Notes to Condensed Consolidated Financial
Statements
March 31, 2014
(Unaudited)
Note 1 – General
NeoMedia Technologies, Inc. (the “Company,”
“NeoMedia,” “we,” “us,” “our,” and similar terms), a Delaware corporation, was
founded in 1989 and is headquartered in Boulder, Colorado. We have positioned ourselves to lead the development of 2D mobile barcode
technology and infrastructure solutions that enable the mobile barcode ecosystem world-wide. NeoMedia harnesses the power of the
mobile phone in innovative ways with state-of-the-art mobile barcode technology solutions. With this technology, mobile devices
with cameras become barcode scanners, enabling a range of practical applications including mobile marketing and mobile commerce.
In addition, we offer licensing of our extensive intellectual property portfolio.
Note 2 – Summary of Significant
Accounting Policies
The accompanying unaudited condensed consolidated
financial statements have been prepared without audit pursuant to the rules and regulations of the United States Securities
and Exchange Commission (“SEC”). Certain information and footnote disclosures normally included in financial statements
prepared in accordance with US GAAP have been condensed or omitted pursuant to such rules and regulations, although we believe
that the disclosures made are adequate to make the information not misleading. We believe these statements include all adjustments,
which are of a normal and recurring nature, considered necessary for a fair presentation of the financial statements. The unaudited
condensed consolidated financial statements included herein should be read in conjunction with the financial statements and notes
thereto included in our annual report on Form 10-K filed with the SEC on March 17, 2014. The results of operations for
the three months ended March 31, 2014 are not necessarily indicative of the results to be expected for the full year.
Basis of Presentation
–
The condensed consolidated financial statements include the accounts of NeoMedia and its wholly-owned subsidiaries. We operate
as one reportable segment. All intercompany accounts, transactions and profits have been eliminated in consolidation. Certain
prior period amounts in the condensed consolidated financial statements and notes thereto have been reclassified to conform to
the current year's presentation.
Use of Estimates
–
The preparation of consolidated financial statements in conformity with US GAAP requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses during the reporting period. Changes in facts and circumstances
may result in revised estimates, which are recorded in the period in which they become known.
Change in
Estimates
– For the three month period ended March 31, 2014 fair value accounting of the derivative financial
instruments and debentures payable, we reassessed the valuation techniques used to estimate the liability fair values. Based
on the assessment, including discussions with the third-party valuation firm assisting us with the calculation, we determined
that the valuation technique should be modified to consider the potentially dilutive impact on the stock price resulting from
the issuance of additional shares of common stock upon the conversion of the instruments as well as the resulting value
in comparison to our market capitalization. The change in estimate from the valuation technique modification had the
following impact on the financial instruments as of and for the three months ended March 31, 2014 (in thousands):
|
|
Decrease in
liability
|
|
|
Gain from change
in fair value
|
|
|
|
|
|
|
|
|
Derivative financial instrument - warrants
|
|
$
|
20
|
|
|
$
|
20
|
|
Derivative financial instrument - Series C and D Convertible Preferred Stock
|
|
|
23,278
|
|
|
|
23,278
|
|
Debentures payable - carried at fair value
|
|
|
219,136
|
|
|
|
219,136
|
|
The modification of the valuation technique represents a change
in accounting estimate as discussed in Accounting Standards Codification (“ASC”) Topic 250-10-45-17,
Accounting
Changes and Error Corrections
. The impact from the modification in valuation technique has therefore been reflected in the
period of change and will be reflected in future periods. See Note 3 – Financing for additional discussion.
Going Concern
– We
have historically incurred operating losses, and we may continue to generate negative cash flows as we implement our business
plan. There can be no assurance that our continuing efforts to execute our business plan will be successful and that we will be
able to continue as a going concern. The accompanying condensed consolidated financial statements have been prepared in conformity
with US GAAP, which contemplates our continuation as a going concern given fair value accounting related to our debentures. Our
net income for the three months ended March 31, 2014 and 2013 was $242.6 million as compared to $9.0 million, respectively, including
$242.5 million and $9.6 million, respectively, of net gains related to our financing instruments.
Net cash provided by operations during
the three months ended March 31, 2014 was $27,000 as compared to net cash used in operations of $0.5 million during the three
months ended March 31, 2013. As of March 31, 2014, we have an accumulated deficit of $236.9 million. We also have a working capital
deficit of $41.3 million, including $39.2 million in current liabilities for our derivative and debenture financing instruments.
We currently do not have sufficient cash
or commitments for financing to sustain our operations for the next twelve months if we are unable to generate sufficient cash
flows from operations. Our plan is to develop new client and customer relationships and substantially increase our revenue derived
from our products/services and IP licensing. If our revenues do not reach the level anticipated in our plan, we may require additional
financing in order to execute our operating plan. If additional financing is required, we cannot predict whether this additional
financing will be in the form of equity, debt, or another form, and we may not be able to obtain the necessary additional capital
on a timely basis, on acceptable terms, or at all. In the event that financing sources are not available, or that we are unsuccessful
in increasing our revenues and profits, we may be unable to implement our current plans for expansion, repay our debt obligations
or respond to competitive pressures, any of which would have a material adverse effect on our business, prospects, financial condition
and results of operations.
The convertible debentures and preferred
stock used to finance the Company, which may be converted into common stock at the sole option of the holders, have a highly dilutive
impact when they are converted, greatly increasing the number of shares of common stock outstanding. During 2013, there were 2,879
million shares of common stock issued for these conversions. We cannot predict if or when each holder may or may not elect to
convert into shares of common stock.
Our financial statements do not include
any adjustments relating to the recoverability and reclassification of recorded asset amounts or the amounts and classification
of liabilities that might be necessary should we be unable to continue as a going concern.
Revisions to 2013 Interim Reporting
–
In connection with the completion of our third quarter 2013 and first quarter 2014 reporting, we identified certain
errors associated with our first quarter 2013 interim reporting. We assessed the impact of these errors and concluded that the
errors did not result in a material misstatement. To correct the errors, we have revised the three months ended March 31,
2013 reporting as discussed below. Our assessment considered the guidance provided by ASC Topic 250,
Accounting Changes
and Error Corrections
and ASC Topic 250-10-S99-1,
Assessing Materiality
. Based on our conclusion that the errors
were not material individually or in aggregate to any of the prior reporting periods, we determined amendments to previously filed
financial statement reports were not required in accordance with the applicable ASC guidance. We also concluded that the revisions
applicable to prior periods should be reflected herein and will be reflected in future filings containing such information.
The condensed consolidated statements
of operations and cash flows for the three months ended March 31, 2013 originally reported a loss from change in fair value of
hybrid financial instruments of $299,000 but should have reflected a gain of $6,774,000. Additionally, the Company reported a
gain from change in fair value of derivative liability – Series C and D Convertible Preferred Stock and debentures of $6,774,000
but should have reflected a loss of $299,000. The errors were due to clerical transposing of the amounts and have been revised
herein to reflect the proper amounts. The foreign currency translation adjustment within comprehensive income (loss) originally
reflected a $111,000 loss but should have reflected a $111,000 gain. The reporting has been revised herein to reflect the proper
amounts. Additionally, the fully diluted net income per share was reflected as $0.003 but should have been $0.000. The reporting
has been revised herein to reflect the proper amount.
The condensed consolidated statements
of cash flows for the three months ended March 31, 2013 overstated net cash used in operating activities and the effect of exchange
rate changes on cash by approximately $113,000. The revised net cash used in operating activities was approximately $547,000
and the effect of exchange rate changes on cash was negative $2,000. The amounts have been revised herein to reflect the proper
amounts.
Basic
and Diluted Net Income Per Common Share
– The components of basic and diluted
income per share attributable to the Company’s common stock shareholders were as follows (in thousands, except share and
per share data):
|
|
Three Months Ended
|
|
|
|
March 31,
|
|
|
|
2014
|
|
|
2013
|
|
|
|
|
|
|
(revised)
|
|
Numerator:
|
|
|
|
|
|
|
|
|
Net income available to common shareholders
|
|
$
|
242,590
|
|
|
$
|
9,038
|
|
Effect of dilutive securities:
|
|
|
|
|
|
|
|
|
Hybrid financial instruments
|
|
|
(29,151
|
)
|
|
|
(6,774
|
)
|
Derivative liability - warrants
|
|
|
(40
|
)
|
|
|
-
|
|
Derivative liability - Series C and D Convertible Preferred Stock and debentures
|
|
|
(1,992
|
)
|
|
|
299
|
|
Numerator for diluted income per common share
|
|
$
|
211,407
|
|
|
$
|
2,563
|
|
|
|
|
|
|
|
|
|
|
Denominator:
|
|
|
|
|
|
|
|
|
Weighted average shares used to compute basic income per common share
|
|
|
4,984,827,279
|
|
|
|
2,789,315,439
|
|
Effect of dilutive securities:
|
|
|
|
|
|
|
|
|
Hybrid financial instruments
|
|
|
233,957,214,103
|
|
|
|
22,595,466,030
|
|
Derivative liability - warrants
|
|
|
440,652,725
|
|
|
|
-
|
|
Derivative liability - Series C and D preferred stock and debentures
|
|
|
26,618,556,701
|
|
|
|
2,546,882,671
|
|
Denominator for diluted income per common share
|
|
|
266,001,250,808
|
|
|
|
27,931,664,140
|
|
|
|
|
|
|
|
|
|
|
Basic income per common share
|
|
$
|
0.049
|
|
|
$
|
0.003
|
|
Diluted income per common share
|
|
$
|
0.001
|
|
|
$
|
0.000
|
|
We excluded approximately 1,173,000 and
1,883,833,000 dilutive securities from the calculation of diluted income per common share for the three months ended March 31,
2014 and 2013, respectively, because inclusion of these securities would be antidilutive.
Recent Accounting Pronouncements
– From time to time, new accounting pronouncements are issued that we adopt as of the specified effective date.
We believe that the impact of recently issued standards that are not yet effective will not have a material impact on our results
of operations and financial position.
Note 3 – Financing
At March 31, 2014, financial instruments arising from our financing
transactions with YA Global Investments, L.P. (“YA Global”), an accredited investor, included shares of our Series
C Convertible Preferred Stock issued in February 2006, Series D Convertible Preferred Stock issued in January 2010, a series of
six consolidated secured convertible debentures (the “Consolidated Debentures”) issued July 1, 2013 and various warrants
to purchase shares of our common stock. All of our assets are pledged to secure our obligations under the debt securities. At
various times, YA Global has assigned or distributed portions of its holdings of these securities to other holders, including
persons who are officers of YA Global and its related entities, as well as to other holders who are investors in YA Global’s
funds.
Secured Debentures –
We had originally
entered into financing transactions with YA Global, which included a series of twenty-seven secured convertible debentures issued
between August 2006 and July 2012. Effective July 1, 2013, the terms of the debentures held by YA Global were modified to consolidate
the principal and interest amounts outstanding under all of the outstanding secured convertible debentures previously issued by
us to YA Global, such that, upon the issuance of the Consolidated Debentures and cancellation of the prior debentures, the amount
of outstanding debentures issued to YA Global decreased from twenty-seven to six debentures. The maturity dates of these secured
convertible debentures were also extended from August 1, 2014 to August 1, 2015.
The underlying agreements for each of the Consolidated Debentures
are very similar in form. The Consolidated Debentures are convertible into our common stock, at the option of the holder, at the
lower of a fixed conversion price per share or a percentage of the lowest volume-weighted average price (“VWAP”) for
a specified number of days prior to the conversion (the “look-back period”). The conversion is limited such that the
holder cannot exceed 9.99% ownership of the outstanding common stock, unless the holder waives their right to such limitation.
All of the debentures are secured according to the terms of a Security Pledge Agreement dated August 23, 2006, which was entered
into in connection with the first convertible debenture issued to YA Global and which provides YA Global with a security interest
in substantially all of our assets. The debentures are also secured by a Patent Security Agreement dated July 29, 2008. On August
13, 2010, our wholly owned subsidiary, NeoMedia Europe GmbH, became a guarantor of all outstanding financing transactions between
us and YA Global, through pledges of their intellectual property and other movable assets. As security for our obligations to
YA Global, all of our Pledged Property, Patent Collateral and other collateral is affirmed through the several successive Ratification
Agreements executed in connection with each of the 2010, 2011 and 2012 financings. The 2013 modification and consolidation of
the outstanding secured convertible debentures as well as the execution of an Amended and Restated Patent Security Agreement in
2013 reaffirmed the Pledged Property, Patent Collateral and other collateral pledged as security for our obligations to YA Global.
We evaluated the financing transactions in accordance with
ASC 815,
Derivatives and Hedging
, and determined that the conversion features of the Series C and Series D Convertible
Preferred Stock and the Consolidated Debentures were not afforded the exemption for conventional convertible instruments due to
their variable conversion rates. The contracts have no explicit limit on the number of shares issuable, so they did not meet the
conditions set forth in current accounting standards for equity classification. Accordingly, either the embedded derivative instruments,
including the conversion option, must be bifurcated and accounted for as derivative instrument liabilities or, as permitted by
ASC 815-15-25-4,
Recognition of Embedded Derivatives
, the instruments may be carried in their entirety at fair value.
At inception, we elected to bifurcate the embedded derivatives
related to the Series C and Series D Convertible Preferred Stock, while electing the fair value option for the Consolidated Debentures.
ASC 825, Fi
nancial Instruments
, allows us to elect the fair value option for recording financial instruments when they
are initially recognized or if there is an event that requires re-measurement of the instruments at fair value, such as a significant
modification of the debt.
On
February 4, 2013, we entered into a Debenture Extension Agreement with YA Global to extend the maturity dates of the secured convertible
debentures to August 1, 2014. Because the effect of the extension did not exceed a significance threshold relative
to cash flows prescribed by ASC 470-50,
Debt Modifications and Extinguishments
, extinguishment accounting was not applicable.
On
July
1, 2013, in addition to consolidating the secured debentures into six Consolidated Debentures, the maturity date was extended
to August 1, 2015. Four of the Consolidated Debentures are non-interest bearing while the remaining two Consolidated Debentures
accrue interest at 9.5% as outlined in further detail below. Debentures assigned to other investors by YA Global were also modified
effective July 1, 2013 to extend the maturity date to August 1, 2015. We evaluated the impact of the modification on the accounting
for the Consolidated Debentures in accordance with ASC 470-50-40-6 through 12 to determine whether extinguishment accounting was
appropriate. Because the effect of the extension did not exceed a significance threshold relative to cash flows prescribed by
ASC 470-50,
Debt Modifications and Extinguishments
, extinguishment accounting was not applicable.
The following table summarizes the significant terms of each
of the debentures for which the entire hybrid instrument is recorded at fair value as of March 31, 2014:
|
|
|
|
|
|
|
|
|
|
|
Conversion Price – Lower of Fixed
Price or Percentage of VWAP for
Look-back period
|
|
|
|
|
|
|
|
|
|
|
|
|
Anti-
Dilution
|
|
|
|
|
|
|
|
Debenture
|
|
Face
|
|
|
Interest
|
|
|
Fixed
|
|
|
Adjusted
|
|
|
|
|
|
Look-back
|
|
Issuance Year
|
|
Amount
|
|
|
Rate
|
|
|
Price
|
|
|
Price
|
|
|
%
|
|
|
Period
|
|
|
|
(in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
$
|
1,962
|
|
|
|
9.5
|
%
|
|
$
|
2.00
|
|
|
$
|
0.00018
|
|
|
|
90
|
%
|
|
|
125 Days
|
|
2007
|
|
|
567
|
|
|
|
9.5
|
%
|
|
$
|
2.00
|
|
|
$
|
0.00018
|
|
|
|
90
|
%
|
|
|
125 Days
|
|
2007
|
|
|
272
|
|
|
|
-
|
|
|
$
|
2.00
|
|
|
$
|
0.00019
|
|
|
|
95
|
%
|
|
|
125 Days
|
|
2008
|
|
|
1,217
|
|
|
|
9.5
|
%
|
|
$
|
2.00
|
|
|
$
|
0.00018
|
|
|
|
90
|
%
|
|
|
125 Days
|
|
2008
|
|
|
830
|
|
|
|
-
|
|
|
$
|
2.00
|
|
|
$
|
0.00019
|
|
|
|
95
|
%
|
|
|
125 Days
|
|
2009
|
|
|
134
|
|
|
|
9.5
|
%
|
|
$
|
2.00
|
|
|
$
|
0.00018
|
|
|
|
90
|
%
|
|
|
125 Days
|
|
2011
|
|
|
852
|
|
|
|
9.5
|
%
|
|
$
|
2.00
|
|
|
$
|
0.00018
|
|
|
|
90
|
%
|
|
|
125 Days
|
|
2012
|
|
|
762
|
|
|
|
9.5
|
%
|
|
$
|
2.00
|
|
|
$
|
0.00018
|
|
|
|
90
|
%
|
|
|
125 Days
|
|
2012
|
|
|
210
|
|
|
|
-
|
|
|
$
|
2.00
|
|
|
$
|
0.00019
|
|
|
|
95
|
%
|
|
|
125 Days
|
|
2013
|
|
|
22,084
|
|
|
|
9.5
|
%
|
|
$
|
2.00
|
|
|
$
|
0.00018
|
|
|
|
90
|
%
|
|
|
125 Days
|
|
2013
|
|
|
12,127
|
|
|
|
-
|
|
|
$
|
2.00
|
|
|
$
|
0.00019
|
|
|
|
95
|
%
|
|
|
125 Days
|
|
Total
|
|
$
|
41,017
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
We bifurcate the compound embedded derivatives related to the
Series C and Series D Convertible Preferred Stock and carry these financial instruments as liabilities in the accompanying balance
sheet. Election to carry the instruments at fair value in their entirety is not available since their terms have not been
modified. Significant components of the compound embedded derivative include (i) the embedded conversion feature, (ii) down-round
anti-dilution protection features and (iii) default, non-delivery and buy-in puts, all of which were combined into one compound
instrument that is carried at fair value as a derivative liability. Changes in the fair value of the compound derivative liability
are recorded within income each period.
Conversions and Repayments
– Our preferred
stock and convertible debentures are convertible into shares of our common stock. Upon conversion of any of the convertible financial
instruments in which the compound embedded derivative is bifurcated, the carrying amount of the instrument and the related derivative
liability are credited to the capital accounts upon conversion to reflect the stock issued and no gain or loss is recognized.
For instruments that are recorded in their entirety at the fair value of the hybrid instrument, the fair value of the hybrid instrument
converted is credited to the capital accounts upon conversion to reflect the stock issued and no gain or loss is recognized. The
trading market price of our common stock (and the conversion price) has been less than its par value from time to time. We are
limited to issuing shares of common stock at no less than the par value, and all shares of our common stock issued in those conversions
were issued at par value. However, the methodology used to estimate the number of shares of convertible debentures and preferred
stock converted during this time are based upon the value received for the shares issued, with the difference between that value
and the par value recorded as a deemed dividend.
The following table provides a summary of the preferred stock
conversions that have occurred since inception and the number of common shares issued upon conversion.
|
|
Preferred
shares
|
|
|
Preferred
shares
|
|
|
Preferred
shares
|
|
|
Common
shares
|
|
|
|
issued
|
|
|
converted
|
|
|
remaining
|
|
|
issued
|
|
|
|
(in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Series C Convertible Preferred Stock
|
|
|
22
|
|
|
|
17
|
|
|
|
5
|
|
|
|
314,619
|
|
Series D Convertible Preferred Stock
|
|
|
25
|
|
|
|
22
|
|
|
|
3
|
|
|
|
245,162
|
|
The outstanding principal and accrued interest for the debentures
as of March 31, 2014 is reflected in the following table in addition to the principal and interest converted since inception and
the number of shares of common stock issued upon conversion.
|
|
Outstanding
principal and
accrued interest
at March
31, 2014
|
|
|
Principal and
accrued interest
converted since
inception
|
|
|
Common
Shares
issued
|
|
|
|
(in thousands)
|
|
Debentures
|
|
$
|
43,468
|
|
|
$
|
11,747
|
|
|
|
4,403,415
|
|
Warrants
– YA Global holds warrants
to purchase shares of our common stock that were issued in connection with the convertible debentures and the Series C and Series
D Convertible Preferred Stock. The warrants are exercisable at a fixed exercise price which, from time to time, has been reduced
due to anti-dilution provisions when we have entered into subsequent financing arrangements with a lower price. The exercise prices
may be reset again in the future if we subsequently issue stock or enter into a financing arrangement with a lower price. In addition,
upon each adjustment in the exercise price, the number of warrant shares issuable is adjusted to the number of shares determined
by multiplying the warrant exercise price in effect prior to the adjustment by the number of warrant shares issuable prior to
the adjustment divided by the warrant exercise price resulting from the adjustment.
The warrants issued to YA Global do not meet all of the established
criteria for equity classification in ASC 815-40,
Derivatives and Hedging – Contracts in Entity’s Own Equity,
and accordingly, are recorded as derivative liabilities at fair value. Changes in the fair value of the warrants are charged or
credited to income each period.
Effective February 1, 2013, 1.4 billion of the 1.9 billion
warrants held by YA Global were cancelled and the remaining 500 million had their exercise price reduced to $0.0001 per share.
These changes resulted in a decrease in fair value of the warrants of approximately $1.6 million during the first quarter of 2013
as reflected in the gain from change in fair value of derivative liabilities - warrants.
Fair value disclosures for Series C and D Bifurcated
Embedded Derivative Instruments
– For financings in which the embedded derivative instruments are bifurcated
and recorded separately, the compound embedded derivative instruments are valued using a Monte Carlo Simulation methodology because
that model embodies certain relevant assumptions (including, but not limited to, interest rate risk, credit risk, and conversion/redemption
privileges) that are necessary to value these complex derivatives.
Assumptions used in calculating the preferred share values
as of March 31, 2014 included remaining equivalent term of 1.34 years, annualized volatility of 187%, stated dividend of
8%, equivalent credit-risk adjusted rate of 13.0% and conversion price of $0.000194. Equivalent amounts reflect the net results
of multiple modeling simulations that the Monte Carlo Simulation methodology applies to underlying assumptions. We modified the
valuation technique to consider the potentially dilutive impact on the stock price resulting from the issuance of additional common
shares upon the conversion of the preferred shares and convertible debentures. Approximately $23.3 million of the gain from change
in fair value of derivative liability – Series C and D Convertible Preferred Stock and debentures was attributable to the
change in valuation technique for the three months ended March 31, 2014. The Company determined inclusion of the impact from potentially
dilutive shares in the valuation technique to be a change in accounting estimate as discussed in ASC Topic 250-10-45-17,
Accounting
Changes and Error Corrections
, and is therefore reflected in the period of change and will be reflected in future periods.
The following table reflects the face value of the instruments
and the fair value of the separately-recognized compound embedded derivative, as well the number of common shares into which the
instruments are convertible as of March 31, 2014 and December 31, 2013.
March 31, 2014
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Face
|
|
|
Carrying
|
|
|
Embedded
Conversion
|
|
|
Common
Stock
|
|
|
|
Value
|
|
|
Value
|
|
|
Feature
|
|
|
Shares
|
|
|
|
(in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Series C Convertible Preferred Stock
|
|
$
|
4,816
|
|
|
$
|
4,816
|
|
|
$
|
148
|
|
|
|
24,823,015
|
|
Series D Convertible Preferred Stock
|
|
|
348
|
|
|
|
348
|
|
|
|
11
|
|
|
|
1,794,330
|
|
Total
|
|
$
|
5,164
|
|
|
$
|
5,164
|
|
|
$
|
159
|
|
|
|
26,617,345
|
|
December 31, 2013
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Face
|
|
|
Carrying
|
|
|
Embedded
Conversion
|
|
|
Common
Stock
|
|
|
|
Value
|
|
|
Value
|
|
|
Feature
|
|
|
Shares
|
|
|
|
(in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Series C Convertible Preferred Stock
|
|
$
|
4,816
|
|
|
$
|
4,816
|
|
|
$
|
22,015
|
|
|
|
24,823,015
|
|
Series D Convertible Preferred Stock
|
|
|
348
|
|
|
|
348
|
|
|
|
1,591
|
|
|
|
1,794,330
|
|
Total
|
|
$
|
5,164
|
|
|
$
|
5,164
|
|
|
$
|
23,606
|
|
|
|
26,617,345
|
|
The terms of the embedded conversion features in the convertible
instruments presented above provide for variable conversion rates that are indexed to our quoted common stock price. As a result,
the number of indexed shares is subject to continuous fluctuation. For presentation purposes, the number of shares of common stock
into which the embedded conversion feature of the Series C and Series D Convertible Preferred Stock was convertible as of March
31, 2014 and 2013 was calculated as face value plus assumed dividends (if declared), divided by the lesser of the fixed rate or
the calculated variable conversion price using the 125 day look-back period.
Changes in the fair value of derivative instrument liabilities
related to the bifurcated embedded derivative features of the convertible instruments are reported as Gain (loss) from Change
in Fair Value of Derivative Liability – Series C and Series D Convertible Preferred Stock and Debentures in the accompanying
condensed consolidated statements of operations.
Gain (loss) from change in fair value of derivative liability
– Series C and D Convertible Preferred Stock and debentures
|
|
Three months ended
March 31,
|
|
|
|
2014
|
|
|
2013
|
|
|
|
(in thousands)
|
|
Series C Convertible Preferred Stock
|
|
$
|
21,867
|
|
|
$
|
(289
|
)
|
Series D Convertible Preferred Stock
|
|
|
1,580
|
|
|
|
(21
|
)
|
|
|
|
|
|
|
|
|
|
Debentures:
|
|
|
|
|
|
|
|
|
2006
|
|
|
-
|
|
|
|
11
|
|
Gain (loss) from change in fair value of derivative liability - Series C and D Convertible Preferred Stock and debentures
|
|
$
|
23,447
|
|
|
$
|
(299
|
)
|
Hybrid Financial Instruments Carried at Fair Value
–
At inception, the March 2007, August 2007, April 2008, May 2008 and April 2012 convertible debentures were recorded in their entirety
at fair value as hybrid instruments in accordance with ASC 815-15-25-4 with subsequent changes in fair value charged or credited
to income each period. As of May 25, 2012, we elected the fair value option for all other convertible debentures held by YA Global
upon a re-measurement date that was triggered by significant modifications of the financial instruments. The convertible
debentures continued to be recorded in their entirety at fair value upon their consolidation into six Consolidated Debentures
effective July 1, 2013. The conversion price in each of the convertible debentures is subject to adjustment for down-round, anti-dilution
protection. Accordingly, if we sell common stock or common share indexed financial instruments below the stated or variable conversion
price of the debenture, the conversion price adjusts to that lower amount.
Because these debentures are carried in their entirety
at fair value, the value of the embedded conversion feature is embodied in those fair values. We estimate the fair value
of the hybrid instrument as the present value of the cash flows of the instrument, using a risk-adjusted interest rate,
enhanced by the value of the conversion option, valued using a Monte Carlo model. This method was considered by our
management to be the most appropriate method of encompassing the credit risk and exercise behavior that a market participant
would consider when valuing the hybrid financial instrument. Inputs used to value the hybrid instruments as of March 31, 2014
included: (i) present value of future cash flows for the debentures using an effective market interest rate of 13.0%, (ii)
remaining term of 1.34 years, (iii) annualized volatility of 187%, and (iv) anti-dilution adjusted conversion prices ranging
from $0.00018 - $0.00019. We also modified the valuation technique to consider the potentially dilutive impact on the stock
price from the issuance of common shares upon the conversion of the debentures. An approximately $219.1 million gain from
change in fair value of hybrid financial instruments was attributable to the change in valuation technique for the three
months ended March 31, 2014. The Company determined inclusion of the impact from potentially dilutive shares in the valuation
technique to be a change in accounting estimate as discussed in ASC Topic 250-10-45-17,
Accounting Changes and Error
Corrections
, and is therefore reflected in the period of change and will be reflected in future periods.
The following table reflects the face value of the financial
instruments, the fair value of the hybrid financial instrument and the number of shares of common stock into which the instruments
are convertible as of March 31, 2014 and December 31, 2013.
March 31, 2014
|
|
|
|
|
|
|
|
Common
|
|
|
|
Face
|
|
|
Fair
|
|
|
Stock
|
|
|
|
Value
|
|
|
Value
|
|
|
Shares
|
|
|
|
(in thousands)
|
|
Debentures:
|
|
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
$
|
1,962
|
|
|
$
|
2,041
|
|
|
|
12,285,288
|
|
2007
|
|
|
839
|
|
|
|
950
|
|
|
|
3,244,058
|
|
2008
|
|
|
2,047
|
|
|
|
1,898
|
|
|
|
11,689,415
|
|
2009
|
|
|
134
|
|
|
|
155
|
|
|
|
923,440
|
|
2011
|
|
|
852
|
|
|
|
866
|
|
|
|
5,226,562
|
|
2012
|
|
|
972
|
|
|
|
1,013
|
|
|
|
8,524,582
|
|
2013
|
|
|
34,211
|
|
|
|
31,872
|
|
|
|
192,394,516
|
|
Total
|
|
$
|
41,017
|
|
|
$
|
38,795
|
|
|
|
234,287,861
|
|
December 31, 2013
|
|
|
|
|
|
|
|
Common
|
|
|
|
Face
|
|
|
Fair
|
|
|
Stock
|
|
|
|
Value
|
|
|
Value
|
|
|
Shares
|
|
|
|
(in thousands)
|
|
Debentures:
|
|
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
$
|
1,962
|
|
|
$
|
13,512
|
|
|
|
12,285,288
|
|
2007
|
|
|
839
|
|
|
|
3,587
|
|
|
|
3,244,058
|
|
2008
|
|
|
2,047
|
|
|
|
12,825
|
|
|
|
11,689,415
|
|
2009
|
|
|
134
|
|
|
|
1,018
|
|
|
|
923,440
|
|
2011
|
|
|
852
|
|
|
|
5,745
|
|
|
|
5,226,562
|
|
2012
|
|
|
972
|
|
|
|
9,369
|
|
|
|
8,524,582
|
|
2013
|
|
|
34,211
|
|
|
|
211,395
|
|
|
|
192,394,516
|
|
Total
|
|
$
|
41,017
|
|
|
$
|
257,451
|
|
|
|
234,287,861
|
|
Changes in the fair value of convertible instruments that are
carried in their entirety at fair value are reported as gain from change in fair value of hybrid financial instruments in the
accompanying condensed consolidated statements of operations. The changes in fair value of these hybrid financial instruments
were as follows:
Gain from change in fair value of hybrid financial instruments
|
|
Three months ended
March 31,
|
|
|
|
2014
|
|
|
2013
|
|
|
|
(in thousands)
|
|
|
|
|
|
|
|
|
2006
|
|
$
|
11,471
|
|
|
$
|
1,887
|
|
2007
|
|
|
2,637
|
|
|
|
2,329
|
|
2008
|
|
|
10,927
|
|
|
|
1,657
|
|
2009
|
|
|
863
|
|
|
|
(74
|
)
|
2010
|
|
|
-
|
|
|
|
623
|
|
2011
|
|
|
4,879
|
|
|
|
249
|
|
2012
|
|
|
8,356
|
|
|
|
103
|
|
2013
|
|
|
179,523
|
|
|
|
-
|
|
Gain from changes in fair value of hybrid instruments
|
|
$
|
218,656
|
|
|
$
|
6,774
|
|
Warrants –
The following table summarizes
the warrants outstanding, their fair value and their exercise price after adjustment for anti-dilution provisions:
|
|
|
|
|
March 31, 2014
|
|
|
December 31, 2013
|
|
|
|
|
|
|
Anti-
Dilution
|
|
|
|
|
|
|
|
|
Anti-
Dilution
|
|
|
|
|
|
|
|
|
|
|
|
|
Adjusted
|
|
|
|
|
|
|
|
|
Adjusted
|
|
|
|
|
|
|
|
|
|
Expiration
|
|
|
Exercise
|
|
|
|
|
|
Fair
|
|
|
Exercise
|
|
|
|
|
|
Fair
|
|
|
|
Year
|
|
|
Price ($)
|
|
|
Warrants
|
|
|
Value
|
|
|
Price ($)
|
|
|
Warrants
|
|
|
Value
|
|
|
|
|
|
|
|
|
|
(in thousands)
|
|
|
|
|
|
(in thousands)
|
|
Warrants issued with preferred stock:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Series D Convertible Preferred Stock
|
|
|
2017
|
|
|
|
0.000100
|
|
|
|
87,368
|
|
|
$
|
44
|
|
|
|
0.000100
|
|
|
|
87,368
|
|
|
$
|
121
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Warrants issued with debentures:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2008
|
|
|
2015
|
|
|
|
0.000100
|
|
|
|
238,079
|
|
|
|
117
|
|
|
|
0.000100
|
|
|
|
238,079
|
|
|
|
324
|
|
2010
|
|
|
2015
|
|
|
|
0.000100
|
|
|
|
81,340
|
|
|
|
40
|
|
|
|
0.000100
|
|
|
|
81,340
|
|
|
|
111
|
|
2011
|
|
|
2016
|
|
|
|
0.000100
|
|
|
|
58,256
|
|
|
|
29
|
|
|
|
0.000100
|
|
|
|
58,256
|
|
|
|
80
|
|
2012
|
|
|
2017
|
|
|
|
0.000100
|
|
|
|
34,947
|
|
|
|
17
|
|
|
|
0.000100
|
|
|
|
34,947
|
|
|
|
48
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
499,990
|
|
|
$
|
247
|
|
|
|
|
|
|
|
499,990
|
|
|
$
|
684
|
|
The warrants are valued using a binomial lattice option valuation
methodology because that model embodies all of the significant relevant assumptions that address the features underlying these
instruments. Significant assumptions used in this model as of March 31, 2014 included an expected life equal to the remaining
term of the warrants, an expected dividend yield of zero, estimated volatility ranging from 165% to 194%, and risk-free rates
of return ranging from 0.14% to 1.04%. For the risk-free rates of return, we use the published yields on zero-coupon Treasury
Securities with maturities consistent with the remaining term of the warrants and volatility is based upon our expected common
stock price volatility over the remaining term of the warrants. The exercise price of the warrants is currently $0.0001, which
was also estimated to be the exercise price for purposes of the valuation technique. The anti-dilution provisions of the
warrants allow for the fixed exercise price to be reset to the lowest price of any subsequently issued common share indexed instruments
with a conversion price below the current exercise price of the warrant. However, the likelihood of the Company issuing additional
equity below the current strike price was deemed impractical and as a result, the anti-dilutive protection was not factored into
the calculation. We also modified the valuation technique to consider the potentially dilutive impact on the stock price from
the issuance of shares of common stock upon the exercise of the warrants on the fair value estimate of the warrants. We estimated
that the exercise of the warrants would result in 7.6% decline in the stock price and a corresponding decline in the fair value
of the warrants of approximately $20,000 as compared to the fair value assuming no dilution. The Company determined inclusion
of the impact from potentially dilutive shares in the valuation technique to be a change in accounting estimate as discussed in
ASC Topic 250-10-45-17,
Accounting Changes and Error Corrections
, and is therefore reflected in the period of change and
will be reflected in future periods.
Changes in the fair value of the warrants are reported as gain
from change in fair value of derivative liability – warrants in the accompanying condensed consolidated statement of
operations. The changes in the fair value of the warrants were as follows:
Gain from change in fair value of derivative liability
– warrants
|
|
Three months ended
March 31,
|
|
|
|
2014
|
|
|
2013
|
|
|
|
(in thousands)
|
|
Warrants issued with preferred stock:
|
|
|
|
|
|
|
|
|
Series D Convertible Preferred Stock
|
|
$
|
77
|
|
|
$
|
608
|
|
|
|
|
|
|
|
|
|
|
Warrants issued with debentures:
|
|
|
|
|
|
|
|
|
2008
|
|
|
207
|
|
|
|
1,424
|
|
2010
|
|
|
71
|
|
|
|
480
|
|
2011
|
|
|
51
|
|
|
|
387
|
|
2012
|
|
|
31
|
|
|
|
223
|
|
Gain from change in fair value of derivative liability – warrants
|
|
$
|
437
|
|
|
$
|
3,122
|
|
Reconciliation of changes in fair value –
Assets
and liabilities measured at fair value are classified in their entirety based on the lowest level of input that is significant
to their fair value measurement. Our derivative financial instruments that are measured at fair value on a recurring basis are
all measured at fair value using Level 3 inputs. Level 3 inputs are unobservable inputs that are supported by little or no market
activity and that are significant to the fair value of the assets or liabilities.
The following represents a reconciliation of the changes in
fair value of financial instruments measured at fair value using Level 3 inputs during the three months ended March 31, 2014 (in
thousands):
|
|
Compound
|
|
|
|
|
|
|
|
|
|
|
|
|
Embedded
|
|
|
Warrant
|
|
|
Hybrid
|
|
|
|
|
|
|
Derivatives
|
|
|
Derivatives
|
|
|
Instruments
|
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Beginning balance, December 31, 2013:
|
|
$
|
23,606
|
|
|
$
|
684
|
|
|
$
|
257,451
|
|
|
$
|
281,741
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair value adjustments:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Compound embedded derivatives
|
|
|
(23,447
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
(23,447
|
)
|
Warrant derivatives
|
|
|
-
|
|
|
|
(437
|
)
|
|
|
-
|
|
|
|
(437
|
)
|
Hybrid instruments
|
|
|
-
|
|
|
|
-
|
|
|
|
(218,656
|
)
|
|
|
(218,656
|
)
|
Ending balance, March 31, 2014
|
|
$
|
159
|
|
|
$
|
247
|
|
|
$
|
38,795
|
|
|
$
|
39,201
|
|
Estimating fair values of derivative financial instruments
requires the development of significant and subjective estimates that may, and are likely to, change over the duration of the
instrument with related changes in internal and external market factors. In addition, valuation techniques are sensitive to changes
in the trading market price of our common stock, which has a high estimated historical volatility. Because derivative financial
instruments are initially and subsequently carried at fair values, our income will reflect the volatility in these estimate and
assumption changes.
Note 4 – Stock-Based Compensation
The status of our outstanding, vested and exercisable options
during the three months ended March 31, 2014 is as follows:
|
|
|
|
|
|
|
|
|
|
|
Weighted-
|
|
|
|
|
|
|
|
|
|
|
|
|
Average
|
|
|
|
|
|
|
Weighted-
|
|
|
|
|
|
Contractual
|
|
|
|
|
|
|
Average
|
|
|
Aggregate
|
|
|
Life
|
|
|
|
|
|
|
Exercise
|
|
|
Intrinsic
|
|
|
Remaining
|
|
|
|
Shares
|
|
|
Price
|
|
|
Value
|
|
|
in Years
|
|
|
|
(in thousands)
|
|
|
|
|
|
(in thousands)
|
|
|
|
|
Outstanding at December 31, 2013
|
|
|
1,173
|
|
|
$
|
0.017
|
|
|
|
-
|
|
|
|
|
|
Outstanding at March 31, 2014
|
|
|
1,173
|
|
|
$
|
0.017
|
|
|
$
|
-
|
|
|
|
7.5
|
|
Exercisable at March 31, 2014
|
|
|
972
|
|
|
$
|
0.018
|
|
|
$
|
-
|
|
|
|
7.3
|
|
The following table summarizes information
about our stock options outstanding at March 31, 2014:
Options Outstanding
|
|
Options Exercisable
|
|
Exercise Prices
|
|
Number of Shares
|
|
|
Weighted-
Average
Remaining
Life
|
|
|
Weighted-
Average Exercise
Price
|
|
|
Number of Shares
|
|
|
Weighted-
Average
Exercise Price
|
|
|
|
(in thousands)
|
|
|
(in years)
|
|
|
|
|
|
(in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$0.008
|
|
|
200
|
|
|
|
8.5
|
|
|
$
|
0.008
|
|
|
|
65
|
|
|
$
|
0.008
|
|
$0.014 to $0.03
|
|
|
884
|
|
|
|
7.3
|
|
|
|
0.015
|
|
|
|
818
|
|
|
|
0.016
|
|
$0.050
|
|
|
89
|
|
|
|
6.9
|
|
|
|
0.047
|
|
|
|
89
|
|
|
|
0.047
|
|
|
|
|
1,173
|
|
|
|
7.5
|
|
|
$
|
0.017
|
|
|
|
972
|
|
|
$
|
0.018
|
|
Note 5 – Accrued Liabilities
The following table summarized our accrued liabilities (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
March 31,
|
|
|
December 31,
|
|
|
|
2014
|
|
|
2013
|
|
|
|
|
|
Accrued operating expenses
|
|
$
|
112
|
|
|
$
|
112
|
|
Accrued payroll related expenses
|
|
|
134
|
|
|
|
65
|
|
Accrued legal fees
|
|
|
227
|
|
|
|
114
|
|
Total
|
|
$
|
473
|
|
|
$
|
291
|
|
Note 6 – Contingencies
Legal
– From time to time, we are involved
in various legal actions arising in the normal course of business, both as claimant and defendant. Although it is not possible
to determine with certainty the outcome of these matters, we believe the eventual resolution of any ongoing legal actions is unlikely
to have a material impact on our financial position or operating results.
Other
– On February 21, 2014, the Company
received a correspondence (the “Delta Notice”) from Delta Capital Partners LLC (“Delta”), asserting a
claim for certain amounts owed under a secured convertible debenture. The principal amount outstanding and conversion rights under
such instrument had been assigned to Delta by YA Global (the “Assignment”), several years subsequent to the original
issuance of the instrument by the Company to YA Global. The Company’s understanding is that pursuant to the terms of the
Assignment, YA Global, as collateral agent, retained all rights in connection with the enforcement of any claims under Delta’s
secured convertible debenture. YA Global has indicated that it does not intend to assert any of the claims described by
Delta in the Delta Notice.
Note 7 – Geographic Information
Revenue, classified by geographic location
from which the revenue was originated, is as follows:
|
|
Three Months
Ended March 31,
|
|
|
|
2014
|
|
|
2013
|
|
|
|
(in thousands)
|
|
United States
|
|
$
|
1,003
|
|
|
$
|
589
|
|
Germany
|
|
|
-
|
|
|
|
13
|
|
Total revenue
|
|
$
|
1,003
|
|
|
$
|
602
|
|
Approximately $64,000 and $142,000 of
total assets were located in Germany as of March 31, 2014 and December 31, 2013, respectively. All other assets were located in
the U.S.
Note 8 – Plan of Merger
On February 21, 2014, the Company entered into an Agreement
and Plan of Merger (the “Merger Agreement”) with Qode Services Corporation (“Qode”), a wholly owned subsidiary
of the Company. Under the terms of the Merger Agreement, Qode will be merged into the Company and will cease to exist upon the
completion of certain conditions. The Company shall continue as the surviving corporation.
Under the terms of the Merger Agreement, the Company’s
charter shall be amended to provide for an increase in the amount of common stock authorized shares, and each share of the Company’s
common stock issued and outstanding immediately prior to merger shall continue to remain outstanding and remain unchanged, except
that (i) the par value shall change from $0.001 per share to no par value per share, and (ii) each fifteen (15) shares of common
stock issued and outstanding shall be combined and converted into one (1) share of common stock. Upon the consummation of the
merger and reverse stock split effected thereunder, the amount of authorized shares of common stock shall be increased from 5
billion to 7.5 billion shares.
The Company’s Board of Directors determined that the
Merger Agreement was the only option available to avoid default after the holder of a majority of the outstanding secured convertible
debentures communicated its intent to foreclose on all of the Company’s assets in the event that the Company’s share
reserves were not sufficient to honor conversions under such instruments (a potential default thereunder). Further, the holder
of the secured convertible debentures agreed to enter into amendments to the secured convertible debentures to decrease the aggregate
amount of debt by $5.0 million if the Company resolved the issue.
The Company anticipates closing the merger
on May 11, 2014.
Note 9 – Subsequent Events
On April 25,
2014, the Company entered into a Reaffirmation and Ratification Agreement with YA Global. Under the terms of the agreement, YA
Global agreed to reduce the outstanding principal for certain of the Consolidated Debentures by $5.0 million. The agreement also
summarizes and affirms all principal amounts presently outstanding and owed by the Company to YA Global under all of the outstanding
financing documents and debentures issued by the Company to YA (the “Financing Documents”). Pursuant to the agreement,
the Company (i) ratified the terms of the Financing Documents and agreed that they remain in full force and effect, (ii) confirmed
that the collateral rights granted to YA Global under the Financing Documents secure the obligations created thereunder, (iii)
confirmed that the occurrence of an “event of default” under any of the Financing Documents would constitute an “event
of default” under all of the Financing Documents, and (iv) agreed to execute and deliver to YA Global all such additional
documents as reasonably required by YA Global to correct any document deficiencies, or to vest or perfect the Financing Documents
and the collateral granted therein, and authorized YA Global to file any financing statements and take any other actions necessary
to perfect YA Global’s security interests in any such collateral.