Here's an interesting post from "over there":

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SFMI’s mythical dilution

First off, here’s the link to the procedure for SFMI to access the LOC:

link

And here’s the procedure itself:

[quote]The procedure under which we may put shares to Centurion under the Investment Agreement is as follows:
Between 5 and 10 days prior to an intended Put Date, we must deliver an Advance Put Notice to Centurion stating the number of shares (the “Put Shares”) that we intend to put to Centurion, the maximum dollar amount of shares we shall sell to Centurion, and the minimum price per share, if any, that we will sell shares to Centurion, provided that the maximum amount of any put is $300,000. The minimum price per share that we specify can be no greater than 80% of the closing bid price for the common stock on the day before the Advance Put Notice or the closing bid price on the day before the Advance Put Notice minus $0.0125 per share.

On the Put Date, we are required to deliver a second notice to Centurion stating the number of shares that we intend to put to Centurion, the maximum dollar amount of shares it shall sell to Centurion, and the minimum price per share that we will sell shares to Centurion. We are also required to deliver on or before the Put Date the number of shares that we intend to sell to Centurion, a legal opinion, an officer’s certificate and under certain circumstances a cold comfort letter from our auditors. We are required to deliver the Put Shares by crediting Centurion’s account at DTC through its Deposit/Withdrawal at Custodian (DWAC) system.

The maximum number of shares which we can sell to Centurion in any put is the lesser of (a) 2,000,000 shares, (b) 15% of sum of the trading volumes in our common stock during the put pricing period (excluding certain excluded days and any block trades that exceed 20,000 shares of stock), (c) a number of shares whose aggregate purchase prices would exceed $300,000, or (d) that number of shares which would cause Centurion’s ownership in us to exceed 5%.

The price at which Centurion is obligated to purchase the Put Shares will be the lesser of 97% of the market price of our common stock or the market price minus $0.01 per share, but in no event shall it be less than the minimum price stated in the Advance Put Notice. The market price of our common stock for each Put shall be the average of the three lowest volume weighted average prices for our common stock during a 15 day Put Pricing Period immediately following the Put Date.

A Put Closing shall occur within five business days following the end of the Put Pricing Period, at which time Centurion shall deliver the purchase price for the Put Shares if we have delivered to Centurion all of the documents required for the Put Closing. If the actual number of shares purchased at the Put Closing is less than the number delivered on the Put Date, Centurion is required to return the excess shares.
Each Put Date must be no sooner than five business days after the end of the previous Put Pricing Period.[/quote]

Some things to note:

There is a time period involved in any transaction- a minimum of 20, and a maximum of 25 days. And the next transaction cannot start sooner than 5 days after the previous one- so a minimum range of 25-30 days between transactions, or a maximum of about one transaction per month.

There are limits on the size of the blocks that SFMI can access at any one time. The MAXIMUM dollar amount that can be accessed at any one time is $300,000, about once a month. For the 24 months of the LOC, that’s a maximum of about $300k x 24 = $7.2M, the maximum amount of the LOC. This is an indication that SFMI does not expect to need huge amounts of money (i.e. millions) at any one time. Also, the amount of shares involved in any one transaction cannot exceed 2M shares (or 15% of the volume during the put pricing period). But 2M is the maximum. That’s again a max of 2M/month, or about 100k shares per trading day. And remember these are absolute maxima that likely will be reduced by other language in the agreement. So much for huge dilution.

And what is the price?

The minimum SFMI can specify (note that SFMI specifies the put price) is no greater than 80% of the closing price the day before the put notice or the closing price minus .0125. Since SFMI knows the closing price of the day before, they know what the minimum will be, and can in fact choose a day with a high closing price the previous day to deliver the put notice.

So SFMI gives Centurion 5-10 days notice (Advanced Put Notice) of a put for the lesser of

a. 2,000,000 shares
b. 15% of sum of the trading volumes during the Put Pricing Period (excluding certain excluded days and any block trades that exceed 20,000 shares of stock)
c. a number of shares whose aggregate purchase prices would exceed $300,000
d. that number of shares which would cause Centurion’s ownership in SFMI to exceed 5%.

After the 5-10days, a 15 day Put Pricing period begins to determine the “market price” that will be used to determine how much Centurion will actually pay. The amount Centurion pays will be the lesser of

a. 97% of the market price
b. the market price minus .01
BUT NEVER less than the minimum price stated in the Advanced Put Notice.

The absolute minimum price SFMI gets for the shares is ultimately determined by the closing price the day before SFMI notifies Centurion (80% of it or the closing price minus .0125). This is important: SFMI knows what the floor pricing will be when they notify Centurion of the Put. Nothing Centurion does after the notice (such as shorting) can lower this floor. In addition, it also means that SFMI can choose a date after a high sp close to notify Centurion of a Put.

What does that mean in practical terms?

Let’s assume the Put Date (5-10 days after the Advance Put Notice) was 6/30 of this year. The Pricing Period would be 7/1 through 7/15.

The volume during the period 7/1 to 7/15 was 12.7M. So that means the maximum number of shares SFMI can put is the lesser of 2M or 15% of 12.7M, or 1.9M shares. So they can only put 1.9M shares. Obviously the limit of 5% of outstanding shares does not apply here. And I did not exclude block trades of 20k shares or greater, which would have further reduced the max number of shares.

So the max number of shares is 1.9M or $300k worth of shares at the price determined by the agreement. But what is that price? The “market price” is the weighted average of the price on the three lowest volume days. The totals for those days (7/7, 7/11, and 7/15) were $154,000 and 1.84M shares, for an average price of .0836. Note- since the three lowest volume days are used, that means that if there are any days when any significant amount of shorting occurs, they would not be used in the calculation since it would increase the volume above the low volume days. Assuming, of course, that significant shorting will occur, which is not a given. And also remember- shorting cannot reduce the price below the minimum determined BEFORE Centurion was notified of the put.

The “market price” that Centurion will actually pay is the lesser of 97% of .0836 = .0811 or .0836 - .01 = .0736. And the actual transaction will be 1.9M shares at .0736 = $140k. That is assuming, of course, that the .0736 figure is not below the price determined before the original notification- which could have been any day in a window of 5 days depending on how long (5-10 days) SFMI takes between the Advance Put Notice and the Put Date.

So for the previous month, the maximum number of shares SFMI could have put would have been 1.9M shares for a minimum of $140k (the dollar amount could have been larger depending on the day SFMI delivered the Advanced Put Notice). That’s not a lot of money (remember the maximum SFMI can get is ~$300k/month), and it’s not a lot of dilution. It’s obvious that the LOC is not intended to be the primary source of funding for SFMI, and it won’t be a source of huge dilution. And it's also designed to discourage and minimize the effects of shorting (in addition to the restrictions on shorting in the agreement).

Any statements that the LOC is the primary source of funding SFMI will be relying on, or that the LOC will result in huge dilution or massive shorting are false.

Adapted from an analysis by, and with thanks to, Imperial Whazoo.