000 shares. During the year ended December 31, 2001, the Company drew down on the equity line of credit and issued 21,737 shares of treasury stock resulting in net proceeds of $50,474 (see Note 11C). No securities were issued under this agreement for the year ended December 31, 2000. D. Warrants In connection with the issuance of convertible debentures in 1997, the Company issued warrants to the placement agent to purchase up to an aggregate of 10,775 shares of common stock of the Company. The warrants are exercisable for a five-year term commencing February 1997 at an exercise price of $10.30 per share. In connection with the issuance of notes payable to the Company's president/principal stockholder and principal stockholder during 1998, 536,000 detachable warrants were issued (see Note 10). As the warrants vested, they were valued and recorded as additional paid-in capital in the accompanying balance sheet. In connection with the issuance of a $150,000 convertible note payable to the Company's president/principal stockholder during 1999, 128,000 detachable warrants were issued. The value assigned to the warrants, amounting to $73,219, has been reflected as additional paid-in capital in the accompanying balance sheet. During the year ended 2000, the Company's president/principal stockholder exercised these warrants (see Note 11B). In connection with common stock issued to the Company's president/principal stockholder during 2000, the Company issued warrants to purchase 33,900 shares of common stock at exercise prices ranging from $1.63 to $3.42 per share. The warrants vested immediately and have a three-year term. During 2000, 25,000 of these warrants were exercised. (see Note 11B). As of December 31, 2001, 8,900 of these warrants remain outstanding. 24 INFINITE GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ================================================================================ NOTE 11. - STOCKHOLDERS' EQUITY - CONTINUED D. Warrants In connection with a private placement transaction during 2000, the Company issued warrants to various accredited investors to purchase an aggregate of 4,300 shares of common stock at an exercise price of $3.95 per share. The warrants vest immediately and have a three- year term. In connection with a private placement transaction during 2000, the Company issued a warrant to purchase 50,000 shares of common stock. The warrant is exercisable for a four-year term commencing May 31, 2001 at an exercise price of $1.63 per share. For services rendered in connection with the financing the Company also granted the purchaser's designee a warrant to purchase 100,000 common shares at a price of $2.00 per share, exercisable for a four-year period commencing May 31, 2001. In connection with the equity line of credit, discussed in Note 11C, the Company issued a warrant to purchase 200,000 shares of the Company's common stock. In addition, the Company issued, to a placement agent, a warrant to purchase 100,000 shares of common stock. Both warrants are exercisable immediately for a price of $3.135 and expire in November 2003. In connection with the private placement transactions during 2001, the Company issued warrants to various accredited investors to purchase in aggregate 24,000 shares of common stock at exercise prices ranging from $3.00 to $4.00. The warrants vested immediately and have a three-year term. In addition, in connection with the private placement transactions during 2001, the Company issued warrants to various placement agents to purchases, in aggregate, 49,400 warrants at exercise prices ranging from $3.00 to $4.00. The warrants vested immediately and have a three year term. All warrants issued in connection with debt and equity financing transactions, exclusive of those issued with the purchase of common stock, have been valued utilizing the Black-Scholes pricing model. 25 INFINITE GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ================================================================================ NOTE 11. - STOCKHOLDERS' EQUITY - CONTINUED The following is a summary of the warrant activity for the past two years: Number Weighted of Warrants Average Outstanding Exercise Price ----------- -------------- Outstanding at December 31, 1999 890,775 $ 4.54 Granted 488,200 2.68 Forfeited/expired (216,000) 3.72 Exercised (153,000) 1.13 --------- Outstanding at December 31, 2000 1,009,975 4.34 Granted 73,400 3.41 --------- Outstanding at December 31, 2001 1,083,375 4.28 ========= All warrants are exercisable as of December 31, 2001 and 2000. Warrants outstanding at December 31, 2001 are made up of the following: Weighted Number Average of Warrants Exercise Price ----------- -------------- $2.00 and Less 150,000 $ 1.88 --------- ---------- $2.01 - $4.00 386,600 $ 3.20 --------- ---------- Greater than $4.00 546,775 $ 5.69 --------- ---------- Total 1,083,375 $ 4.28 ========= ========== NOTE 12. - STOCK OPTION PLANS The Company's Board of Directors has approved stock option plans adopted in 1993, 1994, 1995, 1996, 1997, 1998 and 1999 authorizing the granting of options to purchase up to an aggregate of 2,340,000 shares. Such options may be designated at the time of grant as either incentive stock options or nonqualified stock options. As of December 31, 2001, options to purchase 1,025,477 shares remain un-issued under these plans. 26 INFINITE GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ================================================================================ NOTE 12. - STOCK OPTION PLANS - CONTINUED A. Employee Stock Option Plans The Company grants stock options to its key employees, as it deems appropriate. In addition, the Company previously followed an All Employee Incentive Stock Option Plan whereby all full-time employees of the Company who met certain eligibility requirements were granted stock options from the above plans. Subsequent to January 2, 1999 the Company discontinued grants under this plan. The options are only exercisable so long as the optionee continues to be an employee of the Company. The following is a summary of stock option activity for individuals classified as employees for the past two years:
Number Weighted of Shares Average Under Option Exercise Price ------------ -------------- Outstanding at December 31, 1999 406,113 $ 2.20 Granted 663,731 1.52 Exercised (167,074) 1.71 Forfeited (22,506) 2.10 --------- Outstanding at December 31, 2000 880,264 1.76 Granted 175,000 2.02 Exercised (105,913) 1.41 Expired (12,814) 2.50 --------- Outstanding at December 31, 2001 936,537 1.84 --------- Exercisable at December 31, 2001 372,794 2.08 =========
The average fair value of options granted was $1.58 and $1.40 per share for the years ended December 31, 2001 and 2000, respectively. The exercise price for all options granted equaled or exceeded the market value of the Company's common stock on the date of grant. 27 INFINITE GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ================================================================================ NOTE 12. - STOCK OPTION PLANS - CONTINUED Options outstanding at December 31, 2001 are made up of the following:
Options Outstanding Options Exercisable ---------------------------------------- -------------------------- Weighted Average Remaining Weighted Weighted Number Contracted Average Number Average of Life in Exercise of Exercise Options Years Price Options Price ------- ----- ----- ------- ----- $1.50 and Less 570,237 8.49 $ 1.50 183,570 $ 1.50 ======= ====== ======== $1.51 - $2.50 350,978 5.39 $ 2.25 175,979 $ 2.48 ======= ====== ======== Greater than $2.50 15,322 2.02 $ 4.93 13,245 $ 5.06 ---------- ======= ====== ---------- ======== Total 936,537 7.22 372,794 ========== ======= ==========
B. Nonqualified Stock Option In connection with services performed for the Company during 2000, 65,000 options to purchase shares of common stock at a price of $1.50 were granted. The options were immediately exercisable and expire on December 31, 2009. The fair value assigned to these options, determined utilizing the Black Scholes pricing model, amounted to approximately $47,000 and has been reflected as additional paid-in capital in the accompanying balance sheet. C. Directors' Stock Option Plan In April 1993, the Board of Directors and stockholders of the Company adopted a non-discretionary outside directors' stock option plan that provides for the grant to non-employee directors of non-qualified stock options to purchase up to 50,000 shares of common stock. Under this plan, each non-employee director is granted 7,500 options upon becoming a director and 5,000 each year thereafter. In 2001, there were 10,000 options granted (17,500 - 2000) and 15,500 forfeited (0 - 2000). At December 31, 2001, there were 34,500 (40,000 - 2000) options outstanding to directors under this plan, of which 23,667 options were exercisable (27,498 - 2000). These options are exercisable at prices ranging from $1.375 to $9.40 per share. The options vest over a two-year service period. The options expire at various dates from 2005 to 2011. 28 INFINITE GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ================================================================================ NOTE 12. - STOCK OPTION PLANS - CONTINUED The Company has adopted the disclosure-only provisions of Statement of Financial Accounting Standards (SFAS) No. 123 - "Accounting for Stock-Based Compensation," and, accordingly, does not recognize compensation cost for stock option grants under fixed awards. If the Company had elected to recognize compensation cost based on the fair value of the options granted at grant date as prescribed by SFAS No. 123, net loss and loss per share from continuing operations would have increased as follows: 2001 2000 ----------- ----------- Net loss: As reported (000's) $ 3,006 $ 2,094 Pro forma (000's) $ 3,353 $ 2,275 Loss per share: As reported $ .73 $ .72 Pro forma $ .81 $ .78 The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model based on the following weighted-average assumptions: 2001 2000 ----------- ----------- Expected dividend yield 0% 0% Expected stock price volatility 100% 100% Risk-free interest rate 4.0% 5.4% Expected life of options 5.27 years 10 years NOTE 13. - INCOME TAXES At December 31, 2001, the Company had federal net operating loss carryforwards of approximately $21,000,000 and state net operating loss carryforwards of approximately $10,000,000, which expire from 2009 through 2021. Due to a greater than 50% change in stock ownership of certain subsidiaries, the utilization of net operating loss carryforwards generated to the date of such change may be limited. At December 31, 2001, a net deferred tax asset, representing the future benefit attributed primarily to the available net operating loss carryforwards, in the amount of approximately $6,440,000 had been fully offset by a valuation allowance because management believes that the regulatory limitations on utilization of the operating losses and concerns over achieving profitable operations diminish the Company's ability to demonstrate that it is more likely than not that these future benefits will be realized before they expire. INFINITE GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ================================================================================ NOTE 13. - INCOME TAXES - CONTINUED The following is a summary of the Company's temporary differences and carryforwards which give rise to deferred tax assets and liabilities: December 31, ------------------------- 2001 2000 ----------- ----------- Deferred tax assets: Net operating loss and tax credit carryforwards $ 6,950,000 $ 7,046,000 Reserves and other 402,000 426,000 ----------- ----------- Gross deferred tax asset 7,352,000 7,472,000 Deferred tax liabilities: Property and equipment (550,000) (624,000) Defined benefit pension asset (362,000) (290,000) ----------- ----------- Gross deferred tax liability (912,000) (914,000) ----------- ----------- Net deferred tax asset 6,440,000 6,558,000 Deferred tax asset valuation allowance (6,440,000) (6,558,000) ----------- ----------- Net deferred tax asset $ -- $ -- =========== =========== NOTE 14. - EMPLOYEE PENSION AND PROFIT-SHARING PLANS Profit Sharing Plans - LF has a qualified salary reduction profit sharing 401(k) plan for eligible employees. Participants may defer up to 20% of their compensation each year up to the dollar limit set by the Internal Revenue Code. LF's contribution to the profit-sharing plan is discretionary. During 2001, a $27,836 ($14,439 - 2000) contribution was made to the profit-sharing plan. Defined Benefit Plan - The Company has a contributory defined benefit pension plan that covered all salaried and hourly employees at O&W that were scheduled to work at least 1,000 hours per year. During the year ended December 31, 2001 the Company discontinued the operations of O&W (see Note 4). The termination of the employees' services earlier than expected resulted in a plan curtailment, accounted for in accordance with Statement of Financial Standards Statement 88. No future benefits will be earned by plan participants. However, the plan will remain in existence and continue to pay benefits as participants qualify, invest assets and receive contributions. The Company's policy is to fund pension costs accrued. Net periodic pension expense includes the following components: 2001 2000 ----------- ----------- Service cost $ 246,386 $ 246,541 Interest cost 359,922 334,125 Expected return on plan assets (526,588) (537,891) Actuarial loss 11,933 -- ----------- ----------- Total pension expense $ 91,653 $ 42,775 =========== =========== 29 INFINITE GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ================================================================================ NOTE 14. - EMPLOYEE PENSION AND PROFIT-SHARING PLANS - CONTINUED The following sets forth the funded status of the plan and the amounts shown in the accompanying balance sheets: 2001 2000 ----------- ----------- Projected benefit obligation: Benefit obligation at beginning of year $ 5,336,583 $ 4,367,511 Service cost 246,386 246,541 Interest cost 359,922 334,145 Plan participants' contributions 142,767 163,987 Actuarial loss (gain) (37,077) 469,609 Curtailment (774,183) -- Benefits paid (255,147) (201,158) Expenses paid (50,829) (44,052) ----------- ----------- Benefit obligation at end of year 4,968,422 5,336,583 Plan assets at fair value: Fair value of plan assets at beginning of year 5,305,009 5,318,523 Actual return of plan assets (391,871) 67,709 Employer contributions 270,000 -- Plan participants' contributions 142,767 163,987 Benefits paid (255,147) (201,158) Expenses paid (50,829) (44,052) ----------- ----------- Fair value of plan assets at end of year 5,019,929 5,305,009 ----------- ----------- Funded status 51,507 (31,574) Unrecognized actuarial loss 853,166 757,900 ----------- ----------- Prepaid pension cost $ 904,673 $ 726,326 =========== =========== The major actuarial assumptions used in the calculation of the pension obligation were as follows: 2001 2000 ----------- ----------- Discount rate 7% 7% Expected return on plan assets 10.0% 10.0% Rate of increase in compensation N/A 5.5% 30 INFINITE GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ================================================================================ NOTE 15. - EXTRAORDINARY LOSS In December 2001, the outstanding balance of the ten-year promissory note, payable to the president/principal stockholder was applied to the purchase of common stock of the Company (see Note 10). As a result, the unamortized deferred financing costs and note discount relating to the detachable warrants issued with the debt were written off in 2001. The aggregate amount of $273,813 is considered a loss on early extinguishment of debt and is classified as an extraordinary item in the accompanying consolidated statement of operations. NOTE 16. - COMMITMENTS A. Lease Commitments The Company utilizes certain equipment, vehicles and facilities under operating leases that expire at various dates through 2005. Rent expense under operating leases for the years ended December 31, 2001 and 2000, was approximately $319,000 and $246,000, respectively. Following is the approximate future minimum payments required under these leases: 2002 $321,000 2003 272,000 2004 228,000 2005 177,000 -------- $998,000 ======== B. Employment Contracts The Company is obligated under various employment agreements with certain officers and other employees that expire at various times from 2002 through 2003. The agreements provide for minimum aggregate annual salaries of approximately $900,000. Certain agreements also provide for, among other things, cash bonuses and stock options if certain performance measures are met, and for severance payments. For the years ended December 31, 2001 and 2000 no bonuses or stock options were earned. 31 INFINITE GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ================================================================================ NOTE 17. - SUPPLEMENTAL CASH FLOW INFORMATION Noncash investing and financing transactions, including non-monetary exchanges, consist of the following: 2001 2000 ---------- ---------- Satisfaction of obligations to stockholders and related accrued interest in lieu of cash payments as consideration for stock issued (see Notes 8, 10 and 11) $1,393,852 $ 800,278 ========== ========== Intellectual property received in exchange for preferred stock investment and satisfaction of accounts receivable (see Note 3) $ 353,512 $ -- ========== ========== Contribution of common stock to pension plan to satisfy obligation (see Note 14) $ 270,000 $ -- ========== ========== Acquisition of equipment in exchange for services rendered (see Note 6) $ 239,476 $ 556,524 ========== ========== Advance - stockholder satisfied in lieu of cash payment as consideration for long-term obligation - stockholder $ 50,249 $ -- ========== ========== Satisfaction of employee liabilities in lieu of cash payment as consideration for the exercise of stock options and warrants (see Note 11) $ -- $ 450,592 ========== ========== Property and equipment acquired under capital leases $ -- $ 418,918 ========== ========== Conversion of debentures and related accrued interest to common stock (see Note 11) $ -- $ 135,000 ========== ========== Common stock, stock options and warrants issued for services provided $ 7,500 $ 46,695 ========== ========== Common stock issued as satisfaction of accounts payable (see Note 11) $ -- $ 22,699 ========== ========== 32 INFINITE GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ================================================================================ NOTE 18. - BUSINESS SEGMENTS The Company's businesses were organized, managed and internally reported as three segments. The segments are determined based on differences in products, production processes and internal reporting. During the year ended December 31, 2001 the Company approved of a plan to discontinue the operations of the Plastics Group (see Note 4). Going forward the Company's businesses will be organized, managed and internally reported as two segments. All of the segments of the Company operate entirely within the United States. Revenues from customers in foreign countries are minimal. Transactions between reportable segments are recorded at cost. The Company relies on intersegment cooperation and management does not represent that these segments, if operated independently, would report the results shown. A summary of selected consolidated information for the Company's industry segments during 2001 and 2000 is set forth as follows: 33 INFINITE GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ================================================================================ NOTE 18. - BUSINESS SEGMENTS - CONTINUED
Laser Photonics Plastics 2001 Group Group Group -------------- -------------- -------------- Sales to unaffiliated customers $ 7,305,574 $ 1,202,074 $ -- Intersegment sales 188,235 84,136 -- -------------- -------------- -------------- Total revenue $ 7,493,809 $ 1,286,210 $ -- ============== ============== ============== Operating loss $ 140,742 $ 332,245 $ -- ============== ============== ============== Loss from discontinued operations, including corporate overhead allocation $ -- $ -- $ 1,774,085 ============== ============== ============== Interest income $ 3,338 $ 59 $ -- ============== ============== ============== Interest expense $ 282,940 $ -- $ -- ============== ============== ============== Extraordinary loss $ -- $ -- $ -- ============== ============== ============== Identifiable assets $ 6,371,894 $ 452,211 $ 2,566,674 ============== ============== ============== Depreciation and amortization $ 710,650 $ 2,346 $ -- ============== ============== ============== Capital expenditures $ 362,928 $ 29,456 $ -- ============== ============== ============== Capital expenditures of discontinued segment $ -- $ -- $ 430,224 ============== ============== ============== 2000 Sales to unaffiliated customers $ 6,285,882 $ 341,688 $ -- Intersegment sales -- -- -- -------------- -------------- -------------- Total revenue $ 6,285,882 $ 341,688 $ -- ============== ============== ============== Operating loss (income) $ 239,704 $ (84,727) $ -- ============== ============== ============== Loss from discontinued operations, including corporate overhead allocation $ -- $ -- $ 775,827 ============== ============== ============== Interest income $ 13,989 $ 440 $ -- ============== ============== ============== Interest expense $ 377,791 $ -- $ -- ============== ============== ============== Identifiable assets $ 6,244,114 $ 114,971 $ 4,507,335 ============== ============== ============== Depreciation and amortization $ 706,788 $ 10,664 $ -- ============== ============== ============== Capital expenditures $ 719,225 $ 11,986 $ -- ============== ============== ============== Capital expenditures of discontinued segment $ -- $ -- $ 62,597 ============== ============== ============== Unallocated 2001 Corporate Eliminations Consolidated -------------- -------------- -------------- Sales to unaffiliated customers $ -- $ -- $ 8,507,648 Intersegment sales -- (272,371) -- -------------- -------------- -------------- Total revenue $ -- $ (272,371) $ 8,507,648 ============== ============== ============== Operating loss $ 833,296 $ (3,019) $ 1,303,264 ============== ============== ============== Loss from discontinued operations, including corporate overhead allocation $ (749,197) $ (30,833) $ 994,055 ============== ============== ============== Interest income $ 48,963 $ (33,852) $ 18,508 ============== ============== ============== Interest expense $ 173,239 $ -- $ 456,179 ============== ============== ============== Extraordinary loss $ (273,813) $ -- $ (273,813) ============== ============== ============== Identifiable assets $ 1,547,224 $ -- $ 10,938,003 ============== ============== ============== Depreciation and amortization $ 62,928 $ -- $ 775,924 ============== ============== ============== Capital expenditures $ -- $ -- $ 392,384 ============== ============== ============== Capital expenditures of discontinued segment $ -- $ -- $ 430,224 ============== ============== ============== 2000 Sales to unaffiliated customers $ -- $ -- $ 6,627,570 Intersegment sales -- -- -- -------------- -------------- -------------- Total revenue $ -- $ -- $ 6,627,570 ============== ============== ============== Operating loss $ 902,595 $ -- $ 1,057,572 ============== ============== ============== Loss from discontinued operations, including corporate overhead allocation $ (328,437) $ (63,725) $ 383,665 ============== ============== ============== Interest income $ 70,299 $ (63,725) $ 21,003 ============== ============== ============== Interest expense $ 202,448 $ -- $ 580,239 ============== ============== ============== Identifiable assets $ 506,914 $ -- $ 11,373,334 ============== ============== ============== Depreciation and amortization $ 37,600 $ -- $ 755,052 ============== ============== ============== Capital expenditures $ -- $ -- $ 731,211 ============== ============== ============== Capital expenditures of discontinued segment $ -- $ -- $ 62,597 ============== ============== ==============
34 INFINITE GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ================================================================================ NOTE 19. - SUBSEQUENT EVENTS On January 4, 2002, the Company consummated a securities purchase agreement (the "Agreement") with the estate of a former stockholder of O&W (the "Estate"). The Agreement provides that the Estate will purchase 379,253 shares of the Company's common stock, which will be paid for by the cancellation of certain indebtedness of the Company to the Estate of $758,507 (the "Indebtedness"). The Indebtedness relates to past due consulting fees and outstanding debt owed to the estate by the Company at December 31, 2001 (see Note 9). The agreement puts certain restrictions on the amount of shares of common stock that may be sold on any day by the Estate. In addition, at any time prior to May 31, 2002, the Company has the option to repurchase any shares still held by the Estate for a price equal to the difference between the aggregate net proceeds received by the Estate on sales of the underlying stock and the Indebtedness. If on April 15, 2002, the proceeds received by the Estate from the sale of the Company's common stock is less than the Indebtedness, then at any time on or after April 16, 2002 and on or before May 31, 2002, the Estate may notify the Company that it wishes the Company to repurchase the shares then held by the Estate. The purchase price to the Company will be equal to the difference between the Indebtedness and the aggregate proceeds received by the Estate on sales of the Company's common stock. On February 5, 2002 the Company entered into a $1 million convertible note with a third party, the proceeds of which are restricted for the use in the operations of Infinite Photonics. The note accrues interest at an annual rate of 15% and is convertible, at the holder's option, into shares of the Company's common stock at a price of $2.25 per share. For every $100,000 converted by the holder, the Company will receive an interest rate reduction of 1% retroactively to February 5, 2002. On March 14, 2002, the Company consummated the sale of the net assets of its subsidiary, Express Pattern (see Note 4). NOTE 20. - LITIGATION The Company is the plaintiff in a lawsuit filed in the Rhode Island Superior Court on August 13, 1999 captioned Infinite Group, Inc. vs. Spectra Science Corporation and Nabil Lawandy. In the action, the Company asserts that by fraud and in breach of fiduciary duties owed, Spectra and its president, Nabil Lawandy, caused the Company to sell to Spectra shares of Spectra's Series A Preferred stock at a substantial discount to fair market value. The Company alleges that in entering into the transaction it relied on various representations made by Spectra and Mr. Lawandy, which were untrue at the time they were made. In the action, the Company seeks compensatory damages in the amount of $500,000 plus punitive damages as well as an award of attorney's fees and costs. In its response to the complaint, Spectra has asserted counterclaims against the Company which management believes are without merit. The Company intends to vigorously prosecute this action and defend the counterclaims. 35 EX-10.17 3 ex10_17.txt SECURITIES PURCHASE AGREEMENT EXHIBIT 10.17 INFINITE GROUP, INC. SECURITIES PURCHASE AGREEMENT February 5, 2002 TABLE OF CONTENTS Page ---- 1. AGREEMENT TO SELL AND PURCHASE.............................................1 2. FEES AND WARRANTS..........................................................2 3. CLOSING, DELIVERY AND PAYMENT..............................................2 3.1 Closing..............................................................2 3.2 Delivery.............................................................2 4. REPRESENTATIONS AND WARRANTIES OF THE COMPANY..............................3 4.1 Organization, Good Standing and Qualification........................3 4.2 Subsidiaries.........................................................3 4.3 Capitalization; Voting Rights........................................3 4.4 Authorization; Binding Obligations...................................4 4.5 Liabilities..........................................................4 4.6 Agreements; Action...................................................4 4.7 Obligations to Related Parties.......................................5 4.8 Changes..............................................................5 4.9 Title to Properties and Assets; Liens, Etc...........................6 4.10 Intellectual Property................................................7 4.11 Compliance with Other Instruments....................................7 4.12 Litigation...........................................................7 4.13 Tax Returns and Payments.............................................8 4.14 Employees............................................................8 4.15 Registration Rights and Voting Rights................................8 4.16 Compliance with Laws; Permits........................................9 4.17 Environmental and Safety Laws........................................9 4.18 Valid Offering.......................................................9 4.19 Full Disclosure......................................................9 4.20 Insurance...........................................................10 4.21 SEC Reports.........................................................10 4.22 No Market Manipulation..............................................10 4.23 Listing.............................................................10 4.24 No Integrated Offering..............................................10 -i- 4.25 Stop Transfer.......................................................11 4.26 Dilution............................................................11 5. REPRESENTATIONS AND WARRANTIES OF THE PURCHASERS..........................11 5.1 Requisite Power and Authority.......................................11 5.2 Investment Representations..........................................11 5.3 Purchaser Bears Economic Risk.......................................11 5.4 Acquisition for Own Account.........................................11 5.5 Purchaser Can Protect Its Interest..................................11 5.6 Accredited Investor.................................................12 5.7 Legends.............................................................12 6. COVENANTS OF THE COMPANY..................................................13 6.1 Stop-Orders.........................................................13 6.2 Listing.............................................................13 6.3 Market Regulations..................................................13 6.4 Reporting Requirements.............................................13 6.5 Intentionally Omitted...............................................14 6.6 Access to Facilities................................................14 6.7 Taxes...............................................................14 6.8 Insurance...........................................................14 6.9 Intellectual Property...............................................14 6.10 Properties..........................................................15 6.11 Confidentiality.....................................................15 6.12 Required Approvals..................................................15 6.13 Reissuance of Securities............................................16 6.14 Opinion.............................................................16 7. COVENANTS OF THE COMPANY AND PURCHASERS REGARDING INDEMNIFICATION.........16 7.1 Company Indemnification.............................................16 7.2 Purchaser's Indemnification.........................................16 7.3 Procedures..........................................................16 8. CONVERSION OF CONVERTIBLE NOTES...........................................17 8.1 Mechanics of Conversion.............................................17 8.2 Mandatory Redemption................................................18 -ii- 8.3 Maximum Conversion.................................................18 8.4 Injunction - Posting of Bond.......................................18 8.5 Buy-In.............................................................19 9. REGISTRATION RIGHTS.......................................................19 9.1 Registration Rights Granted........................................19 9.2 Registration Procedures............................................20 9.3 Provision of Documents.............................................21 9.4 Non-Registration Events............................................22 9.5 Expenses...........................................................22 9.6 Indemnification and Contribution...................................23 10. RIGHT OF FIRST REFUSAL....................................................25 10 Offering Restrictions..............................................25 12. MISCELLANEOUS.............................................................25 12.1 Governing Law......................................................25 12.2 Survival...........................................................25 12.3 Successors and Assigns.............................................26 12.4 Entire Agreement...................................................26 12.5 Severability.......................................................26 12.6 Amendment and Waiver...............................................26 12.7 Delays or Omissions................................................26 12.8 Notices............................................................26 12.9 Attorneys' Fees....................................................27 12.10 Titles and Subtitles...............................................27 12.11 Counterparts.......................................................27 12.12 Broker's Fees......................................................27 12.13 Indemnification....................................................27 12.14 Construction.......................................................27 -iii- INFINITE GROUP, INC. SECURITIES PURCHASE AGREEMENT THIS SECURITIES PURCHASE AGREEMENT (the "Agreement") is made and entered into as of February 5, 2002, by and among Infinite Group, Inc., a Delaware corporation (the "Company"), and the Purchaser listed on Exhibit A hereto (the "Purchaser"). RECITALS WHEREAS, the Company has authorized the sale of 5% Convertible Notes in an aggregate principal amount of $1,000,000 (the "Notes"), convertible into shares of the Company's common stock, $0.001 par value per share (the "Common Stock"); WHEREAS, the Company wishes to issue warrants (the "Warrants") to the Purchaser to purchase shares of the Company's Common Stock in connection with Purchaser's purchase of the Notes; WHEREAS, the Company and the Purchaser intend to allow the Company to have complete discretion in its ability to repay the Notes; WHEREAS, Purchaser desires to purchase the Notes and Warrants on the terms and conditions set forth herein; and WHEREAS, the Company desires to issue and sell the Notes and Warrants to Purchaser on the terms and conditions set forth herein. AGREEMENT NOW, THEREFORE, in consideration of the foregoing recitals and the mutual promises, representations, warranties and covenants hereinafter set forth and for other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties hereto agree as follows: 1. AGREEMENT TO SELL AND PURCHASE. Pursuant to the terms and conditions set forth in this Agreement, on the Closing Date (as defined in Section 3), the Company agrees to sell to the Purchaser, and the Purchaser hereby agrees to purchase from the Company Notes in the amount set forth next to the Purchaser's name on Exhibit A under the column heading "Closing Date Notes," convertible in accordance with the terms thereof into shares of the Company's Common Stock, which amount shall be equal to $1,000,000. The Notes purchased on the Closing Date shall be known as the "Offering." The form of Notes is annexed hereto as Exhibit B. The Notes will have a Maturity Date (as defined in the Notes) two years from the date of issuance. Collectively, the Notes and Warrants (as defined in Section 2) and Common Stock issuable upon conversion of the Notes and exercise of the Warrants are referred to as the "Securities." 2. FEES AND WARRANTS. (a) The Company will issue and deliver to the persons listed on Exhibit A under the column heading "Warrant Holders", or to such other persons as the Purchaser shall otherwise designate (such named persons, as they may be so otherwise designated, being referred to as the "Warrant Recipients"), Warrants to purchase shares of Common Stock in the amounts designated on Exhibit A hereto in connection with the Offering (the "Warrants") pursuant to Section 1 hereof. The Warrants must be delivered on the Closing Date. The aggregate number of shares of Common Stock purchasable upon exercise of the Warrants granted on the Closing Date is set forth on Exhibit A hereto. A form of Warrant is annexed hereto as Exhibit C. The per share "Purchase Price" of Common Stock as defined in the Warrants shall be equal to $2.65. All the representations, covenants, warranties, undertakings, and indemnification, and other rights made or granted to or for the benefit of Purchaser are hereby also made and granted to the holders of the Warrants in respect of the Warrants and shares of the Company's Common Stock issuable upon exercise of the Warrants (the "Warrant Shares"). (b) The Company shall reimburse Purchaser for its reasonable legal fees of $20,000 for services rendered to Purchaser in preparation of this Agreement and the Related Agreements, and an additional amount not to exceed $2,500 in connection with its due diligence review of the Company and relevant matters. Amounts required to be paid hereunder will be paid at the Closing. (c) The Company will pay a cash fee in the amount of five percent (5%) of the aggregate gross purchase price to be paid to the Company from the sale of Notes in the Offering (the "Fund Manager's Fee") to the persons listed on Exhibit A under the column heading "Fund Manager's Fee Recipient." The Fund Manager's Fee must be paid on the Closing Date. The aforementioned Fund Manager's Fee and legal fees will be payable at the Closing out of funds held pursuant to a Funds Escrow Agreement to be entered into by the Company, Purchaser and an Escrow Agent. 3. CLOSING, DELIVERY AND PAYMENT. 3.1 Closing. Subject to the terms and conditions herein, the closing of the transactions contemplated hereby (the "Closing"), which closing is comprised of Purchaser's purchase of Notes in the aggregate principal amount of $1,000,000, shall take place on the date hereof, at the offices of Daniel M. Laifer, Esq., 152 West 57th Street, 4th Floor, New York, New York 10019, or at such other time or place as the Company and Purchaser may mutually agree (such date is hereinafter referred to as the "Closing Date"). 3.2 Delivery. At the Closing, subject to the terms and conditions hereof, the Company will deliver to the Purchaser an applicable Note representing the aggregate principal amount borrowed by the Company at the Closing from the Purchaser and a warrant certificate registered in the Purchaser's name representing the number of Warrant Shares as to which the Warrant is exercisable pursuant to this Agreement, against payment of the purchase price therefor by certified funds or wire transfer made payable to the order of the Company, cancellation of indebtedness or any combination of the foregoing. -2- 4. REPRESENTATIONS AND WARRANTIES OF THE COMPANY. The Company hereby represents and warrants to the Purchaser that except as set forth on Schedule 4 hereto, as of the date of this Agreement as set forth below. 4.1 Organization, Good Standing and Qualification. The Company is a corporation duly organized, validly existing and in good standing under the laws of the State of Delaware. The Company has the corporate power and authority to own and operate its properties and assets, to execute and deliver this Agreement, the Warrants to be issued in connection with this Agreement, the Funds Escrow Agreement, the Security Agreement and all other agreements referred to herein (collectively, the "Related Agreements"), to issue and sell the Notes and the shares of Common Stock issuable upon conversion of the Notes (the "Conversion Shares"), to issue and sell the Warrants and the Warrant Shares, and to carry out the provisions of this Agreement and the Related Agreements and to carry on its business as presently conducted and as presently proposed to be conducted. The Company is duly qualified and is authorized to do business and is in good standing as a foreign corporation in all jurisdictions in which the nature of its activities and of its properties (both owned and leased) makes such qualification necessary, except for those jurisdictions in which failure to do so would not have a material adverse effect on the Company or its business. 4.2 Subsidiaries. Except as disclosed in the SEC Documents, the Company does not own or control any equity security or other interest of any other corporation, limited partnership or other business entity. The Company owns a controlling interest in such entity, and each of the representations and warranties set forth in this Section 4 are being hereby restated with respect to such entity (modified as appropriate to the nature of such entity.) 4.3 Capitalization; Voting Rights. (a) The authorized capital stock of the Company, immediately prior to the Closing, consists of 20,000,000 shares of Common Stock, par value $0.001 per share, 5,361,743 shares of which are issued and outstanding. (b) Other than (i) the shares reserved for issuance under the Company's stock option plans filed under Form S-8; (ii) shares which may be granted pursuant to this Agreement and the Related Agreements; and (iii) shares which may be granted pursuant to the Company's Registration Statements under Forms S-2 and S-3, there are no outstanding options, warrants, rights (including conversion or preemptive rights and rights of first refusal), proxy or stockholder agreements, or arrangements or agreements of any kind for the purchase or acquisition from the Company of any of its securities. Neither the offer, issuance or sale of any of the Notes or Warrants, or the issuance of any of the Conversion Shares or Warrant Shares, nor the consummation of any transaction contemplated hereby will result in a change in the price or number of any securities of the Company outstanding, under anti-dilution or other similar provisions contained in or affecting any such securities. (c) All issued and outstanding shares of the Company's Common Stock (i) have been duly authorized and validly issued and are fully paid and nonassessable and -3- (ii) were issued in compliance with all applicable state and federal laws concerning the issuance of securities. (d) The rights, preferences, privileges and restrictions of the shares of the Common Stock are as stated in the Certificate of Incorporation (the "Charter"). The Conversion Shares and Warrant Shares have been duly and validly reserved for issuance. When issued in compliance with the provisions of this Agreement and the Company's Charter, the Securities will be validly issued, fully paid and nonassessable, and will be free of any liens or encumbrances; provided, however, that the Securities may be subject to restrictions on transfer under state and/or federal securities laws as set forth herein or as otherwise required by such laws at the time a transfer is proposed. (e) No stock plan, stock purchase, stock option or other agreement or understanding between the Company and any holder of any equity securities or rights to purchase equity securities provides for acceleration or other changes in the vesting provisions or other terms of such agreement or understanding as the result of any merger, consolidated sale of stock or assets, change in control or any other transaction(s) by the Company, including the transactions contemplated hereunder. 4.4 Authorization; Binding Obligations. All corporate action on the part of the Company, its officers, directors and stockholders necessary for the authorization of this Agreement and the Related Agreements, the performance of all obligations of the Company hereunder at the Closing and the authorization, sale, issuance and delivery of the Securities pursuant hereto and the Related Agreements has been taken or will be taken prior to the Closing. The Agreement and the Related Agreements, when executed and delivered, will be valid and binding obligations of the Company enforceable in accordance with their terms, except (a) as limited by applicable bankruptcy, insolvency, reorganization, moratorium or other laws of general application affecting enforcement of creditors' rights, and (b) general principles of equity that restrict the availability of equitable remedies. Except for an agreement dated November 20, 2000 with Cockfield Holdings, LLC ("Cockfield"), (i) the sale of the Notes and the subsequent conversion of the Notes into Conversion Shares are not and will not be subject to any preemptive rights or rights of first refusal that have not been properly waived or complied with and (ii) the sale of the Warrants and the subsequent exercise of the Warrants for Warrant Shares are not and will not be subject to any preemptive rights or rights of first refusal that have not been properly waived or complied with. The Notes and the Warrants, when executed and delivered in accordance with the terms of this Agreement, will be valid and binding obligations of the Company, enforceable in accordance with their respective terms. 4.5 Liabilities. Except as included in the SEC Documents, the Company has no material liabilities and, to the best of its knowledge, knows of no material contingent liabilities, except current liabilities incurred in the ordinary course of business since September 30, 2001. 4.6 Agreements; Action. (a) There are no agreements, understandings, instruments, contracts, proposed transactions, judgments, orders, writs or decrees to which the Company is a party or to -4- its knowledge by which it is bound which may involve (i) obligations (contingent or otherwise) of, or payments to, the Company in excess of $50,000 (other than obligations of, or payments to, the Company arising from purchase or sale agreements entered into in the ordinary course of business), or (ii) the transfer or license of any patent, copyright, trade secret or other proprietary right to or from the Company (other than licenses arising from the purchase of "off the shelf" or other standard products), or (iii) provisions restricting the development, manufacture or distribution of the Company's products or services, or (iv) indemnification by the Company with respect to infringements of proprietary rights. (b) The Company has not (i) declared or paid any dividends, or authorized or made any distribution upon or with respect to any class or series of its capital stock, (ii) incurred any indebtedness for money borrowed or any other liabilities individually in excess of $50,000 or, in the case of indebtedness and/or liabilities individually less than $50,000, in excess of $100,000 in the aggregate, (iii) made any loans or advances to any person, other than ordinary advances for travel expenses, or (iv) sold, exchanged or otherwise disposed of any of its assets or rights, other than the sale of its inventory in the ordinary course of business. 4.7 Obligations to Related Parties. There are no obligations of the Company to officers, directors, stockholders or employees of the Company other than (a) for payment of salary for services rendered, (b) reimbursement for reasonable expenses incurred on behalf of the Company and (c) for other standard employee benefits made generally available to all employees (including stock option agreements outstanding under any stock option plan approved by the Board of Directors of the Company). None of the officers, directors or stockholders of the Company, or any members of their immediate families, are indebted to the Company. None of the officers, directors or, to the best of the Company's knowledge, key employees or stockholders of the Company or any members of their immediate families, are indebted to the Company or have any direct or indirect ownership interest in any firm or corporation with which the Company is affiliated or with which the Company has a business relationship, or any firm or corporation which competes with the Company, other than passive investments in publicly traded companies (representing less than 1% of such company) which may compete with the Company. No officer, director or stockholder, or any member of their immediate families, is, directly or indirectly, interested in any material contract with the Company and no agreements, understandings or proposed transactions are contemplated between the Company and any such person. The Company is not a guarantor or indemnitor of any indebtedness of any other person, firm or corporation, other than subsidiaries of the Company. 4.8 Changes. Since September 30, 2001, there has not been: (a) Any change in the assets, liabilities, financial condition, prospects or operations of the Company, other than changes in the ordinary course of business, none of which individually or in the aggregate has had or is reasonably expected to have a material adverse effect on such assets, liabilities, financial condition, prospects or operations of the Company, other than the closure of the Company's Osley & Whitney subsidiary; (b) Any resignation or termination of any officer, key employee or group of employees of the Company; -5- (c) Any material change, except in the ordinary course of business, in the contingent obligations of the Company by way of guaranty, endorsement, indemnity, warranty or otherwise, other than as disclosed in the SEC Documents; (d) Any damage, destruction or loss, whether or not covered by insurance, materially and adversely affecting the properties, business or prospects or financial condition of the Company; (e) Any waiver by the Company of a valuable right or of a material debt owed to it; (f) Any direct or indirect loans made by the Company to any stockholder, employee, officer or director of the Company, other than advances made in the ordinary course of business; (g) Any material change in any compensation arrangement or agreement with any employee, officer, director or stockholder; (h) Any declaration or payment of any dividend or other distribution of the assets of the Company; (i) Any labor organization activity related to the Company; (j) Any debt, obligation or liability incurred, assumed or guaranteed by the Company, except those for immaterial amounts and for current liabilities incurred in the ordinary course of business; (k) Any sale, assignment or transfer of any patents, trademarks, copyrights, trade secrets or other intangible assets; (l) Any change in any material agreement to which the Company is a party or by which it is bound which may materially and adversely affect the business, assets, liabilities, financial condition, operations or prospects of the Company; (m) Any other event or condition of any character that, either individually or cumulatively, has or may materially and adversely affect the business, assets, liabilities, financial condition, prospects or operations of the Company; or (n) Any arrangement or commitment by the Company to do any of the acts described in subsection (a) through (m) above. 4.9 Title to Properties and Assets; Liens, Etc. Except as set forth in the SEC Documents, the Company has good and marketable title to its properties and assets, and good title to its leasehold estates, in each case subject to no mortgage, pledge, lien, lease, encumbrance or charge, other than (a) those resulting from taxes which have not yet become delinquent, (b) minor liens and encumbrances which do not materially detract from the value of the property subject thereto or materially impair the operations of the Company, and (c) those that have otherwise arisen in the ordinary course of business. All facilities, machinery, equipment, -6- fixtures, vehicles and other properties owned, leased or used by the Company are in good operating condition and repair and are reasonably fit and usable for the purposes for which they are being used. The Company is in compliance with all material terms of each lease to which it is a party or is otherwise bound. 4.11 Intellectual Property. (a) The Company owns or possesses sufficient legal rights to all patents, trademarks, service marks, trade names, copyrights, trade secrets, licenses, information and other proprietary rights and processes necessary for its business as now conducted and to the Company's knowledge as presently proposed to be conducted (the "Intellectual Property"), without any known infringement of the rights of others. There are no outstanding options, licenses or agreements of any kind relating to the foregoing proprietary rights, nor is the Company bound by or a party to any options, licenses or agreements of any kind with respect to the patents, trademarks, service marks, trade names, copyrights, trade secrets, licenses, information and other proprietary rights and processes of any other person or entity other than such licenses or agreements arising from the purchase of "off the shelf" or standard products, other than as described in Section 4.4 through 4.9 above. (b) The Company has not received any communications alleging that the Company has violated any of the patents, trademarks, service marks, trade names, copyrights or trade secrets or other proprietary rights of any other person or entity, nor is the Company aware of any basis therefor. (c) The Company does not believe it is or will be necessary to utilize any inventions, trade secrets or proprietary information of any of its employees made prior to their employment by the Company, except for inventions, trade secrets or proprietary information that have been rightfully assigned to the Company. 4.12 Compliance with Other Instruments. The Company is not in violation or default of any term of the Charter or Bylaws, or of any provision of any mortgage, indenture, contract, agreement, instrument or contract to which it is party or by which it is bound or of any judgment, decree, order or writ, except as may arise from its closure of its Osley & Whitney subsidiary. The execution, delivery and performance of and compliance with this Agreement and the Related Agreements, and the issuance and sale of Securities pursuant hereto, will not, with or without the passage of time or giving of notice, result in any such material violation, or be in conflict with or constitute a default under any such term or provision, or result in the creation of any mortgage, pledge, lien, encumbrance or charge upon any of the properties or assets of the Company or the suspension, revocation, impairment, forfeiture or nonrenewal of any permit, license, authorization or approval applicable to the Company, its business or operations or any of its assets or properties. 4.13 Litigation. Except as set forth in the SEC Documents, there is no action, suit, proceeding or investigation pending or, to the Company's knowledge, currently threatened against the Company that questions the validity of this Agreement or the Related Agreements or the right of the Company to enter into any of such agreements, or to consummate the transactions contemplated hereby or thereby, or which might result, either individually or in the aggregate, in -7- any material adverse change in the assets, condition, affairs or prospects of the Company, financially or otherwise, or any change in the current equity ownership of the Company, nor is the Company aware that there is any basis for any of the foregoing, other than as may arise from the closure of the Company's Osley & Whitney subsidiary. The Company is not a party or subject to the provisions of any order, writ, injunction, judgment or decree of any court or government agency or instrumentality. There is no action, suit, proceeding or investigation by the Company currently pending or which the Company intends to initiate. 4.13 Tax Returns and Payments. The Company has timely filed all tax returns (federal, state and local) required to be filed by it. All taxes shown to be due and payable on such returns, any assessments imposed, and to the Company's knowledge all other taxes due and payable by the Company on or before the Closing, have been paid or will be paid prior to the time they become delinquent. The Company has not been advised (a) that any of its returns, federal, state or other, have been or are being audited as of the date hereof, or (b) of any deficiency in assessment or proposed judgment to its federal, state or other taxes. The Company has no knowledge of any liability of any tax to be imposed upon its properties or assets as of the date of this Agreement that is not adequately provided for. 4.14 Employees. The Company has no collective bargaining agreements with any of its employees. There is no labor union organizing activity pending or, to the Company's knowledge, threatened with respect to the Company. The Company is not a party to or bound by any currently effective employment contract, deferred compensation arrangement, bonus plan, incentive plan, profit sharing plan, retirement agreement or other employee compensation plan or agreement. To the Company's knowledge, no employee of the Company, nor any consultant with whom the Company has contracted, is in violation of any term of any employment contract, proprietary information agreement or any other agreement relating to the right of any such individual to be employed by, or to contract with, the Company because of the nature of the business to be conducted by the Company; and to the Company's knowledge the continued employment by the Company of its present employees, and the performance of the Company's contracts with its independent contractors, will not result in any such violation. The Company is not aware that any of its employees is obligated under any contract (including licenses, covenants or commitments of any nature) or other agreement, or subject to any judgment, decree or order of any court or administrative agency, that would interfere with their duties to the Company. The Company has not received any notice alleging that any such violation has occurred. No employee of the Company has been granted the right to continued employment by the Company or to any material compensation following termination of employment with the Company, except as disclosed in the SEC Documents. The Company is not aware that any officer, key employee or group of employees intends to terminate his, her or their employment with the Company, nor does the Company have a present intention to terminate the employment of any officer, key employee or group of employees. 4.15 Registration Rights and Voting Rights. Except as set forth in the SEC Documents, the Company is presently not under any obligation, and has not granted any rights, to register any of the Company's presently outstanding securities or any of its securities that may hereafter be issued. To the Company's knowledge, no stockholder of the Company has entered into any agreement with respect to the voting of equity securities of the Company. -8- 4.16 Compliance with Laws; Permits. To its knowledge, the Company is not in violation of any applicable statute, rule, regulation, order or restriction of any domestic or foreign government or any instrumentality or agency thereof in respect of the conduct of its business or the ownership of its properties which violation would materially and adversely affect the business, assets, liabilities, financial condition, operations or prospects of the Company. No governmental orders, permissions, consents, approvals or authorizations are required to be obtained and no registrations or declarations are required to be filed in connection with the execution and delivery of this Agreement and the issuance of any of the Securities, except such as has been duly and validly obtained or filed, or with respect to any filings that must be made after the Closing, as will be filed in a timely manner. The Company has all franchises, permits, licenses and any similar authority necessary for the conduct of its business as now being conducted by it, the lack of which could materially and adversely affect the business, properties, prospects or financial condition of the Company. 4.17 Environmental and Safety Laws. The Company is not in violation of any applicable statute, law or regulation relating to the environment or occupational health and safety, and to its knowledge, no material expenditures are or will be required in order to comply with any such existing statute, law or regulation. No Hazardous Materials (as defined below) are used or have been used, stored, or disposed of by the Company or, to the Company's knowledge, by any other person or entity on any property owned, leased or used by the Company. For the purposes of the preceding sentence, "Hazardous Materials" shall mean (a) materials which are listed or otherwise defined as "hazardous" or "toxic" under any applicable local, state, federal and/or foreign laws and regulations that govern the existence and/or remedy of contamination on property, the protection of the environment from contamination, the control of hazardous wastes, or other activities involving hazardous substances, including building materials, or (b) any petroleum products or nuclear materials. 4.18 Valid Offering. Assuming the accuracy of the representations and warranties of the Purchaser contained in this Agreement, the offer, sale and issuance of the Securities will be exempt from the registration requirements of the Securities Act of 1933, as amended (the "Securities Act"), and will have been registered or qualified (or are exempt from registration and qualification) under the registration, permit or qualification requirements of all applicable state securities laws. Neither the Company nor any agent on its behalf has solicited or will solicit any offers to sell or has offered to sell or will offer to sell all or any part of the Securities to any person or persons so as to bring the sale of such Securities by the Company within the registration provisions of the Securities Act or any state securities laws. 4.19 Full Disclosure. The Company has provided the Purchaser with all information requested by the Purchaser in connection with its decision to purchase the Notes and Warrants, including all information the Company believes is reasonably necessary to make such investment decision. Neither this Agreement, the exhibits and schedules hereto, the Related Agreements nor any other document delivered by the Company to Purchaser or its attorneys or agents in connection herewith or therewith or with the transactions contemplated hereby or thereby, contain any untrue statement of a material fact nor omit to state a material fact necessary in order to make the statements contained herein or therein not misleading. To the Company's knowledge, there are no facts which (individually or in the aggregate) materially adversely affect the business, assets, liabilities, financial condition, prospects or operations of the Company that -9- have not been set forth in the Agreement, the exhibits and schedules hereto, the Related Agreements or in other documents delivered to Purchaser or its attorneys or agents in connection herewith. 4.20 Insurance. The Company has general commercial, product liability, fire and casualty insurance policies with coverage customary for companies similarly situated to the Company. 4.21 SEC Disclosure. The Company has filed all proxy statements, reports and other documents required to be filed by it under the Exchange Act. The Company has furnished the Purchaser with copies of (i) its Annual Report on Form 10-KSB for the fiscal year ended December 31, 2000, (ii) its Quarterly Reports on Form 10-Q for the fiscal quarters ended March 31, 2001, June 30, 2001 and September 30, 2001, (iii) its Proxy Statement dated February 27, 2001, (iv) Registration Statement on Form S-8 dated May 4, 2000, (v) Registration Statement on Form S-2, dated December 13, 2000, (vi) Registration Statements on Form S-3, dated February 15, 2001 and December 17, 2001 and (vii) Current Reports on Form 8-K dated February 10, 2001, August 6, 2001, November 29, 2001 and December 12, 2001 (collectively, the "SEC Documents"). Each SEC Document was in substantial compliance with the requirements of its respective form and none of the SEC Documents, nor the financial statements (and the notes thereto) included in the SEC Documents, as of their respective dates, contained any untrue statement of a material fact or omitted 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. 4.22 No Market Manipulation. The Company has not taken, and will not take, directly or indirectly, any action designed to, or that might reasonably be expected to, cause or result in stabilization or manipulation of the price of the Common Stock of the Company to facilitate the sale or resale of any of the Securities being offered hereby or affect the price at which any of the Securities being offered hereby may be issued. 4.23 Listing. The Company's Common Stock is listed for trading on the NASDAQ SmallCap Market and satisfies all requirements for the continuation of such listing. The Company has received notice that its Common Stock may be delisted from the NASDAQ SmallCap Market or that the Common Stock may not meet all requirements for the continuation of such listing. 4.24 No Integrated Offering. Neither the Company, nor any of its affiliates, nor any person acting on its or their behalf, has directly or indirectly made any offers or sales of any security or solicited any offers to buy any security under circumstances that would cause the offering of the Securities pursuant to this Agreement to be integrated with prior offerings by the Company for purposes of the Securities Act which would prevent the Company from selling the Securities pursuant to Rule 506 under the Securities Act, or any applicable exchange-related stockholder approval provisions. Nor will the Company or any of its affiliates or subsidiaries take any action or steps that would cause the offering of the Securities to be integrated with other offerings. -10- 4,25 Stop Transfer. The Securities are restricted securities as of the date of this Agreement. The Company will not issue any stop transfer order or other order impeding the sale and delivery of any of the Securities at such time as the Securities are registered for public sale or an exemption from registration is available, except as required by federal securities laws. 4.26 Dilution. The Company's executive officers and directors have studied and fully understand the nature of the Securities being sold hereby and recognize that they have a potential dilutive effect. The Board of Directors of the Company has concluded, in its good faith business judgment, that such issuance is in the best interests of the Company. The Company specifically acknowledges that subject to the terms of the Related Agreements, its obligation to issue the shares of Common Stock upon conversion of the Notes and exercise of the Warrants is binding upon the Company and enforceable regardless of the dilution such issuance may have on the ownership interests of other shareholders of the Company. 5. REPRESENTATIONS AND WARRANTIES OF THE PURCHASER. The Purchaser hereby represents and warrants to the Company with respect to itself or himself as follows (such representations and warranties do not lessen or obviate the representations and warranties of the Company set forth in this Agreement): 5.1 Requisite Power and Authority. Purchaser has all necessary power and authority under all applicable provisions of law to execute and deliver this Agreement and the Related Agreements and to carry out their provisions. All action on Purchaser's part required for the lawful execution and delivery of this Agreement and the Related Agreements have been or will be effectively taken prior to the Closing. Upon their execution and delivery, this Agreement and the Related Agreements will be valid and binding obligations of Purchaser, enforceable in accordance with their terms, except (a) as limited by applicable bankruptcy, insolvency, reorganization, moratorium or other laws of general application affecting enforcement of creditors' rights, and (b) as limited by general principles of equity that restrict the availability of equitable remedies. 5.2 Investment Representations. Purchaser understands that the Securities are being offered and sold pursuant to an exemption from registration contained in the Securities Act based in part upon Purchaser's representations contained in the Agreement. 5.3 Purchaser Bears Economic Risk. Purchaser has substantial experience in evaluating and investing in private placement transactions of securities in companies similar to the Company so that it is capable of evaluating the merits and risks of its investment in the Company and has the capacity to protect its own interests. Purchaser must bear the economic risk of this investment until the Securities are registered pursuant to the Securities Act, or an exemption from registration is available. 5.4 Acquisition for Own Account. Purchaser is acquiring the Notes for Purchaser's own account for investment only, and not with a view towards their distribution. 5.5 Purchaser Can Protect Its Interest. Purchaser represents that by reason of its, or of its management's, business or financial experience, Purchaser has the capacity to protect its own interests in connection with the transactions contemplated in this Agreement, and -11- the Related Agreements. Further, Purchaser is aware of no publication of any advertisement in connection with the transactions contemplated in the Agreement. 5.6 Accredited Investor. Purchaser represents that it is an accredited investor within the meaning of Regulation D under the Securities Act. 5.7 Legends. (a) The Notes shall bear the following legend until the Notes and Conversion Shares are covered by an effective registration statement filed with the SEC: "THIS NOTE AND THE COMMON STOCK ISSUABLE UPON CONVERSION OF THIS NOTE HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED, OR, IF APPLICABLE, STATE SECURITIES LAWS. THIS NOTE AND THE COMMON STOCK ISSUABLE UPON CONVERSION OF THIS NOTE MAY NOT BE SOLD, OFFERED FOR SALE, PLEDGED OR HYPOTHECATED IN THE ABSENCE OF AN EFFECTIVE REGISTRATION STATEMENT AS TO THIS NOTE OR SUCH SHARES UNDER SAID ACT AND APPLICABLE STATE SECURITIES LAWS OR AN OPINION OF COUNSEL REASONABLY SATISFACTORY TO INFINITE GROUP, INC. THAT SUCH REGISTRATION IS NOT REQUIRED." (b) The Conversion Shares and the Warrant Shares shall bear a legend which shall be in substantially the following form until such shares are covered by an effective registration statement filed with the SEC: "THE SHARES REPRESENTED BY THIS CERTIFICATE HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED, OR IF APPLICABLE, STATE SECURITIES LAWS. THESE SHARES MAY NOT BE SOLD, OFFERED FOR SALE, PLEDGED OR HYPOTHECATED IN THE ABSENCE OF AN EFFECTIVE REGISTRATION STATEMENT UNDER SUCH SECURITIES ACT AND APPLICABLE STATE LAWS OR AN OPINION OF COUNSEL REASONABLY SATISFACTORY TO INFINITE GROUP, INC. THAT SUCH REGISTRATION IS NOT REQUIRED." (c) The Warrants shall bear the following legend: "THIS WARRANT AND THE COMMON SHARES ISSUABLE UPON EXERCISE OF THIS WARRANT HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED, OR APPLICABLE STATE SECURITIES LAWS. THIS WARRANT AND THE COMMON SHARES ISSUABLE -12- UPON EXERCISE OF THIS WARRANT MAY NOT BE SOLD, OFFERED FOR SALE, PLEDGED OR HYPOTHECATED IN THE ABSENCE OF AN EFFECTIVE REGISTRATION STATEMENT AS TO THIS WARRANT OR THE UNDERLYING SHARES OF COMMON STOCK UNDER SAID ACT AND APPLICABLE STATE SECURITIES LAWS OR AN OPINION OF COUNSEL REASONABLY SATISFACTORY TO INFINITE GROUP, INC. THAT SUCH REGISTRATION IS NOT REQUIRED." 5.8 No Shorting. The Purchaser will not and will not cause any person or entity to engage in "short sales" of the Company's Common Stock. 6. COVENANTS OF THE COMPANY. The Company covenants and agrees with the Purchaser as follows: 6.1 Stop-Orders. The Company will advise the Purchaser, promptly after it receives notice of issuance by the Securities and Exchange Commission (the "SEC"), any state securities commission or any other regulatory authority of any stop order or of any order preventing or suspending any offering of any securities of the Company, or of the suspension of the qualification of the Common Stock of the Company for offering or sale in any jurisdiction, or the initiation of any proceeding for any such purpose. 6.2 Listing. The Company shall promptly secure the listing of the shares of Common Stock issuable upon conversion of the Notes and upon the exercise of the Warrants upon the Principal Market upon which shares of Common Stock are then listed (subject to official notice of issuance) and shall maintain such listing so long as any other shares of Common Stock shall be so listed. The Company will maintain the listing of its Common Stock on a Principal Market, and will comply in all respects with the Company's reporting, filing and other obligations under the bylaws or rules of the National Association of Securities Dealers ("NASD") and such exchanges, as applicable. The Company will provide the Purchaser copies of all notices it receives notifying the Company of the threatened and actual delisting of the Common Stock from any Principal Market. 6.3 Market Regulations. The Company shall notify the SEC, NASD and applicable state authorities, in accordance with their requirements, of the transactions contemplated by this Agreement, and shall take all other necessary action and proceedings as may be required and permitted by applicable law, rule and regulation, for the legal and valid issuance of the Securities to Purchaser and promptly provide copies thereof to Purchaser. 6.4 Reporting Requirements. (a) Until at least two (2) years S-3 from the date hereof, the Company will (i) cause its Common Stock to continue to be registered under Sections 12(b) or 12(g) of the Exchange Act, (ii) comply in all respects with its reporting and filing obligations under the Exchange Act, (iii) comply with all reporting requirements that is applicable to an issuer with a class of shares registered pursuant to Section 12(g) of the Exchange Act, and (iv) comply with all requirements related to any registration statement filed pursuant to this Agreement. The Company will not take any action or file any document (whether or not -13- permitted by the Securities Act or the Exchange Act or the rules thereunder) to terminate or suspend such registration or to terminate or suspend its reporting and filing obligations under said Acts until the earlier of (y) two (2) years S-3 from the date hereof, or (z) the sale by the Purchaser of all the Securities issuable by the Company pursuant to this Agreement. Until at least two (2) years after the Warrants have been exercised, the Company will use its commercial best efforts to continue the listing of the Common Stock on the NASD OTC Bulletin Board and will comply in all respects with the Company's reporting, filing and other obligations under the bylaws or rules of the NASD and NASDAQ. 6.5 Intentionally Omitted. 6.6 Access to Facilities. Until the Notes have been repaid in full, the Company will permit any representatives designated by the Purchaser (or any transferee of the Purchaser), so long as such person holds any Securities upon reasonable notice and during normal business hours, at such person's expense and accompanied by a representative of the Company, to (a) visit and inspect any of the properties of the Company, (b) examine the corporate and financial records of the Company (unless such examination is not permitted by federal, state or local law or by contract) and make copies thereof or extracts therefrom and (c) discuss the affairs, finances and accounts of any such corporations with the directors, officers and independent accountants of the Company. 6.7 Taxes. Until the Notes have been repaid in full, the Company will promptly pay and discharge, or cause to be paid and discharged, when due and payable, all lawful taxes, assessments and governmental charges or levies imposed upon the income, profits, property or business of the Company; provided, however, that any such tax, assessment, charge or levy need not be paid if the validity thereof shall currently be contested in good faith by appropriate proceedings and if the Company shall have set aside on its books adequate reserves with respect thereto, and provided, further, that the Company will pay all such taxes, assessments, charges or levies forthwith upon the commencement of proceedings to foreclose any lien which may have attached as security therefor. 6.8 Insurance. Until the Notes have been repaid in full, the Company will keep its assets which are of an insurable character insured by financially sound and reputable insurers against loss or damage by fire, explosion and other risks customarily insured against by companies in the Company's line of business, in amounts sufficient to prevent the Company from becoming a co-insurer and not in any event less than 100% of the insurable value of the property insured; and the Company will maintain, with financially sound and reputable insurers, insurance against other hazards and risks and liability to persons and property to the extent and in the manner customary for companies in similar businesses similarly situated and to the extent available on commercially reasonable terms. 6.9 Intellectual Property. Until the Notes have been repaid in full, the Company shall maintain in full force and effect its corporate existence, rights and franchises and all licenses and other rights to use Intellectual Property owned or possessed by it and reasonably deemed to be necessary to the conduct of its business. -14- 6.10 Properties. Until the Notes have been repaid in full, the Company will keep its properties in good repair, working order and condition, reasonable wear and tear excepted, and from time to time make all needful and proper repairs, renewals, replacements, additions and improvements thereto; and the Company will at all times comply with each provision of all leases to which it is a party or under which it occupies property if the breach of such provision could reasonably be expected to have a material adverse effect. 6.11 Confidentiality. The Company agrees that it will not disclose, and will not include in any public announcement, the name of the Purchaser, unless expressly agreed to by the Purchaser or unless and until such disclosure is required by law or applicable regulation, and then only to the extent of such requirement. 6.1 Required Approvals. For so long as at least 20% of the principal amount of the Notes are outstanding, the Company, without the prior written consent of the Purchaser, shall not: (a) directly or indirectly declare or pay any dividends or make any distributions upon any of its capital stock or other equity securities (or any securities directly or indirectly convertible into or exercisable or exchangeable for equity securities); (b) except as set forth on Schedule 4, directly or indirectly redeem, purchase or otherwise acquire any of the Corporation's capital stock or other equity securities (including, without limitation, the Securities or any warrants, options and other rights to acquire such capital stock or other equity securities) or directly or indirectly redeem, purchase or make any payments with respect to any stock appreciation rights, phantom stock plans or similar rights or plans; (c) except as set forth on Schedule 4, sell, lease or otherwise dispose of more any of the assets of the Company (computed on the basis of book value, determined in accordance with GAAP consistently applied, or fair market value, determined by the Board of Directors in its reasonable good faith judgment) in any transaction or series of related transactions (other than sales of inventory in the ordinary course of business) or sell or permanently dispose of any of its intellectual property; (d) liquidate, dissolve or effect a recapitalization, reclassification or reorganization in any form of transaction (including, without limitation, any reorganization into a limited liability company, a partnership or any other non-corporate entity which is treated as a partnership for federal income tax purposes or a stock split or "reverse" stock split of the Common Stock); (e) become subject to (including, without limitation, by way of amendment to or modification of) any agreement or instrument which by its terms would (under any circumstances) restrict the Company's right to perform the provisions of this Agreement or any of the agreements contemplated thereby; (f) amend, alter or repeal the Company's Bylaws or Charter in order to change the name of the Company or its state of incorporation, or except for the issuance of any Preferred Stock, materially affect the rights or other powers of the Conversion Shares, or -15- otherwise take any action which is designed to, or could have the effect of, adversely affecting the rights or other powers of the Conversion Shares; or (g) materially alter or change the business of the Company. 6.13 Reissuance of Securities. The Company agrees to reissue certificates representing the Securities without the legends set forth in Section 5.7 above at such time as (a) the holder thereof is permitted to dispose of such Securities pursuant to Rule 144(k) under the Securities Act, or (b) upon resale subject to an effective registration statement after such Securities are registered under the Securities Act. The Company agrees to cooperate with the Purchaser in connection with all resales pursuant to Rule 144(d) and Rule 144(k) and provide legal opinions necessary to allow such resales provided the Company and its counsel receive reasonably requested representations from the selling Purchaser and broker, if any. 6.14 Opinion. On the Closing Date, the Company will deliver to the Purchaser an opinion acceptable to the Purchaser from the Company's legal counsel in the form annexed hereto as Exhibit D. The Company will provide, at the Company's expense, such other legal opinions in the future as are reasonably necessary for the conversion of the Notes and exercise of the Warrants. 7. COVENANTS OF THE COMPANY AND PURCHASER REGARDING INDEMNIFICATION. 7.1 Company Indemnification. The Company agrees to indemnify, hold harmless, reimburse and defend Purchaser, each of Purchaser's officers, directors, agents, affiliates, control persons, and principal shareholders, against any claim, cost, expense, liability, obligation, loss or damage (including reasonable legal fees) of any nature, incurred by or imposed upon the Purchaser which results, arises out of or is based upon (i) any misrepresentation by Company or breach of any warranty by Company in this Agreement or in any exhibits or schedules attached hereto or any Related Agreement, or (ii) any breach or default in performance by Company of any covenant or undertaking to be performed by Company hereunder, or any other agreement entered into by the Company and Purchaser relating hereto. 7.2 Purchaser's Indemnification. Purchaser agrees to indemnify, hold harmless, reimburse and defend the Company and each of the Company's officers, directors, agents, affiliates, control persons and principal shareholders, at all times against any claim, cost, expense, liability, obligation, loss or damage (including reasonable legal fees) of any nature, incurred by or imposed upon the Company which results, arises out of or is based upon (a) any misrepresentation by Purchaser in this Agreement or in any exhibits or schedules attached hereto or any Related Agreement; or (b) any breach or default in performance by Purchaser of any covenant or undertaking to be performed by Purchaser hereunder, or any other agreement entered into by the Company and Purchaser relating hereto. 7.3 Procedures. The procedures and limitations set forth in Section 9.6 shall apply to the indemnifications set forth in Sections 7.1 and 7.2 above. -16- 8. CONVERSION OF CONVERTIBLE NOTES. Subject to the provisions of Section 2 of the Notes, the following provisions shall apply: 8.1 Mechanics of Conversion. (a) Upon the conversion of the Notes or part thereof, the Company shall, at its own cost and expense, take all necessary action (including the issuance of an opinion of counsel) to assure that the Company's transfer agent shall issue stock certificates in the name of the Purchaser (or its nominee) or such other persons as designated by the Purchaser and in such denominations to be specified representing the number of Conversion Shares issuable upon such conversion. The Company warrants that no instructions other than these instructions have been or will be given to the transfer agent of the Company's Common Stock and that the Conversion Shares issued will be unlegended, free-trading, and freely transferable, and will not contain a legend restricting the resale or transferability of the Conversion Shares, provided the Purchaser has notified the Company of the Purchaser's intention to sell the Conversion Shares and the Conversion Shares are included in an effective registration statement or are otherwise exempt from registration when sold; provided further, that if prior to the time the Conversion Shares have been sold, the registration statement shall no longer be effective, the Purchaser shall return the Conversion Shares to the Company for the placement of a legend. (b) Purchaser will give notice of its decision to exercise its right to convert the Notes or part thereof by telecopying or otherwise delivering an executed and completed notice of the number of shares to be converted to the Company (the "Notice of Conversion"). The Purchaser will not be required to surrender the Notes until the Purchaser receives a certificate or certificates, as the case may be, representing the Conversion Shares or until the Note has been fully satisfied. Each date on which a Notice of Conversion is telecopied or delivered to the Company in accordance with the provisions hereof shall be deemed a "Conversion Date." The Company will or will cause the transfer agent to transmit the Company's Common Stock certificates representing the shares issuable upon conversion of the Notes (and a certificate representing the balance of the Notes not so converted, if requested by Purchaser) to the Purchaser via express courier for receipt by such Purchaser within three trading days after receipt by the Company of the Notice of Conversion (the "Delivery Date"). (c) The Company understands that a delay in the delivery of the Conversion Shares in the form required pursuant to Section 8 hereof, or the Mandatory Redemption Payment described in Section 8.2 hereof, beyond the Delivery Date or Mandatory Redemption Payment Date (as defined in Section 8.2) could result in economic loss to the Purchaser. As compensation to the Purchaser for such loss, the Company agrees to pay late payments to the Purchaser for late issuance of the Conversion Shares in the form required pursuant to Section 8 hereof upon conversion of the Notes or late payment of the Mandatory Redemption Payment, in the amount of $100 per business day after the Delivery Date or Mandatory Redemption Payment Date, as the case may be, for each $10,000 Note principal being converted or redeemed. The Company shall pay any payments incurred under this Section in immediately available funds upon demand. Furthermore, in addition to any other remedies which may be available to the Purchaser, in the event that the Company fails for any reason to effect delivery of the Conversion Shares by the Delivery Date or make payment by the -17- Mandatory Redemption Payment Date, the Purchaser will be entitled to revoke all or part of the relevant Notice of Conversion or rescind all or part of the notice of Mandatory Redemption by delivery of a notice to such effect to the Company whereupon the Company and the Purchaser shall each be restored to their respective positions immediately prior to the delivery of such notice, except that late payment charges described above shall be payable through the date notice of revocation or rescission is given to the Company. (d) Nothing contained herein or in any document referred to herein or delivered in connection herewith shall be deemed to establish or require the payment of a rate of interest or other charges in excess of the maximum permitted by applicable law. In the event that the rate of interest or dividends required to be paid or other charges hereunder exceed the maximum amount permitted by such law, any payments in excess of such maximum shall be credited against amounts owed by the Company to a Purchaser and thus refunded to the Company. 8.2 Mandatory Redemption. In the event the Company is unable to issue Conversion Shares on a Delivery Date or at any time when a Note is convertible, for any reason, then at the Purchaser's election, the Company must pay to the Purchaser five (5) business days after request by the Purchaser or on the Delivery Date (if requested by the Purchaser) a sum of money determined by multiplying the principal of the Note required to be converted and not so converted (or otherwise not convertible, as applicable) by 130%, together with accrued but unpaid interest thereon ("Mandatory Redemption Payment"). The Mandatory Redemption Payment must be received by the Purchaser on the same date as the Conversion Shares are otherwise deliverable or within five (5) business days after request, whichever is sooner ("Mandatory Redemption Payment Date"). Upon receipt of the Mandatory Redemption Payment, the corresponding Note principal and interest will be deemed paid and no longer outstanding. 8.3 Maximum Conversion. The Purchaser shall not be entitled to convert on a Conversion Date that amount of a Note or Notes in connection with that number of shares of Common Stock which would be in excess of the sum of (i) the number of shares of Common Stock beneficially owned by the Purchaser on a Conversion Date, and (ii) the number of shares of Common Stock issuable upon the conversion of the Notes with respect to which the determination of this proviso is being made on a Conversion Date, which would result in beneficial ownership by the Purchaser of more than 4.99% of the outstanding shares of Common Stock of the Company on such Conversion Date. For the purposes of the proviso to the immediately preceding sentence, beneficial ownership shall be determined in accordance with Section 13(d) of the Exchange Act and Regulation 13d-3 thereunder. Subject to the foregoing, a Purchaser shall not be limited to aggregate conversions of only 4.99%. A Purchaser may void the conversion limitation described in this Section 8.3 upon 75 days prior notice to the Company or upon an Event of Default under the Note. A Purchaser may allocate which of the equity of the Company deemed beneficially owned by such Purchaser shall be included in the 4.99% amount described above and which shall be allocated to the excess above 4.99%. 8.4 Injunction - Posting of Bond. In the event a Purchaser shall elect to convert a Note or part thereof, the Company may not refuse conversion for any reason, unless an injunction from a court, on notice, restraining and or enjoining conversion of all or part of said -18- Note shall have been sought and obtained and the Company posts a surety bond for the benefit of such Purchaser in the amount of 130% of the amount of the Note, which is subject to the injunction, which bond shall remain in effect until the completion of arbitration/litigation of the dispute and the proceeds of which shall be payable to such Purchaser to the extent it obtains judgment. 8.5 Buy-In. In addition to any other rights available to the Purchaser, if the Company fails to deliver to the Purchaser Conversion Shares by the Delivery Date and if after the Delivery Date the Purchaser purchases (in an open market transaction or otherwise) shares of Common Stock to deliver in satisfaction of a sale by such Purchaser of the Common Stock which the Purchaser anticipated receiving upon such conversion (a "Buy-In"), then the Company shall pay in cash to the Purchaser (in addition to any remedies available to or elected by such Purchaser) the amount by which (A) the Purchaser's total purchase price (including brokerage commissions, if any) for the shares of Common Stock so purchased exceeds (B) the aggregate principal and/or interest amount of the Note, for which such conversion was not timely honored, together with interest thereon at a rate of 15% per annum, accruing until such amount and any accrued interest thereon is paid in full (which amount shall be paid as liquidated damages and not as a penalty). For example, if the Purchaser purchases shares of Common Stock having a total purchase price of $11,000 to cover a Buy-In with respect to an attempted conversion of $10,000 of Note principal and/or interest, the Company shall be required to pay the Purchaser $1,000, plus interest. The Purchaser shall provide the Company written notice indicating the amounts payable to the Purchaser in respect of the Buy-In. 8.6 NASDAQ Approval. The Company and the Purchaser agree that until the Company either obtains shareholder approval of the issuance of the Conversion Shares, or an exemption from NASDAQ's corporate governance rules as they may apply to the Conversion Shares, and an opinion of counsel reasonably acceptable to the Purchaser that NASDAQ's corporate governance rules do not conflict with nor may result in a delisting of the Company's common stock from the SmallCap Market (the "Approval") upon the conversion of the Notes, the Purchaser may not receive upon conversion of the Notes more than the number of common shares greater than 19.9% of the shares of Company's common stock outstanding on the Closing Date. The Company covenants to obtain the Approval required pursuant to the NASDAQ's corporate governance rules to allow conversion of all the Notes and interest thereon. The Company further covenants to file the preliminary proxy statement relating to the Approval with the Commission on or before thirty days after the Company and Purchaser determine that such filing is necessary ("Proxy Filing Date"). The Company further covenants to obtain the Approval no later than sixty days after the Proxy Filing Date ("Approval Date"). The Company's failure to (i) file the proxy on or before the Proxy Filing Date; or (ii) the Company's failure to obtain the Approval on or before the Approval Date (each being an "Approval Default") shall be deemed an Event of Default under the Note, but only to the extent the Notes and interest thereon that may not be converted due to the Company's failure to obtain such Approval. 9. REGISTRATION RIGHTS. 9.1 Registration Rights Granted. The Company hereby grants the following registration rights to holders of the securities purchased hereby. -19- (a) Intentionally omitted. (b) Intentionally omitted. (c) Intentionally omitted. (d) The Company shall file with the SEC no later than 5 days after the filing with the SEC of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2001, but no event later than within 65 days of the Closing Date (the "Filing Date"), and use its reasonable commercial efforts to cause to be declared effective a Form S-3 registration statement (or such other form that it is eligible to use) within 105 days of the Closing Date in order to register the Conversion Shares and the Warrant Shares issued or issuable with respect to all Notes and Warrants to be issued hereunder (the "Registrable Securities") for resale and distribution under the Securities Act. The holder thereof shall provide the Company with such information as the Company reasonably requests. The registration statement described in this paragraph must be declared effective by the SEC within 120 days of the Closing Date (as defined herein) ("Effective Date"). The Company will register not less than a number of shares of Common Stock in the aforedescribed registration statement that is equal to the Warrant Shares and 200% of the Conversion Shares issuable at the Conversion Prices set forth in the Warrants and Notes, respectively, that would be in effect on the Closing Date or the date of filing of such registration statement (employing the conversion price which would result in the greater number of Shares), assuming the conversion of 100% of the Notes which are then outstanding or issuable hereunder, and at least one share of common stock for each common share issuable upon exercise of the Warrants which are then outstanding or issuable hereunder (employing the Conversion Price that would result in the greater number of shares). The Registrable Securities shall be reserved and set aside exclusively for the benefit of the Purchaser and the holders of the Warrants, as the case may be, and not issued, employed or reserved for anyone other than the Purchaser and the holders of the Warrants. Such registration statement will be promptly amended or additional registration statements will be promptly filed by the Company as necessary to register additional Company Shares to allow the public resale of all Common Stock included in and issuable by virtue of the Registrable Securities. 9.2 Registration Procedures. If and whenever the Company is required by the provisions hereof to effect the registration of any shares of Registrable Securities under the Act, the Company will, as expeditiously as possible: (a) prepare and file with the SEC a registration statement with respect to such securities and use its best efforts to cause such registration statement to become and remain effective for the period of the distribution contemplated thereby (determined as herein provided), and promptly provide to the holders of Registrable Securities copies of all filings and SEC letters of comment; (b) prepare and file with the SEC such amendments and supplements to such registration statement and the prospectus used in connection therewith as may be necessary to keep such registration statement effective until the later of: (i) six months after the latest exercise period of the Warrants; (ii) twelve months after the Maturity Date of the last maturing Notes or (iii) four years after the Closing Date, and comply with the provisions of the Securities -20- Act with respect to the disposition of all of the Registrable Securities covered by such registration statement in accordance with the Seller's intended method of disposition set forth in such registration statement for such period; (c) furnish to the Seller, and to each underwriter if any, such number of copies of the registration statement and the prospectus included therein (including each preliminary prospectus) as such persons reasonably may request to facilitate the public sale or their disposition of the securities covered by such registration statement; (d) use its best efforts to register or qualify the Seller's Registrable Securities covered by such registration statement under the securities or "blue sky" laws of such jurisdictions as the Seller and in the case of an underwritten public offering, the managing underwriter shall reasonably request, provided, however, that the Company shall not for any such purpose be required to qualify generally to transact business as a foreign corporation in any jurisdiction where it is not so qualified or to consent to general service of process in any such jurisdiction; (e) list the Registrable Securities covered by such registration statement with any securities exchange on which the Common Stock of the Company is then listed; (f) immediately notify the Seller and each underwriter under such registration statement at any time when a prospectus relating thereto is required to be delivered under the Securities Act, of the happening of any event of which the Company has knowledge as a result of which the prospectus contained in such registration statement, as then in effect, includes an untrue statement of a material fact or omits to state a material fact required to be stated therein or necessary to make the statements therein not misleading in light of the circumstances then existing; and (g) make available for inspection by the Seller, any underwriter participating in any distribution pursuant to such registration statement, and any attorney, accountant or other agent retained by the Seller or underwriter, all publicly available, non-confidential financial and other records, pertinent corporate documents and properties of the Company, and cause the Company's officers, directors and employees to supply all publicly available, non-confidential information reasonably requested by the seller, underwriter, attorney, accountant or agent in connection with such registration statement. 9.3 Provision of Documents. In connection with each registration hereunder, the Seller will furnish to the Company in writing such information and representation letters with respect to itself and the proposed distribution by it as reasonably shall be necessary in order to assure compliance with federal and applicable state securities laws. In connection with each registration pursuant to Section 9 covering an underwritten public offering, the Company and the Seller agree to enter into a written agreement with the managing underwriter in such form and containing such provisions as are customary in the securities business for such an arrangement between such underwriter and companies of the Company's size and investment stature. -21- 9.4 Non-Registration Events. The Company and the Purchaser agree that the Seller will suffer damages if any registration statement required under Section 9.1(d) above is not filed on or before the Filing Date and not declared effective by the SEC on or before the Effective Date, and maintained in the manner and within the time periods contemplated by Section 9 hereof, and it would not be feasible to ascertain the extent of such damages with precision. Accordingly, if the registration statement on Form S-3 or such other form as described in Section 9.1(d) is not filed on or before the Filing Date or not declared effective on or before the sooner of the Effective Date, or within five days of receipt by the Company of a communication from the SEC that the registration statement described in Section 9.1(d) will not be reviewed, or (iii) any registration statement described in Section 9.1(d) is filed and declared effective but shall thereafter cease to be effective (without being succeeded immediately by an additional registration statement filed and declared effective) for a period of time which shall exceed 30 days in the aggregate per year but not more than 20 consecutive calendar days (defined as a period of 365 days commencing on the date the Registration Statement is declared effective) (each such event referred to in this Section 9.4 is referred to herein as a "Non-Registration Event"), then, for so long as such Non-Registration Event shall continue, (i) the Company shall pay in cash as Liquidated Damages to each holder of any Registrable Securities an amount equal to two percent (2%) per month or part thereof during the pendency of such Non-Registration Event of the principal of the Notes issued in connection with the Offering, whether or not converted, then owned of record by such holder or issuable as of or subsequent to the occurrence of such Non-Registration Event and (ii) the Conversion Price as defined in Section 2.1 of the Notes shall be reduced by 10% for each 30-day period following the Effective Date that the Registration Statement is not declared effective by the SEC. Payments to be made pursuant to this Section shall be due and payable immediately upon demand in immediately available funds. In the event a Mandatory Redemption Payment is demanded from the Company by the holder pursuant to Section 8.2 of this Agreement, then the Liquidated Damages described in this Section 9.4 shall no longer accrue on the portion of the purchase price underlying the Mandatory Redemption Payment, from and after the date the holder receives the Mandatory Redemption Payment. It shall be deemed a Non-Registration Event to the extent that all the Common Stock included in the Registrable Securities and underlying the Securities is not included in an effective registration statement as of and after the Effective Date at the conversion prices in effect from and after the Effective Date. 9.5 Expenses. All expenses incurred by the Company in complying with Section 9, including, without limitation, all registration and filing fees, printing expenses, fees and disbursements of counsel and independent public accountants for the Company, fees and expenses (including reasonable counsel fees) incurred in connection with complying with state securities or "blue sky" laws, fees of the NASD, transfer taxes, fees of transfer agents and registrars, fees of, and disbursements incurred by, one counsel for the Seller, and costs of insurance are called "Registration Expenses". All underwriting discounts and selling commissions applicable to the sale of Registrable Securities, including any fees and disbursements of any special counsel to the Seller beyond those included in Registration Expenses, are called "Selling Expenses." The Company will pay all Registration Expenses in connection with the registration statement under Section 9. All Selling Expenses in connection with each registration statement under Section 9 shall be borne by the Seller and may be apportioned among the Sellers -22- in proportion to the number of shares sold by the Seller relative to the number of shares sold under such registration statement or as all Sellers thereunder may agree. 9.6 Indemnification and Contribution. (a) In the event of a registration of any Registrable Securities under the Securities Act pursuant to Section 9, the Company will indemnify and hold harmless each Seller, each officer of each Seller, each director of each Seller, each underwriter of such Registrable Securities thereunder and each other person, if any, who controls any such Seller or underwriter within the meaning of the Securities Act, against any losses, claims, damages or liabilities, joint or several, to which the Seller, or such underwriter or controlling person may become subject under the Securities Act or otherwise, insofar as such losses, claims, damages or liabilities (or actions in respect thereof) arise out of or are based upon any untrue statement or alleged untrue statement of any material fact contained in any registration statement under which such Registrable Securities was registered under the Securities Act pursuant to Section 9, any preliminary prospectus or final prospectus contained therein, or any amendment or supplement thereof, or arise out of or are based upon the omission or alleged omission to state therein a material fact required to be stated therein or necessary to make the statements therein not misleading, and will reimburse the Seller, each such underwriter and each such controlling person for any legal or other expenses reasonably incurred by them in connection with investigating or defending any such loss, claim, damage, liability or action; provided, however, that the Company will not be liable in any such case if and to the extent that any such loss, claim, damage or liability arises out of or is based upon an untrue statement or alleged untrue statement or omission or alleged omission so made in conformity with information furnished by any such Seller, the underwriter or any such controlling person in writing specifically for use in such registration statement or prospectus. (b) In the event of a registration of any of the Registrable Securities under the Securities Act pursuant to Section 9, the Seller will indemnify and hold harmless the Company, and each person, if any, who controls the Company within the meaning of the Securities Act, each officer of the Company who signs the registration statement and each director of the Company, against all losses, claims, damages or liabilities, joint or several, to which the Company or such officer or director may become subject under the Securities Act or otherwise, insofar as such losses, claims, damages or liabilities (or actions in respect thereof) arise out of or are based upon any untrue statement or alleged untrue statement of any material fact contained in the registration statement under which such Registrable Securities were registered under the Securities Act pursuant to Section 9, any preliminary prospectus or final prospectus contained therein, or any amendment or supplement thereof, or arise out of or are based upon the omission or alleged omission to state therein a material fact required to be stated therein or necessary to make the statements therein not misleading, and will reimburse the Company and each such officer or director for any legal or other expenses reasonably incurred by them in connection with investigating or defending any such loss, claim, damage, liability or action, provided, however, that the Seller will be liable hereunder in any such case if and only to the extent that any such loss, claim, damage or liability arises out of or is based upon an untrue statement or alleged untrue statement or omission or alleged omission made in reliance upon and in conformity with information pertaining to such Seller, as such, furnished in writing to the Company by such Seller specifically for use in such registration statement or prospectus, and -23- provided, further, however, that the liability of the Seller hereunder shall be limited to the proportion of any such loss, claim, damage, liability or expense which is equal to the proportion that the public offering price of the Registrable Securities sold by the Seller under such registration statement bears to the total public offering price of all securities sold thereunder, but not in any event to exceed the net proceeds received by the Seller from the sale of Registrable Securities covered by such registration statement. (c) Promptly after receipt by an indemnified party hereunder of notice of the commencement of any action, such indemnified party shall, if a claim in respect thereof is to be made against the indemnifying party hereunder, notify the indemnifying party in writing thereof, but the omission so to notify the indemnifying party shall not relieve it from any liability which it may have to such indemnified party other than under this Section 9.6(c) and shall only relieve it from any liability which it may have to such indemnified party under this Section 9.6(c) if and to the extent the indemnifying party is prejudiced by such omission. In case any such action shall be brought against any indemnified party and it shall notify the indemnifying party of the commencement thereof, the indemnifying party shall be entitled to participate in and, to the extent it shall wish, to assume and undertake the defense thereof with counsel satisfactory to such indemnified party, and, after notice from the indemnifying party to such indemnified party of its election so to assume and undertake the defense thereof, the indemnifying party shall not be liable to such indemnified party under this Section 9.6(c) for any legal expenses subsequently incurred by such indemnified party in connection with the defense thereof other than reasonable costs of investigation and of liaison with counsel so selected, provided, however, that, if the defendants in any such action include both the indemnified party and the indemnifying party and the indemnified party shall have reasonably concluded that there may be reasonable defenses available to it which are different from or additional to those available to the indemnifying party or if the interests of the indemnified party reasonably may be deemed to conflict with the interests of the indemnifying party, the indemnified parties shall have the right to select one separate counsel and to assume such legal defenses and otherwise to participate in the defense of such action, with the reasonable expenses and fees of such separate counsel and other expenses related to such participation to be reimbursed by the indemnifying party as incurred. (d) In order to provide for just and equitable contribution in the event of joint liability under the Securities Act in any case in which either (i) the Seller, or any controlling person of the Seller, makes a claim for indemnification pursuant to this Section 9.6 but it is judicially determined (by the entry of a final judgment or decree by a court of competent jurisdiction and the expiration of time to appeal or the denial of the last right of appeal) that such indemnification may not be enforced in such case notwithstanding the fact that this Section 9.6 provides for indemnification in such case, or (ii) contribution under the Securities Act may be required on the part of the Seller or controlling person of the Seller in circumstances for which indemnification is provided under this Section 9.6; then, and in each such case, the Company and the Seller will contribute to the aggregate losses, claims, damages or liabilities to which they may be subject (after contribution from others) in such proportion so that the Seller is responsible only for the portion represented by the percentage that the public offering price of its securities offered by the registration statement bears to the public offering price of all securities offered by such registration statement, provided, however, that, in any such case, (A) the Seller will not be required to contribute any amount in excess of the public offering price of all such securities offered by it pursuant to such registration statement; and (B) no person or entity guilty -24- of fraudulent misrepresentation (within the meaning of Section 10(f) of the Act) will be entitled to contribution from any person or entity who was not guilty of such fraudulent misrepresentation. 10. OFFERING RESTRICTIONS. Except as previously disclosed in the SEC Documents, as set forth on Schedule 4 or stock or stock options granted to employees or directors of the Company; or equity or debt issued in connection with an acquisition of a business or assets by the Company; or the issuance by the Company of stock in connection with the establishment of a joint venture partnership or licensing arrangement (these exceptions hereinafter referred to as the "Excepted Issuances"), the Company will not issue any equity, convertible debt or other securities which are or could be (by conversion or registration) free-trading securities prior to the expiration of 12 months from the actual effective date of the registration statement described in Section 9.1(d) above (the "Exclusion Period") for a price per share less than the then applicable Conversion Price of the Note. This restriction shall not prohibit the Company from issuing any equity, convertible debt or other securities prior to the expiration of the Exclusion Period, provided that such equity, convertible debt or other securities are restricted securities when issued and remain restricted until the expiration of the Exclusion Period. Notwithstanding the above, if the Purchaser elects not to further fund the Company following the transaction contemplated hereby, the Purchaser shall waive the provisions of this Section 10. The provisions of this Section 10 shall become null and void upon the payment in full of all obligations owing under the Note. 11. SECURITY INTEREST. As a condition of Closing, the Company will provide to the Purchaser a security interest in certain assets of the Company as set forth in a Security Agreement. The Company will execute all such documents reasonably necessary to memorialize and further protect the security interest described above. 12. MISCELLANEOUS. 12.1 Governing Law. 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 laws. Any action brought by either party against the other concerning the transactions contemplated by this Agreement shall be brought only in the state courts of New York or in the federal courts located in the state of New York. Both parties and the individuals executing this Agreement and other agreements on behalf of the Company agree to submit to the jurisdiction of such courts and waive trial by jury. The prevailing party shall be entitled to recover from the other party its reasonable attorney's fees and costs. In the event that any provision of this Agreement or any other agreement delivered in connection herewith is invalid or unenforceable under any applicable statute or rule of law, then such provision shall be deemed inoperative to the extent that it may conflict therewith and shall be deemed modified to conform with such statute or rule of law. Any such provision which may prove invalid or unenforceable under any law shall not affect the validity or enforceability of any other provision of any agreement. 12.2 Survival. The representations, warranties, covenants and agreements made herein shall survive any investigation made by the Purchaser and the closing of the transactions contemplated hereby. All statements as to factual matters contained in any certificate or other instrument delivered by or on behalf of the Company pursuant hereto in -25- connection with the transactions contemplated hereby shall be deemed to be representations and warranties by the Company hereunder solely as of the date of such certificate or instrument. 12.3 Successors and Assigns. Except as otherwise expressly provided herein, the provisions hereof shall inure to the benefit of, and be binding upon, the successors, assigns, heirs, executors and administrators of the parties hereto and shall inure to the benefit of and be enforceable by each person who shall be a holder of the Securities from time to time. 12.4 Entire Agreement. This Agreement, the exhibits and schedules hereto, the Related Agreements and the other documents delivered pursuant hereto constitute the full and entire understanding and agreement between the parties with regard to the subjects hereof and no party shall be liable or bound to any other in any manner by any representations, warranties, covenants and agreements except as specifically set forth herein and therein. 12.5 Severability. In case any provision of the Agreement shall be invalid, illegal or unenforceable, the validity, legality and enforceability of the remaining provisions shall not in any way be affected or impaired thereby. 12.6 Amendment and Waiver. (a) This Agreement may be amended or modified only upon the written consent of the Company and the Purchaser. (b) The obligations of the Company and the rights of the holders of the Securities under the Agreement may be waived only with the written consent of such holders of Securities. The rights of the holder of a Note may be waived only with the written consent of the holder of such Note. 12.7 Delays or Omissions. It is agreed that no delay or omission to exercise any right, power or remedy accruing to any party, upon any breach, default or noncompliance by another party under this Agreement or the Related Agreements, shall impair any such right, power or remedy, nor shall it be construed to be a waiver of any such breach, default or noncompliance, or any acquiescence therein, or of or in any similar breach, default or noncompliance thereafter occurring. It is further agreed that any waiver, permit, consent or approval of any kind or character on the Purchaser's part of any breach, default or noncompliance under this Agreement, the Notes or the Related Agreements or any waiver on such party's part of any provisions or conditions of the Agreement, a Note or the Related Agreements must be in writing and shall be effective only to the extent specifically set forth in such writing. All remedies, either under this Agreement, the Notes or the Related Agreements, by law or otherwise afforded to any party, shall be cumulative and not alternative. 12.8 Notices. All notices required or permitted hereunder shall be in writing and shall be deemed effectively given: (a) upon personal delivery to the party to be notified, (b) when sent by confirmed telex or facsimile if sent during normal business hours of the recipient, if not, then on the next business day, (c) five days after having been sent by registered or certified mail, return receipt requested, postage prepaid, or (d) one day after deposit with a nationally recognized overnight courier, specifying next day delivery, with written verification of receipt. All communications shall be sent to the Company at the address as set forth on the -26- signature page hereof and to the Purchaser at the address set forth on the signature page hereto for such Purchaser, with a copy in the case of the Purchaser to Daniel M. Laifer, Esq., 152 West 57th Street, 4th Floor, New York, NY 10019, facsimile number (212) 541-4434, or at such other address as the Company or the Purchaser may designate by ten days advance written notice to the other parties hereto. 12.9 Attorneys' Fees. In the event that any suit or action is instituted to enforce any provision in this Agreement, the prevailing party in such dispute shall be entitled to recover from the losing party all fees, costs and expenses of enforcing any right of such prevailing party under or with respect to this Agreement, including, without limitation, such reasonable fees and expenses of attorneys and accountants, which shall include, without limitation, all fees, costs and expenses of appeals. 12.10 Titles and Subtitles. The titles of the sections and subsections of the Agreement are for convenience of reference only and are not to be considered in construing this Agreement. 12.11 Counterparts. This Agreement may be executed in any number of counterparts, each of which shall be an original, but all of which together shall constitute one instrument. 12.12 Broker's Fees. Each party hereto represents and warrants that no agent, broker, investment banker, person or firm acting on behalf of or under the authority of such party hereto is or will be entitled to any broker's or finder's fee or any other commission directly or indirectly in connection with the transactions contemplated herein, except as specified herein with respect to the Purchaser. Each party hereto further agrees to indemnify each other party for any claims, losses or expenses incurred by such other party as a result of the representation in this Section 12.12 being untrue. 12.13 Indemnification. The Company shall indemnify the Purchaser for any losses or expenses incurred by the Purchaser in connection with any claims brought against the Purchaser by any third party (including any other stockholder of the Company) as a result of the transactions contemplated by this Agreement, other than for a breach of representation or warranty made by the Purchaser herein. 12.14 Construction. Each party acknowledges that its legal counsel participated in the preparation of this Agreement and, therefore, stipulates that the rule of construction that ambiguities are to be resolved against the drafting party shall not be applied in the interpretation of this Agreement to favor any party against the other. -27- IN WITNESS WHEREOF, the parties hereto have executed the SECURITIES PURCHASE AGREEMENT as of the date set forth in the first paragraph hereof. COMPANY: PURCHASER: INFINITE GROUP, INC. LAURUS MASTER FUND, LTD. By: By: ---------------------------- -------------------------------------------- Name: Name: Title: Address: c/o Onshore Corporate Services Ltd. Address: 2364 Post Road P.O. Box 1234 G.T., Queensgate House, Warwick, Rhode Island 02886 South Church Street Grand Cayman, Cayman Islands [Securities Purchase Agreement Signature Page] LIST OF EXHIBITS Schedule of Purchasers Exhibit A Form of Offering Convertible Note Exhibit B Form of Warrant Exhibit C Form of Opinion Exhibit D EXHIBIT A SCHEDULE OF PURCHASERS - -------------------------------------------------------------------------------- Purchaser Closing Date Notes - -------------------------------------------------------------------------------- Laurus Master Fund, Ltd. $1,000,000 TOTAL $1,000,000 - -------------------------------------------------------------------------------- SCHEDULE OF WARRANT HOLDERS - -------------------------------------------------------------------------------- Name of Warrant Holder Number of Warrant Shares - -------------------------------------------------------------------------------- Laurus Master Fund, Ltd. 50,000 - -------------------------------------------------------------------------------- SCHEDULE OF FUND MANAGER'S FEE RECIPIENTS - -------------------------------------------------------------------------------- Fund Manager Closing Date Fund Manager's Fees - -------------------------------------------------------------------------------- Laurus Capital Management, L.L.C. $50,000 - -------------------------------------------------------------------------------- TOTAL $50,000 (5% of Closing) - -------------------------------------------------------------------------------- A-1 EXHIBIT B THIS NOTE AND THE COMMON SHARES ISSUABLE UPON CONVERSION OF THIS NOTE HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED. THIS NOTE AND THE COMMON SHARES ISSUABLE UPON CONVERSION OF THIS NOTE MAY NOT BE SOLD, OFFERED FOR SALE, PLEDGED OR HYPOTHECATED IN THE ABSENCE OF AN EFFECTIVE REGISTRATION STATEMENT AS TO THIS NOTE UNDER SAID ACT OR AN OPINION OF COUNSEL REASONABLY SATISFACTORY TO INFINITE GROUP, INC., THAT SUCH REGISTRATION IS NOT REQUIRED. CONVERTIBLE NOTE FOR VALUE RECEIVED, INFINITE GROUP, INC., a Delaware corporation (hereinafter called the "Borrower"), hereby promises to pay to LAURUS MASTER FUND, LTD., c/o Onshore Corporate Services Ltd., P.O. Box 1234 G.T., Queensgate House, South Church Street, Grand Cayman, Cayman Islands, Fax: 345-949-9877 (the "Holder") on order, without demand, the sum of One Million Dollars ($1,000,000), with simple interest accruing at the annual rate of 5%, on February 5, 2004 (the "Maturity Date"). The following terms shall apply to this Note: ARTICLE I DEFAULT RELATED PROVISIONS 1.1 Payment Grace Period. The Borrower shall have a ten (10) day grace period to pay any monetary amounts due under this Note, after which grace period a default interest rate of five percent (5%) per annum above the then applicable interest rate hereunder shall apply to the amounts owed hereunder. 1.2 Conversion Privileges. The Conversion Privileges set forth in Article II shall remain in full force and effect immediately from the date hereof and until the Note is paid in full. 1.3 Interest Rate. (a) Interest payable on this Note shall accrue at the annual rate of five percent (5%) and be payable in arrears commencing March 31, 2002 and on the last day of each quarter thereafter, and on the Maturity Date, accelerated or otherwise, when the principal and remaining accrued but unpaid interest shall be due and payable, or sooner as described below. (b) In addition to the interest rate set forth above in Section 1.3(a), an additional fee on this Note shall accrue at the annual rate of ten percent (10%) and be payable in arrears commencing March 31, 2002 and quarterly thereafter, and on the Maturity Date, accelerated or otherwise, when the principal and accrued but unpaid interest shall be due and payable, or sooner as described below. Notwithstanding the foregoing, for every $100,000 in principal amount of the Note that the Holder actually converts into Common Stock solely in connection with an Optional Conversion Notification, the annual rate of the additional fees payable as set forth in this subsection shall be reduced by 1% and shall be deemed the rate retroactive to the date hereof. In such event, any amounts already received by the Holder with respect to such additional fees shall be rebated to the Borrower. 1.4 Prepayment. All or any portion of this Note shall be prepayable at any time by the Borrower. ARTICLE II CONVERSION RIGHTS At any time during the term of this Note, the Borrower may deliver a written notification (the "Optional Conversion Notification") to the Holder setting forth the portion of the principal amount of the Note and/or interest due and payable (the "Investment Amount") that the Borrower authorizes the Holder to exercise its conversion rights with respect thereto, subject to the terms and provisions set forth below. Except upon the occurrence of an Event of Default hereunder, in which event the Holder shall have the right to convert the entire principal amount and interest due under this Note into shares of the Borrower's Common Stock, as set forth below, unless the Borrower delivers an Optional Conversion Notification to the Holder, the Holder will not be permitted to exercise its rights to convert any portion of the Note to Common Stock. 2.1. Conversion into the Borrower's Common Stock. (a) Subject to the Holder's receipt of an Optional Conversion Notification, as described above or following the occurrence of an Event of Default hereunder, the Holder shall have the right, but not the obligation, from and after the receipt of an Optional Conversion Notification or the occurrence of any Event of Default, as the case may be, and then at any time until this Note is fully paid, to convert the principal portion of this Note and/or interest due and payable set forth in each such Optional Conversion Notification or the entire principal portion of this Note and/or interest due and payable following the occurrence or an Event of Default, as the case may be, into fully paid and nonassessable shares of common stock of the Borrower as such stock exists on the date of issuance of this Note, or any shares of capital stock of the Borrower into which such stock shall hereafter be changed or reclassified (the "Common Stock") at the conversion price as defined in Section 2.1(b) hereof (the "Conversion Price"), determined as provided herein. Upon delivery to the Borrower of a Notice of Conversion as described in Section 8 of the Securities Purchase Agreement entered into between the Borrower and certain persons who are signatories thereto, including the Holder, relating to this Note (the "Purchase Agreement") of the Holder's written request for conversion (the date of giving such notice of conversion being a "Conversion Date"), the Borrower shall issue and deliver to the Holder within three business days from the Conversion Date that number of shares of Common Stock for the portion of the Note converted in accordance with the foregoing. At the election of the Holder, the Borrower will deliver accrued but unpaid interest on the Note through the Conversion Date directly to the Holder on or before the Delivery Date (as defined in the Purchase Agreement). The number of shares of Common Stock to be issued upon each conversion of this Note shall be determined by dividing that portion of the principal of the Note to be converted and interest, if any, by the Conversion Price. (b) Subject to adjustment as provided in Section 2.1(c) hereof, the Conversion Price per share shall be $2.25 per share (the "Maximum Base Price"). If an Event of Default shall have occurred and be continuing hereunder then the Conversion Price shall be equal to the lower of (i) the Maximum Base Price or (ii) ninety percent (90%) of the average of the five lowest closing prices for the Common Stock on the on the NASD OTC Bulletin Board, NASDAQ SmallCap Market, NASDAQ National 3 Market System, American Stock Exchange, or New York Stock Exchange (whichever of the foregoing is at the time the principal trading exchange or market for the Common Stock, the "Principal Market"), or on any securities exchange or other securities market on which the Common Stock is then being listed or traded, for the twenty two (22) trading days prior to but not including the Conversion Date. (c) The Maximum Base Price described in Section 2.1(b)(i) above, and number and kind of shares or other securities to be issued upon conversion determined pursuant to Section 2.1(a) and 2.1(b), shall be subject to adjustment from time to time upon the happening of certain events while this conversion right remains outstanding, as follows: A. Merger, Sale of Assets, etc. If the Borrower at any time shall consolidate with or merge into or sell or convey all or substantially all its assets to any other person or entity, this Note, as to the unpaid principal portion thereof and accrued interest thereon, shall thereafter be deemed to evidence the right to purchase such number and kind of shares or other securities and property as would have been issuable or distributable on account of such consolidation, merger, sale or conveyance, upon or with respect to the securities subject to the conversion or purchase right immediately prior to such consolidation, merger, sale or conveyance. The foregoing provision shall similarly apply to successive transactions of a similar nature by any such successor or purchaser. Without limiting the generality of the foregoing, the anti-dilution provisions of this Section shall apply to such securities of such successor or purchaser after any such consolidation, merger, sale or conveyance. B. Reclassification, etc. If the Borrower at any time shall, by reclassification or otherwise, change the Common Stock into the same or a different number of securities of any class or classes, this Note, as to the unpaid principal portion thereof and accrued interest thereon, shall thereafter be deemed to evidence the right to purchase an adjusted number of such securities and kind of securities as would have been issuable as the result of such change with respect to the Common Stock immediately prior to such reclassification or other change. C. Stock Splits, Combinations and Dividends. If the shares of Common Stock are subdivided or combined into a greater or smaller number of shares of Common Stock, or if a dividend is paid on the Common Stock in shares of Common Stock, the Conversion Price shall be proportionately reduced in case of subdivision of shares or stock dividend or proportionately increased in the case of combination of shares, in each such case by the ratio which the total number of shares of Common Stock outstanding immediately after such event bears to the total number of shares of Common Stock outstanding immediately prior to such event. (d) During the period the conversion right exists, the Borrower will reserve from its authorized and unissued Common Stock a sufficient number of shares to provide for the issuance of Common Stock upon the full conversion of this Note. The Borrower represents that upon issuance, such shares will be duly and validly issued, fully paid and non-assessable. The Borrower agrees that its issuance of this Note shall constitute full authority to its officers, agents, and transfer agents who are charged with the duty of executing and issuing stock certificates to execute and issue the necessary certificates for shares of Common Stock upon the conversion of this Note. 2.2 Method of Conversion. This Note may be converted by the Holder in whole or in part as described in Section 2.1(a) hereof and the Purchase Agreement. Upon partial conversion of this Note, a new Note containing the same date and provisions of this Note shall, at the request of the Holder, be issued by the Borrower to the Holder for the principal balance of this Note and interest which shall not have been converted or paid. 4 ARTICLE III EVENT OF DEFAULT The occurrence of any of the following events of default ("Event of Default") shall, at the option of the Holder hereof, make all sums of principal and interest and other fees then remaining unpaid hereon and all other amounts payable hereunder immediately due and payable, all without demand, presentment or notice, or grace period, all of which hereby are expressly waived, except as set forth below: 3.1 Failure to Pay Principal or Interest or other Fees. The Borrower fails to pay any installment of principal or interest or fees hereon or on any other promissory note issued pursuant to the Purchase Agreement, when due and such failure continues for a period of ten (10) days after the due date. 3.2 Breach of Covenant. The Borrower breaches any material covenant or other term or condition of this Note in any material respect and such breach, if subject to cure, continues for a period of ten (10) days after written notice to the Borrower from the Holder. 3.3 Breach of Representations and Warranties. Any representation or warranty of the Borrower made herein, in the Purchase Agreement, or in any agreement, statement or certificate given in writing pursuant hereto or in connection therewith shall be materially false or misleading. 3.4 Receiver or Trustee. The Borrower shall make an assignment for the benefit of creditors, or apply for or consent to the appointment of a receiver or trustee for it or for a substantial part of its property or business; or such a receiver or trustee shall otherwise be appointed. 3.5 Judgments. Any money judgment, writ or similar final process shall be entered or filed against the Borrower or any of its property or other assets for more than $50,000, and shall remain unvacated, unbonded or unstayed for a period of forty-five (45) days. 3.6 Bankruptcy. Bankruptcy, insolvency, reorganization or liquidation proceedings or other proceedings or relief under any bankruptcy law or any law for the relief of debtors shall be instituted by or against the Borrower, and, in the case of an involuntary case under any such bankruptcy laws, the Borrower shall have failed to have dismissed within thirty (30) days any such case. 3.7 Delisting. Delisting of the Common Stock from the Principal Market or such other principal exchange on which the Common Stock is listed for trading; or the Borrower's failure to comply with the conditions for listing. 3.8 Stop Trade. An SEC stop trade order or Principal Market trading suspension in the Conversion Shares. 3.9 Failure to Deliver Common Stock or Replacement Note. The Borrower's failure to timely deliver Common Stock to the Holder pursuant to and in the form required by this Note and Section 8 of the Purchase Agreement, or if required a replacement Note. 3.10 Registration Default. The occurrence of a Non-Registration Event as described in Section 9.4 of the Purchase Agreement. 3.11 Default Under Related Agreements. An Event of Default occurs under and as defined in any one or more of the following agreements which is not cured during any applicable cure or grace 5 period: (a) the Security Agreement dated as of the date hereof between Borrower and Holder, (b) the Security Agreement dated as of the date hereof between Holder and Infinite Photonics, Inc. ("Photonics") or (c) the Pledge and Security Agreement dated as of the date hereof between Holder and Photonics, as each such agreement may be amended, modified and supplemented from time to time. ARTICLE IV MISCELLANEOUS 4.1 Failure or Indulgence Not Waiver. No failure or delay on the part of the Holder hereof in the exercise of any power, right or privilege hereunder shall operate as a waiver thereof, nor shall any single or partial exercise of any such power, right or privilege preclude other or further exercise thereof or of any other right, power or privilege. All rights and remedies existing hereunder are cumulative to, and not exclusive of, any rights or remedies otherwise available. 4.2 Notices. Any notice herein required or permitted to be given shall be in writing and shall be deemed effectively given: (a) upon personal delivery to the party notified, (b) when sent by confirmed telex or facsimile if sent during normal business hours of the recipient, if not, then on the next business day, (c) five days after having been sent by registered or certified mail, return receipt requested, postage prepaid, or (d) one day after deposit with a nationally recognized overnight courier, specifying next day delivery, with written verification of receipt. All communications shall be sent to the Borrower at the address as set forth on the signature page to the Purchase Agreement executed in connection herewith and to the Holder at the address set forth on the signature page to the Purchase Agreement for such Holder, with a copy to Daniel M. Laifer, Esq., 152 West 57th Street, 4th Floor, New York, New York 10019, facsimile number (212) 541-4434, or at such other address as the Borrower or the Holder may designate by ten days advance written notice to the other parties hereto. A Notice of Conversion shall be deemed given when made to the Borrower pursuant to the Purchase Agreement. 4.3 Amendment Provision. The term "Note" and all reference thereto, as used throughout this instrument, shall mean this instrument as originally executed, or if later amended or supplemented, then as so amended or supplemented. 4.4 Assignability. This Note shall be binding upon the Borrower and its successors and assigns, and shall inure to the benefit of the Holder and its successors and assigns, and may be assigned by the Holder. 4.5 Cost of Collection. If default is made in the payment of this Note, the Borrower shall pay the Holder hereof reasonable costs of collection, including reasonable attorneys' fees. 4.6 Governing Law. This Note shall be governed by and construed in accordance with the laws of the State of New York, without regard to principles of conflicts of laws. Any action brought by either party against the other concerning the transactions contemplated by this Agreement shall be brought only in the state courts of New York or in the federal courts located in the state of New York. Both parties and the individual signing this Note on behalf of the Borrower agree to submit to the jurisdiction of such courts. The prevailing party shall be entitled to recover from the other party its reasonable attorney's fees and costs. In the event that any provision of this Note is invalid or unenforceable under any applicable statute or rule of law, then such provision shall be deemed inoperative to the extent that it may conflict therewith and shall be deemed modified to conform with such statute or rule of law. Any such provision which may prove invalid or unenforceable under any law shall not affect the validity or unenforceability of any other provision of this Note. 6 4.7 Maximum Payments. Nothing contained herein shall be deemed to establish or require the payment of a rate of interest or other charges in excess of the maximum permitted by applicable law. In the event that the rate of interest required to be paid or other charges hereunder exceed the maximum permitted by such law, any payments in excess of such maximum shall be credited against amounts owed by the Borrower to the Holder and thus refunded to the Borrower. 4.8 Security Interest. The holder of this Note has been granted a security interest in the Borrower's assets as more fully described in a Security Agreement. 4.9 Construction. Each party acknowledges that its legal counsel participated in the preparation of this Note and, therefore, stipulates that the rule of construction that ambiguities are to be resolved against the drafting party shall not be applied in the interpretation of this Note to favor any party against the other. 7 IN WITNESS WHEREOF, the Borrower has caused this Note to be signed in its name by its Chief Executive Officer on this 5th day of February, 2002. INFINITE GROUP, INC. By: _____________________________ WITNESS: - ------------------------------- 8 NOTICE OF CONVERSION (To be executed by the Holder in order to convert the Note) The undersigned hereby elects to convert $_________ of the principal and $_________ of the interest due on the Note issued by INFINITE GROUP, INC. on February 5, 2002 into Shares of Common Stock of INFINITE GROUP, INC. (the "Company") according to the conditions set forth in such Note, as of the date written below. Date of Conversion:_____________________________________________________________ Conversion Price:_______________________________________________________________ Shares To Be Delivered:_________________________________________________________ Signature:______________________________________________________________________ Print Name:_____________________________________________________________________ Address:________________________________________________________________________ ------------------------------------------------------------------------ B-1 EXHIBIT C Form of warrant THIS WARRANT AND THE COMMON SHARES ISSUABLE UPON EXERCISE OF THIS WARRANT HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED. THIS WARRANT AND THE COMMON SHARES ISSUABLE UPON EXERCISE OF THIS WARRANT MAY NOT BE SOLD, OFFERED FOR SALE, PLEDGED OR HYPOTHECATED IN THE ABSENCE OF AN EFFECTIVE REGISTRATION STATEMENT AS TO THIS WARRANT UNDER SAID ACT OR AN OPINION OF COUNSEL REASONABLY SATISFACTORY TO INFINITE GROUP, INC. THAT SUCH REGISTRATION IS NOT REQUIRED. Right to Purchase 50,000 Shares of Common Stock of Infinite Group, Inc. (subject to adjustment as provided herein) COMMON STOCK PURCHASE WARRANT No. 2002-1 Issue Date: February 5, 2002 INFINITE GROUP, INC., a corporation organized under the laws of the State of Delaware (the "Company"), hereby certifies that, for value received, LAURUS MASTER FUND, LTD., or assigns (the "Holder"), is entitled, subject to the terms set forth below, to purchase from the Company from and after the Issue Date of this Warrant and at any time or from time to time before 5:00 p.m., New York time, through five (5) years after such date (the "Expiration Date"), up to 50,000 fully paid and nonassessable shares of Common Stock (as hereinafter defined), $.001 par value per share, of the Company, at a purchase price of $2.65 per share (such purchase price per share as adjusted from time to time as herein provided is referred to herein as the "Purchase Price"). The number and character of such shares of Common Stock and the Purchase Price are subject to adjustment as provided herein. As used herein the following terms, unless the context otherwise requires, have the following respective meanings: (a) The term "Company" shall include Infinite Group, Inc. and any corporation which shall succeed or assume the obligations of Infinite Group, Inc. hereunder. (b) The term "Common Stock" includes (a) the Company's Common Stock, $.001 par value per share, as authorized on the date of the Securities Purchase Agreement referred to in Section 9 hereof, (b) any other capital stock of any class or classes (however designated) of the Company, authorized on or after such date, the holders of which shall have the right, without limitation as to amount, either to all or to a share of the balance of current dividends and liquidating dividends after the payment of dividends and distributions on any shares entitled to preference, and the holders of which shall ordinarily, in the absence of contingencies, be entitled to vote for the election of a majority of directors of the Company (even if the right so to vote has been suspended by the happening of such a contingency) and (c) any other securities into which or for which any of the securities described in (a) or (b) may be converted or exchanged pursuant to a plan of recapitalization, reorganization, merger, sale of assets or otherwise. (c) The term "Other Securities" refers to any stock (other than Common Stock) and other securities of the Company or any other person (corporate or otherwise) which the holder of the Warrant at any time shall be entitled to receive, or shall have received, on the exercise of the Warrant, in lieu of or in addition to Common Stock, or which at any time shall be issuable or shall have been issued in exchange for or in replacement of Common Stock or Other Securities pursuant to Section 4 or otherwise. 1. Exercise of Warrant. 1.1. Number of Shares Issuable upon Exercise. From and after the date hereof through and including the Expiration Date, the holder hereof shall be entitled to receive, upon exercise of this Warrant in whole in accordance with the terms of subsection 1.2 or upon exercise of this Warrant in part in accordance with subsection 1.3, shares of Common Stock of the Company, subject to adjustment pursuant to Section 4. 1.2. Full Exercise. This Warrant may be exercised in full by the holder hereof by delivery of an original or fax copy of the form of subscription attached as Exhibit A hereto (the "Subscription Form") duly executed by such Holder, to the Company at its principal office or at the office of its warrant agent (as provided hereinafter), accompanied by payment, in cash, wire transfer, or by certified or official bank check payable to the order of the Company, in the amount obtained by multiplying the number of shares of Common Stock for which this Warrant is then exercisable by the Purchase Price (as hereinafter defined) then in effect. 1.3. Partial Exercise. This Warrant may be exercised in part (but not for a fractional share) by surrender of this Warrant in the manner and at the place provided in subsection 1.2 except that the amount payable by the holder on such partial exercise shall be the amount obtained by multiplying (a) the number of shares of Common Stock designated by the holder in the Subscription Form by (b) the Purchase Price then in effect. On any such partial exercise, the Company, at its expense, will forthwith issue and deliver to or upon the order of the holder hereof a new Warrant of like tenor, in the name of the holder hereof or as such holder (upon payment by such holder of any applicable transfer taxes) may request, the number of shares of Common Stock for which such Warrant may still be exercised. 1.4. Company Acknowledgment. The Company will, at the time of the exercise of the Warrant, upon the request of the holder hereof acknowledge in writing its continuing obligation to afford to such holder any rights to which such holder shall continue to be entitled after such exercise in accordance with the provisions of this Warrant. If the holder shall fail to make any such request, such failure shall not affect the continuing obligation of the Company to afford to such holder any such rights. 1.5. Trustee for Warrant Holders. In the event that a bank or trust company shall have been appointed as trustee for the holders of the Warrants pursuant to Subsection 3.2, such bank or trust company shall have all the powers and duties of a warrant agent (as hereinafter described) and shall accept, in its own name for the account of the Company or such successor person as may be entitled thereto, all amounts otherwise payable to the Company or such successor, as the case may be, on exercise of this Warrant pursuant to this Section 1. 3 2.1 Delivery of Stock Certificates, etc. on Exercise. The Company agrees that the shares of Common Stock purchased upon exercise of this Warrant shall be deemed to be issued to the holder hereof as the record owner of such shares as of the close of business on the date on which this Warrant shall have been surrendered and payment made for such shares as aforesaid. As soon as practicable after the exercise of this Warrant in full or in part, and in any event within 7 days thereafter, the Company at its expense (including the payment by it of any applicable issue taxes) will cause to be issued in the name of and delivered to the holder hereof, or as such holder (upon payment by such holder of any applicable transfer taxes) may direct in compliance with applicable Securities Laws, a certificate or certificates for the number of duly and validly issued, fully paid and nonassessable shares of Common Stock (or Other Securities) to which such holder shall be entitled on such exercise, plus, in lieu of any fractional share to which such holder would otherwise be entitled, cash equal to such fraction multiplied by the then closing price of one full share, together with any other stock or other securities and property (including cash, where applicable) to which such holder is entitled upon such exercise pursuant to Section 1 or otherwise. 3. Adjustment for Reorganization, Consolidation, Merger, etc. 3.1. Reorganization, Consolidation, Merger, etc. In case at any time or from time to time, the Company shall (a) effect a reorganization, (b) consolidate with or merge into any other person, or (c) transfer all or substantially all of its properties or assets to any other person under any plan or arrangement contemplating the dissolution of the Company, then, in each such case, as a condition to the consummation of such a transaction, proper and adequate provision shall be made by the Company whereby the holder of this Warrant, on the exercise hereof as provided in Section 1 at any time after the consummation of such reorganization, consolidation or merger or the effective date of such dissolution, as the case may be, shall receive, in lieu of the Common Stock (or Other Securities) issuable on such exercise prior to such consummation or such effective date, the stock and other securities and property (including cash) to which such holder would have been entitled upon such consummation or in connection with such dissolution, as the case may be, if such holder had so exercised this Warrant, immediately prior thereto, all subject to further adjustment thereafter as provided in Section 4. 3.2. Dissolution. In the event of any dissolution of the Company following the transfer of all or substantially all of its properties or assets, the Company, prior to such dissolution, shall at its expense deliver or cause to be delivered the stock and other securities and property (including cash, where applicable) receivable by the holders of the Warrants after the effective date of such dissolution pursuant to this Section 3 to a bank or trust company having its principal office in New York, NY, as trustee for the holder or holders of the Warrants. 3.3. Continuation of Terms. Upon any reorganization, consolidation, merger or transfer (and any dissolution following any transfer) referred to in this Section 3, this Warrant shall continue in full force and effect and the terms hereof shall be applicable to the shares of stock and other securities and property receivable on the exercise of this Warrant after the consummation of such reorganization, consolidation or merger or the effective date of dissolution following any such transfer, as the case may be, and shall be binding upon the issuer of any such stock or other securities, including, in the case of any such transfer, the person acquiring all or substantially all of the properties or assets of the Company, whether or not such person shall have expressly assumed the terms of this Warrant as provided in Section 4. In the event this Warrant does not continue in full force and effect after the consummation of the transaction described in this Section 3, then only in such event will the 4 Company's securities and property (including cash, where applicable) receivable by the holders of the Warrants be delivered to the Trustee as contemplated by Section 3.2. 4. Extraordinary Events Regarding Common Stock. In the event that the Company shall (a) issue additional shares of the Common Stock as a dividend or other distribution on outstanding Common Stock, (b) subdivide its outstanding shares of Common Stock, or (c) combine its outstanding shares of the Common Stock into a smaller number of shares of the Common Stock, then, in each such event, the Purchase Price shall, simultaneously with the happening of such event, be adjusted by multiplying the then Purchase Price by a fraction, the numerator of which shall be the number of shares of Common Stock outstanding immediately prior to such event and the denominator of which shall be the number of shares of Common Stock outstanding immediately after such event, and the product so obtained shall thereafter be the Purchase Price then in effect. The Purchase Price, as so adjusted, shall be readjusted in the same manner upon the happening of any successive event or events described herein in this Section 4. The number of shares of Common Stock that the holder of this Warrant shall thereafter, on the exercise hereof as provided in Section 1, be entitled to receive shall be increased to a number determined by multiplying the number of shares of Common Stock that would otherwise (but for the provisions of this Section 4) be issuable on such exercise by a fraction of which (a) the numerator is the Purchase Price that would otherwise (but for the provisions of this Section 4) be in effect, and (b) the denominator is the Purchase Price in effect on the date of such exercise. 5. Certificate as to Adjustments. In each case of any adjustment or readjustment in the shares of Common Stock (or Other Securities) issuable on the exercise of the Warrants, the Company at its expense will promptly cause its Chief Financial Officer or other appropriate designee to compute such adjustment or readjustment in accordance with the terms of the Warrant and prepare a certificate setting forth such adjustment or readjustment and showing in detail the facts upon which such adjustment or readjustment is based, including a statement of (a) the consideration received or receivable by the Company for any additional shares of Common Stock (or Other Securities) issued or sold or deemed to have been issued or sold, (b) the number of shares of Common Stock (or Other Securities) outstanding or deemed to be outstanding, and (c) the Purchase Price and the number of shares of Common Stock to be received upon exercise of this Warrant, in effect immediately prior to such adjustment or readjustment and as adjusted or readjusted as provided in this Warrant. The Company will forthwith mail a copy of each such certificate to the holder of the Warrant and any Warrant agent of the Company (appointed pursuant to Section 11 hereof). 6. Reservation of Stock, etc. Issuable on Exercise of Warrant; Financial Statements. The Company will at all times reserve and keep available, solely for issuance and delivery on the exercise of the Warrants, all shares of Common Stock (or Other Securities) from time to time issuable on the exercise of the Warrant. This Warrant entitles the holder hereof to receive copies of all financial and other information distributed or required to be distributed to the holders of the Company's Common Stock. 7. Assignment; Exchange of Warrant. Subject to compliance with applicable Securities laws, this Warrant, and the rights evidenced hereby, may be transferred by any registered holder hereof (a "Transferor") with respect to any or all of the Shares. On the surrender for exchange of this Warrant, with the Transferor's endorsement in the form of Exhibit B attached hereto (the "Transferor Endorsement Form") and together with evidence reasonably satisfactory to the Company demonstrating compliance with applicable Securities Laws, the Company at its expense but with payment by the Transferor of any applicable transfer taxes) will issue and deliver to or on the order of 11 the Transferor thereof a new Warrant or Warrants of like tenor, in the name of the Transferor and/or the transferee(s) specified in such Transferor Endorsement Form (each a "Transferee"), calling in the aggregate on the face or faces thereof for the number of shares of Common Stock called for on the face or faces of the Warrant so surrendered by the Transferor. 8. Replacement of Warrant. On receipt of evidence reasonably satisfactory to the Company of the loss, theft, destruction or mutilation of this Warrant and, in the case of any such loss, theft or destruction of this Warrant, on delivery of an indemnity agreement or security reasonably satisfactory in form and amount to the Company or, in the case of any such mutilation, on surrender and cancellation of this Warrant, the Company at its expense will execute and deliver, in lieu thereof, a new Warrant of like tenor. 9. Registration Rights. The Holder of this Warrant has been granted certain registration rights by the Company. These registration rights are set forth in a Securities Purchase Agreement entered into by the Company and Purchaser of the Company's 5% Convertible Notes (the "Notes") at or prior to the issue date of this Warrant. The terms of the Securities Purchase Agreement are incorporated herein by reference. Upon the occurrence of a Non-Registration Event as described in the Securities Purchase Agreement, in the event the Company is unable to issue Common Stock upon exercise of this Warrant that has been registered in the Registration Statement described in the Securities Purchase Agreement, within the time periods described in the Securities Purchase Agreement, which Registration Statement must be effective throughout the exercise period of this Warrant, then upon written demand made by the Holder, the Company will pay to the Holder of this Warrant, in lieu of delivering Common Stock, a sum equal to the closing ask price of the Company's Common Stock on the Principal Market (as defined in the Securities Purchase Agreement) or such other principal trading market for the Company's Common Stock on the trading date immediately preceding the date notice is given by the Holder, less the Purchase Price, for each share of Common Stock designated in such notice from the Holder. 10. Maximum Exercise. The Holder shall not be entitled to exercise this Warrant on an exercise date, in connection with that number of shares of Common Stock which would be in excess of the sum of (i) the number of shares of Common Stock beneficially owned by the Holder and its affiliates on an exercise date, and (ii) the number of shares of Common Stock issuable upon the exercise of this Warrant with respect to which the determination of this proviso is being made on an exercise date, which would result in beneficial ownership by the Holder and its affiliates of more than 4.99% of the outstanding shares of Common Stock of the Company on such date. For the purposes of the proviso to the immediately preceding sentence, beneficial ownership shall be determined in accordance with Section 13(d) of the Securities Exchange Act of 1934, as amended, and Regulation 13d-3 thereunder. Subject to the foregoing, the Holder shall not be limited to aggregate exercises which would result in the issuance of more than 4.99%. The restriction described in this paragraph may be revoked upon 75 days prior notice from the Holder to the Company or upon an Event of Default under the Notes. The Holder may allocate which of the equity of the Company deemed beneficially owned by the Subscriber shall be included in the 4.99% amount described above and which shall be allocated to the excess above 4.99%. 11. Warrant Agent. The Company may, by written notice to the each holder of the Warrant, appoint an agent for the purpose of issuing Common Stock (or Other Securities) on the exercise of this Warrant pursuant to Section 1, exchanging this Warrant pursuant to Section 7, and replacing this Warrant pursuant to Section 8, or any of the foregoing, and thereafter any such issuance, exchange or replacement, as the case may be, shall be made at such office by such agent. 6 12. Transfer on the Company's Books. Until this Warrant is transferred on the books of the Company, the Company may treat the registered holder hereof as the absolute owner hereof for all purposes, notwithstanding any notice to the contrary. 13. Notices, etc. All notices and other communications from the Company to the holder of this Warrant shall be mailed by first class registered or certified mail, postage prepaid, at such address as may have been furnished to the Company in writing by such holder or, until any such holder furnishes to the Company an address, then to, and at the address of, the last holder of this Warrant who has so furnished an address to the Company. 14. Voluntary Adjustment by the Company. The company may at any time during the term of this Warrant reduce the then current Exercise Price to any amount and for any period of time deemed appropriate by the Board of Directors of the Company. 15. Miscellaneous. This Warrant and any term hereof may be changed, waived, discharged or terminated only by an instrument in writing signed by the party against which enforcement of such change, waiver, discharge or termination is sought. This Warrant shall be governed by and construed in accordance with the laws of State of New York without regard to principles of conflicts of laws. Any action brought concerning the transactions contemplated by this Warrant shall be brought only in the state courts of New York or in the federal courts located in the state of New York. The individuals executing this Warrant on behalf of the Company agree to submit to the jurisdiction of such courts and waive trial by jury. The prevailing party shall be entitled to recover from the other party its reasonable attorney's fees and costs. In the event that any provision of this Warrant is invalid or unenforceable under any applicable statute or rule of law, then such provision shall be deemed inoperative to the extent that it may conflict therewith and shall be deemed modified to conform with such statute or rule of law. Any such provision which may prove invalid or unenforceable under any law shall not affect the validity or enforceability of any other provision of this Warrant. The headings in this Warrant are for purposes of reference only, and shall not limit or otherwise affect any of the terms hereof. The invalidity or unenforceability of any provision hereof shall in no way affect the validity or enforceability of any other provision. The Company acknowledges that legal counsel participated in the preparation of this Warrant and, therefore, stipulates that the rule of construction that ambiguities are to be resolved against the drafting party shall not be applied in the interpretation of this Warrant to favor any party against the other party. 7 IN WITNESS WHEREOF, the Company has executed this Warrant under seal as of the date first written above. INFINITE GROUP, INC. By:_________________________________ Witness: - ------------------------------ 8 Exhibit A FORM OF SUBSCRIPTION (To be signed only on exercise of Warrant) TO: Infinite Group, Inc. The undersigned, pursuant to the provisions set forth in the attached Warrant (No.____), hereby irrevocably elects to purchase (check applicable box): ___ ________ shares of the Common Stock covered by such Warrant. The undersigned herewith makes payment of the full purchase price for such shares at the price per share provided for in such Warrant, which is $___________. Such payment takes the form of (check applicable box or boxes): ___ $__________ in lawful money of the United States; and/or ___ the cancellation of such portion of the attached Warrant as is exercisable for a total of _______ shares of Common Stock (using a market value of $_______ per share for purposes of this calculation). The undersigned requests that the certificates for such shares be issued in the name of, and delivered to ____________________ whose address is_________________ ______________________________________ ____________________________________. The undersigned represents and warrants that all offers and sales by the undersigned of the securities issuable upon exercise of the within Warrant shall be made pursuant to registration of the Common Stock under the Securities Act of 1933, as amended (the "Securities Act") or pursuant to an exemption from registration under the Securities Act. Dated:___________________ ______________________________________ (Signature must conform to name of holder as specified on the face of the Warrant) ------------------------------------- (Address) EX-23 4 ex-23.txt CONSENT OF INDEPENDENT ACCOUNTANTS EXHIBIT 23 CONSENT OF INDEPENDENT ACCOUNTANTS We hereby consent to the incorporation of our report dated March 15, 2002, included in this 10-KSB, in the previously filed Registration Statements of Infinite Group, Inc. on Form S-8 (No. 333-36266) and Form S-2 (No. 333-51768). FREED MAXICK & BATTAGLIA, CPAs, PC Buffalo, New York March 28, 2002 -----END PRIVACY-ENHANCED MESSAGE-----