MATERIAL U.S. FEDERAL INCOME TAX CONSEQUENCES TO NON-U.S. HOLDERS
General
The following is a discussion of the material U.S. federal income tax consequences of the acquisition, ownership, and disposition of our common stock by a non-U.S. holder, as defined below, that acquires our common stock pursuant to this offering. This discussion assumes that a non-U.S. holder will hold our common stock issued pursuant to this offering as a capital asset within the meaning of Section 1221 of the Code. This discussion does not address all aspects of U.S. federal income taxation that may be relevant to a particular investor in light of the investor’s individual circumstances. In addition, this discussion does not address (i) U.S. federal non-income tax laws, such as gift or estate tax laws, (ii) state, local or non-U.S. tax consequences, (iii) the special tax rules that may apply to certain investors, including, without limitation, banks, insurance companies, financial institutions, controlled foreign corporations, passive foreign investment companies, broker-dealers, grantor trusts, personal holding companies, taxpayers who have elected mark-to-market accounting, tax-exempt entities, regulated investment companies, real estate investment trusts, a partnership or other entity or arrangement classified as a partnership for United States federal income tax purposes or other pass-through entities, or an investor in such entities or arrangements, or U.S. expatriates or former long-term residents of the United States, (iv) the special tax rules that may apply to an investor that acquires, holds, or disposes of our common stock as part of a straddle, hedge, constructive sale, conversion or other integrated transaction, or (v) the impact, if any, of the alternative minimum tax.
This discussion is based on current provisions of the Code, applicable U.S. Treasury Regulations promulgated thereunder, judicial opinions, and published rulings of the Internal Revenue Service, or the IRS, all as in effect on the date of this prospectus and all of which are subject to differing interpretations or change, possibly with retroactive effect. We have not sought, and will not seek, any ruling from the IRS or any opinion of counsel with respect to the tax consequences discussed herein, and there can be no assurance that the IRS will not take a position contrary to the tax consequences discussed below or that any position taken by the IRS would not be sustained.
As used in this discussion, the term “U.S. person” means a person that is, for U.S. federal income tax purposes, (i) a citizen or individual resident of the United States, (ii) a corporation (or other entity taxed as a corporation) created or organized (or treated as created or organized) in the United States or under the laws of the United States or any state thereof or the District of Columbia, (iii) an estate the income of which is subject to U.S. federal income taxation regardless of its source, or (iv) a trust if (A) a court within the United States is able to exercise primary supervision over the administration of the trust and one or more U.S. persons have the authority to control all substantial decisions of the trust, or (B) it has in effect a valid election under applicable U.S. Treasury Regulations to be treated as a U.S. person. As used in this discussion, the term “non-U.S. holder” means a beneficial owner of our common stock (other than a partnership or other entity treated as a partnership or as a disregarded entity for U.S. federal income tax purposes) that is not a U.S. person.
The tax treatment of a partnership and each partner thereof will generally depend upon the status and activities of the partnership and such partner. A holder that is treated as a partnership for U.S. federal income tax purposes or a partner in such partnership should consult its own tax advisor regarding the U.S. federal income tax consequences applicable to it and its partners of the acquisition, ownership and disposition of our common stock.
THIS DISCUSSION IS ONLY A SUMMARY OF MATERIAL U.S. FEDERAL INCOME TAX CONSEQUENCES TO NON-U.S. HOLDERS OF THE ACQUISITION, OWNERSHIP AND DISPOSITION OF OUR COMMON STOCK. IT IS NOT TAX ADVICE. EACH PROSPECTIVE INVESTOR SHOULD CONSULT ITS OWN TAX ADVISOR WITH RESPECT TO THE PARTICULAR TAX CONSEQUENCES OF THE ACQUISITION, OWNERSHIP AND DISPOSITION OF OUR COMMON STOCK, INCLUDING THE APPLICABILITY AND EFFECT OF ANY STATE, LOCAL, AND NON-U.S. TAX LAWS, AS WELL AS U.S. FEDERAL ESTATE AND GIFT TAX LAWS, AND ANY APPLICABLE TAX TREATY.
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Income Tax Consequences of an Investment in Common Stock
Distributions on Common Stock
As discussed under “Dividend Policy,” we do not anticipate paying dividends. If we pay cash or distribute property to holders of shares of common stock, such distributions generally will constitute dividends for U.S. federal income tax purposes to the extent paid from our current or accumulated earnings and profits, as determined under U.S. federal income tax principles. Distributions in excess of current and accumulated earnings and profits will constitute a return of capital that will be applied against and reduce (but not below zero) the holder’s adjusted tax basis in our common stock. Any remaining excess will be treated as gain from the sale or exchange of the common stock and will be treated as described under “— Gain or Loss on Sale, Exchange or Other Taxable Disposition of Common Stock” below.
Dividends paid to a non-U.S. holder that are not effectively connected with the non-U.S. holder’s conduct of a trade or business in the United States generally will be subject to withholding of U.S. federal income tax at a rate of 30% or such lower rate as may be specified by an applicable income tax treaty. A non-U.S. holder that wishes to claim the benefit of an applicable tax treaty withholding rate generally will be required to (i) complete IRS Form W-8BEN (or other applicable form) and certify under penalties of perjury that such holder is not a U.S. person and is eligible for the benefits of the applicable tax treaty or (ii) if our common stock is held through certain foreign intermediaries, satisfy the relevant certification requirements of applicable U.S. Treasury Regulations. These forms may need to be periodically updated.
A non-U.S. holder eligible for a reduced rate of withholding of U.S. federal income tax pursuant to an income tax treaty may obtain a refund of any excess amounts withheld by timely filing an appropriate claim for refund with the IRS. Non-U.S. holders should consult their own tax advisors regarding their entitlement to benefits under an applicable income tax treaty and the manner of claiming the benefits of such treaty (including, without limitation, the need to obtain a U.S. taxpayer identification number).
Dividends that are effectively connected with a non-U.S. holder’s conduct of a trade or business in the United States, and, if required by an applicable income tax treaty, attributable to a permanent establishment or fixed base maintained by the non-U.S. holder in the United States, are subject to U.S. federal income tax on a net income basis at the U.S. federal income tax rates generally applicable to a U.S. holder and are not subject to withholding of U.S. federal income tax, provided that the non-U.S. holder establishes an exemption from such withholding by complying with certain certification and disclosure requirements. Any such effectively connected dividends (and, if required, dividends attributable to a U.S. permanent establishment or fixed base) received by a non-U.S. holder that is treated as a foreign corporation for U.S. federal income tax purposes may be subject to an additional branch profits tax at a 30% rate, or such lower rate as may be specified by an applicable income tax treaty.
Gain or Loss on Sale, Exchange or Other Taxable Disposition of Common Stock
Any gain recognized by a non-U.S. holder on a sale or other taxable disposition of our common stock generally will not be subject to U.S. federal income tax, unless:
| (i) | the gain is effectively connected with a trade or business of the non-U.S. holder in the United States (and, if required by an applicable income tax treaty, is attributable to a U.S. permanent establishment or fixed base of the non-U.S. holder), |
| (ii) | the non-U.S. holder is an individual who is present in the United States for 183 days or more in the taxable year of that disposition, and certain other conditions are met, or |
| (iii) | we are or have been a United States real property holding corporation, or a USRPHC, for U.S. federal income tax purposes at any time during the shorter of the five-year period ending on the date of disposition or the period that the non-U.S. holder held the common stock, and, in the case where the shares of our common stock are regularly traded on an established securities market, the non-U.S. holder holds or held (at any time during the shorter of the five-year period ending on the date of disposition or the non-U.S. holder’s holding period) more than 5% of our common stock. A corporation generally is a USRPHC if the fair market value of its U.S. real property interests equals or exceeds 50% of the sum of the fair market value of its worldwide real property interests plus its |
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| | other assets used or held for use in a trade or business. We believe that we currently are a USRPHC, and we expect to remain a USRPHC. |
Any gain recognized by a non-U.S. holder that is described in clause (i) or (iii) of the preceding paragraph generally will be subject to tax at the U.S. federal income tax rates generally applicable to a U.S. person and be required to file a U.S. tax return. Such non-U.S. holders are urged to consult their tax advisors regarding the possible application of these rules. Any gain of a corporate non-U.S. holder that is described in clause (i) above may also be subject to an additional branch profits tax at a 30% rate, or such lower rate as may be specified by an applicable income tax treaty. An individual non-U.S. holder that is described in clause (ii) of such paragraph generally will be subject to a flat 30% tax (or a lower applicable tax treaty rate) on the U.S. source capital gain derived from the disposition, which may be offset by U.S. source capital losses during the taxable year of the disposition.
Information Reporting and Backup Withholding
We generally must report annually to the IRS and to each non-U.S. holder of our common stock the amount of dividends paid to such holder on our common stock and the tax, if any, withheld with respect to those dividends. Copies of the information returns reporting those dividends and withholding may also be made available to the tax authorities in the country in which the non-U.S. holder is a resident under the provisions of an applicable income tax treaty or agreement. Information reporting also is generally required with respect to the proceeds from sales and other dispositions of our common stock to or through the U.S. office (and in certain cases, the foreign office) of a broker.
Under some circumstances, U.S. Treasury Regulations require backup withholding of U.S. federal income tax, currently at a rate of 28%, on reportable payments with respect to our common stock. A non-U.S. holder generally may eliminate the requirement for information reporting (other than in respect to dividends, as described above) and backup withholding by providing certification of its foreign status, under penalties of perjury, on a duly executed applicable IRS Form W-8 or by otherwise establishing an exemption. Notwithstanding the foregoing, backup withholding and information reporting may apply if either we or our paying agent has actual knowledge, or reason to know, that a holder is a U.S. person.
Backup withholding is not a tax. Rather, the amount of any backup withholding will be allowed as a credit against a non-U.S. holder’s U.S. federal income tax liability, if any, and may entitle such non-U.S. holder to a refund, provided that certain required information is timely furnished to the IRS. Non-U.S. holders should consult their own tax advisors regarding the application of backup withholding and the availability of and procedure for obtaining an exemption from backup withholding in their particular circumstances.
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UNDERWRITING
Aegis Capital Corp.We are offering the shares of our common stock described in this prospectus in an underwritten offering in which Piper Jaffray & Co., or the underwriter, is acting as the representative of the underwriters of the offering. We have entered into an underwriting agreement dated , 2012 with the representative.sole underwriter. Subject to the terms and conditions of the underwriting agreement, we have agreed to sell to eachthe underwriter named below and each underwriter named below has severally agreed to purchase all of the shares of common stock being offered pursuant to this prospectus.
The underwriter is committed to purchase and pay for all of the shares if any are purchased, other than those shares covered by the over-allotment option described below. The underwriter proposes to offer the common stock directly to the public at the public offering price less the underwriting discounts and commissions set forth on the cover page of this prospectus the number of shares of common stock listed next to its name in the following table:
 | | |
Name | | Number of
Shares |
Aegis Capital Corp. | | | | |
| | | | |
Total | | | | |
The underwriting agreement provides that the obligations of the underwriters are subjectand to certain conditions precedent and that the underwriters have agreed, severally and not jointly, to purchase all of the shares of common stock sold under the underwriting agreement if any of these shares are purchased. If an underwriter defaults, the underwriting agreement provides that the purchase commitments of the non-defaulting underwriters may be increased or the underwriting agreement may be terminated.
We have agreed to indemnify the underwriters against specified liabilities, including liabilities under the Securities Act, and to contribute to payments the underwriters may be required to make in respect thereof.
The underwriters are offering our common stock, subject to prior sale, when, as and if issued to and accepted by them, subject to approval of legal matters by their counsel and other conditions specified in the underwriting agreement. The underwriters reserve the right to withdraw, cancel or modify offers to the public and to reject orders in whole or in part.
The underwriters propose to offer the shares of our common stock offered by us to the public at the public offering price set forth on the cover of this prospectus. In addition, the underwriters may offer some of the shares of our common stock to other securities dealers at suchthat price less a concession of $ per share. The underwriters may also allow, and such dealers may re-allow, a concession not in excess of $ per shareshare. After this offering, the underwriter may change the offering price and other selling terms.
We have granted the underwriter an option to other dealers. Afterbuy up to an additional shares of our common stock to cover over-allotments. The underwriter may exercise this option at any time and from time to time during the public offering30-day period from the date of this prospectus. If any additional shares of common stock are purchased, the underwriter will offer the additional shares on the same terms as those on which the shares are being offered.
The underwriting discount is equal to the public offering price per share and other selling terms may be changedof common stock less the amount paid by the underwriters.
Commissions and Discounts
underwriter to us per share of common stock. The following table shows the per share and total underwriting discounts and commissions that we arediscount to paybe paid to the underwritersunderwriter in connection with this offering.offering, assuming both no exercise and full exercise of the over-allotment option.
 | | | | | | |
| | Per Share | | Total Withoutwith
Over-Allotment
OptionNo Exercise | | Total With
Over-Allotment
Option Exercise |
Public offering pricePaid by us | | $ | | | | $ | | | | $ | | |
Underwriting discount (7%) | | $ | | | | $ | | | | $ | | |
Non-accountable expense allowance (1%) | | $ | | | | $ | | | | $ | | |
Proceeds, before expenses, to us | | $ | | | | $ | | | | $ | | |
We have paid an expense depositestimate expenses payable by us in connection with this offering of $25,000common stock, other than the underwriting discounts referred to the representative whichabove, will be applied againstapproximately $ . This estimate includes $150,000 of fees and expenses of the non-accountable expenses thatunderwriter. The underwriter has not received and will not receive from us any other item of compensation or expense in connection with this offering considered by the Financial Industry Regulatory Authority to be underwriting compensation under its rule of fair price. The underwriting discount was determined through an arms’ length negotiation between us and the underwriter. Aegis Capital Corp. is acting as a financial advisor in connection with this offering and will be entitled to a financial advisory fee of $50,000, which amount will be paid by us to the underwriters in connection with this offering.
We estimate that the total expensesunderwriter out of the offering, including registration, filing and listing fees, printing fees and legal and accounting expenses, but excluding the underwriting discount, will be approximately $450,000.commission.
AspenBio Pharma, Inc.
Notes to Financial Statements
Note 1. Organization and summary of significant accounting policies: - (continued)
The Company invests excess cash from time to time in highly-liquid debt and equity investments of highly-rated entities which are classified as trading securities. The purpose of the investments is to fund research and development, product development, U.S. Food and Drug Administration (the “FDA”)FDA approval-related activities and general corporate purposes. Such amounts are recorded at market values using Level 1 inputs in determining fair value and are classified as current, as the Company does not intend to hold the investments beyond twelve months. Investment securities classified as trading are those securities that are bought and held principally for the
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Venaxis, Inc.
Notes to Financial Statements
Note 1. Organization and summary of significant accounting policies: – (continued)
purpose of selling them in the near term, with the objective of preserving principal and generating profits. These securities are reported at fair value with unrealized gains and losses reported as an element of other income (expense) in current period earnings. The Board of Directors has approved an investment policy covering the investment parameters to be followed with the primary goals being the safety of principal amounts and maintaining liquidity of the fund. The policy provides for minimum investment rating requirements as well as limitations on investment duration and concentrations. Based upon market conditions, the investment guidelines have been tightened to increase the minimum acceptable investment ratings required for investments and shorten the maximum investment term. As of December 31, 2011, 64%2012, 89% of the investment portfolio was in cash equivalents, which is presented as such on the accompanying balance sheet, and the remaining funds were invested in short-term marketable securities with none individually representing more than 16% ofa material amount to the portfolio and none with maturities past June 2012. To date,November 2013. As of December 31, 2012, the Company’s cumulative realized market loss from the investments has not been in excess of $5,000. For the year ended December 31, 2012, there was $11,192 in unrealized loss, $102 in realized gain for the year and $5,532 in management fees. For the year ended December 31, 2011, there was $1,004 in unrealized loss, $3,505 in realized loss, $1,073 in realized gain for the year and $9,248 in management fees. For the year ended December 31, 2010, there was $1,065 in unrealized income, $1,388 in unrealized loss, $2,023 in realized gain for the year and $17,959 in management fees. For
Fair value of financial instruments:
The Company accounts for financial instruments under Financial Accounting Standards Board (FASB) Accounting Standards Codification Topic (ASC) 820, Fair Value Measurements. This statement defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. To increase consistency and comparability in fair value measurements, ASC 820 establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three levels as follows:
| Level 1 — | quoted prices (unadjusted) in active markets for identical assets or liabilities; |
| Level 2 — | observable inputs other than Level 1, quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets and liabilities in markets that are not active, and model-derived prices whose inputs are observable or whose significant value drivers are observable; and |
| Level 3 — | assets and liabilities whose significant value drivers are unobservable. |
Observable inputs are based on market data obtained from independent sources, while unobservable inputs are based on the Company’s market assumptions. Unobservable inputs require significant management judgment or estimation. In some cases, the inputs used to measure an asset or liability may fall into different levels of the fair value hierarchy. In those instances, the fair value measurement is required to be classified using the lowest level of input that is significant to the fair value measurement. Such determination requires significant management judgment. There were no financial assets or liabilities measured at fair value, with the exception of cash, cash equivalents (level 1) and short-term investments (level 2) as of December 31, 2012 and December 31, 2011.
The carrying amounts of the Company’s financial instruments (other than cash, cash equivalents and short-term investments as discussed above) approximate fair value because of their variable interest rates and/or short maturities combined with the recent historical interest rate levels.
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Venaxis, Inc.
Notes to Financial Statements
Note 1. Organization and summary of significant accounting policies: – (continued)
Revenue recognition and accounts receivable:
We recognize sales of goods under the provisions of the FASB ASC 605 (“ASC 605”) and the U.S. Securities and Exchange Commission (SEC) Staff Accounting Bulletin (SAB) 104,Revenue Recognition. Future revenue is expected to be generated primarily from the sale of products. Product revenue primarily consists of sales of instrumentation and consumables.
Revenue is recognized when the following four basic criteria have been met: (i) persuasive evidence of an arrangement exists; (ii) delivery has occurred and risk of loss has passed; (iii) the seller’s price to the buyer is fixed or determinable; and (iv) collectability is reasonably assured.
In international markets, the Company sells its products to distributors or re-sellers, who subsequently resell the products to hospitals. The Company has an agreement with the distributor which provides that title and risk of loss pass to the distributor upon shipment of the products, FOB to the distributor. Revenue is recognized upon shipment of products to the distributor as the products are shipped based on FOB shipping point terms.
Revenues are recorded less a reserve for estimated product returns and allowances which to date has not been significant. Determination of the reserve for estimated product returns and allowances is based on management’s analyses and judgments regarding certain conditions. Should future changes in conditions prove management’s conclusions and judgments on previous analyses to be incorrect, revenue recognized for any reporting period could be adversely affected.
The Company extends credit to customers generally without requiring collateral. Historically, the Company’s base antigen business has sold products primarily throughout North America. At December 31, 2012, the Company did not have any accounts receivable. At December 31, 2011, two customers accounted for 73% and 19% of total accounts receivable. During the year ended December 31, 2012, three customers accounted for a total of 83% of net sales, each representing 40%, 30% and 13%, respectively. During the years ended December 31, 2011 and 2010, one European-based company, accounted for a total of 3% and 4%, respectively of our net sales. During the year ended December 31, 2011, two customers accounted for a total of 42% of net sales, each representing 28% and 14%, respectively. During the year ended December 31, 2010, four customers accounted for a total of 58% of net sales, each representing 19%, 18%, 11% and 10%, respectively.
Property and equipment:
Property and equipment is stated at cost and depreciated using the straight-line method over the estimated useful lives of the assets, generally twenty-five years for the building, ten years for land improvements, five years for equipment and three years for computer related assets.
Goodwill:
Goodwill, arose from the initial formation of the Company, and represents the purchase price paid and liabilities assumed in excess of the fair market value of tangible assets acquired. The Company performs a goodwill impairment analysis in the fourth quarter of each year, or whenever there is an indication of impairment. When conducting its annual goodwill impairment assessment, the Company initially performs a qualitative evaluation to determine if it is more likely than not that the fair value of its reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform a two-step goodwill impairment test. The Company has determined, based on its qualitative evaluation, that it was not necessary to perform the two-step goodwill impairment test and that no impairment had occurred as of December 31, 2012.
Impairment of long-lived assets:
Management reviews long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is
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Venaxis, Inc.
Notes to Financial Statements
Note 1. Organization and summary of significant accounting policies: – (continued)
measured by a comparison of the carrying amount of an asset to undiscounted future cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets. Based on its review, including an updated assessment subsequent to year end, management determined that certain costs previously incurred for patents had been impaired during the years ended December 31, 2012, 2011 and 2010. Approximately $45,000, $275,000 and $107,000 of such patent costs were determined to be impaired during the years ended December 31, 2012, 2011 and 2010, respectively resulting from management’s decisions not to pursue patents based upon a cost benefit analysis of patent expenses and coverage protection in several smaller world markets that were determined to not have the economic or fiscal potential to make the patent pursuit viable. Impairment charges are included in research and development expenses in the accompanying statements of operations.
Research and development:
Research and development costs are charged to expense as incurred.
Use of estimates:
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (GAAP) requires management to make estimates and assumptions that affect reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the balance sheet and the reported amounts of revenue and expenses during the reporting periods. Actual results could differ significantly from those estimates.
Income taxes:
The Company accounts for income taxes under the asset and liability method, in which deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carry forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in operations in the period that includes the enactment date. A valuation allowance is required to the extent any deferred tax assets may not be realizable.
The Company does not have an accrual for uncertain tax positions as of December 31, 2012 and 2011. The Company files corporate income tax returns with the Internal Revenue Service and the states where the Company determines it is required to do so, and there are open statutes of limitations for tax authorities to audit the Company’s tax returns from 2009 through the current period.
The Company’s policy is to recognize interest and penalties accrued on any unrecognized tax benefits as a component of income tax expense. At December 31, 2012, the Company did not have any accrued interest or penalties associated with any unrecognized tax benefits, nor was any interest expense recognized during the years ended December 31, 2012, 2011 or 2010.
Stock-based compensation:
Venaxis recognizes the cost of employee services received in exchange for an award of equity instruments in the financial statements and is measured based on the grant date fair value of the award. Stock option compensation expense is recognized over the period during which an employee is required to provide service in exchange for the award (generally the vesting period). The Company estimates the fair value of each stock option at the grant date by using the Black-Scholes option pricing model.
Reclassifications:
Certain prior period amounts in the accompanying financial statements have been reclassified to conform to the presentation used in 2012.
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Venaxis, Inc.
Notes to Financial Statements
Note 1. Organization and summary of significant accounting policies: – (continued)
Income (loss) per share:
ASC 260, Earnings Per Share, requires dual presentation of basic and diluted earnings per share (EPS) with a reconciliation of the numerator and denominator of the basic EPS computation to the numerator and denominator of the diluted EPS computation. Basic EPS excludes dilution. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the entity.
Basic earnings (loss) per share includes no dilution and is computed by dividing net earnings (loss) available to stockholders by the weighted average number of common shares outstanding for the period. Diluted earnings per share reflect the potential dilution of securities that could share in the Company’s earnings (loss). The effect of the inclusion of the dilutive shares would have resulted in a decrease in loss per share during the years ended December 31, 2012, 2011 and 2010. Accordingly, the weighted average shares outstanding have not been adjusted for dilutive shares. Outstanding stock options and warrants are not considered in the calculation, as the impact of the potential common shares (totaling approximately 1,306,000, 497,000 and 214,000 shares for each of the years ended December 31, 2012, 2011 and 2010, respectively) would be to decrease the net loss per share.
In May 2012, the Board of Directors authorized a reverse stock split of the Company’s common stock at a ratio of one-for-six, whereby each six shares of common stock were combined into one share of common stock (the “2012 Reverse Stock Split”). All historical references to shares and share amounts in this report have been retroactively revised to reflect the 2012 Reverse Stock Split, the principal effects of which were to:
| 1. | reduce the number of shares of common stock issued and outstanding by a factor of 6; |
| 2. | increase the per share exercise price of options and warrants by a factor of 6, and decrease the number of shares issuable upon exercise by a factor of 6, for all outstanding options and warrants entitling the holders to purchase shares of the Company’s common stock; and |
| 3. | proportionately reduce the number of shares authorized and reserved for issuance under the Company’s existing equity compensation plans. |
A reconciliation of historical basic and diluted weighted average number of shares outstanding retroactively adjusted for the 2012 Reverse Stock Split follows:
| | | | |
| | Year ended December 31, |
| | | 2011 | | 2010 |
Basic and diluted weighted average number of shares outstanding
| | | | | | | | |
| Pre-split | | | 8,032,178 | | | | 7,876,081 | |
| Post-split | | | 1,341,379 | | | | 1,310,956 | |
Recently issued and adopted accounting pronouncements:
The Company has evaluated all recently issued accounting pronouncements and believes such pronouncements do not have a material effect on the Company’s financial statements.
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Venaxis, Inc.
Notes to Financial Statements
Note 2. Property and equipment:
Property and equipment consisted of the following as of December 31:
| | | | |
| | 2012 | | 2011 |
| Land and improvements | | $ | 1,107,508 | | | $ | 1,107,508 | |
| Building | | | 2,589,231 | | | | 2,589,231 | |
| Building improvements | | | 251,049 | | | | 251,049 | |
| Laboratory equipment | | | 1,211,418 | | | | 1,175,047 | |
| Office and computer equipment | | | 403,692 | | | | 398,295 | |
| | | | 5,562,898 | | | | 5,521,130 | |
| Less accumulated depreciation | | | 3,078,359 | | | | 2,725,981 | |
| | | $ | 2,484,539 | | | $ | 2,795,149 | |
Depreciation expense totaled approximately $352,000, $402,000 and $395,000 for each of years ended December 31, 2012, 2011 and 2010, respectively.
Note 3. Other long-term assets:
Other long-term assets consisted of the following as of December 31:
| | | | |
| | 2012 | | 2011 |
| Patents, trademarks and applications, net of accumulated amortization of $345,692 and $273,550 | | $ | 1,210,698 | | | $ | 1,214,748 | |
| Goodwill | | | 387,239 | | | | 387,239 | |
| Other | | | 3,957 | | | | 9,665 | |
| | | $ | 1,601,894 | | | $ | 1,611,652 | |
The Company capitalizes legal costs and filing fees associated with obtaining patents on its new discoveries. Once the patents have been issued, the Company amortizes these costs over the shorter of the legal life of the patent or its estimated economic life using the straight-line method. Based upon the current status of the above intangible assets, the aggregate amortization expense is estimated to be approximately $75,000 for each of the next five fiscal years. The Company tests intangible assets with finite lives upon significant changes in the Company’s business environment. The testing resulted in approximately $45,000, $275,000, and $107,000 of patent impairment charges during the years ended December 31, 2012, 2011, and 2010, respectively.
Note 4. Notes and other obligations:
Notes payable and installment obligations consisted of the following as of December 31:
| | | | |
| | 2012 | | 2011 |
| Mortgage notes | | $ | 2,435,073 | | | $ | 2,545,312 | |
| Termination obligation (Note 7) | | | 397,588 | | | | 1,152,753 | |
| Other short-term installment obligations | | | 220,763 | | | | 206,161 | |
| | | | 3,053,424 | | | | 3,904,226 | |
| Less current portion | | | 2,290,292 | | | | 1,074,185 | |
| | | $ | 763,132 | | | $ | 2,830,041 | |
Mortgage notes:
The Company has a mortgage facility on its land and building. The mortgage is held by a commercial bank and includes approximately 35% that is guaranteed by the U.S. Small Business Administration (SBA). The loan is collateralized by the real property and is also personally guaranteed by a former officer of the Company. The interest rate on the bank portion is one percentage over the Wall Street Journal Prime Rate
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Venaxis, Inc.
Notes to Financial Statements
Note 4. Notes and other obligations: – (continued)
(minimum 7%), with 7% being the approximate effective rate for 2012 and 2011, and the SBA portion bears interest at the rate of 5.86%. The commercial bank portion of the loan requires total monthly payments of approximately $14,200, which includes approximately $9,500 per month in interest, through July 2013 when the then remaining principal balance is due which is estimated to be approximately $1.6 million at that time. The SBA portion of the loan requires total monthly payments of approximately $9,200 through July 2023, which includes approximately $3,900 per month in interest and fees.
Termination obligation:
In November 2011, the Company entered into a Termination Agreement with Novartis Animal Health, Inc. (the “Novartis Termination Agreement”) to terminate the Novartis License Agreement (Note 7). Under the Novartis Termination Agreement, the termination obligation originally totaled $1,374,000, which was payable $150,000 upon signing the Novartis Termination Agreement and in six equal subsequent quarterly installments of $204,000 each. The Company discounted this obligation at an assumed interest rate of 7% (which represents the rate management believes it could have borrowed at for similar financings), which totaled $1,303,000. At December 31, 2012, the remaining outstanding termination obligation totaled approximately $398,000 which is due in 2013.
Other short-term installment obligations:
The Company has executed financing agreements for certain of the Company’s insurance premiums. At December 31, 2012, these obligations totaled $220,763 all of which are due in 2013.
Future maturities:
The Company’s total debt obligations require minimum annual principal payments of approximately $2,290,000 in 2013, $65,000 in 2014, $68,000 in 2015, $72,000 in 2016, $75,000 in 2017 and $483,000 thereafter, through the terms of the applicable debt agreements. The Company’s Exclusive License Agreement with The Washington University also requires minimum annual royalty payments of $20,000 per year during its term (Note 7).
Note 5. Stockholders’ equity:
2012 Transactions:
In June 2012, the Company completed a public offering of securities consisting of 6,100,000 shares of common stock at an offering price of $2.00 per share, generating approximately $12.2 million in total proceeds. Fees and other expenses totaled $1,261,000, including an underwriter’s fee of 7%. In connection with the offering, the underwriter received warrants to purchase a total of 305,000 shares of the Company’s common stock. The exercise price of the warrants is $2.50 per share; the warrants become exercisable in June 2013 and expire in June 2017.
In November 2012, the Company completed a public offering of securities consisting of 1,946,000 shares of common stock at an offering price of $2.10 per share, generating approximately $3.6 million in total proceeds. Fees and other expenses totaled $445,000, including a underwriter’s fee of 7%. In connection with the offering, the underwriter exercised an over-allotment option to purchase 291,900 additional shares of common stock at $2.10 per share generating approximately $566,000 net of expenses of approximately $47,000.
Under the terms of an agreement for investor relations services, the Company issued a total of 8,334 shares of common stock; 4,167 shares of the total were issued in April 2012, at $4.26 per share and the remaining 4,167 shares were issued in June 2012, at $2.88 per share. The issuance resulted in a total of $29,776 of stock-based compensation being recorded.
2011 Transactions:
In July 2011 at the annual shareholders meeting the Board of Directors approved an amendment to the Company’s Articles of Incorporation to reduce the authorized common shares from 60 million to 30 million.
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Venaxis, Inc.
Notes to Financial Statements
Note 5. Stockholders’ equity: – (continued)
In December 2011, the Company completed a registered direct offering of securities consisting of 267,500 units for a negotiated price of $6.12 per unit, generating approximately $1,456,000 in net proceeds to the Company. Fees and other expenses totaled $181,000, including a placement fee of 6.79%. Each unit consisted of one share of the Company’s no par value common stock and one warrant to purchase one share of common stock. The exercise price of each warrant is $7.32 per share; the warrants are exercisable beginning June 30, 2012 and expire in June 2017.
2010 Transactions:
In May 2010, the Company completed a registered direct offering of securities consisting of 80,321 units (Units) for a negotiated price of $124.50 per Unit, generating approximately $9,117,000 in net proceeds to the Company. Fees and other expenses totaled $883,000, including a placement fee of 6.5%. Each Unit consisted of one share of the Company’s no par value common stock and one warrant to purchase 0.285 shares of common stock. Accordingly, a total of 80,321 shares of common stock and warrants to purchase 22,892 shares of common stock were issued. The exercise price of the warrants was $144.60 per share; the warrants were exercisable upon issuance for an eight month term and expired in January 2011.
During the year ended December 31, 2010, consultants exercised options outstanding under the Company’s 2002 Stock Incentive Plan (the Plan) as amended and approved by the Company’s shareholders, to purchase 8,702 shares of common stock generating $291,028 in cash proceeds to the Company.
Note 6. Stock options and warrants:
The Company currently provides stock-based compensation to employees, directors and consultants, both under the Company’s 2002 Stock Incentive Plan, as amended (the “Plan”) and non-qualified options and warrants issued outside of the Plan. In 2012, the Company’s shareholders approved amendments to the Plan to increase the number of shares reserved under the Plan from 250,000 to 1,487,205. The Company estimates the fair value of the share-based awards on the date of grant using the Black-Scholes option-pricing model (the “Black-Scholes model”). Using the Black-Scholes model, the value of the award that is ultimately expected to vest is recognized over the requisite service period in the statement of operations. Option forfeitures are estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. The Company attributes compensation to expense using the straight-line single option method for all options granted.
The Company’s determination of the estimated fair value of share-based payment awards on the date of grant is affected by the following variables and assumptions:
The grant date exercise price — the closing market price of the Company’s common stock on the date of the grant;
Estimated option term — based on historical experience with existing option holders;
Estimated dividend rates — based on historical and anticipated dividends over the life of the option;
Term of the option — based on historical experience, grants have lives of approximately 3 – 5 years;
Risk-free interest rates — with maturities that approximate the expected life of the options granted;
Calculated stock price volatility — calculated over the expected life of the options granted, which is calculated based on the daily closing price of the Company’s common stock over a period equal to the expected term of the option; and
Option exercise behaviors — based on actual and projected employee stock option exercises and forfeitures.
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Venaxis, Inc.
Notes to Financial Statements
Note 6. Stock options and warrants: – (continued)
The Company recognized stock-based compensation during the years ended December 31, as follows:
| | | | | | |
| | 2012 | | 2011 | | 2010 |
| Stock options to employees, officers, and directors | | $ | 833,351 | | | $ | 1,200,118 | | | $ | 2,103,276 | |
Stock options to consultants for:
| | | | | | | | | | | | |
| Investor relations activities | | | 23,598 | | | | 57,309 | | | | 61,174 | |
| APPY1 activities | | | 38,460 | | | | 54,304 | | | | 38,064 | |
| Animal health activities | | | 5,752 | | | | 24,446 | | | | 161,357 | |
| Total stock-based compensation | | $ | 901,161 | | | $ | 1,336,177 | | | $ | 2,363,871 | |
The above expenses are included in the accompanying Statements of Operations for the years ended December 31, in the following categories:
| | | | | | |
| | 2012 | | 2011 | | 2010 |
| Selling, general and administrative expenses | | $ | 862,701 | | | $ | 1,281,873 | | | $ | 2,325,807 | |
| Research and development expenses | | | 38,460 | | | | 54,304 | | | | 38,064 | |
| Total stock-based compensation | | $ | 901,161 | | | $ | 1,336,177 | | | $ | 2,363,871 | |
Stock incentive plan options:
The Company currently provides stock-based compensation to employees, directors and consultants under the Plan. The Company utilized assumptions in the estimation of fair value of stock-based compensation for the years ended December 31, as follows:
| | | | | | |
| | 2012 | | 2011 | | 2010 |
| Dividend yield | | | 0 | % | | | 0 | % | | | 0 | % |
| Expected price volatility | | | 121 to 127 | % | | | 119 to 120 | % | | | 110 to 119 | % |
| Risk free interest rate | | | .60 to 1.03 | % | | | 1.32 to 2.14 | % | | | 1.60 to 2.62 | % |
| Expected term | | | 5 years | | | | 5 years | | | | 5 years | |
A summary of stock option activity under the Plan for options to employees, officers, directors and consultants, for the year ended December 31, 2012, is presented below:
| | | | | | | | |
| | Shares Underlying Options | | Weighted Average Exercise Price | | Weighted Average Remaining Contractual Term (Years) | | Aggregate Intrinsic Value |
| Outstanding at January 1, 2012 | | | 215,321 | | | $ | 53.94 | | | | | | | | | |
| Granted | | | 540,378 | | | | 2.29 | | | | | | | | | |
| Exercised | | | — | | | | — | | | | | | | | | |
| Forfeited | | | (47,759 | ) | | | 61.79 | | | | | | | | | |
| Outstanding at December 31, 2012 | | | 707,940 | | | $ | 13.98 | | | | 8.8 | | | $ | 228,800 | |
| Exercisable at December 31, 2012 | | | 199,505 | | | $ | 40.17 | | | | 6.2 | | | $ | 16,250 | |
The aggregate intrinsic value in the table above represents the total intrinsic value (the difference between the Company’s closing stock price on December 31, 2012 and the exercise price, multiplied by the number of in-the-money options) that would have been received by the option holders, had all option holders been able to, and in fact had, exercised their options on December 31, 2012.
During the year ended December 31, 2012, 540,378 options were granted under the Plan to employees, officers, directors and consultants with a weighted average exercise price at grant date of $2.29 per option. Included in the 540,378 options issued, the independent directors were granted a total of 151,992 options at an
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Venaxis, Inc.
Notes to Financial Statements
Note 6. Stock options and warrants: – (continued)
average exercise price of $2.28 per share; 12,502 of these director options were granted at an exercise price of $4.26 per share, vesting over a three year period annually in arrears and 139,490 director options were granted at an exercise price of $2.10 per share vesting after one year. Officers were granted a total of 301,362 options at an average exercise price of $2.29 per share; 40,668 officer options were granted at an average exercise price of $3.50 per share, vesting over a twelve month period following grant and 260,694 officer options were granted at an exercise price of $2.10 per share, vesting after one year. Employees were granted a total of 62,024 options at an average exercise price of $2.46 per share, 11,142 employee options at an average exercise price of $4.11 per share which vest over a twelve month period following grant and 50,882 options were granted at an exercise price of $2.10 per share, vesting after one year. Substantially all of the grants to officers and employees were awarded as retention incentive options. The Company also issued 25,000 options to a consultant at an exercise price of $1.91 per share, vesting after ninety days. All options granted under the Company’s 2002 Stock Incentive Plan expire ten years from the grant date.
During the year ended December 31 2012, a total of 47,759 options that were granted under the Plan to directors, employees, including an officer, and consultants were forfeited, 23,283 of which were vested and 24,476 were unvested. The options were exercisable at an average of $61.79 per share and were forfeited upon the employees’ termination from the Company. During the year ended December 31, 2012, no options were exercised.
During the year ended December 31, 2011, 52,267 stock options were granted under the Plan to employees, officers, directors, and consultants with a weighted average fair value at the grant date of $19.14 per option. Included in the 52,267 options issued, existing directors and officers were granted a total of 40,834 options at an exercise price of $19.02 per share and existing employees were granted 4,317 options at an exercise price of $18.30 per share, all vesting over a three-year period annually in arrears and expiring in ten years. Four newly hired employees were granted a total of 450 options at $19.86 per share, all vesting over a three-year period annually in arrears and expiring in ten years. The Company also issued 6,667 non-qualified options to a consultant at an exercise price of $20.40 per share which expire in ten years. These non-qualified options are performance related with vesting tied to achieving specificAPPY1 clinical and regulatory milestones. During the year ended December 31, 2011, no options were exercised.
During the year ended December 31, 2011, a total of 20,912 options granted under the Plan were forfeited, 11,402 of which were vested and 9,510 which were unvested. The options were exercisable at an average of $52.50 per share and were forfeited upon the employees’, officers and consultant’s termination from the Company. During the year ended December 31, 2010, a total of 1,523 options were forfeited, 445 of which were vested and 1,078 were unvested. The options were exercisable at an average of $79.50 per share and were forfeited upon the employees’ terminations from the Company.
During the year ended December 31, 2010, 46,600 stock options were granted under the Plan to employees, officers, directors and consultants with a weighted average fair value at the grant date of $51.30 per option. During the year ended December 31, 2010, consultants exercised 8,702 options outstanding under the Company’s Plan generating $291,028 in cash and which had an intrinsic value when exercised of $371,130.
The total fair value of stock options granted to employees, directors and consultants that vested and became exercisable during the years ended December 31, 2012, 2011 and 2010, was $1,486,000, $2,063,000 and $2,327,000, respectively. Based upon the Company’s experience, approximately 85% of the outstanding stock options, or approximately 432,000 options, are expected to vest in the future, under their terms. A summary of the activity of non-vested options under the Company’s Plan to acquire common shares granted to employees, officers, directors and consultants during the year ended December 31, 2012 is presented below:
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Venaxis, Inc.
Notes to Financial Statements
Note 6. Stock options and warrants: – (continued)
| | | | | | |
| Nonvested Shares | | Nonvested Shares Underlying Options | | Weighted Average Exercise Price | | Weighted Average Grant Date Fair Value |
| Nonvested at January 1, 2012 | | | 88,986 | | | $ | 35.64 | | | $ | 28.98 | |
| Granted | | | 540,378 | | | | 2.29 | | | | 1.92 | |
| Vested | | | (96,453 | ) | | | 18.92 | | | | 15.40 | |
| Forfeited | | | (24,476 | ) | | | 28.58 | | | | 23.35 | |
| Nonvested at December 31, 2012 | | | 508,435 | | | $ | 3.70 | | | $ | 3.07 | |
At December 31, 2012, based upon employee, officer, director and consultant options granted to that point, there was $4,709approximately $914,000 additional unrecognized compensation cost related to stock options that will be recorded over a weighted average future period of approximately one year.
Effective as of January 1, 2013, in connection with the addition of a new director, 48,000 stock options were issued to the director, under the Plan, exercisable at $2.56 per share. The options expire ten years from date of grant and vest as to 50% of the total over three years, annually in arrears and the remaining 50% commencing quarterly in advance upon the grant date over the following four quarters. During January 2013, in connection with its annual option grant award cycle, 426,270 options were issued under the Plan to directors, officers and employees, at an exercise price of $2.04 per share. The options expire ten years from date of grant and vest as to non-employee directors quarterly in advance over four quarters and as to officers, and employees 50% upon the six month anniversary of grant date and the balance equally over the following six quarters in arrears. Subsequent to December 31, 2012, 6,582 options related to employee terminations expired which were exercisable at an average of $2.42 per share.
Other common stock purchase options and warrants:
As of December 31, 2012, in addition to the stock incentive plan options discussed above, the Company had 598,507 non-qualified options and warrants outstanding in connection with offering warrants, an officer’s employment and investor relations consulting.
The Company utilized assumptions in the estimation of the fair value of stock-based compensation for the years ended December 31, as follows:
| | | | | | |
| | 2012 | | 2011 | | 2010 |
| Dividend yield | | | 0 | % | | | 0 | % | | | 0 | % |
| Expected price volatility | | | 121 | % | | | 119 to 145 | % | | | 128 to 130 | % |
| Risk free interest rate | | | 0.74 | % | | | 1.20 to 1.95 | % | | | 1.26 to 1.70 | % |
| Contractual term | | | 5 years | | | | 3 to 10 years | | | | 3 years | |
Operating expenses for the years ended December 31, 2012, 2011 and 2010, include approximately $71,000, $92,000 and $61,000, respectively, related to non-qualified options and warrants.
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Venaxis, Inc.
Notes to Financial Statements
Note 6. Stock options and warrants: – (continued)
Following is a summary of outstanding options and warrants that were issued outside of the Plan for the year ended December 31, 2012:
| | | | | | | | |
| | Shares Underlying Options/ Warrants | | Weighted Average Exercise Price | | Weighted Average Remaining Contractual Term (Years) | | Aggregate Intrinsic Value |
| Outstanding at January 1, 2012 | | | 282,178 | | | $ | 8.70 | | | | | | | | | |
| Granted | | | 325,000 | | | | 2.56 | | | | | | | | | |
| Exercised | | | — | | | | — | | | | | | | | | |
| Forfeited | | | (8,671 | ) | | | 33.44 | | | | | | | | | |
| Outstanding at December 31, 2012 | | | 598,507 | | | $ | 5.01 | | | | 4.6 | | | $ | 18,300 | |
| Exercisable at December 31, 2012 | | | 285,174 | | | $ | 7.74 | | | | 4.6 | | | $ | — | |
The aggregate intrinsic value in the table above represents the total intrinsic value (the difference between the Company’s closing stock price on December 31, 2012 and the exercise price, multiplied by the number of in-the-money options) that would have been received by the option holders, had all option holders been able to, and in fact had, exercised their options on December 31, 2012.
In June 2012, the Company completed a $12.2 million public offering of securities and in connection with that offering, granted the Underwriter warrants to purchase a total of 305,000 shares of common stock. These warrants which are included in the above table are not exercisable until June 2013 at an exercise price of $2.50 per share, and expire in June 2017. Included at December 31, 2012 in the 598,507 total outstanding options and warrants are 572,505 non-compensatory rights granted in connection with public offerings and 26,002 rights issued under compensatory arrangements.
During the year ended December 31, 2012, the Company hired a Senior Vice President and Chief Commercial Officer who previously had a consulting relationship with the Company. As part of the employment arrangement, the Board of Directors approved an employment-inducement grant made outside of the Company’s Plan, and granted 20,000 options which are exercisable at $3.42 per share. The options vest as to 50% of the total on the six month anniversary following the grant date and the remaining 50% vesting one-sixth monthly over months seven through twelve following the grant date. The options expire ten years from the grant date. During the year ended December 31, 2012, 2,004 vested options previously granted to an investor relations firm expired.
During the year ended December 31, 2011, the Company hired a Vice President of Marketing and Business who previously had a consulting relationship with the Company. As part of the employment arrangement, the Board approved an employment-inducement grant made outside of the Company’s Stock 2002 Incentive Plan, and he was granted 6,667 options for services which are exercisable at $19.50 per share. The options were scheduled to vest equally over a three year period however they were forfeited upon the officer’s termination from the Company in 2012. Also, during the year ended December 31, 2011, an investor relations firm was granted 5,000 warrants to purchase shares of common stock scheduled to vest equally over twelve months from the date of grant and are exercisable at $30.00 per share and expire in three years. During the year ended December 31, 2011, 4,584 investor relations consultant options expired of which 1,500 were exercisable at $360.00 per share, 1,251 options were exercisable at $180.30 per share, 1,667 options were exercisable at $167.10 per share and 166 options at $ $149.70 per share. In addition 22,892 warrants granted at $144.60 per share in connection with the 2010 public registered direct offering expired.
During the year ended December 31, 2010, 23,892 stock options and warrants were granted to an investor relations firm and under a registered direct offering with a weighted average fair value at the grant date of $141.00 per option.
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Venaxis, Inc.
Notes to Financial Statements
Note 6. Stock options and warrants: – (continued)
During the years ended December 31, 2012, 2011 and 2010, no options granted outside of the Plan were exercised.
The total fair value of stock options granted to an investor relations consulting firm that vested and became exercisable during the years ended December 31, 2012, 2011 and 2010, was $89,000, $61,000 and $61,000, respectively.
A summary of the activity of nonvested, non-qualified options and warrants granted outside of the Plan in connection with employment and investor relations consulting services for the year ended December 31, 2012, is presented below:
| | | | | | |
| Nonvested Shares | | Nonvested Shares Underlying Options | | Weighted Average Exercise Price | | Weighted Average Grant Date Fair Value |
| Nonvested at January 1, 2012 | | | 7,917 | | | $ | 21.18 | | | $ | 16.14 | |
| Granted | | | 20,000 | | | | 3.42 | | | | 2.84 | |
| Vested | | | (15,137 | ) | | | 7.97 | | | | 5.89 | |
| Forfeited | | | (4,447 | ) | | | 19.50 | | | | 16.11 | |
| Nonvested at December 31, 2012 | | | 8,333 | | | $ | 3.42 | | | $ | 2.84 | |
At December 31, 2012, there was approximately $22,000 in unrecognized cost for non-qualified options that will be recorded over a weighted average future period of less than one year.
Subsequent to December 31, 2012, 501 investor relations options which were exercisable at $54.00 per share expired.
Note 7. Animal Health License Agreements:
Effective May 1, 2004 Washington University in St. Louis (WU) and Venaxis entered into an Exclusive License Agreement (WU License Agreement) which grants Venaxis exclusive license and right to sublicense WU’s technology (as defined under the WU License Agreement) for veterinary products worldwide, except where such products are prohibited under U.S. laws for export. The term of the WU License Agreement continues until the expiration of the last of WU’s patents (as defined in the WU License Agreement) expire. Venaxis has agreed to pay minimum annual royalties of $20,000 annually during the term of the WU License Agreement and such amounts are creditable against future royalties. Royalties payable to WU under the WU License Agreement for covered product sales by Venaxis carry a mid-single digit royalty rate and for sublicense fees received by Venaxis carry a low double-digit royalty rate. The WU License Agreement contains customary terms for confidentiality, prosecution and infringement provisions for licensed patents, publication rights, indemnification and insurance coverage. The WU License Agreement is cancelable by Venaxis with ninety days advance notice at any time and by WU with sixty days advance notice if Venaxis materially breaches the WU License Agreement and fails to cure such breach.
In July 2012, the Company entered into an Exclusive License Agreement (the “License Agreement”) with a licensee (“Licensee”), under which the Company granted the Licensee an exclusive royalty-bearing license to the Company’s intellectual property and other assets, including patent rights and know-how, relating to recombinant single chain reproductive hormone technology for use in non-human mammals (the “Company’s Animal Health Assets”). The License Agreement includes a sublicense of the technology licensed to the Company by WU. Under the terms of the WU License Agreement, a portion of license fees and royalties Venaxis receives from sublicensing agreements will be paid to WU. The obligation for such license fees due to WU is included in accrued expenses at December 31, 2012.
Under the License Agreement, the Licensee obtained a worldwide exclusive license to develop, seek regulatory approval for and offer to sell, market, distribute, import and export luteinizing hormone (“LH”)
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Venaxis, Inc.
Notes to Financial Statements
Note 7. Animal Health License Agreements: – (continued)
and/or follicle-stimulating hormone (“FSH”) products for bovine (cattle), equine and swine in the field of the assistance and facilitation of reproduction in bovine, equine and swine animals. The Company also granted the Licensee an option and right of first refusal to develop additional animal health products outside of the licensed field of use or any diagnostic pregnancy detection tests for non-human mammals.
Under the License Agreement as of December 31, 2012, the following future license fees and milestone payments are provided, assuming future milestones are successfully achieved:
License fees of $408,000 payable in quarterly installments of $204,000;
Milestone payments, totaling up to a potential of $1.1 million in the aggregate, based on the satisfactory conclusion of milestones as defined in the License Agreement;
Potential for milestone payments of up to an additional $2 million for development and receipt of regulatory approval for additional licensed products; and
Royalties, at low double digit rates, based on sales of licensed products.
Revenue recognition related to the License Agreement and WU Agreement is based primarily on the Company’s consideration of ASC 808-10-45, “Accounting for Collaborative Arrangements”. For financial reporting purposes, the license fees and milestone payments received from the License Agreement, net of the amounts due to third parties, including WU, have been recorded as deferred revenue and are amortized over the term of the License Agreement. License fees and milestone revenue totaling a net of approximately $1,182,000 commenced being amortized into income upon the July 2012 date of milestone achievement. As of December 31, 2012, deferred revenue of $79,803 has been classified as a current liability and $1,081,706 has been classified as a long-term liability. The current liability includes the next twelve months’ portion of the amortizable milestone revenue. During the year ended December 31, 2012, $20,571 was recorded as the amortized license fee revenue arising from the License Agreement.
A tabular summary of the revenue categories and amounts of revenue recognition associated with the License Agreement follows:
| | |
| Category | | Totals |
| License fees and milestone amounts paid/achieved | | $ | 1,512,000 | |
| Third party obligations recorded, including WU | | | (329,920 | ) |
| Deferred revenue balance | | | 1,182,080 | |
| Revenue amortization to December 31, 2012 | | | (20,571 | ) |
| Net deferred revenue balance at December 31, 2012 | | $ | 1,161,509 | |
| | |
| Category | | Totals |
| Commencement of license fees revenue recognition | | Upon signing or receipt |
| Commencement of milestone revenue recognition | | Upon milestone achievement over then remaining life |
| Original amortization period | | 197 months |
The animal health technology, licensed from WU in 2004 was sub-licensed in 2008 to Novartis Animal Health (“Novartis”) under a long-term world-wide development and marketing agreement. In November 2011, the Company entered into a Termination Agreement with Novartis Animal Health, Inc. (the “Novartis Termination Agreement”) to terminate the Novartis License Agreement. Under the Novartis Termination Agreement, the original termination obligation totaled $1,374,000, which was payable $150,000 upon signing the Novartis Termination Agreement and six equal subsequent quarterly installments of $204,000 each. At December 31, 2012, the remaining outstanding termination obligation totaled $397,588 which is due in 2013. Between 2008 and 2011, the Company received up-front license fees which were recorded, net of the amounts due to WU, in accordance with ASC 808. The non-refundable net amount of $810,000 was being amortized to license fee
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Venaxis, Inc.
Notes to Financial Statements
Note 7. Animal Health License Agreements: – (continued)
revenue over the 152 month original license period. During the years ended December 31, 2011 and 2010, $62,179 and $68,394, respectively, was recorded as the amortized license fee revenue arising from the Novartis License Agreement. Upon execution of the Termination Agreement with Novartis, the Company recorded a gain of $938,896, arising from the elimination of both the $900,000 in remaining deferred revenue and the net accounts payable to Novartis the total of which exceeded the net settlement obligation to Novartis. As of the date of termination, future amortization of the deferred revenue was terminated.
Note 8. Other income:
In 2010, the Company received $244,479 from the U.S. Department of Treasury under the qualifying therapeutic discovery project under Section 48D of the Internal Revenue Code which is included in other income for the year ended December 31, 2010.
Note 9. Income taxes:
Income taxes at the federal statutory rate are reconciled to the Company’s actual income taxes as follows:
| | | | | | |
| | 2012 | | 2011 | | 2010 |
| Federal income tax benefit at 34% | | $ | (3,132,000 | ) | | $ | (3,473,000 | ) | | $ | (4,535,000 | ) |
| State income tax net of federal tax effect | | | (276,000 | ) | | | (306,000 | ) | | | (400,000 | ) |
| Permanent items | | | 339,000 | | | | 504,000 | | | | 881,000 | |
| Other | | | 121,000 | | | | — | | | | — | |
| Valuation allowance | | | 2,948,000 | | | | 3,275,000 | | | | 4,054,000 | |
| | | $ | — | | | $ | — | | | $ | — | |
As of December 31, 2012, the Company has net operating loss carry forwards of approximately $68 million for federal and state tax purposes, which are available to offset future taxable income, if any, expiring through December 2032. A valuation allowance was recorded at December 31, 2012 due to the uncertainty of realization of deferred tax assets in the future.
The tax effects of temporary differences that give rise to significant portions of deferred tax assets and liabilities at December 31, 2012 and 2011 are as follows:
| | | | |
| | 2012 | | 2011 |
Deferred tax assets (liabilities):
| | | | | | | | |
| Net operating loss carry forwards | | $ | 25,100,000 | | | $ | 22,767,000 | |
| Property and equipment | | | 32,000 | | | | 8,000 | |
| Patents and other intangible assets | | | 17,000 | | | | 23,000 | |
| Other | | | — | | | | 15,000 | |
| Deferred revenue | | | 551,000 | | | | — | |
| Research and development credit | | | 753,000 | | | | 692,000 | |
| Deferred tax asset | | | 26,453,000 | | | | 23,505,000 | |
| Valuation allowance | | | (26,453,000 | ) | | | (23,505,000 | ) |
| | $ | — | | | $ | — | |
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Venaxis, Inc.
Notes to Financial Statements
Note 10. Commitments and contingencies:
Commitments:
Employment commitments:
As of December 31, 2012, the Company has employment agreements with three officers providing aggregate annual minimum commitments totaling $780,000. The agreements automatically renew at the end of each year unless terminated by either party and contain customary confidentiality and benefit provisions.
Contingencies:
On September 1, 2010, the Company received a complaint, captioned Mark Chipman v. AspenBio Pharma, Inc. (now Venaxis, Inc.), Case No. 2:10-cv-06537-GW-JC (“Chipman Suit”). The complaint was filed in the U.S. District Court in the Central District of California by an individual investor. The complaint included allegations of fraud, negligent misrepresentation, violations of Section 10(b) of the Exchange Act and SEC Rule 10b-5, and violations of Sections 25400 and 25500 of the California Corporations Code, all related to the Company’s blood-based acute appendicitis test in development. On the Company’s motion, the action was transferred to the U.S. District Court for the District of Colorado by order dated January 21, 2011. The action was assigned a District of Colorado Civil Case No. 11-cv-00163-REB-KMT.
On October 7, 2011, the Company filed a motion to dismiss the complaint. On September 17, 2012, the United States District Court for Colorado granted the Company’s motion to dismiss, dismissing the plaintiff’s claims against the Company without prejudice. On the same day, the court also entered final judgment without prejudice in favor of the Company and against the plaintiff in the Chipman Suit. The plaintiff in the Chipman Suit did not file a Notice of Appeal.
On October 1, 2010, the Company received a complaint, captioned John Wolfe, individually and on behalf of all others similarly situated v. AspenBio Pharma, Inc. (now Venaxis, Inc.) et al., Case No. CV10 7365 (“Wolfe Suit”). This federal securities purported class action was filed in the U.S. District Court in the Central District of California on behalf of all persons, other than the defendants, who purchased common stock of the Company during the period between February 22, 2007 and July 19, 2010, inclusive. The complaint named as defendants certain officers and directors of the Company during such period. The complaint included allegations of violations of Section 10(b) of the Exchange Act and SEC Rule 10b-5 against all defendants, and of Section 20(a) of the Exchange Act against the individual defendants, all related to the Company’s blood-based acute appendicitis test in development known asAPPY1. On the Company’s motion, this action was also transferred to the U.S. District Court for the District of Colorado by order dated January 21, 2011. The action has been assigned a District of Colorado Civil Case No. 11-cv-00165-REB-KMT. On July 11, 2011, the court appointed a lead plaintiff and approved lead counsel. On August 23, 2011, the lead plaintiff filed an amended putative class action complaint, alleging the same class period. Based on a review of the amended complaint, the Company and the individual defendants believe that the plaintiffs’ allegations are without merit, have vigorously defended against these claims, and intend to continue to do so.
On October 7, 2011, the Company filed a motion to dismiss the amended complaint, and the plaintiff’s response and the Company’s reply thereto were subsequently filed. On September 13, 2012, the United States District Court for Colorado granted the Company’s motion to dismiss, dismissing the plaintiffs’ claims against all defendants without prejudice. On September 14, 2012, the court entered Final Judgment without prejudice on behalf of all defendants and against all plaintiffs in the Wolfe Suit. The Order to dismiss the action found in favor of the company and all of the individual defendants. On October 12, 2012, the plaintiffs filed a Notice of Appeal of the Order granting the motion to dismiss and of the Final Judgment in the Wolfe Suit. The plaintiffs filed their opening brief with the Tenth Circuit Court of Appeals on March 1, 2013.
On January 4, 2011, a plaintiff filed a complaint in the U.S. District Court for the District of Colorado captioned Frank Trpisovsky v. Pusey, et al, Civil Action No. 11-cv-00023-PAB-BNB, that purports to be a shareholder derivative action on behalf of the Company against thirteen individual current or former officers
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Venaxis, Inc.
Notes to Financial Statements
Note 10. Commitments and contingencies: – (continued)
and directors. The complaint also names the Company as a nominal defendant. The plaintiff asserts violations of Section 14(a) of the Exchange Act, SEC Rule 14a-9, breach of fiduciary duty, waste of corporate assets, and unjust enrichment. On motion of the Company and the individual defendants, the U.S. District Court has stayed this derivative action by order dated March 15, 2011, and this action continues to be stayed. On October 18, 2012, the parties filed a Joint Status Report, reporting on updates in the Chipman Suit and the Wolfe Suit and stating that the stay should remain in place at this time and that a further status report should be submitted after appeals in the Wolfe Suit have been resolved. On October 25, 2012, the magistrate judge issued a recommendation that the case be administratively closed, subject to reopening for good cause. The U.S. District Court on November 14, 2012, accepted the recommendation and ordered this action administratively closed, subject to reopening for good cause.
In the ordinary course of business and in the general industry in which the Company is engaged, it is not atypical to periodically receive a third party communication which may be in the form of a notice, threat, or ‘cease and desist’ letter concerning certain activities. For example, this can occur in the context of the Company’s pursuit of intellectual property rights. This can also occur in the context of operations such as the using, making, having made, selling, and offering to sell products and services, and in other contexts. The Company makes rational assessment of each situation on a case-by-case basis as such may arise. The Company periodically evaluates its options for trademark positions and considers a full spectrum of alternatives for trademark protection and product branding.
Note 11. Supplemental data: Selected quarterly financial information (unaudited)
| | | | | | | | |
| | March 31, | | June 30, | | September 30, | | December 31, |
Fiscal 2012 quarters ended:
| | | | | | | | | | | | | | | | |
| Total revenues | | $ | 7,000 | | | $ | 27,000 | | | $ | 6,000 | | | $ | 2,000 | |
| Gross margin | | $ | 7,000 | | | $ | 27,000 | | | $ | 6,000 | | | $ | 1,000 | |
| Net loss | | $ | (1,938,000 | ) | | $ | (2,310,000 | ) | | $ | (2,460,000 | ) | | $ | (2,504,000 | ) |
| Loss per share – Basic and diluted | | $ | (1.20 | ) | | $ | (1.19 | ) | | $ | (.32 | ) | | $ | (0.87 | ) |
Market price of common stock
| | | | | | | | | | | | | | | | |
| High | | $ | 5.88 | | | $ | 4.44 | | | $ | 2.77 | | | $ | 2.93 | |
| Low | | $ | 3.90 | | | $ | 1.88 | | | $ | 1.33 | | | $ | 2.04 | |
Fiscal 2011 quarters ended:
| | | | | | | | | | | | | | | | |
| Total revenues | | $ | 97,000 | | | $ | 55,000 | | | $ | 22,000 | | | $ | 45,000 | |
| Gross margin | | $ | 85,000 | | | $ | 52,000 | | | $ | 22,000 | | | $ | 44,000 | |
| Net loss | | $ | (2,806,000 | ) | | $ | (2,787,000 | ) | | $ | (3,064,000 | ) | | $ | (1,557,000 | ) |
| Loss per share – Basic and diluted | | $ | (2.10 | ) | | $ | (2.10 | ) | | $ | (2.28 | ) | | $ | (0.96 | ) |
Market price of common stock
| | | | | | | | | | | | | | | | |
| High | | $ | 25.50 | | | $ | 23.61 | | | $ | 22.50 | | | $ | 17.53 | |
| Low | | $ | 16.80 | | | $ | 18.60 | | | $ | 14.40 | | | $ | 5.82 | |
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Venaxis, Inc.
Balance Sheets
| | | | |
| | March 31,
2013
(Unaudited) | | December 31,
2012 |
ASSETS
| | | | | | | | |
Current assets:
| | | | | | | | |
| Cash and cash equivalents | | $ | 2,491,838 | | | $ | 10,977,974 | |
| Short-term investments (Note 1) | | | 6,775,800 | | | | 1,162,904 | |
| Prepaid expenses and other current assets | | | 286,761 | | | | 387,480 | |
| Total current assets | | | 9,554,399 | | | | 12,528,358 | |
| Property and equipment, net (Note 2) | | | 2,428,789 | | | | 2,484,539 | |
| Other long term assets, net (Notes 1 and 3) | | | 1,610,964 | | | | 1,601,894 | |
| Total assets | | $ | 13,594,152 | | | $ | 16,614,791 | |
LIABILITIES AND STOCKHOLDERS' EQUITY
| | | | | | | | |
Current liabilities:
| | | | | | | | |
| Accounts payable | | $ | 704,782 | | | $ | 613,925 | |
| Accrued compensation | | | 31,695 | | | | 452,878 | |
| Accrued expenses | | | 452,749 | | | | 642,055 | |
| Notes and other obligations, current portion (Note 4) | | | 1,945,383 | | | | 2,290,292 | |
| Deferred revenue, current portion (Note 7) | | | 84,995 | | | | 79,803 | |
| Total current liabilities | | | 3,219,604 | | | | 4,078,953 | |
| Notes and other obligations, less current portion (Note 4) | | | 746,776 | | | | 763,132 | |
| Deferred revenue, less current portion (Note 7) | | | 1,254,719 | | | | 1,081,706 | |
| Total liabilities | | | 5,221,099 | | | | 5,923,791 | |
Commitments and contingencies (Notes 7 and 8)
| | | | | | | | |
Stockholders' equity (Notes 5 and 6):
| | | | | | | | |
Common stock, no par value, 30,000,000 shares authorized;
9,954,380 shares issued and outstanding | | | 85,408,355 | | | | 84,924,133 | |
| Accumulated deficit | | | (77,035,302 | ) | | | (74,233,133 | ) |
| Total stockholders' equity | | | 8,373,053 | | | | 10,691,000 | |
| Total liabilities and stockholders' equity | | $ | 13,594,152 | | | $ | 16,614,791 | |
See Accompanying Notes to Unaudited Condensed Financial Statements
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Venaxis, Inc.
Statements of Operations
Three Months Ended March 31
(Unaudited)
| | | | |
| | 2013 | | 2012 |
| Sales | | $ | — | | | $ | 7,275 | |
| Cost of sales | | | — | | | | 184 | |
| Gross profit | | | — | | | | 7,091 | |
| Other revenue – fee (Note 7) | | | 18,655 | | | | — | |
Operating expenses:
| | | | | | | | |
| Selling, general and administrative | | | 1,427,955 | | | | 1,204,675 | |
| Research and development | | | 1,411,973 | | | | 676,618 | |
| Total operating expenses | | | 2,839,928 | | | | 1,881,293 | |
| Operating loss | | | (2,821,273 | ) | | | (1,874,202 | ) |
| Other income (expense), net | | | 19,104 | | | | (64,069 | ) |
| Net loss | | $ | (2,802,169 | ) | | $ | (1,938,271 | ) |
| Basic and diluted net loss per share (Note 1) | | $ | (0.28 | ) | | $ | (1.21 | ) |
| Basic and diluted weighted average number of shares outstanding (Note 1) | | | 9,954,380 | | | | 1,608,146 | |
See Accompanying Notes to Unaudited Condensed Financial Statements
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Venaxis, Inc.
Statements of Cash Flows
Three Months Ended March 31
(Unaudited)
| | | | |
| | 2013 | | 2012 |
Cash flows from operating activities:
| | | | | | | | |
| Net loss | | $ | (2,802,169 | ) | | $ | (1,938,271 | ) |
Adjustments to reconcile net loss to net cash used in operating activities:
| | | | | | | | |
| Stock-based compensation for services | | | 484,222 | | | | 221,996 | |
| Depreciation and amortization | | | 86,808 | | | | 112,325 | |
| Impairment charges | | | — | | | | 41,950 | |
| Amortization of license fees | | | (18,655) ) | | | | — | |
Change in:
| | | | | | | | |
| Accounts payable | | | 90,857 | | | | (121,135 | ) |
| Accounts receivable | | | — | | | | 28,028 | |
| Prepaid expenses and other current assets | | | 100,719 | | | | 109,043 | |
| Deferred revenue | | | 196,860 | | | | — | |
| Accrued compensation | | | (421,183 ) | | | | — | |
| Accrued expenses | | | (189,306 | ) | | | (188,522 | ) |
| Net cash used in operating activities | | | (2,471,847 | ) | | | (1,734,586 | ) |
Cash flows from investing activities:
| | | | | | | | |
| Purchases of short-term investments | | | (5,612,896 | ) | | | — | |
| Sales of short-term investments | | | — | | | | 441,346 | |
| Purchases of property and equipment | | | (10,844 | ) | | | — | |
| Purchases of patent and trademark application costs | | | (29,284 | ) | | | (23,099 | ) |
| Net cash provided by investing activities | | | (5,653,024 ) | | | | 418,247 | |
Cash flows from financing activities:
| | | | | | | | |
| Repayment of notes payable and other obligations | | | (361,265 | ) | | | (335,303 | ) |
| Net cash used in financing activities | | | (361,265 | ) | | | (335,303 | ) |
| Net decrease in cash and cash equivalents | | | (8,486,136 ) | | | | (1,651,642 | ) |
| Cash and cash equivalents at beginning of period | | | 10,977,974 | | | | 2,968,104 | |
| Cash and cash equivalents at end of period | | $ | 2,491,838 | | | $ | 1,316,462 | |
Supplemental disclosure of cash flow information:
| | | | | | | | |
| Cash paid during the period for interest | | $ | 47,120 | | | $ | 64,768 | |
See Accompanying Notes to Unaudited Condensed Financial Statements
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Venaxis, Inc.
Notes to Condensed Financial Statements
(Unaudited)
INTERIM FINANCIAL STATEMENTS
The accompanying financial statements of Venaxis, Inc. (the “Company,” “we,” or “Venaxis”) have been prepared in accordance with the instructions to quarterly reports on Form 10-Q. In the opinion of management, all adjustments (which include only normal recurring adjustments) necessary to present fairly the financial position, results of operations and changes in financial position at March 31, 2013 and for all periods presented have been made. Certain information and footnote data necessary for fair presentation of financial position and results of operations in conformity with accounting principles generally accepted in the United States of America have been condensed or omitted. It is therefore suggested that these financial statements be read in conjunction with the summary of significant accounting policies and notes to financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2012. The results of operations for the period ended March 31, 2013 are not necessarily an indication of operating results for the full year.
Management’s plans and basis of presentation:
The Company has experienced recurring losses and negative cash flows from operations. At March 31, 2013, the Company had approximate balances of cash and liquid investments of $9,268,000, working capital of $6,335,000, stockholders’ equity of $8,373,000 and an accumulated deficit of $77,035,000. To date, the Company has in large part relied on equity financing to fund its operations. The Company expects to continue to incur losses from operations for the near-term and these losses could be significant as product development, clinical and regulatory activities, consulting expenses and other product development related expenses are incurred. The Company believes that its current working capital position will be sufficient to meet its estimated cash needs for the remainder of 2013 and at least into 2014. If the Company does not obtain additional capital, the Company would potentially be required to reduce the scope of its research and development activities or cease operations. The Company continues to explore obtaining additional financing. The Company is closely monitoring its cash balances, cash needs and expense levels. In addition, the Company’s first mortgage which is held by a commercial bank requires a balloon payment of approximately $1.6 million due in July, 2013. Subsequent to March 31, 2013, the Company received a loan commitment to refinance the commercial bank obligation (Note 4).
Management’s strategic plans include the following:
| — | continuing to advance development of the Company’s principal product,APPY1; |
| — | pursuing additional capital raising opportunities; |
| — | continuing to explore prospective partnering or licensing opportunities with complementary opportunities and technologies; |
| — | continuing to monitor and implement cost control initiatives to conserve cash; and |
| — | refinancing the portion of the mortgage payable in July 2013. |
Note 1. Significant accounting policies:
Cash, cash equivalents and investments:
The Company considers all highly liquid investments with an original maturity of three months or less at the date of acquisition to be cash equivalents. From time to time, the Company’s cash account balances exceed the balances as covered by the Federal Deposit Insurance System. The Company has never suffered a loss due to such excess balances.
The Company invests excess cash from time to time in highly-liquid debt and equity investments of highly-rated entities which are classified as trading securities. The purpose of the investments is to fund research and development, product development, United States Food and Drug Administration (“FDA”) clearance-related activities and general corporate purposes. Such amounts are recorded at market values using Level 1 inputs in
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Venaxis, Inc.
Notes to Condensed Financial Statements
(Unaudited)
Note 1. Significant accounting policies: – (continued)
determining fair value and are classified as current, as the Company does not intend to hold the investments beyond twelve months. Investment securities classified as trading are those securities that are bought and held principally for the purpose of selling them in the near term, with the objective of preserving principal and generating profits. These securities are reported at fair value with unrealized gains and losses reported as an element of other (expense) income in current period earnings. The Company’s Board of Directors has approved an investment policy covering the investment parameters to be followed with the primary goals being the safety of principal amounts and maintaining liquidity of the fund. The policy provides for minimum investment rating requirements as well as limitations on investment duration and concentrations. Based upon market conditions, the investment guidelines have been tightened to increase the minimum acceptable investment ratings required for investments and shorten the maximum investment term. As of March 31, 2013, 24% of the investment portfolio was in cash and cash equivalents, which is presented as such on the accompanying balance sheet, and the remaining funds were invested in short-term marketable securities with none individually representing more than 5% of the portfolio and none with maturities past January 2014. To date, the Company’s cumulative realized market loss from the investments has not been in excess of $5,000. For the three months ended March 31, 2013, there was approximately $38,869 in unrealized income, there wasloss, no realized gain or loss, and $18,271$3,893 in management fees. For the three months ended March 31, 2012, there was approximately $1,260 in unrealized income, no realized gain or loss, and $657 in management fees.
Fair value of financial instruments:
The Company accounts for financial instruments under Financial Accounting Standards Board (FASB) Accounting Standards Codification Topic (ASC) 820, (formerly Statement of Financial Accounting Standard (SFAS) No. 157),Fair Value Measurements. This statement defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. To increase consistency and comparability in fair value measurements, ASC 820 establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three levels as follows:
Level 1 — quoted prices (unadjusted) in active markets for identical assets or liabilities;
Level 2 — observable inputs other than Level 1, quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets and liabilities in markets that are not active, and model-derived prices whose inputs are observable or whose significant value drivers are observable; and
Level 3 — assets and liabilities whose significant value drivers are unobservable.
Observable inputs are based on market data obtained from independent sources, while unobservable inputs are based on the Company’s market assumptions. Unobservable inputs require significant management judgment or estimation. In some cases, the inputs used to measure an asset or liability may fall into different levels of the fair value hierarchy. In those instances, the fair value measurement is required to be classified using the lowest level of input that is significant to the fair value measurement. Such determination requires significant management judgment. There were no financial assets or liabilities measured at fair value, with the exception of cash, cash equivalents and short-term investments as of DecemberMarch 31, 20112013 and December 31, 2010.2012.
The carrying amounts of the Company’s financial instruments (other than cash, cash equivalents and short-term investments as discussed above) approximate fair value because of their variable interest rates and / and/or short maturities combined with the recent historical interest rate levels.
The Company capitalizes legal costs and filing fees associated with obtaining patents on its new discoveries. Once the patents have been issued, the Company amortizes these costs over the shorter of the legal life of the patent or its estimated economic life using the straight-line method. Based upon the current status of the above intangible assets, the aggregate amortization expense is estimated to be approximately $69,000$75,000 for each of the next five fiscal years. The Company tests intangible assets with finite lives upon significant changes in the Company’s business environment. The testing resulted in no patent impairment charges during the three months ended March 31, 2013 and approximately $42,000 of patent impairment charges during the three months ended March 31, 2012.
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