ENDOVASC, INC.
NOTES TO UNAUDITED CONDENSED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT SHARE DATA)
1. | Interim Financial Statements |
The accompanying interim condensed financial statements and notes to the financial statements for the interim period as of March 31, 2006 and for the three months and nine months ended March 31, 2006 and 2005, are unaudited. The accompanying interim unaudited financial statements have been prepared by the Company in accordance with accounting principles generally accepted in the United States of America for interim financial statements and pursuant to the requirements for reporting on Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included. Operating results for the nine month period ended March 31, 2006, are not necessarily indicative of the results that may be expected for the year ending June 30, 2006. The condensed financial statements should be read in conjunction with the financial statements and notes thereto included in the Form 10-KSB of the Company as of and for the year ended June 30, 2005.
In accordance with Article 6 of Regulation S-X under the Securities Act of 1933 and Securities Exchange Act of 1934, the Company does not consolidate portfolio company investments in which the Company has a controlling interest.
2. | Organization and Summary of Significant Accounting Policies |
Endovasc, Inc. (the "Company") is incorporated under the laws of the State of Nevada. On October 6, 2004 the Company filed its election with the SEC (Form N-54A) to adopt business development company ("BDC") status under the Investment Company Act of 1940 ("1940 Act"). A BDC is a specialized type of investment company under the 1940 Act. A BDC may primarily be engaged in the business of furnishing capital and managerial expertise to companies that do not have ready access to capital through conventional financial channels; such companies are termed "eligible portfolio companies". The Company, as a BDC, may invest in other securities; however, such investments may not exceed 30% of the Company's total asset value at the time of such investment. The accompanying financial statements reflect the accounts of Endovasc, Inc., and the related results of operations. In accordance with Article 6 of Regulation S-X under the Securities Act of 1933 and Securities Exchange Act of 1934, the Company does not consolidate portfolio company investments in which the Company has a controlling interest. Accounting principles used in the preparation of the financial statements beginning October 6, 2004 are different than those of prior periods and, therefore, the financial position and results of operations of these periods are not directly comparable. The primary differences in accounting principles relate to the carrying value of investments.
The Company currently has investments in five portfolio companies as follows:
Liprostin, Inc.
The Company has an investment in the wholly-owned, unconsolidated subsidiary, Liprostin, Inc., which is engaged in the development of liposome drug delivery systems. Liposomes, which are microscopic cell-like spheres composed of a thin, durable lipid membrane surrounding a hollow compartment, can be used to entrap and protect drugs from degradation in the blood stream and can be engineered to regulate the transport of molecules across their outer membrane. On March 6, 2006, The Company announced that it has submitted to the U.S. Food and Drug Administration (FDA) its protocol for a phase IIIa clinical trial of Liprostin for the treatment of intermittent claudication, a symptom of peripheral arterial disease. As outlined in the protocol, the phase IIIa trial is randomized, placebo-controlled, double-blinded, pharmacokinetic study of two dose levels of Liprostin or placebo administered once-weekly for six weeks.
ENDOVASC, INC.
NOTES TO UNAUDITED CONDENSED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT SHARE DATA)
Angiogenix Limited, Inc.
The Company also has an investment in the wholly-owned, unconsolidated subsidiary, Angiogenix Limited, Inc (Angiogenix). Angiogenix has an exclusive licensing agreement (the "Stanford License Agreement") with the Board of Trustees of the Leland Stanford University relating to US Patent Application 60/146,233 (issued as US Patent No. 6,417,205 B1 on July 9, 2002) relating to the administration of Nicotine or Nicotine Receptor Agonist (NRA) to induce the growth of new blood vessels ("angiogenesis"). During the quarter ended June 30, 2005, the Company canceled its license agreement with Leland J. Stanford University.
Nutraceutical Development Corporation
The Company has an investment in the wholly-owned, unconsolidated subsidiary, Nutraceutical Development Corporation ("NDC"). NDC was formed to develop certain technologies now owned by the Company's other subsidiaries for use in dietary products designed to enhance health and provide beneficial biological effects ("nutraceuticals").
Endovasc-TissueGen Research Sponsors, L.C.C.
The Company has a 49.9% investment in a joint venture named Endovasc-TissueGen Research Sponsors, L.L.C. (the "Partnership"). The purpose of the Partnership is to develop a bioresorbable drug-eluting cardiovascular stent for the advanced treatment of coronary artery disease
Endovasc-TissueGen-Blumberg Research Sponsors, L.C.C
The Company has a 39.9% investment in a joint venture named Endovasc-TissueGen Blumberg Research Sponsors, L.L.C. (the "Joint Venture"). The purpose of the Joint Venture is to develop biodegradable stents for ureteral and prostate applications.
Significant Estimates
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. While it is believed that such estimates are reasonable, actual results could differ from those estimates.
As a business development company, the Company's investments are in private companies with no publicly available market price. Business development companies are required to carry investments at fair value. Generally, the fair value of a private security will initially be based primarily on its original cost to the Company. Management and the Company's board of directors must evaluate the actual and expected future operations of the portfolio companies, monitor market conditions and evaluate any new financings or other significant events that the portfolio companies may sustain in order to estimate a fair value for the investments in these companies at least quarterly. If the Company's estimates of the future differ from actual events in the future, for any reason, the Company may fail to record an unrecognized gain or loss or may record it later or earlier than it would with a perfect forecast of the future. Because these investments are restricted and illiquid, even if the Company correctly estimates a fair value for an investment today, that investment could lose some or all of its value in the near future without the Company realizing any benefit from its investments or recognizing any cash proceeds from the sale of these investments. If, in the future, the Company determines that a loss has occurred in any of its investments, that loss will be reflected as a reduction in the value of its investments on the Company's consolidated balance sheet, and the reduced values will negatively impact earnings and be reflected as a loss on the statements of operations.
ENDOVASC, INC.
NOTES TO UNAUDITED CONDENSED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT SHARE DATA)
Investments
The Company's investments potentially subject the Company to various levels of risk associated with economic changes, interest rate fluctuations, political events, war and terrorism, and operating conditions beyond the control of the Company. Consequently, management's judgment as to the level of losses that currently exist or may develop in the future, if any, involves the consideration of current and anticipated conditions and their potential effects on the Company's investments. Due to the level of risk associated with investment securities and the level of uncertainty related to changes in the value of investment securities, it is at least reasonably possible that changes in risks in the near term could materially impact the value of the amounts reflected in the accompanying financial statements. Investments are carried at fair value as determined in good faith by or under the direction of the Board of Directors of the Company based on information, including an independent valuation, and using valuation methodologies considered appropriate and reliable by the Board. Generally, the fair value of a private security will initially be based primarily on its original cost to the Company. Cost will be the primary factor used to determine fair value on an ongoing basis until significant developments or other factors affecting the investment (such as results of the portfolio company's operations, changes in general market conditions, subsequent financings, independent valuations or the availability of market quotations) provide a basis for value other than cost. For investments in which the Company earns an interest for services rendered, the Board estimates the fair value of the services as the initial basis for estimating fair value of the securities received. The Board believes that the methods used to value the investments reflected in the accompanying financial statements have been valued appropriately and that the values reflected herein have been calculated in accordance with generally accepted valuation methods which result in valuations in the Company's financial statements being recorded in accordance with generally accepted accounting principles in the United States of America. However, losses may occur, which may be material to the financial condition of the Company and proceeds, if any, from the disposition of securities could differ significantly from the values reflected herein. In particular, early stage and seed round investments in private companies, which is the focus of the Company, are typically in illiquid restricted securities with no current market and therefore no market prices or comparables are available upon which to base estimates. These portfolio companies are often development stage with no operations and no positive cash flow. These factors, among others, make determination of fair value more difficult and subject to significant judgment errors by the Company's board of directors.
Stock-based compensation
Adoption of SFAS 123(R)
Until June 30, 2005, the Company accounted for employee stock options using the intrinsic value method in accordance with Accounting Principles Board Opinion ("APB") No. 25, Accounting for Stock Issued to Employees, and had adopted the disclosure-only alternative of SFAS No. 123, Accounting for Stock-Based Compensation, as amended by SFAS No. 148, Accounting for Stock-Based Compensation-Transition and Disclosure which requires pro-forma disclosure of compensation expense associated with stock options under the fair value method. Under the intrinsic value method, the Company only recorded stock-based compensation resulting from options granted at below fair market value. Effective July 1, 2005, the Company adopted SFAS No. 123R, "Share Based Payment", which requires that they measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award, and recognize that cost over the vesting period.
Valuation and Amortization Method—The Company estimates the fair value of stock options granted using the Black-Scholes option-pricing formula and a single option award approach. This fair value is then amortized on a straight-line basis over the requisite service periods of the awards, which is generally the vesting period.
Expected Term—The expected term represents the period that the Company's stock-based awards are expected to be outstanding and is determined based on historical experience of similar awards, giving consideration to the contractual terms of the stock-based awards, vesting schedules and expectations of future employee behavior as influenced by changes to the terms of its stock-based awards.
ENDOVASC, INC.
NOTES TO UNAUDITED CONDENSED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT SHARE DATA)
Expected Volatility—Stock-based payments made prior to July 1, 2005 were accounted for using the intrinsic value method under APB 25. The fair value of stock based payments made subsequent to June 30, 2005 is valued using the Black-Scholes valuation method with a volatility factor based on our historical stock trading history.
Risk-Free Interest Rate—The Company bases the risk-free interest rate used in the Black-Scholes valuation method on the implied yield currently available on U.S. Treasury securities with an equivalent term.
Estimated Forfeitures—When estimating forfeitures, the Company considers voluntary termination behavior as well as analysis of actual option forfeitures.
On October 21, 2005, the Company's Board of Directors adopted the 2005 Executive Compensation Plan (the "Plan"). Amendment No. 1 to the Plan was adopted by the Board of Directors on November 14, 2005. On December 16, 2005, the stockholders approved the 2005 Plan and the grant of stock options. The maximum number of shares currently reserved for issuance is equal to 15% of the number of shares of Common Stock issued and outstanding at any time.
The Company is not presently able to compensate its officers and employees with cash because of the lack of available funds from operations. The Plan was adopted to provide a means by which the Company can attract and retain officers and employees and give such officers and employees an interest in the success of the Company. Under the Plan, the Board of Directors (or a committee designated by the Board of Directors) may grant options to purchase shares of the Company Common Stock to officers and employees. Directors are not eligible to receive options under the Plan. As of March 31, 2006, no stock options are outstanding at this time.
During the nine months ended March 31, 2006, the Company recognized $186 compensation expense for employee stock options grants. Restricted stock is expensed based on the fair market value on the grant date. There was no impact on cash flows from financing activities.
The fair value of each option grant was estimated on the grant date using the Black-Scholes option-pricing model with the following assumptions:
| | March 31, 2006 |
| Expected option term (1) | 10 years |
| Expected volatility factor (2) | 100.0% |
| Risk-free interest rate (3) | 5.0% |
| Expected annual dividend yield | 0.0% |
(1) The option life was determined using the simplified method for estimating expected option life, which qualify as "plain-vanilla" options.
(2) The stock volatility for each grant is determined based on the review of the experience of the weighted average of historical monthly price changes of the Company's common stock over the most recent ten years, which is the contractual term of the option awards.
(3) The risk-free interest rate for periods equal to the expected term of the stock option is based on the U.S. Treasury yield curve in effect at the time of the grant.
ENDOVASC, INC.
NOTES TO UNAUDITED CONDENSED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT SHARE DATA)
A summary of option activity under the Company's employee stock option plans in the nine months ended March 31,2006, is presented below:
| Options | | Shares (‘000) | | Weighted Average Exercise Price | | Weighted Average Remaining Contractual Terms | | Aggregate Intrinsic Value | |
| Outstanding at July 1, 2005 | | - | | - | | - | | - | |
| Granted | | | 6,790 | | $ | 0.03 | | | 10 Years | | | - | |
| Exercised | | | 6,790 | | $ | 0.03 | | | - | | | - | |
| Forfeited or expired | | | - | | | - | | | - | | | - | |
| Outstanding at March 31, 2006 | | | - | | | - | | | - | | | - | |
Concentration of credit risk
Financial instruments which potentially subject the Company to concentrations of credit risk consist principally of investments and cash. The Company places its cash with high credit quality financial institutions. At times in the future, such amounts may exceed the FDIC insured limits.
Revenue Recognition
As a business development company, the Company's revenue will be recognized primarily based on security transactions and related income. Security transactions are accounted for on a trade date basis. Net realized gains or losses on sales of securities are determined on the specific identification method. Interest income and expenses are recognized on the accrual basis. Dividend income is recorded on cumulative preferred equity securities on an accrual basis to the extent that such amounts are expected to be collected and on common equity securities on the record date for private companies or on the ex-dividend date for publicly traded companies. The Company assesses the collectibility of dividends and interest income receivables in connection with its determination of the fair value of the related security. To the extent that there are adverse future developments, previously recognized dividend and interest income may not be realized.
Through March 31, 2006, the Company had not received any taxable interest or taxable dividend income, or any other form of cash income or revenues, nor had it sold any investments, thus the Company has not recognized any realized gains or losses on its investments. When fees are paid to the Company by portfolio companies in their stock, in accordance with generally accepted accounting principles, the Company generally recognizes fee income to the extent of par value in the case of a new company or fair value in the case of an existing company, as determined by the Company's board of directors. Fees paid in shares of the stock of portfolio companies are both restricted and illiquid thus the Company may be unable to convert these shares of stock to cash in the future. Increases or decreases in the fair value of investments above or below accounting cost basis are not included in investment income but are included in the Statement of Operations as unrealized gains or losses until such time as the investment is liquidated or sold.
3. | Going Concern Considerations |
The Company's financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the settlement of liabilities and commitments in the normal course of business. The Company has had recurring losses and continues to suffer cash flow and working capital shortages. Since conversion to business development corporation in October 2004 through March 31, 2006 the losses totaled approximately $1,297. As of March 31, 2006, the Company had a working capital deficit of approximately $313. These factors taken together with the lack of revenues and the absence of significant financial commitments raise substantial doubt about the Company's ability to continue as a going concern.
ENDOVASC, INC.
NOTES TO UNAUDITED CONDENSED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT SHARE DATA)
In October 2004, the Company began operating as a business development company, so that it is no longer a development stage company. Nevertheless, the Company is subject to many of the risks associated with development and early stage companies that lack working capital, operating resources and contracts, cash and ready access to the credit and equity markets. The Company hopes to obtain additional debt and equity financing from various sources in order to finance its operations and to continue to grow through investment opportunities. In the event the Company is unable to obtain additional debt or equity financing, the Company will not be able to continue its current level of operations. If the Company is unable to continue its operations, the Company's assets will experience a significant decline in value and the Company will need to rely on funding, if available, in order to continue its limited operations. The Company's continuation as a going concern is dependent upon its ability to generate sufficient cash flow to meet its obligations on a timely basis, to comply with the terms of its financing agreements, to obtain additional financing or refinancing as may be required, and ultimately to attain positive cash flows from operations and profits. The Company's investments in portfolio investment companies are reflected on the accompanying balance sheets at the board of directors' best estimate of fair value. Because the investments are illiquid, the Company is limited in its ability to sell the investments in its portfolio companies. The value of these investments may decline substantially resulting in the Company receiving little or no cash value for their services and investments in these portfolio companies.
Management plans to take specific steps to address its difficult financial situation as follows:
In the near term the Company plans additional private sales of debt and common and preferred stock to qualified investors to fund its current operations.
In the long-term, the Company believes that cash flows from commercialization of its products will provide the resources for continued operations.
There can be no assurance that the Company's planned private sales of debt and equity securities or its planned public registration of common stock will be successful or that the Company will have the ability to commercialize its products and ultimately attain profitability. The Company's long-term viability as a going concern is dependent upon three key factors, as follows:
| | · | The Company's ability to obtain adequate sources of debt or equity funding to meet current commitments and fund the commercialization of its products. |
| | · | The ability of the Company to obtain positive test results of its products in clinical trials. |
| | · | The ability of the Company to ultimately achieve adequate profitability and cash flows to sustain its operations. |
4. | Notes Payable Shareholders |
During the nine months ended March 31, 2006 the company repaid $10 to the Company's Chief Operations Officer ("COO"), which reduced the note payable to the COO to $105 at March 31, 2006.
ENDOVASC, INC.
NOTES TO UNAUDITED CONDENSED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT SHARE DATA)
The difference between the 34% federal statutory income tax rate and amounts shown in the accompanying interim financial statements is primarily attributable to an increase in the valuation allowance applied against the tax benefit from utilization of net operating loss carryforwards.
On August 28, 2003, Cause No. 03-08-0681-CV, "The Dow Chemical Company. Endovasc LTD., Inc.," was filed against the Company in the District Court of Montgomery County, Texas, 359th Judicial District. Dow Chemical Company ("Dow") filed a complaint against the Company for breach of contract and damages. The amount of damages sought is approximately $230,000. This case is being vigorously defended against the allegations made by Dow. The Company has filed a counter-claim against Dow for breach of contract and damages. A prediction cannot be made as to the final outcome of the complaint and damages allegedly owed to Dow or the Company. This case is being adjudicated and the verdict is pending. No amounts have been accrued for this contingency.
On November 7, 2003, Cause No. 03-11-08112-CV, "Greg Creekmore vs. Endovasc, Inc. and Endovasc, LTD., Inc.," was filed against the Company in the District Court of Montgomery County, Texas, 284th Judicial District. Greg Creekmore ("Creekmore") filed a complaint against the Company for breach of a consulting contract between the parties. Creekmore seeks payment of $114,000 plus interest, one million shares of common stock and reimbursement of court costs including reasonable attorneys' fees allowed by law. This case is being vigorously defended against the allegations made by Creekmore. A prediction cannot be made as to the final outcome of the complaint and damages allegedly owed to Creekmore. However, management believes it will prevail and accordingly, no amounts have been accrued for this contingency.
On January 13, 2004, Case No. H-03-5226, "Lorenz M. Hofmann, Ph.D. and LMH Associates, Inc. vs. Endovasc, LTD., Inc., Endovasc, Inc., David P. Summers, Ph.D. and M. Dwight Cantrell" was filed against the Company in the United States District Court for the Southern District of Texas Houston Division. Lorenz M. Hofmann, Ph.D. and LMH Associates, Inc. ("LMH") filed a complaint against the Company for breach of contract and damages. LMH seeks payment of $96,000. The Company filed a counter-claim against LMH for breach of contract and damages. During this quarter the company was rendered an adverse decision in the case. The plaintiff's award, including attorneys fees total $96,000 and are reflected as a payable in the accompanying financial statements.
The Company is a defendant in an arbitration proceeding entitled vFinance Investments and vFinance Capital and Endovasc, Ltd., Inc., AAA No. 32 M 181 0011602. vFinance claims an entitlement to certain fees and an unspecified amount of damages for the value of the warrants to which they claim entitlement. There was a mediation hearing on December 14, 2004 and no definitive agreement was reached. In October of 2005, the Company reached an agreement with vFinance whereby the Company will pay $62,500 as a settlement over a nine month period of time. The related liability is recorded in the balance sheet as of March 31, 2006.
In November 2004, the Company filed a lawsuit against its former President & CEO, David P. Summers in the 284th District Court of Montgomery County, Texas. The suit filed on behalf of the Company alleges a civil conspiracy, breach of fiduciary duty and breach of contract and recision by David P. Summers and seeks restitution and damages in excess of $3.5 million.
The Company is subject to certain other legal proceedings and claims which arose in the ordinary course of its business. In the opinion of management, the amount of ultimate liability with respect to these actions will not materially affect the financial position, results of operations or cash flows of the Company.
| ITEM 2 | MANAGEMENT'S DISCUSSION AND ANALYSIS |
The information contained in this section should be read in conjunction with the Selected Consolidated Financial and Other Data, the Selected Operating Data and our Consolidated Financial Statements and notes thereto appearing elsewhere in this Quarterly Report. This Quarterly Report, including the Management's Discussion and Analysis of Financial Condition and Results of Operations, contains forward-looking statements that involve substantial risks and uncertainties. These forward-looking statements are not historical facts, but rather are based on current expectations, estimates and projections about our industry, our beliefs, and our assumptions. Words such as "anticipates", "expects", "intends", "plans", "believes", "seeks", and "estimates" and variations of these words and similar expressions are intended to identify forward-looking statements. These statements are not guarantees of future performance and are subject to risks, uncertainties, and other factors, some of which are beyond our control and difficult to predict and could cause actual results to differ materially from those expressed or forecasted in the forward-looking statements including without limitation (1) any future economic downturn could impair our customers' ability to repay our loans and increase our non-performing assets, (2)economic downturns can disproportionately impact certain sectors in which we concentrate, and any future economic downturn could disproportionately impact the industries in which we concentrate causing us to suffer losses in our portfolio and experience diminished demand for capital in these industry sectors, (3) a contraction of available credit and/or an inability to access the equity markets could impair our lending and investment activities, (4) interest rate volatility could adversely affect our results, (5) the risks associated with the possible disruption in our operations due to terrorism and (6) the risks, uncertainties and other factors we identify from time to time in our filings with the Securities and Exchange Commission, including our Form 10-Ks, Form 10-Qs and Form 8-Ks. Although we believe that the assumptions on which these forward-looking statements are based are reasonable, any of those assumptions could prove to be inaccurate, and as a result, the forward-looking statements based on those assumptions also could be incorrect. In light of these and other uncertainties, the inclusion of a projection or forward-looking statement in this Quarterly Report should not be regarded as a representation by us that our plans and objectives will be achieved. You should not place undue reliance on these forward-looking statements, which apply only as of the date of this Quarterly Report.
CRITICAL ACCOUNTING POLICIES
We believe that of the significant accounting policies used in the preparation of our financial statements (See Note 1 to the audited financial statements for the year ended June 30, 2005), the following are critical accounting policies, which may involve a higher degree of judgment, complexity and estimates.
SIGNIFICANT ESTIMATES
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of revenues and expenses during the periods. Actual results could differ from estimates making it reasonably possible that a change in the estimates could occur in the near term.
INVESTMENTS
Investments are reported at fair market value. The most significant estimate inherent in the preparation of our consolidated financial statements is the valuation of its investment and the related unrealized appreciation or depreciation. Upon our conversion to a business development company, we employed an independent business valuation expert to value our portfolio companies. The Board of Directors determined all portfolio companies and investments at fair market value under a good faith standard.
STOCK-BASED COMPENSATION
Adoption of SFAS 123(R)
Until June 30, 2005, the we accounted for employee stock options using the intrinsic value method in accordance with Accounting Principles Board Opinion ("APB") No. 25, Accounting for Stock Issued to Employees, and had adopted the disclosure-only alternative of SFAS No. 123, Accounting for Stock-Based Compensation, as amended by SFAS No. 148, Accounting for Stock-Based Compensation-Transition and Disclosure which requires pro-forma disclosure of compensation expense associated with stock options under the fair value method. Under the intrinsic value method, we only recorded stock-based compensation resulting from options granted at below fair market value. Effective July 1, 2005, we adopted SFAS No. 123R, "Share Based Payment", which requires that they measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award, and recognize that cost over the vesting period.
Valuation and Amortization Method—We estimate the fair value of stock options granted using the Black-Scholes option-pricing formula and a single option award approach. This fair value is then amortized on a straight-line basis over the requisite service periods of the awards, which is generally the vesting period.
Expected Term—The expected term represents the period that our stock-based awards are expected to be outstanding and is determined based on historical experience of similar awards, giving consideration to the contractual terms of the stock-based awards, vesting schedules and expectations of future employee behavior as influenced by changes to the terms of its stock-based awards.
Expected Volatility—Stock-based payments made prior to July 1, 2005 were accounted for using the intrinsic value method under APB 25. The fair value of stock based payments made subsequent to June 30, 2005 is valued using the Black-Scholes valuation method with a volatility factor based on our historical stock trading history.
Risk-Free Interest Rate—We base the risk-free interest rate used in the Black-Scholes valuation method on the implied yield currently available on U.S. Treasury securities with an equivalent term.
Estimated Forfeitures—When estimating forfeitures, we consider voluntary termination behavior as well as analysis of actual option forfeitures.
On October 21, 2005, our Board of Directors adopted the 2005 Executive Compensation Plan (the "Plan"). Amendment No. 1 to the Plan was adopted by the Board of Directors on November 14, 2005. On December 16, 2005, the stockholders approved the 2005 Plan and the grant of stock options. The maximum number of shares currently reserved for issuance is equal to 15% of the number of shares of Common Stock issued and outstanding at any time.
We are not presently able to compensate our officers and employees with cash because of the lack of available funds from operations. The Plan was adopted to provide a means by which the Company can attract and retain officers and employees and give such officers and employees an interest in the success of the Company. Under the Plan, the Board of Directors (or a committee designated by the Board of Directors) may grant options to purchase shares of the Company Common Stock to officers and employees. Directors are not eligible to receive options under the Plan. As of March 31, 2006, no stock options are outstanding under the Plan.
During the nine months ended March 31, 2006, we recognized $186,000 compensation expense for employee stock options grants. Restricted stock is expensed based on the fair market value on the grant date. There was no impact on cash flows from financing activities.
CONCENTRATION OF CREDIT RISK
Financial instruments which potentially subject us to concentrations of credit risk consist principally of investments and cash. We place our cash with high credit quality financial institutions. At times in the future, such amounts may exceed the FDIC insured limits.
OVERVIEW
Endovasc, Inc. is a Nevada corporation and the successor to a biopharmaceutical company incorporated on June 10, 1996. Effective September 17, 2004, most of our assets and liabilities were transferred to wholly owned subsidiaries, and we became an internally managed "Non-diversified Closed-end Company" as defined by Section 5 of the Investment Company act of 1940 (the "40 Act") that elected to be treated as a "Business Development Company" pursuant to Section 54 of the 40 Act. We will not elect to be treated for federal income tax purposes as a regulated investment company under the Internal Revenue Code with the filing of its federal corporate income tax return for 2005.
PORTFOLIO INVESTMENTS
Investments are reported at fair value. The most significant estimate inherent in the preparation of our financial statements is the valuation of our investments and the related unrealized appreciation or depreciation.
Upon our conversion to a business development company, we employed an independent business valuation expert to value our portfolio companies. The Board of Directors determined all portfolio companies and investments at fair value under a good faith standard.
We currently have investments in five portfolio companies as follows:
We have an investment in a wholly-owned portfolio company Liprostin, Inc. ("Liprostin"), which is engaged in the development of liposome drug delivery systems. We are having exceptional reception of this treatment in the European community.
On March 6, 2006, we submitted to the U.S. Food and Drug Administration (FDA) our protocol for a phase IIIa clinical trial of Liprostin for the treatment of intermittent claudication, a symptom of peripheral arterial disease. As outlined in the protocol, the phase IIIa trial is randomized, placebo-controlled, double-blinded, pharmacokinetic study of two dose levels of Liprostin or placebo administered once-weekly for six weeks. We continue to work on revisions to the protocol for submissions to the FDA.
| 2. | Nutraceutical Development Corporation |
We have an investment in a wholly-owned portfolio company, Nutraceutical Development Corporation ("NDC"), which develops certain technologies for use in dietary products designed to enhance health and provide beneficial biological effects ("nutraceuticals").
Sales for the products for the current fiscal year are approximately $4,010,000 resulting in net royalties of $401,000.
| 3. | Endovasc-TissueGen Research Sponsors, L.L.C. |
We have a 49.9% investment in a joint venture named Endovasc-TissueGen Research Sponsors, L.L.C. (the "Partnership"). The purpose of the Partnership is to develop a bioresorbable drug-eluting cardiovascular stent for the advanced treatment of coronary artery disease.
| 4. | Endovasc-TissueGen-Blumberg Research Sponsors, L.L.C. |
We have a 39.9% investment in a joint venture named Endovasc-TissueGen Blumberg Research Sponsors, L.L.C. (the "Joint Venture"). The purpose of the Joint Venture is to develop biodegradable stents for ureteral and prostate applications.
Angiogenix had an exclusive licensing agreement (the "Stanford License Agreement") with the Board of Trustees of the Leland Stanford University relating to US Patent Application 60/146,233 (issued as US Patent No. 6,417,205 B1 on July 9, 2002) relating to the administration of Nicotine or Nicotine Receptor Agonist (NRA) to induce the growth of new blood vessels ("angiogenesis"). During the quarter ended June 30, 2005, we cancelled our license agreement with Leland J. Stanford University
RESULTS OF OPERATIONS THREE MONTHS ENDED MARCH 31, 2006 AND 2005
During the quarter ending March 31, 2006 our income increased to $250,000 compared with income of $21,000 for the quarter ending March 31, 2005. This increase is a result of management fees and expense reimbursements from our portfolio companies.
During the quarter ending March 31, 2006, operating, general and administrative expenses were $383,000 compared to $293,000 for the quarter ending March 31, 2005. The decrease is primarily due to a decrease in public relations and consulting fees.
There were no research and development expenses in either the three months ended March 31, 2006 or the three months ended March 31, 2005.
RESULTS OF OPERATIONS NINE MONTHS ENDED MARCH 31, 2006 AND 2005
During the nine months ended March 31, 2006 our income increased to $412,000 compared with income of $60,000 for the nine months ended March 31, 2005. This increase is a result of management fees and expense reimbursements from our portfolio companies.
During the nine months ended March 31, 2006, operating, general and administrative expenses were $937,000 compared to $1,304,000 for the nine months ended March 31, 2005. The decrease is primarily due to a decrease in public relations and consulting fees.
Research and development expenses totaled $-0- during the nine months ending March 31, 2006, a decrease of $77,000 from $77,000 for the nine months ended March 31, 2005. This decrease results from portfolio companies reflecting research and development expenses in their results of operations since our conversion to a Business Development Company in October 2004.
Cash flows used in operating activities for the nine months ended March 31, 2006 decreased $541,000 to $168,000 compared to $709,000 for the nine months ended March 31, 2005, primarily due to a decrease operating expenses.
LIQUIDITY AND CAPITAL RESOURCES (IN THOUSANDS)
We had a working capital deficit at March 31, 2006 of $284,000 compared to a deficit of $285,000 at June 30, 2005. This increase is due to the utilization of cash assets.
Our continuation as a going concern is dependent upon our ability to generate sufficient cash flow to meet our obligations on a timely basis, to comply with the terms of our financing agreements, to obtain additional financing or refinancing as may be required, and ultimately to attain positive cash flows from operations and profits. Our investments in our portfolio investment companies are reflected on the accompanying balance sheets at the board of directors' best estimate of fair value. Because the investments are illiquid, we are limited in our ability to sell the investments in our portfolio companies. The value of these investments may decline substantially resulting in us receiving little or no cash value for our services and investments in these portfolio companies.
These events raise doubt as to our ability to continue as a going concern. The report of our independent public accountants, which accompanied our financial statements for the year ended June 30, 2005, was qualified with respect to that risk. In order to continue as a going concern, we must raise additional funds as noted above and ultimately achieve profit from our operations.
| ITEM 3 | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK |
Interest rate sensitivity refers to the change in earnings that may result from the changes in the level of interest rates. Our net interest income can be affected by changes in various interest rates, including LIBOR, prime rates and commercial paper rates.
As a business development company, we use a greater portion of equity to fund our business. Accordingly, other things being equal, increases in interest rates will result in greater increases in our net interest income and reductions in interest rates will result in greater decreases in our net interest income compared with the effects of interest rate changes on our results under more highly leveraged capital structures.
Currently, we do not engage in hedging activities because we have determined that the cost of hedging the risks associated with interest rate changes outweighs the risk reductions benefit. We monitor this position on an ongoing basis.
| ITEM 4 | CONTROLS AND PROCEDURES |
As of March 31, 2006, we carried out an evaluation, under the supervision and with the participation of management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Exchange Act Rule 13a-15(e) and Rule 15d-15(e)). Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that the disclosure controls and procedures are effective at a reasonable level in timely alerting them to material information relating to Endovasc that is required to be included in our filings with the Securities and Exchange Commission. There has been no change in our internal control over financial reporting that occurred during the most recent fiscal quarter that has materially affected or is reasonably likely to materially affect our internal control over financial reporting.
Our management, including the Chief Executive Officer and Chief Financial Officer, do not expect that our disclosure controls or internal controls will prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met due to numerous factors, ranging from errors to conscious acts of an individual, or individuals acting together. In addition, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in a cost-effective control system, misstatements due to error and/or fraud may occur and not be detected.
PART II
ITEM 1 LEGAL PROCEEDINGS
On August 28, 2003, Cause No. 03-08-0681-CV, "The Dow Chemical Company. Endovasc LTD., Inc.," was filed against us in the District Court of Montgomery County, Texas, 359th Judicial District. Dow Chemical Company ("Dow") filed a complaint against us for breach of contract and damages. The amount of damages sought is approximately $230,000. This case is being vigorously defended against the allegations made by Dow. We have filed a counter-claim against Dow for breach of contract and damages. A prediction cannot be made as to the final outcome of the complaint and damages allegedly owed to Dow or to us. This case is being adjudicated and the verdict is pending. No amounts have been accrued for this contingency.
On November 7, 2003, Cause No. 03-11-08112-CV, "Greg Creekmore vs. Endovasc, Inc. and Endovasc, LTD., Inc.," was filed against us in the District Court of Montgomery County, Texas, 284th Judicial District. Greg Creekmore ("Creekmore") filed a complaint against us for breach of a consulting contract between the parties. Creekmore seeks payment of $114,000 plus interest, one million shares of our common stock and reimbursement of court costs including reasonable attorneys' fees allowed by law. This case is being vigorously defended against the allegations made by Creekmore. A prediction cannot be made as to the final outcome of the complaint and damages allegedly owed to Creekmore. However, management believes it will prevail and accordingly, no amounts have been accrued for this contingency.
On January 13, 2004, Case No. H-03-5226, "Lorenz M. Hofmann, Ph.D. and LMH Associates, Inc. vs. Endovasc, LTD., Inc., Endovasc, Inc., David P. Summers, Ph.D. and M. Dwight Cantrell" was filed against us in the United States District Court for the Southern District of Texas Houston Division. Lorenz M. Hofmann, Ph.D. and LMH Associates, Inc. ("LMH") filed a complaint against us for breach of contract and damages. LMH seeks payment of $96,000. We filed a counter-claim against LMH for breach of contract and damages. During this quarter we were rendered an adverse decision in the case. The plaintiff's award, including attorneys fees, total $96,000 and are reflected as a payable in the accompanying financial statements.
We are a defendant in an arbitration proceeding entitled vFinance Investments and vFinance Capital and Endovasc, Ltd., Inc., AAA No. 32 M 181 0011602. vFinance claims an entitlement to certain fees and an unspecified amount of damages for the value of the warrants to which they claim entitlement. There was a mediation hearing on December 14, 2004 and no definitive agreement was reached. In October of 2005, we reached an agreement with vFinance whereby we will pay $62,500 as a settlement over a nine month period of time. The related liability is recorded in the balance sheet as of March 31, 2006.
In November 2004, we filed a lawsuit against our former President and CEO, David P. Summers in the 284th District Court of Montgomery County, Texas. The suit filed on our behalf alleges a civil conspiracy, breach of fiduciary duty and breach of contract and rescission by David P. Summers and seeks restitution and damages in excess of $3.5 million.
We are subject to certain other legal proceedings and claims which arose in the ordinary course of our business. In the opinion of management, the amount of ultimate liability with respect to these actions will not materially affect our financial position, results of operations or cash flows.
| ITEM 2 | Unregistered Sales of Securities |
In October of 2004 a form 1-E filing was made which indicated our intent to raise capital under regulation E. During the nine months ended March 31, 2006, the following transactions were effected by us in reliance upon exemptions from registration under the Securities Act of 1933 as amended (the "Act"). Unless stated otherwise, we believe that each of the persons who received these unregistered securities had knowledge and experience in financial and business matters which allowed them to evaluate the merits and risk of the receipt of these securities, and that they were knowledgeable about our operations and financial condition. No underwriter participated in, nor did we pay any commissions or fees to any underwriter in connection with the transactions. These transactions did not involve a public offering. Each certificate issued for these unregistered securities contained a legend stating that the securities have not been registered under the Act and setting forth the restrictions on the transferability and the sale of the securities. During the nine months ended March 31, 2006, we issued 34,086,340 shares of common stock to 13 individuals with an aggregate value of $754,750. These transactions were exempt from registration pursuant to Regulation E.
| ITEM 3 | Defaults Upon Senior Securities |
None.
| ITEM 4 | Submission of Matters to a Vote of Security Holders |
On October 28, 2005 we filed a PRE 14A notifying stockholders of our Annual Shareholders meeting to be held on December 16, 2005. On November 28, 2005 the DEF 14A was filed. The purpose of the meeting was (1) To elect one director to serve for a three-year term and until his or her successor is elected and qualified, (2) To ratify the selection of McConnell & Jones, L.L.P. as our registered public accounting firm for the fiscal year ending June 30, 2006, (3) To amend our Articles of Incorporation to increase to 500,000,000 the number of shares of Common Stock, $.001 par value per share, we are authorized to issue, (4) To approve the company's 2005 Executive Compensation Plan, (5) To amend the Certificate of Designation of Powers, Preferences, Limitation, and Relative Rights for the Series NDC Stock to permit the redemption thereof by the company, and (6) To transact such other business as may properly come before the Annual Meeting or any adjournments thereof. The record date for the Annual Meeting was October 28, 2005. Holders of Common Stock and holders of our Series NDC Common Stock of record as of October 28, 2005 were entitled to notice of and to vote at the Annual Meeting.
We convened our Annual Meeting of Stockholders on December 16, 2005. The meeting was adjourned before all items of business were voted on and reconvened on January 13, 2006. Each matter acted upon at the meeting and the number of votes cast for, against or withheld, abstaining or not voting as to each matter is set forth below.
1. Election of Directors:
| | For | Withheld |
| | | |
| Barbara J. Richardson | 99,172,066 | 4,708,649 |
Dr. Diane Dottavio, Donald Leonard, and M. Dwight Cantrell continued as directors after the meeting.
2. Approval of McConnell & Jones LLP as Independent Auditor of the Company for the year ending June 30, 2006:
For | Against | Abstain | Non-vote |
| | | | |
| 100,338,894 | 4,963,115 | 167,886 | - |
3. Approval of amendment of the Articles of Incorporation to increase the authorized capital to 500,000,000 shares:
For | Against | Abstain | Non-vote |
| | | | |
| 94,759,777 | 10,584,280 | 125,838 | - |
4. Adoption of the 2005 Executive Compensation Plan and certain options granted to officers of the Company:
For | Against | Abstain | Non-vote |
| | | | |
| 35,566,659 | 7,020,077 | 416,619 | 62,466,540 |
5. Approval of amendment of the Certificate of Designations of the Series NDC Stock to permit redemption by the Company:
For | Against | Abstain | Non-vote |
| | | | |
| 4,593,455 | 3,015,184 | 36,208 | - |
The fifth issue, pertaining to amending the Certificate of Designation of Powers, Preferences, Limitations, and Relative Rights for the Series NDC Stock to permit the redemption by the Company, did not pass. While the amendment received enough votes to constitute a quorum, and approval by a majority of the shareholders that voted, it did not receive the required majority of all the outstanding shares of the Series NDC Stock.
None.
| | | Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
| | | Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
| | | Certification of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
| | | Certification of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
SIGNATURES
In accordance with the requirements of Sections 13 and 15(d) of the Exchange Act, the registrant has caused this report to be signed on its behalf by the undersigned, thereto duly authorized.
| | ENDOVASC, INC. |
| | |
| | |
| Date: May 12, 2006 | By: /s/ Diane Dottavio |
| | Diane Dottavio |
| | Chief Executive Officer |
| | |
| Date: May 12, 2006 | By: /s/ Clarice Motter |
| | Clarice Motter |
| | Chief Financial Officer |
22
