NOTES TO CONSOLIDATED FINAN
CIAL STATEMENTS
NOTE 1. Basis of Presentation and Going Concern
Considerations
Basis of Presentation
The consolidated financial statements have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). The preparation of financial statements in conformity with United States (U.S.) generally accepted accounting principles requires management to make estimates and assumptions that affect reported assets, liabilities, revenues and expenses, as well as disclosure of contingent assets and liabilities. Actual results could differ from those estimates and assumptions. The Company maintains a web site at
www.appliedvs.com,
which makes available free of charge our recent annual report and other filings with the SEC.
Description of Business
Applied Visual Sciences, Inc. was incorporated under the name Guardian Technologies International, Inc., in the Commonwealth of Virginia in 1989 and reincorporated in State of Delaware in February 1996. We changed our name to Applied Visual Sciences, Inc., on July 9, 2010. The Company, previously an operating stage company, became a development stage company on April 1, 2012, the date of inception as a development stage company for financial reporting. Applied Visual Sciences, Inc. and its subsidiaries are collectively referred to herein as the “Company,” “Applied Visual Sciences, Inc.,” “Applied Visual,” “us,” “we,” or “our.”
Applied Visual Sciences is a software technology company that designs and develops imaging informatics solutions for delivery to its target markets, aviation/homeland security and healthcare. Our two product lines are offered through our two operating subsidiaries as follows: Guardian Technologies International, Inc. for aviation/homeland security products and Signature Mapping Medical Sciences, Inc., for healthcare. On March 23, 2012, the Company established a new entity; Instasis Imaging, Inc., for the development, marketing, and sales of a suite of imaging analytic applications for the automated detection of breast cancer. We may engage in one or more acquisitions of businesses that are complementary, and may form wholly-owned subsidiaries to operate within defined vertical markets products.
The Company utilizes imaging technologies and analytics to create integrated information management technology products and services that address critical problems experienced by corporations and governmental agencies in healthcare and homeland security. Each product and service can improve the quality and response time of decision-making, organizational productivity, and efficiency within the enterprise. Our product suite integrates, streamlines, and distributes business and clinical information and images across the enterprise.
Our Business Strategy
Our strategic vision is to position our core technology as the de facto standard for digital image analysis, knowledge extraction, and detection. Our strategy is based upon the following principal objectives:
·
Maintain product development and sales/marketing focus on large, underserved, and rapidly growing markets with a demonstrated need for intelligent imaging informatics.
·
Leverage Applied Visual Sciences, Inc.’s technology, experienced management team, research and development infrastructure.
·
Focus our talents on solving highly challenging information problems associated with digital imaging analysis.
·
Establish an international market presence through the development of a significant OEM/Reseller network.
·
Build and maintain a strong balance sheet to ensure the availability of capital for product development, acquisitions, and growth.
·
Seek to broaden our investment appeal to large institutions.
To achieve our strategic vision, we are aware of the need to exercise the financial and operational discipline necessary to achieve the proper blend of resources, products and strategic partnerships. These efforts can accelerate our ability to develop, deploy and service a broad range of intelligent imaging informatics solutions directly to our target markets and indirectly through OEM/value added reseller (“VAR”) partners. During 2013, we continued implementing changes across the spectrum of our business. We refined our marketing strategy for PinPoint™ and Signature Mapping™, and enhanced our Signature Mapping™ product offerings.
We may engage in one or more acquisitions of businesses that are complementary, and may form wholly-owned subsidiaries to operate within defined vertical markets.
Our Core Technology
Our core technology is an “intelligent imaging informatics” (“3i™”) engine that is capable of extracting embedded knowledge from digital images, and has the capacity to analyze and detect image anomalies. The technology is not limited by type of digital format. It can be deployed across divergent digital sources such as still images, x-ray images, video and hyper-spectral imagery. To date, the technology has been tested in the area of threat detection for baggage scanning at airports, for bomb squad applications and the detection of tuberculosis by analyzing digital images of stained sputum slides captured through a photo microscopy system. Varying degrees of research and development have been conducted in the areas of detection for cargo scanning, people scanning, military target acquisition in a hyper-spectral environment, satellite remote sensing ground surveys and mammography CAD products and radiologists’ diagnostic imaging tools, and while product development in these areas is ongoing, there can be no assurance that we will successfully develop product offerings in these areas.
We are currently focused on providing software technology solutions and services in two primary markets - aviation/homeland security with PinPoint™ and healthcare technology with Signature Mapping™ solutions. However, as new or enhanced solutions are developed, we expect to expand into other markets such as military and defense utilizing hyper-spectral technology, and imaging diagnostics for the medical industry.
Financial Condition, Going Concern
Considerations and Events of Default
The Company, previously an operating stage company, became a development stage company on April 1, 2012, the date of inception as a development stage company for financial reporting. A development stage company, as defined by ASC-915-10 “Accounting and Reporting by Development Stage Enterprise”, is an entity that devotes substantially all of its efforts to establish a business and either of the following conditions exists: 1) the principal operations have not commenced, or 2) the principal operations have commenced, but there has been no significant revenue therefrom. During 2013, Applied Visual Sciences’ revenue generating activities have not produced sufficient funds for profitable operations and we have incurred operating losses since inception. In view of these matters, realization of certain of the assets in the accompanying consolidated balance sheet is dependent upon continued operations, which in turn is dependent upon our ability to meet our financial requirements, raise additional financing on acceptable terms, and the success of future operations. Our independent registered public accounting firm’s report on the consolidated financial statements included herein, and in our Annual Report on Form 10-K for the year ended December 31, 2012, contains an explanatory paragraph wherein they expressed an opinion that there is substantial doubt about our ability to continue as a going concern. Accordingly, careful consideration of such opinion should be given in determining whether to continue or become our stockholder.
As of December 31, 2013, the Company has outstanding trade and accrued payables of $1,689,147, other accrued liabilities of $144,579, and accrued salaries and related expenses due to our employees and management of $8,099,945. Also, the Company has an outstanding noninterest-bearing loan from its Chief Executive Officer of $80,500, and $739,500 short-term notes from eleven (11) investors, which has debt discount outstanding of $20,570.
The principal amount of our outstanding Series A Debentures of $1,688,205 became due on July 1, 2011, and such amount was not paid. Therefore, the Company may be considered in default. The debentures provide that any default in the payment of principal, which default is not cured within the five trading days of the receipt of notice of such default or ten trading days after the Company becomes aware of such default, will be deemed an event of default and may result in enforcement of the debenture holders’ rights and remedies under the debentures and applicable law. The Company is in discussions with the debenture holders to re-negotiate the terms of the debentures, including the repayment or repurchase of the debentures and/or seek to extend their maturity date, although we have not reached any agreement with the debenture holders with regard to any such repayment, repurchase or extension. Our ability to repay or repurchase the debentures is contingent upon our ability to raise additional financing, of which there can be no assurance. Also, as a condition to any such extension, debenture holders may seek to amend or modify certain other terms of the debentures. When an event of default occurs under the debentures, the debenture holders may elect to require us to make immediate repayment of the mandatory default amount, which equals the sum of (i) the greater of either (a) 120% of the outstanding principal amount of the debentures, or (b) the outstanding principal amount unpaid divided by the conversion price on the date the mandatory default amount is either (1) demanded or otherwise due or (2) paid in full, whichever has the lower conversion price, multiplied by the variable weighted average price of the common stock on the date the mandatory default amount is either demanded or otherwise due, whichever has the higher variable weighted average price, and (ii) all other amounts, costs, expenses, and liquidated damages due under the debentures. In anticipation of such election by the debenture holders, due to the nonpayment of principal amount on the due date of July 1, 2011, we measured the mandatory default at approximately $337,641 and subsequently on each balance sheet date, which is reflected in the carrying value of the debentures and also recognized as interest expense. We re-measured the mandatory default amount as of December 31, 2012 and December 31, 2013 at approximately $337,641, respectively. As of the date of this report, the debenture holders have not made an election requiring
immediate repayment of the mandatory amount, although there can be no assurance they will not do so.
The Company currently has insufficient funds to repay the outstanding amount in the event the debenture holders make a demand for payment.
During 2013, the Company issued nine promissory notes to eight accredited investors in the aggregate principal amount of $179,500 ($179,275, net of commissions and expenses in the amount of $225), of which five notes for an aggregate of $48,500 originally matured during 2013 and were amended to mature on June 30, 2014, $14,000 matures on April 25, 2014, $100,000 matures on September 21, 2014, and $17,000 matures on October 25, 2014. The terms of the notes are essentially the same as the 2011 and 2012 short-term promissory notes, except that $40,000 of the notes accrue interest at a rate of 12% per annum, one note for $8,500 was noninterest bearing during 2013 and accrues interest at a rate of 10% effective January 1, 2014, one note for $14,000 accrues interest at a rate of 10% per annum, one note for $8,500 accrues interest at a rate of 5.9%, with two notes for $108,500 being noninterest bearing. Consideration for one $8,500 noninterest bearing note during 2013 received a modification to 540,000 warrants to include a cashless provision, one note of $8,500 received an extension of 4,632,725 warrants to December 31, 2018, and one for $100,000 received a 2% royalty payment of future TBDx™ net revenue in South Africa up to $300,000. The Company issued to six of the note holders an aggregate of 450,000 shares of common stock, and the relative fair value of the common stock of $31,100 will be amortized over the term of the notes.
As of December 31, 2013, the Company had a cash balance of $1,108. Management believes these funds to be insufficient to fund our operations for the next twelve months absent any cash flow from operations or funds from the sale of our equity or debt securities. Currently, we are spending or incurring (and accruing) expenses of approximately $190,000 per month on operations and the continued research and development of our 3i technologies and products, including with regard to salaries and consulting fees. Management believes that we will require an aggregate of approximately $2,280,000 to fund our operations for the next 12 months and to repay certain outstanding trade payables and accrued expenses. This assumes that holders of our outstanding debentures convert such debt into shares of our common stock or that we are able to extend the term of the debentures, of which there can be no assurance. In the event we are unable to extend the term of the debentures beyond their new maturity date, the debenture holders do not convert such debt or require payment of principal, partially convert such debt, or effect the buy-in provision related to the warrants and the debentures, we shall be required to raise additional financing. Also, this assumes that we are able to continue to defer the amounts due to our employees for accrued and unpaid salaries and that we are able to continue to extend or defer payment of certain amounts due to our trade creditors, of which there can be no assurance.
The Company has relied and continues to rely substantially upon equity and debt financing to fund its ongoing operations, including the research and development conducted in connection with its products and conversion of accounts payable for stock. The proceeds from our financings have been and continue to be insufficient to fund our operations, pay our trade payables, and repay our unconverted debentures or accrued and unpaid wages to our employees. Therefore, the debentures holders, our employees, or trade creditors may seek to enforce payment of amounts due to them, and our results of operations and financial condition could be materially and adversely affected and we may be unable to continue our operations. Also, in the event we continue to be unable to pay our employees, we may suffer further employee attrition. There can be no assurances that we will be successful in our efforts to raise any additional financing, any bank borrowing, and research or grant funding. Moreover, in view of the current market price of and limited trading volume in our stock, we may have limited or no access to the capital markets. Furthermore, under the terms of our agreements with the debenture holders, we are subject to restrictions on our ability to engage in any transactions in our securities in which the conversion, exercise or exchange rate or other price of such securities is below the current conversion price or is based upon the trading price of our securities after initial issuance or otherwise subject to re-set. In view of the foregoing, we may be required to curtail operations significantly, or obtain funds through entering into arrangements with collaborative partners or others that may require us to relinquish rights to certain of our technologies or products.
During 2013, our total stockholders’ deficit increased by $1,690,726 to $12,926,077, and our consolidated net loss for the period was $2,437,304. Notwithstanding the foregoing discussion of management’s expectations regarding future cash flows, Applied Visual Sciences’ insolvency continues to increase the uncertainties related to its continued existence. Both management and the Board of Directors are carefully monitoring the Company’s cash flows and financial position in consideration of these increasing uncertainties and the needs of both creditors and stockholders.
NOTE 2. Significant Accounting Policies
Development Stage Company
– The Company, previously an operating stage company, became a development stage company on April 1, 2012, the date of inception as a development stage company for financial reporting. A development stage company, as defined by ASC-915-10 “Accounting and Reporting by Development Stage Enterprise”, is an entity that devotes substantially all of its efforts to establish a business and either of the following conditions exists: 1) the principal operations have not commenced, or 2) the principal operations have commenced, but there has been no significant revenue therefrom.
Principles of Consolidation
– The accompanying consolidated financial statements include the accounts of the Company and its subsidiaries, Guardian Technologies International, Inc., Signature Mapping Medical Sciences, Inc., RJL Marketing Services, Guardian Healthcare Systems UK, Ltd., and Wise Systems Ltd., in which it has the controlling interest. Subsidiaries acquired are consolidated from the date of acquisition. All significant intercompany balances and transactions have been eliminated. On March 23, 2012, the Company established a new entity; Instasis Imaging, Inc., for the development, marketing, and sales of a suite of imaging analytic applications for the automated detection of breast cancer. Certain amounts in the consolidated financial statements of prior periods have been reclassified to conform to current period presentation.
Fair Value of Financial Instruments
– The carrying value of cash, accounts receivable, accounts payable, and derivative liability features and detachable warrants approximates fair value based on the liquidity of these financial instruments and their short-term nature.
Convertible Instruments
– The Company reviews the terms of convertible debt and equity securities for indications requiring bifurcation, and separate accounting, for the derivative liability feature. Under guidelines of ASC 815-40, “Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock,” public companies that are required, or that could be required, to deliver shares of common stock as part of a physical settlement or a net-share settlement, under a freestanding financial instrument, are required to initially measure the contract at fair value (or allocate on a fair value basis if issued as part of a debt financing), and report the value in permanent equity. However, in certain circumstances (e.g. the company could not ascertain whether sufficient authorized shares exist to settle the contract), permanent equity classification should be reassessed. The classification of the contract as permanent equity should be reassessed at each balance sheet date and, if necessary, reclassified as a liability on the date of the event causing the reclassification. If a reclassification occurs from permanent equity to a liability, the fair value of the financial instrument should be removed from permanent equity as an adjustment to stockholders’ deficit. Any portion of the contract that could be net-share settled as of the balance sheet date would remain classified in permanent equity. Subsequent to the initial reclassification event, changes in fair value of the instrument are charged to expense until the conditions giving rise to the reclassification are resolved. When a company has more than one contract subject to reclassification, it must determine a method of reclassification that is systematic, rational, and consistently applied. The Company adopted a reclassification policy that reclassifies contracts with the latest inception date first. To the extent that changes in fair value of equity instruments relates to financings since November 8, 2006 (the date of first closing under the debenture financing with reset provisions that made the number of potentially issuable shares indeterminable), the increase or decrease in the fair value of the warrants is charged or credited to interest expense. To the extent the equity instruments relate to other transactions (e.g. consulting expense), the increases or decreases are charged or credited based on the nature of the transaction. The number of additional shares potentially issuable under the November 8, 2006, outstanding convertible debentures and related outstanding warrants and other subsequent warrants issued was determinable as of the debentures’ final milestone reset date on May 20, 2008, and, therefore, the outstanding fair value of the warrants issued to the debenture holders, other subsequent warrants issued through May 20, 2008, and the warrants’ related beneficial conversion feature were reclassified as stockholders’ deficit in accordance with currently effective generally accepted accounting principles.
Cash –
Cash is stated at cost, which approximates fair value, and consists of interest and noninterest bearing accounts at a bank. Balances may periodically exceed federal insurance limits. The Company does not consider this to be a significant risk. The Company considers all highly liquid debt instruments with initial maturities of 90 days or less to be cash equivalents. There were no cash equivalents as of December 31, 2013 and 2012, respectively.
Accounts Receivable –
Accounts receivable are customer obligations due under normal trade terms and is stated net of the allowance for doubtful accounts. The Company records an allowance for doubtful accounts based on specifically identified amounts that the Company believes to be uncollectible. The Company did not record accounts receivable or an allowance for doubtful accounts as of December 31, 2013 and 2012, respectively.
Customer Concentration Risks –
The Company did not have revenue during fiscal 2013 or 2012. Although, the Company may be subject to a material customer concentration risk if a customers comprises a large percentage of our revenue, which may occur as the Company produces revenue.
Straight Line Lease –
For consolidated financial statement purposes, rent expense is recorded on a straight-line basis over the term of the lease term. The difference between the rent expense incurred and the amount paid is recorded as deferred rent and is being amortized over the term of the lease.
Fixed Assets –
Property and equipment are carried at cost less accumulated depreciation and amortization. For financial statement purposes, depreciation and amortization is provided on the straight-line method over the estimated useful live of the asset ranging from 3 to 10 years.
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December 31
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Asset (Useful Life)
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2013
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2012
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Software (3 years)
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$ 84,224
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$ 84,224
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Computer equipment (3 - 5 years)
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329,861
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329,861
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Furniture and fixtures (7 - 10 years)
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231,033
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323,639
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Equipment (7 - 10 years)
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80,727
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80,727
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Fixed assets, gross
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725,845
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818,451
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Less accumulated depreciation
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670,827
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702,316
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Fixed assets, net
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$ 55,018
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$ 116,135
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Depreciation for property and equipment was $40,521, $58,852, and $82,920 in the years ended December 31, 2013, 2012, and the period of April 1, 2012 through December 31, 2013 (the development stage), respectively, and is reflected in selling, general and administrative expenses in the accompanying consolidated statements of operations and comprehensive income.
During 2013, 2012, and the period of April 1, 2012 through December 31, 2013 (the development stage), the Company received proceeds in the amount of $28,934, $35,650, and $64,584, respectively, for the sale of furniture. The book value of the assets sold in 2013 was $37,267 (gross cost of $109,277 and accumulated depreciation of $72,010), and the book value in 2012 was $47,937 (gross cost of $164,600 and accumulated depreciation of $116,663), resulting in a gain on the sale of fixed assets in 2013 of $8,338, and a loss on the sale of fixed assets in 2012 of $12,287, and a net loss for the period of April 1, 2012 through December 31, 2013 (the development stage) of $3,949.
Intangible Assets –
Intangible assets consist of acquired software and patents. Under ASC 350, “Goodwill and Other Intangible Assets,” such assets acquired including software technology is considered to have a finite life. Management has estimated the useful life to be 5 years and amortized such costs on a straight-line basis over this period. In addition, ASC 985-20, “Accounting for the Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed,” requires the Company to consider whether or not the software technology is impaired using a net realizable value analysis based on projected discounted cash flows. The Company prepared this analysis as of December 31, 2013 and 2012, and concluded that the intangible assets are not impaired. Patent acquisition costs pertaining to the Company’s 3i technology that covers its PinPoint
™
and Signature Mapping
™ intellectual property
(technology not acquired through acquisition), have been capitalized and are being amortized over the 20-year legal life of the patents. The Company has been granted by the United States Patent & Trademark Office (“USPTO”) six patents related to its 3i technology. The Company evaluates the periods of amortization continually to determine whether later events or circumstances require revised estimates of useful lives. The Company’s intangible acquired software technology was fully amortized as of December 31, 2009. Therefore, there was no amortization costs associated with acquired software during the fiscal year 2013 and 2012, respectively. Amortization expense for patent acquisition costs was $14,618, $32,911, and $39,301 in fiscal year 2013, 2012, and the period of April 1, 2012 through December 31, 2013 (the development stage), respectively, and is reflected in selling, general and administrative expenses in the accompanying consolidated statements of operations and comprehensive income. The Company anticipates incurring additional patent acquisition costs during Fiscal Year 2014.
Excess of Purchase Price over Net Assets Acquired (Goodwill) –
The Company follows the provisions of ASC 805-10, “Business Combinations” and ASC 350-10, “Goodwill and Other Intangible Assets.” These statements establish financial accounting and reporting standards for acquired goodwill. Specifically, the standards address how acquired intangible assets should be accounted for both at the time of acquisition and after they have been recognized in the financial statements. Effective January 1, 2002, with the adoption of ASC 350-10, goodwill must be evaluated for impairment and is no longer amortized. Excess of purchase price over net assets acquired (“goodwill”) represents the excess of acquisition purchase price over the fair value of the net assets acquired. To the extent possible, a portion of the excess purchase price is assigned to identifiable intangible assets. There was no goodwill on the consolidated balance sheet of the Company during Fiscal 2013 and 2012, as a net realizable value analysis was made for goodwill in prior years during the Company’s operating stage and such asset was fully impaired during those prior years.
Impairment of Excess Purchase Price over Net Assets Acquired –
The Company follows the provisions of ASC 350-10 “Goodwill and Other Intangible Assets” for the impairment of goodwill. The Company determines impairment by comparing the fair value of the goodwill, using the undiscounted cash flow method, with the carrying amount of that goodwill. Impairment is tested annually or whenever indicators of impairment arise. There was no goodwill on the consolidated balance sheet of the Company during Fiscal 2013 and 2012, as a net realizable value analysis was made for goodwill in prior years and such asset was considered fully impaired during those prior years.
Impairment of Long-Lived Assets –
The Company evaluates the carrying value of long-lived assets for impairment, whenever events or changes in circumstances indicate that the carrying value of an asset within the scope of ASC 360-10, “Accounting of the Impairment or Disposal of Long-Lived Assets” may not be recoverable. The Company’s assessment for impairment of assets involves estimating the undiscounted cash flows expected to result from use of the asset and its eventual disposition. An impairment loss recognized is measured
as the amount by which the carrying amount of the asset exceeds the fair value of the asset, and considers year-end the date for its annual impairment testing.
Foreign Currency Translation –
The accounts of the Company’s foreign subsidiary are maintained using the local currency as the functional currency. For the subsidiary, assets and liabilities are translated into U.S. dollars at the period end exchange rates, and income and expense accounts are translated at average monthly exchange rates. Net gains or losses from foreign currency translation are excluded from operating results and are accumulated as a separate component of stockholders’ deficit.
Comprehensive Income –
The Company adopted ASC 220-10, “Reporting Comprehensive Income,” (“ASC 220-10”). ASC 220-10 requires the reporting of comprehensive income in addition to net income from operations. The comprehensive loss reflects the change in equity of a business enterprise during a period from transactions and other events and circumstances from non-owner sources. Comprehensive loss is comprised of net loss and foreign currency translation adjustments.
Revenue Recognition -
Revenues are derived primarily from the research activities, and sublicensing and licensing of computer software, installations, training, consulting, third party hardware, and software maintenance. Inherent in the revenue recognition process are significant management estimates and judgments, which influence the timing and amount of revenue recognized.
For software arrangements, the Company recognizes revenue according to ASC 985-605, “Software Revenue Recognition,” and related amendments. ASC 985-605 generally requires revenue earned on software arrangements involving multiple elements to be allocated to each element based on the relative fair values of those elements. Revenue from multiple-element software arrangements is recognized using the residual method. Under the residual method, revenue is recognized in a multiple element arrangement when vendor-specific objective evidence of fair value exists for all of the undelivered elements in the arrangement, but does not exist for one or more of the delivered elements in the arrangement. The Company allocated revenue to each undelivered element in a multiple element arrangement based on its respective fair value, with the fair value determined by the price charged when that element is sold separately. Specifically, the Company determines the fair value of the maintenance portion of the arrangement based on the renewal price of the maintenance offered to customers, which is stated in the contract, and fair value of the installation based upon the price charged when those services are sold separately. If evidence of the fair value cannot be established for undelivered elements of a software sale, the entire amount of revenue under the arrangement is deferred until these elements have been delivered or vendor-specific objective evidence of fair value can be established.
Revenue from sublicenses sold on an individual basis and computer software licenses are recognized upon shipment, provided that evidence of an arrangement exists, delivery has occurred and risk of loss has passed to the customer, fees are fixed or determinable and collection of the related receivable is reasonably assured. Revenue from software usage sublicenses sold through annual contracts and software maintenance is deferred and recognized ratably over the contract period. Revenue from installation, training, and consulting services is recognized as services are performed. Revenue from research activities, if a fixed price contract, is based on the percentage of completion method.
Cost of goods sold incorporates direct costs of raw materials, consumables, staff costs associated with installation and training services, and the amortization of the intangible assets (developed software) related to products sold.
Research and Development –
The Company accounts for its software and solutions research and development costs in accordance with ASC 985-20, “Accounting for the Costs of Computer Software to Be Sold, Leased or Otherwise Marketed.”
During the years ended December 31, 2013 and 2012, and the period of April 1, 2012 through December 31, 2013 (the development stage), the Company expensed $80,094, $82,300, and $144,382, respectively for such costs. No amounts were capitalized in these years.
Loss per Common Share -
Basic net loss per share is calculated using the weighted-average number of shares of common stock outstanding, including restricted shares of common stock. The effect of common stock equivalents is not considered as it would be anti-dilutive.
Use of Estimates –
The preparation of these consolidated financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements. Changes in these estimates and assumptions may have a material impact on the consolidated financial statements. Certain estimates and assumptions are particularly sensitive to change in the near term, and include estimates of net realizable value for long-lived and intangible assets, the valuation allowance for deferred tax assets and the assumptions used for measuring stock-based payments and derivative liabilities.
Income Taxes –
The Company accounts for income taxes under the liability method. Under the liability method, deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities, and are measured using
enacted tax rates and laws that will be in effect when the differences are expected to reverse. Valuation allowances are established, when necessary, to reduce tax assets to the amounts more likely than not to be realized.
Uncertainty in Income Taxes –
In June 2006, ASC 740-10 was established regarding the uncertainty in income taxes. ASC 740-10 establishes a recognition threshold and measurement for income tax positions recognized in an enterprise’s financial statements in accordance with accounting for income taxes. ASC 740-10 also prescribes a two-step evaluation process for tax positions. The first step is recognition and the second step is measurement. For recognition, an enterprise judgmentally determines whether it is more-likely-than-not that a tax position will be sustained upon examination, including resolution of related appeals or litigation processes, based on the technical merits of the position. If the tax position meets the more-likely-than-not recognition threshold, it is measured and recognized in the financial statements as the largest amount of tax benefit that is greater than 50% likely of being realized. If a tax position does not meet the more-likely-than-not recognition threshold, the benefit of the position is not recognized in the financial statements.
Tax positions that meet the more-likely-than-not recognition threshold, at the effective date of ASC 740-10, may be recognized or, continued to be recognized, upon adoption of ASC 740-10. The cumulative effect of applying the provision of ASC 740-10 shall be reported as an adjustment to the opening balance of retained earnings for that fiscal year. ASC 740-10 applies to fiscal years beginning after December 15, 2006 with earlier adoption permitted. The Company has determined that as of December 31, 2013 and 2012, no additional accrual for income taxes is necessary.
Segment Information –
ASC 280-10, “Disclosures about Segments of an Enterprise and Related Information,” establishes standards for the manner in which public companies report information about operating segments in annual and interim financial statements. It also establishes standards for related disclosures about products and services, geographic areas, and major customers. The method for determining what information to report is based on the way management organizes the operating segments within the Company for making operating decisions and assessing financial performance. The Company’s chief operating decision-maker is considered to be the Company’s chief executive officer (“CEO”). The CEO reviews financial information presented on an entity level basis accompanied by disaggregated information about revenues by product type and certain information about geographic regions for purposes of making operating decisions and assessing financial performance. The entity level financial information is identical to the information presented in the accompanying consolidated statements of operations.
The Company has two groups of products and services - Security (PinPoint™) and Healthcare (Signature Mapping™ Medical Computer Aided Detection (“Medical CAD”)). The Company has determined that as a result of no revenue generated for the two years ending December 31, 2013, we operate under one business unit in The America’s, and have pursued one product line, Healthcare’s Tuberculosis Detection (“TBDx™”) software in Africa.
Stock-Based Compensation –
On January 1, 2006, the Company adopted the provisions of ASC 718-10, which requires recognition of stock-based compensation expense for all share-based payments based on fair value. Prior to January 1, 2006, the Company measured compensation expense for its employee stock based compensation plans using the intrinsic value method. Under ASC 718-10, when the exercise price of the Company’s employee stock options equals the market price of the underlying stock on the date of grant, no compensation expense is recognized. The Company applied the disclosure provisions of ASC 718-10 as if the fair value-based method had been applied in measuring compensation expense for those years. ASC 718-10 required that the Company provide pro forma information regarding net earnings and net earnings per common share as if compensation expense for its employee stock-based awards had been determined in accordance with the fair value method prescribed therein.
ASC 718-10, “Share-Based Payment” defines fair value-based methods of accounting for stock options and other equity instruments. The Company has adopted the method, which measures compensation costs based on the estimated fair value of the award and recognizes that cost over the service period. ASC 505-50, “Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods, or Services” (“ASC 505-50”), establishes the measurement principles for transactions in which equity instruments are issued in exchange for the receipt of goods or services. The Company has relied upon the guidance provided under ASC 505-50 to determine the measurement date and the fair value re-measurement principles to be applied. Based on these findings, the Company determined that the unamortized portion of the stock compensation should be re-measured on each interim reporting date and proportionately amortized to stock-based compensation expense for the succeeding interim reporting period until goods are received or services are performed. The Company recognizes compensation costs, net of an estimated forfeiture rate, on a pro rata basis over the requisite service period of each vesting tranche of each award. The Company considers voluntary termination behavior as well as trends of actual option forfeitures when estimating the forfeiture rate.
The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options, which have no vesting restrictions and are not transferable. The fair value of each option granted was estimated on the date of grant using the Black-Scholes Merton option pricing model (Black-Scholes model) with the following weighted-average assumptions used for the years ended December 31, 2013 and 2012:
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Black-Scholes Model Assumptions
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2013
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2012
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Risk-free interest rate (1)
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0.66%
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0.99%
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Expected volatility (2)
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189.1%
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163.6%
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Dividend yield (3)
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0.0%
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0.0%
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Expected life (4)
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4.5 years
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5.4 years
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(1)
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The risk-free interest rate is based on US Treasury debt securities with maturities similar to the expected term of the option.
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(2)
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Expected volatility is based on historical volatility of the Company*s stock factoring in daily share price observations.
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(3)
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No cash dividends have been declared on the Company*s common stock since the Company*s inception, and the Company currently does not anticipate paying cash dividends over the expected term of the option.
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(4)
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The expected term of stock option awards granted is derived from historical exercise experience under the Company*s stock option plan and represents the period of time that stock option awards granted are expected to be outstanding. The expected term assumption incorporates the contractual term of an option grant, which is usually ten years, as well as the vesting period of an award, which is generally pro rata vesting over two years for employees and one year for board of directors. Although, the Compensation Committee may chose a different vesting period based on the circumstances.
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Recently Adopted Accounting Standards
In December 2011, the FASB issued authoritative guidance that creates new disclosure requirements about the nature of an entity’s rights of offset and related arrangements associated with its financial instruments and derivative instruments. This revised guidance helps reconcile differences in the offsetting requirements under U.S. GAAP and International Financial Reporting Standards (“IFRS”). These requirements mandate that entities disclose both gross and net information about instruments and transactions eligible for offset in the statement of financial position as well as instruments and transactions subject to an agreement similar to a master netting arrangement. The Company currently does not hold any financial or derivative instruments that are subject to an enforceable master netting arrangement. However, the Company currently utilizes the right of offset when netting certain negative cash balances in its statement of financial position. This disclosure-only guidance became effective for the Company’s fiscal 2013 third quarter, with retrospective application required, and did not have a material impact on the Company’s consolidated financial statements.
In June 2011, the FASB amended its authoritative guidance related to the presentation of comprehensive income, requiring entities to present items of net income and other comprehensive income either in one continuous statement or in two separate consecutive statements. This guidance also required entities to present reclassification adjustments for each component of accumulated other comprehensive income in both net income and other comprehensive income on the face of the financial statements. In December 2011, the FASB issued an update to this guidance deferring the requirement to present reclassification adjustments on the face of the financial statements. However, the Company is still required to present reclassification adjustments on either the face of the financial statement where comprehensive income is reported or disclose the reclassification adjustments in the notes to the financial statements. This guidance, including the deferral, becomes effective for the Company’s fiscal 2013 first quarter, with early adoption permitted and full retrospective application required. The guidance did not have a material impact on the Company’s consolidated financial statements.
Recently Issued Accounting Standards
In July 2013, the FASB issued authoritative guidance that requires an entity to present an unrecognized tax benefit, or a portion of an unrecognized tax benefit, in the financial statements as a reduction to a deferred tax asset for a net operating loss (“NOL”) carryforward, a similar tax loss, or a tax credit carryforward. If either (i) an NOL carryforward, a similar tax loss, or tax credit carryforward is not available as of the reporting date under the governing tax law to settle taxes that would result from the disallowance of the tax position or (ii) the entity does not intend to use the deferred tax asset for this purpose (provided that the tax law permits a choice), an entity should present an unrecognized tax benefit in the financial statements as a liability and should not net the unrecognized tax benefit with a deferred tax asset. This guidance becomes effective prospectively for unrecognized tax benefits that exist as of the Company’s fiscal 2015 first quarter, with retrospective application and early adoption permitted. The Company is currently evaluating the timing of adoption and the impact of this balance sheet presentation guidance but does not expect it to have a significant impact on the Company’s consolidated financial statements.
In February 2013, the Financial Accounting Standards Board (“FASB”) issued authoritative guidance requiring an entity to present, in a single location either parenthetically on the face of the financial statements or in a separate note, significant amounts reclassified from each component of accumulated other comprehensive income (loss) (“AOCI”) and the income statement line items affected by the reclassification. An entity is not permitted to provide this information parenthetically on the face of the income statement if it has items that are not required to be reclassified in their entirety to net income. Instead of disclosing the income statement line
affected, a cross reference to other disclosures that provide additional details on these items is required. This guidance became effective prospectively for the Company’s fiscal 2014 first quarter and the adoption of this disclosure-only guidance is not expected to have an impact on the Company's consolidated financial statements.
In July 2012, the FASB amended its authoritative guidance related to testing indefinite-lived intangible assets for impairment. Under the revised guidance, entities testing their indefinite-lived intangible assets for impairment have the option of performing a qualitative assessment before performing further impairment testing. If entities determine, on the basis of qualitative factors, that it is more-likely-than-not that the asset is impaired, a quantitative test is required. The guidance becomes effective in the beginning of the Company's fiscal 2014, with early adoption permitted. The Company is currently evaluating the timing of adopting this guidance which is not expected to have an impact on the Company's consolidated financial statements.
Other ASU’s that have been issued or proposed by the FASB ASC that do not require adoption until a future date and are not expected to have a material impact on the financial statements upon adoption.
NOTE 3. Accrued Liabilities
Accrued liabilities consist of the following:
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December 31
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Classification
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2013
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2012
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Accrued wages and related
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Accrued employer taxes
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$ 583,710
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$ 534,277
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Accrued vacation
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16,252
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14,230
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Accrued salaries
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7,499,983
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6,629,246
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Total accrued wages and related
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$ 8,099,945
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$ 7,177,753
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Other Accrued Liabilities
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Accrued interest
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$ 144,579
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$ 72,804
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Total other accrued liabilities
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$ 144,579
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$ 72,804
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NOTE 4. Financing Arrangements
2013 Short-Term Promissory Notes
During 2013, the Company issued nine promissory notes to eight accredited investors in the aggregate principal amount of $179,500 ($179,275, net of commissions and expenses in the amount of $225), of which five notes for an aggregate of $48,500 originally matured during 2013 and were amended to mature on June 30, 2014, $14,000 matures on April 25, 2014, $100,000 matures on September 21, 2014, and $17,000 matures on October 25, 2014. The terms of the notes are essentially the same as the 2011 and 2012 short-term promissory notes, except that $40,000 of the notes accrue interest at a rate of 12% per annum, one note for $8,500 was noninterest bearing during 2013 and accrues interest at a rate of 10% effective January 1, 2014, one note for $14,000 accrues interest at a rate of 10% per annum, one note for $8,500 accrues interest at a rate of 5.9%, with two notes for $108,500 being noninterest bearing. Consideration for one $8,500 noninterest bearing note during 2013 received a modification to 540,000 warrants to include a cashless provision, one note of $8,500 received an extension of 4,632,725 warrants to December 31, 2018, and one for $100,000 received a 2% royalty payment of future TBDx™ net revenue in South Africa up to $300,000. The Company issued to six of the note holders an aggregate of 450,000 shares of common stock, and the relative fair value of the common stock of $31,100 will be amortized over the term of the notes.
2012 Short-Term Promissory Notes
During 2012, the Company issued six promissory notes to accredited investors in the aggregate principal amount of $160,000. The twelve-month notes accrue interest at a rate of 12% per annum. The Company also issued to the note holders an aggregate of 285,000 shares of common stock. The relative fair value of the common stock of $11,715 will be amortized over the term of the notes. The Company also issued 10,800 shares of common stock as compensation in connection with the financing for a fair value of $2,700.
2011 Short-Term Promissory Notes
During October and November 2011, the Company issued twelve-month promissory notes to accredited investors in the aggregate principal amount of $400,000. The twelve-month notes accrue interest at a rate of 12% per annum. The Company also issued
to the two note holders an aggregate of 400,000 shares of common stock. The relative fair value of the common stock of $34,700 will be amortized over the term of the notes. The Company also issued 250,000 shares of common stock as compensation in connection with the financing for a fair value of $25,000.
2011 Securities Purchase Agreement
On February 23, 2011, the Company entered into a Securities Purchase Agreement (the “SPA”) with an institutional accredited investor for an investment up to $1,000,000, subject to certain stock price and volume conditions. Subsequently on February 24, 2011, we sold to the institutional investor at the first closing of the private placement of securities, an aggregate of 600,000 shares of common stock, and 600,000 common stock purchase warrants to purchase an aggregate of 600,000 shares of common stock, for gross proceeds of $150,000 ($136,000 net of certain expenses and sales commissions in the amount of $14,000). The warrants are exercisable at a price of $0.25 per share for a period of five years after the date of issuance, contain a cashless exercise provision and other customary provisions. Also, we issued to a broker an aggregate of 72,000 placement agent’s warrants as compensation in connection with the offering. The placement agent’s warrants are under the same terms and conditions as those issued to the institutional investor.
In addition, under the SPA, the investor has agreed to provide additional financing to us by purchasing shares of our common stock at seven subsequent closings and subject to certain share price and volume requirements. However, the subsequent closings scheduled during March through September 2011, did not take place since the stock price and volume conditions were not met.
We granted to the investor piggy back registration rights with regard to the shares issued in the financing, including the shares underlying the Warrants. The SPA contains representations and warranties of the Company and investor, certain indemnification provisions and customary conditions to each closing. We may terminate the SPA on ten days prior written notice to the investor, and the investor may terminate the SPA at any time prior to a subsequent financing upon written notice to us if we consummate a reverse stock split or a subsequent financing to which the investor is not a party.
We agreed to pay the investor’s counsel with regard to the first closing in the amount of $25,000, $5,000 of which was paid at the first closing and $5,000 was to be paid at each of the first four subsequent closings. As mentioned above, the subsequent closings did not take place and the Company did not pay the four additional $5,000 payments to the investor’s counsel. We also agreed to pay additional fees for their counsel for each subsequent closing in the amount of $2,500. A broker acted as placement agent for the offering. Under the terms of a Non-Circumvention and Compensation Agreement, dated January 12, 2011, between the Company and the broker, in connection with the offering, we agreed to pay or issue the broker at each subsequent closing a placement fee equal to 6% of the proceeds received by us at each closing and placement agent’s warrants equal to 6% of the shares sold at the closing (including the shares underlying the Warrants).
2006 through 2013 Short-Term Promissory Notes, Related Party
On October 18, 2006, the Company entered into a Loan Agreement with Mr. Michael W. Trudnak, our Chairman and Chief Executive Officer pursuant to which Mr. Trudnak loaned the Company $100,000. The Company issued a non-negotiable promissory note, dated effective October 18, 2006, to Mr. Trudnak in the principal amount of $100,000. The note is unsecured, non-negotiable and non-interest bearing. The note is repayable on the earlier of (i) six months after the date of issuance, (ii) the date the Company receives aggregate proceeds from the sale of its securities after the date of the issuance of the Note in an amount exceeding $2,000,000, or (iii) the occurrence of an event of default. The following constitute an event of default under the note: (a) the failure to pay when due any principal or interest or other liability under the loan agreement or under the note; (b) the material violation by us of any representation, warranty, covenant or agreement contained in the loan agreement, the note or any other loan document or any other document or agreement to which the Company is a party to or by which the Company or any of our properties, assets or outstanding securities are bound; (c) any event or circumstance shall occur that, in the reasonable opinion of the lender, has had or could reasonably be expected to have a material adverse effect; (d) an assignment for the benefit of our creditors; (e) the application for the appointment of a receiver or liquidator for us or our property; (f) the issuance of an attachment or the entry of a judgment against us in excess of $100,000; (g) a default with respect to any other obligation due to the lender; or (h) any voluntary or involuntary petition in bankruptcy or any petition for relief under the federal bankruptcy code or any other state or federal law for the relief of debtors by or with respect to us, provided however with respect to an involuntary petition in bankruptcy, such petition has not been dismissed within 30 days of the date of such petition. In the event of the occurrence of an event of default, the loan agreement and note shall be in default immediately and without notice, and the unpaid principal amount of the loan shall, at the option of the lender, become immediately due and payable in full. The Company agreed to pay the reasonable costs of collection and enforcement, including reasonable attorneys’ fees and interest from the date of default at the rate of 18% per annum. The note is not assignable by Mr. Trudnak without our prior consent. The Company may prepay the note in whole or in part upon ten days notice. On November 10, 2006, Mr. Trudnak extended the due date of the note to May 31, 2007. Mr. Trudnak made an additional $24,000 loan to the company on June 25, 2008, and $5,000 on September 14, 2011, for cumulative outstanding loans of $129,000. The maturity date of the outstanding loans was extended to May 31, 2009, then to May 31,
2010 and June 30, 2011, and subsequently to December 31, 2011 and then to June 30, 2012. On June 30, 2012, the outstanding loans were extended to December 30, 2012, and then to June 30, 2013, and subsequently to December 31, 2013. On December 31, 2013, the outstanding loans were extended to June 30, 2014. The Company repaid an aggregate of $6,900 of the notes during 2010, an aggregate $33,100 during 2011, an aggregate of $8,500 during 2013, resulting in an outstanding balance at December 31, 2013 of $80,500. The terms of the above transaction were reviewed and approved by the Company’s audit committee and by the independent members of our Board of Directors.
2006 and 2007 Series A Debentures (as Amended on October 15, 2010)
Under a securities purchase agreement, dated November 3, 2006, between the Company and certain institutional accredited investors, the Company sold an aggregate of $5,150,000 in principal amount of our Series A Debentures and Series D Common Stock Purchase Warrants to purchase an aggregate of 4,453,709 shares of our common stock. On November 8, 2006, the Company issued to the institutional investors an aggregate of $2,575,000 in principal amount of Series A Debentures and 4,453,709 Series D Warrants. On April 12, 2007, the Company issued an additional $2,575,000 in principal amount of the Series A Debentures, which followed the effectiveness of a registration statement registering the shares of our common stock underlying the Series A Debentures and Series D Warrants. Proceeds of the two offerings were used for the purpose of new personnel, research and development, registration expenses, for general working capital purposes, and repaying $200,000 in loans made to us by Mr. Michael W. Trudnak, our Chairman and CEO. The Company allocated proceeds from each closing to the derivative liability features of the Series A Debentures and Series D Warrants that were recognizable as a liability under generally accepted accounting principles. We also issued at the first closing an aggregate of 623,520 common stock purchase warrants to the placement agent as compensation in the offering, which were upon terms substantially similar to the Series D Warrants. One-half of the Series D Warrants (2,226,854 warrants) and the placement agent warrants (311,760 warrants) became exercisable on November 8, 2006. The remaining one-half of the Series D Warrants (2,226,855 warrants) and the placement agent warrants (311,760 warrants) became exercisable on April 12, 2007. The Series D Warrants and the placement agent’s warrants may be exercised via a cashless exercise if certain conditions are met. Due to the potential of the milestone-related adjustments, the initial exercise price of $1.15634 may be reset and the maximum number of shares to be issued under the debentures was at that time indeterminable, and the Company considered the guidance of ASC 815-40, “Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock”, whereby public companies that are or could be required to deliver shares of common stock as part of a physical settlement or a net-share settlement, under a freestanding financial instrument, are required to initially measure the contract at fair value, and concluded that the potential of the milestone-related adjustments at that time may cause insufficient shares to share settle the contracts. On April 1, 2007, due to the various milestone-related provisions, the conversion price of the Series A Debentures and the exercise price of the Series D Warrants and Placement Agent’s Warrants were reset to a price of $0.7453 per share, then to $0.6948 effective October 1, 2007, and the final milestone reset of $0.4089 effective April 1, 2008. The Series A Debentures and Series D Warrants also have a fully ratchet anti-dilution provision, whereby any subsequent equity transaction entitling a person to acquire shares of common stock at an effective price per share that is lower then the then conversion price, then the conversion price of the Debentures and Warrants shall be reduced to equal the lower subsequent equity transaction price. Subsequently, as a result of a June 2009 financing in which the Company elected to issue shares of common stock and warrants at $0.25 per share, the conversion price of our debentures and the exercise price of the Series D Warrants was adjusted under the anti-dilution provisions of such instruments to a price of $0.25 per share, and the number of shares underlying the Series D Warrants (including the warrants the Company issued to the placement agent in the financing) were increased by an aggregate of 2,677,417 Series D warrants. On July 10, 2007, a debenture holder exercised 864,798 Series D Warrants for 864,798 shares of common stock, and 914,798 warrants were exercised during 2010 under the cashless provision for 420,166 shares of common stock. Of the remaining Series D Warrants and Placement Agent Warrants, 3,062,527 warrants expired on November 11, 2011, and 3,012,523 warrants expired on April 12, 2012.
As of December 31, 2013, an aggregate of $3,461,795 in principal amount of the Series A Debentures have been converted into 8,730,037 shares of common stock, an aggregate of $663,043 in interest amount have been converted into 2,675,576 shares of common stock, and an aggregate of 1,779,596 Series D Warrants have been exercised resulting in the issuance of 1,284,964 shares of common stock. Accordingly, as of December 31, 2013, an aggregate of $1,688,205 of principal amount of the debentures remain unconverted.
Our outstanding Series A 10% Convertible Debentures originally became due on November 7, 2008. On October 15, 2010, we entered into an agreement with our two remaining Series A Debenture holders to amend and effect a restructuring of the debentures that originally became due on November 7, 2008. Under the amendment agreement, the Company and two debenture holders agreed: (i) to an extension of the maturity date of the debentures to June 30, 2011, (ii) that the $1,688,205 of outstanding principal amount will not bear interest from July 1, 2010 through the new maturity date, (iii) that, in exchange for the payment in cash of amounts of accrued but unpaid regular interest of approximately $638,163, and waived all additional interest and late fees, liquidated damages and certain other amounts due under the debentures (“Interest and Default Amounts”) the Company issued an aggregate of 2,552,653 shares of common stock, (iv) that all claims with regard to the payment of the Interest and Default Amounts and all prior events of default under the Debentures and breaches of any covenant, agreement, term or condition (“Defaults”) under our debentures and debenture transaction documents would be waived and the Company was released from any claims with respect to the Additional Interest and Late Fees of approximately $773,314,
and Default Amounts of approximately $2,541,739, and prior Defaults Events, (v) to terminate the registration rights agreements between the Company and each debenture holder, and (vi) that the Company may force a conversion of the debentures if our common stock equals or exceeds certain price and volume conditions. There were no conversions of our debentures during 2012 or 2013.
Under the Debenture amendment agreement, the Debenture holders agreed, commencing March 3, 2011, that the Company may force a conversion of the Debentures. Such a forced conversion may only be effected once every 90 days and the ability of the Company to force any such conversion is subject to certain equity conditions, which conditions were amended under the terms of the Debenture Amendment Agreement in accordance with the following:
·
if the variable weighted average price for the Company’s common stock (“VWAP”) for any five consecutive trading days exceeds $0.50 and the average daily dollar trading volume for the Company’s common stock during such period equals or exceeds $50,000, the Company may require a Holder to convert up to 25% of the outstanding principal amount of its Debenture on September 3, 2010, plus any liquidated damages or other amounts owing under the Debenture;
·
if the VWAP for any five consecutive trading days exceeds $0.75 and the average daily dollar trading volume for the common stock during such period equals or exceeds $75,000, the Company may require a Holder to convert up to an additional 25% of the outstanding principal amount of its Debenture on September 3, 2010, plus any liquidated damages or other amounts owing under the Debenture;
·
if the VWAP for any five consecutive trading days exceeds $1.00 and the average daily dollar trading volume for the common stock during such period equals or exceeds $100,000, the Company may require a Holder to convert up to 100% of the outstanding principal amount of its Debenture on September 3, 2010, plus any liquidated damages or other amounts owing under the Debenture.
The principal amount of our outstanding Series A Debentures of $1,688,205 became due on July 1, 2011, and such amount was not paid. Therefore, the Company may be considered in default. The debentures provide that any default in the payment of principal, which default is not cured within the five trading days of the receipt of notice of such default or ten trading days after the Company becomes aware of such default, will be deemed an event of default and may result in enforcement of the debenture holders’ rights and remedies under the debentures and applicable law. We are in discussions with the debenture holders to re-negotiate the terms of the debentures, including the repayment or repurchase of the debentures and/or seek to extend their maturity date, although we have not reached any agreement with the debenture holders with regard to any such repayment, repurchase or extension. Our ability to repay or repurchase the debentures is contingent upon our ability to raise additional financing, of which there can be no assurance. Also, as a condition to any such extension, debenture holders may seek to amend or modify certain other terms of the debentures. When an event of default occurs under the debentures, the debenture holders may elect to require us to make immediate repayment of the mandatory default amount, which equals the sum of (i) the greater of either (a) 120% of the outstanding principal amount of the debentures, or (b) the outstanding principal amount unpaid divided by the conversion price on the date the mandatory default amount is either (1) demanded or otherwise due or (2) paid in full, whichever has the lower conversion price, multiplied by the variable weighted average price of the common stock on the date the mandatory default amount is either demanded or otherwise due, whichever has the higher variable weighted average price, and (ii) all other amounts, costs, expenses, and liquidated damages due under the debentures. In anticipation of such election by the debenture holders, due to the nonpayment of principal amount on the due date of July 1, 2011, we measured the mandatory default at approximately $337,641 and subsequently on each balance sheet date, which is reflected in the carrying value of the debentures and also recognized as interest expense. We remeasured the mandatory default amount as of December 31, 2012 and December 31, 2013 at approximately $337,641, respectively. As of the date of this report, the debenture holders have not made an election requiring immediate repayment of the mandatory amount, although there can be no assurance they will not do so.
The Company currently has insufficient funds to repay the outstanding amount in the event the debenture holders make a demand for payment.
Prior to the Debenture amendment agreement and absent a default, the Debentures bore interest at the rate of 10% per annum. The Debenture agreement, as amended on October 15, 2010, continues to permit the payment of interest due under the Debentures in cash or registered shares of our common stock. If we elected to pay the interest due in shares of our common stock, the number of shares to be issued in payment of interest is determined on the basis of 85% of the lesser of the daily volume weighted average price of our common stock as reported by Bloomberg LP (“VWAP”) for the five trading days ending on the date that is immediately prior to (a) date the interest is due or (b) the date such shares are issued and delivered to the holder. We could pay interest in shares of our common stock only if the equity conditions, described below, have been met during the 20 consecutive trading days prior to the date the interest is due and through the date the shares are issued. The payment of interest in shares of our stock, the redemption of the Debentures and the occurrence of certain other events, was subject to a requirement that certain equity conditions (“equity conditions”) were met, as follows: (i) we have honored all conversions and redemptions of a Debenture by the holder, (ii) we have paid all liquidated damages and other amounts due to the holder, (iii) the registration statement covering the resale of the shares underlying the Debentures and Series D Warrants is effective permitting a holder to utilize the registration statement to resell its shares, (iv) our stock is traded on the OTC Markets, OTCQB or other securities exchange and all of the shares upon conversion or exercise of the Debentures and Series D Warrants are listed for trading, (v) we have sufficient authorized but unreserved shares of our common stock to cover the issuance of the shares
upon conversion or exercise of the Debentures and Series D Warrants, (vi) there is no event of default under the Debentures, (vii) the issuance of the shares would not violate a holder’s 4.99% or 9.99% ownership restriction cap, (viii) we have not made a public announcement of a pending merger, sale of all of our assets or similar transaction or a transaction in which a greater than 50% change in control of the Company may occur and the transaction has not been consummated, (ix) the holder is not in possession of material public information regarding us, and (x) the daily trading volume of our shares for 20 consecutive trading days prior to the applicable date exceeds 100,000 shares. Under the terms of the Debenture Amendment Agreement, (A) the equity condition in (iii) above was amended to provide that such condition is met if, in the alternative, the shares issuable upon conversion of the Debentures may then be resold pursuant to Rule 144 without restriction or limitation and the Company has delivered to a holder an opinion of the Company’s counsel that such resale may legally be made and provided the holder has furnished a representation letter reasonable acceptable to the Company’s counsel that the holder is not an “affiliate” for purposes of Rule 144; (B) the equity condition in (vi) above was amended to except an event of default that has previously been waived; and (C) the equity condition in (x) above was amended to except circumstances where another volume condition is applicable.
The Debentures contain a limitation on the amount of Debenture that may be converted at any one time in the event the holder owns beneficially more than 4.99% of our common stock without regard to the number of shares underlying the unconverted portion of the Debenture. This limitation may be waived upon 61 days’ notice to us by the holder of the Debenture permitting the holder to change such limitation to 9.99%.
An event of default may occur under the Debentures if (a) the Company defaults in the payment of principal or, liquidated damages , (b) the Company fails to materially observe or perform a covenant or agreement in the Debentures, (c) a default or event of default occurs under any other transaction document related to the financing or in any other material agreement to which the Company is a party that results in a material adverse effect on the Company, (d) any representation or warranty the Company made to investors in the transaction documents related to the financing is materially untrue or incorrect, (e) a bankruptcy event occurs with regard to the Company, (f) the Company defaults on any other loan, mortgage, or credit arrangement that involves an amount greater than $150,000 and results in the obligation becoming declared due prior to the due date, (g) the Company’s common stock is not eligible for quotation on the OTC Markets or other exchange on which the Company’s shares are traded, (h) a transaction occurs in which the control of the Company changes, the Company effects a merger or consolidation, the Company sells substantially all of the assets, a tender offer is made for the Company’s shares, the Company reclassify their shares or a compulsory share exchange, or the Company agrees to sell more than 33% of the assets, unless the Company receives the consent of holders of 67% of then outstanding principal of the Company’s Debentures, (i) the Company fails to deliver certificates for shares to be issued on conversion within seven trading days, (j) the Company has a judgment against it for more than $150,000. We have agreed to compensate a holder of a Debenture in the event our transfer agent fails to deliver shares upon conversion of the Debentures within three trading days of the date of conversion, and the holder’s broker is required to purchase shares of our common stock in satisfaction of a sale by a holder.
The conversion price of the Debentures or the number of shares to be issued upon conversion or exercise of the Debentures are subject to adjustment in the event of a stock dividend, stock split, subdivision or combination of our shares of common stock, reclassification, sales of our securities below their then conversion or exercise price (“subsequent equity sales anti-dilution adjustment provisions”), a subsequent rights offering, or a reclassification of our shares. Also, if we effect a merger or consolidation with another company, we sell all or substantially all of our assets, a tender offer or exchange offer is made for our shares, or we effect a reclassification of our shares or a compulsory share exchange, a holder that subsequently converts its Debenture will be entitled to receive the same kind and amount of securities, cash or property as if the shares it is entitled to receive on the conversion had been issued and outstanding on the date immediately prior to the date any such transaction occurred. Except as discussed above, no such events have occurred through the date of this report.
We were not required to make an adjustment to the conversion or exercise price or the number of shares to be issued upon conversion or exercise of the Debentures pursuant to the subsequent equity sales anti-dilution adjustment provisions related to an “exempt issuance,” which is defined as: (A) any stock or options that are issued under our stock option plans or are approved by a majority of non-employee directors and issued (i) to employees, officers or directors or (ii) to consultants, but only if the amount issued to consultants does not exceed 400,000 shares in a 12 month period, (B) securities issued under the Debentures, (C) shares of common stock issued upon conversion or exercise of, or in exchange for, securities outstanding on the date we entered into the securities purchase agreement, or (D) the issuance of securities in an acquisition or strategic transaction approved by our disinterested directors. Under the Debenture Amendment Agreement, commencing October 15, 2010, Debenture holders agreed that an “exempt issuance” shall also include the issuance of stock or common stock equivalents authorized and approved in advance by the Company’s disinterested directors at a price per share or at a conversion or exercise price per share equal to or greater than $0.25.
In connection with our Series A Debenture financing, we entered into a registration rights agreement with purchaser of our debentures pursuant to which we agreed we would use our best efforts to file a registration statement under the Securities Act within 45 days of the first closing to permit the public resale by debenture holders of the shares that may be issued upon conversion of the
Debentures and upon exercise of the Series D Warrants, including the shares of our common stock underlying the Debentures to be issued at the second closing. Pursuant to the amendments we entered into with the current debenture holders on October 15, 2010, the debenture holders agreed to terminate their registration rights agreements with us. Accordingly, we are not required to register or maintain the registration of the shares underlying the Series A Debentures, however, the Company was obligated under the terms of the Registration Rights Agreement that the Company entered into with each purchaser that has fully converted its Debenture.
We also granted to each purchaser of the Debentures the right to participate in any offering by us of common stock or common stock equivalents until the later of (i) 12 months after the effective date of the registration statement and (ii) the date a purchaser holds less than 20% of the principal amount of the Debenture the purchaser originally agreed to purchase, except for an exempt issuance or an underwritten public offering of our common stock. Purchasers may participate in such an offering up to the lesser of 100% of the future offering or the aggregate amount subscribed for under the securities purchase agreement by all purchasers. Although such common stock offerings have occurred, the Debenture holders have notified the Company that they do not want to participate in any future financings.
The securities purchase agreement also contained representations and warranties of both us and purchasers, conditions to closing, certain indemnification provisions, and other customary provisions. Also the Debenture Amendment Agreement amended certain provisions covering events of default under the Debentures, contained certain representations and warranties of the Company, a reaffirmation of certain of the representations and warranties in the securities purchase agreement, contained certain conditions to closing, and certain other customary provisions.
We were prohibited from effecting a reverse or forward stock split or reclassification of our common stock except as may be required to comply with the listing standards of any national securities exchange.
The Company had interest expense of $71,775, $64,382, and $121,188 for the fiscal year ended December 31, 2013, 2012, and the period of April 1, 2012 through December 31, 2013 (the development stage), respectively. Debt discount amortization costs of $10,826, $40,006, and $40,996 for the fiscal year ended December 31, 2013, 2012, and the period of April 1, 2012 through December 31, 2013 (the development stage), respectively.
NOTE 5. Fair Value Measurement
The Company records its financial assets and liabilities at fair value, which is defined as the price that would be received to sell the asset or paid to transfer a liability, in the principal or most advantageous market for the asset or liability, in an orderly transaction between market participants at the measurement date. The fair value measurement of these liabilities is consistent with ASC 820, "Fair Value Measurements", whereby the Company is required to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The three levels of inputs that may be used to measure fair value are as follows:
Level 1:
Inputs based on quoted market prices for identical assets or liabilities in active markets at the measurement date.
Level 2:
Observable inputs other than quoted prices included in Level 1, such as quoted prices for similar assets and liabilities in active markets; quoted prices for identical or similar assets and liabilities in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.
Level 3:
Inputs reflect management’s best estimate of what market participants would use in pricing the asset or liability at the measurement date. The inputs are unobservable in the market and significant to the instrument’s valuation.
The following table presents the Company’s hierarchy for its financial assets and liabilities measured at fair value on a recurring basis as of December 31, 2013:
|
|
|
|
|
|
|
|
|
|
|
|
|
Level 1
|
|
Level 2
|
|
Level 3
|
|
Total
|
|
Assets
|
|
|
|
|
|
|
|
|
|
Cash
|
|
$ 1,108
|
|
$ -
|
|
$ -
|
|
$ 1,108
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities
|
|
|
|
|
|
|
|
|
|
Convertible debentures
|
|
$ -
|
|
$ -
|
|
$ 2,025,846
|
|
$ 2,025,846
|
|
Derivative liabilities
|
|
-
|
|
-
|
|
540,226
|
|
540,226
|
|
Notes payable, net of discount
|
|
-
|
|
-
|
|
718,930
|
|
718,930
|
|
Notes payable and advances, related parties
|
|
80,500
|
|
-
|
|
-
|
|
80,500
|
|
Total
|
|
$ 80,500
|
|
$ -
|
|
$ 3,285,002
|
|
$ 3,365,502
|
The following table presents the Company’s hierarchy for its financial assets and liabilities measured at fair value on a recurring basis as of December 31, 2012:
|
|
|
|
|
|
|
|
|
|
|
|
|
Level 1
|
|
Level 2
|
|
Level 3
|
|
Total
|
|
Assets
|
|
|
|
|
|
|
|
|
|
Cash
|
|
$ 3,445
|
|
$ -
|
|
$ -
|
|
$ 3,445
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities
|
|
|
|
|
|
|
|
|
|
Convertible debentures
|
|
$ -
|
|
$ -
|
|
$ 2,025,846
|
|
$ 2,025,846
|
|
Derivative liabilities
|
|
-
|
|
-
|
|
202,585
|
|
202,585
|
|
Notes payable, net of discount
|
|
-
|
|
-
|
|
559,704
|
|
559,704
|
|
Notes payable and advances, related parties
|
|
89,000
|
|
-
|
|
-
|
|
89,000
|
|
Total
|
|
$ 89,000
|
|
$ -
|
|
$ 2,788,135
|
|
$ 2,877,135
|
The estimated fair values of the Company’s derivative liabilities are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
Convertible Debentures (1)
|
|
Embedded Conversion Feature of Debentures (2)
|
|
Notes Payable (3)
|
|
Total
|
|
|
|
|
|
Liabilities Measured at Fair Value
|
|
Beginning balance as of December 31, 2011
|
|
$ 2,025,846
|
|
$ 270,113
|
|
$ 371,413
|
|
$ 2,667,372
|
|
Revaluation (gain)/loss in interest expense
|
|
-
|
|
(67,528)
|
|
-
|
|
(67,528)
|
|
Issuances, net of discount
|
|
-
|
|
-
|
|
148,285
|
|
148,285
|
|
Amortization of discount
|
|
-
|
|
-
|
|
40,006
|
|
40,006
|
|
Balance as of December 31, 2012
|
|
$ 2,025,846
|
|
$ 202,585
|
|
$ 559,704
|
|
$ 2,788,135
|
|
Revaluation (gain)/loss in interest expense
|
|
-
|
|
337,641
|
|
-
|
|
337,641
|
|
Issuances, net of discount
|
|
-
|
|
-
|
|
148,400
|
|
148,400
|
|
Amortization of discount
|
|
-
|
|
-
|
|
10,826
|
|
10,826
|
|
Ending balance as of December 31, 2013
|
|
$ 2,025,846
|
|
$ 540,226
|
|
$ 718,930
|
|
$ 3,285,002
|
|
|
|
|
|
|
|
|
|
|
|
Total (gain)/loss from revaluation of derivatives and event of default included in earnings for the period and reported as an adjustment to interest is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
For fiscal 2012
|
|
$ -
|
|
$ (67,528)
|
|
$ 40,006
|
|
$ (27,522)
|
|
For fiscal 2013
|
|
-
|
|
337,641
|
|
10,826
|
|
348,467
|
|
April 1, 2012 through December 31, 2013 (the development stage)
|
|
-
|
|
202,585
|
|
40,996
|
|
243,581
|
|
|
|
|
|
|
|
|
|
|
|
(1) The balance as of December 31, 2013 and 2012, includes $1,688,205 for the outstanding convertible debentures issued November 8, 2006 and April 12, 2007, and an additional amount of $337,641 for the event of default provision under the debentures October 15, 2010 amendment agreement.
|
|
(2) Represents the conversion feature of outstanding convertible debentures issued November 8, 2006 and April 12, 2007. The fair value of the conversion feature since May 20, 2009, the final milestone reset date of the debentures, was determined using market quotation.
|
|
(3) The balance represents the outstanding short-term notes payable issued since October 2011, less remaining notes discount for the fair value of common stock when issued in conjunction with the notes. The note discount is being amortized over the original term of the notes. The outstanding notes payable at December 31, 2012 and December 31, 2013 is $560,000 and $739,500, respectively, and the outstanding notes discount at December 31, 2012 and December 31, 2013 is $3,869 and $20,570, respectively.
|
NOTE 6. Stockholders’ (Deficit)
Unless otherwise indicated, fair value is determined by reference to the closing price of the Company’s common stock on the measurement date. Prior to January 1, 2006, stock options included in stockholders’ (deficit) reflect only those granted at an exercise price that was less than fair value (the intrinsic value). Subsequently, stock options for employees are recognized and disclosed pursuant to ASC 718-10, “Stock-based Payment.” Generally, the measurement date for employee stock compensation is the grant date. However, in the case of non-employees, the initial measurement date is the date of binding commitment to perform services for the Company. This initial-measurement cost is first reflected as deferred compensation in stockholders’ (deficit) and then amortized to compensation expense on a straight-line basis over the period over which the services are performed. For non-employee grants, the total cost is re-measured at the end of each reporting period based on the fair value on that date, and the amortization is adjusted in accordance with ASC 718-10 and ASC 505-50, “Accounting For Equity Instruments That Are Issued To Other Than Employees For Acquiring, Or In Conjunction With Selling, Goods Or Services” and, accordingly, recognizes as expense the estimated fair value of such options as calculated using the Black-Scholes model.
Preferred Stock
– The Company has the authority to issue 1,000,000 shares of $0.20 par value preferred stock, of which 6,000 shares have been designated as Series A Convertible Preferred Stock, 6,000 shares as Series B Convertible Preferred Stock, and 1,000 shares as Class C Convertible Preferred Stock The Board of Directors is authorized to issue shares of preferred stock from time to time in one or more series and, subject to the limitations contained in the certificate of incorporation and any limitations prescribed by law, to establish and designate a series and to fix the number of shares and the relative conversion rights, voting rights and terms of redemption (including sinking fund provisions) and liquidation preferences. The Company has not had any preferred shares outstanding for any of the two years in the period ended December 31, 2012. New issuances of shares of preferred stock with voting rights can affect the voting rights of the holders of outstanding shares of preferred stock and common stock by increasing the number of outstanding shares having voting rights and by the creation of class or series voting rights. Furthermore, additional issuances of shares of preferred stock with conversion rights can have the effect of increasing the number of shares of common stock outstanding up to the amount of common stock authorized by the articles of incorporation and can also, in some circumstances, have the effect of delaying or preventing a change in control of the Company and/or otherwise adversely affect the rights of holders of outstanding shares of preferred stock and common stock. To the extent permitted by the certificate of incorporation, a series of preferred stock may have preferences over the common stock (and other series of preferred stock) with respect to dividends and liquidation rights.
Common Stock
– The Company has the authority to issue up to 200,000,000 shares of $0.001 par value common stock. The Board of Directors has the authority to issue such common shares in series and determine the rights and preferences of such shares. As of March 24, 2014, there were approximately 102,927,612 shares of our common stock issued and outstanding and approximately 262 holders of record of the common stock. Each share of common stock entitles the holder thereof to one vote on each matter submitted to our stockholders for a vote. The holders of common stock: (a) have equal ratable rights to dividends from funds legally available therefore when, as and if declared by the board of directors; (b) are entitled to share ratably in all of our assets available for distribution to holders of common stock upon liquidation, dissolution or winding up of our affairs; (c) do not have preemptive, subscription or conversion rights, or redemption or applicable sinking fund provisions; and (d) as noted above, are entitled to one non-cumulative vote per share on all matters submitted to stockholders for a vote at any meeting of stockholders. We anticipate that, for the foreseeable future, we will retain earnings, if any, to finance the operations of our businesses. The payment of dividends in the future will depend upon, among other things, our capital requirements and our operating and financial conditions.
Stock Warrants
– The Company has issued warrants as compensation to its placement agent and other consultants, as well as to incentivize investors in each of the Company’s private offering or debt financings.
Issuance of Common Stock and Related Common Stock Warrants Issued to Investors
The Company did not issue common stock or common stock warrants to investors during fiscal 2013.
On March 15, 2012, the Company sold to accredited investor an aggregate of 100,000 shares of common stock and 300,000 Class Q Warrants for gross proceeds of $25,000. The Class Q Warrants are exercisable at a price of $0.25 per share; contain a conditional call provision if the market price of each share exceeds $3.00, certain anti-dilution and other customary provisions. The warrants expire three years after the date of issuance. Common stock was increased by $100 for the par value of the shares and $24,900 to paid-in capital.
Other Common Stock Issued Including Exercise of Warrants and Stock Options
During 2013, the Company issued nine promissory notes to eight accredited investors in the aggregate principal amount of $179,500 ($179,275, net of commissions and expenses in the amount of $225), of which five notes for an aggregate of $48,500 originally matured during 2013 and were amended to mature on June 30, 2014, $14,000 matures on April 25, 2014, $100,000 matures on September 21, 2014, and $17,000 matures on October 25, 2014. The terms of the notes are essentially the same as the 2011 and 2012 short-term promissory notes, except that $40,000 of the notes accrue interest at a rate of 12% per annum, one note for $8,500 was noninterest bearing during 2013 and accrues interest at a rate of 10% effective January 1, 2014, one note for $14,000 accrues interest at a rate of 10% per annum, one note for $8,500 accrues interest at a rate of 5.9%, with two notes for $108,500 being noninterest bearing. Consideration for one $8,500 noninterest bearing note during 2013 received a modification to 540,000 warrants to include a cashless provision, one note of $8,500 received an extension of 4,632,725 warrants to December 31, 2018, and one for $100,000 received a 2% royalty payment of future TBDx™ net revenue in South Africa up to $300,000. The Company issued to six of the note holders an aggregate of 450,000 shares of common stock, and the relative fair value of the common stock of $31,100 will be amortized over the term of the notes. Common stock was increased by $450 for the par value of the shares, $30,650 was applied to paid-in-capital, and $31,100 will be recorded to other expense for the amortization of the debt discount over the term of the notes.
During 2013, company employees converted accrued and unpaid wages for an aggregate of 1,833,333 shares of common stock. The shares were issued under the 2009 Stock Compensation Plan. Common stock was increased by approximately $1,834 for the par value of the shares, paid-in capital was increased by $68,167, and accrued wages was reduced by the fair value of the stock of $70,001.
On November 22, 2013, the Company issued 150,000 shares of common stock to an employee who exercised 240,000 stock options under a cashless exercise provision. The shares were issued under the 2003 Stock Incentive Plan. Common stock was increased by $150 for the par value of the shares, and paid-in capital was increased by $11,850. Stock compensation expense of $12,000 was also recorded for the fair value of the shares issued on the date exercised. There were no stock options granted or exercised during fiscal 2012.
On January 17, 2013, the Company issued an aggregate of 4,500,000 shares of common stock to two of its named executives, and a consultant/director, which vest 50% three months from the date of issuance and 50% upon six months from date of issuance. The shares were issued under the 2009 Stock Compensation Plan in consideration for the continued deferral of salaries during 2012 and 2013 to-date, as well as for the incentive for ongoing contributions in moving our product development efforts forward. Our Compensation Committee, under the direction of the Board of Directors, administers the 2009 Plan based on the above factors, and the Board approved the grant of stock options to all current employees, including its named executives. Common stock was increased by $4,500 for the par value of the shares, paid-in capital was increased by $130,500, and $135,000 was recorded as deferred stock compensation. During fiscal 2013, $176,250 was expensed as stock compensation, and $41,250 was recorded for the revaluation of such shares outstanding at each period end until fully vested.
On January 17, 2013, the Company agreed to convert $5,150 of outstanding accrued payables and $5,500 other services to a consultant for an aggregate of 280,000 shares of common stock. The average conversion price was $0.04. Common stock was increased in the aggregate of $280 for the par value of the shares, paid-in capital was increased in the aggregate of $10,370, and accrued payables were reduced by the outstanding amount of $5,150 and $5,500 expensed to consulting stock compensation.
On December 5, 2012, the Company issued to two employees an aggregate of 1,850,000 shares of common stock. The shares were issued under the 2009 Stock Compensation Plan. Common stock was increased by $1,850 for the par value of the shares, paid-in capital was increased by $72,150, and stock compensation expense of $74,000 was recorded.
During fiscal 2012, the Company issued promissory notes to four accredited investors in the aggregate principal amount of $160,000, of which $100,000 matures on December 31, 2012 and was subsequently extended to June 30, 2013, $50,000 matures on January 24, 2013, and $10,000 matures on April 11, 2013. The notes accrue interest at a rate of 12% per annum. The Company also issued to the note holders an aggregate of 285,000 shares of common stock. The relative fair value of the common stock of $11,715 was recorded as a discount to the notes payable and will be amortized over the term of the notes. Common stock was increased by $285 for the par value of the shares, $11,430 was applied to paid-in-capital, and $10,405 was recorded to other expense for the amortization of the debt discount during 2012. The Company also issued 10,800 shares of common stock to a broker as a placement fee for the issuance of short-term notes. Common stock was increased by $11 for the par value of the shares, paid-in capital was increased by $2,689 for the fair value of the shares, and $2,700 was charged to interest expense.
During fiscal 2012, company employees converted accrued and unpaid wages for an aggregate of 3,919,425 shares of common stock. The shares were issued under the 2009 Stock Compensation Plan. Common stock was increased by $3,919 for the par value of the shares, paid-in capital was increased by $166,099, and accrued wages was reduced by the fair value of the stock of $170,018.
On May 24, 2012 and June 5, 2012, the Company issued to two consultants an aggregate of 246,749 shares of common stock as compensation in lieu of cash for services rendered. The shares were issued under the 2009 Stock Compensation Plan. Common stock was increased by $247 for the par value of the shares and paid-in capital was increased by approximately $10,044. Stock compensation expense of $10,291 was also recorded.
In February and March 2012, the Company agreed to convert outstanding accounts payable to a consultant for an aggregate of 400,000 shares of common stock under the 2009 Stock Compensation Plan. The conversion price was $0.25. Common stock was increased in the aggregate of $400 for the par value of the shares, paid-in capital was increased in the aggregate of $99,600, and accounts payable was reduced by the outstanding amount of $100,000.
Other Common Stock Warrants Issued, Expired or Forfeited
During fiscal 2013, an aggregate of 6,913,403 common stock purchase warrants expired, of which 160,000 warrants were issued to consultants, and 6,753,403 warrants were issued to investors (3,642,850 Class H, 750,000 Class I, 565,328 Class J, 513,575 Class K, 853,650 Class L, and 428,000 Class P). The fair value of the warrants on their date of issuance was $1,746,275.
During fiscal 2012, an aggregate of 5,076,670 common stock purchase warrants and related placement agent warrants expired, of which 47,564 were placement agent warrants, 3,012,523 Series D warrants related to the Series A convertible debentures, and 2,016,583 were issued to investors (864,798 Class E, 937,500 Class G, 214,285 Class J). The fair value of the warrants on their date of issuance was $1,325,396.
The Company has issued warrants as compensation to its bridge note holders, placement agents and other consultants, as well as to incentivize investors in each of the Company’s private placement financings. The table below shows by category, the warrants issued and outstanding at December 31, 2013:
|
|
|
|
|
|
|
|
|
|
|
Common Stock Purchase Warrants
|
|
Number of Warrants Outstanding and Exercisable
|
|
Date Warrants are Exercisable
|
|
Exercise Price
|
|
Date Warrants Expire
|
|
Note and debenture holders
|
|
10,000
|
|
December 2007
|
|
$ 0.70
|
|
December 2014
|
|
|
|
18,293
|
|
February 2009
|
|
0.41
|
|
February 2014
|
|
|
|
150,000
|
|
January 2010
|
|
0.25
|
|
January 2015
|
|
|
|
78,750
|
|
September 2010
|
|
0.25
|
|
September 2015
|
|
|
|
257,043
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Private placement investors
|
|
214,285
|
|
March 2008
|
|
0.75
|
|
December 2014
|
|
|
|
4,358,981
|
|
Jan to April 2009
|
|
0.41
|
|
Jan to April 2014
|
|
|
|
800,000
|
|
June to July 2009
|
|
0.25
|
|
June to July 2014
|
|
|
|
3,881,973
|
|
July to August 2009
|
|
0.25
|
|
December 2018
|
|
|
|
2,099,007
|
|
Oct to Dec 2009
|
|
0.25
|
|
Oct to December 2014
|
|
|
|
400,000
|
|
November 2009
|
|
0.25
|
|
December 2016
|
|
|
|
200,000
|
|
March 2010
|
|
0.25
|
|
December 2016
|
|
|
|
2,499,568
|
|
March to June 2010
|
|
0.25
|
|
March to June 2015
|
|
|
|
750,752
|
|
May to Aug 2010
|
|
0.25
|
|
December 2018
|
|
|
|
3,731,155
|
|
July to Sept 2010
|
|
0.25
|
|
July to September 2015
|
|
|
|
5,301,345
|
|
Oct to Dec 2010
|
|
0.25
|
|
Oct to December 2015
|
|
|
|
800,000
|
|
February 2011
|
|
0.25
|
|
February 2014
|
|
|
|
600,000
|
|
February 2011
|
|
0.25
|
|
February 2016
|
|
|
|
88,000
|
|
October 2011
|
|
0.25
|
|
October 2014
|
|
|
|
300,000
|
|
March 2012
|
|
0.25
|
|
March 2015
|
|
|
|
26,025,066
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Placement agents
|
|
272,827
|
|
June 2009
|
|
0.45
|
|
June 2014
|
|
|
|
108,000
|
|
July 2009
|
|
0.25
|
|
July 2014
|
|
|
|
205,000
|
|
December 2009
|
|
0.28
|
|
December 2014
|
|
|
|
72,000
|
|
February 2011
|
|
0.25
|
|
February 2016
|
|
|
|
657,827
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Consultants
|
|
200,000
|
|
December 2009
|
|
0.25
|
|
December 2014
|
|
|
|
63,000
|
|
June to August 2009
|
|
0.25
|
|
June to August 2014
|
|
|
|
14,000
|
|
August 2010
|
|
0.28
|
|
August 2015
|
|
|
|
14,000
|
|
September 2010
|
|
0.25
|
|
September 2015
|
|
|
|
291,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Warrants Issued/Outstanding
|
|
27,230,936
|
|
|
|
|
|
|
As of December 31, 2013, approximately 9,475,781 of the above warrants may be exercised pursuant to the cashless exercise provisions of such warrants and, if so exercised, the shares may be subsequently resold under the provisions of Rule 144 under the Securities Act. Increased sales volume of the Company’s common stock could cause the market price of the Company’s common stock to drop.
Stock-Based Compensation
The Company has two active equity compensation plans which include the Amended and Restated 2003 Stock Incentive Plan and the 2009 Stock Compensation Plan (collectively, the “Plans”). A total of 50,000,000 shares were reserved for issuance under these Plans in the form of stock-based awards to employees, non-employee directors and outside consultants of the Company, of which 185,000 shares remain available for issuance thereunder as of December 31, 2013. The grant of awards under the Plans require approval by the Compensation Committee of the Board of Directors of the Company (or the Board of Directors, in the absence of such a committee) (the “Committee”), and the Committee is authorized under the Plans to take all actions that it determines to be necessary or appropriate in connection with the administration of the Plans.
The Company adopted the provisions of ASC 718-10, “Share-Based Payment” to account for its share-based payments. ASC 718-10 requires all share-based payments to employees, or to non-employee directors as compensation for service on the Board of Directors, to be recognized as compensation expense in the consolidated financial statements based on the estimated fair values of such options as calculated using the Black-Scholes model, and the related expense is recognized on a straight-line basis over the service period to vesting for each grant, net of estimated forfeitures. The Company’s estimated forfeiture rates are based on its historical experience within separate groups of employees. In accordance with ASC 718-10, the Company recognized total stock-based compensation expense for employees and non-employee members of the Board of Directors of $634,829, $74,000, and $708,829 for the year ended December 31, 2013, 2012, and the period of April 1, 2012 through December 31, 2013 (the development stage), respectively.
The Company accounts for stock options granted to non-employees in accordance with ASC 718-10 and ASC 505-50, “Accounting For Equity Instruments That Are Issued To Other Than Employees For Acquiring, Or In Conjunction With Selling, Goods Or Services.” ASC 505-50 establishes the measurement principles for transactions in which equity instruments are issued in exchange for the receipt of goods or services. The Company has relied upon the guidance provided under ASC 505-50 to determine the measurement date and the fair value re-measurement principles to be applied, and recognizes as an expense the estimated fair value of such options as calculated using the Black-Scholes model. The fair value is remeasured during the service period at each balance sheet date, and is amortized over the remaining service period to vesting for each option or the remaining term of the recipient’s contractual arrangement, whichever is shorter. The Company recognizes compensation costs, net of an estimated forfeiture rate, on a pro rata basis over the requisite service period of each vesting tranche of each award. The Company considers voluntary termination behavior as well as trends of actual option forfeitures when estimating the forfeiture rate. Total stock-based compensation expense for consultants of $5,500, $11,125, and $15,792 for the year ended December 31, 2013, 2012, and the period of April 1, 2012 through December 31, 2013 (the development stage), respectively.
The Amended and Restated 2003 Stock Incentive Plan
The Board of Directors adopted the 2003 Stock Incentive Plan on August 29, 2003 and terminated on August 29, 2013. The termination of the plan does not affect the outstanding options without the consent of the optionee. The Board of Directors amended and restated the plan on December 2, 2003. The Amended and Restated 2003 Stock Incentive Plan (“2003 Plan”) was approved by the shareholders on February 13, 2004, pursuant to which it grants stock-based compensation in the form of options, which could result in the issuance of up to an aggregate of 30,000,000 shares of the Company’s common stock. The aggregate number of shares and the number of shares in an award (as well as the option price) may be adjusted if the outstanding shares of the Company are increased, decreased or exchanged through merger or other stock transaction. The Plan provides for options which qualify as Incentive Stock Options under Section 422 of the Internal Revenue Code of 1986, as well as the issuance of Non-Qualified Options, which do not so qualify. Pursuant to the terms of the 2003 Plan, the Company, as determined by the Board of Directors or a committee appointed by the Board, may grant Non-Qualified Stock Options (“NQSOs”) to its executive officers, non-employee directors, or consultants of the Company and its subsidiaries at any time, and from time to time. The 2003 Plan also provides for Incentive Stock Options (“ISOs”) to be granted to any officer or other employee of the Company or its subsidiaries at any time, and from time to time, as determined by the Compensation Committee. Such stock options granted allow a grantee to purchase a fixed number of shares of the Company’s common stock at a fixed exercise price not be less than the quoted market price (or 110% thereof for Incentive Stock Options issued to a holder of 10% or greater beneficial ownership) of the shares on the date granted. The options may vest on a single date or over a period of time, but normally they do not vest unless the grantee is still employed by, or a director of, the Company on the vesting date. Generally for all employees, the options vest 50% after the first year from the date of grant and the remaining 50% after the second year from the date of grant. Stock options granted to independent board of directors vest 100% after the service period, which generally is one year from the date of grant.
Factors considered in granting stock options included: (i) the general policy during the past five, and in the foreseeable future, of not increasing base salaries of all employees, (ii) the performance of employees, (iii) the employees’ increasing responsibilities in a dynamic, and shrinking organization, and (iv) the accomplishments achieved by the Company during the prior year. The 2003 Plan has been the principal method for our employees and executive officers to acquire equity interests in the Company. We believe that the annual aggregate value of these awards should be set near competitive median levels for comparable companies. We may provide a greater portion of total compensation to our executives and employees through stock options given the general policy of not increasing base salaries in the foreseeable future. Our Compensation Committee administers the 2003 Plan based on the above factors, and the Committee approved the grant of stock options to all current employees, including its named executives, during 2007 through 2009 as an incentive for continued contributions in moving our product development efforts forward. Stock options were not granted to employees, including its named executives, during 2012 and 2011, as the Company did not achieve the desired results during 2010 and 2011. Also, the Compensation Committee, based on management’s recommendation and discussions with the Committee, may grant stock options to new employees. There were no stock options granted to new employees during fiscal 2013, since there were no new employees hired during this period.
Options granted under the Plan must be evidenced by a stock option agreement in a form consistent with the provisions of the 2003 Plan. Each option shall expire on the earliest of (a) ten (10) years from the date it is granted, (b) sixty (60) days after the optionee dies or becomes disabled, (c) immediately upon the optionee's termination of employment or service or cessation of Board service, whichever is applicable, or (d) such date as the Committee shall determine, as set forth in the relevant option agreement; provided, however, that no ISO which is granted to an optionee who, at the time such option is granted, owns stock possessing more than ten (10) percent of the total combined voting power of all classes of stock of the Company or any of its subsidiaries, shall be exercisable after the expiration of five (5) years from the date such option is granted.
To exercise an option, the 2003 Plan participant, in accordance with the relevant option agreement, must provide the Company a written notice setting forth the number of options being exercised and their underlying shares, and tender an amount equal to the total exercise value of the options being exercised. The right to purchase shares is cumulative so that once the right to purchase any shares has vested; those shares or any portion of those shares may be purchased at any time thereafter until the expiration or termination of the option. ISOs and NQSOs that are not exercised in accordance with the terms and provisions of the stock option agreement, or as amended, will expire as to any then unexercised portion. Stock options that expire, are cancelled, or forfeited will again become available for issuance under the 2003 Plan as described below. The aggregate number of shares and the number of shares in an award (as well as the option price) may be adjusted if the outstanding shares of the Company are increased, decreased or exchanged through merger or other stock transaction. The shares issued by the Company under the 2003 Plan may be either treasury shares or authorized but unissued shares as the Company’s board of directors or the Compensation Committee may determine from time to time. Except as specifically provided in an option agreement, options granted under the 2003 Plan may not be sold, pledged, transferred or assigned in any way, except by will or by the laws of descent and distribution, and during the lifetime of a participant to whom the ISOs is granted, and the ISOs may only be exercised by the participant.
The Board of Directors granted 16,353,000 stock options to all employees, including its named executives, under the 2003 Plan during fiscal 2013, and the fair value of the options is $507,620, of which $415,961 was recognized as stock-based compensation expense during the period. The stock options were granted in consideration for the continued deferral of salaries during 2012 and 2013, as well as for the incentive for ongoing contributions in moving our product development efforts forward. The Company has reserved under the plan 27,695,700 shares to be issued upon exercise of outstanding options, and 2,033,353 unissued options were cancelled upon termination of the 2003 Plan on August 29, 2013. Therefore, there are no shares of common stock that remain available for future awards. Compensation expense for stock options granted is recognized over the requisite service period, which is typically the period over which the stock-based compensation awards vest.
Stock Options Exercised under the 2003 Plan
On November 22, 2013, the Company issued 150,000 shares of common stock to an employee who exercised 240,000 stock options pursuit to a cashless exercise provision. Common stock was increased by $150 for the par value of the shares, and paid-in capital was increased by $11,850. Stock compensation expense of $12,000 was also recorded for the fair value of the shares issued on the date exercised. There were no stock options granted or exercised during fiscal 2012.
Summary of stock option activity under the 2003 Plan issued to employees, non-employee members of the Board of Directors and consultants, for the two fiscal years ended December 31, 2013 is as follows:
|
|
|
|
|
|
|
Fiscal Year and Activity
|
|
Weighted- Average Exercise Price
|
|
Number of Options
|
|
Outstanding December 31, 2011
|
|
$ 0.32
|
|
14,788,489
|
|
|
|
|
|
|
|
Fiscal 2012 activity
|
|
|
|
|
|
Granted
|
|
-
|
|
-
|
|
Exercised
|
|
-
|
|
-
|
|
Cancelled ($0.30)
|
|
0.30
|
|
(5,279,142)
|
|
Outstanding December 31, 2012
|
|
0.32
|
|
9,509,347
|
|
|
|
|
|
|
|
Fiscal 2013 activity
|
|
|
|
|
|
Granted
|
|
-
|
|
16,353,000
|
|
Exercised
|
|
0.03
|
|
(240,000)
|
|
Cancelled ($0.30)
|
|
0.30
|
|
(200,000)
|
|
Outstanding December 31, 2013
|
|
$ 0.14
|
|
25,422,347
|
|
|
|
|
|
|
The following table summarizes additional information about the 2003 Plan stock options outstanding at December 31, 2013:
|
|
|
|
|
|
|
|
|
|
|
|
|
Issued and Outstanding
|
|
Exercisable
|
|
Type of Option and Range of Exercise Prices
|
|
Number of Options
|
|
Weighted-Average Remaining Contractual Life (Yrs)
|
|
Weighted-Average Exercise Price
|
|
Number of Options
|
|
Weighted-Average Price
|
|
Nonqualified Stock Options $0.30 (1) (5)
|
|
650,000
|
|
0.1
|
|
$ 0.30
|
|
650,000
|
|
$ 0.30
|
|
Nonqualified Stock Options $0.30 (2) (5)
|
|
44,000
|
|
1.1
|
|
0.30
|
|
44,000
|
|
0.30
|
|
Incentive Stock Options $0.15 - $4.05 (3) (5)
|
|
649,300
|
|
4.1
|
|
0.98
|
|
649,300
|
|
0.98
|
|
Incentive Stock Options $0.15 - $0.30 (4) (5)
|
|
24,079,047
|
|
7.5
|
|
0.12
|
|
22,616,047
|
|
0.12
|
|
Total
|
|
25,422,347
|
|
7.2
|
|
$ 0.14
|
|
23,959,347
|
|
$ 0.15
|
|
|
|
(1) Issued to employees below fair value and during the period of July 2003 to February 2004.
|
|
(2) Issued to directors below fair value and during the period of February 2004 to September 2005.
|
|
(3) Issued to consultants at fair value.
|
|
(4) Issued to directors and employees at fair value, or above fair value for those individuals with greater than 10% beneficial ownership.
|
|
(5) The exercise price reflects the repricing of stock options as approved by the Compensation Committee on April 24, 2010, and subsequent issuances at fair value on the date of grant.
|
The 2009 Stock Compensation Plan
On June 4, 2009, the Board of Directors adopted the 2009 Stock Compensation Plan (“2009 Plan) which provides for the grant or issuance of up to an aggregate of 20,000,000 shares of the Company’s common stock pursuant to non-qualified stock options (“NQSOs”), restricted stock awards (“RSAs”), restricted stock rights (“RSRs”), or common stock awards (“Common Stock Awards”) (a NQSO, RSA, RSR or Common Stock Award, individually, an “Award;” collectively, “Awards”). Our Board of Directors has delegated its authority to administer the 2009 Plan to the Compensation Committee. The exercise price of NQSOs may not be less than 100% of the fair market value of the stock on the date of the option grant, and may only be exercised at such times as may be specified by the Committee and provided for in an award agreement, but may not be exercised after ten years from the date on which it was granted. RSAs and RSRs consist of a specified number of shares of the Company’s Common Stock that are, or may be, subject to restrictions on transfer, conditions of forfeiture, and any other terms and conditions for periods determined by the Committee. Generally, unless the Committee determines otherwise, once the restricted stock vests, the shares of Common Stock specified in the Award will be free of restriction, subject to any applicable lock up period. Prior to the termination of the restrictions, under a RSA (but not a RSR), a participant may vote and receive dividends on the restricted stock unless the Committee determines otherwise, but may not sell or otherwise transfer the shares. Common Stock Awards under the plan may be issued free of restriction and may vest immediately; however, the Committee may impose vesting and other restrictions related to the grant of such common stock Awards. Compensation expense for these Awards is recognized over the period they vest, although generally Common Stock Awards vest immediately, while the RSAs, RSRs and NQSOs will have a vesting period.
The purpose of the 2009 Plan is to foster our success and the success of our subsidiaries and affiliates by providing incentives to employees, directors, officers and consultants to promote our long-term financial success. The Plan complements our 2003 Amended and Restated Stock Incentive Plan (the “2003 Plan”) and provides greater flexibility to us in that it permits us to compensate and award employees, directors, officers and consultants through the issuance of certain options, RSAs, RSRs, and stock awards in addition, or as an alternative, to the incentive and non-qualified stock options that may be awarded under the 2003 Plan. The 2009 Plan terminates on June 4, 2019, and no award may be made after that date, however, awards made before that date may extend beyond that date. If an award under the 2009 Plan is cancelled, expires, forfeited, settled in cash or otherwise terminates without being exercised in full, the shares of common stock not acquired pursuant to the award will again become available for issuance under the 2009 Plan.
Subject to the provisions of the 2009 Plan, the Compensation Committee has the power to:
·
Prescribe, amend, and rescind rules and regulations relating to the 2009 Plan and to define terms not otherwise defined therein;
·
Determine which persons are eligible to participate, to which of such participants, if any, awards shall be granted, and the timing of any such awards;
·
Grant awards to participants and determine the terms and conditions thereof, including the number of shares subject to awards and the exercise or purchase price of such shares and the circumstances under which awards become exercisable or vested or are forfeited or expire;
·
Establish any performance goals or other conditions applicable to the grant, issuance, exercisability, vesting and/or ability to retain any award;
·
Prescribe and amend the terms of the agreements or other communications evidencing awards made under the 2009 Plan (which need not be identical) and the terms or form of any document or notice required to be delivered to us by participants under the 2009 Plan;
·
Determine the appropriate adjustment, if any, required as a result of any reorganization, reclassification, combination of shares, stock split, reverse stock split, spin-off or dividend (other than regular, quarterly cash dividends), or other changes in the number or kind of outstanding shares or any stock or other securities into which such shares shall have been exchanged;
·
Interpret and construe the 2009 Plan, any rules and regulations under the 2009 Plan and the terms and conditions of any award granted thereunder, and to make exceptions to any such provisions in good faith and for the benefit of the Company; and
·
Make all other determinations deemed necessary or advisable for the administration of the 2009 Plan.
Unless the Board expressly provides otherwise prior to a change of control or in an award agreement, in the event of a change of control of the Company, all outstanding options under the 2009 Plan vest and become exercisable on the date immediately before the change of control and all restrictions under RSAs and RSRs shall lapse or be deemed satisfied on the date immediately prior to the change of control. A change of control is deemed to have occurred upon the occurrence of one of the following events: (i) any person or group of persons becomes the beneficial owner of shares of the Company to which 50% or more of the total number of votes for the election of directors may be cast; (ii) as a result of a cash tender offer, exchange offer, merger or other business combination, sale of assets or contested election, persons who were directors immediately prior to the event cease to constitute a majority of the board; (iii) stockholders approve an agreement providing either that the Company will cease to be an independent publicly owned corporation or for sale or other disposition of all or substantially all the assets of the Company; or (iv) a tender offer or exchange offer is made for shares of our common stock (other than one made by us) and shares of common stock are acquired.
The Compensation Committee determines all awards to non-employee directors and such awards are not subject to management’s discretion. From time to time, the committee will set the amount and the type of award that will be granted to non-employee directors on a periodic, nondiscriminatory basis, including pursuant to any plan adopted by the Compensation Committee or Board for the compensation of non-employee directors. The committee may set additional awards to be granted to non-employee directors also on a periodic, nondiscriminatory basis based on one or more of the following criteria: (i) service as the chair of a Board committee; (ii) service as chairman of the Board; (iii) the number or type of Board committees on which a director serves; or (iv) the first selection or appointment of an individual to the Board.
Non-qualified stock options may be granted pursuant to non-qualified stock option award agreements and certificates adopted by the Board, as amended by the Compensation Committee. The Compensation Committee determines the terms of each stock option granted under the 2009 Plan, including the number of shares covered by an option, exercise price and means of payment, the vesting and exercisability of the option, and restrictions on transfer and the term. The exercise price of an option granted under the Plan may not be less than the fair market value on the date of option grant and may only be exercised at such times as may be specified by the Committee and provided for in an award agreement. The options expire on the earliest of ten years after the date of grant, 90 days after the death or disability of the recipient, immediately upon termination of employment or service other than by death or disability, or such date as the Compensation Committee determines. The Compensation Committee, in its sole discretion, may change by agreement the post-termination rights of a recipient, including accelerating the date or dates on which the option becomes vested and is exercisable following termination of employment or service, or extend the period. Options granted under the plan may be exercised by delivering cash, a cashless exercise, or by delivering to us the proceeds of shares of our common stock issuable under an option. Compensation expense for non-qualified stock options is recognized over the period they vest.
An award of restricted stock consists of a specified number of shares of our common stock that are, or may be, subject to restrictions, forfeiture conditions, and any other terms and conditions for periods determined by the Committee. The Compensation Committee has discretion to determine the terms of any award of restricted stock, including the number of shares subject to the award, and the minimum period over which the award may vest, and the acceleration of any vesting in the event of death, disability or change of control. RSAs are not transferable or assignable unless provided otherwise by the Compensation Committee with respect to certain specified family-related transfers. Unless the Committee determines otherwise, once the restricted stock vests, the shares of common stock specified in the Award will be free of restriction, subject to any applicable lock up period. Prior to the termination of the restrictions under a RSA, a participant may vote and receive dividends on the restricted stock unless the Committee determines otherwise, but may not sell or otherwise transfer the shares until such time as the restrictions of the award have been satisfied. Compensation expense for restricted stock awards is recognized over the period they vest.
An award of restricted stock rights entitles a participant to receive a specified number of shares of our common stock that are, or may be, subject to restrictions, forfeiture conditions, and any other terms and conditions for periods determined by the Committee. It may also include the right to dividend equivalents if and as so determined by the committee. The Compensation Committee has discretion to determine the terms of any award of restricted stock or RSRs, including the number of shares subject to the award, and the minimum period over which the award may vest, and the acceleration of any vesting in the event of death, disability or change of control. RSRs are not transferable or assignable unless provided otherwise by the Compensation Committee with respect to certain specified family-related transfers. Unless the committee determines otherwise, once a RSR vests, the shares of common stock specified in the award will be issued to the participant. A participant who has been awarded RSRs may not vote the shares of common stock subject to the rights until the shares are issued. Until the vesting period applicable to a RSRs award expires and the shares are issued, the participant also may not transfer or encumber any interest in the RSRs or in any related dividend equivalents. Compensation expense for restricted stock rights is recognized over the period they vest.
The Compensation Committee may also make stock awards of common stock without restrictions, except that if the award is in lieu of salary, service fee, cash bonus or other cash compensation, the number of shares covered by an award shall be based on the fair market value of such shares on the date of grant. Common Stock Awards under the plan may be issued free of restriction and may vest immediately; however, the Committee may impose vesting and other restrictions related to the grant of such common stock awards. Compensation expense for common stock awards is recognized over the period they vest, although generally the awards vest immediately.
The Board may amend, terminate, or modify the 2009 Plan at any time, without shareholder approval, unless required by the Internal Revenue Code of 1986, pursuant to Section 16 under the Securities Exchange Act of 1934, as amended, or by any national securities exchange or system on which our common stock is then listed or reported, or by any regulatory body.
The following is a summary of the number and type of awards granted to, or exercised or forfeited by, employees, non-employee members of the Board of Directors and consultants pursuant to the Company’s 2009 Stock Compensation Plan for the two fiscal years ended December 31, 2013 is as follows:
|
|
|
|
|
|
|
Shares Issued and Reserved for Future Issuance
|
|
Weighted-Average Grant or Exercise Price Per Share
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fiscal Year and Activity
|
|
|
Number of Shares
|
|
Shares reserved for future issuance at December 31, 2011
|
|
|
|
13,334,507
|
|
|
|
|
|
|
|
Fiscal 2012 activity:
|
|
|
|
|
|
Stock awards
|
|
$ 0.11
|
|
6,666,174
|
|
Restricted stock awards
|
|
-
|
|
-
|
|
Restricted stock rights
|
|
-
|
|
-
|
|
Non-qualified stock options
|
|
-
|
|
-
|
|
Issued during Fiscal 2012
|
|
0.11
|
|
6,666,174
|
|
|
|
|
|
|
|
Fiscal 2013 activity:
|
|
|
|
|
|
Stock awards
|
|
0.03
|
|
6,483,333
|
|
Restricted stock awards
|
|
-
|
|
-
|
|
Restricted stock rights
|
|
-
|
|
-
|
|
Non-qualified stock options
|
|
-
|
|
-
|
|
Issued during Fiscal 2013
|
|
0.03
|
|
6,483,333
|
|
|
|
|
|
|
|
Shares reserved for future issuance as of December 31, 2013
|
|
|
|
185,000
|
|
|
|
|
|
|
Common Shares Reserved
–
At December 31, 2013, the activity to date for shares of common stock reserved for future issuance were as follows:
|
|
|
|
2003 Amended and Restated Stock Incentive Plan:
|
|
|
Stock options outstanding
|
25,422,347
|
|
Stock options available for grant (plan expired August 29, 2013)
|
0
|
|
|
|
|
2009 Stock Compensation Plan:
|
|
|
Stock options or restricted stock rights outstanding
|
0
|
|
Shares available for grant
|
185,000
|
|
|
|
|
Warrants to purchase common stock (includes 9,475,781 warrants that contain a cashless exercise provision)
|
27,230,936
|
Stock Compensation Issued under the 2009 Plan
On January 17, 2013, the Company issued an aggregate of 4,500,000 shares of common stock to two of its named executives, and a consultant/director, which vest 50% three months from the date of issuance and 50% upon six months from date of issuance. The shares were issued under the 2009 Stock Compensation Plan in consideration for the continued deferral of salaries during 2012 and 2013 to-date, as well as for the incentive for ongoing contributions in moving our product development efforts forward. Our Compensation Committee, under the direction of the Board of Directors, administers the 2009 Plan based on the above factors, and the Board approved the grant of stock options to all current employees, including its named executives. Common stock was increased by $4,500 for the par value of the shares, paid-in capital was increased by $130,500, and $135,000 was recorded as deferred stock compensation. During fiscal 2013, $176,250 was expensed as stock compensation, and $41,250 was recorded for the revaluation of such shares outstanding at each period end until fully vested.
During 2013, company employees converted accrued and unpaid wages for an aggregate of 1,833,333 shares of common stock. The shares were issued under the 2009 Stock Compensation Plan. Common stock was increased by approximately $1,834 for the par value of the shares, paid-in capital was increased by $68,167, and accrued wages was reduced by the fair value of the stock of $70,001.
On May 24, 2012 and June 5, 2012, the Company issued to two consultants an aggregate of 246,749 shares of common stock as compensation in lieu of cash for services rendered. The shares were issued under the 2009 Stock Compensation Plan. Common stock was increased by $247 for the par value of the shares and paid-in capital was increased by approximately $10,044. Stock compensation expense of $10,291 was also recorded.
During January through September 2012, employees converted accrued and unpaid wages for 3,919,425 shares of common stock. The shares were issued under the 2009 Stock Compensation Plan. Common stock was increased by $3,919 for the par value of the shares, paid-in capital was increased by $166,099, and accrued wages was reduced by the fair value of the stock of $170,018.
In February and March 2012, the Company agreed to convert outstanding accounts payable to a consultant for an aggregate of 400,000 shares of common stock under the 2009 Stock Compensation Plan. The conversion price was $0.25. Common stock was increased in the aggregate of $400 for the par value of the shares, paid-in capital was increased in the aggregate of $99,600, and accounts payable was reduced by the outstanding amount of $100,000.
NOTE 7. Goodwill and Intangible Assets
We follow the provisions of ASC 805-10, “Business Combinations” and ASC 350-10, “Goodwill and Other Intangible Assets.” These statements establish financial accounting and reporting standards for acquired goodwill. Specifically, the standards address how acquired intangible assets should be accounted for both at the time of acquisition and after they have been recognized in the financial statements. Effective January 1, 2002, with the adoption of ASC 350-10, goodwill must be evaluated for impairment and is no longer amortized. Excess of purchase price over net assets acquired (“goodwill”) represents the excess of acquisition purchase price over the fair value of the net assets acquired. To the extent possible, a portion of the excess purchase price is assigned to identifiable intangible assets. We determine impairment by comparing the fair value of the goodwill, using the undiscounted cash flow method, with the carrying amount of that goodwill. Impairment is tested annually or whenever indicators of impairment arise. There was no goodwill on the consolidated balance sheet of the Company during Fiscal 2013and 2012, as a net realizable value analysis was made for goodwill in prior years during the Company’s operating stage and such asset was fully impaired during those prior years.
The Company incurs costs for intangible assets related to our patents. Under ASC 350 goodwill and other intangible assets acquired including software technology is considered to have a finite life. Patent acquisition costs pertaining to PinPoint™ and Signature Mapping™ (products not acquired through acquisition) have been capitalized, and are being amortized on a straight-line basis over the expected 20-year legal life of the patents. The Company evaluates the periods of amortization continually to determine whether later events or circumstances require revised estimates of useful lives. In addition, ASC 985-20, “Accounting for the Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed,” requires the Company to consider whether or not the software technology is impaired on a quarterly basis. We evaluate the carrying value of long-lived assets for impairment, whenever events or changes in circumstances indicate that the carrying value of an asset within the scope of ASC 360-10, “Accounting of the Impairment or Disposal of Long-Lived Assets” may not be recoverable. Our assessment for impairment of intangible assets involves estimating the undiscounted cash flows expected to result from use of the asset and its eventual disposition. An impairment loss recognized is measured as the amount by which the carrying amount of the asset exceeds the fair value of the asset, and considers year-end the date for its annual impairment testing. The Company prepared this analysis as of the year ended December 31, 2013, and 2012, and concluded that the intangible assets are not impaired. Therefore, there was no impairment expense during Fiscal 2013, 2012, or the period of April 1, 2012 through December 31, 2013 (the development stage).
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31, 2013
|
|
|
Beginning Period Cost
|
|
Additions
|
|
Reductions
|
|
Net Book Value
|
|
Intangibles with finite lives:
|
|
|
|
|
|
|
|
|
Patent acquisition costs
|
331,163
|
|
(690)
|
|
14,618
|
|
315,855
|
|
|
$ 331,163
|
|
$ (690)
|
|
$ 14,618
|
|
$ 315,855
|
|
|
|
|
|
|
|
|
|
We anticipate incurring additional patent acquisition costs during the year ending December 31, 2014 (Fiscal 2014). Based on the net book value of patents acquisition costs at December 31, 2013, the Company estimates amortization expense for intangible assets to be $32,911 for each of the Fiscal years 2014 through 2018, and $151,300 thereafter. The Company abandoned $3,310 in patents during fiscal 2013.
NOTE 8. Income Taxes
There is no benefit or provision for income taxes reflected in the accompanying financial statements. Reconciliation between the provision for income taxes computed by applying the statutory Federal income tax rate and the provision for income taxes is as follows:
|
|
|
|
|
|
|
|
|
|
A reconciliation between the provision for income taxes computed by applying the statutory federal income tax rate and the provision for income taxes is as follows for the years ended December 31, 2013 and 2012:
|
|
|
|
|
|
|
|
|
|
|
YEAR ENDED DECEMBER 31
|
|
|
2013
|
|
2012
|
|
Federal benefit at statutory rate
|
|
|
$ (828,683)
|
-34.0%
|
|
$ (613,394)
|
-34.0%
|
|
Increase (decrease) due to:
|
|
|
|
|
|
|
|
|
State benefits, net of federal benefits
|
|
|
(97,492)
|
-4.0%
|
|
(72,164)
|
-4.0%
|
|
Stock based compensation
|
|
|
(19,391)
|
-0.8%
|
|
0
|
0.0%
|
|
Foreign income subject to foreign income tax
|
|
|
0
|
0.0%
|
|
0
|
0.0%
|
|
Other, net
|
|
|
821
|
0.0%
|
|
1,096
|
0.1%
|
|
Valuation allowance
|
|
|
944,745
|
38.8%
|
|
684,462
|
37.9%
|
|
Provision for income taxes
|
|
|
$ -
|
0.0%
|
|
$ -
|
0.0%
|
|
|
|
|
|
|
|
|
|
|
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amount of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company's net deferred tax assets as of December 31, 2013 and 2012 were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2013
|
|
|
2012
|
|
|
Deferred tax assets:
|
|
|
|
|
|
|
|
|
Accrued salaries
|
|
|
$ 370,322
|
|
|
$ 377,774
|
|
|
Accrued leave
|
|
|
768
|
|
|
(2,436)
|
|
|
Accrued Payroll Taxes
|
|
|
19,081
|
|
|
19,408
|
|
|
Revaluation of Derivative Liability
|
|
|
128,304
|
|
|
(25,661)
|
|
|
Net operating loss carryforwards, not yet utilized
|
|
|
18,126,053
|
|
|
17,810,865
|
|
|
Total deferred tax assets
|
|
|
18,644,528
|
|
|
18,179,950
|
|
|
Valuation allowance for deferred tax assets
|
|
|
(18,644,528)
|
|
|
(18,179,950)
|
|
|
Net deferred tax assets
|
|
|
$ -
|
|
|
$ -
|
|
|
|
|
|
|
|
|
|
|
|
For income tax purposes, the Company has a cumulative net operating loss carryforwards at December 31, 2013 of approximately $48,821,903 that, subject to applicable limitations, may be applied against future taxable income. If not utilized, the net US operating loss carryforward will begin to expire in 2023 through 2033.
|
NOTE 9. Commitments and Contingencies
Contractual Obligations
The following table summarizes scheduled maturities of our contractual obligations extending beyond one year for which cash flows are fixed and determinable as of December 31, 2013.
|
|
|
|
|
|
|
|
|
|
Category
|
Payments Due in Fiscal
|
|
Total
|
2014
|
2015
|
2016
|
2017
|
2018
|
Thereafter
|
|
Convertible debentures (1)
|
$ 1,688,205
|
$ 1,688,205
|
$ -
|
$ -
|
$ -
|
$ -
|
$ -
|
|
Notes payable (2)
|
739,500
|
739,500
|
-
|
-
|
-
|
-
|
-
|
|
Notes payable and advances, related parties (3)
|
80,500
|
80,500
|
-
|
-
|
-
|
-
|
-
|
|
Interest payments (4)
|
181,582
|
181,582
|
-
|
-
|
-
|
-
|
-
|
|
Operating lease commitments (5)
|
-
|
-
|
-
|
-
|
-
|
-
|
-
|
|
Unconditional purchase obligations (6)
|
-
|
-
|
-
|
-
|
-
|
-
|
-
|
|
Total contractual obligations
|
$ 2,689,787
|
$ 2,689,787
|
$ -
|
$ -
|
$ -
|
$ -
|
$ -
|
|
|
|
|
|
|
|
|
|
|
(1) Represents the outstanding Series A Convertible Debentures that originally matured November 8, 2008, and were amended October 15, 2010. Under terms of the amendment, the Company and the debenture holders agreed to an extension of the maturity date to June 30, 2011. The Company is currently in default under the amendment agreement and is negotiating with the debenture holders to extend the maturity date. Commencing March 3, 2011, the Company may force a conversion of the debentures if certain trading price and volume conditions are met.
|
|
(2) Represents outstanding notes payable issued in 2011 of $400,000, in 2012 of $160,000, and $179,500 in 2013. The original term of the notes varried from three (3) months to 18 months, with interest rates from noninterest bearing to 12% per annum. The notes have subsequently been extended and they mature between June 30, 2014 and October 25, 2014. See Other Liabilities above for further information on the 2011, 2012, and 2013 Short-Term Promissory Notes.
|
|
(3) Represents outstanding notes payable from our chief executive officer. The notes are non-negotiable, unsecured, and non-interest bearing. The term of the original note was six (6) months, and all notes were subsequently amended to extend the maturity date to June 30, 2014. See Other Liabilities above for further information on the 2006 through 2011 Short-Term Promissory Notes, Related Party.
|
|
(4) The outstanding Series A convertible debentures, under the October 15, 2010 amendment, did not bear interest through the new maturity date of June 30, 2011, and the amendment agreement does not require interest after the maturity date. The Company is in negotiations with the debenture holders to extend the maturity date of the convertible debentures, and the holders may require interest to be paid for such extension. Interest reflected represents accrued interest on the outstanding notes payable from the date of note to their current maturity date during 2014. See Other Liabilities above for further information on the 2011, 2012 and 2013 Short-Term Promissory Notes.
|
|
(5) The Company's office lease expired on January 31, 2013, and was not renewed. Total rental expense included in the accompanying consolidated statements of earnings was $22,745 in fiscal 2013, and $71,738 in fiscal 2012.
|
|
(6) The company currently does not have any outstanding unconditional purchase obligations. They would though include inventory commitments, future royalty, consulting agreements, other than month-to-month arrangements or those that expire in less then one year, or commitments pursuant to executive compensation arrangements.
|
|
|
|
|
|
|
|
|
|
Default under Series A Debentures
The principal amount of our outstanding Series A Debentures of $1,688,205 became due on July 1, 2011, and such amount was not paid. Therefore, the Company may be considered in default. The debentures provide that any default in the payment of principal, which default is not cured within the five trading days of the receipt of notice of such default or ten trading days after the Company becomes aware of such default, will be deemed an event of default and may result in enforcement of the debenture holders’ rights and remedies under the debentures and applicable law. We are in discussions with the debenture holders to re-negotiate the terms of the debentures, including the repayment or repurchase of the debentures and/or seek to extend their maturity date, although we have not reached any agreement with the debenture holders with regard to any such repayment, repurchase or extension. Our ability to repay or repurchase the debentures is contingent upon our ability to raise additional financing, of which there can be no assurance. Also, as a condition to any such extension, debenture holders may seek to amend or modify certain other terms of the debentures. When an event of default occurs under the debentures, the debenture holders may elect to require us to make immediate repayment of the mandatory default amount, which equals the sum of (i) the greater of either (a) 120% of the outstanding principal amount of the debentures, or (b) the outstanding principal amount unpaid divided by the conversion price on the date the mandatory default amount is either (1) demanded or otherwise due or (2) paid in full, whichever has the lower conversion price, multiplied by the variable weighted average price of the common stock on the date the mandatory default amount is either demanded or otherwise due, whichever has the higher variable weighted average price, and (ii) all other amounts, costs, expenses, and liquidated damages due under the debentures. In anticipation of such election by the debenture holders, due to the nonpayment of principal amount on the due date of July 1, 2011, we measured the mandatory default at approximately $337,641 and subsequently on each balance sheet date, which is reflected in the carrying value of the debentures and also recognized as interest expense. We remeasured the mandatory default amount as of December 31, 2013 at approximately $337,641. As of the date of this report, the debenture holders have not made an election requiring immediate repayment of the mandatory amount, although there can be no assurance they will not do so.
The Company currently has insufficient funds to repay the outstanding amount in the event the debenture holders make a demand for payment.
NOTE 10. Employment Agreements With Executive Officers
The employment agreements for each named executive officer are multiple years in duration. Each of the named executive officers employment agreement provides for an annual base salary and a discretionary annual incentive cash bonus and/or equity awards. In subsequent years, the amount of annual incentive cash and/or equity award bonus is subject to determination by our Board of Directors without limitation on the amount of the award. Each of the agreements provides for a severance payment over a prescribed term in the event the named executive is terminated without cause, including for Mr. Donovan and Mr. Hare, if their duties are materially changed in connection with a change in control. Each agreement also provides that no severance payment is due in the event of termination for cause, which includes termination for willful misconduct, conviction of a felony, dishonesty or fraud. Each agreement further contains an agreement by the named executive officer not to compete with us for a defined term equal in length to the applicable severance payment in the respective employment agreement, which the Company feels is reasonable and consistent with industry guidelines.
Michael W. Trudnak
. Mr. Trudnak serves as Chairman of the Board, Secretary, and Chief Executive Officer and a Class III director. The Company entered into an employment agreement with Mr. Trudnak, which commenced on January 1, 2003. The Company amended his agreement effective December 10, 2004. The amended agreement is for a three year term commencing June 26, 2003, and is renewable for one year terms. The employment agreement provides for annual compensation to Mr. Trudnak of $275,000 and a monthly automobile allowance of $500. Mr. Trudnak’s original employment agreement provided for the grant of an aggregate of 400,000 shares of our restricted stock. However, effective June 21 2004, Mr. Trudnak agreed to accept in lieu of the issuance of such shares, ten year nonqualified options to purchase an aggregate of 400,000 shares of common stock at an exercise price of $.36 per share. The employment agreement also provides for incentive compensation and/or bonuses as determined by the Company, participation in the Company’s stock option plan, and participation in any company employee benefit policies or plans. The employment agreement may be terminated upon the death or disability of the employee or for cause, in which event the Company’s obligation to pay compensation shall terminate immediately. In the event the agreement is terminated by us other than by reason of the death or disability of the employee or for cause, the employee is entitled to payment of his base salary for one year following termination. The employee may terminate the agreement on 30 days’ prior notice to the Company. The employee has entered into an employee proprietary information, invention assignment and non-competition agreement, pursuant to which the employee agrees not to disclose confidential information regarding the Company, agrees that inventions conceived during his employment become the property of the Company, agrees not to compete with the business of the Company for a period of one year following termination of employment, and agrees not to solicit employees or customers of the Company following termination of employment.
William J. Donovan.
Mr. Donovan serves as President and Chief Operating Officer of the Company, and previously served as Chief Financial Officer. The Company entered into a new employment agreement with Mr. Donovan on November 18, 2005, which superseded his previous employment agreement with the Company, dated effective August 18, 2003. The new employment agreement is for a term of three years unless earlier terminated, and is automatically renewable for one year terms. The employment agreement provides for an annual salary of $265,000. The agreement provides for annual performance bonuses based on goals established by the Company and agreed to by Mr. Donovan, a monthly automobile allowance of $500, participation in our stock option and other award plans (which options or awards shall immediately vest upon a “change in control”), and participation in any benefit policies or plans adopted by us on the same basis as other employees at Mr. Donovan’s level.
The employment agreement may be terminated by Mr. Donovan on 30 days’ prior written notice. The employment agreement may be terminated by us by reason of death, disability or for cause. In the event the agreement is terminated for death or disability of the employee, our obligation to pay compensation to the employee shall terminate immediately; provided that if the Company does not maintain disability insurance for the employee, he is entitled to be paid his base salary for one year following his disability. In the event the he is terminated other than by reason of his death, disability, for cause, or change in control, Mr. Donovan is entitled to payment of his base salary for one year following termination. Further if Mr. Donovan terminates his employment for the following material reasons (each a “material reason”): written demand by us to change the principal workplace of the employee to a location outside of a 50-mile radius from the current principal address of the Company; a material reduction in the number or seniority of personnel reporting to employee or a material reduction in the frequency or in nature of matters with respect to which such personnel are to report to employee, other than as part of a company-wide reduction in staff; an adverse change in employee’s title; a material decrease in employee’s responsibilities; or a material demotion, Mr. Donovan is entitled to be paid the greater of the base salary remaining under the employment agreement or twelve months base salary.
In the event of a “change in control” of the Company and, within 12 months of such change of control, employee’s employment is terminated or one of the events in the immediately preceding sentence occurs, Mr. Donovan is entitled to be paid his base salary for 18 months following such termination or event. A “change in control” would include the occurrence of one of the following events:
·
the approval of the stockholders for a complete liquidation or dissolution of the Company;
·
the acquisition of 20% or more of the outstanding common stock of the Company or of voting power by any person, except for purchases directly from the Company, any acquisition by the Company, any acquisition by a the Company employee benefit plan, or a permitted business combination;
·
if two-thirds of the incumbent board members as of the date of the agreement cease to be board members, unless the nomination of any such additional board member was approved by three-quarters of the incumbent board members;
·
upon the consummation of a reorganization, merger, consolidation, or sale or other disposition of all or substantially all of the assets of the Company, except if (i) all of the beneficial owners of the Company’s outstanding common stock or voting securities who were beneficial owners before such transaction own more than 50% of the outstanding common stock or voting power entitled to vote in the election of directors resulting from such transaction in substantially the same proportions, (ii) no person owns more than 20% of the outstanding common stock of the Company or the combined voting power of voting securities except to the extent it existed before such transaction, and (iii) at least a majority of the members of the board before such transaction were members of the board at the time the employment agreement was executed or the action providing for the transaction.
Also, Mr. Donovan has entered into a proprietary information, invention assignment and non-competition agreement (“non-competition agreement”), pursuant to which he has agreed not to disclose confidential information regarding us, agrees that inventions conceived during his employment become our property, agrees not to compete with our business for a period of one year following termination or expiration of his employment, and agrees not to solicit our employees or customers following termination of his employment. The employment agreement provides for arbitration in the event of any dispute arising out of the agreement or his employment, other than disputes arising under the non-competition agreement.
Gregory E. Hare.
Mr. Hare serves as our Chief Financial Officer and Treasurer. The Company entered into an employment agreement with Mr. Hare commencing on January 30, 2006. The employment agreement is essentially the same as the agreement the Company entered into with Mr. Donovan, except that the agreement is for a term of two years unless earlier terminated and shall automatically renew for successive one year terms unless terminated prior thereto. The employment agreement provides for a base salary of $200,000 per annum and no automobile allowances. The agreement provides for annual performance bonuses based on goals established by the Company and agreed to by Mr. Hare, participation in the Company’s stock option and other award plans, and participation in any company benefit policies or plans adopted by us on the same basis as other employees at Mr. Hare’s level. The Company agreed to grant to Mr. Hare, subject to approval of our Compensation Committee, stock options to purchase 200,000 shares of our common stock pursuant to our 2003 Stock Incentive Plan, one-half of which options will vest on the one year anniversary of the commencement of his employment and the remaining options vesting on the two year anniversary of the commencement of his employment.
Also, Mr. Hare has entered into a proprietary information, invention assignment and non-competition agreement (“non-competition agreement”), pursuant to which he has agreed not to disclose confidential information regarding us, agrees that inventions conceived during his employment become our property, agrees not to compete with our business for a period of one year following termination or expiration of his employment, and agrees not to solicit our employees or customers following termination of his employment. The employment agreement provides for arbitration in the event of any dispute arising out of the agreement or his employment, other than disputes arising under the non-competition agreement.
NOTE 11. Related Par
ty Transactions
Note Payable to Stockholder and Executive Officer
On October 18, 2006, the Company entered into a Loan Agreement with Mr. Michael W. Trudnak, our Chairman and Chief Executive Officer pursuant to which Mr. Trudnak loaned the Company $100,000. The Company issued a non-negotiable promissory note, dated effective October 18, 2006, to Mr. Trudnak in the principal amount of $100,000. The note is unsecured, non-negotiable and non-interest bearing. The note is repayable on the earlier of (i) six months after the date of issuance, (ii) the date the Company receives aggregate proceeds from the sale of its securities after the date of the issuance of the Note in an amount exceeding $2,000,000, or (iii) the occurrence of an event of default. The following constitute an event of default under the note: (a) the failure to pay when due any principal or interest or other liability under the loan agreement or under the note; (b) the material violation by us of any representation, warranty, covenant or agreement contained in the loan agreement, the note or any other loan document or any other document or agreement to which the Company is a party to or by which the Company or any of our properties, assets or outstanding securities are bound; (c) any event or circumstance shall occur that, in the reasonable opinion of the lender, has had or could reasonably be expected to have a material adverse effect; (d) an assignment for the benefit of our creditors; (e) the application for the appointment of a receiver or liquidator for us or our property; (f) the issuance of an attachment or the entry of a judgment against us in excess of $100,000; (g) a default with respect to any other obligation due to the lender; or (h) any voluntary or involuntary petition in bankruptcy or any petition for relief under the federal bankruptcy code or any other state or federal law for the relief of debtors by or with respect to us, provided however with respect to an involuntary petition in bankruptcy, such petition has not been dismissed within 30 days of the date of such petition. In the event of the occurrence of an event of default, the loan agreement and note shall be in default immediately and without notice, and the unpaid principal amount of the loan shall, at the option of the lender, become immediately due and payable in full. The Company agreed to pay the reasonable costs of collection and enforcement, including reasonable attorneys’ fees and interest from the date of default at the rate of 18% per annum. The note is not assignable by Mr. Trudnak without our prior consent. The Company may prepay the note in whole or in part upon ten days notice. On November 10, 2006, Mr. Trudnak extended the due date of the note to May 31, 2007. Mr. Trudnak made an additional $24,000 loan to the company on June 25, 2008, and $5,000 on September 14, 2011, for cumulative outstanding loans of $129,000. The maturity date of the outstanding loans was extended to May 31, 2009, then to May 31, 2010 and June 30, 2011, and subsequently to December 31, 2011 and then to June 30, 2012. On June 30, 2012, the outstanding loans were extended to December 30, 2012, and then to June 30, 2013, and subsequently to December 31, 2013. On December 31, 2013, the outstanding loans were extended to June 30, 2014. The Company repaid an aggregate of $6,900 of the notes during 2010, an aggregate $33,100 during 2011, an aggregate of $8,500 during 2013, resulting in an outstanding balance at December 31, 2013 of $80,500. The terms of the above transaction were reviewed and approved by the Company’s audit committee and by the independent members of our Board of Directors.
Consulting Agreement with BND Software, Principal Owner Sean Kennedy, a Director of the Company
On July 15, 2008, Applied Visual Sciences, Inc. entered into a consulting agreement with BND Software
,
Inc. (“BND”), a corporation that is owned and controlled by Mr. Sean W. Kennedy, a director of the Company. BND agreed to provide certain consulting services to the Applied Visual including managing the research, development and information systems activities of the Company. The agreement is for a term of one year commencing on May 27, 2008, and on May 31, 2009. The agreement provided for an extension of a twelve (12) month period upon mutual agreement by both parties. The agreement may be terminated upon 60 days prior written notice by one party to the other party. The agreement provided for an annual compensation of $216,000. The Company did not renew the agreement with BND, although Mr. Kennedy continued to provide management services for the research, development and information systems activities. We paid or agreed to pay BND consulting fees of $141,661 during 2013, and $168,663 during 2012. As of December 31, 2013, the Company has accrued and unpaid fees payable to BND Software of $804,250. On February 15, 2014, Mr. Kennedy resigned as a director and consultant to the Company.
NOTE 12. Operating Leases
Total rental expense for the leased offices included in the accompanying consolidated statements of operations and comprehensive income was $22,745 in 2013, $71,738 in 2012, and $76,624 for the period of April 1, 2012 through December 31, 2013 (the development stage). The lease is currently on a month-to-month basis.
NOTE 13. Subsequent Events
Subsequent events are reported by the Company to disclose events that have occurred after the balance sheet date, but before the financial statements are issued. Such events may be to provide additional information about conditions that existed at the date of the balance sheet, or conditions that did not exist at the balance sheet date. The Company has evaluated subsequent events through the date of this report.
During the three months ended March 31, 2014, a Company employee converted accrued wages for the exercise of 396,000 stock options that resulted in the issuance of 396,000 shares of common stock. Common stock was increased by $396 for the par value of the shares, paid-in capital was increased by $11,484, and accrued wages were reduced by $11,880.