NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. Business Organization,
Nature of Operations and Basis of Presentation
Provectus Biopharmaceuticals, Inc., a Delaware corporation (together with its subsidiaries,
Provectus or the Company), is a biopharmaceutical company that is focusing on developing minimally invasive products for the treatment of psoriasis and other topical diseases, and certain forms of cancer including melanoma,
breast cancer, and cancers of the liver. To date, the Company has not generated any revenues from planned principal operations. The Companys activities are subject to significant risks and uncertainties, including failing to successfully
develop and license or commercialize the Companys prescription drug candidates, or sell or license the Companys
over-the-counter
(OTC) products
or
non-core
technologies.
The accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with accounting principles generally accepted in the United States of America (GAAP) for interim financial information pursuant to
Regulation S-X.
Accordingly, they do
not include all of the information and footnotes required by GAAP for complete financial statements and should be reviewed in conjunction with the Companys audited consolidated financial statements included in Form
10-K
for the year ended December 31, 2016 filed with the U.S. Securities and Exchange Commission (SEC) on March 31, 2017. In the opinion of management, all adjustments (consisting of normal
recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three months ended March 31, 2017 are not necessarily indicative of the results that may be expected for the year ending
December 31, 2017.
2. Liquidity and Financial Condition
The Companys cash and cash equivalents were $436,952 at March 31, 2017, compared with $1,165,738 at December 31, 2016. The Company continues
to incur significant operating losses and management expects that
significant on-going operating
expenditures will be necessary to successfully implement the Companys business plan and develop
and market its products. These circumstances raise substantial doubt about the Companys ability to continue as a going concern within one year after the date that the financial statements are issued. Implementation of the Companys plans
and its ability to continue as a going concern will depend upon the Companys ability to
develop PV-10 and
raise additional capital.
Term Sheet for 2017 Financing
On March 23, 2017,
the Company entered into an exclusive Definitive Financing Commitment Term Sheet with a group of the Companys stockholders (the PRH Group), which was amended and restated effective as of March 19, 2017 (the Term
Sheet), which sets forth the terms on which the PRH Group will use their best efforts to arrange for a financing of a minimum of $10,000,000 and maximum of $20,000,000 (the 2017 Financing), $2,500,000 of which was funded into
Escrow (as defined below) upon the execution of definitive documents, and the $2,500,000 Wachter Note (as defined below) was exchanged for a PRH Note (as defined below) on the terms described below upon the funding of such First Tranche into Escrow.
The 2017 Financing will be in the form of a secured convertible loan (the Loan) from the PRH Group or other investors in the 2017 Financing
(the Investors). The Loan will be evidenced by secured convertible promissory notes (individually a PRH Note and collectively, the PRH Notes) from the Company to the PRH Group or the Investors. In addition to the
customary provisions, the PRH Note shall contain the following provisions:
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(i)
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It will be secured by a first priority security interest on the Companys intellectual property (the IP);
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(ii)
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The Loan will bear interest at the rate of eight percent (8%) per annum on the outstanding principal amount of the Loan that has been funded to the Company;
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(iii)
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The Loan proceeds will be held in one or more accounts (the Escrow) pending the funding of the tranches of the 2017 Financing pursuant to borrowing requests made by the Company;
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(iv)
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In the event there is a change of control of the Companys board of directors (Board) as proposed by any person or group other than the Investors, the term of the PRH Note will be accelerated and all
amounts due under the PRH Note will be immediately due and payable, plus interest at the rate of eight percent (8%) per annum, plus a penalty in the amount equal to ten times (10x) the outstanding principal amount of the Loan that has been funded to
the Company;
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(v)
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The outstanding principal amount and interest payable under the Loan will be convertible at the sole discretion of the Investors into shares of the Companys Series D Preferred Stock, a new series of preferred
stock to be designated by the Board, at a price per share equal to $0.2862; and
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5
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(vi)
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Notwithstanding (v) above, the principal amount of the PRH Note and the interest payable under the Loan will automatically convert into shares of the Companys Series D Preferred Stock at a price per share
equal to $0.2862 effective on the 18 month anniversary of the funding of the final tranche of the 2017 Financing subject to certain exceptions.
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The Series D Preferred Stock shall have a first priority right to receive proceeds from the sale, liquidation or dissolution of the Company or any of the
Companys assets (each, a Company Event). If a Company Event occurs within two (2) years of the date of issuance of the Series D Preferred Stock (the Date of Issuance), the holders of Series D Preferred Stock shall
receive a preference of four times (4x) their respective investment amount. If a Company Event occurs after the second (2nd) anniversary of the Date of Issuance, the holders of the Series D Preferred Stock shall receive a preference of six times
(6x) their respective investment amount.
The Series D Preferred Stock shall be convertible at the option of the holders thereof into shares of the
Companys common stock based on a formula to achieve
a one-for-one conversion
ratio. The Series D Preferred Stock shall automatically convert into shares
of Common Stock upon the fifth anniversary of the Date of Issuance. On
an as-converted basis,
the Series D Preferred Stock shall carry the right to one (1) vote per share. The Series D Preferred
Stock shall not have any dividend preference but shall be entitled to receive, on a pari passu basis, dividends, if any, that are declared and paid on any other class of the Companys capital stock. The holders of Series D Preferred Stock shall
not have anti-dilution protection.
Subsequent to March 31, 2017, the Company received an aggregate of $3,000,000 in the form of secured convertible
loans in connection with the First Tranche and Second Tranche, as described in the Term Sheet. See Note 7 Subsequent Events.
The Company plans to
access capital resources through possible public or private equity offerings, including the 2017 Financing, exchange offers, debt financings, corporate collaborations or other means. In addition, the Company continues to explore opportunities to
strategically monetize its lead drug
candidates, PV-10 and PH-10, through
potential co-development and
licensing transactions, although there can be no assurance that the Company will be successful with such plans. The Company has historically been able to raise capital
through equity offerings, although no assurance can be provided that it will continue to be successful in the future. If the Company is unable to raise sufficient capital through the 2017 Financing or otherwise, it will not be able to pay its
obligations as they become due.
NYSE Delisting
On
October 13, 2016, the Company received notice from NYSE MKT that NYSE MKT commenced delisting procedures and immediately suspended trading in the Companys common stock and class of warrants that was listed on NYSE MKT (Listed
Warrants) and on October 17, 2016, our common stock began trading on the OTCQB Marketplace. On October 20, 2016, the Company submitted a request for a review of such delisting determination and on November 10, 2016, the Company
submitted to the Listing Qualifications Panel its written submission in connection with its appeal. In addition, on November 23, 2016, the Company received notice from NYSE MKT stating that the Company is not in compliance with the
Exchanges continued listing standards. Specifically, the Company is not in compliance with Section 1003(a)(iii) of the NYSE MKT Company Guide (requiring stockholders equity of $6.0 million or more if the Company has reported losses
from continuing operations and/or net losses in its five most recent fiscal years). As of December 31, 2016, the Company had stockholders equity of approximately $3.5 million.
The hearing before the Listing Qualifications Panel occurred on January 25, 2017. On January 31, 2017, the Company received notice from the Listing
Qualifications Panel that it affirmed NYSE MKTs original determination to delist the Companys common stock and Listed Warrants. On February 14, 2017, the Company submitted a request for the Committee for Review to reconsider the
Listing Qualification Panels decision. The Committee for Review considered the Companys request for review on March 30, 2017. On April 21, 2017, the NYSE MKT filed a Form 25 with the SEC, notifying the SEC of the NYSE
MKTs intention to remove the Companys shares of common stock and Listed Warrants from listing and registration on the NYSE MKT effective May 1, 2017, pursuant to the provisions of Rule
12d2-2(b)
of the Securities Exchange Act of 1934, as amended. The Companys common stock and Listed Warrants continue to trade on the OTCQB following the delisting from the NYSE MKT under the trading
symbols PVCT and PVCTWS, respectively. The Company can provide no assurance that its common stock and Listed Warrants will continue to trade on the OTCQB in the future, however.
3. Significant Accounting Policies
The Companys
significant accounting policies are disclosed in Note 3 Significant Accounting Policies in the Companys Annual Report on Form
10-K
for the year ended December 31, 2016. Since the date of the
Annual Report, there have been no material changes to the Companys significant accounting policies, except as disclosed below.
Recent Accounting
Pronouncements
In March 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU)
No. 2016-03,
Derivatives and Hedging (Topic 815): Contingent Put and Call Options in Debt Instruments, which clarifies the requirements for assessing whether contingent call or put options that can
accelerate the repayment of principal on debt instruments are clearly and
6
closely related to their debt hosts. This guidance will be effective for annual reporting periods beginning after December 15, 2016, including interim periods within those annual reporting
periods, and early adoption is permitted. The adoption of this ASU did not have a material impact on the Companys condensed consolidated financial statements.
In March 2016, the FASB issued
ASU No. 2016-09, Compensation-Stock
Compensation (Topic 718):
Improvements to Employee Share-Based Payment Accounting. This ASU makes targeted amendments to the accounting for employee share-based payments. This guidance is to be applied using various transition methods such as full retrospective,
modified retrospective, and prospective based on the criteria for the specific amendments as outlined in the guidance. The guidance is effective for annual periods, and interim periods within those annual periods, beginning after December 15,
2016. Early adoption is permitted, as long as all of the amendments are adopted in the same period. The Company intends to apply this ASU prospectively and its adoption is not expected to have a material impact on the Companys condensed
consolidated financial statements.
In October 2016, the FASB issued ASU
No. 2016-17,
Consolidation
(Topic 810) Interests Held through Related Parties That Are under Common Control (ASU
2016-17).
ASU
2016-17
requires, when assessing which party
is the primary beneficiary in a VIE, that the decision maker considers interests held by entities under common control on a proportionate basis instead of treating those interests as if they were that of the decision maker itself, as current GAAP
requires. The ASU is effective for annual periods, and interim periods therein, beginning after December 15, 2016. Early application is permitted in any interim or annual period. The adoption of this ASU did not have a material impact on the
Companys condensed consolidated financial statements.
4. Related Party Transactions
Convertible Promissory Note
On February 21, 2017,
the Company issued a promissory note in favor of Eric A. Wachter, the Companys Chief Technology Officer (Lender), evidencing an unsecured loan from Lender to the Company in the original principal amount of up to $2,500,000 (the
Wachter Note). Interest accrues on the outstanding balance of the Wachter Note at six percent (6%) per annum calculated on
a 360-day basis.
Pursuant to the terms of the Wachter Note, in the event that, prior to the repayment in full of the Wachter Note, the Company consummates a bona fide equity
financing conducted with the principal purpose of raising capital, pursuant to which the Company sells shares or units of an equity security or preferred equity approved by the board of directors, which board of directors must consist of at least a
majority of the members on the board of directors serving as of the date of the Wachter Note (a Qualified Equity Financing), then such amount of the outstanding principal due under the Wachter Note plus all accrued but unpaid interest
that may be included in the Qualified Equity Financing shall automatically convert into the equity securities or securities convertible into equity securities of the Company issued in such Qualified Equity Financing (New Securities) at
the price per New Security at which the Company issues any New Securities in any public or private offering during the period that the Wachter Note is outstanding and otherwise on the same terms (including the same rights, preferences and
privileges) as the other investors that purchase New Securities in such Qualified Equity Financing.
The Wachter Note matures on the earlier of
(i) May 22, 2017, (ii) the date upon which the Company defaults under the Wachter Note or (iii) the date on which the Wachter Note is converted into New Securities (the earliest of such dates, the Maturity Date). In lieu
of repayment on the Maturity Date, Lender may elect in his sole discretion to apply any and all amounts due and owing to Lender under the Wachter Note to Lenders obligations under that certain Settlement Agreement dated June 6, 2014 by
and between Lender and the Company.
As of March 31, 2017, the Company has borrowed the entire $2,500,000 principal amount under the Wachter Note.
The Company evaluated the terms of the Wachter Note and determined that since the conversion price is not yet fixed and will be based upon the price per New Security issued upon the completion of a future Qualified Equity Financing, that the
measurement of a beneficial conversion feature cannot be completed. The Wachter Note was amended and restated on April 3, 2017. See Note 7 Subsequent Events.
Further, under the Wachter Note, the Company has agreed to pay to Lender up to $25,000 for Lenders reasonable legal fees and expenses incurred in
connection with the transactions contemplated by the Wachter Note. As of March 31, 2017, the Company has not paid any of Lenders legal expenses. The Company may prepay principal and interest under the Wachter Note at any time, in whole or
in part, without premium or other prepayment charges.
Pursuant to a Waiver of Rights Agreement, Lender further agreed to waive his rights (A) to
foreclose on the assets of the Company or (B) to initiate, or cause the initiation of, any proceeding in bankruptcy or the appointment of any custodian, trustee or liquidator of the Company or of all or a portion of the Companys assets in
the event of default under the Wachter Note so long as (i) any shares of Series C Preferred Stock of the Company issued pursuant to the Rights Offering commenced by the Company on January 30, 2017 remain outstanding (other than such shares
of Series C Preferred Stock held by Lender) and (ii) a change in control of the Company has not occurred, which is any transaction that results in either (a) the shareholders of the Company not continuing to hold at least 50% of the voting
interest in the Company after such transaction or (b) the directors of the Company serving on the board of directors as of February 21, 2017 no longer represent a majority of the outstanding board members.
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5. Stockholders Deficiency
Termination of Rights Offering
On October 5, 2016,
the Company filed a registration statement on
Form S-1 with
the SEC, as amended on November 1, 2016, November 22, 2016, December 6, 2016, December 21, 2016, January 19, 2017
and January 26, 2017 to issue subscription rights (Rights) to the Companys existing common stockholders and holders of the Companys class of warrants with an exercise price of $0.85 expiring June 19, 2020 (the
Listed Warrants) to purchase units (Units) consisting of shares of common stock and Series C Preferred Stock (the Rights Offering). Each share of Series C Preferred Stock was to be convertible into eight
(8) shares of common stock. Each Right would have entitled holders of the Companys common stock and Listed Warrants to purchase one Unit. On March 20, 2017, the Company announced the termination of the Rights Offering without
accepting any funds from investors. Broadridge Corporate Issuer Solutions, Inc., the subscription agent for the Rights Offering (Broadridge), returned all subscription payments received by Broadridge to investors, without interest or
penalty. All subscription rights expired upon termination of the Rights Offering. On March 24, 2017, the Company filed a Certificate of Elimination to cancel the Series C Preferred Stock with the Secretary of State of the State of Delaware.
Conversion of Series B Preferred Stock
During the
three months ended March 31, 2017, holders converted 8,500 shares of Series B Preferred Stock into 3,986,676 shares of common stock such that they were entitled to dividends, including a make-whole payment, that the Company elected to pay in
shares of common stock. As a result, the Company issued 1,594,670 shares of common stock related to the Series B Preferred Stock dividends during the three months ended March 31, 2017. The Company recorded aggregate dividends paid in kind of
$14,007 during the three months ended March 31, 2017.
6. Litigation
Kleba Shareholder Derivative Lawsuit
On January 2,
2013, Glenn Kleba, derivatively on behalf of the Company, filed a shareholder derivative complaint in the Circuit Court for the State of Tennessee, Knox County (the Court), against Dr. Dees, Timothy C. Scott, Eric A. Wachter, and
Peter R. Culpepper (collectively, the Executives), Stuart Fuchs, Kelly M. McMasters, and Alfred E. Smith, IV (collectively, together with the Executives, the Individual Defendants), and against the Company as a nominal
defendant (the Shareholder Derivative Lawsuit). The Shareholder Derivative Lawsuit alleged (i) breach of fiduciary duties, (ii) waste of corporate assets, and (iii) unjust enrichment, all three claims based on
Mr. Klebas allegations that the defendants authorized and/or accepted stock option awards in violation of the terms of the Companys 2002 Stock Plan (the Plan) by issuing stock options in excess of the amounts authorized
under the Plan and delegated to defendant Dr. Dees the sole authority to grant himself and the other Executives cash bonuses that Mr. Kleba alleges to be excessive.
In April 2013, the Companys Board of Directors appointed a special litigation committee to investigate the allegations of the Shareholder Derivative
Complaint and make a determination as to how the matter should be resolved. The special litigation committee conducted its investigation, and proceedings in the case were stayed pending the conclusion of the committees investigation. At that
time, the Company established a reserve of $100,000 for potential liabilities because such is the amount of the self-insured retention of its insurance policy. On February 21, 2014, an Amended Shareholder Derivative Complaint was filed which
added Don B. Dale (Mr. Dale) as a plaintiff.
On March 6, 2014, the Company filed a Joint Notice of Settlement (the Notice of
Settlement) in the Shareholder Derivative Lawsuit. In addition to the Company, the parties to the Notice of Settlement are Mr. Kleba, Mr. Dale and the Individual Defendants.
On June 6, 2014, the Company, in its capacity as a nominal defendant, entered into a Stipulated Settlement Agreement and Mutual Release (the
Settlement) in the Shareholder Derivative Lawsuit. In addition to the Company and the Individual Defendants, Plaintiffs Glenn Kleba and Don B. Dale are parties to the Settlement.
By entering into the Settlement, the settling parties resolved the derivative claims to their mutual satisfaction. The Individual Defendants have not admitted
the validity of any claims or allegations and the settling plaintiffs have not admitted that any claims or allegations lack merit or foundation. Under the terms of the Settlement, (i) the Executives each agreed
(A) to re-pay to
the Company $2.24 million of the cash bonuses they each received in 2010 and 2011, which amount equals 70% of such bonuses or an estimate of
8
the after-tax net
proceeds to each Executive; provided, however, that subject to certain terms and conditions set forth in the Settlement, the
Executives are entitled to a 2:1 credit such that total actual repayment may be $1.12 million each; (B) to reimburse the Company for 25% of the actual costs, net of recovery from any other source, incurred by the Company as a result of the
Shareholder Derivative Lawsuit; and (C) to grant to the Company a first priority security interest in 1,000,000 shares of the Companys common stock owned by each such Executive to serve as collateral for the amounts due to the Company
under the Settlement; (ii) Drs. Dees and Scott and Mr. Culpepper agreed to retain incentive stock options for 100,000 shares but shall forfeit 50% of the nonqualified stock options granted to each such Executive in both 2010 and 2011. The
Settlement also requires that each of the Executives enter into new employment agreements with the Company, which were entered into on April 28, 2014, and that the Company adhere to certain corporate governance principles and processes in the
future. Under the Settlement, Messrs. Fuchs and Smith and Dr. McMasters have each agreed to pay the Company $25,000 in cash, subject to reduction by such amount that the Companys insurance carrier pays to the Company on behalf of such
defendant pursuant to such defendants directors and officers liability insurance policy. The Settlement also provides for an award to plaintiffs counsel of attorneys fees and reimbursement of expenses in connection with their role
in this litigation, subject to Court approval.
On July 24, 2014, the Court approved the terms of the proposed Settlement and awarded $911,000 to
plaintiffs counsel for attorneys fees and reimbursement of expenses in connection with their role in the Shareholder Derivative Lawsuit. The payment to plaintiffs counsel was made by the Company during October 2014 and was recorded
as other current assets at December 31, 2014, as the Company is seeking reimbursement of the full amount from its insurance carrier. If the full amount is not received from insurance, the amount remaining will be reimbursed to the Company from
the Individual Defendants. As of March 31, 2017 and December 31, 2016, the net amount of the receivable of $455,500 is reported as
non-current assets
on the condensed consolidated balance
sheets.
On October 3, 2014, the Settlement was effective and stock options for Dr. Dees, Dr. Scott and Mr. Culpepper were rescinded,
totaling 2,800,000. $900,000 was repaid by the Executives as of December 31, 2015 and $600,000 was repaid by the Executives during the year ended December 31, 2016. The remaining cash settlement amounts will continue to be repaid to the
Company over the next three years with the final payment to be received by October 3, 2019. The remaining balance due the Company as of March 31, 2017 is $1,224,345, including a reserve for uncollectibility of $1,549,043 in connection with
the resignation of Dr. Dees and termination of Mr. Culpepper, with a present value discount remaining of $57,623. As a result of his resignation, Dr. Dees is no longer entitled to the 2:1 credit, such that his total repayment
obligation of $2,040,000 (the total $2.24 million owed by Dr. Dees pursuant to the Settlement less the $200,000 that he repaid) plus Dr. Deess proportionate share of the litigation costs is immediately due and payable. The
Company sent Dr. Dees a notice of default in March 2016 for the total amount he owes the Company. As a result of his termination for cause, Mr. Culpepper is no longer entitled to the 2:1 credit, such that his total repayment
obligation of $2,051,083 (the total $2,240,000 owed by Mr. Culpepper pursuant to the Settlement plus Mr. Culpeppers proportionate share of the litigation cost of $227,750 less the $416,667 that he repaid) is immediately due and
payable. The Company sent Mr. Culpepper a notice of default in January 2017 for the total amount he owes the Company. Mr. Culpepper disputes that he was terminated for cause and thus disputes that he owes the full $2,051,083
repayment amount under the Settlement.
Dees Collection Lawsuit
On May 5, 2016, the Company filed a lawsuit in the United States District Court for the Eastern District of Tennessee at Knoxville against Dr. Dees
and his wife, Virginia Godfrey (together with Dr. Dees, the Defendants). The Company alleges that between 2013 and the present, Dr. Dees received approximately $2.4 million in advanced or reimbursed travel and
entertainment expenses from the Company and that Dr. Dees did not use these funds for legitimate travel and entertainment expenses as he requested and the Company intended. Instead, the Company alleges that Dr. Dees created false receipts
and documentation for the expenses and applied the funds to personal use. The Company and Dr. Dees are parties to a Stipulated Settlement Agreement dated June 6, 2014 (the Kleba Settlement Agreement) that was negotiated to
resolve certain claims asserted against Dr. Dees derivatively. Pursuant to the terms of the Kleba Settlement Agreement, Dr. Dees agreed to repay the Company compensation that was paid to him along with legal fees and other expenses
incurred by the Company. As of the date of his resignation, Dr. Dees still owed the Company $2,267,750 under the Kleba Settlement Agreement. Dr. Dees has failed to make such payment, and the Company has notified him that he is in default
and demanded payment in full. The Company has established a reserve of $2,267,750 as of March 31, 2017 and December 31, 2016, which amount represents the amount the Company currently believes Dr. Dees owes to the Company, while the
Company pursues collection of this amount. Therefore, the Company is alleging counts of conversion, fraud, breach of fiduciary duty, breach of contract, breach of Kleba Settlement Agreement, unjust enrichment and punitive damages in this lawsuit.
The Company is seeking that the Defendants be prohibited from disposing of any property that may have been paid for with the misappropriated funds, the Defendants be disgorged of any funds shown to be fraudulently misappropriated and that the
Company be awarded compensatory damages in an amount not less than $5 million. Furthermore, the Company is seeking for the damages to be joint and several as to the Defendants and that punitive damages be awarded against Dr. Dees in the
Companys favor. The Company is also seeking foreclosure of the Companys first-priority security interest in the 1,000,000 shares of common stock granted by Dr. Dees to the Company as collateral pursuant to that certain Stock Pledge
Agreement dated October 3, 2014, between Dr. Dees and the Company in order to secure Dr. Dees obligations under the Kleba Settlement Agreement. The United States District Court for the Eastern District of Tennessee at Knoxville
entered a default judgment against the Defendants on July 20, 2016; however, the Company cannot predict when these
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shares will be recovered by the Company. The Court recently issued a Temporary Restraining Order upon the Companys application for same upon notice that Dr. Dees was attempting to sell
his shares of the Companys common stock. The Temporary Restraining Order was converted to a Preliminary Injunction on September 16, 2016, which order will remain in place until the resolution of the underlying lawsuit absent further court
order or agreement of the parties. On March 15, 2017, the Court granted Ms. Godfreys motion to set aside the default judgment against her and set a deadline of March 30, 2017 for Ms. Godfrey to file an answer to the
Companys complaint. Ms. Godfrey filed her answer on March 28, 2017 demanding that the complaint against her be dismissed. The Court held a hearing on April 26, 2017 to determine damages with respect to the motion for default
judgment against Dr. Dees. The Court requested additional briefing on damages. The Companys brief is due on May 26, 2017.
Mr. Culpepper Travel Expenses and Related Collection Efforts
On December 27, 2016, the Companys Board of Directors unanimously voted to terminate Peter R. Culpepper, effective immediately, from all positions
he held with the Company and each of its subsidiaries, including Interim Chief Executive Officer and Chief Operating Officer of the Company, for cause, in accordance with the terms of the Amended and Restated Executive Employment Agreement entered
into by Peter R. Culpepper and the Company on April 28, 2014 (the Culpepper Employment Agreement) based on the results of the investigation conducted by a Special Committee of the Board of Directors regarding improper travel expense
advancements and reimbursements to Mr. Culpepper.
The Special Committee retained independent counsel and an advisory firm with forensic accounting
expertise to assist the Special Committee in conducting the investigation. The Special Committee found that Mr. Culpepper received $294,255 in travel expense reimbursements and advances that were unsubstantiated. The Company seeks to recover
from Mr. Culpepper the entire $294,255 in unsubstantiated travel expense reimbursements and advances, as well as all attorneys fees and auditors/experts fees incurred by the Company in connection with the examination of his
travel expense reimbursements.
Under the terms of the Culpepper Employment Agreement, Mr. Culpepper is owed no severance payments as a result of his
termination for cause as that term is defined in the Culpepper Employment Agreement. Under section 6 of the Culpepper Employment Agreement, Effect of Termination, a termination for cause terminates any payments
due to Mr. Culpepper as of the last day of his employment. Furthermore, Mr. Culpepper is no longer entitled to the 2:1 credit under the Kleba Settlement Agreement (see Note 11 to the financial statements), such that the total $2,240,000
owed by Mr. Culpepper pursuant to the Kleba Settlement Agreement plus Mr. Culpeppers proportionate share of the litigation cost in the amount of $227,750 less the amount that he repaid as of December 31, 2016 is immediately due
and payable. The Company sent Mr. Culpepper a notice of default in January 2017 for the total amount he owes the Company and intends to resolve these claims pursuant to the alternative dispute resolution provision of the Culpepper Employment
Agreement. The Company has established a reserve of $2,051,083 as of March 31, 2017 and December 31, 2016, which amount represents the amount the Company currently believes Mr. Culpepper owes to the Company, while the Company pursues
collection of this amount.
Mr. Culpepper disputes that he was terminated for cause under the Culpepper Employment Agreement and
Mr. Culpepper has demanded this issue be resolved by mediation in accordance with the Culpepper Employment Agreement. The Company is in the process of responding to Mr. Culpeppers demand, and the mediation has been scheduled for
June 28, 2017. Concurrently, the Company is seeking from Mr. Culpepper immediate payment of amounts due under the Kleba Settlement Agreement as noted above.
The Bible Harris Smith Lawsuit
On November 17,
2016, the Company filed a lawsuit in the Circuit Court for Knox County, Tennessee against Bible Harris Smith PC (BHS) for professional negligence, common law negligence and breach of fiduciary duty arising from accounting services
provided by BHS to the Company. The Company alleges that between 2013 and the present, Dr. Dees received approximately $2.4 million in advanced or reimbursed travel and entertainment expenses from the Company and that Dr. Dees did not
submit back-up documentation
in support of substantially all of the advances he received purportedly for future travel and entertainment expenses. The Company further alleges that had BHS provided
competent accounting and tax preparation services, it would have discovered Dr. Deess failure to
submit back-up documentation
supporting the advanced travel funds at the inception of
Dr. Deess conduct, and prevented the misuse of these and future funds. The Company has made a claim for damages against BHS in an amount in excess of $3 million. The Complaint against BHS has been filed and served, an answer has been
received and the parties have begun discovery.
Other Regulatory Matters
The Company has received a subpoena from the staff of the SEC related to the travel expense advancements and reimbursements received by H. Craig Dees, the
Companys former Chief Executive Officer, and the Company has received a subsequent subpoena from the staff of the SEC related to the travel expense advancements and reimbursements received by Peter R. Culpepper, the Companys former
Interim Chief Executive Officer and Chief Operating Officer and former Chief Financial Officer. At this time, the staffs investigation into these matters remains ongoing. The Company is cooperating with the staff but cannot predict with any
certainty what the outcome of the foregoing may be.
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7. Subsequent Events
The Company has evaluated subsequent events through the date of the filing of these financial statements.
First Tranche of 2017 Financing
In connection with the
funding of the First Tranche of the 2017 Financing, as described in the Term Sheet, on April 3, 2017, the Company entered into a PRH Note with Cal Enterprises LLC, a Nevada limited liability company, an affiliate of Dominic Rodrigues, a
director of the Company (the Rodrigues Note), in the principal amount of up to $2.5 million. In addition, the Wachter Note was amended and restated in order to modify the terms of the Wachter Note to mirror the PRH Notes. See Note 2
Liquidity and Financial Condition for terms of the PRH Notes. On April 3, 2017, the Company received $500,000 under the Rodrigues Note.
Second Tranche of 2017 Financing
In connection with the
funding of the Second Tranche of the 2017 Financing, as described in the Term Sheet, on April 20, 2017, the Company entered into a PRH Note with an accredited investor (the Second Tranche Note), in the principal amount of up to
$2.5 million. See Note 2 Liquidity and Financial Condition for terms of the PRH Note. As of May 1, 2017, the Company had received the entire $2,500,000 under the Second Tranche Note.
Director Resignations and Appointments
On April 3,
2017, each of Alfred E. Smith, IV, Timothy C. Scott and Kelly M. McMasters, MD notified the Company of their decision to resign from the Board effective immediately, and in connection therewith, the Board reduced the size of the Board to four
directors. On April 3, 2017, the Board appointed each of Dominic Rodrigues and Bruce Horowitz to the Board to fill two vacancies.
NYSE Delisting
See Note 2 - Liquidity and Financial Condition NYSE Delisting for details.
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