NOTES TO FINANCIAL STATEMENTS
Years ended December 31, 2012 and 2011 and
the period
from August 1, 2005 (inception) to December
31, 2012
1. DESCRIPTION OF BUSINESS
Arno Therapeutics, Inc. (“Arno”
or the “Company”) develops innovative drug candidates for the treatment of patients with cancer. The following is a
summary of the Company’s product development pipeline:
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·
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Onapristone
–
Onapristone is an anti-progestin hormone blocker that has been shown to have considerable
anti-tumor activity in patients with breast cancer. In prior clinical studies, onapristone has demonstrated a 56% objective response
rate as a first line “hormone” treatment of breast cancer. In connection with the development of onapristone, the Company
intends to develop a companion diagnostic product to selectively identify patients who express the activated form of the progesterone
receptor and therefore may be more likely to benefit from treatment with onapristone. The Company is currently conducting pre-clinical
toxicology studies and manufacturing activities and plans to file an investigational new drug application (“IND”) or
foreign equivalent in 2013.
|
|
·
|
AR-42
– AR-42 is an orally available, broad spectrum inhibitor of both histone and non-histone deacetylation proteins, or Pan-DAC, which play an important role in the regulation of gene expression, cell growth and survival. AR-42 is currently being studied in an investigator-initiated Phase I/II clinical study in adult subjects with relapsed or refractory multiple myeloma, chronic lymphocytic leukemia (CLL), or lymphoma. The protocol has been amended to include a solid tumor dose escalation cohort which is currently open for patient enrollment.
|
|
·
|
AR-12
– AR-12 is a potentially first-in-class, orally available, targeted anti-cancer agent that has been shown in pre-clinical studies to inhibit phosphoinositide dependent protein kinase-1, or PDK-1, a protein in the PI3K/Akt pathway that is involved in the growth and proliferation of cells, including cancer cells. AR-12 has also been reported to cause cell death through the induction of endoplasmic reticulum stress and work is ongoing to further understand the mechanism of action. The Company is currently conducting a multi-centered Phase I clinical study of AR-12 in adult subjects with advanced or recurrent solid tumors or lymphoma.
|
The Company was incorporated in Delaware
in March 2000 under the name Laurier International, Inc. (“Laurier”). Pursuant to an Agreement and Plan of Merger dated
March 6, 2008 (as amended, the “Merger Agreement”), by and among the Company, Arno Therapeutics, Inc., a Delaware corporation
formed on August 1, 2005 (“Old Arno”), and Laurier Acquisition, Inc., a Delaware corporation and wholly-owned subsidiary
of the Company (“Laurier Acquisition”), on June 3, 2008, Laurier Acquisition merged with and into Old Arno, with Old
Arno remaining as the surviving corporation and a wholly-owned subsidiary of Laurier. Immediately following this merger, Old Arno
merged with and into Laurier and Laurier’s name was changed to Arno Therapeutics, Inc. These two merger transactions are
hereinafter collectively referred to as the “Merger.” Immediately following the Merger, the former stockholders of
Old Arno collectively held 95% of the outstanding common stock of Laurier, assuming the issuance of all shares issuable upon the
exercise of outstanding options and warrants, and all of the officers and directors of Old Arno in office immediately prior to
the Merger were appointed as the officers and directors of Laurier immediately following the Merger. Further, Laurier was a non-operating
shell company prior to the Merger. The merger of a private operating company into a non-operating public shell corporation with
nominal net assets is considered to be a capital transaction in substance, rather than a business combination, for accounting purposes.
Accordingly, the Company treated this transaction as a capital transaction without recording goodwill or adjusting any of its other
assets or liabilities. All costs incurred in connection with the Merger have been expensed. Upon completion of the Merger, the
Company adopted Old Arno’s business plan.
2. LIQUIDITY AND CAPITAL RESOURCES
The Company is a development stage enterprise
since it has not yet generated any revenue from the sale of products and, through December 31, 2012, its efforts have been principally
devoted to developing its licensed technologies, recruiting personnel, establishing office facilities, and raising capital. Accordingly,
the accompanying financial statements have been prepared in accordance with the provisions of Accounting Standards Codification
(“ASC”) 915, “
Development Stage Entities
.” The Company has experienced net losses since its inception
and has an accumulated deficit of approximately $49.9 million at December 31, 2012. The Company expects to incur substantial and
increasing losses and have negative net cash flows from operating activities as it expands its technology portfolio and engages
in further research and development activities, particularly the conducting of pre-clinical and clinical trials.
Cash resources as of December 31, 2012
were approximately $10.9 million, compared to $6.7 million as of December 31, 2011. Based on its resources at December 31,
2012 and the current plan of expenditure on continuing development of the Company’s current product candidates, the Company
believes that it has sufficient capital to fund its operations through approximately the third quarter of 2013. However, the Company
will need substantial additional financing in the future until it can achieve profitability, if ever. The Company’s continued
operations will depend on its ability to raise additional funds through various potential sources, such as equity and debt financing,
or to license its product candidates to another pharmaceutical company. The Company will continue to fund operations from cash
on hand and through sources of capital similar to those previously described. The Company cannot assure that it will be able to
secure such additional financing, or if available, that it will be sufficient to meet its needs.
The success of the Company depends on its
ability to discover and develop new products to the point of FDA approval and subsequent revenue generation and, accordingly, to
raise enough capital to finance these developmental efforts. Management plans to raise additional equity capital or license one
or more of its products to finance the continued operating and capital requirements of the Company. Amounts raised will be used
to further develop the Company’s products, acquire additional product licenses and for other working capital purposes. While
the Company will extend its best efforts to raise additional capital to fund all operations for the next 12 to 24 months, management
can provide no assurances that the Company will be able to raise sufficient funds.
These factors raise substantial doubt about
the Company's ability to continue as a going concern. The Company’s financial statements have been prepared on a going concern
basis, which contemplates the realization of assets and the settlement of liabilities and commitments in the normal course of business.
The financial statements do not include any adjustments that might result from the inability of the Company to continue as a going
concern.
3. THE MERGER AND BASIS OF PRESENTATION
The accompanying audited financial statements
of the Company have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) and the
instructions to Form 10-K promulgated by the Securities and Exchange Commission (“SEC”).
(a) Description of the Merger and Private Placement Offering
The Company completed the Merger on June
3, 2008. In accordance with the terms of the Merger, each share of common stock of Old Arno that was outstanding
immediately prior to the Merger was exchanged for 1.99377 shares of the Company’s common stock. In addition, all
securities convertible into or exercisable for shares of Old Arno common stock outstanding immediately prior to the Merger were
cancelled, and the holders thereof received similar securities convertible into or exercisable for the purchase of an aggregate
of 1,611,760 shares of the Company’s common stock. In consideration for their shares of the Company’s pre-merger common
stock, the Company’s shareholders received an aggregate of 19,291,824 shares of Laurier common stock. Immediately
prior to the effective time of the Merger, 1,100,200 shares of Laurier’s common stock were issued and outstanding. Upon completion
of the Merger, the Old Arno shareholders owned approximately 95% of the Company’s issued and outstanding common stock, assuming
the exercise of all of the issued and outstanding common stock options and warrants.
Following the Merger, the business conducted
by the Company is the business conducted by Old Arno prior to the Merger. In addition, the directors and officers of Laurier were
replaced by the directors and officers of Old Arno.
As a condition and immediately prior to the
closing of the Merger, on June 2, 2008, Old Arno completed a private placement of its equity securities whereby it received gross
proceeds of approximately $17,732,000 through the sale of approximately 3,691,900 shares of Old Arno Common Stock to selected accredited
investors, which shares were exchanged for approximately 7,360,700 shares of Company Common Stock after giving effect to the Merger.
Contemporaneously with the June 2008 private placement, the Old Arno’s outstanding 6% Notes (defined below) converted into
984,246 shares of Old Arno’s common stock and the holders of the Notes received warrants to purchase an aggregate of 98,409
shares of Old Arno common stock at an exercise price equal to $4.83 per share. The shares issued upon conversion were exchanged
for an aggregate of approximately 1,962,338 shares of the Company’s Common Stock and the warrants were exchanged for
five-year warrants to purchase an aggregate of approximately 196,189 shares of the Company’s Common Stock at an exercise
price equal to $2.42 per share. See “Note 8. Convertible Debentures and Notes Payable.”
All references to share and per share amounts
in these financial statements have been restated to retroactively reflect the number of common shares of Arno common stock issued
pursuant to the Merger.
(b) Accounting Treatment of the Merger; Financial Statement
Presentation
The Merger was accounted for as a reverse
acquisition pursuant to Accounting Standards Codification (“ASC”) 805-40-25, which provides that the “merger
of a private operating company into a non-operating public shell corporation with nominal net assets typically results
in the owners and management of the private company having actual or effective operating control of the combined company after
the transaction, with the shareholders of the former public shell continuing only as passive investors. These transactions
are considered by the Securities and Exchange Commission to be capital transactions in substance, rather than business combinations.
That is, the transaction is equivalent to the issuance of stock by the private company for the net monetary assets of
the shell corporation, accompanied by a recapitalization.” Accordingly, the Merger has been accounted for
as a recapitalization, and, for accounting purposes, Old Arno is considered the acquirer in a reverse acquisition.
Laurier’s historical accumulated
deficit for periods prior to June 3, 2008, in the amount of $120,538, was eliminated against additional-paid-in-capital, and the
accompanying financial statements present the previously issued shares of Laurier common stock as having been issued pursuant to
the Merger on June 3, 2008. The shares of common stock of the Company issued to the Old Arno stockholders in the Merger are presented
as having been outstanding since August 2005 (the month when Old Arno first sold its equity securities).
Because the Merger was accounted for as
a reverse acquisition under GAAP, the financial statements for periods prior to June 3, 2008 reflect only the operations of Old
Arno.
4. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) Use of Estimates
The preparation of financial statements
in conformity with GAAP requires that management 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 revenues and expenses during the reporting periods. Estimates and assumptions principally relate to services performed by third
parties but not yet invoiced, estimates of the fair value and forfeiture rates of stock options issued to employees, directors
and consultants, valuation of derivatives and estimates of the probability and potential magnitude of contingent liabilities. Actual
results could differ from those estimates.
(b) Cash and Cash Equivalents
The Company considers all highly liquid
investments with a remaining maturity of three months or less at the time of acquisition to be cash equivalents.
(c) Deferred Financing Fees
Finance costs relating to debt issued are
recorded as a deferred charge and amortized to interest expense over the expected term of the debt using the effective interest
method.
(d) Prepaid Expenses
Prepaid expenses consist of payments made
in advance to vendors relating to service contracts for clinical trial development, insurance policies and license fees. These
advanced payments are amortized to expense either as services are performed or over the relevant service period using the straight
line method.
(e) Property and Equipment
Property and equipment consist primarily
of furnishings, fixtures, leasehold improvements and computer equipment and are recorded at cost. Repairs and maintenance costs
are expensed in the period incurred. Depreciation of property and equipment is provided for by the straight-line method over the
estimated useful lives of the related assets. Leasehold improvements are amortized using the straight-line method over the remaining
lease term or the life of the asset, whichever is shorter.
Description
|
|
Estimated
Useful Life
|
|
|
|
Office equipment and furniture
|
|
5 to 7 years
|
Leasehold improvements
|
|
3 years
|
Computer equipment
|
|
3 years
|
(f) Fair Value of Financial Instruments
The Company measures fair value in accordance
with generally accepted accounting principles. Fair value measurements are applied under other accounting pronouncements that require
or permit fair value measurements. Financial instruments included in the Company’s balance sheets consist of cash and cash
equivalents, accounts payable, accrued expenses, due to related parties, and warrant liability. The carrying amounts of these instruments
reasonably approximate their fair values due to their short-term maturities.
(g) Convertible Debentures and Warrant Liability
The Company accounts for the convertible
debentures and warrants issued in connection with the 2012 Purchase Agreement (see Note 8) and for the warrants issued in connection
with the 2010 Purchase Agreement (see Note 10) in accordance with the guidance on Accounting for Certain Financial Instruments
with Characteristics of both Liabilities and Equity, which provides that the Company classify the warrant instrument as a liability
at its fair value and adjusts the instrument to fair value at each reporting period. This liability is subject to re-measurement
at each balance sheet date until exercised, and any change in fair value is recognized as a component of other income or expense.
The fair value of warrants issued by the Company, in connection with private placements of securities, has been estimated using
a Monte Carlo simulation model and, in doing so, the Company’s management utilized a third-party valuation report. The Monte
Carlo simulation is a generally accepted statistical method used to generate a defined number of stock price paths in order to
develop a reasonable estimate of the range of the Company’s future expected stock prices and minimizes standard error.
(h) Concentration of Credit Risk
Financial instruments which potentially subject
the Company to concentrations of credit risk consist principally of cash and cash equivalents. The Company deposits cash and cash
equivalents with high credit quality financial institutions and is insured to the maximum limitations. Balances in these accounts
may exceed federally insured limits at times, which expose the Company to institutional risk.
(i) Research and Development
Research and development costs are charged
to expense as incurred. Research and development includes employee costs, fees associated with operational consultants, contract
clinical research organizations, contract manufacturing organizations, clinical site fees, contract laboratory research organizations,
contract central testing laboratories, licensing activities, and allocated executive, human resources and facilities expenses.
The Company accrues for costs incurred as the services are being provided by monitoring the status of the trial and the invoices
received from its external service providers. As actual costs become known, the Company adjusts its accruals in the period when
actual costs become known. Costs related to the acquisition of technology rights and patents for which development work is still
in process are charged to operations as incurred and considered a component of research and development expense.
(j) Stock-Based Compensation
Stock-based compensation cost is measured
at the grant date based on the value of the award and is recognized as expense over the required service period, which is generally
equal to the vesting period. Share-based compensation is recognized only for those awards that are ultimately expected to vest.
Common stock, stock options or other equity
instruments issued to non-employees (including consultants and all members of the Company’s Scientific Advisory Board) as
consideration for goods or services received by the Company are accounted for based on the fair value of the equity instruments
issued (unless the fair value of the consideration received can be more reliably measured). The fair value of stock options is
determined using the Black-Scholes option-pricing model. The fair value of any options issued to non-employees is recorded
as expense over the applicable service periods.
(k) Loss per Common Share
Basic loss per share is computed by dividing
the loss available to common shareholders by the weighted-average number of common shares outstanding. Diluted loss per share is
computed similarly to basic loss per share except that the denominator is increased to include the number of additional common
shares that would have been outstanding if the potential common shares had been issued and if the additional common shares were
dilutive.
|
|
For the Year Ended December 31,
|
|
|
|
2012
|
|
|
2011
|
|
|
|
Loss
|
|
|
Shares
|
|
|
Per Share
|
|
|
Loss
|
|
|
Shares
|
|
|
Per Share
|
|
|
|
(Numerator)
|
|
|
(Denominator)
|
|
|
Amount
|
|
|
(Numerator)
|
|
|
(Denominator)
|
|
|
Amount
|
|
Net loss
|
|
$
|
(14,387,782
|
)
|
|
|
|
|
|
|
|
|
|
$
|
(7,909,113
|
)
|
|
|
|
|
|
|
|
|
Less: Preferred stock dividends
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
(81,651
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic and Diluted EPS
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss available to common stockholders
|
|
$
|
(14,387,782
|
)
|
|
|
36,322,565
|
|
|
$
|
(0.40
|
)
|
|
$
|
(7,990,764
|
)
|
|
|
34,514,594
|
|
|
$
|
(0.23
|
)
|
For all periods presented, potentially dilutive securities are
excluded from the computation of fully diluted loss per share as their effect is anti-dilutive.
Potentially dilutive securities include:
|
|
December 31, 2012
|
|
|
December 31, 2011
|
|
Options to purchase common stock
|
|
|
–
|
|
|
|
-
|
|
For the year ended December 31, 2012 and
2011, 165,810,057 and 15,817,737 shares of warrants, options and shares issuable under convertible debentures have been excluded
from the computation of potentially dilutive securities, respectively, as their conversion and/or exercise prices are greater than
the fair market price per common share as of December 31, 2012 and 2011, respectively.
(l) Comprehensive Loss
The Company has no components of other comprehensive
loss other than its net loss, and accordingly, comprehensive loss is equal to net loss for all periods presented.
(m) Income Taxes
The Company recognizes deferred tax assets
and liabilities for the expected future tax consequences of events that have been included in the financial statements or tax returns.
Under this method, deferred income taxes are recognized for the tax consequences in future years of differences between the tax
bases of assets and liabilities and their financial reporting amounts at each year-end based on enacted tax laws and statutory
tax rates applicable to the period in which the differences are expected to affect taxable income. The Company provides a valuation
allowance when it appears more likely than not that some or all of the net deferred tax assets will not be realized.
A tax position is recognized as a benefit
only if it is “more likely than not” that the tax position would be sustained in a tax examination, with a tax examination
being presumed to occur. The amount recognized is the largest amount of tax benefit that is greater than 50% likely of being realized
on examination. For tax positions not meeting the “more likely than not” test, no tax benefit is recorded.
The Company’s policy is to include
interest and penalties related to unrecognized tax benefits within the Company’s provision for (benefit from) income taxes.
The Company recognized no amounts for interest and penalties related to unrecognized tax benefits in 2012 and 2011 respectively.
In addition, the Company had no amounts accrued for interest and penalties as of December 31, 2012 and 2011, respectively.
(n) Recently Issued Accounting Pronouncements
In May 2011, the Financial Accounting Standards
Board (“FASB”) issued additional guidance relating to fair value measurement and disclosure requirements. For fair
value measurements categorized in Level 3 of the fair value hierarchy, the new guidance requires (1) disclosure of quantitative
information about unobservable inputs; (2) a description of the valuation processes used by the entity; and (3) a qualitative discussion
about the sensitivity of the fair value measurements to changes in unobservable inputs and interrelationships between those unobservable
inputs, if any. Entities must report the level in the fair value hierarchy of assets and liabilities that are not recorded at fair
value in the statement of financial position but for which fair value is disclosed. The new requirements clarify that the concepts
of highest and best use and valuation premise only apply to measuring fair value of nonfinancial assets. The new requirements also
specify that in the absence of a Level 1 input, a reporting entity should incorporate a premium or discount in a fair value measurement
if a market participant would take into account such an input in pricing an asset or liability. Additionally, the new guidance
introduces an option to measure certain financial assets and financial liabilities with offsetting positions on a net basis if
certain criteria are met. For public entities, these new requirements become effective for interim and annual periods beginning
on or after December 15, 2011. These requirements are applicable to our fiscal year beginning January 1, 2012. The adoption of
this new guidance did not have a material effect on the Company’s financial statements.
Management does not believe that any other
recently issued, but not yet effective, accounting pronouncements, if currently adopted, would have a material effect on the Company’s
financial statements.
5. PROPERTY AND EQUIPMENT
Property and equipment as of December 31,
2012 and 2011 consist of the following:
|
|
2012
|
|
|
2011
|
|
Computer equipment and software
|
|
$
|
17,721
|
|
|
$
|
17,721
|
|
Office furniture and equipment
|
|
|
52,242
|
|
|
|
52,242
|
|
Leasehold improvements
|
|
|
8,449
|
|
|
|
8,449
|
|
Total property and equipment
|
|
|
78,412
|
|
|
|
78,412
|
|
Accumulated depreciation
|
|
|
(53,575
|
)
|
|
|
(39,739
|
)
|
Total property and equipment, net
|
|
$
|
24,837
|
|
|
$
|
38,673
|
|
Depreciation expense for the years ended
December 31, 2012, 2011, and the period from August 1, 2005 (inception) through December 31, 2012, was $13,836, $11,677 and $69,979,
respectively.
6. INTANGIBLE ASSETS AND INTELLECTUAL PROPERTY
(a) Onapristone License Agreement
The Company’s rights to onapristone
are governed by a license agreement with Invivis Pharmaceuticals, Inc. (“Invivis”), dated February 13, 2012. Under
this agreement, the Company holds an exclusive, royalty-bearing license for the rights to commercialize onapristone for all therapeutic
uses. The license agreement provides the Company with worldwide rights to onapristone with the exception of France; provided, however,
that the Company has an option to acquire French commercial rights from Invivis upon notice to Invivis together with a cash payment.
The onapristone license agreement provides
the Company with exclusive, worldwide rights to a U.S. provisional patent application that relates to assays for predictive biomarkers
for anti-progestin efficacy. The Company intends to expand its patent portfolio by filing additional patent applications covering
the use of onapristone and/or a companion diagnostic product. If the pending patent application issues, the issued patent would
be scheduled to expire in 2031.
The Company made a one-time cash payment
of $500,000 to Invivis upon execution of the license agreement on February 13, 2012. Additionally, Invivis will receive performance-based
cash payments of up to an aggregate of $15.1 million upon successful completion of clinical and regulatory milestones relating
to onapristone, which milestones include the marketing approval of onapristone in multiple indications in the United States or
the European Union as well as Japan. The Company will make the first milestone payment to Invivis upon the dosing of the first
subject in the first company sponsored Phase 1 clinical trial of onapristone, which is anticipated in the third quarter of 2013.
In addition, the Company will pay Invivis low single digit sales royalties based on net sales of onapristone by the Company or
any of its sublicensees. Pursuant to a separate services agreement, Invivis will provide the Company with certain clinical development
support services, which includes the assignment of up to two full-time employees to perform such services, in exchange for a monthly
cash payment.
Under the license agreement with Invivis,
the Company also agreed to indemnify and hold Invivis and its affiliates harmless from any and all claims arising out of or in
connection with the production, manufacture, sale, use, lease, consumption or advertisement of onapristone, provided, however,
that the Company shall have no obligation to indemnify Invivis for claims that (a) any patent rights infringe third party intellectual
property, (b) arise out of the gross negligence or willful misconduct of Invivis, or (c) result from a breach of any representation,
warranty confidentiality obligation of Invivis under the license agreement. The license agreement will terminate upon the later
of (i) the last to expire valid claim contained in the patent rights, and (ii) February 13, 2032. In general, Invivis may terminate
the license agreement at any time upon a material breach by the Company to the extent the Company fails to cure any such breach
within 90 days after receiving notice of such breach or in the event the Company files for bankruptcy. The Company may terminate
the agreement for any reason upon 90 days’ prior written notice.
(b) AR-12 and AR-42 License Agreements
The Company’s rights to both AR-12
and AR-42 are governed by separate license agreements with The Ohio State University Research Foundation (“Ohio State”)
entered into in January 2008. Pursuant to each of these agreements, Ohio State granted the Company exclusive, worldwide, royalty-bearing
licenses to commercialize certain patent applications, know-how and improvements relating to AR-42 and AR-12 for all therapeutic
uses.
Pursuant to the Company’s license
agreements for AR-12 and AR-42, the Company made one-time cash payments to Ohio State in the aggregate amount of $450,000 and reimbursed
it for past patent expenses in the aggregate amount of approximately $174,000. Additionally, the Company will be required to make
performance-based cash payments upon successful completion of clinical and regulatory milestones relating to AR-12 and AR-42 in
the United States, Europe and Japan. The first milestone payment for each of the licensed compounds will be due when the first
patient is dosed in the first Company sponsored Phase I clinical trial of each of AR-12 and AR-42. In October 2009, the Company
remitted a milestone payment to Ohio State for the first patient dosed in the first Company sponsored Phase I clinical trial of
AR-12. To the extent the Company enters into a sublicensing agreement relating to either or both of AR-12 or AR-42, it will be
required to pay Ohio State a portion of all non-royalty income received from such sublicensee. The Company made no milestone payments
under these license agreements during 2012. The Company does not expect to make any milestone payments under these agreements during
2013.
The license agreements with Ohio State further
provide that the Company will indemnify Ohio State from any and all claims arising out of the death of or injury to any person
or persons or out of any damage to property, or resulting from the production, manufacture, sale, use, lease, consumption or advertisement
of either AR-12 or AR-42, except to the extent that any such claim arises out of the gross negligence or willful misconduct of
Ohio State. The license agreements for AR-12 and AR-42 each expire on the later of (i) the expiration of the last valid claim contained
in any licensed patent and (ii) 20 years after the effective date of the license. Ohio State will generally be able to terminate
either license upon the Company’s breach of the terms of the license to the extent the Company fails to cure any such breach
within 90 days after receiving notice of such breach or the Company files for bankruptcy. The Company may terminate either license
upon 90 days prior written notice.
(c) AR-67 License Agreement
The Company’s rights to AR-67 were
governed by an October 2006 license agreement with the University of Pittsburgh (“Pitt”). Under this agreement, Pitt
granted the Company an exclusive, worldwide, royalty-bearing license for the rights to commercialize technologies embodied by certain
issued patents, patent applications and know-how relating to AR-67 for all therapeutic uses.
Under the terms of the license agreement
with Pitt, the Company made a one-time cash payment of $350,000 to Pitt and reimbursed it for past patent expenses of approximately
$373,000. Additionally, Pitt was entitled to receive performance-based cash payments upon successful completion of clinical and
regulatory milestones relating to AR-67. The Company would have made the first milestone payment to Pitt upon the acceptance of
the first new drug application by the FDA for AR-67. The Company was also required to pay to Pitt an annual maintenance fee of
$200,000 upon the third and fourth anniversaries, $250,000 upon the fifth and sixth anniversaries, and $350,000 upon the seventh
anniversary and annually thereafter and to pay Pitt a royalty equal to a percentage of net sales of AR-67, pursuant to the license
agreement. The Company did not have any milestone payment obligations during 2012 under this license agreement.
Under the license agreement with Pitt, the
Company also agreed to indemnify and hold Pitt and its affiliates harmless from any and all claims, actions, demands, judgments,
losses, costs, expenses, damages and liabilities (including reasonable attorneys’ fees) arising out of or in connection with
(i) the production, manufacture, sale, use, lease, consumption or advertisement of AR-67, (ii) the practice by the Company or any
affiliate or sublicensee of the licensed patent; or (iii) any obligation of the Company under the license agreement unless any
such claim is determined to have arisen out of the gross negligence, recklessness or willful misconduct of Pitt.
In January 2012, Pitt provided notice to
the Company that it was in default of the terms of the license agreement for failing to pay the $250,000 annual maintenance fee.
In March 2012, following the Company’s determination not to proceed with further development of AR-67, the parties agreed
to terminate the license agreement. As a result, the Company no longer has rights in AR-67; however, the Company retains ownership
of all data accumulated during the Company’s development of AR-67. On March 28, 2013, the Company entered into a settlement
agreement with Pitt pursuant to which the Company agreed to make a one-time payment of $235,000 in full satisfaction of all obligations
under the license agreement with Pitt. See Note 16. Subsequent Events.
7. ACCRUED LIABILITIES
Accrued liabilities as of December 31, 2012
and 2011 consist of the following:
|
|
2012
|
|
|
2011
|
|
|
|
|
|
|
|
|
|
|
Accrued compensation and related benefits
|
|
$
|
304,772
|
|
|
$
|
272,342
|
|
Accrued research and development expense
|
|
|
713,099
|
|
|
|
915,699
|
|
Accrued liquidated damages
|
|
|
594,288
|
|
|
|
–
|
|
Accrued other expense
|
|
|
40,000
|
|
|
|
–
|
|
|
|
|
|
|
|
|
|
|
Total accrued liabilities
|
|
$
|
1,652,159
|
|
|
$
|
1,188,041
|
|
8. CONVERTIBLE DEBENTURES AND NOTES PAYABLE
On November 26, 2012, the Company entered
into a Securities Purchase Agreement, or the 2012 Purchase Agreement, with a number of institutional and accredited investors pursuant
to which the Company sold in a private placement an aggregate principal amount of $14,857,200 of three-year 8% Senior Convertible
Debentures, or the Debentures. In accordance with the 2012 Purchase Agreement, as amended on December 13, 2012, the Company also
issued five-year Series A warrants to purchase an aggregate of 49,524,003 shares of common stock at an initial exercise price of
$0.50 per share and 18-month Series B warrants to purchase an aggregate of 49,524,003 shares of common stock at an initial exercise
price of $0.30 per share. The sale of the Debentures and 2012 Warrants, which occurred in two closings on November 26, 2012 and
December 18, 2012, resulted in aggregate gross proceeds of approximately $14.9 million, before deducting placement agent fees and
other transaction-related expenses of approximately $1.2 million. The 2012 Warrants were valued at $12,430,525 (see Note 9).
The conversion price of the Debentures is
subject to a “full-ratchet” anti-dilution provision, such that in the event the Company makes an issuance of common
stock (subject to customary exceptions) at a price per share less than the applicable exercise price of the Debentures, the applicable
conversion price will be reduced to the price per share applicable to such new issuance. However, after such time as the Company
has raised at least $12 million in subsequent equity financings, the conversion price of the Debentures will be subject to a customary
weighted-average price adjustment with respect to new issuances. This conversion feature of the Debentures is considered an embedded
derivative and was accounted for separately from the Debentures and was valued at $7,548,500 (see Note 9).
Pursuant to the terms of a Registration
Rights Agreement entered into on November 26, 2012 in connection with the Company’s entry into the 2012 Purchase Agreement,
the Company agreed to file a registration statement under the Securities Act of 1933, as amended, covering the resale of: (i) 100%
of the shares of common stock issuable as payment of accrued interest under the Debentures and upon exercise of the Series A Warrants;
and (ii) 150% of the shares of common stock issuable upon conversion of the Debentures and upon exercise of the Series B Warrants
(collectively, the “Registrable Securities”). The Company further agreed to cause such registration statement to be
filed with 30 days following the date of the Registration Rights Agreement, or by December 26, 2012, and to cause such registration
statement to be declared effective within 60 days following the date of the Registration Rights Agreement, or by January 25, 2013,
or, if the registration statement was subject to review by the SEC, to cause such registration statement to be declared effective
within 120 days following the date of the Registration Rights Agreement, or by March 26, 2013. If such registration statement,
covering 100% of the Registrable Securities, was not declared effective by the SEC by the applicable date, the Company agreed to
pay liquidated damages to the investors in the amount of 2% of each investor’s aggregate investment amount per month until
the registration statement is declared effective or until such earlier time as the Registrable Securities may be traded pursuant
to Rule 144. On March 25, 2013, the Company and holders of over two-thirds of the Debentures entered into an amendment to the Registration
Rights Agreement, permitting the Company, in its sole discretion, to elect to pay such liquidated damages by issuing shares of
common stock in lieu of cash (see Note 16).
The Company filed the registration statement
on December 26, 2012, and, following the receipt of comments from the SEC on January 7, 2013, the Company filed an amendment to
the registration statement on January 29, 2013. As of the date of this report, the registration statement has not been declared
effective by the SEC, and the Company does not anticipate being able to register 100% of the Registrable Securities. Accordingly,
because the registration statement was not declared effective by March 26, 2013, the investors are each entitled to liquidated
damages in the amount of 2% of their investment amount per month until the Registrable Securities may be traded pursuant to Rule
144. Because Rule 144 will become available to the investors six months after the applicable closing date, the investors will be
entitled to approximately two months’ of liquidated damages, or approximately $0.6 million in the aggregate.
9. FAIR VALUE OF FINANCIAL INSTRUMENTS
The Company defines fair value as the amount
at which an asset (or liability) could be bought (or incurred) or sold (or settled) in a current transaction between willing parties,
that is, other than in a forced or liquidation sale. The fair value estimates presented in the table below are based on information
available to the Company as of December 31, 2012.
The accounting standard regarding fair value
measurements discusses valuation techniques, such as the market approach (comparable market prices), the income approach (present
value of future income or cash flow), and the cost approach (cost to replace the service capacity of an asset or replacement cost).
The standard utilizes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into
three broad levels. The following is a brief description of those three levels:
|
·
|
Level 1: Observable inputs such as quoted prices (unadjusted) in active
markets for identical assets or liabilities.
|
|
·
|
Level 2: Inputs other than quoted prices that are observable for the
asset or liability, either directly or indirectly. These include quoted prices for similar assets or liabilities in active markets
and quoted prices for identical or similar assets or liabilities in markets that are not active.
|
|
·
|
Level 3: Unobservable inputs that reflect the reporting entity’s
own assumptions.
|
The Company has determined the fair value of certain
liabilities using the market approach: the following tables present the Company’s fair value hierarchy for these assets measured
at fair value on a recurring basis as of December 31, 2012 and 2011:
|
|
|
|
|
Quoted Market
|
|
|
|
|
|
|
|
|
|
|
|
|
Prices in Active
|
|
|
Significant Other
|
|
|
Significant
|
|
|
|
Fair Value December
|
|
|
Markets
|
|
|
Observable Inputs
|
|
|
Unobservable Inputs
|
|
|
|
31, 2012
|
|
|
(Level 1)
|
|
|
(Level 2)
|
|
|
(Level 3)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Warrant liability - 2010 Series A&B
|
|
$
|
898,722
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
898,722
|
|
Debenture conversion feature -2012
|
|
|
7,548,500
|
|
|
|
-
|
|
|
|
-
|
|
|
|
7,548,500
|
|
Warrant liability - 2012 placement agent
|
|
|
542,530
|
|
|
|
-
|
|
|
|
-
|
|
|
|
542,530
|
|
Warrant liability - 2012 Series A&B
|
|
|
12,430,525
|
|
|
|
-
|
|
|
|
-
|
|
|
|
12,430,525
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
21,420,277
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
21,420,277
|
|
|
|
|
|
|
Quoted Market
|
|
|
|
|
|
|
|
|
|
|
|
|
Prices in Active
|
|
|
Significant Other
|
|
|
Significant
|
|
|
|
Fair Value December
|
|
|
Markets
|
|
|
Observable Inputs
|
|
|
Unobservable Inputs
|
|
|
|
31, 2011
|
|
|
(Level 1)
|
|
|
(Level 2)
|
|
|
(Level 3)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Warrant liability - 2010 Series A&B
|
|
$
|
3,705,472
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
3,705,472
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
3,705,472
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
3,705,472
|
|
The fair value of these derivative liabilities
was estimated by management using a third party valuation report. The third-party estimated the value of the warrants using a Monte
Carlo simulation model. The Monte Carlo simulation is a generally accepted statistical method used to generate a defined number
of stock price paths in order to develop a reasonable estimate of the range of our future expected stock prices and minimizes standard
error. The changes in the fair value of these derivative liabilities are estimated quarterly after issuance and are recorded in
other income (expense) on the statement of operations.
The following table provides a summary of
changes in fair value of the Company’s liabilities, as well as the portion of losses included in income attributable to unrealized
appreciation that relate to those liabilities held at December 31, 2012:
Fair Value Measurements Using
Significant Unobservable Inputs (Level 3)
|
|
|
Warrant Liability
|
|
Balance at January 1, 2011
|
|
$
|
(3,420,780
|
)
|
Purchases, sales and settlements:
|
|
|
|
|
Warrants issued
|
|
|
-
|
|
Total gains or losses:
|
|
|
|
|
Unrealized depreciation
|
|
|
(284,692
|
)
|
Balance at January 1, 2012
|
|
|
(3,705,472
|
)
|
Purchases, sales and settlements:
|
|
|
|
|
Warrants and other derivatives issued
|
|
|
(20,521,555
|
)
|
Total gains or losses:
|
|
|
|
|
Unrealized depreciation
|
|
|
2,806,750
|
|
Balance at December 31, 2012
|
|
$
|
(21,420,277
|
)
|
Significant assumptions used at December
31, 2012 and 2011for the warrants and embedded conversion discount derivative liability of the Debentures are as follows:
|
|
December 31, 2012
|
|
|
December 31, 2011
|
|
|
|
|
|
|
|
|
Weighted average term
|
|
|
3 years
|
|
|
|
4 years
|
|
Volatility
|
|
|
200
|
%
|
|
|
120
|
%
|
Risk-free interest rate
|
|
|
1.05
|
%
|
|
|
0.83
|
%
|
10. STOCKHOLDERS’ EQUITY
On November 21, 2012, the Company amended
its Amended & Restated Certificate of Incorporation to increase the number of shares of common stock that the Company is authorized
to issue from 80,000,000 shares to 500,000,000 shares.
On April 25, 2011, the Company issued 250,000
shares of restricted common stock under the Company’s 2005 Stock Option Plan to its new Chief Executive Officer pursuant
to his employment agreement. These shares vested in 12 equal monthly installments and have a total fair value of $172,750, or $0.69
per share, as estimated by management using a Monte Carlo simulation model using the significant assumptions described below
in addition to a discount for the restrictions and, in doing so, utilizing a third-party valuation report. The shares
are recognized as compensation expense upon vesting. The shares are recognized as compensation expense upon vesting. The Company
has recognized $57,584, $115,168 and $172,572 of compensation expense for the years ended December 31, 2012, 2011 and the period
from inception to December 31, 2012, respectively, in connection with the restricted shares.
On February 9, 2011, the Company issued
an aggregate of 15,274,000 shares of its common stock upon the automatic conversion of all 15,274,000 of its issued and outstanding
shares of Series A Convertible Preferred Stock. In accordance with their terms, the shares Series A Convertible Preferred Stock
automatically converted upon the effectiveness of the Company’s registration statement covering the resale under the Securities
Act of 1933 of the shares of common stock issuable upon conversion of such preferred shares. See Note 10(b) Preferred
Stock,. In addition, the Company elected to satisfy accrued dividends on the Series A Convertible Preferred Stock of
$319,074 by issuing an additional 319,074 shares of common stock.
On November 15, 2010, the Company’s
stockholders authorized the amendment of the Company’s amended and restated certificate of incorporation in order to effect
a combination (reverse split) of its common stock at a ratio not to exceed one-for-eight, provided that the Company’s board
of directors shall have absolute discretion to determine and fix the exact ratio of such combination (not to exceed one-for-eight)
and the time at which such combination shall become effective, if ever. The Company’s board of directors has taken
no further action to implement a combination of our common stock and reserves the right to abandon the proposed reverse stock split
in its sole discretion.
As of December 31, 2012, the Company has
36,364,942 shares of common stock issued and outstanding and an additional 116,286,054 shares of common stock reserved for issuance
upon the exercise of outstanding options and warrants.
(b) Preferred Stock
On August 11, 2010, the Company amended
and restated its certificate of incorporation, increasing the number of shares of preferred stock authorized for issuance thereunder
from 10,000,000 to 35,000,000.
On September 3, 2010, the Company entered
into a Securities Purchase and Registration Rights Agreement (the “2010 Purchase Agreement”), with a number of institutional
and other accredited investors pursuant to which the Company sold in a private placement an aggregate of 15,274,000 shares of newly-designated
Series A Convertible Preferred Stock, par value $0.0001 per share, or Series A Preferred Stock, at a per share purchase price of
$1.00. In accordance with the 2010 Purchase Agreement, the Company also issued two-and-one-half-year Class A warrants
to purchase an aggregate of 1,221,920 shares of Series A Preferred Stock at an initial exercise price of $1.00 per share and five-year
Class B warrants to purchase an aggregate of 6,415,080 shares of Series A Preferred Stock at an initial exercise price of $1.15
per share. The terms of the Class A and Class B warrants contain an anti-dilutive price adjustment provision, such that, in the
event the Company issues common shares at a price below the current exercise price of the warrants, the exercise price of the Class
A and Class B warrants will be adjusted based on the lower issuance price. The sale of the shares and warrants resulted in aggregate
gross proceeds of approximately $15.3 million, before expenses.
The terms, conditions, privileges, rights
and preferences of the Series A Convertible Preferred Stock are described in a Certificate of Designation filed with the Secretary
of State of Delaware on September 3, 2010.
Each share of Series A Preferred Stock
was initially convertible at the holder’s election into one share of common stock. Upon the effective date of
the registration statement on February 9, 2011, each share of Series A Preferred Stock automatically converted into one share of
common stock. In addition, all outstanding warrants to purchase Series A Preferred Stock automatically converted into warrants
to purchase common stock.
Issuance costs related to the financing
were approximately $1.8 million, of which approximately $0.5 million was non-cash for issuance of warrants (“Placement Warrants”)
to purchase 1,056,930 shares of the Company’s common stock at 110% of the Series A Preferred Stock purchase price per share
to designees of Riverbank Capital Securities, Inc. (“Riverbank”), a related party controlled by several officers and/or
directors of the Company (see Note 12), and I-Bankers Securities, Inc. (“IBS”), that acted as placement agents
for the Company in connection with the private placement.
On February 9, 2011, the Company’s
registration statement was declared effective and the 15,274,000 shares of Series A Convertible Preferred Stock converted into
15,274,000 shares of common stock. In addition, the Company elected to pay the $319,074 in accrued dividends in shares of common
stock resulting in the issuance of 319,074 shares.
(c) Warrants
In accordance with the 2010 Purchase Agreement,
the Company issued two-and-one-half-year Class A warrants to purchase an aggregate of 1,221,920 shares of Series A Preferred Stock
at an initial exercise price of $1.00 per share and five-year Class B warrants to purchase an aggregate of 6,415,080 shares of
Series A Preferred Stock at an initial exercise price of $1.15 per share. As noted above, all outstanding warrants to purchase
shares of Series A Preferred Stock automatically converted into warrants to purchase common stock on February 9, 2011, when the
Company’s registration statement was declared effective. The terms of the warrants contain an anti-dilutive price adjustment
provision, such that, in the event the Company issues common shares at a price below the current exercise price of the warrants,
the exercise price will be adjusted based on the lower issuance price. Because of this anti-dilution provision and the inherent
uncertainty as to the probability of future common share issuances, the Black-Scholes option pricing model the Company uses for
valuing stock options could not be used. Management used a Monte Carlo simulation model and, in doing so, utilized a
third-party valuation report to determine the warrant liability to be approximately $0.9 million and approximately $3.7 million
at December 31, 2012 and 2011, respectively. The Monte Carlo simulation is a generally accepted statistical method used to generate
a defined number of stock price paths in order to develop a reasonable estimate of the range of the Company’s future expected
stock prices and minimizes standard error. This valuation is revised on a quarterly basis until the warrants are exercised or they
expire with the changes in fair value recorded in other expense on the statement of operations.
Pursuant to the 2012 Purchase Agreement,
the Company issued five-year Series A warrants to purchase an aggregate of 49,524,003 shares of common stock at an initial exercise
price of $0.50 per share and 18-month Series B warrants to purchase an aggregate of 49,524,003 shares of common stock at an initial
exercise price of $0.30 per share. The terms of the warrants contain an anti-dilutive price adjustment provision, such that, in
the event the Company issues common shares at a price below the current exercise price of the warrants, the exercise price will
be adjusted based on the lower issuance price. Because of this anti-dilution provision and the inherent uncertainty as to the probability
of future common share issuances, the Black-Scholes option pricing model the Company uses for valuing stock options could not be
used. Management used a Monte Carlo simulation model and, in doing so, utilized a third-party valuation report to determine
the warrant liability to be approximately $12.4 million at December 31, 2012
In connection with the 2012 offering of
Debentures and Warrants, the Company engaged Maxim Group LLC, or Maxim Group, to serve as placement agent. In consideration for
its services, the Company paid Maxim Group a placement fee of $1,035,000. In addition, the Company issued to Maxim Partners LLC,
or Maxim Partners, an affiliate of Maxim Group, 60,000 shares of common stock and five-year warrants to purchase an additional
2,270,000 shares of common stock at an initial exercise price of $0.33 per share. The warrants issued to Maxim Partners are in
substantially the same form as the Warrants issued to the investors, except that they do not include certain anti-dilution provisions
contained in the Warrants. However, the placement warrants do contain a provision that could require the Company to repurchase
the warrants from the holder under certain conditions. These placement warrants were valued at $542,530 (see Note 9).
Below is a table that summarizes all outstanding
warrants to purchase shares of the Company’s common stock as of December 31, 2012.
Grant Date
|
|
Warrants Issued
|
|
|
Exercise Price
|
|
|
Weighted
Average
Exercise
Price
|
|
|
Expiration
Date
|
|
Exercised
|
|
|
Warrants
Outstanding
|
|
01/02/2008
|
|
|
299,063
|
|
|
$
|
2.42
|
|
|
$
|
2.42
|
|
|
01/02/2013
|
|
|
-
|
|
|
|
299,063
|
|
06/02/2008
|
|
|
196,189
|
|
|
$
|
2.42
|
|
|
$
|
2.42
|
|
|
06/02/2013
|
|
|
-
|
|
|
|
196,189
|
|
09/03/2010
|
|
|
1,221,920
|
|
|
$
|
0.53
|
|
|
$
|
0.53
|
|
|
03/03/2013
|
|
|
-
|
|
|
|
1,221,920
|
|
09/03/2010
|
|
|
6,415,080
|
|
|
$
|
0.56
|
|
|
$
|
0.56
|
|
|
09/03/2015
|
|
|
-
|
|
|
|
6,415,080
|
|
09/03/2010
|
|
|
1,056,930
|
|
|
$
|
1.10
|
|
|
$
|
1.10
|
|
|
09/03/2015
|
|
|
-
|
|
|
|
1,056,930
|
|
11/26/2012
|
|
|
42,350,002
|
|
|
$
|
0.30
|
|
|
$
|
0.30
|
|
|
05/26/2014
|
|
|
-
|
|
|
|
42,350,002
|
|
12/18/2012
|
|
|
7,174,001
|
|
|
$
|
0.30
|
|
|
$
|
0.30
|
|
|
06/18/2014
|
|
|
-
|
|
|
|
7,174,001
|
|
11/26/2012
|
|
|
42,350,002
|
|
|
$
|
0.50
|
|
|
$
|
0.50
|
|
|
11/26/2017
|
|
|
-
|
|
|
|
42,350,002
|
|
11/26/2012
|
|
|
2,090,000
|
|
|
$
|
0.33
|
|
|
$
|
0.33
|
|
|
11/26/2017
|
|
|
-
|
|
|
|
2,090,000
|
|
12/18/2012
|
|
|
7,174,001
|
|
|
$
|
0.50
|
|
|
$
|
0.50
|
|
|
12/18/2017
|
|
|
-
|
|
|
|
7,174,001
|
|
12/18/2012
|
|
|
180,000
|
|
|
$
|
0.33
|
|
|
$
|
0.33
|
|
|
12/18/2017
|
|
|
-
|
|
|
|
180,000
|
|
|
|
|
110,507,188
|
|
|
|
|
|
|
$
|
0.43
|
|
|
|
|
|
-
|
|
|
|
110,507,188
|
|
11. STOCK OPTION PLAN
The Company’s 2005 Stock Option Plan
(the “Plan”) was originally adopted by the Board of Directors of Old Arno in August 2005, and was assumed by the Company
on June 3, 2008 in connection with the Merger. After giving effect to the Merger, there were initially 2,990,655 shares of the
Company’s common stock reserved for issuance under the 2005 Plan. On April 25, 2011, the Company’s Board of Directors
approved an amendment to the 2005 Plan to increase the number of shares of common stock issuable thereunder to 7,000,000 shares.
Under the Plan, incentives may be granted to officers, employees, directors, consultants, and advisors. Incentives under the Plan
may be granted in any one or a combination of the following forms: (a) incentive stock options and non-statutory stock options,
(b) stock appreciation rights, (c) stock awards, (d) restricted stock and (e) performance shares.
The Plan is administered by the Board of
Directors, or a committee appointed by the Board, which determines recipients and types of awards to be granted, including the
number of shares subject to the awards, the exercise price and the vesting schedule. The term of stock options granted under the
Plan cannot exceed 10 years. Options shall not have an exercise price less than the fair market value of the Company’s common
stock on the grant date, and generally vest over a period of three to four years.
As of December 31, 2012, an aggregate of
901,290 shares remained available for future grants and awards under the Plan, which covers stock options, warrants and restricted
awards. The Company issues unissued shares to satisfy stock options, warrants exercises and restricted stock awards.
No options were granted by the Company during
the year ended December 31, 2012. For the year ended December 31, 2011, the Company estimated the fair value of each option award
granted using the Black-Scholes option-pricing model. The following assumptions were used for the year ended December 31, 2011:
|
|
2011
|
|
Expected Volatility
|
|
|
87
|
%
|
Expected Term
|
|
|
5-10 years
|
|
Dividend yield
|
|
|
0.0
|
%
|
Risk-free interest rate
|
|
|
1.5-2.0%
|
|
Stock price
|
|
|
$0.69 - $0.72
|
|
Forfeiture rate
|
|
|
0.0
|
%
|
The valuation assumptions were determined
as follows:
|
·
|
Expected volatility – The expected volatility on the average expected volatilities of a sampling of five companies with
similar attributes to the Company, including industry, stage of life cycle, size and financial leverage.
|
|
·
|
Expected term – The expected term of the awards represents the period of time that the awards are expected to be outstanding.
Management considered historical data and expectations for the future to estimate employee exercise and post vest termination behavior.
Consultant options are assigned an expected term equal to the maximum term of the option grant.
|
|
·
|
Dividend yield – The estimate for annual dividends is zero, because the Company has not historically paid dividends and
does not intend to in the foreseeable future.
|
A summary of the status of the options issued
under the Plan as of December 31, 2012, and information with respect to the changes in options outstanding is as follows:
|
|
|
|
|
Options Outstanding
|
|
|
|
Shares
|
|
|
Outstanding
|
|
|
Weighted-
|
|
|
Aggregate
|
|
|
|
Available for
|
|
|
Stock
|
|
|
Average
|
|
|
Intrinsic
|
|
|
|
Grant
|
|
|
Options
|
|
|
Exercise Price
|
|
|
Value
|
|
Balance at January 1, 2011
|
|
|
1,077,352
|
|
|
|
1,893,303
|
|
|
$
|
1.36
|
|
|
|
|
|
Shares authorized for issuance
|
|
|
4,009,345
|
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
Options granted under the Plan
|
|
|
(5,054,317
|
)
|
|
|
5,054,317
|
|
|
$
|
1.03
|
|
|
|
|
|
Restricted stock granted under the Plan
|
|
|
(250,000
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
Options exercised
|
|
|
-
|
|
|
|
(49,844
|
)
|
|
$
|
0.13
|
|
|
|
|
|
Options forfeited
|
|
|
269,221
|
|
|
|
(269,221
|
)
|
|
$
|
1.53
|
|
|
|
|
|
Balance at December 31, 2011
|
|
|
51,601
|
|
|
|
6,628,555
|
|
|
$
|
1.31
|
|
|
|
|
|
Options forfeited
|
|
|
849,689
|
|
|
|
(849,689
|
)
|
|
$
|
1.00
|
|
|
|
|
|
Balance at December 31, 2012
|
|
|
901,290
|
|
|
|
5,778,866
|
|
|
$
|
1.11
|
|
|
$
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercisable at December 31, 2012
|
|
|
|
|
|
|
3,566,669
|
|
|
$
|
1.17
|
|
|
$
|
-
|
|
The following table summarizes information
about stock options outstanding at December 31, 2012:
|
|
|
Outstanding
|
|
|
Exercisable
|
|
Exercise
Price
|
|
|
Shares
|
|
|
Weighted-
Average
Remaining
Contractual Life
(Years)
|
|
|
Weighted-
Average
Exercise Price
|
|
|
Shares
|
|
|
Weighted-
Average
Exercise Price
|
|
$
|
1.00
|
|
|
|
5,388,133
|
|
|
|
7.8
|
|
|
$
|
1.00
|
|
|
|
3,175,936
|
|
|
$
|
1.00
|
|
$
|
2.42
|
|
|
|
299,066
|
|
|
|
3.6
|
|
|
$
|
2.42
|
|
|
|
299,066
|
|
|
$
|
2.42
|
|
$
|
3.00
|
|
|
|
91,667
|
|
|
|
1.2
|
|
|
$
|
3.00
|
|
|
|
91,667
|
|
|
$
|
3.00
|
|
|
Total
|
|
|
|
5,778,866
|
|
|
|
7.6
|
|
|
$
|
1.11
|
|
|
|
3,566,669
|
|
|
$
|
1.17
|
|
Stock-based compensation costs for the years
ended December 31, 2012 and 2011 and for the cumulative period from August 1, 2005 (inception) through December 31,
2012, are as follows:
|
|
Year Ended December 31,
|
|
|
|
|
|
|
2012
|
|
|
2011
|
|
|
Period from August 1, 2005
(inception) through
December 31, 2012
|
|
General and administrative
|
|
$
|
441,983
|
|
|
$
|
449,652
|
|
|
$
|
1,986,610
|
|
Research and development
|
|
|
280,828
|
|
|
|
372,800
|
|
|
|
1,684,605
|
|
Total
|
|
$
|
722,811
|
|
|
$
|
822,452
|
|
|
$
|
3,671,215
|
|
The fair value of options vested under the
2005 Plan was approximately $863,892 and $443,507 for the years ended December 31, 2012 and 2011, respectively, and approximately
$3,218,757 for the period from August 1, 2005 (inception) through December 31, 2012.
At December 31, 2012, total unrecognized
estimated compensation cost related to stock options granted prior to that date was approximately $1.1 million which is expected
to be recognized over a weighted-average vesting period of 1.5 years. This unrecognized estimated employee compensation cost does
not include any estimate for forfeitures of performance-based stock options.
Common stock, stock options or other equity
instruments issued to non-employees (including consultants and all members of the Company’s Scientific Advisory Board) as
consideration for goods or services received by the Company are accounted for based on the fair value of the equity instruments
issued (unless the fair value of the consideration received can be more reliably measured). The fair value of stock options is
determined using the Black-Scholes option-pricing model and is expensed as underlying options vest. The fair value of
any options issued to non-employees is recorded as expense over the applicable service periods.
For the year ended December 31, 2012, the
Company did not issue any options. For the year ended December 31, 2011, the Company issued options to purchase a total of 5,054,317
shares of common stock to employees and consultants with exercise prices ranging from $1.00 to $2.42 and terms of up to 10 years. Of
this total, 10-year options to purchase 2,354,379 shares at an exercise price of $1.00 were issued to the Company’s new President
and Chief Executive Officer and 10-year options to purchase 1,750,000 shares at an exercise price of $1.00 were issued to the Company’s
new Chief Medical Officer.
12. RELATED PARTIES
On June 1, 2009, the Company entered into
a services agreement with Two River Consulting, LLC (“TRC”) to provide various clinical development, operational, managerial,
accounting and financial, and administrative services to the Company for a period of one year. David M. Tanen, the Company’s
then President, Secretary and director, Arie S. Belldegrun, the Chairman of the Board of Directors, and Joshua A. Kazam, a director
until September 2010, are each partners of TRC. The terms of the Services Agreement were reviewed and approved by a special committee
of the Company’s Board of Directors consisting of independent directors. None of the members of the special committee has
any interest in TRC or the services agreement. As compensation for the services contemplated by the services agreement, the Company
pays TRC a monthly cash fee of $55,000. The services agreement with TRC expired on April 1, 2011 and until a new agreement
is in place, TRC is billing the Company for actual hours worked on a monthly basis. For the year ended December 31,
2012, TRC billed Arno $273,171 for services rendered, an average of approximately $22,764 per month.
On occasion, some of the Company’s
expenses are paid by TRC. No interest is charged by TRC on any outstanding balance owed by the Company. For the years ended December
31, 2012 and 2011 and for the period from August 1, 2005 (inception) through December 31, 2012, total cash services and
reimbursed expenses totaled $327,452, $655,923 and $2,131,217, respectively. As of December 31, 2012 the Company had
a payable to TRC of $28,268, which was paid in full during the first two months of 2013.
The financial condition and results of operations
of the Company, as reported, are not necessarily indicative of results that would have been reported had the Company operated completely
independently.
13. PENSION PLAN
On October 1, 2007, the Company adopted
a 401(k) savings plan (the “401(k) Plan”) for the benefit of its employees. Under the 401(k) Plan, the Company was
required to make contributions equal to 3% of eligible compensation for each eligible employee whether or not the employee contributes
to the 401(k) Plan. During 2011, the Company terminated the 401(k) Plan. For the years ended December 31, 2012 and 2011 and
for the cumulative period from August 1, 2005 (inception) through December 31, 2012, the Company has recorded $0, $0 and $16,064
of matching contributions to the 401(k) Plan.
14. INCOME TAXES
The Company accounts for income taxes using
the liability method, which requires the determination of deferred tax assets and liabilities, based on the differences between
the financial statement and tax bases of assets and liabilities, using enacted tax rates in effect for the year in which differences
are expected to reverse. The net deferred tax asset is adjusted by a valuation allowance, if, based on the weight of available
evidence, it is more likely than not that some portion or all of the net deferred tax asset will not be realized. The income tax
returns of the Company are subject to examination by federal and state taxing authorities. Such examination could result in adjustments
to net income or loss, which changes could affect the income tax liabilities of the Company. The Company’s tax returns are
open for inspection for all tax years from 2008 to present.
The Company’s policy is to include
interest and penalties related to unrecognized tax benefits within the Company’s provision for (benefit from) income taxes.
The Company recognized no amounts for interest and penalties related to unrecognized tax benefits in 2012, 2011 and the period
from August 1, 2005 (inception) through December 31, 2012 and as of December 31, 2012 and 2011, had no amounts accrued for
interest and penalties.
At December 31, 2012, the Company had no
Federal income tax expense or benefit but did have Federal tax net operating loss carry-forwards of approximately $26.2 million.
The federal net operating loss carry-forwards will begin to expire in 2026, unless previously utilized.
Deferred income taxes reflect the net effect
of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts
used for income tax purposes. Significant components of the Company’s net deferred tax assets at December 31, 2012 and 2011
are shown below.
|
|
For Years Ended December 31,
|
|
|
|
2012
|
|
|
2011
|
|
Non-current deferred tax assets
|
|
|
|
|
|
|
|
|
Research tax credit
|
|
$
|
2,005,000
|
|
|
$
|
1,631,000
|
|
Net operating loss carry forwards
|
|
|
15,700,000
|
|
|
|
11,720,000
|
|
Stock based compensation
|
|
|
446,000
|
|
|
|
848,000
|
|
Total deferred tax assets
|
|
|
18,151,000
|
|
|
|
14,199,000
|
|
Non-current deferred tax liability
|
|
|
|
|
|
|
|
|
Depreciation and amortization
|
|
|
(10,000
|
)
|
|
|
(10,000
|
)
|
Total net deferred tax assets
|
|
|
18,141,000
|
|
|
|
14,189,000
|
|
Valuation allowance
|
|
|
(18,141,000
|
)
|
|
|
(14,189,000
|
)
|
Net deferred tax assets
|
|
$
|
-
|
|
|
$
|
-
|
|
The Company records a valuation allowance
for temporary differences for which it is more likely than not that the Company will not receive future tax benefits. At December 31,
2012 and 2011 the Company recorded valuation allowances of $18.6 million and $14.2 million, respectively, representing
a change in the valuation allowance of $4.4 million for the previous fiscal year-ends, due to the uncertainty regarding the
realization of such deferred tax assets, to offset the benefits of net operating losses generated during those years.
A reconciliation of the statutory tax rates
and the effective tax rates for the years ended December 31, 2012 and 2011 are as follows:
|
|
2012
|
|
|
2011
|
|
|
|
Amount
|
|
|
Rate
|
|
|
Amount
|
|
|
Rate
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Federal tax
|
|
$
|
(3,388,000
|
)
|
|
|
34.0
|
%
|
|
$
|
(2,689,000
|
)
|
|
|
34.0
|
%
|
State tax
|
|
|
(592,000
|
)
|
|
|
5.9
|
%
|
|
|
(390,000
|
)
|
|
|
5.9
|
%
|
R&D Credit
|
|
|
(373,000
|
)
|
|
|
2.7
|
%
|
|
|
(339,000
|
)
|
|
|
4.37
|
%
|
Incentive stock options
|
|
|
(30,000
|
)
|
|
|
4.7
|
%
|
|
|
(48,000
|
)
|
|
|
7.8
|
%
|
Valuation allowance
|
|
|
4,383,000
|
|
|
|
(47.3
|
)%
|
|
|
3,466,000
|
|
|
|
(52.1
|
)%
|
Net
|
|
$
|
-
|
|
|
|
-
|
|
|
$
|
-
|
|
|
|
-
|
|
There was no income tax benefit recorded for the years ended December 31, 2012 and 2011.
15. COMMITMENTS AND CONTINGENCIES
On March 31, 2011, the Company exercised
its early termination option on the Parsippany, NJ office lease, submitting written notice to the landlord and making a payment
of $53,641. The Company continued to make monthly lease payments under the Parsippany lease through December 31, 2011, at
which time, this lease terminated.
On August 4, 2011, the Company entered into
a lease for new office space of approximately 4,168 square feet in Flemington, New Jersey (the “Flemington Lease”).
The lease commencement date was November 17, 2011, with lease payments beginning in February 2012. The lease expiration date
is three years from the rent commencement date. The Company provided a cash security deposit of $10,455, or two months’
base rent. The Company is also responsible for payment of its share of common area maintenance costs and taxes. The aggregate
remaining minimum future payments under the Flemington Lease at December 31, 2012 are approximately $150,531 including common area
maintenance charges and taxes. The Flemington Lease contains a three-month free rent period and annual escalations, as such, the
Company accounts for rent expense on a straight-line basis. The Company recognized $85,362 and $7,351 in rent expense for the Flemington
Lease for the years ended December 31, 2012 and 2011, respectively.
Future minimum lease payments under operating
leases as of December 31, 2012 are as follows:
2013
|
|
$
|
69,981
|
|
2014
|
|
|
71,816
|
|
2015
|
|
|
8,734
|
|
|
|
|
|
|
Total future minimum lease payments
|
|
$
|
150,531
|
|
On April 21, 2011, the Company entered into
an employment agreement with Glenn Mattes, as its Chief Executive Officer, with an effective commencement date of employment beginning
on April 25, 2011. The agreement provides for a term of three years, expiring on April 25, 2014, and initial base salary of $100,000.
On and after the first anniversary date of the effective commencement date, Mr. Mattes’ base salary shall be increased to
$350,000. In addition, Mr. Mattes is eligible to receive an annual target performance bonus of up to 50% of his base salary, but
up to $175,000 during the first year of employment. Additionally, the Company shall issue to Mr. Mattes, 250,000 shares of restricted
common stock. These shares vest in 12 equal monthly installments and have a total fair value of $172,750, or $0.69 per share, as
estimated by management using a Monte Carlo simulation model using the significant assumptions described below in addition to a
discount for the restrictions and, in doing so, utilizing a third-party valuation report. The shares are recognized
as compensation expense upon vesting. The Company has recognized $57,584, $115,168 and $172,572 of compensation expense for the
years ended December 31, 2012, 2011 and the period from inception to December 31, 2012, respectively, in connection with the restricted
shares.
In addition, Mr. Mattes was granted 10-year
options to purchase a total of 2,354,379 shares of the Company’s common stock at an exercise price equal to $1.00 per share. Options
relating to 60% of such shares are designated as “Employment Options” and options relating to the remaining 40%
of the shares are designated as “Performance Options.” The right to purchase 25% of the shares subject
to the Employment Options vested on April 25, 2012, and thereafter the remaining shares subject to the Employment Options will
vest and become exercisable in 24 equal monthly installments. The right to purchase the shares subject to the Performance
Options shall vest and become exercisable, if at all, in three equal annual installments during the Term, subject to the successful
achievement of specific performance objectives to be established by the Board. The Employment Options, Performance
Options, and Restricted Shares were awarded to Mr. Mattes pursuant to the Plan. The employment agreement also entitles Mr. Mattes
to certain change of control and severance benefits.
On June 22, 2011, the Company entered into
an employment agreement with Alexander Zukiwski, M.D., as its Chief Medical Officer, with an effective commencement date of employment
beginning on June 22, 2011. The agreement provides for a term of three years, expiring on June 22, 2014, and initial base salary
of $375,000. The Employment Agreement further provides that, subject to the successful achievement of specific performance objectives
to be established by the Board, Dr. Zukiwski will be eligible to receive an annual performance bonus of up to 50% of his annualized
base salary. The Company has also agreed to reimburse Dr. Zukiwski in an amount up to $200,000 for expenses incurred
in connection with the relocation of Dr. Zukiwski’s primary residence to the northern New Jersey area. As of March 29, 2013,
Dr. Zukiwski has not relocated to the northern New Jersey area and the Company has not reimbursed him for any moving expenses.
In addition, Dr. Zukiwski was granted 10-year
options to purchase a total of 1,750,000 shares of the Company’s common stock at an exercise price equal to $1.00 per share. Options
relating to 50% of such shares are designated as “Employment Options” and options relating to the remaining 50%
of the shares are designated as “Performance Options.” The right to purchase 25% of the shares subject to
the Employment Options will vested on June 22, 2012, and thereafter the remaining shares subject to the Employment Options will
vest and become exercisable in 24 equal monthly installments. The right to purchase the shares subject to the Performance
Options shall vest and become exercisable, if at all, in three equal annual installments during the Term, subject to the successful
achievement of specific performance objectives to be established by the Board. The employment agreement also entitles Dr. Zukiwski
to certain change of control and severance benefits.
The Company has entered into various contracts
with third parties in connection with the development of the licensed technology described in Note 6.
The aggregate minimum commitment under these
contracts as of December 31, 2012 is approximately $4.5 million, all expected to be due during 2013 and 2014.
In the normal course of business, the Company
enters into contracts that contain a variety of indemnifications with its employees, licensors, suppliers and service providers.
Further, the Company indemnifies its directors and officers who are, or were, serving at the Company’s request in such capacities.
The Company’s maximum exposure under these arrangements is unknown as of December 31, 2012. The Company does not anticipate
recognizing any significant losses relating to these arrangements.
16. SUBSEQUENT EVENTS
In January 2012, the Company received
a notice from the University of Pittsburgh, or Pitt, claiming that the Company was in default under its license agreement
relating to AR-67 for failure to pay a $250,000 annual license fee under the terms of that agreement and providing the
Company with 60 days’ notice to remedy the default. On March 29, 2012, following the Company’s determination not
to proceed with further development of AR-67, the Company agreed with Pitt to terminate the license agreement. In February
2013, Pitt commenced an action in the Court of Common Pleas of Allegheny County, Pennsylvania, seeking damages of $250,000,
plus interest and costs, based on its claim that the Company breached the license agreement by failing to pay the annual
license fee. On March 28, 2013, the Company entered into a settlement agreement with Pitt pursuant to which the Company
agreed to pay $235,000 in full satisfaction of all remaining obligations under the license agreement.
On January 30, 2013, the Company’s
Board of Directors appointed Randy Thurman as a director of the Company. Mr. Thurman, age 63, is an Operating Executive at AEA
Investments LP, a private equity firm. As consideration for his service on the Board, Mr. Thurman will receive an annual cash stipend
of $50,000, payable quarterly in arrears. In addition, Mr. Thurman was granted a 10-year option under the 2005 Plan to purchase
200,000 shares of the Company’s common stock at an exercise price of $0.30 per share. The right to purchase one-third of
the shares subject to the option vested immediately and the remaining shares subject to the option will vest and become exercisable
in two equal annual installments on the first and second anniversaries of Mr. Thurman’s appointment. Mr. Thurman will also
receive additional option grants on an annual basis, consistent with the Board’s compensation plan for non-employee directors.
On March 25, 2013, the Company and holders
of approximately 80% of the Debentures sold pursuant to the 2012 Purchase Agreement entered into an amendment to the Registration
Rights Agreement (see Note 8), permitting the Company, in its sole discretion, to elect to pay liquidated damages resulting from
the Company’s failure to successfully cause the registration statement covering the resale of 100% of the Registrable Securities
to be declared effective by the SEC by March 26, 2013, by issuing shares of common stock in lieu of cash. If electing to issue
shares in lieu of paying cash, the Company shall issue to each investor a number of shares of common stock equal to (a) the aggregate
amount of liquidated damages that the Company is electing to pay to such investor in the form of shares, divided by (b) thirty
cents ($0.30). Pursuant to the terms of the Registration Rights Agreement, because holders of over two-thirds of the Debentures
consented in writing to the March 25, 2013 amendment, such amendment is binding on all holders of Registrable Securities. On March
27, 2013, in accordance with the amendment to the Registration Rights Agreement, the Company issued an aggregate of 990,477 shares
of common stock to the investors in lieu of an aggregate cash payment of $297,144, representing the first monthly installment
of liquidated damages under the Registration Rights Agreement, as amended.
In late March 2013, the Company sought the agreement of the
Debenture holders to amend their respective Debentures to provide for the accrual of all interest payments under such Debentures
until the applicable maturity date in November or December of 2015, with such interest accruing at the rate of 8% per annum, compounding
quarterly. As of March 28, 2013, the Company had entered into such amendments with the holders of Debentures in the aggregate principal
amount of $7,875,000.