Employee Pension Plan

9 Months Ended

Sep. 30, 2011

Employee Pension Plan

Note 7.  Employee Pension Plan

Background

Prior to December 30, 2002, the Company owned 100% of the common stock of Osley & Whitney, Inc. (“O&W”).  On December 30, 2002, the Company sold 100% of the O&W common stock to a third party, but continued to act as the sponsor of the O&W Retirement Plan (the “O&W Plan”).  Although the Company continued to act as the sponsor of the O&W Plan after the sale, during 2007 management determined that it had no legal obligation to do so.

During 2007, the Company submitted information to the Department of Treasury (“Treasury”) advocating that it had no legal obligation to act as the sponsor of the O&W Plan to ascertain whether the Treasury concurred or disagreed with this position.  The Company subsequently provided responses to Treasury inquiries related to this determination.  In October 2009, the Company received a report from the Treasury that stated that the Treasury staff disagreed with the Company’s position and as a result, the Company is responsible for excise taxes attributed to the funding deficiency of $1,836,359 for the years 2003 through 2007 which funding deficiency can only be corrected by contributing $1,836,359 to the O&W Plan.  The report also stated that proposed 10% excise taxes of $348,500, penalties for late payment of excise taxes of approximately $1.2 million and 100% excise taxes of approximately $3.5 million related to the years ended December 31, 2006 and 2007 may be imposed.  Penalties for late payment may be removed if the Company provides reasonable cause for not paying the excise taxes and the Treasury concurs with the Company’s position.  The Company and its outside legal counsel disagree with significant aspects of both the factual findings and legal conclusions set forth in the report and, in accordance with Treasury procedures, have responded with a detailed analysis of its opposition to the findings.  The Company plans to diligently pursue all appropriate steps to perfect its appeal rights and attempt to prevail on the merits of its position, which will include filing a protest, requesting an appeals conference, and, if needed, petitioning the tax court and advocating its position in that forum.

As of September 30, 2011, if the Company does not ultimately prevail, it will become obligated for O&W Plan contributions of approximately $2.2 million and 10% excise taxes on accumulated unfunded contributions for the years ended December 31, 2006 and 2007 of approximately $348,500, as stated above, and potentially additional 10% excise taxes of approximately $440,000 for the years ended December 31, 2009 and 2008, which have not been accrued based upon the Company’s determination that it has no legal obligation to act as the O&W Plan sponsor and the Company’s belief that the likelihood is not probable that it will be required to pay these excise taxes.  Further, if the Company does not ultimately prevail, it may be required to pay interest on these excise taxes and potentially incur penalties for late payment of excise taxes and additional excise taxes up to 100% of each year’s funding deficiency.  The Company has accrued amounts related to excise taxes, including late fees and interest, on unfunded contributions for 2003, 2004 and 2005 of approximately $478,000 as of September 30, 2011 ($470,000 at December 31, 2010).  No excise taxes, late fees or interest for 2006, 2007, 2008, 2009, and 2010 have been accrued at September 30, 2011 or December 31, 2010.  The Company does not have the funds available to make required contributions which approximate $2.2 million and does not intend to make any contributions to the O&W Plan during 2011.

During 2006, the Pension Benefit Guarantee Corporation (“PBGC”) placed a lien on all of the Company’s assets to secure the contributions due to the O&W Plan.  This lien is subordinate to liens that secure accounts receivable financing and certain notes payable.

On April 29, 2009, acting for the O&W Plan, the Company sent the O&W Plan participants a notice of intent to terminate the O&W Plan in a distress termination with a proposed termination date of June 30, 2009.  The Company also provided additional documentation regarding the Company’s status and the status of the O&W Plan.

Current Status

During 2011, the Company completed discussions of settlement terms with the PBGC with the objective of terminating the O&W Plan.  On September 6, 2011, the Company received notification from the PBGC that it had executed a Settlement Agreement with the Company, effective September 1, 2011 (the “Settlement Agreement”), and  issued a Notice of Determination (the “PBGC Determination”) that the O&W Plan had not met the minimum funding standard required under section 412 of the Internal Revenue Code and would be unable to pay benefits when due, which PBGC Determination was a condition precedent to the Company’s obligations under the Settlement Agreement.

On October 17, 2011, in accordance with the Settlement Agreement, the Company: (i) purchased 500,000 shares of its common stock from the O&W Plan for $130,000; (ii) issued a secured promissory note in favor of the PBGC for $300,000 bearing interest at 6% per annum amortizing in quarterly payments over a seven year period (the “PBGC Note”); and (iii) has agreed to make future payments through December 31, 2017 out of the Company’s “Free Cash Flow”, as defined in the Settlement Agreement, not to exceed $569,999.  The Settlement Agreement contains  specific events of default and provisions for remedies upon default.  The purchase price for the 500,000 shares was funded from the proceeds of the placement by the Company of a convertible note in the principal amount of $100,000 (the “Convertible Note”) to a non-affiliated accredited investor on October 4, 2011 and $30,000 of the Company's available cash.  The Convertible Note bears interest at the rate of 7% per annum, matures on October 3, 2016 and is secured by a subordinate lien on all of the Company’s assets.  The Convertible Note’s principal is convertible at the option of the holder into shares of the Company’s common stock at $.10 per share.  The shares purchased from the O&W Plan were retired and restored to the status of authorized but unissued shares.

On November 1, 2011, in accordance with the terms of the Settlement Agreement, the Company received from the PBGC the executed Agreement for Appointment of Trustee and Termination of the O&W Plan (the “Trusteeship Agreement”).  The Trusteeship Agreement: (i) terminated the O&W Plan; (ii) appointed the PBGC as the statutory trustee of the O&W Plan; and (iii) established November 30, 2001 as the termination date for the O&W Plan.

As a result of the PBGC’s termination of the O&W Plan as of November 30, 2001, the Company has no further obligations to the O&W Plan or the PBGC other than those stated in the Settlement Agreement.  Further, the Company believes that the outcome with the PBGC and specifically the O&W Plan's termination date of November 30, 2001, increases the likelihood of the Company prevailing with the Treasury in its position that it had no legal obligation to act as the sponsor of the O&W Plan.   However, there is no assurance that the Company will prevail in its position with Treasury. The Company's balance sheet at September 30, 2011 includes reclassifications to the current and long-term portions of accrued pension expense to reflect the current maturities of long-term obligations according to the terms of the Settlement Agreement.  The  Company will record the effects of the termination of the O&W Plan in its financial statements during the fourth quarter of 2011.

At September 30, 2011, the O&W Plan had an accrued pension obligation liability of $4,680,584 ($4,314,883 at December 31, 2010), which included the underfunded amount plus interest on past due payments and excise taxes including penalties and interest of approximately $478,000 as discussed above.  Accumulated other comprehensive loss of $2,961,147 at September 30, 2011 ($2,961,147 at December 31, 2010) has been recorded as a reduction of stockholders’ deficiency.

The market value of the O&W Plan assets decreased from $1,601,276 at December 31, 2010 to $1,215,557 at September 30, 2011.  The decrease was comprised of net investment losses of $13,539, benefit payments of $337,455 and expenses of $34,725.

Net periodic pension cost recorded in the accompanying statements of operations includes the following components of expense (benefit) for the periods presented.

	Three Months  ended September 30, 2011			Three Months ended September 30, 2010			Nine Months ended September 30, 2011			Nine Months ended September 30, 2010
Interest cost	$	67,878		$	72,531		$	203,634		$	217,594
Expected return on plan assets		(30,193	)		(39,148	)		(90,579	)		(117,443	)
Service cost		10,500			12,500			31,500			37,500
Actuarial loss		33,960			31,882			101,881			95,645
Net periodic pension cost	$	82,145		$	77,765		$	246,436		$	233,296

There were no holdings of Level 3 investments and there were no purchases, sales, issuances, and settlements of Level 3 investments during the three and nine months ended September 30, 2011 and 2010.  Additionally, there were no transfers between Level 1 and Level 2 assets during the nine months ended September 30, 2011.