10-Q 1 a14-19952_110q.htm 10-Q

Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


 

FORM 10-Q

 


 

x      QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the Quarterly Period Ended September 30, 2014

 

OR

 

o         TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from            to            

 

Commission File No.:  000-53072

 


 

EMMAUS LIFE SCIENCES, INC.

(Exact name of Registrant as specified in its charter)

 


 

Delaware

 

41-2254389

(State or other jurisdiction of incorporation or organization)

 

(I.R.S. Employer Identification No.)

 

20725 S. Western Avenue, Suite 136, Torrance, California 90501

(Address of principal executive offices) (Zip code)

 

(310) 214-0065

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x    No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes x     No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer  o

 

Accelerated filer  o

 

 

 

Non-accelerated filer  o

(Do not check if a smaller reporting company)

 

Smaller reporting company   x

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o  No x

 

The registrant had 27,960,487 shares of common stock, par value $0.001 per share, outstanding as of November 13, 2014.

 

 

 



Table of Contents

 

EMMAUS LIFE SCIENCES, INC.

 

FORM 10-Q

 

For the Quarterly Period Ended September 30, 2014

 

INDEX

 

 

 

 

Page

Part I

Financial Information

 

 

 

 

 

 

Item 1.

Financial Statements

 

 

 

 

 

 

 

(a)

Condensed Consolidated Balance Sheets as of September 30, 2014 (Unaudited) and December 31, 2013

1

 

 

 

 

 

 

(b)

Condensed Consolidated Statements of Comprehensive Loss for the Three and Nine Months Ended September 30, 2014 and 2013 (Unaudited)

2

 

 

 

 

 

 

(c)

Condensed Consolidated Statement of Changes in Stockholders’ Deficit for the Nine Months Ended September 30, 2014 (Unaudited)

3

 

 

 

 

 

 

(d)

Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2014 and 2013 (Unaudited)

4

 

 

 

 

 

 

(e)

Notes to Condensed Consolidated Financial Statements as of and for the Nine Months Ended September 30, 2014 (Unaudited)

5

 

 

 

 

 

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

18

 

 

 

 

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

30

 

 

 

 

 

Item 4.

Controls and Procedures

30

 

 

 

 

Part II

Other Information

 

 

 

 

 

 

Item 1.

Legal Proceedings

32

 

 

 

 

 

Item 1A.

Risk Factors

32

 

 

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

32

 

 

 

 

 

Item 3.

Defaults Upon Senior Securities

32

 

 

 

 

 

Item 4.

Mine Safety Disclosures

32

 

 

 

 

 

Item 5.

Other Information

32

 

 

 

 

 

Item 6.

Exhibits

33

 

 

 

 

Signatures

 

 


 


Table of Contents

 

Item 1. Financial Statements

 

EMMAUS LIFE SCIENCES, INC.

 

CONDENSED CONSOLIDATED BALANCE SHEETS

 

 

 

As of

 

 

 

September 30, 2014

 

December 31, 2013

 

 

 

(unaudited)

 

 

 

ASSETS

 

CURRENT ASSETS

 

 

 

 

 

Cash and cash equivalents

 

$

1,640,532

 

$

3,638,600

 

Accounts receivable

 

53,654

 

35,237

 

Inventories, net

 

223,780

 

239,009

 

Marketable securities

 

90,768

 

162,564

 

Prepaid expenses and other current assets

 

144,374

 

81,046

 

Total current assets

 

2,153,108

 

4,156,456

 

 

 

 

 

 

 

PROPERTY AND EQUIPMENT, Net

 

39,224

 

26,120

 

 

 

 

 

 

 

OTHER ASSETS

 

 

 

 

 

Marketable securities, pledged to creditor

 

383,080

 

686,090

 

Intangibles, net

 

946,429

 

1,107,143

 

Deposits

 

135,860

 

137,900

 

Total other assets

 

1,465,369

 

1,931,133

 

Total Assets

 

$

3,657,701

 

$

6,113,709

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY (DEFICIT)

 

CURRENT LIABILITIES

 

 

 

 

 

Accounts payable and accrued expenses

 

$

2,063,277

 

$

2,283,446

 

Due to related party

 

394,446

 

394,446

 

Dissenting stockholders payable

 

 

125,000

 

Notes payable, net

 

1,110,000

 

1,765,070

 

Notes payable to related parties, net

 

825,562

 

925,641

 

Convertible notes payable, net

 

3,549,221

 

4,802,472

 

Convertible notes payable to related parties

 

525,066

 

560,706

 

Total current liabilities

 

8,467,572

 

10,856,781

 

 

 

 

 

 

 

LONG-TERM LIABILITIES

 

 

 

 

 

Liability classified warrants

 

9,594,000

 

5,928,000

 

Notes payable

 

833,335

 

200,000

 

Notes payable to related parties

 

133,333

 

 

Convertible notes payable, net

 

4,387,780

 

2,966,588

 

Convertible notes payable to related parties, net

 

200,000

 

 

Total long-term liabilities

 

15,148,448

 

9,094,588

 

Total Liabilities

 

23,616,020

 

19,951,369

 

 

 

 

 

 

 

COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS’ EQUITY (DEFICIT)

 

 

 

 

 

Preferred stock — par value $0.001 per share, 20,000,000 shares authorized, none issued and outstanding

 

 

 

Common stock — par value $0.001 per share, 100,000,000 shares authorized, 30,390,103 and 29,228,306 shares issued and outstanding at September 30, 2014 and December 31, 2013, respectively

 

30,390

 

29,228

 

Additional paid-in capital

 

47,772,911

 

35,669,291

 

Accumulated other comprehensive (loss) income

 

(117,804

)

262,683

 

Accumulated deficit

 

(67,643,816

)

(49,798,862

)

Total Stockholders’ Deficit

 

(19,958,319

)

(13,837,660

)

Total Liabilities & Stockholders’ Deficit

 

$

3,657,701

 

$

6,113,709

 

 

The accompanying notes are an integral part of these financial statements.

 

1



Table of Contents

 

EMMAUS LIFE SCIENCES, INC.

 

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS

(UNAUDITED)

 

 

 

Three Months Ended September 30,

 

Nine Months Ended September 30,

 

 

 

2014

 

2013

 

2014

 

2013

 

 

 

 

 

 

 

 

 

 

 

REVENUES, Net

 

$

155,644

 

$

66,129

 

$

347,737

 

$

246,897

 

 

 

 

 

 

 

 

 

 

 

COST OF GOODS SOLD

 

90,421

 

48,445

 

198,203

 

147,418

 

GROSS PROFIT

 

65,223

 

17,684

 

149,534

 

99,479

 

 

 

 

 

 

 

 

 

 

 

OPERATING EXPENSES

 

 

 

 

 

 

 

 

 

Research and development

 

507,377

 

490,138

 

1,708,766

 

1,801,399

 

Selling

 

115,060

 

120,647

 

363,874

 

377,335

 

General and administrative

 

2,759,098

 

2,506,808

 

9,012,391

 

7,338,211

 

Transaction costs

 

 

1,014,019

 

 

1,014,019

 

 

 

3,381,535

 

4,131,612

 

11,085,031

 

10,530,964

 

 

 

 

 

 

 

 

 

 

 

LOSS FROM OPERATIONS

 

(3,316,312

)

(4,113,928

)

(10,935,497

)

(10,431,485

)

 

 

 

 

 

 

 

 

 

 

OTHER INCOME (EXPENSE)

 

 

 

 

 

 

 

 

 

Gain on derecognition of accounts payable

 

 

 

 

341,361

 

Change in fair value of liability classified warrants

 

84,000

 

291,000

 

(1,895,744

)

291,000

 

Warrant exercise inducement expense

 

 

 

(3,523,000

)

 

Interest and other income

 

97,370

 

5,089

 

74,204

 

15,811

 

Interest expense

 

(591,494

)

(567,491

)

(1,562,417

)

(1,668,501

)

 

 

(410,124

)

(271,402

)

(6,906,957

)

(1,020,329

)

 

 

 

 

 

 

 

 

 

 

LOSS BEFORE INCOME TAXES

 

(3,726,436

)

(4,385,330

)

(17,842,454

)

(11,451,814

)

INCOME TAXES (BENEFIT)

 

 

(51,129

)

2,500

 

(450,381

)

NET LOSS

 

(3,726,436

)

(4,334,201

)

(17,844,954

)

(11,001,433

)

 

 

 

 

 

 

 

 

 

 

COMPONENTS OF OTHER COMPREHENSIVE (LOSS) INCOME

 

 

 

 

 

 

 

 

 

Unrealized holding (loss) gain on securities available-for-sale

 

(80,593

)

81,261

 

(374,806

)

719,857

 

Unrealized foreign translation

 

(5,006

)

(7,949

)

(5,681

)

(34,381

)

COMPREHENSIVE LOSS

 

$

(3,812,035

)

$

(4,260,889

)

$

(18,225,441

)

$

(10,315,957

)

NET LOSS PER COMMON SHARE

 

$

(0.12

)

$

(0.16

)

$

(0.60

)

$

(0.43

)

WEIGHTED AVERAGE COMMON SHARES OUTSTANDING

 

30,303,396

 

27,066,743

 

29,637,402

 

25,694,988

 

 

The accompanying notes are an integral part of these financial statements.

 

2



Table of Contents

 

EMMAUS LIFE SCIENCES, INC.

 

CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ DEFICIT

FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2014

(UNAUDITED)

 

 

 

Common stock –par value
$0.001 per share,
100,000,000 shares authorized

 

Additional

 

Accumulated
Other

 

 

 

 

 

 

 

Shares

 

Common
Stock

 

Paid-in
Capital

 

Comprehensive
Income (Loss)

 

Accumulated
Deficit

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance, December 31, 2013

 

29,228,306

 

$

29,228

 

$

35,669,291

 

$

262,683

 

$

(49,798,862

)

$

(13,837,660

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Beneficial conversion feature relating to convertible notes payable

 

 

 

465,926

 

 

 

465,926

 

Warrant issued in conjunction with convertible note

 

 

 

126,732

 

 

 

126,732

 

Proceeds from exercise of warrants

 

1,208,379

 

1,208

 

4,215,870

 

 

 

4,217,078

 

Conversion of notes payable to common stock

 

453,418

 

454

 

1,497,925

 

 

 

1,498,379

 

Excess value of liability classified warrants upon exercise

 

 

 

1,752,744

 

 

 

1,752,744

 

Common stock repurchased and cancelled

 

(500,000

)

(500

)

(377,000

)

 

 

(377,500

)

Share-based compensation

 

 

 

4,421,423

 

 

 

4,421,423

 

Unrealized loss on marketable securities, net of tax

 

 

 

 

(374,806

)

 

(374,806

)

Foreign currency translation effect

 

 

 

 

(5,681

)

 

(5,681

)

Net loss

 

 

 

 

 

(17,844,954

)

(17,844,954

)

Balance, September 30, 2014

 

30,390,103

 

$

30,390

 

$

47,772,911

 

$

(117,804

)

$

(67,643,816

)

$

(19,958,319

)

 

The accompanying notes are an integral part of these financial statements.

 

3



Table of Contents

 

EMMAUS LIFE SCIENCES, INC.

 

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

 

 

 

Nine Months Ended September 30,

 

 

 

2014

 

2013

 

CASH FLOWS FROM OPERATING ACTIVITIES

 

 

 

 

 

Net loss

 

$

(17,844,954

)

$

(11,001,433

)

Adjustments to reconcile net loss to net cash flows used in operating activities

 

 

 

 

 

Depreciation and amortization

 

172,713

 

177,886

 

Interest expense accrued from discount of convertible note

 

680,994

 

762,000

 

Gain on derecognition of accounts payable

 

 

(341,361

)

Share-based compensation

 

4,421,423

 

3,677,967

 

Warrant exercise inducement expense

 

3,523,000

 

 

Change in fair value of liability classified warrants

 

1,895,744

 

(291,000

)

Tax benefit recognized on unrealized gain on marketable securities available-for-sale

 

 

(452,931

)

Transaction costs related to private placement

 

 

1,014,019

 

Net changes in operating assets and liabilities

 

 

 

 

 

Accounts receivable

 

(19,241

)

54,672

 

Inventories

 

14,657

 

27,349

 

Prepaid expenses and other current assets

 

(66,992

)

(15,016

)

Deposits

 

(338

)

140,776

 

Accounts payable and accrued expenses

 

(43,559

)

610,466

 

Net cash flows used in operating activities

 

(7,266,553

)

(5,636,606

)

 

 

 

 

 

 

CASH FLOWS FROM INVESTING ACTIVITIES

 

 

 

 

 

Purchases of property and equipment

 

(25,775

)

(5,495

)

Net cash flows used in investing activities

 

(25,775

)

(5,495

)

 

 

 

 

 

 

CASH FLOWS FROM FINANCING ACTIVITIES

 

 

 

 

 

Proceeds from notes payable issued

 

 

4,705,467

 

Proceeds from convertible notes payable issued

 

1,720,000

 

3,147,298

 

Due to dissenters

 

(125,000

)

(75,000

)

Repurchase of common stock

 

(377,500

)

 

Payments of notes payable

 

 

(4,298,385

)

Payments of convertible notes payable

 

(138,744

)

(754,480

)

Proceeds from private placement units, net of transaction costs

 

 

6,435,055

 

Proceeds from exercise of warrants

 

4,217,078

 

 

Proceeds from issuance of common stock

 

 

1,890,122

 

Net cash flows from financing activities

 

5,295,834

 

11,050,077

 

Effect of exchange rate changes on cash

 

(1,574

)

(37,615

)

 

 

 

 

 

 

Net (decrease) increase in cash and cash equivalents

 

(1,998,068

)

5,370,361

 

Cash and cash equivalents, beginning of period

 

3,638,600

 

402,823

 

Cash and cash equivalents, end of period

 

$

1,640,532

 

$

5,773,184

 

 

 

 

 

 

 

SUPPLEMENTAL DISCLOSURES OF CASH FLOW ACTIVITIES

 

 

 

 

 

Interest paid

 

$

322,445

 

$

187,823

 

Income taxes paid

 

$

2,500

 

$

2,550

 

Non-cash financing activities:

 

 

 

 

 

Stock issued as a payment of professional fee

 

$

 

$

118,224

 

Conversion of notes payable to common stock

 

$

1,404,552

 

$

2,606,100

 

Conversion of accrued interest payable to common stock

 

$

93,827

 

$

20,872

 

 

The accompanying notes are an integral part of these financial statements.

 

4



Table of Contents

 

EMMAUS LIFE SCIENCES, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2014

(UNAUDITED)

 

NOTE 1 — DESCRIPTION OF BUSINESS

 

Organization — Emmaus Life Sciences, Inc. (the “Company” or “Emmaus”), which is engaged in the discovery, development, and commercialization of innovative treatments and therapies primarily for rare and orphan diseases, was incorporated in the state of Delaware on September 24, 2007. Pursuant to an Agreement and Plan of Merger, dated April 21, 2011 (the “Merger Agreement”), by and among the Company, AFH Merger Sub, Inc., a wholly-owned subsidiary of the Company (“AFH Merger Sub”), AFH Holding and Advisory, LLC (“AFH Advisory”), and Emmaus Medical, Inc. (“Emmaus Medical”), Emmaus Medical merged with and into AFH Merger Sub with Emmaus Medical continuing as the surviving entity (the “Merger”). Upon the closing of the Merger, the Company changed its name from “AFH Acquisition IV, Inc.” to “Emmaus Holdings, Inc.” and became the parent company of Emmaus Medical. The Company changed its name from “Emmaus Holdings, Inc.” to “Emmaus Life Sciences, Inc.” on September 14, 2011.

 

Emmaus Medical is a Delaware corporation originally incorporated on September 12, 2003. Emmaus Medical, LLC was organized on December 20, 2000. In October 2003, Emmaus Medical, LLC conducted a reorganization and merged with Emmaus Medical. As a result of the merger, Emmaus Medical acquired the exclusive patent rights for a treatment for sickle cell disease (“SCD”).

 

In October 2010, the Company established Emmaus Medical Japan, Inc., a Japanese corporation (“EM Japan”) by funding 97% of the initial capital. EM Japan is engaged in the business of trading in nutritional supplements and other medical products and drugs. The results of EM Japan have been included in the consolidated financial statements of the Company since the date of formation. The aggregate formation cost was $52,500. Emmaus Medical acquired the additional 3% of the outstanding shares of EM Japan during the three months ended March 31, 2011 and is now the 100% owner of the outstanding share capital.

 

In November 2011, the Company formed Emmaus Medical Europe, Ltd. (“EM Europe”), a wholly-owned subsidiary of Emmaus Medical. EM Europe’s primary focus is expanding the business of Emmaus Medical in Europe.

 

Emmaus, its wholly-owned subsidiary, Emmaus Medical, and Emmaus Medical’s wholly-owned subsidiaries, Newfield Nutrition Corporation, EM Japan and EM Europe, are collectively referred to herein as the “Company.”

 

Nature of BusinessThe Company has undertaken the business of developing and commercializing cost-effective treatments and therapies for rare diseases. The Company’s primary business purpose is to commercialize its treatment for SCD.

 

To a lesser extent, the Company is also engaged in the marketing and sale of NutreStore®, which has received approval from the U.S. Food and Drug Administration (“FDA”), as a treatment for short bowel syndrome (“SBS”) in patients receiving specialized nutritional support when used in conjunction with a recombinant human growth hormone that is approved for this indication. The Company’s indirect wholly-owned subsidiary, Newfield Nutrition Corporation, sells L-glutamine as a nutritional supplement under the brand name AminoPure® through retail stores in multiple states and via importers and distributors in Japan, Taiwan and South Korea. The Company also owns a minority interest of less than 1% in CellSeed, Inc., a Japanese company listed on the Tokyo Stock Exchange, which is engaged in research and development of regenerative medicine products and the manufacture and sale of temperature-responsive cell culture equipment.

 

The Company also has certain rights to regenerative medicine products owned by CellSeed and is involved in research focused on providing innovative solutions for tissue-engineering through the development of novel cell harvest methods and 3-dimensional living tissue replacement products for “cell sheet therapy” and regenerative medicine and the commercialization of such products.

 

NOTE 2 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

Basis of presentation — The accompanying condensed consolidated financial statements are unaudited and have been prepared by the Company in accordance with accounting principles generally accepted in the United States (“GAAP”) as found in the Accounting Standards Codification (“ASC”) and Accounting Standards Update (“ASU”) of the Financial Accounting Standards Board (“FASB”). Certain information and footnote disclosures normally included in the Company’s annual financial statements have been condensed or omitted. These condensed consolidated financial statements, in the opinion of management, reflect all normal recurring adjustments necessary for a fair presentation of the Company’s financial position and results of operations for the interim periods ended September 30, 2014 and 2013.

 

5



Table of Contents

 

The results of operations for the interim periods are not necessarily indicative of the results of operations to be expected for the full year. These interim financial statements should be read in conjunction with the audited financial statements as of and for the year ended December 31, 2013, and the notes thereto, which are included in the Company’s filings with the Securities and Exchange Commission (“SEC”).

 

Going concern — The accompanying condensed consolidated financial statements have been prepared on the basis that the Company will continue as a going concern. The Company had losses for the nine months ended September 30, 2014 totaling $17,844,954. In addition, the Company has a significant amount of notes payable and other obligations due within the next twelve months and is projecting that its operating losses and expected capital needs, including the expected costs relating to the commercialization of the Company’s pharmaceutical grade L-glutamine treatment for SCD, will exceed its existing cash balances and cash expected to be generated from operations for the foreseeable future. In order to meet the Company’s expected obligations, management intends to raise additional funds through equity and debt financings and partnership agreements. However, there can be no assurance that the Company will be able to complete any additional equity or debt financings or enter into partnership agreements. Therefore, due to the uncertainty of the Company’s ability to meet its current operating and capital expenses, there is substantial doubt about the Company’s ability to continue as a going concern, as the continuation and expansion of its business is dependent upon obtaining further financing, receiving FDA and other regulatory approval of its products, successful and sufficient market acceptance of its products, and finally, achieving a profitable level of operations. The condensed consolidated financial statements do not include any adjustments that might result from the outcome of these uncertainties.

 

Principles of consolidation — The condensed consolidated financial statements include the accounts of the Company (and its wholly-owned subsidiary, Emmaus Medical, and Emmaus Medical’s wholly-owned subsidiaries, Newfield Nutrition Corporation, EM Japan and EM Europe). All significant intercompany transactions have been eliminated.

 

Estimates — Financial statements prepared in accordance with GAAP require management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Among other things, management has estimated the useful lives of equipment and other assets, along with the variables used to calculate the valuation of stock options and warrants using the Black-Scholes-Merton option valuation model.

 

The warrants issued by the Company in a private placement in September 2013 were recorded as liability classified warrants. The initial value of such warrants as well as the fair value of additional warrants issued to replace the warrants exercised and the change in fair value of such warrants and replacement warrants were determined using a Binomial Monte-Carlo Cliquet (aka Ratchet) Option Pricing Model. The model is similar to traditional Black-Scholes-type option pricing models except that the exercise price resets at certain dates in the future. Actual results could differ from those estimates.

 

Inventories — Inventories as of September 30, 2014 are valued on a first-in, first-out basis at the lower of cost or market value. Work-in-process inventories consist of raw material L-glutamine for the Company’s AminoPure and NutreStore products that has not yet been packaged and labeled for sale.

 

All of the raw material purchased during the nine months ended September 30, 2014 were from one vendor and during 2013 were from two vendors.

 

Inventory by category

 

September 30, 2014

 

December 31, 2013

 

Raw material

 

$

 

$

20,700

 

Work-in-process

 

 

68,887

 

Finished goods

 

223,780

 

149,422

 

 

 

$

223,780

 

$

239,009

 

 

Advertising cost — Advertising costs are expensed as incurred. Advertising costs for the nine months ended September 30, 2014 and 2013 were $185,465 and $161,301, respectively.

 

Comprehensive (loss) income — Comprehensive (loss) income includes net loss and other comprehensive (loss) income. The items of other comprehensive (loss) income for the Company are unrealized gains and losses on marketable securities classified as available-for-sale and foreign translation adjustments relating to its subsidiaries. When the Company realizes a gain or loss on securities available-for-sale for which an unrealized gain or loss was previously recognized, a corresponding reclassification adjustment is made to remove the unrealized gain or loss from accumulated other comprehensive income and reflect the realized gain or loss in current operations.

 

6



Table of Contents

 

Marketable securities — Investment securities as of September 30, 2014 and December 31, 2013 are classified as available-for-sale. Available-for-sale securities are recorded at cost and any increases or decreases in fair market value are recorded as unrealized gain or loss, net of taxes in accumulated other comprehensive income. The Company monitors these investments for impairment and makes appropriate reductions in carrying values when necessary. CellSeed, Inc. securities are the only marketable security the Company currently carries on its books. The Company’s marketable securities consist of 48,550 shares of CellSeed stock which are part of 147,100 shares acquired in January 2009 for 100,028,000 Japanese Yen (equivalent to $1,109,819), at 680 Yen per share. CellSeed’s IPO (Tokyo Stock Exchange symbol 7776) was completed on March 16, 2010. As of September 30, 2014 and December 31, 2013, the closing price per share was 1,072 Yen and 1,840 Yen, respectively.

 

In July 2013, based on an increase in market value of CellSeed shares, Mitsubishi UFJ Capital III Limited Partnership (Mitsubishi) released to the Company 34,300 shares of CellSeed stock. This was part of the 73,550 shares of CellSeed stock held by Mitsubishi as collateral to secure a $500,000 convertible note issued to Mitsubishi which is due in 2016. The note is now secured by the remaining 39,250 shares of CellSeed stock held by Mitsubishi as collateral.

 

During the fourth quarter of 2013, the Company sold 25,000 of the shares released by Mitsubishi in open market transactions. As of September 30, 2014 and December 31, 2013, 9,300 shares of CellSeed stock are classified as a current asset, as they are available for sale by the Company. The remaining 39,250 shares of CellSeed stock are pledged to secure the Mitsubishi note and are classified as marketable securities, pledged to creditor.

 

Fair value measurements — The Company defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The Company measures fair value under a framework that provides a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy are described as follows:

 

Level 1: Inputs to the valuation methodology are unadjusted quoted prices for identical assets or liabilities in active markets that the Company has the ability to access.

 

Level 2: Inputs to the valuation methodology include:

 

·                  Quoted prices for similar assets or liabilities in active markets;

·                  Quoted prices for identical or similar assets or liabilities in inactive markets;

·                  Inputs other than quoted prices that are observable for the asset or liability; and

·                  Inputs that are derived principally from or corroborated by observable market data by correlation or other means.

 

If the asset or liability has a specified (contractual) term, the Level 2 inputs must be observable for substantially the full term of the asset or liability.

 

Level 3: Inputs to the valuation methodology are unobservable and significant to the fair value measurement.

 

The asset’s or liability’s fair value measurement level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement. Valuation techniques used need to maximize the use of observable inputs and minimize the use of unobservable inputs. The fair value assigned to marketable securities is determined by obtaining quoted prices on nationally recognized securities exchanges, and are classified as Level 1 investments at September 30, 2014. The fair value of the Company’s debt instruments is not materially different from their carrying values as presented. The fair value of the Company’s convertible debt instruments was determined based on Level 2 inputs. The carrying value of the debt was discounted based on allocating proceeds to other financial instruments within the arrangement as discussed in Note 6.

 

The Company issued stock purchase warrants in conjunction with its September 2013 private placement and issued replacement warrants upon the exercise of certain of such warrants in June 2014 (see Note 7). Such warrants and replacement warrants are accounted for as liability classified warrants whose fair market value is determined using Level 3 inputs. These inputs include expected term and expected volatility.

 

The following table presents the activity for those items measured at fair value on a recurring basis using Level 3 inputs during the nine months ended September 30, 2014 and the year ended December 31, 2013:

 

7



Table of Contents

 

 

 

Liability Classified warrants –
Stock Purchase Warrants

 

 

 

September 30, 2014

 

December 31, 2013

 

Balance, beginning of period

 

$

5,928,000

 

$

 

Fair value at issuance date

 

3,523,000

 

6,860,000

 

To reduce the warrants exercised to intrinsic value

 

(1,770,256

)

 

To record settlement of liability associated with warrants exercised

 

(1,752,744

)

 

Change in fair value included in the statement of comprehensive loss

 

3,666,000

 

(932,000

)

Balance, end of period

 

$

9,594,000

 

$

5,928,000

 

 

The initial value of the liability classified warrants as of September 11, 2013 and the change in fair value of the liability classified warrants as of December 31, 2013, June 10, 2014 (the date of exercise and issuance) and September 30, 2014 were determined using a Binomial Monte-Carlo Cliquet (aka Ratchet) Option Pricing Model. The model is similar to traditional Black-Scholes-type option pricing models except that the exercise price resets at certain dates in the future. The values as of September 11, 2013, December 31, 2013, June 10, 2014 and September 30, 2014 were calculated based on the following assumptions:

 

 

 

September 30, 2014

 

June 10, 2014

 

December 31, 2013

 

Initial Value

 

Stock price

 

$

5.10

 

$

5.10

 

$

3.60

 

$

3.60

 

Risk-free interest rate

 

1.43

%

1.32

%

1.75

%

1.72

%

Expected volatility (peer group)

 

69.50

%

68.20

%

63.20

%

72.40

%

Expected life (in years)

 

3.95

 

4.26

 

4.70

 

5.00

 

Expected dividend yield

 

 

 

 

 

Number outstanding

 

3,020,501

 

3,020,501

 

3,020,501

 

3,020,501

 

Balance, end of period

 

$

9,594,000

 

$

9,714,000

 

$

5,928,000

 

$

6,860,000

 

 

Debt and Related Party Debt — The Company accounts for the proceeds from the issuance of convertible notes payable with detachable stock purchase warrants and embedded conversion features in accordance with FASB ASC 470-20, Debt with Conversion and Other Options. Under FASB ASC 470-20, the proceeds from the issuance of a debt instrument with detachable stock purchase warrants is allocated to the two elements based on the relative fair values of the debt instrument without the warrants and of the warrants themselves at the time of issuance. The portion of the proceeds allocated to the warrants is accounted for as additional paid-in capital and the remaining proceeds are allocated to the debt instrument, which results in a discount to debt that is amortized and charged as interest expense over the term of the note agreement. Additionally, pursuant to FASB ASC 470-20, the intrinsic value of the embedded conversion feature of the convertible notes payable is included in the discount to debt and amortized and charged to interest expense over the term of the note agreement. The following chart shows the effective interest rates on the original loan principal amount for loans originated in the respective periods that either had a beneficial conversion interest or an attached warrant:

 

Type of Loan

 

Term of
Loan

 

Stated
Annual
Interest
Rate

 

Original
Loan
Principal
Amount

 

Conv.
Rate

 

Beneficial
Conversion
Discount
Amount

 

Warrants
Issued with
Notes

 

Exercise
Price

 

Warrant
FMV
Discount
Amount

 

Effective
Interest Rate
Including
Discounts

 

2013 convertible notes payable

 

1~2 years

 

10

%

$

3,079,666

 

$3.30

 

$

396,801

 

50,000

 

 

$

116,831

 

19.1% ~ 61.6%

 

2014 convertible notes payable

 

6 mo.~ 2 years

 

10

%

859,320

 

$3.05 ~ $3.30

 

465,926

 

50,000

 

$

3.50

 

$

126,732

 

28.0% ~ 100.4%

 

Total

 

 

 

 

 

$

3,938,986

 

 

 

$

862,727

 

100,000

 

 

 

$

243,563

 

 

 

 

Related party notes are disclosed as separate line items in the Company’s balance sheet presentation.

 

Net loss per share — In accordance with FASB ASC Topic 260, Earnings per Share, the basic loss per common share is computed by dividing net loss available to common stockholders by the weighted average number of common shares outstanding. Dilutive loss per share is computed in a manner similar to the basic loss per common share, except the denominator is increased to include the number of additional common shares that would have been outstanding if the potential common shares had been issued and if the additional common shares were dilutive. As of September 30, 2014 and 2013, there were 13,993,997 and 13,811,989 shares of potentially dilutive securities outstanding, respectively. As the Company reported a net loss, none of the potentially dilutive securities were included in the calculation of diluted loss per share since their effect would be anti-dilutive for all periods presented.

 

Recent accounting pronouncements — In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers. This amendment will eliminate transaction- and industry-specific revenue recognition guidance under current GAAP and replace it with a principle-based approach for determining revenue recognition. The core principle of the revenue recognition guidance is that an entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. To achieve that core principle, an entity should apply the following steps: (1) identify the contract(s) with a customer; (2) identify the performance obligations in the contract(s);

 

8



Table of Contents

 

(3) determine the transaction price; (4) allocate the transaction price to the performance obligations in the contract(s); and (5) recognize revenue when (or as) the entity satisfies a performance obligation. For public companies, these amendments are effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period (early adoption prohibited). The standard permits the use of either the retrospective or cumulative effect transition method. Currently, the Company is assessing the impact of adoption of the amendment on its financial statements and accompanying notes.

 

In August 2014, the FASB issued ASU No. 2014-15, Presentation of Financial Statements - Going Concern Sub-topic 205-40. The new guidance addresses management’s responsibility to evaluate whether there is substantial doubt about an entity’s ability to continue as a going concern and to provide related footnote disclosures. This ASU is effective for interim and annual periods beginning on or after December 15, 2016, and early adoption is permitted. The Company does not expect the adoption of this guidance to have a material impact on its financial position or results of operations.

 

NOTE 3 — PROPERTY AND EQUIPMENT

 

Property and equipment consisted of the following at:

 

 

 

September 30, 2014

 

December 31, 2013

 

Equipment

 

$

137,038

 

$

128,343

 

Leasehold improvements

 

31,304

 

23,054

 

Furniture and fixtures

 

60,194

 

52,269

 

Sub total

 

228,536

 

203,666

 

Less: accumulated depreciation

 

(189,312

)

(177,546

)

Total

 

$

39,224

 

$

26,120

 

 

During the nine months ended September 30, 2014 and 2013, depreciation expense was $11,999 and $17,172, respectively.

 

NOTE 4 — INTANGIBLE ASSETS

 

The Company is licensed to market and sell NutreStore L-glutamine powder for oral solution as a treatment for SBS.

 

In April 2011, the Company entered into a Research Agreement and an Individual Agreement with CellSeed and, in August 2011, entered into an addendum to the Research Agreement. Pursuant to the Individual Agreement, CellSeed granted the Company the exclusive right to manufacture, sell, market and distribute Cultured Autologous Oral Mucosal Epithelial Cell Sheet (“CAOMECS”) for the cornea in the United States and agreed to disclose to the Company its accumulated information package for the joint development of CAOMECS. Under the Individual Agreement, the Company agreed to pay CellSeed $1.5 million, which it paid in February 2012. The technology acquired under the Individual Agreement is being used to support an ongoing research and development project, and management believes the technology has alternative future uses in other future development initiatives.

 

Pursuant to the Research Agreement, the Company and CellSeed formed a relationship regarding the future research and development of cell sheet engineering regenerative medicine products and the future commercialization of such products. Under the Research Agreement, as supplemented by the addendum, the Company agreed to pay CellSeed $8.5 million within 30 days after the completion of all of the following: (i) the execution of the Research Agreement; (ii) the execution of the Individual Agreement; and (iii) CellSeed’s delivery of the accumulated information package, as defined in the Research Agreement, to the Company and the Company providing written confirmation of its acceptance of the complete Package, which has not yet been completed as of September 30, 2014.

 

The Company has estimated the economic life of the CAOMECS produced in connection with the CellSeed Research and Individual Agreement at seven years. The determination of this life is based in part on the Company’s estimate of economic useful life and the time period in which the Company may enjoy an advantage over competing technologies and techniques. Key reasons for a useful life shorter than the life of a patent include: (i) the patents related to this technology are yet to be approved, (ii) potential redundancy with similar medication/device due to changes in market preferences, (iii) uncertainty of regulatory approval, and (iv) potential development of new treatments for the same disease.

 

9



Table of Contents

 

Intangible assets consisted of the following at:

 

 

 

September 30, 2014

 

December 31, 2013

 

License fees and patent filing costs

 

$

2,250,000

 

$

2,250,000

 

Less: accumulated amortization

 

(1,303,571

)

(1,142,857

)

Total

 

$

946,429

 

$

1,107,143

 

 

During the nine months ended September 30, 2014 and 2013, amortization expense was $160,714 in each period. As of September 30, 2014, aggregate amortization expense for the next five years is estimated to be as follows:

 

Periods ending December 31,

 

Amount

 

2014 (fourth quarter)

 

$

53,572

 

2015

 

214,286

 

2016

 

214,286

 

2017

 

214,286

 

2018

 

214,286

 

Thereafter

 

35,713

 

Total

 

$

946,429

 

 

NOTE 5 — ACCOUNTS PAYABLE AND ACCRUED EXPENSES

 

Accounts payable and accrued expenses consisted of the following at:

 

 

 

September 30, 2014

 

December 31, 2013

 

Accounts payable

 

 

 

 

 

Clinical trial management expenses

 

$

 

$

270,694

 

Legal expenses

 

113,457

 

178,119

 

Other vendors

 

541,388

 

386,847

 

Subtotal

 

654,845

 

835,660

 

Accrued interest payable, related parties

 

99,518

 

195,051

 

Accrued interest payable

 

837,172

 

473,356

 

Accrued expenses

 

180,075

 

294,379

 

Deferred salary

 

291,667

 

485,000

 

Total accounts payable and accrued expenses

 

$

2,063,277

 

$

2,283,446

 

 

10



Table of Contents

 

NOTE 6 — NOTES PAYABLE

 

Notes payable consisted of the following at September 30, 2014:

 

Year
Issued

 

Interest
rate
range

 

Term of Notes

 

Conv. Price

 

Principal
Outstanding
September
30, 2014

 

Discount
Amount
September
30, 2014

 

Carrying
Amount
September
30, 2014

 

Shares
Underlying
Principal

as of
September
30, 2014

 

Principal
Outstanding
December
31, 2013

 

Discount
Amount
December
31, 2013

 

Carrying
Amount
December
31, 2013

 

Shares
Underlying
Principal
as of
December
31, 2013

 

Convertible notes payable 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2009

 

6.50%

 

5 years

 

$3.05

 

$

 

$

 

$

 

 

$

254,460

 

$

 

$

254,460

 

83,366

 

2010

 

0 ~ 6.0%

 

5 years

 

$3.05

 

74,000

 

4,473

 

69,527

 

24,248

 

74,000

 

8,308

 

65,692

 

24,248

 

2011

 

10%

 

5 years

 

$3.05

 

500,000

 

 

500,000

 

163,809

 

500,000

 

 

500,000

 

163,809

 

2012

 

10%

 

2 years

 

$3.30 ~$3.60

 

201,600

 

 

201,600

 

56,000

 

251,100

 

 

251,100

 

71,000

 

2013

 

10%

 

6 months ~ 2 years

 

$3.30 ~$3.60

 

4,599,445

 

32,687

 

4,566,758

 

1,307,922

 

6,913,606

 

215,798

 

6,697,808

 

1,998,215

 

2014

 

10%

 

Due on demand ~ 2 years

 

$3.05 ~$7.00

 

2,720,412

 

121,296

 

2,599,116

 

578,832

 

 

 

 

 

 

 

 

 

 

 

 

 

$

8,095,457

 

$

158,456

 

$

7,937,001

 

2,130,811

 

$

7,993,166

 

$

224,106

 

$

7,769,060

 

2,340,638

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Current

 

 

 

$

3,678,504

 

$

129,283

 

$

3,549,221

 

1,070,975

 

$

4,955,868

 

$

153,396

 

$

4,802,472

 

1,438,033

 

 

 

 

 

Non-current

 

 

 

$

4,416,953

 

$

29,173

 

$

4,387,780

 

1,059,836

 

$

3,037,298

 

$

70,710

 

$

2,966,588

 

902,605

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Convertible notes payable - related party

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2012

 

10%

 

Due on demand

 

$3.30

 

$

373,000

 

$

 

$

373,000

 

113,030

 

$

373,000

 

$

 

$

373,000

 

113,030

 

2013

 

10%

 

1 year

 

$3.60

 

152,066

 

 

152,066

 

42,241

 

187,706

 

 

187,706

 

52,141

 

2014

 

10%

 

2 years

 

$7.00

 

200,000

 

 

200,000

 

28,571

 

 

 

 

 

 

 

 

 

 

 

 

 

$

725,066

 

$

 

$

725,066

 

183,842

 

$

560,706

 

$

 

$

560,706

 

165,171

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Current

 

 

 

$

525,066

 

$

 

$

525,066

 

155,271

 

$

560,706

 

$

 

$

560,706

 

165,171

 

 

 

 

 

Non-current

 

 

 

$

200,000

 

$

 

$

200,000

 

28,571

 

$

 

$

 

$

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Notes payable

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2012

 

11%

 

2 years

 

NA

 

$

 

$

 

$

 

 

$

833,335

 

$

18,265

 

$

815,070

 

 

2013

 

2% ~ 10%

 

Due on demand ~ 2 years

 

NA

 

1,110,000

 

 

1,110,000

 

 

1,150,000

 

 

1,150,000

 

 

2014

 

11%

 

2 years

 

NA

 

833,335

 

 

833,335

 

 

 

 

 

 

 

 

 

 

 

 

 

 

$

1,943,335

 

$

 

$

1,943,335

 

 

$

1,983,335

 

$

18,265

 

$

1,965,070

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Current

 

 

 

$

1,110,000

 

$

 

$

1,110,000

 

 

$

1,783,335

 

$

18,265

 

$

1,765,070

 

 

 

 

 

 

Non-current

 

 

 

$

833,335

 

$

 

$

833,335

 

 

$

200,000

 

$

 

$

200,000

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Notes payable - related party

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2012

 

8% ~ 10%

 

Due on demand

 

NA

 

$

656,730

 

$

 

$

656,730

 

 

$

880,062

 

$

4,421

 

$

875,641

 

 

2013

 

8%

 

Due on demand

 

NA

 

50,000

 

 

50,000

 

 

50,000

 

 

50,000

 

 

2014

 

11%

 

Due on demand ~ 2 years

 

NA

 

252,165

 

 

252,165

 

 

 

 

 

 

 

 

 

 

 

 

 

 

$

958,895

 

$

 

$

958,895

 

 

$

930,062

 

$

4,421

 

$

925,641

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Current

 

 

 

$

825,562

 

$

 

$

825,562

 

 

$

930,062

 

$

4,421

 

$

925,641

 

 

 

 

 

 

Non-current

 

 

 

$

133,333

 

$

 

$

133,333

 

 

$

 

$

 

$

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Grand Total

 

 

 

$

11,722,753

 

$

158,456

 

$

11,564,297

 

2,314,653

 

$

11,467,269

 

$

246,792

 

$

11,220,477

 

2,505,809

 

 

The average stated interest rate of notes payable as of September 30, 2014 and December 31, 2013 was 10%. The average effective interest rate of notes payable as of September 30, 2014 and December 31, 2013 was 16% and 15%, respectively, after giving effect to discounts relating to beneficial conversion features and the fair value of warrants issued in connection with these notes. The notes payable and convertible notes payable do not have restrictive financial covenants or acceleration clauses associated with a material adverse change event. The holders of the convertible notes have the option to convert their notes into the Company’s common stock at the stated conversion price at any time during the term of their convertible notes. Conversion prices on the convertible notes payable range from $3.05 to $7.00 per share. All due on demand notes are treated as current liabilities.

 

Contractual principal payments due on notes payable are as follows at September 30, 2014:

 

In calendar year

 

Payments Due

 

2014 (fourth quarter)

 

$

3,391,977

 

2015

 

2,749,155

 

2016

 

5,581,621

 

Total

 

$

11,722,753

 

 

11



Table of Contents

 

The Company estimated the total fair value of any beneficial conversion feature and accompanying warrants in allocating the debt proceeds. The proceeds allocated to the beneficial conversion feature were determined by taking the estimated fair value of shares issuable under the convertible notes less the fair value of the number of shares that would be issued if the conversion rate equaled the fair value of the Company’s common stock as of the date of issuance (see Note 2). In situations where the debt included both a beneficial conversion feature and a warrant, the proceeds were allocated to the warrants and beneficial conversion feature based on the pro-rata fair value.

 

NOTE 7 — STOCKHOLDERS’ DEFICIT

 

Private Placement — On September 11, 2013, the Company issued an aggregate of 3,020,501 units at a price of $2.50 per unit (the “Private Placement”). Each unit consisted of one share of common stock and one common stock warrant for the purchase of an additional share of common stock. The aggregate purchase price for the units was $7,551,253.

 

The warrants entitle the holders thereof to purchase, at any time on or prior to September 11, 2018, shares of common stock of the Company at an exercise price of $3.50 per share. The warrants contain non-standard anti-dilution protection and, consequently, are being accounted for as liability classified warrants, were originally recorded at fair value, and will be adjusted to fair market value each reporting period.

 

Stock warrants — In addition to the warrants issued in connection with the Private Placement discussed above, during the year ended December 31, 2013, the Company issued warrants in connection with the issuance of a convertible note to purchase an aggregate of 50,000 shares of common stock at a per share exercise price of $3.30 per share. Also, in December 2013, warrants to purchase 500,000 shares of common stock at an exercise price of $1.00 per share that had previously been issued to a director expired. On May 1, 2014, in connection with the issuance of a convertible note, the Company issued a five year warrant to purchase an aggregate of 50,000 shares of common stock at an exercise price of $3.50 per share.

 

Warrant exercises and issuance — On June 10, 2014, certain warrant holders exercised 1,095,465 warrants issued in the Private Placement for the exercise price of $3.50 per share, resulting in the Company receiving aggregate exercise proceeds of $3.8 million and issuing 1,095,465 shares of common stock. Prior to exercise, these Private Placement warrants were accounted for at fair value as liability classified warrants. As of June 10, 2014, immediately prior to exercise, the carrying value of these Private Placement warrants was reduced to their fair value immediately prior to exercise of $1.8 million, representing their intrinsic value, with this adjusted carrying value of $1.8 million being transferred to additional paid in capital. Also on June 10, 2014, based on an offer made to holders of Private Placement warrants in connection with such exercises, the Company issued an aggregate of 1,095,465 replacement warrants to holders exercising Private Placement warrants, which replacement warrants have terms that are generally the same as the exercised warrants, including an expiration date of September 11, 2018 and an exercise price of $3.50 per share. The replacement warrants are treated for accounting purposes as liability classified warrants, and their issuance gave rise to a $3.5 million warrant exercise inducement expense based on their fair value as of issuance as determined using a Binomial Monte-Carlo Cliquet (aka Ratchet) Option Pricing Model.

 

In addition to the above, during the nine months ended September 30, 2014, the Company issued 112,914 shares of common stock upon the exercise of warrants at exercise prices ranging from $3.05 to $3.825 per share, including 5,246 warrants exercised on a cashless basis.

 

A summary of outstanding warrants as of September 30, 2014 is presented below.

 

 

 

Nine months ended
September 30, 2014

 

Year ended
December 31, 2013

 

Warrants outstanding, beginning of period

 

6,279,296

 

3,408,795

 

Granted

 

1,145,465

 

3,370,501

 

Exercised

 

(1,208,379

)

 

Cancelled, forfeited and expired

 

(419,153

)

(500,000

)

Warrants outstanding, end of period

 

5,797,229

 

6,279,296

 

 

12



Table of Contents

 

A summary of outstanding warrants by year issued and exercise price as of September 30, 2014 is presented below.

 

 

 

Outstanding

 

Exercisable

 

Year issued and
Exercise Price

 

Number of
Warrants
 Issued

 

Weighted
Average
Remaining
Contractual
Life (Years)

 

Weighted
Average
Exercise Price

 

Total

 

Weighted
Average
Exercise
Price

 

Balance 2012

 

 

 

 

 

 

 

 

 

 

 

$1.00

 

946,576

 

0.29

 

$

1.00

 

946,576

 

$

1.00

 

$2.50

 

1,000,000

 

0.91

 

$

2.50

 

1,000,000

 

$

2.50

 

$3.05

 

241,495

 

0.77

 

$

3.05

 

241,495

 

$

3.05

 

75% of FMV

 

188,657

 

0.10

 

75% of FMV

 

188,657

 

75% of FMV

 

2012 total

 

2,376,728

 

 

 

 

 

2,376,728

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

During 2013

 

 

 

 

 

 

 

 

 

 

 

$3.30

 

50,000

 

3.59

 

$

3.30

 

50,000

 

$

3.30

 

$3.50

 

2,225,036

 

3.95

 

$

3.50

 

2,225,036

 

$

3.50

 

2013 total

 

2,275,036

 

 

 

 

 

2,275,036

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

During 2014

 

 

 

 

 

 

 

 

 

 

 

$3.50

 

1,145,465

 

3.98

 

$

3.50

 

1,145,465

 

$

3.50

 

Total

 

5,797,229

 

 

 

 

 

5,797,229

 

 

 

 

Stock options Management has valued stock options at their date of grant utilizing the Black-Scholes-Merton Option pricing model. The fair value of the underlying shares was determined by the market value of stock of similar companies and recent arm’s length transactions involving the sale of common stock. The expected volatility was calculated using the historical volatility of a similar public entity in the industry through August 2013 and a group of similar public entities thereafter. The following table shows assumptions used on recent dates on which options were granted by the Board of Directors.

 

 

 

July 17, 2014

 

May 8, 2014

 

February 26, 2014

 

July 18, 2013

 

February 28, 2013

 

Stock price

 

$

5.10

 

$

4.90

 

$

3.60

 

$

3.60

 

$

3.60

 

Exercise price

 

$

5.10

 

$

4.90

 

$

3.60

 

$

3.60

 

$

3.60

 

Term

 

10 years

 

10 years

 

10 years

 

10 years

 

10 years

 

Risk-Free Interest Rate

 

2.47

%

2.61

%

2.67

%

2.56

%

1.89

%

Dividend Yield

 

0.00

%

0.00

%

0.00

%

0.00

%

0.00

%

Volatility

 

77.90

%

75.50

%

76.60

%

113.60

%

119.30

%

 

In making the determination of fair value and finding similar companies, the Company considered the industry, stage of life cycle, size and financial leverage of such other entities. While the Company was initially able to identify only one similar public company using these criteria, based on the more advanced stage of development of the Company additional similar companies with enough historical data that met the industry criterion have now been identified. Accordingly, the Company has based its expected volatility on the historical stock prices of a group of companies since September 2013.

 

The risk-free interest rate is based on the implied yield available on U.S. Treasury issues with an equivalent term approximating the expected life of the options depending on the date of the grant and expected life of the options. The expected life of options used was based on the contractual life of the option granted.

 

During the nine months ended September 30, 2014, the Company’s Board of Directors granted 840,000 options to its directors, employees and consultants. Of these options, 438,000 options will vest over three years starting February 26, 2015, have an exercise price of $3.60 per share, and are exercisable through 2024, 302,000 options will vest over three years starting May 8, 2015, have an exercise price of $4.90 per share, and are exercisable through 2024, and 100,000 options will vest over three years starting July 17, 2015, have an exercise price of $5.10 per share, and are exercisable through 2024. In addition, 340,000 options that were approved by the Company’s Board of Directors in April 2012 were deemed issued during the nine months ended September 30, 2014. Two-thirds of these options have vested and the remaining one-third will vest by April 2015. These options have an exercise price of $3.60 per share and are exercisable through 2022. The aggregate fair value of these groups of options was approximately $2.7 million. As of September 30, 2014, there were 5,669,000 options outstanding under the 2011 Stock Incentive Plan and 11,795 options outstanding that were issued prior to the 2011 Stock Incentive Plan.

 

13



Table of Contents

 

A summary of outstanding options as of September 30, 2014 is presented below.

 

 

 

 

 

2011 Stock Incentive Plan

 

 

 

Prior Plan

 

September 30, 2014

 

December 31, 2013

 

Options outstanding, beginning of period

 

11,795

 

4,504,000

 

1,199,000

 

Granted

 

 

1,180,000

 

3,305,000

 

Exercised

 

 

 

 

Cancelled, forfeited and expired

 

 

(15,000

)

 

Options outstanding, end of period

 

11,795

 

5,669,000

 

4,504,000

 

 

Registration Rights — Pursuant to the Subscription Agreements and certain warrants, the Company has agreed to use its commercially reasonable best efforts to have on file with the SEC, by September 11, 2014 and at the Company’s sole expense, a registration statement to permit the public resale of 4,115,966 shares of the Company’s common stock and 3,320,501 shares of common stock underlying warrants (collectively, the “Registrable Securities”). In the event such registration statement includes securities to be offered and sold by the Company in a fully underwritten primary public offering pursuant to an effective registration under the Securities Act, and the Company is advised in good faith by any managing underwriter of securities being offered pursuant to such registration statement that the number of Registrable Securities proposed to be sold in such offering is greater than the number of such securities which can be included in such offering without materially adversely affecting such offering, the Company will include in such registration the following securities in the following order of priority: (i) any securities the Company proposes to sell; and (ii) the Registrable Securities, with any reductions in the number of Registrable Securities actually included in such registration to be allocated on a pro rata basis among the holders thereof. The registration rights described above apply until all Registrable Securities have been sold pursuant to Rule 144 under the Securities Act or may be sold without registration in reliance on Rule 144 under the Securities Act without limitation as to volume and without the requirement of any notice filing. If the shares of common stock underlying warrants to purchase 2,225,036 shares are not registered for resale at the time of exercise on or after September 11, 2014 or if the shares of common stock underlying warrants to purchase 1,095,465 shares are not registered for resale at the time of exercise on or after June 10, 2015, and in each such case the registration rights described above then apply with respect to the holder of such warrants, such holder may exercise such warrants on a cashless basis. The Company has not yet filed a registration statement with respect to the resale of the Registrable Securities because doing so is not feasible prior to the completion by the Company of its initial public offering.

 

NOTE 8 — COMMITMENTS AND CONTINGENCIES

 

Distribution contract — Cardinal Health Specialty Pharmacy Services has been contracted to distribute NutreStore to other wholesale distributors and some independent pharmacies since April 2008. For these services, the Company pays a monthly commercialization management fee of $5,000.

 

Operating leases — The Company leases its office space under operating leases with unrelated entities. The rent expense during the nine months ended September 30, 2014 and 2013 amounted to $163,605 and $101,891, respectively.

 

Future minimum lease payments under the agreements are as follows:

 

2014

 

$

50,304

 

2015

 

122,434

 

2016

 

41,067

 

 

 

$

213,805

 

 

Licensing agreement The Company licensed certain current and future technology from CellSeed (see Note 4 for further discussion). CellSeed may terminate these agreements with the Company if the Company is unable to make timely payments required under the agreements. At the time the Company entered into the agreements with CellSeed, it left for further negotiation provisions covering how the Company and CellSeed will share any financial results of commercializing any cell sheet engineering regenerative medicine products that it is seeking to develop in collaboration with CellSeed. If the Company is not able to successfully negotiate these terms, its current development and commercialization plans with respect to any of these products would be materially adversely affected.

 

14



Table of Contents

 

NOTE 9 — RELATED PARTY TRANSACTIONS

 

The following table sets forth information relating to the Company’s loans from related persons outstanding as of September 30, 2014.

 

Class

 

Lender

 

Interest
rate

 

Date of
loan

 

Term of Loan

 

Principal
Amount
Outstanding
at
September 30,
2014

 

Highest
Principal
outstanding

 

Amount of
Principal
Repaid

 

Amount of
Interest
Paid

 

Conv.
Rate

 

Shares
underlying
principal
at
September 30,
2014

 

Current, Promissory note payable to related parties:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Hope Int’l Hospice (1)

 

8

%

1/17/2012

 

Due on demand

 

$

200,000

 

$

200,000

 

$

 

$

12,000

 

 

 

 

 

Hope Int’l Hospice (1)

 

8

%

6/14/2012

 

Due on demand

 

200,000

 

200,000

 

 

16,000

 

 

 

 

 

Hope Int’l Hospice (1)

 

8

%

6/21/2012

 

Due on demand

 

100,000

 

100,000

 

 

6,000

 

 

 

 

 

Yutaka Niihara (2)(4)

 

10

%

12/5/2012

 

Due on demand

 

156,730

 

1,213,700

 

1,056,970

 

60,851

 

 

 

 

 

Hope Int’l Hospice (1)

 

8

%

2/11/2013

 

Due on demand

 

50,000

 

50,000

 

 

3,000

 

 

 

 

 

Lan T. Tran (2)

 

11

%

2/10/2014

 

2 years (3)

 

106,976

 

106,976

 

 

 

 

 

 

 

Cuc T. Tran (5)

 

11

%

3/5/2014

 

1 year

 

11,856

 

11,856

 

 

 

 

 

 

 

 

 

 

 

 

 

Sub total

 

$

825,562

 

$

1,882,532

 

$

1,056,970

 

$

97,851

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Current, Convertible notes payable to related parties:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Yasushi Nagasaki (2)

 

10

%

6/29/2012

 

Due on demand

 

$

373,000

 

$

388,800

 

$

15,800

 

$

67,680

 

$

3.30

 

113,030

 

 

 

MLPF&S Cust. FBO Willis C.Lee (2)

 

10

%

10/5/2013

 

1 year

 

152,066

 

152,066

 

 

 

$

3.60

 

42,241

 

 

 

 

 

 

 

 

 

Sub total

 

$

525,066

 

$

540,866

 

$

15,800

 

$

67,680

 

 

155,271

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Long-term, Promissory note payable to related parties:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Hideki & Eiko Uehara (5)

 

11

%

2/15/2014

 

2 years

 

$

133,333

 

$

133,333

 

$

 

$

11,030

 

 

 

 

 

 

 

 

 

 

 

Sub total

 

$

133,333

 

$

133,333

 

$

 

$

11,030

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Long-term, Convertible notes payable to related parties:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Phillip M. Satow (4)

 

10

%

6/6/2014

 

2 years

 

$

100,000

 

$

100,000

 

$

 

$

 

$

7.00

 

14,286

 

 

 

Richard S. Pechter (5)

 

10

%

6/11/2014

 

2 years

 

100,000

 

100,000

 

 

 

$

7.00

 

14,286

 

 

 

 

 

 

 

 

 

Sub total

 

$

200,000

 

$

200,000

 

$

 

$

 

 

28,572

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

1,683,961

 

$

2,756,731

 

$

1,072,770

 

$

176,561

 

 

183,843

 

 


(1)    Dr. Niihara is also the CEO of Hope International Hospice, Inc.

(2)    Officer

(3)    Due on demand

(4)    Director

(5)    Family of Officer/Director

 

The following table sets forth information relating to the Company’s loans from related persons outstanding as of December 31, 2013.

 

Class

 

Lender

 

Interest
rate

 

Date of
loan

 

Term of Loan

 

Principal
Amount
Outstanding
as  of
December 31,
2013

 

Highest
Principal
outstanding

 

Amount of
Principal
Repaid

 

Amount of
Interest
Paid

 

Conv.
Rate

 

Shares
Underlying
Principal
as of
December
31, 2013

 

Current, Promissory note payable to related parties:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Hope Int’l Hospice(1)

 

8

%

1/17/2012

 

Due on demand

 

$

200,000

 

$

200,000

 

$

 

$

20,000

 

 

 

 

 

Lan T. Tran(2)

 

11

%

2/10/2012

 

2 years(3)

 

80,000

 

205,000

 

125,000

 

 

 

 

 

 

Hideki & Eiko Uehara(5)

 

11

%

2/15/2012

 

2 years(3)

 

133,333

 

133,333

 

 

14,433

 

 

 

 

 

Hope Int’l Hospice(1)

 

8

%

6/14/2012

 

Due on demand

 

200,000

 

200,000

 

 

20,000

 

 

 

 

 

Hope Int’l Hospice(1)

 

8

%

6/21/2012

 

Due on demand

 

100,000

 

100,000

 

 

10,000

 

 

 

 

 

Cuc T. Tran(5)

 

11

%

6/27/2012

 

1 year

 

10,000

 

10,000

 

 

 

 

 

 

 

Yutaka Niihara(2)(4)

 

10

%

12/5/2012

 

Due on demand

 

156,730

 

1,213,700

 

1,056,970

 

 

 

 

 

 

Hope Int’l Hospice(1)

 

8

%

2/11/2013

 

Due on demand

 

50,000

 

50,000

 

 

3,000

 

 

 

 

 

 

 

 

 

 

 

Sub total

 

$

930,063

 

$

2,112,033

 

$

1,181,970

 

$

67,433

 

 

 

 

 

 

 

 

 

 

 

Less discount

 

$

(4,422

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

925,641

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Current, Convertible notes payable to related parties:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Yasushi Nagasaki(2)

 

10

%

6/29/2012

 

Due on demand

 

$

373,000

 

$

388,800

 

$

15,800

 

$

 

$

3.30

 

113,030

 

 

 

Hideki & Eiko Uehara(5)

 

10

%

9/7/2013

 

1 year

 

35,640

 

35,640

 

 

 

$

3.60

 

9,900

 

 

 

MLPF&S Cust. FBO Willis C.Lee(2)(4)

 

10

%

10/5/2013

 

1 year

 

152,066

 

152,066

 

 

 

$

3.60

 

42,240

 

 

 

 

 

 

 

 

 

Sub total

 

$

560,706

 

$

576,506

 

$

15,800

 

$

 

 

165,170

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

1,486,347

 

$

2,688,539

 

$

1,197,770

 

$

67,433

 

 

165,170

 

 


(1)    Dr. Niihara, who is the Company’s CEO, is also the CEO of Hope International Hospice, Inc.

(2)    Officer

(3)    Due on demand

(4)    Director

(5)    Family of Officer/Director

 

Since July 2012, the Company has been engaged in litigation with AFH Advisory, which was the sole stockholder of AFH Acquisition IV immediately prior to its combination with Emmaus Medical pursuant to the Merger in May 2011. In September 2012, AFH Advisory and related parties filed a complaint against the Company in the Superior Court of Delaware. In October 2012, the Company filed counterclaims against the plaintiffs and third-party claims against Amir Heshmatpour. Mr. Heshmatpour is a former officer of AFH Acquisition IV, Inc. (prior to the Merger) and former director of the Company and is the Managing Partner of AFH Advisory. On June 27, 2013, the Superior Court of the State of Delaware issued an order implementing a partial summary judgment in favor of the Company in its litigation against AFH Advisory, Griffin, the Foundation and Mr. Heshmatpour. The order, among other things,

 

15



Table of Contents

 

(i) stated that a letter of intent previously entered into between the Company and AFH Advisory (the “Letter of Intent”) was properly terminated as of July 19, 2012 by the Company, and (ii) ordered the transfer agent for the Company to effect the cancellation of 2,504,249 shares of the Company’s common stock held by AFH Advisory, Griffin and the Foundation. The cancellation of such shares was effected by the Company’s transfer agent on June 28, 2013. While no appeal of this ruling has been pursued, if the court’s ruling is appealed, it could result in the Company incurring liabilities and expenses that may have a material adverse effect on its financial condition and cash flows. The cancellation of such shares is subject to appeal until 30 days after the completion of trial court proceedings. While the partial summary judgment in favor of the Company in this litigation noted above led to the cancellation of 2,504,249 shares of the Company’s common stock by the transfer agent on June 28, 2013, the Company will continue to present these shares in its financial statements as outstanding until the right of appeal has lapsed and all contingencies have been resolved. The Company’s cause of action for fraud, which was not part of the summary judgment, has not yet been litigated or settled.

 

NOTE 10 — GEOGRAPHIC INFORMATION

 

For the nine months ended September 30, 2014 and 2013, the Company earned revenue from countries outside of the United States as outlined in the table below. The Company did not have any significant currency translation or foreign transaction adjustments during the nine months ended September 30, 2014 or 2013.

 

Country

 

Sales nine months ended
September 30, 2014

 

% of Total revenue
nine months ended
September 30, 2014

 

Sales nine months ended
September 30, 2013

 

% of Total revenue
nine months ended
September 30, 2013

 

Japan

 

$

132,145

 

38

%

$

125,590

 

51

%

South Korea

 

45,312

 

13

%

 

 

Taiwan

 

129,310

 

37

%

7,980

 

3

%

 

NOTE 11 — SUBSEQUENT EVENTS

 

In October 2014, $131,717 in principal amount of a convertible note was converted into common stock at a conversion price of $3.60 per share.

 

In October 2014, warrants to purchase 35,556 shares of the Company’s common stock were exercised at an exercise price of $1.00 per share.

 

In October 2014, the Company refinanced its principal obligation under a convertible note payable in the amount of $2,136,146 by issuing a new convertible note in the same principal amount and having the same interest rate, same conversion terms and a two year maturity. In addition, a new promissory note bearing interest at 11% was issued to this same lender to evidence $213,615 of accrued interest on the initial note and $400,000 of additional loan proceeds. A summary of these notes is as follows:

 

Notes issued after
September 30, 2014

 

Loan Principal
Outstanding

 

Annual
Interest Rate

 

Term of Notes

 

Conversion
Price

 

Date of loan

 

Convertible note

 

$

2,136,146

 

10.00

%

2 years

 

$

3.60

 

10/10/2014

 

Promissory note

 

613,615

 

11.00

%

On demand up to 2 years

 

 

10/10/2014

 

 

 

$

2,749,761

 

 

 

 

 

 

 

 

 

 

In October 2014, the Company entered into a fifty-one-and-a-half month office lease agreement. The lease term commences on November 14, 2014 and expires on February 28, 2019. The lease agreement provides for the lease by the Company of approximately 13,329 square feet of space at 21250 Hawthorne Boulevard in Torrance, California. Base rent is set at $36,370 per month and the total rent payable over the lease term is $1,873,075.

 

16



Table of Contents

 

NOTE 12 — AMOUNTS RECLASSIFIED OUT OF ACCUMULATED OTHER COMPREHENSIVE INCOME

 

The following tables show amounts added to and reclassified out of accumulated other comprehensive income:

 

 

 

Unrealized holding
gain (loss) on
securities
available-for-sale

 

Unrealized
foreign
translation

 

Total

 

Balance — December 31, 2013

 

$

289,389

 

$

(26,706

)

$

262,683

 

Other comprehensive income before reclassifications

 

(374,806

)

(5,681

)

(380,487

)

Amounts reclassified from accumulated other comprehensive income

 

 

 

 

Net current period other comprehensive income

 

(374,806

)

(5,681

)

(380,487

)

Balance — September 30, 2014

 

$

(85,417

)

$

(32,387

)

$

(117,804

)

 

 

 

 

 

 

 

 

Balance — December 31, 2012

 

$

(4,386

)

$

(8,046

)

$

(12,432

)

Other comprehensive income before reclassifications

 

719,857

 

(34,381

)

685,476

 

Amounts reclassified from accumulated other comprehensive income

 

 

 

 

Net current period other comprehensive income

 

719,857

 

(34,381

)

685,476

 

Balance — September 30, 2013

 

$

715,471

 

$

(42,427

)

$

673,044

 

Amounts in parentheses indicate debits.

 

 

 

 

 

 

 

All amounts are net of tax.

 

 

 

 

 

 

 

 

17



Table of Contents

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

The following discussion relates to the financial condition and results of operations of Emmaus Life Sciences, Inc. (the “Company”, “we”, “us” and similar pronouns), its wholly-owned subsidiary Emmaus Medical, Inc., a Delaware corporation (“Emmaus Medical”), and Emmaus Medical’s wholly-owned subsidiaries Newfield Nutrition Corporation, a Delaware corporation (“Newfield”), Emmaus Medical Japan, Inc., a Japanese corporation (“EM Japan”), and Emmaus Medical Europe, Ltd. (“EM Europe”).

 

Forward-Looking Statements

 

This management’s discussion and analysis of financial condition and results of operations should be read in conjunction with the audited consolidated financial statements for the years ended December 31, 2013 and 2012 and the related notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013 filed with the Securities and Exchange Commission (“SEC”) on May 8, 2014 (the “Annual Report”).

 

This Quarterly Report contains forward-looking statements that involve substantial risks and uncertainties. All statements other than historical facts contained in this report, including statements regarding our future financial position, capital expenditures, cash flows, business strategy and plans and objectives of management for future operations are forward-looking statements. The words “anticipate,” “believe,” “expect,” “plan,” “intend,” “seek,” “estimate,” “project,” “could,” “may,” and similar expressions are intended to identify forward-looking statements. These statements include, among others, information regarding future operations, future capital expenditures, and future net cash flow. Such statements reflect our management’s current views with respect to future events and financial performance and involve risks and uncertainties, including, without limitation, our ability to raise additional capital to fund our operations, obtaining U.S. Food and Drug Administration (“FDA”) and other regulatory authorization to market our drug and biological products, successful completion of our clinical trials, our ability to achieve regulatory authorization to market our pharmaceutical grade L-glutamine treatment for SCD, our ability to commercialize our pharmaceutical grade L-glutamine treatment for SCD, our reliance on third party manufacturers for our drug products, market acceptance of our products, our dependence on licenses for certain of our products, our reliance on the expected growth in demand for our products, exposure to product liability and defect claims, development of a public trading market for our securities, and various other matters, many of which are beyond our control.

 

Should one or more of these risks or uncertainties occur, or should underlying assumptions prove to be incorrect, actual results may vary materially and adversely from those anticipated, believed, estimated or otherwise indicated. Consequently, all of the forward-looking statements made in this Form 10-Q are qualified by these cautionary statements and accordingly there can be no assurances made with respect to the actual results or developments.

 

Company Overview

 

We are a biopharmaceutical company engaged in the discovery, development and commercialization of innovative treatments and therapies primarily for rare and orphan diseases. We are initially focusing our product development efforts on sickle cell disease (“SCD”), a debilitating genetic disorder. Our lead product candidate is an oral pharmaceutical grade L-glutamine treatment that has demonstrated positive clinical results in our completed Phase 3 clinical trial for sickle cell anemia and sickle ß0-thalassemia, two of the most common forms of SCD.

 

SCD is an inherited blood disorder characterized by the production of an altered form of hemoglobin in the patient’s red blood cells. This altered form of hemoglobin causes the patient’s red blood cells to become rigid and sickle-shaped instead of soft, flexible and rounded. Patients with SCD suffer debilitating episodes of sickle cell crisis when their sickle-shaped, inflexible red blood cells adhere to each other and the walls of blood vessels. This blockage, or occlusion, of the patient’s blood vessels restricts the delivery of oxygen to tissues, a condition referred to as tissue ischemia, and also causes inflammation. In addition to being excruciatingly painful, sickle cell crises can lead to organ damage, stroke, pulmonary complications, skin ulceration, infection and a variety of other adverse outcomes. The only treatment for SCD that is approved in the United States is hydroxyurea, a cytotoxic drug first synthesized in the 19th century and approved in 1967 by the U.S. Food and Drug Administration, or FDA, for treating certain types of leukemia. In 1998, FDA approved the use of hydroxyurea for treating SCD in adults. There are no approved treatments in the United States for pediatric patients with SCD.

 

In December 2013 we completed a 230 patient randomized, double-blind, placebo-controlled, parallel-group, multi-center Phase 3 clinical trial which enrolled adult and pediatric patients as young as five years of age, involving 31 sites in the United States. Our L-glutamine treatment and the placebo were randomized by site and by use of hydroxyurea.

 

18



Table of Contents

 

We analyzed the preliminary data from this clinical trial by adjusting, or stratifying, for patients who were, or were not being treated with hydroxyurea. This analysis demonstrated that patients treated with our L-glutamine product candidate over a 48-week period experienced a statistically significant 25% reduction (from four to three; p-value = 0.008) in the median frequency of sickle cell crises and a statistically significant 33% reduction (from three to two; p-value = 0.005) in the median frequency of hospitalizations, the primary and secondary endpoints, respectively. As compared to placebo, positive results were observed for both those patients taking hydroxyurea and those not taking hydroxyurea.

 

The statistical analysis plan for the clinical trial also called for stratification by site. For this additional stratification, the sites were grouped into five geographic regions. Once stratified for both hydroxyurea use and geographic region, the p-value for the reduction in the number of painful sickle cell crises was 0.063, which did not meet the p-value of 0.045 that had been pre-specified for this Phase 3 clinical trial. However, using the same stratification factors, the p-value for the reduction in hospitalization was 0.041, which did meet the pre-specified p-value of 0.05.

 

On June 11, 2014, we met with the FDA to discuss the preliminary data from our Phase 3 clinical trial and our plans to submit to the FDA a New Drug Application (“NDA”) based on our single Phase 3 clinical trial. In the minutes of the meeting that the FDA has provided to us, based on its review of preliminary data from our Phase 3 clinical trial, the FDA expressed concern that the primary endpoint of reduction in painful sickle cell crisis (controlling for both geographic region and hydroxyurea use) did not reach the pre-specified p-value significance level of 0.045.

 

The FDA commented that the primary efficacy results were inconsistent among geographic regions, as shown by the large difference in observed results between the stratified analysis adjusted for both geographic region and hydroxyurea use and the stratified analysis adjusted for hydroxyurea use only. The FDA also commented that a reduction in the median number of painful sickle cell crises by one (from four to three) is not clinically meaningful and is not consistent across geographic regions. The FDA asked us to provide explanations for the differences in results observed based on the stratified analysis adjusted for geographic region and hydroxyurea.

 

The FDA also commented on the number of patients who discontinued the study, which was greater in the L-glutamine group, and that the FDA would need to understand what impact the imputation of such data, which is a method of accounting for missing information, would have on the interpretation of the results.

 

Based on the preliminary data, the FDA recommended a second Phase 3 clinical trial be conducted to support the indication for SCD and suggested enrolling patients with a higher baseline level of sickle cell crises to help demonstrate a larger difference in the mean results.

 

Based on other questions we submitted to the FDA regarding the previous pre-clinical work and evidence gathered for the L-glutamine treatment related to pharmacology, toxicology, and clinical pharmacology, the FDA noted that the information we provided appeared to be acceptable, but that final affirmations regarding these matters would be made during the FDA’s review of an NDA. The FDA also made certain recommendations to the chemistry, manufacturing and controls of our oral pharmaceutical grade L-glutamine treatment for SCD, which we intend to address.

 

In September 2014 we submitted to the FDA the Clinical Study Report for our Phase 3 clinical trial, supplemental analyses and a new meeting request. Consequently, we met again with the FDA on October 15, 2014. In the minutes of the October 15 meeting, the FDA noted that it continued to be concerned that the primary endpoint did not meet the pre-specified p-value and observed that our efficacy finding would be more persuasive if supported by an additional, confirmatory study. We communicated to the FDA that over-stratification in our statistical analysis plan led to the pre-specified p-value not being met. We also provided sensitivity analyses and results to address the over stratification which demonstrated a statistically significant p-value for the primary endpoint.

 

At the October 15 meeting, in response to a question raised by the FDA at the June 11 meeting, we provided evidence of the clinical meaningfulness of a reduction in the median number of painful sickle cell crises by one (from four to three). In the October 15 minutes the FDA expressed the view that the reduction of one sickle cell crises may not be clinically significant and advised us to provide all information and data to support this clinical meaningfulness and the FDA stated they will evaluate the overall clinical benefit and risk of L-glutamine based on results from our Phase 3 trial and all available safety data.

 

In the October 15 minutes the FDA reiterated certain concerns outlined in the June 11 minutes. Other questions that we posed for discussion at the October 15 meeting related to the safety of L-glutamine use, the benefit-risk margin for L-glutamine use, the sufficiency of our Phase 2 and 3 trials to support an NDA submission and whether a confirmatory trial could be conducted as a post-marketing commitment. The FDA noted that its decisions regarding these questions would be made after the submission of an NDA.

 

19



Table of Contents

 

Based on our discussions with the FDA, we intend to conduct a confirmatory study of our L-glutamine treatment for SCD. We submitted a draft protocol outline to the FDA. We plan to work with the FDA to finalize the study design.

 

In addition to planning and conducting a confirmatory trial, we plan to submit an NDA for our L-glutamine treatment for SCD during 2015 containing all efficacy and safety data through our completed Phase 3 trial and additional analyses and information in accord with the comments FDA provided during the June 11 and October 15 FDA meetings. This NDA would include a request that our planned confirmatory trial be accepted by the FDA as a post-approval study that is, a study to be completed after approval of the NDA. There can be no assurance that the FDA will accept our submission for filing before the completion of a confirmatory trial or that the information and data in the NDA will satisfy the FDA’s concerns.

 

Regarding the submission of NDAs that include only one Phase 3 clinical trial, the FDA has in some cases accepted evidence from one clinical trial to support a finding of substantial evidence of effectiveness. A change in the law under the U.S. Food and Drug Administration Modernization Act of 1997 made clear that the FDA may consider data from only one adequate and well-controlled clinical investigation and confirmatory evidence if the FDA determines that such evidence is sufficient to establish effectiveness of the medicine under study. In a guidance document titled “Providing Clinical Evidence of Effectiveness for Human Drug and Biological Products” (May 1998), the FDA stated that reliance on a single clinical trial is generally limited to situations in which a trial has demonstrated a clinically meaningful effect on mortality, irreversible morbidity, or prevention of a disease with a potential serious outcome, and where confirmation of the result in a second trial would be impractical or unethical. The factors the FDA considers for accepting a single clinical trial include, but are not limited to, having large multi-centered studies, consistent data across subgroups, multiple endpoints, and statistically very persuasive findings.

 

We have extensive experience in the field of SCD, including the development, outsourced manufacturing and conduct of clinical trials of our L-glutamine product candidate for the treatment of SCD. Our chief executive officer, Yutaka Niihara, M.D., MPH, is a leading hematologist in the field of SCD. Dr. Niihara is licensed to practice medicine in both the United States and Japan and has been actively engaged in SCD research and the care of patients with SCD for over 20 years, primarily at the University of California Los Angeles and the Los Angeles Biomedical Research Institute (“LA BioMed”), a nonprofit biomedical research institute at Harbor-UCLA Medical Center.

 

To a lesser extent, we are also engaged in the marketing and sale of NutreStore L-glutamine powder for oral solution, which has received FDA approval as a treatment for SBS in patients receiving specialized nutritional support when used in conjunction with a recombinant human growth hormone that is approved for this indication. Since formed in May 2006, Newfield has engaged in the sale L-glutamine as a nutritional supplement under the brand name AminoPure through retail stores in multiple states and via importers and distributors in Japan, Taiwan and South Korea. In October 2010, we formed EM Japan to market and sell AminoPure in Japan and other countries in Asia. EM Japan also manages our distributors in Japan and may also import other medical products in the future. Since inception, we have generated minimal revenues from the sale and promotion of NutreStore and AminoPure.

 

In November 2011, we formed EM Europe, a wholly-owned subsidiary of Emmaus Medical, whose primary focus is expanding our business in Europe. Our corporate structure is illustrated as follows:

 

 

Emmaus Medical, LLC was organized on December 20, 2000. In October 2003, Emmaus Medical, LLC undertook a reorganization and merged with Emmaus Medical, Inc., which was originally incorporated in September 2003.

 

Pursuant to an Agreement and Plan of Merger dated April 21, 2011, which we refer to as the Merger Agreement, by and among us, AFH Merger Sub, Inc., our wholly-owned subsidiary, which we refer to as AFH Merger Sub, AFH Advisory and Emmaus Medical, Emmaus Medical merged with and into AFH Merger Sub on May 3, 2011 with Emmaus Medical continuing as the surviving entity, which we refer to as the Merger. Upon the closing of the Merger, we changed our name from “AFH Acquisition IV, Inc.” to “Emmaus Holdings, Inc.” Subsequently, on September 14, 2011, we changed our name from “Emmaus Holdings, Inc.” to “Emmaus Life Sciences, Inc.”

 

20



Table of Contents

 

Our future capital requirements are substantial and may increase beyond our current expectations depending on many factors, including, but not limited to: the duration and results of the clinical trials for our various product candidates going forward; unexpected delays or developments when seeking regulatory approvals; the time and cost in preparing, filing, prosecuting, maintaining and enforcing patent claims; current and future unexpected developments encountered in implementing our business development and commercialization strategies; the outcome of litigation in which we are currently engaged or may become engaged in the future; and further arrangements, if any, with collaborators. Until we can generate a sufficient amount of product revenue, future cash requirements are expected to be financed through public or private equity offerings, debt financings or corporate collaboration and licensing arrangements. As of September 30, 2014, our accumulated deficit was $67.6 million and we had cash and cash equivalents of $1.6 million. Since inception we have had minimal revenues and have been required to rely on funding from sales of equity securities and borrowings. Currently, we estimate we will need approximately $0.9 million to administratively close out the post-clinical aspects of our Phase 3 clinical trial of our pharmaceutical grade L-glutamine treatment for SCD and submit a new drug application (“NDA”) to the FDA.

 

We also own a minority interest of less than 1% in CellSeed, Inc., a Japanese company listed on the Tokyo Stock Exchange, which is engaged in research and development of regenerative medicine products and the manufacture and sale of temperature-responsive cell culture equipment. In collaboration with CellSeed, we are engaged in research and development of cell sheet engineering regenerative medicine products and the future commercialization of such products.

 

Recent Highlights

 

In July and August 2014, an aggregate of $1,473,179 in principal and accrued interest on convertible notes was converted into common stock at a conversion price of $3.30 per share.

 

In September 2014, $25,200 in principal amount of a convertible note was converted into common stock at a conversion price of $3.60 per share.

 

From July to September 2014, warrants to purchase 101,857 shares of the Company’s common stock were exercised at exercise prices ranging from $3.05 to $3.825 per share, including 5,246 warrants exercised on a cashless basis.

 

Financial Overview

 

Revenue

 

Since our inception in 2000, we have had limited revenue from the sale of NutreStore, an FDA approved prescription drug to treat SBS, and AminoPure, a nutritional supplement. We have funded our operations principally through the private placement of equity securities and debt financings. Our operations to date have been primarily limited to staffing, licensing and promoting products for SBS, outsourcing distribution and sales activities, sponsoring clinical trials of our pharmaceutical grade L-glutamine treatment for SCD, manufacturing products and maintaining and improving our patent portfolio.

 

Currently, we generate revenue through the sale of NutreStore and AminoPure. Pursuant to the exclusive sublicense agreement of US Patent No. 5,288,703, or SBS Patent, we are required to pay an annual royalty equal to 10% of adjusted gross sales of NutreStore to CATO Holding Company (“CATO”). We made a royalty payment to CATO in the amount of $6,501 in June 2014. Management expects that any revenues generated from the sale of NutreStore and AminoPure will fluctuate from quarter to quarter based on the timing of orders and the amount of product sold.

 

Cost of Goods Sold

 

Cost of goods sold includes the raw materials, packaging, shipping and distribution costs of NutreStore and AminoPure.

 

Research and Development Expenses

 

Research and development costs consist of expenditures for new products and technologies, which primarily involve fees paid to the contract research organization (“CRO”) that conducts the clinical trials of our product candidates, payroll-related expenses, study site payments, consultant fees, and activities related to regulatory filings, manufacturing development costs and other related supplies. The costs of later stage clinical studies, such as Phase 2 and 3 trials, are generally higher than those of earlier stages of development, such as preclinical studies and Phase 1 trials. This is primarily due to the increased size, expanded scope, patient-related healthcare and regulatory compliance costs, and generally longer duration of later stage clinical studies.

 

21



Table of Contents

 

The most significant clinical trial expenditures are related to the CRO costs and the payments to study sites. The contract with the CRO is based on time and materials expended, whereas the study site agreements are based on per patient costs as well as other pass-through costs, including, but not limited to, start-up costs and institutional review board fees. The financial terms of these agreements are subject to negotiation and vary from contract to contract and may result in uneven payment flows. Payments under some of these contracts depend on factors such as the successful enrollment of patients and the completion of clinical trial milestones.

 

Future research and development expenses will depend on any new product candidates or technologies that we may introduce into our research and development pipeline. In addition, we cannot forecast with any degree of certainty which of our product candidates may be subject to future collaborations, when such arrangements will be secured, if at all, and to what degree, if any, such arrangements would affect our development plans and capital requirements. We currently estimate that we will need an additional $0.9 million to administratively close out the post-clinical aspects of our Phase 3 clinical trial and submit a NDA to the FDA. Our current cash burn rate is approximately $0.8 million per month. We also intend to conduct a confirmatory study of our pharmaceutical grade L-glutamine treatment for SCD. We are still in the process of finalizing the study design at this time.

 

At this time, due to the inherently unpredictable nature of the process for developing drugs, biologics and cell-based therapies and the interpretation of the regulatory requirements, we are unable to estimate with any degree of certainty the amount of costs which will be incurred in obtaining FDA approval of our pharmaceutical grade L-glutamine treatment for SCD and the continued development of our other preclinical and clinical programs. Clinical development timelines, the probability of success and development costs can differ materially from expectations and can vary widely. These and other related risks and uncertainties are described in our Annual Report under the headings “Risk Factors — Risks Related To Development of our Product Candidates”, “Risk Factors — Risks Related to our Reliance on Third Parties”, and “Risk Factors — Risks Related to Regulatory Approval of our Drug Candidates and Other Legal Compliance Matters.”

 

We estimate that the cost to us to develop in the United States corneal cell sheet products based on Cultured Autologous Oral Mucosal Epithelial Cell Sheet (“CAOMECS”) technology will be approximately $3.0 million, in addition to the $8.5 million fee payable to CellSeed under the Research Agreement. This estimate includes the anticipated cost of obtaining FDA approval for the corneal cell sheets and assumes that we will need the FDA to approve a Biologic License Application (“BLA”) for the corneal cell sheets, rather than a NDA. We estimate that we will need another $2.0 million to commercialize any approved products based on corneal cell sheet technology.

 

In addition, we estimate that we will need $2.5 million for research related to other cell sheet applications and to build a cGMP laboratory to establish the infrastructure and production capabilities related to regenerative medicine products. At this time, we do not plan to incur any additional research and development costs for our NutreStore and AminoPure products.

 

General and Administrative Expenses

 

General and administrative expenses consist principally of salaries and related costs for personnel in executive, finance, business development, information technology, marketing, and legal functions. Other general and administrative expenses include share-based compensation, facility costs, patent filing costs, and professional fees for legal, consulting, auditing and tax services. Inflation has not had a material impact on our general and administrative expenses over the past two years.

 

Environmental Expenses

 

The cost of compliance with environmental laws has not been material over the past two years and any such costs are included in general and administrative costs.

 

Inventories

 

Inventories consist of finished goods that are valued on a first-in, first-out basis and at the lower of cost or market value. All of the raw materials purchased during the nine months ended September 30, 2014 were from one vendor and during 2013 were from two vendors.

 

22



Table of Contents

 

Results of operations

 

 

 

Three Months Ended September 30,

 

Nine Months Ended September 30,

 

 

 

2014

 

2013

 

2014

 

2013

 

 

 

 

 

 

 

 

 

 

 

REVENUES, Net

 

$

155,644

 

$

66,129

 

$

347,737

 

$

246,897

 

 

 

 

 

 

 

 

 

 

 

COST OF GOODS SOLD

 

90,421

 

48,445

 

198,203

 

147,418

 

GROSS PROFIT

 

65,223

 

17,684

 

149,534

 

99,479

 

 

 

 

 

 

 

 

 

 

 

OPERATING EXPENSES

 

 

 

 

 

 

 

 

 

Research and development

 

507,377

 

490,138

 

1,708,766

 

1,801,399

 

Selling

 

115,060

 

120,647

 

363,874

 

377,335

 

General and administrative

 

2,759,098

 

2,506,808

 

9,012,391

 

7,338,211

 

Transaction costs

 

 

1,014,019

 

 

1,014,019

 

 

 

3,381,535

 

4,131,612

 

11,085,031

 

10,530,964

 

 

 

 

 

 

 

 

 

 

 

LOSS FROM OPERATIONS

 

(3,316,312

)

(4,113,928

)

(10,935,497

)

(10,431,485

)

 

 

 

 

 

 

 

 

 

 

OTHER INCOME (EXPENSE)

 

 

 

 

 

 

 

 

 

Gain on derecognition of accounts payable

 

 

 

 

341,361

 

Change in fair value of liability classified warrants

 

84,000

 

291,000

 

(1,895,744

)

291,000

 

Warrant exercise inducement expense

 

 

 

(3,523,000

)

 

Interest and other income

 

97,370

 

5,089

 

74,204

 

15,811

 

Interest expense

 

(591,494

)

(567,491

)

(1,562,417

)

(1,668,501

)

 

 

(410,124

)

(271,402

)

(6,906,957

)

(1,020,329

)

 

 

 

 

 

 

 

 

 

 

LOSS BEFORE INCOME TAXES

 

(3,726,436

)

(4,385,330

)

(17,842,454

)

(11,451,814

)

INCOME TAXES (BENEFIT)

 

 

(51,129

)

2,500

 

(450,381

)

NET LOSS

 

(3,726,436

)

(4,334,201

)

(17,844,954

)

(11,001,433

)

 

 

 

 

 

 

 

 

 

 

COMPONENTS OF OTHER COMPREHENSIVE (LOSS) INCOME

 

 

 

 

 

 

 

 

 

Unrealized holding (loss) gain on securities available-for-sale

 

(80,593

)

81,261

 

(374,806

)

719,857

 

Unrealized foreign translation

 

(5,006

)

(7,949

)

(5,681

)

(34,381

)

COMPREHENSIVE LOSS

 

$

(3,812,035

)

$

(4,260,889

)

$

(18,225,441

)

$

(10,315,957

)

NET LOSS PER COMMON SHARE

 

$

(0.12

)

$

(0.16

)

$

(0.60

)

$

(0.43

)

WEIGHTED AVERAGE COMMON SHARES OUTSTANDING

 

30,303,396

 

27,066,743

 

29,637,402

 

25,694,988

 

 

23



Table of Contents

 

Three months ended September 30, 2014 and 2013

 

Net Losses. Net losses decreased by $0.6 million, or 14%, to $3.7 million from $4.3 million for the three months ended September 30, 2014 as compared to the three months ended September 30, 2013. The decrease in losses is primarily a result of $1.0 million decrease in transaction costs incurred in connection with the September 2013 Private Placement and a $0.1 million increase in sales, partially offset by a $0.2 million change in fair value of liability classified warrants and increased general and administrative expenses of $0.3 million as discussed below. As of September 30, 2014, we had an accumulated deficit of approximately $67.6 million. Losses will continue as we advance our pharmaceutical grade L-glutamine treatment for SCD toward regulatory approval and potential commercialization. As a result, we anticipate that we will continue to incur net losses and be unprofitable for the foreseeable future. There can be no assurance that we will ever operate at a profit, even if all of our products are commercialized.

 

Revenues, Net. Revenues, net increased to just under $0.2 million from just under $0.1 million for the three months ended September 30, 2014 and 2013, respectively. We estimate our sales returns based upon our prior sales and return history. We continue to monitor our sales returns and will adjust our estimates based on our actual sales return experience.

 

Cost of Goods Sold. Cost of goods sold increased to $0.09 million from $0.05 million for the three months ended September 30, 2014 and 2013. Cost of goods sold includes costs for raw materials, packaging, testing, shipping and costs related to scrapped inventory. All purchases of raw materials during the three months ended September 30, 2014 and 2013 were from one vendor.

 

Research and Development Expenses. Research and development expenses remained approximately the same at just over $0.5 million and just under $0.5 million for the three months ended September 30, 2014 and 2013, respectively. Costs in 2013 were primarily CRO costs and payments to sites. Costs in 2014 are primarily related to the cost of compiling and analyzing data from our Phase 3 clinical trial and other end of study costs. We expect such costs to continue for the remainder of 2014.

 

Selling Expenses. Selling expenses remained approximately the same at just over $0.1 million for the three months ended September 30, 2014 and 2013. Selling expenses includes the costs for distribution, promotion, travel, tradeshows and exhibits related to NutreStore and AminoPure.

 

General and Administrative Expenses. General and administrative expenses increased by $0.3 million, or 10%, to $2.8 million from $2.5 million for the three months ended September 30, 2014 as compared to the three months ended September 30, 2013. The increase was primarily due to a $0.2 million increase in professional fees including accounting and consulting fees and a $0.1 million increase in payroll related costs.

 

Other Income and Expense. Total other income and expense increased by $0.1 million, or 51%, to $0.4 million from $0.3 million for the three months ended September 30, 2014, as compared to the three months ended September 30, 2013, primarily due to a $0.2 million increase in fair value of liability classified warrants offset in part by a $0.1 million increase in interest and other income.

 

We anticipate that our operating expenses will increase for, among others, the following reasons:

 

·                  as a result of increased payroll, expanded infrastructure and higher consulting, legal, accounting and investor relations costs, and director and officer insurance premiums associated with being a public company;

 

·                  to support research and development activities, which we expect to expand as development of our product candidates continues; and

 

·                  to build a sales and marketing team before we receive regulatory approval of our pharmaceutical grade L-glutamine treatment for SCD in anticipation of commercial launch.

 

Nine months ended September 30, 2014 and 2013

 

Net Losses. Net losses increased by $6.8 million, or 62%, to $17.8 million from $11.0 million for the nine months ended September 30, 2014 as compared to the nine months ended September 30, 2013. The increase in losses is primarily a result of a $3.5 million warrant exercise inducement expense incurred in connection with warrant exercises and issuance in June 2014, an increase in fair value of liability classified warrants of $2.2 million, and a $1.7 million increase in general and administrative expenses as discussed below, partially offset by the absence of transaction costs of $1.0 million. As of September 30, 2014, we had an accumulated deficit of approximately $67.6 million. Losses will continue as we advance our pharmaceutical grade L-glutamine treatment for SCD toward regulatory approval and potential commercialization. As a result, we anticipate that we will continue to incur net losses and be unprofitable for the foreseeable future. There can be no assurance that we will ever operate at a profit, even if all of our products are commercialized.

 

24



Table of Contents

 

Revenues, Net. Revenues, net increased $0.1 million, or 41%, to $0.35 million from $0.25 million for the nine months ended September 30, 2014 and 2013. We estimate our sales returns based upon our prior sales and return history. We continue to monitor our sales returns and will adjust our estimates based on our actual sales return experience.

 

Cost of Goods Sold. Cost of goods sold remained approximately the same at just under $0.2 million for the nine months ended September 30, 2014 and 2013. Cost of goods sold includes costs for raw material, packaging, testing, shipping and costs related to scrapped inventory. All purchases of raw materials during the nine months ended September 30, 2014 were from one vendor and during 2013 were from two vendors.

 

Research and Development Expenses. Research and development expenses decreased $0.1 million, or 5%, from $1.8 million to $1.7 million for the nine months ended September 30, 2014 as compared to the nine months ended September 30, 2013. Costs in 2013 were primarily CRO costs and payments to sites. Costs in 2014 are primarily related to the cost of compiling and analyzing data from our Phase 3 clinical trial and other end of study costs. Such costs will continue for the remainder of 2014.

 

Selling Expenses. Selling expenses remained approximately the same at just under $0.4 million for the nine months ended September 30, 2014 and 2013. Selling expenses includes the costs for distribution, promotion, travel, tradeshows and exhibits related to NutreStore and AminoPure.

 

General and Administrative Expenses. General and administrative expenses increased $1.7 million, or 23%, to $9.0 million from $7.3 million for the nine months ended September 30, 2014 as compared to the nine months ended September 30, 2013. The increase is primarily due to a $0.7 million increase in share-based compensation, a $0.5 million increase in professional fees, a $0.1 million increase in travel expense, and a $0.2 million increase in payroll expense.

 

Other Income and Expense. Total other income and expense decreased by $5.9 million, or 577%, for the nine months ended September 30, 2014 as compared to the nine months ended September 30, 2013, primarily due to a warrant exercise inducement expense of $3.5 million incurred in connection with warrant exercises and issuance in June 2014, an increase in fair value of liability classified warrants of $2.2 million and the absence of gain on derecognition of accounts payable that was $0.3 million for the nine months ended September 30, 2013.

 

Liquidity and Capital Resources

 

Based on our losses to date, anticipated future revenue and operating expenses, debt repayment obligations and cash and cash equivalents balance of $1.6 million as of September 30, 2014, we do not have sufficient operating capital for our business without raising additional capital. We incurred losses of $17.8 million for the nine months ended September 30, 2014 and $11.0 million for the nine months ended September 30, 2013. We had an accumulated deficit at September 30, 2014 of $67.6 million. We anticipate that we will continue to incur net losses for the foreseeable future as we incur expenses for the commercialization of our pharmaceutical grade L-glutamine for treatment of sickle cell disease, research costs for corneal cell sheets using CAOMECS technology, and the expansion of corporate infrastructure, including costs associated with being a public reporting company. We have previously relied on private equity offerings, debt financings, and loans, including loans from related parties. As part of this effort, we have received various loans from officers, stockholders and other investors. As of September 30, 2014, we had total outstanding notes payable of $11.7 million, consisting of $2.9 million of non-convertible promissory notes and $8.8 million of convertible notes. Of the $11.7 million aggregate outstanding principal amount of notes outstanding as of September 30, 2014, approximately $6.1 million is either due on demand or will become due and payable within the next twelve months. Our failure to raise capital as and when needed would have a negative impact on our financial condition and our ability to pursue our business strategies, including the commercialization of our pharmaceutical grade L-glutamine treatment for SCD and development in the United States of CAOMECS-based corneal cell sheet technology.

 

As described in Note 2 to the condensed consolidated financial statements, we have had recurring operating losses, have a significant amount of notes payable and other obligations due within the next year and projected operating losses including the expected costs relating to the commercialization of our pharmaceutical grade L-glutamine treatment for SCD that exceed both the existing cash balances and cash expected to be generated from operations for at least the next year. In order to meet our expected obligations, management intends to raise additional funds through equity and debt financings and partnership agreements. In addition, we may seek to raise additional funds through collaborations with other companies or financing from other sources. Additional funding may not be available in amounts or on terms which are acceptable to us, if at all. Due to the uncertainty of our ability to meet our current operating and capital expenses, there is substantial doubt about our ability to continue as a going concern.

 

On April 8, 2011, pursuant to a Research Agreement with CellSeed, we agreed to pay CellSeed $8.5 million within 30 days after the completion of all of the following: (i) the execution of the Research Agreement; (ii) the execution of the Individual Agreement; and (iii) CellSeed’s delivery to us of the accumulated information package, as defined in the Research Agreement.

 

25



Table of Contents

 

Pursuant to the Individual Agreement with CellSeed, we agreed to pay $1.5 million to CellSeed and a royalty to be agreed upon by the parties. We paid the $1.5 million due to CellSeed pursuant to the Individual Agreement in February 2012. We currently anticipate that the additional $8.5 million payment obligation under the Research Agreement will become due and payable after we begin to generate revenues from the commercialization of our pharmaceutical grade L-glutamine treatment for SCD. If the payment obligation becomes due and payable prior to our generation of revenue from the commercialization of our pharmaceutical grade L-glutamine treatment for SCD, we will need to seek other funding sources, including the sale of additional equity or debt securities, and partnership arrangements in order to make the payment. CellSeed may terminate these agreements if we are unable to make timely payments as required under the agreements.

 

In addition, we currently estimate that we will need an additional $0.9 million to perform the post-clinical study tasks required for closing our Phase 3 clinical trial, completing the associated end-of-study data analysis and report, and submitting a NDA to the FDA. Our current cash burn rate is approximately $0.8 million per month. We also intend to conduct a confirmatory study of our pharmaceutical grade L-glutamine treatment for SCD. We are still in the process of finalizing the study design at this time.

 

As discussed under the caption “Company Overview” above, if the FDA does not accept our NDA for filing or does not approve our NDA based on a single Phase 3 clinical trial, in each case unless we conduct a second Phase 3 clinical trial, the potential approval of our product candidate will be delayed. Under these circumstances, we will incur additional costs to seek to convince the FDA that a second clinical trial is unnecessary, or to design and conduct a second Phase 3 clinical trial, or both. If we conduct a second Phase 3 clinical trial, it is possible that the results of that trial will be less favorable than the results of our completed trial and further delay or complicate the approval process. The incurrence of additional costs may require us to raise additional capital, and any delay in obtaining approval of our product candidate will reduce the period during which we can market and sell our product with patent protection and may affect our ability to obtain other protections against competition.

 

Our cash flow from operations is not adequate and our future capital requirements will be substantial and may increase beyond our current expectations depending on many factors including, but not limited to: the number, duration and results of the clinical trials for our various product candidates going forward; unexpected delays or developments in seeking regulatory approvals; the time and cost in preparing, filing, prosecuting, maintaining and enforcing patent claims; other unexpected developments encountered in implementing our business and commercialization strategies; the outcome of existing and any future litigation; and further arrangements, if any, with collaborators. We will rely, in part, on sales of AminoPure for revenues, which we expect will increase due to the expected growth in its export volume as we have added additional distributors and expanded retail markets outside of the United States. Revenues from NutreStore are currently not significant and we are unsure whether sales of NutreStore will increase. Until we can generate a sufficient amount of product revenue, future cash needs are expected to be financed through public or private equity offerings, debt financings, loans, including loans from related parties, or other sources, such as strategic partnership agreements and corporate collaboration and licensing arrangements. Until we can generate a sufficient amount of product revenue, there can be no assurance of the availability of such capital on terms acceptable to us (or at all).

 

For the nine months ended September 30, 2014 and during the year ended December 31, 2013, we borrowed varying amounts pursuant to convertible notes and non-convertible promissory notes, the majority of which have been issued to our officers and stockholders. As of September 30, 2014 and December 31, 2013, the amounts outstanding under convertible notes and non-convertible promissory notes totaled $11.7 million and $11.5 million, respectively. The convertible notes and non-convertible promissory notes bear interest at rates ranging from 0% to 11% and, except for the 2011 convertible note listed below in the principal amount of $0.5 million, are unsecured. Interest on 0% loans was imputed at the incremental borrowing rate of 6.25% per annum. The net proceeds of the loans were used for working capital.

 

26



Table of Contents

 

The table below lists our outstanding notes payable as of September 30, 2014 and the material terms of our outstanding borrowings:

 

Year
Issued

 

Interest
rate
range

 

Term of Notes

 

Conv. Price

 

Principal
Outstanding
September
30, 2014

 

Discount
Amount
September
30, 2014

 

Carrying
Amount
September
30, 2014

 

Shares
Underlying
Principal

as of
September
30, 2014

 

Principal
Outstanding
December
31, 2013

 

Discount
Amount
December
31, 2013

 

Carrying
Amount
December
31, 2013

 

Shares
Underlying
Principal
as of
December
31, 2013

 

Convertible notes payable 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2009

 

6.50%

 

5 years

 

$3.05

 

$

 

$

 

$

 

 

$

254,460

 

$

 

$

254,460

 

83,366

 

2010

 

0 ~ 6.0%

 

5 years

 

$3.05

 

74,000

 

4,473

 

69,527

 

24,248

 

74,000

 

8,308

 

65,692

 

24,248

 

2011

 

10%

 

5 years

 

$3.05

 

500,000

 

 

500,000

 

163,809

 

500,000

 

 

500,000

 

163,809

 

2012

 

10%

 

2 years

 

$3.30 ~$3.60

 

201,600

 

 

201,600

 

56,000

 

251,100

 

 

251,100

 

71,000

 

2013

 

10%

 

6 months ~ 2 years

 

$3.30 ~$3.60

 

4,599,445

 

32,687

 

4,566,758

 

1,307,922

 

6,913,606

 

215,798

 

6,697,808

 

1,998,215

 

2014

 

10%

 

Due on demand ~ 2 years

 

$3.05 ~$7.00

 

2,720,412

 

121,296

 

2,599,116

 

578,832

 

 

 

 

 

 

 

 

 

 

 

 

 

$

8,095,457

 

$

158,456

 

$

7,937,001

 

2,130,811

 

$

7,993,166

 

$

224,106

 

$

7,769,060

 

2,340,638

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Current

 

 

 

$

3,678,504

 

$

129,283

 

$

3,549,221

 

1,070,975

 

$

4,955,868

 

$

153,396

 

$

4,802,472

 

1,438,033

 

 

 

 

 

Non-current

 

 

 

$

4,416,953

 

$

29,173

 

$

4,387,780

 

1,059,836

 

$

3,037,298

 

$

70,710

 

$

2,966,588

 

902,605

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Convertible notes payable - related party

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2012

 

10%

 

Due on demand

 

$3.30

 

$

373,000

 

$

 

$

373,000

 

113,030

 

$

373,000

 

$

 

$

373,000

 

113,030

 

2013

 

10%

 

1 year

 

$3.60

 

152,066

 

 

152,066

 

42,241

 

187,706

 

 

187,706

 

52,141

 

2014

 

10%

 

2 years

 

$7.00

 

200,000

 

 

200,000

 

28,571

 

 

 

 

 

 

 

 

 

 

 

 

 

$

725,066

 

$

 

$

725,066

 

183,842

 

$

560,706

 

$

 

$

560,706

 

165,171

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Current

 

 

 

$

525,066

 

$

 

$

525,066

 

155,271

 

$

560,706

 

$

 

$

560,706

 

165,171

 

 

 

 

 

Non-current

 

 

 

$

200,000

 

$

 

$

200,000

 

28,571

 

$

 

$

 

$

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Notes payable

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2012

 

11%

 

2 years

 

NA

 

$

 

$

 

$

 

 

$

833,335

 

$

18,265

 

$

815,070

 

 

2013

 

2% ~ 10%

 

Due on demand ~ 2 years

 

NA

 

1,110,000

 

 

1,110,000

 

 

1,150,000

 

 

1,150,000

 

 

2014

 

11%

 

2 years

 

NA

 

833,335

 

 

833,335

 

 

 

 

 

 

 

 

 

 

 

 

 

 

$

1,943,335

 

$

 

$

1,943,335

 

 

$

1,983,335

 

$

18,265

 

$

1,965,070

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Current

 

 

 

$

1,110,000

 

$

 

$

1,110,000

 

 

$

1,783,335

 

$

18,265

 

$

1,765,070

 

 

 

 

 

 

Non-current

 

 

 

$

833,335

 

$

 

$

833,335

 

 

$

200,000

 

$

 

$

200,000

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Notes payable - related party

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2012

 

8% ~ 10%

 

Due on demand

 

NA

 

$

656,730

 

$

 

$

656,730

 

 

$

880,062

 

$

4,421

 

$

875,641

 

 

2013

 

8%

 

Due on demand

 

NA

 

50,000

 

 

50,000

 

 

50,000

 

 

50,000

 

 

2014

 

11%

 

Due on demand ~ 2 years

 

NA

 

252,165

 

 

252,165

 

 

 

 

 

 

 

 

 

 

 

 

 

 

$

958,895

 

$

 

$

958,895

 

 

$

930,062

 

$

4,421

 

$

925,641

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Current

 

 

 

$

825,562

 

$

 

$

825,562

 

 

$

930,062

 

$

4,421

 

$

925,641

 

 

 

 

 

 

Non-current

 

 

 

$

133,333

 

$

 

$

133,333

 

 

$

 

$

 

$

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Grand Total

 

 

 

$

11,722,753

 

$

158,456

 

$

11,564,297

 

2,314,653

 

$

11,467,269

 

$

246,792

 

$

11,220,477

 

2,505,809

 

 

Cash flows for the nine months ended September 30, 2014 and September 30, 2013

 

Net cash used in operating activities

 

Net cash flows used in operating activities increased by $1.6 million, or 29%, to $7.2 million from $5.6 million for the nine months ended September 30, 2014 as compared to the nine months ended September 30, 2013. This increase was primarily due to a $6.8 million increase in net loss, the absense of an add-back of transaction costs of $1.0 million, $0.9 million change in working capital and offset by $7.1 million in higher non-cash components of that net loss. This includes $3.5 million in warrant exercise inducement expense, a $2.2 million higher change in fair value of liability classified warrants and $0.7 million higher share-based compensation.

 

Net cash used in investing activities

 

Net cash flows used in investing activities increased by $0.02 million to $0.02 million from $0.0 million for the nine months ended September 30, 2014 as compared to the nine months ended September 30, 2013. The increase was due to purchases of property and equipment. No other investing activities occurred in the nine months ended September 30, 2014 or 2013.

 

27



Table of Contents

 

Net cash from financing activities

 

Net cash flows from financing activities decreased by $5.8 million, or 52%, to $5.3 million from $11.1 million for the nine months ended September 30, 2014 as compared to the nine months ended September 30, 2013, primarily as a result of a $10.2 million decrease in proceeds received from issuance of notes and common stock from $16.1 million to $5.9 million which was partially offset by a $4.9 million decrease in payment on notes.

 

Off-Balance-Sheet Arrangements

 

Since our inception, we have not engaged in any off-balance sheet arrangements, including the use of structured finance, special purpose entities or variable interest entities.

 

Critical Accounting Policies

 

Management’s discussion and analysis of financial condition and results of operations is based on our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”). The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities and expenses. On an ongoing basis, we evaluate these estimates and judgments, including those described below. We base our estimates on our historical experience and on various other assumptions that we believe to be reasonable under the present circumstances. These estimates and assumptions form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ materially from these estimates. While our significant accounting policies are more fully described in Note 2 to our condensed consolidated financial statements which are provided in Item 1 of this Form 10-Q, we believe that the following accounting policies are the most critical to assist you in fully understanding and evaluating our reported financial results and affect the more significant judgments and estimates that we use in the preparation of our financial statements.

 

Notes Payable, Convertible Notes Payable and Warrants

 

From time to time, we obtain financing in the form of notes payable and/or notes with detachable warrants, some of which are convertible into shares of our common stock and some of which are issued to related parties. We analyze all of the terms of our convertible notes and notes issued with warrants to determine the appropriate accounting treatment, including determining whether conversion features are required to be bifurcated and treated as a discount, allocation of fair value of the issuance to the debt instrument, detachable stock purchase warrant, and any beneficial conversion features, and the applicable classification of the convertible notes payable and warrants as debt, equity or temporary equity (mezzanine).

 

We allocate the proceeds from the issuance of a debt instrument with detachable stock purchase warrants to the two elements based on the relative fair values of the debt instrument without the warrants and of the warrants themselves at the time of issuance. We account for the portion of the proceeds allocated to warrants in additional paid-in capital and the remaining proceeds are allocated to the debt instrument. The allocation to warrant results in a discount to notes payable which is amortized using the effective interest method to interest expense over the expected term of the note. We also include the intrinsic value of the embedded conversion feature of convertible notes payable in the discount to notes payable, which is amortized and charged to interest expense over the expected term of the note.

 

We also estimate the total fair value of any beneficial conversion feature and accompanying warrants in allocating debt proceeds. The proceeds allocated to the beneficial conversion feature are determined by taking the estimated fair value of shares issuable under the convertible notes less the fair value of the number of shares that would be issued if the conversion rate equaled the fair value of our common stock as of the date of issuance. In situations where the debt includes both a beneficial conversion feature and a warrant, the proceeds are allocated to the warrants and beneficial conversion feature based on the pro-rata fair value. We use the Black Scholes-Merton option pricing model to determine the fair value of our warrants.

 

Notes payable to related parties and interest expense and accrued interest to related parties are separately identified in our condensed consolidated financial statements. We also disclose significant terms of all transactions with related parties.

 

Share-based Compensation

 

We recognize compensation cost for share-based compensation awards during the service term of the recipients of the share-based awards. The fair value of share-based awards is calculated using the Black-Scholes-Merton pricing model. The Black-Scholes-Merton model requires subjective assumptions regarding future stock price volatility and expected time to exercise, which greatly affect the calculated values. The expected term of awards granted is derived from historical data on awards exercised and post-vesting employment termination behavior. The risk-free rate selected to value any particular grant is based on the U.S. Treasury rate that corresponds to the vesting period of the grant effective as of the date of the grant. The expected volatility is based on the historical volatility of the common stock of comparable publicly traded companies. These factors could change, affecting the determination of stock-based awards expense in future periods.

 

28



Table of Contents

 

Fair Value of Common Stock

 

The fair value of the common stock underlying our share-based awards was determined on each grant date by our board of directors, with input from management, primarily based on the market value of stock of similar companies and recent arm’s length transactions involving the sale of common stock as well as other factors our board of directors considered relevant to the valuation of our common stock. Given the absence of a public trading market for our common stock, our board of directors exercised reasonable judgment and considered a range of objective and subjective factors to estimate the fair value of our common stock.

 

More specifically, the fair value of the underlying shares was determined based on recent arms-length sales of our equity to third parties and other factors determined by management to be relevant to the valuation of such shares, including:

 

·                  progress of our research and development efforts;

 

·                  our operating results and financial condition, including our levels of available capital resources;

 

·                  our stages of development and material risks related to our business;

 

·                  the achievement of enterprise milestones, including entering into collaboration or license agreements and our progress in clinical trials;

 

·                  the valuation of publicly-traded companies in the life sciences and biotechnology sectors, as well as recently completed mergers and acquisitions of peer companies;

 

·                  equity market conditions affecting comparable public companies;

 

·                  the likelihood of achieving a liquidity event for the shares of common stock, such as an initial public offering, sale, licensing or other strategic transaction, given prevailing market and biotechnology sector conditions; and

 

·                  the illiquid nature of our common stock.

 

Fair Value Measurements

 

We define fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. We measure fair value under a framework that provides a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy are described as follows:

 

Level 1: Inputs to the valuation methodology are unadjusted quoted prices for identical assets or liabilities in active markets that we have the ability to access.

 

Level 2: Inputs to the valuation methodology include:

 

·                  Quoted prices for similar assets or liabilities in active markets;

 

·                  Quoted prices for identical or similar assets or liabilities in inactive markets;

 

·                  Inputs other than quoted prices that are observable for the asset or liability; and

 

·                  Inputs that are derived principally from or corroborated by observable market data by correlation or other means.

 

29



Table of Contents

 

If the asset or liability has a specified (contractual) term, the Level 2 input must be observable for substantially the full term of the asset or liability.

 

Level 3: Inputs to the valuation methodology are unobservable and significant to the fair value measurement.

 

The asset’s or liability’s fair value measurement level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement. Valuation techniques used need to maximize the use of observable inputs and minimize the use of unobservable inputs. The fair value assigned to marketable securities is determined by obtaining quoted prices on nationally recognized securities exchanges, and are classified as Level 1 investments at September 30, 2014. The fair value of our debt instruments is not materially different from their carrying values as presented. The fair value of our convertible debt instruments was determined based on Level 2 inputs. The carrying value of the debt was discounted based on allocating proceeds to other financial instruments within the arrangement as discussed in Note 6 to our condensed consolidated financial statements.

 

The Company issued stock purchase warrants in conjunction with its September 2013 private placement and issued replacement warrants upon the exercise of certain of such warrants in June 2014 (see Note 7). Such warrants and replacement warrants are accounted for as liability classified warrants whose fair market value is determined using Level 3 inputs. These inputs include expected term and expected volatility.

 

Marketable Securities

 

Securities available-for-sale are recorded at cost and any increases or decreases in fair market value are recorded as unrealized gains or losses, net of taxes in accumulated other comprehensive income. We monitor these investments for impairment and make appropriate reductions in carrying values when necessary.

 

Revenue Recognition

 

Revenue is recognized when there is persuasive evidence that an arrangement exists, delivery has occurred, the price is fixed and determinable and collection is reasonably assured. With our prior written approval, in certain situations, product is returnable only by our direct customers for a returned goods credit, for product that is expired, damaged in transit, or which is discontinued, withdrawn or recalled. We estimate our sales returns based upon our prior sales and return history and accrue a Sales Return Allowance at the time of sale. We pay royalties on an annual basis based on existing license arrangements. These royalties are recognized as cost of goods sold upon sale of the products.

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk

 

Not required for a smaller reporting company.

 

Item 4. Controls and Procedures

 

Evaluation of Disclosure Controls and Procedures

 

Disclosure controls and procedures are controls and other procedures that are designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Securities Exchange Act of 1934 (“Exchange Act”) is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by us in the reports that we file under the Exchange Act is accumulated and communicated to our management, including our principal executive and financial officers, as appropriate to allow timely decisions regarding required disclosure.

 

As of the end of the period covered by this Form 10-Q, we conducted an evaluation, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) of the Exchange Act). Based upon this evaluation and due to the material weakness in our internal control over financial reporting as of December 31, 2013 described below, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are not effective.

 

Changes in Internal Control Over Financial Reporting

 

Based on the evaluation of our management as required by paragraph (d) of Rule 13a-15 of the Exchange Act, and the material weakness described below, our management concluded that our internal control over financial reporting was not effective as of December 31, 2013. We are in the process of strengthening our internal control documentation and procedures to develop clear identification of key financial and reporting controls over complex or significant unusual transactions.

 

30



Table of Contents

 

Material Weakness and Plan of Remediation

 

A material weakness is a deficiency, or combination of deficiencies, in internal control over financial reporting such that there is a reasonable possibility that a material misstatement of our annual or interim financial statements will not be prevented or detected on a timely basis. Material weaknesses would permit information required to be disclosed by us in the reports that we file or submit to not be recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. In conducting our review of our internal control over financial reporting as of December 31, 2013, we identified a material weakness in our internal control over financial reporting relating to the adequacy of resources and controls resulting from us not having an adequate level of resources with the appropriate level of training and experience in regards to the application of GAAP for certain complex transactions. In addition, we did not maintain effective controls over the completeness and accuracy of financial reporting for complex or significant unusual transactions. This material weakness resulted in a material misstatement of our liabilities, shareholders’ deficit, net loss, non-cash expenses and related financial disclosures for the three month period ended September 30, 2013 that was not prevented or detected on a timely basis and, consequently, a restatement of the unaudited condensed consolidated financial statements contained in our Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2013.

 

To remediate this existing material weakness, we have hired one additional accounting professional and engaged a consulting professional with knowledge and experience in GAAP. We are also evaluating and improving our existing internal control documentation and procedures to develop clear identification of key financial and reporting controls over complex or significant unusual transactions. We continue to strengthen our procedures and staffing levels in order to fully address this material weakness.

 

31



Table of Contents

 

Part II. Other Information

 

Item 1. Legal Proceedings

 

Please refer to the Company’s Annual Report on Form 10-K for the year ended December 31, 2013, filed with the SEC on May 8, 2014 (the “Annual Report”), for a summary of material developments regarding legal proceedings reported in the Annual Report.

 

Item 1A. Risk Factors

 

There have been no material changes from the risk factors disclosed in the “Risk Factors” section of the Annual Report. Please see the information under the caption “Company Overview” in Item 2 of Part I of this Form 10-Q for developments relating to the risks summarized in the risk factor in the Annual Report under the caption “Risk Factors — Risks Related To Development of our Product Candidates — If the FDA does not accept for filing the NDA with only one Phase 3 clinical trial, instead of two such studies, to demonstrate substantial evidence of effectiveness of our pharmaceutical grade L-glutamine product candidate for the treatment of SCD, we may be forced to incur the time, expense, and risk of undertaking a second such study, which could have a material adverse effect on our business, financial condition and operating results.”

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

 

In July and August 2014, an aggregate of $1,473,179 in principal and accrued interest on convertible notes was converted into common stock at a conversion price of $3.30 per share.

 

In September 2014, $25,200 in principal amount of a convertible note was converted into common stock at a conversion price of $3.60 per share.

 

From July to September 2014, warrants to purchase 101,857 shares of common stock were exercised at exercise prices ranging from of $3.05 to $3.825 per share, including 5,246 warrants exercised on a cashless basis.

 

All such securities were issued in reliance upon the exemption from registration provided by Section 4(a)(2) of the Securities Act and/or Rule 506 promulgated thereunder. The issuance of these securities was in each case exempt from the registration requirements of the Securities Act as a transaction by an issuer not involving a public offering. No underwriters were used in connection with such sales of unregistered securities.

 

Item 3. Defaults Upon Senior Securities

 

None.

 

Item 4. Mine Safety Disclosures

 

Not applicable.

 

Item 5. Other Information

 

None.

 

32



Table of Contents

 

Item 6. Exhibits

 

(a)           Exhibits

 

Exhibit
Number

 

Description of Document

 

 

 

4.1

 

Convertible Promissory Note, Dated October 10, 2014, issued by the registrant to The Shitabata Family Trust.

 

 

 

10.1

 

Promissory Note, Dated October 10, 2014, issued by the registrant to The Shitabata Family Trust.

 

 

 

31.1

 

Certification of Chief Executive Officer Pursuant to Item 601(b)(31) of Regulation S-K, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

 

 

31.2

 

Certification of Chief Financial Officer Pursuant to Item 601(b)(31) of Regulation S-K, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

 

 

32.1

 

Certification of the Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.*

 

 

 

101.INS

 

XBRL Instance Document

 

 

 

101.SCH

 

XBRL Taxonomy Extension Schema Document

 

 

 

101.CAL

 

XBRL Taxonomy Extension Calculation Linkbase Document

 

 

 

101.DEF

 

XBRL Taxonomy Extension Definition Linkbase Document

 

 

 

101.LAB

 

XBRL Taxonomy Extension Label Linkbase Document

 

 

 

101.PRE

 

XBRL Taxonomy Extension Presentation Linkbase Document

 


*

This exhibit shall not be deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934 or otherwise subject to the liabilities of that section, nor shall it be deemed incorporated by reference in any filing under the Securities Act of 1933 or the Securities Exchange Act of 1934, whether made before or after the date hereof and irrespective of any general incorporation language in any filings.

 

33



Table of Contents

 

EMMAUS LIFE SCIENCES, INC.

 

SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

 

Emmaus Life Sciences, Inc.

 

 

 

 

 

 

Dated: November 13, 2014

By:

/s/ Yutaka Niihara

 

Name:

Yutaka Niihara, M.D., MPH

 

Its:

President and Chief Executive Officer (principal executive officer and duly authorized officer)

 

 

 

 

By:

/s/ Peter Ludlum

 

Name:

Peter Ludlum

 

Its:

Chief Financial Officer (principal financial and accounting officer)

 

34