UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
FORM
10-Q
|
x
|
QUARTERLY
REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
|
For
the quarterly period ended June 30, 2009
Or
|
¨
|
TRANSITION
REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
|
For
the transition period from ___________________to____________________
Commission
file number 001-33874
XCORPOREAL,
INC.
(Exact
name of small business issuer as specified in its charter)
Delaware
|
75-2242792
|
(State
or other jurisdiction of
incorporation
or organization)
|
(I.R.S.
Employer Identification No.)
|
12121
Wilshire Blvd., Suite 350, Los Angeles, California 90025
(Address
of principal executive offices) (Zip Code)
(310)
923-9990
(Registrant’s
telephone number, including area code)
Not
applicable
(Former
name, former address and former fiscal year, if changed since last
report)
Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days. Yes R No ¨
Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding
12 months (or for such shorter period that the registrant was required to
submit and post such files). Yes ¨ No ¨
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer or a smaller reporting
company. See the definitions of “large accelerated filer,”
“accelerated filer” and “smaller reporting company” in Rule 12b-2 of the
Exchange Act.
|
¨
Large accelerated filer
|
¨ Accelerated filer
|
|
|
|
|
|
|
¨ Non-accelerated filer (Do not check if a smaller reporting company)
|
R Smaller reporting company
|
|
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act).Yes ¨ No R
Indicate
the number of shares outstanding of each of the issuer's classes of common
stock, as of the latest practicable date.
Class
|
|
Outstanding
as of August 11, 2009
|
Common
Stock, $0.0001 par value
|
|
14,754,687
shares
|
INDEX
PART
I — FINANCIAL INFORMATION
|
2
|
|
|
Item
1. Financial Statements
|
2
|
|
|
Balance
Sheets at June 30, 2009 (unaudited) and December 31, 2008
|
2
|
|
|
Statements
of Operations (unaudited) for the three and six months ended June 30, 2009
and June 30, 2008 and the period from inception (May 4, 2001) to June 30,
2009
|
3
|
|
|
Statements
of Cash Flows (unaudited) for the six months ended June 30, 2009 and June
30, 2008 and the period from inception (May 4, 2001) to June 30,
2009
|
4
|
|
|
Statement
of Stockholders Equity (Deficit) for the six months ended June 30, 2009
and the period from inception (May 4, 2001) to June 30, 2009
(unaudited)
|
5
|
|
|
Notes
to the Interim Financial Statements
|
6
|
|
|
Item
2. Management’s Discussion and Analysis of Financial Condition and Results
of Operations
|
18
|
|
|
Item
3. Quantitative and Qualitative Disclosures about Market
Risk
|
28
|
|
|
Item
4. Controls and Procedures
|
28
|
|
|
PART
II — OTHER INFORMATION
|
30
|
|
|
Item
1. Legal Proceedings
|
30
|
|
|
Item
1A. Risk Factors
|
32
|
|
|
Item
2. Unregistered Sales of Equity Securities and Use of
Proceeds
|
35
|
|
|
Item
6. Exhibits
|
35
|
|
|
Signatures
|
36
|
PART
I — FINANCIAL INFORMATION
ITEM
1. Financial Statements
XCORPOREAL,
INC.
(a
Development Stage Company)
BALANCE
SHEETS
(Unaudited)
|
|
June 30,
|
|
|
December 31,
|
|
|
|
2009
|
|
|
2008
|
|
|
|
|
|
|
|
|
ASSETS
|
|
|
|
|
|
|
Current
|
|
|
|
|
|
|
Cash
and cash equivalents
|
|
$ |
92,116 |
|
|
$ |
407,585 |
|
Marketable
securities, at fair value
|
|
|
406,927 |
|
|
|
2,955,714 |
|
Restricted
cash
|
|
|
305,871 |
|
|
|
301,675 |
|
Prepaid
expenses and other current assets
|
|
|
168,911 |
|
|
|
260,024 |
|
Tenant
improvement allowance receivable
|
|
|
88,865 |
|
|
|
87,658 |
|
Total
Current Assets
|
|
|
1,062,690 |
|
|
|
4,012,656 |
|
|
|
|
|
|
|
|
|
|
Property
and equipment, net
|
|
|
277,462 |
|
|
|
337,554 |
|
|
|
|
|
|
|
|
|
|
Other
assets
|
|
|
833 |
|
|
|
863 |
|
|
|
|
|
|
|
|
|
|
Total
Assets
|
|
$ |
1,340,985 |
|
|
$ |
4,351,073 |
|
|
|
|
|
|
|
|
|
|
LIABILITIES
|
|
|
|
|
|
|
|
|
Current
|
|
|
|
|
|
|
|
|
Accounts
payable
|
|
$ |
791,850 |
|
|
$ |
789,827 |
|
Accrued
legal fees and licensing expense
|
|
|
1,871,430 |
|
|
|
2,873,396 |
|
Accrued
royalties
|
|
|
- |
|
|
|
583,333 |
|
Accrued
professional fees
|
|
|
452,013 |
|
|
|
211,820 |
|
Accrued
compensation
|
|
|
127,262 |
|
|
|
149,664 |
|
Accrued
other liabilities
|
|
|
57,824 |
|
|
|
54,429 |
|
Payroll
liabilities
|
|
|
1,731 |
|
|
|
7,448 |
|
Deferred
rent
|
|
|
256,635 |
|
|
|
148,651 |
|
Total
Current Liabilities
|
|
|
3,558,745 |
|
|
|
4,818,568 |
|
|
|
|
|
|
|
|
|
|
Shares
issuable
|
|
|
- |
|
|
|
1,569,100 |
|
|
|
|
|
|
|
|
|
|
COMMITMENTS
& CONTINGENCIES
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
STOCKHOLDERS'
DEFICIT
|
|
|
|
|
|
|
|
|
Preferred
stock, $0.0001 par value, 10,000,000 shares authorized, none
outstanding
|
|
|
- |
|
|
|
- |
|
Common
stock, $0.0001 par value, 40,000,000 shares authorized, 14,754,687 and
14,754,687 issued and outstanding on June 30, 2009 and December 31, 2008,
respectively
|
|
|
1,475 |
|
|
|
1,475 |
|
Additional
paid-in capital
|
|
|
43,598,317 |
|
|
|
42,547,023 |
|
Deficit
accumulated during the development stage
|
|
|
(45,817,552 |
) |
|
|
(44,585,093 |
) |
Total
Stockholders' Deficit
|
|
|
(2,217,760 |
) |
|
|
(2,036,595 |
) |
Total
Liabilities & Stockholders' Deficit
|
|
$ |
1,340,985 |
|
|
$ |
4,351,073 |
|
See
accompanying notes to interim financial statements.
XCORPOREAL,
INC.
(a
Development Stage Company)
STATEMENTS
OF OPERATIONS
(Unaudited)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
May 4, 2001 (Date
|
|
|
|
Three Months Ended
|
|
|
Six Months Ended
|
|
|
of Inception) to
|
|
|
|
June 30,
|
|
|
June 30,
|
|
|
June 30,
|
|
|
|
2009
|
|
|
2008
|
|
|
2009
|
|
|
2008
|
|
|
2009
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating
Expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling,
general and administrative
|
|
$ |
1,062,131 |
|
|
$ |
1,895,013 |
|
|
$ |
2,569,027 |
|
|
$ |
5,644,652 |
|
|
$ |
25,973,538 |
|
Research
and development
|
|
|
611,085 |
|
|
|
3,473,480 |
|
|
|
1,828,314 |
|
|
|
6,205,972 |
|
|
|
31,171,631 |
|
Other
expenses
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
1,871,430 |
|
Depreciation
and amortization
|
|
|
30,753 |
|
|
|
26,076 |
|
|
|
61,602 |
|
|
|
48,584 |
|
|
|
198,587 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss
before other income, income taxes and other expenses
|
|
|
(1,703,969 |
) |
|
|
(5,394,569 |
) |
|
|
(4,458,943 |
) |
|
|
(11,899,208 |
) |
|
|
(59,215,186 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Reduction
of liabilities due to arbitrator's ruling & settlement
|
|
|
645,833 |
|
|
|
- |
|
|
|
1,647,799 |
|
|
|
- |
|
|
|
1,647,799 |
|
Loss
on disposal
|
|
|
(382 |
) |
|
|
|
|
|
|
(382 |
) |
|
|
|
|
|
|
(382 |
) |
Interest
and other income
|
|
|
2,835 |
|
|
|
78,196 |
|
|
|
10,742 |
|
|
|
234,070 |
|
|
|
1,601,221 |
|
Change
in and reduction of shares issuable
|
|
|
- |
|
|
|
- |
|
|
|
1,569,100 |
|
|
|
- |
|
|
|
10,153,000 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss
before income taxes and other expenses
|
|
|
(1,055,683 |
) |
|
|
(5,316,373 |
) |
|
|
(1,231,684 |
) |
|
|
(11,665,138 |
) |
|
|
(45,813,548 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
taxes
|
|
|
(54 |
) |
|
|
- |
|
|
|
775 |
|
|
|
1,600 |
|
|
|
4,004 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
loss
|
|
$ |
(1,055,629 |
) |
|
$ |
(5,316,373 |
) |
|
$ |
(1,232,459 |
) |
|
$ |
(11,666,738 |
) |
|
$ |
(45,817,552 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
and diluted loss per share
|
|
$ |
(0.07 |
) |
|
$ |
(0.36 |
) |
|
$ |
(0.08 |
) |
|
$ |
(0.81 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
average number of shares outstanding
|
|
|
14,754,687 |
|
|
|
14,593,485 |
|
|
|
14,754,687 |
|
|
|
14,488,473 |
|
|
|
|
|
See
accompanying notes to interim financial statements.
XCORPOREAL, INC.
(a
Development Stage Company)
STATEMENTS
OF CASH FLOWS
(Unaudited)
|
|
|
|
|
|
|
|
May 4, 2001 (Date
|
|
|
|
Six Months Ended
|
|
|
of Inception) to
|
|
|
|
June 30,
|
|
|
June 30,
|
|
|
|
2009
|
|
|
2008
|
|
|
2009
|
|
Cash
flows used in operating activities
|
|
|
|
|
|
|
|
|
|
Net
loss for the period
|
|
$ |
(1,232,459 |
) |
|
$ |
(11,666,738 |
) |
|
$ |
(45,817,552 |
) |
Adjustments
to reconcile net loss to net cash (used in) operating
activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Directors,
officers, employees stock based compensation
|
|
|
1,047,628 |
|
|
|
2,081,958 |
|
|
|
9,737,404 |
|
Consultants
stock based compensation
|
|
|
3,666 |
|
|
|
84,745 |
|
|
|
5,174,892 |
|
Common
stock issuance for consulting services rendered
|
|
|
- |
|
|
|
798,000 |
|
|
|
912,000 |
|
Increase
in shares issuable
|
|
|
- |
|
|
|
- |
|
|
|
10,153,000 |
|
Mark
to market of shares issuable
|
|
|
(1,569,100 |
) |
|
|
- |
|
|
|
(10,153,000 |
) |
Depreciation
|
|
|
61,571 |
|
|
|
48,554 |
|
|
|
198,418 |
|
Net
change in assets and liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Increase
in Receivables
|
|
|
(1,207 |
) |
|
|
- |
|
|
|
(88,865 |
) |
Decrease
(increase) in prepaid expenses and other current assets
|
|
|
91,113 |
|
|
|
46,878 |
|
|
|
(168,911 |
) |
Decrease
(increase) in other assets
|
|
|
30 |
|
|
|
30 |
|
|
|
(833 |
) |
(Decrease)
increase in accounts payable and accrued liabilities
|
|
|
(1,367,806 |
) |
|
|
1,470,703 |
|
|
|
3,264,740 |
|
Increase
in deferred rent
|
|
|
107,984 |
|
|
|
38,309 |
|
|
|
256,635 |
|
Net
cash used in operating activities
|
|
|
(2,858,580 |
) |
|
|
(7,097,561 |
) |
|
|
(26,532,072 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash
flows from investing activities
|
|
|
|
|
|
|
|
|
|
|
|
|
Capital
expenditures
|
|
|
(1,480 |
) |
|
|
(101,892 |
) |
|
|
(475,882 |
) |
Restricted
cash
|
|
|
(4,196 |
) |
|
|
143 |
|
|
|
(305,871 |
) |
Purchase
of marketable securities
|
|
|
(22,044,286 |
) |
|
|
(8,598,102 |
) |
|
|
(55,642,388 |
) |
Sale
of marketable securities
|
|
|
24,593,073 |
|
|
|
15,758,904 |
|
|
|
55,235,461 |
|
Net
cash provided by (used in) investing activities
|
|
|
2,543,111 |
|
|
|
7,059,053 |
|
|
|
(1,188,680 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash
flows from financing activities
|
|
|
|
|
|
|
|
|
|
|
|
|
Capital
stock issued
|
|
|
- |
|
|
|
- |
|
|
|
27,549,748 |
|
Advances
from related party
|
|
|
- |
|
|
|
- |
|
|
|
64,620 |
|
Additional
proceeds from the sale of common stock in 2006
|
|
|
- |
|
|
|
- |
|
|
|
198,500 |
|
Net
cash provided by financing activities
|
|
|
- |
|
|
|
- |
|
|
|
27,812,868 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(Decrease)
increase in cash during the period
|
|
|
(315,469 |
) |
|
|
(38,508 |
) |
|
|
92,116 |
|
Cash
at beginning of the period
|
|
|
407,585 |
|
|
|
106,495 |
|
|
|
- |
|
Cash
at end of the period
|
|
$ |
92,116 |
|
|
$ |
67,987 |
|
|
$ |
92,116 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Supplemental
disclosure of cash flow information; cash paid for:
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
|
|
$ |
- |
|
|
$ |
- |
|
|
$ |
- |
|
Income
taxes
|
|
$ |
775 |
|
|
$ |
1,600 |
|
|
$ |
4,004 |
|
See
accompanying notes to interim financial statements.
XCORPOREAL,
INC.
(a
Development Stage Company)
STATEMENTS
OF STOCKHOLDERS’ EQUITY (DEFICIT)
For
the Period May 4, 2001 (Inception) to June 30, 2009
(Unaudited)
|
|
|
|
|
|
|
|
|
|
|
Deficit
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accumulated
|
|
|
|
|
|
|
|
|
|
|
|
|
Additional
|
|
|
During
|
|
|
|
|
|
|
Common Stock
|
|
|
Paid-in
|
|
|
Development
|
|
|
|
|
|
|
Shares
|
|
|
Amount
|
|
|
Capital
|
|
|
Stage
|
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Common
stock issued for cash at $0.01 per share
|
|
|
2,500,000 |
|
|
$ |
250 |
|
|
$ |
24,750 |
|
|
|
|
|
$ |
25,000 |
|
Net
Loss for the year ended December 31, 2001
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
(40,255 |
) |
|
|
(40,255 |
) |
Balance
as of December 31, 2001
|
|
|
2,500,000 |
|
|
|
250 |
|
|
|
24,750 |
|
|
|
(40,255 |
) |
|
|
(15,255 |
) |
Common
stock issued for cash at $0.05 per share
|
|
|
1,320,000 |
|
|
|
132 |
|
|
|
65,868 |
|
|
|
|
|
|
|
66,000 |
|
Net
Loss for the year ended December 31, 2002
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(31,249 |
) |
|
|
(31,249 |
) |
Balance
as of December 31, 2002
|
|
|
3,820,000 |
|
|
|
382 |
|
|
|
90,618 |
|
|
|
(71,504 |
) |
|
|
19,496 |
|
Net
Loss for the year ended December 31, 2003
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(12,962 |
) |
|
|
(12,962 |
) |
Balance
as of December 31, 2003
|
|
|
3,820,000 |
|
|
|
382 |
|
|
|
90,618 |
|
|
|
(84,466 |
) |
|
|
6,534 |
|
Net
Loss for the year ended December 31, 2004
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(23,338 |
) |
|
|
(23,338 |
) |
Balance
as of December 31, 2004
|
|
|
3,820,000 |
|
|
|
382 |
|
|
|
90,618 |
|
|
|
(107,804 |
) |
|
|
(16,804 |
) |
Net
Loss for the year ended December 31, 2005
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(35,753 |
) |
|
|
(35,753 |
) |
Balance
as of December 31, 2005
|
|
|
3,820,000 |
|
|
|
382 |
|
|
|
90,618 |
|
|
|
(143,557 |
) |
|
|
(52,557 |
) |
Common
stock issued for license rights at $0.0001 per share
|
|
|
9,600,000 |
|
|
|
960 |
|
|
|
40 |
|
|
|
|
|
|
|
1,000 |
|
Capital
stock cancelled
|
|
|
(3,420,000 |
) |
|
|
(342 |
) |
|
|
342 |
|
|
|
|
|
|
|
- |
|
Warrants
granted for consulting fees
|
|
|
|
|
|
|
|
|
|
|
2,162,611 |
|
|
|
|
|
|
|
2,162,611 |
|
Forgiveness
of related party debt
|
|
|
|
|
|
|
|
|
|
|
64,620 |
|
|
|
|
|
|
|
64,620 |
|
Common
stock issued for cash at $7.00, net of placement fees of
$2,058,024
|
|
|
4,200,050 |
|
|
|
420 |
|
|
|
27,341,928 |
|
|
|
|
|
|
|
27,342,348 |
|
Consultants
stock-based compensation expense
|
|
|
|
|
|
|
|
|
|
|
88,122 |
|
|
|
|
|
|
|
88,122 |
|
Directors,
officers, employees stock based compensation expense
|
|
|
|
|
|
|
|
|
|
|
176,129 |
|
|
|
|
|
|
|
176,129 |
|
Net
loss for the period
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(4,380,212 |
) |
|
|
(4,380,212 |
) |
Balance
as of December 31, 2006
|
|
|
14,200,050 |
|
|
|
1,420 |
|
|
|
29,924,410 |
|
|
|
(4,523,769 |
) |
|
|
25,402,061 |
|
Capital
stock cancelled
|
|
|
(200,000 |
) |
|
|
(20 |
) |
|
|
20 |
|
|
|
|
|
|
|
- |
|
Common
stock issued pursuant to consulting agreement at $4.90 per
share
|
|
|
20,000 |
|
|
|
2 |
|
|
|
97,998 |
|
|
|
|
|
|
|
98,000 |
|
Recapitalization
pursuant to merger
|
|
|
352,422 |
|
|
|
35 |
|
|
|
(37,406 |
) |
|
|
|
|
|
|
(37,371 |
) |
Consultants
stock-based compensation expense
|
|
|
|
|
|
|
|
|
|
|
2,917,309 |
|
|
|
|
|
|
|
2,917,309 |
|
Directors,
officers, employees stock based compensation expense
|
|
|
|
|
|
|
|
|
|
|
3,721,485 |
|
|
|
|
|
|
|
3,721,485 |
|
Additional
proceeds from the sale of common stock in 2006
|
|
|
|
|
|
|
|
|
|
|
198,500 |
|
|
|
|
|
|
|
198,500 |
|
Net
loss for the period
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(17,074,051 |
) |
|
|
(17,074,051 |
) |
Balance
as of December 31, 2007
|
|
|
14,372,472 |
|
|
|
1,437 |
|
|
|
36,822,316 |
|
|
|
(21,597,820 |
) |
|
|
15,225,933 |
|
Common
stock issued as compensation for consulting services at $3.61 per
share
|
|
|
200,000 |
|
|
|
20 |
|
|
|
721,980 |
|
|
|
|
|
|
|
722,000 |
|
Common
stock issued as compensation for consulting services at $3.80 per
share
|
|
|
20,000 |
|
|
|
2 |
|
|
|
75,998 |
|
|
|
|
|
|
|
76,000 |
|
Cashless
exercise of warrants
|
|
|
112,215 |
|
|
|
11 |
|
|
|
(11 |
) |
|
|
|
|
|
|
- |
|
Common
stock issued as compensation for consulting services at $0.32 per
share
|
|
|
50,000 |
|
|
|
5 |
|
|
|
15,995 |
|
|
|
|
|
|
|
16,000 |
|
Reversal
of liability from the sale of common stock in 2006
|
|
|
|
|
|
|
|
|
|
|
115,400 |
|
|
|
|
|
|
|
115,400 |
|
Consultants
stock-based compensation expense
|
|
|
|
|
|
|
|
|
|
|
91,306 |
|
|
|
|
|
|
|
91,306 |
|
Directors,
officers, employees stock based compensation expense
|
|
|
|
|
|
|
|
|
|
|
4,704,039 |
|
|
|
|
|
|
|
4,704,039 |
|
Net
loss for the period
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(22,987,273 |
) |
|
|
(22,987,273 |
) |
Balance
as of December 31, 2008
|
|
|
14,754,687 |
|
|
|
1,475 |
|
|
|
42,547,023 |
|
|
|
(44,585,093 |
) |
|
|
(2,036,595 |
) |
Consultants
stock-based compensation expense
|
|
|
|
|
|
|
|
|
|
|
1,771 |
|
|
|
|
|
|
|
1,771 |
|
Directors,
officers, employees stock based compensation expense
|
|
|
|
|
|
|
|
|
|
|
385,848 |
|
|
|
|
|
|
|
385,848 |
|
Net
loss for the period
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(176,830 |
) |
|
|
(176,830 |
) |
Balance
as of March 31, 2009
|
|
|
14,754,687 |
|
|
$ |
1,475 |
|
|
$ |
42,934,642 |
|
|
$ |
(44,761,923 |
) |
|
$ |
(1,825,806 |
) |
Consultants
stock-based compensation expense
|
|
|
|
|
|
|
|
|
|
|
1,895 |
|
|
|
|
|
|
|
1,895 |
|
Directors,
officers, employees stock based compensation expense
|
|
|
|
|
|
|
|
|
|
|
661,780 |
|
|
|
|
|
|
|
661,780 |
|
Net
loss for the period
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1,055,629 |
) |
|
|
(1,055,629 |
) |
Balance
as of June 30, 2009
|
|
|
14,754,687 |
|
|
$ |
1,475 |
|
|
$ |
43,598,317 |
|
|
$ |
(45,817,552 |
) |
|
$ |
(2,217,760 |
) |
See
accompanying notes to interim financial statements.
XCORPOREAL, INC.
(a
Development Stage Company)
NOTES
TO INTERIM FINANCIAL STATEMENTS
June
30, 2009
(Unaudited)
Note 1 - Interim Reporting
While information presented in the
accompanying interim financial statements is unaudited, it includes normal and
recurring adjustments, which are, in the opinion of management, necessary to
present fairly the financial position, results of operations, and cash flows for
the interim period presented.
The
results of operations for the period ended June 30, 2009 are not necessarily
indicative of the results that can be expected for the year ending December 31,
2009.
Note
2 – Nature of Operations and Going Concern Uncertainty
On
October 12, 2007, pursuant to a merger agreement with Xcorporeal, Inc.
(hereinafter referred to as “Operations”), our wholly-owned subsidiary, merged
with and into Operations, which became our wholly-owned subsidiary and changed
its name to “Xcorporeal Operations, Inc.” In connection with the merger, we
changed our name from CT Holdings Enterprises, Inc. (“CTHE”), to “Xcorporeal,
Inc.” In this merger, CTHE was considered to be the legal acquirer and
Xcorporeal to be the accounting acquirer. As the former stockholders of
Operations owned over 97% of the outstanding voting common stock of CTHE
immediately after the merger and CTHE was a public shell company, for accounting
purposes Operations was considered the accounting acquirer and the transaction
was considered to be a recapitalization of Operations. As a result of the
merger, we transitioned to a development stage company focused on researching,
developing, and commercializing technology and products related to the treatment
of kidney failure.
As of
August 11, 2009, we had available cash of approximately $327,000, excluding
restricted cash. We currently have a monthly burn rate of approximately
$120,000. Under these current conditions, we will run out of cash in
approximately 90 days. In addition to previously taken restructuring efforts,
including reduction of personnel, we have also taken steps to reduce our cash
outflows by means of deferring 50% of the monthly compensation for 5 of our 6
active employees. We may consider further reduction of costs in the near future.
However, we need to raise additional funds to be able to continue our
operations. If we are unable to secure additional capital within approximately
the next 90 days, we will be forced to file for bankruptcy and/or cease our
operations. The accompanying financial statements have been prepared on the
basis of a going concern and do not reflect any adjustments due to these
conditions.
We are
currently actively considering all potential transactions, which may include the
Proposed Transaction or another Transaction (as described below under Note 4,
“Legal Proceedings”), strategic partnership(s), disposition of a part,
substantially all or all of our assets or a business combination with another
entity in a transaction where we would not be the surviving entity. Because
of the current economic conditions and those particularly affecting healthcare
related companies and because of our lack of liquidity, there is no assurance
that any such transaction will occur or that it would be accretive to our
stockholders or result in any payment being made to our stockholders. If we are
unsuccessful in obtaining immediate debt or equity financing on terms acceptable
to us or otherwise unsuccessful in addressing our liquidity concerns or if we
are unable to enter into any such transaction, this could have a material
adverse effect on our plan of operations, may result in the curtailment of our
operations and/or require us to file for bankruptcy.
To the
extent we are unsuccessful in having our common stock continuing to list on NYSE
Amex or if NYSE Amex delists our common stock from the exchange and/or as part
of our analysis of ways to reduce costs and in light of the high cost of
continuing to be a public reporting company under the Securities Exchange
Act of 1934, as amended (the “Exchange Act”), and complying with the
Sarbanes-Oxley Act of 2002, we are contemplating exploring and may be required
to explore alternative platforms, such as having our common stock quoted on the
FINRA Over-The-Counter Bulletin Board (“OTCBB”) or deregistering under the
Exchange Act, or “going dark”, and having our common stock quoted on the “pink
sheets”, which is an automated quotation system under which broker-dealers
publish quotes for trading in over-the-counter securities. Therefore, we
are evaluating the benefits of having our common stock quoted on the OTCBB or
the “pink sheets”. We anticipate that the move to the OTCBB would provide
meaningful savings to us as a result of the elimination of fees associated with
being listed on a national stock exchange and the move to the pink sheets would
provide substantial savings as a result of the elimination of the costs of being
registered under the Exchange Act. Analysis of a move to the OTCBB or the
“pink sheets” involves not only reducing costs, but also our expected sources of
future capital as well as the number of record holders of our outstanding common
stock. A move to having our common stock quoted on the OTCBB or the “pink
sheets” may result in a less liquid market for our shares and with respect to
the “pink sheets” less readily available information on us, but would result in
continued public trading of our common stock by holders wishing to
trade.
We expect to incur negative cash flows
and net losses for the foreseeable future. Based upon our current plans, we
believe that our existing cash reserves will not be sufficient to meet our
current liabilities and other obligations as they become due and payable.
Accordingly, in approximately the next three months we will need to seek to
obtain additional debt or equity financing through a public or private placement
of shares of our preferred or common stock or through a public or private
financing or we will need to effect a transaction for the sale or license of a
part, substantially all or all of our assets. Our ability to meet such
obligations will depend on our ability to sell securities, borrow funds, reduce
operating costs, effect a transaction for the sale or license of a part,
substantially all or all of our assets, or some combination thereof. We may not
be successful in obtaining necessary financing on acceptable terms, if at all.
As of June 30, 2009, we had negative working capital of $2,496,055, accumulated
deficit of $45,817,552 and total stockholders’ deficit of $2,217,760. Cash used
in operations for the six months ended June 30, 2009 was $2,858,580. As a result
of these conditions, there is substantial doubt about our ability to continue as
a going concern. The financial statements filed as part of this Quarterly Report
on Form 10-Q do not include any adjustments that might result from the outcome
of this uncertainty.
Upon
receipt of approximately $27.3 million raised through a private placement of our
common stock which was completed in the fourth quarter of 2006, we strategically
began our operating activities and research and development efforts which
resulted in a net loss of $23.0 million in 2008 and $1.2 million during the six
months ended June 30, 2009, including a reduction in arbitration liabilities of
approximately $1.6 million and change in fair value of shares issuable of
approximately $1.6 million as a result of the issuance of the Partial Final
Award and the execution of the Agreement and Stipulation regarding Partial Final
Award entered into between us and National Quality Care, Inc. (NQCI) in
connection with the arbitration proceeding between us and NQCI discussed in Note
4, “Legal Proceedings” below. Both the reduction of $1.6 million and the change
in fair value of $1.6 million were non-cash items. In addition, we invested
$25.0 million in high grade money market funds and marketable securities during
the first quarter of 2007 and since then, we sold $24.6 million of these
investments, leaving a balance of $0.4 million as of June 30,
2009.
Pursuant
to the terms of the Partial Final Award issued on April 13, 2009, NQCI was
awarded an amount equal to approximately $1.87 million in attorneys’ fees and
costs consistent with the Arbitrator’s order issued on August 13, 2008 related
to the same and NQCI’s application for interim royalties and expenses was
denied. For a further discussion of the Partial Final Award, see Note 4, “Legal
Proceedings” below. We intend to pay the $1.87 million in attorneys’ fees and
costs due to NQCI from the proceeds received in connection with the consummation
of the Proposed Transaction or another Transaction (each term as defined below
in Note 4, “Legal Proceedings”), if such transaction is consummated, or upon
raising of additional capital to sufficiently satisfy the award and/or other
immediate liquidity requirements, which funds we will need to obtain within
approximately the next 90 days. Pursuant to the terms of the Stipulation entered
into between Operations and NQCI on August 7, 2009, in connection with the
Memorandum, as more fully explained below in Note 4, “Legal Proceedings”, NQCI
agreed not to attempt before December 1, 2009 to execute on or file any motion,
petition or application or commence any proceeding seeking the collection of
such award of attorneys’ fees and costs, which is intended to allow us,
Operations and NQCI a sufficient period within which to execute a definitive
acquisition agreement in connection with the Proposed Transaction or another
Transaction. Such period shall automatically be extended for a period of 120
days from December 1, 2009 if the acquisition agreement is executed in full on
or before December 1, 2009. In addition, if the execution of the acquisition
agreement occurs on or before December 1, 2009, the December 1, 2009 deadline
shall automatically be further extended for a period of 60 days for each
amendment to a proxy or information statement related to the transactions
contemplated by the acquisition agreement, filed by us in response to comments
made by the U.S. Securities and Exchange Commission (the “SEC”). However, there
can be no assurances that the Proposed Transaction or any other Transaction will
occur.
We are a
medical device company developing an innovative extra-corporeal platform
technology to be used in devices to replace the function of various human
organs. We hope that the platform will lead to three initial products: (i) a
Portable Artificial Kidney (PAK) for attended care Renal Replacement Therapy,
(ii) a PAK for home hemodialysis and (iii) a Wearable Artificial Kidney (WAK)
for continuous ambulatory hemodialysis. Our rights to the WAK derive in part
from the License Agreement between Operations and NQCI, dated as of September 1,
2006 (License Agreement), pursuant to which we obtained a perpetual exclusive
license in the Technology. See Note 4, “Legal Proceedings” below.
We have
focused much of our efforts on development of the PAK, which has not been
derived from the technology covered by the License Agreement. Through our
research and development efforts, we have completed functional prototypes of our
hospital and home PAKs that we plan to commercialize after 510(k) notification
clearance from the Food and Drug Administration (FDA) which we plan to seek in
the future, provided funds are available for further development of our
prototype devices. Prior to the 510(k) submission to the FDA for clinical use
under direct medical supervision, the units will undergo final verification and
validation. It generally takes 4 to 12 months from the date of a 510(k)
submission to obtain clearance from the FDA, although it may take longer. We
hope to begin to shift out of the development and build phase of the prototype
equipment and into product phase, which should help us to reduce the related
spending on research and development costs as well as consulting and material
costs. See Note 15, “Product Development Agreement” below. With this transition,
we hope to shift available resources towards verification and validation of our
devices along with developing a marketing plan for the PAK.
In addition, we have used some of our
resources for the development of the WAK of which we have demonstrated a
feasibility prototype. Commercialization of the WAK will require development of
a functional prototype and likely a full pre-market approval by the FDA, which
could take several years. Once the results of the arbitration proceeding
described in Note 4, “Legal Proceedings” are final, we will determine whether to
devote available resources to the development of the WAK.
Because
neither the PAK nor the WAK is yet at a stage where it can be marketed
commercially, we are not able to predict the portion of our future business
which will be derived from each.
Note 3 – Development Stage
Company
We are a
development stage company, devoting substantially all of our efforts to the
research, development, and commercialization of kidney failure treatment
technologies.
Risks and Uncertainties — We
operate in an industry that is subject to intense competition, government
regulation, and rapid technological change. Our operations are subject to
significant risk and uncertainties including financial, operational,
technological, legal, regulatory, and other risks associated with a development
stage company, including the potential risk of business failure.
Note
4 – Legal Proceedings
Partial Final
Award
On
December 1, 2006, Operations initiated the arbitration proceeding (Proceeding)
against NQCI for its breach of the License Agreement. On April 13, 2009, the
arbitrator (Arbitrator) issued a Partial Final Award (Partial Final Award)
which resolved the remaining issues that were pending for decision in the
Proceeding. The Partial Final Award adopted one of the proposals submitted to
the Arbitrator by us and provides that we and Operations shall have a perpetual
exclusive license (Perpetual License) in the Technology (as defined in the
Merger Agreement, dated as of September 1, 2006 (Merger Agreement), among the
Company, Operations and NQCI and the License Agreement) primarily related to the
WAK and any other Technology contemplated to be transferred under the Technology
Transaction (as defined in the Merger Agreement). Under the terms of the Partial
Final Award, in consideration of the Perpetual License to us, NQCI was awarded a
royalty of 39% of all net income, ordinary or extraordinary, received by us
(Royalty) and NQCI is to receive 39% of any shares received in any merger
transaction to which we or Operations may become a party. NQCI’s interest as
licensor under the Perpetual License shall be freely assignable. In addition,
the Partial Final Award provides that we shall pay NQCI an amount equal to
approximately $1,871,000 in attorneys’ fees and costs previously awarded by the
Arbitrator in an order issued on August 13, 2008, that NQCI’s application for
interim royalties and expenses is denied and that NQCI is not entitled to
recover any additional attorneys’ fees. Finally, the Partial Final Award also
provides that the Arbitrator shall retain jurisdiction to supervise specific
performance of the terms and obligations of the Award including, but not limited
to, any dispute between the parties over the manner of calculation of the
Royalty. The Partial Final Award was issued as a result of each party’s request
for the Arbitrator to order alternative relief due the parties’ inability to
proceed with the Technology Transaction. For a full description of the
Proceeding and the Arbitrator’s interim awards issued in connection therewith,
please see Item 3 - Legal Proceedings of our Annual Report on Form 10-K for the
year ended December 31, 2008.
As a result of the award to NQCI under
the terms of the Partial Final Award of approximately $1.87 million in
attorneys’ fees and costs but denial of NQCI’s application of interim expenses,
we reversed the accruals for the related expenses resulting in an approximately
$1.0 million non-operating reduction in arbitration liabilities to the statement
of operations for the six months ended June 30, 2009. The $1.87
million award of NQCI’s attorneys’ fees and costs was recognized as “Other
expenses” during the year ended December 31, 2008, and remains accrued under
“Accrued legal fees & licensing expense” as of June 30, 2009.
On April 17, 2009, NQCI requested that
the Arbitrator correct material terms of the Partial Final Award relating to the
meaning and calculation of the Royalty terms. We opposed the request and on May
1, 2009, the Arbitrator denied NQCI’s request to modify the language of the
Partial Final Award. The Arbitrator further held that past expenses shall not be
included in net income computations for purposes of the Royalty, that NQCI may
make an application to the Arbitrator requesting a royalty distribution,
specifying the amount sought and basis for the claimed amount, and that NQCI is
entitled to audit our financial statements, books and records to verify our net
income, on an annual basis, or more often, if the Arbitrator
permits.
Binding Memorandum of
Understanding
On August
7, 2009, to clarify, resolve and settle certain issues and any disputes that
have arisen between us and NQCI with respect to the Partial Final Award and the
Proceeding, we and Operations (collectively, the “Xcorp Parties”) entered into a
Binding Memorandum of Understanding (the “Memorandum”) with NQCI (NQCI, together
with the Xcorp Parties is collectively referred to as the “Parties”). Under the
terms of the Memorandum, among other things, the Parties agreed to: (i) assign
and transfer all of their rights, title and interest in and to
certain technology comprised of a certain U.S. Patent Application and
related intellectual property (as described in the Memorandum) (the “Polymer
Technology”) to a limited liability company to be formed under the laws of the
State of Delaware (the “Joint Venture”), which will be jointly owned by the
Parties and through which the Parties will jointly pursue the development and
exploitation of the Polymer Technology, and (ii) negotiate, execute and deliver
within 60 days following the Stockholder Vote Date (as defined below) an
operating agreement governing the operation of the Joint Venture based on the
terms set forth in the Memorandum (the “Operating Agreement”).
The Xcorp
Parties and NQCI will be the initial two members of the Joint
Venture (Xcorp Parties’ interest shall be held of record by either us or
Operations, as determined by the Xcorp Parties) with NQCI and the Xcorp Parties
having a 60% and 40% membership interest (the “Membership Interests”) in the
Joint Venture, respectively. Subject to such other terms and provisions as the
Parties may agree upon, the Operating Agreement shall include the following
terms:
|
·
|
the
Joint Venture shall be managed by a three-member board of managers (the
“JV Board”);
|
|
·
|
until
such time as NQCI fails to hold a greater percentage of the Membership
Interests than the Xcorp Parties, two members of the JV Board (each, a “JV
Manager”) shall be designated by NQCI and until such time as the Xcorp
Parties fail to hold at least 10% of the Membership Interests and one JV
Manager shall be designated by the Xcorp
Parties;
|
|
·
|
NQCI
shall have the right to appoint a Chairman and/or a Chief Executive
Officer of the Joint Venture, who will have day-to-day management
authority with respect to the Joint Venture, subject to oversight by the
JV Board and the terms and conditions of the Memorandum and the Operating
Agreement, and a Chief Scientific Officer, who may be employed by the
Joint Venture upon customary and reasonable terms and
conditions;
|
|
·
|
if
a JV Manager provides additional services to the Joint Venture as an
employee or a consultant, he or she may be compensated by the Joint
Venture as is mutually reasonably approved in writing by the Parties;
provided that with the exception of reimbursement of reasonable expenses
incurred in connection with their services performed for the Joint Venture
in their official officer capacity, neither Robert Snukal, the Chief
Executive Officer of NQCI, nor Kelly McCrann, our Chairman and Chief
Executive Officer, (or such other persons as may be appointed or elected
in their place) shall in any event receive a salary or other compensation
from the Joint Venture;
|
|
·
|
except
as otherwise required by law, all decisions related to the operations of
the Joint Venture shall be made by a majority of the JV Board, except that
certain actions (as described in the Memorandum) by the Joint Venture or
any of its subsidiaries shall require the affirmative vote or written
consent of the holders of at least 90.1% of the Membership Interests then
outstanding; and
|
|
·
|
from
and after August 1, 2009, the Xcorp Parties shall pay 61% and NQCI shall
pay 39% of the reasonable costs and expenses related to protecting,
preserving and exploiting the Licensed Technology (as defined
below).
|
In
addition, the Xcorp Parties agreed to contribute $500,000 in cash to the bank
account established by the Joint Venture, on the later of (x) three business
days of the consummation of the first to occur of the Proposed Transaction or
another Transaction (as such terms are defined below) and (y) the date on which
the Joint Venture establishes such bank account, for which the Parties (or their
representatives) shall be joint signatories. Furthermore, provided that the
Proposed Transaction or a Transaction has been consummated, NQCI agreed to
contribute on the Xcorp Parties’ behalf an additional $500,000 in cash to the
Joint Venture at such time as the JV Board reasonably determines that such funds
are required to facilitate the Joint Venture’s development of the Polymer
Technology. This additional contribution amount will be reimbursed to NQCI by
the Xcorp Parties from the first funds distributed to the Xcorp Parties by the
Joint Venture (other than pursuant to certain quarterly tax related
distributions). Additionally, with respect to the Joint Venture, the Parties
agreed to certain liquidity rights consisting of customary rights of first
refusal and co-sale rights, unlimited piggyback registration rights and the
right to up to two demand registrations (subject to lock-ups and other
underwriter requirements), customary preemptive rights (available to a member of
the Joint Venture for so long as such member holds at least 10% of the
Membership Interests then outstanding), customary anti-dilution protections and
other standard distribution and information rights.
The
Parties also agreed to cooperate as reasonably required by the Xcorp Parties in
order for us to consummate a transaction involving an exclusive
license and/or sale to a third party (the “Proposed Transaction”) of a
part, substantially all or all of our technology and other intellectual property
rights licensed to us under the License Agreement and which transaction may also
include an arrangement with respect to the Polymer Technology (the “Licensed
Technology”), or any other transaction (a “Transaction”) involving the
sale, license or other disposition by us of a part, substantially all or all of
the Licensed Technology. The Parties further agreed that upon the consummation
of a Proposed Transaction, they will allocate any license fees and any other
additional consideration received in such transaction between the Parties
(collectively, the “Transaction Proceeds”), in accordance with the terms set
forth in the Memorandum and summarized below, subject to the actual terms of the
Proposed Transaction, when and if such transaction is consummated. However,
there can be no assurances that the Proposed Transaction or any other
Transaction will occur or that the terms thereof will be similar to those
provided for in the Memorandum and summarized below, and the actual terms of the
Proposed Transaction or another Transaction will be provided for in the
definitive agreement entered into in connection with such
transaction.
|
·
|
NQCI
shall receive 36.96% of the Transaction Proceeds (which amount is intended
to represent an amount equal to 39% of the net royalty payments provided
for by the terms of the Partial Final Award following the deduction
therefrom of the Xcorp Parties expenses incurred in connection with
the Proposed Transaction), plus $1,871,430 in attorneys’ fees and costs
payable to NQCI pursuant to the terms of the Partial Final Award
(collectively, the “NQCI Amount”);
|
|
·
|
The
third party will pay the Xcorp Parties $250,000 upon the earlier of the
signing of a letter of intent and an acquisition agreement providing for
the Proposed Transaction, approximately 50% (less the foregoing $250,000)
of the Transaction Proceeds payable in cash to the Xcorp Parties upon the
closing of the Proposed Transaction (the “First Installment”),
approximately 25% of such proceeds such number of months after the
consummation of the Proposed Transaction as provided in the documents
governing the Proposed Transaction (the “Second Installment”) and 25% of such
proceeds about 12 months after the payment of the Second Installment (the
“Third Installment”, and collectively with the First Installment and the
Second Installment, the
“Installments”).
|
|
·
|
The
Transaction Proceeds shall be allocated between the Parties as
follows: (i) $250,000 to the Xcorp Parties, payable to the Xcorp
Parties on the earlier of the signing of a letter of intent and an
acquisition agreement providing for the Proposed Transaction, (ii) to
NQCI, an amount equal to the NQCI Amount less the sum of the Second
Installment and the Third Installment, payable to NQCI within seven
business days of receipt of the First Installment, (iii) to the Xcorp
Parties, the remainder of the First Installment, (iv) to NQCI, the amount
of the Second Installment, payable to NQCI within three business days of
receipt of the Second Installment, (v) to NQCI, the amount of the Third
Installment, payable to NQCI within three business days of receipt of the
Third Installment (the “Third NQCI Payment”) and (vi) the remainder
of the Transaction Proceeds shall be retained by the Xcorp Parties;
provided that under no circumstances shall NQCI be entitled to or receive
from the Transaction Proceeds an amount greater than the NQCI
Amount;
|
|
·
|
In
the event any of the Installments are paid by the third party in other
than cash, NQCI shall receive its proportionate share of such
consideration in accordance with the terms of the Memorandum;
and
|
|
·
|
The
Xcorp Parties shall also pay to NQCI 39% of any royalty or other payments
received by the Xcorp Parties in excess of the Transaction Proceeds in
connection with the Proposed
Transaction.
|
In the event that the timing or the
amount of the payments from the third party under the terms of the Proposed
Transaction (or another Transaction) is other than as contemplated in the
Memorandum, the Parties shall make such equitable adjustments as are required to
preserve, to the maximum extent possible, the intent of the distribution of
Transaction Proceeds provisions of the Memorandum. In the event that the Xcorp
Parties do not consummate the Proposed Transaction or if the terms of the
Proposed Transaction are other than what is contemplated under the Memorandum
and the Xcorp Parties instead consummate an alternative Transaction, the Parties
shall apply the methodology specified in the Memorandum to the maximum extent
possible in order to allocate between them the proceeds of such
Transaction.
Additionally, NQCI agreed to use its
best efforts to enter into an agreement with a certain third party pursuant to
which such third party and NQCI will each (a) confirm and acknowledge (i) their
joint ownership of the Polymer Technology, (ii) the existence and validity of
the exclusive license to NQCI of the medical applications of the Polymer
Technology and (iii) the existence and validity of the exclusive license to such
third party of the non-medical applications of the Polymer Technology; and
(b) agree to prepare, execute and deliver as promptly as practicable upon
request by either of such parties a definitive license agreement reflecting the
terms and conditions of the foregoing exclusive licenses. The Parties also
agreed to certain customary representation and warranty, indemnity and other
miscellaneous terms.
The
foregoing summary of the Memorandum and the transactions contemplated thereby,
does not purport to be complete and is subject to, and qualified in its entirety
by, the full text of the Memorandum, which is filed as part of this Quarterly
Report as Exhibit 10.1.
Agreement and Stipulation
Regarding Partial Final Award
In
connection with the issuance of the Partial Final Award and the execution of the
Memorandum between the Parties, on August 7, 2009 Operations entered into an
Agreement and Stipulation Regarding Partial Final Award (the “Stipulation”) with
NQCI. Pursuant to the terms of the Stipulation, Operations and NQCI agreed (i)
not to challenge the terms of the Partial Final Award or any portion of such
award, (ii) that any of the Parties may, at any time, seek to confirm all but
not part of the Partial Final Award through the filing of an appropriate
petition or motion with the appropriate court and in response to such action to
confirm the Partial Final Award, no Party will oppose, object to or in any way
seek to hinder or delay the court’s confirmation of the Partial Final Award, but
will in fact support and stipulate to such confirmation, (iii) to waive any and
all right to appeal from, seek appellate review of, file or prosecute any
lawsuit, action, motion or proceeding, in law, equity, or otherwise,
challenging, opposing, seeking to modify or otherwise attacking the confirmed
Partial Final Award or the judgment thereon and (iv) subject to certain
conditions, NQCI will not attempt before December 1, 2009 (the “Non-Execution
Period”) to execute on or file any motion, petition or application or
commence any proceeding seeking the collection of any attorneys’ fees that have
been awarded in NQCI’s favor under the terms of the Partial Final Award, which
is intended to allow the Parties a sufficient period within which to execute a
definitive acquisition agreement (the “Acquisition Agreement”) in connection
with the Proposed Transaction or another Transaction; provided that such period
shall automatically be extended for a period of 120 days from December 1, 2009
(the “Extension Date”) if the Acquisition Agreement is executed in full on or
before December 1, 2009. If the execution of the Acquisition Agreement occurs on
or before December 1, 2009, the Extension Date shall automatically be further
extended for a period of 60 days for each amendment to a proxy or information
statement related to the transactions contemplated by the Acquisition Agreement,
filed by us in response to comments made by the SEC.
In the
event we enter into an Acquisition Agreement for the Proposed Transaction or
another Transaction, we anticipate that we will call a special or annual meeting
of our stockholders at which our stockholders will be asked to vote on the terms
of such transaction, pursuant to a proxy or information statement that we would
file with the SEC in connection therewith (the “Stockholder Vote Date”). If and
when we do file such proxy or information statement with the SEC, our
stockholders and other investors are urged to carefully read such statement and
any other relevant documents filed with the SEC when they become available,
because they will contain important information about us and the transaction.
Copies of such proxy or information statement and other documents filed by us
with the SEC will be available at the Web site maintained by the SEC at
www.sec.gov.
The
foregoing summary of the Stipulation and the transactions contemplated thereby,
does not purport to be complete and is subject to, and qualified in its entirety
by, the full text of the Stipulation, which is filed as part of this Quarterly
Report as Exhibit 99.2.
As a result of the issuance of the
Partial Final Award and the execution of the Stipulation and the Memorandum, the
Technology Transaction will not occur, we will no longer be obligated to issue
the 9,230,000 shares of our common stock (Shares) to NQCI formerly required
pursuant to the terms of the Second Interim Award issued by the Arbitrator on
August 4, 2008, and we will no longer be required to file a resale registration
statement under the Securities Act of 1933, as amended, for the Shares.
Accordingly, the net fair value of $1,569,100 for the 9,230,000 issuable shares
accrued under “Shares issuable” as of December 31, 2008, was reversed resulting
in an adjustment of $1,569,100 to non-operating income in the statement of
operations, recognized as “Change in and reduction of shares issuable”, for the
six months ended June 30, 2009.
In addition, pursuant to the terms of
the Stipulation and the Memorandum, we reversed the accruals for the minimum
royalty under the terms of the License Agreement, resulting in a $645,833
non-operating reduction in arbitration liabilities to the statement of
operations for the three and six months ended June 30, 2009. See Note 12,
“License Agreement” below.
In the event we are unable to comply
with the terms of the Stipulation, this could have a material adverse effect on
our capital structure, business and financial condition.
Note
5 – Cash Equivalents and Marketable Securities
We invest
available cash in short-term commercial paper, certificates of deposit, money
market funds, and high grade marketable securities. We consider any liquid
investment with an original maturity of three months or less when purchased to
be cash equivalents. Investments, including certificates of deposit with
maturity dates greater than three months when purchased, and which have readily
determined fair values, are classified as available-for-sale investments and
reflected in current assets as marketable securities at fair market value.
Historically, we have complied with our investment policy which requires that
all investments be investment grade quality and no more than ten percent of our
portfolio may be invested in any one security or with one institution. However,
recently, our ability to continue to follow this policy has not been practicable
due to the small aggregate amount of investment funds that has been remaining
for investment. As a result, as of June 30, 2009, all of our cash was held in
high grade money market funds and commercial paper.
Restricted
cash represents deposits secured as collateral for a letter of credit pursuant
to our operating facility lease agreement at June 30, 2009.
Note
6 – Fair Value Measurements
Effective
January 1, 2008, we adopted SFAS No. 157, “Fair Value Measurements,” (“SFAS
157”). SFAS 157 defines fair value, establishes a framework for measuring fair
value, and expands disclosures about fair value measurements. This statement
does not require any new fair value measurements; rather, it applies to other
accounting pronouncements that require or permit fair value measurements. In
February 2008, FSP FAS 157-2, “Effective Date of FASB Statement
No. 157”, was issued, which delays the effective date of SFAS 157 to
fiscal years and interim periods within those fiscal years beginning after
November 15, 2008 for non-financial assets and non-financial liabilities,
except for items that are recognized or disclosed at fair value in the financial
statements on a recurring basis (at least annually). We elected to defer the
adoption of the standard for these non-financial assets and liabilities and
adopted the deferred provisions of the standard effective January 1, 2009, with
no significant effect.
Fair
value is defined under SFAS 157 as the price that would be received to sell an
asset or paid to transfer a liability in the principal or most advantageous
market in an orderly transaction between market participants on the measurement
date. SFAS 157 also establishes a three-level hierarchy, which requires an
entity to maximize the use of observable inputs and minimize the use of
unobservable inputs when measuring fair value.
Beginning
January 1, 2008, assets and liabilities recorded at fair value in the balance
sheets are categorized based upon the level of judgment associated with the
inputs used to measure their fair value. Level inputs, as defined by SFAS 157,
are as follows:
|
·
|
Level
I - inputs are unadjusted, quoted prices for identical assets or
liabilities in active markets at the measurement
date..
|
|
·
|
Level
II - inputs, other than quoted prices included in Level I, that are
observable for the asset or liability through corroboration with market
data at the measurement date.
|
|
·
|
Level
III - unobservable inputs that reflect management’s best estimate of what
market participants would use in pricing the asset or liability at the
measurement date.
|
The
following table summarizes fair value measurements by level at June 30, 2009 for
assets and liabilities measured at fair value on a recurring basis:
|
|
Level I
|
|
|
Level II
|
|
|
Level III
|
|
|
Total
|
|
Cash
and cash equivalents
|
|
$ |
92,116 |
|
|
$ |
- |
|
|
$ |
- |
|
|
$ |
92,116 |
|
Marketable
securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial
paper
|
|
|
250,000 |
|
|
|
- |
|
|
|
- |
|
|
|
250,000 |
|
Corporate
securities fixed rate
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
Money
market fund
|
|
|
156,927 |
|
|
|
- |
|
|
|
- |
|
|
|
156,927 |
|
Restricted
cash
|
|
|
305,871 |
|
|
|
- |
|
|
|
- |
|
|
|
305,871 |
|
Total
assets (1)
|
|
$ |
804,914 |
|
|
$ |
- |
|
|
$ |
- |
|
|
$ |
804,914 |
|
(1) The
carrying amount for cash and cash equivalents, marketable securities, and
restricted cash approximates the fair value of such instruments due to the
variable rate of interest and/or the short maturities of these financial
instruments.
FASB
Statement 107, Disclosures
about Fair Value of Financial Instruments, requires disclosure of fair
value information about certain financial instruments for which it is practical
to estimate that value. The carrying amounts reported on our balance sheet for
cash and cash equivalents, marketable securities and restricted cash
approximates the fair value because of the variable rate of interest and/or
short-term maturity of these financial instruments. The total aggregate carrying
value of our cash and cash equivalents, marketable securities and restricted
cash was $804,914 and $3,664,974 as of June 30, 2009 and December 31, 2008,
respectively, which approximates the total aggregate fair value at the end of
the same periods. As considerable judgment is required to develop estimates of
fair value, the estimates are not necessarily indicative of the amounts we could
realize in a current market exchange. The use of different market assumptions
and/or estimation methodologies may have a material effect on the estimated fair
value amounts.
Short-term
investments classified as available-for-sale were as follows:
|
|
June 30, 2009
|
|
|
|
Aggregate Fair
Value
|
|
|
Gross Unrealized
Gains / (Losses)
|
|
|
Estimated Fair
Value
|
|
Commercial
paper
|
|
$ |
250,000 |
|
|
$ |
- |
|
|
$ |
250,000 |
|
Corporate
securities fixed rate
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$ |
250,000 |
|
|
$ |
- |
|
|
$ |
250,000 |
|
We review
impairments associated with the above in accordance with SFAS No. 115,
“Accounting for Certain Investments in Debt and Equity Securities,” and FASB
Staff Position FAS 115-1 and FAS 124-1, “The Meaning of Other-Than-Temporary
Impairment and Its Application to Certain Investments,” to determine the
classification of the impairment as temporary or other-than-temporary. We
consider these investments not to be impaired as of June 30, 2009.
There
were no gross unrealized gains or losses as of June 30, 2009.
Note
7 – Property and Equipment
Property
and equipment consist of the following at June 30, 2009:
Property
and equipment
|
|
$
|
474,244
|
|
Accumulated
depreciation
|
|
|
(196,782
|
)
|
Property
and equipment, net
|
|
$
|
277,462
|
|
Depreciation
expense for the three and six months ended June 30, 2009 was $30,738 and
$61,571, respectively, compared to $26,061 and $48,554, respectively, for the
same periods in 2008.
During
the three months ended June 30, 2009, we disposed of two fixed assets decreasing
our property and equipment by an aggregate of $2,514 and as a result, we
recognized a total net loss on disposal in the amount of $382.
In
accordance with SFAS 144, Accounting for the Impairment or
Disposal of Long-Lived Assets, we performed a test of recoverability on
our property and equipment as of June 30, 2009. As a result of this test, we
determined our property and equipment not to be impaired and the carrying value
to be recoverable.
Formerly,
pursuant to the terms of the Second Interim Award issued on August 4, 2008,
which stated that, if the Technology Transaction is submitted to and approved by
our stockholders, 9,230,000 shares of our common stock were required to be
issued to NQCI to effectuate the transaction, we accrued for the issuance of
9,230,000 shares of our common stock to NQCI. As the Second Interim Award stated
that we must issue 9,230,000 upon the closing of the Technology Transaction and
we were unable to consummate the transaction, such contingency not being within
our control, we therefore, recorded the issuance as a liability, rather than as
an equity issuance. As of December 31, 2008, we accrued for the 9,230,000 shares
of our common stock to be issued to NQCI in accordance with FASB 5, Accounting for Contingencies,
with the initial fair value of the shares measured on August 4, 2008, the date
of the Second Interim Award. Until issued, the
shares were marked to market in accordance with Emerging Issues Task Force No.
00-19, Accounting for
Derivative Financial Instruments Indexed to and Potentially Settled in, a
Company’s Own Stock (“EITF 00-19”), with subsequent changes in fair value
recorded as non-operating change in fair value of shares issuable to our
statement of operations. The fair value of the shares was measured using the
closing price of our common stock on the reporting date. The measured fair value
of $10,153,000 for the accrued 9,230,000 shares on August 4, 2008, the date of
the Second Interim Award, was accrued under “Shares issuable” and expensed to
“Research and development.” From marking to market, the fair value of the shares
issuable was revalued at $1,569,100 as of December 31, 2008. The resulting
non-operating adjustment in fair value of $8,583,900 to the statement of
operations for the year ended December 31, 2008 was recognized as “Change in
fair value of shares issuable.”
As a
result of the issuance of the Partial Final Award and the execution of the
Stipulation and the MOU, see Note 4, “Legal Proceedings” above, the Technology
Transaction will not occur, we will no longer be obligated to issue the Shares
to NQCI formerly required pursuant to the terms of the Second Interim Award, we
will no longer be required to file a resale registration statement under the
Securities Act for the Shares and the Technology Transaction will not be
submitted to our stockholders for approval. Accordingly, the net fair value of
$1,569,100 for the 9,230,000 issuable shares accrued under “Shares issuable” as
of December 31, 2008, was reversed due to the arbitrator’s Partial Final Award,
resulting in an adjustment of $1,569,100 to non-operating income in the
statement of operations, recognized as “Change in and reduction of shares
issuable”, for the six months ended June 30, 2009.
As of
February 22, 2008, we entered into a 5-year lease agreement and relocated our
corporate office to a location in Los Angeles, CA. The total lease payments will
be $1,096,878 over the lease term. As of June 30, 2009, our remaining total
lease payments for our corporate office are $850,381.
The
following is a schedule by years of future minimum lease payments required under
the 5-year corporate office lease as of June 30, 2009:
Year
ending December 31:
|
|
|
|
2009
|
|
$ |
108,626 |
( 1
) |
2010
|
|
|
224,650 |
|
2011
|
|
|
233,528 |
|
2012
|
|
|
242,842 |
|
2013
|
|
|
40,735 |
( 2
) |
|
|
|
|
|
Total
minimum payments required
|
|
$ |
850,381 |
|
( 1 )
excludes lease payments made through June 30, 2009
( 2 )
initial term of the lease agreement ends February 2013
In
October 2008, we entered into a 5-year lease agreement through November 26,
2013, for our new operating facility in Lake Forest, CA. The lease agreement
includes a tenant improvement allowance of $363,800, 50% of which can be applied
to rent payments with the remaining 50% applied to tenant improvement and
related expenditures. As of June 30, 2009, we expended $88,865 in improvement
and related expenses. After the drawdown of the 50% of the tenant improvement
allowance applicable to rent payments, in lieu of reimbursement to us of cash by
the landlord for the incurred improvements, the $88,865 will be applied to rent
payments going forward. The $88,865 was recognized under “Tenant improvement
allowance receivable” as of June 30, 2009. The total lease payments, including
the 50% of the tenant improvement allowance applied to rent payments, will
amount to $1,367,507 over the lease term. As of June 30, 2009, our remaining
total lease payments for our new operating facility are $1,317,288.
The
following is a schedule, by years, of future minimum lease payments required
under the 5-year operating facility lease as of June 30, 2009:
Year
ending December 31:
|
|
|
|
2009
|
|
|
112,297 |
( 1
) |
2010
|
|
|
293,722 |
|
2011
|
|
|
303,994 |
|
2012
|
|
|
314,266 |
|
2013
|
|
|
293,009 |
( 2
) |
|
|
|
|
|
Total
minimum payments required
|
|
$ |
1,317,288 |
|
( 1 )
excludes lease payments made through June 30, 2009
( 2 )
initial term of the lease agreement ends November 2013
All of
the space is in good condition and we expect it to remain suitable to meet our
needs for the foreseeable future. We intend to consolidate our offices and
sublease our current corporate office located in Los Angeles, California. As of
June 30, 2009, we continued to utilize both locations.
Note
10 – Interest Income
Interest
income of $2,835 and $10,742 and $82,226 and $234,694 was reported for the three
and six months ended June 30, 2009 and 2008, respectively.
Note
11 – Related Party Transactions
In
connection with the contribution of the assets to us, on August 31, 2006 we issued to
Consolidated National, LLC (CNL) of which Terren Peizer, a member of our Board
of Directors, who beneficially owns 42.2% of our outstanding common stock as of
June 30, 2009, is the sole managing member and beneficial owner, an aggregate of
9,600,000 shares of our common stock of which 6,232,596 shares are still held by
CNL.
We
previously entered into an Executive Chairman Agreement with Terren Peizer,
formerly our Executive Chairman and currently a member of our Board of
Directors, for an initial term of three years, with automatic one-year renewals.
Mr. Peizer served as our Executive Chairman until October 2008, however the
Executive Chairman Agreement was not terminated and remains in place. For his
services as our Executive Chairman, Mr. Peizer was (i) scheduled to receive
compensation in the amount of $450,000 per annum as of July 1, 2007, with a
signing bonus of $225,000, (ii) scheduled to receive an annual bonus at the
discretion of our Board of Directors based on our performance goals and targeted
at 100% of his base compensation and (iii) eligible to participate in any of our
equity incentive plans. In the event Mr. Peizer’s position was terminated
without good cause or he resigned for good reason, we were obligated to pay
Mr. Peizer a lump sum in an amount equal to three years’ base compensation
plus 100% of the targeted bonus. Pursuant to the Executive Chairman Agreement,
Mr. Peizer was paid as an independent consultant. In August 2008, we agreed with
Mr. Peizer that effective then we would cease making cash compensation payments
to him under his Executive Chairman Agreement and would defer such cash
compensation payments until further notice. As such, and in accordance with the
terms of his agreement, we accrued, under “Accrued professional fees”, $393,750
of his deferred compensation as of June 30, 2009.
Dr.
Victor Gura, our Chief Medical and Scientific Officer, owns 15,497,250 shares of
common stock of NQCI (or approximately 20.9% of NQCI’s common stock outstanding
as of January 31, 2009), the company with which we entered into the License
Agreement. Such shares include 800,000 shares owned by Medipace Medical Group,
Inc., an affiliate of Dr. Gura (or approximately 1.1% of NQCI’s common stock
outstanding as of January 31, 2009), and 250,000 shares subject to warrants held
by Dr. Gura which are currently exercisable (or approximately less than 1.0% of
NQCI’s common stock outstanding as of January 31, 2009).
Dr. Gura
maintains an office located in Beverly Hills, California. Pursuant to a
reimbursement agreement effective January 29, 2008, we reimburse 50% of the
rental and 50% of his monthly parking. The term of the agreement commenced on
April 23, 2007, the date of the office lease agreement, and will continue until
the date on which Dr. Gura ceases to use the remote office to perform his duties
as our Chief Medical and Scientific Officer. From commencement through June 30,
2009, we reimbursed Dr. Gura $2,115 and $52,204 for 50% of the monthly parking
and rental, respectively.
Note
12 – License Agreement
On August
31, 2006, we entered into a Contribution Agreement with CNL. We issued CNL
9,600,000 shares of common stock in exchange for (a) the right, title, and
interest to the name “Xcorporeal” and related trademarks and domain names, and
(b) the right to enter into a License Agreement with NQCI, pursuant to which we
obtained the exclusive rights to the technology relating to our kidney failure
treatment and other medical devices which, as listed under “Technology” on the
License Agreement, are “all existing and hereafter developed Intellectual
Property, Know-How, Licensor Patents, Licensor Patent Applications, Derivative
Works and any other technology, invented, improved or developed by Licensor, or
as to which Licensor owns or holds any rights, arising out of or relating to the
research, development, design, manufacture or use of (a) any medical device,
treatment or method as of the date of this Agreement, (b) any portable or
continuous dialysis methods or devices, specifically including any Wearable
Artificial Kidney and related devices, (c) any device, methods or treatments for
congestive heart failure, and (d) any artificial heart or coronary device.”
Operations was a shell corporation prior to the transaction. We valued the
License Agreement at the carry-over basis of $1,000. As consideration for being
granted the License, we agreed to pay to NQCI a minimum annual royalty of
$250,000, or 7% of net sales, although we have asserted in the Proceeding that
NQCI’s breaches of the License Agreement excused our obligation to make the
minimum royalty payments. However, as a result of the execution of the
Memorandum and the Stipulation, NQCI agreed to forego the interim royalties and,
we will no longer be obligated to pay NQCI any interim royalty payments under
the License Agreement. For a more detailed discussion of the Memorandum and the
Stipulation, see Note 4, “Legal Proceedings” above.
Although
under the terms of the Partial Final Award the Arbitrator denied NQCI’s
application for interim royalties, we recorded $645,833 in royalty expenses
covering the minimum royalties from commencement of the License Agreement
through March 31, 2009. On August 7, 2009, Operations and us entered into the
Memorandum and the Stipulation with NQCI pursuant to which the parties agreed to
forego the interim royalties (provided for under the terms of the Partial Final
Award). As a result, we reversed the accruals for the minimum royalty payments,
resulting in a $645,833 non-operating reduction in arbitration liabilities to
the statement of operations for the three and six months ended June 30, 2009.
See Note 4, “Legal Proceedings” above.
Note
13 – Stock Options and Warrants
Incentive
Compensation Plan
On
October 12, 2007, we adopted the Xcorporeal, Inc. 2007 Incentive Compensation
Plan and the related form of option agreement that is substantially identical to
the 2006 Incentive Compensation Plan that was in effect at Operations
immediately prior to the merger.
The plan
authorizes the grant of stock options, restricted stock, restricted stock units,
and stock appreciation rights. There are 3,900,000 shares of common stock
authorized for issuance under to the 2007 Incentive Compensation Plan (subject
to adjustment in accordance with the provisions of the plan). The plan will
continue in effect for a term of up to ten years. As of June 30, 2009, there
were outstanding options to purchase 720,000 shares of our common stock and
3,180,000 shares were available for issuance under the 2007 Incentive
Compensation Plan.
On
October 12, 2007, we also assumed options to purchase up to 3,880,000 shares of
common stock that were granted by Operations under its 2006 Incentive
Compensation Plan, of which 1,635,000 have since been forfeited, canceled, or
expired, and therefore, options to purchase 2,245,000 shares of our common stock
remain outstanding.
Stock
Options to Employees, Officers and Directors
The
Compensation Committee of our board of directors determines the terms of the
options granted, including the exercise price, the number of shares subject to
option, and the vesting period. Options generally vest over five years and have
a maximum life of ten years.
During
the three months ended June 30, 2009, an aggregate of 178,500 options were
forfeited due to the termination of a certain employee and the expiration of
vested shares on May 12, 2009 unexercised by the employees terminated on March
13, 2009.
We
reported $661,780 and $1,047,628 in stock-based compensation expense for
employees, officers, and directors for the three and six months ended June 30,
2009, respectively. For the three and six months ended June 30, 2008, we
reported $960,840 and $2,081,958 in stock-based compensation expense for
employees, officers, and directors, respectively.
All
compensation expense for stock options granted has been determined under the
fair value method using the Black-Scholes option-pricing model with the
following assumptions:
|
|
For the six months ended
|
|
|
|
June 30, 2009
|
|
Expected
dividend yields
|
|
zero
|
|
Expected
volatility
|
|
|
130 |
% |
Risk-free
interest rate
|
|
|
3.53-3.81 |
% |
Expected
terms in years
|
|
2.38-9.26
years
|
|
Warrants
and Stock Options to Non-Employees
During
the three months ended June 30, 2009, we did not issue any warrants. As of June
30, 2009, there were 551,721 warrants outstanding, which were fully vested and
exercisable.
We reported $1,895 and $3,666 in
stock-based compensation expenses for consultants for the three and six months
ended June 30, 2009, respectively. We reported $9,256 and $84,745 in stock-based
compensation expense for consultants for the three and six months ended June 30,
2008, respectively. The reduction in stock-based compensation expense was a
result of options and warrants vesting and their forfeiture as a result of a
termination of a consultant.
Compensation
for options granted to non-employees has been determined in accordance with SFAS
No. 123R, EITF 96-18, and EITF 00-18, Accounting for Equity Instruments
that are Issued to Other Than Employees for Acquiring, or in Conjunction with
Selling, Goods or Services. Accordingly, compensation is determined using
the fair value of the consideration received or the fair value of the equity
instruments issued, whichever is more reliably measured.
For
options and warrants issued as compensation to non-employees for services that
are fully vested and non-forfeitable at the time of issuance, the estimated
value is recorded in equity and expensed when the services are performed and
benefit is received as provided by Financial Accounting and Standards Board
(FASB) Emerging Issues Task Force No. 96-18, Accounting For Equity Instruments
That Are Issued To Other Than Employees For Acquiring or In Conjunction With
Selling Goods Or Services.
All
charges for warrants granted have been determined under the fair value method
using the Black-Scholes option-pricing model with the following
assumptions:
|
|
For the six months ended
|
|
|
|
June 30, 2009
|
|
Expected
dividend yields
|
|
zero
|
|
Expected
volatility
|
|
|
130 |
% |
Risk-free
interest rate
|
|
|
1.05-3.19 |
% |
Expected
terms in years
|
|
0.39-7.87
years
|
|
The
following table shows the change in unamortized compensation expense for stock
options and warrants issued to employees, officers, directors and non-employees
during the six months ended June 30, 2009:
|
|
Stock Options
and Warrants
Outstanding
|
|
|
Unamortized Compensation
Expense
|
|
|
|
|
|
|
|
|
January
1, 2009
|
|
|
4,429,221 |
|
|
$ |
10,092,109 |
|
|
|
|
|
|
|
|
|
|
Granted
in the period
|
|
|
- |
|
|
|
- |
|
|
|
|
|
|
|
|
|
|
Forfeited
& Cancelled in the period
|
|
|
(912,500 |
)(1) |
|
|
(2,932,478 |
) |
|
|
|
|
|
|
|
|
|
Expensed
in the period
|
|
|
- |
|
|
|
(1,488,719 |
) |
|
|
|
|
|
|
|
|
|
Exercised
in the period
|
|
|
- |
|
|
|
- |
|
|
|
|
|
|
|
|
|
|
June
30, 2009
|
|
|
3,516,721 |
|
|
$ |
5,670,912 |
|
(1) As
part of streamlining our operations, we terminated 19 employees on March 13,
2009 and one employee on April 30, 2009. As a result, the terminated employees’
unvested and unexercised vested options were forfeited. The employees terminated
on March 13, 2009 did not exercise their vested options and therefore, the
vested options expired on May 12, 2009, 60 days from termination.
|
|
Number of
Options and
Warrants
|
|
|
Weighted
Average
Exercise
Price
|
|
Stock Options and Warrants
|
|
|
|
|
|
|
Balance
at January 1, 2009
|
|
|
4,429,221 |
|
|
$ |
5.62 |
|
Granted
|
|
|
- |
|
|
|
- |
|
Exercised
|
|
|
- |
|
|
|
- |
|
Forfeited
& Cancelled
|
|
|
(912,500 |
) |
|
|
7.00 |
|
Balance
at June 30, 2009
|
|
|
3,516,721 |
|
|
$ |
5.26 |
|
Note
14 – Stockholders’ Deficit
Our
“Total Stockholders’ Deficit” as of June 30, 2009, is a result of our continued
operating losses with our deficit accumulated during the development stage being
greater than our additional paid in capital.
Note
15 – Product Development Agreement
In July
2007, we entered into the Aubrey Agreement for assistance with the development
of the PAK. As of March 31, 2009, the work was completed and we terminated the
agreement with Aubrey.
Note
16 – Subsequent Events
In the ongoing efforts to reduce our
burn rate as well as refocusing current resources to improve our liquidity
position, we have deferred 50% of the compensation for 5 of our 6 active
employees effective July 1, 2009. See Part 1, Item 2 “Management’s Discussion
and Analysis of Financial Condition and Results of Operations” below for
additional information on our operations and liquidity.
On August
7, 2009, to clarify, resolve and settle certain issues and any disputes that
have arisen between us and NQCI with respect to the Partial Final Award and the
Proceeding, we and Operations entered into a Binding Memorandum of Understanding
with NQCI. Under the terms of the Memorandum, among other things, the Parties
agreed to assign and transfer all of their rights, title and interest in and to
the Polymer Technology to a limited liability company to be formed by us and
NQCI, which will be jointly owned by us, Operations and NQCI and through which
such parties will jointly pursue the development and exploitation of the Polymer
Technology, and to negotiate, execute and deliver an operating agreement
governing the operation of such joint venture based on the terms set forth in
the Memorandum. The Parties also agreed to cooperate as reasonably required
by the Xcorp Parties in order for us to consummate the Proposed
Transaction or any other Transaction. The Parties further agreed that upon
the consummation of a Proposed Transaction, they will allocate any license fees
and any other additional consideration received in such transaction between
themselves in accordance with the terms of the Memorandum
In
connection with the issuance of the Partial Final Award and the execution of the
Memorandum between the Parties, on August 7, 2009 Operations also entered into
the Stipulation with NQCI. Pursuant to the terms of the Stipulation, Operations
and NQCI agreed (i) not to challenge the terms of the Partial Final Award or any
portion of such award, (ii) that any of the Parties may, at any time, seek to
confirm all but not part of the Partial Final Award through the filing of an
appropriate petition or motion with the appropriate court and in response to
such action to confirm the Partial Final Award, no Party will oppose, object to
or in any way seek to hinder or delay the court’s confirmation of the Partial
Final Award, but will in fact support and stipulate to such confirmation, (iii)
to waive any and all right to appeal from, seek appellate review of, file or
prosecute any lawsuit, action, motion or proceeding, in law, equity, or
otherwise, challenging, opposing, seeking to modify or otherwise attacking the
confirmed Partial Final Award or the judgment thereon and (iv) subject to
certain conditions, NQCI will not attempt during the Non-Execution
Period to execute on or file any motion, petition or application or commence any
proceeding seeking the collection of any attorneys’ fees that have been awarded
in NQCI’s favor under the terms of the Partial Final Award, which is intended to
allow the Parties a sufficient period within which to execute the Acquisition
Agreement in connection with the Proposed Transaction or a Transaction; provided
that such period shall automatically be subject to extension as more fully
described in the Memorandum.
Pursuant
to the terms of the Stipulation and the Memorandum, the parties agreed to forego
the interim royalties provided for under the terms of the Partial Final Award.
As a result, we reversed the accruals for the minimum royalty payments,
resulting in a $645,833 non-operating reduction in arbitration liabilities to
the statement of operations for the three and six months ended June 30, 2009.
For a more detailed discussion of the specific terms of the Memorandum and the
Stipulation, see Note 4 “Legal Proceedings” above.
Management
has evaluated subsequent events, and the impact on the reported results and
disclosures, through August 13, 2009, which is the date these financial
statements were issued and filed with the SEC.
ITEM
2. Management’s Discussion and Analysis
of Financial Condition
and Results of Operations.
The
following discussion of our financial condition and results of operations should
be read in conjunction with our interim financial statements and the related
notes, and the other financial information included in this report.
Forward-Looking
Statements
Unless
the context otherwise indicates or requires, as used in this Quarterly Report on
Form 10-Q, or the “Quarterly Report”, references to “Xcorporeal, ”“we,” “us,”
“our” or the “Company” refer to Xcorporeal, Inc., a Delaware corporation, and
prior to October 12, 2007, the company which is now our subsidiary and known as
Xcorporeal Operations, Inc., or “Operations”.
This
Quarterly Report contains “forward-looking statements” within the meaning of the
Private Securities Litigation Reform Act of 1995 with respect to the financial
condition, results of operations, business strategies, operating efficiencies or
synergies, competitive positions, growth opportunities for existing products,
plans and objectives of management, markets for our stock and other matters.
Statements in this Quarterly Report that are not historical facts are
“forward-looking statements” for the purpose of the safe harbor provided by
Section 21E of the Securities Exchange Act of 1934, as amended, or the “Exchange
Act”, and Section 27A of the Securities Act of 1933, or the “Securities Act”.
Forward-looking statements reflect our current expectations or forecasts of
future events. Forward-looking statements generally can be identified by the use
of forward-looking terminology such as “may,” “will,” “expect,” “anticipate,”
“intend,” “estimate,” “believe,” “project,” “continue,” “plan,” “forecast,” or
other similar words. Such forward-looking statements, including, without
limitation, those relating to our future business prospects, revenues and
income, wherever they occur, are necessarily estimates reflecting the best
judgment of our senior management on the date on which they were made, or if no
date is stated, as of the date of this Quarterly Report. These
forward-looking statements are subject to risks, uncertainties and assumptions,
including those described below in Item 1A - Risk Factors, in the section
captioned “Risk Factors” of our Annual Report on Form 10-K, or the “Annual
Report”, filed with the United States Securities and Exchange Commission, or the
“SEC”, on March 31, 2009, and in the section captioned “Risk Factors” of
our Quarterly Report on Form 10-Q, or the “Quarterly Report”, filed with the
SEC, on May 15, 2009, that may affect the operations, performance, development
and results of our business. Because these factors could cause our actual
results or outcomes to differ materially from those expressed in any
forward-looking statements made by us or on our behalf, you should not
place undue reliance on any such forward-looking statements. New factors emerge
from time to time, and it is not possible for us to predict which factors will
arise. In addition, we cannot assess the impact of each factor on our business
or the extent to which any factor, or combination of factors, may cause
actual results to differ materially from those contained in any forward-looking
statements.
You
should understand that, in addition to those factors discussed below in Item 1A
- Risk Factors and in the section captioned “Risk Factors” of our Annual
Report and events discussed below in the section captioned “Recent
Developments,” factors that could affect our future results and could cause our
actual results to differ materially from those expressed in such
forward-looking statements, include, but are not limited to:
|
·
|
the
effect of receiving a “going concern” statement in our independent
registered public accounting firm’s report on our 2008 financial
statements;
|
|
·
|
our
significant capital needs and ability to obtain financing both on a
short-term and a long-term
basis;
|
|
·
|
the
results of the arbitration proceeding with National Quality Care, Inc., or
“NQCI”, and its impact on our ability to exercise our rights under the
Perpetual License in the Technology (each capitalized term as defined
below) granted to us by
NQCI;
|
|
·
|
our
ability to meet continued listing standards of NYSE Amex (formerly
American Stock
Exchange);
|
|
·
|
our
ability to successfully research and develop marketable
products;
|
|
·
|
our
ability to obtain regulatory approval to market and distribute our
products;
|
|
·
|
anticipated
trends and conditions in the industry in which we operate, including
regulatory changes;
|
|
·
|
general
economic conditions; and
|
|
·
|
other
risks and uncertainties as may be detailed from time to time in our public
announcements and filings with the
SEC.
|
Although
we believe that our expectations are reasonable, we cannot assure you that our
expectations will prove to be correct. Should any one or more of these risks or
uncertainties materialize, or should any underlying assumptions prove incorrect,
actual results may vary materially from those described in this Quarterly Report
as anticipated, believed, estimated, expected or intended.
These
factors are not exhaustive, and new factors may emerge or changes to the
foregoing factors may occur that could impact our business. Except to the extent
required by law, we undertake no obligation to publicly update or revise any
forward-looking statements, whether as a result of new information, future
events or any other reason. All subsequent forward-looking statements
attributable to us or any person acting on our behalf are expressly qualified in
their entirety by the cautionary statements contained or referred to herein. In
light of these risks, uncertainties and assumptions, the forward-looking events
discussed in this Quarterly Report may not occur. You should review carefully
Item 1A - Risk Factors, this Item 2 and the section captioned “Risk Factors”
included in our Annual Report for a more complete discussion of these and other
factors that may affect our business.
Overview
We are a
medical device company developing an innovative extra-corporeal platform
technology to be used in devices to replace the function of various human
organs. These devices will seek to provide patients with improved, efficient and
cost effective therapy. The platform leads to three initial
products:
|
·
|
A
Portable Artificial Kidney, or “PAK”, for attended care Renal Replacement
Therapy, or “RRT”, for patients suffering from Acute Renal Failure, or
“ARF”
|
|
·
|
A
PAK for home hemodialysis for patients suffering from End Stage Renal
Disease, or “ESRD”
|
|
·
|
A
Wearable Artificial Kidney, or “WAK”, for continuous ambulatory
hemodialysis for treatment of ESRD
|
We have
completed functional prototypes of our attended care and home PAKs that we plan
to commercialize after obtaining notification clearance from the Food and Drug
Administration, or “FDA”, under Section 510(k) of the Federal Food, Drug and
Cosmetic, or “FDC”, Act based on the existence of predicate devices, which,
subject to our capital limitations described below, we plan to seek in the
future. We have demonstrated a feasibility prototype of the WAK and we will
determine whether to devote any available resources to the development of
the WAK; commercialization of the WAK will require development of a functional
prototype and likely a full pre-market approval, or “PMA”, by the FDA, which
could take several years or longer. Unless we are able to raise funds to
satisfy our current liabilities and other obligations as they become due
and obtain additional debt or equity financing, as more fully described below
under “Recent Developments”, we will not be able to submit a 510(k) notification
with the FDA for the PAK or the WAK.
Our PAK
for the attended care market is a portable, multifunctional renal replacement
device that will offer cost-effective therapy for those patients suffering from
ARF, causing a rapid decline in kidney function. We have completed our
functional prototype of this product, which is currently undergoing bench
testing, and, subject to our capital limitations described below, plan to submit
a 510(k) filing with the FDA in the future. We plan to commercialize this
product after receiving clearance from the FDA. Timing of FDA clearance is
uncertain at this time. Unless we are able to raise funds to satisfy our current
liabilities and other obligations as they become due and obtain additional debt
or equity financing, we will not be able to submit a
510(k) notification with the FDA for this product.
Our PAK
for the home hemodialysis market is a device for patients suffering from ESRD,
in whom the kidneys have ceased to function. We have also completed our
functional prototype of this product, which is currently undergoing bench
testing, and, subject to our capital limitations described below, we intend to
submit a 510(k) with the FDA in the future. Unless we are able to raise funds to
satisfy our current liabilities and other obligations as they become due and
obtain additional debt or equity financing, we will not be able to submit a
510(k) notification with the FDA for this product. Clinical trials would be
anticipated to commence after the FDA clearance is received.
Our WAK
is a device for the chronic treatment of ESRD. We have successfully demonstrated
a prototype system that weighs less than 6 kg., is battery operated, and can be
worn by an ambulatory patient. Subject to us first entering into a transaction
for the sale of a part, substantially all or all of our assets, assuming we are
able to raise funds to satisfy our current liabilities and other obligations as
they become due and obtain additional debt or equity financing, we will continue
to evaluate the feasibility of furthering our development of this
product.
In 2009,
to the extent we have or are able to obtain sufficient funds to do so, we plan
to continue testing and developing the technology for our extra-corporeal platform. We
will also implement our validation and verification strategy including bench
testing, clinical testing and regulatory strategy in the U.S. and
abroad.
While we
may eventually exploit our technology’s potential Congestive Heart Failure, or
“CHF”, applications through licensing or strategic arrangements, we will focus
initially on the renal replacement applications described above.
We have
focused much of our efforts on development of the PAK, which we do not believe
has been derived from the Technology (as defined below) covered by the License
Agreement (as defined below). As described below under “Recent
Developments,” assuming the results of the arbitration proceeding are final
and subject to us first entering into a transaction for the sale of a part,
substantially all or all of our assets, we will determine whether to devote any
available resources to development of the WAK. Because none of our products is
yet at a stage where it can be marketed commercially and because of the capital
limitations that we are experiencing, we are not able to predict what portion of
our future business, if any, will be derived from each of our
products.
We are a
development stage company, have generated no revenues to date and have been
unprofitable since our inception, and will incur substantial additional
operating losses for at least the next twelve months as we continue, to the
extent available, to allocate resources to research, development, clinical
trials, commercial operations, and other activities. We do not believe our
existing cash reserves will be sufficient to satisfy our current liabilities and
other obligations before we achieve profitability. Our ability to meet such
obligations as they become due will depend on our ability to secure debt or
equity financing. Unless we are able to obtain funds sufficient to support our
operations and to satisfy our ongoing capital requirements, as more fully
described below, we will not be able to develop any of our products, submit
510(k) notifications or PMA applications to the FDA, conduct clinical trials or
otherwise commercialize any of our products. We may not be able
to obtain needed funds on acceptable terms, or at all, and there is substantial
doubt of our ability to continue as a going concern. Accordingly, our historical
operations and financial information are not indicative of our future operating
results, financial condition, or ability to operate profitably as a commercial
enterprise.
Recent
Developments
Issuance
of the Partial Final Award; Execution of the Agreement and Stipulation Regarding
Partial Final Award and Binding Memorandum of Understanding with
NQCI
Partial Final
Award
On April
13, 2009, the arbitrator (the “Arbitrator”) in the arbitration proceeding (the
“Proceeding”) between us, Operations and NQCI issued a Partial Final Award (the
“Partial Final Award”), which resolved the remaining issues that were
pending for decision in the Proceeding. The Partial Final Award provided that we
and Operations shall have a perpetual exclusive license (the “Perpetual
License”) in the Technology (as defined in the Merger Agreement, dated as of
September 1, 2006, or the “Merger Agreement”, among us, Operations and NQCI and
the License Agreement, dated as of September 1, 2006, or the “License
Agreement”, between us and NQCI) primarily related to the WAK and any other
Technology contemplated to be transferred under the Technology Transaction.
Under the terms of the Partial Final Award, in consideration of the award of the
Perpetual License to us, NQCI was awarded a royalty of 39% of all net income,
ordinary or extraordinary, to be received by us (the “Royalty”) and NQCI is to
receive 39% of any shares received in any merger transaction to which we or
Operations may become a party. NQCI’s interest as licensor under the Perpetual
License shall be freely assignable. In addition, the Partial Final Award
provided that we shall pay NQCI an amount equal to approximately $1,871,000 in
attorneys’ fees and costs previously awarded by the Arbitrator in an order
issued on August 13, 2008, that NQCI’s application for interim royalties and
expenses is denied and that NQCI is not entitled to recover any additional
attorneys’ fees. Finally, the Partial Final Award also provided that the
Arbitrator shall retain jurisdiction to supervise specific performance of the
terms and obligations of the Partial Final Award including, but not limited to,
any dispute between the parties over the manner of calculation of the Royalty.
The Partial Final Award was issued by the Arbitrator as a result of each party’s
request for the Arbitrator to order alternative relief due to the parties’
inability to proceed with the Technology Transaction.
On April
17, 2009, NQCI requested that the Arbitrator correct material terms of the
Partial Final Award relating to the meaning and calculation of the Royalty
terms. We opposed the request and on May 1, 2009, the Arbitrator denied NQCI’s
request to modify the language of the Partial Final Award. The Arbitrator
further held that past expenses shall not be included in net income computations
for purposes of the Royalty, that NQCI may make an application to the Arbitrator
requesting a royalty distribution, specifying the amount sought and basis for
the claimed amount, and that NQCI is entitled to audit our financial statements,
books and records to verify our net income, on an annual basis, or more
often, if the Arbitrator permits.
Binding Memorandum of
Understanding
On August
7, 2009, to clarify, resolve and settle certain issues and any disputes that
have arisen between us and NQCI with respect to the Partial Final Award and the
Proceeding, we and Operations (collectively, the “Xcorp Parties”) entered into a
Binding Memorandum of Understanding (the “Memorandum”) with NQCI (NQCI, together
with the Xcorp Parties is collectively referred to as the “Parties”). Under the
terms of the Memorandum, among other things, the Parties agreed to: (i) assign
and transfer all of their rights, title and interest in and to
certain technology comprised of a certain U.S. Patent Application and
related intellectual property (as described in the Memorandum) (the “Polymer
Technology”) to a limited liability company to be formed under the laws of the
State of Delaware (the “Joint Venture”), which will be jointly owned by the
Parties and through which the Parties will jointly pursue the development and
exploitation of the Polymer Technology, and (ii) negotiate, execute and deliver
within 60 days following the Stockholder Vote Date (as defined below) an
operating agreement governing the operation of the Joint Venture based on the
terms set forth in the Memorandum (the “Operating Agreement”).
The Xcorp
Parties and NQCI will be the initial two members of the Joint Venture (Xcorp
Parties’ interest shall be held of record by either us or Operations, as
determined by the Xcorp Parties) with NQCI and the Xcorp Parties having a 60%
and 40% membership interest (the “Membership Interests”) in the Joint Venture,
respectively. Subject to such other terms and provisions as the Parties may
agree upon, the Operating Agreement shall include the following
terms:
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the
Joint Venture shall be managed by a three-member board of managers (the
“JV Board”);
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until
such time as NQCI fails to hold a greater percentage of the Membership
Interests than the Xcorp Parties, two members of the JV Board (each, a “JV
Manager”) shall be designated by NQCI and until such time as the Xcorp
Parties fail to hold at least 10% of the Membership Interests and one JV
Manager shall be designated by the Xcorp
Parties;
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NQCI
shall have the right to appoint a Chairman and/or a Chief Executive
Officer of the Joint Venture, who will have day-to-day management
authority with respect to the Joint Venture, subject to oversight by the
JV Board and the terms and conditions of the Memorandum and the Operating
Agreement, and a Chief Scientific Officer, who may be employed by the
Joint Venture upon customary and reasonable terms and
conditions;
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if
a JV Manager provides additional services to the Joint Venture as an
employee or a consultant, he or she may be compensated by the Joint
Venture as is mutually reasonably approved in writing by the Parties;
provided that with the exception of reimbursement of reasonable expenses
incurred in connection with their services performed for the Joint Venture
in their official officer capacity, neither Robert Snukal, the Chief
Executive Officer of NQCI, nor Kelly McCrann, our Chairman and Chief
Executive Officer, (or such other persons as may be appointed or elected
in their place) shall in any event receive a salary or other compensation
from the Joint Venture;
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except
as otherwise required by law, all decisions related to the operations of
the Joint Venture shall be made by a majority of the JV Board, except that
certain actions (as described in the Memorandum) by the Joint Venture or
any of its subsidiaries shall require the affirmative vote or written
consent of the holders of at least 90.1% of the Membership Interests then
outstanding; and
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from
and after August 1, 2009, the Xcorp Parties shall pay 61% and NQCI shall
pay 39% of the reasonable costs and expenses related to protecting,
preserving and exploiting the Licensed Technology (as defined
below).
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In
addition, the Xcorp Parties agreed to contribute $500,000 in cash to the bank
account established by the Joint Venture, on the later of (x) three business
days of the consummation of the first to occur of the Proposed Transaction or
another Transaction (as such terms are defined below) and (y) the date on which
the Joint Venture establishes such bank account, for which the Parties (or their
representatives) shall be joint signatories. Furthermore, provided that the
Proposed Transaction or a Transaction has been consummated, NQCI agreed to
contribute on the Xcorp Parties’ behalf an additional $500,000 in cash to the
Joint Venture at such time as the JV Board reasonably determines that such funds
are required to facilitate the Joint Venture’s development of the Polymer
Technology. This additional contribution amount will be reimbursed to NQCI by
the Xcorp Parties from the first funds distributed to the Xcorp Parties by the
Joint Venture (other than pursuant to certain quarterly tax related
distributions). Additionally, with respect to the Joint Venture, the Parties
agreed to certain liquidity rights consisting of customary rights of first
refusal and co-sale rights, unlimited piggyback registration rights and the
right to up to two demand registrations (subject to lock-ups and other
underwriter requirements), customary preemptive rights (available to a member of
the Joint Venture for so long as such member holds at least 10% of the
Membership Interests then outstanding), customary anti-dilution protections and
other standard distribution and information rights.
The
Parties also agreed to cooperate as reasonably required by the Xcorp Parties in
order for us to consummate a transaction involving an exclusive
license and/or sale to a third party (the “Proposed Transaction”) of a
part, substantially all or all of our technology and other intellectual property
rights licensed to us under the License Agreement and which transaction may also
include an arrangement with respect to the Polymer Technology (the
“Licensed Technology”), or any other transaction (a “Transaction”)
involving the sale, license or other disposition by us of a part, substantially
all or all of the Licensed Technology. The Parties further agreed that upon the
consummation of a Proposed Transaction, they will allocate any license fees and
any other additional consideration received in such transaction between the
Parties (collectively, the “Transaction Proceeds”), in accordance with the terms
set forth in the Memorandum and summarized below, subject to the actual terms of
the Proposed Transaction, when and if such transaction is consummated. However,
there can be no assurances that the Proposed Transaction or any other
Transaction will occur or that the terms thereof will be similar to those
provided for in the Memorandum and summarized below, and the actual terms of the
Proposed Transaction or another Transaction will be provided for in the
definitive agreement entered into in connection with such
transaction.
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NQCI
shall receive 36.96% of the Transaction Proceeds (which amount is intended
to represent an amount equal to 39% of the net royalty payments provided
for by the terms of the Partial Final Award following the deduction
therefrom of the Xcorp Parties expenses incurred in connection with
the Proposed Transaction), plus $1,871,430 in attorneys’ fees and costs
payable to NQCI pursuant to the terms of the Partial Final Award
(collectively, the “NQCI Amount”);
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The
third party will pay the Xcorp Parties $250,000 upon the earlier of
the signing of a letter of intent and an acquisition agreement providing
for the Proposed Transaction, approximately 50% (less the foregoing
$250,000) of the Transaction Proceeds payable in cash to the Xcorp Parties
upon the closing of the Proposed Transaction (the “First Installment”),
approximately 25% of such proceeds such number of months after the
consummation of the Proposed Transaction as provided in the documents
governing the Proposed Transaction (the “Second Installment”) and 25% of such
proceeds about 12 months after the payment of the Second Installment (the
“Third Installment”, and collectively with the First Installment and the
Second Installment, the
“Installments”).
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The
Transaction Proceeds shall be allocated between the Parties as
follows: (i) $250,000 to the Xcorp Parties, payable to the Xcorp
Parties on the earlier of the signing of a letter of intent and an
acquisition agreement providing for the Proposed Transaction, (ii) to
NQCI, an amount equal to the NQCI Amount less the sum of the Second
Installment and the Third Installment, payable to NQCI within seven
business days of receipt of the First Installment, (iii) to the Xcorp
Parties, the remainder of the First Installment, (iv) to NQCI, the amount
of the Second Installment, payable to NQCI within three business days of
receipt of the Second Installment, (v) to NQCI, the amount of the Third
Installment, payable to NQCI within three business days of receipt of the
Third Installment (the “Third NQCI Payment”) and (vi) the remainder
of the Transaction Proceeds shall be retained by the Xcorp Parties;
provided that under no circumstances shall NQCI be entitled to or receive
from the Transaction Proceeds an amount greater than the NQCI
Amount;
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In
the event any of the Installments are paid by the third party in other
than cash, NQCI shall receive its proportionate share of such
consideration in accordance with the terms of the Memorandum;
and
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The
Xcorp Parties shall also pay to NQCI 39% of any royalty or other payments
received by the Xcorp Parties in excess of the Transaction Proceeds in
connection with the Proposed
Transaction.
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In the event that the timing or the
amount of the payments from the third party under the terms of the Proposed
Transaction (or another Transaction) is other than as contemplated in the
Memorandum, the Parties shall make such equitable adjustments as are required to
preserve, to the maximum extent possible, the intent of the distribution of
Transaction Proceeds provisions of the Memorandum. In the event that the Xcorp
Parties do not consummate the Proposed Transaction or if the terms of the
Proposed Transaction are other than what is contemplated under the Memorandum
and the Xcorp Parties instead consummate an alternative Transaction, the Parties
shall apply the methodology specified in the Memorandum to the maximum extent
possible in order to allocate between them the proceeds of such
Transaction.
Additionally, NQCI agreed to use its
best efforts to enter into an agreement with a certain third party pursuant to
which such third party and NQCI will each (a) confirm and acknowledge (i) their
joint ownership of the Polymer Technology, (ii) the existence and validity of
the exclusive license to NQCI of the medical applications of the Polymer
Technology and (iii) the existence and validity of the exclusive license to such
third party of the non-medical applications of the Polymer Technology; and
(b) agree to prepare, execute and deliver as promptly as practicable upon
request by either of such parties a definitive license agreement reflecting the
terms and conditions of the foregoing exclusive licenses. The Parties also
agreed to certain customary representation and warranty, indemnity and other
miscellaneous terms.
The
foregoing summary of the Memorandum and the transactions contemplated thereby,
does not purport to be complete and is subject to, and qualified in its entirety
by, the full text of the Memorandum, which is filed as part of this Quarterly
Report as Exhibit 10.1.
Agreement and Stipulation
Regarding Partial Final Award
In
connection with the issuance of the Partial Final Award and the execution of the
Memorandum between the Parties, on August 7, 2009 Operations entered into an
Agreement and Stipulation Regarding Partial Final Award (the “Stipulation”) with
NQCI. Pursuant to the terms of the Stipulation, Operations and NQCI agreed (i)
not to challenge the terms of the Partial Final Award or any portion of such
award, (ii) that any of the Parties may, at any time, seek to confirm all but
not part of the Partial Final Award through the filing of an appropriate
petition or motion with the appropriate court and in response to such action to
confirm the Partial Final Award, no Party will oppose, object to or in any way
seek to hinder or delay the court’s confirmation of the Partial Final Award, but
will in fact support and stipulate to such confirmation, (iii) to waive any and
all right to appeal from, seek appellate review of, file or prosecute any
lawsuit, action, motion or proceeding, in law, equity, or otherwise,
challenging, opposing, seeking to modify or otherwise attacking the confirmed
Partial Final Award or the judgment thereon and (iv) subject to certain
conditions, NQCI will not attempt before December 1, 2009 (the “Non-Execution
Period”) to execute on or file any motion, petition or application or
commence any proceeding seeking the collection of any attorneys’ fees that have
been awarded in NQCI’s favor under the terms of the Partial Final Award, which
is intended to allow the Parties a sufficient period within which to execute a
definitive acquisition agreement (the “Acquisition Agreement”) in connection
with the Proposed Transaction or a Transaction; provided that such period shall
automatically be extended for a period of 120 days from December 1, 2009 (the
“Extension Date”) if the Acquisition Agreement is executed in full on or before
December 1, 2009. If the execution of the Acquisition Agreement occurs on or
before December 1, 2009, the Extension Date shall automatically be further
extended for a period of 60 days for each amendment to a proxy or information
statement related to the transactions contemplated by the Acquisition Agreement,
filed by us in response to comments made by the SEC.
In the
event we enter into an Acquisition Agreement for the Proposed Transaction
or another Transaction, we anticipate that we will call a special or annual
meeting of our stockholders at which our stockholders will be asked to vote on
the terms of such transaction, pursuant to a proxy or information statement
that we would file with the SEC in connection therewith (the “Stockholder Vote
Date”). If and when we do file such proxy or information statement with the SEC,
our stockholders and other investors are urged to carefully read such statement
and any other relevant documents filed with the SEC when they become available,
because they will contain important information about us and the transaction.
Copies of such proxy or information statement and other documents filed by us
with the SEC will be available at the Web site maintained by the SEC at
www.sec.gov.
The
foregoing summary of the Stipulation and the transactions contemplated thereby,
does not purport to be complete and is subject to, and qualified in its entirety
by, the full text of the Stipulation, which is filed as part of this Quarterly
Report as Exhibit 99.2.
As a
result of the issuance of the Partial Final Award and the execution of the
Stipulation and the Memorandum, the Technology Transaction will not occur, we
will no longer be obligated to issue the 9,230,000 shares of our common stock,
or the “Shares”, to NQCI formerly required pursuant to the terms of the Second
Interim Award issued by the Arbitrator on August 4, 2008, and we will no
longer be required to file a resale registration statement under the Securities
Act for the Shares.
As
described in the MOU and the Stipulation, we intend to focus our efforts to
pursue the formation of the Joint Venture and to effect the Proposed Transaction
or another Transaction and to continue to explore various strategic
alternatives, which may include the license of certain of our intellectual
property rights as a means to further develop our technologies, among other
possible transactions, to the extent such efforts do not violate the terms of
the MOU and the Stipulation.
Corporate
Restructuring
The
deterioration of the economy over the last year, coupled with the prolonged
delay in our ability to reach a resolution with respect to the consummation of
the Technology Transaction, has significantly adversely affected us. Many
of the expectations on which we had based our 2008 and 2009 business development
plans slowly eroded as a result of the lengthy arbitration proceeding with NQCI
commenced in 2006 and continuing into the second quarter of 2009. The
possibility of an adverse decision in the arbitration proceeding with respect to
our ownership right to the Technology has been a major factor in our inability
to secure debt or equity financing. Accordingly, we have had to modify our
activities and business. In response to the general economic downturn affecting
the development of our products and liquidity condition, we have instituted a
variety of measures in an attempt to conserve cash and reduce our operating
expenses. Our actions included:
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Reductions in our labor
force – On March 13, 2009, we gave notice of employment
termination to 19 employees. This represents a total work-force reduction
of approximately 73%. We paid accrued vacation benefits of approximately
$70,000 to the terminated employees. The layoffs and our other efforts
focused on streamlining our operations designed to reduce our annual
expenses by approximately $3.5 million to an operating burn rate of
approximately $200,000 per month. Additionally, we have taken certain
further actions, including deferral of compensation for 5 of our 6
employees and reaching an agreement with the landlord for our operating
facility in Lake Forest, CA, to apply $88,865, in lieu of reimbursement of
such amount to us expended for the incurred improvements at such facility,
toward rent payments going forward (after the drawdown of the 50% of the
tenant improvement allowance applicable to rent payments), to reduce our
burn rate going forward to a current operating burn rate of approximately
$120,000 per month. These actions had to be carefully and
thoughtfully executed and we will take additional actions, if necessary.
Most important to us, in making these difficult decisions, is to give as
much consideration as possible to all of our employees, whom we greatly
value. We hope to be in the financial position in the near future to offer
re-employment to certain of our terminated
employees.
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Refocusing
our available assets and employee resources on the development of the
PAK.
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Continuing
vigorous efforts to minimize or defer our operating
expenses.
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Exploring
various strategic alternatives, which may include the license of certain
of our intellectual property rights, as a means to further develop our
technologies, among other possible transactions and
alternatives.
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Intensifying
our search to obtain additional financing to support our operations and to
satisfy our ongoing capital requirements in order to improve our liquidity
position.
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Continuing to
prosecute our patents and take other steps to perfect our intellectual
property rights.
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In light
of the unprecedented economic slow down, lack of access to capital markets and
prolonged arbitration proceeding with NQCI, we were compelled to undertake the
efforts outlined above in order to remain in the position to continue our
operations. We hope to be able to obtain additional financing to meet our cash
obligations as they become due and otherwise proceed with our business plan. Our
ability to execute on our current business plan is dependent upon our ability to
obtain equity or debt financing, develop and market our products, and,
ultimately, to generate revenue. Unless we are able to raise financing
sufficient to support our operations and to satisfy our ongoing financing
requirements, we will not be able to develop any of our products, submit 510(k)
notifications to the FDA, conduct clinical trials or otherwise commercialize any
of our products. We will make every effort however, to continue the development
of the PAK. As a result of these conditions, there is substantial doubt about
our ability to continue as a going concern. Our ability to continue as a going
concern is substantially dependent on the successful execution of many of the
actions referred to above, on the timeline contemplated by our plans and
our ability to obtain additional financing. We cannot assure you that we will be
successful now or in the future in obtaining any additional financing on terms
favorable to us, if at all. The failure to obtain financing will have a material
adverse effect on our financial condition and operations.
Other
Considerations – Royalty and Other Payments Under the License
Agreement
Initially,
as consideration for entering into the License Agreement, we agreed to pay to
NQCI a minimum annual royalty of $250,000, or 7% of net sales. Although, under
the terms of the Partial Final Award the Arbitrator denied NQCI's application
for interim royalties, we recorded $645,833 in royalty expenses, covering the
minimum royalties, from commencement of the License Agreement through March 31,
2009. Pursuant to the terms of the Partial Final Award issued on April 13, 2009
and the Stipulation and the Memorandum, we have obtained a Perpetual
License in the Technology, the License Agreement will not be terminated and
transfer of the Technology will not occur. In addition, under the terms of the
Partial Final Award, the Arbitrator denied the royalty payments requested by
NQCI to be awarded in the Proceeding and as a result of the execution of the
Stipulation and the Memorandum, we will not be obligated to pay to NQCI any
royalties under the License Agreement going forward. Pursuant to the terms of
the Stipulation and the Memorandum, the accrued royalty expenses of $645,833
were reversed, resulting in a $645,833 non-operating reduction in arbitration
liabilities to the statement of operations for the three and six months ended
June 30, 2009.
The
License Agreement also requires us to reimburse NQCI’s reasonable and necessary
expenses incurred in the ordinary course of business consistent with past
practices, or the “Licensor Expenses”, until the closing or the termination of
the Merger Agreement. Under the terms of the Partial Final Award, the Arbitrator
denied NQCI’s request for award of any additional Licensor Expenses. For a
complete description of the License Agreement and the Proceeding please see Item
3 - “Legal Proceedings” below.
Management’s
Discussion and Analysis
Basis
of Presentation
This “Management’s Discussion and
Analysis of Financial Condition and Results of Operations” section should be
read in conjunction with the accompanying unaudited interim financial statements
which have been prepared assuming that we will continue as a going concern,
which contemplates the realization of assets and the satisfaction of liabilities
in the normal course of business. Our recurring losses from operations and net
capital deficiency raise substantial doubt about our ability to continue as a
going concern. Our ability to continue as a going concern is substantially
dependent on the successful execution of many of the actions referred to above
and otherwise discussed in this “Management’s Discussion and Analysis of
Financial Condition and Results of Operations” section and in Note 2, “Nature of
Operations and Going Concern Uncertainty” to our unaudited interim financial
statements filed as part of this Quarterly Report, on the timeline contemplated
by our plans and our ability to obtain additional financing. The uncertainty of
successful execution of our plans, among other factors, raises substantial doubt
as to our ability to continue as a going concern. The accompanying unaudited
interim financial statements do not include any adjustments that might result
from the outcome of this uncertainty.
Results
of Operations for the three and six months ended June 30, 2009.
We have
not generated any revenues since inception. We incurred a net loss of $1.1
million and $1.2 million for the three and six months ended June 30, 2009,
respectively, compared to a net loss of $5.3 million and $11.7 million for the
three and six months ended June 30, 2008, respectively. The decrease in net loss
was primarily due to (i) non-operating income resulting from accrual reversals
resulting from the issuance of the Partial Final Award and the execution of the
Stipulation and the Memorandum entered into with NQCI in connection with the
Proceeding, (ii) corporate restructuring, (iii) completion and termination of
the Aubrey Agreement, (iv) less legal fees, (v) forfeitures of terminated
employees’ unvested stock options, and (vi) continuous efforts to minimize
current operating expenses. At June 30, 2009, we had a negative working capital
of $2.5 million compared to a positive working capital of $6.2 million at June
30, 2008. At June 30, 2009, our total assets were $1.3 million compared to $4.4
million at December 31, 2008, which consisted primarily of cash raised from the
sale of our common stock sold in December 2006.
Interest
Income
For the
three and six months ended June 30, 2009, respectively, we earned interest
income of $2,835 and $10,742 compared to $82,226 and $234,694 for the three
and six months ended June 30, 2008, respectively. The decrease in interest
income was due to the depletion of cash held in our investment account as a
result of our use of cash for operations.
Liquidity
and Capital Resources
We expect
to incur operating losses and negative cash flows for the foreseeable future.
During the fourth quarter 2006, we raised approximately $27.3 million (net of
placement fees of $2.1 million) through a private placement. Our ability to
execute on our current business plan is dependent upon our ability to secure
additional funding, develop and market our products, and, ultimately, to
generate revenue.
As of
June 30, 2009, we had cash, cash equivalents and marketable securities of
approximately $0.5 million. We expended $0.9 million and $2.9 million of cash
during the three and six months ended June 30, 2009, respectively, and we
project to expend cash at a rate below $0.2 million per month for the remainder
of the 2009 fiscal year based upon the recent restructuring effected by us going
forward. Some of the these restructuring efforts undertaken included deferral of
compensation for 5 of our 6 employees and reaching an agreement with the
landlord for our operating facility in Lake Forest, CA, to apply $88,865, in
lieu of reimbursement of such amount to us expended for the incurred
improvements at such facility, toward rent payments going forward (after the
drawdown of the 50% of the tenant improvement allowance applicable to rent
payments). For a more detailed discussion of our restructuring efforts
undertaken to date, please see above section captioned “Recent Developments -
Corporate Restructuring”. In addition, in accordance with the terms of the
Stipulation and the MOU entered into with NQCI in connection with the
Proceeding, we are obligated to pay damages, costs and legal fees in connection
with the Proceeding described above in an amount of $1.87 million. Based on our current
cash and cash equivalent resources, other current assets, current monthly
operating burn rate, and using assumptions that by nature are imprecise, our
management believes we have available liquidity to fund our limited restructured
operations for the next three months. In addition, our current liabilities
exceeded our current assets as at December 31, 2008 and at the date of this
report. Therefore, we will have to obtain additional debt or equity
financing in approximately the next three months. We may not be successful
in doing so on terms acceptable to us, and the inability to raise capital could
require us to curtail our current plans, which could have a material adverse
effect on our plan of operation or could result in the curtailment of our
operations. Our ability to execute on our current business plan is dependent
upon our ability to obtain equity financing, develop and market our products,
and, ultimately, to generate revenue.
As of
August 11, 2009, we had available cash of approximately $327,000, excluding
restricted cash. We currently have a monthly burn rate of approximately
$120,000. Under these current conditions, we will run out of cash in
approximately 90 days. In addition to previously taken restructuring efforts,
including reduction of personnel, we have also taken steps to reduce our cash
outflows by means of deferring 50% of the monthly compensation for 5 of our 6
active employees. We may consider further reduction of costs in the near future.
However, we need to raise additional funds to be able to continue our
operations. If we are unable to secure additional capital within approximately
the next 90 days, we will be forced to file for bankruptcy and/or cease our
operations. The accompanying financial statements have been prepared on the
basis of a going concern and do not reflect any adjustments due to these
conditions.
We expect
to incur negative cash flows and net losses for the foreseeable future. In
addition, pursuant to the terms of the Partial Final Award, NQCI was awarded an
amount equal to approximately $1.87 million in attorneys’ fees and costs
consistent with the Arbitrator’s order issued on August 13, 2008 related to the
same and NQCI’s application for interim royalties and expenses was denied. We
intend to pay such attorneys’ fees and costs due to NQCI from the proceeds
received in connection with the consummation of the Proposed Transaction, or
another Transaction, if such transaction is consummated, or upon raising of
additional capital to sufficiently satisfy the award and or other immediate
liquidity requirements, which funds we will need to obtain within approximately
the next 90 days. Pursuant to the terms of the Stipulation, NQCI agreed not to
attempt before December 1, 2009 to execute on or file any motion, petition or
application or commence any proceeding seeking the collection of such award of
attorneys’ fees and costs, which is intended to allow the Parties a sufficient
period within which to execute an Acquisition Agreement in connection with the
Proposed Transaction or a Transaction. Such period shall automatically be
extended for a period of 120 days from December 1, 2009 if the acquisition
agreement is executed in full on or before December 1, 2009. In addition, if the
execution of the Acquisition Agreement occurs on or before December 1, 2009, the
December 1, 2009 deadline shall automatically be further extended for a period
of 60 days for each amendment to a proxy or information statement related to the
transactions contemplated by the acquisition agreement, filed by us in
response to comments made by the SEC. However, there can be no assurances that
the Proposed Transaction or any other Transaction will occur.
If we are
unable to enter into an Acquisition Agreement and otherwise comply with the
deadlines and requirements summarized above, under the terms of the Stipulation,
NQCI will have the right to execute on or file any motion, petition or
application or commence any proceeding seeking the collection of the sum of
approximately $1.87 million in attorneys’ fees and costs that have been awarded
in NQCI’s favor under the terms of the Partial Final Award, which would impact
our ability to use and develop our technologies, would have a material adverse
effect on our business and results of operations and may cause us to cease our
operations and/or file for bankruptcy.
Based
upon our current plans, we believe that our existing cash reserves will not be
sufficient to meet our operating expenses and capital requirements before we
achieve profitability. Accordingly, we will be required to seek additional funds
through public or private placement of shares of our preferred or common stock
or through public or private debt financing, or the sale or licensing of our
assets, including the sale of a part, substantially all or all of our assets.
Our ability to meet our cash obligations as they become due and payable will
depend on our ability to sell securities, borrow funds, further reduce operating
costs, sell or license our assets, including the sale of a part, substantially
all or all of our assets, or some combination thereof. We may not be successful
in obtaining necessary funds on acceptable terms, if at all. The inability to
obtain financing could require us to curtail our current plans, which could have
a material adverse effect on our plan of operations. Our ability to execute on
our current business plan is dependent upon our ability to obtain equity
financing, develop and market our products, and, ultimately, to generate
revenue. As a result of these conditions, there is substantial doubt about our
ability to continue as a going concern.
We are
currently actively considering all potential transactions, which may include the
Proposed Transaction (as described above), strategic partnership(s), disposition
of a part, substantially all or all of our assets or a business combination with
another entity in a transaction where we would not be the surviving
entity. Because of the current economic conditions and those particularly
affecting healthcare related companies and because of our lack of liquidity,
there is no assurance that any such transaction will occur or that it would be
accretive to our stockholders or result in any payment being made to our
stockholders. If we are unsuccessful in obtaining immediate debt or equity
financing on terms acceptable to us or otherwise unsuccessful in addressing our
liquidity concerns or if we are unable to enter into any such transaction, this
could have a material adverse effect on our plan of operation, may result in the
curtailment of our operations and/or require us to file for
bankruptcy.
To the
extent we are unsuccessful in having our common stock continuing to list on NYSE
Amex or if NYSE Amex delists our common stock from the exchange and/or as part
of our analysis of ways to reduce costs and in light of the high cost of
continuing to be a public reporting company under the Exchange Act and complying
with the Sarbanes-Oxley Act of 2002, we are contemplating exploring and may be
required to explore alternative platforms, such as having our common stock
quoted on the FINRA Over-The-Counter Bulletin Board (“OTCBB”) or deregistering
under the Exchange Act, or “going dark”, and having our common stock quoted on
the “pink sheets”, which is an automated quotation system under which
broker-dealers publish quotes for trading in over-the-counter
securities. Therefore, we are evaluating the benefits of having our common
stock quoted on the OTCBB or the “pink sheets”. We anticipate that the move
to the OTCBB would provide meaningful savings to us as a result of the
elimination of fees associated with being listed on a national stock exchange
and the move to the pink sheets would provide substantial savings as a result of
the elimination of the costs of being registered under the Exchange
Act. Analysis of a move to the OTCBB or the “pink sheets” involves not only
reducing costs, but also our expected sources of future capital as well as the
number of record holders of our outstanding common stock. A move to having our
common stock quoted on the OTCBB or the “pink sheets” may result in a less
liquid market for our shares and with respect to the “pink sheets” less readily
available information on us, but would result in continued public trading of our
common stock by holders wishing to trade.
Upon
receipt of approximately $27.3 million raised through a private placement during
the fourth quarter of 2006, we strategically began our operating activities and
research and development efforts which resulted in a net loss of $23.0 million
in 2008 and $1.1 million and $1.2 during the three and six months ended June 30,
2009, respectively. In addition, we invested $25.0 million in high grade money
market funds and marketable securities of which we sold $24.6 million of the
investments, leaving a balance of $0.4 million as of June 30,
2009.
We have
focused much of our efforts on development of the PAK, which has not been
derived from the technology covered by the License Agreement. Through the
productive research and development efforts of the PAK, we have completed
functional prototypes of our attended care and home PAKs that we plan to
commercialize after 510(k) clearance from the FDA which we plan to
submit in 2010. Prior to the 510(k) submission to the FDA for clinical use
under direct medical supervision, the units will undergo final verification and
validation. It generally takes 4 to 12 months from the date of a 510(k)
submission to obtain clearance from the FDA, although it may take longer.
We expect that our monthly expenditures will increase as we shift resources
towards developing a marketing plan for the PAK. This plan will be dependant on
our ability to raise funds to satisfy our current liabilities and other
obligations as they become due and obtain additional debt or equity financing.
If we are unsuccessful, we will not be able to submit a 510(k)
notification with the FDA for this product.
We have
used some of our resources for the development of the WAK and have demonstrated
a feasibility prototype. Commercialization of the WAK will require development
of a functional prototype and likely a full pre-market approval by the FDA,
which could take several years. Our rights to the WAK derive in part from the
License Agreement pursuant to which we obtained the exclusive rights to the
Technology. Subject to us first entering into a transaction for the sale of a
part, substantially all or all of our assets, we will determine whether to
devote additional resources to the development of the WAK.
Because
neither the PAK nor the WAK is yet at a stage where it can be marketed
commercially, we are not able to predict the portion of our future business
which will be derived from each.
Research
and Development
We
employed an interdisciplinary team of scientists and engineers who were
developing the PAK and a separate, interdisciplinary team developing the WAK. As
a result of general economic conditions in 2008 and a deterioration of our
liquidity position, coupled with the prolonged delay in our ability to reach a
resolution with respect to the consummation of the Technology Transaction,
we have been significantly adversely affected. As a result, on March 13, 2009 we
terminated 19 employees or 73% of our staff. However, our downsized team is
continuing development of the PAK and we continue to evaluate devoting
additional resources to the development of the WAK. We hope to be in the
financial position in the near future to offer re-employment to certain of our
terminated employees.
In
addition, we had previously retained Aubrey Group, Inc. (“Aubrey”), an
FDA-registered third-party contract developer and manufacturer of medical
devices, to assist with the design and development of subsystems of the PAK,
referred to herein as the “Aubrey Agreement.” As of December 31, 2008, Aubrey
substantially completed its work and we terminated the agreement as of March 31,
2009. A variation of this device will be developed for chronic home
hemodialysis. At the inception of the Aubrey Agreement, total labor and material
costs over the term of the agreement were budgeted to amount to approximately
$5.1 million and as of March 31, 2009, the agreement was completed under the
budgeted amount at a cost of $3.2 million.
The PAK
is a multifunctional device that will perform hemodialysis, hemofiltration and
ultrafiltration under direct medical supervision. A variation of this device
will be developed for chronic home hemodialysis. An initial prototype of the
PAK, capable of performing the basic functions of a hemodialysis machine, and
demonstrating our unique new fluidics circuit, was completed at the end of 2007.
The first physical prototype including industrial design of the PAK was
completed in October 2008. We hope to further refine this prototype by adding to
it safety sensors and electronic controls. Subject to our ability to obtain
debt or equity financing to satisfy our current liabilities and other
obligations as they become due, as more fully described above in the section
captioned “Recent Developments,” we hope to complete the final product
design of the PAK. The PAK units will undergo final verification and validation
prior to a 510(k) submission for clinical use under direct medical supervision.
A clinical study will not be required for this submission.
In a
clinical feasibility study conducted in London in March 2007, a research
prototype of the WAK was demonstrated in eight patients with end-stage renal
disease. Patients were treated for up to eight hours with adequate clearances of
urea and creatinine. The device was well tolerated and patients were able
to conduct activities of normal daily living including walking and sleeping.
There were no serious adverse events although clotting of the dialyzer occurred
in two patients. To our knowledge, this is the first successful demonstration of
a WAK in humans. Subject to us first entering into the Proposed
Transaction or another Transaction for the sale of a part, substantially all or
all of our assets and further subject to availability of sufficient working
capital to us, we hope to make substantial improvements to the WAK. This work
will result in a WAK Generation 2.0. Pending FDA approval of an investigational
Device Exemption (IDE), additional clinical studies will be conducted upon
completion of the Generation 2.0 WAK prototype.
If we
successfully obtain additional financing, we plan to make improvements to the
WAK design intended to move it from a feasibility prototype to a product
prototype. These include improvement of the heparin pumping system intended to
address the dialyzer clotting problem, the addition of safety sensors required
for commercial dialysis equipment, the addition of electrical controls to
provide a convenient user interface, improvements to the blood flow circuit, and
further miniaturization of the device to improve fit to the human body.
Additional clinical studies will be conducted upon completion of the
prototype.
We
incurred $0.6 million and $1.8 million in research and development costs during
the three and six months ended June 30, 2009, respectively. This compares
to $3.5 million and $6.2 incurred during the three and six months ended June 30,
2008, respectively. The decrease in research and development costs is
attributable to the completion and termination of the Aubrey Agreement, our
research and development progress, corporate restructuring, and the entry into
the Stipulation and the MOU with NQCI as described above.
Contractual
Obligations and Commercial Commitments
The
following table sets forth a summary of our material contractual obligations and
commercial commitments as of June 30, 2009:
Contractual Obligations:
|
|
Total
|
|
|
Less than
1 year
|
|
|
1 - 3 years
|
|
|
3 - 5 years
|
|
|
More than
5 years
|
|
Capital
Lease Obligations
|
|
$ |
- |
|
|
$ |
- |
|
|
$ |
- |
|
|
$ |
- |
|
|
$ |
- |
|
Operating
Lease Obligations (1)
|
|
|
2,256,148 |
|
|
|
245,062 |
|
|
|
1,677,342 |
|
|
|
333,744 |
|
|
|
- |
|
Research
& Development Contractual Commitments
|
|
|
10,000 |
|
|
|
10,000 |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
Other
Liabilities
|
|
|
2,510 |
|
|
|
2,510 |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
$ |
2,268,658 |
|
|
$ |
257,572 |
|
|
$ |
1,677,342 |
|
|
$ |
333,744 |
|
|
$ |
- |
|
(1)
Operating lease commitments for our corporate office, operating facility, Dr.
Gura’s office (a related party transaction), and equipment. On April 18, 2009,
the lease for our remaining corporate apartment expired and said property was
vacated.
Off-Balance
Sheet Arrangements
As of
June 30, 2009, we had no off-balance sheet arrangements that have or are
reasonably likely to have a current or future effect on our financial condition,
results of operations or cash flows.
Critical
Accounting Policies and Estimates
The
discussion and analysis of our financial condition and results of operations is
based upon our unaudited interim financial statements, which have been prepared
in accordance with accounting principles generally accepted in the United
States. Generally accepted accounting principles require management to make
estimates, judgments and assumptions that affect the reported amounts of assets,
liabilities, revenues and expenses, and the disclosure of contingent assets and
liabilities. We base our estimates on experience and on various other
assumptions that we believe to be reasonable under the circumstances, the
results of which form the basis for making judgments about the carrying values
of assets and liabilities that may not be readily apparent from other sources.
Our actual results may differ from those estimates.
We
consider our critical accounting policies to be those that involve significant
uncertainties, require judgments or estimates that are more difficult for
management to determine or that may produce materially different results when
using different assumptions. We consider the following accounting policies to be
critical:
Marketable
Securities
We
classify investments with maturity dates greater than three months when
purchased as marketable securities. Investments, including certificates of
deposit with maturity dates greater than three months when purchased, and which
have readily determined fair values, are classified as available-for-sale
investments and reflected in current assets as marketable securities at fair
market value. Historically, we have complied with our investment policy
which requires that all investments be investment grade quality and no more than
ten percent of our portfolio may be invested in any one security or with one
institution. However, recently, our ability to continue to follow this policy
has not been practicable due to the small aggregate amount of investment funds
that has been remaining for investment. As a result, as of June 30, 2009, all of
our cash was held in high grade money market funds and commercial
paper.
Short-term investments classified as
available-for-sale were as follows:
|
|
June 30, 2009
|
|
|
|
Aggregate Fair
Value
|
|
|
Gross Unrealized
Gains / (Losses)
|
|
|
Estimated Fair
Value
|
|
Commercial
paper
|
|
$ |
250,000 |
|
|
$ |
- |
|
|
$ |
250,000 |
|
Corporate
securities fixed rate
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$ |
250,000 |
|
|
$ |
- |
|
|
$ |
250,000 |
|
We review
impairments associated with the above in accordance with SFAS No. 115,
“Accounting for Certain Investments in Debt and Equity Securities,” and FASB
Staff Position FAS 115-1 and FAS 124-1, “The Meaning of Other-Than-Temporary
Impairment and Its Application to Certain Investments,” to determine the
classification of the impairment as temporary or other-than-temporary. We
consider these investments not to be impaired as of June 30, 2009.
There
were no gross unrealized gains or losses as of June 30, 2009.
Shares
Issuable
Pursuant
to the August 4, 2008, Second Interim Award, stating that, if the Technology
Transaction is submitted to and approved by our stockholders, 9,230,000 shares
of our common stock should be issued to NQCI to effectuate the transaction, we
accrued for the 9,230,000 shares of our common stock. As the Second Interim
Award stated that we must issue 9,230,000 upon the closing of the Technology
Transaction and we have been unable to consummate such transaction, such
contingency not within our control and we have therefore, recorded the issuance
as a liability, rather than as an equity issuance. As of December 31, 2008, we
accrued for the 9,230,000 shares of our common stock to be issued to NQCI in
accordance with FASB 5,
Accounting for Contingencies, with the initial fair value of the shares
measured on August 4, 2008, the date of the Second Interim Award. Until issuance, the
shares were being marked to market in accordance with Emerging Issues Task Force
No. 00-19, Accounting for
Derivative Financial Instruments Indexed to and Potentially Settled in, a
Company’s Own Stock (“EITF 00-19”),
with subsequent changes in fair value recorded as non-operating change in fair
value of shares issuable to our statement of operations. The fair value of the
shares was measured using the closing price of our common stock on the reporting
date. The measured fair value of $10,153,000 for the accrued 9,230,000 shares on
August 4, 2008, the date of the Second Interim Award, was accrued under “Shares
issuable” and expensed to “Research and development.” From marking to market,
the fair value of the shares issuable was revalued at $1,569,100 as of December
31, 2008. The resulting non-operating adjustment in fair value of $8,583,900 to
the statement of operations for the year ended December 31, 2008 was recognized
as “Change in fair value of shares issuable.” The Technology
Transaction was not submitted to our stockholders for approval.
As a
result of the issuance of the Partial Final Award and the execution of the
Stipulation and the Memorandum, see Note 4, “Legal Proceedings” above, the
Technology Transaction will not occur and we will no longer be obligated to
issue the Shares to NQCI formerly required pursuant to the terms of the Second
Interim Award issued by the Arbitrator on August 4, 2008, and will no longer be
required to file a resale registration statement under the Securities Act for
the Shares. Accordingly, the net fair value of $1,569,100 for the 9,230,000
issuable shares accrued under “Shares issuable” as of December 31, 2008, was
reversed resulting in an adjustment of $1,569,100 to non-operating income in the
statement of operations, recognized as “Change in and reduction of shares
issuable”, for the six months ended June 30, 2009.
Stock-Based
Compensation
Statements
of Financial Accounting Standards (SFAS) No. 123 (revised 2004), Share-Based Payment, (SFAS
123(R)) and Securities and Exchange Commission issued Staff Accounting Bulletin
(SAB) No. 107 (SAB 107) require the measurement and recognition of compensation
expense for all share-based payment awards made to employees and directors based
on estimated fair values. We have applied the provisions of SAB 107 in its
adoption of SFAS 123(R).
In
determining stock based compensation, we consider various factors in our
calculation of fair value using a black-scholes pricing model. These factors
include volatility, expected term of the options, and forfeiture rates. A change
in these factors could result in differences in the stock based compensation
expense.
Recent
Accounting Pronouncements
In
April 2009, the FASB released FSP SFAS No. 107-1 and APB 28-1, Interim Disclosure about Fair Value
of Financial Instruments (“SFAS No. 107-1”). SFAS No. 107-1
requires interim disclosures regarding the fair values of financial instruments
that are within the scope of SFAS No. 107, Disclosures about the Fair Value of
Financial Instruments. Additionally, SFAS No. 107-1 requires
disclosure of the methods and significant assumptions used to estimate the fair
value of financial instruments on an interim basis as well as changes of the
methods and significant assumptions from prior periods. SFAS No. 107-1 does
not change the accounting treatment for these financial instruments and is
effective for interim and annual periods ending after June 15, 2009. We
adopted SFAS No. 107-1 for the interim period ended June 30, 2009.
In
May 2009, the FASB issued SFAS No. 165, “Subsequent Events,” or SFAS
165. SFAS 165 sets forth the period after the balance sheet date during which
management of a reporting entity should evaluate events or transactions that may
occur for potential recognition or disclosure in the financial statements, the
circumstances under which an entity should recognize events or transactions
occurring after the balance sheet date in its financial statements, and the
disclosures that an entity should make about events or transactions that
occurred after the balance sheet date. SFAS 165 will be effective for interim or
annual periods ending after June 15, 2009 and will be applied
prospectively. We adopted the provisions of FAS 165 for the quarter ended
June 30, 2009. The adoption of SFAS No. 165 did have a material impact
on our financial position, results of operations and cash flows.
In
June 2009, the FASB issued FAS No. 168, “The FASB Accounting Standards
Codification (Codification) and the Hierarchy of GAAP” (FAS No. 168), which
replaces FAS No. 162, “The Hierarchy of GAAP” and establishes the
Codification as the single source of authoritative U.S. GAAP recognized by the
FASB to be applied by nongovernmental entities. SEC rules and interpretive
releases are also sources of authoritative GAAP for SEC registrants. FAS
No. 168 modifies the GAAP hierarchy to include only two levels of GAAP:
authoritative and non-authoritative. FAS No. 168 is effective beginning for
periods ended after September 15, 2009. As FAS No. 168 is not intended
to change or alter existing GAAP, it will not impact the Company’s financial
position, results of operations and cash flows.
ITEM
3. Quantitative and Qualitative Disclosures
about Market Risk
We invest
our cash in short term high grade commercial paper, certificates of deposit,
money market accounts, and marketable securities. We consider any liquid
investment with an original maturity of three months or less when purchased to
be cash equivalents. We classify investments with maturity dates greater than
three months when purchased as marketable securities, which have readily
determined fair values and are classified as available-for-sale securities. Our
investment policy requires that all investments be investment grade quality and
no more than ten percent of our portfolio may be invested in any one security or
with one institution. Historically, we complied with our investment
diversification policy which states that no more than ten percent of our total
marketable securities will be invested in a single, specific security. However,
our ability to continue to abide by this stipulation has not been practicable
based upon the small total amount of investment funds.
Investments
in both fixed rate and floating rate interest earning instruments carry a degree
of interest rate risk arising from changes in the level or volatility of
interest rates; however, interest rate movements do not materially affect the
market value of our portfolio because of the short-term nature of these
investments. A reduction in the overall level of interest rates may produce
less interest income from our investment portfolio. The market risk associated
with our investments in debt securities is substantially mitigated by the
frequent turnover of our portfolio.
ITEM
4. Controls and Procedures
Evaluation
of Disclosure Controls and Procedures
Our
management, with the participation of our Chief Executive Officer and our Chief
Financial Officer, conducted an evaluation of the effectiveness of our
disclosure controls and procedures as of the end of the period covered by this
Quarterly Report, as is defined in Rules 13a-15(e) and 15d-15(e) promulgated
under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Our
disclosure controls and procedures are intended to ensure that the information
we are required to disclose in the reports that we file or submit under the
Exchange Act is (i) recorded, processed, summarized and reported within the time
periods specified in the SEC’s rules and forms and (ii) accumulated and
communicated to our management, including the Chief Executive Officer and Chief
Financial Officer, as appropriate, as the principal executive and financial
officer, to allow timely decisions regarding required disclosures.
Based on
that evaluation, our Chief Executive Officer and Chief Financial Officer
concluded that, as of the end of the period covered by this Quarterly Report,
our disclosure controls and procedures were effective. Our management has
concluded that the financial statements included in this Quarterly Report
present fairly, in all material respects our financial position, results of
operations and cash flows for the periods presented in conformity with generally
accepted accounting principles.
It should
be noted that any system of controls, however well designed and operated, can
provide only reasonable, and not absolute, assurance that the objectives of the
system will be met. In addition, the design of any control system is based in
part upon certain assumptions about the likelihood of future events. Because of
these and other inherent limitations of control systems, there can be no
assurance that any design will succeed in achieving its stated goals under all
potential future conditions.
Changes
in Internal Control over Financial Reporting
In
connection with the evaluation of our internal controls during our last fiscal
quarter, our Chief Executive Officer and Chief Financial Officer concluded that
there have been no changes in our internal control over financial reporting, as
defined in Rule 13a-15(f) under the Exchange Act during our most recent fiscal
quarter that have materially affected, or are reasonably likely to materially
affect our internal control over financial reporting.
PART
II — OTHER INFORMATION
ITEM
1. Legal Proceedings.
From time
to time we may be a defendant or plaintiff in various legal proceedings arising
in the normal course of our business. Except as set forth below, we are
currently not a party to any material pending legal proceedings or government
actions, including any bankruptcy, receivership, or similar proceedings. In
addition, except as set forth below, our management is not aware of any known
litigation or liabilities that could affect our operations. Furthermore, with
the exception of Dr. Gura, our Chief Medical and Scientific Officer, who
according to NQCI’s preliminary Proxy Statement on Schedule 14A, Amendment No.
2, filed with the SEC on February 13, 2009, owns 15,497,250 shares of NQCI’s
common stock which includes 800,000 shares held by Medipace Medical Group, Inc.
an affiliate of Dr. Gura and includes 250,000 shares subject to warrants held by
Dr. Gura which are currently exercisable, or approximately 20.9% of its total
outstanding shares as of January 31, 2009, we do not believe that there are any
proceedings to which any of our directors, officers, or affiliates, any owner of
record who beneficially owns more than five percent of our common stock, or any
associate of any such director, officer, affiliate of ours, or security holder
is a party adverse to us or has a material interest adverse to us.
On
December 1, 2006, Operations initiated the Proceeding against NQCI for its
breach of the License Agreement. On April 13, 2009, the Arbitrator issued a
Partial Final Award which resolved the remaining issues that were pending
for decision in the Proceeding. The Partial Final Award adopted one of the
proposals submitted to the Arbitrator by us and provides that we and Operations
shall have a perpetual exclusive license (the “Perpetual License”) in the
Technology (as defined in the Merger Agreement, dated as of September 1, 2006
(the “Merger Agreement”), among the Company, Operations and NQCI and the License
Agreement, dated as of September 1, 2006 (the “License Agreement”), between the
Company and NQCI) primarily related to the Wearable Artificial Kidney and any
other Technology contemplated to be transferred under the Technology Transaction
(as defined in the Merger Agreement). Under the terms of the Partial Final
Award, in consideration of the Perpetual License to the Company, NQCI was
awarded a royalty of 39% of all net income, ordinary or extraordinary,
received by us (the “Royalty”) and NQCI is to receive 39% of any shares received
in any merger transaction to which the Company or Operations may become a party.
NQCI’s interest as licensor under the Perpetual License shall be freely
assignable. In addition, the Partial Final Award provides that we shall pay NQCI
an amount equal to approximately $1,871,000 in attorneys’ fees and costs
previously awarded by the Arbitrator in an order issued on August 13, 2008, that
NQCI’s application for interim royalties and expenses is denied and that NQCI is
not entitled to recover any additional attorneys’ fees. Finally, the Partial
Final Award also provides that the Arbitrator shall retain jurisdiction to
supervise specific performance of the terms and obligations of the Award
including, but not limited to, any dispute between the parties over the manner
of calculation of the Royalty. The Partial Final Award was issued by the
Arbitrator as a result of each party’s request for the Arbitrator to order
alternative relief due the parties’ inability to proceed with the Technology
Transaction. For a full description of the Proceeding and the Arbitrator’s
interim awards issued in connection therewith, please see Item 3 - Legal
Proceedings of our Annual Report.
On April
17, 2009, NQCI requested that the Arbitrator correct material terms of the
Partial Final Award relating to the meaning and calculation of the Royalty
terms. We opposed the request and on May 1, 2009, the Arbitrator denied NQCI’s
request to modify the language of the Partial Final Award. The Arbitrator
further held that past expenses shall not be included in net income computations
for purposes of the Royalty, that NQCI may make an application to the Arbitrator
requesting a royalty distribution, specifying the amount sought and basis for
the claimed amount, and that NQCI is entitled to audit our financial statements,
books and records to verify our net income, on an annual basis, or more often,
if the Arbitrator permits.
Binding Memorandum
of
Understanding
On August
7, 2009, to clarify, resolve and settle certain issues and any disputes that
have arisen between us and NQCI with respect to the Partial Final Award and the
Proceeding, the Xcorp Parties entered into the Memorandum with NQCI. Under the
terms of the Memorandum, among other things, the Parties agreed to: (i) assign
and transfer all of their rights, title and interest in and to the Polymer
Technology to the Joint Venture, which will be jointly owned by the Parties and
through which the Parties will jointly pursue the development and
exploitation of the Polymer Technology, and (ii) negotiate, execute and deliver
within 60 days following the Stockholder Vote Date the Operating Agreement
governing the operation of the Joint Venture based on the terms set forth in the
Memorandum.
The Xcorp
Parties and NQCI will be the initial two members of the Joint Venture (Xcorp
Parties’ interest shall be held of record by either us or Operations, as
determined by the Xcorp Parties) with NQCI and the Xcorp Parties having a 60%
and 40% membership interest (the “Membership Interests”) in the Joint Venture,
respectively. Subject to such other terms and provisions as the Parties may
agree upon, the Operating Agreement shall include the following
terms:
|
·
|
the
Joint Venture shall be managed by a three-member JV
Board;
|
|
·
|
until
such time as NQCI fails to hold a greater percentage of the Membership
Interests than the Xcorp Parties, two members of the JV Board shall be
designated by NQCI and until such time as the Xcorp Parties fail to hold
at least 10% of the Membership Interests and one JV Manager shall be
designated by the Xcorp Parties;
|
|
·
|
NQCI
shall have the right to appoint a Chairman and/or a Chief Executive
Officer of the Joint Venture, who will have day-to-day management
authority with respect to the Joint Venture, subject to oversight by the
JV Board and the terms and conditions of the Memorandum and the Operating
Agreement, and a Chief Scientific Officer, who may be employed by the
Joint Venture upon customary and reasonable terms and
conditions;
|
|
·
|
if
a JV Manager provides additional services to the Joint Venture as an
employee or a consultant, he or she may be compensated by the Joint
Venture as is mutually reasonably approved in writing by the Parties;
provided that with the exception of reimbursement of reasonable expenses
incurred in connection with their services performed for the Joint Venture
in their official officer capacity, neither Robert Snukal, the Chief
Executive Officer of NQCI, nor Kelly McCrann, our Chairman and Chief
Executive Officer, (or such other persons as may be appointed or elected
in their place) shall in any event receive a salary or other compensation
from the Joint Venture;
|
|
·
|
except
as otherwise required by law, all decisions related to the operations of
the Joint Venture shall be made by a majority of the JV Board, except that
certain actions (as described in the Memorandum) by the Joint Venture or
any of its subsidiaries shall require the affirmative vote or written
consent of the holders of at least 90.1% of the Membership Interests then
outstanding; and
|
|
·
|
from
and after August 1, 2009, the Xcorp Parties shall pay 61% and NQCI shall
pay 39% of the reasonable costs and expenses related to protecting,
preserving and exploiting the Licensed
Technology.
|
In
addition, the Xcorp Parties agreed to contribute $500,000 in cash to the bank
account established by the Joint Venture, on the later of (x) three business
days of the consummation of the first to occur of the Proposed Transaction or
another Transaction and (y) the date on which the Joint Venture establishes such
bank account, for which the Parties (or their representatives) shall be joint
signatories. Furthermore, provided that the Proposed Transaction or a
Transaction has been consummated, NQCI agreed to contribute on the Xcorp
Parties’ behalf an additional $500,000 in cash to the Joint Venture at such time
as the JV Board reasonably determines that such funds are required to facilitate
the Joint Venture’s development of the Polymer Technology. This additional
contribution amount will be reimbursed to NQCI by the Xcorp Parties from the
first funds distributed to the Xcorp Parties by the Joint Venture (other than
pursuant to certain quarterly tax related distributions). Additionally, with
respect to the Joint Venture, the Parties agreed to certain liquidity rights
consisting of customary rights of first refusal and co-sale rights, unlimited
piggyback registration rights and the right to up to two demand registrations
(subject to lock-ups and other underwriter requirements), customary preemptive
rights (available to a member of the Joint Venture for so long as such member
holds at least 10% of the Membership Interests then outstanding), customary
anti-dilution protections and other standard distribution and information
rights.
The
Parties also agreed to cooperate as reasonably required by the Xcorp Parties in
order for us to consummate the Proposed Transaction for the sale of the Licensed
Technology or another Transaction involving the sale, license or other
disposition by us of the Licensed Technology. The Parties further agreed that
upon the consummation of a Proposed Transaction, they will allocate the
Transaction Proceeds received in such transaction in accordance with the terms
set forth in the Memorandum and summarized below, subject to the actual terms of
the Proposed Transaction, when and if such transaction is consummated. However,
there can be no assurances that the Proposed Transaction or any other
Transaction will occur or that the terms thereof will be similar to those
provided for in the Memorandum and summarized below, and the actual terms of the
Proposed Transaction or another Transaction will be provided for in the
definitive agreement entered into in connection with such
transaction.
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NQCI
shall receive the NQCI Amount;
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The
third party will pay the Xcorp Parties $250,000 upon the earlier of the
signing of a letter of intent and an acquisition agreement providing for
the Proposed Transaction, approximately 50% (less the foregoing $250,000)
of the Transaction Proceeds payable in cash to the Xcorp Parties as the
First Installment, approximately 25% of such proceeds as the Second
Installment and 25% of such
proceeds as the Third Installment;
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The
Transaction Proceeds shall be allocated between the Parties as follows:
(i) $250,000 to the Xcorp Parties, payable to the Xcorp Parties on the
earlier of the signing of a letter of intent and an acquisition agreement
providing for the Proposed Transaction, (ii) to NQCI, an amount equal to
the NQCI Amount less the sum of the Second Installment and the Third
Installment, payable to NQCI within seven business days of receipt of the
First Installment, (iii) to the Xcorp Parties, the remainder of the First
Installment, (iv) to NQCI, the amount of the Second Installment, payable
to NQCI within three business days of receipt of the Second Installment,
(v) to NQCI, the amount of the Third Installment, payable to NQCI within
three business days of receipt of the Third Installment and (vi) the
remainder of the Transaction Proceeds shall be retained by the Xcorp
Parties; provided that under no circumstances shall NQCI be entitled to or
receive from the Transaction Proceeds an amount greater than the NQCI
Amount;
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In
the event any of the Installments are paid by the third party in other
than cash, NQCI shall receive its proportionate share of such
consideration in accordance with the terms of the Memorandum;
and
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The
Xcorp Parties shall also pay to NQCI 39% of any royalty or other payments
received by the Xcorp Parties in excess of the Transaction Proceeds in
connection with the Proposed
Transaction.
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In the event that the timing or the
amount of the payments from the third party under the terms of the Proposed
Transaction (or another Transaction) is other than as contemplated in the
Memorandum, the Parties shall make such equitable adjustments as are required to
preserve, to the maximum extent possible, the intent of the distribution of
Transaction Proceeds provisions of the Memorandum. In the event that the Xcorp
Parties do not consummate the Proposed Transaction or if the terms of the
Proposed Transaction are other than what is contemplated under the Memorandum
and the Xcorp Parties instead consummate an alternative Transaction, the Parties
shall apply the methodology specified in the Memorandum to the maximum extent
possible in order to allocate between them the proceeds of such
Transaction.
Additionally, NQCI agreed to use its
best efforts to enter into an agreement with a certain third party pursuant to
which such third party and NQCI will each (a) confirm and acknowledge (i) their
joint ownership of the Polymer Technology, (ii) the existence and validity of
the exclusive license to NQCI of the medical applications of the Polymer
Technology and (iii) the existence and validity of the exclusive license to such
third party of the non-medical applications of the Polymer Technology; and (b)
agree to prepare, execute and deliver as promptly as practicable upon request by
either of such parties a definitive license agreement reflecting the terms and
conditions of the foregoing exclusive licenses. The Parties also agreed to
certain customary representation and warranty, indemnity and other miscellaneous
terms.
The
foregoing summary of the Memorandum and the transactions contemplated thereby,
does not purport to be complete and is subject to, and qualified in its entirety
by, the full text of the Memorandum, which is filed as part of this Quarterly
Report as Exhibit 10.1.
Agreement and Stipulation
Regarding Partial Final Award
In
connection with the issuance of the Partial Final Award and the execution of the
Memorandum between the Parties, on August 7, 2009 Operations entered into the
Stipulation with NQCI, pursuant to which, Operations and NQCI agreed (i) not to
challenge the terms of the Partial Final Award or any portion of such award,
(ii) that any of the Parties may, at any time, seek to confirm all but not part
of the Partial Final Award through the filing of an appropriate petition or
motion with the appropriate court and in response to such action to confirm the
Partial Final Award, no Party will oppose, object to or in any way seek to
hinder or delay the court’s confirmation of the Partial Final Award, but will in
fact support and stipulate to such confirmation, (iii) to waive any and all
right to appeal from, seek appellate review of, file or prosecute any lawsuit,
action, motion or proceeding, in law, equity, or otherwise, challenging,
opposing, seeking to modify or otherwise attacking the confirmed Partial Final
Award or the judgment thereon and (iv) subject to certain conditions, NQCI will
not attempt during the Non-Execution Period to execute on or file any motion,
petition or application or commence any proceeding seeking the collection of any
attorneys’ fees that have been awarded in NQCI’s favor under the terms of the
Partial Final Award, which is intended to allow the Parties a sufficient period
within which to execute an Acquisition Agreement in connection with the Proposed
Transaction or a Transaction; provided that such period shall automatically be
subject to an Extension Date if the Acquisition Agreement is executed in full on
or before December 1, 2009. If the execution of the Acquisition Agreement occurs
on or before December 1, 2009, the Extension Date shall automatically be further
extended for a period of 60 days for each amendment to a proxy or information
statement related to the transactions contemplated by the Acquisition Agreement,
filed by us in response to comments made by the SEC.
In the
event we enter into an Acquisition Agreement for the Proposed Transaction
or another Transaction, we anticipate that we will call a special or annual
meeting of our stockholders at which our stockholders will be asked to vote on
the terms of such transaction, pursuant to a proxy or information statement that
we would file with the SEC in connection therewith. If and when we do file such
proxy or information statement with the SEC, our stockholders and other
investors are urged to carefully read such statement and any other relevant
documents filed with the SEC when they become available, because they will
contain important information about us and the transaction. Copies of such proxy
or information statement and other documents filed by us with the SEC will be
available at the Web site maintained by the SEC at www.sec.gov.
The
foregoing summary of the Stipulation and the transactions contemplated thereby,
does not purport to be complete and is subject to, and qualified in its entirety
by, the full text of the Stipulation, which is filed as part of this Quarterly
Report as Exhibit 99.2.
As a
result of the issuance of the Partial Final Award and the execution of the
Stipulation and the Memorandum, the Technology Transaction will not occur, we
will no longer be obligated to issue the 9,230,000 shares of our common stock,
or the “Shares”, to NQCI and we will no longer be required to file a resale
registration statement under the Securities Act for the Shares.
ITEM
1A. Risk Factors.
Investing
in our common stock involves a high degree of risk. In addition to the
information set forth in this report, you should carefully consider and evaluate
the risks described under section captioned “Risk Factors” in Part I, Item 1A of
our Annual Report and the updated risk factors noted below. While we
describe each risk separately herein and in the Annual Report, some of these
risks are interrelated and certain risks could trigger the applicability of
other risks described below. Also, the risks and uncertainties described below
and in the Annual Report are not the only ones that we may face. Additional
risks and uncertainties not presently known to us, or that we currently do not
consider significant, could also potentially impair, and have a material adverse
effect on, our business, results of operations and financial condition. If any
of these risks occur, our business, results of operations and financial
condition could be harmed, the price of our common stock could decline, and
future events and circumstances could differ significantly from those
anticipated in the forward-looking statements contained in this Quarterly
Report. As a result the trading price of our common stock may decline, and you
might lose part or all of your investment.
Except
for the updated risk factors set forth below, there have been no material
changes in our risk factors from those described in Part 1, Item 1A, “Risk
Factors”, in our Annual Report, other than those risk factors updated in Part
II, Item 1A, “Risk Factors”, in our Quarterly Report, on Form 10-Q for the three
months ended March 31, 2009 as filed with the SEC on May 15, 2009.
If
we are unable to enter into an Acquisition Agreement before December 1, 2009 and
otherwise comply with the deadlines and requirements summarized below, under the
terms of the Stipulation, NQCI will have the right to execute on or file any
motion, petition or application or commence any proceeding seeking the
collection of the sum of approximately $1.87 million in attorneys’ fees and
costs that have been awarded in NQCI’s favor under the terms of the Partial
Final Award, which would impact our ability to use and develop our
technologies, would have a material adverse effect on our business and
results of operations and may cause us to cease our operations and/or file for
bankruptcy.
On
December 1, 2006, Operations initiated the Proceeding against NQCI for its
breach of the License Agreement. On April 13, 2009, the Arbitrator issued a
Partial Final Award which resolved the remaining issues that were pending
for decision in the Proceeding. Among other things, the Partial Final Award
provided that we shall pay NQCI an amount equal to approximately $1,871,000 in
attorneys’ fees and costs previously awarded by the Arbitrator in an order
issued on August 13, 2008, that NQCI’s application for interim royalties and
expenses is denied and that NQCI is not entitled to recover any additional
attorneys’ fees.
On August
7, 2009, in connection with the issuance of the Partial Final Award and the
execution of the Memorandum between the Parties, Operations entered into the
Stipulation with NQCI, pursuant to which, Operations and NQCI agreed (i) not to
challenge the terms of the Partial Final Award or any portion of such award,
(ii) that any of the Parties may, at any time, seek to confirm all but not part
of the Partial Final Award through the filing of an appropriate petition or
motion with the appropriate court and in response to such action to confirm the
Partial Final Award, no Party will oppose, object to or in any way seek to
hinder or delay the court’s confirmation of the Partial Final Award, but will in
fact support and stipulate to such confirmation, (iii) to waive any and all
right to appeal from, seek appellate review of, file or prosecute any lawsuit,
action, motion or proceeding, in law, equity, or otherwise, challenging,
opposing, seeking to modify or otherwise attacking the confirmed Partial Final
Award or the judgment thereon and (iv) subject to certain conditions, NQCI will
not attempt during the Non-Execution Period to execute on or file any
motion, petition or application or commence any proceeding seeking the
collection of any attorneys’ fees that have been awarded in NQCI’s favor under
the terms of the Partial Final Award, which is intended to allow the Parties a
sufficient period within which to execute an Acquisition Agreement providing for
the Proposed Transaction or a Transaction; provided that such period shall
automatically be extended until the Extension Date (March 31, 2010, or 120 days
from December 1, 2009) if the Acquisition Agreement is executed in full on or
before December 1, 2009. If the execution of the Acquisition Agreement occurs on
or before December 1, 2009, the Extension Date shall automatically be further
extended for a period of 60 days for each amendment to a proxy or information
statement related to the transactions contemplated by the Acquisition Agreement,
filed by us in response to comments made by the SEC.
If we are
unable to enter into an Acquisition Agreement providing for the Proposed
Transaction or another Transaction before December 1, 2009, if we fail to file
an information or proxy statement related to such transaction before the
Extension Date (March 31, 2010) or if we are unable to file an amendment to such
information or proxy statement within 60 days after the applicable extended
Extension Date, under the terms of the Stipulation, NQCI will have the right to
execute on or file any motion, petition or application or commence any
proceeding seeking the collection of any attorneys’ fees that have been awarded
in NQCI’s favor under the terms of the Partial Final Award, which would impact
our ability to use and develop our technologies, would have a material adverse
effect on our business and results of operations and may cause us to cease our
operations and/or file for bankruptcy.
If
we fail to meet continued listing standards of NYSE Amex or NYSE Amex commences
a proceeding to delist our common stock from the exchange, our common stock may
be delisted from NYSE Amex which would have a material adverse effect on
the price of our common stock.
Our
common stock is currently traded on the NYSE Amex under the symbol “XCR”. In
order for our securities to be eligible for continued listing on NYSE Amex, we
must remain in compliance with certain NYSE Amex continued listing standards. As
of December 31, 2008, we were not in compliance with Sections 1003(a)(i),
1003(a)(ii) and 1003(a)(iii) of the Amex Company Guide (the “Company Guide”)
because our stockholders’ equity was below the level required by the NYSE Amex
continued listing standards. Our stockholders’ equity fell below the required
standard due to several years of operating losses. NYSE Amex will normally
consider suspending dealings in, or removing from the listing of, securities of
a company under Section 1003(a)(i) for a company that has stockholders’ equity
of less than $2,000,000 if such company has sustained losses from continuing
operations and/or net losses in two of its three most recent fiscal years, under
Section 1003(a)(ii) for a company that has stockholders’ equity of less than
$4,000,000 if such company has sustained losses from continuing operations
and/or net losses in three of its four most recent fiscal years or under Section
1003(a)(iii) for a company that has stockholders’ equity of less than $6,000,000
if such company has sustained losses from continuing operations and/or net
losses in its five most recent fiscal years. As of December 31, 2008, our
stockholders' equity was below that required under Sections 1003(a)(i),
1003(a)(ii) and 1003(a)(iii) of the Amex Company Guide and we have sustained net
losses in our five most recent fiscal years.
On May
15, 2009, we received notice (the “Notice”) from the staff of the NYSE Amex
indicating that we were not in compliance with certain of NYSE Amex’s continued
listing standards as set forth in Part 10 of the Company Guide. Specifically,
according to the Notice, we were not in compliance with
Section 1003(a)(iv) of the Company Guide in that we have “sustained losses
which are so substantial in relation to [our] overall operations or [our]
existing financial resources, or [our] financial condition has become so
impaired that it appears questionable, in the opinion of NYSE Amex, as to
whether [we] will be able to continue operations and/or meet [our] obligations
as they mature.”
In order
to maintain its listing on Amex, we were required to submit a plan of compliance
(a “Plan”) to NYSE Amex by June 15, 2009, advising NYSE Amex of the actions
we have taken or intend to take to regain compliance with
Section 1003(a)(iv) by November 16, 2009. Subsequently, we submitted a Plan
to NYSE Amex before the June 15, 2009 deadline and NYSE Amex is currently in the
process of reviewing the Plan. If the Plan is not accepted by NYSE Amex, we will
be subject to delisting proceedings. If NYSE Amex accepts the Plan, then we will
be able to continue our listing during the Plan period, during which time we
will be subject to periodic reviews to determine whether it is making progress
consistent with the Plan. Even if the Plan is accepted, if we are not in
compliance with the continued listing standards of the Company Guide by November
16, 2009, or if we do not make progress consistent with the Plan during such
period, NYSE Amex will initiate delisting proceedings as
appropriate.
In
accordance with the terms of the Notice, we have been included in a list of
issuers that are not in compliance with NYSE Amex’s continued listing standards,
which is posted at www.amex.com and includes the specific listing standard(s)
with which a company does not comply. Our common stock continues to trade on
NYSE Amex. NYSE Amex has advised us that NYSE Amex is utilizing the
financial status indicator fields in the Consolidate Tape Association’s
Consolidated Tape System (“CTS”) and Consolidated Quote Systems (“CQS”) Low
Speed and High Speed Tapes to identify companies that are noncompliant with NYSE
Amex’s continued listing standards and/or delinquent with respect to a required
federal securities law periodic filing. Accordingly, we have become subject to
the trading symbol extension “.BC” to denote our noncompliance. The indicator
will not change our trading symbol itself, but will be disseminated as an
extension of our symbol on the CTS and CQS whenever our trading symbol is
transmitted with a quotation or trade.
If NYSE
Amex does not accept our Plan or we receive notification from the NYSE Amex that
we are no longer in compliance with other continued listing requirements and if
we fail to regain compliance with such continued listing requirements,
our common stock may be delisted which would have a material adverse affect
on the price and liquidity of our common stock.
Furthermore,
we cannot assure you that we will continue to satisfy other requirements
necessary to remain listed on the NYSE Amex or that the NYSE Amex will not take
additional actions to delist our common stock. If for any reason, our common
stock were to be delisted from the NYSE Amex, we may not be able to list our
common stock on another national exchange or market. If our common stock is not
listed on a national exchange or market, the trading market for our common stock
may become illiquid.
The
requirements of being a public company, including compliance with the reporting
requirements of the Exchange Act and the requirements of the Sarbanes-Oxley Act
of 2002, strains our resources, increases our costs and may distract management,
and we may be unable to comply with these requirements in a timely or
cost-effective manner.
As a public company, we need to comply
with laws, regulations and requirements, including certain corporate governance
provisions of the Sarbanes-Oxley Act of 2002 and related regulations of the SEC.
Complying with these statutes, regulations and requirements occupies a
significant amount of the time of our board of directors and management. We are
or may be required to:
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institute
a comprehensive compliance
function;
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establish
internal policies, such as those relating to disclosure controls and
procedures and insider trading;
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design,
establish, evaluate and maintain a system of internal controls over
financial reporting in compliance with the requirements of Section 404 of
the Sarbanes-Oxley Act of 2002 and the related rules and regulations of
the SEC and the Public Company Accounting Oversight
Board;
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prepare
and distribute periodic reports in compliance with our obligations under
the federal securities laws;
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involve
and retain outside counsel and accountants in the above activities;
and
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establish
an investor relations function.
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In addition, rules adopted by the SEC
pursuant to Section 404 of the Sarbanes-Oxley Act of 2002 require annual
assessment of our internal control over financial reporting and will require
attestation of the assessment by our independent registered public accountants.
The requirement for the attestation of the assessment by our independent
registered public accountants, as the rules now stand, will first apply to our
annual report for the fiscal year ending December 31, 2009. In the future, our
ability to continue to comply with our financial reporting requirements and
other rules that apply to reporting companies could be impaired, and we may be
subject to sanctions or investigation by regulatory authorities. In addition,
failure to comply with Section 404 or a report of a material weakness may cause
investors to lose confidence in us and may have a material adverse effect on our
stock price.
Because of the high cost of compliance,
our Board of Directors may in the near future recommend that we deregister from
the Exchange Act, if possible, if in its best judgment the costs of the
requirements of being a compliant public company outweigh the benefits to
stockholders and if we are eligible to deregister. If we deregister,
the market for trading in our common stock could become even less liquid, and
information regarding our company could be less available.
As
a result of the execution of the Stipulation and the Memorandum, the following
risk factor included in the section captioned “Risk Factors” in Part II, Item 1A
of our Quarterly Report on Form 10-Q for the three months ended March 31, 2009,
is no longer applicable to us, under the terms of the Stipulation the Parties
agreed, among other things, (i) not to challenge the terms of the Partial Final
Award or any portion of such award, (ii) that any of the Parties may, at any
time, seek to confirm all but not part of the Partial Final Award through the
filing of an appropriate petition or motion with the appropriate court and in
response to such action to confirm the Partial Final Award, no Party will
oppose, object to or in any way seek to hinder or delay the court’s confirmation
of the Partial Final Award, but will in fact support and stipulate to such
confirmation, or (iii) to waive any and all right to appeal from, seek appellate
review of, file or prosecute any lawsuit, action, motion or proceeding, in law,
equity, or otherwise, challenging, opposing, seeking to modify or otherwise
attacking the confirmed Partial Final Award or the judgment
thereon.
We
intend to seek confirmation of the portions of the Partial Final Award
relating to the grant of the Perpetual License in the Technology to us,
including the Royalty terms by filing a petition in Los Angles Superior Court.
NQCI will have the opportunity to oppose the petition and appeal the
confirmation of the petition, if granted. If our petition to confirm
portions of the Partial Final Award is denied, or if NQCI successfully
appeals the confirmation, these outcomes could have a material adverse effect on
our capital structure, business and financial condition and may result in a
material change to the Partial Final Award.