Notes to Consolidated Financial Statements
December 31, 2013
NOTE A — THE COMPANY AND BASIS OF PRESENTATION
Torvec, Inc. was incorporated as a New York business corporation on September 25, 1996. Upon its incorporation, the Company acquired numerous patents, inventions and know-how created by Vernon E. Gleasman and his sons, James and Keith Gleasman, a family with more than fifty years of experience in the automotive industry. Since its inception, the Company has endeavored to design, develop, build and commercialize its automotive technology portfolio. We have not yet had any significant revenue-producing operations and, as such, we are a development stage entity. The Company currently is focusing its commercialization strategies on the following technologies: the IsoTorque® differential and the Torvec hydraulic pump.
NOTE B — 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 at December 31, 2013). As of December 31, 2013, each of the subsidiaries is non-operational. During 2012, we dissolved Creative Performance Consultants, Variable Gear LLC, and Torvec China, LLC. We are intending to let Ice Surface Development, Inc. dissolve by proclamation. All material intercompany transactions and account balances have been eliminated in consolidation.
Use of Estimates:
The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Such estimates are used in valuing the useful lives of any intangible assets and the future realizable value of such assets. These estimates are subject to a high degree of judgment and potential change. Actual results could differ from those estimates.
Reclassifications:
Certain reclassifications have been made to prior year balances to conform to the current year’s presentation.
Cash and Cash Equivalents:
Cash and cash equivalents may include time deposits, certificates of deposit, and highly liquid debt instruments with original maturities of three months or less. We maintain cash and cash equivalents at financial institutions which periodically may exceed federally insured amounts.
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. There was $0 allowance for doubtful accounts as of December 31, 2013 and 2012, as determined by management.
Inventories
: Inventories are stated at the lower of cost or market with cost determined under the first-in, first-out (FIFO) method. We record provisions for excess, obsolete or slow-moving inventory based on changes in customer demand, technology developments or other economic factors. There was a $26,000 and $0 provision for excess, obsolete or slow-moving inventory as of December 31, 2013 and December 31, 2012, respectively, as determined by management.
Property and Equipment:
Property and equipment are stated at cost. Estimated useful lives are as follows:
|
Office Equipment and Software (years)
|
3
|
–
|
7
|
|
Leasehold Improvements
|
|
Lesser of useful life or lease term
|
|
|
Shop Equipment (years)
|
|
7
|
|
|
Transportation Equipment (years)
|
5
|
–
|
7
|
Depreciation and amortization are computed using the straight-line method. Betterments, renewals and extraordinary 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 operating income (expense). Depreciation and amortization expense for the years ended December 31, 2013 and 2012 amounted to $127,000 and $88,000, respectively.
Whenever events or circumstances indicate, our long-lived assets, including any intangible assets with finite useful lives, are tested for impairment by using the estimated future cash flows directly associated with, and that are expected to arise as a direct result of, the use of the assets. If the carrying amount exceeds the estimated undiscounted cash flows, an impairment may be indicated. The carrying amount is then compared to the estimated discounted cash flows, and if there is an excess, such amount is recorded as an impairment. During the years ended December 31, 2013 and 2012, we recorded $0 in impairment charges.
Fair Value of Financial Instruments:
As defined by U.S. GAAP
,
fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. All assets and liabilities are required to be measured and reported on a fair value basis. 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, 2013 and 2012. The carrying amount of cash, accounts receivable, accounts payable, and accrued expenses approximates their fair value due to their short maturity. The carrying amount of notes payable approximates fair value because stated or implied interest rates approximate current interest rates that are available for debt with similar terms.
Revenue Recognition:
Our terms provide that customers are obligated to pay for products sold to them within a specified number of days from the date that title to the products is transferred to the customers. Our standard terms are typically net 30 days. We recognize revenue when transfer of title occurs, risk of ownership passes to a customer at the time of shipment or delivery depending on the terms of the agreement with a particular customer and collection is reasonably assured. The sale price of our products is substantially fixed and determinable at the date of the sale based upon purchase orders generated by a customer and accepted by us.
We occasionally enter into prototype development contracts with customers. In such cases, revenue is recognized using either (a) the proportional effort method based on the relationship of costs incurred to date to the total estimated cost to complete a contract, or (b) where appropriate, the milestone method, if milestones are clearly identifiable and substantive.
During the first quarter of 2011, we entered into a prototype development agreement to design, build and integrate our IsoTorque differential into the product of a customer for total consideration of $120,000. Milestones include completion of design, manufacturing of a prototype, and installation / integration of the prototype. The payment required for each milestone was considered to be substantive based on the fact that performance required by us in order to achieve the milestone enhanced the value of the item delivered and is reasonable in relation to all of the deliverables. The first milestone consisted of completion and delivery of the design for the prototype, which was completed and delivered during the first quarter of 2011 and resulted in the recognition of revenue in the amount of $30,000, as well as the related costs incurred to complete this milestone. The second milestone consisted of the manufacture and delivery of two prototype differentials to our customer, which was completed in March 2012 and resulted in the recognition of revenue in the amount of an additional $60,000, as well as the related costs incurred to complete this milestone. Further revenue will be recognized, as well as related costs, upon reaching other milestones defined in the contract.
Research and Development and Patents:
Research and development costs and patent expenses are charged to operations as incurred. Research and development includes personnel-related costs, materials and supplies, depreciation, consulting services, and amortization of acquired technology. Depreciation expense in each of the years ended December 31, 2013 and 2012 that was charged to research and development was $66,000 and $30,000, respectively.
Patent costs for the years ended December 31, 2013 and 2012 amounted to $141,000 and $207,000, 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. Under the modified prospective method that we adopted, awards that were granted, modified, or settled on or after January 1, 2006 are measured and accounted for in accordance with ASC 718-10. Unvested equity-classified awards that were granted prior to January 1, 2006 will continue to be accounted for in accordance with ASC 718-10, except that the grant date fair value of all awards are recognized in the results of operations over the remaining vesting periods. The impact of forfeitures that may occur prior to vesting is also estimated and considered in the amount recognized. In addition, the realization of tax benefits in excess of amounts recognized for financial reporting purposes will be recognized as a financing activity in accordance with ASC 718-10.
No tax benefits were attributed to the stock-based compensation expense because a valuation allowance was maintained for substantially all net deferred tax assets. We elected to adopt the alternative method of calculating the historical pool of windfall tax benefits as permitted by ASC 718-10-65 (previously known as FASB Staff Position (FSP) No. SFAS 123(R)-c, “Transition Election Related to Accounting for the Tax Effects of Share-Based Payment Awards”). This is a simplified method to determine the pool of windfall tax benefits that is used in determining the tax effects of stock compensation in the results of operations and cash flow reporting for awards that were outstanding as of the adoption of ASC 718-10.
FASB ASC 505-50, “Equity-Based Payments to Non-Employees,” requires all share-based payments to non-employees, including grants of stock options, to be recognized in the consolidated financial statements as compensation expense generally over the service period of the consulting arrangement or until performance conditions are expected to be met. Using a Black-Scholes valuation model, we periodically reassess the fair value of non-employee options until service conditions are met, which generally aligns with the vesting period of the options, and we adjust the expense recognized in the consolidated financial statements accordingly.
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.
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, 2013, there was $0 accrued interest or penalties related to uncertain tax positions.
Loss per Common Share:
FASB’s ASC 260-10 (previously known as: FASB Statement 128, “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, 2013 and 2012, we excluded 28,705,081 and 29,092,600 potential common shares, respectively, relating to convertible preferred stock, 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, 2013 and 2012 as the conditions for their vesting are not time-based.
Recent Accounting Pronouncements:
In July 2013, FASB issued Accounting Standards Update (“ASU”) 2013-11, “Income Taxes (Topic 740): Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists.” The amendments in this ASU state that an unrecognized tax benefit, or a portion of an unrecognized tax benefit, should be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward, except as follows. To the extent a net operating loss carryforward, a similar tax loss, or a tax credit carryforward is not available at the reporting date under the tax law of the applicable jurisdiction to settle any additional income taxes that would result from the disallowance of a tax position or the tax law of the applicable jurisdiction does not require the entity to use, and the entity does not intend to use, the deferred tax asset for such purpose, the unrecognized tax benefit should be presented in the financial statements as a liability and should not be combined with deferred tax assets. The amendments in this ASU are effective for fiscal years, and interim periods within those years, beginning after December 15, 2013. The adoption of this standard is not expected to have a material impact on the Company’s consolidated financial position and results of operations.
NOTE C — RELATED PARTY TRANSACTIONS
[1]
Effective January 1, 2008, the board instituted a compensation plan for James Gleasman, our chief executive officer, and Keith Gleasman, our president, each of whom were major shareholders and co-founders of the Company. The compensation plan was designed to compensate each of them for services performed, and inventions and know-how transferred to us, at the rate of $300,000 per year. Actual payment of this compensation, or any portion thereof, was conditioned upon a determination by the board that we had the requisite cash to make payment, after the complete funding of all ongoing Company projects.
We did not have the requisite cash available to pay the Gleasmans’ compensation under this arrangement from January 1, 2008 through August 17, 2009, the date on which each of the Gleasmans waived all of his rights and interest in and to the board-created compensation plan, including all of his rights and interest in and to the amount(s) under the plan accrued to such date. As a result of such waiver, of the $942,000 accrued under the plan at June 30, 2009, $900,000 was reclassified to equity as a contribution of services and $42,000 accrued under the plan for payroll taxes was recorded as a reduction to general and administrative expenses in the quarter ended June 30, 2009.
For subsequent periods, there has not been a compensation plan in place for the Gleasmans. However, due to the significance of their ownership interest at the time and their influence within the Company, we were required to record the estimated value of each of the Gleasman’s services rendered to us (estimated at $300,000 each per annum) as a contribution of services in accordance with generally accepted accounting principles, and we allocated the amount of such contribution between research and development expenses and general and administrative expenses, based upon management’s estimate of the Gleasmans’ time allocation. Effective March 14, 2010, James Gleasman retired as our chief executive officer, interim chief financial officer and as a member of the board of directors. As of October 1, 2011 following our September 2011 private placement, we reassessed the estimated value of the services we were receiving from Keith Gleasman as a result of the reduction of his overall ownership interest, and reduced the amount we were recording for his contribution for shareholder services to the equivalent of $100,000 per annum. On January 9, 2012, the board approved a base salary for Keith Gleasman of $100,000 per annum to be effective as of January 1, 2012. The board’s decision was based upon the recommendation of our chief executive officer and our Governance and Compensation Committee, composed entirely of independent directors.
Effective as of January 1, 2012, we no longer impute an expense related to contributed shareholder services.
[2]
On September 14, 2007, we moved our executive offices from Pittsford, New York to Rochester, New York, which includes both a manufacturing and executive office facility. The Rochester facility is owned by a partnership, with which Asher J. Flaum, a Company director, is associated. On April 28, 2008, our board of directors approved the terms of a lease and such lease was executed on April 29, 2008.
Effective October 24, 2012, we amended certain terms of the lease for our Rochester facility. The primary changes that were made include a two-year extension of the current lease originally set to expire as of May 31, 2013 at the same rent rate, and the addition of two three-year renewal options with a 10% rate increase at each subsequent renewal period. These renewal options replace the previous renewal options of three five-year renewal periods which had incorporated 15% rate increases at each subsequent renewal period. (See Note I [1].)
[3]
On June 29, 2000, we granted an exclusive world-wide license of all our automotive technologies to Variable Gear, LLC for the aeronautical and marine markets for $150,000 cash. We recorded the receipt of the $150,000 as deferred revenue to be recognized when all conditions for earning such fees were complete. At the time of its formation and through June 6, 2007 when his interest was purchased, Robert C. Horton, a Company shareholder, owned 51% of Variable Gear, LLC. On June 6, 2007, we purchased Mr. Horton’s entire interest in Variable Gear for 5,000 shares of common stock valued at $19,250. In fiscal 2007, we recognized the deferred revenue of $150,000 as other income and recorded an impairment of the goodwill of $19,250, since there were no operations of the entity since inception.
[4]
On August 17, 2005, we repaid $28,000 indebtedness to a stockholder by issuing 11,667 restricted common shares, such number of shares based upon the closing price of our common stock on August 16, 2005.
[5]
On June 19, 2006, we awarded an aggregate 360,000 nonqualified common stock warrants with no expiration date, valued at approximately $629,000, to a director for additional services rendered by such director as chairman of the board’s executive committee during 2006.
[6]
On August 18, 2006, we granted 400,000 nonqualified common stock warrants valued at approximately $1,237,000 for consulting services to an enterprise, one of whose members was a director. The warrants were immediately exercisable at $3.27 per common share for a period of ten years. These warrants were modified by mutual agreement of the parties effective October 15, 2010. These modified warrants are immediately exercisable at $.44 per common share for a period of ten years from the modification date. This modification was valued at $68,000 and we recognized this expense in the fourth quarter of 2010.
[7]
On April 28, 2008, the board of directors approved a one-time payment to our chairman of the governance and compensation committee of $46,000 for special services rendered in connection with required compliance under the Sarbanes-Oxley Act. This amount was paid by the issuance of 19,167 common shares valued as of the closing price on April 28, 2008. We charged $46,000 to operations in connection with such services.
[8]
On October 26, 2010, we issued 164,187 common shares valued at approximately $62,400 to each of our chairman of the board and general counsel for services rendered in connection with the engagement of the Company’s new chief executive officer.
[9]
On December 13, 2010, we executed a three-year consultant agreement with a director to provide consulting services to us at a rate of $200 per hour. Pursuant to the agreement, we also agreed to pay the consultant an incentive fee equal to $10,000 or proportionate part thereof for each $1,000,000 of revenue or proportionate part thereof actually received by us for a period of five years, provided the definitive agreement with the third party results from the material efforts of the consultant. During 2013 and 2012, we recorded an expense of $1,000 and $2,000, respectively, for services rendered in relation to this agreement. In December 2013, the agreement was automatically renewed for an additional three years through December 13, 2016.
[10]
On September 23, 2011, we sold and issued a total of 16,250,000 shares of Series C Voting Convertible Preferred Stock and warrants to purchase 1,625,000 shares of our common stock in a private placement transaction, generating gross proceeds of $6,500,000. Three members of our board of directors and one executive officer participated in the transaction, acquiring 687,500 preferred shares and associated warrants for $275,000 (approximately 4.2 percent of the entire transaction). (See Note H[5](c).)
[11]
Effective on March 27, 2012, we hired Dr. William Mark McVea as our Chief Technology Officer. Prior to joining the Company, Dr. McVea provided us with consulting services through KBE
+
, Inc., a group of consulting engineers engaged in the design and development of gear trains and power transmission devices, and of which Dr. McVea was the principal engineer and president. At the time Dr. McVea joined the Company in March 2012, we had an outstanding liability of $41,000 to KBE
+
, Inc. related to consulting services provided to the Company, which was paid in full by April 2012.
On April 30, 2012, we purchased various test equipment, office furniture, and supplies from KBE
+
, Inc. for a total of $162,500. We have entered into a financing agreement with KBE
+
, Inc., whereby we are paying KBE
+
, Inc. over 24 months in equal monthly installments of approximately $6,800, beginning on May 1, 2012. Based on an imputed interest rate of approximately 5%, the initial principal of the note was approximately $154,000. As of December 31, 2013 and 2012, the outstanding principal on the note was approximately $27,000 and $105,000, respectively. Interest expense pertaining to this note amounted to approximately $3,000 and $4,000 for the twelve month periods ended December 31, 2013 and 2012, respectively.
In May 2012, we purchased certain additional testing tools and supplies from KBE
+
, Inc. for approximately $5,700. At December 31, 2012, we had an outstanding payable of $2,000 to KBE
+
, Inc. related to this purchase. At December 31, 2013, the outstanding payable to KBE
+
, Inc. related to this purchase was fully paid.
[12]
Effective as of January 1, 2013, we entered into a one-year consulting agreement with SCIRE Corporation, of which one of our directors is president, to provide us with expertise and advice on hydraulic pump technology and related markets. The consulting agreement provided for a guaranteed minimum of $3,840 per month, based on 32 hours of consulting, plus travel costs. During the twelve month period ended December 31, 2013, we recorded an expense of approximately $51,000 for consulting services and travel costs related to this agreement. On December 4, 2013, we extended this consulting agreement for another year through December 31, 2014, providing for a guaranteed minimum of $2,000 per month, based on 16 hours of consulting, plus travel costs. Additional hours above this minimum in 2014 will be billed at a rate of $125 per hour.
NOTE D — INVENTORIES
The composition of inventories, comprised mainly of components for the production of the IsoTorque differential, was:
|
|
|
December 31,
2013
|
|
|
December 31,
2012
|
|
|
Raw Materials
|
|
$
|
26,000
|
|
|
$
|
65,000
|
|
|
Work in Process
|
|
|
0
|
|
|
|
0
|
|
|
Finished Goods
|
|
|
0
|
|
|
|
0
|
|
|
Total Inventories
|
|
|
26,000
|
|
|
|
65,000
|
|
|
Reserve for Excess / Obsolete Inventory
|
|
|
(26,000
|
)
|
|
|
0
|
|
|
Inventories, Net
|
|
$
|
0
|
|
|
$
|
65,000
|
|
NOTE E — 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, 2013 and 2012 is summarized below:
|
|
|
December 31,
2013
|
|
|
December 31,
2012
|
|
|
Current tax expense (benefit):
|
|
|
|
|
|
|
|
|
|
Federal
|
|
$
|
0
|
|
|
$
|
0
|
|
|
State
|
|
|
0
|
|
|
|
0
|
|
|
|
|
|
|
|
|
|
|
|
|
Deferred tax expense (benefit):
|
|
|
|
|
|
|
|
|
|
Federal
|
|
|
(502,000
|
)
|
|
|
3,135,000
|
|
|
State
|
|
|
(112,000
|
)
|
|
|
315,000
|
|
|
Increase (decrease) in valuation allowance
|
|
|
614,000
|
|
|
|
(3,450,000
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Provision for income taxes
|
|
$
|
0
|
|
|
$
|
0
|
|
The difference between income taxes at the statutory federal income tax rate and income taxes reported in the statements of operations is attributable to the following:
|
|
|
December 31,
2013
|
|
|
December 31,
2012
|
|
|
|
|
|
|
|
|
|
|
|
|
Income tax benefit at the federal statutory rate
|
|
$
|
(955,000
|
)
|
|
$
|
(1,166,000
|
)
|
|
State income tax benefit, net of effect of federal taxes
|
|
|
(74,000
|
)
|
|
|
208,000
|
|
|
Expiration of net operating loss carryforwards
|
|
|
0
|
|
|
|
29,000
|
|
|
Adjustments to deferred tax assets
|
|
|
378,000
|
|
|
|
2,596,000
|
|
|
Uncertain tax position
|
|
|
0
|
|
|
|
1,732,000
|
|
|
ISO stock compensation
|
|
|
32,000
|
|
|
|
47,000
|
|
|
Other
|
|
|
5,000
|
|
|
|
4,000
|
|
|
Increase (decrease) in valuation allowance
|
|
|
614,000
|
|
|
|
(3,450,000
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Provision for income taxes
|
|
$
|
0
|
|
|
$
|
0
|
|
During the year ended December 31, 2012, we conducted a review of our historical tax net operating losses and deferred startup costs. Our review resulted in the conclusion that for tax purposes we have yet to begin an active trade or business since our inception. The review resulted in an adjustment of prior year deferred tax assets along with a reclassification of expenses resulting in a reduction to our tax net operating loss carryforwards and an increase in deferred startup costs of approximately $13,500,000, which had no net effect on the balance sheets and statements of operations for periods prior to 2012 as the deferred tax benefits were fully reserved.
The deferred tax asset at December 31, 2013 and 2012 consists of the following:
|
|
|
2013
|
|
|
2012
|
|
|
Deferred income tax assets:
|
|
|
|
|
|
|
|
|
|
Net operating loss carryforwards
|
|
$
|
3,057,000
|
|
|
$
|
3,261,000
|
|
|
Deferred startup costs
|
|
|
13,122,000
|
|
|
|
12,562,000
|
|
|
Stock-based compensation
|
|
|
2,854,000
|
|
|
|
3,096,000
|
|
|
Other
|
|
|
34,000
|
|
|
|
80,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
19,067,000
|
|
|
|
18,999,000
|
|
|
Less: Valuation allowance
|
|
|
(16,243,000
|
)
|
|
|
(15,629,000
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Net deferred tax asset
|
|
|
2,824,000
|
|
|
|
3,370,000
|
|
|
|
|
|
|
|
|
|
|
|
|
Deferred income tax liabilities:
|
|
|
|
|
|
|
|
|
|
Tax accounting method change
|
|
|
(1,092,000
|
)
|
|
|
(1,638,000
|
)
|
|
Less: Uncertain tax benefit liability
|
|
|
(1,732,000
|
)
|
|
|
(1,732,000
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Net deferred tax assets
|
|
$
|
0
|
|
|
$
|
0
|
|
At December 31, 2013, we have approximately $7,946,000 and $7,458,000 of adjusted federal and New York State net operating loss carryforwards, respectively, to offset future taxable income. These net operating losses begin expiring in 2021 through 2031. Additionally, from the date of inception through 2013, we have accumulated approximately $33,920,000 of adjusted deferred startup costs, subject to certain alternative minimum tax limitations. Start-up costs will be amortized over a 15 year period beginning in the year we begin an active trade or business. We have provided a full valuation allowance on the net deferred tax assets due to uncertainty of realization through future earnings.
Based upon the change in ownership rules under Section 382 of the Internal Revenue Code of 1986, if a company issues common stock or other equity instruments convertible into common shares which result in an ownership change exceeding a 50% limitation threshold over a rolling three-year timeframe as imposed by that Section, all of that company’s net operating loss carryforwards may be significantly limited as to the amount of use in any particular year. At December 31, 2011, we conducted an analysis relative to the Section 382 regulations, and concluded that we have not had a cumulative ownership change that would limit the use of our net operating loss carryforwards.
A reconciliation of the beginning and ending amounts of unrecognized tax benefits for the years ended December 31, 2013 and 2012 are as follows:
|
|
|
2013
|
|
|
2012
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance as of January 1
|
|
$
|
1,732,000
|
|
|
$
|
0
|
|
|
Additions based on tax positions related to the current year
|
|
|
0
|
|
|
|
0
|
|
|
Additions for tax positions of prior years
|
|
|
0
|
|
|
|
1,732,000
|
|
|
Reductions for tax positions of prior years
|
|
|
0
|
|
|
|
0
|
|
|
Settlements
|
|
|
0
|
|
|
|
0
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance as of December 31
|
|
$
|
1,732,000
|
|
|
$
|
1,732,000
|
|
Tax years that remain subject to examination for our major tax jurisdictions include the year ended December 31, 2010 through December 31, 2013. In addition, the Company's 2009 tax year was examined by the Internal Revenue Service resulting in an inconclusive adjustment due to the expiration of the statute of limitations. Therefore, the Internal Revenue Service will conclude on any findings during a subsequent audit. The Company has determined that there are no additional uncertain tax positions as a result of the 2009 audit findings.
NOTE F — ACCRUED LIABILITIES
At December 31, 2013 and 2012, accrued liabilities consist of the following:
|
|
|
2013
|
|
|
2012
|
|
|
Accrued Compensation
|
|
$
|
53,000
|
|
|
$
|
51,000
|
|
|
Accrued Payroll Taxes Payable
|
|
|
7,000
|
|
|
|
212,000
|
|
|
Accrued Legal
|
|
|
8,000
|
|
|
|
8,000
|
|
|
Other
|
|
|
2,000
|
|
|
|
7,000
|
|
|
|
|
$
|
70,000
|
|
|
$
|
278,000
|
|
NOTE G — NOTES PAYABLE
As of December 31, 2013 and 2012, notes payables consist of the following:
|
|
|
2013
|
|
|
2012
|
|
|
Additional Office Space (1)
|
|
$
|
0
|
|
|
$
|
6,000
|
|
|
Copy Machine (2)
|
|
|
3,000
|
|
|
|
5,000
|
|
|
Engineering Design Software (3)
|
|
|
14,000
|
|
|
|
36,000
|
|
|
Test Equipment and Supplies (4)
|
|
|
27,000
|
|
|
|
105,000
|
|
|
Automobile (5)
|
|
|
10,000
|
|
|
|
15,000
|
|
|
|
|
$
|
54,000
|
|
|
$
|
167,000
|
|
|
|
(1)
|
In November 2010, we completed a construction project for additional office space at our leased corporate office facility. The cost of the leasehold improvement was $32,500 and the landlord agreed to finance this cost over the remaining initial term of the lease which expires in May 2013. The monthly payments are approximately $1,100 per month, with an implicit interest rate of approximately 2.5%. At December 31, 2012, the outstanding balance on this note was approximately $6,000, which matured and was paid in full in 2013.
|
|
|
(2)
|
In November 2010, we entered into a capital lease for a copy machine over a 5 year term, with a fair market value buyout option. The capitalized value of the lease was approximately $8,900, and the monthly payment is approximately $170 with an implicit interest rate of approximately 5.3%. At December 31, 2012, the outstanding balance on this note was approximately $5,000, of which $3,000 was classified as a non-current liability. At December 31, 2013, the outstanding balance on this note was approximately $3,000, of which $2,000 was classified as a non-current liability.
|
|
|
(3)
|
In August 2011, we financed the purchase of engineering design software, along with a one-year maintenance agreement, through a three year loan maturing in August 2014, and collateralized by the software. The total cost of the software and the maintenance agreement was approximately $64,800. The monthly payments are approximately $2,100 per month with an implicit interest rate of approximately 9.6%. At December 31, 2012, the outstanding balance on this note was approximately $36,000, of which $14,000 was classified as a non-current liability. At December 31, 2013, the outstanding balance on this note was approximately $14,000, which was classified as a current liability.
|
|
|
(4)
|
In April 2012, we financed the purchase of various test equipment, office furniture, and supplies from KBE
+
, Inc. (of which our chief technology officer is an officer) through a 24 month promissory note for a total amount to be paid of $162,500. Based on an imputed interest rate of approximately 5%, the initial principal of the note was approximately $154,000. The monthly payments are approximately $6,800 per month. At December 31, 2012, the outstanding balance on this related party note was approximately $105,000, of which $27,000 was classified as a non-current liability. At December 31, 2013, the outstanding balance on this related party note was approximately $27,000, which was classified as a current liability.
|
|
|
(5)
|
In August 2012, we purchased an automobile for $16,600, a vehicle that we had previously been leasing. We financed this purchase with a 36- month promissory note. The interest rate on the loan is approximately 10%, and the payments are approximately $540 per month. At December 31, 2012, the outstanding balance on this note was approximately $15,000, of which $10,000 was classified as a non-current liability. At December 31, 2013, the outstanding balance on this note was approximately $10,000, of which $4,000 was classified as a non-current liability.
|
The following represents the required minimum payments for the outstanding loans as of December 31, 2013:
|
Period Ending
December 31,
|
|
|
|
|
|
2014
|
|
|
50,000
|
|
|
2015
|
|
|
6,000
|
|
|
Total Minimum payments
|
|
|
56,000
|
|
|
Less - amount representing interest
|
|
|
2,000
|
|
|
|
|
|
54,000
|
|
|
Less - Current Maturities
|
|
|
48,000
|
|
|
Long Term Portion
|
|
$
|
6,000
|
|
NOTE H — STOCKHOLDERS’ EQUITY
[1] Private Placements of Common Stock
We received net proceeds of $550,000, $1,230,000 (of which $507,000 was received from the Gleasman family), $758,000, $1,068,000 and $331,000 from private placements of our common stock for the years ended December 31, 2000, 1999, 1998 and 1997 and for the period ended December 31, 1996, respectively.
During 2002, we sold 508,897 common shares for net proceeds of approximately $668,000.
In 2003, an existing stockholder purchased 361,112 common shares for $300,000 and was paid 70,000 common shares at market value on the date of issuance (valued at $158,000) for consulting services and rent for our use of a facility and technicians. We also sold an additional 8,000 common shares to an unrelated party for $20,000.
In 2004, the same existing stockholder purchased 60,000 common shares for $301,000 and was paid 35,000 common shares at market value on the date of issuance (valued at $194,000) as rent for our use of a facility and technicians.
In 2005, this stockholder was paid 90,000 common shares at market value on the date of issuance (valued at $259,000) for consulting services rendered to us.
In 2008, we sold 101,364 shares of common stock to accredited investors for proceeds of approximately $198,000.
In 2009, we sold 551,483 shares of common stock to accredited investors for proceeds of approximately $335,000.
During 2010, we sold an aggregate of 432,738 restricted common shares in a series of non-brokered private placements for proceeds of approximately $139,000 at an average of approximately $.32 per common share. In addition, in October 2010, we sold 6,834,002 restricted common shares for approximately $2,050,000 of proceeds in a non-brokered private placement of our common stock at $.30 per common share.
During 2011, 2012 and 2013, we did not issue any shares of common stock resulting from private placement transactions.
[2] Initial Public Offering Consultant
In February 1997, we entered into a three-year agreement with an IPO consulting firm (“IPO Consultant”) to arrange for an initial public offering of our common stock and to provide financial advisory services. In consideration, we issued an aggregate 1,000,000 restricted common shares to five principals of the IPO Consultant for an aggregate $50. In addition, we granted an aggregate 500,000 warrants to the same principals. Such warrants were only exercisable in the event we conducted an initial public offering for our common stock. In such event, the warrants were exercisable for a term of five years after the IPO and were exercisable at the per share public offering exercise price (unless during the warrant term after the IPO, at least 50% of our assets were acquired by a third party in which case the exercise price was $1.50 per share).
In February 1999, we entered into a one-year consulting agreement directly with two of the former principals of the IPO Consultant to provide financial advisory services. In connection with this agreement, we and the two former principals agreed to convert the 375,000 warrants they owned into 375,000 common stock purchase options exercisable immediately through February 2004 at $5.00 per common share. We valued these options at $2,780,000 using the Black-Scholes option-pricing model with the following weighted average assumptions for the year ended December 31, 1999: risk free interest rate of 5%, dividend yield of 0%, volatility of 40% and expected life of the options granted of 5 years. These options were charged to operations over the term of the consulting agreement. In February 1999, 21,000 of these options were exercised for proceeds of $105,000. The term of the remaining 354,000 options expired in February 2004.
As of December 31, 2013, none of the 125,000 remaining outstanding warrants is exercisable.
[3] Equity Funding Commitment
On September 5, 2000, we entered into an agreement with Swartz Private Equity, LLC (“Swartz”) pursuant to which Swartz granted the Company a $50,000,000, three-year equity funding commitment. The agreement provided that, from time to time, at our request, Swartz would purchase from us that number of common shares equal to 15% of the number of shares traded in the market in the 20 business days occurring after the date of the requested purchase. The purchase price was the lesser of 91% of the average market price during that 20 day period or the average market price less $.20. As a commitment fee, we granted Swartz a commitment warrant to purchase, in the aggregate, 960,101 common shares at a price which equaled the lowest closing price of our common stock during the five trading days ending on each six-month anniversary of the warrant issue date.
During 2002, 76,456 commitment warrants were exercised for proceeds of approximately $60,000. During 2003, Swartz exercised the remaining 883,645 commitment warrants in a cashless exercise transaction, and received 647,270 common shares.
Swartz was also issued a warrant to purchase one share of our common stock for every ten shares it purchased from us under the agreement. During 2002, 47,992 of such warrants were exercised for proceeds of approximately $67,000. In 2003, Swartz exercised the balance of its purchase warrants (9,875) in a cashless exercise transaction and received 7,162 common shares.
The agreement with Swartz terminated on September 5, 2003.
[4] Common Stock Subject to Resale Guarantee
During 2002, we issued 190,695 common shares to former officers and certain minority shareholders of Ice Surface Development, Inc. in exchange for approximately $269,000 owed to them. During 2002, all of such shares were sold for proceeds of approximately $269,000. We have no further liability with respect to this transaction.
[5] Preferred Stock
On August 30, 2000, we amended our certificate of incorporation to permit the Company to issue up to 100,000,000 shares of $.01 par value preferred stock. Under the amendment, 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.
|
(a)
|
Class A Preferred Stock
|
In 2002, our board designated the first series of preferred shares, authorizing 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.
In connection with the 2002 offering of Class A Preferred, we granted the placement agent 5,000 Class A Warrants, exercisable for five years at an exercise price of $1.52 per share into common stock. Such warrants were treated as a cost of the offering. Also, the placement agent was granted 10,000 warrants for providing certain financial analysis for us. The warrants were immediately exercisable at $.30 per share for five years. The warrant contained a cashless exercise feature. We valued the warrant at $8,000 using the Black-Scholes option-pricing model and charged operations.
We also granted to these investors 2,500 Class A Warrants, exercisable for five years at an exercise price of $0.01 per share. On July 8, August 14, and September 11, 2003 and August 4, 2006, we issued 2,500, 7,480, 1,200 and 2,500 common shares, respectively, to the placement agent upon the exercise of warrants issued in connection with this offering.
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.
Since its designation in March 2002, we have sold an aggregate 765,512 shares of Class A Preferred for proceeds of approximately $3,062,000. No Class A Preferred shares were sold during the years ended December 31, 2013 and 2012.
Since its designation in March 2002, Class A Preferred shareholders have converted an aggregate 189,750 Class A Preferred into our common stock (on a one to one basis) through December 31, 2013, with 0 Class A Preferred shares converted in each of the years ended December 31, 2013 and 2012.
For each of the years ended December 31, 2013 and 2012, we settled 0 Class A Preferred dividends. Since its inception in March 2002 through December 31, 2013, we have settled an aggregate Class A Preferred dividend amounting to approximately $242,000 through the issuance of 11,339 Class A Preferred shares and 100,924 common shares.
At December 31, 2013, there were 587,101 outstanding shares of Class A Preferred stock, of which 11,339 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 575,762 outstanding shares of Class A Preferred stock amounted to approximately $2,019,000 at December 31, 2013.
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 $2,019,000 and $1,788,000 at December 31, 2013 and 2012, respectively. In the event of a 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.
|
(b)
|
Class B Preferred Stock
|
In September 2004, the board created a second series of preferred stock by authorizing 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 IsoTorque 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.
Since its designation in September 2004, we have sold an aggregate 97,500 Class B Preferred in a number of private placements for proceeds of approximately $487,500. No Class B Preferred shares were sold during the years ended December 31, 2013 and 2012.
Since its designation, Class B Preferred shareholders have converted an aggregate 30,000 Class B Preferred into our common stock (on a one to one basis) through December 31, 2013.
Through December 31, 2013, no Class B Preferred shares have been issued to converting Class B Preferred shareholders as a dividend.
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 year ended December 31, 2013, we settled 0 Class B Preferred dividends. For the year ended December 31, 2012, we settled Class B Preferred dividends amounting to approximately $27,000 through the issuance of 5,328 shares of common stock. Cumulatively through December 31, 2013, we have issued 35,431 restricted common shares in payment of Class B dividends amounting to approximately $51,000.
At December 31, 2013, dividends payable upon the conversion of 67,500 outstanding shares of Class B Preferred amounted to approximately $285,000. 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 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 $285,000 and $251,000 at December 31, 2013 and 2012, 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.
|
(c)
|
Class C Preferred Stock
|
In September 2011, the board of directors authorized, and Class A Preferred and Class B Preferred shareholders approved, a third series of preferred stock, namely 16,250,000 shares of Class C Voting Convertible Preferred Stock. On September 23, 2011, we sold and issued a total of 16,250,000 shares of Series C Voting Convertible Preferred Stock and warrants to purchase 1,625,000 shares of our common stock in a private placement transaction, generating gross proceeds of $6,500,000. Direct expenses of approximately $106,000 pertaining to the transaction, consisting of primarily external legal costs, were incurred, resulting in net proceeds of approximately $6,394,000.
Each Class 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 Class 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 Class C Preferred shares have no right to receive dividends and have no redemption right. The Class C Preferred shares vote with the common stock on an as-converted basis.
The associated warrants have a ten (10) year term and are immediately exercisable for 1,625,000 shares of common stock. The warrants are exercisable, at the holder’s election, for shares of the Company’s common stock in either a cash or cashless exercise. The warrants have an exercise price equal to the greater of (i) $0.01 or (ii) eighty percent (80%) of the volume weighted average sale price per share of our common stock during the ten (10) consecutive trading days immediately preceding the notice of exercise. The number of warrants and exercise price are 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. At the time of issuance, we estimated a value of $.50 per warrant, or a total of approximately $812,000, using a weighted average of assigned probabilities for various gain scenarios at certain price points based on expected volatility. As a result of the combined issuance of the Class C Preferred stock with the associated warrants, we reflected a non-cash distribution on the Class C Preferred shares for the warrants issued in our consolidated statements of operations for 2011. (See Note H[12](o).)
In conjunction with the issuance of the 16,250,000 shares of Class C Preferred stock, we computed the value of the non-cash beneficial conversion feature associated with the right to convert the shares into common stock on a one-for-one basis. We compared the fair value of our common stock on the date of issuance with the effective conversion price after allocation of the proceeds to the related warrants, and determined that the value of the non-cash beneficial conversion feature is approximately $5,582,000, which was reflected in our consolidated statements of operations for the year ended December 31, 2011 as an adjustment to arrive at the net loss attributable to common stockholders. (See Note H[12](o).)
Cumulatively through December 31, 2013, Class C Preferred shareholders have converted 0 shares of Class C Preferred into common stock. At December 31, 2013, there were 16,250,000 shares of Preferred C stock outstanding. The value of the Class C Preferred shareholders’ liquidation preference was $6,500,000 at December 31, 2013 and 2012.
On March 24, 2014, the board of directors authorized, and the preferred shareholders approved the content and filing of Certificates of Amendment to the Company’s Certificate of Incorporation to create two new series of preferred stock, namely Series C-2 Voting Convertible Preferred stock and Series C-3 Voting Convertible Preferred stock. We filed a Certificate of Amendment to the Certificate of Incorporation on March 28, 2014 (the “Certificate of Amendment”), authorizing 25,000,000 shares of Series C-2 Voting, Convertible Preferred stock with a stated value of $.20 per share. The creation the Series C-3 Voting Convertible Preferred stock is subject to the determination of its stated value by a special committee of the board of directors.
On March 28, 2014, we closed on a private placement transaction that generated gross proceeds of approximately $5,000,000, resulting from the issuance of 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 the Company’s 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, as described in the Certificate of Amendment.
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. 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, and vote with the common stock on an as-converted basis.
We expect to conduct an offering to sell the Series C-3 Preferred stock within the next several months, where up to an additional $1,000,000 of gross proceeds will be raised. Direct expenses associated with these transactions, primarily legal fees, are expected to be in the range of approximately $100,000, which will be offset against the gross proceeds. The Series C-2 Preferred Shares and the Series C-3 Preferred Shares to be sold in the Series C-3 Preferred Offering will not be and have not been registered under the Securities Act of 1933, as amended, or the Securities Act, and may not be offered or sold in the United States absent registration or an applicable exemption from registration requirements. There can be no assurance that the Company will be successful in raising any needed amounts on these terms for these uses or that these amounts will be sufficient for its plans. This disclosure relating to this equity financing from private sources does not constitute an offer to sell or the solicitation of an offer to buy any of the Company’s securities, and is made only as required under applicable law and related reporting requirements, and as permitted under Rule 135c under the Securities Act. (See Note J.)
[6] Business Consultants Stock Plan
In June 1999, we adopted the Business Consultants Stock Plan (the “Stock Plan”). The Stock Plan, as amended, provided for the issuance of up to 15,000,000 registered common shares to be awarded from time to time to officers, directors, employees and consultants in exchange for business, financial, legal, accounting, engineering, research and development, technical, governmental relations and other similar services.
Share issuances under the Stock Plan were valued generally on the date immediately prior to the date of issuance, except for shares issued to pay invoices which were valued as of the invoice date and except for shares issued under the Nonmanagement Directors Plan which were valued as of the end of each month effective February 17, 2009.
|
For the year ended
December 31,
|
|
Common Shares Issued to Business
Consultants and Other Third Parties
in Exchange for Services
|
|
|
Amount Charged to
Operations
|
|
Note
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2011
|
|
|
0
|
|
|
|
$
|
0
|
|
|
|
2010
|
|
|
2,398,264
|
|
|
|
$
|
928,000
|
|
|
|
2009
|
|
|
2,243,296
|
|
|
|
$
|
1,603,000
|
|
|
|
2008
|
|
|
1,000,348
|
|
|
|
$
|
2,040,000
|
|
|
|
2007
|
|
|
359,432
|
|
|
|
$
|
1,245,000
|
|
|
|
2006
|
|
|
983,230
|
|
|
|
$
|
1,861,000
|
|
A
|
|
2005
|
|
|
836,309
|
|
|
|
$
|
1,874,000
|
|
|
|
2004
|
|
|
469,883
|
|
|
|
$
|
2,352,000
|
|
|
|
2003
|
|
|
738,184
|
|
|
|
$
|
832,000
|
|
|
|
2002
|
|
|
1,057,455
|
|
|
|
$
|
1,036,000
|
|
B
|
|
2001
|
|
|
361,100
|
|
|
|
$
|
1,011,000
|
|
|
|
2000
|
|
|
196,259
|
|
|
|
$
|
840,000
|
|
|
|
1999
|
|
|
45,351
|
|
|
|
$
|
327,000
|
|
|
|
|
|
|
|
A-
|
|
Includes 448,000 business consulting shares issued upon exercise of warrants for which a compensation charge of approximately $629,000 had been previously recognized.
|
|
|
|
|
|
B-
|
|
Includes 190,965 shares issued in settlement of amounts owed of approximately $269,000 (see Note H[4]).
|
On September 18, 2011, the board of directors voted to terminate the Business Consultants Stock Plan, effective immediately. As of September 18, 2011, a total of 10,988,283 shares had been issued under the Business Consultants Stock Plan. On October 7, 2011, we filed a Form S-8 with the Securities and Exchange Commission to deregister the remaining 4,011,717 shares that were available for future issuance.
[7] Nonmanagement Directors Compensation Plan
On October 1, 2004, the board of directors approved a Nonmanagement Directors Plan pursuant to which each nonmanagement director was entitled to receive, if certain conditions were met, on an annual basis for services rendered as a director, warrants to purchase 12,000 shares of our common stock at $.01 per share. In addition, the chairman of the audit committee was entitled to receive, on an annual basis for services rendered as chairman, additional warrants for 5,000 shares of our common stock at $.01 per share.
For the years ended December 31, 2004, 2005 and 2006, we issued an aggregate 123,500 warrants immediately exercisable for a ten year term at $.01 per common share to our nonmanagement directors for services rendered to the board under the Nonmanagement Directors Stock Plan. For the years ended December 31, 2004, 2005 and 2006, we recognized compensation expense related to these warrants of approximately $297,000, $110,000 and $48,000, respectively. During fiscal 2005 and 2006, 21,000 and 42,000 of these warrants, respectively, were exercised.
Due to changes made to the Nonmanagement Directors Plan described below, we did not issue any warrants under the plan for the years ended December 31, 2008 and 2007. No previously issued warrants were exercised during the year ended December 31, 2008, and 6,000 warrants were exercised during the year ended December 31, 2007.
On October 10, 2007, the Nonmanagement Directors Plan was modified, effective July 1, 2007, to increase the fees payable to our nonmanagement directors. As adjusted, each nonmanagement director (a total of 4 persons) would receive $26,460 for board and committee service per annum. The chairman of the audit committee would receive an additional $12,600 per annum and the chairman of the nominating committee would receive an additional $5,355 per annum.
The Nonmanagement Directors Plan was also modified to provide that the chairman of the board, chairman of the executive committee and chairman of the governance and compensation committee, one person, will be paid an aggregate $110,000 per annum for all services rendered by him as a director and in such capacities. The effective date for these adjustments to the plan was July 1, 2007.
On April 28, 2008, the plan was again modified to increase the compensation of the person serving as chairman of the board, chairman of the executive committee, chairman of the governance and compensation committee (one person) to $125,000 per annum.
On April 28, 2008, the board of directors approved a one-time payment to our chairman of the governance and compensation committee of $46,000 for special services rendered in connection with required compliance under the Sarbanes-Oxley Act. This amount was paid by the issuance of 19,167 common shares under the Business Consultants Plan valued at the closing price on April 28, 2008. We charged $46,000 to operations in connection with such services.
During the year ended December 31, 2010, we issued 889,195 common shares under the Business Consultants Plan to satisfy payables for services rendered by our nonmanagement directors in their capacity as directors and valued these shares at $339,000. Of the total shares issued in 2010, shares valued at $21,000 were for services provided and accrued for in 2009.
On November 3, 2010, the board of directors terminated the Nonmanagement Directors Plan.
[8] Shares Issued for Consulting Services through Business Consultant Trust
On September 17, 2005, certain consultants created a trust to enable them to sell business consultants shares issued to them by the Company under their consultant agreements. We issued business consultant common shares to the trust from time to time, contingent on the performance of services by the consultants under such consulting agreements. We fair valued the shares issued to the trust using the closing market price on the date immediately prior to the date of issuance. Shares issued in excess of the consulting invoices were classified as shares issued for consulting services.
During the year ended December 31, 2009, we issued to the trust an aggregate 899,271 business consultant common shares with an aggregate value when issued of $610,000 to satisfy the payment of invoices submitted by the consultants for services rendered. During the year ended December 31, 2009, the trustee sold 770,720 business consultants common shares for aggregate proceeds of approximately $536,100 and distributed the proceeds from the trust to the consultants in payment of invoices submitted by the consultants.
During the year ended December 31, 2010, we issued to the trust an aggregate 104,167 business consultant common shares with an aggregate value when issued of approximately $50,000 to satisfy the payment of invoices submitted by the consultants for services rendered. During 2010, the trustee sold 177,495 business consultants common shares for aggregate proceeds of approximately $83,600 and distributed the proceeds from the trust to the consultants in payment of invoices submitted by the consultants.
Our payment obligations with respect to the consultant agreements were met once we issued shares to the trust in accordance with directives received from the consultants and the consultants, not the Company, bear the risk of loss in the event the proceeds of stock sales by the trustee were less than the value of the stock contributed to the trust by the Company on the date of contribution.
During March 2010, the trust was effectively terminated and our common shares were no longer issued to the trust to pay for the consultants. In May 2010, the trust returned 88,857 of undistributed common shares to us. We credited the fair value of the shares returned to general and administrative expenses for approximately $45,000.
[9] Commercializing Event Plan
On October 13, 2006, the board of directors adopted a Commercializing Event Plan (“2006 Event Plan”) designed to reward our directors, executives and certain administrative personnel for the successful completion of one or more commercializing events. No payments were made under the 2006 Event Plan.
On October 31, 2007, the board of directors terminated the 2006 Event Plan and approved a new 2007 Commercializing Event Plan (the “2007 Event Plan”), effective October 10, 2007. The 2007 Event Plan provided that upon the happening of any commercializing event, each of our directors and officers as well as certain management personnel shall be entitled to share equally in 6% of the gross amounts derived or to be derived from the transaction and/or transactions constituting a commercializing event. Upon the happening of any commercializing event, each of our engineering and security consultants shall be entitled to share equally in 2% of the gross amounts derived and/or to be derived from the transaction and/or transactions constituting a commercializing event. In order to actually receive payment under the 2007 Event Plan, each participant must be both a) employed by, a consultant to or associated with the Company and b) judged to be “in good standing” with the Company at the time of any and all such payments, all as determined by the board of directors as of the date of the board’s authorization of payments to be made.
The 2007 Event Plant specifically provides that the participants in the commercializing event plan shall be entitled to receive payments as described in the plan regardless of the number of commercializing events, in the aggregate or with respect to any given technology.
We issued an aggregate 4,669 common shares with a value upon issuance of $14,000 to participants under the 2007 Event Plan for the year ended December 31, 2009. For the year ended December 31, 2010, we issued an aggregate 32,077 common shares with a value upon issuance of $13,000 to participants under the 2007 Event Plan.
In 2007, certain engineering consultants agreed to cancel 445,000 warrants issued in 2005 and 2006 in exchange for their participation in the 2007 Event Plan. The exchange of the warrants for the participation rights in a commercializing event did not result in an accounting charge. The warrants at the date of the exchange were considered to have no value because the underlying condition for vesting the warrants was not satisfied. The Company determined that the fair value of the rights to be de minimis at the date of the exchange.
Effective November 3, 2010, our board of directors terminated the 2007 Event Plan. In connection with such termination, the board of directors, on December 2, 2010, granted 360,000 common stock options to certain engineering participants in the 2007 Event Plan, exercisable for 6 years at an exercise price of $5.00 per common share. The transaction was considered a modification of a stock-based award and we recorded a charge of approximately $508,000. The fair value of the 360,000 options granted was estimated on the date of grant using the Black-Scholes option-pricing model.
[10] Restricted Shares Issued for Services and Rent
From 1998 through December 31, 2010, we granted an aggregate 478,737 restricted shares of common stock, valued at approximately $811,500, as payment for services and rent.
Since December 31, 2010, we have issued 0 restricted shares of common stock.
[11] Stock Options
|
(a)
|
1998 Stock Option Plan
|
In December 1997, our board approved a Stock Option Plan (the “1998 Plan”) which provided for the granting of up to 2,000,000 shares of common stock, pursuant to which officers, directors, key employees and key consultants/advisors are eligible to receive incentive, nonqualified or reload stock options which plan was ratified by the shareholders on May 28, 1998. Options granted under the 1998 Plan are exercisable for a period of up to 10 years from date of grant at an exercise price which is not less than the fair value on date of grant, except that the exercise period of options granted to a stockholder owning more than 10% of the outstanding capital stock may not exceed five years and their exercise price may not be less than 110% of the fair value of the common stock at date of grant. Options may vest over five years.
In 1997, in connection with certain consulting agreements, we granted an aggregate 75,000 nonqualified options at an exercise price of $5.00 per common share. The options vested at a rate of 20% per annum and were exercisable through November 30, 2007. We valued these options using the Black-Scholes option-pricing method. The fair value of these options was expensed over the term of the consulting agreements. The options expired on November 30, 2007 and were not replaced.
In 1998, we granted three directors an aggregate 380,000 options under the 1998 Plan, all exercisable immediately at $5.00 per common share. These options expired on January 1, 2007. In 2001, we granted 100,000 options to an officer in his capacity as a consultant under the 1998 Plan exercisable immediately at $5.00 per common share and with a ten year term. In connection with this grant, we recorded a stock compensation charge of $398,000.
In 2002, in connection with the consulting agreements, we granted an aggregate 727,047 options under the 1998 Plan, all exercisable immediately at $5.00 per common share. The options were granted in payment of an aggregate $653,000 owed under the consulting agreements. These options expired on September 30, 2007 and were not replaced.
In 2003, in connection with the same consulting agreements, we granted 166,848 options under the 1998 Plan, all exercisable immediately at $5.00 per common share. The options were granted in payment of an aggregate $265,000 owed under the consulting agreements. These options expire on December 22, 2013.
In 2003, we granted an aggregate 225,000 options under the 1998 Plan to three directors, all immediately exercisable at $5.00 per common share. These options expire on October 15, 2013.
In 2003, we granted 50,000 options to a consultant under the 1998 Plan, immediately exercisable at $2.26 per common share. In connection with this grant, we recorded a stock compensation charge of $46,000. These options expire on May 20, 2013.
In 2005, we granted 100,000 options to a consultant under the 1998 Plan, immediately exercisable at $5.00 per common share. In connection with this grant, we recorded a stock compensation charge of $247,000 allocated to research and development. These options expire on June 30, 2015.
By its terms, our 1998 Plan terminated as to the grant of future options on May 27, 2008. Consequently, no additional stock options have been granted under the 1998 Plan, although outstanding options remain available for exercise in accordance with their terms. No options were granted or exercised under the 1998 Plan during the years ended December 31, 2013 and 2012. In 2013 and 2012, 441,848 and 0 options, respectively, that had previously been granted under the 1998 Plan, expired by their terms.
Through December 31, 2013, a total of 1,823,895 stock options had been granted under the 1998 Plan, no stock options had been exercised, and 1,723,895 stock options have expired. As of December 31, 2013, there were 100,000 outstanding stock options under the 1998 Plan, all of which were fully vested. The following table summarizes information relating to stock options outstanding under the 1998 Plan at December 31, 2013:
Options Outstanding and Exercisable
|
|
Shares
|
|
|
Weighted
Average
Exercise
Price
|
|
|
Weighted
Average
Remaining Life
in Years
|
|
|
Aggregate
Intrinsic
Value
|
|
|
|
100,000
|
|
|
$
|
5.00
|
|
|
|
1.5
|
|
|
$
|
0
|
|
As of December 31, 2013, we did not have any unrecognized stock compensation related to unvested awards under the 1998 Plan.
|
(b)
|
2011 Stock Option Plan
|
On November 3, 2010, the board adopted, and on January 27, 2011 the shareholders approved, the 2011 Stock Option Plan (“2011 Plan”) which provides for the grant of up to 3,000,000 common stock options to provide equity incentives to directors, officers, employees and consultants. Two types of options may be granted under the 2011 Plan: non-qualified stock options and incentive stock options.
Non-qualified stock options may be granted to our officers, directors, employees and outside consultants. Incentive stock options may be granted only to our employees, including officers and directors who are also employees. In the case of non-qualified stock options, the exercise price may be less than the fair market value of our stock on the date of grant. In the case of incentive stock options, the exercise price may not be less than such fair market value and in the case of an employee who owns more than 10% of our common stock, the exercise price may not be less than 110% of such market price. Options generally are exercisable for ten years from the date of grant, except that the exercise period for an incentive stock option granted to an employee who owns more than 10% of our stock may not be greater than five years.
Effective January 28, 2011, our board of directors appointed Wesley K. Clark as a member of the board of directors. Our board voted to grant Gen. Clark a non-qualified stock option for 250,000 common shares under the 2011 Plan, effective January 28, 2011 and exercisable at $.90 per share. The option is conditioned upon Gen. Clark serving as a director and vests in four tranches of 62,500 shares on each of the four annual anniversary dates of January 28, 2011. The original terms of the option required the optionee to exercise each 62,500 tranche within two and one-half months following the calendar year in which the tranche vests or lose the tranche. However, on March 20, 2012, the board approved a modification of these options to provide for a 10 year term with an expiration date of January 28, 2021, and this modification was subsequently approved by shareholders at the Company’s annual meeting on June 14, 2012. We used the Black-Scholes option-pricing model to value the cost of this modification at approximately $56,000, which is being recognized ratably over the vesting periods of the respective tranches.
Our board also voted to grant Gen. Clark a non-qualified stock option for 25,000 common shares under the 2011 Plan, effective January 28, 2011 and exercisable at $.90 per share. This 25,000 share option vested immediately and is exercisable for 10 years.
In the fourth quarter of 2011, we granted incentive stock options to certain of our engineering employees for 405,000 common shares at an exercise price of $1.14 per share with a ten year term and a three year vesting period. These 405,000 options were established to replace an equivalent number of previously issued and outstanding options and warrants having an exercise of price of $5.00 per share. As the new options vest, an equal number of the previously issued options and warrants will be cancelled. The expense related to these replacement options amounts to the difference between the fair value of the replacement options on the date of grant and the fair value of the options / warrants that they will replace on the same date. We used the Black-Scholes option-pricing model to value the cost of these replacement options at approximately $117,000, which is being recognized ratably over the vesting period of the new options.
In March 2012, we granted an incentive stock option to our new chief technology officer to acquire 250,000 common shares at an exercise price of $.82 per share, exercisable for 10 years. The option vests in four tranches of 25% of the total granted shares on each of the four annual anniversary dates from the initial date of grant.
In December 2012, we granted a non-qualified stock option to a new director to acquire 250,000 common shares at an exercise price of $.70 per share, exercisable for 10 years. The option vests in four tranches of 25% of the total granted shares on each of the four annual anniversary dates from the initial date of grant.
In August 2013, we granted an incentive stock option to an existing employee to acquire 25,000 common shares at an exercise price of $.45 per share, exercisable for 10 years. The option vests in four tranches of 25% of the total granted shares on each of the four annual anniversary dates from the initial date of grant.
In November 2013, we granted a non-qualified stock option to our chairman of the board to acquire 100,000 common shares at an exercise price of $.36 per share, exercisable for 10 years. This grant relates to the chairman’s services as a director and replaced a previously issued option that had recently expired by its terms. The option vests in four tranches of 25% of the total granted shares on each of the four annual anniversary dates from the initial date of grant.
For the years ended December 31, 2013 and 2012, we granted 125,000 and 501,000 stock options under the 2011 Plan, and no options expired or were exercised. As of December 31, 2013, there were 1,307,000 stock options outstanding under the 2011 Plan, 545,746 of which were vested. At December 31, 2013, there were 1,693,000 options remaining available for future grant under the 2011 Plan.
During 2010, we granted non-plan, non-qualified stock options to acquire 5,910,000 shares of our common stock to certain of our officers, directors, and engineering consultants, at exercise prices ranging from $.36 to $5.00 per share with various vesting criteria and expiration dates. During 2011, we granted non-plan, non-qualified stock options to acquire 1,350,000 shares of our common stock to certain of our directors and a special advisor to the board at an exercise price of $.90 per share with various vesting criteria an expiration date of approximately 5 years. Additional information pertaining to the various non-plan option grants is highlighted below.
On September 30, 2010, we granted a stock option for 5,150,000 common shares exercisable for ten years at an exercise price of $0.36 per common share to our newly appointed chief executive officer. The option vests and is exercisable as follows: 1,000,000 options vest and are exercisable immediately upon grant; a second 1,000,000 options vest and are exercisable upon the trading price of our common stock closing at a minimum of $1.00 per share; a third 1,000,000 options vest and are exercisable upon the trading price of our common stock closing at a minimum of $2.00 per share; a fourth 1,000,000 options vest and are exercisable upon the trading price of our common stock closing at a minimum of $3.00 per share and the balance of the options, namely 1,150,000 options, vest and are exercisable upon the trading price of our common stock closing at a minimum of $4.00 per share. We valued the option using a variation of a Black-Scholes model, with the following assumptions: (a) an average expected term of 8 years; (b) an expected forfeiture rate of 0%; (c) a risk-free interest rate of 2.1%; (d) an average volatility of 96%; and (f) a dividend yield of 0%. The weighted average value of a single option was determined to be $0.29. Immediate vesting was utilized for the initial tranche, and the shorter of the expected vesting period or the 5¼ years expected service period will be utilized to amortize the expense related to each of the other tranches, but amortization will be accelerated if the market price milestone is achieved prior to the end of the amortization period. For the year ended December 31, 2010, three of the tranches met the vesting criteria and the expense associated with those tranches was accelerated accordingly. Through December 31, 2013, no other tranches had vested. We charged $873,000 to general and administrative expense during the year ended December 31, 2010, including $841,000 for the vesting of the first three tranches. We charged $129,000 and $129,000 to general and administrative expense during the years ended December 31, 2012 and 2013, respectively, pertaining to this grant.
In the fourth quarter of 2010, we granted stock options for 760,000 common shares exercisable for 10 years at exercise prices ranging from $.85 to $5.00 per share to certain of our officers, directors, and engineering consultants. The vesting periods of the options range from immediate vesting to 3 years.
During the first quarter of 2011, we granted a total of 1,350,000 non-plan stock options. On January 27, 2011, our shareholders approved the issuance of stock options to 5 directors each for 250,000 common shares, and the issuance of stock options to a consultant acting in the capacity as a special advisor to the board for 100,000 common shares, exercisable at $.90 per common share. Each option is conditioned upon the optionee serving as a director or consultant and vests in four tranches of 25% of the total granted shares on each of the four annual anniversary dates of January 27, 2011. The original terms of the options required the optionee to exercise each tranche within two and one-half months following the calendar year in which the tranche vests or lose the tranche. However, on March 20, 2012, the board approved a modification of these options to provide for a 10 year term with a uniform expiration date of January 27, 2021, and this modification was subsequently approved by shareholders at the Company’s annual meeting on June 14, 2012. We used the Black-Scholes option-pricing model to value the cost of this modification at approximately $304,000, which is being recognized ratably over the vesting periods of the respective tranches.
The expense recognized for the options that were granted to the special advisor to the board (a non-employee) reflect fair value. Such expense, based on updated valuation assumptions using the Black-Scholes valuation model at each measurement period, is apportioned over the requisite service period of the consultant, which is concurrent with the vesting dates of the various tranches. In 2013, we recorded a credit adjustment of approximately $129,000 in the consolidated statements of operations due to a decrease in the fair value of these options.
As of December 31, 2013, there were a total of 7,063,336 non-plan options outstanding, of which 4,238,336 were fully vested. During the twelve-month periods ended December 31, 2013 and 2012, 400,000 and 462,500 non-plan stock options, respectively, became vested. During the twelve-month periods ended December 31, 2013 and 2012, 98,332 and 98,332 non-plan stock options, respectively, were cancelled. No non-plan stock options were exercised in 2013 or 2012.
For the years ended December 31, 2013 and 2012, we recorded compensation expense of $530,000 and $1,080,000, respectively, related to the non-plan options.
For the years ended December 31, 2013 and 2012, compensation cost related to all stock options amounted to $635,000 and $1,360,000, respectively. As of December 31, 2013, there was approximately $634,000 of total unrecognized compensation costs related to outstanding stock options, which are expected to be recognized over the next 3.8 years.
The weighted average grant date fair value of all stock options granted during the years ended December 31, 2013 and 2012 was $.34 and $.68, respectively. The total grant date fair value of all stock options vested during the years ended December 31, 2013 and 2012 was approximately $808,000 and $694,000, respectively.
The fair value of each option granted was estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions:
|
|
|
2013
|
|
|
2012
|
|
|
Expected Term (years)
|
|
|
6.2
|
|
|
|
6.0
|
|
|
Expected forfeiture rate
|
|
|
0
|
%
|
|
|
0
|
%
|
|
Risk-free rate
|
|
|
1.8
|
%
|
|
|
1.2
|
%
|
|
Volatility
|
|
|
133.2
|
%
|
|
|
131.3
|
%
|
|
Dividend yield
|
|
|
0.0
|
%
|
|
|
0.0
|
%
|
The average risk-free interest rate is based on the U.S. treasury security rate in effect as of the grant date. We determined expected volatility using the historical closing stock price. The expected life was generally determined using the simplified method as we do not believe we have sufficient historical stock option exercise experience on which to base the expected term.
The following summarizes the activity of all of our outstanding stock options for the years ended December 31, 2013 and 2012:
|
|
|
Shares
|
|
|
|
Weighted
Average
Exercise
Price
|
|
|
Weighted
Average
Remaining
Contractual
Term (years)
|
|
|
Aggregate
Intrinsic
Value
|
|
|
Outstanding at January 1, 2012
|
|
|
8,482,848
|
|
(A)
|
|
$
|
1.00
|
|
|
|
|
|
|
|
|
|
|
Granted
|
|
|
501,000
|
|
|
|
|
.76
|
|
|
|
|
|
|
|
|
|
|
Exercised
|
|
|
0
|
|
|
|
|
.00
|
|
|
|
|
|
|
|
|
|
|
Canceled or expired
|
|
|
(98,332
|
)
|
|
|
|
5.00
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at January 1, 2013
|
|
|
8,885,516
|
|
(A)
|
|
$
|
.94
|
|
|
|
|
|
|
|
|
|
|
Granted
|
|
|
125,000
|
|
|
|
|
.38
|
|
|
|
|
|
|
|
|
|
|
Exercised
|
|
|
0
|
|
|
|
|
.00
|
|
|
|
|
|
|
|
|
|
|
Canceled or expired
|
|
|
(540,180
|
)
|
|
|
|
4.75
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at December 31, 2013
|
|
|
8,470,336
|
|
(A)
|
|
$
|
.69
|
|
|
|
6.9
|
|
|
$
|
0
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercisable at December 31, 2012
|
|
|
4,701,264
|
|
|
|
$
|
1.23
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercisable at December 31, 2013
|
|
|
4,884,082
|
|
|
|
$
|
.80
|
|
|
|
6.7
|
|
|
$
|
0
|
|
Note (A) – Figures include the impact of 405,000 options that were granted in 2011 to replace options / warrants previously granted to certain engineering personnel. The previously issued options / warrants will expire as these newer options vest on a one-to-one basis. During 2012, 134,998 of these options vested, and 98,332 previously issued options and 36,666 previously issued warrants were cancelled concurrently in conjunction with the vesting of the 2011 options. Again during 2013, 134,998 of these options vested, and 98,332 previously issued options and 36,666 previously issued warrants were cancelled concurrently in conjunction with the vesting of the 2011 options. As of December 31, 2013, there are 135,004 of the 2011 options remaining to vest.
As of December 31, 2013, the exercise prices of all outstanding stock options, as well as all vested stock options, ranged from $.36 per share to $5.00 per share.
[12] Warrants
As of December 31, 2013, outstanding warrants to acquire shares of our common stock are as follows:
|
|
Exercise
Price
|
|
|
Expiration
|
|
|
Number of
Warrants
Outstanding
|
|
|
|
Number of
Warrants
Exercisable
|
|
|
|
|
Not yet determinable
|
|
|
|
Not yet determinable
|
|
|
|
|
125,000
|
|
(a)
|
|
|
0
|
|
|
|
$
|
.75
|
|
|
|
None
|
|
|
|
|
500,000
|
|
(b)
|
|
|
0
|
|
|
|
$
|
.01
|
|
|
2015
|
-
|
2016
|
|
|
|
54,500
|
|
(c)
|
|
|
54,500
|
|
|
|
$
|
.01
|
|
|
|
None
|
|
|
|
|
3,000
|
|
(d)
|
|
|
3,000
|
|
|
|
$
|
5.00
|
|
|
|
None
|
|
|
|
|
55,000
|
|
(e)
|
|
|
55,000
|
|
|
|
$
|
5.00
|
|
|
|
2016
|
|
|
|
|
66,668
|
|
(e)
|
|
|
66,668
|
|
|
|
$
|
.01
|
|
|
|
None
|
|
|
|
|
60,000
|
|
(f)
|
|
|
60,000
|
|
|
|
$
|
.01
|
|
|
|
2016
|
|
|
|
|
3,750
|
|
(g)
|
|
|
3,750
|
|
|
|
$
|
1.00
|
|
|
|
None
|
|
|
|
|
20,500
|
|
(h)
|
|
|
20,500
|
|
|
|
$
|
.44
|
|
|
|
2020
|
|
|
|
|
400,000
|
|
(i)
|
|
|
400,000
|
|
|
|
$
|
3.75
|
|
|
|
2016
|
|
|
|
|
200,000
|
|
(j)
|
|
|
200,000
|
|
|
|
$
|
5.00
|
|
|
|
2016
|
|
|
|
|
30,000
|
|
(k)
|
|
|
30,000
|
|
|
|
$
|
5.00
|
|
|
|
2017
|
|
|
|
|
50,000
|
|
(l)
|
|
|
50,000
|
|
|
|
$
|
5.00
|
|
|
|
2017
|
|
|
|
|
100,000
|
|
(m)
|
|
|
100,000
|
|
|
|
$
|
2.50
|
|
|
|
2020
|
|
|
|
|
100,000
|
|
(
n
)
|
|
|
100,000
|
|
|
|
|
Not yet determinable
|
|
|
|
2021
|
|
|
|
|
1,625,000
|
|
(
o
)
|
|
|
1,625,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
3,393,418
|
|
|
|
|
2,768,418
|
|
|
(a)
|
|
Exercisable only if we have an IPO and exercisable at the IPO price five years from IPO. Through December 31, 2013, we have not conducted an IPO.
|
|
|
|
|
|
(b)
|
|
On April 15, 2002, we issued 1,000,000 warrants at prices ranging from $.30 to $.75 to our then chairman of the board of directors and chief executive officer. Of the total warrants, 250,000 were exercisable at $.30, and 250,000 were exercisable at $.50 on the date the then board elected the executive to the board and named him chief executive officer. During the year ended December 31, 2002, 250,000 warrants were exercised for $.30 per share, resulting in proceeds of $75,000. During the year ended December 31, 2003, 250,000 warrants were exercised for $.50 per share, resulting in proceeds of $125,000. The remaining 500,000 warrants are exercisable upon the occurrence of a significant transaction, which includes execution by us of a binding agreement for the sale, transfer, license or assignment for value of any and/or all of our automotive technology, at $.75 per share. We will record a charge representing the fair value of the warrants when the warrants become exercisable.
|
|
(c)
|
|
We issued an aggregate 123,500 warrants at an exercise price of $0.01 with a ten year term to our nonmanagement directors for services rendered to the board under our Nonmanagement Directors Plan prior to its amendment on October 13, 2006. No further warrants are issuable under the Plan as modified by the board of directors on October 13, 2006. An aggregate 69,000 warrants have been exercised for proceeds of $690.
|
|
|
|
|
|
(d)
|
|
In 2005, we issued 12,500 warrants to consultants, immediately exercisable at $0.01 per common share. During 2005 and 2006, 3,500 of these warrants were exercised. During 2010, an additional 6,000 of these warrants were exercised. The 3,000 remaining outstanding warrants have no expiration date.
|
|
|
|
|
|
(e)
|
|
In 2005, we issued 95,000 warrants to two engineering and administrative consultants, exercisable immediately at $5.00 per common share. During 2006, we issued an additional 100,000 warrants to these same consultants exercisable over a ten year term at $5.00 per common share, but only exercisable if there is a commercializing event as determined by the board of directors. During 2008, these warrants were cancelled and new warrants were issued to the same consultants for an aggregate 195,000 shares exercisable until 2016 at $5.00 per common share and conditioned upon the happening of a commercializing event as determined by the board. We recorded a charge of $249,000 in 2008 to general and administrative expense. In 2010, 95,000 of the total number of 195,000 warrants issued to these consultants were modified to eliminate both the term and the commercializing event condition for exercise. The charge related to the 2010 modification was insignificant. Effective in November 2011, 110,000 of these outstanding warrants were amended so that they will be cancelled in conjunction with the vesting of stock options that were granted to replace such warrants, with each option having an exercise price of $1.14 per share, and proportionate vesting on each of the succeeding anniversary dates over a three year period. The approximately $16,000 expense related to the issuance of the stock options to replace the warrants is being amortized over the vesting period of the stock options. In the fourth quarter of 2012, 36,666 of these warrants were cancelled as the corresponding number of options vested. In the fourth quarter of 2013, another 36,666 of these warrants were cancelled as the corresponding number of options vested.
|
|
|
|
|
|
(f)
|
|
During 2005, we issued 60,000 warrants to an engineering consultant exercisable immediately at $5.00 per common share and with no expiration date.
|
|
|
|
|
|
(g)
|
|
During 2005, we issued 62,500 warrants to investors in connection with their purchase of 62,500 Class A Preferred, immediately exercisable at $.01 per common share and with a ten year term. During 2006, we issued 135,849 warrants to investors along with their purchase 162,000 Class A Preferred and 20,000 Class B Preferred, all immediately exercisable at $.01 per common share and with a ten year term. Through December 31, 2013, an aggregate of 194,599 of these warrants have been exercised for proceeds of approximately $1,258. No warrants were exercised during 2013 or 2012.
|
|
|
|
|
|
(h)
|
|
During 2006, one investor purchased 20,500 warrants with no expiration date and an exercise price of $1.00 per common share, for a purchase price of $2,000.
|
|
|
|
|
|
(i)
|
|
During 2006, we issued 400,000 warrants immediately exercisable for ten years at an exercise price of $3.27 per common share to a business consultant. Effective October 15, 2010, these warrants were modified and reissued upon the mutual agreement of the parties. Effective October 15, 2010, we issued 400,000 warrants immediately exercisable at $.44 per common share for a period of ten years from the modification date. As a result of the modification, we recorded a charge of $68,000 to general and administrative expenses in the fourth quarter of 2010. No warrants were exercised during 2013 or 2012.
|
|
|
|
|
|
(j)
|
|
During 2006, we issued 200,000 warrants immediately exercisable for ten years at an exercise price of $3.75 per common share to a former governmental affairs consultant.
|
|
|
|
|
|
(k)
|
|
In 2006, we issued 30,000 warrants to consultants exercisable immediately for a ten year term at $5.00 per common share.
|
|
(l)
|
|
During 2007, we issued 50,000 warrants exercisable for ten years at $5.00 per common share upon the happening of a commercializing event. The warrants were issued to a consultant who assisted us to potentially place our products in various state school bus programs. We recorded a charge of $249,000 to general and administrative expenses.
|
|
|
|
|
|
(m)
|
|
During 2007, we issued 100,000 warrants immediately exercisable for ten years at an exercise price of $5.00 per common share to two engineering consultants in connection with our engagement to furnish constant velocity joints to a military contractor. We recorded a charge of $401,000 to general and administrative expenses.
|
|
|
|
|
|
(n)
|
|
On February 17, 2010, we issued 100,000 common stock warrants exercisable for ten years at an exercise price of $2.50 per common share to an adviser. We recorded a charge of $45,000 to general and administrative expenses in the first quarter of 2010.
|
|
|
|
|
|
(o)
|
|
On September 23, 2011, we issued 1,625,000 common stock warrants in connection with the sale and issuance of a total of 16,250,000 shares of Series C Voting Convertible Preferred Stock in a private placement transaction, generating gross proceeds of $6,500,000. The warrants have a ten (10) year term and are immediately exercisable for 1,625,000 shares of common stock. The warrants are exercisable, at the holder’s election, for shares of our common stock in either a cash or cashless exercise. The warrants have an exercise price equal to the greater of (i) $0.01 or (ii) eighty percent (80%) of the volume weighted average sale price per share of our common stock during the ten (10) consecutive trading days immediately preceding the notice of exercise. The number of warrants and exercise price are 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. (See Note H[5](c).)
|
|
|
|
|
|
|
|
We typically use the Black-Scholes option-pricing model to estimate the fair value of stock-based awards. However, for the 1,625,000 warrants issued in September 2011, the exercise price is variable based on 80% of the price of our common stock on the date of exercise. For the valuation of these particular warrants, we used a weighted average of assigned probabilities for various gain scenarios at certain price points based on expected volatility of approximately 136% over an assumed term of five years to estimate an overall value of these warrants, which amounted to approximately $812,000, or $.50 per warrant. These inputs are unobservable inputs based on our own assumptions used to measure the value of the instrument. Accordingly, these warrants are classified within Level 3 of the fair value hierarchy in accordance with FASB ASC 820.
|
The following summarizes the activity of our outstanding warrants for the year ended December 31, 2013 and 2012:
|
|
|
Shares
|
|
|
Weighted
Average
Exercise
Price
|
|
|
|
Weighted
Average
Remaining
Contractual
Term (years)
|
|
|
|
Aggregate
Intrinsic
Value
|
|
|
Outstanding at January 1, 2012
|
|
|
3,466,750
|
|
|
$
|
2.18
|
|
(A)
|
|
|
|
|
|
|
|
|
|
|
Granted
|
|
|
0
|
|
|
|
0
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercised
|
|
|
0
|
|
|
|
0
|
|
|
|
|
|
|
|
|
|
|
|
|
Canceled or expired
|
|
|
(36,666
|
)
|
|
|
5.00
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at January 1, 2013
|
|
|
3,430,084
|
|
|
$
|
2.12
|
|
(A)
|
|
|
|
|
|
|
|
|
|
|
Granted
|
|
|
0
|
|
|
|
0
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercised
|
|
|
0
|
|
|
|
0
|
|
|
|
|
|
|
|
|
|
|
|
|
Canceled or expired
|
|
|
(36,666
|
)
|
|
|
5.00
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at December 31, 2013
|
|
|
3,393,418
|
|
|
$
|
2.06
|
|
(A)
|
|
|
6.6
|
|
(B)
|
|
$
|
135,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercisable at December 31, 2012
|
|
|
2,805,084
|
|
|
$
|
2.70
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercisable at December 31, 2013
|
|
|
2,768,418
|
|
|
$
|
2.63
|
|
|
|
|
6.6
|
|
(C)
|
|
$
|
135,000
|
|
|
|
(A)
|
The weighted average exercise price for warrants outstanding as of December 31, 2013, January 1, 2013 and 2012 excludes 1,750,000 warrants in each period with no determined exercise price.
|
|
|
(B)
|
The weighted average remaining contractual term for warrants outstanding as of December 31, 2013 excludes 763,500 warrants with no expiration date.
|
|
|
(C)
|
The weighted average remaining contractual term for warrants exercisable as of December 31, 2013 excludes 138,500 warrants with no expiration date.
|
[13] Warrants Issued to Business, Financial and Engineering Consultants
In 2005, we issued 12,500 warrants to certain consultants, with an exercise price of $0.01 and valued at approximately $43,000. Of the total issued, 3,500 warrants were exercised in 2005 and 2006. Another 6,000 of these warrants were exercised during the year ended December 31, 2010.
During the year ended December 31, 2005, we issued 210,000 warrants valued at approximately $377,000 to certain engineering consultants, immediately exercisable over a ten year term at an exercise price of $5.00 per common share. The engineering consultants holding 150,000 of these warrants agreed to cancel them in the fourth quarter of 2007 in exchange for their participation in the company’s 2007 Commercializing Event Plan. (See Note H[9].)
In connection with our business and financial operations for the year ended December 31, 2006, we issued 91,583 warrants valued at approximately $167,000 to a number of business and financial consultants. Such warrants were immediately exercisable at $.01 per common share, each with a ten year term. During the year ended December 31, 2006, 91,083 of these warrants were exercised for proceeds of $910 and the remaining 500 warrants were exercised during the year ended December 31, 2007 for proceeds of $5.00.
In 2006, we issued 30,000 warrants valued at approximately $168,000 immediately exercisable over a ten year term at $5.00 per common share to certain design engineers.
We issued 400,000 warrants valued at approximately $1,237,000 to a business consultant on August 18, 2006, immediately exercisable over a ten year term at an exercise price of $3.27 per common share. These warrants were modified and reissued upon mutual agreement of the parties effective October 15, 2010. The modification resulted in a replacement warrant for 400,000 shares of common stock immediately exercisable at $.44 per common share for a period of ten years from the modification date. As a result of the modification, we recorded a charge of $68,000 to general and administrative expenses in the fourth quarter of 2010. (See Note H[12]).
On November 21, 2006, we issued 200,000 warrants valued at approximately $948,000 in connection with the engagement of a governmental affairs consultant, immediately exercisable over a ten year term at an exercise price of $3.75 per common share.
During the year ended December 31, 2006, we issued 295,000 warrants to certain engineering consultants, exercisable over a ten year term at an exercise price of $5.00 per common share but only if we were to consummate a commercializing event involving a transaction or series of transactions which results in the sale, license or other technology transfer of one or more of its technologies to a third party for value. These warrants are contingent upon an event occurring in the future and we will fair value these warrants when the contingency is resolved. The engineering consultants holding 295,000 of these warrants agreed to cancel them in the fourth quarter of 2007 in exchange for their participation in our 2007 Commercializing Event Plan. (See Note H[9].)
In 2007, we issued 50,000 warrants, valued at approximately $249,000, immediately exercisable for ten years at an exercise price of $5.00 per common share upon the happening of a commercializing event. The warrants were issued to a consultant to assist us with placing our products in various state school bus programs.
In 2007, we issued 100,000 warrants, valued at approximately $401,000, immediately exercisable for ten years at an exercise price of $5.00 per common share to engineering consultants.
In 2008, we issued 195,000 warrants, valued at approximately $249,000, immediately exercisable for ten years at an exercise price of $5.00 per common share to engineering consultants. In 2010, 95,000 of the total 195,000 warrants issued to these consultants were modified to eliminate the ten-year term and the commercializing event condition for exercise. The charge related to the 2010 modification was insignificant. (See Note H[12e].)
In 2010, we issued a warrant for 100,000 common shares exercisable for 10 years at $2.50 per common share to business consultants.
In December 2011, we amended 110,000 warrants previously issued to an engineering consultant in 2005 and 2006 so that these warrants will be cancelled in conjunction with the vesting of stock options that were issued to replace such warrants, with each option having an exercise price of $1.14 per share, and proportionate vesting on each of the succeeding anniversary dates over a three year period. In 2012, 36,666 warrants were cancelled as the corresponding options vested. In 2013, another 36,666 warrants were cancelled as the corresponding options vested. (See Note H[11](b).)
In 2013 and 2012, 0 common stock warrants were exercised. (See Note H[12].)
[14] Issuance of Stock and Warrants by Subsidiary
In 2003, our majority-owned subsidiary, Ice Surface Development, Inc. issued 308,041 shares of its common stock at a price of $.76 per share and realized aggregate proceeds of $234,000 in a private placement. These issuances reduced our interest in Ice from 72% to approximately 69.26%. Based upon our accounting policy, the change in our proportionate share of Ice’s equity resulting from the additional equity raised by the subsidiary was accounted for as a capital transaction.
In connection with the private placement, Ice issued 53,948 warrants to the placement agent immediately exercisable at $.76 per common share through June 9, 2007. In addition, 50,000 warrants were issued by Ice to a consultant immediately exercisable at $.76 per common share through June 9, 2007. In connection with the issuance of these warrants, a compensation charge of $36,000 was recognized.
These warrants were cancelled effective June 7, 2007 upon the adoption by Ice’s shareholders of a Plan for the Complete Liquidation and Dissolution of Ice.
NOTE I — COMMITMENTS AND OTHER MATTERS
[1] Leases
We lease a facility from a related party (see Note C[2]) located at 1999 Mount Read Blvd., Rochester, New York. On April 29, 2008, we executed a five and one-half year lease for the premises (with a December 1, 2007 lease commencement date), providing for rent to be paid at a rate of $5,687 per month ($68,244 per annum) and in addition, for the payment of our proportionate share of yearly real estate taxes and yearly common area operating costs. Under the lease, monthly rental payments commenced June 1, 2008 and were to continue through May 2013. The lease contained three 5-year renewal options and grants us an option to lease additional adjacent manufacturing and assembly space.
Effective October 24, 2012, we amended certain terms of the lease. The primary changes that were made include a two-year extension of the current lease originally set to expire as of May 31, 2013 at the same rent rate, and the addition of two three-year renewal options with a 10% rate increase at each subsequent renewal period. These renewal options replace the previous renewal options of three 5-year renewal periods which had incorporated 15% rate increases at each subsequent renewal period. (See Note C[2].)
Rent expense for the years ended December 31, 2013 and 2012 was approximately $59,000 and $59,000, respectively. Rent payments required under the amended lease for the years ending December 31, 2014 and 2015 amount to approximately $68,000 and $28,000, respectively.
[2] Employment Agreements
Effective October 4, 2010, we appointed a new chief executive officer and executed a five year employment agreement pursuant to which we will pay base compensation of $50,000 per annum, which compensation increases to $200,000 per annum on the first day of the calendar year immediately following the calendar year in which we have adjusted EBITDA of at least $300,000 (earnings before interest, taxes, depreciation and amortization, but excluding all non-cash expenses associated with stock options). Under the agreement, the executive is entitled to a performance bonus based upon financial targets established each year in good faith by the Governance and Compensation Committee and the achievement of individual management objectives established annually by such committee. The executive is entitled to participate in all employee benefit plans as are provided from time to time for senior executives. If we terminate the executive without cause, remove him as CEO, or a change in control of the Company occurs, the executive is entitled to three years’ severance pay, consisting of base pay and any incentive compensation.
Effective October 18, 2010, we engaged a new chief financial officer under a letter agreement dated October 18, 2010. If we terminate the executive, remove him as CFO, or a change in control of the company occurs, the executive is entitled to 12 months’ severance pay.
[3] Consulting Agreements
Effective July 1, 2010, in two separate agreements, we engaged the services of a consulting firm to provide expertise with business development initiatives, strategic planning and general funding opportunities. We agreed to pay the consultant an annual retainer of $82,500 for both agreements combined, to be paid in quarterly installments. We also agreed to pay the consultant a commission equal to 4% of the value received by us from third parties introduced by or through the auspices of the consultant for a period of a minimum of 4 years beyond the initial term of the agreement. The agreements were for one and two year terms. On March 31, 2011, we signed a modification agreement pursuant to which, in exchange for a one-time payment of $17,250, all of the cash obligations under these two agreements were cancelled. The obligation to pay a 4% commission with respect to the generation of business from efforts initiated by the consultant remains in effect through January 1, 2017.
On December 13, 2010, we executed a three-year consultant agreement with a director to provide consulting services to us at a rate of $200 per hour. Pursuant to the agreement, we also agreed to pay the consultant an incentive fee equal to $10,000 or proportionate part thereof for each $1,000,000 of revenue or proportionate part thereof actually received by us for a period of five years, provided the definitive agreement with the third party results from the material efforts of the consultant. During 2013 and 2012, we recorded an expense of $1,000 and $2,000, respectively, for services rendered in relation to this agreement. In December 2013, the agreement was automatically renewed for an additional three years through December 13, 2016.
Effective as of January 1, 2013, we entered into a one-year consulting agreement with SCIRE Corporation, of which one of our directors is president, to provide us with expertise and advice on hydraulic pump technology and related markets. The consulting agreement provided for a guaranteed minimum of $3,840 per month, based on 32 hours of consulting, plus travel costs. During the twelve month period ended December 31, 2013, we recorded an expense of approximately $51,000 for consulting services and travel costs related to this agreement. On December 4, 2013, we extended this consulting agreement for another year through December 31, 2014, providing for a guaranteed minimum of $2,000 per month, based on 16 hours of consulting, plus travel costs. Additional hours above this minimum in 2014 will be billed at a rate of $125 per hour.
[4] Prototype Development Agreements
On January 28, 2011, we announced that we entered into a contract with a West Virginia remanufacturer of components for the mining and associated industrial equipment industry to develop, evaluate, manufacture and sell our IsoTorque® differential technology in mining shuttle cars. The contract calls for us to design and build a prototype IsoTorque® unit for installation in a 21 SC model mining shuttle car. The remanufacturer will pay us $120,000 for the initial development. Upon successful completion of the prototype phase, the parties have agreed that we will sell 100% of the differential requirements for all 21 SC model mining shuttle cars remanufactured by the remanufacturer on an exclusive basis. Minimum purchase requirements will be established after the first anniversary of the agreement. Through December 31, 2013, we have recorded $90,000 in revenue associated with this agreement, and we have received payment accordingly.
In January 2013, after many months of discussions, we entered into a development agreement with Chinese automotive manufacturer, BAIC Motor Co., Ltd. (“BAIC”). Under the agreement, BAIC will pay us to manufacture a number of prototypes of our IsoTorque® differential for one of BAIC’s anticipated future car models. We will supply BAIC with these prototypes for its evaluation and testing. During the third quarter of 2013, we received an initial cash deposit of approximately $20,000 along with initial documentation and hardware, and we have begun the development work on this project. The total value of this development project is approximately $39,000 with a timetable for completion of our work of 25 weeks from the date we received all items specified from BAIC. At the present time, we expect to deliver prototypes in the latter part of the first quarter 2014. Since there essentially is one performance milestone associated with this agreement, we are deferring the recognition of revenue and related expenses on this project until we deliver the prototype units at the completion of the current development agreement. The initial $20,000 deposit we received is reflected as deferred revenue on the consolidated balance sheet as of December 31, 2013. Similarly, we have deferred approximately $7,000 in expenses related to this contract, and these costs are reflected in prepaid expenses and other current assets on the consolidated balance sheet as of December 31, 2013.
NOTE J — SUBSEQUENT EVENTS
Effective January 22, 2014, General Wesley K. Clark tendered his resignation as a voting member of the Company’s board of directors due to personal reasons. In order to continue to support the Company, Gen. Clark agreed to accept a role as a non-voting special advisor to the board. In connection with this event, the board approved a modification to Gen. Clark’s stock option agreement for 250,000 options (as initially granted on January 28, 2011 and subsequently amended on March 20, 2012), to allow for his stock options to remain intact in his new role as special advisor to the board. As of January 22, 2014, Gen. Clark is considered a non-employee for purposes of determining expense associated with stock compensation, and as such the expense reflected on our consolidated statement of operations will fluctuate based on fair value in accordance with FASB ASC 505-50, “Equity-Based Payments to Non-Employees.” We will recognize an initial adjustment to expense during the first quarter of 2014 as a result of this modification. Fair value will be determined based on updated valuation assumptions for the options using the Black-Scholes valuation model as of the applicable measurement date. The period over which the expense will be recognized will be related to Gen. Clark’s requisite service period for the unvested tranches of the options, which is concurrent with the vesting dates of the remaining unvested tranches of the options.
On March 24, 2014, the board of directors authorized, and the preferred shareholders approved the content and filing of Certificates of Amendment to the Company’s Certificate of Incorporation to create two new series of preferred stock, namely Series C-2 Voting Convertible Preferred stock and Series C-3 Voting Convertible Preferred stock. We filed a Certificate of Amendment to the Certificate of Incorporation on March 28, 2014 (the “Certificate of Amendment”), authorizing 25,000,000 shares of Series C-2 Voting, Convertible Preferred stock with a stated value of $.20 per share. The creation the Series C-3 Voting Convertible Preferred stock is subject to the determination of its stated value by a special committee of the board of directors.
On March 28, 2014, we closed on a private placement transaction that generated gross proceeds of approximately $5,000,000, resulting from the issuance of 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 the Company’s 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, as described in the Certificate of Amendment.
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. 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, and vote with the common stock on an as-converted basis.
We expect to conduct an offering to sell the Series C-3 Preferred stock within the next several months, where up to an additional $1,000,000 of gross proceeds will be raised. Direct expenses associated with these transactions, primarily legal fees, are expected to be in the range of approximately $100,000, which will be offset against the gross proceeds. The Series C-2 Preferred Shares and the Series C-3 Preferred Shares to be sold in the Series C-3 Preferred Offering will not be and have not been registered under the Securities Act of 1933, as amended, or the Securities Act, and may not be offered or sold in the United States absent registration or an applicable exemption from registration requirements. There can be no assurance that the Company will be successful in raising any needed amounts on these terms for these uses or that these amounts will be sufficient for its plans. This disclosure relating to this equity financing from private sources does not constitute an offer to sell or the solicitation of an offer to buy any of the Company’s securities, and is made only as required under applicable law and related reporting requirements, and as permitted under Rule 135c under the Securities Act.