NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NOTE A — THE COMPANY AND BASIS OF PRESENTATION
The interim information contained herein with respect to the three month periods ended March 31, 2015 and 2014 has not been audited but was prepared in conformity with generally accepted accounting principles for interim financial information and instructions for Form 10-Q. Accordingly, the condensed consolidated financial statements do not include all information and footnotes required by generally accepted accounting principles for financial statements. Included are ordinary adjustments which, in the opinion of management, are necessary for a fair presentation of the financial information for the three month periods ended March 31, 2015 and 2014. The results are not necessarily indicative of results to be expected for the entire year.
Torvec, Inc. was incorporated as a New York business corporation on September 25, 1996. Since its inception, the Company has endeavored to design, develop, build and commercialize its technology portfolio. It develops and markets advanced technologies in the areas of power and safety. The Company currently is focusing its commercialization strategies on the following technologies: (i) a wearable device, currently named the WAM Watch™ (Warning Alertness Metrics), which measures degradation of alertness, and (ii) the Torvec Hydraulic Pump. The WAM Watch consists of hardware and software that measures multiple metrics in order to establish that a person’s ability to perform a task or job appears to be degrading. The Torvec Hydraulic Pump is an innovative hydraulic design, whose goal is to deliver better efficiencies in a package that is smaller and lighter than existing technologies.
As used in this quarterly report, unless otherwise indicated, the terms “we”, “our”, “us” and “the Company” refer to Torvec, Inc.
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 March 31, 2015 and December 31, 2014). As of March 31, 2015, each of the subsidiaries is non-operational. 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 $20,000 allowance for doubtful accounts as of March 31, 2015 and December 31, 2014, as determined by management.
Property and Equipment:
Property and equipment are stated at cost. Estimated useful lives are as follows:
Office Equipment and Software
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3 – 7 years
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Leasehold Improvements
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Lesser of useful life or lease term
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Shop Equipment
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3 – 7 years
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Transportation Equipment
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5 years
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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 other income (expense). Depreciation and amortization expense for the three month periods ended March 31, 2015 and 2014 amounted to $33,000 and $43,000, 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 three month periods ended March 31, 2015 and 2014, 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 FASB’s (Financial Accounting Standards Board) 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 March 31, 2015 and December 31, 2014. 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.
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 for the three month periods ended March 31, 2015 and 2014 that was charged to research and development was $20,000 and $24,000, respectively.
Patent costs for the three month periods ended March 31, 2015 and 2014 amounted to $38,000 and $32,000, 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.
FASB ASC 718-20 requires that modifications of the terms or conditions of equity awards be treated as an exchange of the original award for a new award. Incremental compensation cost is measured as the excess, if any, of the fair value of the modified award over the fair value of the original award immediately before its terms are modified.
Income Taxes:
We account for income taxes using the asset and liability method, the objective of which is to establish deferred tax assets and liabilities for the temporary differences between the financial reporting and the tax 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 March 31, 2015, there was $0 accrued interest or penalties related to uncertain tax positions. The tax years 2011 through 2014 remain open to examination by the federal and state tax jurisdictions to which we are subject.
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 March 31, 2015 and 2014, we excluded 53,570,093 and 53,721,662 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 March 31, 2015 and 2014 as the conditions for their vesting are not time-based.
Recent Accounting Pronouncements:
ASU 2014-12, Compensation—Stock Compensation (Topic 718): Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period (a consensus of the FASB Emerging Issues Task Force)
.
ASU 2014-12 requires a performance target that affects vesting and that could be achieved after the requisite service period to be treated as a performance condition. To account for such awards, a reporting entity should apply existing guidance in FASB Accounting Standards Codification Topic 718, Compensation – Stock Compensation, as it relates to awards with performance conditions that affect vesting. ASU 2014-12 is effective for annual periods and interim periods within those annual periods beginning after December 15, 2015.
ASU 2015-1, Income Statement—Extraordinary and Unusual Items (Subtopic 225-20): Simplifying Income Statement Presentation by Eliminating the Concept of Extraordinary Items This ASU eliminates from GAAP the concept of extraordinary items. ASU 2015-1 is effective for the annual period ending after December 15, 2015. Early adoption is permitted provided that the guidance is applied from the beginning of the fiscal year of adoption.
NOTE C — RELATED PARTY TRANSACTIONS
We occupy a leased facility for our corporate headquarters building, located in Rochester, New York, which consists of both executive offices and manufacturing space. The facility is owned by a partnership in which one of our directors is associated.
In October 2012, we extended lease for a three-year renewal term through May 18, 2018. The current rental rate is $5,687 per month ($68,244 per annum) and in June 2015 the rental rate increases to $6,256 per month ($75,070 per annum) for the remainder of the lease term. In addition, we are required to pay a proportionate share of the yearly real estate taxes and yearly common area costs. The lease agreement has a three-year renewal option that includes a 10% rate increase at the renewal period. (See Note G)
During 2010 we executed a 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 each of the three month periods ended March 31, 2015 and 2014, we recorded an expense of $0 for services rendered in relation to this agreement. Cumulatively, through March 31, 2015, we have recorded approximately $3,000 of expense for services rendered in relation to this agreement.
During 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. 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. On November 18, 2014, we extended this consulting agreement for another year through December 31, 2015, providing for a guaranteed minimum of $1,200 per month, based on 8 hours of consulting, plus travel costs. During the three month periods ended March 31, 2015 and 2014, we recorded an expense of approximately $4,000 and $7,000, respectively, for consulting services and travel costs related to this agreement.
Effective April 13, 2015, we entered into a consulting agreement with ProNexus LLC, of which one of our directors, Thomas Bonadio, through his affiliation with The Bonadio Group, is a minority investor. ProNexus LLC has been engaged to provide us with outsource finance and accounting expertise and services. The agreement calls for these services to be billed at an hourly rate and are estimated to aggregate $60,000 in 2015.
NOTE
D
— ACCRUED LIABILITIES
At March 31, 2015 and December 31, 2014, accrued liabilities consist of the following:
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March
31
,
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December 31,
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2015
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2014
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Accrued Compensation
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$
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24,000
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$
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29,000
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Accrued Legal
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13,000
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10,000
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Other
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31,000
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2,000
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$
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68,000
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$
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41,000
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NOTE
E
— NOTES PAYABLE
As of March 31, 2015 and December 31, 2014, notes payable consists of the following:
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March
3
1
,
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December 31,
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2015
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|
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2014
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Copy Machine
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$
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1,000
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|
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$
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2,000
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Automobile
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3,000
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|
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4,000
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|
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$
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4,000
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$
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6,000
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In 2010 we entered into a capital lease for a copy machine over a 5 year term, with a fair market value buyout. 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%.
In 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.
NOTE
F
— STOCKHOLDERS’ EQUITY
Common Stock
We have 400 million common shares authorized with a par value of $0.01 per share. During the three months ended March 31, 2015 we issued 21,380 common shares upon the election of a Class A preferred shareholder conversion and 16,363 common shares issued in satisfaction of Class A preferred dividend distribution.
Preferred Stock
Our certificate of incorporation permits the Company to issue up to 100,000,000 shares of $0.01 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.
Class A Preferred Stock
During the three months ending March 31, 2015, holders of Class A Preferred shares converted 21,380 shares into common stock and the Company settled $65,000 Class A Preferred dividends. No Class A Preferred shares were sold during the three month period ended March, 31, 2015. During the three months ended March 31, 2014, no Class A Preferred shares were converted or dividends settled. Since its designation in March 2002, Class A Preferred shareholders have converted an aggregate 211,130 Class A Preferred into our common stock (on a one to one basis) through March 31, 2015
At March 31, 2015, there were 565,271 outstanding shares of Class A Preferred stock, of which 8,709 shares resulted from the settlement of dividends due to conversion, and those shares no longer accrue dividends. The value of dividends payable upon the conversion of the remaining 557,012 outstanding shares of Class A Preferred stock amounted to approximately $2,240,000 at March 31, 2015, of which $56,000 was accrued during three month period ended March 31, 2015.
The Company has authorized the issuance of up to 3,300,000 Class A Non-Voting Cumulative Convertible Preferred Shares. Each Class A Preferred Share is convertible after a one year holding period, at the holder’s election, into one share of our common stock. The conversion rate is subject to adjustment in the event of the issuance of our common stock as a dividend or distribution and in the case of the subdivision or combination of our common stock. The Class A Preferred has no voting rights except with respect to matters directly impacting the rights and privileges accorded to such Class.
The holders of the Class A Preferred are entitled to receive cumulative preferential dividends in the amount of $0.40 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 one share of Class A Preferred for each $4.00 of dividends. If dividends are paid in shares of Class A Preferred, such dividends are not entitled to accumulate additional dividends and themselves may be converted into the common stock of the Company on a one-to-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 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.
The Company 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.
In the event of the liquidation, dissolution and winding up of the Company, and subject to the liquidation rights and privileges of our Class C Preferred, 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 $2,240,000 and $2,249,000 at March 31, 2015 and December 31, 2014, respectively. In the event of liquidation, dissolution or winding up of the Company, unpaid accumulated dividends on the Class A Preferred are payable in Class A Preferred shares at a rate of 1 share of Class A Preferred for each $4.00 of dividends.
Class B Preferred Stock
No Class B Preferred shares were sold during the three month period ended March 31, 2015 and no Class B Preferred shares were issued to Class B Preferred shareholders as a dividend during the three month period ended March 31, 2015. Depending upon our cash position, from time to time we may request that a converting preferred shareholder entitled to receive dividends in cash consent to receive shares of restricted common stock in lieu thereof.
At March 31, 2015, there were 67,500 outstanding shares of Class B Preferred stock. At March 31, 2015, dividends payable upon the conversion of 67,500 outstanding shares of Class B Preferred amounted to approximately $327,000, of which $8,000 was accrued during the three month period ended March 31, 2015.
Subject to the dividend rights and privileges of our Class A Preferred, the holders of the Class B Preferred are entitled to receive cumulative preferential dividends in the amount of $0.50 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 one share of Class B Preferred for each $5.00 of dividends. If dividends are paid in shares of Class B Preferred, such dividends are not entitled to accumulate additional dividends and themselves may be converted into the common stock of the Company on a one-to-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. At times, our board may elect to settle dividends through the issuance of common stock in lieu of cash. 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.
The Company 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.
In the event of the liquidation, dissolution and winding up of the Company, and subject to the liquidation rights and privileges of our Class C Preferred and Class A Preferred shareholders, the 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 $327,000 and $319,000 at March 31, 2015 and December 31, 2014, respectively. In the event of a liquidation, dissolution or winding up of the Company, unpaid accumulated dividends on the Class B Preferred are payable in Class B Preferred shares at a rate of 1 share of Class B Preferred for each $5.00 of dividends.
Series C Preferred Stock
The Company has authorized and issued 16,250,000 shares of Series C Voting Convertible Preferred Stock. No Series C Preferred stock was converted during the three month period ended March 31, 2015 or during the year ended December 31, 2014. The value of the Series C Preferred shareholders’ liquidation preference was $6,500,000 at March 31, 2015.
Each Series C 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 Series C Preferred shares have no right to receive dividends and no redemption right. The Series C Preferred shares vote with the common stock on an as-converted basis.
The Series C Preferred shares have a liquidation preference at their stated value per share of $0.40 that is senior to our common stock, and the Company’s Class A Non-Voting Cumulative Convertible Preferred Shares and Class B Non-Voting Cumulative Convertible Preferred Shares. The liquidation preference is payable upon a liquidation, dissolution or winding up of the Company, weather voluntary or involuntary or upon a deemed liquidation of the Company.
Series C-2 Preferred Stock
In March 2014, the board of directors authorized, and the Class A Preferred, the Class B Preferred and the Series C Preferred shareholders approved, a series of preferred stock, namely 25,000,000 shares of Series C-2 Voting Convertible Preferred Stock. On March 28, 2014, we sold and issued a total of 25,000,000 shares of Series C-2 Voting Convertible Preferred Stock in a private placement transaction, generating gross proceeds of $5,000,000. Direct expenses of approximately $46,000 pertaining to the transaction, consisting of primarily external legal costs, were incurred, resulting in net proceeds of approximately $4,954,000.
As of March 31, 2015, Series C-2 Preferred shareholders have not converted any shares of Series C-2 Preferred into common stock. At March 31, 2015, there were 25,000,000 shares of Preferred C-2 stock outstanding. The value of the Series C-2 Preferred shareholders’ liquidation preference was $5,000,000 at March 31, 2015.
Each Series C-2 Preferred Share is convertible, at the holder’s election, into one share of our common stock, par value $0.01 per share. The conversion rate is subject to adjustment in the event of the issuance of common stock as a dividend or distribution, and the subdivision or combination of the outstanding common stock or a reorganization, recapitalization, reclassification, consolidation or merger of the Company.
The Series C-2 Preferred Shares have a liquidation preference at their stated value per share of $0.20 that ranks pari passu to our existing Series C Voting Convertible Preferred Shares and is senior to our common stock, and our Class A Non-Voting Cumulative Convertible Preferred Shares and Class B Non-Voting Cumulative Convertible Preferred Shares. The liquidation preference is payable upon a liquidation, dissolution or winding up of the Company, whether voluntary or involuntary, or upon a deemed liquidation of the Company. A deemed liquidation includes, unless decided by the holders of at least two-thirds of the Series C-2 Preferred Shares, any consolidation, merger, or reorganization of the Company in which the shareholders of the Company own less than fifty percent of the voting power of the resultant entity, or an acquisition to which the Company is a party in which at least fifty percent of the Company’s voting power is transferred, or the sale, lease, exclusive license or transfer of all or substantially all of the assets or intellectual property of the Company other than to a wholly owned subsidiary.
The Series C-2 Preferred Shares are not entitled to receive preferred dividends and have no redemption right, but are entitled to participate, on an as converted basis, with holders of outstanding shares of common stock in dividends and distributions on liquidation after all preferred shares have received payment in full of any preferred dividends or liquidation preferences. The Series C-2 Preferred Shares vote with the common stock on an as-converted basis. We may not, without approval of the holders of at least two-thirds of the Series C-2 Preferred Shares, (i) create any class or series of stock that is pari passu or senior to the Series C-2 Preferred Shares; (ii) create any class or series of stock that would share in the liquidation preference of the Series C-2 Preferred Shares or that is entitled to dividends payable other than in common stock or Series C-2 Preferred Shares of its own series, (iii) acquire any equity security or pay any dividend, except dividends on a class or series of stock that is junior to the Series C Preferred Shares, payable in such junior stock, (iv) reissue any Series C-2 Preferred Shares, (v) declare or pay any dividend that would impair the payment of the liquidation preference of the Series C-2 Preferred Shares, (vi) authorize or issue any additional Preferred Shares, (vii) change the Certificate of Incorporation to adversely affect the rights of the holders of the Series C-2 Preferred Shares, or (viii) authorize, commit to or consummate any liquidation, dissolution or winding up in which the liquidation preference of the Series C-2 Preferred Shares would not be paid in full.
In conjunction with the issuance of the 25,000,000 shares of Series C-2 Preferred stock, we computed the value of the non-cash beneficial conversion feature associated with the right to convert the shares into common stock on a one-for-one basis. We compared the fair value of our common stock on the date of issuance with the effective conversion price, and determined that the value of the non-cash beneficial conversion feature is approximately $4,250,000, which is reflected in our condensed consolidated statements of operations for the three month period ended March 31, 2014 as an adjustment to arrive at the net loss attributable to common stockholders.
The Series C-2 Preferred Shares will not be and have not been registered under the Securities Act of 1933, as amended, or the Securities Act, and may not be offered or sold in the United States absent registration or an applicable exemption from registration requirements.
Stock Options
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.
By its terms, our 1998 Plan terminated as to the grant of future options on May 27, 2008. Consequently, no additional stock options will be granted under the 1998 Plan, although outstanding options remain available for exercise in accordance with their terms. There were no options exercised under the 1998 Plan during each of the three month periods ended March 31, 2015 and 2014.
Through March 31, 2015, 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 March 31, 2015, there were 100,000 outstanding stock options under the 1998 Plan, all of which were fully vested.
2011 Stock Option Plan
In 2011, shareholders approved the 2011 Stock Option Plan (the “2011 Plan”) which provides for the grant of up to 3,000,000 common stock options to provide equity incentives to directors, officers, employees and consultants. Two types of options may be granted under the 2011 Plan: non-qualified stock options and incentive stock options.
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.
During the three month period ended March 31, 2015, we granted 20,000 stock options under the 2011 Plan, 125,375 options became vested, and no options expired or were exercised. During the three month period ended March 31, 2014, we granted 500 stock options under the 2011 Plan, 125,250 options became vested, and no options expired or were exercised. As of March 31, 2015, there were 1,298,000 stock options outstanding under the 2011 Plan, 837,875 of which were vested. At March 31, 2015, there were 1,702,000 options remaining available for future grant under the 2011 Plan.
During the three months ended March 31, 2015 we modified 50,000 options previously granted to the Company’s former CFO. On February 5, 2015, in consideration for the former CFO’s willingness to assist in the transition to a new accounting team, the Company has agreed to modify the option agreement so that the unvested portion remains intact for the full term of the original stock option agreement. We used the Black-Scholes option-pricing model to value the cost of this modification which was an immaterial amount for the three months ended March 31, 2015. These options vest upon the first day the closing trading price of the common stock of the Company shall be $10.00 or greater. Since they are now held by a non-employee we will revalue the fair value of these options on a quarterly basis through the vesting period.
During 2014, we granted incentive stock options to new and existing employees to acquire a total of 21,000 common shares at exercise prices ranging from $.20 to $.40 per share, exercisable for 10 years. The options vest in four tranches of 25% of the total granted shares on each of the four annual anniversary dates from the initial date of grant. Also in 2014, we granted incentive stock options to several employees to acquire a total of 200,000 common shares at an exercise price of $.22 per share, exercisable for 10 years. The options will fully vest upon the first day the closing trading price of the common stock of the Company shall be $10.00 or greater.
Non-Plan Options
As of March 31, 2015, there were a total of 6,965,000 non-plan options outstanding, of which 4,815,000 were fully vested. During each of the three month periods ended March 31, 2015 and 2014, we granted no non-plan stock options, 337,500 options became vested, and no options were exercised or cancelled.
Option Summary
For the three month periods ended March 31, 2015 and 2014, compensation cost related to all stock options amounted to $53,000 and $13,000, respectively. As of March 31, 2015, there was approximately $178,000 of total unrecognized compensation costs related to outstanding stock options, which are expected to be recognized over a weighted average 1.3 years.
During the three month period ended March 31, 2015 and 2014, we granted 20,000 stock options with a weighted average grant-date fair value of $0.20 and 500 stock options with weighted average grant-date fair value of $0.34 respectively. The total grant date fair value of all stock options vested during the three month periods ended March 31, 2015 and 2014 was approximately $653,000 and $688,000, respectively.
The fair value of each option granted during the three month periods ended March 31, 2015 and 2014 was estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions:
|
|
2015
|
|
|
2014
|
|
Expected Term (in years)
|
|
6.6
|
|
|
6.3
|
|
Expected forfeiture rate
|
|
|
0
|
%
|
|
|
0
|
%
|
Risk-free rate
|
|
|
2.1
|
%
|
|
|
1.9
|
%
|
Volatility
|
|
|
135.0
|
%
|
|
|
134.3
|
%
|
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 term 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 three month period ended March 31, 2015:
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|
|
|
|
|
|
|
Weighted
|
|
|
|
|
|
|
|
|
|
|
|
|
Average
|
|
|
|
|
|
|
|
|
|
|
Weighted
|
|
Remaining
|
|
|
|
|
|
|
|
|
|
|
Average
|
|
Contractual
|
|
Aggregate
|
|
|
|
|
|
|
|
Exercise
|
|
Term
|
|
Intrinsic
|
|
|
|
Shares
|
|
|
Price
|
|
(in years)
|
|
Value
|
|
Outstanding at January 1, 2015
|
|
|
8,343,000
|
|
|
$
|
0.63
|
|
6.0
|
|
|
0
|
|
Granted
|
|
|
20,000
|
|
|
|
0.20
|
|
|
|
|
|
|
Exercised
|
|
|
0
|
|
|
|
0
|
|
|
|
|
|
|
Canceled or expired
|
|
|
0
|
|
|
|
0
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at March 31, 2015
|
|
|
8,363,000
|
|
|
$
|
0.63
|
|
5.8
|
|
$
|
0
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercisable at March 31, 2015
|
|
|
5,752,875
|
|
|
$
|
0.74
|
|
5.6
|
|
$
|
0
|
|
As of March 31, 2015, the exercise prices of all outstanding stock options, as well as all vested stock options, ranged from $0.20 per share to $5.00 per share.
Warrants
The following summarizes the activity of our outstanding warrants for the three month period ended March 31, 2015:
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|
|
|
|
|
|
|
|
|
Weighted
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
|
|
|
Remaining
|
|
|
|
|
|
|
|
|
|
|
|
Average
|
|
|
Contractual
|
|
|
Aggregate
|
|
|
|
|
|
|
|
Exercise
|
|
|
Term
|
|
|
Intrinsic
|
|
|
|
Shares
|
|
|
Price
|
|
|
(in years)
|
|
|
Value
|
|
Outstanding at January 1, 2015
|
|
|
3,356,750
|
|
|
$
|
1.99
|
(A)
|
|
|
5.6
|
|
|
$
|
77,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Granted
|
|
|
0
|
|
|
|
0
|
|
|
|
|
|
|
|
|
|
Exercised
|
|
|
0
|
|
|
|
0
|
|
|
|
|
|
|
|
|
|
Canceled or expired
|
|
|
33,250
|
|
|
|
0.01
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at March 31, 2015
|
|
|
3,323,500
|
|
|
$
|
2.03
|
(A)
|
|
|
5.4
|
(B)
|
|
$
|
56,200
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercisable at March 31, 2015
|
|
|
2,698,500
|
|
|
$
|
2.63
|
|
|
|
5.4
|
(C)
|
|
$
|
56,200
|
|
|
(A)
|
The weighted average exercise price for warrants outstanding as of January 1, 2015 and March 31, 2015 excludes 1,750,000 warrants with no determined exercise price.
|
|
|
|
|
(B)
|
The weighted average remaining contractual term for warrants outstanding as of March 31, 2015 excludes 743,500 warrants with no expiration date.
|
|
|
|
|
(C)
|
The weighted average remaining contractual term for warrants exercisable as of March 31, 2015 excludes 138,500 warrants with no expiration date.
|
NOTE
G
— COMMITMENTS AND OTHER MATTERS
Leases
We occupy a leased facility for our corporate headquarters building, located in Rochester, New York, which consists of both executive offices and manufacturing space. The facility is owned by a partnership in which one of our directors is associated. (See Note C).
In October 2014, we extended lease for a three-year renewal term through May 18, 2018. The current rental rate is $5,687 per month ($68,244 per annum) and in June 2015 the rental rate increases to $6,256 per month ($75,070 per annum) for the remainder of the lease term. In addition, we are required to pay a proportionate share of the yearly real estate taxes and yearly common area costs. The lease agreement has a three-year renewal option that includes a 10% rate increase at the renewal period.
Rent expense for each of the three month periods ended March 31, 2015 and 2014 was approximately $17,000. Including consideration for the first three-year renewal option period, rent payments required under the lease for each the full years ending December 31, 2015, 2016, 2017, 2018 and 2019 amount to approximately $68,000, $72,000, $75,000, $75,000 and $31,000, respectively.
Employment Agreements
In 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).In September 2014, the CEO agreed to temporarily reduce his base compensation to $25,000 per annum. 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, 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.
Consulting Agreements
In 2010, we engaged the services of a consulting firm to provide expertise with business development initiatives, strategic planning and general funding opportunities. In 2011, the agreement was modified to pay the consultant a commission equal to 4% of the value received by us from third parties introduced to us by or through the auspices of the consultant through January 1, 2017.
Cumulatively, through March 31, 2015, we have recorded approximately $3,000 of expense for services rendered in relation to this agreement.
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. In December 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. During the three month periods ended March 31, 2015 and 2014, we recorded an expense of approximately $4,000 and $7,000, respectively, for consulting services and travel costs related to this agreement. In November 2014, we extended this consulting agreement for another year through December 31, 2015, providing for a guaranteed minimum of $1,200 per month, based on 8 hours of consulting, plus travel costs. Additional hours above this minimum in 2015 will be billed at a rate of $150 per hour.
Prototype Development Agreements
In January 2013, we entered into a development agreement with Chinese automotive manufacturer, BAIC Motor Co., Ltd. (“BAIC”). During the second quarter of 2014, we recorded approximately $39,000 in revenue associated with this agreement, along with related expenses of approximately $50,000. In December 2014, we recorded an uncollectible reserve against the outstanding receivable balance of approximately $20,000 due to the delinquency in receiving payment from this customer. Collection efforts continue to be pursued from this customer.