NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2015
(unaudited)
These unaudited consolidated financial
statements of Axion Power International, Inc., a Delaware corporation, include the operations of its wholly owned subsidiary, Axion
Power Battery Manufacturing, Inc., a Pennsylvania corporation, and its two inactive wholly owned subsidiaries, Axion Power Corporation,
a Canadian Federal corporation, and C & T Co. Inc., an Ontario corporation (collectively, the “Company”).
In the opinion of management the accompanying
unaudited consolidated financial statements contain all adjustments (which include normal recurring adjustments) necessary to present
fairly the financial position, statements of income and comprehensive income and cash flows for the periods presented. Certain
information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles
generally accepted in the United States of America (U.S. GAAP) have been condensed or omitted pursuant to the rules and regulations
of the United States Securities and Exchange Commission (SEC). These consolidated financial statements should be read in conjunction
with the audited financial statements and footnotes thereto in the Annual Report on Form 10-K for the year ended December 31, 2015.
The results of income and comprehensive income for the three month period ended March 31, 2016 are not necessarily indicative of
results of income and comprehensive income for the Company’s 2016 calendar year.
As approved by our board of directors and
shareholders, we effected a 1-for-35 stock split of our common shares and Series A warrants on July 14, 2015. During 2015, there
were 582,729 true-up rounding shares issued due to the above mentioned reverse stock split. All share related and per share information
has been adjusted to give effect to the reverse stock split from the beginning of the earliest period presented.
The preparation of consolidated financial statements in conformity
with accounting principles generally accepted in the United States requires management to make estimates, assumptions and judgments
that affect reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial
statement and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from the estimates.
2.
|
New Accounting Pronouncements
|
In March 2016, the FASB issued Accounting Standards
Update (“ASU”) No. 2016-09, Compensation – Stock Compensation (Topic 718): Improvements to employee
share-based payment accounting, which includes provisions intended to simplify various aspects related to how share-based
compensation payments are accounted for and presented in the financial statements. This amendment will be effective
prospectively for reporting periods beginning on or after December 15, 2016, and early adoption is permitted. The Company is
evaluating the impact that the new accounting guidance will have on its consolidated financial statements and related
disclosures.
In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842), which requires lessees to recognize the lease assets and lease liabilities
classified as operating leases on the balance sheet. The amendment will be effective for reporting periods beginning on or after
December 15, 2018, and early adoption is permitted. The Company is evaluating the impact that the new accounting guidance will
have on its consolidated financial statements and related disclosures.
On November 20, 2015, the FASB issued ASU 2015-17, Balance Sheet
Classification of Deferred Taxes. The guidance requires that all deferred tax assets and liabilities, along with any related valuation
allowance, be classified as noncurrent on the balance sheet. As a result, each jurisdiction will now only have one net noncurrent
deferred tax asset or liability. The guidance does not change the existing requirement that only permits offsetting within a jurisdiction.
The new guidance will be effective for public business entities in fiscal years beginning after December 15, 2016, including interim
periods within those years (i.e., in the first quarter of 2017 for calendar year-end companies). Early adoption is permitted for
all entities as of the beginning of an interim or annual reporting period. The Company is currently evaluating the impact, if any,
of the adoption of this newly issued guidance to its consolidated financial statements.
AXION POWER INTERNATIONAL,
INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2015
(unaudited)
In July 2015, the FASB issued ASU 2015-11,
Inventory (Topic
330): Simplifying the Measurement of Inventory
, that simplifies the measurement of inventory for all entities. The amendment
applies to all inventories that are measured using first-in, first-out or average cost. The guidance requires an entity to measure
inventory at the lower of cost and net realizable value. The guidance must be applied prospectively and will be effective for interim
and annual reporting periods beginning after December 15, 2016. The Company is currently evaluating the expected impact, if any,
of the adoption of the newly issued guidance to the consolidated financial statements.
In April 2015, the FASB issued ASU 2015-03,
Interest – Imputation of Interest (Topic 225-20): Simplifying the Presentation of Debt Issue Costs
, that simplifies
the presentation of debt issuance costs. The guidance requires that debt issuance costs related to a recognized debt liability
be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts.
The recognition and measurement guidance for debt issuance costs are not affected by these amendments. This guidance should be
applied on a retrospective basis, wherein the balance sheet of each individual period presented should be adjusted to reflect the
period-specific effects of applying the new guidance. The guidance is effective for financial statements issued for fiscal years
beginning after December 15, 2015, and interim periods within those fiscal years. The Company elected early adoption of this newly
issued guidance, and there was no impact on the Company’s consolidated financial statements.
In February 2015, the FASB issued ASU 2015-02,
Consolidations (Topic 225-20): Amendments to the Consolidation Analysis
, which affects current consolidation guidance. The
guidance changes the analysis that a reporting entity must perform to determine whether it should consolidate certain types of
legal entities. This guidance must be applied using one of two retrospective application methods and is effective for fiscal years,
and for interim periods within those fiscal years, beginning after December 15, 2015. The Company has adopted this new guidance,
and there was no impact on the Company’s consolidated financial statements.
In January 2015, the FASB issued ASU 2015-01,
Income Statement – Extraordinary and Unusual Items (Subtopic 225-20): Simplifying Income Statement Presentation by Eliminating
the Concept of Extraordinary Items
, which changed the requirements for reporting extraordinary and unusual items in the income
statement. The update eliminates the concept of extraordinary items. The presentation and disclosure guidance for items that are
unusual in nature or occur infrequently will be retained and will be expanded to include items that are both unusual in nature
and infrequently occurring. A reporting entity may apply the amendments prospectively or retrospectively to all periods presented
in the financial statements. The guidance is effective for fiscal years, and interim periods within those fiscal years, beginning
after December 15, 2015. The adoption of this newly issued guidance did not have an impact to the Company’s consolidated
financial statements.
AXION POWER INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2015
(unaudited)
Inventory is recorded at the lower of cost or market value,
and adjusted as appropriate for decreases in valuation and obsolescence. Adjustments to the valuation and obsolescence reserves
are made after analyzing market conditions, historical sales activity, inventory costs and inventory composition to determine appropriate
reserve levels. Cost is determined using the first-in first-out (FIFO) method. Many components and raw materials we purchase have
minimum order quantities.
A summary of inventory
at March 31, 2016 and December 31, 2015 is as follows:
|
|
March 31,
2016
|
|
|
December 31,
2015
|
|
Raw materials
|
|
$
|
417,770
|
|
|
$
|
363,559
|
|
Work in process
|
|
|
510,443
|
|
|
|
421,732
|
|
Finished goods
|
|
|
27,564
|
|
|
|
34,581
|
|
Inventory reserves
|
|
|
(630,813
|
)
|
|
|
(540,037
|
)
|
|
|
$
|
324,964
|
|
|
$
|
279,835
|
|
Warrants consist of the following:
|
|
Shares
|
|
|
Weighted
average
exercise price
|
|
|
Weighted average
remaining contract
term (years)
|
|
Outstanding at January 1, 2016
|
|
|
12,582,352
|
|
|
$
|
1.85
|
|
|
|
1.97
|
|
Granted
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Exercised
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Lapsed
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Outstanding at March 31, 2016
|
|
|
12,582,352
|
|
|
$
|
1.85
|
|
|
|
1.71
|
|
As of March 31, 2016, there were
34,521 Series B warrants classified as derivative liabilities which expired on April 29, 2016. As of March 31, 2015, there
were 1,047,947 Series B warrants classified as derivative liabilities relating to the public common stock offering that
occurred October 29, 2014. In addition, there were 11,967,716 warrants also classified as derivative liabilities relating to the
November 2015 private placement of senior convertible notes and warrants.
The Company adopted ASC 718 “
Compensation
– Stock Compensation
” whereby employee-compensation expense related to stock based payments is recorded over the
requisite service period based on the grant date fair value of the awards. The Company’s accounting policy for equity instruments
issued to consultants and vendors in exchange for goods and services follows the provisions of ASC 505-50 “
Equity-Based
Payments to Non-Employees”
. The measurement date for fair value of the equity instruments is determined by
the earlier of (i) the date at which commitment for performance by the vendor or consultant is reached, or (ii) the date at which
the consultant or vendor’s performance is complete. In the case of equity instruments issued to consultants, the fair value
of the equity instrument is recognized over the term of the consulting agreement.
The stock based compensation expense for
the three months ended March 31, 2016 and 2015 was $12,243 and $108,071, respectively, of which $0 and $12,240 was for the Company’s
Directors’ compensation in lieu of cash.
Outstanding compensatory options consist
of the following based on grant date:
|
|
|
|
|
Weighted Average
|
|
|
|
|
|
|
Number of
Options
|
|
|
Exercise
|
|
|
Fair
Value
|
|
|
Remaining
Life
(years)
|
|
|
Aggregate
Intrinsic
Value
|
|
Outstanding at January 1, 2016
|
|
|
15,119
|
|
|
$
|
261.50
|
|
|
$
|
87.08
|
|
|
|
4.9
|
|
|
$
|
-
|
|
Granted
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Forfeited or lapsed
|
|
|
(107
|
)
|
|
|
2,274.17
|
|
|
|
765.74
|
|
|
|
-
|
|
|
|
-
|
|
Outstanding at March 31, 2016
|
|
|
15,012
|
|
|
$
|
246.88
|
|
|
$
|
82.30
|
|
|
|
4.7
|
|
|
$
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercisable at March 31, 2016
|
|
|
11,549
|
|
|
$
|
310.40
|
|
|
$
|
100.32
|
|
|
|
4.2
|
|
|
$
|
-
|
|
AXION POWER INTERNATIONAL,
INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2015
(unaudited)
Non-vested compensatory
options consist of the following based on grant date:
|
|
All Options
|
|
|
|
Shares
|
|
|
Fair Value
|
|
Subject to future vesting at January 1, 2016
|
|
|
5,210
|
|
|
$
|
261.13
|
|
Granted
|
|
|
-
|
|
|
|
-
|
|
Forfeited or lapsed
|
|
|
(15
|
)
|
|
|
133.33
|
|
Vested
|
|
|
(1,732
|
)
|
|
|
20.31
|
|
Subject to future vesting at March 31, 2016
|
|
|
3,463
|
|
|
$
|
22.17
|
|
As of March 31, 2016, there was $70,332
of unrecognized compensation related to non-vested options granted under the plans. The Company expects to recognize this expense
over a weighted average period of 1.75 years. There have been no options granted in 2016.
6.
|
Earnings (Loss) Per Share
|
Basic earnings per share is computed by
dividing income available to common shareholders (the numerator) by the weighted-average number of common shares outstanding (the
denominator) for the period. Diluted earnings per share are computed by assuming that any dilutive convertible securities outstanding
were converted, with related preferred stock dividend requirements and outstanding common shares adjusted accordingly. It also
assumes that outstanding common shares were increased by shares issuable upon exercise of those stock options for which the market
price exceeds the exercise price, less shares which could have been purchased by us with the related proceeds. In periods of losses,
diluted loss per share is computed on the same basis as basic loss per share as the inclusion of any other potential shares outstanding
would be anti-dilutive.
If the Company had generated earnings during the three months
ended March 31, 2016 and 2015, the Company would have added 237,632,851 and 26,816,151 respectively, of common equivalent shares
to the weighted average shares outstanding to compute the diluted weighted average shares outstanding.
For the quarter ended March 31, 2016, the Company recognized
$35,854 in other income. The Company sold various pieces of zero value equipment.
At December 31, 2015, the Company had a remaining balance
of $237,600 in notes with its landlords for its two New Castle facilities. The balance remaining at March 31, 2016 for the notes with
the landlords was $91,703. As per the note agreement the Company made payments of $25,000 per month to Becan Development and
for the final payment due in April reduced the cash payment by the original $19,297 lease deposit. In addition to the
principal payments, Becan Development also received $2,300 in interest. As per the note agreement with S&S Partnership,
the Company made monthly installment payments of $17,200 for a total of $51,600 in principal payments. The Company also paid
$2,955 of accrued interest. As of April 1, 2016, the Company has moved from the Greenridge facility as planned and
consolidated to the Clover Lane facility.
Principal outstanding at March 31, 2016, on the remaining landlord
notes is $91,703 plus interest that continues to accrue.
9.
|
Subordinated Convertible Notes and Subordinated Warrants
|
During 2013
,
the Company sold $1,000,000 principal amount
of its Subordinated Convertible Notes (the “Subordinated Notes”) to investors consisting of management and directors
of the Company and one individual accredited investor. The sale of the Subordinated Notes did not carry any additional fees and
expenses, so the Company received the entire $1 million in proceeds from the Subordinated Notes at closing. The Subordinated Notes
are subordinated in right of repayment to the Company’s now expired 2013 Senior Notes and mature 91 days subsequent to the
maturity date of the 2013 Senior Notes. The Subordinated Notes bear interest at the rate of 8% per year. The Subordinated Notes
may be converted and/or prepaid in cash. The conversion price for the Subordinated Notes is $462.00 per share. The holders of
the Subordinated Convertible Notes were issued five year warrants to purchase 1,097 shares of Company common stock (“Subordinated
Warrants”). Each Subordinated Warrant has an exercise price of $528.50 per share.
The fair value of the warrants, issued
in connection with the Subordinated Notes is $304,000 in the aggregate and was calculated using the Black-Scholes-Merton option
pricing model with the following assumptions: (i) expected life of 5 years, (ii) volatility of 80%, (iii) risk free interest rate
of 0.75% and (iv) dividend yield of zero.
The outstanding principal balance at March 31, 2016
and December 31, 2015, related to the Subordinated Notes is $65,000. The subordinated notes remain outstanding as a result
of a verbal agreement with the noteholders to continue to extend the maturity thereof.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- CONTINUED
10.
|
Public offering of common stock, Series A warrants and Series B warrants
|
Effective October 29, 2014, the Company
consummated an underwritten public offering consisting of 53,572 shares of common stock ("Common Stock"), together with
Series A warrants to purchase 53,572 shares of its Common Stock ("Series A Warrants") and Series B warrants to purchase
1,875,000 shares of its Common Stock (“Series B Warrants”) for gross proceeds to the Company of approximately $6.1
million and net proceeds of $5.5 million. The public offering price for each share of Common Stock, together with one Series A
Warrant and one Series B Warrant, was $113.75. The Series A Warrants may be exercised for a period of five years and have
an exercise price of $113.75 per share of Common Stock. The Series B Warrants were originally exercisable for a period of 15 months
from the date of closing and expired on April 29, 2016 (due to an extension) and had an exercise price of $113.75 per share of
Common Stock. In connection with the offering, the Company granted to the underwriter a 45-day option to acquire up to 8,036 additional
shares of Common Stock and/or up to 8,036 additional Series A Warrants and/or up to 281,250 additional Series B Warrants. The Company
has also closed on the underwriter’s exercise of the over-allotment option on the Series A Warrants and the Series B Warrants.
The Company’s common stock and Series A Warrants are now listed on the OTCQB Capital Market under the symbols “AXPW”
and “AXPWW”, respectively. On June 15, 2015, as the result of an agreement with the holders of our Series A warrants
and Series B warrants, we adjusted the terms of our Series A warrants so that the exercise price was reduced to $.50, which number
was changed to $17.50 as a result of our July 14, 2015 1-for -35 reverse stock split.
As of March 31, 2016, 34,521 Series B warrants
remained unexercised. On April 26, 2016, 10,000 Series B warrants were exercised and 11,250 shares of the Company’s common
stock were issued. The remaining 24,521 unexercised Series B warrants expired on April 29, 2016.
Accounting for the Series B warrants
Pursuant to ASC 815-40, due to the net
settlement terms included in the Series B warrants, which requires an increased number of shares to be issued if the price of the
Company’s common stock falls, the Company determined that the Series B warrants were not indexed to the Company’s own
stock and must be recognized separately as a derivative liability in the consolidated balance sheet, measured at fair value and
marked to market each reporting period.
As of March 31, 2016 and December 31, 2015,
the fair value of the Series B warrants was estimated to be $2,089 and $35,764, respectively.
The change in the fair value of the Series
B warrant liability is as follows:
|
|
Fair
|
|
|
|
Value
|
|
Series B warrant liability, January 1, 2016
|
|
$
|
35,764
|
|
Revaluation of remaining Series B warrants
|
|
|
(33,675
|
)
|
Series B warrant liability, March 31, 2016
|
|
$
|
2,089
|
|
Fair Value Disclosure
The Company has three Level 3 financial instruments - Series
B warrants associated with the public offering of common stock, Senior Warrants and the conversion feature associated with the
2015 Senior Notes, which are recorded at fair value on a periodic basis. The Series B warrants, Senior Warrants and
the conversion feature associated with the 2015 placement, are evaluated under the hierarchy of FASB ASC Subtopic 480-10, FASB
ASC Paragraph 815-25-1 and FASB ASC Subparagraph 815-10-15-74 addressing embedded derivatives. The fair value of the warrants and
the conversion feature are estimated using the Monte Carlo simulation model. In addition, the Company has warrants and a conversion
feature related to the Private Placement note dated November 5, 2015. For the warrants issued in 2015, at inception, the warrants
were valued by calibrating the aggregate fair value of the notes and warrants to the transaction price, as required by ASC 820.
Calibrating the valuation model to ensure that the model is consistent with the fair value at initial recognition provides a basis
for estimating the inputs required in the analysis that are not directly observable. For each subsequent reporting date, the warrants
were valued based on the payoff structure, considering the change in assumptions between the inception and the subsequent reporting
date.
11.
|
Description of the 2015 Private Placement
|
On November 4, 2015, we entered into a financing
transaction for the sale of convertible notes and warrants issued by us with gross proceeds of $9,000,000 to us. Upon closing
of the sale of the notes and warrants, which occurred on November 5, 2015, we received cash proceeds of $1.85 million and
deposit of an additional $7,100,000 million into a series of control accounts in our name. Under the original terms of the
notes, we are permitted to withdraw funds from our control accounts (i) in connection with certain conversions of the notes
or (ii) otherwise, as follows: $1 million on each 30-day anniversary of the commencing on the 30
th
day after the
effective date of a registration statement being filed in connection with the transaction until there are no more funds in
the control accounts, subject in each instance to equity conditions set forth in the convertible notes. As a result of the
January 28, 2016 amendments to the notes, another $1.8 million was released on that date, and the balance of $5.35 million
will be released in 8 equal monthly installments commencing on May 2, 2016 (subsequently amended to be May 6, 2016), subject
to terms and conditions set forth in the notes.
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
We received approximately $1,700,000 in net proceeds at closing,
which occurred on November 5, 2015, after deducting our placement agent’s fee of $138,750. Offering expenses, other than
our placement agent’s fee, were approximately $100,000, which were paid out of the proceeds at Closing. At each release of
funds starting on May 6, 2016, we are to receive approximately $620,000 in net proceeds, after deducting our placement agent’s
fee of $50,000, if equity conditions are met. As a result of a further waiver and amendment entered into on May 1, 2016, the equity
conditions were waived with respect to a release of $310,000 to us on May 6, 2016. Further, the waiver and amendment (i) waives
equity conditions for our ability to make all installment and preinstallment payments in stock through May 6, 2017, and (ii) reduces
the preinstallment and installment conversion prices to 75% of an average vwap price over the five trading days preceding the date
of issuance.
The initial conversion price of the notes was $1.23 per share
(for optional conversions only and not Company amortization payments), and the initial exercise price of the 10,975,608 warrants
was $1.29 per share.
As a result of the “rollover” of $363,530 of principal
amount and accrued and unpaid interest of our August 2015 Bridge Notes, on November 10, 2015, an additional note in the principal
amount of $363,530 of notes, and an additional 443,328 warrants were issued to replace the rolled over Bridge Notes.
The outstanding principal bears interest at 9% per annum and
shall be repaid or converted at monthly installment dates over a 14-month period. Additionally, the notes are convertible by the
holder at any time after issuance. Pursuant to the optional conversion feature of these notes (as opposed to the monthly Company
conversions which are at a discount formula as set forth below), the Company would deliver the number of shares of common stock
equal to the outstanding principal amount, accrued interest amount, and a make whole amount equal to the interest that would be
accrued on the conversion amount until maturity, divided by the fixed conversion price of $1.23. Additionally, a portion of the
outstanding amount is exchanged for common shares at each Monthly Installment Date at a conversion price equal to the lower of
the conversion price in effect and 85% of the fair value of the common shares the trading day prior to the installment date. On
the 23
rd
date prior to any installment date, shares are delivered based upon the conversion price formula for the installment
amount, and then on the installment date in question, the amount of shares to be delivered is recalculated for the conversion price
formula on that installment date, and if the conversion price is lower on the installment date than on the preinstallment date,
a number of shares equal to the number to be delivered on the installment date less the number of shares delivered on the preinstallment
date is delivered to the investor. The number of common shares deliverable under the contract is limited by a beneficial ownership
cap of 4.99% for any single investor (except for one investor which has a cap of 9.99%), so shares may be deemed issued but held
in abeyance by the transfer agent until the investor is able to accept further shares without exceeding the beneficial ownership
cap.
As the Company was required to separate the conversion option
in the notes under ASC 815,
Derivatives and Hedging,
the Company recorded the bifurcated conversion option valued at $1.33
million as a derivative liability, which creates additional discount on the debt. The derivative liability is marked to market
through the income statement each reporting period, while the discount created on the convertible notes is accreted as interest
expense over the maturity period of the debt. Additionally, the convertible notes were issued to the investors in a basket transaction
with warrants that are classified as derivative liabilities. These warrants, initially valued at $725,111 ($691,861 as discount
on the debt and $33,250 as issuance costs for compensation to the underwriter), are also marked through the income statement each
reporting period, while further discount is created on the convertible notes, and is accreted as interest expense using the effective
interest method over the life of the debt.
At inception, the warrants were valued by calibrating the aggregate
fair value of the notes and warrants to the transaction price, as required by ASC 820. Calibrating the valuation model to ensure
that the model is consistent with the fair value at initial recognition provides a basis for estimating the inputs required in
the analysis that are not directly observable. For each subsequent reporting date, the warrants are valued based on the payoff
structure, considering the change in assumptions between the inception and the subsequent reporting date.
The conversion feature fair value is determined at inception
and for each reporting date using a “with” and “without” analysis, based on the payoff structure of the
notes. The same key assumptions utilized in the warrants valuation were considered in the conversion feature fair value,
Using the Calibration model, to calculate the mark to market
value at March 31, 2016, the following key assumptions were utilized in both the valuations of the notes and warrants as follows:
(i) risk free interest rate 0.47%, (ii) credit spread 125%, (iii) volatility 51%, (iv) stock price $0.05.
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Derivative liability relating to the 2015 Private Placement
The change in the fair value of the 2015 Private Placement derivative
liability is as follows:
Private Placement derivative liability, January 1, 2016
|
|
$
|
2,118,156
|
|
Reclassification of derivative liability pertaining to converted stock
|
|
|
(99,703
|
)
|
Revaluation of Private Placement Derivative liability
|
|
|
(736,009
|
)
|
Private Placement Derivative liability March 31, 2016
|
|
$
|
1,282,444
|
|
Securities Purchase Agreement
The notes and warrants were issued pursuant to the terms of
a Securities Purchase Agreement among us and the investors named therein. The Purchase Agreement provided for the sale of the notes
and warrants for gross proceeds of $9,000,000 to us.
Notes
Ranking
The notes are senior unsecured obligations of us.
Maturity Date
Unless earlier converted or redeemed, the notes mature 14 months
from the Closing, subject to the right of the investors to extend the date (i) if an event of default under the notes has occurred
and is continuing or any event shall have occurred and be continuing that with the passage of time and the failure to cure would
result in an event of default under the Notes and (ii) for a period of 20 business days after the consummation of a fundamental
transaction if certain events occur.
Interest
The notes bear interest at the rate of 9% per annum and are
compounded monthly, on the first calendar day of each calendar month. The interest rate will increase to 18% per annum upon the
occurrence and continuance of an event of default (as described below). Interest on the notes is payable in arrears on each installment
date (as defined below). If a holder elects to convert or redeem all or any portion of a note prior to the maturity date, all accrued
and unpaid interest on the amount being converted or redeemed will also be payable. If we elect to redeem all or any portion of
a note prior to the maturity date, all accrued and unpaid interest on the amount being redeemed will also be payable. The amount
of interest due at any time is the amount of any interest that, but for any conversion, installment conversion, acceleration or
redemption hereunder on such given date, would have accrued with respect to the conversion amount or installment amount being converted
or redeemed under the note at the interest rate for the period from such given date through the maturity date of the note.
Optional Conversion
All amounts due under the notes are convertible at any time,
in whole or in part, at the option of the holders into shares of our common stock at a fixed conversion price, which is subject
to adjustment as described below. The notes are initially convertible into shares of our common stock at the initial price of $1.23
per share. This conversion price is subject to adjustment for stock splits, combinations or similar events and “full ratchet”
antidilution provisions.
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Payment of Principal and Interest
We have agreed to make amortization payments with respect to
the principal amount of each note in shares of our common stock, subject to the satisfaction of certain equity conditions, or at
our option, in cash on each of the following installment dates: the twenty-first trading day after the earlier of (x) the initial
effective date of a registration statement filed in connection with this offering or (y) May 2, 2016; the first trading day of
the calendar month immediately following the initial installment date (or if such date is less than twenty trading days after the
initial installment date, the second calendar month immediately following the initial installment date to the extent); and then
each month through and including the Maturity Date, each in an amount equal to 1/11 of the principal amount of each note. Payment
in stock is at 85% of the market price based upon a variable weighted average price formula.
As a result of the amendment agreements entered into by us with
each selling stockholder on January 28, 2016, an additional $1,800,000 million was released from the controlled accounts on January
28, 2016, starting on May 2, 2016, and continuing for seven consecutive months thereafter on the 1
st
business day of
each such month $667,500 shall be released in total from the controlled accounts. As a result of a further waiver and amendment
entered into on May 1, 2016, the equity conditions were waived with respect to a release of $310,000 to us on May 6, 2016. Further,
the waiver and amendment (i) waives equity conditions for our ability to make all installment and preinstallment payments in stock
through May 6, 2017, and (ii) reduces the preinstallment and installment conversion prices to 75% of an average vwap price over
the five trading days preceding the date of issuance.
Acceleration and Deferral of Amortization Amounts
During each period after an installment date and prior to the
immediately subsequent installment date, a holder may elect to accelerate the amortization of the note at the applicable amortization
conversion price for such prior installment date with respect to any given installment period, the holder may not elect to effect
any acceleration during such installment period if either (x) in the aggregate, all the accelerations in such installment period
exceeds the sum of two (2) other installment amounts, or (y) accelerations have been consummated in four (4) prior installment
periods.
The holder of a note may, at the holder’s election by
giving notice to us, defer the payment of the installment amount due on any installment dates, in whole or in part, to another
installment date, in which case the amount deferred will become part of such subsequent installment date and will continue to accrue
interest.
Events of Default
The notes contain standard and customary events of default including
but not limited: (i) failure to register our common stock within certain time periods; (ii) failure to make payments when due under
the Notes; and (iii) bankruptcy or insolvency of us.
If an event of default occurs, each holder may require us to
redeem all or any portion of the notes (including all accrued and unpaid interest thereon), in cash, at a price equal to the greater
of (i) up to 125% of the amount being redeemed, depending on the nature of the default, and (ii) the intrinsic value of the shares
of common stock then issuable upon conversion of the note.
Fundamental Transactions
The notes prohibit us from entering into specified transactions
involving a change of control, unless the successor entity assumes in writing all of our obligations under the notes under a written
agreement.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
– CONTINUED
In the event of transactions involving a change of
control, the holder of a note will have the right to require us to redeem all or any portion of the Note it holds (including
all accrued and unpaid interest thereon) at a price equal to the greater 125% of the amount of the Note being redeemed and
the intrinsic value of the shares of common stock then issuable upon conversion of the note being redeemed.
Limitations on Conversion and Issuance
A note may not be converted and shares of common stock may not
be issued under the notes if, after giving effect to the conversion or issuance, the holder together with its affiliates would
beneficially own in excess of 4.99% of our outstanding shares of common stock. At each holder’s option, the note blocker
may be raised or lowered to any other percentage not in excess of 9.99%.
As a result of the January 28, 2016 amendment agreements, there
is no exchange cap in this transaction.
January 28, 2016 Amendment Agreements
On January 28, 2016, we entered into amendment agreements with
each of the selling stockholders with respect to the November 5, 2015 private placement exempt from securities registration under
Section 4(a)(2) of the Securities Act of 1933 and Rule 506(b) of Regulation D. On or about November 20, 2015, we filed a registration
statement on Form S-1 to register the Registrable Securities, and as a result of comments received from the SEC, we withdrew this
original S-1 on January 21, 2016. Subsequent to the withdrawal of the original S-1, we sought to make certain amendments to the
terms of the securities purchase agreement and registration rights agreement, entered into in connection with the sale of the senior
secured convertible notes, as well as to the notes. The amendments are embodied in the amendment agreements with each of the buyers.
Changes to the securities purchase agreement are as follows:
|
·
|
The term “principal market” was changed from the Nasdaq Capital Market to the OTCQB. This change was also made in the notes and accompanying warrants for conformity.
|
|
·
|
Section 4(d) was amended to add the following at the end of the Section. “Until the later of June 2, 2016 and the date on which the Buyers are eligible to resell all shares of Company Common Stock underlying the Notes and Warrants (assuming cashless exercise of the Warrants)
without restriction under Rule 144 (assuming such Buyers are not then affiliates of we), we may not make any payments to Affiliates
of we other than (i) up to $11,800 to repay, in full, that certain bridge note issued by we to Walker Wainwright; (ii) director
and Board committee fees in the ordinary course of business, consistent with past practices, to its non-management directors accruing
on or after January 1, 2016 in an amount not to exceed $25,000, in the aggregate, per calendar quarter, (iii) current compensation
arrangements (but not accrued and unpaid obligations for compensation to current and former officers of we) to its executive officers
upon terms and conditions publicly existing as of December 31, 2015 and/or disclosed on a Current Report on Form 8-K on January
27, 2016; (iv) stock options and/or restricted stock as per normal Board of Directors policy; and (v) customary, reasonable and
usual travel and lodging expenses for Company business.”
|
|
·
|
We no longer have the obligation to obtain shareholder approval for the issuance of securities with respect to the private placement as we are moving our listing to the OTCQB which does not require shareholder approval for issuance of securities in this transaction. Accordingly, the “exchange cap” at 19.9% of issued and outstanding shares was also omitted.
|
Changes to the notes are as follows:
|
·
|
The definition of an event upon which funds can be released from any of the controlled accounts was amended to read as follows: “Controlled Account Release Event” means, as applicable, (i) with respect to any Restricted Principal designated to be converted in a Conversion Notice, our receipt of both (A) such Conversion Notice hereunder executed by the Holder in which all, or any part, of the Principal to be converted includes any Restricted Principal and (B) written confirmation by the Holder that the shares of Common Stock issued pursuant to such Conversion Notice have been properly delivered in accordance with Section 3(c) (in each case, as adjusted, if applicable, to reflect the withdrawal of any Conversion Notice, in whole or in part, by the Holder, whether pursuant to Section 3(c)(ii) or otherwise), (ii) our receipt of a notice by the Holder electing to effect a release of any Restricted Principal to we, (iii) on the date of execution of the certain Amendment Agreements, dated January 28, 2016, by and among we and certain holders of the Notes, which act as an amendment to the Notes, $1,800,000, and (iv) on May 2, 2016, and the first Trading Day of each of the subsequent seven calendar months thereafter, the lesser of (x) the amount of Restricted Principal then outstanding hereunder and (y) the Holder Pro Rata Amount of $668,750; provided, in the case of clause (iv) above, as of such date of determination, no Equity Conditions Failure then exists. The Buyer hereby waives all Equity Condition Failures existing on or before the date of this Agreement.”
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|
·
|
Each existing note is being split into two notes, one of which is in the principal amount of the buyer’s pro rata portion of the initial $3,650,000 principal amount of funds released from the controlled accounts, and the second of which represents the remaining principal amount of the original note issued to that buyer.
|
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Changes to the registration rights agreement are as follows:
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·
|
The filing deadline for the initial registration statement (registering shares to be issued upon conversion of the $3,650,000 principal amount of the notes and interest thereon representing the total amount of funds released from the controlled accounts to date) was changed to January 29, 2016, and the effectiveness deadline for the initial registration statement was changed to February 16, 2016.
|
|
·
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The number of registrable securities was reduced to 10,735,296 shares of our common stock which may be issued upon conversion of up to $3.65 million principal amount of the notes and 966,178 shares of our common stock which may be issued upon conversion of interest due and owing on the released $3.65 million principal amount.
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|
·
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The initial notice date for installment payments by us is now the earlier of the effectiveness date of the registration statement being filed on January 29, 2016, and May 2, 2016.
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May 1, 2016 Waiver and Amendment
The Company has entered into a Waiver and
Amendment (“Waiver”) with each of the buyers listed on the Schedule of Buyers attached to the securities purchase agreement.
In each Waiver, the Company and the Buyer agreed as follows:
|
•
|
With respect to the Notes, the Buyer waives the Volume Failure (as defined in the securities purchase agreement) and the Price Failure (as defined in the securities purchase agreement) on any and all Installment Conversions (as defined in the securities purchase agreement) and delivery of shares for any Pre-Installment Conversion Shares (as defined in the securities purchase agreement) pursuant to an Installment Notice (as defined in the securities purchase agreement) until May 1, 2017.
|
|
•
|
Section 3(b)(2) of the Notes is amended by replacing the definition of Conversion Price, as defined in the Notes, with the following definition:
|
“as of any Conversion Date
or other date of determination, a price per share equal to the lowest of (x) $1.23, subject to adjustment as provided in this Note
(the price set forth in this clause (x), the "Fixed Conversion Price"), (y) 75% of the arithmetic average of the Weighted
Average Prices of the Common Stock during the five (5) consecutive Trading Day period ending immediately preceding the time of
delivery of the applicable Conversion Notice, and (z) 75% of the Weighted Average Price of the Common Stock on the Trading Day
of the delivery of the applicable Conversion Notice. For the avoidance of doubt, all such foregoing determinations to be appropriately
adjusted for any stock dividend, stock split, stock combination, reclassification or similar transaction during the applicable
calculation period.”
|
•
|
All references in paragraphs 7, 8 and 11 of the Notes to “Conversion Price” are amended to state “Fixed Conversion Price.”
|
|
•
|
Paragraph 4 of the Amendment Agreement, dated January 28, 2016, among the Company and the Buyers, is amended by adding the following sentence at the end of the paragraph:
|
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- CONTINUED
“Notwithstanding
anything to the contrary in this paragraph 4, the Company and the Buyers hereby acknowledge that the Equity Conditions for
the Controlled Account Release Event on May 6, 2016 are not, and are deemed not to be, satisfied, and the Buyers hereby waive
the Equity Conditions for the Controlled Account Release Event on May 6, 2016, for an aggregate release of $310,000, to be
released proportionately among the Buyers based upon the pro rata share as a result of the original principal amounts of the
Notes.”
The Waivers became effective on May 1,
2016.
Warrants
The warrants entitle the holders of
the warrants to purchase, in aggregate, 11,418,936 (10,975,608 shares from the November 5, 2015 closing and 443,328 shares from
the “rollover” of Bridge Notes described at the beginning of this section) shares of our common stock. The warrants
will expire November 5, 2017. The Warrants are initially exercisable at an exercise price equal to the lower of $1.29 and 85% of
the market price at the time of exercise, subject to certain adjustments. The warrants may be exercised for cash, provided that,
if there is no effective registration statement available registering the exercise of the warrants, the warrants may be exercised
on a cashless basis.
The exercise price of the warrants is subject to adjustment
for stock splits, combinations or similar events, and, in this event, the number of shares issuable upon the exercise of the warrant
will also be adjusted so that the aggregate exercise price shall be the same immediately before and immediately after the adjustment.
In addition, the exercise price is also subject to a “full ratchet” anti-dilution adjustment if we issue or are deemed
to have issued securities at a price lower than the then applicable exercise price.
Limitations on Exercise
The warrants may not be exercised if, after giving effect to
the exercise, the holder of the warrant together with its affiliates would beneficially own in excess of 4.99% of our outstanding
shares of common stock. At each holder’s option, the warrant blocker applicable to the exercise of the warrants may be raised
or lowered to any other percentage not in excess of 9.99%.
Fundamental Transactions
The warrants prohibit us from entering into specified transactions
involving a change of control, unless the successor entity assumes all of our obligations under the Warrants under a written agreement
before the transaction is completed.
Registration Rights Agreement
We entered into a Registration Rights Agreement with the Holders
as of the date of Closing. Under this Agreement, we have agreed to register 200% of the shares issuable under the notes and 125%
of the shares issuable under the warrants, with filing to occur no later than 15 days of the Closing and with effectiveness to
occur no later than 75 days of the Closing. If we are unable to meet either of these deadlines, we may be required to pay certain
cash damages under the registration rights agreement or, with the passage of additional time, an event of default under the notes
may occur.
As a result of the January 28, 2016 amendment, the Company was
only required to register shares of stock upon conversion of $3.65 million principal amount of the notes, and interest thereon
with a 200% reserve for registration.
2015 Private Placement Debt Rollforward:
Balance- January 1, 2016
|
|
$
|
7,085,818
|
|
Conversion of senior convertible notes
|
|
|
(722,172
|
)
|
Amortization of senior convertible notes
|
|
|
877,049
|
|
Balance- March 31, 2016
|
|
$
|
7,240,695
|
|
As of March 31, 2016, the Company has
issued 4,443,567 shares of its common stock to convert $722,172 of principal. In addition on March 31, 2016, the Company
issued 366,594 shares of common stock for $59,580 interest and 308,828 shares of common stock for $50,221 make whole
interest. The Company recognized an extinguishment loss of $334,791 on the conversions of the senior convertible notes. The
loss is determined based on the difference between the conversion price as calculated on the installment date versus the
previously calculated price on the notice date. The Company estimates that it will need to issue an additional 13,073,000
shares due to this price variance.
Note 12 – Other Income
For the three months ended March 31, 2016, the Company recognized
$35,854 in other income. The Company sold various zero value equipment.
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS – CONTINUED
13.
|
Related party transactions
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During the first quarter of 2016, the Company engaged
the services of a marketing firm to provide branding and web site development at a cost of $15,000. We engaged the firm
to further provide sales and marketing services for the full year at an estimated cost of $115,000. The principal of this
firm is our Chief Executive Officer’s brother in law; however, neither our Chief Executive Officer nor his immediate
family has any direct or indirect interest in the marketing firm. As of March 31, 2016, the Company has paid $80,000 to this
marketing firm. At March 31, 2016, there was no balance owed to this related party in the Company’s accounts payable
balance.
At March 31, 2016, the Company’s accounts payable
balance included $75,341 as a result of related party transactions. Of those transactions, $59,593 was for consulting fees
associated with the previous CEO, $17,290 was for director related meeting fees, and $3,980 was for employee related travel
expense reimbursement. For the period ended March 31, 2015, the Company’s accounts payable balance included $16,947 in
related party transactions. Of those transactions $8,343, was for fees associated with the previous CEO, and $8,604 were for
employee related travel expense reimbursement.
The accompanying unaudited consolidated
financial statements have been prepared assuming that the Company will continue as a going concern. At March 31, 2016 the Company’s
working capital was $(2.8) million. The financial resources of the Company will not provide sufficient funds for the Company’s
operations beyond the third quarter of 2016, as those operations currently exist. Subsequent funding will be required to fund the
Company’s ongoing operations, working capital, and capital expenditures beyond the third quarter of 2016. No assurances can
be given that the Company will be successful in arranging the further funds needed to continue the execution of its business plan,
which includes the development and commercialization of new products, or even if further funding is available, upon what terms.
Failure to obtain such funds on terms acceptable to the Company’s management will require management to substantially curtail,
if not cease, operations, which will result in a material adverse effect on the financial position and results of operations of
the Company. The unaudited consolidated financial statements do not include any adjustments to reflect the possible future effects
on the recoverability and classification of assets or the amounts and classification of liabilities that might occur if the Company
is unable to continue as a going concern.
On April
27, 2016, there was a cashless exercise of 10,000 Series B warrants that resulted in the issuance of 11,250 shares of the Company’s
common stock. The remaining Series B warrant expired on April 29, 2016.
Effective April 21, 2016, Stanley Hirschman
resigned as a director and chairman and member of the Audit Committee of the Company due to his inability to devote the time and
resources necessary to continue in his role as a director. On April 25, 2016, the Company’s Board of Directors appointed
Richard Bogan, its Chief Executive Officer, as its Chairman in addition to being its CEO, and Donald Farley, as its Vice Chairman.
The Board also appointed Michael Kishinevsky as the interim chairman of its Audit Committee.
On May 1, 2016, the Company has entered
into Waiver and Amendment agreements with each of the investors in its November 2015 private placement. The terms of the Waivers
are described fully in Note 11 to these financial statements.
As of May 13, 2016, 41,289,801 shares
of our common stock have been issued as a result of the conversion of principal, interest and make-whole interest of our November
2015 Senior Convertible Notes which shall be applied consistent with conversion notices and for Pre-Installment Shares, calculation
and application of the applicable Installment Price and share true up arising therefrom.