NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS
1. Basis of Preparation:
The accompanying unaudited
condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the
United States (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 8 of Regulation
S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements.
The preparation of our financial statements requires us to make estimates and assumptions that affect, among other areas, the reported
amounts of assets, long-lived assets, impairment of long-lived assets, and accrued liabilities. These estimates and assumptions
also impact expenses and the disclosures in our condensed consolidated financial statements and the accompanying notes. Although
these estimates are based on our knowledge of current events and actions we may undertake in the future, actual results may ultimately
differ from these estimates and assumptions. In the opinion of management, all adjustments (consisting of normal recurring
accruals) considered necessary for a fair presentation of the results of operations for the periods presented have been included.
Operating results for the three months ended March 31, 2016 and 2015 are not necessarily indicative of the results that may be
expected for the fiscal year. The condensed consolidated balance sheet at December 31, 2015 has been derived from the audited consolidated
financial statements at that date, but does not include all of the information and footnotes required by GAAP for complete financial
statements.
Certain amounts
from prior periods have been reclassified to conform to the current period’s presentation due to the adoption of ASU 2015-03.
The effect of these reclassifications on our previously reported condensed consolidated financial statements was
not material.
You should read these
condensed consolidated financial statements together with the historical consolidated financial statements of the Company for the
years ended December 31, 2015, and 2014 included in the Company’s Annual Report on Form 10-K for the year ended December
31, 2015, filed with the Securities and Exchange Commission, or SEC, on March 22, 2016 (the “Annual Report”).
Adopted Accounting Pronouncements
In March 2015,
the FASB issued ASU No. 2015-03, “Interest-Imputation of Interest” (“ASU 2015-03”), which provides
guidance on the presentation of debt issuance costs. To simplify the presentation of debt issuance costs, the amendments in
this ASU require that debt issuance costs be presented in the balance sheet as a direct deduction from the carrying amount of
the related debt, consistent with the manner in which debt discounts or premiums are presented. The ASU is effective for
fiscal years, and interim periods within those years, beginning after December 15, 2015, which for Rock Creek was the first
quarter of 2016. Accordingly we have included $426 and $478 of debt issuance costs as a direct deduction from the carrying
amount of the related debt on our Consolidated Balance Sheets as of March 31, 2016 and December 31, 2015, respectively.
In January 2015, the
FASB issued ASU No. 2015-01, “Income Statement-Extraordinary and Unusual Items (Subtopic 225-20) Simplifying Income Statement
Presentation by Eliminating the Concept of Extraordinary Items” (“ASU 2015-01).ASU 2015-01 is effective for fiscal
years, and interim periods within those fiscal years, beginning after December 15, 2015. A reporting entity may apply the amendments
prospectively. A reporting entity also may apply the amendments retrospectively to all prior periods presented in the financial
statements. Early adoption is permitted provided that the guidance is applied from the beginning of the fiscal year of adoption.
ASU 2015-01 was issued as part of its initiative to reduce complexity in accounting standards (the Simplification Initiative).
We adopted this standard in the first quarter of 2016. The initial application of the standard did not have a material impact on
our financial position, results of operations or disclosures.
Recently Issued Accounting Pronouncements
From time to time,
new accounting pronouncements are issued by the Financial Accounting Standards Board, or FASB, or other standard setting bodies
that may have an impact on the Company’s accounting and reporting.
In April 2016, the
FASB issued ASU 2016-10, “Revenue from Contracts with Customers (Topic 606). Identifying Performance Obligations and Licensing.
ASU 2016-10 does not change the core principal of ASU 2014-09, ASU 2015-14 (Topic 606), but clarifies the following two aspects
of Topic 606: identifying performance obligations and licensing implementation guidance. Early adoption is not permitted. We are
required to adopt this standard in the first quarter of 2017. The initial application of the standard is not expected to significantly
impact the Company.
In March 2016, the
FASB issued ASU 2016-09, “Compensation – Stock Compensation (topic 718): Improvements to Employee Share-Based Payment
Accounting.” ASU 2016-09 was issued as part of the FASB simplification initiative. The area for simplification involves several
aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards
as either equity or liabilities and classification on the statements of cash flows. For public reporting entities, the amendments
are effective for annual periods beginning after December 15, 2016 and for interim periods within those annual periods. Early adoption
is permitted for any entity during an interim or annual period. The initial application of the standard is not expected to significantly
impact our Company.
In February 2016, the
FASB issued ASU 2016-02, “Leases” (Topic 842). The guidance in ASU 2016-02 supersedes the lease recognition requirements
in ASC Topic 842, Leases. ASU 2016-02 requires an entity to recognize assets and liabilities arising from a lease for both financing
and operating leases, along with additional qualitative and quantitative disclosures. ASU 2016-02 is effective for fiscal years
beginning after December 15, 2018, with early adoption permitted. We are required to adopt this standard in the first quarter of
2019. The Company is currently evaluating the effect this standard will have on its Consolidated Financial Statements.
In August 2015, the
FASB issued ASU No. 2015-14, which defers the effective date of ASU No. 2014-09, “Revenue from Contracts with Customers (Topic
606)” by one year. As a result, the ASU is now effective for fiscal years, and interim periods within those years, beginning
after December 15, 2017. ASU No. 2014-09 provides comprehensive guidance on the recognition of revenue from customers arising from
the transfer of goods and services. The ASU also provides guidance on accounting for certain contract costs, and requires new disclosures.
Early adoption is not permitted. We are required to adopt this standard in the first quarter of 2017. The initial application of
the standard is not expected to significantly impact the Company.
The Company believes
that all recently issued accounting pronouncements and other authoritative guidance for which the effective date is in the future
either will not have an impact on its accounting or reporting or that such impact will not be material to its financial position,
results of operations, and cash flows when implemented.
2. Liquidity and Management’s
Plans:
Liquidity
The Company
has been operating at a loss for several years. Prior to September 2014, it marketed and sold an anatabine-based
dietary supplement under the name Anatabloc®, together with other anatabine-based products, but the Company discontinued
the marketing and sale of such products in August 2014 and has narrowed its focus to become a pharmaceutical development
company dedicated to the discovery, development and commercialization of therapies for chronic inflammatory disease and
neurologic disorders, with an initial emphasis on developing anatabine-based compounds as potential drug candidates. The
Company’s future prospects will depend on its ability to successfully pursue this strategy of pharmaceutical
development, manage overall operating expenses, and obtain additional capital necessary to support its operations. The
Company has historically obtained the capital necessary for its operations through private placements, sales through an
At Market Issuance Sales Agreement (“Sales Agreement”), a registered direct offering, and a private placement
of $20.0 million in principal amount of Senior Secured Convertible Notes (the “Notes”).
Pursuant to an amendment
on February 4, 2016 of the Senior Secured Convertible Notes, the Company’s obligation to maintain a cash reserve with regards
to the Notes will be further reduced, and corresponding amounts held in the Control Accounts transferred to its unrestricted bank
accounts, subject to satisfaction or waiver of certain Equity Conditions (as defined in the Notes), as follows: $1.0 million on
each of April 16, 2016 and the 11
th
trading day of each calendar month thereafter.
These Equity Conditions (as defined in the Notes), include, without limitation, the existence of an effective registration statement
covering the resale of the shares issued in payment (or, in the alternative, the eligibility of the shares issuable pursuant to
the Notes for sale without restriction under Rule 144 and without the need for registration), and a certain minimum trading volume
and trading price in the stock to be issued. The Company filed its registration on February 4, 2016 which was declared effective
with the SEC on February 11, 2016. On February 8 and April 26, 2016, the lenders transferred $1,000,000 and $750,000, respectively,
to the Company’s unrestricted bank account. The Company is currently not in compliance with its Equity Conditions and it
is negotiating with the Holders of the Notes to address whether the Notes will be amended or the Equity Conditions waived to permit
payment in shares and additional disbursements of proceeds.
On March 30, 2016,
the Company entered into a private placement with six accredited investors, pursuant to which the Company sold and issued a total
of 1,428,570 shares of the Company’s common stock at a purchase price of $0.35 per share, and issued seven (7) year warrants
to purchase up to a total of 2,857,140 shares of common stock at an exercise price of $1.12 per share, Rock Creek raised an aggregate
of $500,000 in the private placement.
As of March 31,
2016, the Company is in arrears in paying $312,500 to a former employee. This amount is included in the Company’s
Condensed Consolidated Balance Sheets in accrued liabilities, as of March 31, 2016 and
December 31, 2015, respectively.
As a result of this
uncertainty, there is substantial doubt about the Company’s ability to continue to be a going concern. The Company’s
continuation as a going concern depends upon its ability to negotiate favorable payment terms on various obligations and obtain
additional financing to provide cash to meet its obligations as may be required, and ultimately to attain profitable operations
and positive cash flows. The Company has no commercial products on the market at this time, and no associated revenues due to exiting
the dietary supplement market in the U.S. While the Company is evaluating overseas market opportunities through possible licensing
arrangements, it has not yet entered into any such licensing arrangements.
Management’s
Plans:
The Company’s
research and development efforts in 2015 focused almost exclusively on the development of anatabine citrate and related compounds
as drug candidates and it will maintain this focus in 2016. In particular, the Company expects its efforts will primarily focus
on conducting clinical trials related to the various phases (Phase I, Phase II, and Phase III) of the drug development process.
Rock Creek will continue to leverage the underlying science and clinical data accumulated by it in relation to its dietary supplement
products and many preclinical studies to advance its drug development program.
On October 15, 2015,
Rock Creek announced the completion of the three-part Phase I trial, which it had noted earlier in the year had been approved by
the United Kingdom’s Medicines Healthcare Products Regulatory Agency. The trial was comprised of a three part study to determine
the pharmacokinetic (“PK”) profiles of selected modified release formulation prototypes and to evaluate safety and
tolerability in healthy subjects..
In part one of the
Phase I trial, subjects took six different oral formulations/doses of the Company’s experimental medication while safety
and tolerability were assessed. The formulations differed in dose and time release profile, which produced a range of PK outcomes.
All formulations were generally well tolerated with no serious adverse events or safety issues leading to study withdrawal. Part
two of the trial examined the effects of food on PK profiles produced by single oral doses of the medication. There were no safety
concerns with these “food effect” studies and the medication was again well tolerated. Part three of the Phase I trial
was a randomized, double blind-placebo controlled study design consisting of seven days of oral dosing of the study medication
(or placebo) which demonstrated that the Company’s compound was safe and well tolerated.
All active treatment
parts of the Phase I trial were conducted with the healthy volunteers as inpatients in a clinical trial unit. Although the Company
expects to have a final analysis at a later time, the conclusions from the clinical research organization conducting the studies
were that there were no clinically significant changes in any safety assessments including clinical lab tests, vital signs and
electrocardiograms (“ECGs”) in any of the parts of the Phase I trial.
Even though the Phase
I trial was designed primarily for the assessment of safety, tolerability and PK, the PD report also covered data generated from
the newly developed PD assay, as applied to two dosing regiments in Rock Creek’s Phase I trial. The PD assay examined the
effect of the drug on inflammatory responses induced in blood samples taken from human volunteers. The blood samples were taken
prior to ingestion of the drug and then taken at various times after ingestion. The blood samples were then stimulated with a bacterial
inflammatory molecule called lipopolysaccharide (LPS) and two markers of inflammation were examined. These two inflammation markers
are the transcription factors STAT 3 and NF-kB, which are widely known as key molecular drivers of inflammation, and are responsible
for the production of a variety of inflammatory molecules such as TNF alpha, interleukin-1, interleukin-6 and COX-2, as examples.
In this study, it was
observed that STAT 3 activity was shown to be significantly reduced in blood samples taken after drug administration compared to
blood samples taken before drug administration, when activated STAT 3 values were appropriately normalized by the amount of a reference
protein (GAPDH) that is unaffected by LPS stimulation in the blood samples.
Although observations
for NF-kB activity were generally less consistent than the STAT 3 results, one of the oral dosing regimens within the study also
showed NF-kB reduction, when data was normalized via this newly developed PD assay. This was attributed to the novel PD assay not
being optimized for NF-kB, and that in future studies, the incubation period for the NF-kB samples should be changed to account
for this finding. Analysis of the remaining regimens is ongoing.
Through previous and
ongoing studies, the Company continues to identify human diseases most responsive to the pharmacologic and biologic properties
of its compounds. Importantly, the scientific literature underlines the potential drug-like properties of anatabine-based drugs
including, for instance, binding to known pharmacologically relevant receptors and exhibiting biological effects relevant to disease
states in preclinical models. Further, there are existing anecdotal reports and clinical studies that suggest that anatabine-based
compounds have the potential to be drug candidates. The Company believes that a critical aspect of its strategy is that the preclinical
animal and anecdotal human data suggest anatabine-based compounds have the potential to impact a number of inflammatory disorders
in addition to being able to modulate certain brain receptors. Modulation of brain receptors is potentially important, for instance,
in mitigating nicotine addiction.
Part of the Company’s
drug development strategy is to leverage the previous and ongoing research and development efforts of the Company, much of which
had been undertaken in conjunction with the Roskamp Institute. In particular, in his prior position as Chief Executive Officer
of the Roskamp Institute, Dr. Mullan has been intimately involved with the research being conducted with respect to anatabine over
the last four years. This research shows that, in a number of preclinical cell based and animal models, anatabine inhibits the
activation of Nuclear Factor Kappa B (NF-kB), a critical regulatory protein complex responsible for the generation of inflammatory
molecules in a wide range of inflammatory conditions. As a result, in these preclinical models of inflammatory conditions, in the
presence of anatabine, there is reduced activation of inflammatory cells, reduced release of inflammatory molecules and reduced
tissue damage. Research conducted by the Roskamp Institute also demonstrates that anatabine is well tolerated in anti-inflammatory
doses in animal models.
3. Insurance Proceeds Receivable:
At December 31, 2015,
insurance proceeds receivable consisted of $62,000 due from an insurance claim arising from the Company’s stock delisting
from the NASDAQ Capital Markets exchange.
The receivable
was paid by the insurer in January, 2016.
4. Discontinued Operations:
In August 2014, the
Company suspended all sales of its Anatabloc® products in response to correspondence received from the FDA pertaining to the
Company’s filing on a New Dietary Ingredient Notification (NDIN) with respect to Anatabloc®. Upon further discussion
and analysis, the Company decided to permanently exit the dietary supplement market for all Anatabloc® and CigRx® products.
Information pertaining to components of discontinued operations included in these condensed consolidated financial statements is
included below.
Assets and liabilities
of discontinued dietary supplement operations consisted of the following as of:
$ thousands
|
|
March 31, 2016
|
|
|
December 31,
2015
|
|
|
|
(Unaudited)
|
|
|
|
|
Assets:
|
|
|
|
|
|
|
|
|
Prepaid expenses
|
|
$
|
3
|
|
|
$
|
3
|
|
Machinery and equipment
|
|
|
24
|
|
|
|
24
|
|
Total assets
|
|
$
|
27
|
|
|
$
|
27
|
|
|
|
|
|
|
|
|
|
|
Liabilities:
|
|
|
|
|
|
|
|
|
Accounts payable
|
|
$
|
346
|
|
|
$
|
326
|
|
Accrued expenses
|
|
|
87
|
|
|
|
107
|
|
Total current liabilities
|
|
$
|
433
|
|
|
$
|
433
|
|
Results of discontinued
operations were a loss of $1 thousand and $41 thousand for the three months ended March 31, 2016 and 2015, respectively.
The losses are primarily related to insurance and disposal costs.
5.
Accrued Expenses:
Accrued expenses consisted
of the follow as of:
$ thousands
|
|
March 31, 2016
|
|
|
December 31,
2015
|
|
|
|
(
Unaudited
)
|
|
|
|
|
Accrued Expenses:
|
|
|
|
|
|
|
|
|
Accrued restructuring charges
|
|
$
|
439
|
|
|
$
|
479
|
|
Accrued payroll and related expenses
|
|
|
2,589
|
|
|
|
2,559
|
|
Accrued legal expenses
|
|
|
175
|
|
|
|
340
|
|
Accrued expenses
|
|
|
174
|
|
|
|
507
|
|
Total accrued expenses
|
|
$
|
3,377
|
|
|
$
|
3,885
|
|
6.
Restructure Charge:
As disclosed in the
historical consolidated financial statements of the Company for the years ended December 31, 2015 and 2014 included in the Company’s
Annual Report on Form 10-K for the year ended December 31, 2015, filed with the Securities and Exchange Commission, or “SEC,”
on March 22, 2016 (the “Annual Report”), the Company has focused the business on pharmaceutical drug development. As
part of the refocused business transformation, the Company consolidated its offices in Sarasota, Florida, exited the dietary supplement
and cosmetic business and terminated a number of personnel. The Company entered into severance agreements with the former employees
and accrued the costs of the executed severance agreements. All costs related to the closure of the Gloucester, Massachusetts,
Washington, D.C., and Glen Allen, Virginia offices have also been accrued.
The Company incurred
no restructuring charges for the three months ended March 31, 2016 or March 31, 2015.
For the three months
ended March 31, 2016, the Company paid $40 thousand related to restructuring costs previously accrued, which was primarily related
to involuntary termination costs. For the same period in 2015, the Company paid $206 thousand, of which $185 thousand was related
to involuntary termination costs and $21 thousand was related to the closing of the office in Glen Allen, Virginia.
As of March 31, 2016, the Company was in arrears in severance
payments to one former employee in the amount of $312,500.
7. Stockholders’ Equity:
Stock Option Plans
The Company has
adopted different option plans over the years, including a 1998 Stock Option Plan, a 2000 Equity Incentive Plan, a 2008
Incentive Award Plan and on March 30, 2016 the Company adopted the 2016 Omnibus Incentive Plan (collectively, the
“Plans”). An aggregate of six million (6,000,000) shares of the Company’s common stock have been reserved
for issuance under the 2016 Plan, all of which may be issued upon the exercise of incentive stock options. The 2016 Omnibus
Incentive Plan has not yet been funded with stock or been approved by the shareholders.
The Plans provide
for the award of options to purchase common stock, restricted shares of common stock and certain other equity and
equity-based awards to directors, officers, employees and consultants or advisors of the Company and certain affiliated
entities. In the aggregate, as of March 31, 2016 the Plans provide for grants of both qualified and non-qualified stock
options, as well as other equity-based awards, with respect to up to 6,808,000 shares in the aggregate. Of these shares,
6,000,000 related to the 2016 Omnibus Incentive Plan have not yet been funded.
As of March 31,
2016, there were 840,600 options issued and outstanding with a weighted average exercise price of $55.30 per share.
A summary of the status
of the Company’s unvested stock options at March 31, 2016, and changes during the three months then ended, is presented below.
Non-Vested Stock Options (unaudited)
|
|
Shares
|
|
|
Weighted
Average
Grant-Date Fair
Value
|
|
Non-Vested at December 31, 2015
|
|
|
205,000
|
|
|
$
|
22.12
|
|
Granted
|
|
|
-
|
|
|
|
-
|
|
Vested
|
|
|
-
|
|
|
|
-
|
|
Forfeited
|
|
|
-
|
|
|
|
-
|
|
Non-Vested at March 31, 2016
|
|
|
205,000
|
|
|
$
|
22.12
|
|
As of March 31, 2016,
there was $596 thousand of unrecognized compensation cost related to unvested share-based compensation arrangements under the Plans.
The compensation cost will be recognized over the next 33 months.
Pursuant to the Plan,
on March 30, 2016, the Board of the Company awarded to each non-employee director of the Company an option to purchase 48,000 shares
of Company common stock at an exercise price of $1.12 per share. Such options will expire 10 years from the date of grant unless
they terminate earlier upon a termination of service. The options granted to Lee Canaan and Scott Sensenbrenner are immediately
vested, and the options granted to Sunitha Chundru Samuel and Robert Scannell will vest 50% on the first anniversary of their appointments
to the Board and 50% on the second anniversary of their appointments to the Board. Ms. Chundru’s appointment to the Board
was on April 20, 2015, and Mr. Scannell’s appointment to the Board was on November 17, 2015. As of the date of this filing,
no options have been issued from the 2016 Omnibus Incentive Plan as the plan has not yet been funded with shares.
No stock options were
issued or exercised during the three months ended March 31, 2016.
The outstanding stock
options as of March 31, 2016 had no intrinsic value.
Warrant activity
During the three months
ended March 31, 2016, 20,000 warrants were exercised resulting in gross proceeds to the Company of $11,120.
Stock activity
On March 30, 2016,
the Company entered into a private placement with six accredited investors, pursuant to which the Company sold and issued a total
of 1,428,570 shares of the Company’s common stock at a purchase price of $0.35 per share, issued seven (7) year warrants
to purchase up to a total of 2,857,140 shares of common stock at an exercise price of $1.12 per share, the Company raised an aggregate
of $500,000 in the private placement.
During the three months
ended March 31, 2016, the company issued 2,008,506 shares of common stock to satisfy approximately $768,000 of principal and interest
payments under the Senior Secured Convertible Notes.
8. Commitments, Contingencies and Other Matters:
Derivative Action Lawsuits
Four individuals, David C. Inloes,
William Skillman, Harold Z. Levine and Louis Lim, filed separate, but similar derivative actions naming all or most of our then
current directors, several of the Company’s officers and, in one case, one former director as defendants. Two of the actions
were filed in the United States District Court for the Eastern District of Virginia, Alexandria Division (the “Alexandria
Actions”). The first Alexandria Action, William Skillman v. Jonnie R. Williams et al., was filed on May 2, 2013. The second
Alexandria Action, David C. Inloes v. Jonnie R. Williams et. al., was filed on May 3, 2013. The Alexandria Actions have been consolidated
and co-lead counsel appointed by the Court. Pursuant to a court order, plaintiffs filed a consolidated amended complaint on January
13, 2014 and a motion to dismiss was filed on February 3, 2014 on behalf of all of the defendants. Also, on February 3, 2014, the
Company, as nominal defendant, moved to stay or dismiss this action pending a resolution a securities class action litigation then
pending in federal court in Richmond, Virginia. Separately, on January 29, 2014, the United States moved to stay discovery in the
case pending the completion or other disposition of the criminal trial of former Governor McDonnell and his wife. That motion was
granted by the Court on January 30, 2014. On February 28, 2014, the Court granted the Company’s motion to stay the case,
ruling that the case would be stayed for all purposes pending further order of the Court and ordering the Company, within ten days
of the dismissal or resolution of the Richmond securities class action or the trial court’s verdict in the McDonnell case,
whichever occurred first, to file a report indicating what action, if any, the Company intended to take with regard to this case,
including specifically, without limitation, whether the Company intended to pursue or seek dismissal of the claims asserted against
each of the named individual defendants.
The third derivative action,
Harold Z. Levine v. Jonnie R. Williams, et. al., was filed on July 8, 2013, in the Circuit Court for the City of Richmond (the
“Levine Action”), and the fourth case, Louis Lim v. Christopher C. Chapman, et. al., was filed in the Circuit Court
for Henrico County on July 11, 2013 (the “Lim Action”). In general, the complaints collectively allege that the Company’s
directors and officers breached their fiduciary duties by causing the Company to issue false and misleading statements regarding
our past and future prospects and certain scientific data relating to our products, as well as engaging in certain unspecified
private placements and related party transactions since 2006. On July 1, 2013 and August 1, 2013, stipulations were filed in each
of the state court actions that stayed the period for defendants to respond to the complaints. These stipulations were later entered
by the Courts. In May 2014, the parties to both state court derivative actions filed further stipulations subsequently endorsed
by the Courts that provided for the transfer of the Lim Action to the Circuit Court for the City of Richmond, the consolidation
of the Lim Action with the Levine Action, and a further stay of the deadline for a response to the complaint.
On or around
January 27, 2015, the parties to the derivative actions concluded a stipulation of settlement and the plaintiffs filed a
motion of approval of the settlement. The proposed settlement provided for the Company’s implementation of certain
corporate governance reforms and contemplated payment by the Company of certain attorney’s fees to plaintiffs’
counsel.
On March 27, 2015,
the parties filed a joint submission setting forth additional information responsive to the Court’s order. On March 31, 2015,
the Court entered orders preliminarily approving the proposed settlement and setting a further settlement hearing for July 10,
2015. On June 12, 2015, plaintiffs filed a motion for final approval of the settlement and a motion for attorney’s fees.
On June 19, 2015 the Company filed a response contending that plaintiffs’ request for attorney’s fees was excessive.
At the July 10, 2015 final approval hearing, the Court approved the settlement as fair and adequate and took under advisement plaintiffs’
motion for attorney’s fees. On July 13, 2015 the Court entered final judgment and, on July 17, 2015, issued an order directing
the parties to schedule a settlement conference with the magistrate judge regarding plaintiffs’ motion for attorney’s
fees. The settlement conference was held on August 26, 2015, but the parties were unable to agree on a settlement for attorney’s
fees and the magistrate judge returned the matter to the Court to rule on the plaintiffs’ fee motions. As of the date of
the filing, the Court has not issued a ruling. Pursuant to the stipulation of settlement, plaintiffs were required to dismiss the
state court derivative actions with prejudice and on July 13, 2015 the state court issued an unopposed final order dismissing the
matter with prejudice. At this time, the Company cannot predict the probable outcome of the claims against the Company for attorney’s
fees. Accordingly, no amounts have been accrued in the consolidated financial statements.
Consumer Class Action
On January 27,
2014, Howard T. Baldwin filed a purported class action naming the Company, RCP Development (its subsidiary), and GNC Holding,
Inc. (“GNC”) as defendants. The case was filed in the United States District Court for the Northern District of
Illinois. Generally, the complaint alleged that claims made for the Company’s Anatabloc
®
product have not been proven and that individuals purchased the product based on alleged misstatements
regarding characteristics, uses, benefits, quality and intended purposes of the product. The complaint purported to allege
claims for violation of state consumer protection laws, breach of express and implied warranties and unjust enrichment. The
Company agreed to indemnify and defend GNC pursuant to the terms of the purchasing agreement between RCP Development and
GNC. Consistent with that commitment, the Company agreed to assume the defense of this matter on its behalf as well
as on behalf of GNC. The defendants filed a motion to dismiss the complaint on March 24, 2014. On January 13, 2015, the Court
entered an order dismissing the complaint in its entirety without prejudice.
On February 10,
2015, Mr. Baldwin filed an Amended Complaint against the Company, RCP Development and GNC (collectively,
“Defendants”). The Amended Complaint also includes an additional named plaintiff, Jerry Van Norman, who alleges
that he is a citizen of Parkville, Missouri. The Amended Complaint requests certification of an “Illinois Class”
consisting of “[a]ll persons who paid, in whole or in part, for Anatabloc
®
dietary supplement in Illinois between August 1, 2011 and the present for personal, family or household
uses,” and a “Missouri Class” consisting of “[a]ll persons who paid, in whole or in part, for
Anatabloc
®
dietary supplement in Missouri between August 1, 2011 and the
present for personal, family or household uses.” The Amended Complaint is pleaded in seven counts: (1) violation of the
Consumer Fraud and Deceptive Business Practices Act of Illinois; (2) violation of the Missouri Merchandising Practice Act;
(3) breach of express warranty under Illinois law; (4) breach of express warranty under Missouri law; (5) breach of implied
warranty of merchantability under Illinois law; (6) breach of implied warranty of merchantability under Missouri law; and (7)
unjust enrichment.
Like the original complaint,
the Amended Complaint alleges that Defendants manufactured, marketed and/or sold Anatabloc
®
, a dietary supplement purportedly derived from an anatabine alkaloid, and promoted Anatabloc
®
as a “wonder drug” with a number of medical benefits and uses, from treating excessive inflammation (associated with
arthritis) to Alzheimer’s disease, traumatic brain injury (or concussions), diabetes and multiple sclerosis. Plaintiffs allege
that Defendants have never proven any of these claims in clinical trials or received FDA approval for Anatabloc
®
, and that Anatabloc
®
“was never the ‘wonder drug’ it claimed
to be.” Plaintiffs allege that they purchased Anatabloc
®
based upon claims
that it provides “anti-inflammatory support.” Mr. Baldwin alleges that he purchased Anatabloc
®
to “reduce inflammation and pain in his joints,” and Mr. Van Norman alleges that he “suffers back and knee problems,
as well as arthritis, and expected Anatabloc
®
to be effective in treating these
symptoms and purchased Anatabloc
®
to help alleviate his symptoms.” Both
plaintiffs alleged that Anatabloc
®
did not provide the relief promised by the
Defendants.
Although the Amended
Complaint does not include claims based on the consumer protection laws and breach of warranty laws of several additional states
like the original complaint, on February 10, 2015, counsel for plaintiffs also served a “Notice pursuant to: Alabama Code
§ 8-19-10(e); Alaska Statutes §45.50.535; California Civil Code § 1782; Georgia Code § 10-1-399; Indiana Code
§ 24-5-0.5-5(a); Maine Revised Statutes, Title 5, § 50-634(g); Massachusetts General Laws Chapter 93A, § 9(3); Texas
Business & Commercial Code § 17.505; West Virginia Code § 46A-6-106(b); and Wyoming Statutes § 40-12-109 as
well as state warranty statutes,” which purports to give notice to Defendants on behalf of the named plaintiffs and a “class
of similarly situated individuals” that Defendants have “violated state warranty statutes and engaged in consumer fraud
and deceptive practices in connection with its sale of Anatabloc
®
,”
and demands that “Defendants correct or otherwise rectify the damage caused by such unfair trade practices and warranty breaches
and return all monies paid by putative class members.”
The
Defendants timely moved to dismiss the Amended Complaint on March 10, 2015. Plaintiffs filed a memorandum in response to the
motion to dismiss on April 9, 2015, and Defendants filed their reply memorandum on April 22, 2015. On April 28, 2015,
the Court entered an order lifting the stay of discovery that had been in place in the case. The Plaintiffs served discovery
requests on May 18, 2015, to which the Defendants responded on June 17, 2015. The Company continued to produce responsive
documents to the Plaintiffs on a rolling basis. On February 2, 2016, the Court entered a Memorandum Opinion and Order
granting the motion to dismiss the Amended Complaint and dismissing all claims alleged in the Amended Complaint. The
Plaintiffs’ claims under Illinois and Missouri law for breach of express and implied warranty were dismissed with
prejudice. The remaining claims were dismissed without prejudice. The Court allowed Plaintiffs 28 days to file a Second
Amended Complaint and upon motion granted additional time to respond. The next status hearing before the Court was scheduled
for March 22, 2016 but was postponed and a new status hearing was not set.
In April 2016,
the parties executed a Confidential Settlement and Release for an amount not deemed material to the overall financial statements. Plaintiffs filed with the Court an Amended Joint Stipulation of
Voluntary Dismissal of the lawsuit with prejudice which was entered by the Court and effective April 22, 2016. See Note 9,
Subsequent events for additional details on the Confidential Settlement and Release.
Action by Iroquois Master Fund, Ltd.
and American Capital Management, LLC
On February
19, 2015, the Company became aware of a complaint filed on February 18, 2015, in New York Supreme Court for New York County
in which the Company and its Chief Executive Officer, Dr. Michael J. Mullan, are named as a defendants. The complaint was
filed by Iroquois Master Fund, Ltd. and American Capital Management, LLC, who were investors in a private placement of
the Company’s securities completed in March 2014 (the “Private Placement Transaction”). The complaint
also names as a defendant John J. McKeon, a shareholder of the Company. Iroquois and American Capital are seeking $4.2
million, in the aggregate, in damages or, alternatively, rescission of the Private Placement Transaction, premised on
allegations that the Company entered into a “sham” loan agreement with Mr. McKeon to provide the Company with a
$5.8 million line of credit in order to fraudulently induce Iroquois and American Capital to acquire the Company’s
securities. On April 29, 2015, the Company filed a motion to dismiss the complaint because (i) plaintiffs did not register to
do business with the New York Secretary of State, and thus lack the capacity to sue in New York, and (ii) the court lacks
personal jurisdiction over the company and Dr. Mullan because the defendants were not present in New York in connection with
the Private Placement Transaction, and the critical events relating to it did not take place in New York. Plaintiff served
its papers in opposition to that motion on June 5, 2015 and the Company served its reply papers on July 1, 2015. Oral
argument on the motion was held September 8, 2015. On May 13, 2016, the Court issued a decision, please see Note 9, “Subsequent Events” for additional
details.
Although the Company believes that plaintiffs’ material allegations are without merit and intends
to vigorously defend itself and Dr. Mullan against such allegations, no assurances can be given with respect to the outcome of
the motion to dismiss or more generally to the litigation.
The Company has been
notified by its insurance carrier that the carrier’s position is that legal costs incurred on behalf of the Company for the
Iroquois Master Fund, Ltd. and American Capital Management, LLC action are not covered under the Company’s policy, although
any legal costs incurred on behalf of the Company’s Chief Executive Officer, Dr. Michael J. Mullan, would be covered, subject
to the policy retention. All legal costs incurred to date for this action through March 31, 2016 have been recorded in the
accompanying financial statements accordingly.
Asserted Claims by Jonnie R. Williams
under Employment Agreement
The Company has previously
disclosed that on March 25, 2015, the Company received an email from an attorney representing Jonnie R. Williams, a former director
of the Company and the Company’s former Chief Executive Officer, stating that Mr. Williams is contractually entitled to severance
compensation. At that time, the Company disclosed that it was not aware of the claimed legal or contractual basis for Mr. Williams’
severance claim.
On June 11, 2015, the
Company was informed that Mr. Williams plans to file an arbitration action against the Company under his employment agreement to
assert his alleged contractual severance entitlement. Mr. Williams alleges that the election of the Company’s Board of Directors
at the Company’s December 2013 annual stockholder meeting triggered a provision of his employment agreement that provides
for severance in the amount of $2.5 million. However, the Company disagrees that such stockholder meeting triggered the severance
entitlement and that Mr. Williams voluntarily resigned from his employment with the Company in August 2014 without any contractual
right to severance compensation. No accrual has been made in the accompanying financial statements as the Company does not believe
the claim has merit. As of the date of this filing, Mr. Williams has not filed an arbitration action against the Company.
Commitments
The Company had research
and development and other contracted commitments totaling $0.6 million as of March 31, 2016.
9. Subsequent Events:
In the matter where
Howard T. Baldwin filed a putative claim against the Company, as discussed above, the parties in April 2016, executed a Confidential
Settlement and Release for an amount not deemed material to the overall financial statements. Plaintiffs filed with the Court
an Amended Joint Stipulation of Voluntary Dismissal of the lawsuit with prejudice which was entered by the Court and effective
April 22, 2016.
As of the date of this filing, the Company is in arrears in severance payments to one former employee in
the amount of $312,500.
From April 1,
2016 to May 9, 2016, the Company issued 7,188,377 shares of common stock to satisfy $1,629,433 of principal and interest
payments under the Senior Secured Convertible Notes.
In the matter of
Iroquois Master Fund, Ltd. and American Capital Management, LLC, on May 13, 2016 the Court issued a decision which dismissed
the action against Dr. Mullan, the Company’s Chief Executive Officer for lack of personal jurisdiction, and
therefore he is no longer a party to the action. The decision further directed that plaintiff Iroquois Master Fund,
Ltd. register to do business in the State of New York within 30 days or its claims will be dismissed. During the
aforesaid 30 day period, all action is stayed. The Court also held that it has jurisdiction over the Company. Finally,
the claims of plaintiff American Capital Management, LLC can proceed against the Company when the 30 day stay is
lifted. Similarly, the claims of plaintiff Iroquois Master Fund, Ltd. can proceed against the Company if it registers
to do business in New York.