NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December
31, 2017
NOTE
1
- THE COMPANY AND BASIS OF PRESENTATION
CurAegis Technologies, Inc. (“CurAegis”, “the Company”) was incorporated as a New York business corporation in
September
1996
under the name Torvec, Inc. The Company’s name was changed to CurAegis Technologies, Inc. in
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 safety, wellness and power.
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:
|
●
|
the myCadian watch and app,
|
|
●
|
real-time alertness monitoring,
|
|
●
|
the Group Wellness Index and
|
|
●
|
the Z-Coach wellness program.
|
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:
|
●
|
smaller and lighter than conventional pumps and motors,
|
|
●
|
unique in its ability to scale larger, allowing more powerful pumps and motors.
|
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
.
Current Cash Outlook and Management Plans
As of
December 31,
201
7,
we have cash on hand of
$194,000,
negative working capital of
$69,000,
a stockholders’ deficit of
$3,408,000
and an accumulated deficit of
$80,841,000.
During the year ended
December 31, 2017
we raised
$2,825,500
in gross proceeds through the issuance of
6%
convertible notes and warrants. The proceeds from this private placement has been used to support the ongoing development and marketing of our core technologies and product initiatives.
Management estimates that the
201
8
cash needs, based on its current development and product plans, will range from
$4.5
to
$5.0
million. As of
December 31, 2017,
the Company’s cash on hand is
not
sufficient to cover the Company’s future working capital requirements. This raises substantial doubt as to the Company’s ability to continue as a going concern. Management continues to use its best efforts to develop financing opportunities to fund the development and commercialization of the CURA and Aegis products.
S
ubsequent to
December 31, 2017,
the board of directors increased the limit on the
2017
Convertible Notes from
$4
million to
$5
million. The
2017
Convertible Notes to be sold in a private placement are 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.
Since inception, we have financed our operations by the sale of our securities and debt financings. We need to raise additional funds to meet our working capital needs, to fund expansion of our business, to complete development, testing and marketing of our products, or to make strategic acquisitions or investments.
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 to 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 additional sources of financing, we will have to delay or scale back our growth plans.
The Company
’s ability to fund its current and future commitments from 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; (ii) generate revenue from the licensing or sale of our hydraulic technologies or; (iii) decrease engineering and development and administrative expenses. If these and other factors are
not
met, the Company would need to raise funds in order to meet its working capital needs and pursue its growth strategy. Although there can be
no
such assurances, management believes that sources for these additional funds will be available through either current or future investors.
NOTE
2
- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
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). As of
December 31, 2017,
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 (U.S. GAAP) 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:
We maintain cash 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 money market account to act as collateral for the activity within the corporate card program, up to
$15,000.
Inventory
: Inventory is stated at the lower of cost or net realizable value 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. The allowance for excess, obsolete or slow-moving inventory was
$6,000
and
zero
at
December 31, 2017
and
December 31, 2016,
respectively.
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
December 31, 2017
and
December 31, 2016.
Software, Property and Equipment:
Capitalized software, property and equipment are stated at cost. Estimated useful lives are as follows:
Software (in years)
|
3
|
Office equipment (in years)
|
5
|
-
|
7
|
Leasehold improvements
|
lesser of useful life or lease term
|
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 years ended
December 31,
201
7
and
2016
amounted to
$180,000
and
$173,000,
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 year
ended
December 31, 2017
we recorded an impairment charge of
$357,000
reflecting the write off of previously capitalized software development costs associated with CURA software that was deemed non-recoverable upon future commercialization of the CURA system.
No
impairment charges were recorded in the year ended
December 31, 2016.
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
December 31, 2017
and
2016.
The carrying amount of cash, accounts receivable, prepaid expenses and other current assets, accounts payable, deferred revenue 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. The
6%
senior convertible notes can be converted into common stock with an underlying value of
$6,162,000
as of
December 31, 2017
based on the trading price on
December 31, 2017.
Revenue Recognition and Deferred Revenue:
The Company has
two
sources of revenue: (i) from the sale of CURA System products and (ii) from stand-alone Z-Coach subscriptions.
Revenue from the sale of CURA System products is recognized upon the shipment of myCadian devices to a customer and upon the company
’s satisfaction of all performance obligations as described in customer agreements. The Z-Coach Program provides fatigue 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. Our collection terms provide customers standard terms of net
30
days. Future performance obligations are reflected in deferred revenue.
Three
customers accounted for
75%
of total Z-Coach subscription sales made during the year ended
December 31, 2017.
Our collection terms provide customers standard terms of net
30
days. Future performance obligations are reflected in deferred revenue.
Engineering and Development and Patents:
Engineering and development costs and patent expenses are charged to operations as incurred. Engineering and development includes personnel-related costs, materials and supplies, depreciation and consulting services.
Patent costs for the years ended
December 31,
201
7
and
2016
amounted to
$146,000
and
$96,000,
respectively, and are included in general and administrative expenses.
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 as performance conditions are expected to be met. Using a Black-Scholes valuation model, we periodically reassess the fair value of non-employee options
as 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:
In
March 2016,
the FASB issued ASU
2016
-
09,
"Compensation - Stock Compensation (Topic
718
)", which identifies areas for simplification involving several aspects of accounting for share-based payment transactions, including the income tax consequences, classification of awards as equity or liabilities, an option to recognize gross stock compensation expense with actual forfeitures recognized as they occur, as well as certain classifications on the statement of cash flows. ASU
2016
-
09
is effective for public companies for annual and interim periods beginning after
December 15, 2016.
We adopted the new accounting standard in the
first
quarter of
2017
and will maintain our policy to estimate forfeitures as they occur to determine stock-based compensation expense. Adoption of this new accounting standard resulted in the recognition of an increase in the Company's gross deferred tax asset of
$1,684,000
and an offsetting decrease for the same amount to the deferred tax asset due to the uncertain tax benefits. There was
no
impact to the Company's accumulated deficit as a result of adopting this new accounting standard.
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
December 31,
201
7,
and
December 31, 2016,
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
December 31, 2017
and
2016,
we excluded
80,288,000
and
72,385,000
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
December 31, 2017
and
2016
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
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 address 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
believes the adoption of FASB accounting pronouncements related to revenue from Contracts with Customers (Topic
606
) will
not
be significant.
Other FASB Accounting Pronouncements
In
May 2017,
the FASB issued ASU
No.
2017
-
09
Compensation -Stock Compensation (Topic
718
) "Scope of Modification Accounting." This update provides guidance about which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting. This amendment is effective for annual periods beginning after
December 15, 2017
and interim periods within those fiscal years. The Company believes the adoption of this standard on our consolidated financial statements and related disclosures will
not
be material.
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 believes the adoption of this standard on our consolidated financial statements and related disclosures will
not
be material.
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 believes the adoption of this standard on our consolidated financial statements and related disclosures will
not
be material.
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 believes the adoption of this standard on our consolidated financial statements and related disclosures will
not
be material.
NOTE
3
– INVENTORY AND RELATED VENDOR LIABILITY
The Company had the following inventory held at our manufacturing vendor and on hand as of
December 31, 2017
and
2016:
|
|
December 31,
|
|
|
|
2017
|
|
|
2016
|
|
Raw materials
|
|
$
|
1,681,000
|
|
|
$
|
4,000
|
|
Finished goods
|
|
|
69,000
|
|
|
|
20,000
|
|
|
|
|
1,750,000
|
|
|
|
24,000
|
|
Less: Reserve for quality
|
|
|
(6,000
|
)
|
|
|
-
|
|
Inventory (net)
|
|
$
|
1,744,000
|
|
|
$
|
24,000
|
|
|
|
|
|
|
|
|
|
|
Liability for inventory held at vendor
|
|
$
|
1,678,000
|
|
|
$
|
-
|
|
During
2017,
the Company initiated a purchase order with a
third
party vendor to manufacture and assemble the myCadian watch. In connection with this agreement, the Company agreed to a cancellation charge for products purchased on behalf of the Company in the instance that the purchase order is subsequently modified, delayed or cancelled. The Company has recorded
$1,750,000
in inventory and components which were purchased by the vendor on our behalf and a related liability of
$1,678,000
for amounts payable in connection with this agreement.
NOTE
4
-
6%
SENIOR CONVERTIBLE NOTES AND WARRANTS
The
Company issued
$2,825,000
and
$3,000,000
of convertible notes during the years ended
December 31, 2017
and
2016,
respectively. All of these notes remaining outstanding as
December 31,
2017.
2017
Convertible Notes
Face value of
2017 Convertible Notes
|
|
$
|
2,825,000
|
|
Debt Discount at issuance
|
|
|
(1,523,000
|
)
|
Write off debt discount upon extinguishment
|
|
|
1,183,000
|
|
Amortization of debt discount
since inception
|
|
|
79,000
|
|
6% Senior Convertible Notes (net)
|
|
$
|
2,564,000
|
|
During
2017,
the board of directors authorized the issuance of up to $
4
million in
6%
Senior Convertible Promissory Notes and Warrants (the
“2017
Convertible Notes”) in connection with the
May 31, 2017
Securities Purchase Agreement (the
“2017
SPA”). The
2017
Convertible Notes have a
five
year maturity and a fixed annual interest rate of
6%.
The initial year of interest expense will be paid to the note holders on the
first
anniversary of each note's issuance and quarterly thereafter. Principal is due in full on each note's maturity date.
The conversion rate of the notes was
originally fixed at
$0.50
per share as determined at the close of business on
May 31, 2017
and subsequently modified on
November 30, 2017
to
$0.333
per share. Investments less than
$500,000
were 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 and investments of
$500,000
and greater were granted warrants to purchase an aggregate number of shares of common stock equal to
25%
of the number of shares issuable upon the conversion of the notes. Originally the warrants had a fixed exercise price of
$0.50
and a
ten
-year term from the date of issuance. The conversion price for the warrants was also modified on
November 30, 2017
to
$0.333
per share.
The Company recognized a gain
of
$70,000
on the extinguishment of debt on
November 30, 2017,
resulting from changes to the conversion and exercise price on the
2017
Convertible Notes then outstanding. The
2017
Convertible Notes outstanding on
November 30, 2017,
in the aggregate amount of
$2,450,000,
were re-issued to reflect a reduction of the conversion price on the notes from
$0.50
per share to
$0.333
per share. The exercise price of the underlying warrants was also reduced from
$0.50
per share to
$0.333
per share. The amendment and reissuance of these
2017
Convertible Notes has been accounted for as an extinguishment and re-issuance of the replacement notes and warrants and resulted in a non-cash gain in the results of operations for the year ended
December 31, 2017.
The notes were 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 was available only to “accredited investors” as defined in Rule
501
(a) of Regulation D under the Securities Act of
1933.
T
he Company issued
$2,825,000
in
2017
Convertible Notes representing
8,485,000
common stock potential shares and
1,186,000
warrants.
The Company allocated
$353,000
of the proceeds from the
2017
SPA to debt discount based on the computed fair value of the warrants issued, the beneficial conversion feature and the debt issuance costs.
During the
year ended
December 31, 2017
the Company recorded
$50,000
in interest expense and amortization of debt discount of
$79,000.
As of
December 31, 2017,
the
2017
Convertible Notes had a face value of
$2,825,000
and are presented net of unamortized debt discount of
$261,000
related to warrants, issued in connection with this offering resulting in a carrying value of
$2,564,000.
2016
Convertible Notes
Face
value December 31, 2016
|
|
$
|
3,000,000
|
|
Debt
discount at issuance
|
|
|
(2,551,000
|
)
|
Amortization of debt discount
since inception
|
|
|
550,000
|
|
6% Senior Convertible Notes (net)
|
|
$
|
999,000
|
|
During
2016,
the board of directors authorized,
and the Company issued,
$3
million in
6%
Senior Convertible Promissory Notes and Warrants (the
“2016
Convertible Notes”) in connection with the
August 25, 2016
Securities Purchase Agreement (the
“2016
SPA”). The
2016
Convertible Notes have
five
year maturity dates ranging from
August 2021
through
December 2021
and a fixed annual interest rate of
6%.
The initial year of interest expense was paid to the note holders on the
first
anniversary of each note's issuance and will be paid quarterly thereafter. Principal is due in full on each note's maturity date.
The conversion rate of the notes was fixed at
$0.25
per share as determined at the close of business on
August 25, 2016.
The investors were 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 warrants have a fixed exercise price of
$0.25
and a
ten
-year term from the date of issuance. The notes were 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 was available only to “accredited investors” as defined in Rule
501
(a) of Regulation D under the Securities Act of
1933.
In connection with the
issuance of the
2016
Convertible Notes, the Company granted
1,200,000
warrants with an exercise price of
$0.25
per share and
10
year terms. The Company incurred
$28,000
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
$2,551,000
of the proceeds from the
2016
SPA to debt discount based on the computed fair value of the warrants, the beneficial conversion feature and the debt issuance costs
on the date of investment. As of
December 31, 2017,
these notes have a face value of
$3,000,000
and are presented net of unamortized debt discount of
$2,001,000
related to warrants, beneficial conversion feature and debt issuance costs resulting in a carrying value of
$999,000.
As of
December 31, 2016,
the Convertible Notes have a face value of
$3,000,000
and were presented net of unamortized debt discount of
$2,457,000
related to warrants, beneficial conversion feature and debt issuance costs resulting in a carrying value of
$543,000.
During the year ended
December 31, 2017,
the Company recorded
$180,000
in interest expense and amortization of debt discount of
$456,000.
During the year ended
December 31, 2016
the Company recorded
$129,000
in interest expense and amortization of debt discount of
$94,000.
NOTE
5
- CAPITAL LEASE OBLIGATION
In
2015,
we entered into a capital lease for a copy machine over a
5
year term, with a fair market value buyout option. The capitalized value of the lease was approximately
$9,000
and the monthly payment is approximately
$170
with an implicit interest rate of
5.3%.
Future payments remaining under this lease agreement are less than
$2,000
per year through the lease expiration date in
2020.
NOTE
6
–
SOFTWARE
The Company invested in software for the CURA System during the year ended
December 31, 2016.
These assets are amortized over an estimated useful life of
3
years. Amortization expense recognized for the years ended
December 31,
201
7
and
2016
was
$125,000
and
$114,000,
respectively. The net value of capitalized software at
December 31, 2017
and
2016
was
$102,000
and
$227,000,
respectively. Future amortization expense is expected to be
$92,000
in
2018
and
$10,000
in
2019.
During the year ended
December 31, 2017
the Company recorded an impairment charge of
$357,000
reflecting the write off of previously capitalized software development costs associated with CURA software that was deemed non-recoverable upon future commercialization of the CURA system.
No
impairment charges were recorded in the year ended
December 31, 2016.
NOTE
7
- PROPERTY AND EQUIPMENT
At
December
31,
2017
and
2016
property and equipment consist of the following:
|
|
December 31,
201
7
|
|
|
December 31,
201
6
|
|
Office equipment
|
|
$
|
249,000
|
|
|
$
|
244,000
|
|
Shop equipment
|
|
|
231,000
|
|
|
|
173,000
|
|
Leasehold improvements
|
|
|
253,000
|
|
|
|
253,000
|
|
|
|
|
733,000
|
|
|
|
670,000
|
|
Less accumulated depreciation
|
|
|
(608,000
|
)
|
|
|
(553,000
|
)
|
Net property and equipment
|
|
$
|
125,000
|
|
|
$
|
117,000
|
|
Depreciation expense for the years ended
December 31, 2017
and
2016
was
$55,000
and
$59,000
respectively.
NOTE
8
- BUSINESS SEGMENTS
The Company has
two
operating business segments. The CURA business operates in the fatigue management industry and the Aegis business is focused in the power and hydraulic industry.
Segment information for the year ended
December 31, 2017
for the
C
ompany’s business segments follows:
|
|
CURA
|
|
|
Aegis
|
|
|
Corporate
|
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue
|
|
$
|
39,000
|
|
|
|
-
|
|
|
|
-
|
|
|
$
|
39,000
|
|
Loss on Revenue
|
|
|
122,000
|
|
|
|
-
|
|
|
|
-
|
|
|
|
122,000
|
|
Total Costs and Expenses
|
|
|
2,608,000
|
|
|
|
516,000
|
|
|
|
1,484,000
|
|
|
|
4,608,000
|
|
Impairment loss
|
|
|
357,000
|
|
|
|
-
|
|
|
|
-
|
|
|
|
357,000
|
|
Loss from operations
|
|
|
2,730,000
|
|
|
|
516,000
|
|
|
|
1,484,000
|
|
|
|
4,730,000
|
|
Other
expense
|
|
|
-
|
|
|
|
-
|
|
|
|
693,000
|
|
|
|
693,000
|
|
Net loss
|
|
$
|
2,730,000
|
|
|
$
|
516,000
|
|
|
$
|
2,177,000
|
|
|
$
|
5,423,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock
based compensation
|
|
$
|
55,000
|
|
|
$
|
7,000
|
|
|
$
|
97,000
|
|
|
$
|
159,000
|
|
Depreciation and amortization
|
|
$
|
150,000
|
|
|
$
|
18,000
|
|
|
$
|
12,000
|
|
|
$
|
180,000
|
|
Capital expenditures
|
|
$
|
373,000
|
|
|
$
|
47,000
|
|
|
$
|
-
|
|
|
$
|
420,000
|
|
Assets at December 31, 2017
|
|
$
|
1,894,000
|
|
|
$
|
75,000
|
|
|
$
|
231,000
|
|
|
$
|
2,200,000
|
|
Segment information for the year ended
December 31, 2016
for the
Company’s
business segments follows:
|
|
CURA
|
|
|
Aegis
|
|
|
Corporate
|
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue
|
|
$
|
26,000
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
26,000
|
|
Loss on revenue
|
|
|
101,000
|
|
|
|
-
|
|
|
|
-
|
|
|
|
101,000
|
|
Total costs and expenses
|
|
|
2,078,000
|
|
|
|
527,000
|
|
|
|
1,289,000
|
|
|
|
3,894,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss from operations
|
|
|
2,179,000
|
|
|
|
527,000
|
|
|
|
1,289,000
|
|
|
|
3,995,000
|
|
Other expense
(income)
|
|
|
-
|
|
|
|
-
|
|
|
|
(167,000
|
)
|
|
|
(167,000
|
)
|
Net loss
|
|
$
|
2,179,000
|
|
|
$
|
527,000
|
|
|
$
|
1,456,000
|
|
|
$
|
4,162,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock
based compensation
|
|
$
|
96,000
|
|
|
$
|
8,000
|
|
|
$
|
41,000
|
|
|
$
|
145,000
|
|
Depreciation and amortization
|
|
$
|
124,000
|
|
|
$
|
38,000
|
|
|
$
|
11,000
|
|
|
$
|
173,000
|
|
Capital expenditures
|
|
$
|
86,000
|
|
|
$
|
-
|
|
|
$
|
8,000
|
|
|
$
|
94,000
|
|
Assets at December 31, 2016
|
|
$
|
311,000
|
|
|
$
|
46,000
|
|
|
$
|
2,078,000
|
|
|
$
|
2,435,000
|
|
NOTE
9
- 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 bases 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.
The provision (benefit) for income taxes for the years ended
December 31,
201
7
and
2016
is summarized below:
|
|
December 31,
201
7
|
|
|
December 31,
201
6
|
|
Current tax expense (benefit):
|
|
|
|
|
|
|
|
|
Federal
|
|
$
|
-
|
|
|
$
|
-
|
|
State
|
|
|
-
|
|
|
|
-
|
|
Deferred tax expense (benefit):
|
|
|
|
|
|
|
|
|
Federal
|
|
|
5,418,000
|
|
|
|
(787,000
|
)
|
State
|
|
|
127,000
|
|
|
|
(462,000
|
)
|
Change in valuation allowance
|
|
|
(5,545,000
|
)
|
|
|
1,249,000
|
|
Provision for income taxes
|
|
$
|
-
|
|
|
$
|
-
|
|
The difference between income taxes at the statutory federal income tax rate and income taxes reported in the statements of operations is attributable to the following:
|
|
December 31,
201
7
|
|
|
December 31,
201
6
|
|
|
|
|
|
|
|
|
|
|
Income tax benefit at the federal statutory rate
|
|
$
|
(1,846,000
|
)
|
|
$
|
(1,415,000
|
)
|
State income tax (benefit), net of effect of federal taxes
|
|
|
84,000
|
|
|
|
(305,000
|
)
|
Expiration of non-qualified stock options
|
|
|
-
|
|
|
|
31,000
|
|
Expiration of warrants
|
|
|
221,000
|
|
|
|
424,000
|
|
Non-deductible debt discount
|
|
|
182,000
|
|
|
|
-
|
|
Change in tax rate
|
|
|
6,869,000
|
|
|
|
-
|
|
Other
|
|
|
35,000
|
|
|
|
16,000
|
|
(Decrease) increase in valuation allowance
|
|
|
(5,545,000
|
)
|
|
|
1,249,000
|
|
Provision for income taxes
|
|
$
|
-
|
|
|
$
|
-
|
|
The deferred tax asset at
December 31,
201
7
and
2016
consists of the following:
|
|
201
7
|
|
|
201
6
|
|
Deferred income tax assets:
|
|
|
|
|
|
|
|
|
Net operating loss carryforwards
|
|
$
|
2,604,000
|
|
|
$
|
3,284,000
|
|
Deferred startup costs
|
|
|
9,853,000
|
|
|
|
13,906,000
|
|
Stock-based compensation
|
|
|
1,294,000
|
|
|
|
2,193,000
|
|
Other
|
|
|
153,000
|
|
|
|
66,000
|
|
|
|
|
13,904,000
|
|
|
|
19,449,000
|
|
Less: Valuation allowance
|
|
|
(13,904,000
|
)
|
|
|
(19,449,000
|
)
|
Net deferred tax asset
|
|
|
-
|
|
|
|
-
|
|
Net deferred tax assets
|
|
$
|
-
|
|
|
$
|
-
|
|
On
December 22, 2017
the U. S. government enacted comprehensive tax legislation commonly referred to as the Tax Cuts and Jobs Act (the "Tax Act"). The Tax Act makes broad and complex changes to the U. S. tax code including but
not
limited to: (
1
) reducing the U. S. federal corporate tax rate from
35
percent to
21
percent (
2
) elimination of the corporate alternative minimum tax (AMT) and changing how existing AMT credits can be realized (
3
) changing the rules related to the usage and limitation of net operating loss carryforwards created in tax years beginning after
December 31, 2017 (
4
) generally eliminating U. S. federal income taxes on dividends from foreign subsidiaries for tax years beginning after
December 31, 2017
and (
5
) implementing a territorial tax system and imposing a transition toll tax on deemed repatriated earnings of foreign subsidiaries.
On
December 22, 2017,
the SEC staff issued Staff Accounting Bulletin
No.
118
to address the application of U.S. GAAP on situations when a registrant does
not
have the necessary information available, prepared or analyzed (including computations) in reasonable detail to complete the accounting for certain income tax effects of the Tax Reform Act. The Company has realized the provisional tax impacts related to the revaluation of deferred tax assets and liabilities and included these amounts in its consolidated financial statements for the year ended
December 31,
2107.
As of
December 31, 2017,
we have completed the majority of the accounting for the tax effects of the Act. If revisions are needed as new information becomes available, the final determination of the deemed remeasurement of our deferred tax assets and liabilities or other applicable provisions of the Act will be completed as additional information becomes available, but
no
later than
one
year from the enactment of the
2017
Tax Act.
The deferred U.S. income tax expense for
2017
primarily represents a
one
-time, non-cash expense of
$6,869,000
relating to the revaluation of deferred tax assets offset by a reduction of the valuation allowance in an equal amount. This resulted in a net
zero
effect on the provision for income tax.
At
December
31,
2017,
we have approximately
$10,587,000
and
$9,885,000
of adjusted federal and New York State net operating loss carryforwards, respectively, to offset future taxable income. These net operating losses begin expiring in
2023
through
2037.
In addition, we have
$137,000
of research and development tax credit carryforwards to offset future tax. These credits expire in
2037.
From the date of inception through
2017,
we have accumulated approximately
$39,648,000
of adjusted deferred startup costs. Start-up costs will be amortized over a
15
year period beginning in the year we begin an active trade or business. We have provided a full valuation allowance on the net deferred tax assets due to uncertainty of realization through future earnings.
Effective
January 1, 2017,
the Company adopted ASU
2016
-
09
Compensation - Stock Compensation (Topic
718
) Improvement to Employer Share-Based Payment Accounting. As a result of this adoption, the Company recognized a gross deferred tax asset of
$1,684,000
and a corresponding equal and offsetting uncertain tax position in the same amount resulting in
no
net deferred tax asset recognition. The uncertain tax benefits included in the tabular reconciliation relate to this deferred tax asset.
Based upon the change in ownership rules under Section
382
of the Internal Revenue Code of
1986,
if a company issues common stock or other equity instruments convertible into common shares which result in an ownership change exceeding a
50%
limitation threshold over a rolling
three
-year timeframe as imposed by that Section, all of that company
’s net operating loss carryforwards
may
be significantly limited as to the amount of use in any particular year. During
2016,
we evaluated the Section
382
regulations, and concluded that we have
not
had a cumulative ownership change that would limit the use of our net operating loss and tax credit carryforwards.
Reconciliations of the beginning and ending amounts of unrecognized tax benefits for the years ended
December 31,
201
7
and
2016
are as follows:
|
|
201
7
|
|
|
201
6
|
|
|
|
|
|
|
|
|
|
|
Balance as of January 1
|
|
$
|
1,684,000
|
|
|
$
|
1,666,000
|
|
Additions based on enacted changes in state rate
|
|
|
-
|
|
|
|
18,000
|
|
Reductions based on enacted changes in rates
|
|
|
(572,000
|
)
|
|
|
-
|
|
Balance as of December 31
|
|
$
|
1,112,000
|
|
|
$
|
1,684,000
|
|
Tax years that remain subject to examination for our major tax jurisdictions include the years ended
December 31, 2013
through
December 31, 2017.
NOTE
10
- 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 year ended
December 31,
201
7,
the Company issued
1,872,781
shares of common stock in connection with conversion notices received from various preferred shareholders and
40,000
shares resulting from the exercise of common stock warrants. During the year ended
December 31, 2016,
the Company issued
1,270,000
shares of common stock in connection with conversion notices received from various preferred shareholders.
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, our board
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 year ended
December 31,
201
7,
the Company issued
75,000
shares of common stock in connection with conversion notices received from
one
Series A convertible preferred shareholder. In addition, the company issued an additional
101,281
in common shares attributed to dividends earned on the converted shares.
At
December
31,
2017,
there were
468,221
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
468,221
outstanding shares of Class A Preferred stock amounted to approximately
$2,346,000
and
$2,538,000
at
December 31, 2017
and
2016,
respectively.
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 approximately
$2,346,000
and
$2,538,000
at
December 31, 2017
and
2016,
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 years ended
December 31,
201
7
and
2016,
we settled
no
Class B Preferred dividends.
At
December
31,
2017,
dividends payable upon the conversion of
67,500
outstanding shares of Class B Preferred amounted to approximately
$420,000.
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
$420,000
and
$386,000
at
December 31, 2017
and
2016,
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.
During the year
s ended
December 31, 2017
and
2016,
Series C Preferred shareholders converted
62,500
and
250,000
shares, respectively of Series C Preferred into common stock. At
December 31, 2017
and
2016,
there were
15,937,500
and
16,000,000
shares of Series C Preferred stock outstanding. The value of the Series C Preferred shareholders’ liquidation preference was
$6,375,000
and
$6,400,000
at
December 31, 2017
and
2016,
respectively.
Series C-
2
Preferred
Stock
In
March 2014,
the board of directors authorized, and 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.
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 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.
Cumulatively through
December 31,
201
7,
Series C-
2
Preferred shareholders have converted
no
shares of Series C-
2
Preferred into common stock. At
December 31, 2017
and
2016,
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
December 31, 2017
and
2016.
In connection with the issuance of the Series C-
2
Preferred Shares, the Company entered into an Investors
’ Rights Agreement on
September
23,
2011
(the “Investors’ Rights Agreement”). Pursuant to the Investors’ Rights Agreement, the Company granted registration rights to the investors covering Common Stock issued on the conversion of the Preferred Shares or exercise of the Warrants or other shares issued in connection with the Transaction (the “Underlying Shares”). The registration rights are triggered when the Company is eligible to utilize Form S-
3,
and until such time as (i) the Company is sold, (ii) dissolved, or (iii) the Underlying Shares are eligible for resale without restriction in a
three
month period under Rule
144.
Investors holding shares for sale to receive at least
$500,000
in gross proceeds have the right to make the demand up to
one
time in any such
twelve
month period. The Investors’ Rights Agreement also contains a right of
first
offer for the future issuance of any equity securities of the Company.
Pursuant to the terms of the Investors
’ Rights Agreement, the Company
may
not
(i) grant any equity based compensation; (ii) reduce the per-share exercise price or conversion price of any equity based compensation; (iii) create or incur indebtedness in excess of
$1,000,000
in the aggregate at any time, or (iv) guarantee the indebtedness of any
third
party except for trade account payables arising in the ordinary course of business, without the consent of the lead investor. In the event the Company grants any equity based compensation or reduces the per-share exercise price or conversion price of any equity based compensation in violation of the terms of the Investors’ Rights Agreement, and with the effect that additional equity interests are issuable as a result, then the Company shall be obligated to immediately issue to each Investor such aggregate number of additional shares of Common Stock so that immediately following such violation such Investor’s ownership percentage is unaffected by the violation.
The Investors also agreed to “Market Stand-off” provisions that
may
be requested by an underwriter in an underwritten public offering by the Company. In addition, pursuant to the terms of the Investors
’ Rights Agreement, as long as the lead investor
may
acquire at least
3,000,000
shares of Common Stock by conversion or exercise of his Series C Securities, (i) the lead investor is entitled to inspect the properties, assets, business and operation of the Company and discuss its business and affairs with its officers, consultants, directors and key employees, (ii) the Company shall invite the lead investor or his representative to attend all meetings of the Board of Directors and provide all information provided to directors for such purpose, and (iii) at his request, the Company shall cause him to be appointed to serve as a director until the following annual meeting of shareholders and until a successor is elected.
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.
In
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 was 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 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 have
not
been 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.
During
2016,
the Company 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
$1,495,000.
In conjunction with the issuance of the Series C-
3
Preferred stock
in
2016,
the Company 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. The fair value of our common stock on the date of issuance was compared to the effective conversion price, and determined a value of the non-cash beneficial conversion feature of
$885,000,
which has been reflected in our consolidated statements of operations as an adjustment to arrive at the net loss attributable to common stockholders.
During the year ended
December 31, 2017,
the Company issued
1,634,000
shares of common stock in connection with conversion notices received from various Series C-
3
convertible preferred shareholders. During the year ended
December 31, 2016,
the Company issued
1,020,000
shares of common stock in connection with conversion notices received from various Series C-
3
convertible preferred shareholders.
NOTE
11
- 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. As of
December 31, 2017,
no
options have been granted under this plan.
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 year ended
December 31,
201
7,
we granted a total of
235,000
stock options to employees and non-employee board members. These included stock options granted at exercise prices ranging from
$0.65
to
$1.00
per share, exercisable for
10
years that vest at a rate of
25%
on each anniversary of the date of grant.
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.
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.
Summary
For the years ended
December 31, 2017
and
2016,
compensation cost related to stock option awards amounted to
$159,000
and
$145,000,
respectively. As of
December 31, 2017,
there was approximately
$232,000
of total unrecognized compensation costs related to outstanding stock options, which are expected to be recognized over a weighted average of
1.5
years.
The weighted average grant date fair value of stock options granted during the years ended
December 31,
201
7
and
2016
was
$0.76
and
$0.46,
respectively. The total grant date fair value of stock options vested during the years ended
December 31, 2017
and
2016
was approximately
$173,000
and
$230,000,
respectively.
The fair value of each option granted was estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions:
|
|
201
7
|
|
|
201
6
|
|
Expected term (years)
|
|
6.6
|
|
|
5.4
|
|
Expected forfeiture rate
|
|
0%
|
|
|
0%
|
|
Risk-free rate
|
|
2.1%
|
|
|
2.0%
|
|
Volatility
|
|
130%
|
|
|
130%
|
|
Dividend yield
|
|
0.0%
|
|
|
0.0%
|
|
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 years ended
December 31,
201
7
and
2016:
|
|
|
|
|
|
Weighted
|
|
|
Average
|
|
|
|
|
|
|
|
|
|
|
|
Average
|
|
|
Remaining
|
|
|
Aggregate
|
|
|
|
|
|
|
|
Exercise
|
|
|
Contractual
|
|
|
Intrinsic
|
|
|
|
Shares
|
|
|
Price
|
|
|
Term (years)
|
|
|
Value
|
|
Outstanding at January 1, 201
6
|
|
|
9,013,000
|
|
|
$
|
.57
|
|
|
|
|
|
|
|
|
|
Granted
|
|
|
502,000
|
|
|
|
.46
|
|
|
|
|
|
|
|
|
|
Exercised
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
Canceled or expired
|
|
|
(68,000
|
)
|
|
|
4.79
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at December 31, 201
6
|
|
|
9,447,000
|
|
|
$
|
.53
|
|
|
|
4.8
|
|
|
$
|
2,016,000
|
|
Granted
|
|
|
235,000
|
|
|
|
.76
|
|
|
|
|
|
|
|
|
|
Exercised
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
Canceled or expired
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at December 31, 201
7
|
|
|
9,682,000
|
|
|
$
|
.54
|
|
|
|
3.9
|
|
|
$
|
114,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercisable at December 31, 201
7
|
|
|
6,449,000
|
|
|
$
|
.61
|
|
|
|
3.6
|
|
|
$
|
3,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercisable at December 31, 201
6
|
|
|
6,276,000
|
|
|
$
|
.61
|
|
|
|
4.4
|
|
|
|
|
|
No
options were exercised, cancelled or expired unexercised during the year ended
December 31, 2017.
During year ended
December 31, 2016,
the Company cancelled
3,000
options and
65,000
options expired unexercised. As of
December 31, 2017,
there were
2,782,000
stock options outstanding under the
2011
Plan,
1,699,000
of which were vested at that date; leaving
218,000
options available for future grant under the
2011
Plan.
As of
December 31,
2017,
the exercise prices of all outstanding stock options ranged from
$.20
per share to
$1.58
per share.
NOTE
12
- WARRANTS
The following summarizes the activity of our outstanding warrants for the years ended
December 31,
201
7
and
2016:
|
|
|
|
|
|
|
|
|
|
|
Weighted
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
|
|
|
|
Average
|
|
|
|
|
|
|
|
|
|
|
|
|
Average
|
|
|
|
Remaining
|
|
|
|
Aggregate
|
|
|
|
|
|
|
|
Exercise
|
|
|
|
Contractual
|
|
|
|
Intrinsic
|
|
|
|
Shares
|
|
|
Price
|
|
|
|
Term
|
|
|
|
Value
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at January 1, 201
6
|
|
|
3,315,000
|
|
|
$
|
2.04
|
|
(A)
|
|
|
|
|
|
|
|
|
|
Granted
|
|
|
1,200,000
|
|
|
|
.25
|
|
|
|
|
|
|
|
|
|
|
|
Exercised
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
Canceled or expired
|
|
|
(296,500
|
)
|
|
|
3.88
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at December 31, 201
6
|
|
|
4,218,500
|
|
|
$
|
.95
|
|
(A)
|
|
|
6.1
|
|
(B)
|
|
$
|
874,000
|
|
Granted
|
|
|
1,186,336
|
|
|
|
.33
|
|
|
|
|
|
|
|
|
|
|
|
Exercised
|
|
|
(40,000
|
)
|
|
|
.20
|
|
|
|
|
|
|
|
|
|
|
|
Canceled or expired
|
|
|
(150,000
|
)
|
|
|
5.00
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at December 31, 201
7
|
|
|
5,214,836
|
|
|
|
.57
|
|
(A)
|
|
|
6.5
|
|
(B)
|
|
$
|
103,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercisable at December 31, 201
7
|
|
|
4,589,836
|
|
|
$
|
.55
|
|
|
|
|
6.3
|
|
(C)
|
|
$
|
102,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercisable at December 31, 201
6
|
|
|
3,593,500
|
|
|
$
|
.90
|
|
|
|
|
5.9
|
|
(C)
|
|
|
|
|
|
(A)
|
The weighted average exercise price for warrants outstanding as of
December 31,
201
7
and
2016
and
January 1,
2016
excludes
1,750,000
warrants in each period with
no
determined exercise price.
|
|
(B)
|
The weighted average remaining contractual term for warrants outstanding as of
December 31,
201
7
excludes
743,500
warrants with
no
expiration date.
|
|
(C)
|
The weighted average remaining contractual term for warrants exercisable as of
December 31,
201
7,
and
2016
excludes
118,500
warrants with
no
expiration date.
|
NOTE
13
- RELATED PARTY TRANSACTIONS
During the year ended
December 31, 2017,
the Company issued $
900,000
of
2017
Convertible Notes to
three
members of our board of directors representing
2,702,703
potential shares of common stock and
495,495
in warrants.
During the year ended
December 31, 2016,
the Company issued a total of
1,990,000
shares of our Series C-
3
voting convertible preferred stock generating gross proceeds of
$497,500
to
seven
members of our board of directors and
one
executive officer. During the year ended
December 31, 2016,
the Company issued
$802,500
of
2016
convertible notes to
four
members of our board of directors representing a potential of
3,210,000
convertible common shares and
321,000
in warrants. Also during
2016,
the Company issued
$1,170,000
of senior convertible notes to an investor that is deemed an affiliate through the ownership of the majority of our Series C and C-
2
Preferred Stock. This investor has the right to
4,680,000
convertible common shares and
468,000
warrants as a result of this debt issuance. (See Notes
4
and
10.
)
We occupy a leased facility for our corporate headquarters building, located in Rochester, New York, which consists of both executive offices and manufacturing space. (
See Note
14.
)
NOTE
14
— COMMITMENTS AND OTHER MATTERS
Leases
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
in which a Company director is associated. The current rental rate is
$6,256
per month (
$75,070
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
June 2018
through
May 2021.
Rent expense for each of the years ended
December 31,
201
7
and
2016
was approximately
$80,000
. Rent payments required under the extended lease term for the years ending
December 31, 2018
amount to approximately
$31,000.
Employment Agreements
Our chief executive officer executed a
five
year employment agreement effective
December 31, 2015
pursuant to which his base compensation would be
$50,000
per annum, with a compensation increase to
$200,000
per annum on the
first
day of the calendar year immediately following the calendar year in which we have adjusted EBITDA of at least
$300,000
(earnings before interest, taxes, depreciation and amortization, but excluding all non-cash expenses associated with stock options). Under the employment agreement, the CEO is entitled to a performance bonus based upon financial targets established each year in good faith by the Governance and Compensation Committee and the achievement of individual management objectives established annually by such committee. The CEO is entitled to participate in all employee benefit plans as are provided from time to time for senior executives. If we terminate the CEO without cause, remove him as CEO, or a change in control of the Company occurs, the CEO is entitled to
three
years
’ severance pay, consisting of base pay and any incentive compensation.
In the
third
quarter of
2015,
the Company hired a Vice President of business development for the CURA division. The hiring agreement includes a severance agreement including
six
months salary if a termination by the Company is initiated other than for cause or executive good reason. Such severance will be based on the salary at the time of the action in return for a general release of the Company and its officers, directors and agents satisfactory to the Company.
401
(k) Retirement Benefit Plan
:
The Company has a defined contribution
401
(k) plan covering substantially all employees. Employees can contribute a portion of their salary or wages as prescribed under Section
401
(k) of the Internal Revenue Code and, subject to certain limitations, we
may,
at management’s discretion, authorize an employer contribution based on a portion of the employees' contributions. At the present time, the Company does
not
provide for an employer match. During
2017
and
2016,
we incurred administrative expenses of approximately
$2,000
in each year related to the
401
(k) plan.
NOTE
15
- SUBSEQUENT EVENTS
2017
Convertible Notes
Subsequent to
December 31, 2017,
the Company issued
$1,175,000
in new
2017
Convertible Notes and
694,444
warrants. Also, subsequent to
December 31, 2017,
the board of directors increased authorized offering limit on the
2017
Convertible Notes from
$4
million to
$5
million in connection with the
May 31, 2017
Securities Purchase Agreement. (Note
4
)
Series
C3
Preferred Stock
Conversion
Subsequent to
December 31, 2017,
the Company issued
80,000
shares of common stock in connection with a conversion notice received from a Series
C3
convertible preferred shareholder.
Stock Option Grants
Subsequent to
December 31,
201
7,
the Company granted
30,000
incentive stock options at
$0.31
per share, with a
10
year life.