Spotlight Innovation Inc (AEXP) SEC Quarterly Report (10-Q) for Q3 2016

SPOTLIGHT INNOVATION INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

NOTE 1. DESCRIPTION OF BUSINESS AND BASIS OF PRESENTATION

Spotlight Innovation Inc. (the "Company") was organized under the laws of the state of Nevada on March 23, 2012 under the name Spotlight Innovation, LLC. In December 2013, the Company, through a reverse acquisition, merged with American Exploration Corporation ("American Exploration"). The Company is a life science company that identifies and acquires rights of innovative, proprietary technologies designed to address unmet medical needs, with an emphasis on rare, emerging and neglected diseases. To find and evaluate unique opportunities, we leverage our extensive relationships with leading scientists, academic institutions and other sources. We provide value-added development capability to accelerate progress. When scientifically significant benchmarks have been achieved, we will endeavor to partner with proven market leaders via sale, out-license or strategic alliance.

As of September 30, 2016, the Company had five subsidiaries: Celtic Biotech Iowa, Inc., Memcine Pharmaceuticals, Inc. (see Note 10 below), CDT Veterinary Therapeutics, Inc., Zika Therapeutics, Inc. and Caretta Therapeutics, Inc.

Celtic Biotech Iowa, Inc.

On June 4, 2014, Celtic Biotech Iowa, Inc. (hereinafter "Celtic Iowa," a subsidiary of the Company) acquired Celtic Biotech Limited (hereinafter "Celtic Limited"). Celtic Limited was founded in 2003 in Dublin, Ireland and is developing novel and highly specialized compounds derived from snake venom, for the treatment of solid cancers and cancer imaging.

Memcine Pharmaceuticals, Inc.

The Company acquired approximately 82% of Memcine Pharmaceuticals, Inc. ("Memcine") in June 2015. The Company agreed to provide Memcine with up to $3,000,000 to fund the operations of Memcine via investment, grants or other means over the course of operations, upon the achievement of certain milestones, as determined by the board of directors of Memcine. Memcine, founded in 2010, holds the exclusive worldwide rights to Immunoplex,™, a vaccine platform technology developed at the University of Iowa, with universal application to numerous antigens developed to improve vaccine efficacy by using more efficient targeting and delivery.

On October 12, 2016, the Company terminated its interests in Memcine (see Note 10 below).

CDT Veterinary Therapeutics, Inc.

CDT Veterinary Therapeutics was formed in November 2015 to create reformulated variants of certain compounds, modified to meet the needs of the veterinary market. In September 2016, the Company decided to temporarily suspend its activities in CDT Veterinary Therapeutics, Inc.

Caretta Therapeutics, Inc.

Caretta Therapeutics, Inc. ("Caretta") was formed in August 2016 to develop the commercialization of over-the-counter products. Caretta holds a license agreement to develop, manufacture and sell certain products derived from snake venom that may have analgesic properties.

Zika Therapeutics, Inc.

Zika Therapeutics, Inc. ("ZT") was formed in August 2016 to pursue the therapeutic treatment for this emerging health threat. On August 19, 2016, the Company entered a Sponsored Research Agreement (the "SRA") with the Florida State University Research Foundation ("FSURF") starting September 1, 2016, to perform certain research, over a two-year period, related to the discovery, synthetic modification, and preclinical validation of drug-like compounds intended to treat patients with Zika virus infection to be directed by Dr. Hengli Tang.

Basis of Presentation

The accompanying consolidated financial statements of the Company have been prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP") and the rules of the Securities and Exchange Commission ("SEC") and should be read in conjunction with the audited financial statements and notes thereto contained in the Company's latest Annual Report filed with the SEC on Form 10-K. In the opinion of management, all adjustments, consisting of normal recurring adjustments, necessary for a fair presentation of the financial position and the results of operations for the interim periods presented have been reflected herein. The results of operations for interim periods are not necessarily indicative of the results to be expected for the full year. Notes to the financial statements that would substantially duplicate disclosures contained in the audited financial statements for the most recent fiscal year, as reported in the Form 10-K for the period ended December 31, 2015 filed with the SEC, have been omitted.

NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Use of Estimates

The preparation of consolidated 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 revenue and expenses during the reporting period. Actual results could differ from those estimates. Significant estimates include those regarding the valuation of option and warrant transactions.

Principles of Consolidation

The consolidated financial statements include the Company's accounts, including those of the Company's subsidiaries Celtic Iowa and Memcine. During the year ended December 31, 2014 the Company acquired 95% of the outstanding shares of Celtic Biotech. During the year ended December 31, 2015, the Company acquired 82.25% of the outstanding shares of Memcine. Accordingly, the Company has consolidated Celtic Limited, Celtic Iowa and Memcine. All significant intercompany accounts and transactions have been eliminated.

Non-Controlling Interest

The Company is required to report the non-controlling interest in Celtic Limited, a subsidiary of Celtic Iowa, and Memcine, as a separate component of shareholders' equity. The Company is also required to present the consolidated net income and the portion of the consolidated net income allocable to the non-controlling interest and to the shareholders of the Company separately in its consolidated statements of operations. Losses applicable to the non-controlling interest are allocated to the non-controlling interest even when those losses are in excess of the non-controlling interest's investment basis.

Loss per Common Share

Basic net income (loss) per common share is computed by dividing the net income (loss) attributable to common shareholders by the weighted-average number of common shares outstanding during the period. Diluted net income (loss) per share is computed by dividing the net income (loss) attributable to common shareholders by the weighted-average number of common and common equivalent shares outstanding during the period. Common share equivalents included in the diluted computation represent shares issuable upon assumed exercise of stock options and warrants or the assumed conversion of convertible debt instruments, using the treasury stock and "if converted" method. For periods in which net losses are incurred, weighted average shares outstanding is the same for basic and diluted loss per share calculations, as the inclusion of common share equivalents would have an anti-dilutive effect.

For the nine months ended September 30, 2016 and 2015, the dilutive effect of the issuance of 448,571 and 5,200 options, 208,500 and 885,000 warrants, and 3,317,971, and 1,774,650 common shares issuable for conversion of convertible debt, respectively, were excluded from the diluted earnings per share calculation because their effect would have been anti-dilutive.

Cash and Cash Equivalents

The Company considers all highly liquid investments with maturity of three months or less when purchased to be cash equivalents.

Concentrations of Credit Risk

Financial instruments which potentially subject the Company to concentrations of credit risk include cash deposits placed with financial institutions. The Company maintains its cash in bank accounts which, at times, may exceed federally insured limits as guaranteed by the Federal Deposit Insurance Corporation ("FDIC"). As of September 30, 2016, the Company had $0 of cash balances that were uninsured. The Company has not experienced any losses on such accounts.

Foreign exchange and currency translation

For the three months ended September 30, 2016 and 2015, the Company maintained cash accounts in U.S. Dollars and European Union euros, and incurred certain expenses denominated in European Union euros. The Company's and its consolidated subsidiaries' functional and reporting currency is the U.S. Dollar. Transactions denominated in foreign currencies are remeasured into U.S. Dollars at exchange rates in effect on the date of the transactions. Assets and liabilities are remeasured using exchange rates at the end of each period. Exchange gains or losses on re-measurements are included in earnings.

In the event that the functional currency of a Company's consolidated subsidiary was not the U.S. Dollar, then that subsidiary's foreign currency monetary assets and liabilities are translated into U.S. Dollars at the current exchange rate and non-monetary assets and liabilities are translated using historical exchange rates. Such adjustments resulting from the translation process would be reported in a separate component of other comprehensive income and are not included in the determination of the results of operations. As of September 30, 2016, and 2015, the Company had no subsidiaries with functional currencies that required translation.

In-Process Research and Development

In-process research and development ("IPR&D") represents the estimated fair value assigned to research and development projects acquired in a purchased business combination that have not been completed at the date of acquisition and which have no alternative future use. IPR&D assets acquired in a business combination are capitalized as indefinite-lived intangible assets. These assets remain indefinite-lived until the completion or abandonment of the associated research and development efforts. During the periods prior to completion or abandonment, those acquired indefinite-lived assets are not amortized but are tested for impairment annually, or more frequently, if events or changes in circumstances indicate that the asset might be impaired. During periods after completion, those acquired indefinite-lived assets are amortized based on their useful life. 

Equipment

Equipment is stated at cost less accumulated depreciation and amortization. Maintenance and repairs are charged to expense as incurred. Renewals and betterments which extend the life or improve existing equipment are capitalized. Upon disposition or retirement of equipment, the cost and related accumulated depreciation are removed and any resulting gain or loss is reflected in operations. Depreciation is provided using the straight-line method over the estimated useful lives of the assets, which is 3-10 years.

Impairment of Long-Lived Assets and Intangibles

The Company performs impairment tests on its long-lived assets when circumstances indicate that their carrying amounts may not be recoverable. If required, recoverability is tested by comparing the estimated future undiscounted cash flows of the asset or asset group to its carrying value. If the carrying value is not recoverable, the asset or asset group is written down to fair value. For the nine months ended September 30, 2016 and 2015, the Company recorded $0 in impairment to the Company's long-lived assets. 

Stock-Based Compensation

The Company measures the cost of employee services received in exchange for stock and stock options based on the grant date fair value of the awards. The Company determines the fair value of stock option grants using the Black-Scholes option pricing model. The Company determines the fair value of shares of non-vested stock (also commonly referred to as restricted stock) based on the last quoted price of our stock on the date of the share grant. The fair value determined represents the cost for the award and is recognized over the vesting period during which an employee is required to provide service in exchange for the award. As share-based compensation expense is recognized based on awards ultimately expected to vest, the Company reduces the expense for estimated forfeitures based on historical forfeiture rates, if such historical forfeiture rates are available. Previously recognized compensation costs may be adjusted to reflect the actual forfeiture rate for the entire award at the end of the vesting period. Excess tax benefits, if any, are recognized as an addition to paid-in capital.

Income Taxes

The Company utilizes the asset and liability method in accounting for income taxes. Under this method, deferred tax assets and liabilities are recognized for operating loss and tax credit carry-forwards and for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the year in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the results of operations in the period that includes the enactment date. A valuation allowance is recorded to reduce the carrying amounts of deferred tax assets unless it is more likely than not that the value of such assets will be realized. 

Fair Value of Financial Instruments

The Company follows FASB ASC 820, Fair Value Measurement ("ASC 820"), which clarifies fair value as an exit price, establishes a hierarchal disclosure framework for measuring fair value, and requires extended disclosures about fair value measurements. The provisions of ASC 820 apply to all financial assets and liabilities measured at fair value.

As defined in ASC 820, fair value, clarified as an exit price, represents the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. As a result, fair value is a market-based approach that should be determined based on assumptions that market participants would use in pricing an asset or a liability.

As a basis for considering these assumptions, ASC 820 defines a three-tier value hierarchy that prioritizes the inputs used in the valuation methodologies in measuring fair value.

The fair value hierarchy also requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.

Subsequent Events

The Company evaluated subsequent events through the date when financial statements are issued for disclosure consideration.

Recent Accounting Pronouncements

There were various accounting standards and interpretations issued recently, none of which are expected to have a material effect on the Company's operations, financial position or cash flows.

NOTE 3. GOING CONCERN

The Company is an early stage company and as such has not generated revenues from operations and there is no assurance of any future revenues. The accompanying financial statements have been prepared assuming that the Company will continue as a going concern, which contemplates, among other things, the realization of assets and satisfaction of liabilities in the normal course of business. As of September 30, 2016, the Company had accumulated net losses of $23,171,473, and had a working capital deficit of $5,446,418. These factors raise substantial doubt as to the Company's ability to continue as a going concern.

The ability of the Company to continue as a going concern is dependent upon the Company's successful efforts to raise sufficient capital and then attain profitable operations. Management is investigating all options to raise enough funds to meet the Company's working capital requirements through either the sale of the Company's common stock or other financings. There can be no assurances, however, that management will be able to obtain sufficient additional funds when needed, or that such funds, if available, will be obtained on terms satisfactory to the Company.

NOTE 4. NOTES PAYABLE

On December 16, 2013, the Company assumed the liabilities of American Exploration which included the following notes payable too unrelated third parties:

The Company also assumed $92,923 in accrued interest related to these notes. The Company recorded $21,861 and $21,540 in interest expense for the nine months ended September 30, 2016 and 2015, respectively, on the above notes payable. On September 1, 2016, the Company agreed to a settlement and release agreement with Pierco Management as set forth in the table below:

The Company and Pierco Management agreed to the following:

The Company also assumed a liability for previous advances made by American Exploration's former CEO in the amount of $23,433 of which the Company repaid $3,500 in calendar year 2015 bringing the balance to the current $19,933 at September 30, 2016. These advances are due on demand and do not bear interest.

On December 31, 2015 recorded a guarantee for one of the lenders in the amount of $34,529.

On September 6, 2016, the Company agreed to assume the unpaid interest for the portion of the April and July Letters-of-Credit with Denver Savings Bank that was to be paid from the debt service reserve as set forth in the Termination and Release Agreements in December 2015. The assumption of the interest resulted in the Company recording an additional $83,441 of interest expense for the nine months ended September 30, 2016.

NOTE 5. CONVERTIBLE INSTRUMENTS

Discussion concerning convertible instruments can be found in Note 7 below.

NOTE 6. INCOME TAXES

Realization of deferred tax assets is dependent upon sufficient future taxable income during the period that deductible temporary differences and carry-forwards are expected to be available to reduce taxable income.

At September 30, 2016, the Company's deferred tax assets consisted primarily of net operating loss carry forwards acquired in connection with the merger. For the nine months ended September 30, 2016 and 2015, the material reconciling items between the tax benefit computed at the statutory rate and the actual benefit recognized in the financial statements consisted of expenses related to share-based compensation and the change in the valuation allowance during the applicable period. At September 30, 2016 and 2015, the Company has recorded a 100% valuation allowance as management believes it is likely that any deferred tax assets will not be realized.

As of September 30, 2016, the Company has a net operating loss carry forward of approximately $21 million, which will expire between years 2028 and 2035. Due to the change in ownership provisions of the Tax Reform Act of 1986, our net operating loss carry forwards are expected to be subject to significant annual limitations for the change in ownership that resulted in the Merger.

NOTE 7. EQUITY

The Company has authorized the issuance of 500,000 shares of Series A preferred stock, 500,000 shares of Series C preferred stock, 4,000,000 shares of preferred stock and 4,000,000,000 shares of common stock.

Common Stock

On January 11, 2016, a holder exercised warrants to purchase 100,000 shares of common stock. The exercise price was 60% of the average closing market price for the 20 consecutive trading days preceding the exercise date. Total proceeds received from the exercise was $55,140. On September 8, 2016, the Company sold 108,695 shares for $50,000 in proceeds.

Common Stock Issued for Services

The Company issued common stock for services in April, August, and September, 2016. The table below details the issuances:

Through the nine months ending September 30, 2016, the Company issued 905,000 shares of common stock for services to the Company. The fair value of the common stock at issue dates totaled $470,750 and has been recorded as stock compensation expense.

On September 25, 2016, the Company issued 278,108 shares of common stock for vendor services in accordance with the vendor agreement. The shares had a fair value as issue date of $96,782 and was charged to marketing expense.

Convertible Notes

During the quarter ended September 30, 2016, the Company issued $695,000 in principal amount of convertible notes. The material terms of the notes are as follows:

The Company also issued warrants to purchase 208,500 shares of common stock of the Company (the number of shares is equal to thirty percent of the amount invested in the notes based on the exercise price of the warrants (the exercise price is defined as 110% of the closing bid price of the common stock of the Company on the six month anniversary of the issuance date of the note)).

In connection with the issuance of the notes, Caretta entered into a Royalty Agreement with the investors thereof, whereby the investors will share, pro rata, during years two, three and four of Caretta as follows:

On September 19, 2016, the nine holders of an aggregate of $850,000 principal amount of convertible notes (originally issued in December, 2015 and January, 2016, collectively referred to as the "Notes") agreed to convert the Notes into an aggregate of 3,317,971 shares of common stock. The shares of common stock of the Company were issued pursuant to the terms of the Notes, at a conversion price equal to the average of the closing price of the common stock of the Company for the twenty days preceding August 24, 2016, plus one share of common stock per one dollar principal amount of Notes converted.

The foregoing securities were issued pursuant to Section 4(a)(2) of the Securities Act and/or Regulation D promulgated thereunder.

Options

2009 Plan

In 2009, the Company adopted the 2009 Stock Option Plan (the "2009 Plan"). The 2009 Plan allows the Company to issue options to officers, directors and employees, as well as consultants, to purchase up to 7,000,000 shares of common stock.

As of September 30, 2016, there are 5,200 stock options outstanding under the 2009 Plan which were issued prior to the merger. These stock options were valued at $6,934 using the Black-Scholes model which was included in the purchase price of American Exploration.

2015 Equity Incentive Plan

On November 25, 2015, the Company authorized the Spotlight Innovation Inc. 2015 Equity Incentive Plan (the "Plan") to:

The total number of shares of common stock which may be issued under the options granted pursuant to the Plan is 3,600,000. The shares covered by the portion of any grant under the plan which expires unexercised shall become available again for grant under the plan.

During the quarter ended September 30, 2016, the Company issued options to purchase 448,571 shares of common stock to a former member of the Board of Directors and current Board of Director members. A summary of the stock option activity for the nine months ended September 30, 2016 is presented below.

Warrants

During the nine months ended September 30, 2016, a holder exercised warrants to purchase 100,000 shares of common stock at a price of $0.5514 per share for total proceeds of $55,140.

A summary of the warrant activity for the nine months ended September 30, 2016 is presented below:

The weighted average remaining contractual term of the outstanding warrants and exercisable warrants as of September 30, 2016 is 1.26 years.

During the quarter ended September 30, 2016, the Company issued warrants to purchase 208,500 shares of common stock in connection with the convertible notes described above. The warrants are exercisable in whole or in part during a term of three years commencing on the issuance date.

NOTE 8. RELATED PARTY TRANSACTIONS

As a result of the acquisition of Celtic Limited, Celtic Iowa assumed two short-term notes payable due to a related party (the mother of the founder of Celtic). The debt is denominated in Euros and on June 4, 2014, the date of the acquisition, the carrying amount of the debts were $204,186 after foreign currency remeasurement. The notes accrue compounded interest at 5% per annum and were due in November and December 2014. As of September 30, 2016, these notes are still outstanding and the carrying amount of these notes is $168,515. In March 2016, the Company negotiated an extension for both notes to December 31, 2017.

NOTE 9. SUBSEQUENT EVENTS

On October 12, 2016, the Company entered into a Termination Agreement with Memcine, the University of Iowa Research Foundation, and Dr. Tony Vanden Bush. Pursuant to the termination agreement, the Company terminated and cancelled all of its interest in Memcine, terminated the shareholder agreement of Memcine, and John Krohn and Cristopher Grunewald resigned as officers and directors of Memcine.

On October 18, 2016, the Company entered into a Forbearance and Refinancing Agreement (the "Refinancing Agreement") with K4 to refinance certain financial instruments. Pursuant to the Refinancing Agreement, the Company and K4 agreed as follows: