Item 1. Business
Current business outlook
Since inception, the Company has incurred losses, realized negligible revenues from product sales and has not been able to generate revenues from licensing. All of our 2006, 2007 and 2008 senior convertible notes have fully matured, representing a total amount outstanding of $10,683,875 as of 12/31/2010, and are now subject to repayment in full upon demand by our lenders. During 2010 the Company’s cash position suffered additional deterioration. The Company’s current lenders have not expressed willingness to provide additional financing to support the Company’s operations and we believe access to alternative sources of financing are unlikely due to the Company’s financial condition. Management further believes that the Company's tenuous financial condition has impeded partner relationships and new business generation. In the short term, prospects for additional revenue represent substantial uncertainty, with our government design services contract which funds a major portion of the company's operating expenses, expiring in April of 2011. While we have actively sought a replacement for that contract, none has yet been put in place. Current status of the Government budget, we believe, makes finding a replacement for the expiring contract revenue prior to the next fiscal cycle in September unlikely.
In light of these factors, management believes that a comprehensive financial restructuring is the best way to preserve value, both in improving the balance sheet and in improving the likelihood of consummating a combinatorial transaction or partnership. Management has proposed terms for a restructuring to the Company’s lenders, but the lenders have not to date engaged with the Company in discussions. As a result, there can be no assurance that a financial restructuring can be done and, if done, under what terms such a transaction might take place. Should a financial restructuring be consummated, the resultant debt for equity exchange will most likely result in a near complete loss of shareholder value. Should a restructuring be unachievable, Raptor will be forced to further reduce staff or cease operations resulting in a total loss of shareholder value and liquidation of the Company’s assets.
For further details on the above we refer to the language included under “risk factors” starting on page 8 of this form 10K , “conclusion on capital resources and liquidity” on page 26 of this form 10K and “presentation as a going concern” on page of this form 10K.
Overview
We were organized under the laws of the State of Colorado on January 22, 2001 under the name Pacific InterMedia, Inc. We originally were engaged in the business of offering EDGAR filing services to companies outsourcing the formatting and electronic filing of registration statements, periodic reports and other forms with the U. S. Securities and Exchange Commission (“SEC” or the “Commission”), but generated minimal revenues from these operations. On October 17, 2003, we completed a business combination transaction with Raptor Networks Technology, Inc., a California corporation (“Raptor”), whereby we acquired all of the issued and outstanding capital stock of Raptor in a cashless common stock share-for-share exchange in which Raptor became our wholly-owned subsidiary.
Upon the completion of this acquisition transaction, we changed our name to Raptor Networks Technology, Inc. (the “Company”), terminated our EDGAR filing services operations and, by and through our subsidiary Raptor, became engaged in the data network switching industry. Since that time, our focus has been to design, produce and sell standards-based, proprietary high-speed network switching technologies. Our “distributed network switching technology” allows users to upgrade their traditional networks with our switches to allow for more efficient management of high-bandwidth applications. The implementation of our products in a user’s network provides increased speed and greater capacity and, we believe, a cost-effective alternative to existing switching and routing technologies.
We design, produce and sell standards-based, proprietary high-speed network switching and related “virtualized fabric” technologies. Our “distributed hybrid fabric” networking and integrated systems’ technologies allow users to upgrade both their traditional networks as well as their server and storage arrays with our products to allow for more efficient management of high-bandwidth transport, applications and security. The implementation of our products in a user’s network provides architectural solution alternatives, at a systems level, unavailable from existing switching, routing and server technologies.
We have designed and produced a family of virtualized network switching products branded the “Ether-Raptor” line, which consist of core and edge switch products that operate together in a unique and highly efficient manner. In a departure from traditional, centralized chassis-based switch architectures that were originally designed to handle latency (a time delay in the transfer of data) insensitive traffic such as email and block data transfers, we have developed the ability to “bind” physically separated network switches into a common “virtual chassis,” creating the ability for a single network device to exist in multiple locations at the same time. This contiguous transport architecture allows for very fast data transport while removing the limitations of active/passive link states common in legacy networks. This functionality is believed to be essential to new high-bandwidth, latency sensitive applications such as Voice over Internet Protocol (“VoIP”), streaming video, Internet Protocol Television (“IPTV”) and cloud computing and storage, none of which existed when traditional chassis-based network switch designs were originally designed. We believe that our “distributed fabric” architecture and associated products may redefine the manner in which data distribution occurs for service providers offering VOIP, streaming video, IPTV and cloud computing and access. Due to the full, open-standards compatibility of our Ether-Raptor product line, our network switching products have nearly universal applicability on legacy as well as newly installed Ethernet networks where speed, high bandwidth, cyber resiliency, and survivability are essential.
In 2009 and 2010, we advanced our architecture and intellectual property to design a next-generation network appliance that becomes a “hybrid fabric” device; part core network transport product, part embedded applications server, part content caching device and part secure communications appliance. Management’s belief is that the IT world will ultimately adopt “hybrid fabric” architectures, blurring the distinction between a network device, a computing device and a security device, creating the same degree of convergence in the systems arena that has already occurred in the telecom space. We are thus designing our first “hybrid fabric” converged machine comprising a high performance, virtualized fabric core networking device with a multi-core, applications ready processor and accompanying storage embedded in the transport fabric itself.
We remain an early stage technology company and, commencing with our inception, have operated, and are now operating, at a significant loss. We currently have no commitments for any additional financing and taking into account the financial condition of the Company it is unlikely that we will have access to any sources of financing. In October 2008, we shifted our principal operating model from product development to licensing, enabling a reduction in headcount, footprint and infrastructure to reduce costs. While we shifted principally to licensing, we continue to pursue product and service revenue at a much diminished rate. This change of model enabled the Company to substantially reduce expenses throughout 2009 and 2010. As the Company did not generate any licensing revenues in the past it is unlikely that this business model will be successful in the short term and as a consequence our investors could lose their entire investment in us.
Our principal headquarters are located at 1508 S. Grand Ave., Santa Ana, California 92705 and our phone number is 714-380-6659. Our Internet address is www.raptor-networks.com. Our Code of Ethics, Audit Committee Charter, Nominating and Governance Committee Charter and Compensation Committee Charter may be found on our website at the Internet address set forth above. Our filings with the SEC may be read and copied at the SEC’s Public Reference Room at 100 F Street N.E., Washington, D.C. 20549. You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers, such as us, that file electronically with the SEC. The SEC’s web site address is www.sec.gov.
Industry Background
Distributed computing and accelerating use of the Internet for information access as well as communication have driven an exponential expansion in the use of internetworking for more than thirty years. Most of today’s networks were engineered based upon standards and technology optimized for handling a single data type - character data, which was previously the prevalent form of data. However, today’s sophisticated applications often require multiple data types with speed and bandwidth requirements so high that prevailing network technology becomes stressed. Often times the system upgrades required to support these new applications is not cost justifiable, thereby slowing the rate of adoption and utilization of advanced network applications.
New converged applications including video on demand, remote synchronous data storage mirroring, global server clustering, business continuity, disaster recovery and distance collaboration are just a few of the high-bandwidth network applications that can have great value to an enterprise embracing them. However, the cost to replace or upgrade existing networks with the requisite efficient, high-bandwidth infrastructure to support these new applications is, in many cases, financially prohibitive. For example, a typical chassis-based upgrade, the type of which is offered by some of our competitors, involves replacing the power supplies, management units, backplane, fan trays and interconnect blades in the unit being upgraded. It is not unusual for the upgrade to cost as much or more than the original machine.
Our Strategy
Our answer to the cost barrier of the adoption of high-bandwidth (10 Gigabit and greater) networking is the introduction of next-generation networking and “hybrid fabric” systems products that are fundamentally less complex, more architecturally flexible, compatible with legacy products and faster than traditional chassis-based alternatives. Most importantly, our next-generation appliances were designed to work together seamlessly, “binding” into a common, virtualized chassis despite being physically or geographically separated.
The core philosophy underlying our technological approach is to do at Layer 2 (the Data Link Layer) in hardware what traditional, chassis based network transport architectures require Layer 3 protocols (the Network Layer) in software to achieve. Our “distributed switch fabric” approach provides a means to achieve seamless and coherent peer-to-peer communication between physically separated switches at Layer 2. The result is, effectively, a single network switch consisting of a cluster of standalone, high-performance blades physically separated from one another by currently up to 120 kilometers per hop (in line with what optics technology allows; distance can be increased using lighted fiber). This flexibility permits the use of unique network topologies that allow for highly-robust, super-redundant networks to be designed and implemented that provide data transport at wire-speed (the maximum speed at which the equipment is built to operate) with the versatility to run latency-sensitive data applications (such as VoIP or streaming video) at a cost-effective price without sacrificing quality.
The ultimate goal in networking is to maximize effective transport bandwidth without sacrificing quality. In our architecture, Quality-of-Service is maintained by providing for intelligent management of the different data types traveling from the same source to the same destination. Latency variations caused by heavy traffic can be devastating to certain data types and applications. In traditional centralized architectures, latency problems are resolved with the costly deployment of dedicated parallel networks, increasing system complexity and hampering system scalability. Our technology optimizes the handling of all data packets on a single, common network by monitoring and differentiating between data types and adjusting transport parameters accordingly, thus assuring low latency on common transport paths.
Our proprietary Raptor Adaptive Switch Technology (“RAST”) provides an innovative new way to connect local and wide area networks, allowing users new options in the way they design their distribution networks. Simply stated, RAST allows discrete network elements, separated in distance by more than 120 kilometers each, to “bind” into a common “virtual switch,” providing for ultra-fast Layer 2 transport across those distances. Compatible with existing open standards legacy products, RAST allows customers to add significant capability to converge voice, video and all data types on to their existing network without the need for expensive, end-to-end upgrades. RAST also allows highly resilient networks to be created at lower costs, both in terms of initial capital expenditure and ongoing operating costs, than traditional legacy chassis-based systems. Because RAST allows virtually any network size and topology to be engineered from our common “building block” switches, the cost of adoption, as well as the cost of support, is minimized.
One of the most difficult data types for networks to handle is VoIP. By optimizing the handling of all data packet types on a given network, treating them as though they were all video data, our architecture enables the construction of true wire-speed networks and achieves multiple objectives for the user community. First, it allows for voice, video, storage and other sophisticated applications that can improve operations and establish new revenue streams. Second, it augments, rather than replaces, the existing internetworking infrastructure already in place, leveraging the user’s existing capital investment and minimizing the incremental capital outlay required to support these new applications.
To date, we have filed multiple patents with respect to a range of “distributed hybrid fabric” technologies and architectures, including the application of these architectures to network transport, security, resiliency, encryption and satellite communications. To date, 5 of these patents were approved, published and issued. We believe the newly issued patents and the patents still pending represent a substantial competitive advantage because of the added level of functionality these technologies provide our products.
Our Products
Our flagship product is a virtualized fabric network core switch, the Ether-Raptor-1010E (“ER-1010E”), which superseded the ER-1010A/B/C in March 2008. The ER-1010E is a combination 10Gb/GbE switch. We also offer a pure edge switch, the Ovi-Raptor-1048 (“OR-1048”). All our switches are based upon a common family of merchant silicon and embedded software.
ER-1010E
Our ER-1010E 1Gb/GbE and 10Gb/GbE network switch significantly reduces the cost of adoption of ten gigabit networking by allowing for the construction of an entire network from a series of our common, high performance “building blocks.” The ER-1010E consists of 24 ports of 1Gb/GbE and six ports of 10Gb/GbE. The ER-1010E is built in a 1U high, self-powered, self-managed enclosure. Unlike the large and complex chassis-based switches from which they evolved, our network switches are physically placed near the devices or clients they serve. When these switches are then subsequently connected together, either over copper or fiber links, they collectively “bind” into a single “virtual” network switch. This patented “distributed virtual switch” architecture, filed under Raptor Networks Technology, Inc.’s name, scales linearly, reduces inter-network disconnects and moves data at very high speeds. Because the topology consists of a collection of self-managed, interconnected building blocks of identical composition, the architecture of the ER-1010E improves redundancy, keeps latency very low across broad distances, allows for simpler management and is priced lower than chassis-based alternatives. In 2008 we began offering an ER-1010E version with dual redundant power supply capabilities.
OR-1048
The OR-1048 is a 48-port 1GbE edge switch with the option for two 10GbE uplinks and four optional 1GbE fiber ports. The OR-1048’s standard features include comprehensive management functions and Web management.
Research and Development
We spent $22,336 and $114,387 in 2010 and 2009, respectively, on research and development. The significant reduction in R&D expense can be attributed to completion of ER-1010E product development activity and a sharp downsizing in response to the distressed economic environment in 2009. Additionally, under certain government contracts, we are able to bill for R&D costs that we incur. The amount billed in 2010 was substantially greater than in 2009.
We commenced our transition into the data network switching industry in October 2003. From October 2003 until early 2005, we worked to develop our first network switching product, the ER-1010.
During 2005, our research and development resources were mainly focused on adding features to the ER-1010, such as Data Management Software (software enabling analysis of data flows handled by the ER-1010) and other enriching functions. Throughout 2005, substantial testing of the ER-1010 was carried out internally for the purpose of ensuring that product features worked as expected and extensive external testing was conducted to validate the quality of our products. In the fourth quarter of 2005, certain parts of the ER-1010 were upgraded, including the replacement of certain cables to reduce manufacturing costs and an upgrade to a more powerful processor. We also made significant progress in 2005 debugging software included in the ER-1010, resulting in substantial improvement of the ER-1010’s performance in terms of reduced failover time, increased stacking possibilities and smooth running of jumbo frames.
During 2006, our research and development team completed various enhancements to the ER-1010, resulting in an improvement of the control plane and increasing memory and processing power. We also began work on upgrading the existing ER-1010 to a more powerful product. During the second half of 2006, we continued testing various applications that may better position our products for various markets. We also began testing our products with a government approved test organization.
In 2007, we successfully finished testing of our product with a U.S. federal government-approved test organization. The research and development team spent considerable time developing the ER-1010E, an enhanced version of the ER-1010 as described above under the caption “Our Products.” In addition, we developed a redundant power supply version of the ER-1010E and designed various new boards, which improved the stability of the ER-1010 and ER-1010E and suitability of our core system for the data storage market. Our software development group upgraded our software to include additional protocols addressing customer-reported issues as well as additional supported protocols.
In the first half of 2008, we finished the development of the ER-1010E, including the redundant power supply version, which we made available for shipment in late March 2008. During the remainder of 2008 we started the hardware design of an” IPv6” capable unit. “IPv6” is a feature that facilitates an increase of the number of users on the internet and is a key requirement for obtaining government business. In addition, we are considering developing various security related enhancements.
In 2009, we billed one customer for research and development activities. This trend continued throughout 2010, as we evolved the design of the production ER-1010E from a pure network switching product to a network switching product which was “applications enabled” by embedding new multi-core processors onto the fabric, “caching enabled” through the addition of FLASH and SSD memory and substantially more scalability (up to 32 units in a common fabric compared to 12 units for the ER-1010E) under a government services contract.
Sales and Marketing
We market and sell our products to customers through a combination of direct sales to end users and sales through resellers. Our sales offices are located at our principal headquarters in Santa Ana, California. In addition, we have finder’s fee and consulting agreements in place with a number of independent third parties to facilitate the sale of our products on a global basis. Our services are marketed directly to select governmental entities by full-time Raptor employees.
Competition
We believe the key competitive factors in today’s network switching market are, in order of priority: price, speed, features, brand recognition and interoperability (compatibility with legacy products). We intend to become competitive by offering products that offer architectural performance, resiliency and power efficiency advantages at a price that cannot be matched by today’s centrally-architected legacy networks alternatives. While we seek to gain and expand a market presence through aggressive marketing and sales efforts, our efforts have included, over the past 18 months, a substantial activity aimed at partnering, licensing and transactional alternatives, it has become clear, during the down market economic conditions of the past two years that new customers are hesitant to purchase core network hardware from less known vendors. However, our market remains highly fluid in characteristic and we may find ourselves unable to compete against competitors with strong balance sheets and established channels to market.
We operate in a competitive industry with many established and well-recognized competitors. In particular, Cisco Systems maintains a dominant position in our industry and several of its products compete directly with our products. We also compete with, among others, Extreme Networks, Alcatel/Lucent, Enterasys Networks, 3Com, Huawei Technologies, Force 10 Networks, Juniper Networks and Avaya. Most of our competitors (including all of the competitors referenced above) have substantially greater market leverage, distribution networks, vendor relationships, longer operating histories and industry experience, greater financial, technical, sales, marketing and other resources, more name recognition and larger installed customer bases than we do and can be expected to react strongly to our marketing efforts.
In addition, many competitors exist who, because of their substantial resources, distribution relationships and customer base, could temporarily drop prices to stave off a potential successful market launch by us. Other competitive responses might include, without limitation, intense and aggressive price competition and offers of employment to our key marketing or management personnel. There can be no assurance that we will be successful in the face of increasing competition from existing or new competitors, or that competition will not have a material adverse effect on our business, financial condition and results of operations.
Competitive pressures and other factors, such as new product or technology introductions by us or our competitors, may result in price or market share erosion that could have a material adverse effect on our business, results of operations and financial condition. In addition, there can be no assurance that our products and services will achieve broad market acceptance or will successfully compete with other products targeting the same customers.
Manufacturing and Suppliers
Our primary technology provider is Broadcom Corporation. Broadcom’s 10 Gigabit Ethernet, Gigabit Ethernet and fast Ethernet transceivers provide the Ethernet and 10 Gigabit switching fabric in our distributed architecture. Another major supplier is TTM Corporation, which supplies PCB fabrication and PCB design and analyses support. Our operating system is based on WindRiver’s VxWorks, which is widely used throughout the information technology industry.
All of our manufacturing activities have been outsourced to Express Manufacturing, Inc. (“EMI”), a subcontractor located in the same vicinity as our principal headquarters. EMI’s manufacturing activities for us consist of printed circuit board assembly and final assembly of our products. All of our inventory is stored at our principal headquarters and we supply it to EMI as needed to meet our orders. We currently conduct final systems testing at our principal headquarters.
We utilize high quality providers of merchant silicon, embedded software, production circuit boards and loss-free interconnects to craft our switch products. No extraordinary investments in custom ASICs, software or infrastructure were required to engineer our family of products. In August 2004 we relocated our operations to a Federal Empowerment Zone and local enterprise zone, directly between EMI, our contract manufacturer, and Broadcom, our merchant silicon provider, in order to minimize facility costs and speed the design-to-production transition of new silicon switching innovations. In October of 2008, we moved once again, remaining within the Federal Empowerment Zone, but reducing our footprint and lease rate to further cut expenses in order to attempt to survive the economic downturn.
Employees
As of February 24, 2011 we had 7 full-time employees and one part-time employee. None of our employees are a party to any collective bargaining agreements with us. We consider our relations with our employees to be good.
Patents, Trademarks, and Licensing Agreements
We have ten U.S. patent applications pending, five issued, two foreign applications pending and five additional U.S. provisional applications pending with broad claim sets covering numerous aspects of our Ethernet Distributed Switch Fabrics. The foreign applications pending are in Europe (“EPO”) and Japan.
While we see no evidence that the technology encompassed in the Ethernet Distributed Switch Fabrics patent applications is neither infringed upon by any third party, nor infringes on any prior art of any third party, we are unable to assess the validity, scope or defensibility of our patent applications, and any challenge to or claim of infringement relating to one or more of the patent applications could materially and adversely affect our business and results of operations.
We have not entered into any licensing or franchising agreements for revenue generating purposes.
Organization
We were organized under the laws of the State of Colorado on January 22, 2001 under the name Pacific InterMedia, Inc. We originally were engaged in the business of offering EDGAR filing services to companies outsourcing the formatting and electronic filing of registration statements, periodic reports and other forms with the SEC, but generated minimal revenues from these operations. On October 17, 2003, we completed a business combination transaction with Raptor Networks Technology, Inc., a California corporation (“Raptor”), whereby we acquired all of the issued and outstanding capital stock of Raptor in a cashless common stock share-for-share exchange in which Raptor became our wholly-owned subsidiary (the “Raptor Acquisition”).
The Raptor Acquisition was structured as a share-for-share exchange whereby we issued to Raptor’s shareholders, on a one-for-one basis, an aggregate of 19,161,256 shares of our authorized but previously unissued common stock in exchange for the 19,161,256 shares of Raptor common stock collectively held by them.
As of the date of the Raptor Acquisition, both we and Raptor were start-up, development stage companies and had each realized negligible revenues. We are unable to locate any documentation or other information regarding how the value of our common stock or Raptor’s common stock was calculated in determining that the stock be exchanged on a one-for-one basis in the Raptor Acquisition. In addition, there was no public market for either our or Raptor’s stock at the time of the Raptor Acquisition on which to base such an evaluation. We have no reason to believe the Raptor Acquisition was not an arms-length transaction or that the terms of the Raptor Acquisition were not reasonable at the time the transactions were entered into. However, we can provide no assurance that our common stock or Raptor’s common stock was not over-valued or under-valued in the Raptor Acquisition.
Upon the completion of the Raptor Acquisition, we changed our name to Raptor Networks Technology, Inc., terminated our EDGAR filing services operations and, by and through our subsidiary Raptor, became engaged in the data network switching industry. The Raptor Acquisition has been treated as a reverse merger, with Raptor being considered the acquiring entity for accounting purposes.
Item 1A.
Item 1A. Risk Factors
The level of revenues resulting from our only government contract currently in place funds a major portion of operating expenses and revenues from this specific contract will end in April 2011.
Beginning in October of 2010, the Company billed services against a new government contract for the evolution to an application-enabled network switch which would fully leverage the Company’s hybrid fabric technology. We believe that the funds allocated under this contract alone will not be sufficient to complete the product development of the “hybrid fabric” machine. The level of revenues from this contract currently funds a major portion of our quarterly operating expenses and the revenue stream from this contract will end in April 2011. Taking into account the financial condition of the Company, it is unlikely that we will be successful in capturing additional funding to support continued operations. Should the Company fall short in this respect, it could be compelled to restructure or sell its assets or file for protection under the U.S. Bankruptcy Code. This would result in a loss of all or substantially all of our shareholders’ investments in us.
Public accounting firms have issued a report questioning our ability to continue as a going concern.
Our independent registered public accounting firms have qualified their opinions with respect to our financial statements to include an explanatory paragraph in which they expressed substantial doubt about our ability to continue as a going concern in their report for each of our fiscal years ended December 31, 2003 through December 31, 2010. Reports of independent registered public accounting firms questioning a company’s ability to continue as a going concern generally are viewed very unfavorably by analysts and investors. There are a number of risks and challenges associated with such a qualified report including, but not limited to, a significant impediment to our ability to raise additional capital or seek financing from entities that will not conduct such transactions in the face of such increased level of risk of insolvency and loss, increased difficulty in attracting talent and the diversion of the attention of our executive officers and other key employees to raising capital or financing rather than devoting time to the day-to-day operations of our business. We urge potential investors to review the report of our independent registered public accounting firm and our consolidated financial statements and related notes beginning on page of this Report and to seek independent advice concerning the substantial risks related thereto before making a decision to invest in us. Our consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and satisfaction of liabilities in the normal course of business. The financial statements and financial information included in this filing do not reflect any adjustments that might be necessary if we are unable to continue as a going concern. We currently have no commitment for any additional financing and taking into account the financial condition of the Company it is unlikely that we will be able to obtain requisite financing on acceptable terms, if at all. In October 2008 the principal operating model of the Company was shifted from product development to licensing, enabling a reduction in headcount, footprint and infrastructure to reduce costs. In 2009 and 2010, the Company was not able to negotiate any licensing agreements and as a consequence it is unlikely that this shift in business model will be successful. Should the licensing model prove to be unsuccessful, our investors could lose their entire investment in us
We may require additional financing to continue operations and we may not be able to secure such financing on acceptable terms, if at all.
Our substantial accumulated deficit, limited working capital and expectation of future losses may require that we obtain additional financing to continue operations, however it is unlikely that we will be able to obtain such financing. We have had no significant revenues from operations since our inception. As of December 31, 2010, we had an accumulated deficit of $84,392,048. We have operated at a loss since our inception and expect to continue to experience losses from our operations for the foreseeable future. Our net losses for fiscal 2010 and 2009 were $468,871 and $12,694,997, respectively. During the same periods our losses from operations were $351,140 and $484,251, respectively. We will be required to conduct product feature enhancement and testing activities which, together with expenses to be incurred for the establishment of a sustainable marketing and sales presence and other general and administrative expenses, are expected to result in operating losses through the foreseeable future. Accordingly, there is a risk that we will not achieve profitable operations in the near future, if at all.
Cash from operations may not be sufficient to fund operations in the future.
We funded our deficits in 2007 and 2008 largely by obtaining debt and equity financing from outside providers. In 2009, we changed our operating model to reduce our expenses and mainly financed our operations with the cash flow we generated from operating activities. In July 2010, one of the investors from our previous financings provided an unsecured loan to us in the principal amount of $176,471 for a one-year term. Taking into account the financial condition of the Company it is unlikely that cash from operations will be sufficient to finance our operations in the future.
If we are unable to generate positive cash flows from operations and if we become unable to finance our operations, investors in our common stock or other securities could lose their entire investments.
If we default on our senior secured convertible notes, most of which matured in the past, we could lose all of our assets.
Pursuant to the July 2007, March 2008 and July 2008 senior secured convertible note financings, we granted the investors a security interest in all of our assets. We have not paid these lenders in cash. All reductions in our debt have been the result of conversions of debt into shares of our common stock. Currently, we do not have the cash flow to repay any of the notes and as the 2006, 2007 and 2008 notes have all matured, the lenders could demand repayment in full for all of the before mentioned notes. Until now the lenders have not demanded repayment of the notes. At any time, however, the lenders could do so and force us into default. They could then take all remedies available to them, including conversion of the notes into a very large number of shares of our common stock and/or foreclosing on all of our assets, both tangible and intangible, leaving us with no assets.
The Company is unable to service its debt.
In 2009 and 2010, the Company was unable to service any of its debt in cash. As a result, the interest accrued over those periods was with the approval of the note holders added to the principal balances of our convertible notes. In 2011, we will most likely continue to lack the cash flow to pay interest on the 2006, 2007 and 2008 notes. In the past, as described above, the lenders have agreed to waive default on the notes and allowed us to add the interest due to the principal of the notes. At any time a new interest payment is due, however, the lenders could declare us in default and foreclose on our assets. This would result in a loss of all or substantially all of the shareholders’ investment.
We have no profitable operating history and may never achieve profitability.
We have not generated meaningful revenues from operations since our inception. Our business is subject to numerous risks associated with a low-capitalized company engaged in the network switch industry. Such risks include, but are not limited to, competition from well-established and well-capitalized companies, technological obsolescence and unanticipated difficulties regarding the development and marketing of our products. There can be no assurance that we will ever generate significant commercial sales or achieve profitability. Should this be the case, investors in our common stock or other securities could lose their entire investment.
We depend on a few customers.
We depend on a few major customers for the majority of our revenues. This creates a significant financial risk to the Company because if a major customer were to terminate or materially reduce, for any reason, its business relationship with us, we would suffer an immediate and substantial decline in revenue.
The majority of our revenues in 2010 were from government agency customers. These customers are subject to unique political and budgetary constraints. These constraints imposed upon our customers make it difficult to predict the timing and amount of revenue to expect from these customers in future periods. In addition, our government agency customers have special contracting requirements that affect our ability to obtain new government customers.
We rely heavily on our management and other key personnel, and the loss of their services could materially and adversely affect our business.
Our future success depends to a significant degree on the continued service of our key personnel and on our ability to attract, motivate and retain highly qualified employees. In particular, we are dependent upon the services of our senior management, including, without limitation: Chief Executive Officer and President, Thomas M. Wittenschlaeger and Chief Financial Officer and Secretary, Bob van Leyen. Due to cash flow constraints of the Company, management has deferred its compensation from time to time. The current challenges the Company faces with respect to its debt structure and the lack of active collaboration, seen in times past, between the primary note holder and the Company further exacerbates this risk. The loss of the services of our senior management would have a material adverse effect on our business, financial condition and results of operations and may result in the Company being compelled to cease operations.
We do not presently have a traditional credit facility with a financial institution. This absence may adversely impact our operations.
We do not presently have a traditional credit facility with a financial institution and it is highly unlikely under the current debt structure that one could be put in place. The absence of a traditional credit facility could adversely impact our operations. If adequate funds are not otherwise available, we may be required to delay, scale back or eliminate portions of our operations and product development efforts. In addition, the terms of our senior convertible note financings subject us to certain covenants that prohibit us from borrowing additional funds unless certain conditions are satisfied, including, but not limited to, the closing price of our common stock being greater than $1.00 per share for 40 consecutive trading days or the aggregate dollar trading volume of our common stock being greater than $200,000 per day for 40 consecutive trading days. Further, the terms of our July 2007, April 2008 and July 2008 senior secured convertible note financings provide that while the notes are outstanding, we will not conduct any other securities offerings or be party to any solicitations, negotiations or discussions regarding any other security offerings, except for offerings solely to one or more of the convertible note investors.
Our level of indebtedness reduces our financial and operational flexibility, and our level of indebtedness may increase.
As of March 3, 2011, the principal amount of our total indebtedness was $11,112,854 (see Note 5 of our consolidated financial statements and related notes beginning on page of this Report). This balance includes $252,508 of accrued interest that was added to principal on January 11, 2011 pursuant to a voluntary consent granted by the lender. Our level of indebtedness affects our operations in several ways, including the following:
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A significant portion of our cash flow may be required to service our indebtedness;
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A high level of debt increases our vulnerability to general adverse economic and industry conditions;
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The covenants contained in the agreements governing our outstanding indebtedness significantly limit our ability to borrow additional funds, dispose of assets, pay dividends, sell common stock and make certain investments;
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Our debt covenants may also affect our flexibility in planning for, and reacting to, changes in the economy or in our industry;
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A high level of debt may impair our ability to obtain additional financing in the future for working capital, capital expenditures, acquisitions or general corporate purposes; and
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A default under our debt covenants could result in required principal payments that we may not be able to meet, resulting in higher penalty interest rates and/or debt maturity acceleration.
There is a risk that there may be procedural issues related to our acquisition of Raptor Networks Technology, Inc., a California corporation, which could have a material adverse effect on our business, financial condition and results of operations.
We were organized under the laws of the State of Colorado on January 22, 2001 under the name Pacific InterMedia, Inc. On October 17, 2003, we completed a transaction with Raptor Networks Technology, Inc., a California corporation (“Raptor”), whereby we acquired all of the issued and outstanding capital stock of Raptor in a cashless common stock share-for-share exchange in which Raptor became our wholly-owned subsidiary. With the completion of the acquisition transaction we changed our name to Raptor Networks Technology, Inc., terminated our previous operations (consisting of the “EDGARization” of SEC securities filings) and, by and through our subsidiary Raptor, became engaged in the data network switching industry. After the transaction, our Board of Directors engaged new management to, among other things, review our operating and legal status.
As a result of management’s review of our historical corporate records, it appears that certain material documents and approvals regarding the transaction were not properly retained. Furthermore, it appears that, from a review of the records available to us, certain procedural irregularities may exist regarding the structure and approval of the acquisition transaction under applicable law. After a review of available documents and records relating to the acquisition transaction, Colorado counsel engaged by us has determined that the shares issued in the transaction were lawfully issued. However, there is a risk, given the lack of complete records regarding the transaction, that the acquisition was not properly structured or approved. The inability to resolve such deficiencies, should such deficiencies exist, could have a material adverse effect on our business, financial condition and results of operations. Furthermore, there is a risk that we may be subject to currently unknown liabilities resulting from our operations, or the operations of Raptor, prior to the acquisition transaction. Should a claimed liability arise, we could expend significant time and resources defending or satisfying such claim, including, without limitation, the amount of any judgment or settlement required to satisfy any such claim and the payment of attorneys’ fees and other costs incurred in defending any such claim.
Our inability to successfully achieve sustainable market penetration could adversely affect our financial condition.
No assurance can be given that we will be able to successfully achieve sustainable market penetration with any of our products or the establishment of a license business. Our success in marketing our products and technology will be substantially dependent on educating our targeted markets as to the unique topologies, as well as what we believe are the performance and cost benefits, of our distributed Ethernet switch architecture. There can be no assurance that our efforts or the efforts of others will be successful in fostering acceptance of our technology among the targeted markets.
Many companies with greater resources and operating experience offer technology similar to our products. These companies could successfully compete with us and negatively affect our opportunity to achieve profitability.
We operate in a competitive industry with many established and well-recognized competitors. In particular, Cisco Systems maintains a dominant position in our industry and several of its products compete directly with our products. We also compete with Extreme Networks, Juniper Networks, Networks, Nortel Networks, Enterasys Networks, 3Com, Huawei Technologies, Force 10 Networks and Alcatel, among others. Most of our competitors (including all of the competitors referenced above) have substantially greater market leverage, distribution networks and vendor relationships, longer operating histories and industry experience, greater financial, technical, sales, marketing and other resources, more name recognition and larger installed customer bases than we do and can be expected to react strongly to any successful marketing efforts, if any, that we might achieve in the future. In addition, many competitors exist who, because of their substantial resources, distribution relationships and customer base could temporarily drop prices to stave off a potential successful market launch by our Company. Other competitive responses might include, without limitation, intense and aggressive price competition and offers of employment to our key marketing or management personnel. There can be no assurance that we will be successful in the face of increasing competition from existing or new competitors, or that competition will not have a material adverse effect on our business, financial condition and results of operations.
Our marketing efforts have yielded negligible revenues and there can be no assurance that our future marketing efforts will lead to sales of our products.
Our marketing efforts have yielded negligible revenues and we believe we will have to significantly expand our sales and marketing capabilities in order to establish sufficient awareness to launch broader sales of our products and support services. There can be no assurance that we will be able to expand our sales and marketing efforts to the extent we believe necessary or that any such efforts, if undertaken, will be successful in achieving substantial sales of our products or support services.
The industry of network switch products is subject to rapid technological change. Our products could become obsolete at any time and our limited capital prohibits us from devoting a significant amount of resources to research and development.
Evolving technology, updated industry standards and frequent new product and service introductions characterize the network switching market. Our current products could become obsolete at any time. Competitors could develop products similar to or better than ours, finish development before us or market their products more successfully than ours, any of which could hinder our potential success. In order to be competitive, we must continue to develop and bring to market new products that offer substantially greater performance and support a greater number of users, all at lower price points than our competitors. Our future success depends in significant part on our ability to evolve the performance and software of our existing products and develop and introduce new products and technologies in response to the evolving demands of the market and competitive product offerings. However, unless we are able to raise additional capital or significantly increase revenues, we will not be able to devote a significant amount of resources to research and development, which could increase the likelihood that our current products become obsolete and prevent us from developing new products to keep up with the industry’s rapid technological advancements.
Because we believe that proprietary rights are material to our success, misappropriation of those rights or claims of infringement or legal actions related to intellectual property could adversely impact our financial condition.
Our success is dependent on our ability to protect our proprietary technology. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy or otherwise obtain and use our products or technology. Monitoring unauthorized use of our technology is difficult, and we cannot be certain that the steps we have taken will prevent misappropriation of our technology, particularly in foreign countries where the laws may not protect our proprietary rights as fully as in the U.S. We currently have patented and patent-pending protection for our proprietary technology and plan to rely on non-disclosure agreements to further protect this technology. There can be no assurance that these patents will be granted or that nondisclosure agreements will provide us meaningful protection.
In addition, the network industry is subject to frequent claims and related litigation regarding patent and other intellectual property rights. In particular, some companies in the network industry claim extensive patent portfolios. As a result of the existence of a large number of existing patents and the rate of issuance of new patents in the network industry, it is extremely difficult to determine in advance whether a product or any of its components may infringe upon the intellectual property rights claimed by others. Third parties may in the future assert patent, copyright, trademark and other intellectual property rights claims against us with respect to existing or future products or technology. Regardless of the merits of our position, we may incur substantial legal fees and related costs defending against third party claims, in addition to monetary damages that may be assessed against us. If there is a successful claim of infringement and we fail or are unable to develop non-infringing technology or license the infringed or similar technology on a timely basis, our business and results of operations may be seriously harmed.
Our business could suffer if we are unable to obtain components, software and services from outside suppliers and vendors.
Our products are architected and manufactured through the use of third-party electronic components, device level software and services. We are highly dependent on the services and products of these other companies. A discontinuance, disruption or other similar occurrence to the components, software or services supplied by our vendors and suppliers could materially diminish our ability to operate efficiently.
We acquire components through purchase orders and have no long-term commitments regarding supply or pricing from these suppliers. We depend on anticipated product orders to determine our material requirements. If orders for our products do not match forecasts, or if we do not manage inventory effectively, we may have either excess or insufficient inventory of materials and components, which could negatively affect our operating results and financial condition.
Our reliance on third-party manufacturing vendors to manufacture our products may cause a delay in our ability to fill orders.
We subcontract a significant amount of our manufacturing to Express Manufacturing, Inc. and may, in the future, subcontract with other third-party manufacturers. In addition, some Company-branded products are manufactured by third party original equipment manufacturers (“OEMs”). We may experience delays in product manufacturing and shipments from our manufacturers, which in turn could delay product shipments to our customers. In addition, we may experience problems such as inferior manufacturing quality or failure to manufacture products according to specifications, any of which could have a material adverse effect on our business and operating results. In the event we introduce new products or product enhancements, we may be required to rapidly achieve volume production by coordinating our efforts with suppliers and manufacturers. The inability of our manufacturers or OEMs to provide us with adequate supplies of high-quality products, the loss of any of our third-party manufacturers or the inability to obtain components and raw materials could cause a delay in our ability to fulfill orders.
The average selling prices of our products, and our gross margins resulting from the sale of such products, may decline as a result of competitive pressures, industry trends and other factors.
The network industry has experienced an erosion of the average product selling prices due to a number of factors, particularly competitive and macroeconomic pressures and rapid technological advancements. Our competitors have and will likely continue to lower sales prices from time to time in order to gain market share or create more demand. We may have to reduce the sales prices of our products in response to such intense pricing competition, which could cause our gross margins to decline and may adversely affect our business, operating results or financial condition. Our gross margins could also be adversely affected if we are unable to reduce manufacturing costs and effectively manage our inventory levels or by fluctuations in manufacturing volumes, component costs, the mix of products sold and the mix of distribution channels through which our products are sold.
If our products contain software or hardware errors, we could incur sudden and significant expenses and lost sales and be subject to product liability claims.
Our products are complex and may contain undetected defects or errors, particularly when first introduced or as new enhancements and versions are released. Despite our testing procedures, these defects and errors may be discovered after they have been shipped to customers. Any defects or errors in our products or failures of our customers’ networks, regardless of whether the failure is caused by our products, could result in:
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negative customer reactions;
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product liability claims;
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negative publicity regarding us and our products;
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delays in or loss of market acceptance of our products;
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product returns; and
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unexpected expenses to remedy defects or errors.
Our success is substantially dependent on general economic conditions and business trends, particularly in the information technology industry, a downturn of which could adversely affect our operations.
The success of our operations depends to a significant extent upon a number of factors relating to business spending. These factors include economic conditions such as employment rates and labor supply, general business conditions, cost of goods and materials, inflation, interest rates and taxation. Our business is affected by the general condition and economic stability of our customers as well as our vendors, suppliers and partners and their continued willingness to work with us in the future. Our business is particularly sensitive to information technology (“IT”) spending patterns and preferences. There can be no assurance that IT spending will not be adversely affected by general business trends and economic conditions, thereby impacting our growth, net sales and profitability.
Changes in generally accepted accounting principles could have an adverse effect on our business, financial condition, cash flows, revenue and results of operations.
We are subject to changes in and interpretations of financial accounting matters that govern the measurement of our performance. Based on our reading and interpretations of relevant guidance, principles or concepts issued by, among other authorities, the American Institute of Certified Public Accountants, the Financial Accounting Standards Board and the United States Securities and Exchange Commission, our management believes that our current contract terms and business arrangements have been properly reported. However, there continue to be issued interpretations and guidance for applying the relevant standards to a wide range of contract terms and business arrangements that are prevalent in the industries in which we operate. Future interpretations or changes by the regulators of existing accounting standards or changes in our business practices could result in future changes in our revenue recognition and/or other accounting policies and practices that could have a material adverse effect on our business, financial condition, cash flows, revenue and results of operations.
Our common stock price has been volatile, which could result in substantial losses for investors purchasing shares of our common stock.
The market prices of securities of technology-based companies (such as us) currently are highly volatile. The market price of our common stock has fluctuated significantly in the past. During 2010, the high and low closing sale prices of a share of our common stock were $0.29 and $0.09, respectively. On February 24, 2011, the last reported sale price of a share of our common stock was $0.105. The market price of our common stock may continue to fluctuate in response to the following factors, in addition to others, many of which are beyond our control:
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conversion of our convertible notes and exercise of our warrants and the sale of their underlying common stock;
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changes in market valuations of similar companies and stock market price and volume fluctuations generally;
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economic conditions specific to the network switching or related information technology industries;
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announcements by us or our competitors of new or enhanced products, technologies or services or significant contracts, acquisitions, strategic relationships, joint ventures or capital commitments;
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delays in our introduction of new products or technological innovations or problems in the functioning of our current or new products or innovations;
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third parties’ infringement of our intellectual property rights;
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changes in our pricing policies or the pricing policies of our competitors;
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regulatory developments;
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fluctuations in our quarterly or annual operating results;
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additions or departures of key personnel; and
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future sales of our common stock or other securities.
The price at which you purchase shares of common stock may not be indicative of the price of our stock that will prevail in the trading market. You may be unable to sell your shares of common stock at or above your purchase price, which may result in substantial losses to you. Moreover, in the past, securities class action litigation has often been brought against a company following periods of volatility in the market price of its securities. We may in the future be the target of similar litigation. Securities litigation could result in substantial costs and divert our management’s attention and resources.
Shares of our common stock eligible, or to become eligible, for public sale could adversely affect our stock price and make it difficult for us to raise additional capital through sales of equity securities.
We cannot predict the effect, if any, that market sales of shares of our common stock or the availability of shares of common stock for sale will have on the market price prevailing from time to time. As of December 31, 2010, we had 88,080,979 outstanding shares of common stock, of which 8,819,919 shares were restricted under the Securities Act of 1933, as amended (the “Securities Act”). As of December 31, 2010, we also had outstanding options, warrants, and convertible promissory notes that were exercisable for or convertible into approximately 184,000,000 shares of common stock. Sales of shares of our common stock in the public market, or the perception that sales could occur, could adversely affect the market price of our common stock. Any adverse effect on the market price of our common stock could make it difficult for us to raise additional capital through sales of equity securities at a time and at a price that we deem appropriate.
The conversion of convertible securities and the exercise of outstanding options and warrants to purchase our common stock could substantially dilute your investment, impede our ability to obtain additional financing and cause us to incur additional expenses.
Under the terms of existing notes convertible into our common stock, warrants to purchase our common stock, non-compensatory options to acquire our common stock and other outstanding options to acquire our common stock issued to employees and others, the holders thereof are given an opportunity to profit from a rise in the market price of our common stock that, upon the exercise of such warrants and/or options or conversion of such notes, could result in dilution in the interests of our other shareholders. The terms on which we may obtain additional financing may be adversely affected by the existence and potentially dilutive impact of such convertible notes, options and warrants.
The voting power and value of your investment could decline if our senior convertible notes and warrants are converted at a reduced price due to our issuance of lower-priced shares or market declines which trigger rights of the holders of our convertible notes and warrants to receive additional shares of our stock.
As part of our 2006, 2007 and 2008 senior convertible note financings, we issued a significant additional amount of convertible notes and warrants, the exercise or conversion of which could have a substantial negative impact on the price of our common stock and could result in a dramatic decrease in the value of your investment. The initial conversion price of our senior convertible notes is subject to market-price protection that will cause the conversion price of our senior convertible notes to be reduced in the event of a downward fluctuation in the market price of our common stock. In addition, the initial conversion price of our senior convertible notes and the initial exercise price of a majority of our warrants will be subject to downward anti-dilution adjustments in most cases, from time to time, where we issue securities at a purchase, exercise or conversion price that is less than the then-applicable conversion price of our senior convertible notes or exercise price of our warrants. Consequently, the voting power and value of your investment in each such event would decline if our senior convertible notes or warrants are converted or exercised for shares of our common stock at the new lower price as a result of such declining market-price or sales of our securities are made below the conversion price of the notes and/or the exercise price of the warrants.
The market-price protection feature of our senior convertible notes could also allow those notes to become convertible into a greatly increased number of additional shares of our common stock, particularly if a holder of our senior convertible notes sequentially converts portions of the note into shares of our common stock at alternate conversion prices and resells those shares into the market. If a holder of our senior convertible notes sequentially converts portions of the notes into shares of our common stock at alternate conversion prices and resells those shares into the market, then the market price of our common stock could decline due to the additional shares available in the market, particularly in light of the relatively thin trading volume of our common stock. Consequently, if a holder of our senior convertible notes repeatedly converts portions of the notes at alternate conversion prices and then resells those underlying shares into the market, a continuous downward spiral of the market price of our common stock could occur that would benefit a holder of our senior convertible notes at the expense of other existing or potential holders of our common stock, potentially creating a divergence of interests between a holder of our senior convertible notes and investors who purchase the shares of common stock resold by a holder of the notes following conversion of the notes.
The market price of our common stock and the value of your investment could substantially decline if our convertible notes, warrants or options continue to be converted into shares of our common stock and resold into the market, or if a perception exists that a substantial number of shares will be issued upon conversion or exercise of our convertible notes, warrants or options and then resold into the market.
If the conversion prices at which the balances of our convertible notes, warrants and options are converted are lower than the price at which you made your investment, immediate dilution of the value of your investment will occur. In addition, sales of a substantial number of shares of common stock issued upon conversion of our convertible notes, warrants and options, or even the perception that such sales could occur, could adversely affect the market price of our common stock, which would mean that certain convertible notes and warrants would be convertible into an increased number of shares of our common stock in cases where, as described elsewhere in these risk factors, the conversion price is based upon a discount from the market price of our common stock. You could, therefore, experience a substantial decline in the value of your investment as a result of both the actual and potential conversion of our outstanding convertible notes, warrants or options.
The issuance of shares upon the conversion of convertible notes and the exercise of outstanding options and warrants could result in a change of control of our Company.
As of December 31, 2010, we had outstanding options, warrants, and convertible promissory notes that were exercisable for or convertible into approximately 184,000,000 shares of common stock. In addition, as discussed elsewhere in these Risk Factors, the number of shares exercisable under outstanding warrants and convertible under outstanding notes may be subject to increase in the event of our future issuance of securities or a downward fluctuation in the market price of our common stock. A change of control of our Company could occur if a significant number of shares are issued to the holders of our outstanding warrants or convertible notes. If a change of control occurs, then the stockholders who historically have controlled our Company would no longer have the ability to exert significant control over matters that could include the election of our directors, changes in the size and composition of our Board of Directors and mergers and other business combinations involving our Company. Instead, one or more other stockholders could gain the ability to exert this type of control and may also, through control of our Board of Directors and voting power, be able to control certain decisions, including decisions regarding the qualification and appointment of officers, dividend policy, access to capital (including borrowing from third-party lenders and the issuance of additional equity securities) and the acquisition or disposition of our assets.
The voting power of your investment and our earnings per share would be substantially diluted if all or a significant portion of our convertible notes, warrants or options were converted into shares of our common stock.
If the aggregate number of shares of common stock underlying our convertible notes, warrants or options had been issued and outstanding as of this date, substantial dilution of the voting power of your investment and of our earnings per share would occur.
Because we are subject to “Penny Stock” rules, the level of trading activity in our common stock may be reduced.
Our stock is listed on the Over-the-Counter (“OTC”) Bulletin Board and constitutes “Penny Stock.” Broker-dealer practices in connection with transactions in Penny Stocks are regulated by rules adopted by the SEC. Penny Stocks are generally equity securities with a price per share of less than $5.00 (other than securities registered on certain national exchanges or quoted on the NASDAQ system). The Penny Stock rules require a broker-dealer, prior to a transaction in Penny Stocks not exempt from the rules, to deliver a standardized risk disclosure document that provides information about Penny Stocks and the nature and level of risks in the Penny Stock Market. The broker-dealer must also provide the customer with current bid and offer quotations for the Penny Stock, the compensation of the broker-dealer and the salesperson in the transaction and monthly accounting statements showing the market value of each Penny Stock held in the customer’s account. In addition, the broker-dealer must make a special written determination that the Penny Stock is a suitable investment for the purchaser and receive the purchaser’s written agreement to the transaction. These requirements may have the effect of reducing the level of trading activity in a Penny Stock, such as our common stock, and investors in our common stock may find it difficult to sell their shares.
Because our common stock is not listed on a national securities exchange, you may find it difficult to dispose of or obtain quotations for our common stock.
Our common stock trades under the symbol “RPTN” on the OTC Bulletin Board. Because our stock trades on the OTC Bulletin Board rather than on a national securities exchange, you may find it difficult to either dispose of, or to obtain quotations as to the price of, our common stock.
Item 1B.
Item 1B. Unresolved Staff Comments
Not applicable
Item 2.
Item 2. Properties
In October 2008 we relocated to a smaller facility in the Federal Empowerment Zone of Santa Ana, California, which reduced our overhead expenses and created a more appropriate facility for our activities. The address of our leased facilities is 1508 S. Grand Ave. Santa Ana, California 92705. This facility, consisting of 2,400 square feet, includes our executive offices and research and development laboratory. The initial lease agreement was effective September 22, 2008 for a period of six months. Thereafter the lease was extended for periods of six months and the current extension expires on March 31, 2011. The monthly base rent amounts to $1,560.
We believe that the monthly rental rates are comparable to rents charged for comparable properties in the market area. We require full compliance by the lessor with applicable state and EPA environmental standards at our facility. We believe that the current facilities are adequate for our expected needs through at least the end of 2011.
In October 2008, we rendered possession of our prior operating facility to the landlord. In November 2009, we settled the matter for $216,000, plus simple interest at 10 percent per annum until such amount is paid in full. We paid $7,000 on the date of the agreement. Beginning January 15, 2010 and continuing through January 15, 2012, we will make monthly payments of $9,000. A final payment of $6,106 is due by February 15, 2012. As a result of the settlement, we recorded an additional expense of $21,435 for the year ended December 31, 2009.
Item 3.
Item 3. Legal Proceedings
From time to time, we may be involved in various claims, lawsuits, disputes with third parties, actions involving allegations of discrimination or breach of contract actions incidental to the operation of our business. However, we are not currently involved in any litigation which we believe could have a materially adverse effect on our financial condition or results of operations.
Item 4.
Item 4. (Removed and Reserved)
PART II
Item 5.
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Our $0.001 par value common stock trades under the symbol “RPTN” on the OTC Bulletin Board. The following table sets forth, for the quarters indicated, the high and low bid information for our common stock as reported by Pink Sheets, LLC, a research service that compiles quote information reported on the National Association of Securities Dealers composite feed or other qualified inter-dealer quotation medium. The quotations reflect inter-dealer prices, without retail markup, markdown or commissions, and may not necessarily represent actual transactions.
On February 24, 2011, the high and low sale prices for a share of our common stock as reported by Pink Sheets, LLC, were $0.12 and $0.10, respectively.
Holders
On February 24, 2011, we had 88,080,979 shares of our common stock outstanding held by 968 record shareholders. This number of shareholders does not include beneficial owners, including holders whose shares are held in nominee or “street” name.
Dividends
We have never paid a cash dividend with respect to our common stock, and do not expect to be able to pay cash dividends in the foreseeable future as the terms of our senior convertible notes prohibit us from paying cash dividends for the term of the loan arrangement.
Recent Sales of Unregistered Securities
On October 14, 2010, we issued 1,161,500 shares of common stock for the conversion of $150,000 of the principal balance due on the July 2008 Notes.
These issuances were made in reliance upon the exemption from registration available under Section 4(2) of the Securities Act, among others, as transactions not involving a public offering. This exemption was claimed on the basis that these transactions did not involve any public offering and the purchasers in each offering were accredited or sophisticated and had sufficient access to the kind of information registration would provide. In each case, appropriate investment representations were obtained and certificates representing the securities were issued with restrictive legends.
Item 6.
Item 6. Selected Financial Data
Not applicable.
Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis provides information that our management believes is relevant to an assessment and understanding of our results of operations and financial condition for the fiscal years ended December 31, 2010 and 2009. This discussion should be read in conjunction with our consolidated financial statements and related notes thereto beginning on page of this Report. This Report contains trend analysis and other forward-looking statements that involve risks and uncertainties, such as statements concerning future operating results; developments in markets and strategic focus; and future economic, business and regulatory conditions. Such forward-looking statements are generally accompanied by words such as “plan,” “estimate,” “expect,” “believe,” “should,” “would,” “could,” “anticipate,” “may,” “forecast,” “project,” “pro forma,” “goal,” “continues,” “intend,” “seek” and other words that convey uncertainty of future events or outcomes. The cautionary statements included in the “Risk Factors” section under Item 1A above or elsewhere in this Report should be read as being applicable to all forward-looking statements wherever they may appear. Our actual future results could differ materially from those discussed herein. We disclaim any obligations subsequently to revise any forward-looking statements to reflect events or circumstances after the date of such statement or to reflect the occurrence of anticipated or unanticipated events.
CRITICAL ACCOUNTING POLICIES
Critical Accounting Estimates and Judgments
Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). The preparation of our financial statements requires our management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues, expenses and related disclosures. We base our estimates on historical experience and various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. The significant accounting policies that are believed to be the most critical to aid in fully understanding and evaluating the reported financial results include the valuation of inventories, derivative financial instruments, and stock-based compensation and the recoverability of deferred income tax assets.
Inventories
We determine our inventory value at the lower of average cost or market. When required, a provision is made to reduce excess and obsolete inventories to estimated net realizable value. Our provision for excess and obsolete inventories increased from $201,694 at December 31, 2009 to $245,506 at December 31, 2010 due to an additional charge of $43,812 related to slow-moving products.
Derivative Financial Instruments
Our senior convertible notes are classified as non-conventional convertible debt. In the case of non-conventional convertible debt, we bifurcate our embedded derivative instruments and record them at their fair value as of the inception date of the agreement and at fair value as of each subsequent balance sheet date. Any change in fair value will be recorded as non-operating, non-cash income or expense at each reporting date. If the fair value of the derivatives is higher at the subsequent balance sheet date, we will record a non-operating, non-cash charge. If the fair value of the derivative is lower at the subsequent balance sheet date, we will record non-operating, non-cash income.
To determine the fair value of the derivative instruments, we make certain assumptions regarding the expected term of exercise. Because the expected term of the warrants impacts the volatility and risk-free interest rates used in the Black-Scholes calculations, these must be selected for the same time period as the expected term of the warrants.
Stock-based Compensation
The Company calculates stock-based compensation by estimating the fair value of each option using the Black-Scholes option pricing model. The Company's determination of fair value of share-based payment awards are made as of their respective dates of grant using that option pricing model and is affected by the Company's stock price as well as assumptions regarding a number of subjective variables. These variables include, but are not limited to, the Company's expected stock price volatility over the term of the awards and actual and projected employee stock option exercise behavior. The Black-Scholes option pricing model was developed for use in estimating the value of traded options that have no vesting or hedging restrictions and are fully transferable. Because the Company's employee stock options have certain characteristics that are significantly different from traded options, the existing valuation models may not provide an accurate measure of the fair value of the Company's employee stock options. Although the fair value of employee stock options is determined in accordance with applicable accounting standards using an option-pricing model, that value may not be indicative of the fair value observed in a willing buyer/willing seller market transaction. The calculated compensation cost is recognized on a straight-line basis over the vesting period of the option.
Deferred Income Taxes
We record a valuation allowance to reduce the deferred tax assets to the amount that is more likely than not to be realized. We have considered estimated future taxable income an ongoing tax planning strategies in assessing the amount needed for the valuation allowance.
Selected Financial Data
The following table sets forth selected financial data regarding our financial position and operating results. This data should be read in conjunction with our consolidated financial statements and related notes thereto beginning on page of this Report.
Results of Operations for the Fiscal Year Ended December 31, 2010
Compared to Fiscal Year Ended December 31, 2009
Net Revenues
In 2010, total revenues amounted to $1,785,327 compared to $1,601,906 in 2009, an increase of 11%. The change in revenues is comprised of an increase in service-related revenues of $938,251 over 2009 offset by a decrease in product revenues of $754,830. In 2010, the government funding previously used to purchase products was substantially lower; however, this product funding was replaced by funding related to R&D work. We sold 12 ER1010 core systems in 2010 compared to 51 ER1010 systems in 2009.
Gross Profit
Gross profit decreased from $759,421 in 2009 to $724,138 in 2010, a decrease of $35,283. Gross margin decreased from 47% in 2009 to 41% in 2010. The decrease resulted from a change in the product mix in 2010 as mentioned in the revenue section above. Higher margin product revenues were replaced by lower margin service revenues. Design services carry a substantially lower margin (35%-45%) than product revenues (60%-65%)..
Operating Expenses
The decrease in operating expenses in 2010 resulted primarily because the Company changed from a product development to a service-related model. This change of model resulted in significant decreases of salary expenses, research and development and G&A, as further explained below.
Salary Expense
Employee costs amounted to $639,744 in 2010 compared to $656,813 in total 2009, a decrease of $17,069 or 3%. The change in salary expenses resulted from an increase in management salaries in October 2009, which caused salary expenses to increase by approximately $60,000 in 2010. This increase was offset by a decrease in salaries related to an increase in the charge out of salaries to the government of approximately $50,000 in 2010 and a decrease in vacation expense in 2010 of approximately $19,000.
Research and Development (“R&D”)
Research and development expenses decreased from $114,387 in 2009 to $22,336 in 2010, a decline of $92,051 or 80%. The decrease is due to the charge out of nearly all R&D salaries in 2010, reducing labor expenses to nearly $0.
Selling, General and Administrative (“SG&A”)
SG&A expenses decreased from $472,472 in 2009 to $413,198 in 2010, a decrease of $59,274 or 13%. The decrease in SG&A expenses in 2010 resulted primarily from the following decreases:
Consulting expenses decreased from $126,401 in 2009 to $95,020 in 2010, a decrease of $31,381 or 25%. This decrease resulted from lower product sales in 2010. In 2009, we paid commissions and base retainer fees to third party business development consultants of approximately $80,000 as compared to approximately $49,000 in 2010. We do not pay commissions or business development fees on service revenue.
Legal fees decreased from $32,782 in 2009 to $15,775 in 2010, a decrease of $17,007 or 52%. We had a decrease in patent filings in 2010, which resulted in a decrease in legal fees of $30,003 in 2010. This decrease was partially offset by an increase in corporate legal fees of approximately $12,000 in 2010 in connection with the 2010 financing and increased legal support related to note conversions and quarterly reviews.
Accounting support decreased from $36,308 in 2009 to $24,588 in 2010, a decrease of $11,720 or 32%. This decrease is a result of fewer hours billed by our accounting consultant due to increased familiarity with our closing process. Additionally, we were able to renegotiate a lower rate with the consulting firm, further decreasing expenses.
Depreciation expense decreased from $16,090 in 2009 to $10,103 in 2010, a decrease of $5,987 or 37% due to the fact that the Company has not purchased any new equipment and an increasing portion of our fixed assets is becoming fully depreciated.
Telephone expenses decreased from $30,357 in 2009 to $25,599 in 2010, a decrease of $4,758 or 16%. The decrease was due to the termination of a salesperson in Florida on December 31, 2009, which resulted in a decrease in cell phone and long-distance charges.
The above decreases in SG&A expenses in 2010 were partially offset by the following increases in 2010:
Marketing expenses increased by approximately $12,000 in 2010 due to a long-term loan of equipment to a customer in 2010 that was written off since it is expected that the equipment will have a very low residual value at the end of the two-year period.
Office expenses and postage increased from $24,342 in 2009 to $28,590 in 2010, an increase of $4,248 or 17%. This increase resulted from an increase in procurement and selling activities, especially in the first quarter of 2010 and an increase in design activities in the second half of 2010, resulting in increased expenses for copying and mailing.
Taxes increased from $7,591 in 2009 to $9,047 in 2010, an increase of $1,456 or 19% due to a $1,910 credit applied to our 2009 property tax bill as a result of an audit.
Other Income (Expense)
Net other expense decreased from $12,210,746 in 2009 to $117,731 in 2010 due to the following:
In 2009, we recorded a loss of $7,018,882 on the fair value of our conversion option and warrant liabilities compared to income on the fair value of the conversion option and warrant liabilities of $2,930,077 in 2009. This change is due to the following:
In 2009, our stock price increased from $0.14 at January 1, 2009 to $0.17 at December 31, 2009, which increased the value of these liabilities. Also during 2009, the note holders elected to begin making conversions at the variable conversion prices. Therefore, we valued the conversion option liabilities related to the 2006 Notes, the April 2008 Notes and the July 2008 Notes at the variable conversion rate. The variable conversion rate of the 2006 Notes is 90% of the market price. The variable conversion rate of the April 2008 and July 2008 Notes is 85% of the market price. The 2007 Notes are not convertible at the variable rate until August 1, 2010 and were valued at the fixed conversion rate. The lower conversion rate of the notes caused a dramatic increase in the number of shares into which the notes are convertible. The above factors resulted in an increase in the fair value of the conversion option liabilities in of $7,018,882 in 2009.
In 2010, the price of our stock decreased from $0.14 at January 1, 2010 to $0.10 at December 31, 2010. Additionally, the computed volatilities of the conversion option liabilities decreased from 169%-178% in 2009 to 117%-123% in 2010. The computed volatilities of the 2006 and 2007 Warrants decreased from 169%-177% in 2009 to 119%-123% in 2010. The above factors resulted in a decrease in the fair values of the conversion option and warrant liabilities of $2,930,077 in 2010.
Amortization of the discount on convertible debt decreased from $3,963,457 in 2009 to $2,103,114 in 2010. The primary reason for the decrease resulted from the 2007 Notes, the April 2008 Notes and the July 2008 Notes becoming fully amortized on or before August 1, 2010. This decrease was partially offset by an increase in amortization expense related to the increase in the conversion option liabilities as a result of the variable conversion prices that went into effect in late 2009 for the 2006 Notes, the April 2008 Notes and the July 2008 Notes and in late 2010 for the 2007 Notes. Additionally, we began adding the accrued interest to the principal balances of the April and July 2008 Notes in 2010, which resulted in increased conversion option liabilities of these notes which was expensed immediately.
The decrease in interest expense is primarily attributable to a lower outstanding principal balance due to conversions of the notes.
Loss on lease settlement is attributable to rendering possession of our prior operating facility to the landlord in October 2008. In 2009, we settled with the former landlord. As a result of the settlement, an additional $21,435 was charged to expense for the year ended December 31, 2009. There was no such transaction in 2010.
Miscellaneous income was $86,619 for the year ended December 31, 2010 as a result of the adjustment of liabilities accrued in prior years to their settlement amount. No such adjustment was made in 2009.
Liquidity and Capital Resources
Our independent registered public accounting firm has qualified their opinion with respect to our consolidated financial statements to include an explanatory paragraph related to our ability to continue as a going concern in their reports for each of our fiscal years ended December 31, 2010 and 2009. Reports of independent registered public accounting firms questioning a company's ability to continue as a going concern generally are viewed very unfavorably by analysts and investors. There are a number of risks and challenges associated with such a qualified report including, but not limited to, a significant impediment to our ability to raise additional capital or seek financing from entities that will not conduct such transactions in the face of such increased level of risk of insolvency and loss, increased difficulty in attracting talent and the diversion of the attention of executive officers and other key employees to raising capital or financing rather than devoting time to the day-to-day operations of our business. We urge potential investors to review the report of our independent registered public accounting firm and our consolidated financial statements and related notes beginning on page of this Report, the cautionary statements included in the “Risk Factors” section under Item 1A of this Report and to seek independent advice concerning the substantial risks related thereto before making a decision to invest in us, or to maintain an investment in us.
For the years ended December 31, 2010 and 2009, we incurred net losses of $468,871 and $12,694,997, respectively. Since our inception, including the year ended December 31, 2010, we have realized negligible revenues and have financed our operations almost exclusively from cash on hand raised through the sale of our securities and borrowings. As of December 31, 2010, we had a deficit in working capital of $17,824,757, of which $6,802,053 relates to the fair value of derivative financial instruments.
During 2010, the Company continued its efforts to convert to licensing as a primary, but not exclusive, business model but was unsuccessful in entering into any licensing arrangements. The Company was able to continue to generate revenue in the government business sector for certain design services. As previously described under “Management’s Discussion and Analysis” in this report on Form 10-K, the increase in revenues from design services in 2010 was largely offset by a decrease in product sales. Although revenues increased slightly and expenses decreased slightly in 2010 and despite receiving net proceeds from financing of $150,000, the Company was not able to improve its cash position, resulting in a decrease in cash of $79,465 during 2010 and a year-end cash balance of $82,777. In order to improve its cash position, it will be critical for the Company to increase revenues substantially or/and obtain additional financing. Without this type of improvement of its cash flow, the Company may not be able to fund operations throughout 2011. In addition, throughout 2009 and 2010, the Company was not able to service any of its note debt in cash and all interest on the 2006, 2007 and 2008 notes was, with the approval of the note holders, added to the principal balances of the notes. Additionally, notes with an aggregate principal balance of $10,683,875 as of December 31, 2010 have now matured and are subject to repayment in full upon demand. In the event the note holders demand payment of the notes, including accrued interest and other remedies available under the terms of the notes, the Company could be found in default by the note holders, be compelled to restructure or sell its assets or file a bankruptcy petition under the U.S. Bankruptcy Code. This would result in a loss of all or substantially all of the shareholders’ investment.
2006, 2007 and 2008 Note Financings
On July 30, 2006, we entered into financing agreements with 3 accredited investors. On January 22, 2007, we subsequently entered into Amendment and Exchange Agreements with the same investors providing certain amendments to the July 30, 2006 agreements and increasing the total financing to $8,804,909. The 2006 Notes, as amended, are convertible into shares of the Company’s common stock at the lower of $0.43948 or the optional conversion price, defined as 90% of the arithmetic average of the weighted-average prices of the common stock on each of the five consecutive trading days immediately preceding the applicable optional conversion/redemption date. In the aggregate, we issued series L-1 warrants to purchase an aggregate of 22,754,163 shares of common stock, series L-2 warrants to purchase an aggregate of 7,281,332 shares of common stock, series M-1 warrants to purchase an aggregate of 7,395,103 shares of common stock and series M-2 warrants to purchase an aggregate of 2,366,433 shares of common stock. All these warrants have a strike price of $0.43948. The Company received aggregate gross proceeds from these financings of $6.6 million. These notes bear interest at 9.25% per annum, which increases to 15% in case of a default. The entire outstanding principal balance of $4,987,137 as of December 31, 2010, including any outstanding fees or interest, is currently due and payable in full since the original maturity date of the notes was July 31, 2008.
On July 31, 2007, we entered into a financing agreement with the same investors involved in the June 2006 and January 2007 financings for total gross proceeds of $3.5 million for the issuance of senior secured convertible notes in the aggregate principal amount of $3.5 million, series N warrants to purchase up to an aggregate of 7,000,000 shares of the Company’s common stock (includes dilution from the April 1, 2008 financing), series O warrants to purchase up to an aggregate of 4,550,000 shares of the Company’s common stock (includes dilution from April 2008 financing) and series P warrants to purchase up to an aggregate of 3,000,000 shares of common stock (includes dilution from April 2008 financing). The agreement also granted the investors a first priority perfected security interest in all of our assets. The secured notes bear interest at 9.25% per annum, which may be increased to 15% in case of default. The initial fixed conversion price of the note was $1.20 but was reduced to $0.50 per share in April 2008. The July 2007 Notes are convertible into shares of the Company’s common stock at the lower of $0.50 or the optional conversion price, defined as the lower of (i) 90% of the arithmetic average of the lowest weighted-average price of the common stock during the fifteen consecutive trading days ending on the trading day immediately prior to the optional conversion/redemption date and (ii) 90% of the arithmetic average of the lowest weighted average price of the common stock during any three consecutive trading day period during the fifteen consecutive trading days ending on the trading day immediately prior to the optional conversion/redemption date. The strike price for the N, O and P warrants was initially $1.20 but was reduced to $0.50 in April 2008. The N and P warrants were immediately exercisable. The O warrants become exercisable on a mandatory conversion called by the Company. The entire outstanding principal of $3,084,046 at December 31, 2010, including any outstanding fees or interest, is currently due and payable in full since the notes matured on August 1, 2010.
On April 1, 2008, we entered into a financing agreement with the same investors involved in the previous financings. For total gross proceeds of $3.125 million, we issued senior secured convertible notes in the aggregate principal amount of $3.125 million, series Q warrants to purchase up to an aggregate of 6,250,000 shares of the Company’s common stock and 3,125,000 shares of our common stock. The agreement grants the investors a first priority perfected security interest in all of the Company’s assets. The notes bear interest at 10% per annum, which may be increased to 15% in the event of default. The April 2008 Notes are convertible into shares of the Company’s common stock at the lower of $1.00 or the optional conversion price, defined as the lower of (i) 85% of the arithmetic average of the weighted-average price of the common stock during the thirty consecutive trading days ending on the trading day immediately prior to the optional conversion/redemption date (“measuring period”) and (ii) 85% of the arithmetic average of the weighted average price of the common stock during the first three consecutive trading day period of such measuring period and (iii) the arithmetic average of the weighted average price of the common stock during the last three consecutive trading day period of such measuring period. The Q warrants initially carried a strike price of $1.00 that was reduced to $0.50 in July 2008 and were immediately exercisable. The entire outstanding principal balance of $2,288,392 at December 2010, including any outstanding fees or interest is currently due and payable in full since the maturity date was March 31, 2010.
On July 28, 2008 we entered into a financing agreement with the same investors involved in the 2006, 2007 and April 2008 financings. For total gross proceeds of $1.25 million, we issued senior secured convertible notes in the aggregate principal amount of $1.25 million, series R warrants to purchase up to an aggregate of 2,500,000 shares of the Company’s common stock and 1,250,000 shares of the Company’s common stock. The agreement grants the investors a first priority perfected security interest in all of the Company’s assets. The notes bear interest at 10% per annum, which may be increased to 15% in the event of default. The July 2008 notes are convertible into shares of the Company’s common stock at the lower of $1.00 or the optional conversion price, defined as the lower of (i) 85% of the arithmetic average of the weighted-average price of the common stock during the thirty consecutive trading days ending on the trading day immediately prior to the optional conversion/redemption date and (ii) 85% of the arithmetic average of the weighted average price of the common stock during the three lowest trading days with the lowest weighted average price of the common stock during the thirty consecutive trading days ending on the trading day immediately prior to the optional conversion/redemption date. The R warrants carry a strike price of $0.50 per share and are immediately exercisable. The entire outstanding principal balance of $576,808 at December 31, 2010, including any outstanding fees or interest, is currently due and payable in full since the maturity date was July 28, 2010.
July 2010 Note Financing
On July 27, 2010, pursuant to the terms of a securities purchase agreement with one of our investors involved in the previous financings, we issued an unsecured convertible note payable in the principal amount of $176,471. We received net proceeds of $150,000 from the note as explained below.
The note bears interest at 15% per annum, which may be increased to 21% upon the occurrence of an event of default, and matures on July 27, 2011. This date may be extended, at the option of the investor, by up to two years. Interest on the notes of $26,471, representing one year of interest, was prepaid to the investors at the closing.
The 2010 note is convertible into shares of the Company’s common stock at the lower of $1.00 or the optional conversion price, defined as the lesser of (i) 85% of the arithmetic average of the weighted-average price of the common stock for the 30 consecutive trading days immediately preceding the conversion date and (ii) 85% of the arithmetic average of the weighted-average price of the common stock for the 3 lowest trading days during the 30 consecutive trading days immediately preceding the conversion date. However, following the disclosure of a SEC event, as defined in the 2010 Notes, the conversion price will be computed using the lowest of (i) 50% of the amounts determined as above; (ii) 50% of the closing price of the common stock on the trading day preceding the date of conversion; or (iii) 50% of the closing price of the common stock on the date preceding the SEC event.
If there is an event of default or a fundamental transaction as defined in the agreement, the investors have the right to redeem all or any portion of the 2010 note, at the greater of (i) up to 125% of the sum of the outstanding principal, interest and late fees, depending on the nature of the default, and (ii) the product of (a) the greater of (1) the closing sale price for the Company’s common stock on the date immediately preceding the event of default, (2) the closing sale price for the Company’s common stock on the date immediately after the event of default and (3) the closing sale price for the Company’s common stock on the date an investor delivers its redemption notice for such event of default, multiplied by (b) 200% of the number of shares into which the Note (including all principal, interest and late fees) may be converted.
The conversion price of the note is subject to customary anti-dilution provisions for stock splits and the like, and are also subject to full-ratchet anti-dilution protection such that if the Company issues or is deemed to have issued certain securities at a price lower than the then applicable conversion or exercise price, then the conversion or exercise price will immediately be reduced to such lower price.
The note contains certain limitations on conversion or exercise, including that a holder of those securities cannot convert or exercise those securities to the extent that upon such conversion or exercise, that holder, together with the holder’s affiliates, would own in excess of 4.99% of the Company’s outstanding shares of common stock (subject to an increase upon at least 61-days’ notice, by the investor to the Company, of up to 9.99%).
The holder of the note is entitled to receive any dividends paid or distributions made to the holders of the Company's common stock on an "as if converted" basis.
Conclusion on Capital Resources and Liquidity
As noted elsewhere within this document, our independent registered public accounting firm continues qualifying their opinion with respect to our consolidated financial statements. Since inception, the company has incurred losses, realized negligible revenues from product sales and has not been able to generate revenues from licensing. Our 2006, 2007 and 2008 notes have fully matured representing a total amount outstanding of $10,683,875 as of 12/31/2010 and are subject to full repayment upon demand. During 2010 the Company’s cash position suffered additional deterioration. The current lenders have not expressed willingness to provide additional financing to support the Company’s operations and we believe access to alternative sources of financing are unlikely due to the Company’s financial state and current note holder commitments. Management further believes that the company's tenuous financial condition has impeded partner relationships and new business generation. In the short term, prospects for additional revenue represent substantial uncertainty, with our government design services contract which funds a major portion of the company's operating expenses, being depleted in April of 2011. While we have actively sought a replacement for that contract, none has yet been put in place.
In light of these factors, management believes that a comprehensive financial restructuring is the best way to preserve value, both in improving the balance sheet and in improving the likelihood of consummating a combinatorial transaction or partnership. Management has proposed terms for a restructuring, but has been unsuccessful in progressing those discussions. As a result, it is unlikely that a financial restructuring can be done and, if done, under what terms such a transaction might take place. Should a financial restructuring be consummated, the resultant debt for equity exchange would likely result in substantial dilution. Should a restructuring be unachievable, Raptor may be forced to further reduce staff or cease operations.
Item 8.
Item 8. Financial Statements
The financial statements and corresponding notes to the financial statements called for by this item appear under the caption “Index to Financial Statements” beginning on Page of this Report.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
There have been no events required to be reported by this Item 8.
Item 9A.
Item 9A. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
Our Chief Executive Officer and Chief Financial Officer (our principal executive officer and principal financial officer, respectively) have concluded, based on their evaluation as of December 31, 2010, that the design and operation of our “disclosure controls and procedures” (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (“Exchange Act”)) are effective to ensure that information required to be disclosed by us in the reports filed or submitted by us under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms, including to ensure that information required to be disclosed by us in the reports we file or submit under the Exchange Act is accumulated and communicated to our management, including our principal executive officer and principal financial officer, or persons performing similar functions, as appropriate to allow timely decisions regarding whether or not disclosure is required.
Management’s Report on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining adequate “internal control over financial reporting” (as defined in Rule 13a-15(f) under the Exchange Act). Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework set forth in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, our management concluded that our internal control over financial reporting was effective as of December 31, 2010.
Our internal control over financial reporting is supported by written policies and procedures, that:
(1)
pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets;
(2)
provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of our company are being made only in accordance with authorizations of our management and directors; and
(3)
provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risks that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
This Report does not include an attestation report of our independent registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by our independent registered public accounting firm pursuant to rules of the SEC that permit us to provide only management’s report in this Report.
Changes in Internal Control over Financial Reporting
During the quarter ended December 31, 2010, there were no changes in our internal controls over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.
Item 9B.
Item 9B. Other Information
None.
PART III
Item 10.
Item 10. Directors, Executive Officers and Corporate Governance
Directors and Executive Officers
Set forth below is certain information with respect to our directors and executive officers.
(1)
Member of the Audit, Nominating and Governance, and Compensation Committees.
(2)
Chairperson of the Nominating and Governance Committee.
(3)
Chairperson of the Audit Committee.
(4)
Chairperson of the Compensation Committee.
Thomas M. Wittenschlaeger, (age 53), is our Chief Executive Officer, President, a director and Chairman of the Board. Mr. Wittenschlaeger has accumulated more than twenty-five years of experience in the high technology products and services area, much of it in general management with leadership positions in operating units ranging in size from $3 million to $500 million in annual revenues. From 2002 to 2004, he was Senior Vice President of Corporate Development and Chief Technical Officer at Venturi Partners, Inc., a leading provider of information technology and professional staffing services nationwide. From 2000 to 2002, he was Senior Vice President and General Manager of ViaSat Satellite Networks, the commercial arm of ViaSat, Inc. He is a 1979 graduate of the U.S. Naval Academy in Annapolis, Maryland with a B.S. in electrical engineering and post-graduate work in nuclear engineering. He is also a graduate of the UCLA Executive Program in Business and co-founder of UCLA's Executive Program in Marketing. Mr. Wittenschlaeger has authored and has been granted 5 core patents and is pending on 6 additional Raptor patents related to hybrid fabric transport, communications, computing and security architectures. Mr. Wittenschlaeger serves on the board of directors of Lantronix, Inc. as Chairman of the Nominating and Governance Committee. Mr. Wittenschlaeger has been our Chairman of the Board, President and Chief Executive Officer since March 15, 2004. Mr. Wittenschlaeger’s (CEO) qualifications to serve on the Board include more than twenty-eight years of experience in the high technology products and services arena, much of it in general management with leadership positions in operating units ranging in size from $3 million to $500 million in annual revenues. Earlier positions, in roles ranging from senior systems engineer to chief corporate strategist at the Hughes Aircraft Company, are relevant towards providing entrepreneurial vision to this emerging technologies company. These roles offer the Company necessary expertise in addressing the governmental marketplace with a particular focus on the Department of Defense.
Larry L. Enterline, (age 58) currently Chief Executive Officer of Vulcan Holdings Inc., a private investment company. Mr. Enterline retired in April 2010 as Chief Executive Officer of COMSYS Holdings, Inc. after the sale of the company to Manpower Inc. Mr. Enterline had previously served as the Chief Executive Officer from December 2000 when Comsys was known as Venturi Partners, Inc., until September 30, 2004, when they completed a merger with COMSYS Holding, Inc. He had served as a member of their Board of Directors since December 2000 and served as Chairman of the Board of Directors from December 2000 until the merger. Prior to joining COMSYS, Mr. Enterline served in a number of senior management positions at Scientific-Atlanta, Inc. from 1989 to 2000, the last of which he was Corporate Senior Vice President for Worldwide Sales and Service. He also held management positions in the marketing, sales, engineering and products areas with Bailey Controls Company and Reliance Electric Company from 1974 to 1989. Mr. Enterline serves on the boards of directors of Raptor Networks Technology, Inc. and Concurrent Computer Corporation. Mr. Enterline has consulted for a number of private and public companies over the past 25 years and is an active advisor to several technology companies at present. Mr. Enterline holds a Bachelor of Science in Electrical Engineering from Case Institute of Technology and a Master of Business Administration from Cleveland State University.
Ken Bramlett, (age 51), has been one of our directors since December 2004 and is the Chairperson of the Nominating and Governance Committee and the Compensation Committee. Mr. Bramlett is currently self-employed as a private investor. From January 2006 to April 2010, he served as Senior Vice President and General Counsel of COMSYS IT Partners, Inc., a Houston-based public information technology consulting services company that was sold to Manpower, Inc. Prior to that he was a partner with the Charlotte, North Carolina law firm of Kennedy Covington Lobdell & Hickman, L.L.P. (now K&L Gates) from March 2005 to December 2005. Mr. Bramlett is also a director of World Acceptance Corporation, a publicly traded small consumer loan company based in Greenville, South Carolina, where he has served since 1994. From 1996 to 2004, Mr. Bramlett was Senior Vice President and General Counsel of Venturi Partners, Inc., a leading national provider of information technology and professional staffing services and from 1990 to 1996 he was a partner with the law firm of Robinson, Bradshaw and Hinson, P.A. in Charlotte, North Carolina. He has more than 25 years of experience in the areas of corporate law and governance, public and private equity, mergers and acquisitions and executive compensation and human resources.
Bob Van Leyen, (age 67), is our Chief Financial Officer and Secretary. Mr. Van Leyen has more than twenty-five years of experience working in the high-tech industry, holding various executive positions in finance, operations and general management. From 2002 to 2003, Mr. Van Leyen served as a partner with Tatum CFO, L.L.C. where he provided financial and operational support to start-up companies in the high-tech industry. From 1999 to 2001, he was a divisional Chief Financial Officer at Wyle Electronics. During his twenty-four years of employment, Mr. Van Leyen has managed extensive financial operations organizations in Europe, Asia and the United States, providing financial support to operations. Mr. Van Leyen attended the Dutch Institute of Chartered Auditors and holds a Dutch degree equivalent to a U.S. Bachelor's degree in Business Administration. Mr. Van Leyen has served as our Chief Financial Officer and Secretary since September 29, 2003.
Term of Office and Family Relationships
All directors hold office until the next annual meeting of shareholders or until their respective successors are elected or until their earlier death, resignation or removal. Executive officers are appointed by and serve at the discretion of our Board of Directors. There are no family relationships among our executive officers and directors.
Board Leadership Structure
The Board believes that the Company’s Chief Executive Officer is best situated to serve as Chairman because he is the director most familiar with the Company’s business and industry, and most capable of effectively identifying strategic priorities and leading the discussion and execution of strategy. Independent directors and management have different perspectives and roles in strategy development. The Company’s independent directors bring experience, oversight and expertise from outside the company and industry, while the Chief Executive Officer brings company-specific experience and segment-specific expertise. The Board believes that the combined role of Chairman and Chief Executive Officer promotes strategy development and execution, and facilitates information flow between management and the Board, which are essential to effective governance.
Board’s Role in Risk Oversight
The Board has an active role, as a whole and also at the committee level, in overseeing management of the Company’s risks. The Board regularly reviews information regarding the Company’s credit, liquidity and operations, as well as the risks associated with each. The Company’s Compensation Committee is responsible for overseeing the management of risks relating to the Company’s executive compensation plans and arrangements. The Audit Committee oversees management of financial risks. The Nominating and Corporate Governance Committee manages risks associated with the independence of the Board of Directors and potential conflicts of interest. While each committee is responsible for evaluating certain risks and overseeing the management of such risks, the entire Board of Directors is regularly informed through committee reports about such risks.
Board Committees
Our Board of Directors currently has an Audit Committee, a Nominating and Governance Committee and a Compensation Committee. Our Board of Directors has determined that Larry L. Enterline and Ken Bramlett each qualify as an “independent director” as defined in Rule 5605(a)(2) of the NASDAQ Listing Rules and that Messrs. Enterline and Bramlett meet the applicable NASDAQ listing standards for designation as an “Audit Committee Financial Expert.”
Audit Committee
The Audit Committee consists of two Board members, Larry L. Enterline, and Ken Bramlett. Mr. Enterline is the chairperson of the Audit Committee. The duties of the Audit Committee include meeting with our independent registered public accounting firm to review the scope of the annual audit and to review our quarterly and annual financial statements before the statements are released to our shareholders. The Audit Committee also evaluates the independent registered public accounting firm’s performance and has sole authority to appoint or replace the independent registered public accounting firm (subject, if applicable, to shareholder ratification) and to determine whether the independent registered public accounting firm should be retained for the ensuing fiscal year. In addition, the Audit Committee reviews our internal accounting and financial controls and reporting systems practices. A copy of the Audit Committee’s current charter may be found at our website at www.raptor-networks.com.
Nominating and Governance Committee
The Nominating and Governance Committee consists of two Board members, Larry L. Enterline and Ken Bramlett. Mr. Bramlett is the chairperson of the Nominating and Governance Committee. The Nominating and Governance Committee identifies and reviews the qualifications of candidate nominees to the Board of Directors. The Nominating and Governance Committee utilizes a variety of methods for identifying and evaluating nominees for director, including candidates that may be referred by stockholders. Stockholders that desire to recommend candidates for the board for evaluation may do so by contacting our Secretary in writing, including the candidate’s name and qualifications and a statement from the candidate that he or she consents to being named in our proxy statement and will serve as a director if elected. Candidates may also come to the attention of the Nominating and Governance Committee through current board members, professional search firms and other persons. A copy of the Nominating and Governance Committee’s current charter may be found at our website at www.raptor-networks.com. The Governance Committee follows the guidelines of the Company and examines, among other things, the following qualifications and skills of director candidates-their business or professional experience, their integrity and judgment, their records of public service, their ability to devote sufficient time to the affairs of the Company, the diversity of backgrounds and experience they will bring to the Board, and the needs of the Company. The Governance Committee also believes that all nominees should be individuals of substantial accomplishment with demonstrated leadership capabilities. The Governance Committee does not have a formal policy with regard to the consideration of diversity in indentifying nominees for Director.
Compensation Committee
The Compensation Committee consists of two Board members, Larry L. Enterline and Ken Bramlett. Mr. Bramlett is the chairperson of the Compensation Committee. The Compensation Committee is responsible for advising the Board of Directors regarding our responsibilities relating to compensation of our executive officers and Board members. The Compensation Committee is also responsible for evaluating and recommending to the Board of Directors our executive compensation plans, policies and programs. A copy of the Compensation Committee’s current charter may be found at our website at www.raptor-networks.com.
Code of Ethics
Our board of directors has adopted a Code of Business Conduct and Ethics that applies to all of our directors, officers and employees and an additional Code of Ethics that applies to our Chief Executive Officer and our senior financial officers.
We intend to satisfy the disclosure requirement under Item 5.05 of Form 8-K relating to amendments to or waivers from provisions of these codes that relate to one or more of the items set forth in Item 406(b) of Regulation S-B by describing on our Internet website, located at www.raptor-networks.com, within four business days following the date of a waiver or a substantive amendment, the date of the waiver or amendment, the nature of the amendment or waiver and the name of the person to whom the waiver was granted.
Section 16(a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), requires our executive officers and directors, and persons who beneficially own more than 10% of our common stock, to file initial reports of ownership and reports of changes in ownership with the SEC. These officers, directors and shareholders are required by SEC regulations to furnish us with copies of all such reports that they file.
Based solely upon a review of copies of these reports furnished to us during 2010 and thereafter, or written representations received by us from reporting persons that no other reports were required, we believe that all Section 16(a) filing requirements applicable to our reporting persons during 2010 were complied with.
Item 11.
Item 11. Executive Compensation
Compensation of Executive Officers
The following section contains information about the compensation paid to our executive officers and directors during the years ended December 31, 2010 and 2009.
Summary Compensation Table
The following table provides information concerning the compensation for the years ended December 31, 2009 and 2010 for our principal executive officer and our principal financial officer, who were the only persons that served as executive officers during 2010 (collectively, the “named executive officers”).
Summary Compensation Table
(1)
These amounts are equal to the aggregate grant date fair value, computed in accordance with ASC 718, but without giving effect to estimated forfeitures related to service-based vesting conditions. For additional information on the valuation assumptions with respect to these option grants, refer to Note 1 of our financial statements and related notes beginning on page of this Report. See our “Outstanding Equity Awards at December 31, 2010” table below for more information on options held by the named executive officers.
(2)
Effective January 1, 2008, our compensation committee approved an increase to Mr. Wittenschlaeger’s annual salary from $180,000 to $192,000. Effective November 1, 2008, Mr. Wittenschlaeger’s annual salary was, on a temporary basis, decreased from $192,000 to $152,000 in connection with the cash flow constraints of the Company. Effective September 15, 2009, Mr. Wittenschlaeger’s annual salary was reinstated at $192,000.
(3)
Mainly consists of life and health insurance premiums which are, for the executive officers, fully paid by the company.
(4)
Effective January 1, 2008, our compensation committee approved an increase to Mr. van Leyen’s annual salary from $150,000 to $160,000. Effective November 1, 2008, Mr. van Leyen’s annual salary was on a temporary basis decreased from $160,000 to $120,000 in connection with the cash flow constraints of the Company. Effective September 15, 2009, Mr. van Leyen’s annual salary was reinstated at $160,000.
Employment Agreements and Executive Compensation
On July 26, 2010, Mssrs. Thomas M. Wittenschlaeger and Bob van Leyen, CEO and CFO of the Company, respectively, entered into retention agreements with the Company in recognition of, and as part of an interim financing of $176,471. The significant terms of the agreement are as follows:
·
A six month retention period with the Company effective July 26, 2010;
·
No direct or indirect competition with the business of the Company during their periods of employment and for a six month period following any termination of employment;
·
In the event of termination, their cooperation in the winding up of any pending work; and
·
All right, title and interest in any and all ideas conceived are assigned to the Company.
For additional details, please refer to Exhibits 10.2 and 10.3 to the Company’s current report on Form 8-K filed with the SEC on July 28, 2010.
Other than those mentioned above, there are no employment contracts, termination agreements or change-in-control arrangements between us and any of our named executive officers. The Compensation Committee reviews and, if deemed appropriate, adjusts the annual salaries of our named executive officers on at least an annual basis. The Compensation Committee may from time to time grant performance or similar cash bonuses to our named executive officers at its discretion. The Compensation Committee may also periodically award options or warrants to our named executive officers under our existing option and incentive plans at its discretion.
Outstanding Equity Awards At Fiscal Year End
The following table sets forth information about outstanding equity awards held by our named executive officers as of December 31, 2010.
Outstanding Equity Awards at December 31, 2010
Compensation of Directors
Through June 30, 2008, each of our non-employee directors was entitled to receive cash compensation in the amount of $15,000 per year for service on our board of directors. Effective July 1, 2008, the Board waived payment of Director’s Fees in connection with the current cash flow constraints the Company is experiencing. This situation will continue until the Company is able to improve its cash flow position. We reimburse all directors for out-of-pocket expenses incurred in connection with attendance at board and committee meetings. We currently have a policy in place to grant each non-employee director an option to purchase shares of our common stock on the date of his or her commencement of service as a director. We may also periodically award options or warrants to our directors under our existing option and incentive plans.
The following table provides information concerning the compensation of our directors for the year ended December 31, 2010.
Director Compensation
(1)
These amounts are equal to the aggregate grant date fair value, computed in accordance with ASC 718, but without giving effect to estimated forfeitures related to service−based vesting conditions. For additional information on the valuation assumptions with respect to these option grants, refer to Note 1 of our financial statements and related notes beginning on page of this Report.
(2)
At December 31, 2010, Mr. Enterline held options to purchase an aggregate of 100,000 shares of common stock at an exercise price of $1.00 per share, of which 100,000 options were vested at December 31, 2010. In addition, Mr. Enterline held an additional 90,000 options to purchase common stock at an exercise price of $0.67. Two-thirds of these options (60,000) have vested as of December 31, 2010.
(3)
At December 31, 2010, Mr. Bramlett held options to purchase an aggregate of 100,000 shares of common stock at an exercise price of $1.00 per share, of which all 100,000 options were vested at December 31, 2010. In addition, Mr. Bramlett held an additional 90,000 options to purchase common stock at an exercise price of $0.67. Two-thirds of these options (60,000) have vested as of December 31, 2010.
Stock Option Plan
General
Our 2005 Stock Plan was approved by our Board of Directors on April 7, 2005, approved by our shareholders on June 9, 2005 and amended and restated as the First Amended and Restated 2005 Stock Plan (“2005 Plan”) by our Board of Directors on June, 29, 2007. We filed a registration statement on Form S-8 with the SEC in May 2007 to cover the issuance of up to 3,000,000 shares of common stock underlying options and stock purchase rights authorized for issuance under the 2005 Plan and qualified for issuance the underlying securities with the California Department of Corporations in July 2007.
All stock options issued prior to shareholder approval of our 2005 Plan were granted outside of a formal stock option plan (“Non-Plan Options”). As of February 24, 2011, options to purchase a total of 850,000 shares of common stock were outstanding under Non-Plan Options. As of February 24, 2011, there were 612,000 outstanding options to purchase common stock under the 2005 Plan. Excluding these 612,000 outstanding options, 2,388,000 shares will remain available for issuance under the 2005 Plan, subject to the limitations of authorized common stock. We anticipate that future stock options will be issued pursuant to our 2005 Plan or other stock option plans as may be approved by our Board and shareholders in the future.
Shares Subject to the Plan
A total of 3,000,000 shares of common stock are authorized for issuance under the 2005 Plan. Any shares of common stock that are subject to an award but are not used because the terms and conditions of the award are not met, or any shares that are used by participants to pay all or part of the purchase price of any option, may again be used for awards under the 2005 Plan.
Administration
The 2005 Plan is to be administered by our Board of Directors or an appropriate committee of our Board of Directors. It is the intent of the 2005 Plan that it be administered in a manner such that option grants and exercises would be “exempt” under Rule 16b-3 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”).
Our Board of Directors or an appropriate committee is empowered to select those eligible persons to whom options shall be granted under the 2005 Plan, to determine the time or times at which each option or stock purchase right shall be granted, whether options will be incentive stock options (“ISOs”) or nonqualified stock options (“NQOs”), the number of shares to be subject to each option, and to fix the time and manner in which each such option may be exercised, including the exercise price and option period, and other terms and conditions of such options, all subject to the terms and conditions of the 2005 Plan. Our Board of Directors or an appropriate committee has sole discretion to interpret and administer the 2005 Plan and our decisions regarding the 2005 Plan are final.
The 2005 Plan may be wholly or partially amended or otherwise modified, suspended or terminated at any time and from time to time by our Board of Directors. Neither our Board of Directors nor any committee may materially impair any outstanding options without the express consent of the optionee or increase the number of shares subject to the 2005 Plan, materially increase the benefits to optionees under the 2005 Plan, materially modify the requirements as to eligibility to participate in the 2005 Plan or alter the method of determining the option exercise price without shareholder approval. No option may be granted under the 2005 Plan after April 7, 2015.
Option Terms
ISOs granted under the 2005 Plan must have an exercise price of not less than 100% of the fair market value of the common stock on the date the ISO is granted and must be exercised, if at all, within ten years from the date of grant. In the case of an ISO granted to an optionee who owns more than 10% of our total voting securities on the date of grant, the exercise price may not be less than 110% of the fair market value of the common stock on the date of grant and the option period may not exceed five years. NQOs granted under the 2005 Plan must have an exercise price of not less than 85% of the fair market value of the common stock on the date the NQO is granted.
Options may be exercised during a period of time fixed by our Board of Directors or an appropriate committee, except that no option may be exercised more than ten years after the date of grant. In the discretion of our Board of Directors or an appropriate committee, payment of the purchase price for the shares of stock acquired through the exercise of an option may be made in the manner and for the type of consideration determined by our Board of Directors or an appropriate committee, which may include cash, check, one or more promissory notes, shares of our common stock, consideration received under a cashless exercise program implemented in connection with the 2005 Plan or any combination of the foregoing.
Federal Income Tax Consequences
Holders of NQOs do not realize income as a result of a grant of the option, but normally realize compensation income upon exercise of an NQO to the extent that the fair market value of the shares of common stock on the date of exercise of the NQO exceeds the exercise price paid. We are required to withhold taxes on ordinary income realized by an optionee upon the exercise of a NQO. In the case of an optionee subject to the “short-swing” profit recapture provisions of Section 16(b) of the Exchange Act, the optionee realizes income only upon the lapse of the six-month period under Section 16(b), unless the optionee elects to recognize income immediately upon exercise of his or her option.
Holders of ISOs will not be considered to have received taxable income upon either the grant or the exercise of the option. Upon the sale or other taxable disposition of the shares, long-term capital gain will normally be recognized on the full amount of the difference between the amount realized and the option exercise price paid if no disposition of the shares has taken place within either two years from the date of grant of the option or one year from the date of exercise. If the shares are sold or otherwise disposed of before the end of the one-year or two-year periods, the holder of the ISO must include the gain realized as ordinary income to the extent of the lesser of the fair market value of the option stock minus the option price, or the amount realized minus the option price. Any gain in excess of these amounts, presumably, will be treated as capital gain. We are entitled to a tax deduction in regard to an ISO only to the extent the optionee has ordinary income upon the sale or other disposition of the option shares.
Upon the exercise of an ISO, the amount by which the fair market value of the purchased shares at the time of exercise exceeds the option price will be an “item of tax preference” for purposes of computing the optionee’s alternative minimum tax for the year of exercise. If the shares so acquired are disposed of prior to the expiration of the one-year and two-year periods described above, there should be no “item of tax preference” arising from the option exercise.
The tax discussion set forth above is included for general information only and is based upon present law. Each holder of options under the 2005 Plan should consult his or her own tax advisor as to the specific tax consequences of the transaction to him or her, including application and effect of federal, state, local and other tax laws and the possible effects of changes in federal or other laws.
Indemnification of Directors and Officers
Section 7-109-102 of the Colorado Business Corporations Act (the “Colorado Act”) authorizes a Colorado corporation to indemnify any director against liability incurred in any proceeding if he or she acted in good faith and in a manner he or she reasonably believed to be in or not opposed to the best interests of the corporation and, with respect to any criminal action or proceeding, had no reasonable cause to believe his or her conduct was unlawful.
Unless limited by a corporation’s articles of incorporation, Section 7-109-105 of the Colorado Act authorizes a director to apply for indemnification to the court conducting the proceeding or another court of competent jurisdiction. Unless limited by the articles of incorporation, Section 7-109-107 of the Colorado Act extends this same right to officers of a corporation as well.
Unless limited by a corporation’s articles of incorporation, Section 7-109-103 of the Colorado Act requires that a Colorado corporation indemnify a director who was wholly successful in defending any proceeding to which he or she was a party against reasonable expenses incurred in connection therewith. Unless limited by the articles of incorporation, Section 7-109-107 of the Colorado Act extends this same protection to officers of a corporation as well.
Pursuant to Section 7-109-104 of the Colorado Act, a Colorado corporation may advance a director’s expenses incurred in defending any action or proceeding upon receipt of an undertaking and a written affirmation of his or her good faith belief that he or she has met the standard of conduct specified in Section 7-109-102 described above. Unless limited by the articles of incorporation, Section 7-109-107 of the Colorado Act extends this same protection to officers of a corporation as well.
Regardless of whether a director or officer has the right to indemnity, Section 7-109-108 of the Colorado Act allows a Colorado corporation to purchase and maintain insurance on such directors or officers behalf against liability resulting from his or her role as director or officer.
Our Articles of Incorporation do not limit any of the rights afforded to our directors and officers under the Colorado Act and Article VI of our Bylaws states that any director or officer who is involved in litigation by reason of his or her position with us as a director or officer shall be indemnified and held harmless by us to the fullest extent authorized by law as it now exists or may subsequently be amended (but, in the case of any such amendment, only to the extent that such amendment permits the corporation to provide broader indemnification rights). Our directors and officers are also presently covered by an insurance policy indemnifying them against certain liabilities, including certain liabilities arising under the Securities Act, which might be incurred by them in such capacities and against which they may not be indemnified by us. We believe that the indemnification and insurance provided to our directors and officers is necessary to attract and retain qualified persons as directors and officers.
To the extent indemnification for liabilities arising under the Securities Act of 1933 may be permitted to our directors, officers and controlling persons under the above provisions, or otherwise, we have been advised that in the opinion of the SEC such indemnification is against public policy as expressed in the Securities Act of 1933 and is, therefore, unenforceable.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The following table sets forth, as of February 24, 2011, certain information with respect to the beneficial ownership of our stock by (i) each of our named executive officers, (ii) each of our directors, (iii) each person known to us to be the beneficial owner of more than 5% of each class of our outstanding voting securities, and (iv) all of our directors and executive officers as a group.
Beneficial ownership is determined in accordance with the rules of the SEC, and includes voting or investment power with respect to the securities. To our knowledge, except as indicated by footnote, and subject to community property laws where applicable, the persons named in the table below have sole voting and investment power with respect to all shares of common stock shown as beneficially owned by them. Shares of common stock underlying derivative securities, if any, that currently are exercisable or convertible or are scheduled to become exercisable or convertible for or into shares of common stock within 60 days after the date of the table are deemed to be outstanding in calculating the percentage ownership of each listed person or group but are not deemed to be outstanding as to any other person or group. Percentage of beneficial ownership is based on 88,080,979 shares of common stock outstanding as of February 24, 2011.
* Less than 0.5%.
(1)
Unless otherwise indicated, the address is c/o Raptor Networks Technology, Inc., 1508 S. Grand Avenue, Suite 150, Santa Ana, California 92705.
(2)
Thomas M. Wittenschlaeger is our President, Chief Executive Officer and Chairman of the Board. Includes 440,000 shares of common stock issuable upon the exercise of options which were exercisable as of February 24, 2011 or exercisable within 60 days after February 24, 2011.
(3)
Bob Van Leyen is our Chief Financial Officer and Secretary. Includes 370,000 shares of common stock issuable upon the exercise of options which were exercisable as of February 24, 2011 or exercisable within 60 days after February 24, 2011.
(4)
Ken Bramlett is one of our directors. Represents 190,000 shares of common stock issuable upon the exercise of options which were exercisable as of February 24, 2011 or exercisable within 60 days after February 24, 2011.
(5)
Larry L. Enterline is one of our directors. Represents 190,000 shares of common stock issuable upon the exercise of options which were exercisable as of February 24, 2011 or exercisable within 60 days after February 24, 2011.
(6)
Represents 3,000,000 shares of common stock and 440,000 shares issuable upon the exercise of options held by Thomas M. Wittenschlaeger; 400,000 shares of common stock and 370,000 shares issuable upon the exercise of options held by Bob van Leyen; 190,000 shares issuable upon the exercise of options held by Ken Bramlett; and 190,000 shares issuable upon the exercise of options held by Larry L. Enterline.
(7)
Represents 9,646,922 shares of common stock underlying convertible notes and warrants held by Castlerigg Master Investments Ltd. (“Master”), which represents a portion of the number of shares of common stock that are issuable upon the conversion of principal and/or interest, and the payment of principal and/or interest in shares of common stock, under convertible notes and the exercise of warrants held by Master. The number of shares beneficially owned by Master is capped by a contractual 9.99% beneficial ownership limitation set forth in the convertible notes and warrants held by Master. If the 9.99% beneficial ownership limitation is disregarded, Master would beneficially own 1,162,110 shares of common stock, approximately 20,576,859 shares underlying the convertible notes and 48,330,183 shares underlying the warrants held by it. The actual number of shares of common stock issuable upon conversion of the convertible notes is subject to adjustment and could be materially more than 20,576,859 shares depending on a number of factors including, among other factors, the future market price of our common stock. Sandell Asset Management Corp. (“SAMC”) is the investment manager of Master. Thomas Sandell is the sole shareholder of SAMC and may be deemed to have voting and dispositive power over the shares beneficially owned by Master. No other natural person has voting or dispositive power over the shares owned by Master. Castlerigg International Ltd. (“Castlerigg International”) is the controlling shareholder of Castlerigg International Holdings Limited (“Holdings”). Holdings is the controlling shareholder of Master. Each of Holdings and Castlerigg International may be deemed to share beneficial ownership of the shares beneficially owned by Master. SAMC, Mr. Sandell, Holdings and Castlerigg International each disclaims beneficial ownership of the securities with respect to which indirect beneficial ownership is described.
Equity Compensation Plan Information
The following table sets forth information about our common stock that may be issued upon the exercise of options, warrants and rights under all of our equity compensation plans as of December 31, 2010.
(1)
Our 2005 Stock Plan was approved by our Board of Directors on April 7, 2005 and approved by our shareholders on June 9, 2005 at our 2005 Annual Meeting of Shareholders. Under the 2005 Stock Plan, options to purchase up to 3,000,000 shares of our Common Stock may be granted. As of December 31, 2010, there were 612,000 outstanding options to purchase common stock.
(2)
Consists of stock options to purchase shares of our common stock granted to our employees, executive officers and directors outside of a formal stock option plan. These stock options vest at the rate of 33⅓% on each of the first, second and third anniversaries of the date of grant and expire on the eight-year anniversary of the date of grant.
(3)
Consists of warrants to purchase shares of our common stock granted in consideration for consulting services, advisory services, placement agent services and similar services rendered to us by third parties.
Item 13.
Item 13. Certain Relationships and Related Transactions and Director Independence
Certain Relationships and Related Transactions
There were no related party transactions in 2010 that require disclosure. The Board as a whole reviews any transactions that would require disclosure under this item 13.
Director Independence
Our Board of Directors has determined that Larry L. Enterline and Ken Bramlett each qualify as an “independent director” as defined in Rule 5605(a)(2) of the NASDAQ Listing Rules.
Item 14.
Item 14. Principal Accounting Fees and Services
The following table sets forth the aggregate fees billed to us for the fiscal years ended December 31, 2010 and 2009 by our auditors, Mendoza Berger & Company, LLP.
(1)
Audit Fees consist of fees billed for professional services rendered for the audit of our consolidated annual financial statements and review of the interim consolidated financial statements included in quarterly reports and services that are normally provided by our accountants in connection with statutory and regulatory filings or engagements.
(2)
Audit-Related Fees consist of fees billed for assurance and related services that are reasonably related to the performance of the audit or review of our consolidated financial statements and are not reported under “Audit Fees.” This category includes fees related to due diligence services pertaining to potential business acquisitions/disposition; and consultation regarding accounting or disclosure treatment of transactions or events and/or the actual or potential impact of final or proposed rules, standard or interpretation by the SEC, FASB or other regulatory or standard-setting bodies as well as general assistance with implementation of the requirements of SEC rules or listing standards promulgated pursuant to the Sarbanes-Oxley Act of 2002.
(3)
Tax Fees consist of fees billed for professional services rendered for tax compliance, tax advice and tax planning. These services include assistance regarding federal, state and local tax compliance, planning and advice.
(4)
All Other Fees consist of fees for products and services other than the services reported above.
Our Audit Committee is responsible for approving all Audit, Audit-Related, Tax and Other Services. The Audit Committee pre-approves all auditing services and permitted non-audit services, including all fees and terms to be performed for us by our independent registered public accounting firm at the beginning of the fiscal year. Non-audit services are reviewed and pre-approved by project at the beginning of the fiscal year. Any additional non-audit services contemplated by our company after the beginning of the fiscal year are submitted to the Audit Committee chairman for pre-approval prior to engaging the independent auditor for such services. Such interim pre-approvals are reviewed with the full Audit Committee at its next meeting for ratification.
Part IV
Item 15.
Item 15. Exhibits and Financial Statement Schedules
Exhibit
Number
Description
Exhibit
Number
Description
x Filed herewith.
** This exhibit is a management contract or a compensatory plan or arrangement.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
RAPTOR NETWORKS TECHNOLOGY, INC.
Dated: March 15, 2011
By:
/s/ Thomas M. Wittenschlaeger
Thomas M. Wittenschlaeger,
Chief Executive Officer
(principal executive officer)
Pursuant to requirements of the Securities Exchange Act of 1934, as amended, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated:
Signature
Capacity
Date
/s/ Thomas M. Wittenschlaeger
Director
March 11, 2011
Thomas M. Wittenschlaeger
/s/ Ken Bramlett
Director
March 11, 2011
Ken Bramlett
/s/ Larry L. Enterline
Director
March 11, 2011
Larry L. Enterline
Raptor Networks Technology, Inc.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders
Raptor Networks Technology, Inc. and Subsidiary
We have audited the accompanying consolidated balance sheets of Raptor Networks Technology, Inc. and Subsidiary (a Colorado corporation) (the “Company”) as of December 31, 2010 and 2009, and the related consolidated statements of operations, stockholders' deficit and cash flows for the years then ended. These consolidated 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 the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated 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 Raptor Networks Technology, Inc. as of December 31, 2010 and 2009, and the results of its operations and its cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.
The accompanying consolidated financial statements are presented assuming the Company will continue as a going concern. As more fully described in Note 1 to the consolidated financial statements, the Company has sustained accumulated losses from operations totaling approximately $84 million at December 31, 2010. This condition and the Company’s lack of significant sales of its products to date, raise substantial doubt about its ability to continue as a going concern. Management's plans to address these conditions are also set forth in Note 1 to the consolidated financial statements. The accompanying consolidated financial statements do not include any adjustments which might be necessary if the Company is unable to continue as a going concern.
/s/ Mendoza Berger & Company, LLP
Irvine, California
March 15, 2011
RAPTOR NETWORKS TECHNOLOGY, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
December 31, 2010
The accompanying notes are an integral part of these consolidated financial statements.
RAPTOR NETWORKS TECHNOLOGY, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
For the Years Ended December 31, 2010
The accompanying notes are an integral part of these consolidated financial statements.
RAPTOR NETWORKS TECHNOLOGY, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ DEFICIT
For the Years Ended December 31, 2009 and 2010
The accompanying notes are an integral part of these consolidated financial statements.
RAPTOR NETWORKS TECHNOLOGY, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Years Ended December 31, 2009 & 2010
The accompanying notes are an integral part of these consolidated financial statements.
RAPTOR NETWORKS TECHNOLOGY, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Summary of Significant Accounting Policies
Description
The Company is a provider of integrated high-speed Ethernet switching systems which enable new emerging high bandwidth critical applications. The data network market areas that the Company is targeting include video, storage, Internet Protocol telephony and technology refresh. The Company is currently focusing on the United States market. Principal operations have commenced, although minimal revenues have been recognized to date.
The Company was incorporated under the laws of the state of Colorado on January 22, 2001 under the name Pacific InterMedia, Inc. (“Pacific”). The principal office of the corporation is 1508 South Grand Avenue, Suite 150, Santa Ana, California 92705.
On October 17, 2003, Pacific completed a business combination transaction with Raptor Networks Technology, Inc. (“Raptor”), a closely-held California corporation, through acquisition of all of the issued and outstanding common stock of Raptor in exchange for authorized but previously unissued restricted common stock of Pacific. Immediately prior to completion of the acquisition transaction, Pacific had a total of 4,034,000 shares of its common stock issued and outstanding comprised of 1,034,000 registered shares held by approximately 25 stockholders and 3,000,000 shares of restricted stock held by Pacific’s founder and sole officer and director.
As a material aspect of the acquisition, Pacific re-acquired and cancelled the 3,000,000 restricted shares as consideration for transfer of its remaining assets consisting of cash and office equipment to the officer and director, leaving only the registered common stock, 1,034,000 shares, as all of its issued and outstanding capital stock prior to completion of the Raptor acquisition.
Pursuant to terms of the acquisition agreement, all of the issued and outstanding common stock of Raptor, 19,161,256 shares, was acquired by Pacific, share-for-share, in exchange for its authorized but previously unissued common stock. Upon completion of the acquisition, Raptor became a wholly owned subsidiary of Pacific and the Raptor shareholders became shareholders of Pacific. Unless otherwise indicated, all references in these financial statements to “the Company” include Pacific and its wholly owned subsidiary, Raptor. All intercompany transactions have been eliminated in consolidation. On December 3, 2003, Pacific changed its name to Raptor Networks Technology, Inc.
The acquisition transaction has been treated as a reverse merger, with Raptor considered the accounting acquirer.
Reclassifications
Certain prior year amounts have been reclassified to conform to the current year presentation. These reclassifications had no impact on net earnings, financial position or cash flows.
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. Significant estimates made by management include the collectability of accounts receivable, the realization of inventories, the recoverability of long-lived assets, the valuation of stock-based compensation and the valuation allowance of the deferred tax asset. Actual results could differ from those estimates.
Concentrations of Credit Risk
During 2010, 91% of our revenues were generated by two customers. One customer accounted for 79% and the other accounted for 12%. As of December 31, 2010, 100% of the accounts receivable was owed by the customer accounting for 79% of the revenues. During 2009, 70% of our revenues were generated by one customer. This customer owed 76% of the accounts receivable balance as of December 31, 2009. During 2009, another 25% of revenues were generated by three other customers.
RAPTOR NETWORKS TECHNOLOGY, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Cash and Cash Equivalents
The Company considers all short-term marketable securities with an original maturity of three months or less to be cash equivalents.
Accounts Receivable and Allowance for Doubtful Accounts
Accounts receivable are recorded at the invoiced amount and do not bear interest. The allowance for doubtful accounts is the Company’s best estimate of the amount of probable credit losses in the Company’s existing accounts receivable. The Company establishes provisions for losses on accounts receivable when it is probable that all or part of the outstanding balance will not be collected. The Company regularly reviews collectability and establishes or adjusts the allowance as necessary using the specific identification method. All receivables as of December 31, 2010 and 2009 have been collected. Therefore, there is no allowance for doubtful accounts is included in the accompanying consolidated balance sheets.
Inventories
Inventories are recorded at the lower of cost or market with cost being determined on the average cost method. When required, a provision is made to reduce excess and obsolete inventory to estimated net realizable value. Inventories consist of raw materials, work-in-process and finished goods.
License Fees
The Company capitalizes software license fees of third party software which is included in its systems. These costs are amortized and charged to cost of sales over the projected number of systems expected to be sold incorporating the capitalized software. Amortization of the license fees included in cost of sales for the years ended December 31, 2010 and 2009 totaled $25,920 and $110,160 respectively.
Property and Equipment
Property and equipment are recorded at cost less accumulated depreciation. In certain circumstances, the Company loans inventory to its distributors to be used as a demonstration product to potential customers. Such equipment is removed from inventory and recorded as test equipment at its book value on the date of transfer. When the equipment is returned to the Company, it is removed from test equipment and recorded as inventory at the lower of its net book value or its net realizable value. Depreciation is computed using the straight-line method over the assets’ estimated useful lives as follows: computer equipment, furniture and fixtures and testing equipment are depreciated over three years and office equipment is depreciated over seven years. Repairs and maintenance of a routine nature are charged as incurred. Significant renewals and betterments are capitalized. At the time of retirement or other disposition of property and equipment, the cost and accumulated depreciation are removed from the accounts and any resulting gain or loss is reflected in the consolidated statements of operations.
Debt Issuance Costs
Debt issuance costs reflect fees incurred to obtain financing. Debt issuance costs are amortized to interest expense using the straight-line method over the life of the related debt. Amortization expense for the years ended December 31, 2010 and 2009 was $5,015 and $20,056, respectively.
Convertible Debenture and Beneficial Conversion Feature
If the conversion feature of conventional convertible debt provides for a rate of conversion that is below market value, this feature is characterized as a beneficial conversion feature (“BCF”). A BCF is recorded by the Company as a debt discount. In those circumstances, the convertible debt will be recorded net of the discount related to the BCF. The Company amortizes the discount to interest expense over the life of the debt using the straight-line method, which approximates the effective interest method.
Derivative Financial Instruments
In accounting for non-conventional convertible debt, the Company bifurcates its embedded derivative instruments. The Company’s derivative financial instruments consist of embedded derivatives related to non-conventional debentures entered into with certain investors. These embedded instruments related to the debenture include the conversion feature, liquidated damages related to registration rights and default provisions. The accounting treatment of derivative financial instruments requires that the Company record the derivatives and related warrants at their fair value as of the inception date of the agreement and at fair value as of each subsequent balance sheet date. Any change in fair value will be recorded as non-operating, non-cash income or expense at each reporting period. If the fair value of the derivatives is higher at the subsequent balance sheet date, the Company will record a non-operating, non-cash charge. If the fair value of the derivative is lower at the subsequent balance sheet date, the Company will record non-operating, non-cash income.
RAPTOR NETWORKS TECHNOLOGY, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Revenue Recognition
The Company records revenues when the following criteria are met: (i) persuasive evidence of an arrangement exists; (ii) delivery has occurred; (iii) the price to the customer is fixed or determinable; and (iv) collection of the sales price is reasonably assured. Delivery occurs when goods are shipped and title and risk of loss have passed to the customer. Revenue is deferred in all instances where the earnings process is incomplete. The Company recognizes revenue from distribution sales when all contingencies are satisfied and upon persuasive evidence of a sale to end users until such time that historical sell through ratios have been developed. Payments received before all of the relevant criteria for revenue recognition are satisfied are recorded as deferred revenue in the accompanying consolidated balance sheets. Revenues and costs of revenues from consulting contracts are recognized during the period in which the service is performed. All revenues are reported net of any sales discounts or taxes.
The Company has contracts with various governments and governmental agencies. Government contracts are subject to audit by the applicable governmental agency. Such audits could lead to inquiries from the government regarding the allowability of costs under applicable government regulations and potential adjustments of contract revenues. To date, the Company has not been involved in any such audits.
Research and Development Costs
Research and development (R&D) costs consist of labor, product design costs including rental of design tools, consumables, and costs of prototypes and are expensed as incurred.
Compensated Absences
The Company maintains a personal time off policy. Employees of the Company are entitled to compensated absences depending on their length of service to a maximum of 25 days per calendar year. As of December 31, 2010 and 2009, the balance owed for compensated absences was $46,337 and $56,707, respectively.
Impairment or Disposal of Long-Lived Assets
The Company reviews its long-lived assets and certain related intangibles for impairment periodically, and whenever events or changes in circumstances indicate that the carrying amount of an asset may not be fully recoverable. When necessary, impaired assets are written down to estimated fair value based on the best information available. Estimated fair value is generally based on either appraised value or measured by discounting estimated future cash flows. Considerable management judgment is necessary to estimate discounted future cash flows. Accordingly, actual results could vary significantly from such estimates. There were no assets that were considered to be impaired as of December 31, 2010 and 2009.
Income Taxes
The Company accounts for income taxes in accordance with the asset and liability method. Under the asset and liability method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the consolidated financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates for the periods in which the differences are expected to reverse. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.
The Company records a valuation allowance if based on the weight of available evidence, it is more likely than not that some or all of the deferred tax asset will not be realized. In determining the possible realization of deferred tax assets, the Company considers future taxable income from the following sources: (i) the reversal of taxable temporary differences, (ii) taxable income from future operations and (iii) tax planning strategies that, if necessary, would be implemented to accelerate taxable income into periods in which net operating losses might otherwise expire.
The Company also recognizes the income tax effect of tax positions taken or expected to be taken in a tax return. For those benefits to be recognized, a tax position must be more-likely-than-not to be sustained upon examination by taxing authorities. The amount recognized is measured as the largest amount of benefit that has a greater than 50 percent likelihood of being realized upon ultimate settlement. If recognized, the tax portion of the adjustment would affect the effective tax rate.
RAPTOR NETWORKS TECHNOLOGY, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Fair Value of Financial Instruments
Unless otherwise indicated, the fair value of all reported assets and liabilities which represent financial instruments (none of which are held for trading purposes) approximate the carrying values of such instruments.
Stock-Based Compensation
The Company accounts for stock-based compensation at fair value using the Black-Scholes Option pricing model. All stock-based compensation cost is measured at the grant date using the Black-Sholes Option Pricing Model, based on the fair value of the award. The value of the portion of the award that is ultimately expected to vest is recognized as expense over the requisite service periods in the Company’s consolidated statements of operations.
Stock-based compensation expense recognized during the period is based on the value of the portion of share-based payment awards that is ultimately expected to vest during the period. Forfeitures are estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. The forfeiture rate that the Company presently uses is 10%.
Cash flows resulting from the tax benefits resulting from tax deductions in excess of the compensation cost recognized for those options are classified as financing cash flows. Due to the Company’s loss position, there were no such tax benefits for the years ended December 31, 2010 and 2009.
No options were granted during the years ended December 31, 2010 or 2009.
Loss per Common Share
Basic loss per share is computed by dividing the net loss available to common stockholders for the period by the weighted average number of shares of common stock outstanding during the period. The calculation of diluted net loss per share gives effect to common stock equivalents; however, potential common shares are excluded if their effect is anti-dilutive. For the years ended December 31, 2010 and December 31, 2009, basic and diluted earnings per share were the same.
Recent Accounting Pronouncements
Effective July 1, 2009, the Company adopted the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 105-10, Generally Accepted Accounting Principles - Overall (“ASC 105-10”). ASC 105-10 establishes the FASB Accounting Standards Codification (the “Codification”) as the source of authoritative accounting principles recognized by the FASB to be applied by nongovernmental entities in the preparation of financial statements in conformity with U.S. GAAP. Rules and interpretive releases of the SEC under authority of federal securities laws are also sources of authoritative U.S. GAAP for SEC registrants. All guidance contained in the Codification carries an equal level of authority. The Codification superseded all existing non-SEC accounting and reporting standards. All other non-grandfathered, non-SEC accounting literature not included in the Codification is non-authoritative. The FASB will not issue new standards in the form of Statements, FASB Staff Positions or Emerging Issues Task Force Abstracts. Instead, it will issue Accounting Standards Updates (“ASUs”). The FASB will not consider ASUs as authoritative in their own right. ASUs will serve only to update the Codification, provide background information about the guidance and provide the bases for conclusions on the change(s) in the Codification. References made to FASB guidance throughout this document have been updated for the Codification.
Effective April 1, 2009, the Company adopted FASB ASC 820-10-65, Fair Value Measurements and Disclosures - Overall - Transition and Open Effective Date Information (“ASC 820-10-65”). ASC 820-10-65 provides additional guidance for estimating fair value in accordance with ASC 820-10 when the volume and level of activity for an asset or liability have significantly decreased. ASC 820-10-65 also includes guidance on identifying circumstances that indicate a transaction is not orderly. ASC 825-10-65 also amends ASC 825-10 to require disclosures about the fair value of financial instruments in interim financial statements as well as in annual financial statements and also amends ASC 270-10 to require those disclosures in all interim financial statements. The adoption of ASC 820-10-65 did not have an impact on the Company’s results of operations or financial condition.
RAPTOR NETWORKS TECHNOLOGY, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Effective April 1, 2009, the Company adopted FASB ASC 855-10, Subsequent Events - Overall (“ASC 855-10”). ASC 855-10 establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. It requires the disclosure of the date through which an entity has evaluated subsequent events and the basis for that date - that is, whether that date represents the date the financial statements were issued or were available to be issued. This disclosure should alert all users of financial statements that an entity has not evaluated subsequent events after that date in the set of financial statements being presented. Adoption of ASC 855-10 did not have a material impact on the Company’s consolidated results of operations or financial condition. The Company has evaluated subsequent events from December 31, 2010 to the date the financial statements were issued.
Effective July 1, 2009, the Company adopted FASB ASU No. 2009-05, Fair Value Measurements and Disclosures (Topic 820) (“ASU 2009-05”). ASU 2009-05 provided amendments to ASC 820-10, Fair Value Measurements and Disclosures - Overall, for the fair value measurement of liabilities. ASU 2009-05 provides clarification that in circumstances in which a quoted price in an active market for the identical liability is not available, a reporting entity is required to measure fair value using certain techniques. ASU 2009-05 also clarifies that when estimating the fair value of a liability, a reporting entity is not required to include a separate input or adjustment to other inputs relating to the existence of a restriction that prevents the transfer of a liability. ASU 2009-05 also clarifies that both a quoted price in an active market for the identical liability at the measurement date and the quoted price for the identical liability when traded as an asset in an active market when no adjustments to the quoted price of the asset are required are Level 1 fair value measurements. Adoption of ASU 2009-05 did not have a material impact on the Company’s results of operations or financial condition.
In October 2009, the FASB issued ASU 2009-13, Multiple-Deliverable Revenue Arrangements, (amendments to FASB ASC Topic 605, Revenue Recognition) (“ASU 2009-13”) and ASU 2009-14, Certain Arrangements That Include Software Elements, (amendments to FASB ASC Topic 985, Software) (“ASU 2009-14”). ASU 2009-13 requires entities to allocate revenue in an arrangement using estimated selling prices of the delivered goods and services based on a selling price hierarchy. The amendments eliminate the residual method of revenue allocation and require revenue to be allocated using the relative selling price method. ASU 2009-14 removes tangible products from the scope of software revenue guidance and provides guidance on determining whether software deliverables in an arrangement that includes a tangible product are covered by the scope of the software revenue guidance. ASU 2009-13 and ASU 2009-14 should be applied on a prospective basis for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010, with early adoption permitted. Because the Company believes the software embedded in its products is either incidental to the product as a whole or functions together to deliver the product’s essential functionality, the Company does not expect adoption of ASU 2009-13 or ASU 2009-14 to have a material impact on the Company’s results of operations or financial condition.
Presentation as a Going Concern
The accompanying condensed consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America, which contemplate continuation of the Company as a going concern. The Company has sustained net losses of $468,871 and $12,694,997 for the years ended December 31, 2010 and December 31, 2009, respectively. The Company also has an accumulated deficit of $84,392,048 and a working capital deficit of $17,824,757 at December 31, 2010, of which $6,802,053 relates to the fair value of derivative financial instruments. In September 2008, the Company shifted its principal operating model from product sales to licensing enabling a reduction in headcount, footprint and infrastructure that reduced operating expense run rates substantially. It is unlikely that this shift in business model will be successful as the Company did not generate any revenues from licensing agreements in 2009 or 2010. The Company’s service contract with a government prime contractor enabling the Company to fund the development of a next generation “hybrid fabric” product provides the majority of the revenue absorbing the Company’s current expense run rates. The funds allocated to that contract are alone insufficient to complete product development and this specific funding stream will be depleted in the third quarter of 2011. Taking into account the current status of the Government budget , we believe it is unlikely that we will find a replacement for the expiring contract revenue prior to the next fiscal cycle in September 2011.
The items discussed above raise substantial doubts about the Company's ability to continue as a going concern. If the Company's financial resources are insufficient, the Company may require additional financing in order to execute its operating plan and continue as a going concern. The Company cannot predict whether this additional financing will be in the form of equity, debt or another form. It is unlikely that the Company will be able to obtain the necessary additional capital on a timely basis, on acceptable terms, or at all.
RAPTOR NETWORKS TECHNOLOGY, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
During 2010, the 2007 Notes, April 2008 Notes and July 2008 Notes (see Note 5) matured. The Company did not pay the principal balances and accrued interest at maturity or thereafter. The note holders have not demanded repayment and have agreed to add the accrued interest to the principal balances of the notes. At any time, however, the lenders can deem us to be in default on the notes and could take all remedies available to them, including conversion of the notes into a large number of shares and/or foreclosing on all of our assets, both tangible and intangible, leaving the Company with no assets.
In the event that these financing sources do not materialize, or the Company is unsuccessful in increasing its revenues and profits, the Company will be forced to further reduce its costs and may be unable to repay its other obligations as they become due or respond to competitive pressures, any of which circumstances would have a material adverse effect on its business, prospects, financial condition and results of operations.. Additionally, if these funding sources or increased revenues and profits do not materialize, and the Company is unable to secure additional financing, the Company could be forced to reduce or curtail its business operations unless it is able to engage in a merger or other corporate finance transaction with a better capitalized entity.
The financial statements do not include any adjustments relating to the recoverability and reclassification of recorded asset amounts or amounts and reclassification of liabilities that might be necessary, should the Company be unable to continue as a going concern.
2. Fair Value of Financial Instruments
The Company measures fair value in accordance with a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy are described below:
Level 1
Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities;
Level 2
Quoted prices in markets that are not active, or inputs that are observable, either directly or indirectly, for substantially the full term of the asset or liability; and
Level 3
Prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable (supported by little or no market activity).
The following table sets forth the Company’s financial assets and liabilities measured at fair value by level within the fair value hierarchy. Assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement.
The table below sets forth a summary of the fair values of the Company’s financial assets and liabilities as of December 31, 2010:
RAPTOR NETWORKS TECHNOLOGY, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The table below sets forth a summary of the fair values of the Company’s financial assets and liabilities as of December 31, 2009:
The Company’s detachable warrant and conversion option liabilities are valued using pricing models and the Company generally uses similar models to value similar instruments. Where possible, the Company verifies the values produced by its pricing models to market prices. Valuation models require a variety of inputs, including contractual terms, market prices, yield curves, credit spreads, measures of volatility and correlations of such inputs. These financial liabilities do not trade in liquid markets, and as such, model inputs cannot generally be verified and do involve significant management judgment. Such instruments are typically classified within Level 3 of the fair value hierarchy. See Note 5 for the rollforward of Level 3 liabilities.
3. Inventories
Inventories consisted of the following at December 31:
4. Property and Equipment
Property and equipment consisted of the following as of December 31:
For the year ended December 31, 2010, $27,687 of inventory was loaned to distributors and consequently was transferred from inventories to test equipment. Depreciation and amortization expense related to property and equipment for the years ended December 31, 2010 and 2009 was $10,103 and $16,090, respectively.
RAPTOR NETWORKS TECHNOLOGY, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
5. Securities Purchase Agreements
The Company entered into four separate securities purchase agreements (the “2006 SPA,” the “2007 SPA,” the “April 2008 SPA” and the “July 2008 SPA,” collectively the “SPAs”) with three institutional investors in connection with private placement transactions that provided for, among other things, the issuance of senior convertible notes (the “2006 Notes,” the “2007 Notes,” the “April 2008 Notes” and the “July 2008 Notes,” collectively the “Notes”), warrants to purchase shares of common stock (the “2006 Warrants,” the “2007 Warrants,” “the April 2008 Warrants,” the “July 2008 Warrants” and the “Replacement Warrants,” collectively the “Warrants”) and the issuance of common stock (the “March 2008 Stock” and the “July 2008 Stock”). Following is a summary of the securities issued pursuant to the terms of the SPAs.
On July 27, 2010, the Company issued an unsecured convertible note payable (the “July 2010 Note”) to one of the investors from the previous financings in the principal amount of $176,471. All outstanding notes payable are collectively referred to as (the “Notes”).
The Company allocated the proceeds of the April 2008, July 2008 and July 2010 Notes to the individual financial instruments included in the transactions based on their relative estimated fair values as follows:
The fair value of the common stock was based on the closing market price of the Company’s common stock on the date of the transactions. The fair values of the warrants and conversion options were based on the Black-Scholes Option pricing model. All of the SPAs require the Company to maintain authorized shares of at least 130% of the sum of the maximum number of common shares issuable upon conversion of the Notes and upon exercise of the Warrants.
RAPTOR NETWORKS TECHNOLOGY, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
All of the SPAs contain registration rights agreements which require the Company to file registration statements with the SEC for the resale of the shares of common stock underlying all of the Notes, Warrants and common stock issued. The Company is required to maintain the effectiveness of the registration statements through the latest date at which the Notes can be converted or the Warrants can be exercised. Notwithstanding other remedies available under the SPAs, the Company will be required to pay liquidated damages equal to 2% of the principal amount of the Notes on the date of failure and 2% of the principal amount of the Notes every 30th day thereafter (or for a pro rated period if less than 30 days) for failure to timely file the registration statements or have them declared effective by the SEC and failure to maintain the effectiveness of the registration statements, subject to certain grace periods. Any liquidated damages not paid timely will accrue interest at the rate of 2% per month. Registration penalties under SPAs are capped at 12.5% of the principal amount of the respective Notes. The maximum registration penalties under the Notes are as follows:
The Company is required to assess its potential liability with respect to registration rights agreements. On May 29, 2008, the investors agreed to delay payments in connection with the registration rights agreement contained in the April 2008 SPA and the registration of the shares underlying the L-1 and L-2 warrants. The deadline has been indefinitely extended by the investors. As such, no liability related to the registration rights agreements has been recorded in the accompanying consolidated financial statements.
Significant events of default under the SPAs include:
·
The failure of any registration statement to be declared effective by the SEC within 60 days after the date required by the applicable registration rights agreement or the lapse or unavailability of such registration statement for more than 10 consecutive days or more than an aggregate of 30 days in any 365-day period (other than certain allowable grace periods).
·
The failure to issue unlegended certificates within 3 trading days after the Company receives documents necessary for the removal of the legend.
In January 2007, the Company amended the 2006 SPA (the “2006 Amended SPA”). The amendments included, but were not limited to, a waiver of all fees, penalties and defaults as of January 19, 2007 which related to registration statement filing failures and/or effectiveness failures, as described in the 2006 SPA, an increase in the principal amount of the 2006 Notes from an aggregate of $5 million to an aggregate of $7.2 million, issuance of an additional 5,688,540 of 2006 Warrants which increased the aggregate number of shares of common stock issuable upon exercise of the Series L-1 Warrants from an aggregate of 17,065,623 shares to an aggregate of 22,754,163 shares, and a reduction in the exercise price of the Series L-1 Warrants and the Series M-1 Warrants from $0.5054 per share to $0.43948 per share. The Company did not receive any additional cash consideration for these amendments.
Additionally, pursuant to the terms of the 2006 Amended SPA, the Company entered into a Securities Purchase Agreement with one of the existing institutional investors in a private placement transaction providing for, among other things, the issuance of senior convertible notes (the “2006 Amended Notes) in the principal amount of $1.6 million, Series L-2 Warrants to purchase up to 7,281,332 shares of common stock and Series M-2 Warrants to purchase up to 2,366,433 shares of common stock. The Series L-2 Warrants were immediately exercisable. The Series M-2 warrants were to become exercisable only upon a mandatory conversion of the 2006 Notes, as defined in the 2006 Notes. Both the Series L-2 Warrants and Series M-2 Warrants have an exercise price of $0.43948 per share and expire on July 31, 2013.
RAPTOR NETWORKS TECHNOLOGY, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The April 2008 SPA amended the 2007 Notes and the 2007 Warrants. Pursuant to the 2008 SPA, the conversion price of the 2007 Notes and the exercise price of the 2007 Warrants were reduced from $1.20 to $0.50. The April 2008 SPA had no effect on the 2006 Notes. The July 2008 SPA amended the exercise price of the Series Q warrants from $1.00 to $0.50.
The April 2008 SPA also amended the terms of the Series M-1 and M-2 warrants to eliminate the contingency provisions and therefore, the Series M-1 and Series M-2 warrants became immediately exercisable upon the effective date of the 2008 SPA.
The conversion price of the Notes and the exercise price of the Warrants are subject to customary anti-dilution provisions for stock splits and the like, and are also subject to full-ratchet anti-dilution protection such that if the Company issues or is deemed to have issued certain securities at a price lower than the then applicable conversion or exercise price, then the conversion or exercise price will immediately be reduced to such lower price.
The Notes and the Warrants contain certain limitations on conversion or exercise, including that a holder of those securities cannot convert or exercise those securities to the extent that upon such conversion or exercise, that holder, together with the holder’s affiliates, would own in excess of 4.99% of the Company’s outstanding shares of common stock (subject to an increase or decrease, upon at least 61-days’ notice, by the investor to the Company, of up to 9.99%).
Notes
Information relating to the Notes is as follows:
(1) All information presented reflects amendments made in January 2007.
(2) Fixed conversion price reflects the effect of anti-dilution provision as a result of the April 2008 SPA.
(3) The interest rate may be reduced to 7% at the beginning of each quarter if certain conditions are met. No such conditions have been met to date.
(4) The interest rates for the 2006, 2007, April and July 2008 Notes increase to 15% upon the occurrence of an event of default.
(5) The interest rate on the July 2010 Note increases to 21% upon the occurrence of an event of default.
(6) Interest is calculated on the basis of a 360 day year. (7) Interest for the first two years of the April 2008 Notes and July 2008 Notes was deducted from the proceeds. Interest for the first year of the July 2010 Note was deducted from the proceeds. Prepaid interest is reflected in the accompanying consolidated balance sheets for the years ended:
RAPTOR NETWORKS TECHNOLOGY, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(8) The investors have not demanded repayment
The Company may elect to make monthly installment payments in cash or in shares of the Company’s common stock.
The maturity date of the Notes may be extended at the option of the investors so long as there is not an event of default.
The 2006 and 2007 Notes are convertible into shares of common stock at the option of the holder at the lower of the fixed conversion price or the optional conversion price, defined as 90% of the arithmetic average of the weighted-average price of the common stock for the 5 consecutive trading days immediately preceding the conversion date. However, if the weighted average price for the 20 trading days preceding the date of conversion exceeds $1.00, the conversion price is computed as 92.5% of the weighted average price of the common stock for the 5 consecutive trading days immediately preceding the conversion date. However, the Company may, at its option, redeem in cash, up to an amount equal to 20% of the aggregate dollar trading volume of the Company’s common stock over the prior 20-trading day period on the 2007 Notes.
Subject to certain conditions, the Company may require the investors to convert up to 50% of the 2006 Notes after the SEC has declared effective the initial registration statement at any time when the shares of the Company’s common stock are trading at or above 150% of the initial conversion price or convert up to 100% of the 2006 Notes after the SEC has declared effective the initial registration statement at any time when the shares of the Company’s common stock are trading at or above 175% of the initial conversion price. The 2006 Notes contain certain limitations on optional and mandatory conversion.
The entire outstanding principal balance of the 2007 Notes and any outstanding fees or interest shall be due and payable in full on the maturity date. Interest is payable quarterly, beginning October 1, 2007. Under certain conditions, the Company may require investors to convert up to either 50% or 100% of the outstanding balances of the 2007 Notes at any time the Company shares are trading at or above $1.80 or $2.11, respectively
The April 2008 Notes are convertible into shares of common stock at the lower of the fixed conversion price or the optional conversion price, defined as 85% of the arithmetic average of the weighted-average price of the common stock for the 5 consecutive trading days immediately preceding the conversion date. However, following the disclosure of an SEC event, as defined in the April 2008 Notes, the conversion price will be computed using the lowest of (i) 50% of arithmetic average of the weighted average price for the 30 trading days preceding the date of conversion; (ii) 50% of the closing price of the common stock on the trading day preceding the date of conversion; or (iii) 50% of the closing price of the common stock on the date preceding the SEC event.
The July 2008 and July 2010 Notes are convertible into shares of common stock at the lower of the fixed conversion price or the optional conversion price, defined as the lesser of (i) 85% of the arithmetic average of the weighted-average price of the common stock for the 30 consecutive trading days immediately preceding the conversion date and (ii) 85% of the arithmetic average of the weighted-average price of the common stock for the 3 lowest trading days during the 30 consecutive trading days immediately preceding the conversion date. However, following the disclosure of an SEC event, as defined in the April 2008 Notes, the conversion price of the 2008 Notes will be computed using the lowest of (i) 50% of the amounts determined as above; (ii) 50% of the closing price of the common stock on the trading day preceding the date of conversion; or (iii) 50% of the closing price of the common stock on the date preceding the SEC event.
RAPTOR NETWORKS TECHNOLOGY, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Notes, excluding the July 2010 Note which is unsecured, are secured by a first priority perfected security interest in all of the Company's assets and the common stock of the Company’s subsidiary. Additionally, the Notes, excluding the July 2010 Note, are guaranteed by the Company’s subsidiary.
Significant events of default under the Notes include:
·
The failure of any registration statement to be declared effective by the SEC within 60 days after the date required by the applicable registration rights agreement or the lapse or unavailability of such registration statement for more than 10 consecutive days or more than an aggregate of 30 days in any 365-day period (other than certain allowable grace periods).
·
The suspension from trading or failure of the common stock to be listed for trading on the OTC Bulletin Board or another eligible market for more than 5 consecutive trading days or more than an aggregate of 10 trading days in any 365-day period.
·
The failure to issue shares upon conversion of the Notes or for more than 10 business days after the relevant conversion date or a notice of the Company’s intention not to comply with a request for conversion.
·
The Company’s failure to pay any amount of principal, interest, late charges or other amounts when due.
If there is an event of default, the investors have the right to redeem all or any portion of the Notes, at the greater of (i) up to 125% of the sum of the outstanding principal, interest and late fees, depending on the nature of the default, and (ii) the product of (a) the greater of (1) the closing sale price for the Company’s common stock on the date immediately preceding the event of default, (2) the closing sale price for the Company’s common stock on the date immediately after the event of default and (3) the closing sale price for the Company’s common stock on the date an investor delivers its redemption notice for such event of default, multiplied by (b) 130% of the number of shares into which the notes (including all principal, interest and late fees) may be converted.
In the event of a default or upon the occurrence of certain fundamental transactions as defined in the 2007 Notes, the investors will have the right to require the Company to redeem the 2007 Notes at a premium. In addition, at any time on or after August 1, 2010, the investors may accelerate the partial payment of the 2007 Notes by requiring that the Company convert at the lower of the then conversion price or a 7.5% or 10.0% discount to the recent volume weighted average price of the Company’s common stock, or at the option of the Company, redeem in cash, up to an amount equal to 20% of the aggregate dollar trading volume of the Company’s common stock over the prior 20-trading day period.
RAPTOR NETWORKS TECHNOLOGY, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Warrants
In connection with the SPAs, the Company issued detachable warrants as follows:
(1) All information presented reflects amendments made in January 2007.
(2) Current exercise price reflects the effect of anti-dilution provision as a result of the April 2008 SPA.
(3) The April 2008 SPA modified the warrants to eliminate the contingency provision.
(4) The term begins as of the effective date of the registration statement.
(5) The fair value of the Series O warrants has not yet been recorded since the contingency provisions have not been met.
(6) Additional warrants were granted due to the anti-dilution provisions in the 2007 SPA.
(7) Exercise price is the lesser of $0.50 or 75% of the lowest of the following:
(i) The average of the dollar volume-weighted average price of the stock for the 15 consecutive trading days immediately following the public disclosure of an event of default;
(ii) The lowest of the dollar volume-weighted average price of the stock during the 30 consecutive trading days ending on the date of exercise;
(iii) The average of the dollar volume-weighted average price of the stock for the 3 consecutive trading days immediately preceding the date of exercise; or
(iv) The average of the dollar volume-weighted average price of the stock for the 3 consecutive trading days immediately following the date of exercise.
(8) Exercise price was amended by July 2008 SPA.
(9) The Replacement Warrants are exercisable on a one-to-one basis as the Series Q warrants are exercised. The exercise price is the lowest of $0.50 or 75% of the lowest of the following:
(i) The average of the dollar volume-weighted average price of the stock for the 30 consecutive trading days immediately following the public disclosure of an event of default;
(ii) The average of the dollar volume-weighted average price of the stock for the 30 consecutive trading days immediately preceding the public disclosure of an event of default;
(iii) The average of 3 lowest volume-weighted average prices of the stock during either (i) or (ii) above.
The holders’ rights to exercise the 9,761,536 Series M warrants was contingent on a mandatory conversion of the 2006 Notes at the option of the Company. A mandatory conversion for a portion of the 2006 Notes took place on July 30, 2007 entitling investors to exercise up to 7,646,361 M warrant shares. The April 2008 SPA contained a provision which removed the contingency on the remaining M warrants such that they are immediately exercisable. The Company recognized $1,146,063 of expense related to the M warrants for the year ended December 31, 2008. The value of the M warrants was measured at fair value on January 18, 2007 using the Black-Scholes option pricing model. The Replacement Warrants are exercisable on a one-for-one basis for every Series Q warrant exercised.
RAPTOR NETWORKS TECHNOLOGY, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Since conversion of the Series O warrants is contingent on a mandatory conversion of the 2007 Notes and since the exercise of the Replacement Warrants is contingent on the exercise of the Series Q warrants, the total charge was measured as of the date of issuance of the Series O warrants and the Replacement Warrants. This charge will not be recognized until the mandatory conversion “contingency” has been satisfied. The fair values of the Series O warrants and Replacement Warrants at inception were $1,493,341 and $2,725,625, respectively.
The fair value of the conversion options and the detachable warrant liabilities were calculated using the Black-Scholes Option Pricing Model with the following assumptions for the year ended:
RAPTOR NETWORKS TECHNOLOGY, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Activity in the 2006 Notes and 2006 Warrants was as follows:
Activity in the 2007 Notes and 2007 Warrants is as follows:
RAPTOR NETWORKS TECHNOLOGY, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Activity in the April 2008 Notes and 2008 Warrants is as follows:
Activity in the July 2008 Notes and July 2008 Warrants is as follows:
RAPTOR NETWORKS TECHNOLOGY, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Activity in the July 2010 Notes as follows:
A summary of the balances as of December 31, 2010 and 2009 follows:
6. Stockholders’ Equity
The Company’s authorized capital consists of 200,000,000 shares of common stock, par value $0.001 per share and 5,000,000 shares of preferred stock, no par value per share.
During 2010, the Company issued 200,000 shares of common stock for consulting services valued at $42,000.
During 2010, the Company issued 1,958,235 shares of common stock for the conversion of $300,000 of the principal balance of the July 2008 Notes. Additionally, the Company increased additional paid-in capital by $195,982 for the reduction in the conversion option liability as a result of the conversion.
During 2009, the Company issued 200,000 shares of common stock for consulting services valued at $34,000.
During 2009, the Company issued 14,894,969 shares of common stock for the conversion of $4,376,804 of the principal balance of notes payable. Additionally, the Company increased additional paid-in capital by $1,101,870 for the reduction in the conversion option liability as a result of the conversion.
RAPTOR NETWORKS TECHNOLOGY, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
7. Stock Options
2005 Stock Plan
The Company’s 2005 Stock Plan was approved by the Company’s Board of Directors on April 7, 2005, approved by the Company’s shareholders on June 9, 2005, and amended and restated as the First Amended and Restated 2005 Stock Plan (“2005 Plan”) by the Company’s Board of Directors on June, 29, 2007. The Company filed a registration statement on Form S-8 with the Securities and Exchange Commission (“SEC”) in May 2007 to cover the issuance of up to 3,000,000 shares of common stock underlying options and stock purchase rights authorized for issuance under the 2005 Plan and qualified for issuance the underlying securities with the California Department of Corporations in July, 2007. Prior to that time, the Company issued only non-plan stock options. The 2005 Plan is now the Company’s only formal plan for providing stock-based incentive compensation to the Company’s eligible employees, non-employee directors and certain consultants. The Board of Directors or committee of the Board of Directors administering the 2005 Plan has discretion to set vesting, expiration and other terms of awards under the 2005 Plan. As of December 31, 2010, the 2005 Plan had a total of 612,000 options outstanding and 2,288,000 shares reserved for future grants.
Non-Plan Options
Prior to approval of the 2005 Plan, the Company granted stock options out-of-plan. These non-plan options provided for the periodic issuance of stock options to our employees and non-employee board of directors. The vesting period for the non-plan stock options is three equal annual installments commencing on the first anniversary of the date of grant. The maximum contractual term of stock options granted under these out-of-plan options was eight years. As of December 31, 2010, there were 850,000 non-plan options outstanding.
A summary of the activity of the Company’s stock options for the years ended December 31, 2009 and 2010 is presented below:
As of December 31, 2010, there is no unrecognized stock-based compensation cost related to unvested stock options.
RAPTOR NETWORKS TECHNOLOGY, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A summary of the status of the Company’s unvested stock options as of December 31, 2010 is presented below:
For the year ended December 31, 2010 and 2009, the Company recognized $111,195 and $102,551, respectively, in stock-based compensation costs related to the issuance of options to employees. These costs were calculated using the Black-Scholes Option Pricing Model and are reflected in operating expenses.
8. Warrants
Warrants granted to investors, brokers and other service providers are summarized as follows:
RAPTOR NETWORKS TECHNOLOGY, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table summarizes warrants outstanding at December 31, 2010:
9. Commitments and Leases
The Company leases office space under a non-cancelable operating lease expiring March 31, 2011 for $1,560 per month. Rent expense was $18,720 for both of the years ended December 31, 2010 and 2009.
In October 2008, the Company rendered possession of its prior operating facility to the landlord. In November 2009, the Company settled the matter for $216,000 plus simple interest at 10 percent per annum. The Company paid $7,000 on the date of the agreement. Beginning January 15, 2010 and continuing through January 15, 2012, the Company will make monthly payments of $9,000. A final payment of $6,106 is due on February 15, 2012. As a result of the settlement, the Company recorded additional expense of $21,435 for the year ended December 31, 2009.
Future minimum payments under the settlement agreement are as follows:
RAPTOR NETWORKS TECHNOLOGY, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As of December 31, 2010, the Company had $2,234 in purchase order commitments.
10. Income Taxes
The Company computes and records taxes payable based upon determination of taxable income which is different from pre-tax financial statement income. Such differences arise from the reporting of financial statement amounts in different periods for tax purposes. The timing differences are a result of different accounting methods being used for financial and tax reporting.
The Company’s total deferred tax assets and deferred tax liabilities were as follows at December 31:
A valuation allowance has been established against the realization of the deferred tax assets since the Company has determined that the operating loss carryforwards may not be realized.
The Company has federal and state net operating loss carryforwards of approximately $87,516,000 and $84,530,000, respectively expiring between 2030 and 2025, respectively. Should the Company move out of the enterprise zone, approximately $32,400,000 of the state net operating loss will be suspended leaving approximately $31,000,000 of the general state net operating loss remaining.
Internal Revenue Code Section 382 imposes limitation on our ability to utilize net operating losses if we experience an ownership change and for the NOL’s acquired in the acquisitions of subsidiaries. An ownership change may result from transactions increasing the ownership percentage of 5% or greater stockholders in the stock of the corporation by more than 50 percentage points over a three-year period. The value of the stock at the time of an ownership change is multiplied by the applicable long-term tax exempt interest rate to calculate the annual limitation. Any unused annual limitation may be carried over to later years.
At December 31, 2010 and 2009, the amount of gross unrecognized tax benefits before valuation allowances and the amount that would favorably affect the effective income tax rate in future periods after valuation allowances were zero.
The Company files income tax returns in U.S. federal and various state jurisdictions. The Company is beyond the statute of limitations subjecting it to U.S. federal and state income tax examinations by tax authorities for years before 2007 and 2006, respectively. The Company is not currently subject to any income tax examinations by any tax authority. Should a tax examination be opened, management does not anticipate any tax adjustments, if accepted, that would result in a material change to its financial position.
RAPTOR NETWORKS TECHNOLOGY, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
11. Subsequent Events
The following subsequent events have occurred through the filing date of this report, March 3, 2011.
In a letter agreement dated January 11, 2011, signed by Castlerigg Master Investments, Ltd., Cedar Hill Capital Partners Onshore, LP, Cedar Hill Capital Partners Offshore, Ltd. (the “Investors”) and the Company, the Investors granted the Company a limited waiver by which interest in the amount of $252,508 due under the secured notes payable as of December 31, 2010 will be added to the principal balances of the secured notes rather than be paid in cash or through conversion of the notes.
INDEX TO EXHIBITS FILED WITH THIS REPORT
Exhibit
Number
Description
10.5
Fourth amendment to facility lease agreement with Martin Investment Company dated August 16, 2010
31.1
Certification of the Chief Executive Officer Required by Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2
Certification of the Chief Financial Officer Required by Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1
Certification of the Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2
Certification of the Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002