Quarterly report pursuant to Section 13 or 15(d)

Convertible Promissory Notes and Other Notes Payable

v2.4.0.6
Convertible Promissory Notes and Other Notes Payable
9 Months Ended
Dec. 31, 2012
Notes to Financial Statements  
NOTE 7 - Convertible Promissory Notes and Other Notes Payable

The following table summarizes the components of the company’s secured and unsecured promissory notes and other notes payable at December 31, 2012 and March 31, 2012 (amounts in 100’s).

 

    December 31, 2012     March 31, 2012  
    Principal     Accrued           Principal     Accrued        
    Balance     Interest     Total     Balance     Interest     Total  
Senior Secured 10% Convertible Promissory Notes issued to Platinum:                                    
Exchange Note issued on October 11, 2012   $ 1,272,600     $ 28,900     $ 1,301,500     $ -     $ -     $ -  
Investment Note issued on October 11, 2012     500,000       11,300       511,300       -       -       -  
Investment Note issued on October 19, 2012     500,000       10,200       510,200       -       -       -  
      2,272,600       50,400       2,323,000       -       -       -  
Aggregate note discount     (985,500 )     -       (985,500 )     -       -       -  
    Total Senior notes (non-current)   $ 1,287,100     $ 50,400     $ 1,337,500     $ -     $ -     $ -  
                                                 
Convertible Promissory Notes:                                                
 February 2012 12% convertible promissory notes   $ -     $ -     $ -     $ 500,000     $ 5,300     $ 505,300  
   Note discount     -       -       -       (499,300 )     -       (499,300 )
    Total 12% convertible notes, net (non-current)   $ -     $ -     $ -     $ 700     $ 5,300     $ 6,000  
                                                 
Notes Payable to unrelated parties:                                                
  7.0% Notes payable (April 2011)   $ 11,500     $ 100     $ 11,600     $ 63,800     $ 400     $ 64,200  
  7.0% Notes payable (August 2012)     60,000       1,400       61,400       -       -       -  
      71,500     $ 1,500     $ 73,000       63,800     $ 400     $ 64,200  
 less: current portion     (18,100 )     (1,500 )     (19,600 )     (63,800 )     (400 )     (64,200 )
  7.0% Notes payable - non-current portion   $ 53,400     $ -     $ 53,400     $ -     $ -     $ -  
                                                 
  7.5% Notes payable to service providers for accounts payable                                                
converted to notes payable:                                                
     Burr, Pilger, Mayer   $ 91,800     $ 900     $ 92,700     $ 93,400     $ 1,100     $ 94,500  
     Desjardins     211,700       2,000       213,700       224,300       2,800       227,100  
     McCarthy Tetrault     435,900       200       436,100       459,400       5,700       465,100  
     May 2011 Morrison Foerster     -       -       -       2,420,100       37,900       2,458,000  
     August 2012 Morrison & Foerster Note A     964,700       -       964,700       -       -       -  
     August 2012 Morrison & Foerster Note B (1)     1,379,400       34,600       1,414,000       -       -       -  
     University Health Network  (1)     549,500       9,300       558,800       -       -       -  
      3,633,000       47,000       3,680,000       3,197,200       47,500       3,244,700  
        Note discount     (1,205,500 )     -       (1,205,500 )     (228,900 )     -       (228,900 )
      2,427,500       47,000       2,474,500       2,968,300       47,500       3,015,800  
 less: current portion     (617,000 )     (3,100 )     (620,100 )     (367,700 )     -       (367,700 )
    non-current portion and discount   $ 1,810,500     $ 43,900     $ 1,854,400     $ 2,600,600     $ 47,500     $ 2,648,100  
                                                 
   5.8%  and 8% Notes payable to insurance                                          
premium financing company (current)   $ 15,900     $ -     $ 15,900     $ 4,600     $ -     $ 4,600  
                                                 
  10% Notes payable to vendors for accounts                                          
payable converted to notes payable   $ 144,400     $ 22,100     $ 166,500     $ 165,400     $ 16,800     $ 182,200  
 less: current portion     (144,400 )     (22,100 )     (166,500 )     (146,000 )     -       (146,000 )
    non-current portion   $ -     $ -     $ -     $ 19,400     $ 16,800     $ 36,200  
                                                 
    Total notes payable to unrelated paties   $ 2,659,300     $ 70,600     $ 2,729,900     $ 3,202,100     $ 64,700     $ 3,266,800  
 less: current portion     (795,400 )     (26,700 )     (822,100 )     (582,100 )     (400 )     (582,500 )
    non-current portion and discount   $ 1,863,900     $ 43,900     $ 1,907,800     $ 2,620,000     $ 64,300     $ 2,684,300  
                                                 
Notes payable to related parties:                                                
  April 2011 7 % Note to Cato Holding Co. $ -     $ -     $ -     $ 293,300     $ 6,900     $ 300,200  
  October 2012 7.5% Note to Cato Holding Co.   293,600       1,900       295,500       -       -       -  
  October 2012 7.5% Note to Cato Research Ltd. (1)     1,009,000       17,100       1,026,100       -       -       -  
      1,302,600       19,000       1,321,600       293,300       6,900       300,200  
            Note discount     (157,900 )     -       (157,900 )     (24,300 )     -       (24,300 )
     Total notes payable to related parties   1,144,700     19,000     1,163,700     269,000     6,900     275,900  
 less: current portion     (110,100 )     (1,900 )     (112,000 )     (168,200 )     -       (168,200 )
    non-current portion and discount   $ 1,034,600     $ 17,100     $ 1,051,700     $ 100,800     $ 6,900     $ 107,700  
____________                                                
(1) Note and interest payable solely in restricted shares of the Company's common stock; see description of debt restructuring in Note 7.  

 

Senior Secured Convertible Promissory Notes

 

On July 2, 2012 and on August 31, 2012, the Company issued to Platinum senior secured convertible promissory notes in the principal amount of $500,000 (the “July 2012 Platinum Note”) and $750,000 (the "August 2012 Platinum Note"), respectively. The July 2012 Platinum Note and the August 2012 Platinum Note each accrued interest at the rate of 10% per annum and were due and payable on July 2, 2015. The July 2012 Platinum Note and the August 2012 Platinum Note were each mandatorily convertible into securities that may be issued by the Company in an equity, equity-based, or debt financing, or series of financings, subsequent to the issuance of the note resulting in gross proceeds to the Company of at least $3,000,000, excluding any additional investment by Platinum.

 

On October 11, 2012, the Company and Platinum entered into a Note Exchange and Purchase Agreement (the “October 2012 Agreement”) in which the July 2012 Platinum Note and the August 2012 Platinum Note (together, the “Existing Notes”), as well as the related accrued interest, were consolidated into and exchanged for a single senior secured convertible note in the amount of $1,272,577 (the “Exchange Note”) and Platinum agreed to purchase 10% senior secured convertible promissory notes in the aggregate principal amount of $2.0 million (the “Investment Notes”), issuable over four $500,000 tranches between October 2012 and December 2012.  The first and second $500,000 Investment Notes, in the aggregate principal amount of $1.0 million, were purchased by Platinum on October 11, 2012 and October 19, 2012, respectively. The Company and Platinum also entered into an amended and restated Security Agreement to secure repayment of all obligations due and payable under the terms of the Investment Notes and Exchange Note.

 

On November 14, 2012 and January 31, 2013, the Company and Platinum entered into amendments to the October 2012 Agreement (the “NEPA Amendments”), pursuant to which the final two $500,000 tranches were combined into a single Investment Note in the aggregate principal amount of $1.0 million (the “$1.0 Million Note”). Under the terms and conditions of the NEPA Amendment, Platinum agreed to purchase the $1.0 Million Note within five business days of the Company's notice to Platinum of the consummation of a debt or equity financing, or combination of financings, prior to February 15, 2013, resulting in gross proceeds to the Company of at least $1.0 million (the “Additional Financing Requirement”), provided, however, that the $1.0 Million Note would not be issued prior to January 1, 2013.

 

The Exchange Note and each Investment Note (together, the “Notes”) accrues interest at a rate of 10% per annum and, subject to certain limitations and exceptions set forth in the Notes, will be due and payable in shares of the Company’s common stock on October 11, 2015, or three years from the date of issuance, as determined by the terms of the Investment Notes. At maturity, all principal and accrued interest under the Notes shall be payable by the Company through the issuance of restricted shares of common stock to Platinum.  Subject to certain potential adjustments set forth in the Notes, the number of shares of common stock issuable as payment in full for each note at maturity will be calculated by dividing the outstanding note balance plus accrued interest by $0.50 per share. Prior to maturity, the outstanding principal and any accrued interest on the Exchange Note and each of the Investment Notes is convertible, in whole or in part, at Platinum’s option into shares of the Company’s common stock at a conversion price of $0.50 per share, subject to certain adjustments. The conversion feature in each of the Notes constitutes a beneficial conversion feature at the date of issuance.

 

As additional consideration for the purchase of the Investment Notes, the Company agreed to issue to Platinum a warrant to purchase an aggregate of 2,000,000 shares of the Company’s common stock, issuable in separate tranches of 500,000 shares each, to be issued together with each Investment Note, of which a warrant to purchase 500,000 shares was issued to Platinum on October 11, 2012 and on October 19, 2012 (each an “Investment Warrant”). In addition, the Company issued Platinum a warrant to purchase 1,272,577 shares of the Company’s common stock in connection with the issuance of the Exchange Note (the “Exchange Warrant”). Each warrant has a term of 5 years and an exercise price of $1.50, subject to certain adjustments. The Company and Platinum also executed and subsequently amended a security agreement to secure repayment of all obligations due and payable under the terms of the Exchange Note and all Investment Notes.  

 

As a result of the beneficial conversion feature in the Exchange Note and the issuance of the Exchange Warrant, the Company determined that the cancellation of the Existing Notes and the issuance of the Exchange Note should be accounted for as an extinguishment of debt. The Company determined that the fair value of the Exchange Note, including the beneficial conversion feature, was $2,355,800 using a Monte Carlo simulation model and inception-date assumptions including market price of common stock of $0.75 per share; stock price volatility of 85%; risk-free interest rate of 0.67%; conversion price of $0.50 per share; note term of 3 years; 75% probability that conversion would occur at or immediately prior to maturity; and 25% probability that an event requiring either the repayment of the Exchange Note or its conversion into common stock would occur prior to maturity. The fair value of the Exchange Note at inception represented a substantial premium over its face value. In accordance with the provisions of ASC 470-20, Debt with Conversion and Other Options, the Company recognized the premium in excess of the face value, $1,083,200, as a non-cash charge to loss on early extinguishment of debt in the accompanying Condensed Consolidated Statement of Operations and Comprehensive Income and as a credit to additional paid-in capital and recorded the liability for the Exchange Note at its face value.

 

Subject to limited exceptions, which include issuances of common stock pursuant to the 2012 Private Placement of Units (see Note 9, Capital Stock), the Exchange Warrant and each of the Investment Warrants include certain exercise price reset and anti-dilution protection features in the event that the Company issues other shares of common stock during the five-year term of the warrants at a price less than their initial $1.50 per share exercise price. As a result of these provisions, the Exchange Warrant and the Investment Warrants do not meet the criteria set forth in ASC 815, Derivatives and Hedging, to be considered indexed to the Company’s own stock and treated as equity instruments. Consequently, the Company recorded the Exchange Warrant and each of the Investment Warrants as liabilities at their fair value, which was estimated at the issuance date using a Monte Carlo simulation model, with assumptions including market price of common stock of $0.75 per share, stock price volatility of 85%, risk-free interest rate of 0.67%; exercise price of $1.50 per share and term of 5 years. The fair value of the Exchange Warrant, $672,000 at the date of issuance, was recorded as a liability and as a corresponding charge to loss on early extinguishment of debt in the accompanying Condensed Consolidated Statement of Operations and Comprehensive Income. The fair value of each Investment Warrant, $264,000 at the date of issuance, was recorded as a liability and as a corresponding discount to the related Investment Note. Subject to limitations of the absolute amount of discount attributable to each Investment Note, the Company treated the issuance-date intrinsic value of the beneficial conversion feature embedded in each Investment Note as an additional component of the discount attributable to each Investment Note and recorded $231,000 as a discount attributable to the beneficial conversion feature for each Investment Note. The Company amortizes the aggregate discount attributable to each of the Investment Notes using the interest method over the respective term of each note. The effective interest rate on both the October 11, 2012 Investment Note and the October 19, 2012 Investment Note at the issuance date was 159.05%.

 

The fair value of the Exchange Warrant and Investment Warrants was re-measured as of December 31, 2012 at an aggregate of $1,102,000 and the $98,000 reduction in fair value since inception was reflected in the accompanying Condensed Consolidated Statement of Operations and Comprehensive Income.

 

February 2012 Convertible Promissory Notes

 

On February 28, 2012, the Company completed a private placement of convertible promissory notes to certain accredited investors in the aggregate principal amount of $500,000 (the "Notes"). Each Note accrued interest at the rate of 12% per annum and was to mature on the earlier of (i) twenty-four months from the date of issuance, or (ii) the consummation of an equity, equity-based, or series of equity-based financings resulting in gross proceeds to the Company of at least $4.0 million (the “Qualified Financing Threshold”). The holders of the Notes had the right to voluntarily convert the outstanding principal amount of the Notes and all accrued and unpaid interest (the “Outstanding Balance”) at any time prior to maturity into that number of shares of the Company’s common stock equal to the Outstanding Balance, divided by $3.00 (the "Conversion Shares"). In addition, in the event the Company consummated a financing equal to or exceeding the Qualified Financing Threshold, and the price per unit of the securities sold, or price per share of common stock issuable in connection with such financing, was at least $2.00 (a “Qualified Financing”), the Outstanding Balance would have automatically converted into such securities, including warrants, that were issued in the Qualified Financing, the amount of which would have been determined according to the following formula: (Outstanding Balance at the closing date of the Qualified Financing) x (1.25) / (the per security price of the securities sold in the Qualified Financing). The purchaser of each Note was issued a five-year warrant to purchase, for $2.75 per share, the number of shares of the Company’s common stock equal to 150% of the total principal amount of the Notes purchased by such purchaser, divided by $2.75, resulting in the potential issuance of an aggregate of 272,724 shares of the Company’s common stock upon exercise of the warrants (the “Warrant Shares”).

 

The Company entered into a Registration Rights Agreement with the purchasers of the February 2012 Notes pursuant to which the Company agreed to register for resale the Conversion Shares and the Warrant Shares. The Company agreed to file a registration statement no later than ninety days from the February 28, 2012 closing date, or by May 28, 2012 (the “Filing Deadline”). Should the Company not have filed the registration statement by the Filing Deadline or if the registration statement had not been declared effective by the agreed upon effectiveness deadline, the Company was required to make aggregate payments to the purchasers in an amount equal to 1% of the $500,000 aggregate face amount of the February 2012 Notes for each 30-day period following the Filing Deadline, or pro-rata portion thereof, with an aggregate limitation of $50,000.

 

On November 15, 2012, the holders of the February 2012 Notes entered into an Exchange Agreement with the Company (the "Exchange Agreement"). Under the terms of the Exchange Agreement, (i) the current amount due under the terms of the February 2012 Notes, $678,600, which amount included all accrued interest as well as additional consideration for the conversion, was exchanged for a total of 1,357,281 unregistered shares of the Company's common stock and five-year warrants to purchase 678,641 unregistered shares of the Company's common stock at an exercise price of $1.50 per share (the "Note Exchange Securities"); and (ii) the Registration Rights Agreement was terminated. Additionally, the Company issued a five-year warrant to purchase 72,000 unregistered shares of the Company’s common stock at an exercise price of $1.50 per share as partial compensation to an investment bank that had placed certain of the Notes. The Company recorded the issuance of the warrants with a charge to interest expense of $28,200 and a corresponding credit to additional paid-in capital.

 

The Company determined that the exchange of the Notes into shares of its common stock should be accounted for as an extinguishment of debt. The Company recognized as consideration in the exchange the sum of (i) the fair value of the common stock issued in the exchange at the quoted market price of $0.70 per share on the date of the exchange, or $950,100, and (ii) the fair value of the warrants, which was determined to be $0.39 per share, or $265,500, using the Black Scholes Option Pricing Model and the following assumptions: market price per share: $0.70; exercise price per share: $1.50; risk-free interest rate: 0.62%; contractual term: 5 years; volatility: 89.5%; expected dividend rate: 0%. The aggregate consideration less the net carrying value of the Notes, including accrued interest, resulted in the recognition of $1,145,100 as a non-cash loss on early extinguishment of debt in the accompanying Condensed Consolidated Statements of Operations and Comprehensive Income. The warrants issued to the investment bank were valued using the same assumptions as used for the warrants issued to the exchanging note holders.

 

August 2010 Short-Term Note Converted to 7% Note Payable

 

In August 2010, the Company issued short-term, non-interest bearing, unsecured promissory notes (the “August 2010 Short-Term Notes”) having an aggregate principal amount, as adjusted, of $1,120,000. In May 2011, a total of $840,000 of the aggregate principal amount of the August 2010 Short-Term Notes were converted into Units consisting of shares of the Company’s common stock and three-year warrants to purchase shares of the Company’s common stock at an exercise price of $2.50 per share. Of the remaining balance of the August 2010 Short Term Notes; $105,000 of such amount was converted into a long-term note issued to Cato Holding Company, doing business as Cato BioVentures; and $175,000 of such amount was amended into a note bearing interest at 7% per annum, as described below.

 

In April 2011, the Company and the holder of the $175,000 August 2010 Short-Term Note amended the note, whereby the Company paid $50,000 of the note balance in May 2011 and was to make four monthly payments of $5,000 between May 2011 and August 2011, an additional nine monthly payments of $11,125 per month for the period from September 1, 2011 through May 1, 2012, plus a final payment on May 2, 2012 equal to any remaining balance. In September 2011, the Company and the holder agreed to modify the payment schedule to require payments of $5,000 per month through November 1, 2011, six monthly payments of $11,125 for the period from December 1, 2011 through May 1, 2012, an additional payment of $11,125 on May 2, 2012, plus a final payment on June 30, 2012 equal to any remaining balance. For strategic purposes, the Company did not make the February 2012 and March 2012 payments as scheduled. In March 2012, the Company and the note holder again agreed to modify the payment schedule to require seven monthly payments of $9,171 beginning June 1, 2012 with the final payment due on December 1, 2012 to include interest accrued after March 2012. The Company made payments totaling $55,000 during the period from June 1, 2012 to December 31, 2012.

 

Issuance and Restructuring of Long-Term Promissory Note to Cato Holding Company

 

In April 2011, all amounts owed by the Company to Cato Holding Company ("CHC") and its affiliates, which included the $105,000 balance of the August 2010 Short-Term Note issued to Cato BioVentures discussed above, were consolidated into a single note, in the principal amount of $352,273 (the “2011 CHC Note”). Concurrently, CHC released all of its security interests in certain of the Company’s personal property. The 2011 CHC note bears interest at 7% per annum, compounded monthly. Under the terms of the note, the Company was to make six monthly payments of $10,000 each beginning June 1, 2011, and thereafter to make payments of $12,500 monthly until the note was repaid in full. The Company had the option to prepay the outstanding balance under this note in full or in part at any time during its term without penalty.

 

On October 10, 2012, the Company and CHC restructured the 2011 CHC Note. The 2011 CHC Note was cancelled and exchanged for a new unsecured promissory note in the principal amount of $310,443 (the “2012 CHC Note”) and a five-year warrant to purchase 250,000 shares of the Company’s common stock at a price of $1.50 per share (the “CHC Warrant”). The 2012 CHC Note accrues interest at a rate of 7.5% per annum and is due and payable in monthly installments of $10,000, beginning November 1, 2012 and continuing until the outstanding balance is paid in full.

 

The Company determined that the cancellation of the 2011 CHC Note and the issuance of the 2012 CHC Note should be accounted for as an extinguishment of debt.  Accordingly, the Company recorded the 2012 CHC Note at its fair value of $291,100 based on the present value of its scheduled cash flows and assumptions regarding market interest rates for unsecured debt of similar quality. The Company determined the fair value of the CHC Warrant to be $0.48 per share, or $120,462, using the Black Scholes Option Pricing Model and the following assumptions: market price per share: $0.75; exercise price per share: $1.00; risk-free interest rate: 0.66%; contractual term: 5 years; volatility: 89.9%; expected dividend rate: 0%. The Company recognized the difference between the sum of the fair values of the 2012 CHC Note and the CHC Warrant less the carrying value of the 2011 CHC Note, $119,100, as a non-cash loss on early extinguishment of debt in the accompanying Condensed Consolidated Statements of Operations and Comprehensive Income.  The fair value of the warrant, $120,462, which is treated as an equity instrument, was credited to additional paid in capital at the issuance date. The difference between the face value of the 2012 CHC Note and its fair value, $19,343, has been treated as a discount to the note and is being amortized over the term of the note using the interest method, resulting in an effective interest rate of 11.9% on the CHC 2012 Note.

 

Issuance of Long-Term Notes and Cancellation of Amounts Payable

 

On February 25, 2011, the Company issued to Burr, Pilger, and Mayer, LLC (“BPM”) an unsecured promissory note in the principal amount of $98,674 for amounts payable in connection with valuation services provided to the Company by BPM. The BPM note bears interest at the rate of 7.5% per annum and has payment terms of $1,000 per month, beginning March 1, 2011 and continuing until all principal and interest are paid in full. In addition, a payment of $25,000 shall be due upon the sale of the Company or upon the Company completing a financing transaction of at least $5.0 million during any three-month period, with the payment increasing to $50,000 (or the amount then owed under the note, if less) upon the Company completing a financing of over $10.0 million.

 

On April 29, 2011, the Company issued to Desjardins Securities, Inc. (“Desjardins”) an unsecured promissory note in the principal amount of CDN $236,000 for amounts payable for legal fees incurred by Desjardins in connection with investment banking services provided to the Company by Desjardins. The Desjardins note bears interest at 7.5% and will be due, along with all accrued but unpaid interest on the earliest of (i) June 30, 2014, (ii) the consummation of a Change of Control, as defined in the Desjardins note, and (iii) any failure to pay principal or interest when due. The Company was required to make payments of CDN $4,000 per month beginning May 31, 2011, increasing to CDN $6,000 per month on January 31, 2012. Beginning on January 1, 2012, the Company shall also make payments equal to one-half percent (0.5%) of the net proceeds of all private or public equity financings closed during the term of the note. At September 30, 2012, the Company had not made the monthly payments required for February through September 2012. However, the Company resumed such monthly payments in October 2012. 

 

On May 5, 2011, the Company issued to McCarthy Tetrault LLP (“McCarthy”) an unsecured promissory note in the principal amount of CDN $502,797 for the amounts payable in connection with Canadian legal services provided to the Company. The McCarthy note bears interest at 7.5% and will be due, along with all accrued but unpaid interest on the earliest of (i) June 30, 2014, (ii) the consummation of a Change of Control, as defined in the McCarthy note, and (iii) any failure to pay principal or interest when due. The Company was required to make payments of CDN $10,000 per month beginning May 31, 2011, which payment amounts increased to CDN $15,000 per month on January 31, 2012. Beginning on January 1, 2012, the Company is also required to make payments equal to one percent (1%) of the net proceeds of all private or public equity financings closed during the term of the note. At September 30, 2012, the Company had not made the monthly payments required for February through September 2012. In October 2012, the Company and McCarthy agreed to extend the term of the note through March 2015 and the Company resumed the monthly payments.

 

On August 30, 2012, the Company issued a promissory note in the principal amount of $60,000 and 15,000 shares of its common stock valued at a market price of $0.94 per share to Progressive Medical Research in settlement of past due obligations for clinical research services in the amount of $79,900. Under the terms of the settlement, the company also agreed to make monthly cash payments of $5,000 in August 2012 through December 2012. The promissory note bears interest at 7% per annum and requires payments of $1,000 per month beginning January 15, 2013 until all principal and interest is paid in full. The note requires payment in full upon the sale of all or substantially all of the Company’s assets or upon the Company completing a financing transaction, or series of transactions, resulting in gross proceeds to the Company of at least $4.0 million in any three-month period, excluding proceeds from stock option or warrant exercises. The Company charged the loss on the settlement to interest expense.

 

Restructuring of Note Payable to Morrison & Foerster

 

On May 5, 2011, the Company and Morrison & Foerster LLP (“Morrison & Foerster”), the Company’s legal and intellectual property counsel, amended a previously outstanding note (the “Original Note”) issued by the Company in payment of legal services (the “Amended Note”). Under the Amended Note, the principal balance of the Original Note was increased to $2,200,000, interest accrued at the rate of 7.5% per annum, and the Company was required to make an additional payment of $100,000 within three business days of the date of the Amended Note. The Company made the required $100,000 payment in a timely manner.

 

On August 31, 2012, the Company restructured the Amended Note (the “Restructuring Agreement”). Pursuant to the Restructuring Agreement, the Company issued to Morrison & Foerster two new unsecured promissory notes to replace the Amended Note, one in the principal amount of $1,000,000 ("Replacement Note A") and the other in the principal amount of $1,379,400 ("Replacement Note B") (together, the "Replacement Notes"); amended an outstanding warrant to purchase shares of the Company’s common stock (the “Amended M&F Warrant”); and issued a new warrant to purchase shares of the Company’s common stock (the “New M&F Warrant”). Under the terms of the Restructuring Agreement, the Amended Note was cancelled and all of the Company's past due payment obligations under the Amended Note were satisfied. The Company made a payment of $155,000 to Morrison & Foerster on August 31, 2012 pursuant to the terms of the Amended Note, and issued the Replacement Notes, each dated as of August 31, 2012. Both Replacement Notes accrue interest at the rate of 7.5% per annum and are due and payable on March 31, 2016. Replacement Note A requires monthly payments of $15,000 per month through March 31, 2013, and $25,000 per month thereafter until maturity. Payment of the principal and interest on Replacement Note B will be made solely in shares of the Company’s common stock pursuant to Morrison & Foerster’s surrender from time to time of all or a portion of the principal and interest balance due on Replacement Note B in connection with its exercise of the New M&F Warrant, at an exercise price of $1.00 per share, and concurrent cancellation of indebtedness and surrender of Replacement Note B; provided, however, that Morrison & Foerster shall have the option to require payment of Replacement Note B in cash upon the occurrence of a change in control of the Company or an event of default, and only in such circumstances.

 

 

The Company treated the aggregate of the incremental value of the Amended M&F Warrant and the fair value of the New M&F Warrant as a discount to the Replacement Notes. Under the terms of the Amended M&F Warrant, the Company amended the warrant to purchase 425,000 shares of its common stock originally issued to Morrison & Foerster on March 15, 2010 to extend the expiration date of the warrant from December 31, 2014 to September 15, 2017 and to provide for exercise by paying cash or by the cancellation in whole or in part of the Company’s indebtedness under either of the Replacement Notes. The Company determined that the incremental value of the Amended M&F Warrant was $121,650 at the modification date using the Black-Scholes Option Pricing Model and the following assumptions:

 

Assumption:   Pre-modification     Post-modification  
Market price per share   $ 0.94     $ 0.94  
Exercise price per share   $ 2.00     $ 2.00  
Risk-free interest rate     0.25 %     0.60 %
Expected term (years)     2.33       5.04  
Volatility     77.9 %     88.8 %
Dividend rate     0.0 %     0.0 %
                 
Fair Value per share   $ 0.24     $ 0.52  

 

The New M&F Warrant is exercisable for the number of shares of the Company’s common stock equal to the principal and accrued interest due under the terms of Replacement Note B divided by the warrant exercise price of $1.00 per share. At the August 31, 2012 date of grant, the New M&F Warrant was exercisable to purchase 1,379,376 shares of the Company’s common stock. The New M&F Warrant effectively permits exercise only by the cancellation in whole or in part of the Company’s indebtedness under either of the Replacement Notes. The New M&F Warrant expires on September 15, 2017. The Company determined the fair value of the New M&F Warrant to be $0.64 per share, or $876,800, at the date of grant using the Black Scholes Option Pricing Model and the following assumptions: market price per share: $0.94; exercise price per share: $1.00; risk-free interest rate: 0.61%; contractual term: 5.04 years; volatility: 88.8%; expected dividend rate: 0%. The note discounts totaling $1,197,900, including the $199,500 remaining unamortized discount recorded prior to the modification, will be amortized to interest expense using the effective interest method over the term of the Replacement Notes. The aggregate amount of the incremental fair value of the Amended M&F Warrant and the fair value of the New M&F Warrant, $998,450, was recognized as equity and was credited to additional paid-in capital in the accompanying Condensed Consolidated Balance Sheets. The effective interest rate on the Replacement Notes at the date of issuance was 32.3%, based on the stated interest rate, the amount of discount, and the term of the Replacement Notes. Through December 31, 2012, the Company has adjusted the New M&F Warrant to increase the number of shares available for purchase by 34,579 shares, based on interest accrued on Replacement Note B through that date. The Company has recorded the fair value of the additional shares as a charge to interest expense and a corresponding credit to additional paid-in capital.

 

Restructuring of Accounts Payable to Cato Research Ltd. (“CRL”)

 

On October 10, 2012, the Company issued to CRL: (i) an unsecured promissory note in the initial principal amount of $1,009,000, which is payable solely in restricted shares of the Company’s common stock and which accrues interest at the rate of 7.5% per annum, compounded monthly (the “CRL Note”), as payment in full for all contract research and development services and regulatory advice (“CRO Services”) rendered by CRL to the Company and its affiliates through December 31, 2012 with respect to the preclinical and clinical development of AV-101, and (ii) a five-year warrant to purchase, at a price of $1.00 per share, 1,009,000 restricted shares of the Company’s common stock, the amount equal to the sum of the principal amount of the CRL Note, plus all accrued interest thereon, divided by $1.00 per share (the “CRL Warrant”). The principal amount of the CRL Note may, at the Company’s option, be automatically increased as a result of future CRO Services rendered by CRL to the Company and its affiliates from January 1, 2013 to June 30, 2013. The CRL Note is due and payable on March 31, 2016 and is payable solely by CRL's surrender from time to time of all or a portion of the principal and interest balance due on the CRL Note in connection with its concurrent exercise of the CRL Warrant, provided, however, that CRL will have the option to require payment of the CRL Note in cash upon the occurrence of a change in control of the Company or an event of default, and only in such circumstances.

 

The Company determined that the cancellation of the accounts payable to CRL for CRO Services and the related issuance of the CRL Note should be accounted for as an extinguishment of debt.  Accordingly, the Company recorded the CRL Note at its fair value of $857,900 based on the present value of its scheduled cash flows and assumptions regarding market interest rates for unsecured debt of similar quality. The Company determined the fair value of the CRL Warrant to be $0.48 per share, or $486,164, using the Black Scholes Option Pricing Model and the following assumptions: market price per share: $0.75; exercise price per share: $1.00; risk-free interest rate: 0.66%; contractual term: 5 years; volatility: 89.9%; expected dividend rate: 0%.  The Company recognized the difference between the sum of the fair values of the CRL Note and the CRL Warrant less the accounts payable balance due to CRL, $335,100, as a non-cash loss on early extinguishment of debt in the accompanying Condensed Consolidated Statements of Operations and Comprehensive Income.  The fair value of the warrant, $486,164, which is treated as an equity instrument, was credited to additional paid in capital at the issuance date. The difference between the face value of the CRL Note and its fair value, $151,100, has been treated as a discount to the note and is being amortized over the term of the note using the interest method, resulting in an effective interest rate of 12.1% on the CRL Note.  Through December 31, 2012, the Company has adjusted the CRL Warrant to increase the number of shares available for purchase by 17,095 shares, based on interest accrued on the CRL Note through that date. The Company has recorded the fair value of the additional shares as a charge to interest expense and a corresponding credit to additional paid-in capital.

 

Restructuring of Accounts Payable to University Health Network (“UHN”)

 

On October 10, 2012, the Company issued to UHN: (i) an unsecured promissory note in the principal amount of $549,500, which is payable solely in restricted shares of the Company’s common stock and which accrues interest at the rate of 7.5% per annum, as payment in full for all sponsored stem cell research and development activities by UHN and Gordon Keller, Ph.D. under the SCRA through September 30, 2012 (the “UHN Note”), and (ii) a five-year warrant to purchase, at a price of $1.00 per share, 549,500 restricted shares of the Company’s common stock, the amount equal to the sum of the principal amount of the UHN Note, plus all accrued interest thereon, divided by $1.00 per share (the “UHN Warrant”). The UHN Note is due and payable on March 31, 2016 and is payable solely by UHN's surrender from time to time of all or a portion of the principal and interest balance due on the UHN Note in connection with its concurrent exercise of the UHN Warrant, provided, however, that UHN will have the option to require payment of the UHN Note in cash upon the occurrence of a change in control of the Company or an event of default, and only in such circumstances.

 

The Company determined that the restructuring of the accounts payable to UHN under the SRCA, defined below, and the related issuance of the UHN Note should be accounted for as an extinguishment of debt. Accordingly, the Company recorded the UHN Note at its fair value of $467,211 based on the present value of its scheduled cash flows and assumptions regarding market interest rates for unsecured debt of similar quality. The Company determined the fair value of the UHN Warrant to be $0.48 per share, or $264,775, using the Black Scholes Option Pricing Model and the following assumptions: market price per share: $0.75; exercise price per share: $1.00; risk-free interest rate: 0.66%; contractual term: 5 years; volatility: 89.9%; expected dividend rate: 0%. The Company recognized the difference between the sum of the fair values of the UHN Note and the UHN Warrant less the accounts payable balance due to UHN, $182,500, as a non-cash loss on early extinguishment of debt in the accompanying Condensed Consolidated Statements of Operations and Comprehensive Income. The fair value of the warrant, $264,775, which is treated as an equity instrument, was credited to additional paid in capital at the issuance date. The difference between the face value of the UHN Note and its fair value has been treated as a discount to the note and is being amortized over the term of the note using the interest rate method, resulting in an effective interest rate of 11.3% on the UHN Note. Through December 31, 2012, the Company has adjusted the UHN Warrant to increase the number of shares available for purchase by 9,259 shares, based on interest accrued on the UHN Note through that date. The Company has recorded the fair value of the additional shares as a charge to interest expense and a corresponding credit to additional paid-in capital.