NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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 (Circadian User Risk Assessment) 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 myCadian system) and a uniquely designed hydraulic pump that will be smaller, lighter, less expensive and more efficient than current technology. The Company has not had any significant revenue-producing operations.
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.
CURA Division: the myCadian system
The Company’s CURA division has developed a proprietary technology designed to (i) measure the decrease in a person’s alertness and (ii) to train individuals on how to improve alertness levels. The myCadian system will enable the user to anticipate and avert undesired or disastrous situations caused by the degradation of alertness. With the information provided from the myCadian software analytics, employees can work with Z-Coach, our proprietary sleep training and education solution to correct sleep issues and improve overall wellness.
The myCadian platform is designed to predict and detect a degradation of alertness in a user. The myCadian platform will support multiple wearable technology including IOS and android devices. The myCadian system will include:
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●
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a risk assessment that identifies the degradation of alertness that may affect a wearer’s ability to perform tasks,
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●
|
real-time reporting that distills complex user data into actionable information on mobile devices,
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●
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predictive reporting for a user to take action when alertness begins to wane, before fatigue becomes dangerous,
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●
|
flexible settings to provide employers a customized tool using their defined safety criteria and to create protocols for action,
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●
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pricing that makes it affordable across a broad-based workforce, and
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●
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the Z-Coach wellness program.
|
The Z-Coach wellness program is a key component of the myCadian system. Z-Coach learning topics include: Risks and Costs of Fatigue, Fundamentals of Sleep, Fatigue Mitigation and Countermeasures. Z-Coach participants gain an awareness of the dangers inherent in the lack of sleep and learn to utilize lifestyle tools to make changes to improve their health, mood, productivity and safety.
Aegis Division: Hydraulic Pump
During 2019, the Company initiated discussions with investment bankers and certain hydraulics companies to evaluate the possible monetization of the AEGIS technologies. Management believes these technologies have the potential to fundamentally shift the design and manufacture of future products in the hydraulics pump and motor industries.
The Aegis hydraulic pump technology has been designed to bring to the marketplace a unique concept in hydraulic pumps and motors that will be:
|
●
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smaller, lighter and less expensive than conventional pumps and motors,
|
|
●
|
more efficient, and
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|
●
|
unique in its ability to scale larger, allowing more powerful pumps and motors.
|
The Company has completed a production prototype and is working to align the prototype capability with specific customer applications. The Company achieved significant milestones in the design and testing of this prototype and engineering testing and design of pump and motor functionality is continuing. Our engineering team has progressively made adjustments to traditional valve and piston technologies which have resulted in improvement in the measured efficiency of the pump. We have filed for patent protection for our novel non-rotating group pump concept and continue to file patents as a engineering breakthroughs in our design are identified.
Current Cash Outlook and Management Plans
As of December 31, 2019, we have cash on hand of $18,000, negative working capital of $4,545,000, a stockholders’ deficiency of $12,203,000 and an accumulated deficit of $91,425,000. During the year ended December 31, 2019 we raised $2,375,000 in proceeds through the issuance of demand notes, convertible notes and promissory notes. The proceeds from these private placements have been used to support the ongoing development and marketing of our core technologies and product initiatives.
Management estimates that the 2020 cash needs will be approximately $1.5 to 2 million, based upon the cash used in operations in the fourth quarter of 2019. As of December 31, 2019, 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.
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 will involve dilution to our shareholders or may require that we relinquish rights to certain of our technologies or products. In addition, we will 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 products or (ii) generate proceeds from the monetization of our hydraulic technologies. 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). These subsidiaries are non-operational.
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 $5,000.
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, 2019 and December 31, 2018.
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. Inventory on hand at December 31, 2019 and 2018 has been fully reserved.
Depreciation and amortization: Depreciation and amortization are computed using the straight-line method. Depreciation and amortization expense for the years ended December 31, 2019 and 2018 are as follows:
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|
For Years ended
December 31,
|
|
|
|
2019
|
|
|
2018
|
|
Amortization right-to-use asset
|
|
$
|
98,000
|
|
|
$
|
-
|
|
Software
|
|
|
10,000
|
|
|
|
92,000
|
|
Property and equipment
|
|
|
24,000
|
|
|
|
46,000
|
|
|
|
$
|
132,000
|
|
|
$
|
138,000
|
|
Right to use building asset: The FASB issued ASU No. 2016-02, “Leases,” which requires a lessee to recognize on its balance sheet the assets and liabilities related to long-term leases that were classified as operating leases under previous guidance. An asset is recognized related to the Company's ability to retain the economic benefits and control of the underlying asset. A corresponding liability is recognized related to the Company's obligation to make lease payments over the term of the lease.
The standard became effective for the Company January 1, 2019. The Company utilized the modified retrospective approach to measure the right to use operating lease agreement associated with the office building used for our business operations located in Rochester, New York. The adoption of this accounting standard did not impact our consolidated loss from operations and had no impact on cash flows.
Software, Property and Equipment: Capitalized software, property and equipment are stated at cost. Estimated useful lives for capitalized software is 3 years and for property and equipment is 5 to 7 years. 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).
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, 2018 we recorded an impairment charge of $17,000 on certain property and equipment.
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, 2019 and December 31, 2018. The carrying amount of cash, prepaid expenses and other current assets, liability for inventory, accounts payable, accrued expenses, demand and promissory notes approximates their fair value due to their short maturity. The senior convertible notes can be converted into common stock with an underlying value of $3,436,000 as of December 31, 2019 based on the trading price on December 31, 2019.
Revenue Recognition and Deferred Revenue: On January 1, 2018, the Company adopted FASB ASC 606, "Revenue from Contracts with Customers" and all related amendments for all contracts using the modified retrospective method. There was no impact upon the adoption of FASB ASC 606. The Company has determined that the adoption of this standard did not require a cumulative effect adjustment. For contracts where performance obligations are satisfied at a point in time, the Company recognizes revenue when the product is shipped to the customer. For contracts where the performance obligation is satisfied over time, as in the Z-Coach sales, the Company recognizes revenue over the subscription period. Revenue from the sale of the Company's products is recognized net of cash discounts, sales returns and allowances. The Company has two sources of revenue: (i) from the sale of MyCadian system products and (ii) from stand-alone Z-Coach subscriptions.
The Company's net revenue is derived primarily from domestic customers. For the year ended December 31, 2019 net revenue from products transferred over time amounted to $13,000 and net revenue from products transferred at a point in time amounted to $2,000. One customer accounted for 43% of total Z-Coach subscription sales made during the year ended December 31, 2019. Our collection terms provide customers standard terms of net 30 days. Future performance obligations are reflected in deferred revenue.
CURA revenue is recognized (a) upon receipt of payment at the point of sale of the CURA app, (b) upon the delivery of myCadian products and (c) 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.
Engineering and Development and Patents: Engineering and development costs and patent expenses are charged to operations as incurred. Engineering and development include personnel-related costs, materials and supplies, depreciation and consulting services. Patent costs for the years ended December 31, 2019 and 2018 amounted to $45,000 and $150,000, 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. 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 FASB 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.
During 2018, the Company adopted FASB ASU 2018-07, “Equity-Based Payments to Non-Employees,” which requires all share-based payments to non-employees, including grants of stock options, to be recognized in the consolidated financial statements as expense generally over the service period of the consulting arrangement or as performance conditions are expected to be met. The Company utilized a modified retrospective approach effective as of January 1, 2018 in the adoption of this accounting guidance which resulted in a $10,000 reduction of stock compensation expense previously reported. 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 December 31, 2019, and December 31, 2018, 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, 2019 and 2018, we excluded 105,535,575 and 94,784,206 potential common shares, respectively, relating to convertible preferred stock, convertible notes, future share rights issued with demand 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, 2019 and 2018 as the conditions for their vesting are not time-based.
NOTE 3 – INVENTORY AND RELATED VENDOR LIABILITY
At December 31, 2019 and 2018 inventory consisted of:
|
|
December 31,
|
|
|
|
2019
|
|
|
2018
|
|
Raw materials
|
|
$
|
1,665,000
|
|
|
$
|
1,678,000
|
|
Finished goods
|
|
|
69,000
|
|
|
|
69,000
|
|
|
|
|
1,734,000
|
|
|
|
1,747,000
|
|
Less: Reserve
|
|
|
(1,734,000
|
)
|
|
|
(1,747,000
|
)
|
Inventory (net)
|
|
$
|
-
|
|
|
$
|
-
|
|
|
|
|
|
|
|
|
|
|
Liability for inventory held at vendor
|
|
$
|
1,764,000
|
|
|
$
|
1,462,000
|
|
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. At December 31, 2018, the Company had a reserve of $1,747,000 reflecting a full reserve for all inventory on-hand at that date. Management will evaluate this reserve in future reporting periods.
During 2019, the Company and the third-party vendor agreed to a $300,000 penalty payable to the vendor to reflect the aging on this outstanding liability.
NOTE 4 - DEMAND NOTE
The Company entered into a credit facility with a commercial bank in 2019 for up to $1,500,000 in advances to support working capital needs of the business. The demand notes issued in connection with this commercial bank are supported by individual co-borrowing agreements from certain accredited investors. In connection with this credit agreement, the Company entered into a general security agreement that provides the bank a continuing security interest in all of the Company's personal property and fixtures.
The co-borrowers participating in this credit facility received 30,000 common shares for each $100,000 in principal co-borrowed. The fair market value of these shares was estimated on the date of the note issuance and is reflected in debt issuance costs. The co-borrowers were also granted the right to purchase common shares up to the amount co-borrowed, at a price per share determined based on the closing price of the Company’s common stock one day prior to the agreement. The fair market value of these future rights is reflected in debt issuance costs in the results of operations. The price per share for the future share rights is fixed at the higher of the closing price of the Company’s common stock one day prior to the co-borrowing arrangement or $0.15 per share. Each co-borrower has the right to purchase these common shares until the indebtedness is paid in full or within five business days after the consummation of the sale of the Company’s Aegis division.
At December 31, 2019, the Company had issued $650,000 in demand notes and issued 195,000 shares of common stock in connection with the co-borrowing demand notes. The common shares issued in connection with the co-borrowing demand notes were valued at $21,000 on the date of issuance and have been reported in debt issuance costs. Coincident with the issuance of these notes, these co-borrowers also received the right to purchase up to 4,333,333 shares of the Company’s common stock at a fixed price of $0.15 per share. The fair market value of these future share rights was estimated at $276,000 on the date of the issuance of the notes utilizing the Black Scholes valuation model and has been reported in debt issuance costs.
Advances drawn under this facility have been issued as demand notes with an adjustable interest rate set at the bank’s prime rate, which was 4.75% December 31, 2019. The Company incurred $37,000 in debt issuance costs related to bank and legal fees incurred in connection with this credit facility.
The shares of the Company’s Common Stock are being offered and sold in a private placement exempt from registration under Section 4(a)(2) of the Securities Act of 1933 (“Securities Act”), as amended, and Rule 506 of Regulation D as promulgated by the United States Securities and Exchange Commission thereunder. The shares of the Company’s Common Stock will not be registered under the Securities Act and may not be offered or sold in the United States absent registration or an applicable exemption from registration requirements.
NOTE 5 - SENIOR CONVERTIBLE NOTES AND WARRANTS
At December 31, 2019, the Company had $10,310,000 in convertible notes outstanding which have been presented net of unamortized debt discounts of $1,900,000, resulting in a carrying value of $8,410,000. The 2019 convertible notes have been presented in current liabilities as of December 31, 2019 as these notes mature on the earlier of the Aegis monetization event or five years from the date of issuance. As of December 31, 2018, the Company had $9,160,000 in convertible notes outstanding, presented net of unamortized debt discounts of $2,557,000 resulting in a carrying value of $6,603,000.
Scheduled maturities on the Company’s convertible note are: $650,000 in the twelve months ending 2020; $2,990,000 in the twelve months ending December 31, 2021; $2,775,000 in the twelve months ending in December 31, 2022; $3,395,000 in the twelve months ending December 31, 2023 and $500,000 thereafter.
Included in the face value of convertible notes outstanding at December 31, 2019 and December 31, 2018, is $2,477,000 and $2,252,000, respectively in convertible notes payable to six of our directors and $1,170,000 in convertible notes payable to an investor that is deemed an affiliate.
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|
Total
|
|
|
2019
6%
Notes
|
|
|
JULY
2018
Notes
|
|
|
2018
Notes
|
|
|
2017
6%
Notes
|
|
|
2016
6%
Notes
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Face value 12/31/18
|
|
$
|
9,160,000
|
|
|
$
|
-
|
|
|
$
|
1,175,000
|
|
|
$
|
625,000
|
|
|
$
|
4,370,000
|
|
|
$
|
2,990,000
|
|
Notes issued
|
|
|
1,150,000
|
|
|
|
650,000
|
|
|
|
500,000
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Face value 12/31/19
|
|
$
|
10,310,000
|
|
|
$
|
650,000
|
|
|
$
|
1,675,000
|
|
|
$
|
625,000
|
|
|
$
|
4,370,000
|
|
|
$
|
2,990,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Debt discount 12/31/18
|
|
$
|
(2,557,000
|
)
|
|
$
|
-
|
|
|
$
|
(360,000
|
)
|
|
$
|
(231,000
|
)
|
|
$
|
(456,000
|
)
|
|
$
|
(1,510,000
|
)
|
Debt discount issued
|
|
|
(91,000
|
)
|
|
|
(26,000
|
)
|
|
|
(65,000
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Amortization reported as interest
|
|
|
748,000
|
|
|
|
23,000
|
|
|
|
72,000
|
|
|
|
46,000
|
|
|
|
94,000
|
|
|
|
513,000
|
|
Debt discount 12/31/19
|
|
$
|
(1,900,000
|
)
|
|
$
|
(3,000
|
)
|
|
$
|
(353,000
|
)
|
|
$
|
(185,000
|
)
|
|
$
|
(362,000
|
)
|
|
$
|
(997,000
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Senior convertible notes (net) 12/31/19
|
|
$
|
8,410,000
|
|
|
$
|
647,000
|
|
|
$
|
1,322,000
|
|
|
$
|
440,000
|
|
|
$
|
4,008,000
|
|
|
$
|
1,993,000
|
|
2019 Convertible Notes
The board of directors authorized the issuance of up to $2.5 million in 6% Convertible Promissory Notes (the “2019 Convertible Notes”) in connection with the May 28, 2019 Securities Purchase Agreement (the “2019 SPA”). The 2019 Convertible Notes mature on the earlier of: five days after the sale of substantially all of the assets of the Aegis division or five years from the date of issuance.
The conversion rate of the notes is fixed at the greater of $0.15 per share and the closing market price of the Company’s common stock on the trading day immediately prior to the issuance of the note. Investors receive 30,000 shares of common stock for each $100,000 investment in the 2019 Convertible Notes. The notes were offered in a private placement exempt from registration under Section 4(a)(2) of the Securities Act of 1933 as amended (the "Securities Act") 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.
During the year ended December 31, 2019, the Company issued $650,000 in new notes and allocated $26,000 of the proceeds to debt discount based on the estimated fair value of the common shares issued and debt issuance costs on the date of investment. During the year ended December 31, 2019, the Company recorded $40,000 in interest expense which includes $23,000 of amortization on debt discount.
JULY 2018 Convertible Notes
The board of directors authorized the issuance of up to $2.5 million in non-interest bearing Senior Convertible Promissory Notes and Warrants (the “JULY 2018 Convertible Notes”) in connection with the July 24, 2018 Securities Purchase Agreement (the “JULY 2018 SPA”). The JULY 2018 Convertible Notes have a five-year maturity. In April 2019, the Company’s board approved a resolution to complete this offering.
The conversion rate of the notes was fixed at $0.25 per share as determined at the close of business on July 24, 2018. Investors in this offering were granted warrants to purchase common shares equal to 10% or 25% of the number of shares issuable upon the conversion of the notes based upon the amount of their investment. 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 1933 as amended (the "Securities Act") 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.
During the year ended December 31, 2019, the Company issued $500,000 in new convertible notes and allocated $65,000 of the proceeds to debt discount based on the estimated fair value of the warrants issued and debt issuance costs incurred on the date of investment. In connection with the issuance of these convertible notes, the Company issued 350,000 warrants with an exercise price of $0.25 per share and a 10-year term.
During the year ended December 31, 2019 and December 31, 2018, the Company recorded $72,000 and $20,000 respectively in interest expense which includes amortization of debt discount.
During the year ended December 31, 2018, the Company issued $1,175,000, in convertible notes and allocated $380,000, of the proceeds to debt discount based on the estimated fair value of the warrants issued and debt issuance costs incurred on the date of investment. In connection with the issuance of these convertible notes, the Company issued 590,000 warrants with an exercise price of $0.25 per share and a 10-year term.
2018 Convertible Notes
The board of directors authorized the issuance of up to $1 million in non-interest bearing Senior Convertible Promissory Notes and Warrants (the “2018 Convertible Notes”) in connection with the May 8, 2018 Securities Purchase Agreement (the “2018 SPA”). The 2018 Convertible Notes have five-year maturity. On July 19, 2018, the Company’s board approved a resolution to complete this offering.
The conversion rate of the notes was fixed at $0.25 per share as determined at the close of business on May 8, 2018. Investors in this offering were granted warrants to purchase common stock equal to 10% or 25% of the number of shares issuable upon the conversion of the notes based upon the amount of their investment. 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 1933 as amended (the "Securities Act") 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.
During the year ended December 31, 2019 and December 31, 2018, the Company recorded $45,000 and $19,000 respectively in interest expense which reflects the amortization of debt discount.
2017 Convertible Notes
The board of directors authorized the issuance of up to $5 million in 6% Senior Convertible Promissory Notes and Warrants (the “2017 Convertible Notes”) in connection with the May 31, 2017 Securities Purchase Agreement (as amended, the “2017 SPA”). The 2017 Convertible Notes have a five-year maturity and a fixed annual interest rate of 6%. Investors in this offering were granted warrants to purchase warrants equal to 10% or 25% of the number of shares issuable upon the conversion of the notes based upon the amount of their investment.
The conversion rate of the 2017 Notes was originally set at $0.50 per share and subsequently modified in November 2018 to $0.333 per share. The exercise price of related warrants issued in connection with the 2017 Notes was also subsequently modified in November 2018 to $0.333 per share. The 2017 Convertible Notes were offered in a private placement exempt from registration under Section 4(a)(2) of the Securities Act 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.
During the year ended December 31, 2019 and December 31, 2018 the Company recorded $356,000 and $355,000, respectively, in interest expense including $94,000 and $105,000, respectively of amortization of debt discount.
2016 Convertible Notes
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 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.
During the year ended December 31, 2019 and December 31, 2018 the Company recorded $692,000 and $664,000, respectively, in interest expense including $513,000 and $483,000, respectively of amortization of debt discount.
NOTE 6- UNSECURED SUBORDINATED PROMISSORY NOTES
During the year ended December 31, 2019, the Company issued $800,000, in unsecured subordinated promissory notes to the Company’s Chief Executive Officer and to another board member. These notes bear interest at a rate of 6% per annum and have a maturity date of ninety days from the date of issuance. As of December 31, 2019, all promissory notes outstanding were payable to our Chief Executive Officer and aggregated $425,000 at this date. The maturity dates on the outstanding promissory notes have been amended to reflect a June 30, 2020 date.
During 2019, the Company paid off $150,000 and converted $225,000 of the promissory notes to 2019 convertible notes. The Company recognized interest expense of $15,000 on these notes during the year ended December 31, 2019.
NOTE 7 - RIGHT TO USE BUILDING ASSET
The FASB issued ASU No. 2016-02, “Leases,” which requires a lessee to recognize in its balance sheet the assets and liabilities related to long-term leases that were classified as operating leases under previous guidance. An asset is recognized related to the right to use the underlying asset and a liability is recognized related to the obligation to make lease payments over the term of the lease. The standard became effective for the Company January 1, 2019.
As of January 1, 2019, the Company utilized the modified retrospective approach to measure the right to use operating lease agreement associated with the office building located at 1999 Mt. Read Blvd in Rochester New York. The adoption of this accounting standard did not impact our consolidated loss from operations and had no impact on cash flows. Upon adoption, the Company determined the present value of future lease costs at $257,000, which included monthly rental, common area costs, and taxes. The Company assumed an incremental borrowing rate of 6% as the building lease agreement did not include an implicit rate. The right-to-use asset included two, one-year renewal options that ran through May 2021. On September 1, 2019, the Company vacated this property at the request of the landlord and relocated to a new office. The Company terminated the lease obligation without penalty or liability for unused periods associated with the original lease obligation and as such, the Company did not incur an impairment as a result of this change in lease term. Operating lease costs for this lease aggregated $80,000 for year ended December 31, 2019.
On August 1, 2019, the Company entered into an operating lease obligation for office space located at 350 Linden Oaks in Rochester New York. The Company determined the present value of future lease costs at the inception of the lease was $212,000. The Company assumed an incremental borrowing rate of 6% as the building lease agreement did not include an implicit rate. The lease has a termination date of December 30, 2022. Operating lease costs for the year ended December 31, 2019 were $26,000 with future maturing lease obligations as follows: $64,000 in 2020; $64,000 in 2021 and $63,000 in 2022. Total future lease payments are $212,000 including imputed interest of $21,000.
NOTE 8 - SOFTWARE
The Company investment in software for the CURA division have been amortized over an estimated useful life of 3 years. Amortization expense recognized for the year ended December 31, 2019 and 2018 was $10,000 and $92,000, respectively. All capitalized software was fully amortized as of December 31, 2019. The net value of capitalized software at December 31, 2018 was $10,000.
NOTE 9 - PROPERTY AND EQUIPMENT
At December 31, 2019 and 2018 property and equipment consist of the following:
|
|
December 31,
2019
|
|
|
December 31,
2018
|
|
Office equipment
|
|
$
|
199,000
|
|
|
$
|
249,000
|
|
Shop equipment
|
|
|
132,000
|
|
|
|
182,000
|
|
Leasehold improvements
|
|
|
-
|
|
|
|
253,000
|
|
|
|
|
331,000
|
|
|
|
684,000
|
|
Less accumulated depreciation
|
|
|
(293,000
|
)
|
|
|
(622,000
|
)
|
Net property and equipment
|
|
$
|
38,000
|
|
|
$
|
62,000
|
|
Depreciation expense for the years December 31, 2019 and 2018 was $24,000 and $46,000 respectively.
NOTE 10 - 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, 2019 for the Company’s business segments follows:
|
|
CURA
|
|
|
Aegis
|
|
|
Corporate
|
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue
|
|
$
|
15,000
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
15,000
|
|
Gross margin
|
|
|
2,000
|
|
|
|
-
|
|
|
|
-
|
|
|
|
2,000
|
|
Loss from operations
|
|
|
(614,000
|
)
|
|
|
(513,000
|
)
|
|
|
(1,301,000
|
)
|
|
|
(2,428,000
|
)
|
Non-operating expense
|
|
|
-
|
|
|
|
-
|
|
|
|
(1,848,000
|
)
|
|
|
(1,848,000
|
)
|
Net loss
|
|
$
|
(614,000
|
)
|
|
$
|
(513,000
|
)
|
|
$
|
(3,149,000
|
)
|
|
$
|
(4,276,000
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock based compensation
|
|
$
|
3,000
|
|
|
$
|
17,000
|
|
|
$
|
106,000
|
|
|
$
|
126,000
|
|
Depreciation and amortization
|
|
$
|
14,000
|
|
|
$
|
18,000
|
|
|
$
|
100,000
|
|
|
$
|
132,000
|
|
Assets at December 31, 2019
|
|
$
|
1,000
|
|
|
$
|
36,000
|
|
|
$
|
214,000
|
|
|
$
|
251,000
|
|
Segment information for the year ended December 31, 2018 for the Company’s business segments follows:
|
|
CURA
|
|
|
Aegis
|
|
|
Corporate
|
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue
|
|
$
|
37,000
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
37,000
|
|
Gross margin (loss) on revenue
|
|
|
(73,000)
|
|
|
|
-
|
|
|
|
-
|
|
|
|
(73,000)
|
|
Loss from operations
|
|
|
(3,155,000
|
)
|
|
|
(658,000
|
)
|
|
|
(1,439,000
|
)
|
|
|
(5,252,000
|
)
|
Non-operating expense
|
|
|
-
|
|
|
|
-
|
|
|
|
(1,056,000
|
)
|
|
|
(1,056,000
|
)
|
Net loss
|
|
$
|
(3,155,000
|
)
|
|
$
|
(658,000
|
)
|
|
$
|
(2,495,000
|
)
|
|
$
|
(6,308,000
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock based compensation
|
|
$
|
1,000
|
|
|
$
|
44,000
|
|
|
$
|
135,000
|
|
|
$
|
180,000
|
|
Depreciation and amortization
|
|
$
|
110,000
|
|
|
$
|
20,000
|
|
|
$
|
8,000
|
|
|
$
|
138,000
|
|
Assets at December 31, 2018
|
|
$
|
15,000
|
|
|
$
|
54,000
|
|
|
$
|
81,000
|
|
|
$
|
150,000
|
|
NOTE 11 - 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, 2019 and 2018 is summarized below:
|
|
2019
|
|
|
2018
|
|
Current tax expense (benefit):
|
|
|
|
|
|
|
|
|
Federal
|
|
$
|
-
|
|
|
$
|
-
|
|
State
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
Deferred tax expense (benefit):
|
|
|
|
|
|
|
|
|
Federal
|
|
|
583,000
|
|
|
|
1,093,000
|
|
State
|
|
|
131,000
|
|
|
|
252,000
|
|
Change in valuation allowance
|
|
|
(714,000
|
)
|
|
|
(1,345,000
|
)
|
Provision for income tax
|
|
$
|
-
|
|
|
$
|
-
|
|
The difference between income taxes at the statutory federal income tax rate and income taxes reported in the statements of operations for each of the years ended December 31, 2019 and 2018 is attributable to the following:
|
|
2019
|
|
|
2018
|
|
Income tax benefit at federal statutory rate
|
|
$
|
(898,000
|
)
|
|
$
|
(1,325,000
|
)
|
State income tax (benefit), net of effect of federal taxes
|
|
|
(103,000
|
)
|
|
|
(199,000
|
)
|
Non-deductible debt discount
|
|
|
157,000
|
|
|
|
132,000
|
|
Convertible debt interest expense
|
|
|
96,000
|
|
|
|
-
|
|
Debt issuance expense
|
|
|
70,000
|
|
|
|
-
|
|
Other
|
|
|
(36,000
|
)
|
|
|
47,000
|
|
Increase in valuation allowance
|
|
|
714,000
|
|
|
|
1,345,000
|
|
Provision for income taxes
|
|
$
|
-
|
|
|
$
|
-
|
|
The deferred tax asset at December 31, 2019 and 2018 consists of the following:
|
|
2019
|
|
|
2018
|
|
Deferred income tax assets:
|
|
|
|
|
|
|
|
|
Net operating loss carryforwards
|
|
$
|
3,277,000
|
|
|
$
|
3,044,000
|
|
Deferred startup costs
|
|
|
11,224,000
|
|
|
|
10,787,000
|
|
Stock-based compensation
|
|
|
1,321,000
|
|
|
|
1,302,000
|
|
Other
|
|
|
141,000
|
|
|
|
117,000
|
|
|
|
|
15,963,000
|
|
|
|
15,250,000
|
|
Less: Valuation allowance
|
|
|
(15,963,000
|
)
|
|
|
(15,250,000
|
)
|
Net deferred tax asset
|
|
$
|
-
|
|
|
$
|
-
|
|
At December 31, 2019, we have approximately $12,799,000 and $12,095,000 of adjusted federal net operating loss carryforwards and New York State net operating loss carryforwards, respectively, to offset future taxable income. These net operating losses begin expiring in 2023 through 2038. Beginning with tax years starting after December 31, 2017, NOL’s created can be carried forward indefinitely, however they can only be utilized in any given year, up to 80% of taxable income in that year. In addition, we have $249,000 of research and development tax credits carryforwards to offset future tax. These credits expire in 2039. Furthermore, from the date of inception through 2019, we have accumulated approximately $43,413,000 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, with the exception of a nominal portion of these costs related to the sale of CURA software currently being amortized. We have provided a full valuation allowance on the net deferred tax assets due to uncertainty of realization through future earnings.
The amortization period for a nominal portion of the startup expenses, $273,000, under IRC Section 195 began in 2018 because the active trade or business related to those startup expenses commenced. The Company received revenue in 2018 and 2019 for the sale of subscription software services and demos of the CURA watch. An inventory reserve was booked in 2018 based on changes in technology developments. A full reserve was recorded for all inventory on hand and the Company is no longer pursuing sales of the related product. The Company expects CURA software sales will continue to be relevant to the Company's business. An election was made in 2018 to begin to amortize the IRC Section 195 costs related to the CURA software’s original cost, and modifications, which the Company is currently reselling. The remaining Section 195 costs will be amortized over a 15-year period beginning in the year the Company begins as an active trade or business.
Based upon the change in ownership rules under Section 382 of the Internal Revenue Act of 1986, if a company issues common stock or other equity instruments convertible into common shares which results in an ownership change exceeding a 50% limitation threshold over a rolling three-year time frame 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 a particular year. Utilization of the NOL carry-forwards may be subject to an annual limitation in the case of sufficient equity ownership changes under Section 382 of the tax law or the NOLs may expire unutilized.
Reconciliations of the beginning and ending amounts of unrecognized tax benefits for the years ended December 31, 2019 and 2018 are as follows:
|
|
2019
|
|
|
2018
|
|
Balance as of January 1
|
|
$
|
1,112,000
|
|
|
$
|
1,112,000
|
|
Additions based on tax positions related to current year
|
|
|
-
|
|
|
|
-
|
|
Additions based on enacted tax change in state rate
|
|
|
-
|
|
|
|
-
|
|
Additions for tax positions of prior years
|
|
|
-
|
|
|
|
-
|
|
Reductions for tax positions of prior years
|
|
|
-
|
|
|
|
-
|
|
Reductions based on enacted changes in tax rates
|
|
|
-
|
|
|
|
-
|
|
Settlements
|
|
|
-
|
|
|
|
-
|
|
Balance as of December 31
|
|
$
|
1,112,000
|
|
|
$
|
1,112,000
|
|
Tax years that remain subject to examination for our major tax jurisdictions include the years ended December 31, 2016 through December 31, 2019. NOL's generated in previous years may also be subject to examination.
NOTE 12 - 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, 2019 the Company issued 30,000 shares of common stock in connection with a conversion notice received from a preferred Series C-3 shareholder, 195,415 shares of common stock in payment of interest on the Company’s 2016, 2017 and 2019 Convertible Notes and 390,000 shares of common stock in connection with the issuance of 2019 Convertible Notes and Demand Notes.
During the year ended December 31, 2018, the Company issued 874,000 shares of common stock in connection with conversion notices received from various preferred shareholders and warrant exercises and 320,853 shares at $0.25 per share in payment of interest on the Company’s 2016 and 2017 Convertible Notes. The company also issued 190,150 common shares at $0.25 per share to note holders that initiated conversion of their debt during the year ended December 31, 2018.
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.
At December 31, 2019 and 2018, 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 $2,713,000 and $2,530,000 at December 31, 2019 and 2018, 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 $2,713,000 and $2,530,000 at December 31, 2019 and 2018, 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, 2019 and 2018, we settled no Class B Preferred dividends.
At December 31, 2019, dividends payable upon the conversion of 67,500 outstanding shares of Class B Preferred amounted to approximately $488,000. 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 $488,000 and $454,000 at December 31, 2019 and 2018, 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 ended December 31, 2019 Series C Preferred shareholders converted 250,000 of Series C Preferred into common stock. At December 31, 2019 and 2018, there were 15,687,500 shares of Series C Preferred stock outstanding. The value of the Series C Preferred shareholders’ liquidation preference was $6,275,000 at December 31, 2019 and 2018.
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.
During 2018, Series C-2 Preferred shareholders converted 500,000 of Series C-2 Preferred into common stock. At December 31, 2019 and 2018, there were 24,500,000 shares of Preferred C-2 stock outstanding. The value of the Series C-2 Preferred shareholders’ liquidation preference was $4,900,000 at December 31, 2019 and 2018.
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 the year ended December 31, 2019, the Company issued 30,000 shares of common stock in connection with conversion notices received from a Series C-3 convertible preferred shareholder. During the year ended December 31, 2018, the Company issued 120,000 shares of common stock in connection with conversion notices received from Series C-3 convertible preferred shareholders. At December 31, 2019 and 2018, there were 3,238,000 and 3,268,000 shares of Preferred C-3 stock outstanding, respectively.
NOTE 13 - STOCK OPTIONS
The shareholders approved the 2011 and 2016 Stock Option Plans (the “2016 Plan” and the “2011 Plan”) which provide for the grant of up to 6,000,000 common stock options to provide equity incentives to directors, officers, employees and consultants. Two types of options may be granted under the plans: non-qualified stock options and incentive stock options.
Under the 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 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 incentive stock options granted to any employee who owns more than 10% of our stock may not be greater than five years.
As of December 31, 2019, there are 2,159,500 options are available for future grant under these plans.
Summary For the years ended December 31, 2019 and 2018, compensation expense related to stock option awards amounted to $126,000 and $180,000, respectively. As of December 31, 2019, there was approximately $105,000 of unrecognized compensation costs related to outstanding stock options, which are expected to be recognized over a weighted average term of 11 months.
No employee stock options were granted in the year ended December 31, 2019. During the year ended December 31, 2018, the Company granted 1,787,500 stock options to employees and non-employee board members. The weighted average grant date fair value of stock options granted during the year ended December 31, 2018 was $0.23. The total grant date fair value of stock options vested during the years ended December 31, 2019 and 2018 was approximately $173,000 and $412,000, respectively.
The fair value of options granted was estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions:
|
|
2019
|
|
|
2018
|
|
Expected term (years)
|
|
|
-
|
|
|
|
5.4
|
|
Expected forfeiture rate
|
|
|
-
|
|
|
|
0%
|
|
Risk-free rate
|
|
|
-
|
|
|
|
2.8%
|
|
Volatility
|
|
|
-
|
|
|
|
137%
|
|
Dividend yield
|
|
|
-
|
|
|
|
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 year ended December 31, 2019:
|
|
Shares
|
|
|
Weighted
Average
Exercise
Price
|
|
|
Average
Remaining
Contractual
Term
(years)
|
|
|
Aggregate
Intrinsic
Value
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at January 1, 2019
|
|
|
11,028,500
|
|
|
$
|
0.49
|
|
|
|
3.8
|
|
|
$
|
94,000
|
|
Granted
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
Exercised
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
Canceled or expired
|
|
|
(288,000
|
)
|
|
|
0.28
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at December 31, 2019
|
|
|
10,740,500
|
|
|
$
|
0.50
|
|
|
|
2.6
|
|
|
$
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercisable at December 31, 2019
|
|
|
7,522,750
|
|
|
$
|
0.55
|
|
|
|
2.3
|
|
|
$
|
-
|
|
During the year ended December 31, 2019, 288,000 options were canceled due to employee turnover, no options expired unexercised, and no options were exercised. During the year ended December 31, 2018, no options were exercised and 441,000 options were cancelled due to employee turnover, no options expired unexercised and no options were exercised. As of December 31, 2019, the exercise prices on outstanding stock options ranged from $.22 per share to $1.58 per share.
NOTE 14 - WARRANTS
The following summarizes the activity of our outstanding warrants as of December 31, 2019:
|
|
|
|
|
|
|
|
|
|
|
Weighted
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
|
|
|
|
Average
|
|
|
|
|
|
|
|
|
|
|
|
|
Average
|
|
|
|
Remaining
|
|
|
|
Aggregate
|
|
|
|
|
|
|
|
Exercise
|
|
|
|
Contractual
|
|
|
|
Intrinsic
|
|
|
|
Shares
|
|
|
Price
|
|
|
|
Term
|
|
|
|
Value
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at January 1, 2019
|
|
|
7,381,707
|
|
|
$
|
0.46
|
|
(a)
|
|
|
7.0
|
|
(b)
|
|
$
|
39,000
|
|
Granted
|
|
|
350,000
|
|
|
|
0.25
|
|
|
|
|
|
|
|
|
|
|
|
Exercised
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
Canceled or expired
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at December 31, 2019
|
|
|
7,731,707
|
|
|
$
|
0.45
|
|
(a)
|
|
|
6.2
|
|
(b)
|
|
$
|
33,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercisable at December 31, 2019
|
|
|
7,106,707
|
|
|
$
|
0.49
|
|
|
|
|
6.2
|
|
(c)
|
|
$
|
33,000
|
|
|
(a)
|
The weighted average exercise price for warrants outstanding excludes 1,750,000 warrants in each period with no determined exercise price.
|
|
(b)
|
The weighted average remaining contractual term for warrants outstanding excludes 743,500 warrants with no expiration date.
|
|
(c)
|
The weighted average remaining contractual term for warrants exercisable excludes 118,500 warrants with no expiration date.
|
NOTE 15 - RELATED PARTY TRANSACTIONS
As of December 31, 2019, and December 31, 2018, the Company had outstanding $2,477,000 and $2,252,000, respectively, in senior convertible notes held by six members of our board of directors. These notes represent 9,388,378 of potential shares of common stock at December 31, 2019 and 7,888,378 at December 31, 2018. The Company granted 1,239,288 warrants to these board members in connection with their investment in the convertible notes. During 2019, the Company issued 60,000 and 7,500 common shares to the Company's Chief Executive Officer and to another board member in connection with their investment in the 2019 Convertible Notes, as further described in Note 5. The Company had $164,000 and $33,000 in accrued interest on convertible and promissory notes due to board members outstanding at December 31, 2019 and December 31, 2018, respectively.
As of December 31, 2019, and December 31, 2018, the Company had outstanding a $1,170,000 senior convertible note held by an investor that is deemed an affiliate. This note represents 4,680,000 of potential shares of common stock as of these reporting dates. Underlying warrants associated with this note represent 468,000 of potential shares of common stock. At December 31, 2019 and December 31, 2018, the Company had $88,000 and $17,000 respectively, in accrued interest outstanding on this convertible note.
During 2019, the Company issued unsecured subordinated promissory notes of $800,000 of which $225,000 was subsequently converted into 2019 convertible notes and $150,000 was repaid resulting in $425,000 of outstanding promissory notes payable to our Chief Executive Officer as of December 31, 2019. The unsecured promissory notes have maturity date of June 30, 2020 and accrue interest at 6% per annum. Accrued and unpaid interest due on the promissory notes was $15,000 as of December 31, 2019.
NOTE 16 — COMMITMENTS AND OTHER MATTERS
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 2019 and 2018, we incurred administrative expenses of approximately $2,000 in each year related to this plan.
NOTE 17- SUBSEQUENT EVENTS
2019 Convertible Notes
Subsequent to December 31, 2019, the Company issued $435,000 in new 2019 convertible notes and 112,500 of new common shares to the investors in these notes.
Common Shares Issued in Payment of Interest Expense
Subsequent to December 31, 2019, the Company issued 94,772 shares of common stock representing $14,000 in payment of interest to noteholders.
Stock Compensation Grants
Subsequent to December 31, 2019, the Company granted 2,100,000 incentive stock options exercisable for 10 years from the date of grant at prices ranging from $0.12 to $0.15 per share.