CRGS CurAegis Technologies Inc (CE)

NOTE 1 — THE COMPANY AND BASIS OF PRESENTATION

CurAegis Technologies, Inc. (“CurAegis”, “the Company”) was incorporated as a New York business corporation on September 25, 1996 under the name Torvec, Inc. The Company’s name was changed from Torvec, Inc. to CurAegis Technologies, Inc. in June 2016 in connection with the establishment of its two business divisions. The CURA division is engaged in the fatigue management business and the Aegis division is engaged in the power and hydraulic business.

The Company develops and markets advanced technologies in the areas of power, safety and wellness. The Company is focused on the commercialization of a wellness and safety system (the CURA system and the myCadian watch) and a uniquely designed hydraulic pump that will be smaller, lighter and more efficient than current technology. The Company has not had any significant revenue-producing operations.  

The Company has created the CURA system to market products that reduce fatigue risk in the workplace and help individuals manage their sleep and improve alertness. The CURA system consists of the following capabilities:

Our goal with the Aegis hydraulic pump technology is to bring to the marketplace a unique concept in hydraulic pumps and motors that will be:

It is important to note, regarding both the CURA and Aegis products, that the cycle time from the initiation of the sales process to revenue realization can be highly variable especially as a start-up entity. In addition to the activities to be undertaken to implement our plan of operations, we may expand and/or refocus our activities depending upon future circumstances and developments.

Management Plans As of September 30, 2016, we have cash on hand of $1,069,000, working capital of $823,000, stockholders’ equity of $1,200,000 and an accumulated deficit of $74,213,000. During the nine months ended September 30, 2016 we raised gross proceeds of $1,510,500 through the sale of our Series C-3 preferred stock and $995,000 through the issuance of 6% senior convertible notes and warrants. The proceeds from these private placements are being used to support the ongoing development and marketing of our core technologies and product initiatives.

On December 8, 2015, the Company commenced the offering of up to ten million shares of its Series C-3 Voting Convertible Preferred stock with an offering price of $0.25 per share in a private placement pursuant to Rule 506(c) of Regulation D under the Securities Act of 1933. The offering was made only to “accredited investors” as defined in Rule 501(a) of Regulation D under the Securities Act of 1933. The C-3 preferred stock offering expired on September 1, 2016.

On August 25, 2016 the Company commenced the sales of up to $3 million in 6% senior convertible notes and warrants in a private placement pursuant to Rule 506(c) of Regulation D under the Securities Act of 1933. The offering has been made only to “accredited investors” as defined in Rule 501(a) of Regulation D under the Securities Act of 1933. The Company closed on the sale of $995,000 of the senior convertible notes and warrants during the three-month period ended September 30, 2016.

Management will continue to use its best efforts to develop financing opportunities to fund the development and commercialization of the CURA and Aegis products. Management estimates that the 2016 cash needs, based on its current development and product plans, will be approximately $3.7 million. As of September 30, 2016, the Company’s cash and cash equivalents on hand may not be sufficient to cover the Company’s future working capital requirements. The Company’s ability to fund its current and future commitments out of its available cash depends on a number of factors. These factors include the Company’s ability to (i) launch and generate sales from the CURA division and; (ii) decrease research and overhead expenses. If these and other factors are not met and if the Company cannot generate sufficient cash from its operations, the Company would need to raise additional funds in the future in order to fund its working capital needs and pursue its growth strategy. Although there can be no assurances, management believes that sources for these additional funds will be available through either current or future investors.  

Since inception, we have financed our operations by the sale of our securities and debt financings. We may need to raise additional funds in the future to fund our working capital needs, to fund more aggressive expansion of our business, to complete development, testing and marketing of our products, or to make strategic acquisitions or investments. We may require additional equity or debt financings, collaborative arrangements with corporate partners or funds from other sources for these purposes. No assurance can be given that necessary funds will be available for us to finance our development on acceptable terms, if at all. Furthermore, such additional financings may involve dilution of our shareholders or may require that we relinquish rights to certain of our technologies or products. In addition, we may experience operational difficulties and delays due to working capital restrictions. If adequate funds are not available from operations or additional sources of financing, we may have to delay or scale back our growth plans. 

NOTE 2— SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation: The Company’s unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) for interim financial information and in accordance with the instructions to Form 10-Q and Article 8-03 of Regulation S-X of the Securities and Exchange Commission (“SEC”). Accordingly, the condensed consolidated financial statements do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of the Company’s management, all adjustments considered necessary for a fair presentation (consisting of normal recurring adjustments) have been included. The results for interim periods are not necessarily indicative of what the results will be for the fiscal year. The accompanying condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements as of and for the year ended December 31, 2015 contained in the Company’s 2015 Annual Report on Form 10-K filed with the SEC.

Consolidation: The financial statements include the accounts of the Company, our wholly-owned subsidiary Iso-Torque Corporation, and our majority-owned subsidiary, Ice Surface Development, Inc. (56% owned at September 30, 2016). As of September 30, 2016, each of the subsidiaries is non-operational. The Company intends to let Ice Surface Development, Inc. dissolve by proclamation. All material intercompany transactions and account balances have been eliminated in consolidation.

Use of Estimates: The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. These estimates are subject to a high degree of judgment and potential change. Actual results could differ from those estimates.  

Reclassifications: Certain reclassifications may have been made to prior year balances to conform to the current year’s presentation.

Cash and Cash Equivalents: Cash and cash equivalents may include time deposits, certificates of deposit, and highly liquid debt instruments with original maturities of three months or less. We maintain cash and cash equivalents at financial institutions which periodically may exceed federally insured amounts. We have a corporate credit card program through our primary financial institution, JPMorgan Chase Bank, N.A. In connection with this, the Company granted a security interest to the Bank in our premium commercial money market account to act as collateral for the activity within the corporate card program, up to $25,000.  

Inventory : Inventory is stated at the lower of cost or market with cost determined under the average cost method. We record provisions for excess, obsolete or slow-moving inventory based on changes in customer demand, technology developments or other economic factors. There was no provision for excess, obsolete or slow-moving inventory as of September 30, 2016 and December 31, 2015.

Accounts Receivable : We carry our accounts receivable at invoice amount less an allowance for doubtful accounts.  On a periodic basis, we evaluate our accounts receivable and establish an allowance for doubtful accounts, based on a history of past write-offs and collections and current credit conditions.  We do not accrue interest on past due invoices.  The allowance for doubtful accounts was zero at September 30, 2016 and December 31, 2015.

Software, Property and Equipment: Capitalized software, property and equipment are stated at cost. Estimated useful lives are as follows:

Depreciation and amortization are computed using the straight-line method. Betterments, renewals and significant repairs that extend the life of the assets are capitalized. Other repairs and maintenance costs are expensed when incurred. When disposed, the cost and accumulated depreciation applicable to assets retired are removed from the accounts and the gain or loss on disposition is recognized in other income (expense). Depreciation and software amortization expense for the three months ended September 30, 2016 and 2015 amounted to $45,000 and $27,000, respectively. Depreciation and amortization expense for the nine months ended September 30, 2016 and 2015 amounted to $129,000 and $85,000, respectively.

Whenever events or circumstances indicate, our long-lived assets including any intangible assets with finite useful lives are tested for impairment by using the estimated future cash flows directly associated with, and that are expected to arise as a direct result of, the use of the assets. If the carrying amount exceeds the estimated undiscounted cash flows, impairment may be indicated. The carrying amount is compared to the estimated discounted cash flows and if there is an excess such amount is recorded as impairment. During the three and nine months ended September 30, 2016 and 2015, we recorded no impairment charges.

Fair Value of Financial Instruments: As defined by U.S. GAAP , fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. A hierarchy for ranking the quality and reliability of the information is used to determine fair values. Assets and liabilities carried at fair value will be classified and disclosed in one of the following three categories: 

Level 1: Quoted market prices in active markets for identical assets or liabilities

Level 2: Observable market based inputs or unobservable inputs that are corroborated by market data

Level 3: Unobservable inputs that are not corroborated by market data 

The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The Financial Accounting Standards Board’s (“FASB”) guidance for the disclosure about fair value of financial instruments requires disclosure of an estimate of the fair value of certain financial instruments. The fair value of financial instruments pursuant to FASB’s guidance for the disclosure about fair value of financial instruments approximated their carrying values at September 30, 2016. The carrying amount of cash and cash equivalents, accounts receivable, prepaid expenses and other current assets, accounts payable and accrued expenses approximates their fair value due to their short maturity. The carrying amount of capital lease obligations approximates fair value because stated or implied interest rates approximate current interest rates that are available for debt with similar terms.

Revenue Recognition and Deferred Revenue: The Company began offering the Z-Coach aviation wellness program in the first quarter of 2016. The Z-Coach wellness program provides fatigue safety training over an annual subscription period of twelve months. The Z-Coach program allows the user unlimited access during the annual subscription period. Customers are billed at the acceptance of the subscription and revenue is recognized ratably over the subscription period as our performance obligations are satisfied and when collection is reasonably assured. One customer accounted for 48% of total sales made during the nine-month period ended September 30, 2016 and four other customers accounted for an aggregate of 30% of total sales during this period. Our collection terms provide customers standard terms of net 30 days. Future performance obligations are reflected in deferred revenue.

Research and Development and Patents: Research and development costs and patent expenses are charged to operations as incurred. Research and development includes personnel-related costs, materials and supplies, depreciation and consulting services.

Patent costs for the three months ended September 30, 2016 and 2015 amounted to $31,000 and $22,000, respectively, and are included in general and administrative expenses. Patent costs for the nine months ended September 30, 2016 and 2015 amounted to $55,000 and $69,000, respectively

Stock-based Compensation: FASB Accounting Standards Codification (“ASC”) 718-10 requires all share-based payments to employees, including grants of employee stock options, to be recognized as compensation expense over the service period (generally the vesting period) in the consolidated financial statements based on their fair values on the grant date. The impact of forfeitures that may occur prior to vesting is also estimated and considered in the amount recognized. In addition, the realization of tax benefits in excess of amounts recognized for financial reporting purposes will be recognized as a financing activity in accordance with ASC 718-10.

No tax benefits were attributed to the stock-based compensation expense because a valuation allowance was maintained for substantially all net deferred tax assets.   

FASB ASC 505-50, “Equity-Based Payments to Non-Employees,” requires all share-based payments to non-employees, including grants of stock options, to be recognized in the consolidated financial statements as compensation expense generally over the service period of the consulting arrangement or until performance conditions are expected to be met. Using a Black-Scholes valuation model, we periodically reassess the fair value of non-employee options until service conditions are met, which generally aligns with the vesting period of the options, and we adjust the expense recognized in the consolidated financial statements accordingly.

FASB ASC 718-20 requires that modifications of the terms or conditions of equity awards be treated as an exchange of the original award for a new award.  Incremental compensation cost is measured as the excess, if any, of the fair value of the modified award over the fair value of the original award immediately before its terms are modified.

Income Taxes: We account for income taxes using the asset and liability method, the objective of which is to establish deferred tax assets and liabilities for the temporary differences between the financial reporting and the tax basis of our assets and liabilities at enacted tax rates expected to be in effect when such amounts are realized or settled. A valuation allowance related to deferred tax assets is recorded when it is more likely than not that some portion or all of the deferred tax assets will not be realized.  

We account for uncertain tax positions using a more-likely-than-not recognition threshold based on the technical merits of the tax position taken. Tax benefits that meet the more-likely-than-not recognition threshold should be measured as the largest amount of tax benefits, determined on a cumulative probability basis, which is more likely than not to be realized upon ultimate settlement in the financial statements. It is our policy to recognize interest and penalties related to income tax matters as general and administrative expenses. As of September 30, 2016 and December 31, 2015, there were no accrued interest or penalties related to uncertain tax positions.

Loss per Common Share: FASB’s ASC 260-10 (“Earnings Per Share”) requires the presentation of basic earnings per share, which is based on weighted average common stock outstanding, and dilutive earnings per share, which gives effect to options, warrants and convertible securities in periods when they are dilutive. At September 30, 2016 and 2015, we excluded 60,268,000 and 54,172,000 potential common shares, respectively, relating to convertible preferred stock, convertible notes, options and warrants outstanding from the diluted net loss per common share calculation because their inclusion would be anti-dilutive. In addition, we excluded 625,000 warrants from the diluted net loss per common share calculation at September 30, 2016 and 2015 as the conditions for their vesting are not time-based.  

Recent Accounting Pronouncements: 

FASB Accounting Pronouncements Related to Revenue from Contracts with Customers (Topic 606)

In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2014-09, “Revenue from Contracts with Customers” which supersedes nearly all existing revenue recognition guidance under U.S. GAAP. The core principle of ASU 2014-09 recognizes revenue when promised goods or services are transferred to customers in an amount that reflects the consideration to which an entity expects to be entitled for those goods or services. ASU 2014-09 defines a five step process to achieve this core principle and, in doing so, more judgment and estimates may be required within the revenue recognition process than are required under existing U.S. GAAP.  

In May 2015, the FASB issued ASU 2015-14, “Revenue from Contracts with Customers” extending the date of implementation of this guidance for public companies to reporting periods beginning after December 15, 2017. In March 2016, the FASB issued ASU 2016-08 “Revenue from Contracts with Customers” to provide guidance on the topic of principal versus agent considerations. In April 2016, the FASB issued ASU No. 2016-10, “Revenue from Contracts with Customers" to further clarify identifying performance obligations and licensing in Topic 606.  In May, 2016, the FASB issued ASU No. 2016-12, “Revenue from Contracts with Customers” to addressed narrow-scope improvements and practical expedients relative to certain aspects of Topic 606.

These standards are effective for annual periods beginning after December 15, 2017, and interim periods therein, using either of the following transition methods: (i) a full retrospective approach reflecting the application of the standard in each prior reporting period with the option to elect certain practical expedients, or (ii) a retrospective approach with the cumulative effect recognized at the date of adoption (which includes additional footnote disclosures).

The Company continues to evaluate the impact of the adoption of FASB accounting pronouncements related to revenue from Contracts with Customers (Topic 606) and has not yet determined the method by which we will adopt these standards.

Other FASB Accounting Pronouncements  

In August 2016, the FASB issued ASU No. 2016-15 Statement of Cash Flows: “Classification of Certain Cash Receipts and Cash Payments (topic 230).” There is diversity in practice in how certain cash receipts and cash payments are presented and classified in the statement of cash flows under Topic 230, Statement of Cash Flows, and other Topics. This pronouncement addresses eight specific cash flow issues with the objective of reducing the existing diversity in practice. The amendments are effective for public entities for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. The Company is evaluating the impact of the adoption of this standard on our consolidated financial statements and related disclosures.

In June 2016, the FASB issued ASU No. 2016-13 Financial Instruments- Credit Losses (Topic 326) “Measurement of Credit Losses on Financial Instruments.” The pronouncement affects entities holding financial assets and net investments in leases that are not accounted for at fair value through net income. The amendments affect loans, debt securities, trade receivables, net investments in leases, off-balance-sheet credit exposures, reinsurance receivables, and any other financial assets that have the contractual right to receive cash. This pronouncement will affect an entity to varying degrees depending on the credit quality of the assets held, their duration, and how the entity applies current GAAP. The standard is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. The Company is evaluating the impact of the adoption of this standard on our consolidated financial statements and related disclosures.

On March 30, 2016, the FASB issued ASU No. 2016-09, “Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting,” which amends the current stock compensation guidance. The amendments simplify the accounting for the taxes related to stock based compensation, including adjustments as to how excess tax benefits and a company's payments for tax withholdings should be classified. The standard is effective for fiscal periods beginning after December 15, 2016, with early adoption permitted. The Company is evaluating the impact of the adoption of this standard on our consolidated financial statements and related disclosures.

On February 25, 2016, the FASB issued ASU No. 2016-02, “Leases,” a comprehensive new lease standard which will supersede previous lease guidance. The standard requires a lessee to recognize in its balance sheet assets and liabilities related to long-term leases that were classified as operating leases under previous guidance. An asset will be recognized related to the right to use the underlying asset and a liability will be recognized related to the obligation to make lease payments over the term of the lease. The standard also requires expanded disclosures surrounding leases. The standard is effective for fiscal periods beginning after December 15, 2018, and requires modified retrospective adoption, with early adoption permitted. The Company is evaluating the impact of the adoption of this standard on our consolidated financial statements and related disclosures.

NOTE 3 –CURA SOFTWARE

The Company has invested $364,000 in software for the CURA division. These assets are being amortized over an estimated useful life of 3 years. As of September 30, 2016 accumulated amortization of capitalized software was $119,000 resulting in a net book value of $245,000.

During the nine months ended September 30, 2016, the Company recognized $77,000 in cost of revenue and $8,000 to general and administrative expenses for amortization of the CURA software. Future amortization expense is expected to be $29,000 in 2016, $118,000 in 2017, $84,000 in 2018 and $14,000 in 2019.

Depreciation expense for the three months ended September 30, 2016 and 2015 was $15,000 and $27,000 respectively. Depreciation expense for the nine months ended September 30, 2016 and 2015 was $43,000 and $85,000 respectively.

NOTE 5 — 6% SENIOR CONVERTIBLE NOTES AND WARRANTS

During the third quarter of 2016, the board of directors authorized the issuance of up to $3 million in 6% Senior Convertible Promissory Notes and Warrants (the “Convertible Notes”) in connection with the August 25, 2016 Securities Purchase Agreement (the “2016 SPA”).

The conversion rate of the notes has been fixed at $0.25 per share as determined at the close of business on August 25, 2016. The investors have been granted warrants to purchase an aggregate number of shares of common stock equal to 10% of the number of shares issuable upon the conversion of the notes. The notes have an annual interest rate of 6% and a five-year maturity. The warrants have a fixed exercise price of $0.25 and a ten-year term from the date of issuance. The notes will be offered in a private placement exempt from registration under Section 4(a)(2) of the Securities Act of 1934, as amended and Rule 506(c) of Regulation D as promulgated by the Securities and Exchange Commission. The offering is available only to “accredited investors” as defined in Rule 501(a) of Regulation D under the Securities Act of 1933.

During the quarter ended September 30, 2016, the Company issued six Convertible Notes aggregating $995,000 pursuant to the 2016 SPA. In connection with the notes, the Company granted 398,000 warrants with an exercise price of $0.25 per share and 10 year terms. The Company incurred $12,000 in debt issuance costs in connection with the issuance of the Convertible Notes. In accordance with FASB ASU 2015-03 Interest-Imputation of Interest (Subtopic 835-30), these debt issuance costs have been presented as a direct deduction from the carrying amount of the Convertible Note liability and reflected as a component of debt discount which is amortized and included in interest expense over the five-year term of the Convertible Notes.

The Company allocated $990,000 of the Convertible Note proceeds to debt discount based on the computed fair value of the warrants issued, the beneficial conversion feature and the debt issuance costs. During the three months ended September 30, 2016 the Company recorded $20,000 in interest expense including amortization of debt discount of $14,000. As of September 30, 2016, the Convertible Notes had a face value of $995,000 and are presented net of unamortized debt discount of $975,000 related to warrants, beneficial conversion feature and debt issuance costs resulting in a carrying value of $20,000. The 6% Convertible Notes could be converted into common stock with an underlying value of approximately $1,711,000 as of September 30, 2016 based on the trading price on September 30, 2016.

NOTE 6— CAPITAL LEASE OBLIGATION

In 2015, we entered into a capital lease for a copy machine with a 5-year term, including a fair market value buyout option. The capitalized value of the lease was $8,900, and the monthly payment is $170 with an implicit interest rate of 5.3%. As of September 30, 2016 and December 31, 2015, the outstanding principal balance due on this lease agreement was $7,000.

NOTE 7 — BUSINESS SEGMENTS

The Company operates in two divisions: the CURA division and the Aegis division. The CURA division is focused on the fatigue and wellness business and the Aegis division is currently developing unique applications in the power and hydraulic business. Information concerning the Company’s operations by reportable segment for the three and nine months ended September 30, 2016 for each of the company’s business segments follows: 

Capital expenditures during the third quarter of 2016 for the CURA and Aegis segments were $33,000 and zero, respectively. During the third quarter of 2016, the Company recognized depreciation and amortization expense of $32,000 and $10,000 for the CURA and Aegis divisions, respectively. Depreciation expense not allocated to these business segments was $3,000 in the third quarter of 2016.   

Capital expenditures during the nine months ended September 30, 2016 for the CURA and Aegis segments were $60,000 and zero, respectively. The Company also invested $8,000 in capital expenditures attributed to the corporate segment during this period. During the nine months ended September 30, 2016, the Company recognized depreciation and amortization expense of $90,000 and $31,000 for the CURA and Aegis divisions, respectively. Depreciation expense not allocated to these business segments was $8,000 in the nine months ended September 30, 2016. 

Information concerning the Company’s operations by reportable segment for the three and nine months ended September 30, 2015 for each of the company’s business segments follows:    

Capital expenditures during the third quarter of 2015 for the CURA or Aegis segments were $300,000 and $0, respectively. During the third quarter of 2015, the Company recognized depreciation and amortization expense of $8,000 and $13,000 for the CURA and Aegis divisions, respectively. Depreciation expense not allocated to these business segments was $6,000 in the third quarter of 2015.  

Capital expenditures during the nine months ended September 30, 2015 for the CURA and Aegis segments were $300,000 and $8,000, respectively. During the nine months ended September 30, 2015, the Company recognized depreciation and amortization expense of $8,000 and $51,000 for the CURA and Aegis divisions, respectively. Depreciation expense not allocated to these business segments was $26,000 in the nine months ended September 30, 2015. 

NOTE 8— PREFERRED and COMMON STOCK

Common Stock  

We have authorized 400,000,000 shares of common stock, with a par value of $0.01 per share. 

During the nine months ended September 30, 2016 we issued 760,000 shares of common stock in connection with conversion notices received from several Series C-3 convertible preferred shareholders. During the nine months ended September 30, 2015, the Company issued 37,743 shares of common stock in connection with conversion notices received from a Series A convertible preferred shareholder. The Series A conversion include 21,380 shares of common stock issued in connection with these shares conversions and 16,363 in common shares attributed to dividends earned on the underlying converted shares.

Preferred Stock  

Our certificate of incorporation permits the Company to issue up to 100,000,000 shares of $.01 par value preferred stock. The board of directors has the authority to allocate these shares into as many separate classes of preferred as it deems appropriate and with respect to each class, designate the number of preferred shares issuable and the relative rights, preferences, seniority with respect to other classes and to our common stock and any limitations and/or restrictions that may be applicable without obtaining shareholder approval.

Class A Preferred Stock    We have authorized the issuance of up to 3,300,000 Class A Non-Voting Cumulative Convertible Preferred Shares. Each Class A Preferred Share is convertible after a one year holding period, at the holder’s election, into one share of our common stock. The conversion rate is subject to adjustment in the event of the issuance of our common stock as a dividend or distribution and in the case of the subdivision or combination of our common stock. The Class A Preferred has no voting rights, except with respect to matters directly impacting upon the rights and privileges accorded to such Class.

The holders of the Class A Preferred are entitled to receive cumulative preferential dividends in the amount of $.40 per share of Class A Preferred for each annual dividend period. Dividends payable on the Class A Preferred will be paid in cash out of any funds legally available for the payment of dividends or, in the discretion of the board, will be paid in Class A Preferred at a rate of 1 share of Class A Preferred for each $4.00 of dividends. If dividends are paid in shares of Class A Preferred, such dividend shares are not entitled to accumulate additional dividends and themselves may be converted into the common stock of the Company on a one for one basis. Holders of Class A Preferred are permitted to request that dividends payable in Class A Preferred be immediately converted into shares of our common stock. At times, we may elect to settle the dividends through the issuance of common stock in lieu of cash. Accumulated and unpaid dividends on the Class A Preferred will not bear interest. Class A Preferred shares are also entitled to participate pro rata in dividends declared and/or distributions made with respect to all classes of our outstanding equity.  We may, in the absolute discretion of our board, redeem at any time and from time to time from any source of funds legally available any and all of the outstanding Class A Preferred at the redemption price of $4.00 per Class A Preferred, plus all unpaid accumulated dividends payable with respect to each Class A Preferred Share.  

During the nine months ended September 30, 2015, the Company issued 37,743 shares of common stock in connection with conversion notices received from a Series A convertible preferred shareholder. The Series A conversion include 21,380 shares of common stock issued in connection with these shares conversions and 16,363 in common shares attributed to dividends earned on the underlying converted shares.

At September 30, 2016, there were 543,221 outstanding shares of Class A Preferred stock, of which 8,709 shares resulted from the settlement of dividends due to conversion, and those shares no longer accrue dividends. The value of dividends payable upon the conversion of the remaining 534,512 outstanding shares of Class A Preferred stock was $2,485,000 at September 30, 2016 and $2,325,000 at December 31, 2015.

In the event of a liquidation, dissolution and winding up of the Company, and subject to the liquidation rights and privileges of our Class C Preferred shareholders, Class A Preferred shareholders have a liquidation preference with respect to all accumulated and unsettled dividends. The value of the Class A Preferred shareholders’ liquidation preference was $2,485,000 and $2,325,000 at September 30, 2016 and December 31, 2015, respectively. In the event of liquidation, dissolution or winding up of the Company, unpaid accumulated dividends on the Class A Preferred are payable in Class A Preferred at a rate of 1 share of Class A Preferred for each $4.00 of dividends.  

Class B Preferred Stock The Company authorized the issuance of up to 300,000 Class B Non-Voting, Cumulative Convertible Preferred Shares to fund the business operations of Iso-Torque Corporation, an entity incorporated to separately commercialize the Company’s Iso-Torque differential technology.

Each Class B Preferred Share is convertible after a one year holding period, at the holder’s election, into one share of our common stock or one share of the common stock of Iso-Torque Corporation. The conversion rate is subject to adjustment in the event of the issuance of the Company’s or Iso-Torque Corporation’s common stock as a dividend or distribution and in the case of the subdivision or combination of such common stock. The Class B Preferred has no voting rights, except with respect to matters directly impacting upon the rights and privileges accorded to such Class.

Subject to the dividend rights and privileges of our Class A Preferred, the holders of the Class B Preferred are entitled to receive cumulative dividends in the amount of $.50 per share of Class B Preferred for each annual dividend period. Dividends payable on the Class B Preferred will be paid in cash out of any funds legally available for the payment of dividends or, in the discretion of the board, will be paid in Class B Preferred at a rate of 1 share of Class B Preferred for each $5.00 of dividends. If dividends are paid in shares of Class B Preferred, such dividend shares are not entitled to accumulate additional dividends and themselves may be converted into the common stock of the Company on a one for one basis. Holders of Class B Preferred are permitted to request that dividends payable in Class B Preferred be immediately converted into shares of our common stock.  Accumulated and unpaid dividends on the Class B Preferred will not bear interest. Class B Preferred shares are also entitled to participate pro rata in dividends declared and/or distributions made with respect to all classes of our outstanding equity. We may, in the absolute discretion of our board, redeem at any time and from time to time from any source of funds legally available any and all of the outstanding Class B Preferred at the redemption price of $5.00 per Class B Preferred, plus all unpaid accumulated dividends payable with respect to each Class B Preferred Share.

Depending upon our cash position, from time to time we may request that a converting preferred shareholder receiving dividends in cash consent to receive shares of restricted common stock in lieu thereof. For the three and nine months ended September 30, 2016 and 2015, we settled no Class B Preferred dividends.

At September 30, 2016 and December 31, 2015, dividends payable upon the conversion of 67,500 outstanding shares of Class B Preferred was $378,000 and $353,000, respectively. In the event of liquidation, dissolution and winding up of the Company, and subject to the liquidation rights and privileges of our Class C Preferred shareholders and our Class A Preferred shareholders, Class B Preferred shareholders have a liquidation preference with respect to all accumulated and unsettled dividends. The value of the Class B Preferred shareholders’ liquidation preference was $378,000 and $353,000 at September 30, 2016 and December 31, 2015, respectively. In the event of a liquidation, dissolution or winding up of the Company, unpaid accumulated dividends on the Class B Preferred are payable in Class B Preferred shares at a rate of 1 share of Class B Preferred for each $5.00 of dividends. 

Series C Preferred Stock We have authorized and issued 16,250,000 shares of Series C Voting Convertible Preferred Stock. Each Series C Preferred share is convertible, at the holder’s election, into one share of our common stock. The conversion rate is subject to adjustment in the event of the issuance of common stock as a dividend or distribution, and the subdivision or combination of the outstanding common stock.  

The Series C Preferred shares have a liquidation preference at their stated value per share of $0.40 that is senior to our common stock, and the Company’s Class A Non-Voting Cumulative Convertible Preferred Shares and Class B Non-Voting Cumulative Convertible Preferred Shares. The liquidation preference is payable upon a liquidation, dissolution or winding up of the Company, whether voluntary or involuntary, or upon a deemed liquidation of the Company.

The Series C Preferred shares have no right to receive dividends and have no redemption right. The Series C Preferred shares vote with the common stock on an as-converted basis.

Cumulatively through September 30, 2016, Series C Preferred shareholders have converted no shares of Series C Preferred into common stock. At September 30, 2016 and December 31, 2015, there were 16,250,000 shares of Series C Preferred stock outstanding. The value of the Series C Preferred shareholders’ liquidation preference was $6,500,000 at September 30, 2016 and December 31, 2015.

Series C-2 Preferred Stock    In 2014, the board of directors authorized and the Class A Preferred, Class B Preferred and Series C Preferred shareholders approved, a series of preferred stock, namely 25,000,000 shares of Series C-2 Voting Convertible Preferred Stock. On March 28, 2014, we sold and issued a total of 25,000,000 shares of Series C-2 Voting Convertible Preferred Stock in a private placement transaction, generating gross proceeds of $5,000,000.

Each Series C-2 Preferred Share is convertible, at the holder’s election, into one share of our common stock, par value $0.01 per share. The conversion rate is subject to adjustment in the event of the issuance of common stock as a dividend or distribution, and the subdivision or combination of the outstanding common stock or a reorganization, recapitalization, reclassification, consolidation or merger of the Company.

The Series C-2 Preferred Shares have a liquidation preference at their stated value per share of $0.20 that ranks pari passu to our existing Series C Voting Convertible Preferred Shares and is senior to our common stock, and our Class A Non-Voting Cumulative Convertible Preferred Shares and Class B Non-Voting Cumulative Convertible Preferred Shares. The liquidation preference is payable upon a liquidation, dissolution or winding up of the Company, whether voluntary or involuntary, or upon a deemed liquidation of the Company. A deemed liquidation includes, unless decided by the holders of at least two-thirds of the Series C-2 Preferred Shares, any consolidation, merger, or reorganization of the Company in which the shareholders of the Company own less than fifty percent of the voting power of the resultant entity, or an acquisition to which the Company is a party in which at least fifty percent of the Company’s voting power is transferred, or the sale, lease, exclusive license or transfer of all or substantially all of the assets or intellectual property of the Company other than to a wholly owned subsidiary.

The Series C-2 Preferred Shares are not entitled to receive preferred dividends and have no redemption right, but are entitled to participate, on an as converted basis; with holders of outstanding shares of common stock in dividends and distributions on liquidation after all preferred shares have received payment in full of any preferred dividends or liquidation preferences. The Series C-2 Preferred Shares vote with the common stock on an as-converted basis. We may not, without approval of the holders of at least two-thirds of the Series C-2 Preferred Shares, (i) create any class or series of stock that is pari passu or senior to the Series C-2 Preferred Shares; (ii) create any class or series of stock that would share in the liquidation preference of the Series C-2 Preferred Shares or that is entitled to dividends payable other than in common stock or Series C-2 Preferred Shares of its own series, (iii) acquire any equity security or pay any dividend, except dividends on a class or series of stock that is junior to the Series C Preferred Shares, payable in such junior stock, (iv) reissue any Series C-2 Preferred Shares, (v) declare or pay any dividend that would impair the payment of the liquidation preference of the Series C-2 Preferred Shares, (vi) authorize or issue any additional Preferred Shares, (vii) change the Certificate of Incorporation to adversely affect the rights of the holders of the Series C-2 Preferred Shares, or (viii) authorize, commit to or consummate any liquidation, dissolution or winding up in which the liquidation preference of the Series C-2 Preferred Shares would not be paid in full. 

The Series C-2 Preferred Shares will not be and have not been registered under the Securities Act of 1933, as amended, or the Securities Act, and may not be offered or sold in the United States absent registration or an applicable exemption from registration requirements.

Through September 30, 2016, Series C-2 Preferred shareholders have not converted any shares of Series C-2 Preferred into common stock. At September 30, 2016 and December 31, 2015, there were 25,000,000 shares of Preferred C-2 stock outstanding. The value of the Series C-2 Preferred shareholders’ liquidation preference was $5,000,000 at September 30, 2016 and December 31, 2015.  

Series C-3 Preferred Stock In 2015, the board of directors authorized and the Class A Preferred, Class B Preferred, Series C Preferred and C-2 Preferred shareholders approved, a series of preferred stock, namely 10,000,000 shares of Series C-3 Voting Convertible Preferred Stock. On December 8, 2015, the Company commenced the offering of up to $2,500,000 of the Series C-3 Preferred Shares at the price of $0.25 per share in a private placement pursuant to Rule 506(c) of Regulation D under the Securities Act of 1933. The offering has been made only to “accredited investors” as defined in Rule 501(a) of Regulation D under the Securities Act of 1933. The Series C-3 Preferred Shares are convertible into shares of the Company’s common stock at the rate of one-to-one, subject to adjustment in some circumstances. The Series C-3 Preferred Shares will have an aggregate liquidation preference, ranking pari passu with the Series C Preferred Shares and Series C-2 Preferred Shares and senior to the company’s common stock, the Class A Preferred Shares and Class B Preferred Shares. The Series C-3 Preferred Shares are not entitled to receive preferred dividends and have no redemption rights, but are entitled to participate, on an as converted basis, with holders of the company’s common stock in dividends and distributions. The Series C-3 Preferred Shares vote with the Company’s common stock on an as-converted basis and have certain protective provisions. The Series C-3 Preferred Shares will not be registered under the Securities Act of 1933. Accordingly, those shares and the shares of common stock issuable upon their conversion are “restricted securities” within the meaning of Rule 144 under the Securities Act of 1933 and may not be offered for resale or resold or otherwise transferred except pursuant to a registration statement under the Securities Act of 1933 or an applicable exemption from registration requirements. 

As of September 30, 2016, the Company has sold and issued a total of 6,042,000 shares of Series C-3 Voting Convertible Preferred Stock in a private placement transaction, generating gross proceeds of $1,510,500. Direct expenses of $12,000 pertaining to the transaction, consisting of external legal costs, were incurred, resulting in net proceeds of $1,498,000. 

In conjunction with the issuance of the Series C-3 Preferred stock, we computed the value of the non-cash beneficial conversion feature associated with the right to convert the shares into common stock on a one-for-one basis. We compared the fair value of our common stock on the date of issuance with the effective conversion price, and determined that the value of the non-cash beneficial conversion feature, for the three and nine months ended September 30, 2016, was $285,000, and $885,000 respectively, and is reflected in our condensed consolidated statements of operations as an adjustment to arrive at the net loss attributable to common stockholders.

During the nine months ended September 30, 2016 we issued 760,000 shares of common stock in connection with conversion notices received from several Series C-3 convertible preferred shareholders.  

NOTE 9 — STOCK OPTIONS  

2016 Stock Option Plan    At the 2016 Annual Meeting the shareholders approved the 2016 Stock Option Plan (the “2016 Plan”) which provides for the grant of up to 3,000,000 common stock options to provide equity incentives to directors, officers, employees and consultants. Two types of options may be granted under the 2016 Plan: non-qualified stock options and incentive stock options. No options have been granted under this plan as of September 30, 2016.

2011 Stock Option Plan In 2011, shareholders approved the 2011 Stock Option Plan (the “2011 Plan”) which provides for the grant of up to 3,000,000 common stock options to provide equity incentives to directors, officers, employees and consultants. Two types of options may be granted under the 2011 Plan: non-qualified stock options and incentive stock options.

Under the 2016 and 2011 Stock Option Plans, non-qualified stock options may be granted to our officers, directors, employees and outside consultants. Incentive stock options may be granted only to our employees, including officers and directors who are also employees. In the case of non-qualified stock options, the exercise price may be less than the fair market value of our stock on the date of grant. Stock option grants to non-employees are revalued at each reporting date to reflect the compensation expense over the vesting period. In the case of incentive stock options, the exercise price may not be less than such fair market value and in the case of an employee who owns more than 10% of our common stock, the exercise price may not be less than 110% of such market price. Options generally are exercisable for ten years from the date of grant, except that the exercise period for an incentive stock option granted to an employee who owns more than 10% of our stock may not be greater than five years.

During the nine months ended September 30, 2016, we granted a total of 347,000 stock options to existing employees and non-employee board members. These included 20,000 stock options granted to employees at an exercise prices ranging from $0.41 to $0.46 per share, exercisable for 10 years. These options vest in four tranches at a rate of 25% per year on each of the four anniversary dates from the date of grant. Also included in this total were 327,000 stock options to employees and to our non-employee board members to at an exercise price of $0.34 to $0.53 per share, exercisable for 10 years. This group of options will fully vest upon the trading price of the common stock of the Company reaching $5.00 per share. 

As of September 30, 2016, there were 2,392,000 stock options outstanding under the 2011 Plan, 1,415,000 of which were vested. At September 30, 2016, there were 608,000 options remaining available for future grant under the 2011 Plan. During nine-month period ended September 30, 2016, 3,000 options were cancelled. No options were cancelled during the three and nine month periods ended September 30, 2015. During the three and nine month periods ended September 30, 2016 and 2015, zero and 3,000 options respectively, were cancelled and no options expired.

Non-Plan Options    On occasion, we have granted non-qualified stock options to certain officers, directors and employees that have been outside of established Company Stock Option Plans. All such option grants have been authorized by shareholder approval. 

The expense recognized for options that are granted to consultants (i.e., non-employees) reflect fair value, based on updated valuation assumptions using the Black-Scholes valuation model at each measurement period. Such expense is apportioned over the requisite service period of the consultant, which is concurrent with the vesting dates of the various tranches.

As of September 30, 2016, there were a total of 6,965,000 non-plan options outstanding, of which 4,815,000 were fully vested. In the nine month periods ended September 30, 2016 and 2015, zero non-plan stock options were vested. During the nine months ended September 30, 2016 and 2015, no non-plan stock options were cancelled, respectively. No non-plan stock options were exercised in the nine months ended September 30, 2016 or 2015.

Summary    For the three months ended September 30, 2016 and 2015, compensation cost related to all stock options amounted to $24,000 and $251,000, respectively. For the nine months ended September 30, 2016 and 2015, compensation cost related to all stock options amounted to $100,000 and $349,000, respectively. As of September 30, 2016, there was $222,000 of total unrecognized compensation costs related to outstanding stock options, which are expected to be recognized over a weighted average 1.5 years.

The weighted average grant date fair value of all stock options granted during the nine months ended September 30, 2016 and 2015 was $0.44 and $0.53, respectively. The total grant date fair value of stock options vested during the nine months ended September 30, 2016 and 2015 was $39,000 and $861,000, respectively.  

The fair value of options granted during the nine month periods ended September 30, 2016 and 2015 were measured on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions:

Included in the 2016 assumptions above is the impact of 307,000 stock options, that were granted under the 2011 Plan, that will vest based on certain market conditions, specifically these options will fully vest upon the first day the trading price of the common stock of the Company shall be $5.00 per share.

The average risk-free interest rate is based on the U.S. treasury security rate in effect as of the grant date. We determined expected volatility using the historical closing stock price. The expected life was generally determined using the simplified method as we do not believe we have sufficient historical stock option exercise experience on which to base the expected term. 

The following summarizes the activity of all of our outstanding stock options for the nine months ended September 30, 2016: 

As of September 30, 2016, the exercise prices of all outstanding stock options ranged from $.20 per share to $5.00 per share.  

NOTE 11 — RELATED PARTY TRANSACTIONS AND COMMITMENTS

During the three months and nine months ended September 30, 2016, we sold and issued $600,000 of Senior convertible notes and warrants in a private placement transaction, to two members of our board of directors. (See Note 5).

During the nine months ended September 30, 2016, we sold and issued a total of 1,990,000 shares of our Series C-3 voting convertible preferred stock in a private placement transaction, generating gross proceeds of $497,500 to seven members of our board of directors and one executive officer. No Series C-3 preferred shares were issued to related parties in the quarter ended September 30, 2016. (See Note 8).

We occupy a leased facility for our corporate headquarters building, located in Rochester, New York, which consists of both executive offices and manufacturing space. The facility is owned by a partnership, with which one of our directors, is associated. In 2014 we extended our lease for a three-year renewal term through May 31, 2018. The current rental rate is $6,000 per month ($75,000 per annum) for the remainder of the current lease term. In addition, we are required to pay a proportionate share of yearly real estate taxes and yearly common area operating costs. The lease agreement has a three-year renewal option that includes a 9% rate increase at the renewal period that includes the period from September 2018 through May 2021.  Rent expense for the three months ended September 30, 2016 and 2015 was $19,000 and $18,000, respectively. Rent expense for the nine months ended September 30, 2016 and 2015 was $56,000 and $53,000, respectively. Future rent payments required under the extended lease term for the years ending December 31, 2016, 2017, and 2018 amount to $19,000, $75,000 and $31,000, respectively.  

In December 2010, we executed a three-year consultant agreement with one of our directors to provide consulting services to us at a rate of $200 per hour. Pursuant to the agreement, we also agreed to pay the consultant an incentive fee equal to $10,000 or proportionate part thereof for each $1,000,000 of revenue or proportionate part thereof actually received by us for a period of five years, provided the definitive agreement with the third party results from the material efforts of the consultant. In December 2013, the agreement was automatically renewed for an additional three years through December 13, 2016. During the three and nine month periods ended September 30, 2016 and 2015, we recorded no expense for services in relation to this agreement.