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TROV > SEC Filings for TROV > Form 10-K on 1-Apr-2013All Recent SEC Filings

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Form 10-K for TROVAGENE, INC.


1-Apr-2013

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Forward-Looking Statements

The information in this report contains forward-looking statements. All statements other than statements of historical fact made in this report are forward looking. In particular, the statements herein regarding industry prospects and future results of operations or financial position are forward-looking statements. These forward-looking statements can be identified by the use of words such as "believes," "estimates," "could," "possibly," "probably," anticipates," "projects," "expects," "may," "will," or "should" or other variations or similar words. No assurances can be given that the future results anticipated by the forward-looking statements will be achieved. Forward-looking statements reflect management's current expectations and are inherently uncertain. Our actual results may differ significantly from management's expectations.

The following discussion and analysis should be read in conjunction with our financial statements, included herewith. This discussion should not be construed to imply that the results discussed herein will necessarily continue into the future, or that any conclusion reached herein will necessarily be indicative of actual operating results in the future. Such discussion represents only the best present assessment of our management.

Overview

From August 4, 1999 (inception) through December 31, 2012, we have sustained cumulative total deficit of approximately $55.2 million. From inception through December 31, 2012, we have generated minimal out-licensing, royalty and milestone revenues and expect to incur additional losses to perform further research and development activities and do not currently have any commercial biopharmaceutical products. We expect to commence commercialization of our first products in 2013.

Our product development efforts are in their early stages and we cannot make estimates of the costs or the time they will take to complete. The risk of completion of any program is high because of the many uncertainties involved in bringing new drugs to market including the long duration of clinical testing, the specific performance of proposed products under stringent clinical trial protocols, the extended regulatory approval and review cycles, our ability to raise additional capital, the nature and timing of research and development expenses and competing technologies being developed by organizations with significantly greater resources.

CRITICAL ACCOUNTING POLICIES

Financial Reporting Release No. 60 requires all companies to include a discussion of critical accounting policies or methods used in the preparation of financial statements. Our accounting policies are described in Item 15. Financial Statements-Note 2 Basis of Presentation and Summary of Significant Accounting Policies. The preparation of financial statements in conformity with U.S. GAAP 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


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reporting period. Actual results could differ from those estimates. We believe that the following discussion represents our critical accounting policies.

Royalty and License Revenues

We license and sublicense our patent rights to healthcare companies, medical laboratories and biotechnology partners. These agreements may involve multiple elements such as license fees, royalties and milestone payments. Revenue is recognized for each element when there is persuasive evidence that an arrangement exists, delivery has occurred, the price is fixed or determinable, and collection is reasonably assured.

Up-front nonrefundable license fees pursuant to agreements under which we have no continuing performance obligations are recognized as revenues on the effective date of the agreement and when collection is reasonably assured.

Minimum royalties are recognized as earned, and royalties in excess of minimum amounts are recognized upon receipt of payment when collection is assured.

Milestone payments are recognized when both the milestone is achieved and the related payment is received.

Allowance for Doubtful Accounts

We review the collectability of accounts receivable based on an assessment of historic experience, current economic conditions, and other collection indicators. At December 31, 2012 and 2011, we have not recorded an allowance for doubtful accounts. When accounts are determined to be uncollectible, they are written off against the reserve balance and the reserve is reassessed. When payments are received on reserved accounts, they are applied to the individual's account and the reserve is reassessed. Accounts receivable of $168,381 at December 31, 2012 represents both minimum royalty payments and license fees due as of that date, while $99,140 at December 31, 2011, represents the minimum royalty payments due as of that date.

Derivative Financial Instruments-Warrants

Our derivative liabilities are related to warrants issued in connection with financing transactions and are therefore not designated as hedging instruments. All derivatives are recorded on our balance sheet at fair value in accordance with current accounting guidelines for such complex financial instruments.

We have issued common stock warrants in connection with the execution of certain equity and debt financings. Such warrants are classified as derivative liabilities under the provisions of FASB ASC 815 Derivatives and Hedging ("ASC 815") , and are recorded at their fair market value as of each reporting period. Such warrants do not meet the exemption that a contract should not be considered a derivative instrument if it is (1) indexed to its own stock and (2) classified in stockholders' equity. Changes in fair value of derivative liabilities are recorded in the consolidated statement of operations under the caption "Change in fair value of derivative instruments."

The fair value of warrants is determined using the Black-Scholes option-pricing model using assumptions regarding volatility of our common share price, remaining life of the warrant, and risk-free interest rates at each period end. We thus use model-derived valuations where inputs are observable in active markets to determine the fair value and accordingly classify such warrants in Level 3 per ASC 820. At December 31, 2012 and 2011, the fair value of such warrants was $6,252,760 and $994,627, respectively, which are included in the derivative financial instruments' liability on our balance sheet.

We issued units that were price protected during the years ended December 31, 2012 and 2011, respectively. Based upon our analysis of the criteria contained in ASC Topic 815-40, we have determined that these price protected units issued in connection with the private placements must be recorded as derivative liabilities with a charge to additional paid in capital. The fair value of these price protected units at issuance was estimated using the binomial option pricing model. The binomial model requires the input of variable inputs over time, including the expected stock price volatility, the expected price multiple at which unit holders are likely to exercise their warrants and the expected forfeiture rate. We use historical data to estimate forfeiture rate and expected stock price volatility within the binomial model. The risk-free rate for periods within the contractual life of the warrant is based on the U.S. Treasury yield curve in effect at the date of grant for the expected term of the warrant. At December 31, 2012 and 2011, the fair value of such price protected units was $2,512,868 and $2,846,017, respectively, which are included in the derivative financial instruments' liability on our balance sheet.


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At December 31, 2012 and 2011, the total fair value of all warrants and price protected units, valued using the Black-Scholes option-pricing model and the Binomial option pricing model was $8,765,628 and $3,840,644, respectively, which we classified as derivative financial instruments liability on our balance sheet.

Research and Development

Research and development costs, which include expenditures in connection with an in-house research and development laboratory, salaries and staff costs, application and filing for regulatory approval of proposed products, purchased in-process research and development, regulatory and scientific consulting fees, clinical samples as well as clinical collaborators and insurance, are accounted for in accordance with ASC Topic 730-10-55-2, Research and Development. Also, as prescribed by this guidance, patent filing and maintenance expenses are considered legal in nature and therefore classified as general and administrative expense. We are providing the following summary of our research and development expenses to supplement the more detailed discussions under results of operations. Costs are not allocated to projects as the majority of the costs relate to employees and facilities costs and we do not track employees' hours by project or allocate facilities costs on a project basis.

                                                                                  August 4, 1999
                                        For the years ended December 31,          (Inception) to
                                            2012                  2011           December 31, 2012
Salaries and staff costs             $           950,861    $        468,893    $        10,727,434
Outside services, consultants and
lab supplies                                     594,342             283,350              3,242,502
Facilities                                       352,920             137,793              2,951,613
Other                                             22,175              20,649                527,902
Total Research and Development       $         1,920,298    $        910,685    $        17,449,451

We do not currently have any commercial molecular diagnostic products. Accordingly our research and development costs are expensed as incurred. While certain of our research and development costs may have future benefits, our policy of expensing all research and development expenditures is predicated on the fact that we have no history of successful commercialization of molecular diagnostic products to base any estimate of the number of future periods that would be benefited.

ASC Topic 730, Research and Development requires that non-refundable advance payments for goods or services that will be used or rendered for future research and development activities should be deferred and capitalized. As the related goods are delivered or the services are performed, or when the goods or services are no longer expected to be provided, the deferred amounts would be recognized as an expense. There are no non-refundable advance payments that are deferred and capitalized as of December 31, 2012 and 2011.

Stock-Based Compensation

We rely heavily on incentive compensation in the form of stock options to recruit, retain and motivate directors, executive officers, employees and consultants. Incentive compensation in the form of stock options and warrants are designed to provide long-term incentives, develop and maintain an ownership stake and conserve cash during our development stage.

ASC Topic 718 "Compensation-Stock Compensation" requires companies to measure the cost of employee services received in exchange for the award of equity instruments based on the estimated fair value of the award at the date of grant. The estimated fair value of employee options on the date of grant was determined by using the Black-Scholes option valuation model which requires management to make certain assumptions with respect to selected model inputs. The risk-free interest rate assumption is based upon observed U.S. Treasury interest rates appropriate for the expected term of the individual stock options. We have not paid any dividends on common stock since its inception and do not anticipate paying dividends on our common stock in the foreseeable future. The computation of the expected option term is based on expectations regarding future exercises of options which generally vest over three years and have a ten year life. The expected volatility is based on the historical volatility of our stock. Forfeitures are estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. We estimate future unvested option forfeitures based upon its historical experience and has incorporated this rate in determining the fair value of employee option grants. The expense is to be recognized over the period during which an employee is required to provide services in exchange for the award.

ASC Topic 718 did not change the way we account for non-employee stock-based compensation. We continue to account for shares of common stock, stock options and warrants issued to non-employees based on the fair value of the shares of stock and for the stock option or warrant, using the Black-Scholes options pricing model, if that value is more reliably measurable than the fair value of the consideration or services received. We account for equity instruments granted to non-employees in accordance with ASC Topic 505-50 " Equity-Based Payment to Non-Employees" whereas the value of the stock compensation is based upon the measurement date


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as determined at either a) the date at which a performance commitment is reached, or b) at the date at which the necessary performance to earn the equity instruments is complete. Accordingly the fair value of these options is being "marked to market" quarterly until the measurement date is determined.

In accordance with ASC Topic 718 stock-based compensation expense related to our share-based compensation arrangements attributable to employees and non-employees is being recorded as a component of general and administrative expense and research and development expense in accordance with the guidance of Staff Accounting Bulletin 107, Topic 14, paragraph F, Classification of Compensation Expense Associated with Share-Based Payment Arrangements ("SAB 107").

Fair value of financial instruments

Financial instruments consist of cash and cash equivalents, accounts receivable, accounts payable, debentures and derivative liabilities. We have adopted FASB ASC 820 Fair Value Measurements and Disclosures ("ASC 820") for financial assets and liabilities that are required to be measured at fair value, and non-financial assets and liabilities that are not required to be measured at fair value on a recurring basis. These financial instruments are stated at their respective historical carrying amounts which approximate to fair value due to their short term nature.

ASC 820 provides that the measurement of fair value requires the use of techniques based on observable and unobservable inputs. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect our market assumptions. The inputs create the following fair value hierarchy:

Level 1 - Quoted prices for identical instruments in active markets.

Level 2 - Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations where inputs are observable or where significant value drivers are observable.

Level 3 - Instruments where significant value drivers are unobservable to third parties.

Convertible Debentures

We initially had $2,225,500 of 6% convertible debentures initially due November 14, 2008 (the "Debenture" or "Debentures"). The Debentures accrued interest at the rate of 6% per annum, payable semi-annually on April 1 and November 1 of each year beginning November 1, 2007. We could, in our discretion, elect to pay interest on the Debentures in cash or in shares of our common stock, subject to certain conditions related to the market for shares of our common stock and the registration of the shares issuable upon conversion of the Debentures under the Securities Act. The Debentures were convertible at any time at the option of the holder into shares of our common stock at an initial price of $0.55 per share, subject to adjustment for certain dilutive issuances. During the year ended December 31, 2009, we entered into a Forbearance Agreement that resulted in the issuance of 906,245 shares of common stock in full settlement of amounts claimed for interest, penalties, late fees and liquidated damages related to the Debentures totaling $2,042,205. Under the terms of the Forbearance Agreement the maturity date was extended to December 31, 2010 and the interest rate increased to 11%. A total of 1,013,961 shares of common stock purchase warrants, expiring November 14, 2012, continued to be outstanding. We accounted for the forbearance agreement and subsequent modifications and eventual extinguishment of these convertible debentures in accordance with ASC 470 -50 "Debt Modifications and Extinguishments".

The fair value of the shares on January 30, 2009 was $0.32 based on quoted market prices totaling $1,739,959. The difference between the carrying value of the interest, penalties, late fees and liquidated damages and the fair value of the shares of $302,246 was recorded as settlement costs on the statement of operations in the year ended December 31, 2009.

The aggregate initial principal amount of $2,170,500 plus two additional issuances of $164,550 in 2009 due under the Debentures remained outstanding totaling $2,335,050. Other significant provisions of the Forbearance Agreement included the following:

An extension of the Debentures' maturity date to December 31, 2010

An increase in the interest rate payable on the Debentures from 6% to 11%

The payment of interest in the form of Company common stock on a quarterly basis

Rights of certain holders of a majority of the Debentures regarding the appointment of two persons to our Board of Directors

Conditions regarding the determination of compensation to be paid to our officers and directors

A total of 6,083,763 shares of common stock purchase warrants, expiring November 14, 2012, continued to be outstanding.


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The carrying value of the debenture before modification in the amount of $2,335,050 was exchanged for the fair value of the new debt in the amount of $1,910,710 and the difference of $424,299 was recorded as a reduction of other forbearance agreement settlement costs in the statement of operations in the year ended December 31, 2009.

During the year ended December 31, 2012 no interest expense was incurred, while in the year ended December 31, 2011, we incurred interest expense of $128,421 that was paid in 42,809 shares based on the stock price allocation in the fair value of the price protected units issued. The difference in the fair value of the consideration given and the amounts due to the debt holder was $71,791 for the year ended December 31, 2011, and was recorded as a reduction of the interest expense in our Consolidated Statements of Operations. The Debenture Holders were entitled to interest expense at 11%.

On July 18, 2011 we settled with the holders of the Debentures by converting the amounts outstanding by issuing 4,670,100 shares of common stock pursuant to a note and warrant agreement and we issued an additional 467,010 shares of common stock to the Debenture Holders as consideration for their agreement to extinguish the debt. This resulted in a $1.2 million gain on extinguishment based on the fair value of the stock being $0.22 a share as of the date of the transaction. In addition, the 6,083,763 warrants, originally issued in 2006 with the debentures with an expiration date of November 14, 2012, were exchanged for 6,083,763 new warrants with a new expiration date of December 31, 2018. The additional charge for this modification to the expiration date was $581,503 which offset the gain, resulting in a net gain on extinguishment of $623,383 for the year ended December 31, 2011 on the Consolidated Statements of Operations.

The 6,083,763 warrants had registration rights and in accordance with ASC 815 "Derivatives and Hedging ", ("ASC 815") , we determined that these warrants were derivative liabilities. The fair value of these warrants on January 1, 2009, the date of adoption of ASC 815, was $884,277. This derivative liability has been marked to market at the end of each reporting period since January 1, 2009. The change in fair value for the years ended December 31, 2012, 2011 and inception (August 4, 1999) to December 31, 2012 was a loss of $5,258,133, a gain of $35,127, and a loss of $4,763,420, respectively. The gain for the year ended December 31, 2011 and the loss from inception (August 4, 1999) to December 31, 2012 exclude the $581,503 charge for the modification in the change in fair value of the derivative liability on the Consolidated Statements of Operations.

Off-Balance Sheet Arrangements

We do not believe that we have any off-balance sheet arrangements.

Inflation

It is our opinion that inflation has not had a material effect on our operations.

Recent Accounting Pronouncements

See Note 2 to the Notes to Financial Statements in Item 8 below for further discussion of recent accounting pronouncements.

Results of Operations

YEARS ENDED DECEMBER 31, 2012 AND 2011



Revenues



Our total revenues were $450,404 and $257,696 for the years ended December 31,
2012 and 2011, respectively.  Total revenues consisted of the following:



                            Years ended December 31,
                    2012         2011       (Decrease)/Increase

Royalty income   $  175,404   $  227,696   $             (52,292 )
Milestone           150,000            -                 150,000
License fees        125,000       30,000                  95,000
Total revenues   $  450,404   $  257,696   $             192,708


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Royalty income decreased by $52,292 in the year ended December 31, 2012, primarily due to the termination of the license agreement with Sequenom, Inc. in late 2011. A milestone payment of $150,000 in 2012 was received upon achievement of a milestone with Ipsogen SAS during 2012. License fees increased by $95,000 in the year ended December 31, 2012 as there were more license agreements entered into during the year ended December 31, 2012 as compared to the same period in 2011.

Research and Development Expenses



Research and development expenses consisted of the following:



                                                        For the years ended December 31,
                                                      2012             2011          Increase
Salaries and staff costs                          $     950,861         468,893    $    481,968
Outside services, consultants and lab supplies          594,342         283,350         310,992
Facilities                                              352,920         137,793         215,127
Other                                                    22,175          20,649           1,526
Total research and development                    $   1,920,298    $    910,685    $  1,009,613

Research and development expenses increased by $1,009,613 to $1,920,298 for the year ended December 31, 2012 from $910,685 for the same period in 2011. The $481,968 increase in salaries and staff costs was comprised primarily of an increase of approximately $160,000 related to the addition of personnel for our CLIA lab operations, $170,000 increase from two new personnel added in 2012 as well as bonuses paid to existing personnel and accrued for a new bonus plan in 2012, and an increase of approximately $126,000 in stock based compensation related to options granted to research and development personnel. Of the $310,992 increase in outside services, consultants and lab supplies, approximately $124,000 resulted from the start-up of our CLIA lab in February 2012, an increase of $32,000 related to consultants primarily working on cancer projects, an $111,000 increase in lab supplies purchased to support new projects, and $32,000 related to an increase in research collaborations. The increase in facilities expense is comprised of approximately $159,000 additional rent, maintenance, utilities, insurance and depreciation expenses related primarily to the addition and upgrade of the CLIA lab, and the remainder of the increase related to the expansion of our laboratory space at the end of 2011.

General and Administrative Expenses



General and administrative expenses consisted of the following:



                                                         For the years ended December 31,
                                                   2012            2011         Increase/(Decrease)
Salaries and staff costs                       $    925,166         524,514                  400,652
Outside services and Board of Director fees       1,334,216         553,572                  780,644
Legal and accounting fees                           663,281         949,741                 (286,460 )
Facilities                                          155,069         115,321                   39,748
Insurance                                            83,729          85,822                   (2,093 )
Other                                               217,801          94,844                  122,957
                                               $  3,379,262    $  2,323,814    $           1,055,448

General and administrative expenses increased by $1,055,448 to $3,379,262 for the year ended December 31, 2012 from $2,323,814 for the same period in 2011. The increase in salaries and staff costs consisted of an increase in salaries of approximately $129,000 related to the addition of four personnel in 2012, an increase in accrued bonuses of approximately $282,000 based on the 2012 bonus plan and an increase of approximately $154,000 in stock based compensation, partially offset by a decrease of approximately $157,000 in employment severance agreements. The increase in outside services resulted primarily from approximately $165,000 of stock based compensation related to warrant and stock issuances for advisory and public relations services, approximately $427,000 from the addition of our Chief Executive Officer and Chief Financial Officer in late 2011, as well as services provided by outside business development , investor relations, and finance individuals, an increase of $104,000 related to public relations and an increase of $62,000 in EDGAR and XBRL expenses associated with SEC filings. Legal and accounting fees decreased in the year ended December 31, 2012 compared to the prior year, as services related to assisting us with SEC compliance decreased as a result of completing our Form 10 early in 2012. Facilities expenses increased as a result of $19,000 increase in rent and maintenance due to additional space, $13,000 increase in office supplies related to new employees, and an $8,000 increase in depreciation . . .

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