Notes to Condensed Consolidated Financial Statements
NOTE 1 — THE COMPANY AND BASIS OF PRESENTATION
Torvec, Inc. (“the Company”) was incorporated as a New York business corporation on September 25, 1996. The Company develops and markets advanced technologies in the areas of power, safety and wellness. Currently, the Company is focusing its commercialization strategies on the following technologies: (i) the CURA system (Circadian User Risk Assessment) and (ii) the Aegis hydraulic pump. The Company has not had any significant revenue-producing operations.
Management announced a name change in connection with the establishment of its two business divisions. The CURA division is engaged in the fatigue management business and the Aegis division is engaged in the power and hydraulic business. The company name will be changed to CurAegis Technologies, Inc. at the 2016 shareholders meeting. Until then the company is doing business as CurAegis Technologies, a Torvec company.
The company has created the CURA system to reduce fatigue risk in the workplace and help individuals manage their sleep and overcome fatigue. The CURA system consists of four individual elements:
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real-time alertness monitoring using the myCadian watch,
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●
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panic-button and man-down system,
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●
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the Z-Coach wellness program.
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Our goal with the Aegis hydraulic pump technology is to give the marketplace a revolutionary new concept in hydraulic pumps and motors that will be:
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smaller and lighter than conventional pumps and motors,
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●
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unique in its ability to scale larger, allowing more powerful pumps and motors.
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It is important to note, regarding both the CURA and Aegis products, that the cycle time from the initiation of the sales process to revenue realization can be highly variable especially in a start-up entity.
In addition to the activities to be undertaken to implement our plan of operations, we may expand and/or refocus our activities depending upon future circumstances and developments.
Management Plans
As of March 2016, we have cash on hand of $1,547,000, working capital of $1,360,0000, stockholders’ equity of $1,792,000 and an accumulated deficit of $72,193,000. During the first quarter of 2016 we raised $1,119,000 through a private placement of the initial sale of the Series C-3 preferred stock. The proceeds from this private placement are being used to support the ongoing development and marketing of our core technologies and product initiatives.
On December 8, 2015, the company commenced the offering of up to ten million newly issued preferred shares with an offering price of $0.25 per share of Series C-3 Preferred Shares in a private placement pursuant to Rule 506(c) of Regulation D under the Securities Act of 1933. The offering has been made only to “accredited investors” as defined in Rule 501(a) of Regulation D under the Securities Act of 1933.
The Company closed on the sale of $1,119,000 of the Company’s Series C-3 Voting Convertible Preferred Stock during the first quarter of 2016 and has extended the C-3 offering through June 3, 2016. Under the terms of the offering, we may raise gross proceeds of up to an additional $1,381,000 from the sale of Series C-3 preferred stock. No assurance can be given that we will raise the maximum amount or any additional amount from the sale of our Series C-3 preferred stock before the offering expires.
Management will continue to use its best efforts to develop financing opportunities to fund the development and commercialization of the CURA and Aegis products.
Management estimates that the 2016 cash needs, based on its current development and product plans, will be in the range of $2.2 million to $3.5 million. The Company’s ability to fund its current and future commitments out of its available cash depends on a number of factors. These factors include the Company’s ability to (i) launch and generate sales from the CURA division; (ii) decrease research and overhead expenses and (iii) raise additional funds through equity offerings. During the three months ended March 31, 2016, the Company raised gross proceeds $1,119,000 from the private placement of its Series C-3 preferred stock. As of March 31, 2016, the Company had approximately $1,547,000 in cash and cash equivalents which may not be sufficient to cover the Company’s future working capital requirements if these and other factors are not met. If the Company cannot generate sufficient cash from its operations, the Company may need to raise additional funds in the future in order to fund its working capital needs and pursue its growth strategy, although there can be no assurances, management believes that sources for these additional funds will be available through either current or future investors.
Since inception, we have financed our operations by the sale of our securities and debt financings. We may need to raise additional funds in the future to fund our working capital needs, to fund more aggressive expansion of our business, to complete development, testing and marketing of our products, or to make strategic acquisitions or investments. We may require additional equity or debt financings, collaborative arrangements with corporate partners or funds from other sources for these purposes. No assurance can be given that necessary funds will be available for us to finance our development on acceptable terms, if at all. Furthermore, such additional financings may involve dilution of our shareholders or may require that we relinquish rights to certain of our technologies or products. In addition, we may experience operational difficulties and delays due to working capital restrictions. If adequate funds are not available from operations or additional sources of financing, we may have to delay or scale back our growth plans.
NOTE 2— SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Consolidation:
The financial statements include the accounts of the Company, our wholly-owned subsidiary Iso-Torque Corporation, and our majority-owned subsidiary, Ice Surface Development, Inc. (56% owned at March 31, 2016). As of March 31, 2016, each of the subsidiaries is non-operational. We are intending to let Ice Surface Development, Inc. dissolve by proclamation. All material intercompany transactions and account balances have been eliminated in consolidation.
Use of Estimates:
The preparation of financial statements in conformity with U.S. generally accepted accounting principles 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 revenue and expenses during the reporting period. These estimates are subject to a high degree of judgment and potential change. Actual results could differ from those estimates.
Reclassifications:
Certain reclassifications have been made to prior year balances to conform to the current year’s presentation.
Cash and Cash Equivalents:
Cash and cash equivalents may include time deposits, certificates of deposit, and highly liquid debt instruments with original maturities of three months or less. We maintain cash and cash equivalents at financial institutions which periodically may exceed federally insured amounts. We have a corporate credit card program through our primary financial institution, JPMorgan Chase Bank, N.A. In connection with this, the Company granted a security interest to the Bank in our premium commercial money market account to act as collateral for the activity within the corporate card program, up to $20,000.
Accounts Receivable
: We carry our accounts receivable at invoice amount less an allowance for doubtful accounts. On a periodic basis, we evaluate our accounts receivable and establish an allowance for doubtful accounts, based on a history of past write-offs and collections and current credit conditions. We do not accrue interest on past due invoices. The allowance for doubtful accounts was zero at March 31, 2016 and December 31, 2015.
Software, Property and Equipment:
Capitalized software, property and equipment are stated at cost. Estimated useful lives are as follows:
Software (in years)
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3
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Office equipment (in years)
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5
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-
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7
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Leasehold improvements
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lesser of useful life or lease term
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Depreciation and amortization are computed using the straight-line method. Betterments, renewals and extraordinary repairs that extend the life of the assets are capitalized. Other repairs and maintenance costs are expensed when incurred. When disposed, the cost and accumulated depreciation applicable to assets retired are removed from the accounts and the gain or loss on disposition is recognized in other income (expense). Depreciation and amortization expense for the three months ended March 31, 2016 and 2015 amounted to $41,000 and $33,000, respectively.
Whenever events or circumstances indicate, our long-lived assets including any intangible assets with finite useful lives, are tested for impairment by using the estimated future cash flows directly associated with, and that are expected to arise as a direct result of, the use of the assets. If the carrying amount exceeds the estimated undiscounted cash flows, impairment may be indicated. The carrying amount is compared to the estimated discounted cash flows and if there is an excess, such amount is recorded as impairment. During the three months ended March 31, 2016 and 2015, we recorded no impairment charges.
Fair Value of Financial Instruments:
As defined by U.S. GAAP
,
fair value is 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. A hierarchy for ranking the quality and reliability of the information is used to determine fair values. Assets and liabilities carried at fair value will be classified and disclosed in one of the following three categories:
Level 1: Quoted market prices in active markets for identical assets or liabilities
Level 2: Observable market based inputs or unobservable inputs that are corroborated by market data
Level 3: Unobservable inputs that are not corroborated by market data
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 Financial Accounting Standards Board’s (“FASB”) guidance for the disclosure about fair value of financial instruments requires disclosure of an estimate of the fair value of certain financial instruments. The fair value of financial instruments pursuant to FASB’s guidance for the disclosure about fair value of financial instruments approximated their carrying values at March 31, 2016. The carrying amount of cash and cash equivalents, prepaid expenses and other current assets, accounts payable and accrued expenses approximates their fair value due to their short maturity. The carrying amount of notes payable approximates fair value because stated or implied interest rates approximate current interest rates that are available for debt with similar terms.
Revenue
Recognition and Deferred Revenue
:
The Company began offering the Z-Coach aviation wellness program in the first quarter of 2016. The Z-Coach wellness program provides fatigue safety training over an annual subscription period of twelve months. The Z-Coach program allows the user unlimited access during the annual subscription period. Customers are billed at the acceptance of the subscription and revenue is recognized ratably over the subscription period as our performance obligations are satisfied and when collection is reasonably assured. Our collection terms provide customers standard terms of net 30 days. Future performance obligations are reflected in deferred revenue.
Research and Development and Patents:
Research and development costs and patent expenses are charged to operations as incurred. Research and development includes personnel-related costs, materials and supplies, depreciation and consulting services.
Patent costs for the three months ended March 31, 2016 and 2015 amounted to $17,000 and $38,000, respectively, and are included in general and administrative expenses.
Stock-based Compensation:
FASB Accounting Standards Codification (“ASC”) 718-10 requires all share-based payments to employees, including grants of employee stock options, to be recognized as compensation expense over the service period (generally the vesting period) in the consolidated financial statements based on their fair values on the grant date. The impact of forfeitures that may occur prior to vesting is also estimated and considered in the amount recognized. In addition, the realization of tax benefits in excess of amounts recognized for financial reporting purposes will be recognized as a financing activity in accordance with ASC 718-10.
No tax benefits were attributed to the stock-based compensation expense because a valuation allowance was maintained for substantially all net deferred tax assets.
FASB ASC 505-50, “Equity-Based Payments to Non-Employees,” requires all share-based payments to non-employees, including grants of stock options, to be recognized in the consolidated financial statements as compensation expense generally over the service period of the consulting arrangement or until performance conditions are expected to be met. Using a Black-Scholes valuation model, we periodically reassess the fair value of non-employee options until service conditions are met, which generally aligns with the vesting period of the options, and we adjust the expense recognized in the consolidated financial statements accordingly.
FASB ASC 718-20 requires that modifications of the terms or conditions of equity awards be treated as an exchange of the original award for a new award. Incremental compensation cost is measured as the excess, if any, of the fair value of the modified award over the fair value of the original award immediately before its terms are modified.
Income Taxes:
We account for income taxes using the asset and liability method, the objective of which is to establish deferred tax assets and liabilities for the temporary differences between the financial reporting and the tax bases of our assets and liabilities at enacted tax rates expected to be in effect when such amounts are realized or settled. A valuation allowance related to deferred tax assets is recorded when it is more likely than not that some portion or all of the deferred tax assets will not be realized.
We account for uncertain tax positions using a more-likely-than-not recognition threshold based on the technical merits of the tax position taken. Tax benefits that meet the more-likely-than-not recognition threshold should be measured as the largest amount of tax benefits, determined on a cumulative probability basis, which is more likely than not to be realized upon ultimate settlement in the financial statements. It is our policy to recognize interest and penalties related to income tax matters as general and administrative expenses. As of March 31, 2016 and December 31, 2015, there were no accrued interest or penalties related to uncertain tax positions.
Loss per Common Share:
FASB’s ASC 260-10 (“Earnings Per Share”) requires the presentation of basic earnings per share, which is based on weighted average common stock outstanding, and dilutive earnings per share, which gives effect to options, warrants and convertible securities in periods when they are dilutive. At March 31, 2016 and 2015, we excluded 59,016,206 and 53,570,093 potential common shares, respectively, relating to convertible preferred stock, options and warrants outstanding from the diluted net loss per common share calculation because their inclusion would be anti-dilutive. In addition, we excluded 625,000 warrants from the diluted net loss per common share calculation at March 31, 2016 and 2015 as the conditions for their vesting are not time-based.
Recent Accounting Pronouncements:
On February 25, 2016, the Financial Accounting Standards Board (the “FASB”) issued Accounting Standards Update (“ASU”) No. 2016-02, “Leases,” a comprehensive new lease standard which will supersede previous lease guidance. The standard requires a lessee to recognize in its balance sheet assets and liabilities related to long-term leases that were classified as operating leases under previous guidance. An asset will be recognized related to the right to use the underlying asset and a liability will be recognized related to the obligation to make lease payments over the term of the lease. The standard also requires expanded disclosures surrounding leases. The standard is effective for fiscal periods beginning after December 15, 2018, and requires modified retrospective adoption, with early adoption permitted. The Company is evaluating the impact of the adoption of this standard on our consolidated financial statements and related disclosures.
On March 30, 2016, the FASB issued ASU No. 2016-09, “Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting,” which amends the current stock compensation guidance. The amendments simplify the accounting for the taxes related to stock based compensation, including adjustments as to how excess tax benefits and a company's payments for tax withholdings should be classified. The standard is effective for fiscal periods beginning after December 15, 2016, with early adoption permitted. The Company is evaluating the impact of the adoption of this standard on our consolidated financial statements and related disclosures.
In April, 2016, the FASB issued ASU No. 2016-10, “Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing” to clarify two aspects of Topic 606: (i) identifying performance obligations and (ii) the licensing implementation guidance, while retaining the related principles for those areas. The Company is evaluating the impact of the adoption of this standard on our consolidated financial statements and related disclosures.
NOTE 3 –CURA SOFTWARE
The Company has invested $351,000 in software for the CURA division. These assets are being amortized over an estimated useful life of 3 years. As of March 31, 2016 accumulated amortization of capitalized software was $60,000 resulting in a net book value of $291,000.
With the initial sale of the Z-Coach aviation product in the first quarter of 2016, the Company charged $19,000 to cost of revenue and $8,000 to general and administrative expenses for amortization of the CURA software. Future amortization expense is expected to be $85,000 in 2016, $127,000 in 2017 and $79,000 in 2018.
NOTE 4 –PROPERTY AND EQUIPMENT
At March 31, 2016 and December 31, 2015, property and equipment consist of the following:
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March 31,
2016
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December 31,
2015
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Office equipment
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$
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235,000
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$
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235,000
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|
Shop equipment
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226,000
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226,000
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Leasehold improvements
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253,000
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253,000
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|
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714,000
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714,000
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Less accumulated depreciation
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568,000
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554,000
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Net property and equipment
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$
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146,000
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$
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160,000
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Depreciation expense for the three months ended March 31, 2016 and 2015 was $14,000 and $33,000 respectively.
NOTE 5 — BUSINESS SEGMENTS
The Company operates in two divisions: the CURA division and the Aegis division. The CURA division is focused on the fatigue and wellness business and the Aegis division is currently developing unique applications in the power and hydraulic business. Information concerning the Company’s operations by reportable segment for the three months ended March 31, 2016 for each of the company’s business segments follows:
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CURA
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Aegis
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Corporate
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Total
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Sales
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$
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1,000
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|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
1,000
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|
Gross margin (loss)
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$
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(22,000
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)
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$
|
-
|
|
|
$
|
-
|
|
|
$
|
(22,000
|
)
|
Operating costs and expenses
|
|
$
|
447,000
|
|
|
$
|
167,000
|
|
|
$
|
302,000
|
|
|
$
|
916,000
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|
Loss from operations
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|
$
|
470,000
|
|
|
$
|
167,000
|
|
|
$
|
301,000
|
|
|
$
|
938,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Assets
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|
$
|
292,000
|
|
|
$
|
105,000
|
|
|
$
|
1,632,000
|
|
|
$
|
2,029,000
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|
Capital expenditures during the first quarter of 2016 for the CURA and Aegis segments were $15,000 and zero, respectively. During the first quarter of 2016, the Company recognized depreciation and amortization expense of $28,000 and $11,000 for the CURA and Aegis divisions, respectively. Depreciation expense not allocated to these business segments was $2,000 in the first quarter of 2016.
Information concerning the Company’s operations by reportable segment for the three months ended March 31, 2015 for each of the company’s business segments follows:
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CURA
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Aegis
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Corporate
|
|
|
Total
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Sales
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
Gross margin (loss)
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
Operating costs and expenses
|
|
$
|
52,000
|
|
|
$
|
222,000
|
|
|
$
|
306,000
|
|
|
$
|
580,000
|
|
Loss from operations
|
|
$
|
52,000
|
|
|
$
|
222,000
|
|
|
$
|
303,000
|
|
|
$
|
580,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Assets
|
|
$
|
-
|
|
|
$
|
183,000
|
|
|
$
|
3,333,000
|
|
|
$
|
3,516,000
|
|
Capital expenditures during the first quarter of 2015 for the CURA and Aegis segments were zero and $6,000, respectively. During the first quarter of 2015, the Company recognized depreciation and amortization expense of zero and $21,000 for the CURA and Aegis divisions, respectively. Depreciation expense not allocated to these business segments was $12,000 in the first quarter of 2015.
NOTE 6— NOTES PAYABLE
In 2015, we entered into a capital lease for a copy machine over a 5-year term, with a fair market value buyout option. The capitalized value of the lease was approximately $8,900, and the monthly payment is $170 with an implicit interest rate of approximately 5.3%. As of March 31, 2016 and December 31, 2015, the outstanding principal balance due on this lease agreement was approximately $7,000.
NOTE 7 — PREFERRED and COMMON STOCK
Common Stock
We have authorized 400,000,000 shares of common stock, with a par value of $0.01 per share.
We did not issue any shares of common stock during the three months ended March 31, 2016. During the three months ended March 31, 2015, the Company issued 37,743 shares of common stock in connection with a conversion notice received from a Series A convertible preferred shareholder. The company issued 21,380 shares of common stock in connection with this notice and an additional 16,363 in common shares attributed to dividends earned on these converted shares.
Preferred Stock
Our certificate of incorporation permits the Company to issue up to 100,000,000 shares of $.01 par value preferred stock. The board of directors has the authority to allocate these shares into as many separate classes of preferred as it deems appropriate and with respect to each class, designate the number of preferred shares issuable and the relative rights, preferences, seniority with respect to other classes and to our common stock and any limitations and/or restrictions that may be applicable without obtaining shareholder approval.
Class A Preferred Stock
We have authorized the issuance of up to 3,300,000 Class A Non-Voting Cumulative Convertible Preferred Shares. Each Class A Preferred Share is convertible after a one year holding period, at the holder’s election, into one share of our common stock. The conversion rate is subject to adjustment in the event of the issuance of our common stock as a dividend or distribution and in the case of the subdivision or combination of our common stock. The Class A Preferred has no voting rights, except with respect to matters directly impacting upon the rights and privileges accorded to such Class.
The holders of the Class A Preferred are entitled to receive cumulative preferential dividends in the amount of $.40 per share of Class A Preferred for each annual dividend period. Dividends payable on the Class A Preferred will be paid in cash out of any funds legally available for the payment of dividends or, in the discretion of the board, will be paid in Class A Preferred at a rate of 1 share of Class A Preferred for each $4.00 of dividends. If dividends are paid in shares of Class A Preferred, such dividend shares are not entitled to accumulate additional dividends and themselves may be converted into the common stock of the Company on a one for one basis. Holders of Class A Preferred are permitted to request that dividends payable in Class A Preferred be immediately converted into shares of our common stock. At times, our board may elect to settle the dividends through the issuance of common stock in lieu of cash. Accumulated and unpaid dividends on the Class A Preferred will not bear interest. Class A Preferred shares are also entitled to participate pro rata in dividends declared and/or distributions made with respect to all classes of our outstanding equity. We may, in the absolute discretion of our board, redeem at any time and from time to time from any source of funds legally available any and all of the outstanding Class A Preferred at the redemption price of $4.00 per Class A Preferred, plus all unpaid accumulated dividends payable with respect to each Class A Preferred Share.
We did not convert any shares of preferred stock during the three months ended March 31, 2016. During the three months ended March 31, 2015, the Company issued 37,743 shares of common stock in connection with a conversion notice received from a Series A convertible preferred shareholder. The company issued 21,380 shares of common stock in connection with this notice and an additional 16,363 in common shares attributed to dividends earned on these converted shares.
At March 31, 2016, there were 543,221 outstanding shares of Class A Preferred stock, of which 8,709 shares resulted from the settlement of dividends due to conversion, and those shares no longer accrue dividends. The value of dividends payable upon the conversion of the remaining 534,512 outstanding shares of Class A Preferred stock amounted to approximately $2,378,000 at March 31, 2016. The value of dividends payable upon the conversion of the remaining 534,512 outstanding shares of Class A Preferred stock amounted to approximately $2,325,000 at December 31, 2015.
In the event of a liquidation, dissolution and winding up of the Company, and subject to the liquidation rights and privileges of our Class C Preferred shareholders, Class A Preferred shareholders have a liquidation preference with respect to all accumulated and unsettled dividends. The value of the Class A Preferred shareholders’ liquidation preference was approximately $2,378,000 and $2,325,000 at March 31, 2016 and December 31, 2015, respectively. In the event of liquidation, dissolution or winding up of the Company, unpaid accumulated dividends on the Class A Preferred are payable in Class A Preferred at a rate of 1 share of Class A Preferred for each $4.00 of dividends.
Class B Preferred Stock
The Company authorized the issuance of up to 300,000 Class B Non-Voting, Cumulative Convertible Preferred Shares to fund the business operations of Iso-Torque Corporation, an entity incorporated to separately commercialize the Company’s Iso-Torque differential technology.
Each Class B Preferred Share is convertible after a one year holding period, at the holder’s election, into one share of our common stock or one share of the common stock of Iso-Torque Corporation. The conversion rate is subject to adjustment in the event of the issuance of the Company’s or Iso-Torque Corporation’s common stock as a dividend or distribution and in the case of the subdivision or combination of such common stock. The Class B Preferred has no voting rights, except with respect to matters directly impacting upon the rights and privileges accorded to such Class.
Subject to the dividend rights and privileges of our Class A Preferred, the holders of the Class B Preferred are entitled to receive cumulative dividends in the amount of $.50 per share of Class B Preferred for each annual dividend period. Dividends payable on the Class B Preferred will be paid in cash out of any funds legally available for the payment of dividends or, in the discretion of the board, will be paid in Class B Preferred at a rate of 1 share of Class B Preferred for each $5.00 of dividends. If dividends are paid in shares of Class B Preferred, such dividend shares are not entitled to accumulate additional dividends and themselves may be converted into the common stock of the Company on a one for one basis. Holders of Class B Preferred are permitted to request that dividends payable in Class B Preferred be immediately converted into shares of our common stock. Accumulated and unpaid dividends on the Class B Preferred will not bear interest. Class B Preferred shares are also entitled to participate pro rata in dividends declared and/or distributions made with respect to all classes of our outstanding equity. We may, in the absolute discretion of our board, redeem at any time and from time to time from any source of funds legally available any and all of the outstanding Class B Preferred at the redemption price of $5.00 per Class B Preferred, plus all unpaid accumulated dividends payable with respect to each Class B Preferred Share.
Depending upon our cash position, from time to time we may request that a converting preferred shareholder receiving dividends in cash consent to receive shares of restricted common stock in lieu thereof. For the three months ended March 31, 2016 and 2015, we settled no Class B Preferred dividends.
At March 31, 2016 and December 31, 2015, dividends payable upon the conversion of 67,500 outstanding shares of Class B Preferred amounted to approximately $361,000 and $353,000, respectively. In the event of liquidation, dissolution and winding up of the Company, and subject to the liquidation rights and privileges of our Class C Preferred shareholders and our Class A Preferred shareholders, Class B Preferred shareholders have a liquidation preference with respect to all accumulated and unsettled dividends. The value of the Class B Preferred shareholders’ liquidation preference was $361,000 and $353,000 at March 31, 2016 and December 31, 2015, respectively. In the event of a liquidation, dissolution or winding up of the Company, unpaid accumulated dividends on the Class B Preferred are payable in Class B Preferred shares at a rate of 1 share of Class B Preferred for each $5.00 of dividends.
Series C Preferred Stock
We have authorized and issued 16,250,000 shares of Series C Voting Convertible Preferred Stock. Each Series C Preferred share is convertible, at the holder’s election, into one share of our common stock. The conversion rate is subject to adjustment in the event of the issuance of common stock as a dividend or distribution, and the subdivision or combination of the outstanding common stock.
The Series C Preferred shares have a liquidation preference at their stated value per share of $0.40 that is senior to our common stock, and the Company’s Class A Non-Voting Cumulative Convertible Preferred Shares and Class B Non-Voting Cumulative Convertible Preferred Shares. The liquidation preference is payable upon a liquidation, dissolution or winding up of the Company, whether voluntary or involuntary, or upon a deemed liquidation of the Company.
The Series C Preferred shares have no right to receive dividends and have no redemption right. The Series C Preferred shares vote with the common stock on an as-converted basis.
Cumulatively through March 31, 2016, Series C Preferred shareholders have converted no shares of Series C Preferred into common stock. At March 31, 2016 and December 31, 2015, there were 16,250,000 shares of Series C Preferred stock outstanding. The value of the Series C Preferred shareholders’ liquidation preference was $6,500,000 at March 31, 2016 and December 31, 2015.
Series C-2 Preferred Stock
In 2014, the board of directors authorized and the Class A Preferred, Class B Preferred and Series C Preferred shareholders approved, a series of preferred stock, namely 25,000,000 shares of Series C-2 Voting Convertible Preferred Stock. On March 28, 2014, we sold and issued a total of 25,000,000 shares of Series C-2 Voting Convertible Preferred Stock in a private placement transaction, generating gross proceeds of $5,000,000. Direct expenses of approximately $46,000 pertaining to the transaction, consisting of primarily external legal costs, were incurred, resulting in net proceeds of approximately $4,954,000.
Each Series C-2 Preferred Share is convertible, at the holder’s election, into one share of our common stock, par value $0.01 per share. The conversion rate is subject to adjustment in the event of the issuance of common stock as a dividend or distribution, and the subdivision or combination of the outstanding common stock or a reorganization, recapitalization, reclassification, consolidation or merger of the Company.
The Series C-2 Preferred Shares have a liquidation preference at their stated value per share of $0.20 that ranks pari passu to our existing Series C Voting Convertible Preferred Shares and is senior to our common stock, and our Class A Non-Voting Cumulative Convertible Preferred Shares and Class B Non-Voting Cumulative Convertible Preferred Shares. The liquidation preference is payable upon a liquidation, dissolution or winding up of the Company, whether voluntary or involuntary, or upon a deemed liquidation of the Company. A deemed liquidation includes, unless decided by the holders of at least two-thirds of the Series C-2 Preferred Shares, any consolidation, merger, or reorganization of the Company in which the shareholders of the Company own less than fifty percent of the voting power of the resultant entity, or an acquisition to which the Company is a party in which at least fifty percent of the Company’s voting power is transferred, or the sale, lease, exclusive license or transfer of all or substantially all of the assets or intellectual property of the Company other than to a wholly owned subsidiary.
The Series C-2 Preferred Shares are not entitled to receive preferred dividends and have no redemption right, but are entitled to participate, on an as converted basis; with holders of outstanding shares of common stock in dividends and distributions on liquidation after all preferred shares have received payment in full of any preferred dividends or liquidation preferences. The Series C-2 Preferred Shares vote with the common stock on an as-converted basis. We may not, without approval of the holders of at least two-thirds of the Series C-2 Preferred Shares, (i) create any class or series of stock that is pari passu or senior to the Series C-2 Preferred Shares; (ii) create any class or series of stock that would share in the liquidation preference of the Series C-2 Preferred Shares or that is entitled to dividends payable other than in common stock or Series C-2 Preferred Shares of its own series, (iii) acquire any equity security or pay any dividend, except dividends on a class or series of stock that is junior to the Series C Preferred Shares, payable in such junior stock, (iv) reissue any Series C-2 Preferred Shares, (v) declare or pay any dividend that would impair the payment of the liquidation preference of the Series C-2 Preferred Shares, (vi) authorize or issue any additional Preferred Shares, (vii) change the Certificate of Incorporation to adversely affect the rights of the holders of the Series C-2 Preferred Shares, or (viii) authorize, commit to or consummate any liquidation, dissolution or winding up in which the liquidation preference of the Series C-2 Preferred Shares would not be paid in full.
The Series C-2 Preferred Shares will not be and have not been registered under the Securities Act of 1933, as amended, or the Securities Act, and may not be offered or sold in the United States absent registration or an applicable exemption from registration requirements.
Through March 31, 2016, Series C-2 Preferred shareholders have not converted any shares of Series C-2 Preferred into common stock. At March 31, 2016 and December 31, 2015, there were 25,000,000 shares of Preferred C-2 stock outstanding. The value of the Series C-2 Preferred shareholders’ liquidation preference was $5,000,000 at March 31, 2016 and December 31, 2015.
Series C-3 Preferred Stock
In 2015, the board of directors authorized and the Class A Preferred, Class B Preferred, Series C Preferred and C-2 Preferred shareholders approved, a series of preferred stock, namely 10,000,000 shares of Series C-3 Voting Convertible Preferred Stock. On December 8, 2015, the Company commenced the offering of up to $2,500,000 of the Series C-3 Preferred Shares at the price of $0.25 per share in a private placement pursuant to Rule 506(c) of Regulation D under the Securities Act of 1933. The offering has been made only to “accredited investors” as defined in Rule 501(a) of Regulation D under the Securities Act of 1933. The Series C-3 Preferred Shares are convertible into shares of the Company’s common stock at the rate of one-to-one, subject to adjustment in some circumstances. The Series C-3 Preferred Shares will have an aggregate liquidation preference, ranking
pari passu
with the Series C Preferred Shares and Series C-2 Preferred Shares and senior to the company’s common stock, the Class A Preferred Shares and Class B Preferred Shares. The Series C-3 Preferred Shares are not entitled to receive preferred dividends and have no redemption rights, but are entitled to participate, on an as converted basis, with holders of the company’s common stock in dividends and distributions. The Series C-3 Preferred Shares vote with the Company’s common stock on an as-converted basis and have certain protective provisions. The Series C-3 Preferred Shares will not be registered under the Securities Act of 1933. Accordingly, those shares and the shares of common stock issuable upon their conversion are “restricted securities” within the meaning of Rule 144 under the Securities Act of 1933 and may not be offered for resale or resold or otherwise transferred except pursuant to a registration statement under the Securities Act of 1933 or an applicable exemption from registration requirements.
As of March 31, 2016, the Company has sold and issued a total of 4,478,000 shares of Series C-3 Voting Convertible Preferred Stock in a private placement transaction, generating gross proceeds of $1,119,000. Direct expenses of approximately $5,000 pertaining to the transaction, consisting of external legal costs, were incurred, resulting in net proceeds of approximately $1,114,000.
In conjunction with the issuance of the 4,478,000 shares of Series C-3 Preferred stock, we computed the value of the non-cash beneficial conversion feature associated with the right to convert the shares into common stock on a one-for-one basis. We compared the fair value of our common stock on the date of issuance with the effective conversion price, and determined that the value of the non-cash beneficial conversion feature was approximately $549,000, and is reflected in our condensed consolidated statements of operations for the three months ended March 31, 2016 as an adjustment to arrive at the net loss attributable to common stockholders.
NOTE 8 — STOCK OPTIONS
2011 Stock Option Plan
In 2011, shareholders approved the 2011 Stock Option Plan (the “2011 Plan”) which provides for the grant of up to 3,000,000 common stock options to provide equity incentives to directors, officers, employees and consultants. Two types of options may be granted under the 2011 Plan: non-qualified stock options and incentive stock options.
Non-qualified stock options may be granted to our officers, directors, employees and outside consultants. Incentive stock options may be granted only to our employees, including officers and directors who are also employees. In the case of non-qualified stock options, the exercise price may be less than the fair market value of our stock on the date of grant. Stock option grants to non-employees are revalued at each reporting date to reflect the compensation expense over the vesting period. In the case of incentive stock options, the exercise price may not be less than such fair market value and in the case of an employee who owns more than 10% of our common stock, the exercise price may not be less than 110% of such market price. Options generally are exercisable for ten years from the date of grant, except that the exercise period for an incentive stock option granted to an employee who owns more than 10% of our stock may not be greater than five years.
During the first quarter of 2016, we granted 15,000 stock options to certain of our existing employees at an exercise price of $0.41 per share, exercisable for 10 years. These options vest in four tranches at a rate of 25% per year on each of the four anniversary dates from the date of grant. Also in the first quarter of 2016, we granted 297,000 incentive stock options to several employees and to our non-employee board members to acquire common shares at an exercise price of $0.34 to $0.53 per share, exercisable for 10 years. This group of options will fully vest upon the trading price of the common stock of the Company reaching $5.00 per share.
As of March 31, 2016, there were 2,360,000 stock options outstanding under the 2011 Plan, 1,337,125 of which were vested. At March 31, 2016, there were 640,000 options remaining available for future grant under the 2011 Plan. No 2011 Plan options expired or were exercised during the three month periods ended March 31, 2016 or 2015.
For the three months ended March 31, 2016 and 2015, we recorded compensation expense of $31,000 and $12,000, respectively, related to the 2011 Stock Option Plan.
Non-Plan Options
On occasion, we have granted non-qualified stock options to certain officers, directors and employees that have been outside of established Company Stock Option Plans. All such option grants have been authorized by shareholder approval.
The expense recognized for options that are granted to consultants (i.e., non-employees) reflect fair value, based on updated valuation assumptions using the Black-Scholes valuation model at each measurement period. Such expense is apportioned over the requisite service period of the consultant, which is concurrent with the vesting dates of the various tranches.
As of March 31, 2016, there were a total of 6,965,000 non-plan options outstanding, of which 4,815,000 were fully vested. In the three months ended March 31, 2016 and 2015, zero and 337,500, respectively of non-plan stock options, became vested. During the three months ended March 31, 2016 and 2015, no non-plan stock options were cancelled, respectively. No non-plan stock options were exercised in the three months ended March 31, 2016 or 2015.
For the three months ended March 31, 2016 and 2015, we recorded compensation expense of zero and $43,000, respectively, related to the non-plan options.
Summary
For the three months ended March 31, 2016 and 2015, compensation cost related to all stock options amounted to $31,000 and $55,000, respectively. As of March 31, 2016, there was approximately $305,000 of total unrecognized compensation costs related to outstanding stock options, which are expected to be recognized over a weighted average 1.8 years.
The weighted average grant date fair value of all stock options granted during the three months ended March 31, 2016 and 2015 was $.45 and $.20, respectively. The total grant date fair value of stock options vested during the three months ended March 31, 2016 and 2015 was approximately zero and $653,000, respectively.
The fair value of options granted during the three month periods ended March 31, 2016 and 2015 were estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions:
|
|
2016
|
|
|
2015
|
|
Expected Term (years)
|
|
|
5.1
|
|
|
|
6.6
|
|
Expected forfeiture rate
|
|
|
0
|
%
|
|
|
0
|
%
|
Risk-free rate
|
|
|
2.1
|
%
|
|
|
2.1
|
%
|
Volatility
|
|
|
132
|
%
|
|
|
135
|
%
|
Dividend yield
|
|
|
0
|
%
|
|
|
0
|
%
|
Included in the 2016 assumptions above is the impact of 297,000 stock options that were granted under the 2011 Plan that will vest based on certain market conditions, specifically these options will fully vest upon the first day the trading price of the common stock of the Company shall be $5.00 per share.
The average risk-free interest rate is based on the U.S. treasury security rate in effect as of the grant date. We determined expected volatility using the historical closing stock price. The expected life was generally determined using the simplified method as we do not believe we have sufficient historical stock option exercise experience on which to base the expected term.
The following summarizes the activity of all of our outstanding stock options for the three months ended March 31, 2016 and 2015:
|
|
|
|
|
|
Weighted
|
|
|
Average
|
|
|
|
|
|
|
|
|
|
|
|
Average
|
|
|
Remaining
|
|
|
Aggregate
|
|
|
|
|
|
|
|
Exercise
|
|
|
Contractual
|
|
|
Intrinsic
|
|
|
|
Shares
|
|
|
Price
|
|
|
Term (years)
|
|
|
Value
|
|
Outstanding at January 1, 2016
|
|
|
9,013,000
|
|
|
$
|
.57
|
|
|
|
5.5
|
|
|
$
|
33,000
|
|
Granted
|
|
|
312,000
|
|
|
|
.45
|
|
|
|
|
|
|
|
|
|
Exercised
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
Canceled or expired
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at March 31, 2016
|
|
|
9,325,000
|
|
|
$
|
.56
|
|
|
|
5.4
|
|
|
$
|
274,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercisable at March 31, 2016
|
|
|
6,152,125
|
|
|
$
|
.66
|
|
|
|
5.1
|
|
|
$
|
123,000
|
|
As of March 31, 2016, the exercise prices of all outstanding stock options ranged from $.20 per share to $5.00 per share.
NOTE 9 - WARRANTS
The following table summarizes the activity of the outstanding warrants as of March 31, 2016:
|
|
|
|
|
|
|
|
|
|
Weighted
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
|
|
|
Average
|
|
|
|
|
|
|
|
|
|
|
|
Average
|
|
|
Remaining
|
|
|
Aggregate
|
|
|
|
|
|
|
|
Exercise
|
|
|
Contractual
|
|
|
Intrinsic
|
|
|
|
Shares
|
|
|
Price
|
|
|
Term
|
|
|
Value
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at January 1, 2016
|
|
|
3,315,000
|
|
|
$
|
2.04
|
(A)
|
|
|
4.7
|
(B)
|
|
|
|
|
Granted
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Expired
|
|
|
(4,250
|
)
|
|
$
|
0.01
|
|
|
|
|
|
|
|
|
|
Outstanding at March 31, 2016
|
|
|
3,310,750
|
|
|
$
|
2.05
|
(A)
|
|
|
4.5
|
(D)
|
|
$
|
112,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercisable at March 31, 2016
|
|
|
2,690,000
|
|
|
$
|
1.90
|
(D)
|
|
|
4.2
|
(C)
|
|
$
|
111,000
|
|
|
(A)
|
The weighted average exercise price for warrants outstanding as of March 31, 2016 excludes 1,750,000
warrants with no determined exercise price.
|
|
(B)
|
The weighted average remaining contractual term for warrants outstanding as of March 31, 2016 excludes 743,500 warrants with no expiration date.
|
|
(C)
|
The weighted average remaining contractual term for warrants exercisable as of March 31, 2016 excludes
118,500 warrants with no expiration date.
|
|
(D)
|
The weighted average exercise price for warrants exercisable as of March 31, 2016 excludes 1,625,000
warrants with no determined exercise price.
|
NOTE 10 — RELATED PARTY TRANSACTIONS
We occupy a leased facility for our corporate headquarters building, located in Rochester, New York, which consists of both executive offices and manufacturing space. The facility is owned by a partnership, with which one of our directors, is associated. In 2014 we extended our lease for a three-year renewal term through May 31, 2018. The current rental rate is $6,256 per month ($75,070 per annum) for the remainder of the current lease term. In addition, we are required to pay a proportionate share of yearly real estate taxes and yearly common area operating costs. The lease agreement has a three-year renewal option that includes a 9% rate increase at the renewal period that includes the period from June 2018 through May 2021.
In December 2013, we entered into a consulting agreement with SCIRE Corporation, of which one of our directors is president, to provide us with expertise and advice on hydraulic pump technology and related markets. This consulting agreement expired at December 31, 2015. During the three months ended March 31 2015, we recorded an expense of approximately $18,000 for consulting services and travel costs related to this agreement.
In December 2010, we executed a three-year consultant agreement with one of our directors to provide consulting services to us at a rate of $200 per hour. Pursuant to the agreement, we also agreed to pay the consultant an incentive fee equal to $10,000 or proportionate part thereof for each $1,000,000 of revenue or proportionate part thereof actually received by us for a period of five years, provided the definitive agreement with the third party results from the material efforts of the consultant. In December 2013, the agreement was automatically renewed for an additional three years through December 13, 2016. During the three month periods ended March 31, 2016 and 2015, we recorded no expense for services in relation to this agreement.
NOTE 11 — COMMITMENTS AND OTHER MATTERS
Leases
We occupy a leased facility for our corporate headquarters building, located in Rochester, New York, which consists of both executive offices and manufacturing space. The facility is owned by a partnership in which a Company director is associated. The current rental rate is $6,256 per month ($75,070 per annum) for the remainder of the current lease term. In addition, we are required to pay a proportionate share of yearly real estate taxes and yearly common area operating costs. The lease agreement has a three-year renewal option that includes a 9% rate increase at the renewal period that includes the period from June 2018 through May 2021.
Rent expense for the three months ended March 31, 2016 and 2015 was approximately $19,000 and $17,000, respectively. Rent payments required under the extended lease term for the years ending December 31, 2016, 2017, and 2018 amount to approximately $75,000, $75,000 and $31,000, respectively.
Employment Agreements
On March 24, 2016, the Company’s renewed the employment agreement with the Chief Executive Officer to extend the term of the agreement until December 31, 2018, subject to earlier termination in accordance with its terms. Except for the extension of the term, the employment agreement remains in effect in accordance with its original terms. The executive will continue to be entitled to an annual salary of at least $50,000; provided that if the Company has “Adjusted EBITDA” (as defined in the agreement) of at least $300,000 in any calendar year, then his annual salary shall be at least $200,000 for the following calendar year. The executive is entitled to participate in all employee benefit plans as are provided from time to time for senior executives. If we terminate the CEO without cause, remove him as CEO, or a change in control of the Company occurs, the CEO is entitled to three years’ severance pay, consisting of base pay and any incentive compensation.
On March 3, 2016 the Torvec Board of Directors approved a change in the compensation plan for the Chief Financial Officer, in connection with her transition to full time effective March 1, 2016. The annual salary for this executive has been increased to $150,000 effective March 1, 2016 and will increase to $200,000 effective June 1, 2016. This executive is entitled to six months’ severance in the event that the Company terminates their employment status without cause or in the instance of a change in control of the Company.