Annual report pursuant to section 13 and 15(d)

Preferred Stock And Warrants

v2.4.0.6
Preferred Stock And Warrants
12 Months Ended
Dec. 31, 2011
Preferred Stock And Warrants [Abstract]  
Preferred Stock And Warrants

8. PREFERRED STOCK AND WARRANTS:

At December 31, 2011, the Company is authorized to issue 5,000,000 shares of Preferred Stock, of which 3,000 shares have been designated as Series A Preferred Stock.

On November 11, 2008, the Company entered into a Preferred Stock and Warrant Purchase Agreement (the "Stock Purchase Agreement") with a limited number of accredited investors. Pursuant to the Stock Purchase Agreement, the Company issued Series A convertible preferred stock (the "Preferred Stock") and warrants in a private placement, for aggregate consideration of $7,855,776 (before issuance costs incurred in 2008 of $390,513), consisting of $3,974,600 in cash, cancellation of $3,592,630 in principal and accrued interest on the Company's secured promissory notes and $288,546 as compensation for issuance costs in lieu of cash. The net proceeds were used for working capital and general corporate purposes, including supporting the launch of new products.

The Company issued 1,513.44 units of Preferred Stock and warrants ("Preferred Stock Units") at a stated value of $5,000 per unit for an aggregate consideration of $7,567,230. Each unit consisted of one share of Series A convertible Preferred Stock and warrants to purchase 750 shares of common stock (totaling 1,135,083 common shares under warrants) at an exercise price of $6.40 per share expiring three years from the date of issuance. During 2011, the warrants to purchase 1,135,083 common shares expired unexercised. An additional 57.71 units were issued to the placement agent, consisting of 57.71 shares of Preferred Stock and warrants to purchase 43,282 shares of common stock, at an exercise price of $6.40 per share. During 2011, the warrants to purchase 43,282 common shares expired unexercised. As the Preferred Stock was not redeemed prior to one year after the closing date of the transaction, warrants to purchase 750 additional shares of the Company's common stock per unit were issued. In total, the holders of Preferred Stock were issued warrants to purchase a total of 1,500 shares of common stock for each Preferred Stock Unit (collectively, the "Preferred Warrants"), for a total of 2,356,732 common shares under warrants.

Preferred Stock Units Issued for CashThe Company issued 794.92 Preferred Stock Units for cash consideration of $3,974,600. The Company calculated an effective conversion rate which gives effect to the allocation of proceeds from the transactions to the warrants on a relative fair value basis. The Company allocated the proceeds based on the relative fair values of the Preferred Stock and the Preferred Warrants. Using a simulation model of discounted cash flows, the relative fair value of the Preferred Warrants was estimated to be $1,806,837 on the date of issue, which is recorded in additional paid-in capital. The total allocated to the Preferred Stock was $2,167,763, of which $1,806,838 was allocated to the beneficial conversion feature and is recorded in additional paid-in capital. A beneficial conversion feature is recorded when the consideration allocated to the convertible security, divided by the number of common shares into which the security converts, is below the fair value of the common stock at the date of issuance of the convertible instruments.

 

Preferred Stock Units Exchanged for Promissory NotesIn exchange for the cancellation of $3,500,000 in principal amount of secured promissory notes and $92,630 of accrued interest relating to the promissory notes, the Company issued 718.53 Preferred Stock Units. The fair value of the Preferred Stock Units was determined using a simulation model of discounted cash flows and was estimated to be $5,000 per unit, for a total gross fair value of $3,592,630 on the date of issue. The Company estimated the fair value of the Preferred Warrants to total $1,633,195. The gross fair value of the Preferred Stock totaled $1,959,435, of which $1,633,195 was allocated to the beneficial conversion feature and is recorded in additional paid-in capital.

Preferred Stock Units Issued to the Placement AgentThe Company issued 57.71 Preferred Stock Units to the placement agent in exchange for services received. The Company estimated the fair value of the services received to be $288,546, based on the agreement with the placement agent. Using a simulation model of discounted cash flows, the fair value of the Preferred Warrants was estimated to be $131,172 on the date of issue, which is recorded in additional paid-in capital. The total allocated to the Preferred Stock was $157,374, of which $131,172 was allocated to the beneficial conversion feature and is recorded in additional paid-in capital.

The Preferred Stock was redeemable by the Company at any time and the holders were initially entitled to cumulative dividends at the rate of 8% per annum, increasing to 10% commencing 180 days after the date of issuance and 16% commencing 360 days after the date of issuance. The dividends were payable in cash, with an initial payment date of November 1, 2009. At the option of the holder, the preferred stock was convertible at any time commencing four years after issuance into shares of common stock at a conversion rate equal to the market price of the Company's common stock at the time of the conversion or $6.59, whichever is greater.

Following the allocation of the beneficial conversion features and Preferred Warrants above, the Company considered the probability that the Preferred Stock holders would convert to common stock. The Preferred Stock was redeemable by the Company at any time and a percentage was redeemable at the option of the holder if the Company raised equity capital in excess of $5,000,000. Although the Preferred Stock did not have a stated maturity provision, the Company believed the conversion to common stock or redemption of the Preferred Stock, was more likely than not. As a result, the Company will recognize the amount by which the stated value of the preferred stock exceeded the carrying value as a deemed dividend. The excess of the stated value of the preferred stock over the carrying value of $7,142,409 was recorded as a charge to additional paid-in capital in our Consolidated Statements of Stockholders' Equity, as the Company had an accumulated deficit on the date of the transaction. This deemed distribution is recorded as an accretion to the Preferred Stock over the four-year period from the date of issuance to the earliest conversion date using the effective yield method.

On October 29, 2009, the Company entered into an agreement (the "Exchange Agreement") with the holders (the "Preferred Shareholders") of all of its outstanding Preferred Stock including certain of its directors or entities affiliated with such directors, to exchange all 1,571.15 outstanding shares of Preferred Stock for other securities of the Company (the "Exchange"). The Exchange was contingent upon consummation of a Qualified Public Offering, as such term is defined in the Exchange Agreement. Pursuant to the Exchange Agreement, the holders of the Preferred Stock waived receipt of dividend payments on the Preferred Stock and dividends in excess of 10% per annum until the earlier of the Exchange Date (as such term is defined in the Exchange Agreement), the termination of a Qualified Public Offering, or May 1, 2010. Also on October 29, 2009, the Company filed a registration statement with the Securities and Exchange Commission relating to a proposed follow-on offering of its common stock (the "Follow-on Offering"), which closed on December 21, 2009.

 

The Exchange was effected simultaneously with the closing of the Follow-on Offering. Preferred Shareholders holding an aggregate of 1,091.15 shares of Preferred Stock elected to receive common stock in the Exchange ("Option 1 Exchange"). The number of shares of common stock delivered in the Exchange, amounting to 1,731,994, was determined by dividing $5,455,750 (which represented the stated value of the Preferred Stock being exchanged for common stock) by the greater of (i) $3.15 or (ii) the $3.00 per share public offering price in the Follow-on Offering. The Preferred Shareholders holding the remaining 480 shares of Preferred Stock, which had a stated value of $2,400,000, were Michael Brown, one of the Company's directors, and entities affiliated with Mariner Private Equity, LLC, of which Patrick Doherty, one of the Company's former directors, is president. In the Exchange, these Preferred Shareholders received convertible promissory notes (the "Exchange Notes") with an aggregate principal amount of $2,400,000 and warrants to purchase an aggregate of 935,040 shares of the Company's common stock (the "Exchange Warrants") ("Option 2 Exchange"). The Exchange Notes bear interest at 1% per annum, mature three years from the date of issuance and are convertible into 450,281 shares of common stock at a fixed conversion price of $5.33. The Exchange Warrants have an exercise price of $5.08 and expire three years from issuance. There are no price-based anti-dilution provisions in the Exchange Notes or Exchange Warrants.

Option 1 – The Option 1 Exchange allowed the Preferred Shareholders to exchange their Preferred Stock for shares of the Company's common stock. The Option 1 Exchange meets the definition of an induced conversion as provided in current accounting standards because it (i) provided conversion privileges which were exercisable only for a limited period of time or occurrence of a specific event, at the option of the holders, and (ii) it included the issuance of all of the equity securities which were issuable pursuant to conversion privileges included in the terms of the original convertible contract upon its issuance. As a result, the excess of the fair value of the common stock issued in the Exchange over the common stock equivalent value of the Preferred Stock was reflected as a charge to stockholders' equity in a manner similar to that of a dividend.

Option 2 – The Option 2 Exchange allowed those holders of Preferred Stock to exchange their Preferred Stock for the Exchange Notes and Exchange Warrants. The Option 2 Exchange did not meet the definition of an induced conversion as it did not result in the issuance of the equity securities which were issuable pursuant to conversion privileges included in the terms of the Preferred Stock at issuance. Accordingly, the Option 2 Exchange is treated as redemption of the Preferred Stock which requires recognition of the excess of the fair value of the consideration issued (the Exchange Notes and Exchange Warrants) over the carrying value of the Preferred Stock, less issuance costs, as a return to the Preferred Shareholders. Similar to the accounting recognition provided for inducements, the amount of the excess is treated in a manner similar to the treatment of dividends paid on preferred stock.

The following table illustrates the components of the accounting for the Exchange:

 

     Option 1     Option 2     Total  

Issuances, at fair values:

      

Common Stock

   $ (4,309,436   $ —        $ (4,309,436

Exchange Notes

     —          (2,150,448     (2,150,448

Exchange Warrants

     —          (1,221,256     (1,221,256
  

 

 

   

 

 

   

 

 

 
   $ (4,309,436   $ (3,371,704   $ (7,681,140
  

 

 

   

 

 

   

 

 

 

Redemptions:

      

Series A Preferred Stock

   $ 964,225      $ 424,164      $ 1,388,389   

Associated Issuance Costs

     —          (127,167     (127,167

Deemed Dividends

     3,345,211        3,074,707        6,419,918   
  

 

 

   

 

 

   

 

 

 
   $ 4,309,436      $ 3,371,704      $ 7,681,140   
  

 

 

   

 

 

   

 

 

 

The $3.70 fair value of the Company's common stock was derived from the active trading market for the shares. The fair value of the Exchange Notes was estimated based upon the present value of their future cash flows, using credit risk adjusted rates, as enhanced by the fair value of the embedded conversion feature ("ECF"). Since the Company does not have an established credit rating, the credit risk adjusted yield of 10.3% was determined by reference to comparable instruments in public markets. The fair value of the ECF was determined using the Monte Carlo Simulation ("MCS"). MCS is an option-based model that embodies assumptions that would likely be considered by market participants who trade the financial instrument. In addition to more traditional assumptions, such as trading market values, trading volatilities and risk-free rates, MCS assumptions include credit risk, interest risk and redemption considerations. The fair value of the Exchange Warrants was determined using the Black-Scholes-Merton valuation technique over the term to contractual expiration. Significant assumptions included in these valuation techniques were as follows:

 

     Assumption

Credit-risk adjusted rates (based upon comparables):

  

Exchange of Notes

   10.3%

ECF Range of Rates

   8.5% - 10.3%

Volatility (based upon historical trading volumes and prices):

  

ECF Range of Periods

   53.2% - 68.9 %

Exchange Warrants

   65.6%

In evaluating the accounting for the Exchange, the Company also considered current classification and measurement standards associated with the ECF and the Exchange Warrants. The ECF is an equity-linked feature that is not clearly and closely related to the risks of the host debt instrument. However, current accounting standards afforded an exemption to bifurcation of the ECF because it is both indexed to the Company's own stock and otherwise met the definition of Conventional Convertible based upon the fixed conversion price. The Exchange Warrants are both indexed to the Company's own stock and met all other conditions necessary for their classification in stockholders' equity. Finally, the Company's consideration of whether a beneficial conversion feature ("BCF") was present in the hybrid debt agreement indicated that the effective conversion price was higher than the trading market price on the date of issuance. Accordingly, the Exchange Notes did not embody a BCF.

The final value allocated to the Exchange Notes of $2,150,448 is less than the face value of $2,472,000 on the issuance date. This original issue discount of $321,552 is being amortized through periodic charges to interest expense using the effective method. Amortization charges amounted to $107,266 during the year ended December 31, 2011.