RISK FACTORS
An investment in the common stock offered by this prospectus involves a high degree of risk.
In addition to the other information in this prospectus, you should carefully consider the following risks before making an investment decision. The risks and uncertainties described below are not the only ones we face. Additional risks and
uncertainties not presently known to us or that we currently consider immaterial may also impair our business operations. If any of the following risks actually occur, our business and financial results could be harmed. In that case, the trading
price of our common stock could decline. You should also refer to the other information set forth in our Annual Report on Form 10-K for the fiscal year ended December 31, 2006 filed with the Securities and Exchange Commission (SEC) on
April 2, 2007, including our financial statements and the related notes, as well as our other filings with the SEC.
Risks Related to Our
Business
We have a limited operating history, have incurred significant operating losses in our first few years of operation and have not
consistently achieved profitability on an annual basis.
We have a limited operating history and limited revenues derived from our
operations. We began our business operations in December 1999 and did not generate our first revenues until 2002. Our revenues grew from $4.3 million in 2004 to $12.2 million in 2005 and $17.1 million in 2006. We have incurred significant net losses
attributable to common stockholders since our inception, including net losses of $1.3 million in 2003, $0.6 million in 2004 and $11.2 million in 2006. Our net loss in 2006 resulted in part from reserves we recorded in connection with certain of
our contracts which have ongoing operating costs in excess of our contract revenues. We may not be successful in renegotiating these contracts, and as a result, our losses relating to these contracts may continue longer than we expect. At
December 31, 2006, we had an accumulated deficit of $15.3 million.
1
Our operations prior to 2006 primarily focused on development of our technology and groundwater treatment
system, building our sales and marketing capabilities, commencing the commercial launch of our system and developing and maintaining customer relationships. In addition, our ability to sell our systems and services depends on, among other things,
the level of demand for contaminated groundwater treatment which is an evolving market. Even if we do achieve significant revenues from our business operations, increased operating expenses associated with any expansion of our business may result in
future operating losses in the near term as we, among other things:
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seek to acquire new customers;
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expand geographically beyond the southwest portion of the United States;
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make significant capital expenditures to support our ability to provide services under our recurring revenue contracts;
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expand our internal sales force and develop strategic relationships with companies serving the water industry on a national basis;
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fund development costs for our systems and technology; and
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incur increased general and administrative expenses as our company grows, including increased costs as a result of becoming a public company.
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As a result of these and other factors, we may not achieve, sustain or increase our profitability on an ongoing basis.
Our future operating results will likely fluctuate significantly from period to period.
We expect our future revenues and operating results to fluctuate significantly from period to period due to a number of factors, including:
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customer budgets or commitments for our groundwater treatment system and/or services;
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the effectiveness of our new and expanding internal sales and marketing organization;
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demand for our systems and/or services;
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our ability to develop and market new and enhanced technology, including our proprietary ion exchange technology;
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product and price competition in our market;
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length of our sales cycle;
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general economic conditions;
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ability to control our costs, including labor and the cost of materials to build our system; and
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ability to build and install systems on a timely basis and within budgets.
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Any of the foregoing factors, some of which are out of our control, may cause our operating expenses to be disproportionately high or cause our revenues
and operating results to fluctuate, which could prevent us from maintaining or increasing our business. In addition, our future revenues or our future operating expenses may not be consistent with our past results, which could adversely affect our
stock price.
If we do not manage our anticipated growth effectively, we may not be able to develop or implement the infrastructure to support our
operations, market our services and manage our relationships with customers which could place significant strain on our management and significantly harm our business and operating results.
We have grown rapidly, with our revenues increasing from $4.3 million in 2004 to $12.2 million in 2005 and $17.1 million in 2006, and the number of our
employees increasing from 29 as of December 31, 2004 to 44 as of December 31, 2005 and 65 as of December 31, 2006. We expect to continue to expand significantly our management, research and development, marketing and sales, testing,
quality control, engineering functions, customer service and support operations as well as financial and accounting controls. For instance, we recently expanded our operations to the Southeast U.S. with our acquisition of MPT. This expansion has
placed, and will continue to place, significant strain on our management and administrative, operational, technical and financial infrastructure. If our management is unable to manage growth effectively, the quality of our field services, our
ability to attract and retain key personnel, and our business or prospects could be harmed significantly. To manage growth effectively, we must:
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continue to expand our manufacturing capacity;
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increase the size of and continually monitor our field service support capability;
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meet the demands placed on us by our customers;
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continue to enhance our operations and financial and management systems;
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maintain and improve effective internal control over financial reporting and disclosure controls and procedures; and
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expand, train and manage our employee base.
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We may not be able to effectively manage any expansion in one or more of these areas, and any failure to do so could harm our ability to maintain or increase revenues and operating results. In addition, our growth may require us to make
significant capital expenditures or to incur other significant expenses, and may divert the attention of our personnel from our core business operations, any of which could affect our financial performance adversely.
Our financial success will depend in part on the efforts of strategic partners we may work with in the future.
In December 2005, we entered into a strategic sales and marketing agreement with Shaw Environmental, Inc., an affiliate of The Shaw Group, Inc., to market
our arsenic treatment systems on an exclusive basis to water providers in various states. We may enter into other such strategic relationships with other companies focused on the water industry on a national basis. Our financial success and our
anticipated growth will depend in part on the efforts of these strategic partners in marketing and selling our groundwater treatment systems. If Shaw or any other strategic partners fail to perform satisfactorily under their respective agreements
with us, or if we fail to maintain these relationships or establish new relationships as required, then sales of our systems will likely suffer. In addition, our revenues may not grow as anticipated, and we could be subject to unexpected costs which
could harm our operating results and financial condition significantly. To date, our revenues under the agreement with Shaw have been less than were anticipated.
Our long sales cycles make predicting our financial results difficult.
Typically, our contracts have a term of five or more
years and, with respect to systems that are not sold outright to the water provider, also contain an option either to purchase the system or to renew the contract at the end of the initial contract term. Since most of our sales are based on
long-term contracts, our customers generally take a longer time to decide to purchase our system and/or services, thus creating a lengthy sales cycle. Other reasons for our long sales cycle include:
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the size of the initial capital outlay to be incurred by our customers;
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the availability of many alternatives that may be considered by our customers, including water importation, water blending, coagulation microfiltration (a process
of destabilizing charges on contaminants in water by adding chemical coagulants that can then be filtered and removed), reverse osmosis (a pressure-driven separation process that removes contaminants from water by forcing them through a membrane
barrier), electrodialysis reversal (a process that transfers contaminants by direct electric current flow through membranes thus removing them from water) and ion exchange processes of our competitors;
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the long approval procedures imposed by state agencies; and
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the lengthy approval process of many water providers equipment/contract procurement procedures due to multiple approvals that may be required by municipal
boards, public bidding or state public utility commission requirements, which is sometimes exacerbated by the initial capital outlay needed to purchase our system.
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Our long sales cycles, as well as the placement of large orders with short lead times on an irregular and unpredictable basis, may cause our revenues and
operating results to vary significantly and unexpectedly from period to period. Since our operating expenses are largely based on anticipated revenue trends and a significant portion of our expenses are, and will continue to be, fixed, any delay in
generating or recognizing revenues could harm our operating results or financial condition significantly.
Our groundwater treatment system and the
technology upon which it is based may not achieve widespread market acceptance among our water provider customers which may impact demand for our system and services.
We have developed our proprietary technology and processes for groundwater treatment based on ion exchange technology that competes with other forms of groundwater treatment technologies that currently are in
operation throughout the United States. Our groundwater treatment system and the technology on which it is based may not achieve widespread market acceptance. Our success will depend on our ability to market our system and services to businesses and
water providers on terms and conditions acceptable to us and to establish and maintain successful relationships with various water providers and state regulatory agencies.
We believe that market acceptance of our system and technology and our related success will depend on many factors including:
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the perceived advantages of our system over competing groundwater treatment solutions;
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the actual and perceived safety and efficacy of our system;
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the availability and success of alternative groundwater treatment solutions;
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the pricing and cost effectiveness of our system;
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our ability to access businesses and water providers that may use our system;
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the effectiveness of our sales and marketing efforts;
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the permitting of our technology by state regulatory agencies;
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the willingness of potential customers to enter into long-term contracts;
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publicity concerning our system and technology or competitive solutions;
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timeliness in assembling and installing our system on customer sites;
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the ability of Shaw or other partners to market our systems and related services successfully on a national basis;
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whether or not our existing customers continue to use our system and services and/or renew service contracts after their expiration;
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our ability to respond to changes in the regulatory standards for maximum contaminant levels of various contaminants; and
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our ability to provide effective service and maintenance of our system to our customers satisfaction.
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If our system or technology fail to achieve or maintain market acceptance or if new technologies are introduced by others that are more favorably
received than our technology, are more cost effective or otherwise render our technology obsolete, we may experience a decline in demand for our system. If we are unable to market and sell our system and services successfully, our revenues would
decline and our operating results and prospects would suffer.
We may be unable to attract and retain qualified personnel which could harm our business,
operating results, financial condition and prospects significantly.
Our future success also will depend, in large part, on our ability
to identify, attract and retain sufficient numbers of highly skilled employees, particularly qualified sales, marketing and engineering personnel. As of December 31, 2006, we had 65 employees. Although we have expanded our sales force somewhat,
we have a limited number of sales and marketing employees and consultants, as well as service employees who monitor our installed systems. We may not succeed in identifying, attracting and retaining individuals who qualify for these positions.
Further, competitors and other companies may attempt to recruit our employees or our prospective employees. If we are unable to hire and retain adequate staffing levels, we may not be able to increase sales of our systems or services or adequately
support our installed systems, which could harm our business and prospects.
Our future success also depends on the experience and
expertise of Peter Jensen, our CEO, whose talents, efforts and relationships within the water industry have been, and continue to be, critical to our success. We have an employment agreement with Mr. Jensen that provides for at will
employment. However, we cannot prevent Mr. Jensen from leaving our employ if he chooses to do so. We do not currently carry key man insurance upon the life of Mr. Jensen or the lives of any of our employees or officers. The
loss of Mr. Jensens services and access to his abilities and relationships could adversely affect our ability to maintain or increase our customer base and could harm our operating results and prospects significantly.
The current geographic concentration of our customers in California and Arizona and the location of our headquarters in California make our business particularly
vulnerable to adverse conditions affecting these markets.
Currently, our customers are concentrated geographically, primarily in the
states of California and Arizona. Our revenues and operating results are therefore subject to local regulatory, economic, demographic and weather conditions in those areas. A change in any of these conditions could make it more costly or difficult
for us to conduct our business. In addition, we are subject to greater risk of loss from earthquakes and wildfires because our headquarters, where we assemble our systems, and most of the well locations that utilize our system are concentrated in
California. Any of these occurrences could result in increased costs and a disruption in our operations, which would harm our operating results and financial condition significantly.
Due to our current client concentration, a loss of one of our significant customers could harm our business, operating results, financial condition and prospects.
As of December 31, 2006, we had 26 customers. Our top two customers collectively, accounted for 47% of our revenues during 2006 and typically have
more than one contract with us for services provided to different wells. Our customers, including these top two customers, may, upon the occurrence of certain circumstances, elect to terminate their contracts with us prior to their expiration and
seek services from our competitors. In addition, upon the expiration of these contracts, our customers may decide not to renew such contracts with us. If we were to lose one or more of these significant customers for any reason, our revenues would
decline significantly and our business, operating results and prospects would suffer.
4
Most of our operations are conducted in one facility in Southern California. Any disruption at our manufacturing and
executive office facility could increase our expenses.
Most of our operations are conducted in one facility in Southern California,
with all manufacturing operations and our executive offices located at that facility. We take precautions to safeguard our facilities, including obtaining insurance, maintaining health and safety protocols, and using off-site storage of computer
data. However, a natural disaster, such as an earthquake, fire or flood, could cause substantial delays in our operations, damage or destroy our manufacturing equipment or inventory and cause us to incur additional expenses. The insurance we
maintain against natural disasters may not be adequate to cover our losses in any particular case, which would require us to expend significant resources to replace any destroyed assets, thereby harming our financial condition and prospects
significantly.
We face risks associated with the design and operation of our systems which may prevent us from increasing our revenues.
We take responsibility for the design, construction, initial maintenance and installation of our groundwater treatment system. However, we cannot
predict whether we will be able to design our system for every particular groundwater contaminant. Thus, we may be required to turn away customers that require treatment of chemical contaminants that our system does not treat. We also cannot
guarantee that once constructed, our system will operate according to its design or be free from defects. Because our system treats groundwater for dangerous contaminants, if our systems fail to operate properly, it could cause significant public
harm.
Following installation, testing and regulatory certification of a system, actual day-to-day operation of our groundwater treatment
systems is transitioned to our customers personnel. Though we retain ownership of many of our systems, our customers take responsibility for operation of these systems. We, however, continue to be responsible for the maintenance of the
installed systems in most cases. We may not be able to provide sufficient employees for the maintenance of those systems. In addition, because our systems are located at our customers sites, we will not always be physically present should
problems arise.
If there are defects in our system or if significant reliability, quality or performance problems develop with respect to
our system or services, this may have a number of negative effects on our business, operating results, financial condition and prospects, including:
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loss of existing customers;
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failure to attract new customers and achieve market acceptance;
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delays in collecting accounts receivable;
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diversion of management and development resources and the attention of engineering personnel;
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significant customer relations problems;
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high service, support, repair, warranty and insurance expenses;
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removal of our systems from service by state regulatory agencies for failure to operate properly; and
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legal actions for damages by our customers.
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order to operate our business successfully, we must meet evolving customer requirements for groundwater treatment and invest in the development of our water treatment technology.
If we fail to develop or enhance our system and services to satisfy evolving customer demands, our business, operating results, financial condition and
prospects will be harmed significantly. The market for groundwater treatment is characterized by changing technologies, periodic new product introductions and evolving customer and industry standards. For instance, competitors in the groundwater
treatment industry are continuously searching for methods of water treatment that are more cost-effective and more efficient. Our current and prospective customers may choose groundwater treatment solutions and/or services that are offered at a
lower price than our system and/or services. To achieve market acceptance for our system and services, we must effectively and timely anticipate and adapt to customer requirements and offer products and services that meet customer demands. This may
cause us to pursue other technologies or capabilities through acquisitions or strategic alliances. Our customers may require us to provide water treatment solutions for many different contaminants or higher volumes of water or to decrease the
presence of contaminants well below an applicable MCL. We also may experience design, engineering and other difficulties that could delay or prevent the development, introduction or marketing of any modifications to our system or our new services.
Our failure to develop successfully and offer a system or services that satisfy customer requirements would significantly weaken demand for our system or services, which would likely cause a decrease in our revenues and harm our operating results.
In addition, if our competitors introduce solutions and/or services based on new or alternative water treatment technologies, our existing and future system and/or services could become obsolete, which would also weaken demand for our system or
services, thereby decreasing our revenues and harming our operating results.
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Our reliance on third party suppliers poses significant risks to our business and prospects.
We contract for all of the components in our system, including commodity products such as salt and replacement resin, with third-party suppliers. We are
subject to substantial risks because of our reliance on these suppliers. For example:
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our suppliers may not provide components that meet our specifications in sufficient quantities;
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our suppliers may face a reduction or an interruption of supply of our components;
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our suppliers may face production delays due to natural disasters or strikes, lock-outs or other such actions;
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one or more suppliers could make strategic changes in its or their product lines; and
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many of our suppliers are small companies which are more likely to experience financial and operational difficulties than larger, well-established companies,
because of their limited financial and other resources.
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As a result of any of these factors, we may be required to find
alternative suppliers for the components of our system. It may take considerable amounts of time to identify and qualify such alternative suppliers. In addition, we may be required to redesign our system to conform to the components provided by
these alternative suppliers. As a result of these factors, we may experience delays in obtaining raw materials and components on a timely basis and in sufficient quantities from our suppliers, which could result in delays in the production and
installation of our system. These delays could harm our ability to sell our system or enter into recurring revenue contracts, which would cause our revenues and operating results to decline.
As part of our growth, we intend to increase our ability to provide service to our customers under recurring revenue contracts and develop new technologies
internally. Our failure in these endeavors could negatively impact our stock price and cause our business, operating results, financial condition and prospects to suffer.
We plan to continue to grow rapidly for the foreseeable future. As part of this growth, we intend to make significant capital expenditures in order to
support our operations focused on our recurring revenue contracts. In addition, we plan to continue developing new technologies through our research and development efforts. The capital expenditures we make or the technologies we develop internally
may not result in the financial results that we expected. In addition, developing new technologies may cause diversion of managements attention from our existing business. All of these factors could prevent us from maintaining or increasing
our customer base and business and cause the price of our common stock to decline.
The revenues from our long-term contracts are moderately seasonal,
with higher processing fees received in the summer months and lower processing fees received in the winter months.
Our business,
particularly the revenues we receive from our long-term contracts, is moderately seasonal due to the impact of summer and hot weather conditions on the water requirements of our customers. In the summer and warmer months, our customers have a higher
demand for water and generally increase the utilization of their groundwater resources resulting in a higher volume of groundwater treated during a period and thus higher revenues from our long-term contracts. Conversely, our customers experience
lower demand in cooler months in the first and fourth calendar quarters, resulting in lower revenues from our long-term contracts during those periods. This seasonality in processing fees has resulted in fluctuations in our revenues and operating
results. These moderate seasonal trends can cause some reductions in our profit margin and variations in our financial condition, especially during our slower periods.
Risks Related to Our Intellectual Property
Failure to protect, or uncertainty regarding the validity,
enforceability or scope of, our intellectual property rights could impair our competitive position.
Our groundwater treatment systems
and services utilize a variety of proprietary rights that are important to our competitive position and success. Because the intellectual property associated with our technology is evolving and rapidly changing, our current intellectual property
rights may not protect us adequately. We rely on a combination of patents, trademarks, trade secrets and contractual restrictions to protect the intellectual property we use in our business. In addition, we generally enter into confidentiality or
license agreements, or have confidentiality provisions in agreements, with our employees, consultants, strategic partners and customers and control access to, and distribution of, our technology, documentation and other proprietary information. We
have filed at least six pending patent applications with the USPTO and hold at least four issued United States patents. We have filed at least nine patent applications in key foreign jurisdictions around the world and hold at least five granted
foreign patents on various aspects of our treatment system process. These pending patent applications may not be granted or, if granted, the resulting patent may be challenged or invalidated by our competitors or by other third parties. Despite our
efforts to protect our proprietary rights, unauthorized parties may attempt to copy or otherwise obtain and use our intellectual property. In addition, monitoring unauthorized use of our intellectual property is difficult, and we cannot be certain
the steps we have taken to protect our intellectual property will prevent unauthorized use of it.
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Because legal standards relating to the validity, enforceability and scope of protection of patent and
intellectual property rights in new technologies are uncertain and still evolving, the future viability or value of our intellectual property rights is uncertain. Furthermore, our competitors independently may develop similar technologies that limit
the value of our intellectual property or design around patents issued to us. If competitors or third parties are able to use our intellectual property or are able to successfully challenge, circumvent, invalidate or render unenforceable our
intellectual property, we likely would lose a significant portion of our competitive advantage in the market. We may not be successful in securing or maintaining proprietary or patent protection for the technology used in our system or services, and
protection that is secured may be challenged and possibly lost. We may have to prosecute unauthorized uses of our intellectual property and the expense, time, delay and burden on management of such litigation could prevent us from maintaining or
increasing our business. Our inability to protect our intellectual property adequately for these and other reasons could result in weakened demand for our system or services, which would result in a decline in our revenues.
We could become subject to litigation regarding intellectual property rights, which could harm our business significantly.
Our commercial success will continue to depend in part on our ability to make and sell our systems or provide our services without infringing the patents
or proprietary rights of third parties. Our competitors, many of which have substantially greater resources than us and have made significant investments in competing technologies or products, may seek to apply for and obtain patents that will
prevent, limit or interfere with our ability to make or sell our system or provide our services.
If we are unsuccessful in any challenge
to our rights to market and sell our system or to provide our services, we may, among other things, be required to:
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pay actual damages, royalties, lost profits and/or increased damages and the third partys attorneys fees, which may be substantial;
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cease the development, manufacture and/or sale of our system or the provision of services that use the intellectual property in question through a court-imposed
sanction called an injunction;
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expend significant resources to modify or redesign our system or other technology or services so that they do not infringe others intellectual property rights
or to develop or acquire non-infringing technology, which may not be possible; or
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obtain licenses to the disputed rights, which could require us to pay substantial upfront fees and future royalty payments and may not be available to us on
acceptable terms, if at all.
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Even if we successfully defend any infringement claims, the expense, time, delay and burden
on management of litigation could prevent us from maintaining or increasing our business. Further, negative publicity could decrease demand for our systems and services and cause our revenues to decline, thus harming our operating results
significantly.
If we are unable to protect the confidentiality of our proprietary information and know-how, the value of our technology, system and
services could be harmed significantly.
We also rely on trade secrets, know-how and other proprietary information in operating our
business. We seek to protect this information, in part, through the use of confidentiality agreements with employees, consultants, advisors and others upon commencement of their relationships with us. These agreements require that all confidential
information developed by the individual or made known to the individual by us during the course of the individuals relationship with us be kept confidential and not disclosed to third parties. Our agreements with employees also provide that
any inventions conceived by the individual in the course of rendering services to us shall be our exclusive property. Nonetheless, those agreements may not provide adequate protection for our trade secrets, know-how or other proprietary information
and prevent their unauthorized use or disclosure. In the event of unauthorized use or disclosure of our trade secrets or proprietary information, these agreements may not provide meaningful protection, particularly for our trade secrets or other
confidential information.
To the extent that consultants, key employees or other third parties apply technological information
independently developed by them or by others to our proposed products, disputes may arise as to the proprietary rights to such information which may not be resolved in our favor. The risk that other parties may breach confidentiality agreements or
that our trade secrets become known or independently discovered by competitors, could harm us by enabling our competitors, who may have greater experience and financial resources, to copy or use our trade secrets and other proprietary information in
the advancement of their products, methods or technologies. The disclosure of our trade secrets would impair our competitive position, thereby weakening demand for our system or services and harming our ability to maintain or increase our customer
base.
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Risks Related to Our Industry
We are subject to environmental risks that may prevent us from selling our system and, if such risks are realized, may subject us to clean-up costs or litigation that could adversely affect our business, operating
results, financial condition and prospects.
Our technology relies primarily on the ion exchange process, which ultimately generates a
byproduct known as brine waste. Our customers will be required to dispose of any waste materials or byproducts from our treatment process in a manner mandated by the EPA or state regulatory agencies. The EPA or state regulatory agencies may consider
these or other byproducts of the ion exchange process to be hazardous, and in such cases, our customers will be subject to additional requirements relating to the treatment, storage, disposal and transportation of hazardous substances. Though our
customers take title to all such brine waste, together with all other byproducts of the ion exchange technology process, we generally contract with third parties to secure waste disposal services on our customers behalf. We cannot predict
whether any new laws, statutes, ordinances, rules or regulations will be enacted that may require significant modification to our system or our services, which may weaken demand for our system or services and harm our business significantly.
In addition, we cannot predict whether any third party will assert against us any claims for violations of any federal, state or local
statute, ordinance, law, rule or regulation relating to hazardous or toxic substances in connection with the brine waste or groundwater treatment process or as a result of any actions of the third-party waste disposal services with whom we contract
on behalf of our customers. Furthermore, CERCLA and analogous state laws provide for the remediation of certain contaminated facilities and impose strict, joint and several liability for remediation costs on current and former owners or operators of
a facility at which there has been a release or a threatened release of a hazardous substance. This liability is also imposed on persons who arrange for the disposal or transportation of such substances, and on those who transport such
substances to the facility. Hundreds of substances are defined as hazardous under CERCLA and analogous state laws and their presence, even in small amounts, can result in substantial liability. The expense of conducting a cleanup can be
significant. The actual costs for these liabilities could be significantly greater than the amounts that we might be required to accrue on our financial statements from time to time. In addition to the costs of complying with environmental
regulations, we may incur costs to defend against litigation brought by government agencies and private parties. As a result, we may be required to pay fines to governmental agencies if we are found to have violated these environmental laws. In
addition, we may in the future be a defendant in lawsuits brought by private parties who assert claims alleging environmental damage, natural resource damages, personal injury, property damage and/or violations of permits and licenses by us. If such
claims are asserted against us, and if we do not prevail in defending such claims, we may be required to pay significant damages, causing our financial condition to suffer. Even if we successfully defend against such claims, we may devote
significant time and resources to litigation, which would likely prevent us from maintaining or increasing our customer base and business.
Changes in
governmental regulation and other legal uncertainties could adversely affect our customers or decrease demand for our systems, and thus harm our business, operating results and prospects.
In the United States, many different federal, state and local laws and regulations govern the treatment and distribution of contaminated groundwater and
disposal of attendant wastes. The increased interest in the treatment of contaminated groundwater due to increased media attention on the adverse health effects from contaminated drinking water may result in intervention by the EPA or state
regulatory agencies under existing or newly enacted legislation and in the imposition of restrictions, fees or charges on users and providers of products and services in this area. These restrictions, fees or charges could adversely affect our
customers, which could negatively affect our revenues. Conversely, the failure of the EPA or state regulatory agencies to act on a timely basis to set interim or permanent standards for pollutants such as MCLs, or to delay effective dates for
standards for pollutants, grant waivers of compliance with such standards or take other discretionary actions not to enforce these standards, may decrease demand for our system and services because our customers would not be required to bring their
water into compliance with such regulatory standards. While we are not aware of any currently proposed federal regulation directly affecting our business, we cannot predict whether there will be future legislation regarding the treatment and
distribution of contaminated groundwater and the disposal of attendant wastes. If there are significant changes in such laws and regulations, such changes could weaken demand for our system or services and cause our revenues to decline, thus harming
our operating results and prospects.
Each groundwater treatment solution must be permitted by a regulatory agency prior to its use by our customers,
and changing drinking water standards and other factors could affect the approval process with respect to our system by such regulatory agencies.
Each groundwater treatment solution, including our groundwater treatment system and those of our competitors, must be permitted by applicable state regulatory agencies prior to use of such systems by our customers. We
cannot assure you when or whether the various regulatory agencies will approve our system for use by our customers. The application process for our system is time consuming and often involves several information requests by the regulatory agencies
with respect to our system. Any long waiting periods or difficulties faced by our customers in the application process could cause some of our customers to use competing technologies, products, services or sources of drinking water, rather than use
our technology.
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Also, we cannot predict the impact of changing drinking water standards on the approval of our technology
for groundwater treatment. Our system currently treats groundwater so that it meets the MCL for several different contaminants. MCLs are set by the EPA and/or state regulatory agencies that regulate drinking water contaminants. However, the MCL for
any contaminant is subject to review and revision by the EPA or state regulatory agencies. MCLs may be changed to levels below that which our system can treat, resulting in state regulatory agencies failing to approve our system. Without regulatory
approval, our system could not be used by our customers, and we may be required to develop technology that meets any revised MCLs, and to the extent we cannot do so, sales of our system will suffer. The development of such technology may require
increased expenditures, and during this development, we could be delayed in selling our system, which would cause our revenues to decline, thus harming our operating results significantly.
Demand for our groundwater treatment systems would be adversely affected by a downturn in government spending related to groundwater treatment solutions, or in the
cyclical residential or non-residential building markets.
Our business is dependent upon spending on groundwater treatment solutions by
utilities, municipalities and other organizations that supply water, which in turn is often dependent upon residential construction, population growth, continued contamination of groundwater sources and regulatory responses to this contamination. As
a result, demand for our water treatment systems could be impacted adversely by general budgetary constraints on our governmental or regulated customers, including government spending cuts, the inability of government entities to issue debt to
finance any necessary groundwater treatment projects, difficulty of our customers in obtaining necessary permits or changes in regulatory limits associated with the chemical contaminants we seek to address with our groundwater treatment system. It
is not unusual for the implementation of water treatment solutions to be delayed and rescheduled for a number of reasons, including changes in project priorities and difficulties in complying with environmental and other government regulations. If
implementation of water treatment solutions are delayed or rescheduled by our regulated customers, these customers would not have as great a need for our systems. We cannot assure you that economic conditions will continue such that state and local
governments will address groundwater contaminant needs and consider purchasing or entering into long-term contracts for our systems. In addition, although our target markets have experienced population growth in recent years along with related
residential building market growth, we cannot assure you that this growth will continue in the future. A slowdown of growth in residential and non-residential building would reduce demand for drinking water and for groundwater treatment solutions
such as our system. The residential and non-residential building markets are generally cyclical, and, historically, down cycles have typically lasted a number of years. Any significant decline in the governmental spending on groundwater treatment
solutions or residential or non-residential building markets could weaken demand for our system or services, thus harming our operating results and prospects significantly.
We operate in a competitive market, and if we are unable to compete effectively, our business, operating results and prospects could suffer.
The market environment in which we operate is very dynamic and is characterized by evolving standards, the development of new technology, regulations
which continually reduce the acceptable levels for contaminants and affect the means, methods and costs of disposing of wastes derived from groundwater treatment. Though barriers to entry in this market are high, we expect that competition from
existing market participants will intensify in the future. We believe that in such a rapidly changing market, key competitive factors include:
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development and use of technology;
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effectiveness of treatment and brine waste disposal methods;
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changing requirements of the EPA or state regulatory agencies; and
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the availability of capital to meet evolving customer needs and requirements for the treatment of contaminated water.
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We compete with large groundwater treatment companies, such as Severn Trent PLC and USFilter Corporation, a subsidiary of Siemens AG. Our competition
varies according to the contaminant being removed. Many of our current and potential competitors have technical and financial resources, marketing and service organizations, and market expertise significantly greater than ours. Many of our
competitors also have longer operating histories, greater name recognition and larger customer bases. Moreover, our competitors may forecast the course of market developments more accurately and could in the future develop new technologies that
compete with our system and/or services or even render our system and/or services obsolete. Due to the evolving markets in which we compete, additional competitors with significant market presence and financial resources may enter those markets,
thereby further increasing competition. These competitors may be able to reduce our market share by adopting more aggressive pricing policies than we can or by developing technology and services that gain wider market acceptance than our system
and/or services. Existing and potential competitors also may develop relationships with distributors of our system and services or third parties with whom we have strategic relationships in a manner that could harm our ability to sell, market and
develop our system and services significantly. If we do not compete successfully we may never achieve significant market penetration and we may be unable to maintain or increase our business or revenues, causing our operating results and prospects
to suffer.
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We could become subject to litigation as a result of claims brought against our customers, which could harm our
operating results and financial condition significantly.
Our customers are water providers that supply drinking water treated by our
system to the general public. If our customers faced claims from consumers related to the quality of the drinking water, such consumers also may bring claims against any other party with whom the customer contracted in the groundwater treatment
process. Even if our system treated the groundwater successfully for the contaminants it was designed to remove, we still may be subject to claims from such consumers. Despite any success in defending such claims, the expense, time, delay and burden
on management of litigation would likely prevent us from maintaining or increasing our business and negative publicity could weaken demand for our services, cause our revenues to decline and harm our operating results and financial condition
significantly.
Risks Related to our Finances and Capital Requirements
We will need additional capital to sustain and grow our business and we cannot provide any assurances that additional financing will be available to us on favorable terms when required, or at all.
We expect that our current cash and cash equivalents will be sufficient to fund our anticipated future growth and operations for the foreseeable
future. We cannot guarantee you that we will not need additional capital to finance our growth and operations or to accelerate our expected growth over the next 12-month period. We have based our estimate of liquidity needs on assumptions that may
prove to be incorrect, and we may spend our available financial resources much faster than we currently anticipate.
Adequate funds,
whether obtained through financial markets or collaborative or other arrangements with water providers, corporate partners or from other sources, may not be available when needed or on terms acceptable to us. We also may need to raise additional
funds in order to fund more rapid expansion, to develop new and enhanced technologies, to respond to competitive pressures or to acquire complementary technologies or assets. If additional funds are raised through the issuance of additional common
stock, other equity securities or indebtedness, the percentage ownership of our then-current shareholders may be diluted substantially and the equity or debt securities issued to new investors may have rights, preferences or privileges senior to
those of the holders of our then-existing capital stock. If adequate funds are not available or are not available on acceptable terms, we may not be able to take advantage of unanticipated opportunities, develop new products or services or otherwise
respond to competitive pressures. Such inability could prevent us from maintaining or increasing our business, result in significant harm to our financial condition and prospects and negatively affect our stock price.
We may incur indebtedness that contains terms that place restrictions on the operation of our business; our failure to comply with these terms could put us in
default, which would harm our business and operations.
We may incur indebtedness in the future that contains a number of significant
covenants. These covenants may limit our ability to, among other things, do the following:
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incur additional indebtedness;
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merge, consolidate or dispose of our assets;
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pay dividends or repurchase our capital stock;
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change our line of business;
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accept any prepayments under or otherwise modify contracts with our customers;
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enter into transactions with our affiliates; and
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grant liens on our assets.
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If we
were to incur such indebtedness, a material breach of any of these covenants would result in a default under this indebtedness which could result in significant harm to our business and operations.
We have recorded and will record non-cash expense in future periods that result in a decrease in our net income for a given period.
As required by the Financial Accounting Standards Board, or FASB, we record expense for the fair value of stock options granted and this expense is
reflected in our operating results. We rely on stock options to motivate current employees and attract new employees. As a result of the requirement to expense stock options, we may choose to reduce our reliance on stock options as a motivation
tool. If we reduce our use of stock options, it may be more difficult for us to attract and retain qualified employees. However, if we do not reduce our reliance on stock options, our reported net loss may increase or our reported net income may
decrease.
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We have also applied the provisions of SFAS No. 123R,
Share-Based Payment
, to warrants issued
to lenders and other third parties including Cross Atlantic Partners, Aqua America and BWCA. The fair value of these warrants is expensed over the period of the related agreements, as appropriate. As a result, we recognized expense in 2005 and 2006
which affected our interest expense or selling, general and administrative expense, depending upon the nature of the underlying transaction. In May 2006, we repaid our indebtedness. The remaining fair value of the associated warrants attributed to
the debt was charged to interest expense during that period. In future periods, we will recognize expense for the fair value of the warrants issued to third parties other than the lenders. Early completion of the third party agreements under which
the warrants were issued will accelerate the recognition of this expense.
We have identified material weaknesses in our internal control over financial
reporting and may not be able to report financial results accurately.
We have identified several material weaknesses in our internal
control over financial reporting. We cannot assure you that additional material weaknesses, significant deficiencies and control deficiencies in our internal control over financial reporting will not be identified in the future.
We have incurred and expect to incur substantial expenses relating to the remediation of the material weaknesses in our internal control over financial
reporting. Our accounting and financial reporting functions may not have, or may be unable to maintain, adequate resources to ensure that we will not have any future significant deficiencies or material weaknesses in our system of internal control
over financial reporting. The effectiveness of our internal control over financial reporting may in the future be limited by a variety of factors including:
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faulty human judgment and simple errors, omissions or mistakes;
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inappropriate management override of policies and procedures;
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failure to properly implement our upgraded financial software system; and
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the possibility that any enhancements to disclosure controls and procedures may still not be adequate to assure timely and accurate financial information.
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If we fail to achieve and maintain effective controls and procedures for financial reporting, we could be unable to
provide timely and accurate financial information which may cause investors to lose confidence in our reported financial information and have an adverse effect on the trading price of our common stock and lead to delisting from the Nasdaq Global
Market, an investigation by the Securities and Exchange Commission, or SEC, and civil or criminal sanctions. Additionally, ineffective internal control over financial reporting would place us at increased risk of fraud or misuse of corporate assets.
We intend to pursue, but may not be able to identify, finance or successfully complete, strategic acquisitions.
Our growth strategy includes the pursuit of acquisitions. We may not be able to identify acceptable opportunities or complete acquisitions of targets
identified in a timely manner or on acceptable terms. Acquisitions involve a number of risks, including the following:
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our managements attention will be diverted from our existing business while evaluating acquisitions and thereafter while integrating the operations and
personnel of the new business into our business;
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we may experience adverse short-term effects on our operating results;
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we may be unable to successfully and rapidly integrate the new businesses, personnel and products with our existing business, including financial reporting,
management and information technology systems;
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we may experience higher than anticipated costs of integration and unforeseen operating difficulties and expenditures;
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an acquisition may be in a market or geographical area in which we have little experience;
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we may have difficulty in retaining key employees, including employees who may have been instrumental to the success or growth of the acquired business; and
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we may use a substantial amount of our cash, common stock and other financial resources to consummate an acquisition.
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We recently acquired MPT, which is located in Tennessee, for approximately $12.5 million, consisting of $6.9 million in cash and 462,746 shares of our
common stock with a fair value of $5.3 million and the assumption of $0.3 million of long-term debt. There can be no assurance that we will achieve higher revenues or benefit from any synergies as a result of the acquisition.
In addition, we may require additional debt or equity financing for future acquisitions, and such financing may not be available or on favorable terms,
if available at all. We may not be able to successfully integrate or operate profitably any new business we acquire, and we cannot assure you that any such acquisition will meet our expectations. Finally, in the event we decide to discontinue
pursuit of a potential acquisition, we will be required to immediately expense all costs incurred in pursuit of the possible acquisition which may have an adverse effect on our results of operations in the period in which the expense is recognized.
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Risks Related to Our Common Stock
We expect that the price of our common stock will fluctuate substantially.
The price of our common
stock may decline, and the price of our common stock that prevails in the market may be higher or lower than the price you pay, depending on many factors, some of which are beyond our control. Factors that could cause fluctuations in the trading
price of our common stock include:
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failure of our system or technology to achieve commercial success;
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announcements of the introduction of new products or services by us or our competitors;
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market conditions in our industry sector;
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developments concerning product development results or intellectual property rights of others;
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litigation or public concern about the safety of our system and services;
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actual and anticipated fluctuations in our quarterly operating results;
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securities analyst coverage of our common stock;
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deviations in our operating results from the estimates of securities analysts or other analyst comments;
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additions or departures of key personnel;
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price and volume fluctuations in the overall stock market from time to time;
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general economic trends; or
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sales of large blocks of our stock.
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In addition, the equity markets in general, and the Nasdaq Global Market in particular, have experienced extreme price and volume fluctuations that have often been unrelated or disproportionate to the operating performance of those
companies. Further, the market prices of securities of water-related companies have been particularly volatile. These broad market and industry factors may affect the market price of our common stock adversely, regardless of our operating
performance. In the past, following periods of volatility in the market price of a companys securities, securities class-action litigation often has been instituted against that company. This type of litigation, if instituted against us, could
result in substantial costs and a diversion of managements attention and resources.
Anti-takeover provisions in our charter documents, as amended
and restated, and under Delaware law could delay or discourage a takeover that stockholders may consider favorable.
Provisions in our
amended and restated certificate of incorporation and bylaws may have the effect of delaying or preventing a change of control or changes in our management. Some of these provisions include:
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a board of directors divided into three classes serving staggered three-year terms;
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a prohibition on stockholder action through written consent;
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a requirement that special meetings of stockholders be called only by the chairman of our board of directors, the chief executive officer, the president or by a
majority of the total number of authorized directors;
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advance notice requirements for stockholder proposals and nominations;
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a requirement of approval of not less than 66
2
/3% of all outstanding shares of our capital stock entitled to vote to amend any bylaws by stockholder action, or to amend specific provisions of our certificate of incorporation; and
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the authority of our board of directors to issue preferred stock on terms determined by our board of directors without stockholder approval.
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In addition, because we are a Delaware corporation, we are governed by the provisions of Section 203 of the
Delaware General Corporation Law, which may prohibit certain business combinations with stockholders owning 15% or more of our outstanding voting stock. These and other provisions in our amended and restated certificate of incorporation, amended and
restated bylaws and Delaware law could make it more difficult for stockholders or potential acquirers to obtain control of our board of directors or initiate actions that are opposed by the then-current board of directors, including to delay or
impede a merger, tender offer, or proxy contest involving our company. Any delay or prevention of a change of control transaction or changes in our board of directors could cause the market price of our common stock to decline.
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