UNITED STATES SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

(Mark One)

 

þ

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 2012

  

Or

 

¨

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from          to

 

Commission File Number: 333-128226

 

INTELLECT NEUROSCIENCES, INC.

(Exact Name of Registrant as Specified in Its Charter)

 

Delaware	20-8329066
(State or Other Jurisdiction of	(I.R.S. Employer
Incorporation)	Identification Number)
45 West 36th Street
New York, New York	10018
(Address of Principal Executive Offices)	(Zip Code)

 

(212) 448-9300

(Registrant’s Telephone Number, Including Area Code)

 

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

 

Indicate by checkmark whether the Registrant has submitted electronically and posted on its corporate website, if any, any Interactive Data File required to be submitted and posted pursuant to Rule 405 of regulation S-T (Section 232.405) of this chapter during the preceding 12 months or for such shorter period that the Registrant was required to submit and post such files. Yes¨ No ¨

 

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

 

Large accelerated filer ¨	Accelerated filer ¨	Non-accelerated filer ¨	Smaller reporting company þ
		(Do not check if a smaller reporting company)

 

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

 

The registrant had 107,990,020 shares of Common Stock, par value $.001 par value per share, outstanding as of November 20, 2012.

 

 

Index

 

			PAGE
PART I.	FINANCIAL INFORMATION
Item 1.	Financial Statements: (Unaudited)
	Consolidated Balance Sheets as of September 30, 2012 (unaudited) and June 30, 2011		3
	Consolidated Statements of Operations for the three months ended September 30, 2012 and 2011 and for the period April 25, 2005 (inception) through September 30, 2012 (unaudited)		4
	Consolidated Statements of Cash Flows for the three months ended September 30, 2012 and 2011 and for the period April 25, 2005 (inception) through September 30, 2012 (unaudited)		5
	Notes to Unaudited Consolidated Financial Statements		6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		18
Item 3.	Quantitative and Qualitative Disclosures about Market Risk		23
Item 4.	Controls and Procedures		24
PART II.	OTHER INFORMATION		24
Item 5.	Other		24
Item 6.	Exhibits		24
SIGNATURES			25
CERTIFICATIONS

 

 

Intellect Neurosciences Inc. and Subsidiary

(a development stage company)

 

Consolidated Balance Sheets

  

		September 30, 2012				June 30, 2012
						Restated
ASSETS
Current assets:
Cash and cash equivalents		$	20,553			$	2,307
Pre-paid expenses			11,519				19,585
Total current assets			32,072				21,892
Security deposits			4,715				4,715
Total Assets		$	36,787			$	26,607
LIABILITIES AND CAPITAL DEFICIENCY
Current Liabilities:
Accounts payable and accrued expenses		$	2,388,505			$	2,949,764
Accrued interest - convertible promissory notes			251,829				201,997
Derivative instruments			3,492,036				3,388,482
Preferred stock liability			345,748				518,622
Preferred stock dividend payable			3,535,994				3,605,515
Total Current liabilities		$	10,014,112			$	10,664,380
Long Term Debt
Convertible promissory notes			576,371				442,155
Total Liabilities		$	10,590,483			$	11,106,535
Capital deficiency:
Series B Convertible Preferred stock - 1,000,000 shares designated and 106,878
shares issued at September 30, 2012, and June 30, 2012(classified as liability above)
(liquidation preference $1,870,380)			-				-
Series C Convertible Preferred stock, $.001 par value - 25,000 shares designated and
21,325 and 20,700 shares issued at September 30, 2012 and June 30, 2012
respectively (liquidation preference $21,325,000 and $20,700,000 respectively)		$	21			$	21
Common stock, par value $0.001 per share, 2,000,000,000 shares
authorized; 107,990,020 and 100,240,020 issued and outstanding, respectively			107,990				100,240
Additional paid in capital			63,621,017				62,956,267
Deficit accumulated during the development stage			(74,282,724	)			(74,136,456	)
Total Capital Deficiency		$	(10,553,696	)		$	(11,079,928	)
Total Liabilities and Capital Deficiency		$	36,787			$	26,607

  

See notes to consolidated financial statements

 

  

Intellect Neurosciences Inc. and Subsidiary

(a development stage company)

 

Consolidated Statements of Operations

  

		Three Months Ended								April 25, 2005
		September 30,								(inception) through
		2012				2011				September 30, 2012
						Restated
Revenues:
License fees		$	-			$	6,500,000			$	10,516,667
Total revenue		$	-			$	6,500,000			$	10,516,667
Costs and Expenses:
Research and development			167,920				28,559				14,600,709
General and administrative			379,407				547,491				41,609,206
Total cost and expenses			547,327				576,050				56,209,915
Loss from operations			(547,327	)			5,923,950				(45,693,248	)
Other income/(expenses):
Interest expense			(877,722	)			(2,528,222	)			(64,130,678	)
Interest income			-				-				18,525
Changes in value of derivative instruments and preferred stock liability			1,278,781				(1,659,930	)			43,838,090
Gain (Loss) on extinguishment of debt			-				-				(627,809	)
Other			-				-				(6,587,604	)
Write off of investment			-				-				(150,000	)
Total other income/(expense):			401,059				(4,188,152	)			(27,639,476	)
Net income/(loss)			(146,268	)			1,735,798				(73,332,724	)
Deemed preferred stock dividend			-				-				950,000
Net income (loss) allocable to Common Shareholders		$	(146,268	)		$	1,735,798			$	(74,282,724	)
Basic income (loss) per share		$	(0.00	)		$	0.02
Diluted income (loss) per share		$	(0.00	)		$	0.01
Weighted average number of shares outstanding:
Basic			103,321,542				70,968,534
Diluted			103,321,542				180,318,396

 

See notes to consolidated financial statements

 

  

Intellect Neurosciences Inc. and Subsidiary

(a development stage company)

 

Consolidated Statements of Cash Flows

  

										April 25, 2005
		Twelve Months Ended								(inception)
		March 31,								through September 30,
		2012				2011				2012
						Restated
Cashflows from operating activities:
Net income (loss)		$	(146,268	)		$	1,735,798			$	(73,332,724	)
Adjustments to reconcile net income (loss) to net cash used in operating activities:
Depreciation and amortization			-								836,769
Amortization of financing costs			-								2,403,966
Change in unrealized (gain) loss of derivative instruments			(1,278,781	)			1,659,930				(43,136,229	)
Stock and warrant based compensation			231,265				128				13,569,065
Interest expense related to warrants			137,567				1,742,806				41,526,699
Write-off of investment			-				-				150,000
Shares issued in connection with merger			-				-				7,020,000
Shares issued for note extensions and compensation			-								753,453
Conversion of common stock to new Series B preferred shares			-				-				6,606,532
Non-cash interest expense			740,155				785,416				17,202,416
Non-cash expense related to Series B dividends			-				-				1,802,610
Disposition of fixed assets			-				-				43,412
Loss on sale of fixed assets			-				-				179,516
Loss on extinguishment of debt			-				-				(74,060	)
							-
Changes in:											-
Prepaid expenses and other assets			8,066				-				(12,417	)
License fee receivable			-				(6,500,000	)			(6,963	)
Accounts payable and accrued expenses			(1,258	)			326,076				3,340,591
Accrued interest			-								(71,152	)
Deferred lease liability			-				-				-
Other long term liabilities			-				-				-
Net cash used in operating activities:			(309,254	)			(249,846	)			(21,198,517	)
Cashflows from investing activities:
Security deposit			-				-				(3,912	)
Acquisition of property and equipment			-				-				(1,059,699	)
Cash paid for acquisition			-				-				(150,000	)
Net cash provided by (used in) investing activities:			-				-				(1,213,611	)
Cashflows from financing activities:
Borrowings from stockholders			-				-				6,153,828
Proceeds from sale of common stock			-				-				1,761,353
Proceeds from sale of preferred stock			-				-				7,711,150
Preferred stock issuance costs			-				-				(814,550	)
Proceeds from sale of Convertible Promissory Notes			360,000				150,000				11,318,000
Repayment of borrowings from stockholder			-				-				(1,706,000	)
Convertible Promissory Notes issuance cost			-				-				(466,100	)
Repayment of borrowings from noteholders			(32,500	)			-				(1,725,000	)
Proceeds from excersise of stock warrants			-				-				200,000
Net cash provided by financing activities:			327,500				150,000				22,432,681
Net increase (decrease) in cash and cash equivalents			18,246				(99,846	)			20,553
Cash and cash equivalents beginning of period			2,307				101,325
Cash and cash equivalents end of period		$	20,553			$	1,479			$	20,553
Supplemental disclosure of cash flow informations:
Cash paid during the period for:
Interest			-				-			$	145,115
Non-cash investing and financing transactions:
Conversion of Convertible Notes payable and accrued interest into Common Stock (including derivative liability)			-				-			$	16,285,736
Conversion of Preferred Stock to Common Stock			5,000				370,414				6,803,451
Common Stock issued in repayment of debt			-				-				248,000
Accrued dividend on Series B prefs treated as capital contribution			-				47,329				387,104
Cashless excersise of Warrant for Common Stock			-				-				18,431,745
Debt discount from warrants and beneficial conversion feature			328,129				-				976,629
Deemed preferred stock dividend from beneficial conversion feature			-				-				950,000
Issuance of warrants for repayment of accrued expenses			560,000				-				704,085

 

See notes to consolidated financial statements

 

  

Intellect Neurosciences, Inc. (a development stage company)

Notes to Unaudited Consolidated Condensed Financial Statements

September 30, 2012

 

Note 1. Basis of Presentation

 

The accompanying unaudited consolidated condensed financial statements presented herein have been prepared in accordance with the instructions to Form 10-Q and do not include all the information and note disclosures required by accounting principles generally accepted in the United States. The consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto contained in the Company’s Annual Report on Form 10-K for the fiscal year ended June 30, 2012 filed with the Securities and Exchange Commission (the “SEC”) on October 15, 2012. In the opinion of management, this interim information includes all material adjustments, which are of a normal and recurring nature, necessary for fair presentation.

 

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Estimates that are particularly susceptible to change include assumptions used in determining the fair value of securities owned and non-readily marketable securities.

 

The results of operations for the three months ended September 30, 2012 are not necessarily indicative of the results to be expected for the entire year or for any other period.

 

2. Business Description and Going Concern

 

Intellect Neurosciences, Inc. (“Intellect”, “our”, “us”, “we” or the “Company” refer to Intellect Neurosciences, Inc. and its subsidiaries) a Delaware corporation, is a biopharmaceutical company, which together with its subsidiary Intellect Neurosciences, USA, Inc. (“Intellect USA”), is conducting research regarding proprietary drug candidates to treat Alzheimer’s disease (“AD”) and other diseases associated with oxidative stress. In addition, we have developed and are advancing a patent portfolio related to specific therapeutic approaches for treating AD. Since our inception in 2005, we have devoted substantially all of our efforts and resources to research and development activities and advancing our patent estate. We operate under a single segment. Our fiscal year end is June 30. We have had no product sales through September 30, 2012 though we have received $10,516,667 in up-front and milestone license fees from inception through September 30, 2012. Our losses from operations have been funded primarily with the proceeds of equity and debt financings and fees due under license agreements.

 

We are a development stage company and our core business strategy is to leverage our intellectual property estate through license arrangements and to develop our proprietary compounds that we have purchased, developed internally or in-licensed from universities and others, through human proof of concept (Phase II) studies or earlier if appropriate and then seek to enter into collaboration agreements, licenses or sales to complete product development and commercialize the resulting drug products. Our objective is to obtain revenues from licensing fees, milestone payments, development fees and royalties related to the use of our intellectual property estate and the use of our proprietary compounds for specific therapeutic indications or applications. As of September 30, 2012, we had no self-developed or licensed products approved for sale by the U.S. Food and Drug Administration (“FDA”). There can be no assurance that our research and development efforts will be successful, that any products developed by any of our licensees will obtain necessary government regulatory approval or that any approved products will be commercially viable. In addition, we operate in an environment of rapid change in technology and are dependent upon the continued services of our current employees, consultants and subcontractors.

 

We have limited capital resources and operations since inception have been funded with the proceeds from equity and debt financings and license fee arrangements. As of September 30, 2012, we had cash and cash equivalents of $20,553. We anticipate that our existing capital resources will enable us to continue operations for the next month. If we fail to raise additional capital or obtain substantial cash inflows from existing or potential shareholders or partners within the next month, we may be forced to cease operations.

 

  

Our business will require substantial additional investment that we have not yet secured. We cannot be sure how much we will need to spend in order to develop new products and technologies in the future. Further, we will not have sufficient resources to develop fully any new products or technologies unless we are able to raise substantial additional financing on acceptable terms or secure funds from new or existing partners. If we fail to raise additional capital or obtain substantial cash inflows from existing or potential partners, we will be unable to successfully develop and commercialize our products. We cannot assure you that financing will be available in a timely manner, on favorable terms or at all. No adjustment has been made to the carrying amount and classification of assets and the carrying amount of liabilities based on the going concern uncertainty.

 

Effective April 12, 2011, we completed a 50 for 1 reverse stock split. The accompanying financial statements and notes to the financial statements presented herein give retroactive effect to the reverse split for all periods presented.

 

3. Summary of Significant Accounting Policies

 

Revenue Recognition

 

Upfront License Fees. Consideration that we receive pursuant to patent license agreements is recognized as income when (a) the licensee obtains a license to one or more of our patents, (b) the licensee is responsible for all of the development work on the product candidate, (c) the licensee has the technical ability to perform the development, (d) the licensee requires a license from us to sell the resulting drug product without infringing our patents, (e) payment due under the license agreement is reasonably assured and (f) we have no future performance obligations under the license agreement.

 

Milestones. We enter into patent license agreements, which contain milestones related to reaching particular stages in product development. We recognize revenues from milestones when we have no further obligation with respect to the activities under the agreement and when we have confirmed that the milestone has been achieved. Where we have continuing involvement obligations in the form of development efforts, we recognize revenues from milestones ratably over the development period.

 

Principles of Consolidation. The consolidated financial statements include the accounts of our wholly owned subsidiary, Intellect Israel, and the accounts of Mindgenix, Inc. (“Mindgenix”), a wholly-owned subsidiary of Mindset Biopharmaceuticals, Inc. (“Mindset”). We consolidate Mindgenix because we have agreed to absorb certain costs and expenses incurred by Mindgenix that are attributable to its research. Dr. Chain, our CEO, is a controlling shareholder of Mindset and the President of Mindgenix. All inter-company transactions and balances have been eliminated in consolidation

 

Convertible Instruments. We evaluate and account for conversion options embedded in convertible instruments in accordance with ASC 815 “Derivatives and Hedging Activities”. GAAP requires companies to bifurcate conversion options from their host instruments and account for them as free standing derivative financial instruments according to certain criteria. The criteria include circumstances in which (a) the economic characteristics and risks of the embedded derivative instrument are not clearly and closely related to the economic characteristics and risks of the host contract, (b) the hybrid instrument that embodies both the embedded derivative instrument and the host contract is not re-measured at fair value under other GAAP with changes in fair value reported in earnings as they occur and (c) a separate instrument with the same terms as the embedded derivative instrument would be considered a derivative instrument.

 

We account for convertible instruments (when we have determined that the embedded conversion options should not be bifurcated from their host instruments) as follows: We record when necessary, discounts to convertible notes for the intrinsic value of conversion options embedded in debt instruments based upon the differences between the fair value of the underlying common stock at the commitment date of the note transaction and the effective conversion price embedded in the note. Debt discounts under these arrangements are amortized over the term of the related debt to their stated date of redemption. We also record when necessary, deemed dividends for the intrinsic value of conversion options embedded in preferred shares based upon the differences between the fair value of the underlying common stock at the commitment date of the transaction and the effective conversion price embedded in the preferred shares.

 

 

Common Stock Purchase Warrants. We classify as equity any contracts that require physical settlement or net-share settlement or provide us a choice of net-cash settlement or settlement in our own shares (physical settlement or net-share settlement) provided that such contracts are indexed to our own stock as defined in ASC 815-40 ("Contracts in Entity's Own Equity"). We classify as assets or liabilities any contracts that require net-cash settlement (including a requirement to net cash settle the contract if an event occurs and if that event is outside our control) or give the counterparty a choice of net-cash settlement or settlement in shares (physical settlement or net-share settlement). We assess classification of our common stock purchase warrants and other free standing derivatives at each reporting date to determine whether a change in classification between assets and liabilities is required.

 

Preferred Stock. We apply the guidance enumerated in ASC 480 “Distinguishing Liabilities from Equity” when determining the classification and measurement of preferred stock. Preferred shares subject to mandatory redemption (if any) are classified as liability instruments and are measured at fair value. We classify conditionally redeemable preferred shares (if any), which includes preferred shares that feature redemption rights that are either within the control of the holder or subject to redemption upon the occurrence of uncertain events not solely within our control, as temporary equity. At all other times, we classified our preferred shares in stockholders’ equity.

 

Derivative Instruments. Our derivative financial instruments consist of embedded derivatives related to the convertible debt, warrants and beneficial conversion features embedded within our convertible debt. The accounting treatment of derivative financial instruments requires that we record the derivatives and related warrants at their fair values as of the inception date of the debt agreements and at fair value as of each subsequent balance sheet date. Any change in fair value was recorded as non-operating, non-cash income or expense at each balance sheet date. If the fair value of the derivatives was higher at the subsequent balance sheet date, we recorded a non-operating, non-cash charge. If the fair value of the derivatives was lower at the subsequent balance sheet date, we recorded non-operating, non-cash income.

 

During the three month periods ended September 30, 2012, we recognized other income of approximately $1.3 million respectively, relating to recording the derivative liabilities at fair value. At September 30, 2012 and June 30, 2012, there were approximately $3.5 million and $3.4 million of derivative liabilities, respectively.

 

Our derivative instruments were valued using the Black-Scholes option pricing model, using the following assumptions during the quarter ended September 30, 2012:

 

Estimated dividends:	None
Expected volatility:	167 %
Risk-free interest rate:	1.76 %
Expected term (years):	0.7 to 5 years

 

4. ViroPharma License Transaction

 

On and effective as of September 29, 2011, we entered into an Exclusive License Agreement (the “License Agreement”) with ViroPharma Incorporated, a Delaware corporation (“ViroPharma”), pursuant to which, among other things, we granted an exclusive license to ViroPharma regarding certain of our licensed patents and patent applications related to our clinical stage drug candidate, OX1, an antioxidant molecule containing indole-3-propionic acid. We expect ViroPharma to develop and commercialize OX1 as a treatment of Friedreich’s Ataxia and possibly other diseases for which OX1 may qualify for orphan drug designation.

 

Under the terms of the License Agreement, we agreed to transfer to ViroPharma all of our intellectual property rights, data and know-how related to our OX1 research and development program in exchange for payment by ViroPharma of a $6.5 million up-front licensing fee which was received in October 2011, and additional regulatory milestone payments based upon defined events in the United States and the European Union. The aggregate maximum of these milestone payments assuming successful advancement of the product to market could amount to $120 million. In addition, ViroPharma will pay us a tiered royalty of up to an aggregate maximum of low double digits based on annual net sales. NYU School of Medicine and South Alabama Medical Science Foundation, which own certain patents in relation to OX1, are entitled to a portion of the royalties and revenues received by us from any sale or license of OX1 pursuant to an exclusive license agreement between the universities and us.

 

  

The term of the License Agreement will continue in effect on a licensed product-by-licensed product and country-by-country basis until the expiration of the last royalty obligation with respect to a licensed product in such country. Once the royalty obligation has terminated in a particular country, the license will become non-exclusive and fully paid-up with respect to licensed products in that country.

 

Either party may terminate the License Agreement upon an uncured material breach of the other party. In addition, if ViroPharma determines that it is not feasible or desirable to develop or commercialize licensed products, it may terminate the License Agreement in whole or on a product-by-product basis at any time upon ninety (90) days prior written notice to us. In the event of a termination of the License Agreement, other than ViroPharma’s termination of the License Agreement for our uncured material breach, we will have an exclusive, perpetual, irrevocable, worldwide, royalty-bearing license to exploit the licensed products.

 

5. Notes Payable

 

The “April 2010 Notes”

 

On April 23, 2010, we issued Convertible Promissory Notes (the “April 2010 Notes”) with an aggregate principal amount of $580,000. The April 2010 Notes carry interest at 14% annually (payable in arrears) and mature three years from the date of issuance.

 

We determined the initial fair value of the Warrants issued with the April 2010 Notes to be $41,093,377  based on the Black-Scholes option pricing model, which we treated as a liability with a corresponding decrease in the carrying value of the April 2010 Notes. Under authoritative guidance, the carrying value of the April 2010 Notes may not be reduced below zero. Accordingly, we recorded the excess of the value of the Warrants over the face amount of the April 2010 Notes as interest expense incurred at the time of issuance of the April 2010 Notes. The face amount of the April 2010 Notes will be amortized over the term of the notes as interest expense, calculated using an effective interest method.

 

On November 3, 2010, we borrowed an additional $150,000 from certain holders of the April 2010 Notes and evidenced such borrowing by adding an addendum to the April 2010 Notes whereby the aggregate principal amount of such holders’ Notes was increased by $150,000. As partial consideration for the loan, we reduced the conversion price of such holders’ Notes from $1.50 to $0.125 per common share.  As a result of the “ratchet” provisions contained in the April 2010 Notes and outstanding Warrants, the conversion price of the remaining outstanding April 2010 Notes and exercise price of our outstanding Warrants were adjusted to $0.125 per common share. The conversion price of previously issued and outstanding Series B Convertible Preferred Stock held by holders other than the purchasers is not subject to adjustment as a result of revisions to the April 2010 Notes.

 

The December 2010 Notes

 

On December 15, 2010, we sold investment units for an aggregate purchase price of $500,000. Each unit consisted of a Convertible Promissory Note (the “December 2010 Notes”), shares of Series C Convertible Preferred Stock (“Series C Prefs”) and warrants (the “December 2010 Warrants”). Total proceeds from the sale of these investment units were $500,000.

 

The December 2010 Notes have an aggregate face amount of $500,000, are due on December 15, 2013 and bear interest at 14%, payable at maturity. Principal and accrued interest on the Notes are convertible into shares of our common stock at an initial conversion price of $.125 per share, subject to customary anti-dilution protection in the case of stock dividends, stock splits, reverse splits, reorganizations and recapitalizations and subject to full ratchet protection in the case of any sale of common stock or common stock equivalents by us at a price less than the then effective conversion price of the Notes. As a result of the ratchet provisions contained in the Notes, the holders are entitled to purchase up to 10 million shares of our Common Stock.

 

 

The December 2010 Warrants initially entitle the holders to purchase up to a total of 4 million shares of our common stock at an initial exercise price of $0.125 per share. As a result of the ratchet provisions contained in the December 2010 Warrants, the holders are entitled to purchase up to 10 million shares of our Common Stock at an exercise price of $0.001 per share. Also, we issued an aggregate of 10,000 shares of Series C Prefs with an initial aggregate liquidation preference equal to $10 million, which, as a result of the ratchet provisions contained in the Certificate of Designation of series C Preferred Stock, are convertible into 200 million shares of our Common Stock at a conversion price of $0.05 per share.

 

We allocated the $500,000 of proceeds to the December 2010 Notes and Series C Preferred shares based on their relative fair values at date of issuance, which resulted in an allocation of $25,000 and $475,000, respectively. We determined the initial fair value of the December 2010 Warrants to be $378,017 based on the Black-Scholes option pricing model, which we treated as a liability with a corresponding decrease in the carrying value of the December 2010 Notes. Under authoritative guidance, the carrying value of the December 2010 Notes may not be reduced below zero. Accordingly, we recorded the excess of the value of the December 2010 Warrants over the allocated fair value of the December 2010 Notes as interest expense incurred at the time of issuance of the December 2010 Notes in the amount of $353,017.  The discount related to of the December 2010 Notes will be amortized over the term of the notes as interest expense, calculated using an effective interest method.

 

The guidance provided in ASC 470-20-30-5 has been applied to the amount allocated to the Series C Preferred Stock, and the effective conversion price has been used to measure the intrinsic value of the embedded conversion option, and limited to the amount of proceeds allocated to the convertible instrument.  The intrinsic value of the beneficial conversion feature was calculated by comparing the effective conversion price and the market price of the Company’s common stock on the date of issuance. The fair value of $475,000 of the beneficial conversion feature has been recognized as a deemed dividend on the preferred stock for the year ended June 30, 2011, since the Series C Preferred stock is immediately convertible upon issuance and has no stated redemption date.

 

As a result of the “ratchet” provisions contained in the April 2010 Notes and outstanding Warrants, the conversion price of the remaining outstanding April 2010 Notes and exercise price of our outstanding Warrants and Series B Convertible Preferred Stock were adjusted to $0.001 per common share. The conversion price of previously issued and outstanding Series B Convertible Preferred Stock held by holders other than the purchasers of the April 2010 Notes is not subject to adjustment as a result of the issuance of the December 2010 Notes.

 

 In January 2011, as a result of the “ratchet” provisions contained in the April 2010 Notes, we issued to purchasers of the April 2010 Notes remaining outstanding an additional 2,000 shares of our Series C Prefs with an initial aggregate liquidation preference equal to $2 million, which are convertible into 40 million shares of our common stock at an exercise price of $0.001 per share. In addition, in May 2011, we issued 429,000 shares of our Common Stock as additional compensation to certain holders of the April 2010 Notes as a result of the “ratchet” provisions contained in those Notes.

 

The “March 2011 Notes”

 

On March 15, 2011, we sold investment units for an aggregate purchase price of $500,000. Each unit consisted of a Convertible Promissory Note (the “March 2011 Notes”), shares of Series C Prefs and warrants (the “March 2011 Warrants”). Total proceeds from the sale of these investment units were $500,000.  The terms of the March 2011 Notes and Warrants are the same as the terms contained in the December 2010 Notes and Warrants.

 

The March 2011 Notes have an aggregate face amount of $500,000, are due on March 15, 2014 and bear interest at 14%, payable at maturity. Principal and accrued interest on the Notes are convertible into shares of our common stock at an initial conversion price of $.125 per share, subject to customary anti-dilution protection in the case of stock dividends, stock splits, reverse splits, reorganizations and recapitalizations and subject to full ratchet protection in the case of any sale of common stock or common stock equivalents by us at a price less than the then effective conversion price of the Notes. As a result of the ratchet provisions contained in the March 2011Notes, the holders are entitled to purchase up to 10 million shares of our Common Stock.

 

 

The March 2011 Warrants initially entitle the holders to purchase up to a total of 4 million shares of our common stock at an initial exercise price of $0.125 per share. As a result of the ratchet provisions contained in the March 2011 Warrants, the holders are entitled to purchase up to 10 million shares of our Common Stock at an exercise price of $0.001 per share. Also, we issued an aggregate of 10,000 shares of Series C Prefs with an initial aggregate liquidation preference equal to $10 million, which, as a result of the ratchet provisions contained in the Certificate of Designation of series C Preferred Stock, are convertible into 200 million shares of our Common Stock at a conversion price of $0.001 per share.

 

We allocated the $500,000 of proceeds to the March 2011 Notes and Series C Prefs based on their relative fair values at date of issuance, which resulted in an allocation of $25,000 and $475,000, respectively. We determined the initial fair value of the March 2011 Warrants to be $378,017 based on the Black-Scholes option pricing model, which we treated as a liability with a corresponding decrease in the carrying value of the March 2011 Notes. Under authoritative guidance, the carrying value of the March 2011 Notes may not be reduced below zero. Accordingly, we recorded the excess of the value of the March 2011Warrants over the allocated fair value of the March 2011 Notes as interest expense incurred at the time of issuance of the March 2011 Notes in the amount of $353,017.  The discount related to of the March 2011 Notes will be amortized over the term of the notes as interest expense, calculated using an effective interest method.

 

The guidance provided in ASC 470-20-30-5 has been applied to the amount allocated to the Series C Preferred Stock, and the effective conversion price has been used to measure the intrinsic value of the embedded conversion option, and limited to the amount of proceeds allocated to the convertible instrument.  The intrinsic value of the beneficial conversion feature was calculated by comparing the effective conversion price and the market price of the Company’s common stock on the date of issuance. The fair value of $475,000 of the beneficial conversion feature has been recognized as a deemed dividend on the preferred stock for the year ended June 30, 2011, since the Series C Preferred stock is immediately convertible upon issuance and has no stated redemption date.

 

The “June and July 2011 Notes”

 

On June 30, 2011, we sold investment units (“June 2011 Investment Units”) for an aggregate purchase price of $100,000. Each unit consisted of a Convertible Promissory Note (the “June 2011 Notes”) and warrants (the “June 2011 Warrants”). Total proceeds from the sale of these investment units were $100,000.

 

The June 2011 Notes have an aggregate face amount of $100,000, are due on June 30, 2014 and bear interest at 14%, payable at maturity. Principal and accrued interest on the June 2011 Notes are convertible into shares of our common stock at an initial conversion price of $.05 per share, subject to customary anti-dilution protection in the case of stock dividends, stock splits, reverse splits, reorganizations and recapitalizations and subject to full ratchet protection in the case of any sale of common stock or common stock equivalents by us at a price less than the then effective conversion price of the June 2011 Notes. The June 2011 Warrants entitle the holders to purchase up to a total of 10 million shares of our Common Stock at an initial exercise price of $0.05 per share.

 

We determined the initial fair value of the June 2011 Warrants to be $817,151 based on the Black-Scholes option pricing model, which we treated as a liability with a corresponding decrease in the carrying value of the June 2011 Notes by $100,000 with the excess of $717,151 charged to interest expense. This difference was amortized over the term of the June 2011 Notes as interest expense, calculated using an effective interest method.

 

During July and August, 2011, we sold additional investment units for an aggregate purchase price of $150,000. Each unit consisted of a Convertible Promissory Note (the “July 2011 Notes”) and warrants (the “July 2011 Warrants”). Total proceeds from the sale of these investment units were $150,000.

 

The June 2011 Notes issued in July have an aggregate face amount of $150,000, are due on various dates during July and August, 2014 and bear interest at 14%, payable at maturity. Principal and accrued interest on the July 2011 Notes are convertible into shares of our common stock at an initial conversion price of $.05 per share, subject to customary anti-dilution protection in the case of stock dividends, stock splits, reverse splits, reorganizations and recapitalizations and subject to full ratchet protection in the case of any sale of common stock or common stock equivalents by us at a price less than the then effective conversion price of the Notes. The July 2011 Warrants entitle the holders to purchase up to a total of 20 million shares of our Common Stock at an initial exercise price of $0.05 per share.

 

 

We determined the initial fair value of the July 2011 Warrants to be $1,626,973 based on the Black-Scholes option pricing model, which we treated as a liability with a corresponding decrease in the carrying value of the July 2011 Notes by $150,000 with the excess of $1,476,973 charged to interest expense.

 

In April 2012, we issued 500,000 shares of our common stock to one of the holders of July 2011 Notes upon his conversion of $25,000 principal amount due with respect to such Notes (Note 11.)

 

The “April and May 2012” Financing

 

During April and May 2012, we sold investment units for an aggregate purchase price of $201,500. Each unit consisted of a Convertible Promissory Note (the April and May 2012 Notes”) and warrants (the “April and May 2012 Warrants”). Total proceeds from the sale of these investment units were $201,500.

 

The April and May 2012 Notes have an aggregate face amount of $201,500, are due in April and May 2015 and bear interest at 14%, payable at maturity. Principal and accrued interest are convertible into shares of our common stock at an initial conversion price of $0.05 per share, subject to customary anti-dilution protection in the case of stock dividends, stock splits, reverse splits, reorganizations and recapitalizations and subject to full ratchet protection in the case of any sale of common stock or common stock equivalent by us at a price less than the effective conversion price of the April 2012 Notes. The April and May 2012 Warrants entitle the holders to purchase up to 25,150,000 shares of our Common Stock at an initial exercise price of $0.05 per share.

 

We determined the initial fair value of the April and May 2012 warrants to be $1,100,650 based on the Black-Scholes option pricing model, which we treated as a liability with a corresponding decrease in the carrying value of the April and May 2012 Notes by $201,500 with the excess of $899,150 charged to interest expense. The discount related to the April and May 2012 Notes will be amortized over the term of the notes as interest expense, calculated using an effective interest method.

 

During July, August and September 2012, we sold additional investment units for an aggregate purchase price of $327,500, with the same terms as the April and May 2012 Notes. Each unit consisted of a Convertible Promissory Note and Warrants. Total proceeds from the sale of these investment units were $327,500.

 

These additional April and May 2012 Notes have an aggregate face amount of $360,000, are due in July, August and September 2015 and bear interest at 14%, payable at maturity. Principal and accrued interest are convertible into shares of our common stock at an initial conversion price of $0.05 per share, subject to customary anti-dilution protection in the case of stock dividends, stock splits, reverse splits, reorganizations and recapitalizations and subject to full ratchet protection in the case of any sale of common stock or common stock equivalent by us at a price less than the effective conversion price of the April 2012 Notes. These additional April and May 2012 Warrants entitle the holders to purchase up to 23,000,000 shares of our Common Stock at an initial exercise price of $0.05 per share.

 

6. Convertible Preferred Stock and Derivative Liability

 

Series B Convertible Preferred Stock

 

During the fiscal year ended June 30, 2007, we issued 459,309 shares of Series B Convertible Preferred Stock (the “Series B Prefs”). The shares carry a cumulative dividend of 6% per annum. The initial conversion price is 1.75 per share subject to certain anti-dilution adjustments. Each Series B Preferred share carries a stated value of $17.50 and is convertible into 10 shares of our Common Stock. We issued 3,046,756 warrants in connection with the issuance of the Series B Prefs (the “Series B Warrants”).

 

Based on authoritative guidance, we accounted for the Series B Prefs and the Series B Warrants as derivative liabilities at the time of issuance using the Black Scholes option pricing model. We recorded the amount received in consideration for the Series B Prefs as a liability for the Series B Prefs with an allocation to the Series B Warrants and the difference recorded as additional paid in capital. The liability related to the Series B Prefs and the Series B Warrants will be marked to market for all future periods they remain outstanding with an offsetting charge to earnings.

 

  

At September 30, 2012, the aggregate liquidation value of the Series B Prefs was $1,870,380, with a fair value of $345,748. As of September 30, 2012, we have accrued Series B Preferred Stock dividends payable of $529,414 which has been recognized as interest expense.

 

As a result of the “ratchet” provisions contained in the Certificate of Designation of the Series B Prefs, the conversion price of the remaining Series B Prefs, as subsequently amended by a majority in interest of the holders of the series B Prefs, was reduced to $0.05 per common share as a result of the December 2010 Financing transaction described above. The conversion price of previously issued and outstanding Series B Prefs held by holders other than the purchasers of the April 2010 Notes is not subject to adjustment as a result of the issuance of the December 2010 Notes or March 2011 Notes.

 

Series C Convertible Preferred Stock

 

Effective December 15, 2010, our Board of Directors approved a Certificate of Designation of Series C Convertible Preferred Stock. Each share of Series C Convertible Preferred Stock carries a stated value of $1,000 and a conversion price of $0.05 per common share, subject to customary anti-dilution protection in the case of stock dividends, stock splits, reverse splits, reorganizations and recapitalizations and subject to full ratchet protection in the case of any sale of common stock or common stock equivalents by us at a price less than the then effective conversion price of the Series C Preferred Stock. We issued to the purchasers of the December 2010 Notes 12,000 shares of our Series C Convertible Preferred Stock with an initial aggregate liquidation preference equal to $12 million, which are convertible into 240 million shares of our common stock.

 

On March 15, 2011, we issued to certain purchasers of the March 2011 Notes an additional 10,000 shares of our Series C Convertible Preferred Stock with an initial aggregate liquidation preference equal to $10 million, which are convertible into 200 million shares of our common stock, in exchange for $500,000 (Note 5).

 

During the three month period ended September 30, 2012, we issued 5,000,000 shares of our common stock to holders of Series C Preferred upon conversion of their shares.

 

7. Outstanding Warrants and Warrant Liability

 

The “2006 Warrants”

 

In connection with the sale of the 2006 Notes, we issued warrants (the “2006 Warrants”), entitling the holders to purchase up to 43,428 shares of our common stock. We issued additional 2006 Warrants upon extension of the maturity date of certain of the 2006 Notes. The 2006 Warrants expire five years from date of issuance, except for 22,857 of such warrants, which expire in 2013. The number of shares underlying each 2006 Warrant is the quotient of the face amount of the related 2006 Note divided by 50% of the price per equity security issued in the Next Equity Financing, which occurred on May 12, 2006. The 2006 Warrant exercise price is 50% of the price per equity security issued in the Next Equity Financing. The maximum number of shares available for purchase by an investor is equal to the principal amount of such holder's 2006 Note divided by the warrant exercise price.

 

As of June 30, 2012, a total of 22,857 warrants remain outstanding, with an exercise price of $0.05 per share.

 

The “Convertible Note Warrants”

 

In connection with the sale of the 2007 and 2008 Notes, we issued 76,751 and 3,714 warrants, respectively.   In addition, we issued 7,429 warrants in connection with a Convertible Note issued during fiscal year ended June 30, 2009 (the “Convertible Note Warrants”).

 

 

 The Convertible Note Warrants expire five years from date of issuance. The number of shares underlying each Convertible Note Warrant is the quotient of the face amount of the related Note divided by 87.5. The exercise price of each warrant is $87.50 per share, subject to anti-dilution adjustments. These warrants provide the holder with “piggyback registration rights”, which obligate us to register the common shares underlying the Warrants in the event that we decide to register any of our common stock either for our own account or the account of a security holder (other than with respect to registration of securities covered by certain employee option plans). The terms of the Warrants fail to specify a penalty if we fail to satisfy our obligations under these piggyback registration rights. Presumably, we would be obligated to make a cash payment to the holder to compensate for such failure. Based on authoritative guidance, we have accounted for the Convertible Note Warrants as liabilities. The liability for the Convertible Note Warrants, measured at fair value, based on a Black-Scholes option pricing model, has been offset by a reduction in the carrying value of the related Notes. These warrants expired without being exercised in February 2012.

 

In connection with the Convertible Note Financing, we issued 28,464 warrants to the placement agent. Based on authoritative guidance, we have accounted for these warrants as liabilities. The liability, measured at fair value on the date of issuance using a Black-Scholes option pricing model, will be marked to market for each future period the warrants remain outstanding. As of June 30, 2012, all of these warrants remain outstanding, with an exercise price of $0.05 per share.

 

The “Royalty Warrants”.

 

In connection with the issuance of the Royalty Notes, we issued warrants to purchase up to 65,429 of our common shares (the “Royalty Warrants”).  We issued approximately 7,429 warrants to the lender who advanced to us new funds of $650,000 and issued the remaining 58,000 warrants to the other lenders who exchanged their notes for Royalty Notes. The Royalty Warrants contain the same terms as the Convertible Note Warrants described above.

 

Based on authoritative guidance, we accounted for the 7,429 Royalty Warrants issued to the unrelated lender as a liability. We valued these warrants on the date of issuance based on a Black-Scholes option pricing model and the resulting liability is marked to market for each future period these warrants remain outstanding, with the resulting gain or loss being recorded in the statement of operations. We accounted for the 58,000 Royalty Warrants issued to the other lenders as interest expense incurred in exchange for an extension of the maturity dates of the Royalty Notes exchanged in the transaction.

 

As of June 30, 2010, all of the holders of the Royalty Notes accepted common stock in repayment of their notes and agreed to the cancellation of their Royalty Warrants.

 

The “Purchaser Warrants”.

 

In connection with the sale of the August Note, we agreed, at maturity or early repayment of the note,  to issue either common shares or warrants to purchase up to 60,000 of our common shares (the Purchaser Warrants). The Purchaser Warrants were to contain the same terms as the Convertible Note Warrants described above. Based on authoritative guidance, we accounted for the Purchaser Warrants as a liability as of the date of issuance and reduced the carrying value of the August Note by the initial fair value of these Warrants.  

 

On April 23, 2010, we agreed to issue to the holder of the August 2009 Note 15 million shares of our common stock in lieu of the Purchaser Warrants.

 

The “Series B Warrants”

 

In connection with the issuance of the Series B Preferred, we issued Series B warrants to purchase up to 75,939 shares of our common stock. The initial exercise price of the Series B Warrants was $2.50 per common share, subject to anti-dilution adjustments. The strike price of the Series B Warrants was subsequently reduced to $1.75 per common share pursuant the anti-dilution adjustment. The Series B Warrants have a 5 year term.

 

The Series B Warrants provide for cashless exercise under certain circumstances. Accordingly, the amount of additional shares underlying potential future issuances of Series B Warrants is indeterminate. There is no specified cash payment obligation related to the Series B Warrants and there is no obligation to register the common shares underlying the Series B Warrants except in the event that we decide to register any of our common stock for cash (“piggyback registration rights”). Presumably, we would be obligated to make a cash payment to the holder if we failed to satisfy our obligations under these piggyback registration rights. Based on authoritative guidance, we have accounted for the Series B Warrants as liabilities. As of June 30, 2012, a total of 2,857 Series B Warrants remain outstanding, with a strike price of $0.001 per share.

 

  

The “April 2010 Warrants”.

 

In connection with the April 2010 Financing, we issued a total of 1,546,667 Class A, 1,546,667 Class B and 1,546,667 Class C Warrants (collectively, the “April 2010 Warrants”). The Class A Warrants have a 5 year term, an initial exercise price of $1.50 per common share, subject to anti-dilution adjustments and contain a “cashless exercise feature”. The Class B Warrants have a 9 month term and an initial exercise price of $1.50 per common share, subject to anti-dilution adjustments. The Class C Warrants have a 5 year and 9 month term, an initial exercise price of $1.50 per common share, subject to anti-dilution adjustments and contain a “cashless exercise feature”. The April 2010 Warrants provide the holder with “piggyback registration rights” as described above. Based on authoritative guidance, we have accounted for the April 2010 Warrants as liabilities. The liability, measured at fair value on the date of issuance using a Black-Scholes option pricing model has been offset by a reduction in the carrying value of the April 2010 Notes and will be marked to market for each future period they remain outstanding.

 

On June 28, 2010, holders of 1,013,333 Class A Warrants exercised their Warrants through the cashless exercise feature and received a total of 11,000 shares of Company common stock.

 

As a result of the “ratchet” provisions contained in the April 2010 Warrants, the number of warrants and the exercise price of the warrants are subject to adjustment as a result of the December 2010 Notes described above.

 

On March 15, 2011 holders of 4 million Class B Warrants exercised their Warrants for cash and received a total of 4 million shares of our Common Stock.  The remaining Class B Warrants expired in January 2011.

 

As of June 30, 2012, a total of 53,733,333 April 2010 A and B Warrants remain outstanding, with an exercise price of $0.05 per share.

 

 “Consultant Warrants”

 

In connection with the April 2010 Financing, we issued 700,000 warrants to various consultants (the “Consultant Warrants”) with terms that are the same as those contained in the Class A Warrants. Based on authoritative guidance, we have accounted for the Consultant Warrants as liabilities.

 

On June 28, 2010, holders of all of the outstanding Consultant Warrants exercised their Warrants through the cashless exercise feature and received a total of 11,000 shares of Company common stock.

 

In August and October 2010, we issued an additional 6,000,000 warrants to consultants for investor relations and legal services. These warrants expire five years from the date of issuance. The exercise price of each warrant is $0.05 per share, subject to anti-dilution adjustments. These warrants provide the holder with “piggyback registration rights”, which obligate us to register the common shares underlying the warrants in the event that we decide to register any of our common stock either for our own account or the account of a security holder (other than with respect to registration of securities covered by certain employee option plans. The terms of the warrants fail to specify a penalty if we fail to satisfy our obligation under these piggyback registration rights. Presumably we would be obligated to make a cash payment to the holder to compensate for such failure. Based on authoritative guidance, we have accounted for these consultant warrants as liabilities, measured at fair value, based on a Black-Scholes option pricing model. As of June 30, 2012, 6,000,000 Consultant Warrants remain outstanding, with an exercise price of $0.05 per share

 

“The December 2010 and March 2011 Warrants”

 

In connection with the sale of the December 2010 Notes and March 2011 Notes, we issued warrants, we issued a total of 20,000,000 warrants (the “December 2010 and March 2011 Warrants”). These warrants expire five years from the date of issuance. The exercise price of each warrant is $0.05 per share, subject to anti-dilution adjustments. These warrants provide the holder with “piggyback registration rights”, which obligate us to register the common shares underlying the warrants in the event that we decide to register any of our common stock either for our own account or the account of a security holder (other than with respect to registration of securities covered by certain employee option plans. The terms of the warrants fail to specify a penalty if we fail to satisfy our obligation under these piggyback registration rights. Presumably we would be obligated to make a cash payment to the holder to compensate for such failure. Based on authoritative guidance, we have accounted for these consultant warrants as liabilities, measured at fair value, based on a Black-Scholes option pricing model. As of June 30, 2012, 9,800,000 of December 2010 and March 2011 Warrants, respectively, remain outstanding

 

 

The “June and July 2011 Warrants”

 

In connection with the sale of the June Notes, we issued a total of 30 million warrants (the “June and July 2011 Warrants”). The June and July 2011 Warrants expire five years from date of issuance. The exercise price of each warrant is $0.05 per share, subject to anti-dilution adjustments. These warrants provide the holder with “piggyback registration rights”, which obligate us to register the common shares underlying the warrants in the event that we decide to register any of our common stock either for our own account or the account of a security holder (other than with respect to registration of securities covered by certain employee option plans). The terms of the June and July Warrants fail to specify a penalty if we fail to satisfy our obligations under these piggyback registration rights. Presumably, we would be obligated to make a cash payment to the holder to compensate for such failure. Based on authoritative guidance, we have accounted for the June and July 2011 Warrants as liabilities. The liability for the June and July 2011 Warrants, measured at fair value, based on a Black-Scholes option pricing model, has been offset by a reduction in the carrying value of the related Notes.

 

The “2011 Director Warrants”

 

In October 2011, we issued warrants to purchase 2,881,680 shares of our common stock to our former independent directors in partial satisfaction of outstanding fees owed to such directors (the “2011 Director Warrants”). The 2011 Director Warrants have a 5 year term, an initial exercise price of $0.05 per common share, subject to anti-dilution adjustments, and contain a “cashless exercise feature”. The 2011 Director Warrants provide the holder with “piggyback registration rights” as described above. Based on authoritative guidance, we have accounted for the 2011 Director Warrants as liabilities. The liability, measured at fair value on the date of issuance using a Black-Scholes option pricing model will be marked to market for each future period they remain outstanding.

 

The “April and May 2012” Warrants

 

In connection with the sale of the April and May 2012 Notes, we issued a total of 48,150,000 warrants (the “April and May 2012 Warrants”). The April and May 2012 Warrants expire five years from date of issuance. The exercise price of each warrant is $0.05 per share, subject to anti-dilution adjustments. These warrants provide the holder with “piggyback registration rights”, which obligate us to register the common shares underlying the warrants in the event that we decide to register any of our common stock either for our own account or the account of a security holder (other than with respect to registration of securities covered by certain employee option plans). The terms of the April and May 2012 Warrants fail to specify a penalty if we fail to satisfy our obligations under these piggyback registration rights. Presumably, we would be obligated to make a cash payment to the holder to compensate for such failure. Based on authoritative guidance, we have accounted for the April and May 2012 Warrants as liabilities. The liability for the April and May 2012 Warrants, measured at fair value, based on a Black-Scholes option pricing model, has been offset by a reduction in the carrying value of the related Notes.

 

The MRCT Warrants

 

In September 2012, we issued warrants to purchase 11,200,000 shares of our common stock to MRC Technology in consideration for fees owed to by the Company for their work on a project to humanize one of our beta-amyloid specific, monoclonal antibodies for the treatment of Alzheimer’s Disease. The 2012 MRCT Warrants have a 5 year term, an initial exercise price of $0.0625 per common share, subject to anti-dilution adjustments, and contain a “cashless exercise feature”. The 2012 MRCT Warrants provide the holder with “piggyback registration rights” as described above. Based on authoritative guidance, we have accounted for the 2012 MRCT Warrants as liabilities. The liability, measured at fair value on the date of issuance using a Black-Scholes option pricing model will be marked to market for each future period they remain outstanding.

 

  

8. Capital Deficiency

 

Common stock

 

In July 2012, we issued 2,000,000 shares of our common stock to holders of Series C Convertible Preferred Stock upon their exercise of the conversion feature contained in those securities.

 

In August 2012, we issued 1,000,000 shares of our common stock in consideration for services rendered to the Company.

 

In September 2012, we issued 1,750,000 shares of our common stock in consideration for services rendered to the Company.

 

In September 2012, we issued 3,000,000 shares of our common stock to holders of Series C Convertible Preferred Stock upon their exercise of the conversion feature contained in those securities.

 

9. Per Share Data

 

The following table sets forth the information needed to compute basic and diluted earnings per share:

 

		Three Months Ended
		September 30.				September 30.
		2012				2011
Basic EPS
Net income (loss) attributable to common stockholders, basic		$	(146,268	)		$	1,735,798
Weighted average shares outstanding			103,321,542				70,968,534
Basic income earnings per share		$	(0.00	)		$	0.02
Diluted EPS
Net income (loss) attributable to common stockholders, basic		$	(146,268	)		$	1,735,798
Preferred stock dividends			-				47,329
Interest on convertible notes			-				24,732
Net income (loss) attributable to common stockholders, diluted		$	(146,268	)		$	1,807,859
Weighted average shares outstanding			103,321,542				70,968,534
Dilutive effect of stock options			-				-
Dilutive effect of warrants			-				92,954,293
Dilutive effect of Series B preferred shares			-				12,236
Dilutive effect of Series C preferred shares			-				436,000,000
Dilutive effect of convertible notes			-				16,383,333
Diluted weighted average shares outstanding			103,321,542				616,318,396
Diluted earnings (loss) earnings per share		$	(0.00	)		$	0.00

 

 

10. Income Taxes

 

No provision for income taxes has been recorded due to the utilization of net operating losses for which a 100% valuation allowance had been provided.

 

11. Subsequent Events

 

Management has evaluated events occurring after the date of these financial statements through the date these financial statements were issued. There were no material subsequent events as of that date other than disclosed below.

 

Effective October 24, 2012, our Board of Directors approved a Certificate of Designation of Series D Convertible Preferred Stock. Each share of Series D Convertible Preferred Stock carries a stated value of $1,000 and a conversion price of $0.05 per common share, subject to customary anti-dilution protection in the case of stock dividends, stock splits, reverse splits, reorganizations and recapitalizations and subject to full ratchet protection in the case of any sale of common stock or common stock equivalents by us at a price less than the then effective conversion price of the Series D Preferred Stock.

 

On October 26, 2012, we issued to a holder of the Company’s common stock purchase warrants 1,126 shares of our Series D Convertible Preferred Stock with an initial aggregate liquidation preference equal to $1,126,000, which are convertible into 22,520,000 shares of our common stock, in exchange for 45,011,430 common stock purchase warrants held by such holder.

 

Also on October 26, 2012, we issued to a holder of the Company’s common stock purchase warrants 1,000 shares of our Series D Convertible Preferred Stock with an initial aggregate liquidation preference equal to $1,000,000, which are convertible into 20,000,000 shares of our common stock, in exchange for 40,000,000 common stock purchase warrants held by such holder.

 

On October 19, 2012 and November 5, 2012, the Company sold investment units for an aggregate purchase price of $210,000. Each unit consisted of a Convertible Promissory Note (the “Note”) and warrants. Total proceeds from the sale of these investment units were $201,500.

 

The Notes are due in October and November 2015 and bear interest at 14%, payable at maturity. Principal and accrued interest are convertible into shares of our common stock at an initial conversion price of $0.05 per share, subject to customary anti-dilution protection in the case of stock dividends, stock splits, reverse splits, reorganizations and recapitalizations and subject to full ratchet protection in the case of any sale of common stock or common stock equivalent by us at a price less than the effective conversion price of the Notes. The warrants issued in connection with the sale of the Notes entitle the holders to purchase up to 29,400,000 shares of our Common Stock at an initial exercise price of $0.05 per share.

 

ITEM 2. MANAGEMENTS’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

The following discussion and analysis of our financial condition and results of operations contains information that management believes is relevant to an assessment and understanding of our results of operations. You should read this discussion in conjunction with the Financial Statements and Notes included elsewhere in this report and with Management’s Discussion and Analysis of Financial Condition and Results of Operations for the year ended June 30, 2011 and Risk Factors contained in our Annual Report on Form 10-K filed with the Securities and Exchange Commission (the “SEC”) on October 15, 2012. Certain statements set forth below constitute “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. See “Special Note Regarding Forward-Looking Statements”. References to “Intellect,” the “Company,” “we,” “us” and “our” refer to Intellect Neurosciences, Inc. and its subsidiaries.

 

 

General

 

We are a biopharmaceutical company developing and advancing a patent portfolio related to specific therapeutic approaches for treating Alzheimer’s disease (“AD”). In addition, we are developing proprietary drug candidates to treat AD and other diseases associated with oxidative stress.

 

Since our inception in 2005, we have devoted substantially all of our efforts and resources to advancing our intellectual property portfolio and research and development activities. We have entered into license and other agreements with large pharmaceutical companies related to our patent estate, however, neither we nor any of our licensees have obtained regulatory approval for sales of any product candidates covered by our patents. We operate under a single segment. Our fiscal year end is June 30.

 

Our core business strategy is the licensing of our intellectual property and development of innovative therapeutics that we have purchased, developed internally or in-licensed from universities and others. We seek to complete human proof of concept (Phase II) studies and then enter into collaboration agreements, licenses or sales to complete product development and commercialize the resulting drug products. We intend to obtain revenues from licensing fees, milestone payments, development fees, royalties and/or sales related to the use of our drug candidates or intellectual property for specific therapeutic indications or applications.

 

Our most advanced drug candidate, OX1 (OX1), is a chemically synthesized form of a small, potent, dual mode of action, naturally occurring molecule. In September 2011, we granted an exclusive license to ViroPharma Incorporated (“ViroPharma”) regarding certain of our licensed patents and patent applications related to OX1 and transferred to ViroPharma all of our data and know-how related to OX1 in exchange for payment by ViroPharma of a $6.5 million up-front licensing fee, which we received in October, 2011, and additional regulatory milestone payments based upon future defined events in the United States and the European Union. ViroPharma expects to develop and commercialize OX1 as a treatment of Friedreich’s Ataxia and possibly other diseases for which OX1 may qualify for orphan drug designation.

 

Our pipeline includes drugs based on our immunotherapy platform technologies, ANTISENILIN and RECALL-VAX. These immunotherapy programs are based on monoclonal antibodies and therapeutic vaccines, respectively, to prevent the accumulation and toxicity of the amyloid beta toxin. Both are in pre-clinical development. Our lead product candidate in our immunotherapy programs is IN-N01, a monoclonal antibody that has undergone certain procedures in the humanization process at MRCT in the UK.

 

Our current business is focused on granting licenses to our patent estate to large pharmaceutical companies and on research and development of proprietary therapies for the treatment of AD through outsourcing and other arrangements with third parties. We expect research and development, including patent related costs, to continue to be the most significant expense of our business for the foreseeable future. Our research and development activity is subject to change as we develop a better understanding of our projects and their prospects. Total research and development costs from inception through March 31, 2012 were $13,625,763

 

 

Results of Operations

 

Three Months Ended September 30, 2012 Compared to Three Months Ended September 30, 2011:

 

		Three Months Ended September 30,
		(in thousands)
		2012				2011				Change
Revenue			-				6,500,000				(6,500,000	)
Research and Development Costs			167,920				28,559				(139,361	)
General and Administrative			379,407				547,491				168,084
Income (loss) from operations		$	(547,327	)		$	5,923,950			$	(6,471,277	)

 

		Three Months Ended September 30,
		(in thousands)
		2012				2011				Change
Income (loss) from operations			(547,327	)			5,923,950				(6,471,277	)
Other income (expenses):			401,059				(4,188,152	)			4,589,211
Net income (loss)		$	(146,268	)		$	1,735,798			$	(1,882,066	)

 

Our operating loss increased $6,471,277 to a loss of $547,327 for the three months ended September 30, 2012 from an operating profit of $5,923,950 for the three months ended September 30, 2011. This was due to a decrease in license fees of $6.5 million as we granted our license to ViroPharma for our patents and patent applications to our drug candidate OX1 in the prior year period. Also, our Research and Development costs increased but were offset by a decrease in General and Administrative expenses.

 

Research and Development costs increased by $139,361, from $28,559 for the three months ended September 30, 2011 to $167,920 for the three months ended September 30, 2012, primarily due to the payment of warrants for work performed on a project to humanize one of our beta-amyloid specific, monoclonal antibodies for the treatment of Alzheimer’s disease.

 

General and Administrative expenses decreased by $168,084 to $379,407 for the three months ended September 30, 2012, from $547,491 for the three months ended September 30, 2011. The decrease in General and Administrative expenses was primarily due to a decrease in professional fees, primarily legal and consulting fees as the Company prepared to license its drug candidate OX1 in the prior year quarter.

 

Other income was $401,059 for the three months ended September 30, 2012, compared to an expense of $4,188,152 for the three months ended September 30, 2011. This is due to the recording of a gain on the change in the fair market value of derivative instruments and preferred stock liability of $1,278,781, compared to a loss on the change in the fair market value of our derivative and preferred stock liability of $1,659,930 a decrease of expense of $2,938,711. Interest expense was $877,722 for the three months ended September 30, 2012 compared to an expense of $2,258,222 for the period ended September 30, 2011, a decrease of $1,650,500. The decrease in interest expense was primarily due to a decrease in the amount of warrants granted with the convertible notes sold during the period ended September 30, 2011 compared to the period ended September 30, 2012.

 

Liquidity and Capital Resources

 

Since our inception in 2005, we have mainly generated losses from operations and we anticipate that we will continue to generate significant losses from operations for the foreseeable future. As of September 30, 2012, our deficit accumulated during the development stage was $74,282,724. Our income (loss) from operations for the three months ended September 30, 2012 and 2011 was $(547,327) and $5,923,950, respectively. Our cash used in operations was $309,254 and $249,846 for the three months ended September 30, 2012 and 2011, respectively. Our capital deficiency was $10,553,696 as of September 30, 2012.

 

 

We have limited capital resources and operations since inception have been funded with the proceeds from equity and debt financings and license fee arrangements. As of September 30, 2012, we had cash and cash equivalents of $20,553. In September 2011, we granted an exclusive license to ViroPharma regarding certain of our licensed patents and patent applications related to OX1 in exchange for payment by ViroPharma of a $6.5 million up-front licensing fee which was received in October, 2011, and additional regulatory milestone payments based upon defined events in the United States and the European Union. Proceeds from this transaction were used to pay expenses related to the ViroPharma transaction, payment of accounts payable and fund working capital. We anticipate that our existing capital resources will enable us to continue operations for the next two months. However, our business will require substantial additional investment that we have not yet secured. We cannot be sure how much we will need to spend in order to develop new products and technologies in the future. Further, we will not have sufficient resources to develop fully any new products or technologies unless we are able to raise substantial additional financing on acceptable terms or secure funds from new or existing partners. If we fail to raise additional capital or obtain substantial cash inflows from existing or potential partners within the next six months, we will be unable to successfully develop and commercialize our products. We cannot assure you that financing will be available in a timely manner, on favorable terms or at all.

 

The audit report prepared by our independent registered public accounting firm relating to our consolidated financial statements for the year ended June 30, 2012 includes an explanatory paragraph expressing substantial doubt about our ability to continue as a going concern.

 

Off-Balance Sheet Arrangements

 

As of September 30, 2012, we had no material off-balance sheet arrangements other than obligations under various agreements as follows:

 

Under a License Agreement with NYU and a similar License Agreement with University of South Alabama Medical Science Foundation (“SAMSF”) related to our OX1 program, we are obligated to make future payments totaling approximately $1.5 million to each of NYU and SAMSF upon achievement of certain milestones based on phases of clinical development and approval of the FDA (or foreign equivalent) and also to pay each of NYU and SAMSF a royalty based on product sales by Intellect or royalty payments received by Intellect. In September 2011, we granted a sublicense of the License Agreements to ViroPharma pursuant to which we received a $6.5 million up-front licensing fee and are entitled to receive additional regulatory milestone payments based upon defined events in the United States and the European Union. Pursuant to the terms of the License Agreements, we paid SAMS and NYU $650,000 of the up-front licensing fee and are obligated to pay a portion of future payments we may receive from ViroPharma.

 

Mindset acquired from Mayo Foundation for Medical Education and Research (“Mayo”) a non-exclusive license to use certain transgenic mice as models for AD and is obligated to pay Mayo a royalty of 2.5% of any net revenue that Mindset receives from the sale or licensing of a drug product for AD in which the Mayo transgenic mice were used for research purposes. The Mayo transgenic mice were used by the SAMSF to conduct research with respect to OX1. Pursuant to the Assignment that we executed with the SAMSF, we agreed to assume Mindset’s obligations to pay royalties to Mayo. We have not received any net revenue that would trigger a payment obligation to Mayo.

 

Pursuant to a Letter Agreement with the Institute for the Study of Aging, we are obligated to pay a total of $225,500 of milestone payments contingent upon future clinical development of OX1.

 

Under a Research Agreement with MRC Technology (“MRCT”), we are obligated to make future research milestone payments totaling approximately $560,000 to MRCT related to the development of the 82E1 humanized antibody and to pay additional milestones related to the commercialization, and a royalty based on sales, of the resulting drug products. MRCT has achieved their research milestones and we have included the total $560,000 in accrued expenses. On September 16, 2012 the Company issued to MRCT 11,200,000 warrants with an exercise price of $0.0625 in full consideration for the money owed to MRCT.

 

Under the terms of a Beta-Amyloid Specific, Humanized Monoclonal Antibody Purchase and Sale Agreement with Immuno-Biological Laboratories Co., Ltd (“IBL”), we agreed to pay IBL a total of $2,125,000 upon the achievement of certain milestones plus a specified royalty based on sales of any pharmaceutical product derived from the 82E1or 1A10 antibodies. We have paid $40,000 to date.

 

 

Under the terms of a Royalty Participation Agreement effective as of July 31, 2008, certain of our lenders are entitled to an aggregate share of 25% of future royalties that we receive from the license of our ANTISENILIN patent estate.

 

Under a License Agreement with Northwestern University (“NWU”) related to our TOC-01 program, we are obligated to make future payments totaling approximately $700,000 to NWU upon achievement of certain milestones based on phases of clinical development and also to pay NWU a royalty based on product sales.

 

Under the terms of a consulting agreement with a former member of our Board of Directors, we are obligated to pay $1,000,000 from revenue generated from product sales or licenses. We have paid $119,070 to date.

 

Under an Agreement with The Regents of The University of California, on behalf of its Irvine campus ("University") executed in April 2012, we are obligated to make future payments totaling approximately $176 thousand to the University as payment for research and development work to be conducted by the University related to our Anti-Amyloid RECALL-VAX vaccine, Anti-Tau RECALL-VAX vaccine and the combination of Anti-Beta Amyloid and Anti-Tau RECALL-VAX vaccine.

 

In the ordinary course of business, we enter into agreements with third parties that include indemnification provisions which, in our judgment, are normal and customary for companies in our industry sector. These agreements are typically with business partners, clinical sites, and suppliers. Pursuant to these agreements, we generally agree to indemnify, hold harmless, and reimburse indemnified parties for losses suffered or incurred by the indemnified parties with respect to our product candidates, use of such product candidates, or other actions taken or omitted by us. The maximum potential amount of future payments we could be required to make under these indemnification provisions is unlimited. We have not incurred material costs to defend lawsuits or settle claims related to these indemnification provisions. As a result, the estimated fair value of liabilities relating to these provisions is minimal. Accordingly, we have no liabilities recorded for these provisions as of June 30, 2012 or 2011.

 

In the normal course of business, we may be confronted with issues or events that may result in a contingent liability. These generally relate to lawsuits, claims, environmental actions or the actions of various regulatory agencies. We consult with counsel and other appropriate experts to assess the claim. If, in our opinion, we have incurred a probable loss as set forth by accounting principles generally accepted in the United States, an estimate is made of the loss and the appropriate accounting entries are reflected in our consolidated financial statements. After consultation with legal counsel, we do not anticipate that liabilities arising out of currently pending or threatened lawsuits and claims will have a material adverse effect on our consolidated financial position, results of operations or cash flows.

 

Critical Accounting Estimates and New Accounting Pronouncements

 

Critical Accounting Estimates

 

The preparation of financial statements in accordance with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect reported amounts and related disclosures in the financial statements. Management considers an accounting estimate to be critical if it requires assumptions to be made that were uncertain at the time the estimate was made, and changes in the estimate or different estimates that could have been selected could have a material impact on our consolidated results of operations or financial condition.

 

Convertible Instruments We evaluate and account for conversion options embedded in convertible instruments in accordance with ASC 815 “Derivatives and Hedging Activities”. Applicable GAAP requires companies to bifurcate conversion options from their host instruments and account for them as free standing derivative financial instruments according to certain criteria. The criteria include circumstances in which (a) the economic characteristics and risks of the embedded derivative instrument are not clearly and closely related to the economic characteristics and risks of the host contract, (b) the hybrid instrument that embodies both the embedded derivative instrument and the host contract is not re-measured at fair value under other GAAP with changes in fair value reported in earnings as they occur and (c) a separate instrument with the same terms as the embedded derivative instrument would be considered a derivative instrument.

 

 

We account for convertible instruments (when we have determined that the embedded conversion options should not be bifurcated from their host instruments) as follows: We record when necessary, discounts to convertible notes for the intrinsic value of conversion options embedded in debt instruments based upon the differences between the fair value of the underlying common stock at the commitment date of the note transaction and the effective conversion price embedded in the note. Debt discounts under these arrangements are amortized over the term of the related debt to their stated date of redemption. We also record when necessary, deemed dividends for the intrinsic value of conversion options embedded in preferred shares based upon the differences between the fair value of the underlying common stock at the commitment date of the transaction and the effective conversion price embedded in the preferred shares.

 

Common Stock Purchase Warrants  We classify as equity any contracts that require physical settlement or net-share settlement or provide us a choice of net-cash settlement or settlement in our own shares (physical settlement or net-share settlement) provided that such contracts are indexed to our own stock as defined in ASC 815-40 ("Contracts in Entity's Own Equity"). We classify as assets or liabilities any contracts that require net-cash settlement (including a requirement to net cash settle the contract if an event occurs and if that event is outside our control) or give the counterparty a choice of net-cash settlement or settlement in shares (physical settlement or net-share settlement). We assess classification of our common stock purchase warrants and other free standing derivatives at each reporting date to determine whether a change in classification between assets and liabilities is required.

 

Preferred Stock. We apply the guidance enumerated in ASC 480 “Distinguishing Liabilities from Equity” when determining the classification and measurement of preferred stock. Preferred shares subject to mandatory redemption (if any) are classified as liability instruments and are measured at fair value. We classify conditionally redeemable preferred shares (if any), which includes preferred shares that feature redemption rights that are either within the control of the holder or subject to redemption upon the occurrence of uncertain events not solely within our control, as temporary equity. At all other times, we classified our preferred shares in stockholders’ equity.

 

Derivative Instruments. Our derivative financial instruments consist of embedded derivatives related to the convertible debt, warrants and beneficial conversion features embedded within our convertible debt.  The accounting treatment of derivative financial instruments requires that we record the derivatives and related warrants at their fair values as of the inception date of the debt agreements and at fair value as of each subsequent balance sheet date.  Any change in fair value was recorded as non-operating, non-cash income or expense at each balance sheet date.  If the fair value of the derivatives was higher at the subsequent balance sheet date, we recorded a non-operating, non-cash charge.  If the fair value of the derivatives was lower at the subsequent balance sheet date, we recorded non-operating, non-cash income.

 

Research and Development Costs and Clinical Trial Expenses.  Research and development costs include costs directly attributable to the conduct of research and development programs, including the cost of salaries, payroll taxes, employee benefits, materials, supplies, maintenance of research equipment, costs related to research collaboration and licensing agreements, the cost of services provided by outside contractors, including services related to our clinical trials, clinical trial expenses, the full cost of manufacturing drugs for use in research, preclinical development, and clinical trials. All costs associated with research and development are expensed as incurred.

 

Revenue Recognition. We recognize revenue in accordance with authoritative accounting guidance, which provides that non-refundable upfront and research and development milestone payments and payments for services are recognized as revenue as the related services are performed over the term of the collaboration.

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Not Applicable

 

 

ITEM 4. CONTROLS AND PROCEDURES

 

Evaluation of Disclosure Controls and Procedures

 

Our principal executive officer and principal financial officer have evaluated the effectiveness of our disclosure controls and procedures, as defined in Rules 13a – 15(e) and 15d – 15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), as of the end of the period covered by this quarterly report. They have concluded that, based on such evaluation, our disclosure controls and procedures were not effective due to the material weaknesses in our internal control over financial reporting as of September 30, 2012, as described in our Form 10-K for the year ended June 30, 2012 filed with the SEC on October 15, 2012.

 

Changes in Internal Controls Over Financial Reporting

 

There has been no change in our internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the quarter ended March 31, 2012 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

PART II – OTHER INFORMATION

 

ITEM 5. OTHER

 

None

 

ITEM 6. EXHIBITS

 

31.1 Certification of Chief Executive Officer pursuant to Rule 13a-14(a) and 15d-14(a) as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (filed herewith)

 

31.2 Certification of Chief Financial Officer pursuant to Rule 13a-14(a) and 15d-14(a) as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (filed herewith)

 

32.1 Certification of Chief Executive Officer pursuant to Rule 18 U.S.C Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (filed herewith)

  

32.2 Certification of Chief Financial Officer pursuant to Rule 18 U.S.C Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (filed herewith)

 

  

SIGNATURES 

 

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

 

November 20, 2012	Intellect Neurosciences, Inc.
	/s/ Daniel Chain
	Daniel Chain
	Chief Executive Officer
	/s/ Elliot Maza
	Elliot Maza
	Chief Financial Officer