ITEM 1. BUSINESS
Overview
Corporate Overview of NeuroOne Medical Technologies Corporation
We were originally incorporated as Original Source Entertainment, Inc. under the laws of the State of Nevada on August 20, 2009. Prior to the closing of the Acquisition, as defined below, we completed a series of steps contemplated by a Plan of Conversion pursuant to which we, among other things, changed our name to NeuroOne Medical Technologies Corporation, increased our authorized number of shares of Common Stock from 45,000,000 to 100,000,000, increased our authorized number of shares of preferred stock from 5,000,000 to 10,000,000 and reincorporated in Delaware. On July 20, 2017, we acquired NeuroOne, Inc. (the “Acquisition”). Immediately following the closing of the Acquisition, the business of NeuroOne, Inc. became our sole focus. Unless otherwise stated or unless the context otherwise requires, the description of our business set forth below is provided on a combined basis, taking into account our wholly-owned subsidiary, NeuroOne, Inc.
Corporate Overview and History of NeuroOne, Inc.
NeuroOne, Inc. was incorporated under the laws of the State of Delaware on October 7, 2016. Its predecessor entity, NeuroOne LLC (the “LLC”), was formed on December 13, 2013 and operated as a limited liability company until it was merged with and into NeuroOne, Inc. on October 27, 2016 with NeuroOne, Inc. as the surviving entity (the “Merger”). As a result of the Merger, all of the properties, rights, privileges and powers of the LLC vested in NeuroOne, Inc., and all debts, liabilities and duties of the LLC became the debts, liabilities and duties of NeuroOne, Inc., except for the license agreement (the “WARF License”) with the WARF which was not legally transferred until May 2017. The purposes of the Merger were to: change the jurisdiction of incorporation from Minnesota to Delaware; change the ownership of the LLC’s underlying assets; and convert from a limited liability company to a corporation.
We are a medical technology company focused on the development and commercialization of thin film electrode technology for cEEG and sEEG recording, brain stimulation and ablation solutions for patients suffering from epilepsy, Parkinson’s disease, dystonia, essential tremors and other related brain related disorders. The Company has also initiated a program to develop and commercialize electrodes targeted for spinal cord stimulation procedures to treat back-related pain from failed back surgeries. Additionally, we are investigating the potential applications of our technology associated with artificial intelligence. Members of our management team have held senior leadership positions at a number of medical technology and biopharmaceutical companies, including Boston Scientific, St. Jude Medical, Stryker Instruments, C.R. Bard, A-Med Systems, Sunshine Heart, Empi, Don-Joy and PMT.
We are developing our cortical, sheet and depth electrode technology to provide solutions for diagnosis through cEEG recording and sEEG recording and treatment through brain stimulation and ablation, all in one product. A cEEG is a continuous recording of the electrical activity of the brain that identifies the location of irregular brain activity, which information is required for proper treatment. cEEG recording involves an invasive surgical procedure, referred to as a craniotomy. sEEG involves a less invasive procedure whereby doctors place electrodes in targeted brain areas by drilling small holes through the skull. Both methods of seizure diagnosis are used to identify areas of the brain where epileptic seizures originate in order to precisely locate the seizure source for therapeutic treatment if possible.
Deep brain stimulation, or DBS, therapies involve activating or inhibiting the brain with electricity that can be given directly by electrodes on the surface or implanted deeper in the brain via depth electrodes. Introduced in 1987, this procedure involves implanting a power source referred to as a neurostimulator, which sends electrical impulses through implanted depth electrodes, to specific targets in the brain for the treatment of disorders such as Parkinson’s disease, essential tremor, dystonia, and chronic pain. Alzheimer’s is another indication evaluating the effects of DBS. Unlike ablative technologies, the effects of DBS are reversible.
RF ablation is a procedure that uses radiofrequency under the electrode contacts that is directed to the site of the brain tissue that is targeted for removal. The process involves delivering energy to the contacts, thereby heating them and destroying the brain tissue. The ablation does not remove the tissue. Rather, it is left in place and typically scar tissue forms in the place where the ablation occurs. This procedure is also known as brain lesioning as it causes irreversible lesions.
Failed back surgery syndrome (“FBSS”) is a condition that produces chronic lower back/leg pain due to one or more failed back surgeries. Typically, it is related to patients that suffer with pain after surgery of the lumbar spine for degenerative disc disease. Re-operations are usually not recommended for these patients due to low success rates. These patients experience greater levels of pain, a lower quality of life, varying levels of disability and higher rate of unemployment. Spinal cord stimulation works by placing an electrodes(s) in a targeted area of the spine and then connected to an implantable pulse generator that sends electrical stimulation to the electrode to block the pain signals from reaching the brain.
Our cortical sheet electrode and depth electrode technology has been tested over the years by both WARF, the owners of our licensed patents, and Mayo Clinic located in Rochester, Minnesota, in both pre-clinical models as well as through an IRB approval at Mayo Clinic for clinical research. Regarding our ablation electrode, the Cleveland Clinic has performed testing in bench top models and pre-clinical (or animal testing) modes. These pre-clinical tests have demonstrated that the technology is capable of recording, ablation and acute stimulation, although our technology remains in product development (meaning that additional trials will be needed prior to it being approved for sale by the U.S. Food and Drug Administration (the “FDA”)) for all of the recording (or diagnostic) and therapeutic modalities.
Prior to commercialization of our technology, we will have to obtain regulatory approval as discussed in “-Clinical Development and Regulatory Pathway” and “-Government Regulation” below.
Our Market Opportunity
Epilepsy Market
We expect to initially target the diagnosis and treatment of epilepsy. Epilepsy can be caused by a variety of conditions that affect a person’s brain, some of which are: stroke, brain tumor, traumatic brain injury and central nervous system infections. According to the Centers for Disease Control and Prevention (the “CDC”) and Citizens United for Research in Epilepsy (“CURE”), there are approximately 3,000,000 patients annually suffering with epilepsy in the United States, with an additional 200,000 diagnosed every year. They also estimate that epilepsy costs the United States $15.5 billion per year. We believe the European market is similar. Approximately 720,000 of these patients are not receptive to pharmaceutical treatment and therefore are appropriate for surgical treatment of this disorder. In addition to poor quality of life, epilepsy also is associated with fairly high mortality rates, especially in children. CURE reported that Sudden Unexpected Death in Epilepsy accounts for 34% of all deaths in children. Such deaths have increased by close to 100% from 2005 to 2015 according to the CDC. Despite the large market opportunity, it is estimated that there are only 16,000 craniotomies performed for epilepsy cases each year in the United States with 18,000 performed in Europe.1 These numbers represent an underpenetrated market due to the invasiveness of a full craniotomy required just to perform the diagnostic procedure. After the diagnostic procedure, a second therapeutic procedure is required and at times even a third surgery if the seizures persist. We believe patients are unwilling to proceed due to the long diagnostic times (one-four weeks in the hospital with a craniotomy), infection rates and 50% rate of success in the diagnosis and treatment of the disorder. As detailed above, after the diagnosis is completed, if successful, the patient must undergo an additional procedure to have the affected area of brain tissue removed. The average cost for the diagnostic technology per procedure is $10,000, with ablation devices costing $15,000 and brain stimulation devices costing $25,000 to $30,000. We believe our technology, once developed, will offer an all in one solution with diagnostic and therapeutic capabilities.
We believe that many leading neurologists believe that the limits of today’s current technologies are the reason the exact affected area of the brain causing epileptic seizures is not well-determined. We expect our technology, which has been developed to date by physicians at WARF and Mayo Clinic, will provide a number of advantages over the current commercially available technologies, including the following:
●Our proprietary thin film technology under development has a smaller footprint with many more electrodes.
●We expect that our technology will eventually be able to be implanted using a minimally invasive procedure utilizing a dime sized burr hole rather than a full craniotomy which is typically required to implant the currently available technology.
●Our technology may provide more accurate detection of irregular brain activity over currently available technology. In limited clinical testing, doctors at Mayo Clinic have documented pre-seizure activity (micro-seizures) during their clinical research with their patients using our cEEG technology.
1 American Association of Neurological Surgeons National Neurosurgical Procedural Statistics 2012.
We expect our technology can ablate through the electrodes as well as perform brain stimulation, allowing for diagnosis and treatment through the same product and in the same procedure.
Parkinson’s Disease
The Parkinson’s Disease Foundation estimates that as many as 1,000,000 patients in the United States live with Parkinson’s disease with an additional 60,000 patients diagnosed per year. Over 10,000,000 patients worldwide are living with Parkinson’s disease. There have not been any drugs introduced that have been effective at treating Parkinson’s disease. The average onset is over 60 years old but some people have been diagnosed as young as 40 years old. Parkinson’s is a disorder of the central nervous system caused by loss of brain cells throughout various regions of the brain. It is attributed to the loss of dopamine production in the brain, a messenger in the brain that allows for movement and coordination. There are no objective tests to diagnose Parkinson’s disease, and misdiagnosis rates are still very high. Doctors look to find two or more signs to make a diagnosis, including balance problems, rigidity and tremors that occur during rest. In 2011, the FDA approved the first imaging device called a DaTscan that can capture images of the dopamine system in the brain. By itself, these scans cannot diagnose Parkinson’s but can help confirm a doctor’s diagnosis. Parkinson’s disease is typically not fatal; however, complications caused by the symptoms of Parkinson’s, such as difficulty swallowing causing food to travel to the lungs resulting in pulmonary issues or falls related to loss of balance, can be fatal.
Today’s primary treatment for Parkinson’s disease involves medications that have not proven to resolve symptoms but rather ease symptoms. Years ago, surgical procedures such as thalamotomy and pallidotomy targeted certain parts of the brain and involved destroying the tissue. More recently, these procedures have been replaced with DBS. A doctor evaluates the patient by reviewing the patient’s symptoms and medications taken and administering detailed memory, thinking and imaging tests to determine if they are appropriate for DBS. According to the Michael J. Fox Parkinson’s Disease Research Foundation website, patients that seem to do best with DBS are those that have had the disease for at least four years and have benefited from taking medications prescribed to control the disease. In addition, DBS seems to help with reducing the issues with motor functions such as tremors, stiffness and slowness but not for balance issues. Doctors are evaluating treatment to other parts of the brain in an effort to address more symptoms to treat walking or balance issues. In addition, research is being conducted to provide stimulation when the symptoms return as opposed to all of the time.
Essential Tremors
Essential tremors are thought to be due to electrical irregularities in the brain that send abnormal signals to the muscles. It is a progressive condition that worsens over time and is linked to genetic disorders that typically appear in people who are over 40. Essential tremors usually occur alone and without any other neurological symptoms or signs. The tremors usually occur when the hands are raised and primarily affect the hands. Muscles in the trunk, face and neck may also experience symptoms. Sometimes misdiagnosed as Parkinson’s disease, essential tremors are an involuntary rhythmic shaking of the hands that is not present at rest. It is apparent during activities such as drinking, writing and eating. Symptoms can worsen due to stress, anxiety, smoking, caffeine, fatigue, etc. Genetics Home Reference estimates that as many as 10,000,000 people in the United States are affected by the disease. Treatments for the disease include medical therapy, weighting the limbs and DBS. Patients need to eliminate any medications they are taking that cause tremors as this can exacerbate the symptoms. For some patients, using wrist weights may ease symptoms allowing the patient to function. Other patients may also use relaxation techniques as stress can increase symptoms. Medical therapy is also used to treat patients’ symptoms. Primidone is typically the first drug prescribed as it has had success in some situations for epilepsy. Botox is also used at times to control head tremors. When these fail, surgery is the next alternative. A surgical procedure used years ago created lesions in the ventral intermediate thalamus and was highly successful with treating essential tremors but is no longer commonly used due to increased risk of developing speech problems. The latest therapy is DBS, which, unlike other therapies, is reversible and programmable, helping to adjust the settings to maximize patient benefit. Similar to Parkinson’s disease, the ability to detect this irregular brain activity before it causes a tremor is highly desirable.
Dystonia
Dystonia is a neurological condition recognized as a motion disorder that involves over activity of a variety of different muscles simultaneously that work against each other. It presents itself in a variety of symptoms but typically involves repetitive, patterned and often twisting involuntary muscle contractions resembling tremors. According to the Dystonia Medical Research Foundation, over 300,000 people are affected in the United States and Canada alone. Dystonia is the third most common problem seen in movement disorder clinics. Because it has many different manifestations, it is often misdiagnosed. In addition, similar to Parkinson’s disease, there are no specific tests that can positively diagnose dystonia. A doctor typically will evaluate patient and family history, potentially do genetic testing, EEG testing, blood and urine tests. There are also many treatment options for patients but depend on the type of dystonia. Botox and certain medications may be helpful or DBS may be used.
Spinal Cord Stimulation
The market for spinal cord stimulation was reported to be $1.97 billion in the United States in 2017 as reported by Infinium Research in their Spinal Cord Stimulation Market Research report. The market includes the following indications: Failed Back Surgery Syndrome, Ischemic Limb Pain, and Complex Regional Pain Syndrome. Over half of this market is comprised of patients with FBSS. Certain studies have indicated a benefit for these patients suffering from chronic back and lower limb pain when they have been treated with electrical stimulation. Prior to the patient receiving an implant, they undergo a trial period that allows them to determine if they are receiving relief from the therapy while preventing a surgery to implant the pulse generator that provides the stimulation. If the trial period is successful, then the device is implanted in a follow-up procedure.
Artificial Intelligence
The brain consists of approximately 100 billion nerve cells, which are small wires that pass electrical signals to control all of its functions. There have been a number of successful clinical trials in which small metal wires, known as electrodes, are implanted in the brain to correct nerve damage using wireless communication between implanted wires to simulate functional nerve cells. In addition to correcting damaged nerve cells, certain scientists have theorized that if millions of wires could be implanted in the brain, these electrodes could present an opportunity to use artificial intelligence to create infrared sight, increase hearing or perfect memory recall. However, there currently is no commercially available manufacturing platform capable of making thousands of wires that can be placed within or on the brain and work reliably for the lifetime of a subject, and are soft enough to match the tissue of the brain, that avoid damage to the brain.
Limitations of Currently Available Therapies
There are a limited number of currently available products for diagnosis and treatment for people with neurological disorders such as epilepsy. Although the currently available systems provide diagnosis and treatment for patients, they have certain inherent limitations and shortcomings that we believe limit their use and validate the need for improved technology in the market. These limitations include:
●Lengthy diagnostic times: Patients spend one to four weeks in the hospital waiting to have seizures that will allow doctors to determine where the seizures are occurring.
●Lower Accuracy: Historically, clinical electrode manufacturers primarily provided electrodes that sample brain tissue at approximately centimeter spacial scales. Advances in digital EEG acquisition have made recordings at sub-millimeter spatial scales possible, but high-spatial resolution EEG has been slow to impact clinical practice. Existing, higher spatial scales increase the potential for missing data that may be critical in the removal of brain tissue causing the irregular activity.
●Need to perform a full craniotomy (invasiveness): Currently available cortical electrode technology is placed through a craniotomy, which requires removing the top part of the cranium and is a very painful and invasive procedure. Procedural times for a craniotomy range from a minimum of four to eight hours. A variety of complications can occur when a full craniotomy is performed, including but not limited to: stroke, bleeding, infection, seizures, swelling of the brain (which may require a second craniotomy), nerve damage, which may cause muscle paralysis or weakness, cerebrospinal fluid (CSF) leak, which may require repair, loss of mental functions and permanent brain damage with associated disabilities. The invasiveness, procedural times and possible surgical complications have limited the growth of surgical treatment of epilepsy.
● Requirement for a surgical incision: Currently, when patients have been implanted with paddle electrodes in the spinal area, a surgical incision has been required. A technology that allows for percutaneous placement is desirable.
● Limited number of contacts on an electrode: Paddle electrodes currently are available in a variety of sizes and number of contacts. Physicians want to explore adding a greater number of contacts on the same electrode in order to be able to be more precise in stimulating targeted areas.
Our Solution
As a result of the inherent limitations and inconvenience of existing systems, we believe that there is a significant unmet need among people with neurological disorders for cortical strip, grid and depth electrodes that provide diagnostic capabilities through cEEG and sEEG recording in addition to therapeutic modalities, such as brain stimulation and ablation, offered as an all in one product. In comparison to currently available technologies, we are currently developing our strip, grid and depth electrodes with the goal of providing the following expected advantages:
●Reduced time for diagnosis: If we are successful in identifying brain activity more quickly, in offering a minimally invasive procedure and developing an all in one solution, we expect our technology will reduce overall procedural times. While our pre-clinical and clinical experience to date is very limited, our cortical grid technology under development has, in some cases, demonstrated the ability to provide hi fidelity recordings that have allowed physicians to identify the affected brain tissue causing seizures in hours versus weeks. This represents the potential for meaningful cost savings for hospitals and patients and improved quality of life for patients.
●Improved accuracy of diagnostic technologies: Because we believe our thin film technology will be capable of recording at higher fidelity than current technologies used in EEG recording, we believe our technology may be able to more precisely determine the brain tissue causing seizures. Additionally, in the limited clinical tests performed by Mayo Clinic with five patients to date, our technology under development has identified what clinicians refer to as pre-seizure activity (made possible by the ability to detect brain activity using sub-millimeter spatial scales). We believe our technology under development may be able to improve outcomes compared to using other therapeutic technologies regardless of whether we are able to offer an all in one diagnostic and therapeutic solution.
●Implantation via minimally invasive procedure with fewer post-procedure complications: We are currently developing an approach to deliver the cortical electrodes, including minimizing the invasiveness of the procedure. We expect that patients who have qualified for this therapy will be more accepting of a minimally-invasive procedure. Such a procedure would potentially reduce the patient’s pain, bleeding and other adverse events associated with a full craniotomy. Our technology is expected to also have fewer wires, also referred to as tails, exiting the patient’s head, which can also reduce the potential for infections. Furthermore, the material we currently use in our cortical electrodes has shown in pre-clinical evaluations to cause less inflammation than current electrode substrates as it appears more compatible with brain tissue. As discussed under “Our Strategy” below, our technology under development, if approved, will be implanted via a full craniotomy until such time, if ever, as we are able to develop our minimally invasive procedure.
●All-in-one diagnostic and therapeutic technology solution: Due to the expected high fidelity recording capabilities of our technology under development, we have received feedback from physicians that they will attempt to perform the diagnosis and treatment in a single procedure, thereby eliminating the need for a second surgical procedure, reducing the likelihood of patient infection and minimizing the diagnostic, procedural and hospital costs. As discussed under “Our Strategy” below, our initial product offering will offer diagnostic-only capabilities while we advance the development of our all in one approach.
● Percutaneous placement of spinal cord stimulation paddle electrodes with scalability options: Due to the thin film nature of our electrode technology, we believe that it may allow for percutaneous placement, thereby preventing the need to make surgical incisions to place the electrodes. Minimally invasive and percutaneously placed technologies have become almost a requirement for adoption with patients and physicians. In addition, our technology offers the ability to increase the number of contacts on a film that traditionally offers fewer contacts. Increasing the number of contacts may allow for more precise stimulation in the spine, potentially improving the therapeutic outcomes.
Our Strategy
Our goal is to be the global leader in cEEG and sEEG recording, deep brain stimulation and ablation, owning the procedure from diagnosis through treatment. The key elements of our strategy include:
● Introduce cortical strip and grid electrodes for the diagnosis of epilepsy in United States: In December 2019, we announced that we received U.S. FDA 510(k) clearance to market our thin film cortical electrode technology for temporary (less than 30 days) recording, monitoring, and stimulation on the surface of the brain. Our initial product offering will be placed through traditional surgical means involving a craniotomy until such time, if any, that we launch our minimally invasive procedure. We believe, due to physician feedback, that our technology under development would represent a major improvement over existing cortical electrodes for the recording of brain activity. We are initially targeting epilepsy as we believe this is a clinical area of great need and a market that is underserved with a quick path to commercialization. We believe the largest and quickest-to-market geography for our cortical strip and grid technology under development is in the United States for a number of reasons, including the following: (i) many industry sources believe there is a large underserved U.S. market, (ii) healthy procedural reimbursement for centers and physicians, (iii) robust average selling prices, (iv) physician enthusiasm for our technology under development.
●Launch depth electrodes for sEEG recording: Given the reluctance of patients to undergo epilepsy surgery due to its invasiveness, a number of epilepsy centers have adopted the use of depth electrodes, which are placed by drilling small holes into the patient’s cranium, thereby avoiding a craniotomy. We believe our technology will offer advantages to current depth electrode technology and will enable us to offer a therapeutic solution using this technology in the future. As we develop our technology, we plan to release further information about the expected advantages of our technology over currently available therapies.
●Introduce minimally invasive delivery system for cortical electrodes: Cortical electrodes generally require a craniotomy, which is a very invasive procedure that can cause patient complications. Because of this, many patients have opted to not have epilepsy surgery, instead accepting the consequences and risks associated with epilepsy. We intend to develop a procedure that may include a delivery system placed through a small circular incision in the skull for implantation of the cortical grid and strip electrodes. We believe this will increase patient willingness to accept the surgery and increase market penetration. Until we are able to develop this procedure, if at all, our initial product offering will be placed through traditional surgical means involving a craniotomy and may be less likely to be adopted by physicians and patients due to unwillingness of patients to undergo epilepsy surgery.
● Develop percutaneous placed electrodes for spinal cord stimulation with scalable contact configurations: Given that many surgically placed technologies have become less invasive due to patient and physician demands, we believe that our flexible thin film technology will allow for percutaneous placement, thus potentially eliminating the need to make a surgical incision. By leveraging our existing FDA cleared cortical electrode technology, we may be able to offer the ability to improve precision of where the stimulation is delivered. NeuroOne’s platform thin film technology has the capability to increase the number of contacts in a similar footprint that has fewer contacts.
●Utilize these core technologies to develop all in one diagnostic and therapeutic solutions: Patients currently undergo one surgical procedure for diagnosis (either to have a cortical electrode placed via a craniotomy or depth electrodes placed via holes drilled into the skull) and, hopefully after the brain recordings successfully indicate where the affected brain tissue is located, a second procedure or surgery is then required to treat the patient. There is strong physician interest in being able to perform both the diagnostic and therapeutic procedure concurrently. We are developing our technology with the goal of being able to offer this benefit although there can be no assurance that we will be able to do so. We are pursuing cortical grid, strip and depth electrode technology that can record brain activity (diagnose), ablate brain tissue and also provide both acute and long term stimulation. The technology has demonstrated these functions in acute and short term animal models; however, additional development is required to offer a device that has long term therapeutic application. These therapeutic technologies are expected to require more robust regulatory approvals for the United States, ranging from a 510(k) with human clinical data to PMAs. We will engage the FDA at the proper time to determine the most efficient clinical path.
●Gain approval for other brain or motor related disorders such as Parkinson’s with the therapeutic technologies developed for epilepsy: While we are developing our technology for the diagnosis and treatment of epilepsy, we believe that our technology has strong application and utilization for other brain or motor related disorders such as Parkinson’s disease, dystonia, essential tremors and facial pain as these diseases are currently treated with DBS if medications are not effective. As previously mentioned, we are planning to offer electrodes that can be implanted for long term stimulation applications, but such use will require that we pursue additional approvals from the FDA and any international regulatory bodies where we seek to commercialize our technology.
●Explore partnerships with other companies that leverage our core technology: Given that our technology enables, complements and/or competes with a number of companies that are in the market or attempting to enter the market with diagnostic or therapeutic technologies to treat brain related disorders, we believe there may be opportunities to establish mutually beneficial relationships. In addition, our technology may have application in cardiovascular, orthopedic and pain related indications that could benefit from a hi-fidelity thin film electrode product that can provide stimulation and/or ablation therapies.
●Investigate the potential applications associated with Artificial Intelligence: We have been informed by some of our corporate advisors that the ability to offer scale-able electrode technology that can provide thousands of electrodes in the brain may be helpful in treating medical conditions that may benefit from using artificial intelligence. The Company has formed an advisory board that will provide guidance to the Company as we continue to explore the opportunities in this exciting field.
Our Technology
Epilepsy Mapping and Monitoring
Epileptic seizures occur when the neurons in the brain miscommunicate. This miscommunication typically results in involuntary muscle seizure activities and/or periods of perceptual disconnect where the individual appears frozen. Modern medical science has advanced the treatment of epileptic seizures by mapping the electrical communication activity of neurons and understanding their special orientation in the brain. This mapping is accomplished by access to the cranium (through a craniotomy) and placing conductive contacts on the brain directly. The craniotomy procedure is very invasive, traumatic to the surrounding tissue, results in high patient down time, and increases the risk of infection.
Our Technology
We seek to leverage scale-able technology and produce ultra-thin, or paper-thin electrodes that allow for high-resolution and high-definition recordings, which would improve mapping resolution and signal acquisition. If the Company is able to leverage scale-able technology, it would mean that our technology would be able to incorporate smaller electrodes and thereby increase the number of electrodes on a given surface area. We expect that this would increase the imaging resolution so that brain activity is displayed in greater definition. We also believe that the electrodes’ unique thinness and flexibility will provide a less invasive approach to electrode placement. The electrodes would be able to be placed through a small quarter size hole instead of by an invasive full craniotomy procedure.
The images under “Cortical Electrode,” from bottom to top, are images of our cortical electrode strip, our grid electrode, and the placement of the grid electrode on the brain, respectively. The images under “High Density Interconnect” are both images of our product that connects our electrodes to the head box, which is a piece of hardware that connects to electrodes to acquire, amplify, display, store and archive electrophysiological signals, and is integrated as part of our manufactured electrode product. The images under “Head Box” and “Signal Monitoring and Mapping” are images of the device which processes information received through the high density interconnect, and a sample output of data acquisition, respectively, neither of which is one of a Company product.
Our technology consists of three primary types of cortical electrodes: grid electrodes, strip electrodes and dual-sided electrodes. These electrodes have a patented design that utilizes proprietary processing and materials technology, which we believe will allow the electrodes to have improved features over the current industry standard recording electrodes.
What sets our technology apart from others is the integration of state of the art design leveraging the latest in flexible printed circuit technology. We believe our patented designs will provide the surgeon a higher tactile perspective on electrode placement allowing for ultra-precise neuron recording. We expect the benefits of our electrode designs to include the ability to detect better defined margins between healthy tissue and resect-able tissue, less immune-response from the brain and surrounding tissue, better signal acquisition due to superior conformability of the electrode over the brain, improved flexibility that physicians have requested, which we expect will enable a minimally invasive approach and the electrodes unique thinness that is unmatched by current products being used.
The Future of Neurology Mapping with NeuroOne
We seek to develop superior “scale-able” technology for future product system iterations in higher density contact placement. This will open the doors to other brain related disease recording procedures by providing hi-fidelity, more accurate diagnostic capabilities and also the ability to provide an all in one therapy capable of diagnosis, ablation and/or stimulation. Beyond the brain, we believe our technology under development has applications in other neurological signal recording disease states related to voluntary or involuntary motor neuron abnormalities, understanding sensory neuro behavior (pain), limb prosthetics and degenerative muscle disease.
Clinical Development and Regulatory Pathway
Clinical Experience, Future Development and Clinical Trial Plans
Our technology under development has not been approved for commercialization by any U.S. or foreign regulatory body. To date, the Company has performed a number of bench top (which includes feasibility testing) and pre-clinical tests (which include animal testing of device placement, ergonomics, performance, ease of use, and other tests required by FDA regulations). As described in “-Government Regulation” below, the Company will be required to perform additional testing of its technology in connection with obtaining regulatory approvals.
In parallel with the development and testing needed to launch our cortical strip and grid electrodes, we intend to expand our product offerings to include less invasive means and all in one solutions, thus providing both patients and physicians better options to treat epilepsy and other brain related disorders. While we expect to make modifications to this initial system, we believe that most of our future product development initiatives will involve unique and transformational next generation technology that should drive further appeal of our products with both physicians and patients.
We are utilizing a number of resources to develop these technologies. We license three critical patents from WARF that are the foundation of the technology and we are developing and intend to commercialize and benefit from the thin film technology know-how of Mayo Clinic doctors through our license and development agreement. WARF, Mayo Clinic and Cleveland Clinic have been responsible for all pre-clinical studies of our technology under development to date. See “-WARF License” and “-Mayo Foundation for Medical Education and Research License and Development Agreement” below.
Below we have summarized, for each component of our technology under development, the current stage of development, the pre-clinical testing done to date by WARF, The Cleveland Clinic or Mayo Clinic on such component, if any, our plans for further testing or clinical trials and our expectations regarding the requirements for regulatory approval and timing of regulatory submissions:
Technology
Stage of Development and Pre-Clinical
Testing to Date
Additional Expected Steps for Regulatory
Approval
Cortical strip and grid electrodes for the diagnosis of epilepsy
The Company has finalized the design for the product and there are no further expected changes to the device (“design freeze”).
Pre-clinical testing and clinical testing on the final design has been conducted by Mayo Clinic and WARF (as described in “Mayo Clinic Studies” below).
The Company received FDA 510(k) clearance in the fourth calendar quarter of 2019.
There may be continued clinical evaluation of the technology under a pre-existing IRB research protocol approved by Mayo’s institutional review board, which will provide us with additional clinical evidence that may assist with product acceptance and launch.
Commercial launch is in process.
Depth electrodes for recording (diagnostic) purposes
Design freeze for one design; currently there are additional alternative designs under evaluation.
Bench top testing and pre-clinical tests (animal testing) were conducted in the third and fourth calendar quarters of 2018.
No clinical testing has been conducted to date.
The Company is currently evaluating two additional alternative designs for this product. Design freeze was completed in the fourth calendar quarter of 2018 for one of the three designs in consideration. Additional pre-clinical tests (including safety and performance tests) expected to occur in the first calendar quarter of 2020. The tests will need to demonstrate: biocompatibility (including extractables/leachables (whether the product results in any leaching of metals), and ease of implantation), which we estimate will require $100,000;
Sterilization validation and adoption, which we estimate will require $25,000 to complete; and
Electrical safety, which we estimate will require $60,000 to complete.
Pending the outcome of these tests, we expect to file for FDA 510(k) marketing clearance for one design in the second calendar quarter of 2020.
Minimally invasive cortical electrode delivery system
No design freeze.
An initial pre-clinical feasibility study was conducted by the Mayo Clinic utilizing their device with our cortical film technology in December 2018. Additional testing was completed at the University of Minnesota in the second and third calendar quarters of 2019.
Pre-clinical testing was conducted in the first calendar quarter of 2019, and regulatory requirements will continue to be evaluated as we develop the design of this product. The Company conducted additional cadaver studies in the second and third calendar quarters of 2019.
The Mayo Clinic is conducting testing of its own device. In the event the Mayo Clinic completes development of its own device prior to us, we may forego completing development of our device and seek to enter into an arrangement with Mayo Clinic relating to its device (such as, for example, an acquisition/licensing, or distribution agreement).
Otherwise, to complete development of our own device, testing will need to demonstrate design verification, which we estimate will require $50,000.
Depth electrode diagnostic and ablation devices
No design freeze.
Pre-clinical testing, including benchtop and animal testing, has been conducted on early designs.
No clinical testing has been conducted to date.
The Company has partnered with the Cleveland Clinic to co-develop the product.
Additional pre-clinical testing at the Cleveland Clinic was completed in the second calendar quarter of 2020.
Once the design is finalized we will be required to conduct additional pre-clinical testing, which may include additional benchtop or animal testing for safety and performance. Additionally, the FDA may require that we conduct human clinical studies.
No FDA feedback has been sought or received by us to date on the clinical process that may be required for an ablation indication, but we expect regulatory clearance/approval will require a more robust clinical process, which could range from 510(k) clearance with human clinical data to a PMA, depending on proposed indications for use. We expect that we will need to demonstrate design verification, which we estimate will require $75,000 to complete, biocompatibility, which we estimate will require $100,000 to complete, and sterilization validation and adoption, which we estimate will require $25,000 to complete. We may also need to demonstrate electrical safety, which we estimate will require $60,000.
Future pre-clinical and clinical testing requirements for regulatory clearance will continue to be evaluated as we develop the design of this product
Spinal cord stim electrodes
No design freeze.
No pre-clinical or clinical testing to date.
This device is in early stages of development. We expect to perform pre-clinical testing in mid-2020.
Once the design is finalized we will be required to conduct additional pre-clinical testing, which may include additional benchtop or animal testing for safety and performance. Additionally, the FDA may require that we conduct human clinical studies.
No FDA feedback has been sought or received by us to date on the clinical process that may be required for an ablation indication, but we expect regulatory clearance/approval will require a more robust clinical process, which could range from 510(k) clearance with human clinical data to a PMA, depending on proposed indications for use. We expect that we will need to demonstrate design verification, which we estimate will require $75,000 to complete, biocompatibility, which we estimate will require $100,000 to complete, and sterilization validation and adoption, which we estimate will require $25,000 to complete. We may also need to demonstrate electrical safety, which we estimate will require $60,000.
Future pre-clinical and clinical testing requirements for regulatory clearance will continue to be evaluated as we develop the design of this product
Depth electrode chronic stimulation devices
No design freeze.
No pre-clinical testing, or clinical testing has been conducted to date
This device is in early development, and we do not expect to begin conducting bench top nor pre-clinical testing until the fourth calendar quarter of 2019.
Following a design freeze, we will be required to conduct additional pre-clinical testing, which may include additional benchtop or animal testing for safety and performance. Additionally, FDA-approved human clinical studies will most likely be required.
No FDA feedback has been sought or received by us to date on the clinical process that will be required for chronic stimulation, but we expect regulatory clearance/approval for chronic stimulation may require a more robust clinical process, which could range from 510(k) clearance with human clinical data to a PMA. Because we have not yet met with the FDA, we cannot yet determine what clinical data and testing we will need to complete or what the testing will need to demonstrate. However, we believe, based on the experience of competitors for similar technology, that we will need to conduct clinical trials, which we estimate will require approximately $1,000,000, as well as demonstrate biocompatibility, which we estimate will require $100,000 to complete, and demonstrate sterilization validation and adoption, which we estimate will require $25,000 to complete.
Mayo Clinic Studies
Our cortical technology for the diagnosis of epilepsy has been tested by doctors at Mayo Clinic in multiple pre-clinical tests conducted from 2012 to 2017. In pre-clinical models, doctors examined the biological impact on mammalian brains. Polyimide substrate electrodes (NeuroOne technology) were implanted on the pig’s brain for one week alongside standard competitive electrodes. The tissue underneath the two types of electrodes was removed, fixed, stained, and examined for immunological responses. The results of a histological (evaluation of brain tissue under a microscope) analysis showed reduced immunological reaction to prolonged polyimide substrate implants (NeuroOne technology) compared to standard silicone substrate clinical electrodes. Electrophysiological recordings showed data obtained from polyimide electrodes which showed the feasibility of high fidelity multi-scale electrophysiology while also displaying easier deployment of polyimide electrodes (NeuroOne technology) through minimally invasive burr holes.
Additionally, doctors implanted our polyimide thin film electrodes on five human patients who were undergoing surgery to remove brain tissue for drug resistant epilepsy. Electrophysiological recordings from the polyimide thin film technology displayed in each of these patients demonstrated micro-seizure activity due to the high fidelity multi-scale electrophysiology.
Conclusions reached by the physicians at Mayo Clinic were that thin, flexible polyimide electrodes (NeuroOne technology) provided recordings similar to standard clinical electrodes with reduced immunological response. In addition, the flexibility of polyimide electrodes may reduce pain and swelling associated with implantation of the device, and the single wire exiting the skull may reduce infection risk. The ability to record micro-seizure and single neuron brain activity may also provide additional useful clinical data. Combined, these properties suggest that the replacement of our current competitive silicone electrodes with polyimide substrate electrodes (NeuroOne technology) for recording brain activity for epilepsy could provide enhanced clinical value with reduced cost, reduced infection risk, and improved patient comfort.
In addition, our thin film cortical implant technology has been tested by researchers at the University of Wisconsin-Madison in multiple pre-clinical animal studies conducted from 2006 to 2016, which included mice, rats and primates. In these studies, our technology was able to record brain activity from different areas of the brain, was implanted in a minimally invasive fashion, electrically provided brain stimulation and tissue ablation, and had increased flexibility compared to existing commercially available technology, which allowed the grids to conform more easily to the brain surface (and may have reduced pain and swelling, compared to less flexible devices).
Sales and Marketing
Based on the size and maturity of the U.S. market, our initial commercial focus, if our technology is approved for commercialization for the diagnosis of epilepsy in the United States, will be to invest in developing a direct sales force and infrastructure to support the launch of the product in the United States and target what we estimate to be approximately 188 Level 4 epilepsy centers along with their respective epilepsy teams comprised of neurologists, neurosurgeons and technicians in the United States who are clinically active.
In parallel, we have evaluated the opportunity to commercialize our products in select European markets and have concluded that while there is a market for our technology in Europe, the regulatory changes in the European Union will require a lengthy and costly approval pathway. At this time, we will utilize our resources to remain focused on the opportunity in the United States but will reexamine international opportunities at a later time. If our technology is approved for commercialization for the diagnosis of epilepsy in the United States, we will look to educate neurologists, neurosurgeons and primary care physicians on the advantages to existing epilepsy approaches through a variety of targeted marketing tools and social media.
Reimbursement
Coverage in the United States
Reimbursement from private third-party healthcare payors and, to a lesser extent, Medicare will be an important element of our success. Although the Centers for Medicare and Medicaid Services (“CMS”) and third-party payors have adopted coverage policies for our targeted indications, there is no guarantee this will continue at the same levels or at all in the future. Current Procedural Terminology, or CPT, is a medical code set that is used to report medical, surgical and diagnostic procedures and services to entities such as physicians, health insurance companies and accreditation organizations.
Applicable diagnostic CPT codes for mapping (diagnosing) the brain for diagnostic procedures are as follows:
●61531 Subdural implantation of strip electrodes through one or more burr or trephine (saw) hole(s) for long-term seizure monitoring;
●61533 Craniotomy with elevation of bone flap: for subdural implantation of an electrode array, for long term seizure monitoring;
●61535 Craniotomy with elevation of bone flap; for removal of epidural or subdural electrode array, without excision of cerebral tissue (separate procedure); and
●61760 Stereotactic implantation of depth electrodes into the cerebrum for long term seizure monitoring.
Regarding ICD-10 codes, the International Classification of Diseases, Tenth Edition (ICD-10) is a clinical cataloging system that went into effect for the U.S. healthcare industry on October 1, 2015, after a series of lengthy delays. Accounting for modern advances in clinical treatment and medical devices, ICD-10 codes offer many more classification options compared to those found in its predecessor, ICD-9. Within the healthcare industry, providers, coders, IT professionals, insurance carriers, government agencies and others use ICD codes to properly note diseases on health records, to track epidemiological trends and to assist in medical reimbursement decisions.
ICD-10 codes for epilepsy are as follows:
●G40.0 Localization-related (focal) (partial) idiopathic epilepsy and epileptic syndromes with seizures of localized onset;
●G40.1 Localization-related (focal) (partial) symptomatic epilepsy and epileptic syndromes with simple partial seizures;
●G40.2 Localization-related (focal) (partial) symptomatic epilepsy and epileptic syndromes with complex partial seizures;
●G40.3 Generalized idiopathic epilepsy and epileptic syndromes;
●G40.A Absence epileptic syndrome;
●G40.4 Other generalized epilepsy and epileptic syndromes;
●G40.50 Epileptic seizures related to external causes, not intractable;
●G40.80 Other epilepsy; and
●G40.82 Epileptic spasms.
We believe that many of the indications we are pursuing with our technologies are currently reimbursed on a widespread basis by Medicare, Medicaid and private insurance companies.
Medicare, Medicaid, health maintenance organizations and other third-party payors are increasingly attempting to contain healthcare costs by limiting both coverage and the level of reimbursement of new medical devices, and, as a result, their coverage policies may be restrictive, or they may not cover or provide adequate payment for our products. In order to obtain reimbursement arrangements, we may have to agree to a net sales price lower than the net sales price we might charge in other sales channels. Our revenue may be limited by the continuing efforts of government and third-party payors to contain or reduce the costs of healthcare through various increasingly sophisticated means, such as requiring prospective reimbursement and second opinions, purchasing in groups, or redesigning benefits. Our future dependence on the commercial success of our technologies makes us particularly susceptible to any cost containment or reduction efforts. Accordingly, unless government and other third-party payors provide adequate coverage and reimbursement for our products and the related insertion and removal procedures, our financial performance may be limited.
Coverage Outside the United States
If we seek to commercialize in countries outside the United States, coverage for epilepsy surgical procedures are available from certain governmental authorities, private health insurance plans, and labor unions. Coverage systems in international markets vary significantly by country and, within some countries, by region. If we seek to commercialize our technology, if approved, outside the United States, coverage approvals must be obtained on a country-by-country, region-by-region or, in some instances, a case-by case basis. Based on our ongoing evaluation, certain countries reimburse more highly than others.
We evaluated international opportunities to market our technology under development. While we believe there is a market for our technology in Europe and other foreign jurisdictions, we have determined not to seek to commercialize in any foreign jurisdictions due to time intensive approval processes, the lack of certainty regarding approval, significant cost and the stringency of the regulatory approval process in Europe in particular, among other factors.
Manufacturing, Supply and Quality Assurance
We currently outsource the supply and manufacture of all components of our prototypes of our technology under development. We plan to continue with an outsourced manufacturing arrangement for the foreseeable future. Our third-party manufacturers are recognized in their field for their competency to manufacture the respective portions of our system and have quality systems established that meet FDA requirements. We believe the manufacturers we currently utilize have sufficient capacity to meet our launch requirements if our technology under development is approved in the future and are able to scale up their capacity relatively quickly with minimal capital investment. We believe that, as we increase our demand in the future, our per-unit costs will decrease materially. We have also identified capable second source manufacturers and suppliers in the event of disruption from any of our primary vendors.
Our suppliers meet the latest ISO 13485 certification, which includes design control requirements. As a medical device developer, the facilities of our sterilization and other critical suppliers are subject to periodic inspection by the FDA and corresponding state and foreign agencies. We believe that our quality systems and those of our suppliers are robust and achieve high product quality. We plan to audit our suppliers periodically to ensure conformity with the specifications, policies and procedures for our devices.
Research and Development
Our research and development team, which includes our Chief Technology Officer and two third party consultants who perform research and development activities for us, is focused on the development of thin film cortical grid and strip electrodes and depth electrodes for recording, ablation and chronic stimulation for brain related disorders as well as stimulation for spinal cord stimulation for back related pain.
Our research and development expenses were $1.5 million and $1.0 million for the years ended September 30, 2019 and 2018, respectively.
Competition
In the market for Epilepsy diagnosis, our cortical strip, sheet and depth electrode technology will likely compete with Integra Life Science’s Integra Epilepsy Strip, Grid and depth electrodes, which provide a similar function to our diagnostic technologies under development. These products are well established in the marketplace and Integra has greater resources than us, which could allow them to innovate faster. Ad-Tech Medical Instrument Corporation’s Epilepsy/LTM (subdural grid, strip and depth) electrodes, which have become the market leaders for diagnostic mapping in epilepsy, and PMT’s Cortac Strips and grid electrodes and Depthalon depth electrodes are used for recording brain activity similar to other competitive technologies. In addition, Dixie Medical has launched a product line of depth electrodes and CorTec has launched a cortical electrode product line called AirRay. Today’s success rates for seizure free post-operative conditions remain at 50%, which has limited patients’ willingness to undergo the currently highly invasive surgical procedure. We will also compete against other companies in early stages of development of thin film technologies.
In the neuro-ablation market, we expect to compete with Medtronic’s Visualase guided-laser ablation technology and Monteris Medical’s NeuroBlate technology, which use MRI guided laser surgical ablation for use to ablate, necrotize or coagulate soft tissue through interstitial irradiation or thermal therapy in medicine and surgery in the discipline of neurosurgery with 1064 nm lasers. Their website claims it is used for ablation in the brain for soft tissue and tumors. We believe there are other laser-based systems in development that will compete with these technologies.
In the neurostimulation market, we expect to compete with NeuroPace’s RNS system approved for epilepsy, Medtronic’s Activa system approved for Parkinson’s disease, Boston Scientific Vercise (indicated for Parkinson’s, dystonia and essential tremors), Abbott/St. Jude Medical’s Infinity DBS system (approved for Parkinson’s disease and essential tremors), Liva Nova/Cyberonic’s VNS therapy intended for patients suffering with epilepsy. We believe there are additional companies pursuing thin film electrode technology for use in the brain although none are expected to be commercially available in 2019. Although we will face potential competition from many different sources, we believe that our technology, knowledge, experience and scientific resources will provide us with competitive advantages. We expect the key competitive factors affecting the success of our cortical strip and sheet electrodes under development, if successfully developed and approved, are likely to be: hi-fidelity recording that allows for detection of pre-seizure activity, ability to place the devices minimally invasively, deliverability of cortical grid, strip and depth electrode technology, ability to offer grid, strip and depth electrodes in various electrode shapes and sizes, potential reduction in infections and ability to record brain activity both on the surface using cortical grid and strip technology and deeper into the brain using depth electrodes concurrently.
Many of the companies against which we may compete in the future have significantly greater financial resources and expertise in research and development, manufacturing, preclinical testing, conducting clinical trials, obtaining regulatory approvals and marketing approved products than we do. Mergers and acquisitions in the pharmaceutical, biotechnology and diagnostic industries may result in even more resources being concentrated among a smaller number of our competitors. Smaller or early stage companies may also prove to be significant competitors, particularly through collaborative arrangements with large and established companies. These competitors also compete with us in recruiting and retaining qualified scientific and management personnel and establishing clinical trial sites and subject registration for clinical trials, as well as in acquiring technologies complementary to, or necessary for, our development.
WARF License
We have an Exclusive Start-Up Company License Agreement with WARF, pursuant to which WARF has granted us the WARF License, to make, use and sell, in the United States only, products that employ certain licensed patents for a neural probe array or thin-film micro electrode array and method. We have agreed to pay WARF a royalty equal to a single-digit percentage of our product sales pursuant to the WARF License, with a minimum annual royalty payment of $50,000 for 2019, $100,000 for 2020 and $150,000 for 2021 and each calendar year thereafter that the WARF License is in effect. If we or any of our sublicenses contest the validity of any licensed patent, the royalty rate will be doubled during the pendency of such contest and, if the contested patent is found to be valid and would be infringed by us if not for the WARF License, the royalty rate will be tripled for the remaining term of the WARF License.
We have agreed to diligently develop, manufacture, market and sell products under the WARF License in the United States during the term of the agreement and, specifically, that we would submit a business plan to WARF by February 1, 2018, which we submitted on January 18, 2018, and would file an application for 510(k) marketing clearance with the FDA by February 1, 2019, which we submitted on January 28, 2019. WARF may terminate this license on 30 days’ written notice, if we default on the payments of amounts due to WARF or fail to timely submit development reports, actively pursue our development plan or breach any other covenant in the WARF License and fail to remedy such default in 90 days or in the event of certain bankruptcy events involving us. WARF may also terminate the WARF License (i) on 90 days’ notice if we fail to have commercial sales of one or more FDA-approved products under the WARF License by March 31, 2020 or (ii) if, after royalties earned on sales begin to be paid, such earned royalties cease for more than four calendar quarters. The WARF License otherwise expires by its terms on the date that no valid claims on the patents licensed thereunder remain. We expect the latest expiration of a licensed patent to occur in 2030.
In addition, WARF reserves the right to grant non-profit research institutions and government agencies non-exclusive licenses to practice and use the inventions of the licensed patents for non-commercial research purposes, and we grant WARF a non-exclusive, sub licensable, royalty-free right and license for non-commercial research purposes to use improvements to the licensed patents. In the event that we discontinue use or commercialization of the licensed patents or improvements thereon, we must grant WARF an option to obtain a non-exclusive, sub-licensable royalty-bearing license to use the improvements for commercial purposes.
See “Risk Factors”- We depend on intellectual property licensed from WARF for our technology under development, and the termination of this license would harm our business” for additional information regarding the WARF License.
Mayo Foundation for Medical Education and Research License and Development Agreement
We have entered into the Amended and Restated License and Development Agreement (the “Mayo Development Agreement”) with Mayo Foundation for Medical Education and Research (“Mayo”) to license worldwide (i) certain know how for the development and commercialization of products, methods and processes related to flexible circuit thin film technology for the recording of tissue and (ii) the products developed therefrom, and to partner with Mayo to assist the Company in the investigation, research application, development and improvement of such technology. Mayo has agreed to assist us by providing access to certain individuals at Mayo, or the Mayo Principal Investigators, in developing our cortical thin film flexible circuit technology, including prototype development, animal testing, protocol development for human and animal use, abstract development and presentation and access to and license of any intellectual property that the Mayo Principal Investigators develop relating to the procedure.
We have agreed to pay Mayo a royalty equal to a single-digit percentage of our product sales pursuant to the Mayo Development Agreement. Mayo may purchase any developed products licensed under the Mayo Development Agreement at the best price offered by us to the end user in the prior year. The Mayo Development Agreement generally will expire in October 2034, unless the Mayo know-how and improvements under the Mayo Development Agreement remain in use, and the Mayo Development Agreement may be terminated by Mayo for cause or under certain circumstances.
For additional information regarding the Mayo Development Agreement, see “Risk Factors-We depend on our partnership with Mayo to license certain know how for the development and commercialization of our technology. Termination of this partnership would harm our business, and even if this partnership continues, it may not be successful.”
Intellectual Property
Protection of our intellectual property is a strategic priority for our business. We rely on a combination of patents, trademarks, copyrights, trade secrets as well as nondisclosure and assignment of invention agreements, material transfer agreements, confidentiality agreements and other measures to protect our intellectual property and other proprietary rights.
Patents
As of September 30, 2019, our patent estate consists of three issued United States patents licensed from WARF covering a neural probe array and thin-film micro electrode array and method and two pending U.S. patent applications filed by us and published on October 11, 2018 covering our applications and additional devices used during the diagnostic and therapeutic ablation and stimulation procedures. In addition, we filed a provisional patent in March 2019 to include coatings for application on our thin film electrode technology, a provisional patent application filed in June 2019 relating to minimally invasive delivery devices, electrodes, and related methods, and we filed a patent application in August 2019 relating to our spinal cord stimulation electrode advancements for patients suffering with nerve-related back pain. The licensed issued patents expire between 2025 and 2030, subject to any patent extensions that may be available for such patents. If a patent or patents are issued on our pending patent application, the resulting patent is projected to expire in 2038.
Our patent application may not result in an issued patent, and any patents that have been issued or may be issued in the future may not protect the commercially important aspects of our technology. Furthermore, the validity and enforceability of our issued patents may be challenged by third parties and our patents could be invalidated or modified by the issuing governmental authority. Third parties may independently develop technology that is not covered by our patents that is similar to, or competes with, our technology. In addition, our intellectual property may be infringed or misappropriated by third parties, particularly in foreign countries where the laws and governmental authorities may not protect our proprietary rights as effectively as those in the United States.
The medical device industry in general, and the recording, ablation and neurostimulation sector of this industry in particular, are characterized by the existence of a large number of patents and frequent litigation based on assertions of patent infringement. We are aware of numerous patents issued to third parties that may relate to the technology used in our business, including the design and manufacture of electrodes and pulse generators, as well as methods for device placement. Each of these patents contains multiple claims, any one of which may be independently asserted against us. The owners of these patents may assert that the manufacture, use, sale or offer for sale of our cortical strip and sheet electrodes infringe one or more claims of their patents. Furthermore, there may be additional patents issued to third parties of which we are presently unaware that may relate to aspects of our technology that such third parties could assert against us and materially and adversely affect our business. In addition, because patent applications can take many years to issue, there may be patent applications that are currently pending and unknown to us, which may later result in issued patents that third parties could assert against us and materially and adversely affect our business.
Any adverse determination in litigations, post grant trial proceedings, including interference proceedings, at the Patent Office relating to intellectual property to which we are or may become a party could subject us to significant liabilities to third parties or require us to seek licenses from third parties, and result in the cancellation and/or invalidation of our intellectual property. Furthermore, if a court finds that we have willfully infringed a third party’s intellectual property, we could be required to pay treble damages and/or attorney fees for the prevailing party, in addition to other penalties. Although intellectual property disputes in the medical device area are often settled through licensing or similar arrangements, costs associated with such arrangements can be substantial and often require ongoing royalty payments. We may be unable to obtain necessary licenses on satisfactory terms, if at all. If we do not obtain necessary licenses, we may not be able to redesign our products to avoid infringement; if we are able to redesign our products to avoid infringement, we may not receive FDA approval in a timely manner. Adverse determinations in a judicial or administrative proceeding or failure to obtain necessary licenses could prevent us from manufacturing and selling our products, which could have a significant adverse impact on our business.
Trademarks
We have one pending U.S. trademark application for the “NeuroOneTM” trademark. We were issued a notice of allowance from the U.S. Patent and Trademark Office in December 2017, and on June 11, 2019, we received an approval of our extension request.
Trade Secrets
We also rely on trade secrets, technical know-how and continuing innovation to develop and maintain our competitive position. We seek to protect such intellectual property and proprietary information by generally requiring our employees, consultants, contractors, scientific collaborators and other advisors to execute non-disclosure and assignment of invention agreements upon the commencement of their employment or engagement as the case may be. Our agreements with our employees prohibit them from providing us with any intellectual property or proprietary information of third parties. We also generally require confidentiality agreements or material transfer agreements with third parties that receive or have access to our confidential information, data or other materials. Notwithstanding the foregoing, there can be no assurance that our employees and third parties that have access to our confidential proprietary information will abide by the terms of their agreements. Despite the measures that we take to protect our intellectual property and confidential information, unauthorized third parties may copy aspects of our products or obtain and use our proprietary information.
Government Regulation
Our cortical strip, grid and depth electrodes are a medical device subject to extensive and ongoing regulation by the FDA, the U.S. CMS, the European Commission, and regulatory bodies in other countries. Regulations cover virtually every critical aspect of a medical device company’s business operations, including research activities, product development, quality and risk management, contracting, reimbursement, medical communications, and sales and marketing. In the United States, the Federal Food, Drug and Cosmetic Act (“FDCA”), and the implementing regulations of the FDA govern product design and development, pre-clinical and clinical testing, premarket clearance or approval, product manufacturing, quality systems, import and export, product labeling, product storage, recalls and field safety corrective actions, advertising and promotion, product sales and distribution, and post-market clinical surveillance. Our business is subject to federal, state, local, and foreign regulations, such as ISO 13485, ISO 14971, FDA’s QSR contained in 21 CFR Part 820, and the European Commission’s Directive 93/42/EEC concerning medical devices and its amendments.
Regulatory Framework in the United States
Device classification
The FDA characterizes medical devices into one of three classes. Devices that are considered by the FDA to pose lower risk are classified as Class I or II. Class I devices are subject to controls for labeling, pre-market notification and adherence to the FDA’s QSR. This pertains to manufacturers’ methods and documentation of the design, testing, production, control quality assurance, labeling, packaging, sterilization, storage and shipping of products, but are usually exempt from premarket notification requirements. Class II devices are subject to the same general controls but may be subject to special controls such as performance standards, post-market surveillance, FDA guidelines, or particularized labeling, and may also require clinical testing prior to clearance or approval. Class III devices are those for which insufficient information exists to assure safety and effectiveness solely through general or special controls, including devices that support or sustain human life, are of substantial importance in preventing impairment of human health, or which present a potential, unreasonable risk of illness or injury.
Some Class I and Class II devices are exempted by regulation from the pre-market notification requirement under Section 510(k) of the FDCA, also referred to as a 510(k) clearance, and the requirement of compliance with substantially all of the QSR. However, a pre-market approval (“PMA application”), is required for devices deemed by the FDA to pose the greatest risk, such as life-sustaining, life-supporting or certain implantable devices, or those that are “not substantially equivalent” either to a device previously cleared through the 510(k) process or to a “preamendment” Class III device in commercial distribution before May 28, 1976 when PMA applications were not required. The PMA approval process is more comprehensive than the 510(k) clearance process and typically takes several years to complete. Based on FDA definitions, we believe our diagnostic strip, grid and depth electrode technology will be categorized by the FDA as a Class II device that does not require clinical testing and can be filed as a 510(k), similar to existing competitive technology. The Company expects that indications for treating epilepsy, Parkinson’s and other patients suffering from motor related neurological deficiencies via a permanent implant for chronic treatment will require a PMA process to commercially distribute in the United States.
The 510(k) clearance process
Under the 510(k) clearance process, the manufacturer must submit to the FDA a premarket notification, demonstrating that the device is “substantially equivalent” to a legally marketed predicate device. A predicate device is a legally marketed device that is not subject to a PMA, i.e., a device that was legally marketed prior to May 28, 1976 (pre-amendments device) and for which a PMA is not required, a device that has been reclassified from Class III to Class II or I, or a device that was previously found substantially equivalent through the 510(k) process. To be “substantially equivalent,” the proposed device must have the same intended use as the predicate device, and either have the same technological characteristics as the predicate device or have different technological characteristics and not raise different questions of safety or effectiveness than the predicate device. Clinical data is sometimes required to support substantial equivalence.
After a 510(k) premarket notification is submitted, the FDA determines whether to accept it for substantive review. If it lacks necessary information for substantive review, the FDA will refuse to accept the 510(k) notification. If it is accepted for filing, the FDA begins a substantive review. By statute, the FDA is required to complete its review of a 510(k) notification within 90 days of receiving the 510(k) notification. As a practical matter, clearance often takes longer, and clearance is never assured. Although many 510(k) premarket notifications are cleared without clinical data, the FDA may require further information, including clinical data, to make a determination regarding substantial equivalence, which may significantly prolong the review process. If the FDA agrees that the device is substantially equivalent, it will grant clearance to commercially market the device.
If the FDA determines that the device is not “substantially equivalent” to a predicate device, or if the device is automatically classified into Class III, the device sponsor must then fulfill the more rigorous premarketing requirements of the PMA approval process, or seek reclassification of the device through the de novo process. The de novo classification process is an alternate pathway to classify medical devices that are automatically classified into Class III but which are low to moderate risk. A manufacturer can submit a petition for direct de novo review if the manufacturer is unable to identify an appropriate predicate device and the new device or new use of the device presents a moderate or low risk. De novo classification may also be available after receipt of a “not substantially equivalent” letter following submission of a 510(k) to FDA.
After a device receives 510(k) clearance, any modification that could significantly affect its safety or effectiveness, or that would constitute a new or major change in its intended use, will require a new 510(k) clearance or, depending on the modification, could require a PMA application. The FDA requires each manufacturer to determine whether the proposed change requires a new submission in the first instance, but the FDA can review any such decision and disagree with a manufacturer’s determination. Many minor modifications are accomplished by a letter-to-file in which the manufacture documents the change in an internal letter-to-file. The letter-to-file is in lieu of submitting a new 510(k) to obtain clearance for such change. The FDA can always review these letters to file in an inspection. If the FDA disagrees with a manufacturer’s determination regarding whether a new premarket submission is required for the modification of an existing 510(k)-cleared device, the FDA can require the manufacturer to cease marketing and/or recall the modified device until 510(k) clearance or approval of a PMA application is obtained. In addition, in these circumstances, the FDA can impose significant regulatory fines or penalties for failure to submit the requisite application(s).
The PMA approval process
Following receipt of a PMA application, the FDA conducts an administrative review to determine whether the application is sufficiently complete to permit a substantive review. If it is not, the agency will refuse to file the PMA. If it is, the FDA will accept the application for filing and begin the review. The FDA has 180 days to review a filed PMA application, although the review of an application more often occurs over a significantly longer period of time. During this review period, the FDA may request additional information or clarification of information already provided, and the FDA may issue a major deficiency letter to the applicant, requesting the applicant’s response to deficiencies communicated by the FDA.
Before approving or denying a PMA, an FDA advisory committee may review the PMA at a public meeting and provide the FDA with the committee’s recommendation on whether the FDA should approve the submission, approve it with specific conditions, or not approve it. The FDA is not bound by the recommendations of an advisory committee, but it considers such recommendations carefully when making decisions.
Prior to approval of a PMA, the FDA may conduct inspections of the clinical trial data and clinical trial sites, as well as inspections of the manufacturing facility and processes. Overall, the FDA review of a PMA application generally takes between one and three years, but may take significantly longer. The FDA can delay, limit or deny approval of a PMA application for many reasons, including:
●the device may not be safe, effective, reliable or accurate to the FDA’s satisfaction;
●the data from pre-clinical studies and clinical trials may be insufficient to support approval;
●the manufacturing process or facilities may not meet applicable requirements; and
●changes in FDA approval policies or adoption of new regulations may require additional data.
If an FDA evaluation of a PMA application is favorable, the FDA will either issue an approval letter, or approvable letter, which usually contains a number of conditions that must be met in order to secure final approval of the PMA. When and if those conditions have been fulfilled to the satisfaction of the FDA, the agency will issue a PMA approval letter authorizing commercial marketing of a device, subject to the conditions of approval and the limitations established in the approval letter. If the FDA’s evaluation of a PMA application or manufacturing facilities is not favorable, the FDA will deny approval of the PMA or issue a not approvable letter. The FDA also may determine that additional tests or clinical trials are necessary, in which case the PMA approval may be delayed for several months or years while the trials are conducted and data is submitted in an amendment to the PMA. The PMA process can be expensive, uncertain and lengthy and a number of devices for which FDA approval has been sought by other companies have never been approved by the FDA for marketing.
New PMA applications or PMA supplements may be required for modifications to the manufacturing process, labeling, device specifications, materials or design of a device that has been approved through the PMA process. PMA supplements often require submission of the same type of information as an initial PMA application, except that the supplement is limited to information needed to support any changes from the device covered by the approved PMA application and may or may not require as extensive technical or clinical data or the convening of an advisory panel.
Clinical Trials
Clinical trials are typically required to support a PMA application and are sometimes required for a 510(k) clearance. These trials generally require submission of an application for an IDE, to the FDA. The Investigational Device Exemption (“IDE”) application must be supported by appropriate data, such as animal and laboratory testing results, showing that it is safe to test the device in humans and that the testing protocol is scientifically sound. The IDE application must be approved in advance by the FDA for a specified number of patients, unless the product is deemed a non-significant risk device and eligible for abbreviated IDE requirements. Generally, clinical trials for a significant risk device may begin once the IDE application is approved by the FDA and the study protocol and informed consent are approved by appropriate institutional review boards at the clinical trial sites. The FDA’s approval of an IDE allows clinical testing to go forward, but it does not bind the FDA to accept the results of the trial as sufficient to prove the product’s safety and efficacy, even if the trial meets its intended success criteria. All clinical trials must be conducted in accordance with the FDA’s IDE regulations that govern investigational device labeling, prohibit promotion, and specify an array of recordkeeping, reporting and monitoring responsibilities of study sponsors and study investigators. Clinical trials must further comply with the FDA’s regulations for institutional review board approval and for informed consent and other human subject protections. Required records and reports are subject to inspection by the FDA. The results of clinical testing may be unfavorable or, even if the intended safety and efficacy success criteria are achieved, may not be considered sufficient for the FDA to grant approval or clearance of a product. Clinical trials must be entered into the clinical trials registry at clinicaltrials.gov.
The commencement or completion of any clinical trial may be delayed or halted, or be inadequate to support approval of a PMA application, for numerous reasons, including, but not limited to, the following:
●the FDA or other regulatory authorities do not approve a clinical trial protocol or a clinical trial, or place a clinical trial on hold;
●patients do not enroll in clinical trials at the rate expected;
●patients, sponsor (NeuroOne) or study sites do not comply with trial protocols;
●patient follow-up is not at the rate expected;
●patients experience adverse side effects;
●patients die during a clinical trial, even though their death may not be related to the products that are part of our trial;
●institutional review boards and third-party clinical investigators may delay or reject the trial protocol;
●third-party clinical investigators decline to participate in a trial or do not perform a trial on the anticipated schedule or consistent with the clinical trial protocol, good clinical practices or other FDA requirements;
●the sponsor (NeuroOne) or third-party organizations do not perform data collection, monitoring and analysis in a timely or accurate manner or consistent with the clinical trial protocol or investigational or statistical plans;
●third-party clinical investigators have significant financial interests related to the sponsor (NeuroOne) or the study that the FDA deems to make the study results unreliable, or the company or investigators fail to disclose such interests;
●regulatory inspections of our clinical trials or manufacturing facilities, which may, among other things, require us to undertake corrective action or suspend or terminate our clinical trials;
●changes in governmental regulations or administrative actions;
●the interim or final results of the clinical trial are inconclusive or unfavorable as to safety or efficacy; and
●the FDA concludes that our trial design is inadequate to demonstrate safety and efficacy.
International Regulation
International sales of medical devices are subject to local government regulations, which may vary substantially from country to country. The time required to obtain approval in another country may be longer or shorter than that required for FDA approval, and the requirements may differ. There is a trend towards harmonization of quality system standards among the European Union, United States, Canada and various other industrialized countries.
The primary regulatory body in Europe is that of the European Union, the European Commission, which includes most of the major countries in Europe. Other countries, such as Switzerland, have voluntarily adopted laws and regulations that mirror those of the European Union with respect to medical devices. The European Union has adopted numerous directives and standards regulating the design, manufacture, clinical trials, labeling and adverse event reporting for medical devices. Devices that comply with the requirements of these relevant directives will be entitled to bear the CE conformity marking, indicating that the device conforms to the essential requirements of the applicable directives and, accordingly, can be commercially distributed throughout Europe. The method of assessing conformity varies depending on the class of the product, but normally involves a combination of self-assessment by the manufacturer and a third party assessment by a “Notified Body.” This third-party assessment may consist of an audit of the manufacturer’s quality system and specific testing of the manufacturer’s product. An assessment by a Notified Body of one country within the European Union is required in order for a manufacturer to commercially distribute the product throughout the European Union. Additional local requirements may apply on a country-by-country basis. Outside of the European Union, regulatory approval would need to be sought on a country-by-country basis in order for us to market our products.
Medical devices in Europe are classified into four primary categories. They are as follows:
●Non-invasive devices;
●Invasive medical devices;
●Active medical devices; and
●Special Rules (including contraceptive, disinfectant, and radiological diagnostic medical devices).
Devices are further segmented into the classes noted below. In vitro diagnostic devices have their own classification scheme and while active implantable devices do not follow the same classification system as provided by the Medical Devices Directive, they are subject to similar requirements as Class III devices:
●Class I - Provided non-sterile or do not have a measuring function (low risk);
●Class I - Provided sterile and/or have a measuring function (low/medium risk);
●Class IIa (medium risk);
●Class IIb (medium/high risk); and
●Class III (high risk).
After a review of our technology, an international regulatory consultant advised us that our strip, grid and depth electrode diagnostic technology is likely a Class III device (since it comes into contact with the central nervous system) which will require a lengthy approval process as a design dossier including clinical data will be required for approval.
Other Regulatory Requirements
Even after a device receives clearance or approval and is placed in commercial distribution, numerous regulatory requirements apply. These include:
●establishment registration and device listing;
●QSR, which requires manufacturers, including third party manufacturers, to follow stringent design, testing, risk management, production, control, supplier/contractor selection, complaint handling, documentation and other quality assurance procedures during all aspects of the manufacturing process;
●labeling regulations that prohibit the promotion of products for uncleared, unapproved or “off-label” uses, and impose other restrictions on labeling, advertising and promotion;
●MDR regulations, which require that manufacturers report to the FDA if their device may have caused or contributed to a death or serious injury or malfunctioned in a way that would likely cause or contribute to a death or serious injury if the malfunction were to recur;
●voluntary and mandatory device recalls to address problems when a device is defective and could be a risk to health; and
●corrections and removals reporting regulations, which require that manufacturers report to the FDA field corrections and product recalls or removals if undertaken to reduce a risk to health posed by the device or to remedy a violation of the FDCA that may present a risk to health.
Also, the FDA may require us to conduct post-market surveillance studies or establish and maintain a system for tracking our products through the chain of distribution to the patient level. The FDA enforces regulatory requirements by conducting periodic, unannounced inspections and market surveillance. Inspections may include the manufacturing facilities of our subcontractors.
Failure to comply with applicable regulatory requirements can result in enforcement actions by the FDA and other regulatory agencies. These may include any of the following sanctions or consequences:
●warning letters or untitled letters that require corrective action;
●fines and civil penalties;
●unanticipated expenditures;
●delays in approving or refusal to approve future products;
●FDA refusal to issue certificates to foreign governments needed to export products for sale in other countries;
●suspension or withdrawal of FDA clearance or approval;
●product recall or seizure; interruption of production;
●operating restrictions;
●injunctions; and
●criminal prosecution.
Our contract manufacturers, specification developers and some suppliers of components or device accessories, also are required to manufacture our products in compliance with current good manufacturing practice requirements set forth in the QSR. The QSR requires a quality system for the design, manufacture, packaging, labeling, storage, installation and servicing of marketed devices, and it includes extensive requirements with respect to quality management and organization, device design, buildings, equipment, purchase and handling of components or services, production and process controls, packaging and labeling controls, device evaluation, distribution, installation, complaint handling, servicing, and record keeping. The FDA evaluates compliance with the QSR through periodic unannounced inspections that may include the manufacturing facilities of our subcontractors. If the FDA believes that any of our contract manufacturers or regulated suppliers are not in compliance with these requirements, it can shut down such manufacturing operations, require recall of our products, refuse to approve new marketing applications, institute legal proceedings to detain or seize products, enjoin future violations or assess civil and criminal penalties against us or our officers or other employees.
The Health Insurance Portability and Accountability Act of 1996 (“HIPAA”) and Similar Foreign and State Laws and Regulations Affecting the Transmission, Security and Privacy of Health Information
We may also be subject to data privacy and security regulation by both the federal government and the states in which we conduct our business. HIPAA, as amended by the Health Information Technology for Economic and Clinical Health Act, or HITECH, and their respective implementing regulations, imposes specified requirements relating to the privacy, security and transmission of individually identifiable health information. Among other things, HITECH makes HIPAA’s security standards directly applicable to business associates, defined as service providers of covered entities that create, receive, maintain or transmit protected health information in connection with providing a service for or on behalf of a covered entity. HITECH also created four new tiers of civil monetary penalties and gave state attorneys general new authority to file civil actions for damages or injunctions in federal courts to enforce the federal HIPAA laws and seek attorneys’ fees and costs associated with pursuing federal civil actions. In addition, many state laws govern the privacy and security of health information in certain circumstances, many of which differ from HIPAA and each other in significant ways and may not have the same effect.
Foreign data privacy regulations, such as the EU Data Protection Directive (Directive 95/46/EC), the country-specific regulations that implement Directive 95/46/EC, and the EU General Data Protection Regulation also govern the processing of personally identifiable data, and may be stricter than U.S. laws.
Fraud and Abuse Laws
In addition to FDA restrictions, there are numerous U.S. federal and state laws pertaining to healthcare fraud and abuse, including anti-kickback laws and physician self-referral laws. Our relationships with healthcare providers and other third parties are subject to scrutiny under these laws. Violations of these laws are punishable by criminal and civil sanctions, including, in some instances, imprisonment and exclusion from participation in federal and state healthcare programs, including the Medicare, Medicaid and Veterans Administration health programs.
Federal Anti-Kickback and Self-Referral Laws
The federal Anti-Kickback Statute (the “Anti-Kickback Statute”) prohibits persons from knowingly and willfully soliciting, receiving, offering or providing remuneration (including any kickback, bribe or rebate), directly or indirectly, overtly or covertly, to induce either the referral of an individual, or the furnishing, recommending, or arranging of a good or service, for which payment may be made under a federal healthcare program such as Medicare and Medicaid or other federal healthcare programs. The term “remuneration” has been broadly interpreted to include anything of value, including such items as gifts, discounts, the furnishing of supplies or equipment, credit arrangements, waiver of payments and providing anything at less than its fair market value. Although there are a number of statutory exceptions and regulatory safe harbors protecting some common activities from prosecution, the exceptions and safe harbors are drawn narrowly. Practices that involve remuneration that may be alleged to be intended to induce prescribing, purchases or recommendations may be subject to scrutiny if they do not qualify for an exception or safe harbor. Failure to meet all of the requirements of a particular applicable statutory exception or regulatory safe harbor does not make the conduct per se illegal under the Anti-Kickback Statute. Instead, the legality of the arrangement will be evaluated on a case-by-case basis based on a review of all its relevant facts and circumstances. Several courts have interpreted the statute’s intent requirement to mean that if any one purpose of an arrangement involving remuneration is to induce referrals of (or purchases, or recommendations related to) federal healthcare covered business, the Anti-Kickback Statute has been implicated and potentially violated.
The penalties for violating the Anti-Kickback Statute include imprisonment for up to five years, fines of up to $25,000 per violation and possible exclusion from federal healthcare programs such as Medicare and Medicaid. Many states have adopted prohibitions similar to the Anti-Kickback Statute, some of which do not have the same exceptions and apply to the referral of patients for healthcare services reimbursed by any source, not only by the Medicare and Medicaid programs. Further, the Anti-Kickback Statute was amended by the Patient Protection and Affordable Care Act (“ACA”). Specifically, as noted above, under the Anti-Kickback Statute, the government must prove the defendant acted “knowingly” to prove a violation occurred. The ACA added a provision to clarify that with respect to violations of the Anti-Kickback Statute, “a person need not have actual knowledge” of the statute or specific intent to commit a violation of the statute. This change effectively overturns case law interpretations that set a higher standard under which prosecutors had to prove the specific intent to violate the law. In addition, the ACA codified case law that a claim including items or services resulting from a violation of the Anti-Kickback Statute constitutes a false or fraudulent claim for purposes of the federal civil False Claims Act (the “False Claims Act”).
We plan to provide the initial training to providers and patients necessary for appropriate use of our technology either through our own educators or by contracting with outside educators that have completed an appropriate training course. Outside educators are reimbursed for their services at fair market value.
Noncompliance with the Anti-Kickback Statute could result in our exclusion from Medicare, Medicaid or other governmental programs, restrictions on our ability to operate in certain jurisdictions, and civil and criminal penalties.
The federal Physician Self-Referral Prohibition, commonly known as the “Stark Law,” prohibits a physician from ordering “designated health services,” including durable medical equipment, for Medicare and Medicaid patients from entities with which the physician (or an immediate family member) has a “financial relationship.” Financial relationships include both compensation arrangements and investment and ownership interests. Violation of the Stark Law could result in denial of payment, disgorgement of reimbursements received under a noncompliant arrangement, civil penalties, and exclusion from Medicare, Medicaid or other governmental programs. We believe that we have structured our provider arrangements to comply with current Stark Law requirements.
Nevertheless, a determination of liability under such laws could result in fines and penalties and restrictions on our ability to operate in these jurisdictions.
Additionally, as some of these laws are still evolving, we lack definitive guidance as to the application of certain key aspects of these laws as they relate to our arrangements with providers with respect to patient training. We cannot predict the final form that these regulations will take or the effect that the final regulations will have on us. As a result, our provider and training arrangements may ultimately be found to be not in compliance with applicable federal law.
False Claims Act
The False Claims Act provides, in part, that the federal government may bring a lawsuit against any person whom it believes has knowingly presented, or caused to be presented, a false or fraudulent request for payment from the federal government, or who has made a false statement or used a false record to get a claim approved. In addition, amendments in 1986 to the False Claims Act have made it easier for private parties to bring “qui tam” whistleblower lawsuits against companies under the False Claims Act. Penalties include fines ranging from $5,500 to $11,000 for each false claim, plus three times the amount of damages that the federal government sustained because of the act of that person. Qui tam actions have increased significantly in recent years, causing greater numbers of healthcare companies to have to defend a false claim action, pay fines or be excluded from Medicare, Medicaid or other federal or state healthcare programs as a result of an investigation arising out of such action.
There are other federal anti-fraud laws that prohibit, among other actions, knowingly and willfully executing, or attempting to execute, a scheme to defraud any healthcare benefit program, including private third-party payors, knowingly and willfully embezzling or stealing from a healthcare benefit program, willfully obstructing a criminal investigation of a healthcare offense, and knowingly and willfully falsifying, concealing or covering up a material fact or making any materially false, fictitious or fraudulent statement in connection with the delivery of or payment for healthcare benefits, items or services.
Additionally, HIPAA established two federal crimes related to making false statements in relation to healthcare matters. The healthcare fraud statute prohibits knowingly and willfully executing a scheme to defraud any healthcare benefit program, including private payors. A violation of this statute is a felony and may result in fines, imprisonment or exclusion from government sponsored programs. The false statements statute prohibits knowingly and willfully falsifying, concealing or covering up a material fact or making any materially false, fictitious or fraudulent statement in connection with the delivery of or payment for healthcare benefits, items or services. A violation of this statute is a felony and may result in fines or imprisonment.
Civil Monetary Penalties Law
In addition to the Anti-Kickback Statute and the False Claims Act, the federal government has the authority to seek civil monetary penalties, or CMPs, assessments, and exclusion against an individual or entity based on a wide variety of prohibited conduct. For example, the Civil Monetary Penalties Law authorizes the imposition of substantial CMPs against an entity that engages in activities including, but not limited to: (1) knowingly presenting or causing to be presented, a claim for services not provided as claimed or which is otherwise false or fraudulent in any way; (2) knowingly giving or causing to be given false or misleading information reasonably expected to influence the decision to discharge a patient; (3) offering or giving remuneration to any beneficiary of a federal health care program likely to influence the receipt of reimbursable items or services; (4) arranging for reimbursable services with an entity which is excluded from participation from a federal health care program; (5) knowingly or willfully soliciting or receiving remuneration for a referral of a federal health care program beneficiary; or (6) using a payment intended for a federal health care program beneficiary for another use. The government is authorized to seek different amounts of CMPs and assessments based on underlying violation. For false or fraudulent claims, the government may seek a penalty of up to $10,000 for each item or service improperly claimed, and an assessment of up to three times the amount improperly claimed. For kickback violations, the government may seek a penalty of up to $50,000 for each improper act and damages of up to three times the amount of remuneration at issue.
State Fraud and Abuse Provisions
Many states have also adopted some form of anti-kickback and anti-referral laws and a false claims act. We believe that we are in conformance to such laws. Nevertheless, a determination of liability under such laws could result in fines and penalties and restrictions on our ability to operate in these jurisdictions.
Physician Payment Sunshine Act
Transparency laws regarding payments or other items of value provided to healthcare providers and teaching hospitals may also impact our business practices. The federal Physician Payment Sunshine Act requires most medical device manufacturers to report annually to the Secretary of Human Health Services financial arrangements, payments, or other transfers of value made by that entity to physicians and teaching hospitals. The payment information is made publicly available in a searchable format on a CMS website. Over the next several years, we will need to dedicate significant resources to establish and maintain systems and processes in order to comply with these regulations. Failure to comply with the reporting requirements can result in significant civil monetary penalties. Similar laws have been enacted or are under consideration in foreign jurisdictions.
Foreign Corrupt Practices Act (“FCPA”)
The FCPA prohibits U.S. corporations and their representatives from offering, promising, authorizing or making corrupt payments, gifts or transfers to any foreign government official, government staff member, political party or political candidate in an attempt to obtain or retain business abroad. The FCPA also obligates companies whose securities are listed in the United States to comply with accounting provisions requiring the company to maintain books and records that accurately and fairly reflect all transactions of the corporation, including international subsidiaries, and to devise and maintain an adequate system of internal accounting controls for international operations. Activities that violate the FCPA, even if they occur wholly outside the United States, can result in criminal and civil fines, imprisonment, disgorgement, oversight, and debarment from government contracts.
Employees
As of September 30, 2019, we had four employees, all of whom are full-time, and all of whom are located in the United States, and we also retained the services of approximately 11 regular consultants. None of our employees are represented by a labor union or covered by a collective bargaining agreement. We consider our relationship with our employees to be good.
Corporate Information
Our principal executive offices are located at c/o David Rosa, 7599 Anagram Drive, Eden Prairie, Minnesota 55344, and our telephone number is 952-426-1383. Our website address is www.neurooneinc.com. Information on our website is not part of this Annual Report.
ITEM 1A.
ITEM 1A. RISK FACTORS
Our business, prospects, financial condition or results of operations could be materially adversely affected by any of the risks and uncertainties set forth below, as well as in any amendments or updates reflected in subsequent filings with the SEC. In assessing these risks, you should also refer to other information contained in this Annual Report, including our financial statements and related notes.
Risks Related to Our Business
We have incurred significant operating losses since inception and cannot assure you that we will ever achieve or sustain profitability.
We have incurred losses since inception, and as of September 30, 2019, we had an accumulated deficit of $17.2 million primarily as a result of expenses incurred in connection with our general and administrative expenses associated with our operations and from our research and development programs. We expect to continue to incur significant expenses and increasing operating costs resulting in net losses for the foreseeable future. To date, we have financed our operations primarily through debt and equity financings, and our primary activities have been limited to, and our limited resources have been dedicated to, performing business and financial planning, raising capital, recruiting personnel, negotiating with business partners and the licensors of our intellectual property and conducting development activities.
To implement our business strategy we need to, among other things, successfully complete the development, testing and all required steps for regulatory approval of our depth electrodes for sEEG recording in the U.S., develop and introduce a minimally invasive delivery system for our cortical electrodes, develop an all-in-one diagnostic and therapeutic solution, successfully complete the necessary testing and clinical trials required for regulatory approval of our technology for ablation and stimulation therapies, gain approval for other brain or motor related disorders such as Parkinson’s with the therapeutic technologies developed for epilepsy, convince physicians and patients that our technology, if approved, represents an improvement over existing diagnostic or treatment options, hire direct experienced sales representatives to market our technology, if approved, in the United States, evaluate international opportunities and initiate and successfully complete the approval processes in targeted geographies and engage in beneficial partnerships that can leverage our core technology. We have never been profitable and do not expect to be profitable in the foreseeable future. We expect our expenses to increase significantly as we pursue our objectives. The extent of our future operating losses and the timing of profitability are highly uncertain, and we expect to continue incurring significant expenses and operating losses over the next several years. Our prior losses have had, and will continue to have, an adverse effect on our stockholders’ equity and working capital. Any additional operating losses may have an adverse effect on our stockholders’ equity, and we cannot assure you that we will ever be able to achieve profitability. Even if we achieve profitability, we may not be able to sustain or increase profitability on a quarterly or annual basis. Our failure to become and remain profitable would depress the value of our Company and could impair our ability to raise capital, expand our business, maintain our development efforts, obtain regulatory approvals or continue our operations.
We have a limited operating history, making it difficult for you to evaluate our business and your investment.
Our operating subsidiary, NeuroOne, Inc. was incorporated on October 7, 2016, and our predecessor, the LLC, had very limited operations. We are an early-stage medical technology company developing comprehensive neuromodulation cEEG and sEEG monitoring, ablation, and brain stimulation solutions to diagnose and treat patients with epilepsy, Parkinson’s disease, essential tremors, and other brain related disorders. Our cortical strip technology under development has only been used by Mayo in five patients for research purposes and has not been tested in any clinical trials. Our operations are subject to all of the risks inherent in the establishment of a new business enterprise, including but not limited to the absence of an operating history, lack of fully-developed or commercialized products, insufficient capital, expected substantial and continual losses for the foreseeable future, limited experience in dealing with regulatory issues, lack of manufacturing and marketing experience, need to rely on third parties for the development and commercialization of our proposed products, a competitive environment characterized by well-established and well-capitalized competitors and reliance on key personnel.
Since inception, we have not established any revenues or operations that will provide financial stability in the long term, and there can be no assurance that we will realize our plans on our projected timetable (or at all) in order to reach sustainable or profitable operations.
Investors are subject to all the risks incident to the creation and development of a new business and each investor should be prepared to withstand a complete loss of his, her or its investment. Furthermore, the accompanying financial statements have been prepared assuming that we will continue as a going concern. We have not emerged from the development stage, and may be unable to raise further equity. These factors raise substantial doubt about our ability to continue as a going concern. Our financial statements do not include any adjustments that might result from the outcome of this uncertainty.
Our Company has limited experience in medical device development and may not be able to successfully develop any device or therapy. Our ability to become profitable depends primarily on: our ability to develop our cortical strip, grid electrode and depth electrode technology, our successful completion of all necessary pre-clinical testing and clinical trials on such technology, our ability to obtain approval for such technology and, if approved, successfully commercialize such technology, our ongoing research and development efforts, the timing and cost of clinical trials, our ability to identify personnel with the necessary skill sets or enter into favorable alliances with third-parties who can provide substantial capabilities in clinical development, regulatory affairs, sales, marketing and distribution and our ability to obtain and maintain necessary intellectual property rights to such technology. Our limited experience in medical device development may make it more difficult for us to complete these tasks.
Even if we successfully develop and market such technology, we may not generate sufficient or sustainable revenue to achieve or sustain profitability, which could cause us to cease operations and cause you to lose all of your investment. Because we are subject to these risks, you may have a difficult time evaluating our business and your investment in our Company.
Our ability to continue our operations requires that we raise additional capital and our operations could be curtailed if we are unable to obtain the additional funding as or when needed.
Upon the completion of the audit of our financial statements for the fiscal year ended September 30, 2019, and management’s assessment of our ability to continue as a going concern, we concluded there was substantial doubt about our ability to continue as a going concern. Our independent registered public accounting firm included an explanatory paragraph in its report on our financial statements as of and for the year ended September 30, 2019, noting the existence of substantial doubt about our ability to continue as a going concern.
At September 30, 2019, we had $0.3 million in cash deposits. Our existing cash and cash equivalents will not be sufficient to fund our operating expenses. To continue to fund operations, we will need to secure additional funding. We may obtain additional financing in the future through the issuance of our Common Stock, through other equity or debt financings or through collaborations or partnerships with other companies. We may not be able to raise additional capital on terms acceptable to us, or at all.
We will need to raise substantial additional funds in the future, and these funds may not be available on acceptable terms or at all. A failure to obtain this necessary capital when needed could force us to delay, limit, scale back or cease some or all operations.
The continued growth of our business, including the development, regulatory approval and commercialization of our cortical strip, grid electrode and depth electrode technology, will significantly increase our expenses going forward. As a result, we will be required to seek substantial additional funds in the future. Our future capital requirements will depend on many factors, including:
●the cost of developing our cortical strip, grid electrode and depth electrode technology;
●obtaining and maintaining regulatory clearance or approval for our cortical strip, grid electrode and depth electrode technology;
●the costs associated with commercializing our cortical strip, grid electrode and depth electrode technology;
●any change in our development priorities;
●the revenue generated by sales of our cortical strip, grid electrode and depth electrode technology, if approved;
●the costs associated with expanding our sales and marketing infrastructure for commercialization of our cortical strip grid electrode and depth electrode technology, if approved;
●any change in our plans regarding the manner in which we choose to commercialize any approved product in the United States or internationally;
●the cost of ongoing compliance with regulatory requirements;
●expenses we incur in connection with potential litigation or governmental investigations;
●the costs to develop additional intellectual property;
●anticipated or unanticipated capital expenditures; and
●unanticipated general and administrative expenses.
As a result of these and other factors, we do not know whether and the extent to which we may be required to raise additional capital. We may in the future seek additional capital from public or private offerings of our capital stock, borrowings under credit lines or other sources.
We may not be able to raise additional capital on terms acceptable to us, or at all. Any failure to raise additional capital could compromise our ability to execute on our business plan, and we may be forced to liquidate our assets. In such a scenario, the values we receive for our assets in liquidation or dissolution could be significantly lower than the values reflected in our financial statements.
If we issue equity or debt securities to raise additional funds, our existing stockholders may experience dilution, and the new equity or debt securities may have rights, preferences and privileges senior to those of our existing stockholders. In addition, if we raise additional funds through collaborations, licensing, joint ventures, strategic alliances, partnership arrangements or other similar arrangements, it may be necessary to relinquish valuable rights to our potential future products or proprietary technologies or grant licenses on terms that are not favorable to us.
Medical device development involves a lengthy and expensive process, with an uncertain outcome. We may incur additional costs or experience delays in completing, or ultimately be unable to complete, the development and commercialization of any product.
Before obtaining marketing approval from regulatory authorities for the sale of our cortical strip, grid electrode and depth electrode technology under development in the United States or elsewhere, we must complete all pre-clinical testing, clinical trials and other regulatory requirements necessitated by the FDA and foreign regulatory bodies and demonstrate the performance and safety of our technology. Clinical testing is expensive, difficult to design and implement, can take many years to complete and is inherently uncertain as to outcome. A failure of one or more clinical trials can occur at any stage of testing. Further, the outcomes of completed clinical trials may not be predictive of the success of later clinical trials, and interim results of a clinical trial do not necessarily predict final results. Clinical data is often susceptible to varying interpretations and analyses, and many companies that have believed their products performed satisfactorily in clinical trials have nonetheless failed to obtain marketing approval. We have limited resources to complete the expensive process of medical device development, pre-clinical testing and clinical trials, putting us at a disadvantage, particularly compared to some of our larger and established competitors, and we may not have sufficient resources to commercialize our products under development in a timely fashion, if ever.
We may experience numerous unforeseen events during or as a result of clinical trials that could delay or prevent our ability to receive marketing approval or commercialize our products, including:
●regulators may not authorize us or our investigators to commence a clinical trial or conduct a clinical trial at a prospective trial site;
●the failure to successfully complete pre-clinical testing requirements required by the FDA and international organizations;
●we may experience delays in reaching, or fail to reach, agreement on acceptable clinical trial contracts with third parties or clinical trial protocols with prospective trial sites, the terms of which can be subject to extensive negotiation and may vary significantly among different trial sites;
●clinical trials of our cortical strip, grid electrode and depth electrode technology may produce negative or inconclusive results, including failure to demonstrate statistical significance, and we may decide, or regulators may require us, to conduct additional clinical trials or abandon our development programs;
●the number of people with brain related disorders required for clinical trials may be larger than we anticipate, enrollment in these clinical trials may be slower than we anticipate or people may drop out of these clinical trials or fail to return for post-treatment follow-up at a higher rate than we anticipate;
●our products may have undesirable side effects or other unexpected characteristics, causing us or our investigators, regulators or institutional review boards to suspend or terminate the trials;
●our third-party contractors conducting the clinical trials may fail to comply with regulatory requirements or meet their contractual obligations to us in a timely manner, or at all;
●regulators may require that we or our investigators suspend or terminate clinical development for various reasons, including noncompliance with regulatory requirements or a finding that the participants are being exposed to unacceptable health risks;
●the cost of clinical trials of our products may be greater than we anticipate;
●the supply or quality of our products or other materials necessary to conduct clinical trials of our products may be insufficient or inadequate; and
●delays from our suppliers and manufacturers could impact clinical trial completion and impact revenue.
If we are required to conduct additional clinical trials or other testing of our cortical strip, grid electrode and depth electrode technology under development beyond those that we contemplate, if we are unable to successfully complete clinical trials of our cortical strip, grid electrode and depth electrode technology under development or other testing, if the results of these trials or tests are not favorable or if there are safety concerns, we may:
●not obtain marketing approval at all;
●be delayed in obtaining marketing approval for our cortical strip, grid electrode and depth electrode technology under development in a jurisdiction;
●be subject to additional post-marketing testing requirements; or
●have our cortical strip, grid electrode and depth electrode technology removed from the market after obtaining marketing approval.
Our development costs will also increase if we experience delays in testing or marketing approvals. We do not know whether any of our clinical trials will begin as planned, will need to be restructured or will be completed on schedule, or at all. Significant clinical trial delays also could allow our competitors to bring innovative products to market before we do and impair our ability to successfully commercialize our products.
Changes in the configuration of our cortical strip, grid electrode and depth electrode technology under development may result in additional costs or delay.
As products are developed through pre-clinical testing and clinical trials towards approval and commercialization, it is common that various aspects of the development program, such as manufacturing methods and configuration, are altered along the way in an effort to optimize processes and results. Any changes we make carry the risk that they will not achieve the intended objectives. Any of these changes could cause our products to perform differently and affect the results of planned clinical trials or other future clinical trials conducted with the altered device. Such changes may also require additional testing, regulatory notification or regulatory approval. This could delay completion of pre-clinical testing or clinical trials, increase costs, delay approval of our future products and jeopardize our ability to commence sales and generate revenue.
We have no products that are approved for commercial sale. If we are unable to successfully develop, receive regulatory approval for and commercialize our cortical strip, grid electrode and depth electrode technology under development, or if we experience significant delays in doing so, our business will be harmed.
We have no products that are approved for commercial sale. We initially plan to seek regulatory approval to commercialize our cortical strip, grid electrode and depth electrode technology under development in the United States and we may seek approval to commercialize in select international geographies. Our ability to generate revenue from our developed products, if any, will depend heavily on their successful development, regulatory approval and eventual commercialization. The success of any products that we develop will depend on several factors, including:
●FDA approval of our planned regulatory pathway (or approval of foreign regulatory body if we seek approval in any jurisdiction outside the United States);
●successful completion of all necessary pre-clinical testing and clinical trials;
●receipt of timely commercialization approvals from applicable regulatory authorities;
●our ability to procure and maintain suppliers and manufacturers of the components of our current cortical strip, grid electrode and depth electrode technology and future versions;
●launching commercial sales of our cortical strip, grid electrode and depth electrode technology, if approved for marketing;
●market acceptance of our cortical strip, grid electrode and depth electrode technology, if approved, by people with epilepsy, Parkinson’s disease, essential tremors and other brain related disorders, the medical community and third-party payors;
●our ability to obtain extensive coverage and reimbursement for our cortical strip, grid electrode and depth electrode technology and implantation procedures;
●our success in educating healthcare providers and people with epilepsy, Parkinson’s disease, essential tremors and other brain related disorders about the benefits, administration and use of our cortical strip, grid electrode and depth electrode technology and future versions;
●the prevalence and severity of adverse events;
●the perceived advantages, cost, safety, convenience and accuracy of alternative therapies;
●obtaining and maintaining patent, trademark and trade secret protection and regulatory exclusivity for our cortical strip, grid electrode and depth electrode technology and otherwise protecting our rights in our intellectual property portfolio;
●maintaining compliance with regulatory requirements, including current good manufacturing practices; and
●obtaining and maintaining a continued acceptable performance and safety profile of our cortical strip, grid electrode and depth electrode technology following approval.
Whether regulatory approval will be granted is unpredictable and depends upon numerous factors, including the substantial discretion of the regulatory authorities. Our success in clinical trials will not guarantee regulatory approval. The FDA and, if we seek to commercialize in select international geographies, other comparable foreign regulatory authorities may require that we conduct additional pre-clinical testing or clinical trials, provide additional data, take additional manufacturing steps, or require other conditions before they will grant us approval. If the FDA or other comparable foreign regulatory authorities require additional clinical trials or data, we would incur increased costs and delays in the marketing approval process, which may require us to expend more resources than we have available. In addition, the FDA or other comparable foreign regulatory authorities may not consider sufficient any additional required clinical trials, data or information that we perform and complete or generate.
In cases where we are successful in obtaining regulatory approval to market one or more of our products, our revenue will be dependent, in part, upon the size of the markets in the territories for which we gain regulatory approval, the accepted price for the product, the ability to obtain coverage and reimbursement, and whether we own the commercial rights for that territory. If the number of people we target is not as significant as we estimate or the treatment population is narrowed by competition, physician choice or treatment guidelines, we may not generate significant revenue from sales of such products, even if approved.
Approval or clearance in the United States by the FDA or by a regulatory agency in another country does not guarantee approval by the regulatory authorities in other countries or jurisdictions or ensure approval for the same conditions of use. In addition, clinical trials conducted in one country may not be accepted by regulatory authorities in other countries. Approval processes vary among countries and can involve additional product testing and validation and additional administrative review periods. It is possible that no product we develop will ever obtain regulatory approval in the United States or any other jurisdiction, even if we expend substantial time and resources seeking such approval. If we do not achieve one or more of these approvals in a timely manner or at all, we could experience significant delays or an inability to fully commercialize any product and achieve profitability.
Both before and after a product is commercially released, we will have ongoing responsibilities under U.S. and foreign regulations. We will also be subject to periodic inspections by the FDA and comparable foreign authorities to determine compliance with regulatory requirements, such as the Quality System Regulation, or QSR, of the FDA, medical device reporting regulations, vigilance in reporting of adverse events and regulations regarding notification, corrections, and recalls. These inspections can result in observations or reports, warning letters or other similar notices or forms of enforcement action. If the FDA or any comparable foreign authority concludes that we are not in compliance with applicable laws or regulations, or that any of our products are ineffective or pose an unreasonable health risk, such authority could ban these products, suspend or cancel our marketing authorizations, impose “stop-sale” and “stop-import” orders, refuse to issue export certificates, detain or seize adulterated or misbranded products, order a recall, repair, replacement, correction or refund of such products, or require us to notify health providers and others that the products present unreasonable risks of substantial harm to the public health. Discovery of previously unknown problems with our product’s design or manufacture may result in restrictions on use, restrictions placed on us or our suppliers, or withdrawal of an existing regulatory clearance. The FDA or comparable foreign authorities may also impose operating restrictions, enjoin and restrain certain violations of applicable law pertaining to medical devices, assess civil or criminal penalties against our officers, employees or us, or recommend criminal prosecution of our Company. Adverse regulatory action may restrict us from effectively marketing and selling our products. In addition, negative publicity and product liability claims resulting from any adverse regulatory action could have a material adverse effect on our business, financial condition, and operating results.
Foreign governmental regulations have become increasingly stringent and more extensive, and we may become subject to even more rigorous regulation by foreign governmental authorities in the future. Penalties for a company’s noncompliance with foreign governmental regulation could be severe, including revocation or suspension of a company’s business license and civil or criminal sanctions. In some jurisdictions, such as Germany, a violation of law related to medical devices may also be considered to be a violation of unfair competition law. In such cases, governmental authorities, our competitors and business or consumer associations may file lawsuits to prohibit us from commercializing a product in such jurisdictions. Our competitors may also sue us for damages. Any domestic or foreign governmental law or regulation imposed in the future may have a material adverse effect on our business, financial condition and operating results.
Depending on the cost and market opportunity, we may never seek approval to commercialize our cortical strip, grid electrode and depth electrode technology in the European Union. We anticipate the cost to seek approval to commercialize in the European Union will be significantly greater than the cost to seek approval to commercialize in the United States. This is because we believe commercial approval by the corresponding Notified Body in the European Union and the European Economic Area, or EEA, even for diagnostic purposes, will require human clinical trials, which we do not believe will be required for regulatory approval by the FDA in the United States in order to seek approval of the use of our technology for diagnostic purposes.
Our success depends on our ability to continue to develop, commercialize and gain market acceptance for our product under development, our cortical strip, grid electrode and depth electrode technology.
Our current business strategy is highly dependent on developing and commercially launching one product, our cortical strip, grid electrode and depth electrode technology, and achieving and maintaining market acceptance. In order for us to sell cortical strip, grid electrode and depth electrode technology to people with epilepsy, Parkinson’s disease, essential tremors and other brain related disorders, we must convince them, their caregivers and healthcare providers that cortical strip, grid electrode and depth electrode technology is an attractive alternative to competitive products for neuromodulation cEEG and sEEG recording, ablation, and brain stimulation. Market acceptance and adoption of our cortical strip, grid electrode and depth electrode technology depends on educating people with epilepsy, Parkinson’s disease, essential tremors and other brain related disorders, as well as their caregivers and healthcare providers, and other perceived benefits of our cortical strip, grid electrode and depth electrode technology as compared to competitive products. We may face challenges convincing physicians, many of whom have extensive experience with competitors’ products and established relationships with other companies, to appreciate the benefits of our cortical strip, grid electrode and depth electrode technology and, in particular, its ability to successfully diagnose and treat epilepsy, Parkinson’s disease, and other brain related disorders in a way that is superior to and differentiated from currently available technology, and adopt it for treatment of their patients.
Achieving and maintaining market acceptance of cortical strip, grid electrode and depth electrode technology could be negatively impacted by many factors, including:
●the failure of our cortical strip, grid electrode and depth electrode technology to achieve wide acceptance among people with epilepsy, Parkinson’s disease, essential tremors and other brain related disorders, their caregivers, healthcare providers, third-party payors and key opinion leaders in the community;
●lack of evidence supporting the performance criteria or other perceived benefits of our cortical strip, grid electrode and depth electrode technology over competitive products or other currently available technology;
●perceived risks associated with the use of our cortical strip, grid electrode and depth electrode technology or similar products or technologies generally;
●the introduction of competitive products and the rate of acceptance of those products as compared to our cortical strip, grid electrode and depth electrode technology;
●adverse results of clinical trials relating to our cortical strip, grid electrode and depth electrode technology or similar competitive products; and
●loss of regulatory approval for our cortical strip, grid electrode and depth electrode technology, adverse publicity or other adverse events including any product liability lawsuits.
In addition, our cortical strip, grid electrode and depth electrode technology may be perceived by people with epilepsy, Parkinson’s disease, essential tremors and other brain related disorders, their caregivers or healthcare providers to be more complicated or less effective than current technology, and people may be unwilling to change their current regimens.
Moreover, we believe that healthcare providers tend to be slow to change their medical treatment practices because of perceived liability risks arising from the use of new products and the uncertainty of third-party reimbursement. Accordingly, healthcare providers may not recommend our cortical strip, grid electrode and depth electrode technology until, if ever, there is sufficient evidence to convince them to alter the treatment methods they typically recommend, such as receiving recommendations from prominent healthcare providers or other key opinion leaders in the community.
If we are not successful in convincing people with epilepsy, Parkinson’s disease, essential tremors and other brain related disorders of the benefits of our cortical strip, grid electrode and depth electrode technology, or if we are unable to achieve the support of caregivers and healthcare providers or widespread market acceptance for our cortical strip, grid electrode and depth electrode technology, then our sales potential, strategic objectives and profitability could be negatively impacted, which would adversely affect our business, financial condition and operating results.
We may fail to obtain regulatory approvals to market our products in the United States or in other countries.
Before we can market or sell a new regulated product in the United States, we must obtain either clearance under Section 510(k) of the FDCA or approval of a PMA application from the FDA, unless an exemption from pre-market review applies. In the 510(k) clearance process, the FDA must determine that a proposed device is “substantially equivalent” to a device legally on the market, known as a “predicate” device, with respect to intended use, technology and safety and effectiveness, in order to clear the proposed device for marketing. Clinical data is sometimes required to support substantial equivalence. The PMA pathway requires an applicant to demonstrate the safety and effectiveness of the device based, in part, on extensive data, including, but not limited to, technical, preclinical, clinical trial, manufacturing and labeling data. The PMA process is typically required for devices that are deemed to pose the greatest risk, such as life-sustaining, life-supporting or implantable devices. Both the 510(k) and PMA processes can be expensive and lengthy and require the payment of significant fees, unless exempt. The FDA’s 510(k) clearance process usually takes from three to 12 months, but may last longer. The process of obtaining a PMA is much more costly and uncertain than the 510(k) clearance process and generally takes from one to three years, or even longer, from the time the application is submitted to the FDA until an approval is obtained. The process of obtaining regulatory clearances or approvals to market a medical device can be costly and time-consuming, and we may not be able to obtain these clearances or approvals on a timely basis, if at all.
Even if we obtain clearance or approval by the FDA, said clearance or approval by the FDA does not ensure approval or certification by regulatory authorities in other countries or jurisdictions, and approval or certification by one foreign regulatory authority does not ensure approval or certification by regulatory authorities in other foreign countries or by the FDA. The foreign regulatory approval or certification process may include all of the risks associated with obtaining FDA clearance or approval. We may not obtain foreign regulatory approvals on a timely basis, if at all. We may not be able to file for regulatory approvals or certifications and may not receive necessary approvals to commercialize our products in any market. If we fail to receive necessary approvals or certifications to commercialize our products in foreign jurisdictions on a timely basis, or at all, our business, results of operations and financial condition could be adversely affected.
Failure to secure or retain coverage or adequate reimbursement for our cortical strip, grid electrode and depth electrode technology or future versions thereof, including the implantation procedures, by third-party payors could adversely affect our business, financial condition and operating results.
We plan to derive nearly all of our revenue from sales of our cortical strip, grid electrode and depth electrode technology under development, if approved, in the United States and potentially select international geographies and expect to do so for the next several years. We anticipate a substantial portion of the purchase price of our cortical strip, grid electrode and depth electrode technology will be paid for by third-party payors, including private insurance companies, preferred provider organizations and other managed care providers. Patients who receive treatment for their medical conditions and their healthcare providers generally rely on third-party payors to reimburse all or part of the costs associated with their medical treatment, including healthcare providers’ services. Coverage and adequate reimbursement from third-party payors, including governmental healthcare programs, such as Medicare and Medicaid, and commercial payors, is critical to new product acceptance. Future sales of our cortical strip, grid electrode and depth electrode technology will be limited unless people with epilepsy, Parkinson’s disease, essential tremors and other brain related disorders can rely on third-party payors to pay for all or part of the cost to purchase our cortical strip, grid electrode and depth electrode technology. Access to adequate coverage and reimbursement for our cortical strip, grid electrode and depth electrode technology by third-party payors is essential to the acceptance of our products by people with epilepsy, Parkinson’s disease, essential tremors and other brain related disorders.
In the United States, a third-party payor’s decision to provide coverage for our products does not imply that an adequate reimbursement rate will be obtained. Further, one third-party payor’s decision to cover our products does not assure that other payors will also provide coverage for the products or will provide coverage at an adequate reimbursement rate. Healthcare providers may choose not to order a product unless third-party payors pay a substantial portion of the product. Within and outside the United States, reimbursement is obtained from a variety of sources, including government-sponsored and private health insurance plans. These third-party payors determine whether to provide coverage and reimbursement for specific products and procedures. Coverage determinations and reimbursement levels of both our products and the healthcare provider’s performance of the insertion and removal procedures are critical to the commercial success of our product, and if we are not able to secure positive coverage determinations and reimbursement levels for our products or the insertion and removal procedures, our business would be materially adversely affected.
In addition, there may be significant delays in obtaining reimbursement, and coverage may be more limited than the purposes for which the product is cleared by the FDA or other foreign regulatory authorities. Moreover, eligibility for reimbursement does not imply that any product will be paid for in all cases or at a rate that covers our costs, including research, development, manufacture, sale and distribution. Payment rates may vary according to the use of the product and the clinical setting in which it is used, may be based on payments allowed for lower cost products that are already reimbursed, and may be incorporated into existing payments for other services. Net prices for products may be reduced by mandatory discounts or rebates required by government healthcare programs or third-party payors and by any future relaxation of laws that presently restrict imports of products from countries where they may be sold at lower prices than in the United States.
Because there is generally no separate reimbursement for medical devices and other supplies used in such procedures, including our cortical strip, grid electrode and depth electrode technology, and because we believe that our cortical strip, grid electrode and depth electrode technology, if approved, would be adequately described by existing DRG and ICD-9 codes for epilepsy surgery, some of our target customers may be unwilling to adopt our cortical strip, grid electrode and depth electrode technology over more established or lower cost therapeutic alternatives already available or subsequently become available. Further, any decline in the amount payors are willing to reimburse our customers for procedures using our cortical strip, grid electrode and depth electrode technology could make it difficult for new customers to adopt our cortical strip, grid electrode and depth electrode technology and could create additional pricing pressure for us, which could adversely affect our ability to invest in and grow our business.
Third-party payors, whether foreign or domestic, or governmental or commercial, are developing increasingly sophisticated methods of controlling healthcare costs. In addition, in the United States, no uniform policy of coverage and reimbursement for medical device products and services exists among third-party payors. Therefore, coverage and reimbursement for medical device products and services can differ significantly from payor to payor. In addition, payors continually review new technologies for possible coverage and can, without notice, deny coverage for these new products and procedures. As a result, the coverage determination process is often a time-consuming and costly process that will require us to provide scientific and clinical support for the use of our products to each payor separately, with no assurance that coverage and adequate reimbursement will be obtained, or maintained if obtained.
Reimbursement systems in international markets vary significantly by country and by region within some countries, and reimbursement approvals must be obtained on a country-by-country basis. In many international markets, a product must be approved for reimbursement before it can be approved for sale in that country. Further, many international markets have government-managed healthcare systems that control reimbursement for new devices and procedures. In most markets there are private insurance systems as well as government-managed systems. If sufficient coverage and reimbursement is not available for our any product we develop, in either the United States or internationally, the demand for our products and our revenues will be adversely affected.
Reimbursement by Medicare is highly regulated and subject to change.
The Medicare program is administered by the Centers for Medicare and Medicaid Services, or CMS, which imposes extensive and detailed requirements on medical services providers, including, but not limited to, rules that govern how we structure our relationships with physicians, and how and where we provide our solutions. Our failure to comply with applicable Medicare rules could result in discontinuing the ability for physicians to receive reimbursement as they will likely utilize our cortical strip, grid electrode and depth electrode technology under the Medicare payment program, civil monetary penalties, and/or criminal penalties, any of which could have a material adverse effect on our business and revenues.
The impact of the Patient Protection and Affordable Care Act remains uncertain.
In 2010, significant reforms to the health care system were adopted as law in the United States. The law includes provisions that, among other things, reduce or limit Medicare reimbursement, require all individuals to have health insurance (with limited exceptions) and impose increased taxes. These factors, in turn, could result in reduced demand for our products, if approved, and increased downward pricing pressure. Because other parts of the 2010 health care law remain subject to implementation, the long-term impact on us is uncertain. The new law or any future legislation could reduce medical procedure volumes, lower reimbursement for our products, and impact the demand for our products or the prices at which we sell our products.
In addition, some of the provisions of the ACA have yet to be implemented, and there have been legal and political challenges to certain aspects of the ACA. Since January 2017, President Trump has signed executive orders and other directives designed to delay, circumvent, or loosen certain requirements mandated by the ACA. Concurrently, Congress has considered legislation that would repeal or repeal and replace all or part of the ACA. While Congress has not passed repeal legislation, the Tax Cuts and Jobs Act of 2017 (H.R. 1) (the “Tax Act”) includes a provision repealing, effective January 1, 2019, the tax-based shared responsibility payment imposed by the ACA on certain individuals who fail to maintain qualifying health coverage for all or part of a year that is commonly referred to as the “individual mandate.” Congress may consider other legislation to repeal or replace elements of the ACA. We continue to evaluate the effect that the ACA and its possible repeal and replacement has on our business but expect that the ACA, as currently enacted or as it may be amended in the future, and other healthcare reform measures that may be adopted in the future could have a material adverse effect on our industry generally and on our ability to successfully commercialize our cortical strip, grid electrode and depth electrode technology, if approved. In addition to the ACA, there will continue to be proposals by legislators at both the federal and state levels, regulators and third party payors to keep healthcare costs down while expanding individual healthcare benefits.
Accordingly, while it is too early to understand and predict the ultimate impact of the ACA on our business, the legislation and resulting regulations could have a material adverse effect on our business, cash flows, financial condition and results of operations.
If our competitors are better able to develop and market products for the diagnosis and treatment of epilepsy, Parkinson’s disease, essential tremors and other brain related disorders that are safer, more effective, less costly, easier to use or otherwise more attractive than our cortical strip, grid electrode and depth electrode technology, our business will be adversely impacted.
The medical device industry is highly competitive and subject to technological change. Our success depends, in part, upon our ability to establish a competitive position in the market for the diagnosis and treatment of epilepsy, Parkinson’s disease, essential tremors and other brain related disorders by securing broad market acceptance of our cortical strip, grid electrode and depth electrode technology under development. Any product we develop that achieves regulatory clearance or approval will have to compete for market acceptance and market share. If developed as anticipated, we believe that the primary competitive factors of our cortical strip, grid electrode and depth electrode technology under development will be: reduced infections, ability to record additional brain activity, minimally invasive surgical procedure, ease of use and cost effectiveness. We face significant competition in the United States and internationally, which we believe will intensify. For example, our major competitors (i) in the market for diagnosis are PMT, Ad-Tec Medical and Integra Lifesciences, (ii) in the market for neuro-ablation are Medtronic and Monteris Medical and (iii) in the market for neurostimulation are Medtronic, Boston Scientific, NeuroPace Biotronik and Abbott. Each of the foregoing competitors has systems approved in the United States and certain foreign jurisdictions and has been established for several years. We face a particular challenge overcoming the long-standing practices by some physicians of using the existing technology of our larger, more established competitors. Physicians may be reluctant to try new products from a source with which they are less familiar. If these physicians do not try to subsequently adopt our product, then we may never achieve profitability and such failure to adopt our product could have a material adverse effect on our business, financial condition and operating results.
Additionally, the Mayo Clinic is conducting testing of its own minimally invasive cortical electrode delivery device. In the event the Mayo Clinic completes development of its own device prior to us, we may forego completing development of our device and we may be unable to enter into any arrangement with Mayo Clinic relating to its device. If we are unable to pursue the development of a minimally invasive cortical electrode device, this may delay our ability to become profitable and we could be forced to terminate our operations.
In addition to facing competition from major competitors and potentially our development partner, we may also face competition from other emerging competitors or smaller companies with active development programs that may emerge in the future.
Many of the companies developing or marketing competing products enjoy several advantages over us, including:
●more experienced sales forces;
●greater name recognition;
●more established sales and marketing programs and distribution networks;
●earlier regulatory approval in the United States or foreign jurisdictions;
●long established relationships with physicians and hospitals;
●significant patent portfolios, including issued U.S. and foreign patents and pending patent applications, as well as the resources to enforce patents against us or any of our third-party suppliers and distributors;
●the ability to acquire and integrate our competitors and/or their technology;
●demonstrated ability to develop product enhancements and new product offerings;
●established history of product reliability, safety and durability;
●the ability to offer rebates or bundle multiple product offerings to offer greater discounts or incentives;
●greater financial and human resources for product development, sales, and marketing; and
●greater experience in and resources for conducting research and development, clinical studies, manufacturing, preparing regulatory submissions, obtaining regulatory clearance or approval for products and marketing approved products.
Our competitors may develop and patent processes or products earlier than us, obtain patents that may apply to us at any time, obtain regulatory clearance or approvals for competing products more rapidly than us or develop more effective or less expensive products or technologies that render our technology or products obsolete or less competitive. Furthermore, the frequent introduction by competitors of products that are, or claim to be, superior to our products may create market confusion that may make it difficult to differentiate the benefits of our products over competitive products. In addition, the entry of multiple new products may lead some of our competitors to employ pricing strategies that could adversely affect the pricing of any product we may develop and commercialize. We also face fierce competition in recruiting and retaining qualified sales, scientific, and management personnel, establishing clinical trial sites and enrolling patients in clinical studies. If our competitors are more successful than us in these matters, our business may be harmed.
The size and future growth in the market for our cortical strip, grid electrode and depth electrode technology under development has not been established with precision and may be smaller than we estimate, possibly materially. If our estimates and projections overestimate the size of this market, our sales growth may be adversely affected.
Our estimates of the size and future growth in the market for our cortical strip, grid electrode and depth electrode technology under development, including the number of people with epilepsy, Parkinson’s disease, essential tremors and other brain related disorders who may benefit from and be amenable to using cortical strip, grid electrode and depth electrode technology for diagnosis and treatment, is based on a number of internal and third-party studies, reports and estimates. In addition, our internal estimates are based in large part on current treatment patterns by healthcare providers using current generation technology and our belief is that the incidence of epilepsy, Parkinson’s disease, essential tremors and other brain related disorders in the United States and worldwide is increasing. While we believe these factors have historically provided and may continue to provide us with effective tools in estimating the total market for cortical strip, grid electrode and depth electrode technology, these estimates may not be correct and the conditions supporting our estimates may change at any time, thereby reducing the predictive accuracy of these underlying factors. The actual incidence of brain related disorders, and the actual demand for our products or competitive products, could differ materially from our projections if our assumptions are incorrect. As a result, our estimates of the size and future growth in the market for cortical strip, grid electrode and depth electrode technology may prove to be incorrect. If the actual number of people with brain related disorders who would benefit from cortical strip, grid electrode and depth electrode technology and the size and future growth in the market for cortical strip, grid electrode and depth electrode technology is smaller than we have estimated, it may impair our projected sales growth and have an adverse impact on our business.
We depend on intellectual property licensed from Wisconsin Alumni Research Foundation (“WARF”) for our technology under development, and the termination of this license would harm our business.
WARF has granted us the WARF License, to make, use and sell, in the United States only, products that employ certain licensed patents for a neural probe array or thin-film micro electrode array and method. See “Business - WARF License” for additional information regarding our license agreement with WARF.
We have agreed to diligently develop, manufacture, market and sell products under the WARF License in the United States during the term of the agreement and, specifically, that we would submit a business plan to WARF by February 1, 2018, which we submitted on January 18, 2018 and file an application for 510(k) marketing clearance with the FDA by February 1, 2019, which we filed on January 28, 2019. WARF may terminate this license in the event that we fail to meet these milestones on 30 days’ written notice, if we default on the payments of amounts due to WARF or fail to timely submit development reports, actively pursue our development plan or breach any other covenant in the WARF License and fail to remedy such default in 90 days or in the event of certain bankruptcy events involving us. WARF may also terminate this license (i) on 90 days’ notice if we fail to have commercial sales of one or more FDA-approved products under the WARF License by March 31, 2020 or (ii) if, after royalties earned on sales begin to be paid, such earned royalties cease for more than four calendar quarters. The WARF License otherwise expires by its terms on the date that no valid claims on the patents licensed thereunder remain.
Disputes may arise between us and WARF regarding intellectual property subject to this agreement, including with respect to: the scope of rights granted under the WARF License and other interpretation-related issues; whether and the extent to which our technology and processes infringe on intellectual property of WARF that is not subject to the WARF License; the amount and timing of milestones and royalty payments; the rights of WARF under the license; our right to sublicense; and the ownership of inventions and know-how resulting from the WARF License. For example, if we or any of our sublicenses for any reason contest the validity of any patent licensed under the WARF License, the royalty rate will be doubled during the pendency of such contest and, if the contested patent is found to be valid and would be infringed by us if not for the WARF License, the royalty rate will be tripled for the remaining term of the WARF License.
Any disputes with WARF may prevent or impair our ability to maintain our current licensing arrangement. We depend on the intellectual property licensed from WARF to develop our cortical strip, grid electrode and depth electrode technology. We cannot assure you that we will be able to meet the milestones or commercialize a product under the WARF License by the dates required. In fact, the original license agreement entered into with WARF in 2014 required that we meet certain earlier milestones than set forth above and make certain payments to WARF. We failed to do so and were in default under the original license agreement. Furthermore, the LLC was not able to transfer the rights and obligations under the 2014 WARF Agreement to us at the time of the Merger without the consent of WARF. As a result, in February 2017, we signed an amendment to the WARF License which, among other things, modified and removed certain previous milestones and provided WARF’s consent to such transfer. Because of this past breach, WARF may be less likely to waive future defaults or breaches or further amend the WARF License in the future, to the extent we request any waiver or amendment. See “Note 4-Commitments and Contingencies” to the financial statements included in this report.
Termination of our license could result in the loss of significant rights and would harm our ability to further develop our cortical strip, grid electrode and depth electrode technology. In addition, WARF reserves the right to grant non-profit research institutions and government agencies non-exclusive licenses to practice and use the inventions of the licensed patents for non-commercial research purposes, and we grant WARF a non-exclusive, sub licensable, royalty-free right and license for non-commercial research purposes to use improvements to the licensed patents. In the event that we discontinue use or commercialization of the licensed patents or improvements thereon, we must grant WARF an option to obtain a non-exclusive, sub-licensable royalty-bearing license to use the improvements for commercial purposes. Such rights, if exercised by WARF, could harm our ability to develop and commercialize our cortical strip, grid electrode and depth electrode technology.
We depend on our partnership with Mayo to license certain know how for the development and commercialization of our technology. Termination of this partnership would harm our business, and even if this partnership continues, it may not be successful.
We have entered into the Mayo Development Agreement to (i) exclusively license worldwide certain Mayo improvements for the development and commercialization of products, methods and processes related to flexible circuit technology for the recording and stimulation of tissue and (ii) license, on a non-exclusive basis, worldwide Mayo thin film electrode technology know-how for the development and commercialization of products, methods and processes related to flexible circuit technology for the recording and stimulation of tissue. Mayo has agreed to assist the Company by providing access to the Mayo Principal Investigators in developing a minimally invasive device/delivery system and procedure for a minimally invasive approach for the implantation of any flexible circuit technology developed by the Company, including prototype development, animal testing, protocol development for human and animal use, abstract development and presentation and access to and license of any intellectual property that the Mayo Principal Investigators develop relating to the procedure. See “Business-Mayo Foundation for Medical Education and Research License and Development Agreement” for additional information regarding our agreement with Mayo.
The Mayo Development Agreement generally will expire in October 2034, unless the Mayo know-how and improvements under the Mayo Development Agreement remain in use, and the Mayo Development Agreement may be terminated by Mayo for cause or under certain circumstances. Mayo and the Company may not be successful in their efforts to develop any product, method, process, device, delivery system or minimally invasive approach by such expiration date or termination, if at all. If no such minimally invasive device or delivery system and procedure for minimally invasive approach is developed, the Company may never receive regulatory approval of its cortical strip, grid electrode and depth electrode technology under development or the market may never accept such technology, if approved.
Disputes may arise between us and Mayo regarding intellectual property subject to the Mayo Development Agreement or other matters, including with respect to: the scope of rights granted under the agreement and other interpretation-related issues; the amount and timing of payments; the rights and obligations of Mayo under the license agreement; and the ownership of inventions and know-how resulting from the joint creation or use of intellectual property by Mayo and us.
Any disputes with Mayo may prevent or impair our ability to maintain our current arrangement. We depend on the intellectual property licensed from and development assistance from Mayo to develop our cortical strip, grid electrode and depth electrode technology. We cannot assure you that we will be able to continue to comply with the Mayo Development Agreement. In fact, the original license and development agreement entered into with Mayo in 2014 required that, upon the Merger with the LLC, we make certain payments and issue shares of common stock to Mayo, which we failed to do at such time. We signed the Mayo Development Agreement in May 2017, which, among other things, modified or removed certain provisions of the original agreement, including those we breached. In addition, pursuant to the Mayo Development Agreement signed in May 2017, we agreed to pay Mayo a cash payment of approximately $92,000 on the earlier of September 30, 2017 or the date we raise a minimum amount of financing. We did not make this payment by September 30, 2017 and breached this provision of the Mayo Development Agreement. Mayo granted us an extension of this deadline to December 31, 2017, and we made this payment within such extended deadline. Because of our past breach, Mayo may be less likely to waive future defaults or breaches or further amend the Mayo Development Agreement in the future, to the extent we request any waiver or amendment. Termination of the Mayo Development Agreement could result in the loss of significant rights and would harm our ability to further develop our technology.
Even if we have our cortical strip, grid electrode and depth electrode technology approved for commercial sale, if we are unable to expand our sales and marketing infrastructure, we may not be successful in commercializing our cortical strip, grid electrode and depth electrode technology in the United States.
We are an early stage development company with limited resources. Even if we had products available for sale, which we currently do not, we have not secured sufficient sales and marketing staff at this early stage of operations to sell products. To achieve commercial success in the United States for our cortical strip, grid electrode and depth electrode technology, we will need to expand our sales and marketing infrastructure to drive adoption of our products, which will include a team of educators that will train healthcare providers and people with brain related disorders on the benefits and use of our cortical strip, grid electrode and depth electrode technology. There is significant competition for sales personnel experienced in relevant medical device sales. We expect that we will face significant challenges as we recruit and subsequently grow our sales and marketing infrastructure. If we are unable to attract and retain sufficient, and skilled, sales and marketing representatives, our sales could be adversely affected. If one of our sales or marketing representatives were to depart and be retained by one of our competitors, they could help competitors solicit business from customers, which could further harm our sales. In addition, if our sales and marketing representatives or educators fail to achieve their objectives or if we are not able to recruit and retain a network of educators, we may not be able to successfully train healthcare providers on the use of our cortical strip, grid electrode and depth electrode technology, which could delay new sales and harm our reputation.
As we increase our sales and marketing expenditures with respect to our cortical strip, grid electrode and depth electrode technology under development, if approved, or future versions thereof, we will need to hire, train, retain and motivate skilled sales and marketing representatives with significant industry-specific knowledge in various areas. Our success will depend largely on the competitive landscape for our products and the ability of our sales personnel to obtain access to healthcare providers and persuade those healthcare providers to recommend our cortical strip, grid electrode and depth electrode technology. Recently hired sales representatives require training and take time to achieve full productivity. If we fail to train new hires adequately, or if we experience high turnover in our sales force in the future, we cannot be certain that new hires will become as productive as may be necessary to maintain or increase our sales. In addition, the expansion of our sales and marketing personnel will place significant burdens on our management team.
If approved for sale, we anticipate that we will derive nearly all of our U.S. revenue from the sales of our cortical strip, grid electrode and depth electrode technology or future versions thereof. As a result, our financial condition and operating results will be highly dependent on the ability of our sales representatives to adequately promote, market and sell our cortical strip, grid electrode and depth electrode technology and the ability of our educators to train healthcare providers on the use of our cortical strip, grid electrode and depth electrode technology. If we are unable to expand our sales and marketing capabilities, we may not be able to effectively commercialize our existing or planned products, or enhance the strength of our brand, either of which could impair our projected sales growth and have an adverse impact on our business.
We will depend on a limited number of third-party suppliers for the components of our cortical strip, grid electrode and depth electrode technology under development and the loss of any of these suppliers, or their inability to provide us with an adequate supply of materials, could harm our business.
We will rely on third-party suppliers to supply and manufacture the components of our cortical strip, grid electrode and depth electrode technology. For our business strategy to be successful, our suppliers must be able to provide us with components in sufficient quantities, in compliance with regulatory requirements and quality control standards, in accordance with agreed upon specifications, at acceptable costs and on a timely basis. Future increases in sales of our cortical strip and sheet electrode technology, if approved, whether expected or unanticipated, could strain the ability of our suppliers to deliver an increasingly large supply of components and our cortical strip, grid electrode and depth electrode technology in a manner that meets these various requirements.
We will likely use a small number of suppliers of components for our products. Depending on a limited number of suppliers exposes us to risks, including limited control over pricing, availability, quality and delivery schedules. We may not have long-term supply agreements with our suppliers and, in many cases, we may make our purchases on a purchase order basis. Our ability to purchase adequate quantities of components or our products may be limited and we may not be able to convince suppliers to make components and products available to us. Additionally, our suppliers may encounter problems that limit their ability to supply components or manufacture products for us, including financial difficulties, damage to their manufacturing equipment or facilities, or product discontinuations. As a result, there is a risk that certain components could be discontinued and no longer available to us. We may be required to make significant “last time” purchases of component inventory that is being discontinued by the supplier to ensure supply continuity. If we fail to obtain sufficient quantities of high quality components to meet demand for our products in a timely manner or on terms acceptable to us, we would have to seek alternative sources of supply. Because of factors such as the proprietary nature of our products, our quality control standards and regulatory requirements, we may not be able to quickly engage additional or replacement suppliers for some of our critical components. Failure of any supplier to deliver components at the level our business requires could disrupt the manufacturing of our products and, if approved, limit our ability to meet our sales commitments, which could harm our reputation and adversely affect our business.
Furthermore, vandalism, terrorism or a natural or other disaster, such as an earthquake, fire or flood, could damage or destroy equipment or our inventory of component supplies or finished products, cause substantial delays in development or our operations, result in the loss of key information, and cause us to incur additional expenses. We do not currently have insurance to cover such losses or expenses and, once we obtain such insurance, it may not cover our losses in any particular case. In addition, regardless of the level of insurance coverage, damage to our or our suppliers’ facilities could harm our business, financial condition and operating results.
We may also have difficulty obtaining similar components from other suppliers that are acceptable to the FDA or other regulatory agencies, and the failure of any supplier to comply with strictly enforced regulatory requirements could expose us to regulatory action including warning letters, product recalls, and termination of distribution, product seizures or civil penalties. It could also require us to cease using the components, seek alternative components or technologies and modify our products to incorporate alternative components or technologies, which could result in a requirement to seek additional regulatory approvals. Any disruption of this nature or increased expenses could harm our development, approval or commercialization efforts and adversely affect our operating results.
We plan to contract with third parties for the manufacture of our cortical strip, grid electrode and depth electrode technology under development and expect to continue to do so for clinical trials and commercialization. Risks associated with the manufacturing of our products could reduce our gross margins and negatively affect our operating results.
We currently rely, and expect to continue to rely, on third parties for the manufacture of our cortical strip, grid electrode and depth electrode technology during development, for clinical testing, as well as for commercial manufacture if our cortical strip, grid electrode and depth electrode technology receives regulatory approval. Therefore, our business strategy depends on our third-party manufacturers’ ability to manufacture our cortical strip, grid electrode and depth electrode technology and future generations thereof in sufficient quantities and on a timely basis so as to meet consumer demand, while adhering to product quality standards, complying with regulatory requirements and managing manufacturing costs. To date, we have only had an initial supply of our product manufactured. As a result, we currently have limited data and experience regarding the quality, reliability and timeliness of our third-party manufacturers.
We are subject to numerous risks relating to the manufacturing capabilities of our third-party manufacturers, including:
●quality or reliability defects;
●inability to secure product components in a timely manner, in sufficient quantities or on commercially reasonable terms;
●failure to increase production to meet demand;
●inability to modify production lines to enable us to efficiently produce future products or implement changes in current products in response to regulatory requirements;
●difficulty identifying and qualifying alternative manufacturers in a timely manner;
●inability to manufacture product components cost-effectively;
●inability to establish agreements with future third-party manufacturers or to do so on acceptable terms; or
●potential damage to or destruction of our manufacturers’ equipment or facilities.
These risks are likely to be exacerbated by our limited experience with our cortical strip, grid electrode and depth electrode technology and its manufacturing process. As demand for our products increases, our third-party suppliers will need to invest additional resources to purchase components, hire and train employees, and enhance their manufacturing processes. If our manufacturers fail to increase production capacity efficiently, our sales may not increase in line with our expectations and our operating margins could fluctuate or decline. In addition, manufacturing any future versions of our cortical strip, grid electrode and depth electrode technology may require the modification of production lines, the identification of new manufacturers for specific components, or the development of new manufacturing technologies. It may not be possible for us to manufacture these products at a cost or in quantities sufficient to make any future versions of our cortical strip, grid electrode and depth electrode technology commercially viable.
If we or our third-party suppliers or manufacturers fail to comply with the FDA’s good manufacturing practice regulations, this could impair our ability to market our products in a cost-effective and timely manner.
We and our third-party suppliers are required to comply with the FDA’s QSR, which covers the methods and documentation of the design, testing, production, control, quality assurance, labeling, packaging, sterilization, storage and shipping of our products. The FDA audits compliance with the QSR through periodic announced and unannounced inspections of manufacturing and other facilities. The FDA may impose inspections or audits at any time. If we or our suppliers or manufacturers have significant non-compliance issues or if any corrective action plan that we or our suppliers propose in response to observed deficiencies is not sufficient, the FDA could take enforcement action against us. Any of the foregoing actions could impair our reputation, business, financial condition and operating results.
Various factors outside our direct control may adversely affect manufacturing, sterilization and distribution of our products.
The manufacture, sterilization and distribution of our products is challenging. Changes that our suppliers may make outside the purview of our direct control can have an impact on our processes, quality of our products and the successful delivery of products to our customers. Necessary materials for our product under development may not be available from our third-party suppliers in a timely fashion or at all. Mistakes and mishandling are not uncommon and can affect supply and delivery. Some of these risks include:
●failure to complete sterilization on time or in compliance with the required regulatory standards;
●transportation and import and export risk;
●delays in analytical results or failure of analytical techniques that we will depend on for quality control and release of products;
●natural disasters, labor disputes, financial distress, raw material availability, issues with facilities and equipment or other forms of disruption to business operations affecting our manufacturers or suppliers; and
●latent defects that may become apparent after products have been released and that may result in a recall of such products.
If any of these risks were to materialize, our ability to develop products, conduct clinical trials or provide our products to customers on a timely basis, if approved, would be adversely impacted.
Potential complications from our cortical strip, grid electrode and depth electrode technology may come to light or may not be revealed by our clinical experience.
Based on our industry experience and the experience of the physicians that use products similar to our cortical strip, grid electrode and depth electrode technology, complications from use of our cortical strip, grid electrode and depth electrode technology may include post-operative hemorrhage, infection, brain inflammation, brain tissue necrosis, inability to accurately localize the epileptogenic focus (the area of the cerebral cortex responsible for causing epileptic seizures), neurologic deficit (abnormal function of a body area due to weaker function of the brain, spinal cord, muscles or nerves, such as abnormal reflexes, inability to speak and decreased sensation) and extra axial fluid collections (fluid that occurs in the brain after surgery). If these or unanticipated complications or side-effects result from the use of our cortical strip, grid electrode and depth electrode technology, our product development may be delayed, we may not be able to obtain regulatory approval for any product, we could be subject to liability and, even if approved, our technology would not be widely adopted. Additionally, we have no clinical experience with use of our cortical strip, grid electrode and depth electrode technology. We cannot assure you that use, even for a limited time, would not result in unanticipated complications, even after the device is removed.
Undetected errors or defects in our cortical strip, grid electrode and depth electrode technology under development or future versions thereof could harm our reputation, decrease the market acceptance of our cortical strip, grid electrode and depth electrode technology or expose us to product liability claims.
Our cortical strip, grid electrode and depth electrode technology may contain undetected errors or defects. Disruptions or other performance problems with our cortical strip, grid electrode and depth electrode technology may delay development, prevent regulatory approval or harm our reputation. If that occurs, we may incur significant costs, the attention of our key personnel could be diverted or other significant customer relations problems may arise. We may also be subject to warranty and liability claims for damages related to errors or defects in our cortical strip and sheet electrode technology or future versions thereof. A material liability claim or other occurrence that harms our reputation or decreases market acceptance of our cortical strip, grid electrode and depth electrode technology could harm our business and operating results. This risk exists even if a device is cleared or approved for commercial sale and manufactured in facilities licensed and regulated by the FDA or an applicable foreign regulatory authority. Our products are designed to affect, and any future products will be designed to affect, important bodily functions and processes. Any side effects, manufacturing defects, misuse or abuse associated with our cortical strip, grid electrode and depth electrode technology or future versions thereof could result in patient injury or death. The medical device industry has historically been subject to extensive litigation over product liability claims, and we cannot offer any assurance that we will not face product liability lawsuits.
The sale and use of our cortical strip, grid electrode and depth electrode technology or future versions thereof could lead to the filing of product liability claims if someone were to allege that our cortical strip, grid electrode and depth electrode technology or one of our products contained a design or manufacturing defect. A product liability claim could result in substantial damages and be costly and time consuming to defend, either of which could materially harm our business or financial condition. Product liability claims may be brought against us by patients, healthcare providers or others selling or otherwise coming into contact with our products, among others. If we cannot successfully defend ourselves against product liability claims, we will incur substantial liabilities and reputational harm. In addition, regardless of merit or eventual outcome, product liability claims may result in:
●litigation;
●distraction of management’s attention from our primary business;
●the inability to commercialize our cortical strip, grid electrode and depth electrode technology;
●decreased demand;
●damage to our business reputation;
●product recalls or withdrawals from the market;
●withdrawal of clinical trial participants;
●substantial monetary awards to patients or other claimants; or
●loss of revenue.
Product liability lawsuits and claims, safety alerts or product recalls, with or without merit, could cause us to incur substantial costs, delay our product development efforts, place a significant strain on our financial resources, divert the attention of management from our core business, harm our reputation, increase our product liability insurance rates, once we obtain such insurance, or prevent us from securing such insurance coverage in the future and adversely affect our ability to attract and retain customers, if approved, any of which could harm our business, financial condition and operating results.
We do not currently maintain any product liability insurance and do not anticipate obtaining product liability insurance until we commence clinical trials. Once we obtain such insurance, we cannot assure you that such insurance would adequately protect our assets from the financial impact of defending a product liability claim. Even if any product liability loss is covered by an insurance policy, these policies typically have substantial deductibles for which we are responsible. Product liability claims in excess of applicable insurance coverage would negatively impact our business, financial condition and operating results. Insurance coverage varies in cost and can be difficult to obtain, and we cannot guarantee that we will be able to obtain insurance coverage in the future on terms acceptable to us or at all.
If there are significant disruptions in our information technology systems, our business, financial condition and operating results could be adversely affected.
The efficient operation of our business depends on our information technology systems. We rely on our information technology systems to effectively manage product development tasks, research and development data and accounting and financial functions. We expect in the future we will rely on our information technology systems for inventory management and technical support functions, if and once implemented. Our information technology systems are vulnerable to damage or interruption from earthquakes, fires, floods and other natural disasters, terrorist attacks, attacks by computer viruses or hackers, power losses, and computer system or data network failures. In addition, our data management application and a variety of our software systems are hosted by third-party service providers whose security and information technology systems are subject to similar risks, which could be subject to computer viruses or hacker attacks or other failures. If our or our third-party service provider’s security systems are breached or fail, unauthorized persons may be able to obtain access to sensitive data.
To the extent that any disruption or security breach were to result in a loss of, or damage to, our data or applications, or inappropriate disclosure of confidential or proprietary information, we could incur liability, and the failure of our or our service providers’ information technology systems or our transmitter’s software to perform as we anticipate or our failure to effectively implement new information technology systems could disrupt our entire operation or adversely affect our products and could delay our product development, clinical trial or commercialization efforts, result in increased overhead costs and damage our reputation, all of which could negatively affect our business, financial condition and operating results.
We may enter into collaborations, in-licensing arrangements, joint ventures, strategic alliances or partnerships with third-parties that may not result in the development of commercially viable products or the generation of significant future revenues.
In the ordinary course of our business, we may enter into collaborations, in-licensing arrangements, joint ventures, strategic alliances, partnerships or other arrangements to develop products and to pursue new markets. Proposing, negotiating and implementing collaborations, in-licensing arrangements, joint ventures, strategic alliances or partnerships may be a lengthy and complex process. Other companies, including those with substantially greater financial, marketing, sales, technology or other business resources, may compete with us for these opportunities or arrangements. We may not identify, secure, or complete any such transactions or arrangements in a timely manner, on a cost-effective basis, on acceptable terms or at all. We have limited institutional knowledge and experience with respect to these business development activities, and we may also not realize the anticipated benefits of any such transaction or arrangement. In particular, these collaborations may not result in the development of products that achieve commercial success or result in significant revenues and could be terminated prior to developing any products.
Additionally, we may not be in a position to exercise sole decision making authority regarding the transaction or arrangement, which could create the potential risk of creating impasses on decisions, and our future collaborators may have economic or business interests or goals that are, or that may become, inconsistent with our business interests or goals. It is possible that conflicts may arise with our collaborators, such as conflicts concerning the achievement of performance milestones, or the interpretation of significant terms under any agreement, such as those related to financial obligations or the ownership or control of intellectual property developed during the collaboration. If any conflicts arise with any future collaborators, they may act in their self-interest, which may be adverse to our best interest, and they may breach their obligations to us. In addition, we may have limited control over the amount and timing of resources that any future collaborators devote to our or their future products. Disputes between us and our collaborators may result in litigation or arbitration which would increase our expenses and divert the attention of our management. Further, these transactions and arrangements will be contractual in nature and will generally be terminable under the terms of the applicable agreements and, in such event, we may not continue to have rights to the products relating to such transaction or arrangement or may need to purchase such rights at a premium.
If we enter into in-bound intellectual property license agreements, we may not be able to fully protect the licensed intellectual property rights or maintain those licenses. Future licensors could retain the right to prosecute and defend the intellectual property rights licensed to us, in which case we would depend on the ability of our licensors to obtain, maintain and enforce intellectual property protection for the licensed intellectual property. These licensors may determine not to pursue litigation against other companies or may pursue such litigation less aggressively than we would. Further, entering into such license agreements could impose various diligence, commercialization, royalty or other obligations on us. Future licensors may allege that we have breached our license agreement with them, and accordingly seek to terminate our license, which could adversely affect our competitive business position and harm our business prospects.
We may seek to grow our business through acquisitions of complementary products or technologies, and the failure to manage acquisitions, or the failure to integrate them with our existing business, could harm our business, financial condition and operating results.
From time to time, we may consider opportunities to acquire other companies, products or technologies that may enhance our product platform or technology, expand the breadth of our markets or customer base, or advance our business strategies. Potential acquisitions involve numerous risks, including:
●problems assimilating the acquired products or technologies;
●issues maintaining uniform standards, procedures, controls and policies;
●unanticipated costs associated with acquisitions;
●diversion of management’s attention from our existing business;
●risks associated with entering new markets in which we have limited or no experience;
●increased legal and accounting costs relating to the acquisitions or compliance with regulatory matters; and
●unanticipated or undisclosed liabilities of any target.
We have no current commitments with respect to any acquisition. We do not know if we will be able to identify acquisitions we deem suitable, whether we will be able to successfully complete any such acquisitions on favorable terms or at all, or whether we will be able to successfully integrate any acquired products or technologies. Our potential inability to integrate any acquired products or technologies effectively may adversely affect our business, operating results and financial condition.
Our future success depends on our ability to retain key executives and to attract, retain and motivate qualified personnel.
We are highly dependent on the management, research and development, clinical, financial and business development expertise of our officers and advisory board members. Although we have an employment agreement with David Rosa, he (and each of our other key employees) may terminate his employment with us at any time and will continue to be able to do so. We do not maintain “key person” insurance for any of our executives or employees.
Recruiting and retaining qualified scientific and clinical personnel will also be critical to our success. The loss of the services of our executive officers or other key employees could impede the achievement of our research, development and commercialization objectives and seriously harm our ability to successfully implement our business strategy. Furthermore, replacing executive officers and key employees may be difficult and may take an extended period of time because of the limited number of individuals in our industry with the breadth of skills and experience required to successfully develop, gain regulatory approval of and commercialize our products. Competition to hire from this limited pool is intense, and we may be unable to hire, train, retain or motivate these key personnel on acceptable terms given the competition among numerous medical device companies for similar personnel, many of which have greater financial and other resources dedicated to attracting and retaining personnel. We also experience competition for the hiring of scientific and clinical personnel from universities and research institutions. In addition, we rely on consultants and advisors, including scientific and clinical advisors, to assist us in formulating our research and development and commercialization strategy. Our consultants and advisors may be employed by employers other than us and may have commitments under consulting or advisory contracts with other entities that may limit their availability to us. If we are unable to continue to attract and retain high quality personnel, our ability to pursue our growth strategy will be limited.
Prolonged negative economic conditions could adversely affect us, our customers and third-party partners, manufactures or suppliers, if any, which could harm our financial condition.
We are subject to the risks arising from adverse changes in general economic and market conditions. Uncertainty about future economic conditions could negatively impact our existing and potential customers, adversely affect the financial ability of health insurers to pay claims, adversely impact our expenses and ability to obtain financing of our operations, and cause delays or other problems with key suppliers.
Healthcare spending in Europe and the United States has been, and is expected to continue to be, under significant pressure and there are many initiatives to reduce healthcare costs. As a result, we believe that some insurers are scrutinizing insurance claims more rigorously and delaying or denying coverage and reimbursement more often. Because the sale, if approved, of our cortical strip, grid electrode and depth electrode technology under development will generally depend on the availability of third-party coverage and reimbursement, any delay or decline in coverage and reimbursement will adversely affect our sales.
Risks Related to our Intellectual Property
Our ability to protect our intellectual property and proprietary technology is uncertain.
We rely primarily on patent, trademark and trade secret laws, as well as confidentiality and non-disclosure agreements, to protect our proprietary technologies. Our patent estate consists of three issued United States patents licensed from WARF relating to a neural probe array and thin-film micro electrode array and method, and two pending U.S. patent applications filed by us and published October 11, 2018 relating to a wide variety of concepts, ranging from accessories for brain surgery to ablation and stimulation concepts for both cortical and depth electrodes. The licensed issued patents expire between 2025 and 2030, subject to any patent extensions that may be available for such patents. If a patent is issued on our pending patent application, the resulting patent is projected to expire in 2038. We continue to review new technological developments in order to make decisions about what additional filings would be the most appropriate for us. We also plan to seek patent protection for our proprietary technology in select countries internationally. We also have one pending U.S. trademark application and one pending foreign trademark application, as well as one foreign trademark registration. We have applied for patent protection relating to certain existing and proposed products and processes. Currently, several of our issued U.S. patents licensed from WARF as well as our pending U.S. patent application relate to our cortical and depth electrode technologies and are therefore important to the functionality of our products. If we fail to timely file a patent application in any jurisdiction, we may be precluded from doing so at a later date. Furthermore, we cannot assure you that any patent application will be approved in a timely manner or at all. The rights granted to us under our patents, and the rights we are seeking to have granted in our pending patent applications, may not be meaningful or provide us with any commercial advantage. In addition, those rights could be opposed, contested or circumvented by our competitors, or be declared invalid or unenforceable in judicial or administrative proceedings. The failure of our patents to adequately protect our technology might make it easier for our competitors to offer the same or similar products or technologies. Even if we are successful in receiving patent protection for certain products and processes, our competitors may be able to design around our patents or develop products that provide outcomes which are comparable to ours without infringing on our intellectual property rights. Due to differences between foreign and U.S. patent laws, our patented intellectual property rights may not receive the same degree of protection in foreign countries as they would in the United States. Even if patents are granted outside the United States, effective enforcement in those countries may not be available.
We rely on our trademarks and trade names to distinguish our products from the products of our competitors, and have registered or applied to register many of these trademarks. For example, we have one pending application in the United States for the “NeuroOne” trademark. We cannot assure you that our trademark applications will be approved in a timely manner or at all. Third parties also may oppose our trademark applications, or otherwise challenge our use of the trademarks. In the event that our trademarks are successfully challenged, we could be forced to rebrand our products, which could result in loss of brand recognition, and could require us to devote additional resources to marketing new brands. Further, we cannot assure you that competitors will not infringe upon our trademarks, or that we will have adequate resources to enforce our trademarks.
We also rely on trade secrets, know-how and technology, which are not protectable by patents, to maintain our competitive position. We try to protect this information by entering into confidentiality agreements and intellectual property assignment agreements with our officers, employees, temporary employees and consultants regarding our intellectual property and proprietary technology. In the event of unauthorized use or disclosure or other breaches of those agreements, we may not be provided with meaningful protection for our trade secrets or other proprietary information. In addition, our trade secrets may otherwise become known or be independently discovered by competitors. To the extent that our commercial partners, collaborators, employees and consultants use intellectual property owned by others in their work for us, disputes may arise as to the rights in the related or resulting know-how and inventions. If any of our trade secrets, know-how or other technologies not protected by a patent were to be disclosed to or independently developed by a competitor, our business, financial condition and results of operations could be materially adversely affected.
If a competitor infringes upon one of our patents, trademarks or other intellectual property rights, enforcing those patents, trademarks and other rights may be difficult and time-consuming. Patent law relating to the scope of claims in the industry in which we operate is subject to rapid change and constant evolution and, consequently, patent positions in our industry can be uncertain. Even if successful, litigation to defend our patents and trademarks against challenges or to enforce our intellectual property rights could be expensive and time consuming and could divert management’s attention from managing our business. Moreover, we may not have sufficient resources or desire to defend our patents or trademarks against challenges or to enforce our intellectual property rights. Litigation also puts our patents at risk of being invalidated or interpreted narrowly and our patent applications at risk of not issuing. Additionally, we may provoke third-parties to assert claims against us. We may not prevail in any lawsuits that we initiate and the damages or other remedies awarded, if any, may not be commercially valuable. The occurrence of any of these events may harm our business, financial condition and operating results.
We may not be able to establish or strengthen our brand.
We believe that establishing and strengthening our brand is critical to achieving widespread acceptance of our cortical strip, grid electrode and depth electrode technology. Promoting and positioning our brand will depend largely on the success of our marketing efforts and our ability to provide physicians with a reliable product for successful treatment of brain-related disorders. Additionally, we believe the quality and reliability of our product is critical to building physician support in the United States, and any negative publicity regarding the quality or reliability of our cortical strip, grid electrode and depth electrode technology could significantly damage our reputation in the market. Further, given the established nature of our competitors, it is likely that our future marketing efforts will require us to incur significant additional expenses. These brand promotion activities may not yield increased sales and, even if they do, any sales increases may not offset the expenses we incur to promote our brand. If we fail to successfully promote and maintain our brand, or if we incur substantial expenses in an unsuccessful attempt to promote and maintain our brand, our cortical strip, grid electrode and depth electrode technology may not be accepted by physicians, which would adversely affect our business, results of operations and financial condition.
The medical device industry is characterized by patent litigation, and we could become subject to litigation that could be costly, result in the diversion of management’s time and efforts, stop our development and commercialization measures or require us to pay damages.
Our success will depend in part on not infringing the patents or violating the other proprietary rights of third-parties. Significant litigation regarding patent rights exists in our industry. Our competitors in both the United States and abroad, many of which have substantially greater resources and have made substantial investments in competing technologies, may have applied for or obtained or may in the future apply for and obtain, patents that will prevent, limit or otherwise interfere with our ability to make and sell our products. The large number of patents, the rapid rate of new patent issuances, and the complexities of the technology involved increase the risk of patent litigation.
In the future, we could receive communications from various industry participants alleging our infringement of their intellectual property rights. Any potential intellectual property litigation could force us to do one or more of the following:
●stop selling our products or using technology that contains the allegedly infringing intellectual property;
●incur significant legal expenses;
●pay substantial damages to the party whose intellectual property rights we are allegedly infringing;
●redesign those products that contain the allegedly infringing intellectual property; or
●attempt to obtain a license to the relevant intellectual property from third-parties, which may not be available on reasonable terms or at all, and if available, may be non-exclusive, thereby giving our competitors access to the same technology.
Patent litigation can involve complex factual and legal questions, and its outcome is uncertain. Any litigation or claim against us, even those without merit, may cause us to incur substantial costs, and could place a significant strain on our financial resources, divert the attention of management from our core business and harm our reputation. Further, as the number of participants in the neurostimulation market increases, the possibility of intellectual property infringement claims against us increases.
We may be subject to damages resulting from claims that we, or our employees, have wrongfully used or disclosed alleged trade secrets of our competitors or are in breach of non-competition or non-solicitation agreements with our competitors.
Some of our current or future employees may have previously been employed at other medical device companies, including those that are our direct competitors or could potentially be our direct competitors. We may be subject to claims that we, or our employees, have inadvertently or otherwise used or disclosed trade secrets or other proprietary information of these former employers or competitors. In addition, we may in the future be subject to allegations that we caused an employee to breach the terms of his or her non-competition or non-solicitation agreement. Litigation may be necessary to defend against these claims.
In May 2017, NeuroOne, Inc. received a letter from PMT, the former employer of Mark Christianson and Wade Fredrickson. PMT claimed that these officers had breached their restrictive covenant obligations with PMT by virtue of their work for NeuroOne, Inc. and such officer’s prior work during employment with the prior employer, that these officers had breached their confidentiality and non-disclosure obligations to PMT and federal and state law by misappropriating confidential and trade secret information, and that the Company is responsible for tortious interference with the contracts. The letter demanded that Mr. Fredrickson (who resigned from the Company in June 2017), Mr. Christianson and NeuroOne, Inc. cease and desist all competitive activities, that Mr. Fredrickson step down from his position and that Mr. Christianson and NeuroOne, Inc. provide the former employer access to NeuroOne, Inc.’s systems to demonstrate that it is not using trade secrets or proprietary information nor competing with the former employer.
On March 29, 2018, we were served with a complaint filed by PMT adding the Company, NeuroOne, Inc. and Mr. Christianson to its existing lawsuit against Mr. Fredrickson. In the lawsuit, PMT claims that Mr. Fredrickson and Mr. Christianson breached their non-competition, non-solicitation and non-disclosure obligations, breached their fiduciary duty obligations, were unjustly enriched, engaged in unfair competition, engaged in a civil conspiracy, tortiously interfered with PMT’s contracts and prospective economic advantage, and breached a covenant of good faith and fair dealing. Against Mr. Fredrickson, PMT also alleges that he intentionally or negligently spoliated evidence, made negligent or fraudulent misrepresentations, misappropriated trade secrets in violation of Minnesota law, and committed the tort of conversion and statutory civil theft. Against the Company and NeuroOne, Inc., PMT alleges that the Company and NeuroOne, Inc. were unjustly enriched and engaged in unfair competition. PMT asks the Court to impose a constructive trust over the shares held by Mr. Fredrickson and Mr. Christianson and to award compensatory damages, equitable relief, punitive damages, attorneys’ fees, costs and interest. The Company, NeuroOne, Inc. and Mr. Christianson (who has not worked for PMT since 2012) intend to defend themselves vigorously. Furthermore, Mr. Christianson is a key officer and the loss of him would be detrimental to our operations and prospects.
On April 18, 2018, Mr. Christianson, the Company and NeuroOne, Inc. filed a motion for dismissal, which was heard by the Court on October 11, 2018. The motion for dismissal states that: the contract claims against Mr. Christianson fail because his agreement was not supported by consideration; the Minnesota Uniform Trade Secrets Act preempts plaintiff’s claims for unfair competition, civil conspiracy and unjust enrichment; plaintiff fails to state a claim regarding alleged breach of the duties of loyalty and good faith/fair dealing; plaintiff cannot legally obtain a constructive trust; plaintiff has insufficiently pled its tortious interference claims; and Plaintiff has not stated a claim for unfair competition. On January 7, 2019, the judge granted the motion for dismissal with respect to PMT’s claim for breach of the duty of good faith and fair dealing, and denied the motion for dismissal with respect to the other claims presented. Discovery is now virtually complete. On June 28, 2019, the Company presented to the special master evidence of what it believed to reflect significant litigation misconduct by PMT relating to a manufactured non-compete agreement for Wade Fredrickson that it had attempted to pass off as a business record of PMT. Based on the evidence presented, the special master ruled that PMT had waived the attorney client privilege with respect to certain communications with respect to the Fredrickson non-compete with both its former and current litigation counsel and authorized a deposition of the former litigation counsel concerning these communications. On August 30, 2019 the Hennepin County District Court heard dispositive motions in this case. The district court judge indicated some claims would likely be tried to a jury and encouraged the parties to settle.
On September 12, 2019 the district court heard NeuroOne’s motion for sanctions. The district court has set the sanctions hearing for December 17, 2019 and December 18, 2019, and indicated any remaining claims would be tried in May 2020. NeuroOne and Mark Christianson (who has not worked for PMT since February 2012) intend to continue to defend themselves vigorously.
Even if we successfully defend against these claims, litigation could cause us to incur substantial costs, and could place a significant strain on our financial resources, divert the attention of management from our core business and harm our reputation. If our defense to those claims fails, in addition to paying monetary damages, we may lose valuable intellectual property rights or personnel. There can be no assurance that this type of litigation will not occur, and any future litigation or the threat thereof may adversely affect our ability to hire additional employees. A loss of key personnel or their work product could hamper or prevent our ability to develop or commercialize our cortical strip, grid electrode and depth electrode technology or future versions thereof, which could have an adverse effect on our business, financial condition and operating results.
We are subject to the patent laws of countries other than the United States, which may not offer the same level of patent protection and whose rules could seriously affect how we draft, file, prosecute and maintain patents, trademarks and patent and trademark applications.
Many countries, including certain countries in Europe, have compulsory licensing laws under which a patent owner may be compelled to grant licenses to third parties (for example, the patent owner has failed to “work” the invention in that country, or the third party has patented improvements). In addition, many countries limit the enforceability of patents against government agencies or government contractors. In these countries, the patent owner may have limited remedies, which could materially diminish the value of the patent. Moreover, the legal systems of certain countries, particularly certain developing countries, do not favor the aggressive enforcement of patent and other intellectual property protection which makes it difficult to stop infringement.
We cannot be certain that the patent or trademark offices of countries outside the United States will not implement new rules that increase costs for drafting, filing, prosecuting and maintaining patents, trademarks and patent and trademark applications or that any such new rules will not restrict our ability to file for patent protection. For example, we may elect not to seek patent protection in some jurisdictions in order to save costs. We may be forced to abandon or return the rights to specific patents due to a lack of financial resources.
Intellectual property rights do not necessarily address all potential threats to our competitive advantage.
The degree of future protection afforded by our intellectual property rights is uncertain because intellectual property rights have limitations, and may not adequately protect our business, or permit us to maintain our competitive advantage. The following examples are illustrative:
●others may be able to make devices that are the same as or similar to our cortical strip, grid electrode and depth electrode technology but that are not covered by the claims of the patents that we own;
●we or any collaborators might not have been the first to make the inventions covered by the issued patents or pending patent applications that we own;
●we might not have been the first to file patent applications covering certain of our inventions;
●others may independently develop similar or alternative technologies or duplicate any of our technologies without infringing our intellectual property rights;
●it is possible that our pending patent applications will not lead to issued patents;
●issued patents that we own may not provide us with any competitive advantages, or may be held invalid or unenforceable as a result of legal challenges;
●we might enforce our patent rights or defend a challenge to our issued patents or pending application, putting the patents and patent applications at risk of being invalidated or interpreted narrowly;
●our competitors might conduct research and development activities in the United States and other countries that provide a safe harbor from patent infringement claims for certain research and development activities, as well as in countries where we do not have patent rights, and then use the information learned from such activities to develop competitive products for sale in our major commercial markets; and
●we may not develop additional proprietary technologies that are patentable.
Risks Related to our Legal and Regulatory Environment
Our products and operations are subject to extensive governmental regulation, and failure to comply with applicable requirements could cause our business to suffer.
The medical device industry is regulated extensively by governmental authorities, principally the FDA and corresponding state regulatory agencies in the United States and the European Commission and corresponding Notified Body in the European Union and the EEA. The regulations are very complex and are subject to rapid change and varying interpretations. Regulatory restrictions or changes could limit our ability to carry on or expand our operations or result in higher than anticipated costs or lower than anticipated sales. These governmental authorities enforce laws and regulations that are meant to assure product safety and effectiveness, including the regulation of, among other things:
●product design and development;
●pre-clinical studies and clinical trials;
●product safety;
●establishment registration and product listing;
●labeling, content and language of instructions for use and storage;
●marketing, manufacturing, sales and distribution;
●pre-market clearance or approval;
●servicing and post-market surveillance;
●record-keeping procedures;
●product import and export;
●advertising and promotion; and
●recalls and field safety corrective actions.
The regulations to which we are subject are complex and have tended to become more stringent over time. Regulatory changes could result in restrictions on our ability to carry on or expand our operations, higher than anticipated costs or lower than anticipated revenues.
Failure to comply with applicable regulations could jeopardize our ability to sell our products and result in enforcement actions such as fines, civil penalties, injunctions, warning letters, recalls of products, delays in the introduction of products into the market, refusal of the regulatory agency or other regulators to grant future clearances or approvals, and the suspension or withdrawal of existing approvals by such regulatory agencies. Any of these sanctions could result in higher than anticipated costs or lower than anticipated sales and harm our reputation, business, financial condition and operating results.
The FDA regulatory clearance process is expensive, time-consuming and uncertain, and the failure to obtain and maintain required regulatory clearances and approvals could prevent us from commercializing our cortical strip, grid electrode and depth electrode technology under development and future versions thereof.
Our products and operations are subject to extensive and rigorous regulation by the FDA under the FDCA and its implementing regulations, guidance, and standards. The FDA regulates the research, testing, manufacturing, safety, labeling, storage, recordkeeping, promotion, distribution, and production of medical devices in the United States to ensure that medical products distributed domestically are safe and effective for their intended uses. The FDA also regulates the export of medical devices manufactured in the United States to international markets. Any violations of these laws and regulations could result in a material adverse effect on our business, financial condition and results of operations. In addition, if there is a change in law, regulation or judicial interpretation, we may be required to change our business practices, which could have a material adverse effect on our business, financial condition and results of operations.
Under the FDCA, medical devices are classified into one of three classes-Class I, Class II or Class III-depending on the degree of risk associated with each medical device and the extent of control needed to ensure safety and effectiveness.
Class I devices are those for which safety and effectiveness can be assured by adherence to FDA’s “general controls” for medical devices, which include compliance with the applicable portions of the QSR facility registration and product listing, reporting of adverse medical events, and appropriate, truthful and non-misleading labeling, advertising, and promotional materials. Some Class I devices also require premarket clearance by the FDA through the 510(k) premarket notification process described below.
Class II devices are subject to FDA’s general controls, and any other “special controls” deemed necessary by FDA to ensure the safety and effectiveness of the device. Premarket review and clearance by the FDA for Class II devices is accomplished through the 510(k) premarket notification procedure, though certain Class II devices are exempt from this premarket review process. When a 510(k) is required, the manufacturer must submit to the FDA a premarket notification submission demonstrating that the device is “substantially equivalent” to a legally marketed device, which in some cases may require submission of clinical data. A legally marketed device is defined by statute to mean a device that was legally marketed prior to May 28, 1976, the date upon which the Medical Device Amendments of 1976 were enacted, or another commercially available, similar device that was cleared through the 510(k) process. Unless a specific exemption applies, 510(k) premarket notification submissions are subject to user fees. If the FDA determines that the device, or its intended use, is not substantially equivalent to a legally marketed device, the FDA will place the device, or the particular use of the device, into Class III, and the device sponsor must then fulfill much more rigorous premarketing requirements in the form of a premarket approval, or PMA.
A Class III device includes devices deemed by the FDA to pose the greatest risk such as life-supporting or life-sustaining devices, or implantable devices, in addition to a device that has a new intended use or utilizes advanced technology that is not substantially equivalent to that of a legally marketed device. The safety and effectiveness of Class III devices cannot be assured solely by general and special controls. These devices almost always require formal clinical studies to demonstrate safety and effectiveness. Submission and FDA approval of a PMA application is required before marketing of a Class III device can proceed.
We believe our cortical strip, grid electrode and depth electrode technology under development will be a Class II medical device. The FDA has not made any determination about whether our specific technology is a Class II medical device. While such a determination is not necessary in order for us to list a device with the FDA and bring that device to the U.S. market, we may decide to get clarification from the FDA prior to introducing a product into the market. From time to time, the FDA may disagree with the classification and require us to apply for approval as a Class III medical device. In the event that the FDA determines that our technology should be classified as Class III, we could be precluded from marketing the devices for clinical use within the United States for months, years or longer, depending on the specific change in the classification. Reclassification of our technology as Class III could significantly increase our regulatory costs, including the timing and expense associated with required clinical trials and other costs.
If the FDA requires us to go through more costly, lengthy and uncertain PMA process for our cortical strip, grid electrode and depth electrode technology, future products or modifications to existing products than we had expected, we may be less likely to receive approval for our cortical strip, grid electrode and depth electrode technology or such approval may take longer and be more costly.
The FDA can delay, limit or deny clearance or approval of a device for many reasons, including:
●we may not be able to demonstrate that our products are safe and effective for their intended users;
●the data from our clinical trials may be insufficient to support clearance or approval; and
●the manufacturing process or facilities we use may not meet applicable requirements.
When FDA approval of a device requires human clinical trials, and if the device presents a “significant risk” to human health, the device sponsor is required to file an investigational device exemption, or IDE, application with the FDA and obtain IDE approval prior to commencing the human clinical trial. If the device is considered a “non-significant risk,” IDE submission to FDA is not required. Instead, only approval from the Institutional Review Board, or IRB, overseeing the investigation at each clinical trial site is required. Human clinical studies are generally required in connection with approval of Class III devices and may be required for Class I and II devices. The FDA or the IRB at each institution at which a clinical trial is being performed may suspend a clinical trial at any time for various reasons, including a belief that the subjects are being exposed to an unacceptable health risk. We believe that we will need to complete human clinical trials and submit an application for an IDE in order to seek approval to use of our cortical strip, grid electrode and depth electrode technology for stimulation and ablation but not for diagnostic purposes. Because any IDE, if required, must be cleared by the FDA prior to the start of a clinical investigation, this requirement may delay our product development or clinical trial efforts. Any delay in, or failure to receive or maintain, clearance or approval for our products under development could prevent us from generating revenue from these products or achieving profitability.
In addition, the FDA may change its clearance and approval policies, adopt additional regulations or revise existing regulations, or take other actions which may prevent or delay approval or clearance of our products under development or impact our ability to modify our currently cleared or approved products on a timely basis.
After the FDA permits a device to enter commercial distribution, numerous regulatory requirements apply. These include: compliance with the QSR, which requires manufacturers to follow elaborate design, testing, control, documentation and other quality assurance procedures during the manufacturing process; labeling regulations; the FDA’s general prohibition against promoting products for unapproved or “off-label” uses; the reports of Corrections and Removals regulation, which requires manufacturers to report recalls and field actions to the FDA if initiated to reduce a risk of health posed by the device or to remedy a violation of the FDCA; and the Medical Device Reporting regulation, which requires that manufacturers report to the FDA if their device may have caused or contributed to a death or serious injury or malfunctioned in a way that would likely cause or contribute to a death or serious injury if it were to reoccur. Manufacturers are also required to register and list their devices with the FDA, based on which the FDA will conduct inspections to ensure continued compliance with applicable regulatory requirements.
The FDA has broad post-market and regulatory and enforcement powers. Failure to comply with the applicable U.S. medical device regulatory requirements could result in, among other things, warning letters; fines; injunctions; consent decrees; civil penalties; repairs, replacements or refunds; recalls, corrections or seizures of products; total or partial suspension of production; the FDA’s refusal to grant future premarket clearances or approvals; withdrawals or suspensions of current product applications; and criminal prosecution. Regulatory enforcement or inquiries, or other increased scrutiny on us, could dissuade some people with brain related disorders from using our products and adversely affect our reputation and the perceived accuracy and safety of our products. If any of these events were to occur, they could have a material adverse effect on our business, financial condition and results of operations.
International sales are subject to regulatory requirements in the countries in which our products are sold. The regulatory review process varies from country to country and may in some cases require the submission of clinical data. In addition, the FDA must be notified of, or approve the export to certain countries of devices that require a PMA, and are not yet approved in the United States.
A recall of our products, or the discovery of serious safety issues with our products, could have a significant negative impact on us.
The FDA has the authority to require the recall of commercialized products in the event of material deficiencies or defects in design or manufacture or in the event that a product poses an unacceptable risk to health. Our third-party suppliers may, under their own initiative, recall a product if any material deficiency in a device is found. A government-mandated or voluntary recall by us or one of our third-party distributors, if any, could occur as a result of an unacceptable risk to health, component failures, manufacturing errors, design or labeling defects or other deficiencies and issues. Recalls of any of our products would divert managerial and financial resources and have an adverse effect on our reputation, financial condition and operating results, which could impair our ability to produce our products in a cost-effective and timely manner.
Further, under the FDA’s medical device reporting regulations, we are required to report to the FDA any incident in which our product may have caused or contributed to a death or serious injury or in which our product malfunctioned and, if the malfunction were to recur, would likely cause or contribute to death or serious injury. Repeated product malfunctions may result in a voluntary or involuntary product recall, which could divert managerial and financial resources, impair our ability to manufacture our products in a cost-effective and timely manner and have an adverse effect on our reputation, financial condition and operating results.
Any adverse event involving our products could result in future voluntary corrective actions, such as recalls or customer notifications, or regulatory agency action, which could include inspection, mandatory recall or other enforcement action. Any corrective action, whether voluntary or involuntary, will require the dedication of our time and capital, distract management from operating our business and may harm our reputation and financial results.
We will be subject to the FCPA, the U.K. Bribery Act and other anti-corruption and anti-money-laundering laws, as well as export control laws, customs laws, sanctions laws and other laws governing our future global operations. If we fail to comply with these laws, we could be subject to civil or criminal penalties, other remedial measures and legal expenses, which could adversely affect our business, results of operations and financial condition.
Our future global operations will expose us to trade and economic sanctions and other restrictions imposed by the United States, the European Union and other governments and organizations. The U.S. Departments of Justice, Commerce, State and Treasury and other federal agencies and authorities have a broad range of civil and criminal penalties they may seek to impose against corporations and individuals for violations of economic sanctions laws, export control laws, the FCPA, and other federal statutes and regulations, including those established by the Office of Foreign Assets Control, or OFAC. In addition, the U.K. Bribery Act of 2010, or the Bribery Act, prohibits both domestic and international bribery, as well as bribery across both private and public sectors. An organization that “fails to prevent bribery” by anyone associated with the organization can be charged under the Bribery Act unless the organization can establish the defense of having implemented “adequate procedures” to prevent bribery. Under these laws and regulations, as well as other anti-corruption laws, anti-money-laundering laws, export control laws, customs laws, sanctions laws and other laws governing our operations, various government agencies may require export licenses, may seek to impose modifications to business practices, including cessation of business activities in sanctioned countries or with sanctioned persons or entities and modifications to compliance programs, which may increase compliance costs, and may subject us to fines, penalties and other sanctions. A violation of these laws or regulations could adversely impact our business, results of operations and financial condition.
We will implement and maintain policies and procedures designed to ensure compliance by us, and our directors, officers, employees, representatives, third-party distributors, if any, consultants and agents with the FCPA, OFAC restrictions, the Bribery Act and other export control, anticorruption, anti-money-laundering and anti-terrorism laws and regulations. We cannot assure you, however, that our policies and procedures will be sufficient or that directors, officers, employees, representatives, third-party distributors, if any, consultants and agents have not engaged and will not engage in conduct for which we may be held responsible, nor can we assure you that our business partners have not engaged and will not engage in conduct that could materially affect their ability to perform their contractual obligations to us or even result in our being held liable for such conduct. Violations of the FCPA, OFAC restrictions, the Bribery Act or other export control, anti-corruption, anti-money-laundering and anti-terrorism laws or regulations may result in severe criminal or civil sanctions, and we may be subject to other liabilities, which could have a material adverse effect on our business, financial condition, cash flows and results of operations.
We are subject to additional federal, state and foreign laws and regulations relating to our healthcare business; our failure to comply with those laws could have an adverse impact on our business.
Although we will not provide healthcare services, submit claims for third-party reimbursement, or receive payments directly from government health insurance programs or other third-party payors for our cortical strip, grid electrode and depth electrode technology, we are subject to healthcare fraud and abuse regulation and enforcement by federal, state and foreign governments, which could adversely impact our business. Healthcare fraud and abuse and health information privacy and security laws potentially applicable to our operations include, but are not limited to:
●the Anti-Kickback Statute, which will apply to our marketing practices, educational programs, pricing policies and relationships with healthcare providers, by prohibiting, among other things, soliciting, receiving, offering or providing remuneration intended to induce the purchase or recommendation of an item or service reimbursable under a federal healthcare program, such as the Medicare or Medicaid programs. A person or entity does not need to have actual knowledge of this statute or specific intent to violate it to have committed a violation;
●federal civil and criminal false claims laws and civil monetary penalty laws, including civil whistleblower or qui tam actions that prohibit, among other things, knowingly presenting, or causing to be presented, claims for payment or approval to the federal government that are false or fraudulent, knowingly making a false statement material to an obligation to pay or transmit money or property to the federal government or knowingly concealing or knowingly and improperly avoiding or decreasing an obligation to pay or transmit money or property to the federal government. The government may assert that a claim including items or services resulting from a violation of the Anti-Kickback Statute constitutes a false or fraudulent claim for purposes of the false claims statutes;
●HIPAA, and its implementing regulations, which created federal criminal laws that prohibit, among other things, executing a scheme to defraud any healthcare benefit program or making false statements relating to healthcare matters. A person or entity does not need to have actual knowledge of these statutes or specific intent to violate them;
●HIPAA, as amended by the Health Information Technology for Economic and Clinical Health Act of 2009, and their implementing regulations, also imposes certain regulatory and contractual requirements regarding the privacy, security and transmission of individually identifiable health information;
●federal “sunshine” requirements imposed by the ACA on device manufacturers regarding any “transfer of value” made or distributed to physicians and teaching hospitals. Failure to submit required information may result in civil monetary penalties of up to an aggregate of $150,000 per year (or up to an aggregate of $1 million per year for “knowing failures”), for all payments, transfers of value or ownership or investment interests that are not timely, accurately, and completely reported in an annual submission. Manufacturers must submit reports by the 90th day of each subsequent calendar year;
●federal consumer protection and unfair competition laws, which broadly regulate marketplace activities and activities that potentially harm consumers;
●state law equivalents of each of the above federal laws, such as anti-kickback and false claims laws that may apply to items or services reimbursed by any third-party payor, including commercial insurers; state laws that require device companies to comply with the industry’s voluntary compliance guidelines and the relevant compliance guidance promulgated by the federal government or otherwise restrict payments that may be made to healthcare providers; state laws that require device manufacturers to report information related to payments and other transfers of value to physicians and other healthcare providers or marketing expenditures; and state laws governing the privacy and security of certain health information, many of which differ from each other in significant ways and often are not preempted by HIPAA; and
●foreign data privacy regulations, such as the EU Data Protection Directive (Directive 95/46/EC), and the country-specific regulations that implement Directive 95/46/EC, which impose strict obligations and restrictions on the ability to collect, analyze and transfer personal data, including health data from clinical trials and adverse event reporting, and may be stricter than U.S. laws.
The risk of our being found in violation of these laws and regulations is increased by the fact that the scope and enforcement of these laws is uncertain, many of them have not been fully interpreted by the regulatory authorities or the courts, their provisions are open to a variety of interpretations, or they vary country by country. We are unable to predict what additional federal, state or foreign legislation or regulatory initiatives may be enacted in the future regarding our business or the healthcare industry in general, or what effect such legislation or regulations may have on us. Federal, state or foreign governments may (i) impose additional restrictions or adopt interpretations of existing laws that could have a material adverse effect on us or (ii) challenge our current or future activities under these laws. Any of these challenges could impact our reputation, business, financial condition and operating results.
If our operations are found to be in violation of any of the laws described above or any other governmental regulations that apply to us now or in the future, we may be subject to penalties, including civil and criminal penalties, damages, fines, disgorgement of profits, exclusion from governmental health care programs, and the curtailment or restructuring of our operations, any of which could adversely affect our ability to operate our business and our financial results. Any federal, state or foreign regulatory review to which we may become subject, regardless of the outcome, would be costly and time-consuming.
For example, to enforce compliance with the federal laws, the U.S. Department of Justice, or DOJ, has recently increased its scrutiny of interactions between healthcare companies and healthcare providers, which has led to a number of investigations, prosecutions, convictions and settlements in the healthcare industry. Dealing with investigations can be time and resource consuming and can divert management’s attention from our core business. Additionally, if we settle an investigation with law enforcement or other regulatory agencies, we may be forced to agree to additional onerous compliance and reporting requirements as part of a consent decree or corporate integrity agreement. Any such investigation or settlement could increase our costs or otherwise have an adverse effect on our business.
We may be liable if the FDA or another regulatory agency concludes that we have engaged in the off-label promotion of our products.
Our promotional materials and training methods must comply with FDA and other applicable laws and regulations, including the prohibition of the promotion of the off-label use of our products. Healthcare providers may use our products, if approved, off-label, as the FDA does not restrict or regulate a physician’s choice of treatment within the practice of medicine. However, if the FDA determines that our promotional materials or training constitute promotion of an off-label use, it could request that we modify our training or promotional materials or subject us to regulatory or enforcement actions, including the issuance of an untitled letter, a warning letter, injunction, seizure, civil fine and criminal penalties. It is also possible that other federal, state or foreign enforcement authorities might take action if they consider our promotional or training materials to constitute promotion of an unapproved use, which could result in significant fines or penalties. Although we intend to train our marketing and direct sales force to not promote our products for uses outside of their cleared uses and our policy will be to refrain from statements that could be considered off-label promotion of our products, the FDA or another regulatory agency could disagree and conclude that we have engaged in off-label promotion. In addition, the off-label use of our products may increase the risk of product liability claims. Product liability claims are expensive to defend and could result in substantial damage awards against us and harm our reputation.
Further, if we seek commercial approval in Europe, the advertising and promotion of our products is subject to the laws of EEA Member States implementing Directive 93/42/EEC concerning medical devices, Directive 2006/114/EC concerning misleading and comparative advertising, and Directive 2005/29/EC on unfair commercial practices, as well as other EEA Member State legislation governing the advertising and promotion of medical devices. A new Medical Device Regulation (2017/745) that replaced Directive 93/42/EEC was published in 2017, with a three year implementation period, which will impose significant additional premarket and post-market certification requirements on medical devices marketed in the EU. EEA Member State legislation may also restrict or impose limitations on our ability to advertise our products directly to the general public. In addition, voluntary EU and national codes of conduct provide guidelines on the advertising and promotion of our products to the general public and may impose limitations on our promotional activities with healthcare providers harming our business, operating results and financial condition.
Legislative or regulatory healthcare reforms may make it more difficult and costly for us to obtain regulatory clearance or approval of our products.
Recent political, economic and regulatory influences are subjecting the healthcare industry to fundamental changes. The sales of our products depend in part on the availability of coverage and reimbursement from third-party payors such as government health administration authorities, private health insurers, health maintenance organizations and other healthcare-related organizations. Both the federal and state governments in the United States continue to propose and pass new legislation and regulations designed to contain or reduce the cost of healthcare. This legislation and regulation may result in decreased reimbursement for medical devices, which may further exacerbate industry-wide pressure to reduce the prices charged for medical devices. This could harm our ability to market our products and generate sales.
In addition, FDA regulations and guidance are often revised or reinterpreted by the FDA in ways that may significantly affect our business and our products. Any new regulations or revisions or reinterpretations of existing regulations may impose additional costs or lengthen review times of our products. Delays in receipt of or failure to receive regulatory clearances or approvals for our products would harm our business, financial condition and operating results.
While one often stated goal of healthcare reform is to expand coverage to more individuals, it also involves increased government price controls, additional regulatory mandates and other measures designed to constrain medical costs. For example, the ACA was enacted in March 2010. The ACA substantially changes the way healthcare is financed by both governmental and private insurers, encourages improvements in the quality of healthcare items and services and significantly impacts the medical device industries. Among other things, the ACA:
●establishes a new Patient-Centered Outcomes Research Institute to oversee, identify priorities in and conduct comparative clinical effectiveness research; and
●implements payment system reforms including value-based payment programs, increased funding for comparative effectiveness research, reduced hospital payments for avoidable readmissions and hospital acquired conditions, and pilot programs to evaluate alternative payment methodologies that promote care coordination (such as bundled physician and hospital payments).
At this time, we cannot predict which, if any, additional healthcare reform proposals will be adopted, when they may be adopted or what impact they, or the ACA, may have on our business and operations, and any of these impacts may be adverse on our operating results and financial condition. Our financial performance may be adversely affected by medical device tax provisions in the healthcare reform laws.
The ACA imposes, among other things, an annual excise tax of 2.3% on any entity that manufactures or imports medical devices offered for sale in the United States beginning in 2013. Due to subsequent legislative amendments, the excise tax has been suspended from January 1, 2016 to December 31, 2019, and, absent further legislative action, will be reinstated starting January 1, 2020. We do not believe that our cortical strip, grid electrode and depth electrode technology under development is currently subject to this tax based on the retail exemption under applicable Treasury Regulations. However, the availability of this exemption is subject to interpretation by the Internal Revenue Service, or IRS, and the IRS may disagree with our analysis. In addition, future products that we manufacture, produce or import may be subject to this tax. The financial impact this tax may have on our business is unclear and there can be no assurance that our business will not be materially adversely affected by it.
Tax matters, including the changes in corporate tax rates, disagreements with taxing authorities and imposition of new taxes could impact our results of operations and financial condition.
We are subject to income and other taxes in the U.S. and our operations, plans and results are affected by tax and other initiatives. On December 22, 2017, the Tax Act was signed into law by President Trump. The Tax Act contains significant changes to corporate taxation, including reduction of the corporate tax rate from a top marginal rate of 35% to a flat rate of 21%, limitation of the tax deduction for interest expense to 30% of earnings (except for certain small businesses), limitation of the deduction for net operating losses to 80% of current year taxable income and elimination of net operating loss carrybacks, one-time taxation of offshore earnings at reduced rates regardless of whether they are repatriated, elimination of U.S. tax on foreign earnings (subject to certain important exceptions), immediate deductions for certain new investments instead of deductions for depreciation expense over time, and modifying or repealing many business deductions and credits. Notwithstanding the reduction in the corporate income tax rate, guidance on tax reform continues to be released and such guidance may adversely affect our business and financial condition. While the new federal tax law did not extend the moratorium on the medical device excise tax, the reinstatement of which could negatively impact our operating results as we begin full commercialization of our platforms in the United States, the moratorium was subsequently extended until 2020. It is also unknown if and to what extent various states will conform to the newly enacted federal tax law. The impact of this tax reform on holders of our Common Stock is likewise uncertain and could be adverse. We urge you to consult with your legal and tax advisors with respect to this legislation and the potential tax consequences of investing in our Common Stock. The decrease in the corporate tax rate resulted in changes in the valuation of our deferred tax assets and liabilities.
We are also subject to regular reviews, examinations, and audits by the Internal Revenue Service and other taxing authorities with respect to our taxes. Although we believe our tax estimates are reasonable, if a taxing authority disagrees with the positions we have taken, we could face additional tax liability, including interest and penalties. There can be no assurance that payment of such additional amounts upon final adjudication of any disputes will not have a material impact on our results of operations and financial position.
We also need to comply with new, evolving or revised tax laws and regulations. The enactment of or increases in tariffs, or other changes in the application or interpretation of the Tax Act, or on specific products that we sell or with which our products compete, may have an adverse effect on our business or on our results of operations.
Inadequate funding for the FDA, the SEC and other government agencies could hinder their ability to hire and retain key leadership and other personnel, prevent new products and services from being developed or commercialized in a timely manner or otherwise prevent those agencies from performing normal business functions on which the operation of our business may rely, which could negatively impact our business.
The ability of the FDA to review and approve new products can be affected by a variety of factors, including government budget and funding levels, ability to hire and retain key personnel and accept the payment of user fees, and statutory, regulatory, and policy changes. Average review times at the agency have fluctuated in recent years as a result. Disruptions at the FDA and other agencies may also slow the time necessary for new drugs, devices and treatments to be reviewed and/or approved by necessary government agencies, which would adversely affect our business.
In addition, government funding of the SEC and other government agencies on which our operations may rely, is subject to the political process, which is inherently fluid and unpredictable. For example, over the last several years, including beginning on December 22, 2018, the U.S. government has shut down several times and certain regulatory agencies, such as the FDA and the SEC, have had to furlough critical FDA, SEC and other government employees and stop critical activities. If a prolonged government shutdown occurs, it could significantly impact the ability of the FDA to timely review and process our regulatory submissions, which could have a material adverse effect on our business. Further, upon completion of this offering and in our operations as a public company, future government shutdowns could impact our ability to access the public markets and obtain necessary capital in order to properly capitalize and continue our operations.
Risks Related to our Common Stock
An active and visible public trading market for our Common Stock may not develop.
We do not currently have an active or visible trading market. We cannot predict whether an active market for our Common Stock will ever develop in the future. In the absence of an active trading market:
●Investors may have difficulty buying and selling or obtaining market quotations;
●Trading of our Common Stock may be extremely sporadic;
●Market visibility for shares of our Common Stock may be limited; and
●A lack of visibility for shares of our Common Stock may have a depressive effect on the market price for shares of our Common Stock.
Our Common Stock is quoted over-the-counter on a market operated by OTC Markets Group, Inc. These markets are relatively unorganized, inter-dealer, over-the-counter markets that provide significantly less liquidity than Nasdaq or the NYSE MKT. No assurances can be given that our Common Stock, even if quoted on such markets, will ever actively trade on such markets, much less a senior market like Nasdaq or NYSE MKT. In this event, there would be a highly illiquid market for our Common Stock and you may be unable to dispose of your Common Stock at desirable prices or at all. Moreover, there is a risk that our Common Stock could be delisted from its current tier of the OTC Market, in which case our stock may be quoted on markets even more illiquid.
The price of our Common Stock might fluctuate significantly, and you could lose all or part of your investment.
Volatility in the market price of our Common Stock may prevent you from being able to sell your shares of our Common Stock at or above the price you paid for your shares. The trading price of our Common Stock may be volatile and subject to wide price fluctuations in response to various factors, including:
●actual or anticipated fluctuations in our quarterly financial and operating results;
●our progress toward developing our cortical strip and sheet electrode technology;
●the commencement, enrollment and results of our future clinical trials;
●adverse results from, delays in or termination of our clinical trials;
●adverse regulatory decisions, including failure to receive regulatory approval;
●publication of research reports about us or our industry or positive or negative recommendations or withdrawal of research coverage by securities analysts, if any;
●perceptions about the market acceptance of our products and the recognition of our brand;
●adverse publicity about our products or industry in general;
●overall performance of the equity markets;
●introduction of products, or announcements of significant contracts, licenses or acquisitions, by us or our competitors;
●legislative, political or regulatory developments;
●additions or departures of key personnel;
●threatened or actual litigation and government investigations;
●third-party promotional activities, which are subject to ongoing regulatory obligations;
●sale of shares of our Common Stock by us or members of our management; and
●general economic conditions.
These and other factors might cause the market price of our Common Stock to fluctuate substantially, which may negatively affect the liquidity of our Common Stock. In addition, in recent years, the stock market has experienced significant price and volume fluctuations. This volatility has had a significant impact on the market price of securities issued by many companies across many industries. The changes frequently appear to occur without regard to the operating performance of the affected companies. Accordingly, the price of our Common Stock could fluctuate based upon factors that have little or nothing to do with our Company, and these fluctuations could materially reduce our share price.
Securities class action litigation has often been instituted against companies following periods of volatility in the overall market and in the market price of a company’s securities. This litigation, if instituted against us, could result in substantial costs, divert our management’s attention and resources, and harm our business, operating results and financial condition.
Concentration of ownership of our Common Stock among our existing executive officers, directors and principal stockholders may prevent new investors from influencing significant corporate decisions.
As of September 30, 2019, our executive officers, directors and current beneficial owners of 5% or more of our Common Stock and their respective affiliates, in the aggregate, beneficially own approximately 44.3% of our outstanding Common Stock. As a result, these persons, acting together, would be able to significantly influence all matters requiring stockholder approval, including the election and removal of directors, any merger, consolidation, sale of all or substantially all of our assets, or other significant corporate transactions.
Some of these persons or entities may have interests different than yours. For example, they may be more interested in selling our Company to an acquirer than other investors, or they may want us to pursue strategies that deviate from the interests of other stockholders.
As of September 30, 2018, our management identified certain internal control deficiencies, which management believed constituted material weaknesses. These material weaknesses were remediated as of September 30, 2019; however, any failure to maintain an effective system of internal controls could result in material misstatements of our financial statements or cause us to fail to meet our reporting obligations or fail to prevent fraud in which case, our stockholders could lose confidence in our financial reporting, which would harm our business and could negatively impact the price of our stock.
We are required to comply with the internal control evaluation and certification requirements of Section 404 of the Sarbanes-Oxley Act of 2002 (“SOX”) and management is required to report annually on our internal control over financial reporting. Our independent registered public accounting firm will not be required to formally attest to the effectiveness of our internal control over financial reporting pursuant to Section 404 of SOX until the date we have a public float of $75 million or greater.
During the audits for the period ended September 30, 2018, we determined that our internal control over financial reporting was not effective due to material weaknesses relating to: (i) accounting for non-routine and complex debt and equity transactions, (ii) the financial statement close and reporting process, (iii) accounting for routine transactions, and (iv) segregation of duties. Management determined that we have remediated these material weaknesses as of September 30, 2019.
However, if we fail to maintain effective internal controls and procedures for financial reporting, it could result in material misstatements in the annual or interim financial statements that would not be prevented or detected in a timely manner. We cannot assure you that material weaknesses or significant deficiencies will not occur in the future and that we will be able to remediate such weaknesses or deficiencies in a timely manner, which could impair our ability to accurately and timely report our financial position, results of operations or cash flows.
We intend to issue more shares to raise capital, which will result in substantial dilution.
Our certificate of incorporation authorizes the issuance of a maximum of 100,000,000 shares of Common Stock and 10,000,000 shares of preferred stock. Any additional financings effected by us may result in the issuance of additional securities without stockholder approval and the substantial dilution in the percentage of Common Stock held by our then existing stockholders. Moreover, the Common Stock issued in any such transaction may be valued on an arbitrary or non-arm’s-length basis by our management, resulting in an additional reduction in the percentage of Common Stock held by our current stockholders. Our Board has the power to issue any or all of such authorized but unissued shares without stockholder approval. To the extent that additional shares of Common Stock are issued in connection with a financing, dilution to the interests of our stockholders will occur and the rights of the holder of Common Stock might be materially and adversely affected.
As of September 30, 2019, we had outstanding warrants to purchase an aggregate of 7,265,598 shares of Common Stock at a weighted average exercise price of $2.55 per share, and options to purchase an aggregate of 845,840 shares of Common Stock at a weighted average exercise price of $1.82 per share. For a description of our outstanding warrants and information about the number of shares of Common Stock for which they are exercisable, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations-Liquidity and Capital Resources-Historical Capital Resources.” To the extent these outstanding options or warrants are exercised, there will be further dilution to holders of our Common Stock.
Anti-takeover provisions in the Company’s certificate of incorporation and bylaws may prevent or frustrate attempts by stockholders to change the Board or current management and could make a third-party acquisition of the Company difficult.
The Company’s certificate of incorporation and bylaws contain provisions that may discourage, delay or prevent a merger, acquisition or other change in control that stockholders may consider favorable, including transactions in which stockholders might otherwise receive a premium for their shares. For example, our certificate of incorporation permits the Board without stockholder approval to issue up to 10,000,000 shares of preferred stock and to fix the designation, power, preferences, and rights of those shares. Furthermore, our Board has the ability to increase the size of the Board and fill the newly created vacancies without stockholder approval. These provisions could limit the price that investors might be willing to pay in the future for shares of the Common Stock.
We are a smaller reporting company, and the reduced reporting requirements applicable to smaller reporting companies may make our Common Stock less attractive to investors.
We are a “smaller reporting company” as defined in Section 12 of the Exchange Act. For as long as we continue to be a smaller reporting company, we may take advantage of exemptions from various reporting requirements that are applicable to other public companies that are not smaller reporting companies such as, reduced disclosure obligations regarding executive compensation in our annual and periodic reports and proxy statements, and exemptions from the requirements of holding nonbinding advisory votes on executive compensation, and stockholder approval of any golden parachute payments not previously approved. We will remain a “smaller reporting company” as long as (i) our public float remains less than $250 million or (ii) our annual revenues are less than $100 million and we either have no public float, or our public float is less than $700 million. Public float is measured as of the last business day of our most recently-completed second fiscal quarter, and annual revenues are as of the most recently completed fiscal year for which audited financial statements are available. We cannot predict if investors will find our Common Stock less attractive because we may rely on these exemptions. If some investors find our Common Stock less attractive as a result, there may be a less active trading market for our Common Stock and our stock price may be more volatile.
Our Common Stock is subject to the “penny stock” rules of the SEC, which makes transactions in our stock cumbersome and may reduce the value of an investment in our stock.
The SEC has adopted regulations which generally define a “penny stock” as an equity security that has a market price of less than $5.00 per share, subject to specific exemptions. The SEC’s penny stock rules require a broker-dealer, before a transaction in a penny stock not otherwise exempt from the rules, to deliver a standardized risk disclosure document that provides information about penny stocks and the risks in the penny stock market. The broker-dealer must also provide the customer with current bid and offer quotations for the penny stock, the compensation of the broker-dealer and the salesperson in the transaction, and monthly account statements showing the market value of each penny stock held in the customer’s account. In addition, the penny stock rules generally require that before a transaction in a penny stock occurs, the broker-dealer must make a special written determination that the penny stock is a suitable investment for the purchaser and receive the purchaser’s agreement to the transaction. These rules may restrict the ability of brokers-dealers to sell our Common Stock and may affect the ability of investors to sell their shares, until our Common Stock no longer is considered a penny stock.
The market for penny stocks has experienced numerous frauds and abuses, which could adversely impact investors in our stock.
OTC Market securities are frequent targets of fraud or market manipulation, both because of their generally low prices and because reporting requirements are less stringent than those of the stock exchanges such as Nasdaq and The New York Stock Exchange. Patterns of fraud and abuse include:
●Control of the market for the security by one or a few broker-dealers that are often related to the promoter or issuer;
●Manipulation of prices through prearranged matching of purchases and sales and false and misleading press releases;
●“Boiler room” practices involving high pressure sales tactics and unrealistic price projections by inexperienced sales persons;
●Excessive and undisclosed bid-ask differentials and markups by selling broker-dealers; and
●Wholesale dumping of the same securities by promoters and broker-dealers after prices have been manipulated to a desired level, along with the inevitable collapse of those prices with consequent investor losses.
We have not paid dividends in the past and do not expect to pay dividends in the future, and any return on investment may be limited to the value of our stock.
We have never declared or paid cash dividends on our capital stock. We currently intend to retain all available funds and any future earnings for use in the operation and expansion of our business and do not anticipate paying any cash dividends in the foreseeable future. Accordingly, you may have to sell some or all of your shares of our Common Stock in order to generate cash flow from your investment. You may not receive a gain on your investment when you sell shares and you may lose the entire amount of the investment.
We expect to incur increased costs and demands upon management as a result of being a public company.
As a public company in the United States, we expect to incur significant additional legal, accounting and other costs. These additional costs could negatively affect our financial results. In addition, changing laws, regulations and standards relating to corporate governance and public disclosure, including regulations implemented by the SEC and the stock exchange on which we may list our Common Stock, may increase legal and financial compliance costs and make some activities more time-consuming. These laws, regulations and standards are subject to varying interpretations and, as a result, their application in practice may evolve over time as new guidance is provided by regulatory and governing bodies. We intend to invest resources to comply with evolving laws, regulations and standards, and this investment may result in increased general and administrative expenses and a diversion of management’s time and attention from revenue-generating activities to compliance activities. If, notwithstanding our efforts to comply with new laws, regulations and standards, we fail to comply, regulatory authorities may initiate legal proceedings against us and our business may be harmed.
Failure to comply with these rules might also make it more difficult for us to obtain some types of insurance, including director and officer liability insurance, and we might be forced to accept reduced policy limits and coverage or incur substantially higher costs to obtain the same or similar coverage. The impact of these events could also make it more difficult for us to attract and retain qualified persons to serve on our Board, on committees of our Board or as members of senior management.
If securities or industry analysts do not publish research or reports, or publish unfavorable research or reports, about us, our business or our market, our stock price and trading volume could decline.
The trading market for our Common Stock will be influenced by the research and reports that securities or industry analysts publish about us and our business. Securities or industry analysts may elect not to provide coverage of our Common Stock, and such lack of coverage may adversely affect the market price of our Common Stock. In the event we do not secure additional securities or industry analyst coverage, we will not have any control over the analysts or the content and opinions included in their reports. The price of our stock could decline if one or more securities or industry analysts downgrade our stock or issue other unfavorable commentary or research. If one or more securities or industry analysts ceases coverage of our Company or fails to publish reports on us regularly, demand for our stock could decrease, which in turn could cause our stock price or trading volume to decline.
Risks Related to the Acquisition
We may be subject to unknown risks as a result of our completed acquisition by Original Source Entertainment, Inc.
Original Source Entertainment, Inc., which was renamed NeuroOne Medical Technologies Corporation in connection with the Acquisition, was formed to license songs to the television and movie industry and has generated very little revenues. Prior to the Acquisition, its operations have been primarily limited to organizational, start-up, and capital formation activities, with no employees other than the former officers. On February 5, 2014, the board of directors of Original Source Entertainment, Inc. authorized the spin-off of Original Source Music, Inc., a wholly-owned subsidiary which then held all of our operations and assets, to our stockholders of record as of February 25, 2014. Under the terms of the spin-off, the common stock, par value $0.001 per share, of Original Source Music, Inc. was distributed on a pro-rata basis to each holder of our common stock on the February 25, 2014 record date without any consideration or action on the part of such holders, and the holders of our common stock as of the February 25, 2014 record date became owners of 100% of the common stock of Original Source Music, Inc. The spin-off of Original Source Music, Inc. was effective as of May 13, 2016, due to the satisfactory resolution of all comments from the SEC to the Registration Statement on Form 10 of Original Source Music, Inc. and the Form 10’s effectiveness. Therefore, upon the spinoff of Original Source Music, which held all of our operations and assets at the time, on May 13, 2016, Original Source Entertainment, Inc. ceased having a specific business plan and purpose.
In connection with the Acquisition, the liabilities existing in Original Source Entertainment, Inc. at the time of the Acquisition were cancelled or paid by a related party, as required by the Merger Agreement with NeuroOne, Inc. and OSOK Acquisition Company (the “Merger Agreement”). Despite this requirement and the representations and warranties of Original Source Entertainment, Inc. in the Merger Agreement, there may be unknown liabilities, or liabilities that were known but believed to be immaterial, related to the business of Original Source Entertainment, Inc. that may become material liabilities we are subject to in the future. If we are subject to material liabilities as a result of the conduct of Original Source Entertainment, Inc., we may have limited recourse for such liabilities, which could have a material impact on our business and stock price.
Because we were engaged in a transaction that can be generally characterized as a “reverse merger,” we may not be able to attract the attention of major brokerage firms.
Additional risks may exist since we were engaged in a transaction that can be generally characterized as a “reverse merger.” Securities analysts of major brokerage firms may not provide coverage of the Company since there is little incentive to brokerage firms to recommend the purchase of the Common Stock. No assurance can be given that brokerage firms will want to conduct any secondary offerings.
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS
Not applicable.
ITEM 2.
ITEM 2. PROPERTIES
We currently lease office space in Eden Prairie, Minnesota.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
From time to time, we are subject to litigation and claims arising in the ordinary course of business. In May 2017, NeuroOne, Inc. received a letter from PMT, the former employer of Mark Christianson and Wade Fredrickson. PMT claimed that these officers had breached their restrictive covenant obligations with PMT by virtue of their work for NeuroOne, Inc. and such officer’s prior work during employment with the prior employer, that these officers had breached their confidentiality and non-disclosure obligations to PMT and federal and state law by misappropriating confidential and trade secret information, and that the Company is responsible for tortious interference with the contracts. The letter demanded that Mr. Fredrickson (who resigned from the Company in June 2017), Mr. Christianson and NeuroOne, Inc. cease and desist all competitive activities, that Mr. Fredrickson step down from his position and that Mr. Christianson and NeuroOne, Inc. provide the former employer access to NeuroOne, Inc.’s systems to demonstrate that it is not using trade secrets or proprietary information nor competing with the former employer.
On March 29, 2018, we were served with a complaint filed by PMT adding the Company, NeuroOne, Inc. and Mark Christianson to its existing lawsuit against Wade Fredrickson. In the lawsuit, PMT claims that Mr. Fredrickson and Mr. Christianson breached their non-competition, non-solicitation and non-disclosure obligations, breached their fiduciary duty obligations, were unjustly enriched, engaged in unfair competition, engaged in a civil conspiracy, tortiously interfered with PMT’s contracts and prospective economic advantage, and breached a covenant of good faith and fair dealing. Against Mr. Fredrickson, PMT also alleges that he intentionally or negligently spoliated evidence, made negligent or fraudulent misrepresentations, misappropriated trade secrets in violation of Minnesota law, and committed the tort of conversion and statutory civil theft. Against the Company and NeuroOne, Inc., PMT alleges that the Company and NeuroOne, Inc. were unjustly enriched and engaged in unfair competition. PMT asks the Fourth Judicial District Court of the State of Minnesota (the “Court”) to impose a constructive trust over the shares held by Mr. Fredrickson and Mr. Christianson and to award compensatory damages, equitable relief, punitive damages, attorneys’ fees, costs and interest.
On April 18, 2018, Mr. Christianson, the Company and NeuroOne, Inc. filed a motion for dismissal, which was heard by the Court on October 11, 2018. The motion for dismissal states that: the contract claims against Mr. Christianson fail because his agreement was not supported by consideration; the Minnesota Uniform Trade Secrets Act preempts plaintiff’s claims for unfair competition, civil conspiracy and unjust enrichment; plaintiff fails to state a claim regarding alleged breach of the duties of loyalty and good faith/fair dealing; plaintiff cannot legally obtain a constructive trust; plaintiff has insufficiently pled its tortious interference claims; and Plaintiff has not stated a claim for unfair competition. On January 7, 2019, the judge granted the motion for dismissal with respect to PMT’s claim for breach of the duty of good faith and fair dealing, and denied the motion for dismissal with respect to the other claims presented.
In April 2019 PMT served the Company, NeuroOne, Inc and Christianson with a proposed Second Amended Complaint which included new claims against the Company and NeuroOne, Inc for tortious interference with contract and tortious interference with prospective business advantage and punitive damages against the Company, NeuroOne Inc. and Christianson. On June 28, 2019 the Company presented evidence indicating that PMT had participated in a fraud on the Court, and sought an Order that PMT had waived the attorney client privilege. On August 30, 2019 the Hennepin County District Court heard dispositive motions in this case. The district court judge indicated some claims would likely be tried to a jury and encouraged the parties to settle.
On September 12, 2019 the district court heard NeuroOne’s motion for sanctions. The district court has set the sanctions hearing for December 17, 2019 and December 18, 2019, and indicated any remaining claims would be tried in May 2020. NeuroOne and Mark Christianson (who has not worked for PMT since February 2012) intend to continue to defend themselves vigorously.
ITEM 4.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Price Range of Common Stock
Our Common Stock is not traded on any exchange. Our Common Stock has been quoted on the OTC Market (“OTCQB”) administered by the Financial Industry Regulatory Authority under the symbol “NMTC” since December 19, 2017. Prior to that date, our Common Stock had been quoted on the OTC Pink Sheets since November 2012, under the symbol “NMTC” since August 4, 2017 and under the symbol “OSOK” prior to that time. Trading in stocks quoted on the OTCQB is often thin and is characterized by wide fluctuations in trading prices due to many factors that may be unrelated or have little to do with a company’s operations or business prospects. We cannot assure you that there will be a market for our Common Stock in the future.
The following table presents the range of high and low closing bid information for our common equity for each full quarterly period the three most recent fiscal years, as quoted by the OTC.
Stockholders
On November 30, 2019, there were 146 record holders of our Common Stock. The transfer agent and registrar for our Common Stock is Action Stock Transfer Corporation.
Shares Available Under the Plan
The following table presents information as of September 30, 2019 with respect to compensation plans under which shares of our Common Stock may be issued.
(1)The number of shares of Common Stock reserved for issuance under our 2017 Equity Incentive Plan automatically increases on January 1st of each calendar year, starting on January 1, 2018 through January 1, 2027, to an amount equal to 13% of the total number of fully-diluted shares of our Common Stock as of December 31 of the preceding calendar year, or a lesser number of shares determined by our Board.
(2)Consists of 1,078,663 shares remaining available for issuance under the 2017 Equity Incentive Plan and 411,096 shares remaining available for issuance under the 2016 Equity Incentive Plan. Upon the closing of the Acquisition, we no longer granted awards under the 2016 Equity Incentive Plan, and all awards are granted under the 2017 Equity Incentive Plan.
Recent Sales of Unregistered Equity Securities
All sales of unregistered equity securities have previously been disclosed in our Quarterly Reports on Form 10-Q or Current Reports on Form 8-K.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
Not applicable.
ITEM 7.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
You should read the following discussion and analysis of financial condition and results of operations of NeuroOne Medical Technologies Corporation together with our financial statements and the related notes included elsewhere in this Report. Some of the information contained in this discussion and analysis or set forth elsewhere in this Report, including information with respect to our plans and strategy for our business, includes forward-looking statements that involve risks and uncertainties. You should review the “Risk Factors” section of this Report for a discussion of important factors that could cause actual results to differ materially from the results described in or implied by the forward-looking statements contained in the following discussion and analysis. References in this discussion to “series” or “notes” refer to all of our outstanding notes as of the relevant date of the item being discussed. References in this discussion to “convertible promissory notes” refer to all of our outstanding convertible promissory notes as of the relevant date of the item being discussed.
Change in Fiscal Year
In September 2018, the Board of Directors of the Company, pursuant to the bylaws and based upon the recommendation of its Audit Committee, approved a change in the Company’s fiscal year end from December 31 to September 30. The Company’s fiscal year now begins on October 1 and ends on September 30 of each year. As a result of the change, we reported our financial results for the transition period ended September 30, 2018 on our Transition Report on Form 10-KT filed with the SEC on December 12, 2018, and we are reporting our results for the first full fiscal year ended September 30, 2019 in this Annual Report.
In this Management’s Discussion and Analysis of Financial Condition and Results of Operations, or MD&A, when financial results for the fiscal year ended September 30, 2019 are compared to financial results for the prior year period, the results compare the twelve-month period ended September 30, 2019 to the results for the twelve-month period ended September 30, 2018, which were filed as Exhibit 99.1 to our Transition Report on Form 10-KT.
Overview
To date, our primary activities have been limited to, and our limited resources have been dedicated to, performing business and financial planning, raising capital, recruiting personnel, negotiating with business partners and the licensors of our intellectual property and conducting research and development activities. Our cortical strip, grid electrode and depth electrode technology is still under development, we do not yet have regulatory approval in any jurisdiction to sell any commercial products and we have not generated any revenue from commercial sales.
We have incurred losses since inception. As of September 30, 2019, we had an accumulated deficit of $17.2 million, primarily as a result of expenses incurred in connection with our research and development programs, from general and administrative expenses associated with our operations and interest expense, fair value adjustments and loss on extinguishments related to our debt. We expect to continue to incur significant expenses and increasing operating and net losses for the foreseeable future.
Our main source of cash to date has been proceeds from the issuances of notes, common stock, warrants and unsecured loans. See “-Liquidity and Capital Resources-Historical Capital Resources” below.
At September 30, 2019, we had $0.3 million in cash deposits. Our existing cash and cash equivalents will not be sufficient to fund our operating expenses. We need to obtain substantial additional funding in connection with our continuing operations through public or private equity or debt financings or other sources, which may include collaborations with third parties. However, we may be unable to raise additional funds when needed on favorable terms or at all. Our failure to raise such capital as and when needed would have a negative impact on our financial condition and our ability to develop and commercialize our cortical strip, grid electrode and depth electrode technology and future products and our ability to pursue our business strategy. See “-Liquidity and Capital Resources-Funding Requirements and Outlook” below.
Financial Overview
Revenue
To date, we have not generated any revenue. We do not expect to generate revenue unless or until we develop, obtain regulatory approval for and commercialize our cortical strip, grid electrode and depth electrode technology. If we fail to complete the development of our cortical strip, grid electrode and depth electrode technology, or any other product candidate we may pursue in the future, in a timely manner, or fail to obtain regulatory approval, we may never be able to generate any revenue.
General and Administrative
General and administrative expenses consist primarily of personnel-related costs including stock-based compensation for personnel in functions not directly associated with research and development activities. Other significant costs include legal fees relating to corporate matters, intellectual property costs, professional fees for consultants assisting with regulatory, clinical, product development, financial matters and product costs not directly related to research and development. We anticipate that our general and administrative expenses will significantly increase in the future to support our continued research and development activities, potential commercialization of our cortical strip, grid electrode and depth electrode technology, if approved, and the increased costs of operating as a public company. These increases will include increased costs related to the hiring of additional personnel and fees for legal and professional services, as well as other public-company related costs.
Research and Development
Research and development expenses consist of expenses incurred in performing research and development activities in developing our cortical strip, grid electrode and depth electrode technology. Research and development expenses include compensation and benefits for research and development employees including stock-based compensation, overhead expenses, cost of laboratory supplies, clinical trial and related clinical manufacturing expenses, costs related to regulatory operations, fees paid to consultants and other outside expenses. Research and development costs are expensed as incurred and costs incurred by third parties are expensed as the contracted work is performed. Lastly, de minimis income from the sale of prototype products and related materials are offset against research and development expenses.
We expect our research and development expenses to significantly increase over the next several years as we develop our cortical strip, grid electrode and depth electrode technology and conduct preclinical testing and clinical trials and will depend on the duration, costs and timing to complete our preclinical programs and clinical trials.
Interest Expense
Interest expense primarily consists of amortized discount costs and interest costs related to our Series 1 Notes (as defined below), Series 2 Notes (as defined below) and Series 3 Notes (as defined below) prior to their respective conversions. The Series 1 Notes, Series 2 Notes and Series 3 Notes accrued interest at a fixed rate of 8% per annum while outstanding.
Net change in fair value for the warrant liability and premium conversion derivatives
The net change in fair value for the warrant liability and premium conversion derivatives include the change in the fair value of warrant liability and the premium conversion derivatives during the particular period while the warrant liability and the premium conversion derivatives were outstanding.
Loss on note extinguishments, net
Loss on note extinguishments, net includes the gain or loss associated with debt instrument modifications accounted for as note extinguishments.
Results of Operations
Comparison of the Fiscal Year Ended September 30, 2019 and 2018
The following table sets forth our results of operations for the fiscal years ended September 30, 2019 and 2018.
General and administrative expenses
General and administrative expenses were $4.3 million for the year ended September 30, 2019, compared to $3.2 million for the year ended September 30, 2018. The increase was primarily due to payroll costs associated with new employee hires related to the business development function and due to an increase in legal costs, accounting expenses and board of director fees primarily related to increased public company related costs. These expense increases were offset in part by a decrease in stock-based compensation during the year ended September 30, 2019 when compared to the prior year period.
Research and development expenses
Research and development expenses were $1.5 million for the year ended September 30, 2019, compared to $1.0 million for the year ended September 30, 2018. The increase during fiscal 2019 over the comparable prior year period was attributed to an increase in supporting development activities, which primarily included salary-related expenses and other costs related to consulting services, materials and supplies. Lastly, a de minimis amount of offsetting income from the sale of prototype products and related materials to a medical institution was recorded during the year ended September 30, 2019 in the amount of $6,000. There was no offsetting income recorded against research and development expenses in the prior year.
Interest expense
Interest expense was $0.3 million for year ended September 30, 2019 compared to $1.1 million for the year ended September 30, 2018. The decrease was primarily due to conversion of the Series 1 Notes and Series 2 Notes in July 2018, and the conversion of the Series 3 Notes in February 2019, resulting in lower non-cash interest expense of $51,000 and amortization of debt discount costs of $0.2 million related to the Series 3 Notes during the year ended September 30, 2019 in comparison to interest expense of $0.2 million and amortization of debt issuance costs of $0.9 million related to the Series 1 Notes, Series 2 Notes and Series 3 Notes that were outstanding during the year ended September 30, 2018.
Net change in fair value for the warrant liability and premium conversion derivatives
The net change in fair value for the warrant liability and premium conversion derivatives for the year ended September 30, 2019 and 2018 was an expense of $0.1 million and a benefit of $(0.2) million, respectively. The change was due primarily to fluctuations in our common stock fair value and the number of potential shares of common stock issuable upon conversion of the underlying Series 1 Notes, Series 2 Notes and Series 3 Notes that were outstanding during the relevant period.
Loss on note extinguishments, net
Non-cash loss on note extinguishments, net for the year ended September 30, 2019 was $0.6 million as compared to $1.7 million during the year ended September 30, 2018, resulting in a decrease period over period stemming from the level of modifications to and conversions of the convertible promissory notes period over period.
During the year ended September 30, 2019, the Series 3 Notes were converted on February 28, 2019 and the conversion was accounted for as a note extinguishment given the bifurcated embedded premium debt conversion feature. During the year ended September 30, 2018, the Series 1 Notes and Series 2 Notes were amended in November 2017 and the Series 3 Notes were amended in December 2017. The amendment for the Series 1 Notes extended the maturity date by approximately eight months and revised certain warrant and other provisions. The amendment for the Series 2 Notes added additional warrant coverage and extended the maturity date by approximately five months. The amendment for the Series 3 Notes accelerated the maturity date from October 2022 to December 2018 and revised certain formulaic provisions contained in the underlying embedded conversion features. Lastly, the Series 2 Notes were amended again in March 2018 whereby new warrants and embedded conversion features were added. As a result of the modifications made to the Series 1 Notes, Series 2 Notes and Series 3 Notes as discussed in this paragraph, the amendments were accounted for as note extinguishments.
Liquidity and Capital Resources
Historical Capital Resources
As of September 30, 2019, our principal source of liquidity consisted of cash deposits of $0.3 million. We have not generated any revenue, and we anticipate that we will continue to incur losses for the foreseeable future. We anticipate that our expenses will increase substantially as we develop our cortical strip, grid electrode and depth electrode technology and pursue pre-clinical and clinical trials, seek regulatory approvals, contract to manufacture any products, establish our own sales, marketing and distribution infrastructure to commercialize our cortical strip, grid electrode and depth electrode technology under development, if approved, hire additional staff, add operational, financial and management systems and continue to operate as a public company.
Our source of cash to date has been proceeds from the issuances of notes with warrants, common stock with warrants and unsecured loans, the terms of which are further described below. See also “-Funding Requirements and Outlook” below.
Common Stock Offering:
On October 23, 2019, the Company entered into Securities Purchase Agreements with certain accredited investors, pursuant to which the Company, in a private placement, has issued and sold 141,666 shares of the Company’s common stock to the accredited investors at a price of $1.80 per share, for gross proceeds amounting to $0.3 million before deducting offering expenses.
In connection with the private placement, the Company has agreed to issue and sell to accredited investors up to a maximum of 555,555 shares for total gross proceeds to the Company of up to $1,000,000. The Company intends to use the net proceeds from this private placement for funding operations or working capital and general corporate purposes. The Company has agreed to file a registration statement with the SEC covering the resale of the shares of common stock sold in the private placement within 60 days of the termination of the private placement.
Paulson Convertible Notes Offering
On November 1, 2019, the Company entered into a subscription agreement with certain accredited investors, pursuant to which the Company, in a private placement, agreed to issue and sell to the investors 13% convertible promissory notes (each, a “Paulson Note” and collectively, the “Paulson Notes”) and warrants (each, a “Paulson Warrant” and collectively, the “Paulson Warrants”) to purchase shares of the Company’s common stock.
The initial closing of the private placement was consummated on November 1, 2019, and, on that date and through December 3, 2019, the Company issued Paulson Notes in an aggregate principal amount of $3,234,800 to the Subscribers for gross proceeds equaling the principal amount.
The Paulson Notes bear interest at a fixed rate of 13% per annum and require the Company to repay the principal and accrued and unpaid interest thereon on May 1, 2020. If the Company raises more than $3,000,000 in an equity financing before the Maturity Date (the “Qualified Financing”), each subscriber shall have the option to convert the outstanding principal and accrued and unpaid interest of such subscriber’s Paulson Note (the “Outstanding Balance”) into the securities issued by the Company in such Qualified Financing in an amount equal to (i) the Outstanding Balance divided by (ii) the lower of 0.6 multiplied by (A) the actual per share price of securities issued by the Company in the Qualified Financing and (B) the ten day volume weighted average closing price of the common stock prior to the first closing of a Qualified Financing. If a change of control transaction occurs prior to the earlier of a Qualified Financing or the maturity date, the Paulson Notes would become payable on demand as of the closing date of such transaction. Change of control means a merger or consolidation with another entity in which the Company’s stockholders do not own more than 50% of the outstanding voting power of the surviving entity or the disposition of all or substantially all of the Company’s assets.
Each Paulson Warrant grants the holder the option to purchase the number of shares of common stock equal to (i) 0.5 multiplied by (ii) the principal amount of such subscriber’s Paulson Notes divided by 1.87, with an exercise price per share equal to $1.87. As of the final closing on December 3, 2019, the Company issued Paulson Warrants exercisable for 864,913 shares of Common Stock in connection with all closings of the private placement. The Paulson Warrants are immediately exercisable and expire on November 1, 2022. The exercise price is subject to adjustment in the event of any stock dividends or splits, reverse stock split, recapitalization, reorganization or similar transaction, as described therein.
In connection with the private placement, Paulson Investment Company (“Paulson”) will receive a cash commission equal to 12% of the gross proceeds from the sale of the Paulson Notes, and 10-year warrants to purchase an amount of Common Stock equal to 15% of the total amount of shares of Common Stock into which the Paulson Notes are convertible, at an exercise price equal to the offering price of the Company’s securities in the next Qualified Financing.
Private Placement
On December 12, 2018, the Board of Directors of the Company terminated the 2018 Private Placement (as defined below). On December 28, 2018, the Company entered into Subscription Agreements (each, a “2019 Purchase Agreement”) with certain accredited investors (the “New Purchasers”), pursuant to which the Company, in a private placement (the “2019 Private Placement”), agreed to issue and sell to the New Purchasers units (each, a “Unit”), each consisting of (i) one share (each, a “Share”) of our Common Stock, and (ii) a warrant to purchase one share of Common Stock at an initial exercise price of $3.00 per share (the “2019 Warrants”). The initial closing of the 2019 Private Placement was consummated on December 28, 2018 (the “New First Closing”).
From December 28, 2018 through the termination of the 2019 Private Placement on July 1, 2019, the Company issued and sold an aggregate of 2,338,179 Units to the New Purchasers, for total gross proceeds to the Company of approximately $5.8 million before deducting offering expenses. In connection with the 2019 Private Placement, the Company had agreed to issue and sell to accredited investors up to a maximum of 4,000,000 Units (the “Maximum Offering”) at a price of $2.50 per Unit for total gross proceeds to the Company of up to $10,000,000. The Maximum Offering could have been increased by the Company in its sole discretion, without notice. Under the 2019 Purchase Agreement, the Company had agreed to use the net proceeds from the 2019 Private Placement to pay the outstanding principal and accrued interest on its convertible promissory notes if such notes do not convert prior to maturity, to pay the principal on its unsecured term loans, for research and development, clinical studies, legal fees and sales and marketing expenses, as well as working capital and general corporate purposes. The Company had granted the New Purchasers indemnification rights with respect to its representations, warranties and agreements under the 2019 Purchase Agreement.
In connection with the 2019 Private Placement, the Company entered into a Registration Rights Agreement with each of the New Purchasers, each dated as of the New Purchasers’ respective closing dates, pursuant to which the Company agreed to file a registration statement with the SEC covering the resale of the shares of Common Stock sold in the 2019 Private Placement and the shares of Common Stock issuable upon exercise of the 2019 Warrants. The Company filed the initial registration statement relating to the resale of the Units sold in the 2019 Private Placement on July 15, 2019 and it became effective on August 8, 2019.
The 2019 Warrants are exercisable beginning on the date of issuance and will expire on December 28, 2023, five years from the date of the New First Closing. Prior to expiration, subject to the terms and conditions set forth in the 2019 Warrants, the holders may exercise the 2019 Warrants for shares of Common Stock by providing notice to the Company and paying the $3.00 per share exercise price for each share so exercised.
In connection with the 2019 Private Placement, Paulson received a cash commission equal to 12% of the gross proceeds from the sale of Units sold by Paulson. In addition to the brokers’ commission, the Company issued 5-year warrants Paulson to purchase Common Stock equal to 10% of the total amount of Shares sold by Paulson in the 2019 Private Placement at an exercise price of $2.75 per share. On July 1, 2019, 193,417 broker warrants were issued to Paulson.
Also in connection with 2019 Private Placement, HRA Capital, an affiliate of one of our greater than 5% beneficial owners of our Common Stock, received a cash commission equal to 8% of the gross proceeds from the sale of Units sold by HRA. In addition, the Company issued 5-year warrants to HRA to purchase an amount of Common Stock equal to 8% of the Shares sold by HRA at an exercise price of $3.00 per share. On July 1, 2019, 17,760 broker warrants were issued to HRA. Lastly, in July 2019, we agreed to compensate HRA with additional 5-year warrants to purchase an amount of common stock equal to 135,512 shares at an exercise price of $2.00 per share for HRA’s ultimate participation in the 2019 Private Placement.
Private Placement
From July 9, 2018 through November 30, 2018 (the final closing), the Company entered into subscription agreements (each, a “Purchase Agreement”) with certain accredited investors (the “Purchasers”), pursuant to which the Company, in a private placement (the “2018 Private Placement”), agreed to issue and sell to the Purchasers Units, each consisting of (i) one Share, and (ii) a warrant to purchase one share of Common Stock at an initial exercise price of $3.00 per share (the “2018 Warrants”). The initial closing of the 2018 Private Placement was consummated on July 9, 2018 (the “First Closing”), and through the termination of the 2018 Private Placement, we issued and sold an aggregate of 615,200 Units to the Purchasers, for total gross proceeds to us of $1.5 million before deducting offering expenses.
Under the Purchase Agreement, the Company had agreed to use the net proceeds from the 2018 Private Placement to pay the outstanding principal and accrued interest on our Series 3 Notes if such notes did not convert prior to maturity, to pay the principal on its unsecured term loans, for research and development, clinical studies, legal fees and sales and marketing expenses, as well as working capital and general corporate purposes. The Company granted the Purchasers indemnification rights with respect to its representations, warranties and agreements under the Purchase Agreement.
In connection with the 2018 Private Placement, the Company entered into registration rights agreements with each of the Purchasers pursuant to which the Company agreed to file a registration statement with the SEC covering the resale of the shares of Common Stock sold in the 2018 Private Placement and the shares of Common Stock issuable upon exercise of the 2018 Warrants. The Company filed the registration statement relating to the resale of the Units sold in the 2018 Private Placement which became effective on February 28, 2019.
The 2018 Warrants are exercisable beginning on the date of issuance and will expire on July 9, 2023, five years from the date of the First Closing. Prior to expiration, subject to the terms and conditions set forth in the 2018 Warrants, the holders of such 2018 Warrants may exercise the 2018 Warrants for shares of Common Stock by providing notice to the Company and paying the exercise price per share for each share so exercised.
In connection with the 2018 Private Placement, the brokers received a cash commission equal to 8% of the eligible gross proceeds from the sale of the Units. In addition to the brokers’ commission, we issued 5-year warrants to the brokers to purchase an amount of Common Stock equal to 8% of the total amount of qualifying Shares sold in the 2018 Private Placement at an exercise price of $3.00 per share. On July 1, 2019, 36,096 broker warrants were issued.
Series 3 Notes and Warrants
From October 2017 to May 2018, the Company issued convertible notes (the “Series 3 Notes”) in an aggregate principal amount of $1.5 million that bear interest at a fixed rate of 8% per annum and warrants to purchase shares of the Company’s capital stock (the “Series 3 Warrants”). The Company initially entered into a subscription agreement with certain accredited investors and closed an initial private placement of the Series 3 Notes in October 2017. In December 2017 and December 2018, the Company and holders of a majority in aggregate principal amount of the Series 3 Notes entered into an amended and restated subscription agreement to amend the terms of the Series 3 Notes and Series 3 Warrants. The Series 3 Notes, as amended, required us to repay the principal and accrued and unpaid interest thereon at June 30, 2019.
On February 28, 2019, the outstanding principal and interest on the Series 3 Notes converted into 839,179 shares of common stock and 839,179 common stock purchase warrants with an exercise term of approximately 4.8 years and an exercise price of $3.00 per share in connection with the 2019 Private Placement. An equity round of financing resulting in more than $3 million in gross proceeds (a “Series 3 Qualified Financing”) triggered the conversion of the outstanding principal and accrued and unpaid interest on the Series 3 Notes into the securities issued by the Company in the Series 3 Qualified Financing equal to the outstanding principal and accrued interest on the Series 3 Notes divided by 80% of the price per share of the securities issued by us in the Series 3 Qualified Financing.
Each Series 3 Warrant grants the holder the option to purchase shares of our capital stock equal to the number of shares of capital stock of the Company received by the holder upon conversion of the Series 3 Notes at a per share exercise price equal to $2.50. The Series 3 Warrants are exercisable commencing on February 28, 2019 and have a five year term. The exercise price and number of the shares issuable upon exercising the Series 3 Warrants are subject to adjustment in the event of any stock dividends and splits, reverse stock split, recapitalization, reorganization, business combination or similar transaction, as described therein.
Series 2 Notes and Warrants
In August 2017, the Company entered into a subscription agreement and issued interest free promissory notes in an aggregate principal amount of $253,000 to certain accredited investors. In November 2017, the Company and each subscriber amended the notes to extend the maturity date from February 18, 2018 to July 31, 2018 and to increase warrant coverage. In March 2018, the Company and each subscriber entered into a written consent to again amend and restate the promissory notes (as amended, the “Series 2 Notes”) and to amend the subscription agreement to replace the form of warrant agreement annexed to the subscription agreement (the “Replacement Warrant”) and to provide for the issuance of an additional warrant (the “Additional Warrant”). In March 2018, the Company issued and delivered the Series 2 Notes, the Replacement Warrants and the Additional Warrants to the subscribers. Effective as of July 2, 2018, the Company amended the Series 2 Notes by entering into debt conversion agreements with each subscriber to (i) convert the outstanding principal and accrued and unpaid interest under the Series 2 Notes into shares of Common Stock based on the Outstanding Balance divided by $1.80 per share (the “Series 2 Conversion Shares”); (ii) cancel and extinguish the Series 2 Notes; and (iii) amend and restate the Replacement Warrants and Additional Warrants to make them immediately exercisable upon conversion, at a per share exercise price equal to $1.80 per share. As consideration for the early conversion of the Series 2 Notes, the Company issued each subscriber a new warrant (the “Series 2 Payment Warrants”), exercisable for up to the number of shares of Common Stock equal to the number of Series 2 Conversion Shares received by such subscriber; at a per share exercise price of $1.80 per share. The Series 2 Payment Warrants were exercisable commencing on July 2, 2018 and expire on November 21, 2021. The Replacement Warrants and Additional Warrants became immediately exercisable upon the July 2, 2018 conversion date, at a per share exercise price equal to $1.80 per share and will expire on November 21, 2021.
The exercise price and number of the shares issuable upon exercising the Series 2 Payment Warrants, Replacement Warrants and Additional Warrants are subject to adjustment in the event of any stock dividends and splits, reverse stock split, recapitalization, reorganization or similar transaction, as described therein. The Series 2 Notes were converted into 144,053 shares of Common Stock and warrants exercisable for 477,856 shares of Common Stock were issued as a result of the Series 2 Notes conversion and extinguishment.
Series 1 Notes and Warrants
From November 2016 to June 2017, the Company issued convertible promissory notes in an aggregate principal amount of $1.6 million that bear interest at a fixed rate of 8% per annum and warrants to purchase shares of the Company’s capital stock. In June 2017 and November 2017, the terms of such notes (as amended, the “Series 1 Notes”) and warrants (as amended, the “Series 1 Warrants”) were amended.
Effective as of July 2, 2018, the Company amended the Series 1 Notes by entering into debt conversion agreements with each Series 1 Note subscriber to (i) convert the outstanding principal and accrued and unpaid interest under the Series 1 Notes into shares of the Company’s Common Stock based on the outstanding balance divided by $1.80 per share (the “Series 1 Conversion Shares”); (ii) cancel and extinguish the Series 1 Notes; and (iii) amend and restate the Series 1 Warrants to make them immediately exercisable upon conversion, at a per share exercise price equal to $1.80 per share. As consideration for the early conversion of the Series 1 Notes, the Company issued each subscriber a new warrant (the “Series 1 Payment Warrants”), exercisable for up to the number of shares of Common Stock equal to the number of Series 1 Conversion Shares received by such subscriber; at a per share exercise price of $1.80 per share. The Series 1 Payment Warrants are exercisable commencing on July 2, 2018, and expire on November 21, 2021. The Series 1 Warrants became immediately exercisable upon the July 2, 2018 conversion date, at a per share exercise price equal to $1.80 per share, and will expire on November 21, 2021.
The exercise price and number of the shares issuable upon exercising the Series 1 Payment Warrants and original Series 1 Warrants are subject to adjustment in the event of any stock dividends and splits, reverse stock split, recapitalization, reorganization or similar transaction, as described therein. The Series 1 Notes were converted into 1,002,258 shares of Common Stock and warrants exercisable for 2,004,516 shares of Common Stock were issued on July 2, 2018 as a result of the Series 1 Notes conversion and extinguishment.
The Series 1 Notes, prior to the July 2, 2018 conversion and extinguishment, required us to repay the principal and accrued and unpaid interest thereon at the earlier of July 31, 2018, or the consummation of the next equity or equity-linked round of financing resulting in more than $3 million in gross proceeds.
Unsecured Loans
In December 2018, the Company received gross proceeds from an unsecured loan represented by one promissory note in the amount of $100,000 from a stockholder owning over 5% of the Company’s common stock. The loan was interest free and required that the Company repay the principal in full on the earlier of the closing of an equity round of financing of the Company resulting in more than $5 million in gross proceeds or December 12, 2019. The loan was repaid in full by June 30, 2019,
In November 2018, the Company received cash gross proceeds from unsecured loans represented by two promissory notes in the amounts of $45,000 and $100,000 from a stockholder owning or a stockholder affiliated with stockholders owning over 5% of the Company’s common stock. The loans were interest free and required that the Company repay the principal in full on the earlier of the closing of an equity round of financing of the Company resulting in more than $5 million in gross proceeds or November 14, 2019. The loans were repaid in full by June 30, 2019.
On May 17, 2018, the Company received cash proceeds of $168,000 from unsecured loans, represented by two promissory notes from a stockholder owning or a stockholder affiliated with stockholders owning over 5% of the Company’s common stock. The loans were interest free and required that the Company repay the principal in full on the earlier to occur of (i) May 17, 2019 or (ii) the closing of an equity round of financing of the Company that raises more than $5 million in gross proceeds. The loans included customary events of default provisions. The loans were repaid in full by June 30, 2019.
On March 20, 2018, the Company received cash proceeds from an unsecured loan, represented by a promissory note, for $115,000 from a stockholder owning over 5% of the Company’s common stock. The loan was interest free and the Company repaid the principal in full in the second quarter of 2019 as required on the earlier to occur of (i) March 20, 2019 or (ii) the closing of an equity round of financing of the Company that raises more than $3 million in gross proceeds. The loan included customary events of default provisions. The loan was repaid in full by June 30, 2019.
Funding Requirements and Outlook
We have no current source of revenue to sustain our present activities, outside of our current cash balance of $0.3 million at September 30, 2019, and we do not expect to generate revenue until, and unless, the FDA or other regulatory authorities approve our cortical strip, grid electrode and depth electrode technology under development and we successfully commercialize our cortical strip, grid electrode and depth electrode technology. Until such time, if ever, as we can generate substantial product revenue, we expect to finance our cash needs through a combination of equity and debt financings as well as collaborations, strategic alliances and licensing arrangements. We do not have any committed external source of funds. To the extent that we raise additional capital through the sale of equity or convertible debt securities, the ownership interest of our stockholders will be diluted, and the terms of these securities may include liquidation or other preferences that adversely affect your rights as a common stockholder. Debt financing, if available, may involve agreements that include covenants limiting or restricting our ability to take specific actions, such as incurring additional debt, making capital expenditures or declaring dividends. If we raise additional funds through collaborations, strategic alliances or licensing arrangements with third-party partners, we may have to relinquish valuable rights to our technologies, future revenue streams or grant licenses on terms that may not be favorable to us. If we are unable to raise additional funds through equity or debt financings or through collaborations, strategic alliances or licensing arrangements when needed, we may be required to delay, limit, reduce or terminate our product development, future commercialization efforts, or grant rights to develop and market our cortical strip, grid electrode and depth electrode technology that we would otherwise prefer to develop and market ourselves.
Our independent registered public accounting firm included an explanatory paragraph in its report on our financial statements as of and for the year ended September 30, 2019 and for the nine month transition period ended September 30, 2018, noting the existence of substantial doubt about our ability to continue as a going concern. This uncertainty arose from management’s review of our results of operations and financial condition and its conclusion that, based on our operating plans, we did not have sufficient existing working capital to fund our operating expenses.
We have agreements with WARF and Mayo that require us to make certain milestone and royalty payments.
Under the WARF License, we have agreed to pay WARF a royalty equal to a single-digit percentage of our product sales, with a minimum annual royalty payment of $50,000 for calendar year 2019, $100,000 for 2020 and $150,000 for 2021 and each calendar year thereafter that the WARF License is in effect. If we or any of our sublicenses contest the validity of any licensed patent, the royalty rate will be doubled during the pendency of such contest and, if the contested patent is found to be valid and would be infringed by us if not for the WARF License, the royalty rate will be tripled for the remaining term of the WARF License.
Under the Mayo Development Agreement, we have agreed to pay Mayo a royalty equal to a single-digit percentage of our product sales pursuant to the Mayo Development Agreement. Nothing further is due until we start selling our products.
Refer to: “Item 1 - Business-WARF License,” “Business-Mayo Foundation for Medical Education and Research License and Development Agreement,” “Item 1A - Risk Factors-Risks Relating to Our Business-We depend on intellectual property licensed from Wisconsin Alumni Research Foundation for our technology under development, and the termination of this license would harm our business” and “Item 1A - Risk Factors-We depend on our partnership with Mayo Foundation for Medical Education and Research to license certain know how for the development and commercialization of our technology.”
Our existing cash and cash equivalents will not be sufficient to fund our operating expenses. To continue to fund operations, we will need to secure additional funding or take steps to reduce expenses. We may obtain additional financing in the future through the issuance of our Common Stock and securities convertible into our Common Stock, through other equity or debt financings or through collaborations or partnerships with other companies. We may not be able to raise additional capital on terms acceptable to us, or at all.
The development of our cortical strip, grid electrode and depth electrode technology is subject to numerous uncertainties, and we have based these estimates on assumptions that may prove to be substantially different than we currently anticipate and could use our cash resources sooner than we expect. Additionally, the process of developing medical devices is costly, and the timing of progress in pre-clinical tests and clinical trials is uncertain. Our ability to successfully transition to profitability will be dependent upon achieving FDA approval and then a level of product sales adequate to support our cost structure. We cannot assure you that we will ever be profitable or generate positive cash flow from operating activities.
As noted above, we received 510(k) marketing clearance for our Evo Cortical Electrode in the fourth calendar quarter of 2019.
Cash Flows
The following is a summary of cash flows for each of the periods set forth below.
Net cash used in operating activities
Net cash used in operating activities was $5.4 million for the year ended September 30, 2019, which consisted of a net loss of $6.8 million partially offset by non-cash interest, depreciation related to property and equipment, amortization related to intangibles, stock-based compensation, note discount amortization, revaluation of premium debt conversion derivatives and warrant liabilities and note extinguishments, totaling $1.5 million in the aggregate. Lastly, a net decrease in accounts payable and accrued expenses and an increase in prepaid expenses and other assets, in the aggregate net cash use of $0.1 million, contributed to the net cash usage in operating activities. Net cash used in operating activities over the next year are expected to increase as payments are made related to accrued legal services incurred through September 30, 2019.
Net cash used in operating activities was $2.8 million for the year ended September 30, 2018, which consisted of a net loss of $6.8 million partially offset by non-cash interest, amortization related to intangibles, stock-based compensation, discount amortization, revaluation of premium debt conversion derivatives and warrant liabilities related to the Series 1 Notes, Series 2 Notes and Series 3 Notes, and note extinguishments totaling $3.1 million in the aggregate. Lastly, a $0.8 million net increase in accounts payable and accrued expenses offset a portion of the net cash used in operating activities.
Net cash used in investing activities
Net cash used in investing activities was $0.1 million for the year ended September 30, 2019 and consisted of the payment owed under the terms of the WARF License related to research and development of $65,000 and the purchase of equipment and equipment totaling $58,352.
Net cash used in investing activities was $0.1 million for the year ended September 30, 2018 and consisted of payments owed under the terms of the Mayo Development Agreement and the 2017 WARF Agreement for the purchase of patent licenses for research and development.
Net cash provided by financing activities
Net cash provided by financing activities was $5.8 million for the year ended September 30, 2019, which consisted of net proceeds received from the 2018 and 2019 Private Placement of common stock and warrants totaling $5.6 million. Additionally, proceeds from the exercise of stock options and warrants of $0.5 million, offset by net repayments of unsecured loans in the amount of $0.3 million, contributed to the balance of financing activities during the year ended September 30, 2019.
Net cash provided by financing activities was $2.9 million for the year ended September 30, 2018, which consisted of net proceeds received from the 2018 Private Placement of common stock and warrants totaling $1.1 million, the issuance of the Series 3 Notes and Warrants of $1.5 million and the net issuance of unsecured loans in the amount of $0.3 million during the year ended September 30, 2018.
Critical Accounting Policies and Significant Judgments and Estimates
Critical Accounting Policies
Our management’s discussion and analysis of our financial condition and results of operations is based on our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America, or GAAP. The preparation of these consolidated financial statements requires us to make estimates, judgments and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities as of the dates of the balance sheets and the reported amounts of revenue and expenses during the reporting periods. In accordance with GAAP, we base our estimates on historical experience and on various other assumptions that we believe are reasonable under the circumstances at the time such estimates are made. Actual results may differ materially from our estimates and judgments under different assumptions or conditions. We periodically review our estimates in light of changes in circumstances, facts and experience. The effects of material revisions in estimates are reflected in our consolidated financial statements prospectively from the date of the change in estimate.
While our significant accounting policies are more fully described in the notes to our consolidated financial statements appearing elsewhere in this Report, we believe the following are the critical accounting policies used in the preparation of our consolidated financial statements that require significant estimates and judgments.
Fair Value of Financial Instruments
We account for fair value measurements of assets and liabilities that are recognized or disclosed at fair value in the financial statements on a recurring or nonrecurring basis adhering to the Financial Accounting Standards Board (FASB) fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to measurements involving significant unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy are as follows:
● Level 1 Inputs: Unadjusted quoted prices in active markets for identical assets or liabilities accessible to the Company at the measurement date.
●Level 2 Inputs: Other than quoted prices included in Level 1 inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the asset or liability.
● Level 3 Inputs: Unobservable inputs for the asset or liability used to measure fair value to the extent that observable inputs are not available, thereby allowing for situations in which there is little, if any, market activity for the asset or liability at measurement date.
As of September 30, 2019 and 2018, the fair values of cash, accounts payable, accrued expenses and the unsecured loans approximated their carrying values because of the short-term nature of these assets or liabilities while outstanding. The estimated fair value of the convertible promissory notes while outstanding was based on amortized cost which was deemed to approximate fair value. The fair value of the warrant liability and the premium conversion derivatives associated with the convertible promissory notes while outstanding was based on both the estimated fair value of our Common Stock and cash flow models discounted at current implied market rates evidenced in recent arms-length transactions representing expected returns by market participants for similar instruments which were based on Level 3 inputs.
Warrant Liability
We issued warrants to purchase equity securities in connection with the issuance of convertible promissory notes. We account for these warrants as a liability at fair value when the number of shares is not fixed and determinable and when warrant pricing protections in future equity financings are not available to other common stockholders. Additionally, issuance costs associated with the warrant liability are expensed as incurred and reflected as interest expense in the accompanying consolidated statements of operations. We adjust the liability for changes in fair value until the earlier of the exercise or expiration of the warrants, amendment of warrant terms that no longer require liability treatment, or until such time, if any, as the number of shares to be exercised becomes fixed, at which point the warrants will be classified in stockholders’ (deficit) equity provided that there are sufficient authorized and unissued shares of common stock to settle the warrants and redeem any other contracts that may require settlement in shares of common stock. Any change in fair value of the warrant liability while outstanding is recognized in the consolidated statements of operations.
Premium Debt Conversion Derivatives
We evaluate all conversion and redemption features contained in a debt instrument to determine if there are any embedded derivatives that require separation from the host debt instrument. An embedded derivative that requires separation is bifurcated from its host debt instrument and a corresponding discount to the host debt instrument is recorded. The discount is amortized and recorded to interest expense over the term of the host debt instrument using the straight-line method which approximates the effective interest method. The separated embedded derivatives are accounted for separately on a fair value basis. We record the fair value changes of separated embedded derivatives in the consolidated statements of operations at each reporting period while outstanding.
Common Stock Valuation Methodology
Prior to September 30, 2019, the valuation of our common stock was based on our estimated enterprise value on a continuing operations basis, using the market approach, with certain adjustments relating to the thinly traded status of the Company. The traded price of the Company, prior to September 30, 2019, was deemed not to be an entirely reliable indication of fair market value given the lack of trading liquidity. Therefore, in addition to applying partial weighting to the traded price, we relied on both forward revenue multiples from guideline public companies (“GPC”) for calendar years 2019 through 2021 as well as on private equity transitions that were completed. The resulting equity value from the GPC method was allocated to common stock using the option pricing method, and a DLOM was applied. As of September 30, 2019, we are utilizing the stock market price as quoted on the OTCQB as the basis for the fair value of our common stock given our assessment that the Company is no longer impacted materially by trading liquidity.
There are significant judgments and estimates inherent in the determination of fair value of our common stock, including the contemporaneous valuations. These judgments and estimates include assumptions regarding our future operating performance, and the determination of the appropriate valuation methods. If we had made different assumptions, our stock-based compensation expense, net loss and net loss per common share could have been significantly different.
The fair value of our common stock is used as an input into the fair value determination of the warrants, stock option or other equity awards that we have issued during the year or are outstanding liabilities at our reporting date.
Recent Accounting Pronouncements
See Note 3 - “Summary of Significant Accounting Policies” included in “Item 8 - Financial Statements and Supplementary Data” in this Report regarding the impact of certain recent accounting pronouncements on our financial statements.
Off-Balance Sheet Arrangements
During the periods presented, we did not have, and we do not currently have, any off-balance sheet arrangements, as defined under SEC rules.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Report of Independent Registered Public Accounting Firm
Stockholders and Board of Directors
NeuroOne Medical Technologies Corporation
Eden Prairie, Minnesota
Opinion on the Consolidated Financial Statements
We have audited the accompanying consolidated balance sheets of NeuroOne Medical Technologies Corporation (the “Company”) as of September 30, 2019 and 2018, the related consolidated statements of operations, changes in stockholders’ deficit, and cash flows for the year ended September 30, 2019 and the nine month transition period ended September 30, 2018, and the related notes (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company at September 30, 2019 and 2018, and the results of their operations and their cash flows for the year ended September 30, 2019 and the nine month transition period ended September 30, 2018, in conformity with accounting principles generally accepted in the United States of America.
Going Concern Uncertainty
The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 2 to the consolidated financial statements, the Company has suffered recurring losses from operations and negative cash flows from operations that raise substantial doubt about its ability to continue as a going concern. Management’s plans in regard to these matters are also described in Note 2 to the consolidated financial statements. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.
Basis for Opinion
These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s consolidated financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits, we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.
Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion.
/s/ BDO USA, LLP
We have served as the Company’s auditor since 2016.
Minneapolis, Minnesota
December 20, 2019
NeuroOne Medical Technologies Corporation
Consolidated Balance Sheets
See accompanying notes to consolidated financial statements
NeuroOne Medical Technologies Corporation
Consolidated Statements of Operations
See accompanying notes to consolidated financial statements
NeuroOne Medical Technologies Corporation
Consolidated Statement of Changes in Stockholders’ Deficit
See accompanying notes to consolidated financial statements
NeuroOne Medical Technologies Corporation
Consolidated Statements of Cash Flows
See accompanying notes to consolidated financial statements
NeuroOne Medical Technologies Corporation
Notes to Consolidated Financial Statements
NOTE 1 - Organization and Nature of Operations
NeuroOne Medical Technologies Corporation (the “Company”), a Delaware Corporation, is an early-stage medical technology company developing comprehensive neuromodulation cEEG and sEEG monitoring, ablation, and brain stimulation solutions to diagnose and treat patients with epilepsy, Parkinson’s disease, essential tremors, and other brain related disorders.
To date, the Company has recorded no product sales and has a limited expense history. The Company is currently raising capital to fund the development of its proprietary technology and is seeking regulatory clearances required to initiate commercial activities.
The Company is based in Eden Prairie, Minnesota.
NOTE 2 - Going Concern
The accompanying consolidated financial statements have been prepared on the basis that the Company will continue as a going concern. The Company has incurred losses since inception and had an accumulated deficit of $17,238,871 as of September 30, 2019. The Company has not established a source of revenues to cover its operating costs, and as such, has been dependent on funding operations through the issuance of debt and sale of equity securities. The Company does not have adequate liquidity to fund its operations without raising additional funds. These factors raise substantial doubt about its ability to continue as a going concern. The consolidated financial statements do not include any adjustments that might result from the outcome of this condition. Management intends to continue to seek additional financing to fund operations. If the Company is not able to raise additional working capital, it will have a material adverse effect on the operations of the Company and the development of its technology.
Through September 30, 2019, the Company has completed a $528,000 unsecured loan financing, a $253,000 short-term promissory note financing (which notes were amended and restated to become convertible promissory notes), a $1,625,120 convertible promissory note financing of a planned $2.5 million subscription and a second $1,540,000 convertible promissory note financing of a planned $2 million subscription. All of the convertible notes were ultimately converted into common stock and warrants. In addition, the Company entered into two private placement transactions of its common stock and warrants beginning in July 2018 and December 2018, whereby $7.4 million in gross proceeds were raised out of a planned $11.8 million maximum offering under the subscription agreements for both private placements through September 30, 2019.
The Company does not have adequate liquidity to fund its operations without raising additional funds. Management intends to continue to seek additional debt and/or equity financing to fund operations. However, if the Company is unable to raise additional funds, or the Company’s anticipated operating results are not achieved, management believes planned expenditures may need to be reduced in order to extend the time period that existing resources can fund the Company’s operations. If management is unable to obtain the necessary capital, it may have to cease operations.
NOTE 3 - Summary of Significant Accounting Policies
Basis of Presentation
The accompanying consolidated financial statements have been prepared in accordance with accounting standards generally accepted in the United States of America. In September 2018, the Board of Directors of the Company, pursuant to the bylaws and based upon the recommendation of its Audit Committee, approved a change in the Company’s fiscal year end from December 31 to September 30. The Company’s fiscal year now begins on October 1 and ends on September 30 of each year, starting on October 1, 2018 (“the nine month transition period”). For comparative purposes, the transition period of January 1, 2018 to September 30, 2018 is included in the consolidated financial statements pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”).
Management’s Use of Estimates
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 expenses during the reporting period. Actual results could differ from those estimates.
Concentration of Credit Risk
Financial instruments that potentially subject the Company to a concentration of credit risk consist of cash. The Company’s cash is held by one financial institution in the United States. Amounts on deposit may at times exceed federally insured limits. The Company has not experienced any losses on its deposits since inception, and management believes that minimal credit risk exists with respect to these financial institutions. As of September 30, 2019, the Company had $11,749 of deposits in excess of federally insured amounts.
Common Stock Valuation
As of September 30, 2019, the Company is utilizing pricing as quoted on the OTC Market as the basis for the fair value of the Company’s common stock. Prior to September 30, 2019, the Company utilized methodologies in accordance with the framework of the American Institute of Certified Public Accountants’ Technical Practice Aid, Valuation of Privately-Held Company Equity Securities Issued as Compensation, to estimate the fair value of its common stock (the “AICPA Valuation Framework”). The valuation methodology included estimates and assumptions that required the Company’s judgment. These estimates and assumptions included a number of objective and subjective factors, including external market conditions affecting the biotechnology industry sector, and the likelihood of achieving a liquidity event, such as an offering or sale. Significant changes to the key assumptions used in the valuations would result in different fair values of common stock at each of those valuation dates.
Prior to September 30, 2019, the Company estimated its enterprise value on a continuing operations basis, using the market approach, with certain adjustments relating to the thinly traded status of the Company. The traded price of the Company was deemed not to be an entirely reliable indication of fair market value given the lack of trading liquidity. Therefore, in addition to applying partial weighting to the traded price, the Company relied on forward revenue multiples from guideline public companies (“GPC”) for calendar years 2019 through 2021 and on the sales price of the Company’s common stock in recent private placement transactions (see Note 10 - Stockholders’ Deficit). The resulting equity value from the GPC method portion was allocated to common stock using the option pricing method, and a discount for lack of marketability was applied. Based on the above methodology and weightings, the Company derived a valuation conclusion that ranged from $2.05 to $2.52 per common share for the periods presented through June 30, 2019, the last date for which an evaluation was performed under the AICPA Valuation Framework.
The fair value the Company’s common stock is used as an input into the fair value determination of the warrants, stock option or other equity awards that the Company has issued or are outstanding liabilities at a reporting date.
Fair Value of Financial Instruments
The Company’s accounting for fair value measurements of assets and liabilities that are recognized or disclosed at fair value in the consolidated financial statements on a recurring or nonrecurring basis adheres to the Financial Accounting Standards Board (FASB) fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to measurements involving significant unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy are as follows:
● Level 1 Inputs: Unadjusted quoted prices in active markets for identical assets or liabilities accessible to the Company at the measurement date.
● Level 2 Inputs: Other than quoted prices included in Level 1 inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the asset or liability.
● Level 3 Inputs: Unobservable inputs for the asset or liability used to measure fair value to the extent that observable inputs are not available, thereby allowing for situations in which there is little, if any, market activity for the asset or liability at the measurement date.
As of September 30, 2019 and 2018, the fair values of cash, prepaids and other assets, accounts payable, accrued expenses and the unsecured loans, while outstanding, approximated their carrying values because of the short-term nature of these assets or liabilities. The estimated fair value of the convertible promissory notes of the Company, while outstanding, was based on amortized cost which was deemed to approximate fair value. The fair value of the warrant liability and the premium conversion derivatives associated with the convertible promissory notes of the Company, while outstanding, were based on both the estimated fair value of our common stock of $2.29 and $2.30 per share as of their conversion on February 28, 2019 and as of September 30, 2018, respectively, and cash flow models discounted at current implied market rates evidenced in recent arms-length transactions representing expected returns by market participants for similar instruments and are based on Level 3 inputs. There were no transfers between fair value hierarchy levels during the year ended September 30, 2019 and the nine month transition period ended September 30, 2018.
The fair value of financial instruments measured on a recurring basis is as follows:
The following table provides a roll-forward of the warrant liability and premium debt conversion derivatives measured at fair value on a recurring basis using unobservable level 3 inputs for the year ended September 30, 2019 and the nine month transition period ended September 30, 2018:
Intellectual Property
The Company has entered into two licensing agreements with major research institutions, which allows for access to certain patented technology and know-how. Payments under those agreements are capitalized and amortized to general and administrative expense over the expected useful life of the acquired technology.
Property and Equipment
Property and equipment is recorded at cost and reduced by accumulated depreciation. Depreciation expense is recognized over the estimated useful lives of the assets using the straight-line method. The estimated useful life for equipment ranges from three to five years and three years for software. Tangible assets acquired for research and development activities and have alternative use are capitalized over the useful life of the acquired asset. Estimated useful lives are periodically reviewed, and when appropriate, changes are made prospectively. Software purchased for internal use consists primarily of amounts paid for perpetual licenses to third-party software providers and installation costs. When certain events or changes in operating conditions occur, asset lives may be adjusted and an impairment assessment may be performed on the recoverability of the carrying amounts. Maintenance and repairs are charged directly to expense as incurred.
Impairment of Long-Lived Assets
The Company evaluates its long-lived assets, which consist of licensed intellectual property and property and equipment for impairment whenever events or changes in circumstances indicate that the carrying value of these assets may not be recoverable. The Company assesses the recoverability of long-lived assets by determining whether or not the carrying value of such assets will be recovered through undiscounted expected future cash flows. If the asset is considered to be impaired, the amount of any impairment is measured as the difference between the carrying value and the fair value of the impaired asset. The Company determined that no impairment triggers existed during the periods ended September 30, 2019 and 2018.
Debt Issuance Costs
Debt issuance costs are recorded as a reduction of the convertible promissory notes and short-term notes when applicable. Amortization of debt issuance costs is calculated using the straight-line method over the term of the convertible promissory notes, which approximates the effective interest method, and is recorded in interest expense in the accompanying consolidated statements of operations.
Research and Development Costs
Research and development costs are charged to expense as incurred. Research and development expenses may comprise of costs incurred in performing research and development activities, including clinical trial costs, manufacturing costs for both clinical and pre-clinical materials as well as other contracted services, license fees, and other external costs. Nonrefundable advance payments for goods and services that will be used in future research and development activities are expensed when the activity is performed or when the goods have been received, rather than when payment is made, in accordance with ASC 730, Research and Development. Lastly, de minimis income from the sale of prototype products and related materials are offset against research and development expenses.
Stock-Based Compensation
The Company accounts for stock-based compensation in accordance with the provisions of Accounting Standards Codification (ASC) 718, Compensation - Stock Compensation (ASC 718). Accordingly, compensation costs related to equity instruments granted are recognized at the grant-date fair value. The Company records forfeitures when they occur. Stock-based compensation arrangements to non-employees are accounted for in accordance with the applicable provisions of ASC 718 and ASC 505, Equity, using a fair value approach.
Warrant Liability
The Company issued warrants to purchase equity securities in connection with the issuance of convertible promissory notes (See Note 7- Short-Term Promissory Notes and Unsecured Loans and Note 8 - Convertible Promissory Notes and Warrant Agreements). The Company accounts for these warrants as a liability at fair value when the number of shares is not fixed and determinable in cases where warrant pricing protections in future equity financings are not available to other common stockholders. Additionally, issuance costs associated with the warrant liability are expensed as incurred and reflected as interest expense in the accompanying consolidated statements of operations. The Company adjusts the liability for changes in fair value until the earlier of the exercise or expiration of the warrants for any period when pricing protections in future equity financings remain in place, or until such time, if any, as the number of shares to be exercised becomes fixed, at which point the warrants will be classified in stockholders’ (deficit) equity provided that there are sufficient authorized and unissued shares of common stock to settle the warrants and redeem any other contracts that may require settlement in shares of common stock. Any future change in fair value of the warrant liability, when outstanding, is recognized in the consolidated statements of operations.
Premium Debt Conversion Derivatives
The Company evaluates all conversion and redemption features contained in a debt instrument to determine if there are any embedded derivatives that require separation from the host debt instrument. An embedded derivative that requires separation is bifurcated from its host debt instrument and a corresponding discount to the host debt instrument is recorded. The discount is amortized and recorded to interest expense over the term of the host debt instrument using the straight-line method which approximates the effective interest method. The separated embedded derivatives are accounted for separately on a fair value basis. The Company records the fair value changes of separated embedded derivatives at each reporting period in the consolidated statements of operations (See Note 7- Short-Term Promissory Notes and Unsecured Loans and Note 8 - Convertible Promissory Notes and Warrant Agreements). The Company determined that the redemption features under the convertible promissory notes qualified as embedded derivatives and therefore separated from the debt host with regard to the convertible promissory notes.
Income Taxes
For the Company, income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax base and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Deferred tax assets are reduced by a valuation allowance if it is more likely than not that some portion of all of the deferred tax asset will not be realized.
Net Loss Per Share
For the Company, basic loss per share of common stock is computed by dividing net loss by the weighted average number of shares of common stock outstanding during the period.
Diluted earnings or loss per share of common stock is computed similarly to basic earnings or loss per share except the weighted average shares outstanding are increased to include additional shares from the assumed exercise of any common stock equivalents, if dilutive. The Company’s convertible promissory notes, warrants and stock options and restricted stock units are considered common stock equivalents for this purpose. Diluted earnings is computed utilizing the treasury method for the warrants, restricted stock units and stock options. Diluted earnings with respect to the convertible promissory notes utilizing the if-converted method was not applicable during the year ended September 30, 2019 or the nine month transition period ended September 30, 2018 as no conditions required for conversion had occurred during these periods. No incremental common stock equivalents were included in calculating diluted loss per share because such inclusion would be anti-dilutive given the net loss reported for the year ended September 30, 2019 and the nine month transition period ended September 30, 2018.
The following potential common shares were not considered in the computation of diluted net loss per share as their effect would have been anti-dilutive for the year ended September 30, 2019 and the nine month transition period ended September 30, 2018:
(1)As of September 30, 2018, there were additional potential warrants to be included which would be known, if and when a qualified financing event greater than $3 million or a change of control transaction occurs in the future.
Recent Accounting Pronouncements
In May 2014, the FASB issued Accounting Standards Update (ASU) 2014-09, Revenue from Contracts with Customers (Topic 606), which supersedes the revenue recognition requirements in FASB ASC 605. The new guidance primarily states that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods and services. In January 2017 and September 2017, the FASB issued several amendments to ASU 2014-09, including updates stemming from SEC Accounting Staff Announcement in July 2017. The amendments and updates included clarification on accounting for principal versus agent considerations (i.e., reporting gross versus net), licenses of intellectual property and identification of performance obligations. These amendments and updates do not change the core principle of the standard but provide clarity and implementation guidance. The Company has adopted this standard on October 1, 2018 and selected the modified retrospective transition method. The Company modified its accounting policies to reflect the requirements of this standard; however, the adoption did not affect the Company’s financial statements and related disclosures for this period as the Company has yet to generate any revenues.
In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842) and subsequently amended the guidance relating largely to transition considerations under the standard in January 2017 and July 2018. The objective of this update is to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements. This ASU is effective for fiscal years beginning after December 15, 2018, including interim periods within those annual periods. The Company plans to adopt the standard on October 1, 2019, and will apply the modified retrospective approach to each lease in existence at the adoption date to the extent a lease is subject to this guidance. As such, the Company would not restate comparative periods and would recognize any cumulative adjustment to retained earnings on the date of the adoption. The Company also plans to elect the package of practical expedients provided under the standard. The new standard is not expected to have a material impact on the Company’s statements of comprehensive loss or statements of cash flows for agreements in place as of September 30, 2019. The finalization of our assessment may result in significant changes to our estimates.
In July 2017, the FASB issued ASU No. 2017-11, Earnings Per Share, Distinguishing Liabilities from Equity and Derivatives and Hedging, which changes the accounting and earnings per share for certain instruments with down round features. The amendments in this ASU should be applied using a cumulative-effect adjustment as of the beginning of the fiscal year or retrospective adjustment to each period presented and is effective for annual periods beginning after December 15, 2018 for public business entities, including interim periods within those fiscal years. Early adoption is permitted. The Company is currently evaluating the requirements of this new guidance and has not yet determined its impact on the Company’s consolidated financial statements.
In June 2018, the FASB issued ASU 2018-07, Compensation - Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting (ASU 2018-07), which expands the scope of Topic 718 to include share-based payment transactions for acquiring goods and services from nonemployees. An entity should generally apply the requirements of Topic 718 to nonemployee awards except in circumstances where there is specific guidance on inputs to an option pricing model and the attribution of cost. ASU 2018-07 specifies that Topic 718 applies to all share-based payment transactions in which a grantor acquires goods or services to be used or consumed in a grantor’s own operations by issuing share-based payment awards. The guidance also clarifies that Topic 718 does not apply to share-based payments used to effectively provide (1) financing to the issuer or (2) awards granted in conjunction with selling goods or services to customers as part of a contract accounted for under ASC 606, Revenue from Contracts with Customers (ASC 606). This guidance is effective for annual reporting periods beginning after December 15, 2018, with early adoption permitted, but no earlier than an entity’s adoption date of ASC 606. The Company early adopted ASU 2018-07 effective October 1, 2018. The guidance did not have an impact to the Company’s financial statements.
In August 2018, the FASB issued ASU 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement (ASU 2018-13). The new guidance modifies the disclosure requirements in Topic 820 as follows:
● Removals: the amount of and reasons for transfers between Level 1 and Level 2 of the fair value hierarchy; the policy for timing of transfers between levels; and the valuation processes for Level 3 fair value measurements.
● Modifications: for investments in certain entities that calculate net asset value, an entity is required to disclose the timing of liquidation of an investee’s assets and the date when restrictions from redemption might lapse only if the investee has communicated the timing to the entity or announced the timing publicly; and the amendments clarify that the measurement uncertainty disclosure is to communicate information about the uncertainty in measurement as of the reporting date.
● Additions: the changes in unrealized gains and losses for the period included in other comprehensive income for recurring Level 3 fair value measurements held at the end of the reporting period; and the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements.
This guidance is effective for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. The amendments on changes in unrealized gains and losses, the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements, and the narrative description of measurement uncertainty should all be applied prospectively for only the most recent interim or annual period presented in the initial year of adoption. All other amendments should be applied retrospectively to all periods presented upon their effective date. Early adoption is permitted. An entity is permitted to early adopt any removed or modified disclosures upon issuance of ASU 2018-13 and delay adoption of the additional disclosures until their effective date. The Company is currently evaluating the impact of the new guidance on its financial statements.
NOTE 4 - Commitments and Contingencies
WARF License Agreement
The Company has entered into an exclusive start-up company license agreement with the Wisconsin Alumni Research Foundation (“WARF”) for WARF’s neural probe array and thin film micro electrode technology (the “WARF Agreement”). The Company is obligated to pay royalties to WARF based on a percentage of net sales of products of licensed technology with minimum royalties of $50,000 and $100,000 for calendar years 2019 and 2020, respectively, and $150,000 per year beginning in 2021 through the duration of the WARF Agreement. Subject to earlier termination, the WARF Agreement otherwise expires by its terms on the date that no valid claims on the patents licensed thereunder remain. The Company expects the latest expiration of a licensed patent to occur in 2030. The WARF Agreement is also subject to certain cancellation provisions with 90 days’ notice should the Company elect not to continue to use the licensed technology. As of September 30, 2019, no royalty payments under the WARF Agreement were made or due to WARF.
The Company has agreed to diligently develop, manufacture, market and sell products under the WARF Agreement in the United States during the term of the agreement and, specifically, that the Company would submit a business plan to WARF by February 1, 2018, which the Company submitted on January 18, 2018, and file an application for 510(k) marketing clearance with the FDA by February 1, 2019, which the Company submitted on a timely basis. WARF may terminate the WARF Agreement in the event that the Company fails to meet these milestones on 30 days’ written notice, if the Company defaults on the payments of amounts due to WARF or fails to timely submit development reports, actively pursue the development plan or breaches any other covenant in the WARF Agreement and fails to remedy such default in 90 days or in the event of certain bankruptcy events involving the Company. WARF may also terminate this license (i) on 90 days’ notice if the Company fails to have commercial sales of one or more FDA-approved products under the WARF Agreement by March 31, 2020 or (ii) if, after royalties earned on sales begin to be paid, such earned royalties cease for more than four calendar quarters.
Mayo Agreement
The Company has an exclusive license and development agreement with the Mayo Foundation for Medical Education and Research (“Mayo”) related to certain intellectual property and development services for thin film micro electrode technology (“Mayo Agreement”). If the Company is successful in obtaining regulatory approval, the Company is to pay royalties to Mayo based on a percentage of net sales of products of the licensed technology through the term of the Mayo Agreement, set to expire May 25, 2037.
Legal
From time to time, the Company is subject to litigation and claims arising in the ordinary course of business. In May 2017, NeuroOne received a letter from PMT Corporation (“PMT”), the former employer of Mark Christianson and Wade Fredrickson. PMT claimed that these officers had breached their restrictive covenant obligations with PMT by virtue of their work for NeuroOne and such officer’s prior work during employment with the prior employer, that these officers had breached their confidentiality and non-disclosure obligations to PMT and federal and state law by misappropriating confidential and trade secret information, and that the Company is responsible for tortious interference with contracts. The letter which purported to attach a noncompete agreement signed by Mr. Fredrickson demanded that Mr. Fredrickson (who resigned from the Company in June 2017), Mr. Christianson and NeuroOne cease and desist all competitive activities, that Mr. Fredrickson step down from his position and that Mr. Christianson and NeuroOne provide the former employer access to NeuroOne’s systems to demonstrate that it is not using trade secrets or proprietary information nor competing with the former employer.
On March 29, 2018, the Company was served with a complaint filed by PMT adding the Company, NeuroOne and Mr. Christianson to its existing lawsuit against Mr. Fredrickson in the Fourth Judicial District Court of the State of Minnesota. The complaint purported to attach Mr. Fredrickson’s noncompete agreement as Exhibit A. In the lawsuit, PMT claims that Mr. Fredrickson and Mr. Christianson breached their non-competition, non-solicitation and non-disclosure obligations, breached their fiduciary duty obligations, were unjustly enriched, engaged in unfair competition, engaged in a civil conspiracy, tortiously interfered with PMT’s contracts and prospective economic advantage, and breached a covenant of good faith and fair dealing. Against Mr. Fredrickson, PMT also alleges that he intentionally or negligently spoliated evidence, made negligent or fraudulent misrepresentations, misappropriated trade secrets in violation of Minnesota law, and committed the tort of conversion and statutory civil theft. Against the Company and NeuroOne, PMT alleges that the Company and NeuroOne were unjustly enriched and engaged in unfair competition. PMT asked the Court to impose a constructive trust over the shares held by Mr. Fredrickson and Mr. Christianson and to award compensatory damages, equitable relief, punitive damages, attorneys’ fees, costs and interest.
On April 18, 2018, Mr. Christianson, the Company and NeuroOne, Inc. filed a motion for dismissal, which was heard by the Court on October 11, 2018. The motion for dismissal states that: the contract claims against Mr. Christianson fail because his agreement was not supported by consideration; the Minnesota Uniform Trade Secrets Act preempts plaintiff’s claims for unfair competition, civil conspiracy and unjust enrichment; plaintiff fails to state a claim regarding alleged breach of the duties of loyalty and good faith/fair dealing; plaintiff cannot legally obtain a constructive trust; plaintiff has insufficiently pled its tortious interference claims; and Plaintiff has not stated a claim for unfair competition. On January 7, 2019, the judge granted the motion for dismissal with respect to PMT’s claim for breach of the duty of good faith and fair dealing, and denied the motion for dismissal with respect to the other claims presented.
In April 2019, PMT served the Company, NeuroOne, Inc and Christianson with a proposed Second Amended Complaint which included new claims against the Company and NeuroOne, Inc for tortious interference with contract and tortious interference with prospective business advantage and punitive damages against the Company, NeuroOne Inc. and Christianson. On June 28, 2019 the Company presented evidence indicating that PMT had participated in a fraud on the Court, and sought an Order that PMT had waived the attorney client privilege.
On July 16, 2019, Defendants served PMT with a joint notice of motion for sanctions seeking a variety of sanctions for litigation misconduct including, but not limited to, dismissal of the case and an award of attorneys’ fees. The Company, NeuroOne Inc and Mr. Christianson further intend to move for summary judgment on all remaining claims asserted against them as well as for leave to assert counterclaims against PMT for abuse of process.
On August 30, 2019, the Hennepin County District Court heard dispositive motions in this case. The district court judge indicated some claims would likely be tried to a jury and encouraged the parties to settle.
On September 12, 2019, the district court heard NeuroOne’s motion for sanctions. The district court has set the sanctions hearing for December 17, 2019 and December 18, 2019, and indicated any remaining claims would be tried in May 2020. NeuroOne and Mark Christianson (who has not worked for PMT since February 2012) intend to continue to defend themselves vigorously.
Facility Lease
The Company entered into a non-cancellable facility lease for its operations and headquarters for an eleven month term beginning on December 1, 2018. The monthly rent under the lease is $4,763. During the year ended September 30, 2019, rent expense associated with the facility lease amounted to $47,630. See Note 13 - Subsequent Events regarding a new facility lease that was executed in October 2019.
NOTE 5 - Intangibles and Property and Equipment
Intangibles
Intangible assets rollforward is as follows:
The Company anticipates amortization expense of approximately $21,000 per year for fiscal year 2020 through 2024 based upon the two current license agreements.
Property and Equipment
Property and equipment held for use by category are presented in the following table:
Depreciation expense was $6,326 and zero for the year ended September 30, 2019 and the nine month transition period ended September 30, 2018, respectively.
NOTE 6 - Accrued Expenses
Accrued expenses consisted of the following at September 30, 2019 and 2018:
The “other” category is primarily comprised of board fees.
NOTE 7 - Short-Term Promissory Notes and Unsecured Loans
Unsecured Loans
On May 17, 2018, the Company received cash proceeds of $168,000 from unsecured loans, represented by two promissory notes from a stockholder owning or affiliated with stockholders owning over 5% of the Company’s common stock. The loans were interest free and required that the Company repay the principal in full on the earlier to occur of (i) May 17, 2019 or (ii) the closing of an equity round of financing of the Company that raises more than $5 million in gross proceeds. The loans included customary events of default provisions. The loans were fully repaid by June 30, 2019.
On March 20, 2018, the Company received cash proceeds from an unsecured loan, represented by a promissory note, for $115,000 from a stockholder owning over 5% of the Company’s common stock. The loan was interest free and the Company repaid the principal in full in the second quarter of 2019 as required on the earlier to occur of (i) March 20, 2019 or (ii) the closing of an equity round of financing of the Company that raises more than $3 million in gross proceeds. The loan included customary events of default provisions.
In November 2018, the Company received cash gross proceeds from unsecured loans represented by two promissory notes in the amounts of $45,000 and $100,000 from a stockholder owning or affiliated with stockholders owning over 5% of the Company’s common stock. The loans were interest free and required that the Company repay the principal in full on the earlier of the closing of an equity round of financing of the Company resulting in more than $5 million in gross proceeds or November 14, 2019. The loans were fully repaid by June 30, 2019.
In December 2018, the Company received gross proceeds from an unsecured loan represented by one promissory note in the amount of $100,000 from a stockholder owning over 5% of the Company’s common stock. The loan was interest free and required that the Company repay the principal in full on the earlier of the closing of an equity round of financing of the Company resulting in more than $5 million in gross proceeds or December 12, 2019. The loan was fully repaid by June 30, 2019.
Short-Term Promissory Notes
The Company issued short-term unsecured and interest-free promissory notes (the “Short-Term Notes”) for aggregate gross proceeds of $253,000 in August 2017 which included free standing equity warrants. The Short-Term Notes were subsequently amended in November 2017 and March 2018 to become convertible, extend the maturity date and include additional warrant coverage, new interest payment provisions and new conversion features described more fully below. Effective July 2, 2018, the Company entered into debt conversion agreements (the “Short-Term Note Conversion Agreements”) with each Short-Term Note subscriber to (i) convert the outstanding principal and accrued and unpaid interest (the “Outstanding Balance”) under the Short-Term Notes into shares of the Company’s common stock based on the Outstanding Balance divided by $1.80 per share (the “Short-Term Note Conversion Shares”); (ii) cancel and extinguish the Short-Term Notes; and (iii) amend and restate the Replacement Warrants and Additional Warrants, as described more fully below, to make them immediately exercisable upon the conversion, at a per share exercise price equal to $1.80 per share. Interest on principal during the nine month transition period ended September 30, 2018 up through the July 2, 2018 conversion date was $6,296. As consideration for the early conversion of the Short-Term Notes, the Company issued each subscriber a new warrant (the “Short-Term Note Payment Warrants”), exercisable for up to the number of shares of common stock equal to the number of Short-Term Note Conversion Shares received by such subscriber; at a per share exercise price of $1.80 per share. The Short-Term Note Payment Warrants became exercisable commencing on July 2, 2018, and expire on November 21, 2021.
Pursuant to the Short-Term Note Conversion Agreements, $259,297 of the outstanding principal and interest of the Short-Term Notes was converted into 144,053 shares of common stock with an additional 477,856 shares of common stock issuable upon exercise of the Replacement Warrants, Additional Warrants and Short-Term Payment Warrants. The conversion of the Short Term Notes was accounted for as an extinguishment. The difference in the carrying value of the Short-Term Notes coupled with the fair value of the underlying Replacement Warrants and Additional Warrants on the date of extinguishment relative to the higher fair value of the underlying common stock and collective Replacement Warrants, Additional Warrants and new Short-Term Payment Warrants issued was $148,787. The $148,787 differential was recorded as a loss on note extinguishments in the accompanying consolidated statement of operations during the nine month transition period ended September 30, 2018.
The Replacement Warrants, Additional Warrants and Short-Term Note Payment Warrants were deemed to be free-standing equity instruments upon execution of the July 2, 2018 Short-Term Note Conversion Agreements. All of the warrant terms became fixed and have identical provisions. Due to the previously granted warrants now having fixed terms, the warrant liability value of $148,052 was reclassified to equity. The warrants associated with the Short-Term Notes became immediately exercisable on July 2, 2018 and expire November 21, 2021. The Black-Scholes model was used to determine the July 2, 2018 fair value of the warrants associated with the Short-Term Warrants. Input assumptions used were as follows: a risk-free interest rate of 2.65 percent; expected volatility of 49.8% percent; expected life of 3.39 years; and expected dividend yield of 0 percent. The underlying stock price used in the analysis was on a non-marketable basis and was according to the market approach, considering both the traded price and forward multiples from guideline public companies, using allocation and marketability-discount methodologies.
Activity Prior to the July 2, 2018 Cancellation, Extinguishment and Conversion of the Short-Term Notes
On November 30, 2017, the Short-Term Notes were amended to extend the maturity date from February 18, 2018 to July 31, 2018 and to increase warrant coverage to 189,750 common stock purchase warrants (as amended, the “Original Warrants”). The Original Warrants had a term of 5 years and an exercise price of $1.80 and would have been immediately exercisable upon maturity of the Short-Term Notes prior to the November 30, 2017 amendment.
The Short-Term Notes were subsequently amended and restated on March 12, 2018 (the “Amended and Restated Short-Term Notes”). The Amended and Restated Short-Term Notes became convertible promissory notes that had interest assessed at a fixed rate of 8% per annum and would have required the Company to repay the principal and accrued and unpaid interest thereon on the maturity date of July 31, 2018 (the “Short-Term Note Maturity Date”). Pursuant to the terms of each Amended and Restated Short-Term Note and a consent signed by the Company and each holder, the Original Warrants under the Short-Term Notes were modified whereby each subscriber received a replacement warrant (the “Replacement Warrants”) upon the issuance of the Amended and Restated Short-Term Note, in lieu of the Original Warrant. In addition, each holder was issued an additional warrant (the “Additional Warrants”).
Replacement Warrants
Each Replacement Warrant issued on March 12, 2018 granted the holder the option to purchase up to the number of shares of capital stock of the Company equal to the New Round Stock issued or issuable upon the conversion of the Amended and Restated Short-Term Note held by such holder at a per share exercise price equal to either (i) the actual per share price of New Round Stock if the Amended and Restated Short-Term Notes converted in connection with a Short-Term Note Qualified Financing or (ii) the price at which the Amended and Restated Short-Term Notes converted in connection with a change of control transaction. The Replacement Warrants were exercisable commencing on the Conversion Date and would have expired on November 21, 2021. The exercise price and number of the shares issuable upon exercising the Replacement Warrants were subject to adjustment in the event of any stock dividends and splits, reverse stock split, recapitalization, reorganization or similar transaction, as described therein.
The Replacement Warrants were deemed to be free-standing instruments and were accounted for as a liability given the variable number of shares issuable in connection with a possible change of control conversion event. The Company recorded an initial liability of $137,722 upon issuance with an increase to extinguishment loss described further below. The fair value changes of the warrant liability associated with the Amended and Restated Short-Term Notes were recorded at each reporting date in the consolidated statement of operations which amounted to an expense of $10,330 for the nine month transition period ended September 30, 2018. A Monte Carlo simulation model was used to estimate the aggregate fair value of the Replacement Warrants immediately prior to the July 2, 2018 Short-Term Note Conversion Agreement amendment. Input assumptions used were as follows: a risk-free interest rate of 2.65 percent; expected volatility of 50 percent; expected life of 3.39 years; and expected dividend yield of 0 percent. The underlying stock price used in the analysis was on a non-marketable basis and was according to the market approach, considering both the traded price and forward multiples from guideline public companies, using allocation and marketability-discount methodologies.
Additional Warrants
Each Additional Warrant issued on March 12, 2018 granted the holder the option to purchase up to the number of shares of capital stock of the Company equal to the product obtained by multiplying (i) the outstanding principal amount of the Amended and Restated Short-Term Note held by such holder and (ii) 0.75; at a per share exercise price of $1.80. The Additional Warrants were exercisable commencing on the Conversion Date and would have expired on November 21, 2021. The exercise price and number of the shares issuable upon exercising the Additional Warrants were subject to adjustment in the event of any stock dividends and splits, reverse stock split, recapitalization, reorganization or similar transaction, as described therein.
The Additional Warrants were deemed to be free-standing instruments and were accounted for as equity as there were no variable terms. 189,750 shares of common stock were issuable upon exercise of the Additional Warrants as of the March 12, 2018 amendment date with terms that largely paralleled the provisions of the Original Warrants except that the Additional Warrants were exercisable on the Conversion Date as opposed to the Short-Term Note Maturity Date and the expiration date was moved up to November 21, 2021 from July 31, 2023.
Premium Conversion Derivative
Upon the March 2018 amendment, the Amended and Restated Short-Term Notes contained a 125% conversion premium in the event that a Short Term Note Qualified Financing occurred at a price under $2.25 per share. The Company determined that the redemption feature under the Short-Term Notes qualified as an embedded derivative and was reflected as a liability in the amount of $49,668 at the time of the March 12, 2018 amendment with a corresponding offset to extinguishment loss which is described further below. Subsequent to the amendment, the embedded derivative was accounted for separately on a fair market value basis. The Company recorded the fair value changes of the premium debt conversion derivative associated with the Short-Term Notes in the consolidated statement of operations for a benefit of $(49,668) for the nine month transition period ended September 30, 2018.
Other
The March 2018 amendment resulted in a substantial modification to the Short-Term Notes whereby additional conversion features and warrant coverage were added. The Company recorded the Short-Term Note amendment under the provisions of extinguishment accounting. A loss on note extinguishments in the accompanying consolidated statement of operations for the nine month transition period ended September 30, 2018 was recorded in the amount of $186,220, which represented the difference between the carrying value of the Short-Term Notes and Original Warrants over the combined fair values of the Short-Term Notes, premium conversion derivative, Replacement Warrant and Additional Warrants on the date of the amendment. The fair value decrease of the Short-Term Notes (inclusive of principal and interest, non-bifurcated embedded conversion feature and the Additional Warrants) relative to its adjusted carrying value at the time of the amendment was $1,170 which was recorded as a reduction to additional paid-in capital on the accompanying consolidated balance sheet.
As noted above, the Short-Term Notes were converted into shares of common stock and were not outstanding during the year ended September 30, 2019.
NOTE 8 - Convertible Promissory Notes and Warrant Agreements
2016 Convertible Promissory Notes
From November 2016 to June 2017, the Company issued convertible promissory notes (the “Convertible Notes”) and common stock purchase warrants (the “Warrants”) in an aggregate principal amount of $1,625,120 and entered into subscription agreements with subscribers (the “2016 Private Placement”). Effective July 2, 2018, however, the Company entered into debt conversion agreements (the “2016 Note Conversion Agreements”) with each Convertible Note subscriber to (i) convert the Outstanding Balance under the Convertible Notes into shares of the Company’s common stock based on the Outstanding Balance divided by $1.80 per share (the “2016 Note Conversion Shares”); (ii) cancel and extinguish the Convertible Notes; and (iii) amend and restate the Warrants as defined below to make them immediately exercisable upon the conversion, at a per share exercise price equal to $1.80 per share. As consideration for the early conversion of the Convertible Notes, the Company issued each subscriber an additional new warrant (the “2016 Note Payment Warrants”), exercisable for up to the number of shares of common stock equal to the number of 2016 Note Conversion Shares received by such subscriber; at a per share exercise price of $1.80 per share. The 2016 Note Payment Warrants became exercisable commencing on July 2, 2018 and expire on November 21, 2021.
Pursuant to the 2016 Note Conversion Agreements, $1,804,064 of the outstanding principal and interest of the 2016 Convertible Promissory Notes was converted into 1,002,258 shares of common stock and an additional 2,004,516 shares of common stock became issuable upon exercise of the Warrants and 2016 Note Payment Warrants. The conversion of the Convertible Notes was accounted for as an extinguishment. The difference in the carrying value of the Convertible Notes coupled with the fair value of the underlying Warrants upon conversion relative to the higher fair value of the underlying common stock and collective Warrants and new 2016 Note Payment Warrants issued was $979,480. The $979,480 differential total, inclusive of the unamortized discount remaining on the Convertible Notes of $11,143 as of July 2, 2018, was recorded as a loss on note extinguishments in the accompanying consolidated statement of operations during the nine month transition period ended September 30, 2018.
The Warrants and 2016 Note Payment Warrants were deemed to be free-standing equity instruments upon execution of the 2016 Note Conversion Agreements. All of the warrant terms became fixed and the terms were identical. Due to the previously granted warrants now having fixed terms, the warrant liability value of $1,031,366 was reclassified to equity. The warrants associated with the Convertible Notes became immediately exercisable on July 2, 2018 and expire November 21, 2021. The Black-Scholes model was used to determine the July 2, 2018 fair value of the warrants associated with the Convertible Notes. Input assumptions used were as follows: a risk-free interest rate of 2.65 percent; expected volatility of 49.8% percent; expected life of 3.39 years; and expected dividend yield of 0 percent. The underlying stock price used in the analysis was on a non-marketable basis and was according to the market approach, considering both the traded price and forward multiples from guideline public companies, using allocation and marketability-discount methodologies.
During the nine month transition period ended September 30, 2018, interest on the principal was $65,727, and interest related to amortization of discounts related to the bifurcation of premium derivative liability, separation of warrants, revaluation discounts and issuance costs amounted to $70,324. The fair value changes related to the underlying premium conversion derivative amounted to a benefit of $(333,183) during the nine month transition period ended September 30, 2018. The fair value changes relating to the warrant liability amounted to a benefit of $(14,865) during the nine month transition period ended September 30, 2018.
As noted above, the Convertible Notes were converted into shares of common stock and were not outstanding during the year ended September 30, 2019.
2017 Convertible Notes
From October 2017 to May 2018, the Company issued convertible notes (the “2017 Convertible Notes”) in an aggregate principal amount of $1,540,000 that bear interest at a fixed rate of 8% per annum and warrants to purchase shares of the Company’s capital stock (the “New Warrants”). During the year ended September 30, 2019 and the nine month transition period end September 30, 2018, interest on the principal was $51,333 and $80,022, respectively.
On February 28, 2019 following the 2017 Convertible Notes Qualified Financing (see below for definition), the outstanding principal and interest of $1,678,361 on the 2017 Convertible Notes were converted into 839,179 shares of common stock and 839,179 common stock purchase warrants with an exercise term of approximately 4.8 years and an exercise price $3.00 per share. The conversion was accounted for as a debt extinguishment given the bifurcation of the embedded premium debt conversion feature. The fair value of the newly issued common shares and warrants associated with the 2017 Convertible Notes conversion relative to the carrying value of the debt and fair value of warrant liability and premium derivative liability on the conversion date was $553,447 and was recorded as a loss on note extinguishments in the accompanying consolidated statements of operations for the year ended September 30, 2019. In addition, the previously issued New Warrants became immediately exercisable for 839,179 shares of common stock.
Events Prior to the February 2019 Conversion
On December 31, 2018, the 2017 Convertible Notes were amended to extend the maturity date from December 31, 2018 to June 30, 2019. The amendment was accounted for as a troubled debt restructuring given the Company’s financial condition and given the concession granted by the lenders with regards to pushing out the maturity date to June 30, 2019 with no corresponding compensation paid for the extension. The future undiscounted cash flows of the 2017 Convertible Notes as amended exceeded their carrying value as of December 31, 2018. As such, no gain was recognized on December 31, 2018 and no adjustments were made to the 2017 Convertible Note carrying value.
The 2017 Convertible Notes required the Company to repay the principal and accrued and unpaid interest thereon on June 30, 2019 (the “2017 Convertible Notes Maturity Date”). If the Company consummated an equity round of financing resulting in more than $3 million in gross proceeds before June 30, 2019 (the “2017 Convertible Notes Qualified Financing”), the outstanding principal and accrued and unpaid interest on the 2017 Convertible Notes would have automatically converted into the securities issued by the Company in the 2017 Convertible Notes Qualified Financing equal to the outstanding principal and accrued interest on the 2017 Convertible Notes divided by 80% of the price per share of the securities issued by the Company in the 2017 Convertible Notes Qualified Financing. The New Warrants would have also become exercisable upon a 2017 Convertible Notes Qualified Financing for an amount of shares equal to the number of shares received by the holder in the 2017 Convertible Notes Qualified Financing at the same price per share of the securities issued in the 2017 Convertible Notes Qualified Financing.
Lastly, if a change of control transaction occurred prior to the earlier of a 2017 Convertible Notes Qualified Financing or the 2017 Convertible Notes Maturity Date, the 2017 Convertible Notes would have, at the election of the holders of a majority of the outstanding principal of the 2017 Convertible Notes, either become payable on demand as of the closing date of such transaction, or become convertible into shares of common stock immediately prior to such transaction at a price per share equal to the lesser of (i) the per share value of the common stock as determined by the Board as if in connection with the granting of stock based compensation or in a private sale to a third party in an arms-length transaction or (ii) at the per share consideration to be paid in such transaction. Change of control meant a merger or consolidation with another entity in which the Company’s stockholders do not own more than 50% of the outstanding voting power of the surviving entity or the disposition of all or substantially all of the Company’s assets. The New Warrants would have also become exercisable upon a change of control transaction for an amount of shares equal to the number of shares received by the holder upon conversion in connection with such transaction at the same price per share that the 2017 Convertible Notes converted in the change of control transaction.
The December 2017 amendment resulted in a substantial modification to the original 2017 Convertible Notes whereby the maturity date was moved up to December 2018 from October 2022 and the terms associated with the embedded features were revised as described above. The Company recorded the 2017 Convertible Note amendment under the provisions of extinguishment accounting. As of January 1, 2018, there remained a debt discount of $26,085 of which $6,575 and $19,510 was amortized during the year ended September 30, 2019 and the nine month transition period ended September 30, 2018, respectively.
The 2017 Convertible Notes contained a conversion discount in the event of a 2017 Convertible Notes Qualified Financing to equal the outstanding principal and accrued interest on the 2017 Convertible Notes divided by 80% of the price per share of the securities issued by the Company in the 2017 Convertible Notes Qualified Financing. The embedded feature qualified as an embedded derivative and was separated from its debt host. The bifurcation of the embedded derivative from its debt host resulted in a discount to the 2017 Convertible Notes in the amount of $168,384 for the convertible debt issued during the nine month transition period ended September 30, 2018; there were no issuances of 2017 Convertible Notes during the year ended September 30, 2019. The discount was being amortized to interest expense over the amended term of the 2017 Convertible Notes through December 31, 2018 using the straight-line method which approximated the effective interest method. The amortization expense was $62,158 and $143,166 during the year ended September 30, 2019 and the nine month transition period ended September 30, 2018, respectively. The embedded derivative was accounted for separately on a fair market value basis. The Company recorded the fair value changes of the premium debt conversion derivative associated with all of the 2017 Convertible Notes in the consolidated statements of operations which amounted to an expense of $111,195 and $11,020 during the year ended September 30, 2019 and the nine month transition period ended September 30, 2018, respectively.
The New Warrants were deemed to be free-standing instruments and were accounted initially as a liability given the variable number of shares issuable in connection with a change of control conversion event and ultimately as equity upon conversion of the 2017 Convertible Notes on February 28, 2019 discussed above. A Monte Carlo simulation model was used to estimate the aggregate fair value of the New Warrants up to the conversion date of the 2017 Convertible Notes. Input assumptions used were as follows: risk-free interest rate of 2.52% and 2.94% as of February 28, 2019 and September 30, 2018, respectively; expected volatility of 50% as of February 28, 2019 and September 30, 2018; expected life of 5.0 and 5.21 years as of February 28, 2019 and September 30, 2018, respectively; and expected dividend yield of 0% as of February 28, 2019 and September 30, 2018. The underlying stock price used in the analysis was on a non-marketable basis and was according to the market approach, considering the traded price, forward multiples from guideline public companies and recent private placement transactions, using allocation and marketability-discount methodologies. The 2017 Convertible Note proceeds assigned to the New Warrants were $442,151 during the nine month transition period ended September 30, 2018 and were recorded as a warrant liability. There were no proceeds assigned to warrants in connection with issuances of 2017 Convertible Notes during the year ended September 30, 2019. The discount was amortized to interest expense over the amended term of the 2017 Convertible Notes through December 31, 2018 using the straight-line method which approximated the effective interest method. The amortization expense was $163,060 and $375,076 for the year ended September 30, 2019 and the nine month transition period ended September 30, 2018, respectively. The Company also recorded the fair value changes of the warrant liability associated with all of the 2017 Convertible Notes in the consolidated statements of operations which amounted to an expense of $18,568 and $39,770 for the year ended September 30, 2019 and the nine month transition period ended September 30, 2018, respectively.
In connection with the 2017 Convertible Notes, the Company incurred original issuance costs in the amount of $8,133 which consisted of legal costs and were recorded as issuance cost discounts to the 2017 Convertible Notes, of which $1,431 and $2,944 was amortized to interest expense during the year ended September 30, 2019 and the nine month transition period ended September 30, 2018, respectively.
NOTE 9 - Stock-Based Compensation
During the year ended September 30, 2019 and the nine month transition period ended September 30, 2018, stock-based expense related to the stock options, restricted stock units and stock awards was included in general and administrative and research and development costs as follows in the accompanying consolidated statements of operations:
The Company’s 2016 and 2017 Equity Incentive Plans provide for the issuance of restricted shares and stock options to employees, directors, and consultants of the Company. The Company initially reserved 2,292,265 shares of common stock for issuance under the 2016 and 2017 Equity Incentive Plans on a combined basis.
Evergreen provision
Under the 2017 Plan, the shares reserved automatically increase on January 1st of each year, for a period of not more than ten years from the date the 2017 Plan is approved by the stockholders of the Company, commencing on January 1, 2019 and ending on (and including) January 1, 2027, to an amount equal to 13% of the fully-diluted shares outstanding as of December 31st of the preceding calendar year. Notwithstanding the foregoing, the Board may act prior to January 1st of a given year to provide that there will be no January 1st increase in the share reserve for such year or that the increase in the share reserve for such year will be a lesser number of shares of common stock than would otherwise occur pursuant to the preceding sentence. “Fully Diluted Shares” as of a date means an amount equal to the number of shares of common stock (i) outstanding and (ii) issuable upon exercise, conversion or settlement of outstanding awards under the 2017 Plan and any other outstanding options, warrants or other securities of the Company that are (directly or indirectly) convertible or exchangeable into or exercisable for shares of common stock, in each case as of the close of business of the Company on December 31 of the preceding calendar year. On January 1, 2019, 498,848 shares were added to the 2017 Plan as a result of the evergreen provision.
Stock Options
During the year ended September 30, 2019 and the nine month transition period ended September 30, 2018, 675,667 and 2,500 stock options were granted to employees, directors and consultants at a weighted average exercise price of $2.32 and $5.34 per share, respectively. The stock options granted during the year ended September 30, 2019 and the nine month transition period ended September 30, 2018 had a weighted average grant date fair value of $1.13 and $2.48 per share, respectively, with the vesting period ranging from being immediate to four years. The options expire ten years from the date of grant.
The following table summarizes the Company’s stock option plan activity for the year ended September 30, 2019 and the nine month transition period ended September 30, 2018 as follows:
(1)The aggregate intrinsic value is calculated as the difference between the exercise price of the underlying options and the estimated fair value of our common stock as of September 30, 2019 and 2018 of $1.87 and $2.30 per share, respectively. As of September 30, 2019, 658,730 and 271,201 outstanding and vested options, respectively, have no intrinsic value.
The weighted-average assumptions used in the Black-Scholes option-pricing model are as follows for the stock options granted during the year ended September 30, 2019 and the nine month transition period ended September 30, 2018:
During the year ended September 30, 2019, 288,138 stock options vested having a weighted average grant date fair value per option of $1.11. During the nine month transition period ended September 30, 2018, 2,500 stock options vested with the weighted average grant date fair value per option of $2.48. During the year ended September 30, 2019 and the nine month transition period ended September 30, 2018, no options were forfeited.
Restricted Stock Units
The Company issued 42,018 restricted stock units (“RSUs”) in June 2019 to members of its board of directors that vest monthly over one year upon grant of which 10,503 RSUs had vested as of September 30, 2019 for which common stock was issued. The grant date fair value of the RSUs was $2.38 per unit. There were no RSUs issued during the nine month transition period ended September 30, 2018. The total expense for the year ended September 30, 2019 related to these RSU’s was $32,223.
Other Stock-Based Awards
A total of 250,000 shares of common stock were reserved in February 2018 as a result of a consulting agreement for investor relations services executed in February 2018. Under the agreement, 50,000 and 200,000 shares of common stock were awarded during the year ended September 30, 2019 and the nine month transition period ended September 30, 2018, respectively, subject to time-based vesting conditions. The compensation expense related to the vested common shares was included in the total stock-based compensation expense referenced above which totaled $115,000 and $469,500 during the year ended September 30, 2019 and the nine month transition period ended September 30, 2018, respectively. The expense was based on the fair value of the underlying common stock at the point of vesting which, on a weighted average basis, was $2.30 and $2.35 per share during the year ended September 30, 2019 and the nine month transition period ended September 30, 2018, respectively. The underlying stock price used in the analysis was on a non-marketable basis and was according to the market approach, considering both the traded price and forward multiples from guideline public companies, using allocation and marketability-discount methodologies. As of November 2018, all shares under the February 2018 share reserve were issued from the Company’s authorized but unissued shares, but were not eligible to be issued under the 2016 or 2017 Equity Incentive Plan reserves.
In addition, the Company previously had formal obligations to issue future common stock options relating to several consulting agreements. A total of 38,874 stock options were granted in May 2019 related to those consulting agreements. The corresponding stock-based compensation expense related to the stock-based awards was included in research and development expense in the accompanying consolidated statements of operations.
As of September 30, 2019, 1,489,759 shares were available for future issuance on a combined basis under the 2016 and 2017 Equity Incentive Plans. Unrecognized stock-based compensation was $473,643 as of September 30, 2019. The unrecognized share-based expense is expected to be recognized over a weighted average period of 2.5 years.
NOTE 10 - Stockholders’ Deficit
2018 Private Placement
From July 9, 2018 through November 30, 2018 (the final closing), the Company entered into subscription agreements (each, a “Purchase Agreement”) with certain accredited investors (the “Purchasers”), pursuant to which the Company, in a private placement (the “2018 Private Placement”), agreed to issue and sell to the Purchasers units (each, a “Unit”), each consisting of (i) 1 share (each, a “Share”) of common stock and (ii) a warrant to purchase 1 share of common stock at an initial exercise price of $3.00 per share (the “2018 Warrants”). The initial closing of the 2018 Private Placement was consummated on July 9, 2018. As of the termination of the 2018 Private Placement on December 12, 2018, the Company had issued and sold an aggregate of 615,200 Units at a price of $2.50 per Unit to the Purchasers, for total gross proceeds to the Company of $1,538,000 before deducting offering expenses (170,000 and 445,200 Units were sold during the year ended September 30, 2019 and the nine month transition period ended September 30, 2018, respectively).
Under the Purchase Agreement, the Company agreed to use the net proceeds from the 2018 Private Placement to pay the outstanding principal and accrued interest on its 2017 Convertible Notes if such notes did not convert prior to maturity, to pay the principal on its unsecured term loans, for research and development, clinical studies, legal fees and sales and marketing expenses, as well as working capital and general corporate purposes. The Company granted the Purchasers indemnification rights with respect to its representations, warranties and agreements under the Purchase Agreement.
The 2018 Warrants are exercisable beginning on the date of issuance and will expire on July 9, 2023, five years from the date of the first closing. The 2018 Warrants were accounted for as free standing equity instruments and classified as additional paid-in capital in the accompanying consolidated balance sheets based on their relative fair value to the underlying common shares issued. The relative fair value of the 2018 Warrants issued during the year ended September 30, 2019 and the nine month transition period ended September 30, 2018 was $115,674 and $288,106, respectively, and was based on the Black-Scholes pricing model. Input assumptions used were as follows on a weighted average basis: a risk-free interest rate of 2.9% and 2.8% during the year ended September 30, 2019 and the nine month transition period ended September 30, 2018, respectively; expected volatility of 49.8% during the year ended September 30, 2019 and the nine month transition period ended September 30, 2018; expected life of 4.6 years and 4.9 years during the year ended September 30, 2019 and the nine month transition period ended September 30, 2018, respectively; and expected dividend yield of 0% during the year ended September 30, 2019 and the nine month transition period ended September 30, 2018. The underlying stock price used in the analysis was on a non-marketable basis and was according to the market approach, considering both the traded price and forward multiples from guideline public companies, using allocation and marketability-discount methodologies.
In February 2019, the Company amended its engagement letter with one of its placement agents in the 2018 Private Placement, HRA Capital (“HRA”), acting through its affiliate, Corinthian Partners, LLC, each of which are affiliates of one of the Company’s greater than 5% stockholders. Pursuant to the original agreement (prior to the amendment), the Company agreed to pay HRA 10% of the gross proceeds (the “HRA Fee”) received by the Company in subsequent private placement transactions from investors with whom HRA or Corinthian Partners, LLC had material contact with for purposes of the engagement letter (the “Prospects”), provided such compensation would only be paid in connection with private placement transactions that closed within 12 months of the expiration of the engagement letter (the “Tail Period”). The Company agreed to issue to HRA warrants to purchase shares of Common Stock (or common stock equivalents) in an amount equal to 10% of the shares purchased by Prospects during the Tail Period (“HRA Warrants”).
In February 2019, the Company and HRA agreed (i) to extend the Tail Period until June 30, 2019, (ii) to modify the HRA Fee so that HRA is entitled to receive a cash fee equal to 8% of the gross proceeds received by the Company from Prospects in all subsequent private placement transactions and (iii) to modify the HRA Warrants so that they are exercisable to purchase shares of Common Stock (or common stock equivalents) in an amount equal to 8% of the shares of Common Stock purchased by Prospects in subsequent private placements (collectively, the “HRA Amendments”). Upon issuance, the HRA Warrants will be immediately exercisable and expire five years from the closing of the related transaction.
In connection with the 2018 Private Placement, the Company recorded issuance costs in the amount of $18,320 and $173,067 during the year ended September 30, 2019 and the nine month transition period ended September 30, 2018, respectively. The issuance costs included commissions to the brokers equal to 8% of the gross proceeds from the sale of the Units that qualify for the commission which amounted to $6,440 and $83,800 during the year ended September 30, 2019 and the nine month transition period ended September 30, 2018, respectively. In addition to the brokers’ commission, the issuance costs included the estimated value of the 5-year warrants to be issued to the brokers to purchase an amount of common stock equal to 8% of the total amount of qualifying Shares sold in the 2018 Private Placement at an exercise price of $3.00 per share upon the close of the 2018 Private Placement which resulted in 36,096 broker warrants being issued with a fair value of $31,418 on July 1, 2019. Lastly, third party legal costs in the amount $7,340 and $62,389 comprised the balance of the issuance costs incurred during the year ended September 30, 2019 and the nine month transition period ended September 30, 2018, respectively.
In connection with the 2018 Private Placement, the Company entered into registration rights agreements with each of the Purchasers pursuant to which the Company agreed to file a registration statement with the SEC covering the resale of the shares of common stock sold in the 2018 Private Placement and the shares of common stock issuable upon exercise of the 2018 Warrants. The Company agreed to file such registration statement within 75 days of the final closing of the 2018 Private Placement. Each registration rights agreement included customary indemnification rights in connection with the registration statement. The registration statement was filed with the SEC on February 11, 2019, and declared effective by the SEC on February 28, 2019.
2019 Private Placement
On December 12, 2018, the Board of Directors of the Company terminated the 2018 Private Placement. From December 28, 2018 through July 1, 2019, the Company entered into Subscription Agreements (each, a “2019 Purchase Agreement”) with certain accredited investors (the “New Purchasers”), pursuant to which the Company, in a new private placement (the “2019 Private Placement”), agreed to issue and sell Units (the “2019 Units”), each consisting of (i) 1 share of common stock and (ii) a warrant to purchase 1 share of common stock at an initial exercise price of $3.00 per share (the “2019 Warrants”), to the New Purchasers. The initial closing of the 2019 Private Placement was consummated on December 28, 2018. The Company issued and sold an aggregate of 2,338,179 Units at $2.50 per Unit to the New Purchasers, for total gross proceeds to the Company of approximately $5,845,448 before deducting offering expenses. The 2019 Private Placement was terminated on July 1, 2019.
In connection with the 2019 Private Placement, the Company agreed to issue and sell to accredited investors up to a maximum of 4,000,000 2019 Units (the “Maximum Offering”) at a price of $2.50 per 2019 Unit for total gross proceeds to the Company of up to $10,000,000. The Maximum Offering could have been increased by the Company in its sole discretion, without notice. If the Company had issued the Maximum Offering amount, 4,000,000 shares of common stock would have been issuable upon exercise of the 2019 Warrants. Under the 2019 Purchase Agreement, the Company had agreed to use the net proceeds from the 2019 Private Placement to pay the outstanding principal and accrued interest on its convertible promissory notes if such notes do not convert prior to maturity, to pay the principal on its unsecured term loans, for research and development, clinical studies, legal fees and sales and marketing expenses, as well as working capital and general corporate purposes. The Company has granted the New Purchasers indemnification rights with respect to its representations, warranties and agreements under the 2019 Purchase Agreement.
The 2019 Warrants are exercisable beginning on the date of issuance and will expire on December 28, 2023, five years from the date of the first closing of the 2019 Private Placement. Prior to expiration, subject to the terms and conditions set forth in the 2019 Warrants, the holders may exercise the 2019 Warrants for shares of common stock by providing notice to the Company and paying the $3.00 per share exercise price for each share so exercised. The relative fair value of the 2019 Warrants issued was $1,593,559 during the year ended September 30, 2019, and was based on the Black-Scholes pricing model. Input assumptions used were on a weighted average basis as follows: a risk-free interest rate of 2.4%; expected volatility of 50.6%; expected life of 4.8 years; and expected dividend yield of 0%. The underlying stock price used in the analysis was on a non-marketable basis and was according to the market approach, considering traded price, forward multiples from guideline public companies and recent private placement transactions, using allocation and marketability-discount methodologies.
In connection with the 2019 Private Placement, Paulson Investment Company, LLC (“Paulson”) received a cash commission equal to 12% of the gross proceeds from the sale of the 2019 Units sold by Paulson. In addition to the brokers’ commission, the Company issued 193,417 warrant shares to Paulson to purchase an amount of common stock equal to 10% of the total amount of common stock sold in the 2019 Private Placement at an exercise price of $2.75 per share with a term of 5 years upon the termination of the 2019 Private Placement. HRA received a cash commission equal to 8% of the gross proceeds from the sale of the 2019 Units sold by HRA. In addition to the brokers’ commission, the Company issued 17,760 warrant shares to HRA to purchase an amount of common stock equal to 8% of the total amount of common stock sold by HRA in the 2019 Private Placement at an exercise price of $3.00 per share with a term of 5 years upon the termination of the 2019 Private Placement. Lastly, in July 2019, the Company agreed to compensate HRA with additional 5-year warrants to purchase an amount of common stock equal to 135,512 shares at an exercise price of $2.00 per share for HRA’s ultimate participation in the 2019 Private Placement.
The issuance costs incurred during the year ended September 30, 2019 under the 2019 Private Placement were $1,150,359. Issuance costs incurred through September 30, 2019 included cash commissions equal to $649,654 and third party legal costs in the amount of $153,286. In addition, issuance costs included the value of the 5-year warrants in the amount of $347,419 that were issued on July 1, 2019 to the brokers to purchase an amount of common stock equal to 346,689 shares.
Warrant Activity and Summary
The following table summarizes warrant activity during the year ended September 30, 2019 and the nine month transition period ended September 30, 2018:
The following table summarizes information about warrants outstanding at September 30, 2019:
NOTE 11 - Income Taxes
The effective tax rate for the Company for the year ended September 30, 2019 and the nine month transition period ended September 30, 2018 was zero percent. A reconciliation of income tax computed at the statutory federal income tax rate to the provision (benefit) for income taxes included in the accompanying consolidated statements of operations for the Company is as follows:
Significant components of the Company’s deferred tax assets and liabilities are summarized in the tables below as of September 30, 2019 and 2018:
As of September 30, 2019 and 2018, the Company had gross deferred tax assets of approximately $3,951,000 and $2,115,000, respectively. Realization of the deferred assets is primarily dependent upon future taxable income, if any, the amount and timing of which are uncertain. The Company has had significant pre-tax losses since its inception. The Company has not yet generated revenues and faces significant challenges to becoming profitable. Accordingly, the net deferred tax assets have been fully offset by a valuation allowance of approximately $3,951,000 and $2,115,000 as of September 30, 2019 and 2018, respectively. The U.S. net deferred tax assets will continue to require a valuation allowance until the Company can demonstrate their realizability through sustained profitability or another source of income.
As of September 30, 2019 and 2018, the Company’s federal net operating loss carryforwards were approximately $12,277,000 and $6,393,000, respectively. The Company had federal research credit carryforwards as of September 30, 2019 and 2018 of approximately $166,000 and $83,000, respectively. The federal net operating loss incurred prior to January 1, 2018 and tax credit carryforwards will begin to expire in 2036 if not utilized. Federal net operating losses incurred after December 31, 2017 will not expire. As of September 30, 2019 and 2018, the Company had state net operating loss carryforwards of approximately $12,277,000 and $6,393,000, respectively. The Company had state research credit carryforwards of approximately $110,000 and $57,000 as of September 30, 2019 and 2018, respectively. The state net operating loss carryforwards will begin to expire in 2031, if not utilized, and the state research credit carryforwards will begin to expire in 2032 if not utilized.
Utilization of the net operating loss carryforwards and credits may be subject to a substantial annual limitation due to the ownership change limitations provided by Section 382 of the Internal Revenue Code of 1986, as amended, and similar state provisions. Generally, in addition to certain entity reorganizations, the limitation applies when one or more “5-percent shareholders” increase their ownership, in the aggregate, by more than 50 percentage points over a 36-month testing period or beginning the day after the most recent ownership change, if shorter. The annual limitation may result in the expiration of net operating losses and credits before utilization.
In accordance with ASC 740, Income Taxes (“ASC 740”), specifically related to uncertain tax positions, a Company is required to use a recognition threshold and a measurement attribute for the financial statement recognition and measurement of tax positions taken or expected to be taken in a tax return. For those benefits to be recognized, a tax position must be more likely than not to be sustained upon examination by taxing authorities. The Company believes its income tax filing positions and deductions will be sustained upon examination, and accordingly, no reserves or related accruals for interest and penalties have been recorded at September 30, 2019 and 2018.
In accordance with this guidance, the Company has adopted a policy under which, if required to be recognized in the future, interest related to the underpayment of income taxes will be classified as a component of interest expense and any related penalties will be classified in operating expenses in the consolidated statements of operations.
The Company’s corporate returns are subject to examination for the 2016, 2017 and 2018 tax years for federal and subject to examination for the 2016, 2017 and 2018 tax years in one state jurisdiction.
NOTE 12 - Defined Contribution Plan
The Company has a 401(k) defined contribution plan (the “401K Plan”) for all employees over age 21. Employees can defer up to 100% of their compensation through payroll withholdings into the 401K Plan subject to federal law limits. The Company matches 100% of deferrals up to 3% of one’s contributions. The Company’s matching contributions to employee deferrals are discretionary. The Company may also make discretionary profit sharing contributions under the 401K Plan in the future, but it has not done so through September 30, 2019.
Employee contributions and any employer matching contributions made to satisfy certain non-discrimination tests required by the Internal Revenue Code are 100% vested upon contribution. Discretionary employer matches to employee deferrals vest over a six year period beginning on the second anniversary of an employee’s date of hire. Discretionary profit sharing contributions vest over a five year period beginning on the first anniversary of an employee’s date of hire. The amount of matching contributions made during the year ended September 30, 2019 and the nine month transition period ended September 30, 2018 was a benefit reduction of $(4,359) and $7,779, respectively.
NOTE 13 - Subsequent Events
Facility Lease
On October 7, 2019, the Company entered into a lease agreement (the “Lease”) with Biynah Cleveland, LLC, BIP Cleveland, LLC, and Edenvale Investors (together, the “Landlord”) pursuant to which the Company has agreed to lease office space located at 7599 Anagram Drive, Eden Prairie, Minnesota (the “Premises”). The Company took possession of the Premises on November 1, 2019, with the term of the Lease ending 65 months after such date, unless terminated earlier (the “Term”).
The initial base rent for the Premises is $6,410 per month for the first 17 months, increasing to $7,076 per month by the end of the Term, and adjustable in accordance with the terms of the lease. In addition, as long as the Company is not in default under the Lease Agreement, the Company shall be entitled to an abatement of its base rent for the first 5 months. In addition, the Company will pay its pro rata share of the Landlord’s annual operating expenses associated with the premises, calculated as set forth in the Lease.
Common Stock Offering
On October 23, 2019, the Company entered into Securities Purchase Agreements with certain accredited investors, pursuant to which the Company, in a private placement, has issued and sold 141,666 shares of the Company’s common stock to the accredited investors at a price of $1.80 per share, for gross proceeds amounting to $0.3 million before deducting offering expenses.
In connection with the private placement, the Company has agreed to issue and sell to accredited investors up to a maximum of 555,555 shares for total gross proceeds to the Company of up to $1,000,000. The Company intends to use the net proceeds from this private placement for funding operations or working capital and general corporate purposes. The Company has agreed to file a registration statement with the SEC covering the resale of the shares of common stock sold in the private placement within 60 days of the termination of the private placement.
Paulson Convertible Notes Offering
On November 1, 2019, the Company entered into a subscription agreement with certain accredited investors, pursuant to which the Company, in a private placement, agreed to issue and sell to the investors 13% convertible promissory notes (each, a “Paulson Note” and collectively, the “Paulson Notes”) and warrants (each, a “Paulson Warrant” and collectively, the “Paulson Warrants”) to purchase shares of the Company’s common stock.
The initial closing of the private placement was consummated on November 1, 2019, and, on that date and through December 3, 2019, the Company issued Paulson Notes in an aggregate principal amount of $3,234,800 to the Subscribers for gross proceeds equaling the principal amount. The private placement terminated on December 3, 2019.
The Paulson Notes bear interest at a fixed rate of 13% per annum and require the Company to repay the principal and accrued and unpaid interest thereon on May 1, 2020. If the Company raises more than $3,000,000 in an equity financing before the Maturity Date (the “Qualified Financing”), each subscriber shall have the option to convert the outstanding principal and accrued and unpaid interest of such subscriber’s Paulson Note (the “Outstanding Balance”) into the securities issued by the Company in such Qualified Financing in an amount equal to (i) the Outstanding Balance divided by (ii) the lower of 0.6 multiplied by (A) the actual per share price of securities issued by the Company in the Qualified Financing and (B) the ten day volume weighted average closing price of the common stock prior to the first closing of a Qualified Financing. If a change of control transaction occurs prior to the earlier of a Qualified Financing or the maturity date, the Paulson Notes would become payable on demand as of the closing date of such transaction. Change of control means a merger or consolidation with another entity in which the Company’s stockholders do not own more than 50% of the outstanding voting power of the surviving entity or the disposition of all or substantially all of the Company’s assets.
Each Paulson Warrant grants the holder the option to purchase the number of shares of common stock equal to (i) 0.5 multiplied by (ii) the principal amount of such subscriber’s Paulson Notes divided by 1.87, with an exercise price per share equal to $1.87. As of the final closing on December 3, 2019, the Company issued Paulson Warrants exercisable for 864,913 shares of Common Stock in connection with all closings of the private placement. The Paulson Warrants are immediately exercisable and expire on November 1, 2022. The exercise price is subject to adjustment in the event of any stock dividends or splits, reverse stock split, recapitalization, reorganization or similar transaction, as described therein.
In connection with the private placement, Paulson Investment Company (“Paulson”) will receive a cash commission equal to 12% of the gross proceeds from the sale of the Paulson Notes, and 10-year warrants to purchase an amount of Common Stock equal to 15% of the total amount of shares of Common Stock into which the Paulson Notes are convertible, at an exercise price equal to the offering price of the Company’s securities in the next Qualified Financing.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
Disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the Exchange Act) are controls and other procedures that are designed to provide reasonable assurance that that information required to be disclosed in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer, as appropriate, to allow timely decisions regarding required disclosure.
As of September 30, 2019, our management, with the participation of our Chief Executive Officer, has evaluated the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed in the reports we file or submit under the Exchange Act is accumulated and communicated to management, including our Chief Executive Officer, as appropriate, to allow timely decisions regarding required disclosure. Based on this evaluation, our Chief Executive Officer concluded that our disclosure controls and procedures were effective at the reasonable assurance level as of September 30, 2019.
Management’s Annual Report on Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles. Internal control over financial reporting includes those policies and procedures that: (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with U.S. generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorizations of our management and Board; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on the financial statements.
Our management, including our Chief Executive Officer, recognizes that our internal control over financial reporting cannot prevent or detect all errors and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. The design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Further, because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, have been detected. The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.
Management, with the participation of the Chief Executive Officer, assessed our internal control over financial reporting as of September 30, 2019, the end of our fiscal year. Management based its assessment on criteria established in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.
Remediation of Previously Reported Material Weaknesses
During the nine month transition period ended September 30, 2018, management identified material weaknesses in our internal control over financial reporting stemming primarily from our small size which included the inability to (i) maintain effective controls over accounting for non-routine and/or complex debt and equity transactions and (ii) maintain effective controls over the financial statement close and reporting process and accounting for routine transactions, due to an overall lack of segregation of duties resulting from the limited number of employees we have. These material weaknesses were remediated as of September 30, 2019.
To remediate the material weaknesses described above and prevent similar deficiencies in the future, throughout fiscal 2019 we added additional controls and procedures, including: (i) the addition of an independent review of non-routine transactions by a person independent from the preparer, consultation from third party advisors proactively, when necessary, for assessing complex debt and equity transactions; (ii) an independent review of account reconciliations completed by the preparer in conjunction with the financial statement close process; (iii) controls around cash disbursements and payroll expenses to address segregation of duties and (iv) re-design of internal controls to ensure more timely reviews of technical accounting positions.
During the fourth quarter of 2019, we completed our testing of the operating effectiveness of the implemented controls and found them to be effective. As a result, we have concluded the material weaknesses have been remediated as of September 30, 2019.
We cannot assure you that material weaknesses or significant deficiencies will not occur in the future and that we will be able to remediate such weaknesses or deficiencies in a timely manner, which could impair our ability to accurately and timely report our financial position, results of operations or cash flows. See the related Risk Factor included in this Annual Report on Form 10-K.
Management’s report is not deemed filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, or otherwise subject to the liabilities of that section, unless we specifically state in a future filing that such report is to be considered filed.
This Annual Report does not include an attestation report of our independent registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by our independent registered public accounting firm pursuant to rules of the SEC that permit us to provide only management’s report in this Annual Report, as a smaller reporting company.
Changes in Internal Control Over Financial Reporting
Except as noted above regarding the implementation of internal controls in connection with our remediation plan for the material weaknesses identified during the nine month transition period ended September 30, 2018, no other changes in our system of internal control over financial reporting occurred during the quarter ended September 30, 2019 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
ITEM 9B.
ITEM 9B. OTHER INFORMATION
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The information required by this item is set forth under the following captions in our proxy statement to be filed with respect to the 2020 annual meeting of shareholders (the “Proxy Statement”), all of which is incorporated herein by reference: “Proposal No. 1 - Election of Directors”, “Board Matters - The Board of Directors”, “Board Matters - Committees of the Board”, “Board Matters - Corporate Governance” and “Additional Information - Requirements for Submission of Shareholder Proposals and Nominations for 2020 Annual Meeting.”
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION.
The information required by this item set forth under the following captions in our Proxy Statement, all of which is incorporated herein by reference: “Named Executive Officer Compensation Tables” and “Board Matters - Director Compensation.”
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The information required by this item is set forth under the following captions in our Proxy Statement, all of which is incorporated herein by reference: “Additional Information - Equity Compensation Plans” and “Security Ownership of Certain Beneficial Owners and Management.”
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE
Certain Relationships and Related Transactions
The information required by this item is set forth under the following captions in our Proxy Statement, all of which is incorporated herein by reference: “Related Person Transactions” and “Proposal No. 1 - Election of Directors - Director Independence.”
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
The information required by this item is set forth under the following captions in our Proxy Statement, which is incorporated by reference herein by reference: “Audit Committee Matters.”
PART IV
ITEM 15.
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
The following documents are filed as part of this Annual Report:
(1)Financial Statements: The financial statements filed as part of this Annual Report are listed in Part II, Item 8.
(2)Financial Statement Schedules:
No financial statement schedules are provided because the information called for is not required or is shown either in the financial statements or notes thereto.
(3)Exhibits: The exhibits incorporated by reference or filed as part of this Annual Report are listed in the Index to Exhibits below.
* Pursuant to Item 601(b)(2) of Regulation S-K, the Registrant agrees to furnish supplementally a copy of any omitted schedule or exhibit to the Agreement and Plan of Merger to the Securities and Exchange Commission upon request.
# Portions of this exhibit have been omitted pursuant to a request for confidential treatment and have been separately filed with the Securities and Exchange Commission.
+ Indicates management contract or compensatory plan.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this Annual Report to be signed on its behalf by the undersigned, thereunto duly authorized.
Pursuant to the requirements of the Securities Exchange Act of 1934, this Annual Report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
SIGNATURE
TITLE
DATE
/s/ DAVID ROSA
Chief Executive Officer and Director
December 20, 2019
David Rosa
(Principal Executive Officer and Principal Financial Officer)
/s/ PAUL BUCKMAN
Chairman of the Board of Directors
December 20, 2019
Paul Buckman
/s/ SURAJ KALIA
Member of the Board of Directors
December 20, 2019
Suraj Kalia
/s/ JEFFREY MATHIESEN
Member of the Board of Directors
December 20, 2019
Jeffrey Mathiesen