Notes
to
Condensed Consolidated Financial Statements
June 30, 2016
(Unaudited)
NOTE 1 – ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Organization
Innovus Pharmaceuticals, Inc., together with its subsidiaries (collectively referred to as “Innovus”, “we”, “our” or the “Company”) is a San Diego, California-based pharmaceutical company that delivers safe and effective non-prescription medicine and consumer care products to improve men’s and women’s health and vitality and respiratory diseases.
We currently market 13 products in the United States and six in multiple countries around the world through our commercial partners: (a) BTH® Testosterone Booster, (b) BTH® Human Growth Agent, (c) Zestra® for female arousal and (d) EjectDelay® for premature ejaculation and has an additional five marketed products in this space, including (e) Sensum+® for the indication of reduced penile sensitivity, (for sales outside the U.S. only), (f) Zestra Glide®, (g) Vesele® for promoting sexual and cognitive health, (i) Androferti® (in the US and Canada) to support overall male reproductive health and sperm quality, (j) BTH Vision Formula, (k) BTH Blood Sugar, among others. While we generate revenue from the sale of our six products, most revenue is currently generated by BTH® Testosterone Booster; Zestra®, Zestra® Glide, EjectDelay® and Sensum +®.
Pipeline Products
Fluticare™ (Fluticasone propionate nasal spray).
Innovus acquired the worldwide rights to market and sell the Fluticare™ brand (Fluticasone propionate nasal spray) and the related manufacturing agreement from Novalere FP in February 2015, the Over The Counter (“OTC”) Abbreviated New Drug Application (“ANDA”) filed at the end of 2014 by the manufacturer with the U.S. Food and Drug Administration (“FDA”) which, subject to FDA approval, may allow the Company to market and sell Fluticare™ over-the-counter. An ANDA is an application for a U.S. generic drug approval for an existing licensed medication or approved drug.
Urocis® XR.
On October 27, 2015, the Company entered into an exclusive distribution agreement with Laboratorios Q Pharma (Spain) to distribute and commercialize Urocis(R) XR in the US and Canada. Urocis® XR is a proprietary extended release of Vaccinium Marcocarpon (cranberry) shown to provide 24 hour coverage in the body to increase compliance of the use of the product to get full benefit.
AndroVit®.
On October 27, 2015, the Company entered into an exclusive distribution agreement with Laboratorios Q Pharma (Spain) to distribute and commercialize AndroVit® in the US and Canada. AndroVit® is a proprietary supplement to support overall prostate and male sexual health currently marketed in Europe. AndroVit® was specifically formulated with ingredients known to support the normal prostate health and vitality and male sexual health.
Change in Accounting Principle
On January 1, 2016, the Company retrospectively adopted Financial Accounting Standards Board (“FASB”) Accounting Standards Update (“ASU”) No. 2015-03,
Interest - Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs
. This ASU requires that debt issuance costs be presented as a direct reduction from the carrying amount of debt. As a result of the adoption of this ASU, the condensed consolidated balance sheet at December 31, 2015 was adjusted to reflect the reclassification of $97,577 from deferred financing costs, net to convertible debentures, net. The adoption of this ASU did not have an impact on the Company’s condensed consolidated results of operations.
Basis of Presentation and Principles of Consolidation
These unaudited condensed consolidated financial statements have been prepared by management in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”), and include all assets, liabilities, revenues and expenses of the Company and its wholly owned subsidiaries: FasTrack Pharmaceuticals, Inc., Semprae Laboratories, Inc. (“Semprae”) and Novalere, Inc. (“Novalere”). All material intercompany transactions and balances have been eliminated. These interim unaudited condensed consolidated financial statements and notes thereto should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations and the audited consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015. Certain information required by U.S. GAAP has been condensed or omitted in accordance with the rules and regulations of the U.S. Securities and Exchange Commission (“SEC”). The results for the period ended June 30, 2016, are not necessarily indicative of the results to be expected for the entire fiscal year ending December 31, 2016 or for any future period. Certain items have been reclassified to conform to the current year presentation.
The preparation of these condensed consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the condensed consolidated financial statements and the reported amounts of revenues and expenses during the reporting periods. Such management estimates include the allowance for doubtful accounts and sales return adjustments, realizability of inventories, valuation of deferred tax assets, goodwill and intangible assets, valuation of contingent acquisition considerations, recoverability of long-lived assets and goodwill, fair value of derivative liabilities and the valuation of equity-based instruments and beneficial conversion features. The Company bases its estimates on historical experience and various other assumptions that the Company believes to be reasonable under the circumstances. Actual results could differ from these estimates under different assumptions or conditions.
Liquidity
The Company’s operations have been financed primarily through advances from officers, directors and related parties, outside capital, revenues generated from the launch of its products and commercial partnerships signed for the sale and distribution of its products domestically and internationally. These funds have provided the Company with the resources to operate its business, sell and support its products, attract and retain key personnel and add new products to its portfolio. The Company has experienced net losses from operations each year since its inception. As of June 30, 2016, the Company had an accumulated deficit of $21,349,904 and a working capital deficit of $2,026,504.
The Company has raised funds through the issuance of debt and the sale of common stock. The Company has also issued equity instruments in certain circumstances to pay for services from vendors and consultants. In June and July 2016, the Company raised $3,000,000 in gross proceeds from the issuance of convertible debentures to eight investors (see Notes 5 and 10). In the event the Company does not pay the convertible debentures upon their maturity, or after the remedy period, the principal amount and accrued interest on the convertible debentures is convertible at the Company’s option to common stock at the lower of the fixed conversion price or 60% of the volume weighted average price (“VWAP”) during the ten consecutive trading day period preceding the date of conversion. In February 2016, the Company also raised $550,000 in funds from a note payable with net proceeds of $242,500 to the Company, which was used to pay for the asset acquisition of Beyond Human, LLC (see Note 5), a Texas limited liability company (“Beyond Human”) and for working capital purposes.
As of August 8, 2016, we had approximately $2.3 million in cash and approximately $2.0 million in cash available for use under the line of credit convertible debenture with our Chief Executive Officer (“CEO”). During the six months ended June 30, 2016 we had net cash provided by operating activities of $256,152. The Company expects that its existing capital resources, revenues from sales of its products and upcoming sales milestone payments from the commercial partners signed for its products, along with the funds currently available for use under the line of credit convertible debenture with our CEO and equity instruments available to pay certain vendors and consultants will be sufficient to allow the Company to continue its operations, commence the product development process and launch selected products through at least the next 12 months. In addition, the Company’s CEO, who is also a major shareholder, has deferred the payment of his salary earned thru June 30, 2016 and plans to continue to do so for the remainder of 2016, if needed. He is also able to extend the maturity date of the line of credit, if needed. The Company’s actual needs will depend on numerous factors, including timing of introducing its products to the marketplace, its ability to attract additional ex-US distributors for its products and its ability to in-license in non-partnered territories and/or develop new product candidates. The Company may also seek to raise capital, debt or equity from outside sources to pay for further expansion and development of its business and to meet current obligations. Such capital may not be available to the Company when it needs it on terms acceptable to the Company, if at all.
Fair Value Measurement
The Company’s financial instruments are cash, restricted cash, accounts receivable, accounts payable, accrued liabilities, derivative liabilities, contingent consideration and debt. The recorded values of cash, restricted cash, accounts receivable, accounts payable and accrued liabilities approximate their fair values based on their short-term nature. The recorded fair value of the convertible debentures, net of debt discount, is based upon the relative fair value calculation of the common stock and warrants issued in connection with the convertible debentures and the fair value of the embedded conversion features. The fair values of the warrant derivative liabilities and embedded conversion feature derivative liabilities are based upon the Black Scholes Option Pricing Model (“Black-Scholes”) and the Path-Dependent Monte Carlo simulation model calculations and are a level 3 measurement (see Note 9). The fair value of the contingent acquisition consideration is based upon the present value of expected future payments under the terms of the agreements and is a level 3 measurement (see Note 3). Based on borrowing rates currently available to the Company, the carrying values of the notes payable and convertible debentures approximate their respective fair values. The difference between the fair value and recorded values of the related-party notes payable and convertible debentures is not significant.
The Company follows a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets and liabilities (Level 1) and the
lowest priority to measurements involving significant unobservable inputs (Level 3). The three levels of the fair value hierarchy are as follows:
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Level 1 measurements are quoted prices (unadjusted) in active markets for identical assets or liabilities that the Company has the ability to access at the measurement date.
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Level 2 measurements are inputs other than quoted prices included in Level 1 that are observable either directly or indirectly.
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Level 3 measurements are unobservable inputs.
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Concentration of Credit Risk and Major Customers
Financial instruments that potentially subject the Company to significant concentrations of credit risk consist primarily of cash and accounts receivable. Cash held with financial institutions may exceed the amount of insurance provided by the Federal Deposit Insurance Corporation on such deposits. Accounts receivable consist primarily of online sales of our Zestra® and Beyond Human line of products to U.S. based retailers and Ex-U.S. partners. The Company also requires a percentage of payment in advance for product orders with its larger partners. The Company performs ongoing credit evaluations of its customers and generally does not require collateral.
Revenues consist primarily of product sales and licensing rights to market and commercialize our products. The Company had no customers that accounted for 10% of its total net revenues during the three and six months ended June 30, 2016. Three customers accounted for 29%, 16% and 11%, respectively, of total gross accounts receivable as of June 30, 2016. The Company had three major customers that accounted for 18%, 13% and 11%, respectively, of its total net revenues during the six months ended June 30, 2015. Two customers accounted for 19% and 54%, respectively, of gross accounts receivable as of December 31, 2015.
Over 90% of our sales are currently within the United States and Canada. The balance of the sales are to various other countries, none of which is 10 percent or greater.
Concentration of Suppliers
The Company has manufacturing relationships with a number of vendors or manufacturers for its products including: Sensum+®, EjectDelay®, Vesele®, Androferti®, the Zestra® and Beyond Human lines of products. Pursuant to these relationships, the Company purchases products through purchase orders with its manufacturers.
Restricted Cash
Restricted cash consists of funds from the convertible debenture financing completed on June 30, 2016 but were held in escrow and released to the Company on July 6, 2016 (see Note 5).
Inventories
Inventory is valued at the lower of cost or market using the first-in, first-out method. Inventory is shown net of obsolescence, determined based on shelf life or potential product replacement.
Deferred Financing Costs / Debt Issuance Costs
Deferred financing costs represent costs incurred in connection with the issuance of the convertible debentures during the third quarter of the year ended December 31, 2015 and the note payable and convertible debentures during the six months ended June 30, 2016. Debt issuance costs related to the issuance of the convertible debentures and note payable are recorded as a reduction to the debt balances in the accompanying condensed consolidated balance sheets. The debt issuance costs are being amortized to interest expense over the term of the financing instruments using the effective interest method.
Intangible Assets
Intangible assets with finite lives are amortized on a straight-line basis over their estimated useful lives, which range from 5 to 15 years. The useful life of the intangible asset is evaluated each reporting period to determine whether events and circumstances warrant a revision to the remaining useful life.
We account for business combinations by recognizing the assets acquired, liabilities assumed, contractual contingencies, and contingent consideration at their fair values on the acquisition date. The final purchase price may be adjusted up to one year from the date of the acquisition. Identifying the fair value of the tangible and intangible assets and liabilities acquired requires the use of estimates by management and was based upon currently available data.
The Company allocated the excess of purchase price over the identifiable intangible and net tangible assets to goodwill. Such goodwill is not deductible for tax purposes and represents the value placed on entering new markets and expanding market share (see Note 3).
Unanticipated events and circumstances may occur that may affect the accuracy or validity of such assumptions, estimates or actual results. Additionally, any change in the fair value of the acquisition-related contingent consideration subsequent to the acquisition date, including changes from events after the acquisition date, such as changes in our estimate of relevant revenue or other targets, will be recognized in earnings in the period of the estimated fair value change. A change in fair value of the acquisition-related contingent consideration or the occurrence of events that cause results to differ from our estimates or assumptions could have a material effect on the condensed consolidated statements of operations, financial position and cash flows in the period of the change in the estimate.
Goodwill
The Company tests its goodwill for impairment annually, or whenever events or changes in circumstances indicates an impairment may have occurred, by comparing its reporting unit's carrying value to its implied fair value. Impairment may result from, among other things, deterioration in the performance of the acquired business, adverse market conditions, adverse changes in applicable laws or regulations and a variety of other circumstances. If the Company determines that an impairment has occurred, it is required to record a write-down of the carrying value and charge the impairment as an operating expense in the period the determination is made. In evaluating the recoverability of the carrying value of goodwill, the Company must make assumptions regarding estimated future cash flows and other factors to determine the fair value of the acquired assets. Changes in strategy or market conditions could significantly impact those judgments in the future and require an adjustment to the recorded balances. The goodwill was recorded as part of the acquisition of Semprae that occurred on December 24, 2013, and the acquisition of Novalere that occurred on February 5, 2015. There was no impairment of goodwill for the six months ended June 30, 2016 and 2015.
Long-Lived Assets
The Company reviews its long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of the assets may not be fully recoverable. The Company evaluates assets for potential impairment by comparing estimated future undiscounted net cash flows to the carrying amount of the assets. If the carrying amount of the assets exceeds the estimated future undiscounted cash flows, impairment is measured based on the difference between the carrying amount of the assets and fair value.
Derivative Liabilities
Certain of the Company’s embedded conversion features on debt and issued and outstanding common stock purchase warrants, which have exercise price reset features and other anti-dilution protection clauses, are treated as derivatives for accounting purposes. The common stock purchase warrants were not issued with the intent of effectively hedging any future cash flow, fair value of any asset, liability or any net investment in a foreign operation. The warrants do not qualify for hedge accounting, and as such, all future changes in the fair value of these warrants are recognized currently in earnings until such time as the warrants are exercised, expire or the related rights have been waived. These common stock purchase warrants do not trade in an active securities market, and as such, the Company estimates the fair value of these warrants using a Probability Weighted Black-Scholes Option-Pricing Model and the embedded conversion features using a Path-Dependent Monte Carlo Simulation Model (see Note 9).
Income Taxes
Income taxes are provided for using the asset and liability method whereby deferred tax assets and liabilities are recognized using current tax rates on the difference between the financial statement carrying amounts and the respective tax basis of the assets and liabilities. The Company provides a valuation allowance on deferred tax assets when it is more likely than not that such assets will not be realized.
The Company recognizes the financial statement benefit of a tax position only after determining that the relevant tax authority would more likely than not sustain the position following an audit. For tax positions meeting this standard, the amount recognized in the financial statements is the largest benefit that has a greater than fifty percent (50%) likelihood of being realized upon ultimate settlement with the relevant tax authority. There were no uncertain tax positions at June 30, 2016 and December 31, 2015.
Revenue Recognition and Deferred Revenue
The Company generates revenues from product sales and the licensing of the rights to market and commercialize its products.
The Company recognizes revenue in accordance with FASB Accounting Standards Codification (“ASC”) 605,
Revenue Recognition.
Revenue is recognized when all of the following criteria are met: (1) persuasive evidence of an arrangement exists; (2) title to the product has passed or services have been rendered; (3) price to the buyer is fixed or determinable and (4) collectability is reasonably assured.
Product Sales:
The Company ships product to its wholesale and retail customers pursuant to purchase agreements or orders. Revenue from sales transactions where the buyer has the right to return the product is recognized at the time of sale only if (1) the seller’s price to the buyer is substantially fixed or determinable at the date of sale, (2) the buyer has paid the seller, or the buyer is obligated to pay the seller and the obligation is not contingent on resale of the product, (3) the buyer’s obligation to the seller would not be changed in the event of theft or physical destruction or damage of the product, (4) the buyer acquiring the product for resale has economic substance apart from that provided by the seller, (5) the seller does not have significant obligations for future performance to directly bring about resale of the product by the buyer and (6) the amount of future returns can be reasonably estimated.
License Revenues:
The license agreements the Company enters into normally generate three separate components of revenue: 1) an initial payment due on signing or when certain specific conditions are met; 2) royalties that are earned on an ongoing basis as sales are made or a pre-agreed transfer price and 3) milestone payments that are earned when cumulative sales reach certain levels. Revenue from the initial payments or licensing fee is recognized when all required conditions are met. Royalties are recognized as earned based on the licensee’s sales. Revenue from the milestone payments is recognized when the cumulative revenue levels are reached. FASB ASC 605-28,
Milestone Method
, is not used by the Company as these milestones are sales-based and similar to a royalty and the achievement of the sales levels is neither based, in whole or in part, on the vendor’s performance nor is a research or development deliverable.
Sales Allowances
The Company accrues for product returns, volume rebates and promotional discounts in the same period the related sale is recognized.
The Company’s product returns accrual is primarily based on estimates of future product returns over the period customers have a right of return, which is in turn based in part on estimates of the remaining shelf-life of products when sold to customers. Future product returns are estimated primarily based on historical sales and return rates. The Company estimates its volume rebates and promotional discounts accrual based on its estimates of the level of inventory of its products in the distribution channel that remain subject to these discounts. The estimate of the level of products in the distribution channel is based primarily on data provided by the Company’s customers.
In all cases, judgment is required in estimating these reserves. Actual claims for rebates and returns and promotional discounts could be materially different from the estimates.
The Company provides a customer satisfaction warranty on all of its products to customers for a specified amount of time after product delivery. Estimated return costs are based on historical experience and estimated and recorded when the related sales are recognized. Any additional costs are recorded when incurred or when they can reasonably be estimated.
The estimated reserve for sales returns and allowances, which is included in accounts receivable, was approximately $8,000 and $5,000 at June 30, 2016 and December 31, 2015, respectively.
Cost of Product Sales
Cost of product sales includes the cost of inventory, royalties and inventory reserves. The Company is required to make royalty payments based upon the net sales of three of its marketed products, Zestra®, Sensum+® and Vesele®.
Stock-Based Compensation
The Company accounts for stock-based compensation in accordance with FASB ASC 718,
Stock Based Compensation
, which requires the recognition of the fair value of stock-based compensation as an expense in the calculation of net income. FASB ASC 718 requires that stock-based compensation expense be based on awards that are ultimately expected to vest. Stock-based compensation for the six months ended June 30, 2016 and 2015 have been reduced for estimated forfeitures. When estimating forfeitures, voluntary termination behaviors, as well as trends of actual option forfeitures, are considered. To the extent actual forfeitures differ from the Company’s current estimates, cumulative adjustments to stock-based compensation expense are recorded.
Except for transactions with employees and directors that are within the scope of FASB ASC 718, all transactions in which goods or services are the consideration received for the issuance of equity instruments are accounted for based on the fair value of the consideration received or the fair value of the equity instruments issued, whichever is more reliably measurable.
Equity Instruments Issued to Non-Employees for Services
Issuances of the Company’s equity for services are measured at the fair value of the consideration received or the fair value of the equity instruments issued, whichever is more reliably measurable. The measurement date for the fair value of the equity instruments issued to consultants is determined at the earlier of (a) the date at which a commitment for performance to earn the equity instruments is reached (a “performance commitment” which would include a penalty considered to be of a magnitude that is a sufficiently large disincentive for nonperformance) or (b) the date at which performance is complete, and is based upon the quoted market price of the common stock at the date of issuance (see Note 8).
Net Loss per Share
Basic net loss per share is computed by dividing net loss by the weighted average number of common shares outstanding during the period presented. Diluted net loss per share is computed using the weighted average number of common shares outstanding during the periods plus the effect of dilutive securities outstanding during the periods. For the three and six months ended June 30, 2016 and 2015, basic net loss per share is the same as diluted net loss per share as a result of the Company’s common stock equivalents being anti-dilutive. See Note 8 for more details.
Recent Accounting Pronouncements
In March 2016, the FASB issued ASU No. 2016-09,
Improvements to Employee Share-Based Payment Accounting
, which amends ASC Topic 718,
Compensation - Stock Compensation
. The ASU includes provisions intended to simplify various aspects related to how share-based payments are accounted for and presented in the financial statements. ASU 2016-09 is effective for public business entities for annual reporting periods beginning after December 15, 2016, and interim periods within that reporting period. Early adoption will be permitted in any interim or annual period, with any adjustments reflected as of the beginning of the fiscal year of adoption. Management is currently assessing the impact the adoption of ASU 2016-09 will have on our condensed consolidated financial statements.
In February 2016, the FASB issued its new lease accounting guidance in ASU No. 2016-02,
Leases (Topic 842)
. Under the new guidance, lessees will be required to recognize the following for all leases (with the exception of short-term leases) at the commencement date: A lease liability, which is a lessee’s obligation to make lease payments arising from a lease, measured on a discounted basis; and a right-of-use asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term. Under the new guidance, lessor accounting is largely unchanged. Certain targeted improvements were made to align, where necessary, lessor accounting with the lessee accounting model and ASC 606,
Revenue from Contracts with Customers
. The new lease guidance simplified the accounting for sale and leaseback transactions primarily because lessees must recognize lease assets and lease liabilities. Lessees will no longer be provided with a source of off-balance sheet financing. Public business entities should apply the amendments in ASU 2016-02 for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early application is permitted. Lessees (for capital and operating leases) must apply a modified retrospective transition approach for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the consolidated financial statements. The modified retrospective approach would not require any transition accounting for leases that expired before the earliest comparative period presented. Lessees may not apply a full retrospective transition approach. Management is currently assessing the impact the adoption of ASU 2016-02 will have on our condensed consolidated financial statements.
In November 2015, the FASB issued ASU No. 2015-17,
Balance Sheet Classification of Deferred Taxes
. Current U.S. GAAP requires an entity to separate deferred income tax liabilities and assets into current and noncurrent amounts in a classified statement of financial position. To simplify the presentation of deferred income taxes, the amendments in this update require that deferred tax liabilities and assets be classified as noncurrent in a classified statement of financial position. The amendments in this update apply to all entities that present a classified statement of financial position. The current requirement that deferred tax liabilities and assets of a tax-paying component of an entity be offset and presented as a single amount is not affected by the amendments in this update.
The amendments in this update will align the presentation of deferred income tax assets and liabilities with International Financial Reporting Standards (IFRS) and are effective for fiscal years after December 15, 2016, including interim periods within those annual periods. Management is currently assessing the impact the adoption of ASU 2015-17 will have on our condensed consolidated financial statements.
In September 2015, the FASB issued ASU 2015-16,
Simplifying the Accounting for Measurement-Period Adjustments,
which eliminates the requirement to retrospectively adjust the consolidated financial statements for measurement-period adjustments that occur in periods after a business combination is consummated. Measurement period adjustments are calculated as if they were known at the acquisition date, but are recognized in the reporting period in which they are determined. Additional disclosures are required about the impact on current-period income statement line items of adjustments that would have been recognized in prior periods if prior-period information had been revised. The guidance is effective for annual periods beginning after December 15, 2015 and is to be applied prospectively to adjustments of provisional amounts that occur after the effective date. Early application is permitted. The adoption of this ASU during the six months ended June 30, 2016 did not have a material impact on the Company’s condensed consolidated financial position and results of operations.
In July 2015, the FASB issued ASU No. 2015-11
, Inventory (Topic 330): Simplifying the Measurement of Inventory. Topic 330
. Inventory, currently requires an entity to measure inventory at the lower of cost or market. Market could be replacement cost, net realizable value, or net realizable value less an approximately normal profit margin. The amendments apply to all other inventory, which includes inventory that is measured using first-in, first-out (FIFO) or average cost. An entity should measure in scope inventory at the lower of cost and net realizable value. Net realizable value is the estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. The amendments in this Update more closely align the measurement of inventory in U.S. GAAP with the measurement of inventory in IFRS. For public business entities, the amendments are effective for fiscal years beginning after December 15, 2016, including interim periods within those fiscal years. The amendments should be applied prospectively with earlier application permitted as of the beginning of an interim or annual reporting period. The Company does not believe this update will have a material effect on its condensed consolidated financial statements and related disclosures.
In August 2014, the FASB issued ASU 2014-15,
Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern.
This ASU 2014-15 describes how an entity should assess its ability to meet obligations and sets rules for how this information should be disclosed in the consolidated financial statements. The standard provides accounting guidance that will be used along with existing auditing standards. The ASU 2014-15 is effective for interim and annual periods beginning after December 15, 2016. Early application is permitted. The Company is in the process of evaluating the impact of this standard but does not expect this standard to have a material impact on the Company’s condensed consolidated financial position or results of operation.
In May 2014, the FASB issued ASU 2014-09,
Revenue from Contracts with Customers.
This updated guidance supersedes the current revenue recognition guidance, including industry-specific guidance. The updated guidance introduces a five-step model to achieve its core principal of the entity recognizing revenue to depict the transfer of goods or services to customers at an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The updated guidance is effective for interim and annual periods beginning after December 15, 2016, and early adoption is not permitted. In August 2015, the FASB issued ASU No. 2015-14 which deferred the effective date by one year for public entities and others. The amendments in this ASU are effective for interim and annual periods beginning after December 15, 2017 for public business entities, certain not-for-profit entities, and certain employee benefit plans. Earlier application is permitted only as of annual reporting periods beginning after December 15, 2016, including interim reporting periods within that reporting period. Management has not selected a transition method and is currently assessing the impact the adoption of ASU 2014-09 will have on our condensed consolidated financial statements.
NOTE 2 – LICENSE AGREEMENTS
Sothema Laboratories Agreement
On September 23, 2014, the Company entered into an exclusive license agreement with Sothema Laboratories, SARL, a Moroccan publicly traded company (“Sothema”), under which Innovus granted to Sothema an exclusive license to market and sell Innovus’ topical treatment for Female Sexual Interest/Arousal Disorder (“FSI/AD”) (based on the latest Canadian approval of the indication), Zestra® and its high viscosity low osmolality water-based lubricant Zestra Glide® in the North African countries of Egypt, Morocco, Algeria, Tunisia and Libya, the Middle Eastern countries of Iraq, Jordan, Saudi Arabia and the United Arab Emirates and the West African countries of Benin, Burkina Faso, Cape Verde, Gambia, Ghana, Guinea, Guinea-Bissau, Ivory Coast, Liberia, Mali, Niger, Nigeria, Senegal, Sierra Leone and Togo (collectively the “Territory”).
Under the agreement, Innovus received an upfront payment and is eligible to receive up to approximately $171 million dollars upon and subject to the achievement of sales milestones based on cumulative supplied units of the licensed products in the Territory, plus a pre-negotiated transfer price per unit.
Pursuant to the guidance in ASC 605-28,
Milestone Method
, the milestones are considered substantive. The milestones enhance the value of the products and are the result of the Company’s past efforts. The milestones are reasonable relative to all of the deliverables. The Company will recognize the revenue from the milestone payments when the cumulative supplied units volume is met. During the three and six months ended June 30, 2016 and 2015, the Company recognized $2,563, $11,563, $6,487 and $56,487, respectively, in revenue for the sales of products related to this agreement, and no revenue was recognized for the sales milestones of the agreement. We believe the amount of the upfront payment received is reasonable compared to the amounts to be received upon obtainment of future milestones.
Orimed Pharma Agreement
On September 18, 2014, the Company entered into an exclusive license agreement with Orimed Pharma (“Orimed”), an affiliate of JAMP Pharma, under which Innovus granted to Orimed an exclusive license to market and sell in Canada, Innovus’ (a) topical treatment for FSI/AD, Zestra®, (b) topical treatment for premature ejaculation, EjectDelay®, (c) product Sensum+™ to increase penile sensitivity and (d) high viscosity low osmolality water-based lubricant, Zestra Glide®.
Under the agreement, Innovus received an upfront payment and is eligible to receive up to approximately CN $94.5 million ($72.7 million USD based on June 30, 2016 exchange rate) upon and subject to the achievement of sales milestones based on cumulative gross sales in Canada by Orimed plus certain double-digit tiered royalties based on Orimed’s cumulative net sales in Canada.
Pursuant to the guidance in ASC 605-28,
Milestone Method
, the milestones and quarterly royalty payments are considered substantive. The milestones enhance the value of the products and are the result of the Company’s past efforts. The milestones are reasonable relative to all of the deliverables. The Company will recognize the revenue from the milestone payments when the cumulative gross sales volume is met. The Company will recognize the revenue from the royalty payments on a quarterly basis when the cumulative net sales have been met. During the three and six months ended June 30, 2016 and 2015, the Company recognized $7,483, $63,586, $49,376 and $49,376, respectively, in revenue for the sales of products related to this agreement, and no revenue was recognized for the sales milestones of the agreement. We believe the amount of the upfront payment received is reasonable compared to the amounts to be received upon obtainment of future milestones.
BroadMed SAL Agreements
On May 24, 2016, the Company entered into an exclusive license and distribution agreement with BroadMed SAL, a Lebanese company, under which Innovus granted to BroadMed an exclusive license to market and sell in Lebanon Innovus Pharma’s EjectDelay® for treating premature ejaculation. Under the agreement, the Company is eligible to receive up to $6.2 million dollars in sales milestone payments. For the three and six months ended June 30, 2016, the Company did not recognize revenue for the sales milestones of the agreement.
In April 2015, the Company entered into an exclusive license and distribution agreement with BroadMed SAL under which Innovus granted to BroadMed an exclusive license to market and sell in Lebanon Innovus Pharma’s Sensum+® to increase penile sensitivity. Under the agreement, the Company is eligible to receive up to $11.1 million dollars in upfront and sales milestone payments. For the three and six months ended June 30, 2015, the Company received and recognized $5,000 in upfront payments under this agreement. No amounts were received or recognized during the three and six months ended June 30, 2016.
NOTE 3 – BUSINESS AND ASSET ACQUISITIONS
Acquisition of Assets of Beyond Human in 2016
On February 8, 2016, we entered into an Asset Purchase Agreement (“APA”), pursuant to which Innovus agreed to purchase substantially all of the assets of Beyond Human (the “Acquisition”) for a total cash payment of up to $662,500 (the “Purchase Price”). The Purchase Price is payable in the following manner: (1) $300,000 in cash at the closing of the Acquisition (the “Initial Payment”), (2) $100,000 in cash four months from the closing upon the occurrence of certain milestones as described in the APA, (3) $100,000 in cash eight months from the closing upon the occurrence of certain milestones as described in the APA, and (4) $130,000 in cash in twelve months from the closing upon the occurrence of certain milestones as described in the APA. An additional $32,500 in cash is due if certain milestones occur twelve months from closing. The transaction closed on March 1, 2016.
The fair value of the contingent consideration is based on preliminary cash flow projections and other assumptions for the milestone payments and future changes in the estimate of such contingent consideration will be recognized as a charge to operations expense. The amortization of imputed interest on the contingent consideration is recorded to interest expense in the accompanying condensed consolidated statement of operations.
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The total purchase price is summarized as follows:
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Fair value of future earn out payments
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The Company has preliminary recorded the purchase price of $614,479 as an intangible asset on March 1, 2016 for the trademarks and domain names associated with the Beyond Human products acquired. The identifiable intangible assets are being amortized over their estimated useful lives of five years.
The purchase price allocation is subject to completion of our analysis of the fair value of the assets acquired from Beyond Human as of the date of the acquisition. These adjustments could be material. The final valuation is expected to be completed as soon as practicable but no later than one year from the closing of the transaction. The establishment of the fair value of the contingent consideration, and the allocation to identifiable intangible assets requires the extensive use of accounting estimates and management judgment. The fair values assigned to the assets acquired are based on estimates and assumptions from data currently available. As of June 30, 2016, the estimated fair value of the contingent consideration was $336,813 and the Company recorded imputed interest expense of $16,750 and $22,334 during the three and six months ended June 30, 2016, respectively, which is included in interest expense in the accompanying condensed consolidated statement of operations.
Supplemental Pro Forma Information for Acquisition of Assets of Beyond Human (unaudited)
The following unaudited supplemental pro forma information for the six months ended June 30, 2016 and 2015 and the three months ended June 30, 2015, assumes the asset acquisition of Beyond Human had occurred as of January 1, 2016 and 2015, giving effect to purchase accounting adjustments such as amortization of intangible assets. The pro forma data is for informational purposes only and may not necessarily reflect the actual results of operations had the assets of Beyond Human been operated as part of the Company since January 1, 2016 and 2015.
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Six Months Ended
June 30, 2016
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Six Months Ended
June 30, 2015
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As
Reported
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Pro Forma (unaudited)
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As Reported
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Pro Forma (unaudited)
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Net loss per share of common stock – basic and diluted
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Weighted average number of shares outstanding – basic and diluted
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Three Months Ended
June 30, 2015
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As
Reported
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Pro Forma (unaudited)
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Net loss per share of common stock – basic and diluted
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Weighted average number of shares outstanding – basic and diluted
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The acquisition of the assets of Beyond Human was not individually significant and the Company incurred approximately $70,000 in expenses related to the Acquisition.
Acquisition of Novalere in 2015
On February 5, 2015 (the “Closing Date”), the Company, Innovus Pharma Acquisition Corporation, a Delaware corporation and a wholly-owned subsidiary of Innovus (“Merger Subsidiary I”), Innovus Pharma Acquisition Corporation II, a Delaware corporation and a wholly-owned subsidiary of the Company (“Merger Subsidiary II”), Novalere FP, Inc., a Delaware corporation (“Novalere FP”) and Novalere Holdings, LLC, a Delaware limited liability company (“Novalere Holdings”), as representative of the shareholders of Novalere (the “Novalere Stockholders”), entered into an Agreement and Plan of Merger (the “Merger Agreement”), pursuant to which Merger Subsidiary I merged into Novalere and then Novalere merged with and into Merger Subsidiary II (the “Merger”), with Merger Subsidiary II surviving as a wholly-owned subsidiary of the Company. Pursuant to the articles of merger effectuating the Merger, Merger Subsidiary II changed its name to Novalere, Inc.
With the Merger, the Company acquired the worldwide rights to market and sell the Fluticare™ brand (Fluticasone propionate nasal spray) and the related manufacturing agreement from Novalere FP. The Company currently anticipates that the Abbreviated New Drug Application (“ANDA”) filed in November 2014 by the manufacturer with the U.S. Food and Drug Administration (“FDA”) may be approved in the second half of 2016, which, when and if approved, may allow the Company to market and sell Fluticare™ over the counter. An ANDA is an application for a U.S. generic drug approval for an existing licensed medication or approved drug.
Under the terms of the Merger Agreement, at the Closing Date, the Novalere Stockholders received 50% of the Consideration Shares (the “Closing Consideration Shares”) and the remaining 50% of the Consideration Shares (the “ANDA Consideration Shares”) will be delivered only if an ANDA of Fluticasone Propionate Nasal Spray of Novalere Manufacturing Partners (the “Target Product”) is approved by the FDA (the “ANDA Approval”). A portion of the Closing Consideration Shares and, if ANDA Approval is obtained prior to the 18 month anniversary of the Closing Date, a portion of the ANDA Consideration Shares, will be held in escrow for a period of 18 months from the Closing Date to be applied towards any indemnification claims by the Company pursuant to the Merger Agreement.
In addition, the Novalere Stockholders are entitled to receive, if and when earned, earn-out payments (the “Earn-Out Payments”). For every $5 million in Net Revenue (as defined in the Merger Agreement) realized from the sales of Fluticare™, the Novalere Stockholders will be entitled to receive, on a pro rata basis, $500,000, subject to cumulative maximum Earn-Out Payments of $2.5 million.
The closing price of the Company’s common stock on the Closing Date was $0.20 per share. The Company issued 12,947,657 Closing Consideration Shares of its common stock at the Closing Date, the fair market value of the Closing Consideration Shares was $2,071,625 as of the Closing Date. 12,280,796 shares were placed in escrow to cover any potential claims that the Company might have with respect to disclosures made by Novalere.
The establishment of the fair value of the consideration for a Merger, and the allocation to identifiable tangible and intangible assets and liabilities, requires the extensive use of accounting estimates and management judgment. The fair values assigned to the assets acquired and liabilities assumed were based on estimates and assumptions. There has been no change to the estimated fair value of the contingent consideration of $2,905,425 through June 30, 2016.
Supplemental Pro Forma Information for Acquisition of Novalere (unaudited)
The following unaudited supplemental pro forma information for the six months ended June 30, 2015, assumes the acquisition of Novalere had occurred as of January 1, 2015, giving effect to purchase accounting adjustments such as amortization of intangible assets. The pro forma data is for informational purposes only and may not necessarily reflect the actual results of operations had Novalere been operated as part of the Company since January 1, 2015.
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Six Months Ended
June 30, 2015
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As
Reported
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Pro Forma (unaudited)
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Net loss per share of common stock – basic and diluted
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Weighted average number of shares outstanding – basic and diluted
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Purchase of Semprae Laboratories, Inc. in 2013
On December 24, 2013 (the “Semprae Closing Date”), the Company, through Merger Sub obtained 100% of the outstanding shares of Semprae in exchange for the issuance of 3,201,776 shares of the Company’s common stock, which shares represented fifteen percent (15%) of the total issued and outstanding shares of the Company as of the close of business on the Closing Date, whereupon Merger Sub was renamed Semprae Laboratories, Inc. Also, the Company agreed to pay $343,500 to the New Jersey Economic Development Authority (“NJEDA”) as settlement-in full for an outstanding loan of approximately $640,000 owed by the former stockholder’s of Semprae, in full satisfaction of the obligation to the NJEDA. In addition, the Company agreed to pay the former shareholders an annual royalty (“Royalty”) equal to five percent (5%) of the net sales from Zestra® and Zestra® Glide and any second generation products derived primarily therefrom (“Target Products”) up until the time that a generic version of such Target Product is introduced worldwide by a third party.
The agreement to pay the annual Royalty resulted in the recognition of a contingent consideration, which is recognized at the inception of the transaction, and subsequent changes to estimate of the amounts of contingent consideration to be paid will be recognized as charges or credits in the consolidated statement of operations. The fair value of the contingent consideration is based on preliminary cash flow projections, growth in expected product sales and other assumptions. Based on the assumptions, the fair value of the Royalty was determined to be $308,273 at the date of acquisition. The fair value of the Royalty was determined by applying the income approach, using several significant unobservable inputs for projected cash flows and a discount rate of 40% commensurate with the Company’s cost of capital and expectation of the revenue growth for products at their life cycle stage. These inputs are considered Level 3 inputs under the fair value measurements and disclosure guidance. During the six months ended June 30, 2016 and 2015 no amounts were paid under this arrangement. There were no changes in the fair value of the expected royalties to be paid during the six months ended June 30, 2016 and 2015. The fair value of contingent consideration was $324,379 at June 30, 2016 and December 31, 2015, based on the new estimated fair value of the consideration, net of the amounts to be returned to the Company as discussed above.
NOTE 4 – ASSETS
Inventories
Inventories consist of the following:
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June
30,
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December 31,
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2016
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2015
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Raw materials and supplies
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Intangible Assets
Amortizable intangible assets consist of the following:
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June 30, 2016
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Amount
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Accumulated
Amortization
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Net Amount
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Useful Lives
(years)
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Sensum+(R) License (from CRI)
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December 31, 2015
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Amount
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Accumulated
Amortization
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Net Amount
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Useful Lives
(years)
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Sensum+(R) License (from CRI)
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Amortization expense for the three and six months ended June 30, 2016 and 2015 was $178,083, $335,685, $147,236 and $239,582, respectively. The following table summarizes the approximate expected future amortization expense as of June 30, 2016 for intangible assets:
NOTE 5 – NOTES PAYABLE AND CONVERTIBLE DEBENTURES – NON-RELATED PARTIES
Short-Term Loans Payable
Included in this amount is $71,156 of short-term non-convertible financings. The short-term non-convertible financings are from three funding sources and all balances are guaranteed by the Company’s CEO. The Company repaid these amounts in full in July 2016.
Note Payable and Non-Convertible Debentures
The following table summarizes the outstanding note payable and non-convertible debentures at June 30, 2016 and December 31, 2015:
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2016
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2015
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Note payable and non-convertible debentures:
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February 2016 Note Payable
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July 2015 Debenture (Amended August 2014 Debenture)
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Total note payable and non-convertible debentures
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Note payable and non-convertible debentures, net of current portion
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The following table summarizes the future minimum payments as of June 30, 2016 for the note payable and non-convertible debentures:
July 2015 Debenture (Amended August 2014 Debenture)
On August 30, 2014, the Company issued an 8% debenture to an unrelated third party investor in the principal amount of $40,000 (the “August 2014 Debenture”). The August 2014 Debenture bore interest at the rate of 8% per annum. The principal amount and interest were payable on August 29, 2015. On July 21, 2015, the Company received an additional $30,000 from the investor and amended and restated this agreement to a new principal balance of $73,200 (including accrued interest of $3,200 added to principal) and a new maturity date of July 21, 2016. The note was repaid in full in July 2016.
February 2016 Note Payable
On February 24, 2016, the Company and SBI Investments, LLC, 2014-1 (“SBI”) entered into a closing statement in which SBI loaned the Company gross proceeds of $550,000 pursuant to a purchase agreement, 20% secured promissory note and security agreement (“February 2016 Note Payable”), all dated February 19, 2016 (collectively, the “Finance Agreements”), to purchase substantially all of the assets of Beyond Human (see Note 3). Of the $550,000 gross proceeds, $300,000 was paid into an escrow account held by a third party bank and was released to Beyond Human upon closing of the transaction, $242,500 was provided directly to the Company for use in building the Beyond Human business and $7,500 was provided for attorneys’ fees. The attorneys’ fees were recorded as a discount to the carrying value of the February 2016 Note Payable in accordance with ASU 2015-03.
Pursuant to the Finance Agreements, the principal amount of the February 2016 Note Payable is $550,000 and the interest rate thereon is 20% per annum. The Company began to pay principal and interest on the February 2016 Note Payable on a monthly basis beginning on March 19, 2016 for a period of 24 months and the monthly mandatory principal and interest payment amount thereunder is $28,209. The monthly amount shall be paid by the Company through a deposit account control agreement with a third party bank in which SBI shall be permitted to take the monthly mandatory payment amount from all revenues received by the Company from the Beyond Human assets in the transaction. The maturity date for the February 2016 Note Payable is February 19, 2018.
The February 2016 Note Payable is secured by SBI through a first priority secured interest in all of the Beyond Human assets acquired by the Company in the transaction including all revenue received by the Company from these assets.
May 2016 Debenture
On May 4, 2016, the Company issued a 10% debenture to an unrelated third party investor in the principal amount of $24,000 (the “May 2016 Debenture”). The May 2016 Debenture bore interest at the rate of 10% per annum. The principal amount and interest were payable on May 4, 2017. The note was repaid in full in July 2016.
May 2016 Notes Payable
On May 6, 2016, the Company entered into a securities purchase agreement with an unrelated third party investor in which the investor loaned the Company gross proceeds of $50,000 pursuant to a 3% promissory note (“May 6, 2016 Note Payable”). The May 6, 2016 Note Payable bore interest at the rate of 3% per annum. The principal amount and interest were payable on November 6, 2016. The note was repaid in full in June 2016.
In connection with the May 6, 2016 Note Payable, the Company issued the investor restricted shares of common stock totaling 500,000. The fair value of the restricted shares of common stock issued was based on the market price of the Company’s common stock on the date of issuance of the May 6, 2016 Note Payable. The allocation of the proceeds received to the restricted shares of common stock based on their relative fair value resulted in the Company recording a debt discount of $23,684. The discount was amortized in full to interest expense during the six months ended June 30, 2016.
On May 20, 2016, the Company entered into a securities purchase agreement with an unrelated third party investor in which the investor loaned the Company gross proceeds of $100,000 pursuant to a 3% promissory note (“May 20, 2016 Note Payable”). The May 20, 2016 Note Payable bore interest at the rate of 3% per annum. The principal amount and interest were payable on February 21, 2017. The note was repaid in full in June 2016.
In connection with the May 20, 2016 Note Payable, the Company issued the investor restricted shares of common stock totaling 750,000. The fair value of the restricted shares of common stock issued was based on the market price of the Company’s common stock on the date of issuance of the May 20, 2016 Note Payable. The allocation of the proceeds received to the restricted shares of common stock based on their relative fair value resulted in the Company recording a debt discount of $70,280. The discount was amortized in full to interest expense during the six months ended June 30, 2016.
The Company recognized interest expense on the short-term loans payable and non-related party note payable and non-convertible debentures of $77,550, $88,915, $6,313, and $25,916 for the three and six months ended June 30, 2016 and 2015, respectively. Amortization of the debt discount to interest expense during the three and six months ended June 30, 2016 and 2015 totaled $94,902, $95,371, $65,326, and $188,453, respectively.
Convertible Debentures - Third Quarter 2015 Financing
The following table summarizes the outstanding Third Quarter 2015 Convertible Debentures at December 31, 2015:
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December 31,
2015
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Investor 1 - July 27, 2015
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Investor 1 - September 30, 2015
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Investor 2 - August 25, 2015
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Investor 2 - September 21, 2015
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Investor 3 – August 27, 2015
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Plus: Original issue discount (10%)
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Convertible debentures – long-term
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In the third quarter of 2015, the Company entered into Securities Purchase Agreements with three (3) accredited investors (the “Buyers”), pursuant to which the Company received aggregate gross proceeds of $1,325,000 (net of OID) pursuant to which it sold:
Six (6) Convertible Promissory Notes of the Company. Two in the principal amount of $275,000, one for $550,000, one for $137,500, and two for $110,000 (each a “Q3 2015 Note” and collectively the “Q3 2015 Notes”) (the Q3 2015 Notes were sold at a 10% OID and the Company received an aggregate total of $1,242,500 in funds thereunder after debt issuance costs of $82,500). The principal amount due under the Q3 2015 Notes was $1,457,500. The Q3 2015 Notes and accrued interest were convertible into shares of common stock of the Company (the “Common Stock”) beginning six (6) months from the date of execution, at a conversion price of $0.15 per share, with certain adjustment provisions noted below. The maturity date of the first and second Q3 2015 Note was August 26, 2016. The third Q3 2015 Note had a maturity date of September 24, 2016, the fourth had a maturity date of September 26, 2016, the fifth was October 20, 2016 and the sixth was October 29, 2016. The Q3 2015 Notes bore interest on the unpaid principal amount at the rate of five percent (5%) per annum from the date of issuance until the same became due and payable, whether at maturity or upon acceleration or by prepayment or otherwise. Notwithstanding the foregoing, upon the occurrence of an Event of Default as defined in such Q3 2015 Note, a “Default Amount” equal to the sum of (i) the principal amount, together with accrued interest due thereon through the date of payment payable at the holder’s option in cash or common stock and (ii) an additional amount equal to the principal amount payable at the Company’s option in cash or common stock. For purposes of payments in common stock, the following conversion formula applied: the conversion price shall be the lower of: (i) the fixed conversion price ($0.15) or (ii) 60% multiplied by the volume weighted average price of the Company’s common stock during the ten consecutive trading days immediately prior to the later of the Event of Default or the end of the applicable cure period. Certain other conversion rates applied in the event of the sale or merger of the Company, default and other defined events. The embedded conversion feature of these notes contained anti-dilution protection, therefore, were treated as derivative instruments (see Note 9).
The Company could have prepaid the Q3 2015 Notes at any time on the terms set forth in the Q3 2015 Notes at the rate of 115% of the then outstanding balance of the Q3 2015 Notes. Under the terms of the Q3 2015 Notes, the Company could not effect certain corporate and business actions during the term of the Q3 2015 Notes, although some could have been done with proper notice. Pursuant to the Purchase Agreement, with certain exceptions, the Note holder had a right of participation during the term of the Q3 2015 Notes; additionally, the Company granted the Q3 2015 Note holder registration rights for the shares of common stock underlying the Q3 2015 Notes pursuant to Registration Rights Agreements.
In addition, a Registration Rights Agreement was signed and, as a result, the Company filed a Registration Statement on September 11, 2015 and filed an Amended Form S–1 on October 26, 2015 and November 12, 2015.
During the six months ended June 30, 2016, the Q3 2015 Notes holders elected to convert all principal and interest outstanding of $1,515,635 into 10,104,228 shares of common stock at a conversion price of $0.15 per share (see Note 8). As a result of the conversion of the outstanding principal and interest balance into shares of common stock, the fair value of the embedded conversion feature derivative liabilities of $2,018,565 on the date of conversion was reclassified to additional paid-in capital (see Note 9) and the remaining unamortized debt discount was amortized to interest expense during the six months ended June 30, 2016.
Convertible Debentures - Second Quarter 2016 Financing
The following table summarizes the outstanding Second Quarter 2016 Convertible Debentures at June 30, 2016:
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June 30,
2016
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Investor 1 – June 30, 2016
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Investor 2 – June 30, 2016
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Investor 3 – June 30, 2016
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Sub-total of gross proceeds received
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Plus: Original issue discount (10%)
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Convertible debentures – long-term
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In the second quarter of 2016, the Company entered into Securities Purchase Agreements with three accredited investors (the “Investors”), pursuant to which the Company received aggregate gross proceeds of $1,500,000 (net of OID) pursuant to which it sold:
Three Convertible Promissory Notes of the Company. Two in the principal amount of $275,000 and one for $1,000,000 (each a “Q2 2016 Note” and collectively the “Q2 2016 Notes”) (the Q2 2016 Notes were sold at a 10% OID and the Company received an aggregate total of $1,305,000 in funds thereunder after debt issuance costs of $195,000). The funds from the Q2 2016 Notes were held in escrow and released to the Company on July 6, 2016. The principal amount due under the Q2 2016 Notes is $1,650,000. The Q2 2016 Notes and accrued interest are convertible into shares of common stock of the Company at a conversion price of $0.25 per share, with certain adjustment provisions noted below. The maturity date of the Q2 2016 Note is July 30, 2017. The Q2 2016 Notes bear interest on the unpaid principal amount at the rate of five percent (5%) per annum from the date of issuance until the same becomes due and payable, whether at maturity or upon acceleration or by prepayment or otherwise. Notwithstanding the foregoing, upon the occurrence of an Event of Default as defined in such Q2 2016 Note, a “Default Amount” equal to the sum of (i) the principal amount, together with accrued interest due thereon through the date of payment payable at the holder’s option in cash or common stock and (ii) an additional amount equal to the principal amount payable at the Company’s option in cash or common stock. For purposes of payments in common stock, the following conversion formula shall apply: the conversion price shall be the lower of: (i) the fixed conversion price ($0.25) or (ii) 75% multiplied by the volume weighted average price of the Company’s common stock during the ten consecutive trading days immediately prior to the later of the Event of Default or the end of the applicable cure period. For purposes of the Investors request of repayment in cash but the Company is unable to do so, the following conversion formula shall apply: the conversion price shall be the lower of: (i) the fixed conversion price ($0.25) or (ii) 60% multiplied by the lowest daily volume weighted average price of the Company’s common stock during the ten consecutive trading days immediately prior to the conversion. Certain other conversion rates apply in the event of the sale or merger of the Company, default and other defined events.
The Company may prepay the Q2 2016 Notes at any time on the terms set forth in the Q2 2016 Notes at the rate of 110% of the then outstanding balance of the Q2 2016 Notes. Under the terms of the Q2 2016 Notes, the Company shall not effect certain corporate and business actions during the term of the Q2 2016 Notes, although some may be done with proper notice. Pursuant to the Securities Purchase Agreements, with certain exceptions, the Investors have a right of participation during the term of the Q2 2016 Notes; additionally, the Company granted the Q2 2016 Note holders registration rights for the shares of common stock underlying the Q2 2016 Notes up to $1,000,000 pursuant to Registration Rights Agreements.
In addition, bundled with the convertible debenture, the Company sold:
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1.
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A common stock purchase warrant to each Investor, which allows the Investors to purchase an aggregate of 1,500,000 shares of common stock and the placement agent to purchase 680,000 shares of common stock (aggregating 2,180,000 shares of the Company’s common stock) at an exercise price of $0.40 per share (see Note 8); and
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2.
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3,750,000 restricted shares of common stock to the Investors.
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In addition, a Registration Rights Agreement was signed and, as a result, the Company is expected to file a Registration Statement in August 2016.
The Company allocated the proceeds from the Q2 2016 Notes to the convertible debenture, warrants and restricted shares of common stock issued based on their relative fair values. The Company determined the fair value of the warrants using the Black-Scholes Option Pricing Model with the following range of assumptions:
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June 30,
2016
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Expected terms (in years)
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5.00
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Expected volatility
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229%
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Risk-free interest rate
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1.01%
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Dividend yield
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-
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The fair value of the restricted shares of common stock issued to Investors in July 2016 was based on the market price of the Company’s common stock on the date of issuance of the Q2 2016 Notes. The allocation of the proceeds to the warrants and restricted shares of common stock based on their relative fair values resulted in the Company recording a debt discount of $186,526 and $472,814, respectively. The remaining proceeds of $840,660 were initially allocated to the debt. The Company determined that the embedded conversion features in the Q2 2016 Notes were a derivative instrument which was required to be bifurcated from the debt host contract and recorded at fair value as a derivative liability. The fair value of the embedded conversion features at issuance was determined using a Path-Dependent Monte Carlo Simulation (see Note 9 for assumptions used to calculate fair value). The initial fair value of the embedded conversion features were $1,409,664, of which, $470,824 is recorded as a debt discount. The initial fair value of the embedded conversion feature derivative liabilities in excess of the proceeds allocated to the debt, after the allocation of debt proceeds to the deferred financing costs, was $938,840, and was immediately expensed and recorded as interest expense during the three and six months ended June 30, 2016 in the accompanying condensed consolidated statement of operations. The Q2 2016 Notes were also issued at an OID of 10% and the OID of $150,000 was recorded as an addition to the principal amount of the Q2 2016 Notes and a debt discount in the accompanying condensed consolidated balance sheet.
Total deferred financing costs incurred in connection with the Q2 2016 Notes was $369,836, of which, $140,836 is the fair value of the warrants to purchase 680,000 shares of common stock issued to the placement agents. The deferred financing costs have been recorded as debt discount and are being amortized to interest expense using the effective interest method over the term of the Q2 2016 Notes.
Interest Expense
The Company recognized interest expense on the Q3 2015 Notes and Q2 2016 Notes of $13,213 and $31,381 for the three and six months ended June 30, 2016. The debt discount recorded for the Q2 2016 Notes are being amortized as interest expense over the term of the Q2 2016 Notes using the effective interest method. Total amortization of the debt discount on the Q3 2015 Notes and Q2 2016 Notes to interest expense for the three and six months ended June 30, 2016 was $690,021 and $1,050,041, respectively.
NOTE 6 – DEBENTURES – RELATED PARTY
The following table summarizes the long-term outstanding debentures to a related party at June 30, 2016 and December 31, 2015:
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June 30,
2016
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December 31,
2015
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Line of credit convertible debenture – related party
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2014 non-convertible debenture – related party
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Total long-term debentures – related party
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Line of Credit Convertible Debenture
In January 2013, the Company entered into a line of credit convertible debenture with its CEO (the “LOC Convertible Debenture”). Under the terms of its original issuance: (1) the Company could request to borrow up to a maximum principal amount of $250,000 from time to time; (2) amounts borrowed bore an annual interest rate of 8%; (3) the amounts borrowed plus accrued interest were payable in cash at the earlier of January 14, 2014 or when the Company completes a Financing, as defined, and (4) the holder had sole discretion to determine whether or not to make an advance upon the Company’s request.
During 2013, the LOC Convertible Debenture was further amended to: (1) increase the maximum principal amount available for borrowing to $1 million plus any amounts of salary or related payments paid to Dr. Damaj prior to the termination of the funding commitment; and (2) change the holder’s funding commitment to automatically terminate on the earlier of either (a) when the Company completes a financing with minimum net proceeds of at least $4 million, or (b) July 1, 2016.
On August 12, 2015, the principal amount that may be borrowed was increased to $2,000,000 and the automatic termination date described above was extended to October 1, 2016. The conversion price is $0.16 per share, 80% times the quoted market price of the Company’s common stock on the date of the amendment.
During the six months ended June 30, 2016 and 2015, the Company borrowed $0 and $113, respectively, under the LOC Convertible Debenture and it repaid $119,000 during the six months ended June 30, 2016. The Company recorded a beneficial conversion feature of $1,611 and $3,444 for the three and six months ended June 30, 2016. As of June 30, 2016, the Company owed $290,192 in principal amount under the LOC Convertible Debenture and there was approximately $1.7 million remaining on the line of credit and available to use. The Company repaid the outstanding LOC Convertible Debenture balance in full in August 2016.
2014 Non-Convertible Note – Related Party
On January 29, 2014, the Company issued an 8% note, in the amount of $25,000, to the Company’s CEO. The principal amount and interest were payable on January 22, 2015. This note was amended to extend the maturity date until January 22, 2017. This note is still outstanding at June 30, 2016 and was repaid in full in August 2016.
Interest Expense
The Company recognized interest expense on the outstanding debentures to a related party totaling $6,944, $15,306, $11,437, and $26,817 during the three and six months ended June 30, 2016 and 2015, respectively. Amortization of the debt discount to interest expense during the three and six months ended June 30, 2016 and 2015 totaled $5,448, $15,719, $16,192 and $31,964, respectively.
NOTE 7 – RELATED PARTY TRANSACTIONS
Related Party Borrowings
There were several related party borrowings which are described in more detail in Note 6.
Accrued Compensation – Related Party
Accrued compensation includes accruals for employee wages and vacation pay. The components of accrued compensation as of June 30, 2016 and December 31, 2015 are as follows:
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June 30,
2016
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December 31,
2015
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Payroll taxes on the above
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Accrued employee wages at June 30, 2016 and December 31 2015 are entirely related to wages owed to the Company’s CEO. Under the terms of his employment agreement, wages are to be accrued but no payment made for so long as payment of such salary would jeopardize the Company’s ability to continue as a going concern. The CEO started to receive salary in the third quarter of 2015. Under the third quarter 2015 financing agreement, salaries prior to January 1, 2015 could not be repaid until the debentures were repaid in full or otherwise extinguished by conversion or other means and, accordingly, the accrued compensation is shown as a long-term liability. During the period ended June 30, 2016, the Q3 2015 Notes was fully converted. The Company does not expect to pay such amount classified as long-term within the next twelve months. As of June 30, 2016 and December 31, 2015, the remaining accrued compensation of $815,590 and $535,862, respectively, is included in accounts payable and accrued expenses in the accompanying condensed consolidated balance sheets.
NOTE 8 – STOCKHOLDERS’ DEFICIT
Capital Stock
The Company is authorized to issue 150,000,000 shares, all of which are common stock with a par value of $0.001 per share.
Issuances of Common Stock
On January 6, 2016 and April 5, 2016, the Company entered into a consulting agreement with a third party pursuant to which the Company agreed to issue, over the term of the agreements, an aggregate of 1,560,000 shares of Company common stock in exchange for services to be rendered. During the six months ended June 30, 2016, the Company issued 1,110,000 shares under the agreement related to services provided and recognized the fair value of the shares issued of $67,260 in general and administrative expense in the accompanying condensed consolidated statement of operations. The 1,110,000 shares of common stock vested on the date of issuance and the fair value of the shares of common stock was based on the market price of the Company’s common stock on the date of vesting.
In January 2016, the Company issued 300,000 shares of common stock for services and recorded an expense of $17,000, which is included in general and administrative expense in the accompanying condensed consolidated statement of operations. The 300,000 shares of common stock vested on the date of issuance and the fair value of the shares of common stock was based on the market price of the Company’s common stock on the date of vesting.
On February 10, 2016, the Company entered into an investor relations service agreement with a third party pursuant to which the Company agreed to issue, over the term of the agreement, 3,000,000 shares of Company common stock in exchange for services to be rendered. During the six months ended June 30, 2016, the Company issued 2,500,000 shares under the agreement related to services provided and recognized the fair value of the shares issued of $242,500 in general and administrative expense in the accompanying condensed consolidated statement of operations. The 2,500,000 shares of common stock vested on the date of issuance and the fair value of the shares of common stock was based on the market price of the Company’s common stock on the date of vesting.
On February 19, 2016, the Company entered into a consulting agreement with a third party, pursuant to which the Company agreed to issue, over the term of the agreement, 1,750,000 shares of Company common stock in exchange for services to be rendered. During the six months ended June 30, 2016, the Company issued 1,625,000 shares under the agreement related to services provided in connection with the acquisition of Beyond Human (see Note 3) and recognized the fair value of the shares issued of $122,263 in general and administrative expense in the accompanying condensed consolidated statement of operations. The 1,625,000 shares of common stock vested on the date of issuance and the fair value of the shares of common stock was based on the market price of the Company’s common stock on the date of vesting.
In April 2016, the Company issued 3,193,446 shares of common stock upon the cashless exercise of warrants to purchase 4,797,724 shares of common stock. Upon exercise of the warrants, the fair value of the warrant derivative liability on the date of exercise was reclassified to additional paid-in capital (see Note 9).
In April and May 2016, the Company issued 550,000 shares of common stock for services and recorded an expense of $54,900, which is included in general and administrative expense in the accompanying condensed consolidated statement of operations. The 550,000 shares of common stock vested on the date of issuance and the fair value of the shares of common stock was based on the market price of the Company’s common stock on the date of vesting.
On April 27, 2016, the Company entered into an investor relations service agreement with a third party pursuant to which the Company agreed to issue 300,000 shares of Company common stock in exchange for services to be rendered over the 3 month term of the agreement. The shares of common stock issued were non-forfeitable and the fair value of $28,500 was based on the market price of the Company’s common stock on the date of vesting. During the six months ended June 30, 2016, the Company recognized $19,000 in general and administrative expense in the accompanying condensed consolidated statement of operations. At June 30, 2016, the remaining $9,500 is included in prepaid expenses in the accompanying condensed consolidated balance sheet and will be expensed over the remaining term of the agreement.
In May 2016, the Company issued 1,250,000 shares of restricted common stock to certain note holders in connection with their notes payable. The relative fair value of the shares of restricted common stock issued was determined to be $93,964 and was recorded as a debt discount (see Note 5).
In May and June 2016, the Buyers of the Q3 2015 Notes elected to convert $1,515,635 in principal and interest into 10,104,228 shares of common stock (see Note 5). Upon conversion, the fair value of the embedded conversion feature derivative liability on the date of conversion was reclassified to additional paid-in capital (see Note 9).
During the six months ended June 30, 2016, the Company issued 215,000 shares of common stock for legal fees in connection with the Semprae merger transaction and recognized the fair value of the shares issued of $64,500 in general and administrative expense in the accompanying condensed consolidated statement of operations.
During the six months ended June 30, 2016, the Company issued 18,887,859 shares of common stock in exchange for vested restricted stock units.
Common Stock Subscribed but Unissued
In connection with the issuance of the Q2 2016 Notes, the Company was to issue restricted shares of common stock totaling 3,750,000 to the Investors. The restricted shares of common stock were not issued until July 2016 and thus the relative fair value of the restricted shares of common stock totaling $472,814 was recorded as common stock subscribed but unissued in the accompanying condensed consolidated balance sheet (see Note 5). The amount will be reclassified to common stock par value and additional paid-in capital upon issuance in July 2016.
2013 Equity Plan
The Company has issued common stock, restricted stock units and stock option awards to employees, non-executive directors and outside consultants under the 2013 Incentive Plan, which was approved by the Company’s Board of Directors in February of 2013. The 2013 Incentive Plan allows for the issuance of up to 10,000,000 shares of the Company’s common stock to be issued in the form of stock options, stock awards, stock unit awards, stock appreciation rights, performance shares and other share-based awards. The exercise price for all equity awards issued under the 2013 Incentive Plan is based on the fair market value of the common stock. Currently, because the Company’s common stock is quoted on the OTCQB, the fair market value of the common stock is equal to the last-sale price reported by the OTCQB as of the date of determination, or if there were no sales on such date, on the last date preceding such date on which a sale was reported. Generally, each vested stock unit entitles the recipient to receive one share of Company common stock which is eligible for settlement at the earliest of their termination, a change in control of the Company or a specified date. Restricted stock units can vest according to a schedule or immediately upon award. Stock options generally vest over a three-year period, first year cliff vesting with quarterly vesting thereafter on the three-year awards, and have a ten-year life. Stock options outstanding are subject to time-based vesting as described above and thus are not performance-based. As of June 30, 2016, 386,153 shares were available under this plan.
2014 Equity Plan
The Company has issued common stock, restricted stock units and stock option awards to employees, non-executive directors and outside consultants under the 2014 Incentive Plan, which was approved by the Company’s Board of Directors in November 2014. The 2014 Incentive Plan allows for the issuance of up to 20,000,000 shares of the Company’s common stock to be issued in the form of stock options, stock awards, stock unit awards, stock appreciation rights, performance shares and other share-based awards. The exercise price for all equity awards issued under the 2014 Incentive Plan is based on the fair market value of the common stock. Currently, because the Company’s common stock is quoted on the OTCQB, the fair market value of the common stock is equal to the last-sale price reported by the OTCQB as of the date of determination, or if there were no sales on such date, on the last date preceding such date on which a sale was reported. Generally, each vested stock unit entitles the recipient to receive one share of Company common stock which is eligible for settlement at the earliest of their termination, a change in control of the Company or a specified date. Restricted stock units can vest according to a schedule or immediately upon award. Stock options generally vest over a three-year period, first year cliff vesting with quarterly vesting thereafter on the three-year awards and have a ten-year life. Stock options outstanding are subject to time-based vesting as described above and thus are not performance-based. As of June 30, 2016, 950,001 shares were available under this plan.
Stock-Based Compensation
The stock-based compensation expense for the three and six months ended June 30, 2016 and 2015 was $111,885, $636,518, $121,192 and $751,710, respectively, for the issuance of restricted stock units and stock options to management, directors and consultants. The Company calculates the fair value of the restricted stock units based upon the quoted market value of the common stock at the date of grant. The Company calculates the fair value of each stock option award on the date of grant using Black-Scholes.
Stock Options
For the six months ended June 30, 2016 and 2015, the following weighted average assumptions were utilized for the stock options granted during the period:
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2016
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2015
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Average risk free interest rate
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The dividend yield of zero is based on the fact that the Company has never paid cash dividends and has no present intention to pay cash dividends. Expected volatility is based on the historical volatility of the Company’s common stock over the period commensurate with the expected life of the stock options. Expected life in years is based on the “simplified” method as permitted by ASC Topic 718. The Company believes that all stock options issued under its stock option plans meet the criteria of “plain vanilla” stock options. The Company uses a term equal to the term of the stock options for all non-employee stock options. The risk free interest rate is based on average rates for treasury notes as published by the Federal Reserve in which the term of the rates correspond to the expected term of the stock options.
The following table summarizes the number of stock options outstanding and the weighted average exercise price:
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Options
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Weighted average exercise price
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Weighted remaining contractual life (years)
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Aggregate intrinsic value
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Outstanding at December 31, 2015
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Outstanding at June 30, 2016
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The aggregate intrinsic value is calculated as the difference between the exercise price of all outstanding stock options and the quoted price of the Company’s common stock at June 30, 2016. During the three and six months ended June 30, 2016 and 2015, the Company recognized stock-based compensation from stock options of $4,000, $9,500, $887 and $2,711, respectively.
Restricted Stock Units
The following table summarizes the number of restricted stock units activity for the six months ended June 30, 2016 under both plans:
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Restricted Stock Units
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Outstanding at December 31, 2015
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Outstanding at June 30, 2016
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The vested restricted stock units at June 30, 2016 have not settled and are not showing as issued and outstanding shares of the Company but are considered for earnings per share calculations. Settlement of these vested restricted stock units will occur on the earliest of (i) the date of termination of service of the employee or consultant, (ii) change of control of the Company, or (iii) 10 years from date of issuance. Settlement of vested restricted stock units may be made in the form of (i) cash, (ii) shares, or (iii) any combination of both, as determined by the board of directors and is subject to certain criteria having been fulfilled by the recipient.
During the six months ended June 30, 2016, the Company issued 10,787,947 restricted stock units to employees and board members. In 2016, 787,948 were from the 2013 Plan and vested immediately and the remaining 9,999,999 were from the 2014 Plan. A total of 6,000,001 of 9,999,999 restricted stock units vested immediately and the remaining 3,999,998 vested upon the closing of the Beyond Human asset acquisition. In January 2016, the board of directors approved for grant 3,999,998 restricted stock units to employees and board members subject to the increase in the authorized shares available under the 2014 Plan or the adoption of a new equity inventive plan. The restricted stock units were to vest upon the achievement of a certain milestone by the Company. The restricted stock units were not considered granted under ASC 718 until such time as the authorized shares under the 2014 Plan were increased or a new equity incentive plan was approved. In June 2016, these restricted stock units were cancelled by the board of directors. The grant date fair value of restricted stock units issued during the six months ended June 30, 2016 was $450,269. For the three and six months ended June 30, 2016 and 2015, the Company recognized $107,885, $627,018, $120,305 and $748,999, respectively, of stock-based compensation expense for the vested units. As of June 30, 2016, compensation expense related to unvested shares not yet recognized in the condensed consolidated statement of operations was $265,125 and will be recognized over 0.75 years.
Warrants
In 2014, the Company issued 380,973 warrants in connection with a note payable. The warrants have an exercise price of $0.10 and expire December 6, 2018. Warrants to purchase 245,157 shares of common stock were exercised under the cashless exercise provisions of the warrant agreement in July 2016 (see Note 10).
In February 2014, the Company issued 250,000 warrants in connection with a convertible debenture. The warrants had an exercise price of $0.50 per share and was to expire on February 13, 2019. On March 6, 2015 the Company entered into an agreement with the note holder to extend the convertible debenture for six months. As consideration for the extension, the Company issued the note holder an additional 250,000 warrants, reduced the exercise price of the warrants from $0.50 to $0.30 per share and extended the expiration date to March 12, 2020. The warrants were also amended to include certain anti-dilution protection, including protection upon dilutive issuances. In connection with the third quarter 2015 convertible debenture financing, the exercise price of these warrants was reduced to $0.0896 per share and an additional 1,173,410 warrants were issued per the anti-dilution protection afforded in the warrant agreement during the year ended December 31, 2015. These warrants were exercised under the cashless exercise provisions of the warrant agreement in April 2016. In connection with the exercise of the warrants, the Company agreed to reduce the exercise price of these warrants to $0.07 per share which resulted in an additional 469,447 warrants being issued in April 2016 prior to exercise. The warrants exercised were classified as derivative liabilities and, upon exercise, the fair value of the warrant derivative liability was reclassified to additional paid-in capital (see Note 9).
In January 2015, the Company issued 500,000 warrants in connection with a non-convertible debenture. The warrants are exercisable for five years from the closing date at an exercise price of $0.30 per share of common stock or January 21, 2020. The warrants contain anti-dilution protection, including protection upon dilutive issuances. In connection with the third quarter 2015 convertible debenture financing, the exercise price of these warrants was reduced to $0.0896 per share and an additional 1,173,410 warrants were issued per the anti-dilution protection afforded in the warrant agreement during the year ended December 31, 2015. These warrants were exercised under the cashless exercise provisions of the warrant agreement in April 2016. In connection with the exercise of the warrants, the Company agreed to reduce the exercise price of these warrants to $0.0565 per share which resulted in an additional 981,457 warrants being issued in April 2016 prior to exercise. The warrants exercised were classified as derivative liabilities and, upon exercise, the fair value of the warrant derivative liability was reclassified to additional paid-in capital (see Note 9).
In January 2015, the Company issued 250,000 warrants with an exercise price of $0.30 per share to its former CFO in connection with a non-convertible debenture. The warrants expire on January 21, 2020. The warrants contain anti-dilution protection, including protection upon dilutive issuances. In connection with the third quarter 2015 convertible debenture financing, the exercise price of these warrants was reduced to $0.0896 per share and an additional 586,705 warrants were issued per the anti-dilution protection afforded in the warrant agreement during the year ended December 31, 2015.
In connection with the Third Quarter 2015 Financing the Company issued 1,808,333 warrants with an exercise price of $0.30 per share and expire in 2020. Warrants to purchase 635,000 shares of common stock were exercised in July 2016 (see Note 10).
In connection with the Second Quarter 2016 Financing the Company issued 2,180,000 warrants to the Investors and placement agents with an exercise price of $0.40 per share and expire in 2021.
At June 30, 2016 and December 31, 2015, there are 5,206,011 and 6,372,831 fully vested warrants outstanding, respectively.
Net Loss per Share
The weighted average shares of common stock outstanding used in the basic and diluted net loss per share calculation for the three and six months ended June 30, 2016 was 77,455,497 and 62,335,408, respectively.
The weighted average restricted stock units vested but deferred until the employee or director resigns outstanding used in the basic and diluted net loss per share calculation for the three and six months ended June 30, 2016 was 7,940,349 and 7,935,925, respectively.
The total weighted average shares outstanding used in the basic and diluted net loss per share calculation for the three and six months ended June 30, 2016 was 85,395,846 and 70,271,333, respectively.
The weighted average restricted stock units, vested but deferred until the employee or director resigns, outstanding during the three and six months ended June 30, 2015 was 11,392,909 and 9,316,897, respectively. The total weighted average shares outstanding during the three and six months ended June 30, 2015 would have been 52,209,676 and 47,226,561, respectively. There would have been no impact on the previously reported basic and diluted net loss per share for the three months ended June 30, 2015 but there would have been a decrease in the previously reported basic and diluted net loss per share for the six months ended June 30, 2015 of $0.01 per share.
The following table shows the anti-dilutive shares excluded from the calculation of basic and diluted net loss per common share as of June 30, 2016 and 2015:
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As of June 30,
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2016
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2015
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Gross number of shares excluded:
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Restricted stock units - unvested
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Convertible debentures and accrued interest
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The above table does not include the ANDA Consideration Shares related to the Novalere acquisition, as they are considered contingently issuable (see Note 3).
NOTE 9 – DERIVATIVE LIABILITIES
The warrants issued in connection with certain previously outstanding debentures are measured at fair value and classified as a liability because these warrants contain anti-dilution protection and therefore, cannot be considered indexed to the Company’s own stock which is a requirement for the scope exception as outlined under FASB ASC 815. The estimated fair value of the warrants was determined using the Probability Weighted Black-Scholes Option-Pricing Model, resulting in a value of $226,297 at the date of issuance. The fair value will be affected by changes in inputs to that model including our stock price, expected stock price volatility, the contractual term and the risk-free interest rate. The Company will continue to classify the fair value of the warrants as a liability until the warrants are exercised, expire or are amended in a way that would no longer require these warrants to be classified as a liability, whichever comes first. The anti-dilution protection for the warrants survives for the life of the warrants which ends in January 2020 and March 2020. Certain of these warrants were exercised under the cashless exercise provisions of the warrant agreement in April 2016 and, as a result, the fair value of the warrant derivative liability on the date of exercise totaling $518,224 was reclassified to additional paid-in capital (see Note 8).
The assumptions for the Probability Weighted Black-Scholes Option-Pricing Model for the six months ended June 30, 2016 are represented in the table below for the warrants issued in connection with the debentures, reflected on a per share common stock equivalent basis.
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June 30, 2016
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Average risk free interest rate
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The Company has determined the embedded conversion features of the Q3 2015 Notes and Q2 2016 Notes (see Note 5) to be derivative liabilities because the terms of the embedded conversion features contain anti-dilution protection and therefore, cannot be considered indexed to the Company’s own stock which is a requirement for the scope exception as outlined under FASB ASC 815. The embedded conversion features are to be measured at fair value and classified as a liability with subsequent changes in fair value recorded in earnings at the end of each reporting period. The Company has determined the fair value of the derivative liabilities using a Path-Dependent Monte Carlo Simulation. The fair value of the derivative liabilities using such option pricing model will be affected by changes in inputs to that model and is based on the individual characteristics of the embedded conversion features on the valuation date as well as assumptions for volatility, remaining expected life, risk-free interest rate, credit spread, and
probability of default by the Company and acquisition of the Company. The Company will continue to classify the fair value of the embedded conversion features as a liability until the conversion features are exercised, expire or are amended in a way that would no longer require these embedded conversion features to be classified as a liability, whichever comes first. During the six months ended June 30, 2016, the Q3 2015 Notes were fully converted into shares of common stock which resulted in the fair value of the embedded conversion feature derivative liability on the date of conversion of $2,018,565 to be reclassified to additional paid-in capital (see Note 8). The anti-dilution protection for the embedded conversion features survive the life of the Q2 2016 Notes which mature at June 30, 2017.
The derivative liabilities are a Level 3 fair value measurement in the fair value hierarchy and a summary of quantitative information with respect to valuation methodology and significant unobservable inputs used for the Company’s embedded conversion feature derivative liabilities that are categorized within Level 3 of the fair value hierarchy during the six months ended June 30, 2016 is as follows:
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June 30, 2016
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$
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$
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Average risk free interest rate
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At June 30, 2016, the estimated Level 3 fair values of the embedded conversion feature and warrant derivative liabilities measured on a recurring basis are as follows:
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Fair value
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Level 1
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Level 2
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Level 3
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Total
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Embedded conversion feature derivative liabilities
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Warrant derivative liabilities
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The following table presents the activity for the Level 3 embedded conversion feature and warrant derivative liabilities measured at fair value on a recurring basis for the six months ended June 30, 2016:
Fair Value Measurements Using Level 3 Inputs
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Warrant derivative liabilities
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Beginning balance December 31, 2015
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Reclassification of fair value of warrant derivative liability to
additional paid-in capital upon exercise of warrants
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Ending balance June 30, 2016
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Embedded conversion feature derivative liabilities
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Beginning balance December 31, 2015
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Fair value of Q2 2016 Notes embedded conversion feature derivative liability
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Reclassification of fair value of embedded conversion feature derivative liability to
additional paid-in capital upon conversions of Q3 2015 Notes
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Ending balance June 30, 2016
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NOTE 10 – SUBSEQUENT EVENTS
In July and August 2016, the Company received notifications from five of its warrant holders on their intent to exercise their warrants totaling 792,500 at an exercise price of $0.30 per share. The Company received gross cash proceeds of $237,750.
In July 2016, the Company received notification from one of its warrant holders on their intent to exercise their warrants under the cashless exercise provisions of their respective warrant agreement. The Company issued 191,908 shares of common stock for the cashless exercise of warrants to purchase 245,157 shares of common stock at an exercise price of $0.10 per share.
In July 2016, the Company issued 100,000 shares of common stock to an employee in exchange for vested restricted stock units.
In July 2016, the Company issued 750,000 shares of common stock to various consultants for services rendered and the fair value of the common stock issued was approximately $180,000.
In July 2016, the Company issued 100,000 shares of common stock to Centric Research Institute pursuant to the asset purchase agreement dated April 19, 2013. The shares were issued as a milestone payment due under the asset purchase agreement and the fair value of the common stock was approximately $28,000.
On July 15, 2016 and July 25, 2016, the Company entered into Securities Purchase Agreements with six accredited investors, pursuant to which the Company received aggregate gross cash proceeds of $1,500,000 (net of OID of $153,889) for the sale of convertible promissory notes, warrants and shares of restricted common stock. The Company issued warrants to purchase 1,500,000 shares of common stock at a price per share of $0.40, as well as an aggregate 3,750,000 restricted shares of common stock to the investors. The terms of these Securities Purchase Agreements have the same rights and terms as the Q2 2016 Notes (see Note 5 above), with the exception of the convertible promissory notes issued on July 25, 2016, which have a maturity date of August 25, 2017. The June 30, 2016, July 15, 2016 and July 25, 2016 investments are part of a $3,000,000 total offering of convertible debentures.
The Company has evaluated subsequent events through the filing date of this Form 10-Q and determined that no subsequent events have occurred that would require recognition in the condensed consolidated financial statements or disclosures in the notes thereto other than as disclosed in the accompanying notes to the condensed consolidated financial statements.