10-K 1 spex10k_dec312013.htm FORM 10-K spex10k_dec312013.htm


 UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.  20549
 
FORM 10-K
(Mark one)
 
[X]      ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the fiscal year ended December 31, 2013
 
[  ]
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from __________ to __________
 
Commission file number 0-5576

SPHERIX INCORPORATED
(Exact name of Registrant as specified in its Charter)
 
Delaware
 
52-0849320
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
 
7927 Jones Branch Drive, Suite 3125, Tysons Corner, Virginia 22102
(Address of principal executive offices)

Registrant’s telephone number, including area code: (703) 992-9260 
Securities registered pursuant to Section 12(b) of the Act:
 
Title of each class
 
Name of each exchange on which registered
Common Stock ($0.0001 par value per share)
 
NASDAQ Capital Market
Securities registered pursuant to Section 12(g) of the Act:  None.
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes [  ] No [X]
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes [  ] No [X]
 
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes [X] No [   ]
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes [X] No [   ]
 
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  [   ]

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company (as defined in Rule 12b-2 of the Exchange Act).
 
Large Accelerated Filer [   ]    Accelerated Filer [   ]    Non-accelerated Filer [   ]   Smaller Reporting Company [X]
 
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes [   ] No [X]
 
The aggregate market value of the voting stock held by non-affiliates of the registrant as of the last business day of the registrant’s most recently completed second fiscal quarter: $2,617,379 based upon the closing sale price of our common stock of $4.45 on that date. Common stock held by each officer and director and by each person known to own in excess of 5% of outstanding shares of our common stock has been excluded in that such persons may be deemed to be affiliates.  The determination of affiliate status in not necessarily a conclusive determination for other purposes.
 
There were 7,846,106 shares of the Registrant’s Common Stock outstanding as of March 28, 2014.

 
 



 

PART I
 
SPECIAL CAUTIONARY NOTICE REGARDING FORWARD LOOKING STATEMENTS
 
Certain statements contained in this Form 10-K, including without limitation, statements containing the words “believes,” “estimates,” “expects” and words of similar import, constitute “forward looking statements” within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934.  Such words and expressions are intended to identify such forward looking statements, but are not intended to constitute the exclusive means of identifying such statements.  Such forward looking statements involve known and unknown risks, uncertainties and other factors that may cause the actual results, performance or achievements of Spherix Incorporated (the “Company”), or industry results, to be materially different from any future results, performance or achievements expressed or implied by such forward looking statements.  Given these uncertainties, prospective investors are cautioned not to place undue reliance on such forward looking statements.  

Item 1.  BUSINESS.

General
 
We were formed in 1967 as a scientific research company and for much of our history pursued drug development including through Phase III clinical studies which were discontinued in 2012. We have shifted our focus during 2013 and are now an intellectual property company that owns patented and unpatented intellectual property.

During December 2013, we acquired 101 patents and patent applications from Rockstar Consortium US LP (“Rockstar”) in consideration for approximately $60 million of our securities consisting of common stock and preferred stock (including $20 million of Series I Redeemable Convertible Preferred Stock).  The patents had been developed by Nortel Networks (“Nortel”) and acquired by Rockstar following Nortel’s bankruptcy in 2011.  Rockstar was launched in 2011 as an intellectual property licensing company and manages a patent portfolio related to Nortel’s pre-bankruptcy technology and businesses.  Rockstar was formed and is owned by Apple, Inc. (“Apple”), Microsoft Corporation (“Microsoft”), Sony Corporation (“Sony”), Blackberry Limited (“Blackberry”) and LM Ericsson Telephone Company (“Ericsson”).  The December 2013 acquisition includes patents covering internet access, and video and data transmission, among other things.  Many of the acquired Nortel/Rockstar patents are believed to be standard essential patents, meaning they potentially cover various industry standards in wide use (although there is no assurance that a court or third-party would agree with such description).

During August 2013, we acquired 222 patents in the fields of wireless communications, satellite, solar, and radio frequency and 2 patents in the field of pharmaceutical distribution from North South Holdings, Inc. (“North South”). The 222 patents had been developed by Harris Corporation, a leader in defense communications and electronics and acquired by North South prior to our acquisition of North South.

During July 2013, we acquired 7 patents in the field of mobile communications from Rockstar.  This acquisition represented the first transaction believed to have been completed by Rockstar with any publicly traded company.

Each of the Rockstar acquisitions and the North South acquisition were completed through the issuance of our securities.  Presently, Rockstar, on a fully-diluted basis, would be deemed to own approximately 29% of our common stock.  Rockstar has the right to distribute to its shareholders (Apple, Microsoft, Sony, Blackberry and Ericsson) shares of the Company issued to Rockstar.

We presently have active lawsuits pending against AT&T, Uniden, VTech, T-Mobile and CISCO Systems, Inc. and intend to bring additional lawsuits during 2014.

 
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We have incurred losses from operations for the years ended  December 31, 2013 and 2012.  Our net loss was $18 million for the year ended December 31, 2013.  Our accumulated deficit was $53.3 million at December 31, 2013.  Our loss from continuing operations for the year ended December 31, 2012 was $2.9 million and our net loss was $3.9 million for the year ended December 31, 2012.  Our accumulated deficit was $35.3 million at December 31, 2012. 
 
             Our principal executive offices are located at 7927 Jones Branch Drive, Suite 3125, Tysons Corner, Virginia 22102, and our telephone number is (703) 992-9260.

             Our common stock trades on the NASDAQ Capital Market system under the symbol SPEX.

Available Information

             Our principal Internet address is www.spherix.com.  We make available free of charge on www.spherix.com our annual, quarterly and current reports, and amendments to those reports, as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission (“SEC”).

Industry Overview And Market Opportunity

Under U.S. law an inventor or patent owner has the right to exclude others from making, selling or using their patented invention. Unfortunately, in the majority of cases, infringers are generally unwilling, at least initially, to negotiate or pay reasonable royalties for their unauthorized use of third-party patents and will typically fight any allegations of patent infringement. Inventors and/or patent holders, without sufficient legal, financial and/or expert technical resources to bring and continue the pursuit of legal action, may lack credibility in dealing with potential licensees and as a result, are often ignored. As a result of the reluctance of patent infringers to negotiate and ultimately take a patent license for the use of third-party patented technologies, patent licensing and enforcement often begins with the filing of patent enforcement litigation. However, the majority of patent infringement contentions settle out of court based on the strength of the patent claims, validity, and persuasive evidence and clarity that the patent is being infringed.

Due to the relative infancy of the IP monetization industry, we believe that the absolute size of our market opportunity is very significant but difficult to quantify.

Our Business Model
 
We are a patent commercialization company that realizes revenue from the monetization of IP.  Such monetization includes, but is not limited to, acquiring IP from patent holders in order to maximize the value of the patent holdings by conducting and managing a licensing campaign.  We generate revenues and related cash flows from the granting of intellectual property rights for the use of patented technologies that we own, or that we manage for others.
 
We continually work to enhance our portfolio of intellectual property through acquisition and strategic partnerships. Our mission is to partner with inventors, or other entities, who own undervalued intellectual property.  We then work with the inventors or other entities to commercialize the IP.  Currently, we own over 330 patents and patent applications.
 
Our Products And Services
 
       We acquire IP from patent holders in order to maximize the value of their patent holdings by conducting and managing a licensing campaign. Some patent holders tend to have limited internal resources and/or expertise to effectively address the unauthorized use of their patented technologies or they simply make the strategic business decision to outsource their intellectual property licensing. They can include individual inventors, large corporations, universities, research laboratories and hospitals. Typically, we, or an operating subsidiary acquires a patent portfolio in exchange for a combination of an upfront cash payment, a percentage of our operating subsidiary's net recoveries from the licensing and enforcement of the portfolio, or a combination of the two.

 
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Competition
 
             We expect to encounter significant competition from others seeking to acquire interests in intellectual property assets and monetize such assets. This includes an increase in the number of competitors seeking to acquire the same or similar patents and technologies that we may seek to acquire.  Most of our competitors have much longer operating histories, and significantly greater financial and human resources, than we do. Entities such as Vringo, Inc. (NYSE MKT: VRNG), VirnetX Holding Corp (NYSE MKT: VHC), Acacia Research Corporation (NASDAQ: ACTG), RPX Corporation (NASDAQ: RPXC), and others presently market themselves as being in the business of creating, acquiring, licensing or leveraging the value of intellectual property assets. We expect others to enter the market as the true value of intellectual property is increasingly recognized and validated. In addition, competitors may seek to acquire the same or similar patents and technologies that we may seek to acquire, making it more difficult for us to realize the value of its assets.
 
       We also compete with venture capital firms, strategic corporate buyers and various industry leaders for technology acquisitions and licensing opportunities.  Many of these competitors may have more financial and human resources than we do.  As we become more successful, we may find more companies entering the market for similar technology opportunities, which may reduce our market share in one or more technology industries that we currently rely upon to generate future revenue.
  
       Other companies may develop competing technologies that offer better or less expensive alternatives to our patented technologies that we may acquire and/or out-license.  Many potential competitors may have significantly greater resources than we do.  Technological advances or entirely different approaches developed by one or more of our competitors could render certain of the technologies owned or controlled by our operating subsidiaries obsolete and/or uneconomical.

Intellectual Property and Patent Rights

Our intellectual property is primarily comprised of trade secrets, patented know-how, issued and pending patents, copyrights and technological innovation.

We have a portfolio comprised of over 330 patents and patent applications.  Our patent portfolio includes both U.S. and foreign patents and pending patent applications in the wireless communications and telecommunication sectors including data, optical and voice technology, antenna technology, Wi-Fi, base station functionality, and cellular.  We also own patents related to artificial sweetener and prescription refill technology. 

Most of our patents are publicly accessible on the Internet website of the U.S. Patent and Trademark Office at www.uspto.gov.
 
The lives of our patent rights have a wide duration.  Certain patents have already expired and the latest patents do not expire until 2026.
 
Patent Enforcement Litigation

We may often be required to engage in litigation to enforce our patents and patent rights. We are, or may become a party to ongoing patent enforcement related litigation, alleging infringement by third parties of certain of the patented technologies owned or controlled by us.

Research and Development

We have not expended funds for research and development costs since we sold our consulting business in 2012.  For the year ended December 31, 2013, we had a $10,000 research and development expense associated with assets assumed in the acquisition of North South.  For the year ended December 31, 2012 we had approximately $0.7 million in research and development expenses associated with our discontinued operations.
 
Employees

We employ 3 individuals, all on a full-time basis.
 
 
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Item 1A.  RISK FACTORS.

As a smaller reporting company, we are not required to provide the information required by this item.

Item 1B.  UNRESOLVED STAFF COMMENTS.

As a smaller reporting company, we are not required to provide the information required by this item.

Item 2.  PROPERTIES.

Our office is located in Tysons Corner, Virginia, where we lease 837 square feet of office space under a lease that expires on August 31, 2014. Our monthly lease payment for the Virginia rental is $1,883 per month.  We also lease office space in New York, New York under a lease that expires March 31, 2015 at a monthly rate of $6,000. We believe that the Virginia and New York facilities are sufficient to meet our needs.
 
We are also party to a lease for 5,000 square feet of office space in Bethesda, Maryland under a lease that expires March 31, 2018.  The monthly lease payment for the Maryland rental is $13,090 per month.
 
Item 3.  LEGAL PROCEEDINGS.

In the ordinary course of business, we actively pursue legal remedies to enforce our intellectual property rights and to stop unauthorized use of our technology. Other than ordinary routine litigation incidental to the business and other than as set forth below, we know of no material, active or pending legal proceedings against us, nor are we involved as a plaintiff in any material proceedings or pending litigation. There are no proceedings in which any of our directors, officers or affiliates, or any registered beneficial shareholder are an adverse party or has a material interest adverse to us.
 
Spherix Incorporated v. Elizabethean Court Associates III Limited Partnership
 
    The Company has commenced a lawsuit against the landlord of the Bethesda, Maryland office claiming that the assignment of the lease to the purchaser of the Spherix Consulting business was permitted under the lease and seeking termination of the lease as a result of the landlord's failure to consent to such assignment.  On March 28, 2014, the Company learned that it did not prevail in setting aside the lease.  The Company will continue to use the leased property in the normal course of its business and make the monthly rental payments in accordance with the terms of the lease.
 
LegalLink, Inc. v. Spherix Incorporated
 
        On October 7, 2013, the Company received notice of a complaint filed in the Circuit Court of Montgomery County, Maryland, Case No.: 382667-V, in the matter of LegalLink Inc. vs. Spherix Incorporated. LegalLink, Inc., a Merrill Communications Company alleges that the Company failed to honor their contract regarding services provided by LegalLink, Inc. LegalLink, Inc. alleges that the Company owes them $47,309 for services rendered to the Company, that have gone unpaid. In November 2013, the parties settled this case.

 
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Charter Communications, Inc., Wideopenwest Finance LLC a/k/a Wow! Internet, Cable & Phone, Knology, Inc., Cequel Communications, LLC, d/b/a Suddenlink Communications, and Cable One, Inc. v Rockstar Consortium US LP, Bockstar Technologies LLC, Constellation Technologies LLC, and Spherix Incorporated
 
      On January 17, 2014, an action was filed by several cable operators in the United States District Court for the District of Delaware (No 1:99-mc-09999) against Rockstar, Bockstar Technologies LLC, Constellation Technologies LLC and the Company (collectively, the “Defendants”).  The complaint (the “Complaint”) was filed by Charter Communications, Inc., WideOpenWest Finance, LLC a/k/a WOW! Internet, Cable & Phone, Knology, Inc., Cequel Communications, LLC d/b/a Suddenlink Communications, and Cable One, Inc. (collectively, the “Plaintiffs”).  Plaintiffs are in the communications, cable and/or wireline industries and allege that Rockstar has accused the Plaintiffs of practicing various communication and networking technologies (including many well-established technical standards), related to those industries. The complaint states that in many instances such technical standards are designed into the equipment Plaintiffs purchase from vendors, and must be implemented to interoperate with other communications providers and their end user customers. Rockstar owns (and since December 31, 2013, the Company owns) patents alleged to be infringed by Plaintiffs activities.  The relief sought against the Company is principally for a declaratory judgment that Plaintiffs do not infringe the patents, requiring that the Plaintiffs be granted a patent license, that the Company has misused the patents and it and the other Defendants have waived and are estopped from enforcing the patents in the marketplace, that the Company is liable to Plaintiffs for entering into an illegal conspiracy, and assessing corresponding damages, for direct and consequential damages, attorney’s fees and costs. The Company has not been served with the Complaint and accordingly no answer is due. The Company’s preliminary assessment is that the lawsuit is completely without merit and that it would defend its position vigorously if served.
 
Spherix Incorporated v. Cisco Systems Inc., Case No. 1:14-cv-00374-SLR, in the United States District Court for the District of Delaware 
 
On March 24, 2014, the Company initiated litigation against Cisco Systems Inc. (“Cisco”) in Spherix Inc. v. Cisco Systems Inc., Case No. 1:14-cv-00374-SLR, in the United States District Court for the District of Delaware for infringement of U.S. Patent Nos. RE40467; 6,697,325; 6,578,086; 6,222,848; 6,130,877; 5,970,125; 6,807,174; 7,397,763: 7,664,123; 7,385,998; and 8,607,323 (collectively, the “Asserted Patents”.)  The complaint alleges that Cisco has manufactured, sold, offered for sale and/or imported technology that infringes the Asserted Patents.  Spherix seeks relief in the form of a finding of infringement of the Asserted Patents, an accounting of all damages sustained by the Company as a result of Cisco’s infringement, actual damages, enhanced damages under 35 U.S.C. Section 284, attorney’s fees and costs.  Cisco has not yet responded to the complaint.
 
Item 4.  MINE SAFETY DISCLOSURES

                Not applicable.

 
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PART II

Item 5.
MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.

Our common stock is traded on the NASDAQ Capital Market under the symbol SPEX.  No dividends were paid in 2013 or 2012 and we do not currently anticipate paying any cash dividends on our capital stock in the foreseeable future.

The following table sets forth the high and low closing prices for our common stock, as reported by the NASDAQ Capital Market, for the periods indicated (all adjusted for the September 2012 reverse stock split).

Period
 
High
   
Low
 
2012
           
First Quarter
 
$
35.40
   
$
15.60
 
Second Quarter
 
$
22.40
   
$
10.00
 
Third Quarter
 
$
11.98
   
$
7.22
 
Fourth Quarter
 
$
11.76
   
$
5.85
 
                 
2013
               
First Quarter
 
$
14.99
   
$
5.51
 
Second Quarter
 
$
11.05
   
$
4.07
 
Third Quarter
 
$
27.86
   
$
4.54
 
Fourth Quarter
 
$
13.70
   
$
6.52
 
 
On March 28, 2014, the closing price of our common stock, as reported by the NASDAQ Capital Market, was $3.00.  As of March 28, 2014, we had approximately 259 holders of record of our common stock.

Reverse Stock Split
 
On September 21, 2012, we effected a reverse stock split of our outstanding common stock at an exchange ratio of 1-for-20 in response to NASDAQ deficiency notices concerning the bid price of our common stock.

As a result of the reverse stock split, every 20 shares of our issued and outstanding common stock were combined into one share of common stock.  No fractional shares of common stock were issued as a result of the reverse stock split.  Instead, fractional shares that would otherwise result from the reverse stock split were purchased by the Company based on the closing price of the stock on September 21, 2012.
  
Following the reverse stock split, our common stock price increased and we regained compliance with the NASDAQ minimum bid price rule.

 
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Equity Compensation Plan Information

           The following table provides information about our common stock that may be issued upon the exercise of options, warrants and rights under all of our existing equity compensation plans as of December 31, 2013.

Plan Category
 
Number of securities to be issued upon exercise of outstanding options, warrants and rights
(a)
   
Weighted average exercise price of outstanding options, warrants and rights (b)
   
Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a)) (c)
 
Equity compensation plans approved by security holders
   
2,013,377
(1)
 
$
7.13
     
797,250
(2)

(1)  
Consists of options to acquire 6,663 shares of our Common Stock under the 2012 Equity Incentive Plan and 2,005,000 under the 2013 Equity Incentive Plan.
(2) 
Consists of shares of Common Stock available for future issuance under our equity incentive plan.
 
Item 6.  SELECTED FINANCIAL DATA

As a smaller reporting company we are not required to provide this information.
 
 
Item 7.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Forward-Looking Statements

You should read this discussion together with the Financial Statements, related Notes and other financial information included elsewhere in this Form 10-K. The following discussion contains assumptions, estimates and other forward-looking statements that involve a number of risks and uncertainties. These risks could cause our actual results to differ materially from those anticipated in these forward-looking statements.

Overview 

Spherix Incorporated (“we” or the “Company”) is an intellectual property company that owns patented and unpatented intellectual property.  We were formed in 1967 as a scientific research company and for much of our history pursued drug development including through Phase III clinical studies which were largely discontinued in 2012.  Through our acquisitions of 108 patents and patent applications from Rockstar Consortium US, LP (“Rockstar”) and acquisition of several hundred patents issued to Harris Corporation as a result of our acquisition of North South, we have expanded our activities in wireless communications and telecommunication sectors including antenna technology, Wi-Fi, base station functionality, and cellular. 

Our activities generally include the acquisition and development of patents through internal or external research and development.  In addition, we seek to acquire existing rights to intellectual property through the acquisition of already issued patents and pending patent applications, both in the United States and abroad.  We may alone, or in conjunction with others, develop products and processes associated with our intellectual property and license our intellectual property to others seeking to develop products or processes or whose products or processes infringe our intellectual property rights through legal processes.  Using our patented technologies, we employ strategies seeking to permit us to derive value from licensing, commercialization, settlement and litigation from our patents.  We will continue to seek to obtain patents from inventors and patent owners to monetize patent portfolios.  

 
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On February 2, 2012, the Company entered into a securities purchase agreement with certain investors to sell an aggregate of 53,240 shares of its common stock and warrants to purchase up to an additional 10,648 shares of its common stock to such investors for gross proceeds of approximately $1.15 million.  The common stock and warrants were sold in units, with each unit consisting of one share of common stock and a warrant to purchase 0.2 of a share of common stock.  The purchase price per unit was $21.60.  Subject to certain ownership limitations, the warrants are exercisable for a five-year period at an exercise price of $28.00 per share.  The net proceeds to the Company from the registered direct offering, after deducting placement agent fees and the Company’s offering expenses, and excluding the proceeds, if any, from the exercise of the warrants issued in the offering, were approximately $1.1 million.  The common stock issued in the February 2012 offering and the common stock that may be issued pursuant to the exercise of the warrants have been registered pursuant to a Form S-3 registration statement (File No. 333-161531), which became effective on October 1, 2009.  The warrants are classified as a liability and the common stock is classified as permanent equity.

On September 25, 2012, the Company received written notification from NASDAQ advising the Company that the minimum number of publicly held shares of the Company’s common stock had fallen below the minimum 500,000 shares required for continued listing on the NASDAQ Capital Market.  Following the November 7, 2012 closing of a private placement, the Company’s number of publicly held shares of common stock outstanding increased to 690,741.  On November 15, 2012, NASDAQ provided confirmation to the Company that the Company has regained compliance with the NASDAQ rule.

On November 7, 2012, the Company obtained net proceeds of approximately $2.3 million in a private placement of common stock and warrants.  The Company sold an aggregate of 483,657 shares of common stock at a price of $5.324 per share along with warrants to purchase an additional 483,657 shares of common stock at an exercise price of $6.53 per share.  Subject to certain ownership limitations, the warrants are exercisable for a period of five years.  The common stock and warrants were issued in a private placement of securities exempt from registration pursuant to Section 4(2) of the Securities Act of 1933 and Rule 506 promulgated thereunder.  The warrants were classified as a liability and the common stock is classified as permanent equity.   The investors have the right to participate for 100% of any future debt or equity offerings of the Company during the two years following the Closing.  On December 20, 2012, the owners of a majority of the outstanding shares of common stock agreed to temporarily waive the Company’s requirement to file a registration statement to register shares of common stock issued and issuable in the Company’s November 2012 private placement transaction until a vote of a majority of the holders requests registration.

On December 27, 2012, the Company formed a new wholly-owned subsidiary, Nuta Technology Corp., (“Nuta”), which is incorporated in the state of Virginia. On April 2, 2013, the Company entered into an Agreement and Plan of Merger, as amended (the "Merger Agreement") with its wholly owned subsidiary, Nuta, North South Holdings, Inc., a Delaware corporation ("North South"), the owner or assignee of certain patents, licenses and applications (the “North South Intellectual Property”), and the shareholders of North South (the "North South Shareholders"). On September 10, 2013 the transaction contemplated under the Merger Agreement was completed (the “Merger”). At closing, North South merged with and into Nuta with Nuta as the surviving corporation.  Nuta will continue its operations in the State of Virginia as the record owner of the North South’s intellectual property. Pursuant to the terms and conditions of the Merger, at the closing of the Merger, all of North South’s 5,213 issued and outstanding shares of common stock were converted into an aggregate of 1,203,153 shares of  the Company’s common stock, par value $0.0001 per share (the “Common Stock”), and all of North South’s 491 issued and outstanding shares of Series A Preferred Stock and 107 issued and outstanding shares of Series B Preferred Stock were converted into an aggregate of 1,379,685 shares of the Company's Series D Convertible Preferred Stock, par value $0.0001 per share, which is convertible into shares of the Company’s common stock on a one-for-ten basis (collectively with the 1,203,153 common shares of the Company, the “Merger Consideration”).

Through our acquisition of North South, we acquired a patent portfolio consisting of 222 U.S. patents in the fields of wireless communications, satellite, solar and radio frequency, as well as 2 U.S. patents in pharmaceutical technology. Prior to the Merger, North South acquired and developed patents through internal and/or external research and development and acquired issued U.S. and foreign patents and pending patent applications. We license our patents to companies seeking to develop products and processes that embodied our patented invention or to companies whose products and processes infringed our intellectual property. Prior to our acquisition of North South, North South commenced monetization and commercialization efforts by filing patent infringement litigation against T-Mobile USA on geo-location technology owned by North South, as well as two lawsuits on pharmaceutical distribution, the rights to which we acquired upon consummation of the Merger.

 
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In early March, 2013, the Company and certain  investors which participated in the November 2012 private placement transaction (“Investors”), entered into separate Warrant Exchange Agreements pursuant to which the Investors exchanged all of the common stock purchase warrants they acquired in the private placement transaction for shares of the Company’s Series C Convertible Preferred Stock.  Each share of Series C Convertible Preferred Stock is convertible into one share of Common Stock at the option of the holder of the Series C Convertible Preferred Stock.  The Series C Convertible Preferred Stock was established on March 5, 2013 by the filing in the State of Delaware of a Certificate of Designation of Preferences, Rights and Limitations of Series C Convertible Preferred Stock (“Certificate of Designation”).  The Warrants were exercisable through November 7, 2017 for an aggregate of 474,266 shares of Common Stock at an exercise price of $6.53 per share.  The Warrants were exchanged for an aggregate of 229,337 shares of the Series C Convertible Preferred Stock, convertible into 229,337 shares of Common Stock.  This is the same number of shares of Common Stock issuable upon a “cashless exercise” of the Warrants, as permitted by the terms of the Warrants,  based on the one-day volume weighted average price of the Company’s Common Stock on February 28, 2013 of $12.6439 as reported by Bloomberg.  The Company has agreed to register the shares of Common Stock issuable upon conversion of the Series C Convertible Preferred Stock on the same basis as the shares of Common Stock issued in the November 2012 private placement transaction.

On July 24, 2013, the Company purchased a group of patents in the mobile communication sector (the “Purchased Patents”) from Rockstar Consortium US LP, a Delaware limited partnership (“Rockstar”) at a contractual price of $4.0 million.  In consideration for the Purchased Patents, the Company paid an aggregate $3.0 million in consideration to Rockstar, which consisted of a $2.0 million cash payment and 176,991 shares of common stock accepted by the seller in settlement of the $1.0 million remaining balance of the Company’s common stock (176,991 shares at $5.65 per share).  The Shares are subject to a lock-up agreement, subject to certain leak-out provisions, which shall expire on the earlier of (i) six months from the issuance of the shares or (ii) the date that the Company’s Common Stock achieves a trading volume of at least 50,000 shares per day and a closing price of at least $15 per share for a period of five consecutive days.  The Company has filed a registration statement covering the resale of the shares issued to Rockstar with the Securities and Exchange Commission (the “SEC”) on September 5, 2013.  On the anniversary of one year and one day after the Company files its first complaint against a defendant with any one or more of the patents acquired in this transaction, the Company shall deliver $1.0 million to Rockstar. The initial complaint was filed on August 30, 2013, and at that time the additional $1.0 million was accrued and included in patent portfolio on the condensed consolidated balance sheet. The Company remitted the $1.0 million to Rockstar on January 2, 2014.

The Company in November of 2013 sold an aggregate of 304,250 shares of its newly designated Series F Preferred Stock and 48,438 shares of common stock to five accredited investors for gross proceeds to the Company of $2,235,000 pursuant to subscription agreements. The effective purchase price per share of Common Stock and 156,250 of the Series F Preferred Stock was $6.40 for $1,310,000 of such investment and 148,000 shares of Series F Preferred Stock was $6.25 for $925,000 of such investment. The proceeds of the sale of the common stock and Series F Convertible Preferred Stock will be used to further the operations of the Company.

On November 26, 2013, we entered into separate Amendment and Exchange Agreements with the holders of our outstanding shares of Series F Preferred Stock pursuant to which such holders agreed to return their shares of Series F Preferred Stock to us for cancellation in consideration for which we issued such holder an equal number of shares of Series F-1 Preferred Stock.  Each share of Series F-1 Preferred Stock is entitled to 91% of one vote per share (subject to beneficial ownership limitations described below) and shall vote together with holders of our common stock. Each share of Series F-1 Preferred Stock is convertible into one share of our common stock and has a stated value of $0.0001.  The conversion ratio is subject to adjustment in the event of stock splits, stock dividends, combination of shares and similar recapitalization transactions.   We are prohibited from effecting the conversion of the Series F-1 Preferred Stock to the extent that, as a result of such conversion, the holder beneficially owns more than 9.99%, in the aggregate, of the issued and outstanding shares of our common stock calculated immediately after giving effect to the issuance of shares of common stock upon the conversion of the Series F-1 Preferred Stock. 

On December 31, 2013, through our wholly owned subsidiary, Spherix Portfolio Acquisition II, Inc. (“SPA II, Inc.”) we entered into our second agreement to acquire certain patents from Rockstar.  We acquired a suite of 101 patents and patent applications pursuant to a Patent Purchase Agreement in several technology families, including data, optical and voice technology.  The patents provide us with rights to develop and commercialize products as well as enforcement rights for past, present and future infringement.

 
-9-

 

On December 31, 2013, we designated 459,043 shares of preferred stock as Series H Preferred Stock.  On December 31, 2013, we issued approximately $38.3 million of Series H Preferred Stock (or 459,043 shares) to Rockstar.  Each share of Series H Preferred Stock is convertible into ten (10) shares of common stock and has a stated value of $83.50. The conversion ratio is subject to adjustment in the event of stock splits, stock dividends, combination of shares and similar recapitalization transactions. Holders are prohibited from effecting the conversion of the Series H Preferred Stock effecting the conversion to the extent that, as a result of such conversion, a holder beneficially owns more than 4.99% (which may be increased to 9.99% and subsequently to 19.99%, each upon 61 days’ written notice), in the aggregate, of our issued and outstanding shares of common stock calculated immediately after giving effect to the issuance of shares of common stock upon the conversion of the Series H Preferred Stock. Holders of the Series H Preferred Stock shall be entitled to vote on all matters submitted to our stockholders and shall be entitled to the number of votes equal to the number of shares of common stock into which the shares of Series H Preferred Stock are convertible, subject to applicable beneficial ownership limitations.  The Series H Preferred Stock provides a liquidation preference of $83.50 per share.

On December 31, 2013, we designated 119,760 shares of preferred stock as Series I Preferred Stock. On December 31, 2013, we issued approximately $20 million (or 119,760 shares) of Series I Preferred Stock to Rockstar.  Each share of Series I Preferred Stock is convertible into twenty (20) shares of our common stock and has a stated value of $167. The conversion ratio is subject to adjustment in the event of stock splits, stock dividends, combination of shares and similar recapitalization transactions. Holders are prohibited from effecting the conversion of the Series I Preferred Stock to the extent that, as a result of such conversion, the holder beneficially owns more than 4.99% (which may be increased to 9.99% and subsequently to 19.99%, each upon 61 days’ written notice), in the aggregate, of our issued and outstanding shares of common stock calculated immediately after giving effect to the issuance of shares of common stock upon the conversion of the Series I Preferred Stock.  Holders of the Series I Preferred Stock shall be entitled to vote on all matters submitted to our stockholders and shall be entitled to the number of votes equal to the number of shares of common stock into which the shares of Series I Preferred Stock are convertible, subject to applicable beneficial ownership limitations.  The Series I Preferred stock provides for a liquidation preference of $167 per share.

Critical Accounting Policies and Estimates

Accounting for Warrants
 
We account for the issuance of common stock purchase warrants issued in connection with the equity offerings in accordance with the provisions of ASC 815, Derivatives and Hedging (“ASC 815”).  The Company classifies as equity any contracts that (i) require physical settlement or net-share settlement or (ii) gives the Company a choice of net-cash settlement or settlement in its own shares (physical settlement or net-share settlement).  The Company classifies as assets or liabilities any contracts that (i) require net-cash settlement (including a requirement to net-cash settle the contract if an event occurs and if that event is outside the control of the Company) or (ii) gives the counterparty a choice of net-cash settlement or settlement in shares (physical settlement or net-share settlement).

We assess the classification of its common stock purchase warrants as of the date of each offering and determined that such instruments met the criteria for liability classification.  The warrants are reported on the consolidated balance sheets as a liability at fair value using the Black-Scholes valuation method.  Changes in the estimated fair value of the warrants result in the recognition of other income or expense.
 
Stock-based Compensation

We account for share-based payment awards exchanged for employee services at the estimated grant date fair value of the award.  Stock options issued under the Company’s long-term incentive plans are granted with an exercise price equal to no less than the market price of the Company’s stock at the date of grant and expire up to ten years from the date of grant.  These options generally vest over a four- to ten-year period.

The fair value of stock options granted was determined on the grant date using assumptions for risk free interest rate, the expected term, expected volatility, and expected dividend yield.  The risk free interest rate is based on U.S. Treasury zero-coupon yield curve over the expected term of the option.  The expected term assumption is determined using the weighted average midpoint between vest and expiration for all individuals within the grant.  The expected volatility assumption is based on the standard deviation of the Company’s underlying stock price’s daily logarithmic returns.

 
-10-

 

Our model includes a zero dividend yield assumption, as we have not historically paid nor do we anticipate paying dividends on our common stock.  Our model does not include a discount for post-vesting restrictions, as we have not issued awards with such restrictions.

The periodic expense is then determined based on the valuation of the options, and at that time an estimated forfeiture rate is used to reduce the expense recorded.  Our estimate of pre-vesting forfeitures is primarily based on our historical experience and is adjusted to reflect actual forfeitures as the options vest.

Fair Value of Financial Instruments

Financial instruments, including accounts and other receivables, accounts payable and accrued liabilities are carried at cost, which management believes approximates fair value due to the short-term nature of these instruments. We measure the fair value of financial assets and liabilities based on the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. We maximize the use of observable inputs and minimizes the use of unobservable inputs when measuring fair value.

We use three levels of inputs that may be used to measure fair value:

Level 1 — quoted prices in active markets for identical assets or liabilities
Level 2 — quoted prices for similar assets and liabilities in active markets or inputs that are observable
Level 3 — inputs that are unobservable (for example, cash flow modeling inputs based on assumptions)

Revenue Recognition

Revenue is recognized when persuasive evidence of an arrangement exists, delivery of the product or service has occurred, all obligations have been performed pursuant to the terms of the agreement, the sales price is fixed or determinable, and collectability is reasonably assured.  Revenue from the licensing of the Company’s intellectual property  and settlements reached from legal enforcement of the Company’s patent rights is recognized when the arrangement with the licensee has been signed and the license has been delivered and made effective, provided license fees are fixed or determinable and collectability is reasonably assured.  The fair value of licenses achieved by ordinary business negotiations is recognized as revenue.

The amount of consideration received upon any settlement or judgment is allocated to each element of the settlement based on the fair value of each element.  Elements related to licensing agreements, royalty revenues, net of contingent legal fees, are recognized as revenue in the consolidated statement of operations.  Elements that are not related to license agreements and royalty revenue in nature will be reflected as a separate line item within the other income section of the consolidated statements of operations.  Elements provided in either settlement agreements or judgments include: the value of a license, legal release, and interest.  When settlements or judgments are achieved at discounts to the fair value of a license, the Company allocates the full settlement or judgment, excluding specifically named elements as mentioned above, to the value of the license agreement or royalty revenue under the residual method. Legal release as part of a settlement agreement is recognized as a separate line item in the consolidated statements of operations when value can be allocated to the legal release.  When the Company reaches a settlement with a defendant, no value is allocated to the legal release since the existence of a settlement removes legal standing to bring a claim of infringement and without a legal claim, the legal release has no economic value.  The element that is applicable to interest income will be recorded as a separate line item in other income. The Company does not assume future performance obligations in its license arrangements.  Revenue from the monetization of the Company’s intellectual property during the year ended December 31, 2013 was not significant.

Cost of Revenues

Cost of revenues include the costs and expenses incurred in connection with our patent enforcement activities, including inventor royalties paid to original patent owners, contingent legal fees paid to external patent counsel, other patent-related legal expenses paid to external patent counsel, licensing and enforcement related research, consulting and other expenses paid to third parties and the amortization of patent-related acquisition costs.

 
-11-

 

Inventor Royalties and Contingent Legal Expenses

Inventor royalties are expensed in the period that the related revenues are recognized. In certain instances, pursuant to the terms of the underlying inventor agreements, costs paid by us to acquire patents are recoverable from future net revenues. Patent acquisition costs that are recoverable from future net revenues are amortized over the estimated economic useful life of the related patents, or as the prepaid royalties are earned by the inventor, as appropriate, and the related expense is included in amortization expense.

Contingent legal fees are expensed in the period that the related revenues are recognized. In instances where there are no recoveries from potential infringers, no contingent legal fees are paid; however, we may be liable for certain out of pocket legal costs incurred pursuant to the underlying legal services agreement. Legal fees advanced by contingent law firms that are required to be paid in the event that no license recoveries are obtained are expensed as incurred.

Intangible Assets – Patent Portfolios

Intangible assets include our patent portfolios with original estimated useful lives ranging from 6 months to 12 years. We amortize the cost of the intangible assets over their estimated useful lives on a straight line basis.  Costs incurred to acquire patents, including legal costs, are also capitalized as long-lived assets and amortized on a straight-line basis with the associated patent.

Impairment of Long-lived Assets

We review for the impairment of long-lived assets whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. An impairment loss would be recognized when estimated future cash flows expected to result from the use of the asset and its eventual disposition are less than its carrying amount. We have not identified any such impairment losses.

Goodwill
 
Under ASC No. 350, “Intangibles—Goodwill and Other” (“ASC 350”), goodwill and indefinite lived intangible assets are not amortized but are reviewed annually for impairment, or more frequently, if impairment indicators arise.
 
Goodwill impairment is tested at least annually or when factors indicate potential impairment using a two-step process that begins with an estimation of the fair value of each reporting unit. Step 1 is a screen for potential impairment pursuant to which the estimated fair value of each reporting unit is compared to its carrying value.
 
The Company estimates the fair values of each reporting unit by a combination of (i) estimation of the discounted cash flows of each of the reporting units based on projected earnings in the future (the income approach) and (ii) a comparative analysis of revenue and margins multiples of public companies in similar markets (the market approach). If there is a deficiency (the estimated fair value of a reporting unit is less than its carrying value), a Step 2 test is required.

Discontinued Operations
 
On December 3, 2012, the Company sold all of the issued and outstanding capital stock of its consulting subsidiary, Spherix Consulting, Inc. for nominal consideration. The operations of Spherix Consulting, Inc. have been retroactively adjusted as discontinued operations as a result of the December 3, 2012 sale of the subsidiary.  Certain assets of Spherix Consulting, Inc. were retained by the Company but are presented as assets held for sale in the consolidated balance sheet at December 31, 2012 as they relate to the discontinued operations.

The Spherix Consulting segment generated nearly all of the Company’s revenue in 2012 and provided technical support for the Company’s biospherics segment.
 
 
-12-

 

   
For the Year Ended December 31, 2012
 
Revenues
  $ 728  
         
Operating costs and expenses
       
Compensation and related expenses
    1,450  
Professional fees
    160  
Depreciation
    4  
Other selling, general and administrative
    83  
Total operating expenses
    1,697  
         
Loss from discontinued operations before taxes
  $ (969 )
 
Results of Operations

Fiscal Year Ended December 31, 2013 Compared to Fiscal Year Ended December 31, 2012
 
For the year ended December 31, 2013, we generated $27,000 of revenue from certain licensing and product sales.  For the year ended December 31, 2012, we generated $20,000 in revenue.
 
For the year ended December 31, 2013, we incurred a loss from operations of $15.3 million an increase of $11.9 million or 342%, as compared to $3.5 million for the same period in 2012 and a net loss from continuing operations of $18.0. million, an increase of $15.1 million or 522%, as compared to $2.9 million for the same period in 2012 mainly as a result of stock based compensation expenses (increase of approximately $10.0 million), and increased professional fees incurred in connection with the acquisition of North South (increase of $2.5 million).
 
For the year ended December 31, 2013, we incurred $15.3 million in operating expenses.  These costs relate to the amortization of the patents, compensation and professional fees as well as research and development costs, stock based compensation expenses, professional fees and other selling, general and administrative expenses including acquisition costs related to the merger with North South.
 
For the year ended December 31, 2013, we recorded expense related to a fair value adjustment on the warrant liability of $2.6 million, compared to a $1.2 million gain for the same period in 2012. Fair value adjustments for warrant liabilities is the result of the change in the carrying amount of the warrant liability caused by changes in the fair value as determined using a Black-Scholes option valuation method.  

 
-13-

 

Liquidity and Capital Resources
 
We continue to incur ongoing administrative and other expenses, including public company expenses, in excess of corresponding revenue.

We intend to finance its activities through:

·
managing current cash and cash equivalents on hand from our past equity offerings,
 
·
seeking additional funds raised through the sale of additional securities in the future,
   
·
increasing revenue from the monetization of its patent portfolios, license fees, and new business ventures.

Cash Flows from Operating ActivitiesFor the year ended December 31, 2013, net cash used in continuing operations was $5.3 million compared to net cash used in continuing operations of $3.6 million for the year ended December 31, 2012.  Net cash used in continuing operations for the year ended December 31, 2013 was primarily driven by the Company's net loss and offset by the $10.0 million non-cash expense recorded for stock-based compensation and $2.6 million non-cash expense recorded for the change in fair value of the warrant liability.
 
Cash Flows from Discontinued OperationsFor the year ended December 31, 2013, net cash provided by discontinued operations was $0.1 million as compared to $0.2 million cash used in discontinued operations for the year ended December 31, 2012.

Cash Flows from Investing ActivitiesNet cash provided by investing activities from continuing operations for the year ended December 31, 2013 for $0.6 million related from the purchase of Rockstar patent portfolio of $2.0 million offset by the cash acquired in the acquisition of North South of $2.6 million.
 
Cash Flows from Financing Activities – Net cash flows provided by financing activities from continuing operations in the year ended December 31, 2013 was $3.2 million compared to net cash provided by financing activities of $3.4 million in the same period in 2012.  For the twelve months in 2013, the cash flows provided by financing activities from continuing operations were from $0.5 million in proceeds from notes payable, $2.4 million in proceeds from issuance of Series E and F Convertible Preferred Stock and $0.3 million for the issuance of common stock in a private placement.
 
Our financial statements for the year ended December 31, 2013 indicate there is substantial doubt about our ability to continue as a going concern as we are dependent on our ability to retain short term financing and ultimately to generate sufficient cash flow to meet our obligations on a timely basis in order to attain profitability, as well as successfully obtain financing on favorable terms to fund our long term plans. Our business will require significant amounts of capital to sustain operations and make the investments we need to execute our longer term business plan. Our working capital amounted to approximately $1.8 and $4.0 million at December 31, 2013.  Our existing liquidity is not sufficient to fund our operations, anticipated capital expenditures, working capital and other financing requirements for the foreseeable future. We will need to seek to obtain additional debt or equity financing, especially if we experience downturns or cyclical fluctuations in our business that are more severe or longer than anticipated, or if we experience significant increases in expense levels resulting from being a publicly-traded company.  If we attempt to obtain additional debt or equity financing, we cannot assume that such financing will be available to us on favorable terms, or at all.
 
Disputes regarding the assertion of patents and other intellectual property rights are highly complex and technical.  We may be forced to litigate against others to enforce or defend its intellectual property rights or to determine the validity and scope of other parties’ proprietary rights. The defendants or other third parties involved in the lawsuits in which we are involved may allege defenses and/or file counterclaims or initiate inter parties reviews in an effort to avoid or limit liability and damages for patent infringement or cause the Company to incur additional costs as a strategy.  If such efforts are successful, they may have an impact on the value of the patents and preclude us from deriving revenue from the patents.  The patents could be declared invalid by a court or the US Patent and Trademark Office, in whole or in part, or our costs can increase.
 
 
-14-

 
 
As a result, a negative outcome of any such litigation, or one or more claims contained within any such litigation, could materially and adversely impact our business. Additionally, we anticipate that legal fees which are not included in contingency fee arrangements, experts and other expenses will be material and could have an adverse effect on our financial condition and results of operations if our efforts to monetize these patents are unsuccessful.
 
 
In addition, the costs of enforcing our patent rights may exceed our recoveries from such enforcement activities. Accordingly, in order for us to generate a profit from our patent enforcement and monetization activities, the revenues from such enforcement and monetization activities must be high enough to offset both the cash outlays and the contingent fees payable from such revenues, including any profit sharing arrangements with inventors or prior owners of the patents. Our failure to monetize our patent assets or the occurrence of unforeseen circumstances that could have a negative impact on our liquidity could significantly harm our business.
 
Our existing liquidity is not sufficient to fund our operations, anticipated capital expenditures, working capital and other financing requirements for the foreseeable future. We will need to seek to obtain additional debt or equity financing, especially if we experience downturns or cyclical fluctuations in our business that are more severe or longer than anticipated, or if we experience significant increases in the loss of a significant customer, or increases in our expense levels resulting from being a publicly-traded company. If we attempt to obtain additional debt or equity financing, we cannot assure you that such financing will be available to us on favorable terms, or at all.

Our financial statements for the year ended December 31, 2013 indicate there is substantial doubt about our ability to continue as a going concern as we are dependent on our ability to retain short term financing and ultimately to generate sufficient cash flow to meet our obligations on a timely basis in order to attain profitability, as well as successfully obtain financing on favorable terms to fund the Company’s long term plans. We can give no assurance that our plans and efforts to achieve the above steps will be successful.

Item 7A.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

Not applicable.

Item 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

               Financial statements and supplementary data required by this Item 8 follow.

 
-15-

 

Index to Financial Statements Page
 
 
Page
 
Reports of Independent Registered Public Accounting Firms
F-2
   
Consolidated Balance Sheets as of December 31, 2013 and 2012
F-4
   
Consolidated Statements of Operations for the Years Ended December 31, 2013 and 2012
F-5
   
Consolidated Statements of Changes in Stockholders’ Equity for the Years Ended December 31, 2013 and 2012
F-6
   
Consolidated Statements of Cash Flows for the Years Ended December 31, 2013 and 2012
F-7
   
Notes to the Consolidated Financial Statements
F-8
 

 
F-1

 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
To the Audit Committee of the
Board of Directors and Shareholders
of Spherix Incorporated

We have audited the accompanying consolidated balance sheet of Spherix Incorporated and Subsidiaries (the "Company") as of December 31, 2013, and the related consolidated statements of operations, changes in stockholders' equity and cash flows for the year then ended.  These financial statements are the responsibility of the Company's management.  Our responsibility is to express an opinion on these financial statements based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States).  Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement.  The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting.  Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, 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.  An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation.  We believe that our audit provides a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Spherix Incorporated and Subsidiaries as of December 31, 2013, and the consolidated results of its operations and its cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America.

The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern.  As more fully described in Note 2, the Company has incurred significant losses and needs to raise additional funds to meet its obligations and sustain its operations.  These conditions raise substantial doubt about the Company's ability to continue as a going concern. Management's plans in regard to these matters are also described in Note 2.  The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.

/s/  Marcum  LLP

Marcum  LLP
New  York,  NY
March 31, 2014
 
 
F-2

 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
Board of Directors and Stockholders
Spherix Incorporated


We have audited the accompanying consolidated balance sheet of Spherix Incorporated (a Delaware corporation) and subsidiaries (the “Company”) as of December 31, 2012, and the related consolidated statements of operations, changes in stockholders’ equity, and cash flows for the year ended December 31, 2012. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, 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. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Spherix Incorporated and subsidiaries as of December 31, 2012, and the results of their operations and their cash flows for the year ended December 31, 2012 in conformity with accounting principles generally accepted in the United States of America.


/s/ Grant Thornton LLP
Grant Thornton LLP
McLean, VA
March 31, 2014

 
F-3

 

Spherix Incorporated and Subsidiaries
Consolidated Balance Sheets
(in thousands except share amounts)

   
As of December 31,
 
   
2013
   
2012
 
ASSETS
           
Current assets
           
Cash and cash equivalents
  $ 3,125     $ 4,498  
Other receivables
    -       2  
Prepaid expenses and other assets
    151       102  
Assets of segment held for sale
    -       104  
Total current assets
    3,276       4,706  
                 
Property and equipment, net of accumulated depreciation of $332 and $308
    -       24  
Patent portfolios, net of accumulated amortization of $267 and $0
    64,835       -  
Goodwill
    1,712       -  
Deposit
    30       26  
Total assets
  $ 69,853     $ 4,756  
                 
LIABILITIES AND STOCKHOLDERS' EQUITY
               
Current liabilities
               
Accounts payable and accrued expenses
  $ 270     $ 428  
Accrued salaries and benefits
    233       285  
Accrued patent cost
    1,000       -  
Liabilities of segment held for sale
    -       18  
Total current liabilities
    1,503       731  
                 
Deferred rent
    -       45  
Warrant liability
    48       3,126  
Total liabilities
    1,551       3,902  
                 
Series I redeemable preferred stock, $0.0001 par value; 119,760 shares issued and outstanding; liquidation preference of $167 per share
    20,000       -  
                 
Commitments and contingencies
               
                 
Stockholders' equity
               
Preferred Stock, $0.0001 par value, 5,000,000 shares authorized
               
Series A Preferred: no shares issued and outstanding, at December 31, 2013 and 2012; liquidation preference $0.0001 per share
    -       -  
Convertible preferred stock;
               
Series B: 1 share issued and outstanding, at December 31, 2013 and 2012; liquidation preference $0.0001 per share
    -       -  
Series C: 1 and no shares issued and outstanding, at December 31, 2013 and 2012; liquidation preference $0.0001 per share
    -       -  
Series D: 1,227,582 and no shares issued and outstanding, at December 31, 2013 and 2012; liquidation value of $0.0001  per share
    -       -  
Series D-1: 59,265 and no shares issued and outstanding, at December 31, 2013 and 2012; liquidation value of $0.0001  per share
    -       -  
Series E: no shares issued and outstanding, at December 31, 2013 and 2012; liquidation preference $0.0001 per share
    -       -  
Series F: no shares issued and outstanding, at December 31, 2013 and 2012; liquidation preference $0.0001 per share
    -       -  
Series F-1: 156,250 and no shares issued and outstanding, at December 31, 2013 and 2012; liquidation preference $0.0001 per share
    -       -  
Series H: 459,043 and no shares issued and outstanding at December 31, 2013 and 2012; liquidation preference $83.50 per share
    -       -  
Common stock, $0.0001 par value, 50,000,000 shares authorized; 3,770,113 and 814,114 shares issued at December 31, 2013 and 2012, respectively; 3,769,712 and 813,713 shares outstanding at December 31, 2013 and 2012, respectively
    -       -  
Additional paid-in-capital
    102,043       36,630  
Treasury stock, at cost, 401 shares at December 31, 2013 and 2012, respectively
    (465 )     (465 )
Accumulated deficit
    (53,276 )     (35,311 )
                 
Total stockholders' equity
    48,302       854  
Total liabilities and stockholders' equity
  $ 69,853     $ 4,756  
 
The accompanying notes are an integral part of these consolidated financial statements.

 
F-4

 

Spherix Incorporated and Subsidiaries
Consolidated Statements of Operations
 (in thousands except per share amounts)
 
   
For the Years Ended
December 31,
 
   
2013
   
2012
 
Revenues
  $ 27     $ 20  
                 
Operating costs and expenses
               
Cost of revenues
    3       -  
Amortization of patents
    267       -  
Compensation and compensation-related expenses (including stock-based compensation)
    9,783       1,048  
Research and development
    10       -  
Professional fees
    4,143       1,621  
Rent
    134       164  
Depreciation
    24       64  
Other selling, general and administrative
    1,010       595  
Total operating expenses
    15,374       3,492  
Loss from operations
    (15,347 )     (3,472 )
                 
Other income (expense)
               
Interest income (expense)
    -       4  
Loss on issuance of warrants
    -       (622 )
Fair value adjustments for warrant liabilities
    (2,618 )     1,202  
Total other income (expense)
    (2,618 )     584  
                 
Loss from continuing operations
    (17,965 )     (2,888 )
                 
Discontinued operations
               
Loss from discontinued operations
    -       (969 )
                 
Net loss
  $ (17,965 )   $ (3,857 )
                 
Net loss per share, basic and diluted
               
Continuing operations
  $ (13.64 )   $ (10.54 )
Discontinued operations
    -       (3.54 )
Net loss per share
    (13.64 )     (14.08 )
                 
Weighted average number of shares outstanding
               
Basic and diluted
    1,317       274  
 
The accompanying notes are an integral part of these consolidated financial statements.

 
F-5

 

Spherix Incorporated and Subsidiaries
Consolidated Statements of Changes in Stockholders’ Equity
 (in thousands)

   
Common Stock
   
Preferred Stock
   
Additional
Paid-in Capital
   
Treasury Stock
   
Accumulated
Deficit
   
Total Stockholders'
Equity
 
   
Shares
   
Amount
   
Shares
   
Amount
       
Shares
   
Amount
         
Balance as of January 1, 2012
    155     $ -       -     $ -     $ 35,717       -     $ (465 )   $ (31,454 )   $ 3,798  
Issuance of common stock for cash, net of offering costs of $77
    537       -       -       -       859       -       -       -       859  
Stock-based compensation
    122       -       -       -       56       -       -       -       56  
Fractional shares payment
    -       -       -       -       (2 )     -       -       -       (2 )
Net loss
    -       -       -       -       -       -       -       (3,857 )     (3,857 )
Balance as of December 31, 2012
    814     $ -       -     $ -     $ 36,630       -     $ (465 )   $ (35,311 )   $ 854  
Issuance of common stock for Rockstar patents
    377       -       -       -       2,670       -       -       -       2,670  
Issuance of Series H preferred stock for Rockstar patents
    -       -       459       -       38,330       -       -       -       38,330  
Issuance of common stock for North South acquisition
    1,203       -       1,380       -       5,511       -       -       -       5,511  
Issuance of common stock in connection with private placement
    48       -       -       -       310       -       -       -       310  
Issuance of Series E preferred stock for cash
    -       -       100       -       500       -       -       -       500  
Issuance of Series F preferred stock for cash
    -       -       304       -       1,925       -       -       -       1,925  
Warrants exchange for Series C convertible preferred stock
    -       -       229       -       5,696       -       -       -       5,696  
Conversion of Series C preferred stock to common stock
    229       -       (229 )     -       -       -       -       -       -  
Conversion of Series D preferred stock to common stock
    166       -       (17 )     -       -       -       -       -       -  
Conversion of Series D preferred stock to Series D-1
    -       -       -       -       -       -       -       -       -  
Conversion of Series D1 preferred stock to common stock
    763       -       (76 )     -       -       -       -       -       -  
Conversion of Series F preferred stock to Series F-1
    -       -       -       -       -       -       -       -       -  
Conversion of Series F1 preferred stock to common stock
    148       -       (148 )     -       -       -       -       -       -  
Cashless exercise of warrants
    7       -       -       -       -       -       -       -       -  
Retirement of Series E preferred stock and release of loan to North South
    -       -       (100 )     -       500       -       -       -       500  
Stock-based compensation
    15       -       -       -       9,971       -       -       -       9,971  
Net loss
    -       -       -       -       -       -       -       (17,965 )     (17,965 )
Balance as of December 31, 2013
    3,770     $ -       1,902     $ -     $ 102,043       -     $ (465 )   $ (53,276 )   $ 48,302  
 
The accompanying notes are an integral part of these consolidated financial statements.

 
F-6

 

Spherix Incorporated and Subsidiaries
Consolidated Statements of Cash Flows
(in thousands)

   
For the Years Ended
December 31,
 
   
2013
   
2012
 
Cash flows from operating activities
           
Net loss
  $ (17,965 )   $ (3,857 )
Adjustments to reconcile net loss to net cash used in operating activities:
               
Amortization of patent portfolio
    267       -  
Fair value adjustments for warrant liabilities
    2,618       (1,202 )
Issuance costs of warrants accounted for at fair value
    -       246  
Loss on issuance of warrants
    -       622  
Depreciation
    24       64  
Stock-based compensation
    9,971       56  
Provision for doubtful accounts
    -       (8 )
Changes in assets and liabilities:
               
Other receivables
    2       5  
Prepaid expenses and other assets
    (14 )     236  
Deposit
    (4 )     -  
Accounts payable and accrued expenses
    (158 )     193  
Accrued salaries and benefits
    (52 )     -  
Deferred rent
    (45 )     (3 )
Net cash used in activities of continuing operations
    (5,356 )     (3,648 )
Net cash provided by (used in) activities of discontinued operations
    86       (167 )
Net cash used in operating activities
    (5,270 )     (3,815 )
                 
Cash flows from investing activities
               
 Cash acquired in acquisition of North South
    2,662       -  
  Purchase of Rockstar patent portfolio
    (2,000 )     -  
  Purchase of fixed assets
    -       (2 )
Net cash provided by (used in) activities of continuing operations
    662       (2 )
Net cash provided by activities of discontinued operations
    -       4  
Net cash provided by investing activities
    662       2  
                 
Cash flows from financing activities
               
  Proceeds from issuance of note payable
    500       -  
  Issuance of Series E preferred stock for cash, net
    500       -  
  Issuance of Series F preferred stock for cash, net
    1,925       -  
  Issuance of common stock in connection with private placement, net
    310       3,402  
  Reverse stock split fractional share payment
    -       (2 )
Net cash provided by activities of continuing operations
    3,235       3,400  
Net cash provided by financing activities
    3,235       3,400  
                 
Net decrease in cash and cash equivalents
    (1,373 )     (413 )
Cash and cash equivalents, beginning of year
    4,498       4,911  
                 
Cash and cash equivalents, end of year
  $ 3,125     $ 4,498  
                 
Supplemental schedule of non-cash activities
               
Acquisition of North South Holdings:
               
Prepaid expenses
  $ (35 )   $ -  
Patent portfolio
    (1,102 )     -  
Goodwill
    (1,712 )     -  
Common and preferred stock issued
    5,511       -  
Cash Acquired in acquisition of North South
  $ 2,662     $ -  
                 
Issuance of common and preferred stock for Rockstar patents
  $ 61,000     $ -  
Issuance of Series C Convertible Preferred Stock in connection with exchange of warrants
    5,696       -  
Accrued Rockstar patent cost
    1,000       -  
Retirement of Series E Convertible Preferred stock
  $ 500     $ -  
 
The accompanying notes are an integral part of these consolidated financial statements.

 
F-7

 

Spherix Incorporated and Subsidiaries
Notes to Consolidated Financial Statements

Note 1.                                Organization and Description of Business

Organization

Until the sale of Spherix Consulting, Inc. (“Spherix Consulting”) in December 2012, the principal segments of Spherix Incorporated and Subsidiaries (the “Company”) have been Biospherics Incorporated, the biotechnology research and development business, and Spherix Consulting, the technical and regulatory consulting business. On December 3, 2012, the Company sold all of the stock of Spherix Consulting, accordingly, the operations of Spherix Consulting are reported in the accompanying consolidated financial statements as discontinued operations. The Company is incorporated in the state of Delaware and was formed in 1967 as a scientific research company and for much of its history pursued drug development including through Phase III clinical studies which were discontinued in 2012. The Company has shifted its focus during 2013 and is now an intellectual property company that owns patented and unpatented intellectual property.

On September 21, 2012, the Company effected a reverse stock split of its outstanding common stock at an exchange ratio of 1-for-20.  As a result of the reverse stock split, every 20 shares of the Company’s issued and outstanding common stock were combined into one share of common stock.  No fractional shares of common stock were issued as a result of the reverse stock split.  Instead, fractional shares that would otherwise result from the reverse stock split were purchased by the Company based on the closing price of the stock on September 21, 2012.  All references in these notes and in the related consolidated financial statements to number of shares, price per share and weighted average number of shares outstanding of common stock prior to the reverse stock split (including the share capital decrease) have been adjusted to reflect the reverse stock split (including the share capital decrease) on a retroactive basis, unless otherwise noted.
 
Acquisition of North South Holdings, Inc.

On December 27, 2012, the Company formed a new wholly-owned subsidiary, Nuta Technology Corp., (“Nuta”), which is incorporated in the state of Virginia. On April 2, 2013, the Company entered into an Agreement and Plan of Merger, as amended (the "Merger Agreement") with its wholly owned subsidiary, Nuta, North South Holdings, Inc., a Delaware corporation ("North South"), the owner or assignee of certain patents, licenses and applications (the “North South Intellectual Property”), and the shareholders of North South (the "North South Shareholders"). On September 10, 2013 the transaction contemplated under the Merger Agreement was completed (the “Merger”). At closing, North South merged with and into Nuta with Nuta as the surviving corporation. Nuta will continue its operations in the State of Virginia as the record owner of the North South’s intellectual property. Pursuant to the terms and conditions of the Merger, at the closing of the Merger, all of North South’s 5,213 issued and outstanding shares of common stock were converted into an aggregate of 1,203,153 shares of the Company’s common stock, par value $0.0001 per share (the “Common Stock”), and all of North South’s 491 issued and outstanding shares of Series A Preferred Stock and 107 issued and outstanding shares of Series B Preferred Stock were converted into an aggregate of 1,379,685 shares of the Company's Series D Convertible Preferred Stock, par value $0.0001 per share, which is convertible into shares of the Company’s common stock on a one-for-ten basis (collectively with the 1,203,153 common shares of the Company, the “Merger Consideration”).

The closing of the Merger was subject to customary closing conditions, including the receipt of a fairness opinion that the Merger Consideration is fair to stockholders and the Company from a financial point of view, based on, among other things, the North South Intellectual Property assets, and the approval of the Company’s shareholders holding a majority of the outstanding voting capital stock of the Company as of the record date (July 10, 2013) to issue the Merger Consideration pursuant to NASDAQ listing standards.

 
F-8

 

Acquisition of Patents from Rockstar Consortium US LP – July 2013

On July 24, 2013, the Company purchased a group of patents in the mobile communication sector (the “Purchased Patents”) from Rockstar Consortium US LP, a Delaware limited partnership (“Rockstar”) at a contractual price of $4.0 million. In consideration for the Purchased Patents, the Company paid an aggregate $3.0 million in consideration to Rockstar, which consisted of a $2.0 million cash payment and 176,991 shares of common stock accepted by the seller in settlement of the $1 million (at $5.65 per share) remaining balance. The Shares are subject to a lock-up agreement, subject to certain leak-out provisions, which shall expire on the earlier of (i) six months from the issuance of the shares or (ii) the date that the Company’s Common Stock achieves a trading volume of at least 50,000 shares per day and a closing price of at least $15 per share for a period of five consecutive days. The Company has filed a registration statement covering the resale of the shares issued to Rockstar with the Securities and Exchange Commission (the “SEC”) on September 5, 2013. On the anniversary of one year and one day after the Company files its first complaint against a defendant with any one or more of the patents acquired in this transaction, the Company shall deliver $1.0 million to Rockstar. The initial complaint was filed on August 30, 2013, and at that time the additional $1.0 million was accrued and included in patent portfolio on the consolidated balance sheet. On January 3, 2014, the Company remitted the $1.0 million to Rockstar in satisfaction of this liability.
 
Acquisition of Patents from Rockstar Consortium US LP – December 2013

On December 31, 2013, through the Company’s wholly-owned subsidiary, Spherix Portfolio Acquisition II, Inc., (“SPA II, Inc.”), the Company entered into its second agreement to acquire certain patents from Rockstar.  The Company acquired a suite of 101 patents and patent applications pursuant to a Patent Purchase Agreement in several technology families, including data, optical and voice technology.  The patents provide the Company with rights to develop and commercialize products as well as enforcement rights for past, present and future infringement.  In connection with the patent acquisition, on December 31, 2013, the Company issued (a) 199,990 shares of common stock with a grant date fair value of approximately $1.7 million, or $8.35 per share, (b) 459,043 shares of Series H Convertible Preferred Stock with a grant date fair value of approximately $38.3 million, or $8.35 per share, and (c) 119,760 shares of Series I Convertible Preferred Stock with a mandatory redemption value of $20 million, or $167 per share, for an aggregate value of approximately $60 million in securities issued to Rockstar.
 
Holders of 50.1% of the outstanding common stock of the Company entered into voting agreements to vote in favor of approving the issuance as the Company was required to obtain stockholder approval pursuant to NASDAQ Listing Rule 5635.  Irrespective of the stockholder approval vote, Rockstar is still restricted from transferring or selling any securities for an additional 180 day period following the occurrence of certain Company events (but not more than two such Company events), including the consummation of a public offering in which we receive gross proceeds of at least $5 million and the announcement of any material acquisition.
 
 
F-9

 

Note 2.                                Liquidity and Financial Condition

The Company continues to incur ongoing administrative and other expenses, including public company expenses, in excess of corresponding revenue.

The Company intends to finance its activities through:

·
managing current cash and cash equivalents on hand from the Company’s past equity offerings,
 
·
seeking additional funds raised through the sale of additional securities in the future,
   
·
increasing revenue from the monetization of its patent portfolios, license fees, and new business ventures.

The Company’s financial statements for the year ended December 31, 2013 indicate there is substantial doubt about its ability to continue as a going concern as the Company is dependent on its ability to retain short term financing and ultimately to generate sufficient cash flow to meet its obligations on a timely basis in order to attain profitability, as well as successfully obtain financing on favorable terms to fund the Company’s long term plans. The Company’s business will require significant amounts of capital to sustain operations and make the investments it needs to execute its longer term business plan. The Company’s working capital amounted to approximately $1.8 and $4.0 million at December 31, 2013 and 2012, respectively and, cash and cash equivalents amounted to approximately $3.1 and $4.5 million, respectively.  The Company’s existing liquidity is not sufficient to fund its operations, anticipated capital expenditures, working capital and other financing requirements for the foreseeable future. The Company will need to seek to obtain additional debt or equity financing, especially if the Company experiences downturns or cyclical fluctuations in its business that are more severe or longer than anticipated, or if the Company experiences significant increases in expense levels resulting from being a publicly-traded company.  If the Company attempts to obtain additional debt or equity financing, the Company cannot assume that such financing will be available to the Company on favorable terms, or at all.

Disputes regarding the assertion of patents and other intellectual property rights are highly complex and technical.  The Company may be forced to litigate against others to enforce or defend its intellectual property rights or to determine the validity and scope of other parties’ proprietary rights. The defendants or other third parties involved in the lawsuits in which the Company is involved may allege defenses and/or file counterclaims or initiate inter parties reviews in an effort to avoid or limit liability and damages for patent infringement or cause the Company to incur additional costs as a strategy. If such efforts are successful, they may have an impact on the value of the patents and preclude the Company from deriving revenue from the patents. The patents could be declared invalid by a court or the US Patent and Trademark Office, in whole or in part, or the costs of the Company can increase.

As a result, a negative outcome of any such litigation, or one or more claims contained within any such litigation, could materially and adversely impact the Company’s business. Additionally, the Company anticipates that legal fees which are not included in contingency fee arrangements, experts and other expenses will be material and could have an adverse effect on its financial condition and results of operations if its efforts to monetize these patents are unsuccessful.

In addition, the costs of enforcing the Company’s patent rights may exceed its recoveries from such enforcement activities. Accordingly, in order for the Company to generate a profit from its patent enforcement and monetization activities, the revenues from such enforcement and monetization activities must be high enough to offset both the cash outlays and the contingent fees payable from such revenues, including any profit sharing arrangements with inventors or prior owners of the patents. The Company’s failure to monetize its patent assets or the occurrence of unforeseen circumstances that could have a negative impact on the Company’s liquidity could significantly harm its business.

Note 3.                                Summary of Significant Accounting Policies

Principles of Consolidation
 
The accompanying consolidated financial statements include the accounts of Spherix Incorporated and its wholly-owned subsidiaries, Biospherics Incorporated, Nuta Technology Corp, Spherix Portfolio Acquisition I, Inc., and Spherix Portfolio Acquisition II, Inc.  Prior to the Merger with Nuta, North South had formed three Delaware limited liability corporations on July 26, 2013, Guidance IP, LLC (“Guidance”), Directional IP, LLC. (“Directional”) and CompuFill LLC. All significant intercompany balances and transactions have been eliminated in consolidation.

 
F-10

 

Use of Estimates

The accompanying consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (“US GAAP”).  This requires management to make estimates and assumptions that affect certain reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenue and expenses during the period.  The Company’s significant estimates and assumptions include the recoverability and useful lives of long-lived assets, stock-based compensation, valuation of warrants, the valuation of assets acquired and common and preferred stock issued in the acquisition of North South, and the valuation allowance related to the Company’s deferred tax assets.  Certain of the Company’s estimates, including the carrying amount of the intangible assets, could be affected by external conditions, including those unique to the Company and general economic conditions. It is reasonably possible that these external factors could have an effect on the Company’s estimates and could cause actual results to differ from those estimates and assumptions.

Concentration of Cash

The Company maintains cash balances at four financial institutions in checking accounts and money markets.  The Company considers all highly liquid investments with original maturities of three months or less when purchased to be cash and cash equivalents.  The Company maintains cash balances at several banks.  Interest bearing accounts at each institution are insured by the Federal Deposit Insurance Corporation (“FDIC”) up to $250,000.  At December 31, 2013, the Company’s interest bearing deposits in excess of the FDIC limits was $2.4 million.  The Company has not experienced any losses in such accounts and believes it is not exposed to any significant credit risk on cash.

Revenue Recognition

Revenue is recognized when persuasive evidence of an arrangement exists, delivery of the product or service has occurred, all obligations have been performed pursuant to the terms of the agreement, the sales price is fixed or determinable, and collectability is reasonably assured.  Revenue from the licensing of the Company’s intellectual property  and settlements reached from legal enforcement of the Company’s patent rights is recognized when the arrangement with the licensee has been signed and the license has been delivered and made effective, provided license fees are fixed or determinable and collectability is reasonably assured.  The fair value of licenses achieved by ordinary business negotiations is recognized as revenue.

The amount of consideration received upon any settlement or judgment is allocated to each element of the settlement based on the fair value of each element.  Elements related to licensing agreements, royalty revenues, net of contingent legal fees, are recognized as revenue in the consolidated statement of operations.  Elements that are not related to license agreements and royalty revenue in nature will be reflected as a separate line item within the other income section of the consolidated statements of operations.  Elements provided in either settlement agreements or judgments include: the value of a license, legal release, and interest.  When settlements or judgments are achieved at discounts to the fair value of a license, the Company allocates the full settlement or judgment, excluding specifically named elements as mentioned above, to the value of the license agreement or royalty revenue under the residual method. Legal release as part of a settlement agreement is recognized as a separate line item in the consolidated statements of operations when value can be allocated to the legal release.  When the Company reaches a settlement with a defendant, no value is allocated to the legal release since the existence of a settlement removes legal standing to bring a claim of infringement and without a legal claim, the legal release has no economic value.  The element that is applicable to interest income will be recorded as a separate line item in other income. The Company does not assume future performance obligations in its license arrangements.  Revenue from the monetization of the Company’s intellectual property during the year ended December 31, 2013 was not significant.

Cost of Revenues

Cost of revenues include the costs and expenses incurred in connection with the Company’s patent enforcement activities, including inventor royalties paid to original patent owners, contingent legal fees paid to external patent counsel, other patent-related legal expenses paid to external patent counsel, licensing and enforcement related research, consulting and other expenses paid to third parties and the amortization of patent-related acquisition costs.

 
F-11

 

Inventor Royalties and Contingent Legal Expenses

Inventor royalties are expensed in the period that the related revenues are recognized. In certain instances, pursuant to the terms of the underlying inventor agreements, costs paid by the Company to acquire patents are recoverable from future net revenues. Patent acquisition costs that are recoverable from future net revenues are amortized over the estimated economic useful life of the related patents, or as the prepaid royalties are earned by the inventor, as appropriate, and the related expense is included in amortization expense.

Contingent legal fees are expensed in the period that the related revenues are recognized. In instances where there are no recoveries from potential infringers, no contingent legal fees are paid; however, the Company may be liable for certain out of pocket legal costs incurred pursuant to the underlying legal services agreement. Legal fees advanced by contingent law firms that are required to be paid in the event that no license recoveries are obtained are expensed as incurred.

Accounting for Warrants
 
The Company accounts for the issuance of common stock purchase warrants issued in connection with the equity offerings in accordance with the provisions of ASC 815, Derivatives and Hedging (“ASC 815”).  The Company classifies as equity any contracts that (i) require physical settlement or net-share settlement or (ii) gives the Company a choice of net-cash settlement or settlement in its own shares (physical settlement or net-share settlement).  The Company classifies as assets or liabilities any contracts that (i) require net-cash settlement (including a requirement to net-cash settle the contract if an event occurs and if that event is outside the control of the Company) or (ii) gives the counterparty a choice of net-cash settlement or settlement in shares (physical settlement or net-share settlement).

The Company assessed the classification of its common stock purchase warrants as of the date of each offering and determined that such instruments met the criteria for liability classification.  The warrants are reported on the consolidated balance sheet as a liability at fair value using the Black-Scholes valuation method.  Changes in the estimated fair value of the warrants result in the recognition of other income or expense.

Fair Value of Financial Instruments

Financial instruments, including cash and cash equivalents, accounts and other receivables, accounts payable and accrued liabilities are carried at cost, which management believes approximates fair value due to the short-term nature of these instruments. The Company measures the fair value of financial assets and liabilities based on the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. The Company maximizes the use of observable inputs and minimizes the use of unobservable inputs when measuring fair value.

The Company uses three levels of inputs that may be used to measure fair value:

Level 1 — quoted prices in active markets for identical assets or liabilities
Level 2 — quoted prices for similar assets and liabilities in active markets or inputs that are observable
Level 3 — inputs that are unobservable (for example, cash flow modeling inputs based on assumptions)
 
Intangible Assets – Patent Portfolios

Intangible assets include the Company’s patent portfolios with original estimated useful lives ranging from 6 months to 12 years. The Company amortizes the cost of the intangible assets over their estimated useful lives on a straight line basis.  Costs incurred to acquire patents, including legal costs, are also capitalized as long-lived assets and amortized on a straight-line basis with the associated patent. As disclosed in Note 1, the Company acquired certain patent portfolios in the third and fourth quarters of 2013.

Patents includes the cost of patents or patent rights (hereinafter, collectively “patents”), acquired from third-parties or acquired in connection with business combinations. Patent acquisition costs are amortized utilizing the straight-line method over their remaining economic useful lives, ranging from one to ten years. Certain patent application and prosecution costs incurred to secure additional patent claims, that based on management’s estimates are deemed to be recoverable, are capitalized and amortized over the remaining estimated economic useful life of the related patent portfolio.
 
 
F-12

 

Goodwill
 
Goodwill is the excess of cost of an acquired entity over the fair value of amounts assigned to assets acquired and liabilities assumed in a business combination. Goodwill is subject to impairment testing at least annually and will be tested for impairment between annual tests if an event occurs or circumstances change that would indicated the carrying amount may be impaired. ASC Topic 350 provides an entity with the option to first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If, after assessing the totality of events or circumstances, an entity determines it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, then performing the two-step impairment test is unnecessary. If the two-step impairment test is necessary, a fair-value-based test is applied at the reporting unit level, which is generally one level below the operating segment level. The test compares the fair value of an entity's reporting units to the carrying value of those reporting units. This test requires various judgments and estimates. The Company estimates the fair value of the reporting unit using a market approach in combination with a discounted operating cash flow approach. Impairment of goodwill is measured as the excess of the carrying amount of goodwill over the fair values of recognized and unrecognized assets and liabilities of the reporting unit. An adjustment to goodwill will be recorded for any goodwill that is determined to be impaired. The Company tests goodwill for impairment at least annually in conjunction with preparation of its annual business plan, or more frequently if events or circumstances indicate it might be impaired. ASU 2010-28 modifies Step 1 of the goodwill impairment test for reporting units with zero or negative carrying amounts.  For those reporting units, an entity is required to perform Step 2 of the goodwill impairment test if it is more likely than not that a goodwill impairment exists.  In determining whether it is more likely than not that a goodwill impairment exists, an entity should consider whether there are any adverse qualitative factors indicating that an impairment may exist.  The Company performed the annual assessment and has determined that no impairment is necessary during the year ended December 31, 2013.

Impairment of Long-lived Assets

The Company monitors the carrying value of long-lived assets for potential impairment and tests the recoverability of such assets whenever events or changes in circumstances indicate that the carrying amounts may not be recoverable. If a change in circumstance occurs, the Company performs a test of recoverability by comparing the carrying value of the asset or asset group to its undiscounted expected future cash flows. If cash flows cannot be separately and independently identified for a single asset, the Company will determine whether impairment has occurred for the group of assets for which the Company can identify the projected cash flows. If the carrying values are in excess of undiscounted expected future cash flows, the Company measures any impairment by comparing the fair value of the asset or asset group to its carrying value. The Company deemed there was no impairment of long-lived assets during the years ended December 31, 2013 and 2012.

Property and Equipment

Property and equipment are stated at cost and consist of office furniture and equipment, computer hardware and software, and leasehold improvements. The Company computes depreciation and amortization under the straight-line method and typically over the following estimated useful lives of the related assets:

·
Office furniture and equipment                            3 to 10 years
·
Computer hardware and software                        3 to 5 years

Leasehold improvements are depreciated or amortized over the shorter of the term of the related lease or the estimated useful lives of the assets (generally 5 to 10 years). Major additions, improvements and renewals are capitalized at cost and ordinary repairs, maintenance, and renewals are expensed in the year incurred. Gains or losses from the sale or retirement of property and equipment result from the difference between sales proceeds (if any) and the assets’ net book value, and are recorded in the consolidated statements of operations.


 
F-13

 

Reclassifications

The Company has reclassified certain amounts from its previously reported consolidated financial statements for comparative purposes to conform to the fiscal 2013 presentation. These reclassifications had no impact on the Company’s previously reported consolidated operations or cash flows.
 
   
Revenue
   
Research and Development
   
Other SG&A
   
Total
 
Revenues
  $ 20     $ -     $ -     $ 20  
                                 
Operating costs and expenses
                               
Compensation and related expenses
    -       335       713       1,048  
Professional fees
    -       329       1,292       1,621  
Rent
    -       -       164       164  
Depreciation
    -       -       64       64  
Other selling, general and administrative
    -       63       532       595  
Total operating expenses
    -       727       2,765       3,492  
                                 
Loss from discontinued operations before taxes
  $ 20     $ (727 )   $ (2,765 )   $ (3,472 )
 
Income Taxes

The Company uses the asset and liability method of accounting for income taxes in accordance with ASC 740, “Income Taxes” (“ASC 740”). Under this method, income tax expense is recognized as the amount of: (i) taxes payable or refundable for the current year and (ii) deferred tax consequences of temporary difference resulting from matters that have been recognized in the Company’s financial statement or tax returns. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years 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 provided to reduce the deferred tax assets reported if based on the weight of available evidence it is more likely than not that some portion or all of the deferred tax assets will not be realized.

Discontinued Operations
 
The operations of Spherix Consulting, Inc. were retroactively adjusted as discontinued operations as a result of the December 3, 2012 sale noted above.  The Spherix Consulting segment generated nearly all of the Company’s revenue and provided technical support for the Company’s Biospherics segment.

   
For the Year Ended December 31, 2012
 
Revenues
  $ 728  
         
Operating costs and expenses
       
Compensation and related expenses
    1,450  
Professional fees
    160  
Depreciation
    4  
Other selling, general and administrative
    83  
Total operating expenses
    1,697  
         
Loss from discontinued operations before taxes
  $ (969 )
 
Net Loss Per Share

Basic loss per share is computed by dividing the net income or loss applicable to common shares by the weighted average number of common shares outstanding during the period.  Diluted earnings per share is computed using the weighted average number of common shares and, if dilutive, potential common shares outstanding during the period.  Potential common shares consist of the incremental common shares issuable upon the exercise of stock options (using the treasury stock method) and the conversion of the Company’s convertible preferred stock and warrants (using the if-converted method).  Diluted loss per share excludes the shares issuable upon the conversion of preferred stock and the exercise of stock options and warrants from the calculation of net loss per share if their effect would be antidilutive.

 
F-14

 

Securities that could potentially dilute loss per share in the future that were not included in the computation of diluted loss per share at December 31, 2013 and 2012 are as follows:
  
   
For the Years Ended
December 31,
 
   
2013
   
2012
 
Convertible preferred stock
    20,010,352       1  
Warrants to purchase common stock
    65,263       550,664  
Options to purchase common stock
    2,013,876       7,163  
Total
    22,089,491       557,828  

Stock-based Compensation

The Company accounts for share-based payment awards exchanged for employee services at the estimated grant date fair value of the award.  Stock options issued under the Company’s long-term incentive plans are granted with an exercise price equal to no less than the market price of the Company’s stock at the date of grant and expire up to ten years from the date of grant.  These options generally vest over a four- to ten-year period.

The fair value of stock options granted was determined on the grant date using assumptions for risk free interest rate, the expected term, expected volatility, and expected dividend yield.  The risk free interest rate is based on U.S. Treasury zero-coupon yield curve over the expected term of the option.  The expected term assumption is determined using the weighted average midpoint between vest and expiration for all individuals within the grant.  The expected volatility assumption is based on the standard deviation of the Company’s underlying stock price’s daily logarithmic returns.
 
The Company’s model includes a zero dividend yield assumption, as the Company has not historically paid nor does it anticipate paying dividends on its common stock.  The Company’s model does not include a discount for post-vesting restrictions, as the Company has not issued awards with such restrictions.

The periodic expense is then determined based on the valuation of the options, and at that time an estimated forfeiture rate is used to reduce the expense recorded.  The Company estimates of pre-vesting forfeitures is primarily based on the Company’s historical experience and is adjusted to reflect actual forfeitures as the options vest.

Stock-based compensation for the years ended December 31, 2013 and 2012 was comprised of the following (in thousands):

   
For the Years Ended
December 31,
 
   
2013
   
2012
 
Employee restricted stock awards
  $ 6     $ -  
Employee stock option awards
    8,696       56  
Non-employee restricted stock awards
    937       -  
Non-employee option awards
    332       -  
Total compensation expense
  $ 9,971     $ 56  

Treasury Stock

The Company accounts for the treasury stock using the cost method, which treats it as a reduction in stockholders’ equity.

 
F-15

 

Preferred Stock

The Company applies the accounting standards for distinguishing liabilities from equity when determining the classification and measurement of its preferred stock. Preferred shares subject to mandatory redemption are classified as liability instruments and are measured at fair value. Conditionally redeemable preferred shares (including preferred shares that feature redemption rights that are either within the control of the holder or subject to redemption upon the occurrence of uncertain events not solely within the Company’s control) are classified as temporary equity. At all other times, preferred shares are classified as stockholders’ equity.

Research and Development Costs

Research and development costs are charged to operations as incurred.

Recently Issued Accounting Pronouncements
 
Management does not believe that any recently issued, but not yet effective accounting pronouncements, if adopted, would have a significant effect to the accompanying consolidated financial statements.

Note 4.                                Property and Equipment

The components of property and equipment as of December 31, at cost are (in thousands):
   
As of December 31,
 
   
2013
   
2012
 
Computers
  $ 9     $ 9  
Office furniture and equipment
    94       94  
Leasehold improvements
    229       229  
Total cost
    332       332  
Accumulated depreciation and amortization
    (332 )     (308 )
Property and equipment, net
  $ -     $ 24  
 
The Company’s depreciation expense for the years ended December 31, 2013 and 2012 was $24,000 and $64,000, respectively.

Note 5.                                Goodwill and Intangible Assets
 
Acquisition of North South

As disclosed in Note 1, on September 10, 2013, the Company completed its acquisition of North South.  The Company acquired North South to expand its patent portfolio and continue its business plan of the monetization of its intellectual property.  The Company accounted for its acquisition of North South using the acquisition method of accounting. Accordingly, the results of operations for the year ended December 31, 2013, include operations of the acquired business since September 10, 2013.
 
The fair value of the purchase consideration issued to the sellers of North South was allocated to fair value of the net tangible assets acquired, with the resulting excess allocated to separately identifiable intangibles, and the remainder recorded as goodwill.  Goodwill recognized from the transactions mainly represented the expected operational synergies upon acquisition of the subsidiary and intangibles not qualifying for separate recognition. Goodwill is nondeductible for income tax purposes in the tax jurisdiction of the acquired business.

 
F-16

 

The purchase price was allocated as follows (in thousands):
 
Purchase Consideration:
     
Value of common stock and convertible preferred stock issued to sellers
  $ 5,511  
         
Tangible assets acquired:
       
Cash
    2,662  
Prepaid expenses
    35  
Net tangible assets acquired
    2,697  
         
Purchase consideration in excess of fair value of net tangible assets
    2,814  
         
Allocated to:
       
Patent portfolios
    1,102  
Goodwill
    1,712  
    $ -  

The purchase price allocation was based, in part, on management’s knowledge of North South’s business and the results of a third party appraisal commissioned by management.
  
The following table presents the unaudited pro-forma financial results, as if the acquisition of North South had been completed as of January 1, 2012 and 2013 (in thousands, except per share amounts):
   
For the Years Ended
December 31,
 
   
2013
   
2012
 
Revenues
  $ 121     $ 20  
Net loss
    (18,259 )     (4,023 )
Loss per share - basic and diluted
  $ (8.49 )   $ (2.72 )
 
The unaudited pro-forma results of operations are presented for information purposes only. The unaudited pro-forma results of operations are not intended to present actual results that would have been attained had the acquisition been completed as of January 1, 2012 or to project potential operating results as of any future date or for any future periods.
 
Rockstar Patent Acquisition – July 2013

As disclosed in Note 1, on July 24, 2013, the Company purchased a group of patents in the mobile communication sector from Rockstar at a contractual price of $4.0 million. In consideration for the Purchased Patents, the Company paid an aggregate $3.0 million in consideration to Rockstar, which consisted of a $2.0 million cash payment and 176,991 shares of common stock accepted by the seller in settlement of the $1.0 million (at $5.65 per shares) remaining balance of the Company’s common stock. On the anniversary of one year and one day after the Company files its first complaint against a defendant with any one or more of the patents acquired in this transaction, the Company shall deliver $1.0 million to Rockstar. The initial complaint was filed on August 30, 2013, and at that time the additional $1.0 million was accrued and included in patent portfolio on the consolidated balance sheet. On January 3, 2014, the Company remitted the $1.0 million to Rockstar in satisfaction of this liability.

 
F-17

 

Rockstar Patent Acquisition – December 2013

As disclosed in Note 1, on December 31, 2013, the Company entered into its second agreement to acquire certain patents from Rockstar.  The Company acquired a suite of 101 patents and patent applications pursuant to a Patent Purchase Agreement in several technology families, including data, optical and voice technology.  The patents provide the Company with rights to develop and commercialize products as well as enforcement rights for past, present and future infringement.

Rockstar will also be entitled to receive a contingent recovery percentage of future profits (“Participation Payments”) from licensing, settlements and judgments against defendants; however no payment is required unless the Company receives a recovery. The Participation Payments are equal to zero percent until the Company recovers at least $8 million, then the next $13.0 million to Rockstar, and then up to 70% of the net amounts recovered in excess of $1 billion.  Of the above, the $13.0 million payable to Rockstar is required to be paid on or before the six month anniversary of the recovery, license or settlement of the first action to generate Participation Payments by Company.  The Company’s ability to fund these Participation Payments will depend on the liquidity of the Company’s assets, recoveries, alternative demands for cash resources and access to capital at the time.  The Company’s obligation to fund Participation Payments could adversely impact our liquidity and financial position.
 
Additionally, in the event the Company consummates a Fundamental Transaction (as defined in the Certificate of Designation of Preferences, Rights and Limitations of Series I Convertible Preferred Stock), within two trading days of the closing of the Fundamental Transaction the Company shall be required to redeem such portion of the outstanding shares of Series I Preferred Stock as shall equal (i) 50% of the net proceeds of the Fundamental Transaction after deduction of the amount of net proceeds required to leave the Company with cash and cash equivalents on hand of $5.0 million and up until the net proceeds leave the Company with cash and cash equivalents on hand of $7.5 million and (ii) 100% of the net proceeds of the Fundamental Transaction thereafter.

The Company’s only identifiable intangible assets are patents and patent rights, with estimated remaining economic useful lives ranging from 6 months to 12 years. For all periods presented, all of the Company’s identifiable intangible assets were subject to amortization. The gross carrying amounts and accumulated amortization related to acquired intangible assets as of December 31, 2013 and 2012 are as follows (in thousands, except year amounts): 
 
Date Acquired and Description
 
Amount Recorded
   
Weighted Average Life (in years)
   
Amortization Expense - Year Ended December 31, 2013
   
Patent Portfolio Net
 
7/24/13 - Rockstar patent portfolio
  $ 4,000       8.50     $ 208     $ 3,792  
9/10/13 - North South patent portfolio
    1,102       8.50       40       1,062  
12/31/13 - Rockstar patent portfolio
    60,000       6.50       19       59,981  
    $ 65,102             $ 267     $ 64,835  

Amortization of the intangible assets for year ended December 31, 2013 was approximately $267,000. There was no amortization prior to July 24, 2013 as the first assets were placed into service on July 24, 2013.

 
F-18

 

The weighted average remaining amortization period of the Company’s patents is approximately 8.5 years. Future amortization of all patents is as follows (in thousands):
 
   
Rockstar
   
North South
   
Rockstar
       
   
Portfolio
   
Portfolio
   
Portfolio
       
   
Acquired
   
Acquired
   
Acquired
   
Total
 
For the Years Ending
 
24-Jul-13
   
10-Sep-13
   
31-Dec-13
   
Amortization
 
December 31, 2014
  $ 470     $ 130     $ 9,225     $ 9,825  
December 31, 2015
    470       130       9,225       9,825  
December 31, 2016
    471       130       9,250       9,851  
December 31, 2017
    470       130       9,225       9,825  
December 31, 2018
    470       130       9,225       9,825  
Thereafter
    1,442       416       13,826       15,684  
Total
  $ 3,793     $ 1,066     $ 59,976     $ 64,835  

Note 6.                                Fair Value Measurement

On November 7, 2012, the Company issued an aggregate of 483,657 shares of common stock at a price of $5.324 per share for aggregate net proceeds of $2.6 million. The Company also issued warrants to the investors in the offering to purchase aggregate of 483,657 shares of common stock.  The Warrants were exercisable through November 7, 2017 at an exercise price of $6.53 per share. The warrants contained a provision for net cash settlement at the option of the holder in the event that there is a fundamental transaction (as contractually defined in the warrant agreements) and as a result, were recorded as derivative liabilities on the consolidated balance sheet.

On March 6, 2013, the Company, and certain investors that participated in the November 2012 private placement transaction (“Investors”), entered into separate Warrant Exchange Agreements pursuant to which certain of the Investors exchanged common stock purchase warrants acquired in the private placement for shares of the Company’s newly designated Series C Convertible Preferred Stock.  Each share of Series C Convertible Preferred Stock is convertible into one (1) share of the Company’s common stock, par value $0.0001 per share (the “Common Stock”) at the option of the holder, subject to certain limitations on conversions that would result in the Investors acquiring more than 4.99% (or, if such limitation is waived by the holder upon no less than 61 days prior notice, 9.99%) of the outstanding voting stock of the Company.  The Series C Convertible Preferred Stock was established on March 5, 2013 by the filing in the State of Delaware of a Certificate of Designation of Preferences, Rights and Limitations of Series C Convertible Preferred Stock (“Certificate of Designation”). The liquidation preference of the Series C Convertible Preferred Stock is $0.0001 per share.

Pursuant to the Warrant Exchange Agreements, certain Investors received in exchange for their warrants an aggregate of 229,337 shares of the Series C Convertible Preferred Stock, each convertible into one share of Common Stock.  The number of shares of Common Stock underlying the Series C Convertible Preferred Stock is the same number as would have been-issued upon a “cashless exercise” of the exchanged warrants under the terms of the warrants based on the one-day volume weighted average price of the Company’s Common Stock on February 28, 2013, which was $12.6439 per share, as reported by Bloomberg.  As of December 31, 2013, investors converted 229,336 shares of the Series C Convertible Preferred Stock into 229,336 shares of common stock.
 
 
F-19

 

Fair Value of Financial Assets and Liabilities

Financial liabilities measured at fair value on a recurring basis are summarized below (in thousands):

   
Fair value measured at December 31, 2013
 
   
Total carrying value at December 31,
   
Quoted prices in active markets
   
Significant other observable inputs
   
Significant unobservable inputs
 
   
2013
   
(Level 1)
   
(Level 2)
   
(Level 3)
 
Liabilities
                       
Fair value of warrant liabilities
  $ 48     $ -     $ -     $ 48  
                                 
   
Fair value measured at December 31, 2012
 
   
Total carrying value at December 31,
   
Quoted prices in active markets
   
Significant other observable inputs
   
Significant unobservable inputs
 
      2012    
(Level 1)
   
(Level 2)
   
(Level 3)
 
Liabilities
                               
Fair value of warrant liabilities
  $ 3,126     $ -     $ -     $ 3,126  


Level 3 liabilities are valued using unobservable inputs to the valuation methodology that are significant to the measurement of the fair value of the derivative liabilities. For fair value measurements categorized within Level 3 of the fair value hierarchy, the Company’s accounting and finance department, who report to the Principal Accounting Officer, determine its valuation policies and procedures. The development and determination of the unobservable inputs for Level 3 fair value measurements and fair value calculations are the responsibility of the Company’s management.
 
Level 3 Valuation Techniques

Level 3 financial liabilities consist of the warrant liabilities for which there is no current market for these securities such that the determination of fair value requires significant judgment or estimation. Changes in fair value measurements categorized within Level 3 of the fair value hierarchy are analyzed each period based on changes in estimates or assumptions and recorded as appropriate.

The Company uses the Black-Scholes option valuation model to value Level 3 financial liabilities at inception and on subsequent valuation dates. This model incorporates transaction details such as the Company’s stock price, contractual terms, maturity, risk free rates, as well as volatility.

A significant decrease in the volatility or a significant decrease in the Company’s stock price, in isolation, would result in a significantly lower fair value measurement. Changes in the values of the warrant liabilities are recorded in “Fair value adjustments for warrant liabilities” in the Company’s consolidated statements of operations.

As of December 31, 2013, there were no transfers in or out of Level 3 from other levels in the fair value hierarchy.

 
F-20

 

Liabilities resulting from the Warrants issued in connection with the Company’s November 2012 financing were valued using the Black-Scholes option valuation model and the following assumptions on the following dates (in thousands, except share data):
 
   
December 31,
   
March 6,
   
December 31,
 
Warrants
 
2013
   
2013
   
2012
 
Risk-free interest rate
    0.01% - 0.78 %     0.81 %     0.25% - 0.72 %
Expected volatility
    69.1% - 89.4 %     147.15 %     101.94% - 146.03 %
Expected life (in years)
    0.1 - 3.9       4.7       1.9 - 4.9  
Expected dividend yield
    -       -       -  
Number of warrants
    65,263       474,266       550,664  
Fair value
  $ 48     $ 5,696     $ 3,126  
 
The risk-free interest rate was based on rates established by the Federal Reserve. The expected volatility in the Black-Scholes model is based on the standard deviation of the Company’s underlying stock price's daily logarithmic returns. The expected life of the warrants was determined by the expiration date of the warrants. The expected dividend yield was based upon the fact that the Company has not historically paid dividends on its common stock, and does not expect to pay dividends on its common stock in the future. The volatility rate was computed based on a comparison of average volatility rates of similar companies

The fair value of these warrant liabilities was approximately $48,000 at December 31, 2013. The net change in fair value during the year ended December 31, 2013 was $3.1 million, of which $2.6 million is reported in the Company’s consolidated statement of operations as fair value adjustments for warrant liabilities and approximately $5.7 million as a reclassification of the fair value of the warrant liabilities to stockholders’ equity in connection with the March 2013 exchange of 475,211 Series B Warrants for 229,337 shares of Series C Convertible Preferred Stock (see Note 6 “Stockholders’ Equity”).  The fair value of the warrant liabilities is re-measured at the end of every reporting period and upon the exercise and/or modification of warrants.  The change in fair value is reported in the consolidated statement of operations as fair value adjustments for warrant liabilities.

The following table sets forth a summary of the changes in the fair value of the Company’s Level 3 financial liabilities that are measured at fair value on a recurring basis for the year ended December 31 (in thousands):

   
For the Years Ended
December 31,
 
   
2013
   
2012
 
Beginning balance
  $ 3,126     $ 917  
Issuance of new warrants
    -       214  
Fair value adjustments for warrant liabilities
    2,618       1,995  
Reclassification to stockholders' equity
    (5,696 )     -  
Ending balance
  $ 48     $ 3,126  
 
 
F-21

 

Note 7.                                Stockholders’ Equity
 
Preferred Stock
 
The Company’s certificate of incorporation authorizes 5,000,000 shares of preferred stock.  The Company’ board of directors is authorized, without further stockholder action, to establish various series of such preferred stock from time to time and to determine the rights, preferences and privileges of any unissued series including, among other matters, any dividend rights, dividend rates, conversion rights, voting rights, terms of redemption, liquidation preferences, sinking fund terms, the number of shares constituting any such series, and the description thereof and to issue any such shares.  Although there is no current intent to do so, the board of directors may, without stockholder approval, issue shares of an additional class or series of preferred stock with voting and conversion rights which could adversely affect the voting power of the holders of the common stock.

One of the effects of the preferred stock may be to enable the board of directors to render more difficult or to discourage an attempt to obtain control of the Company by means of a merger, tender offer, proxy contest or otherwise, and thereby to protect the continuity of the management.

The Company has certificates of designation of eleven separate series as summarized below as of December 31, 2013 (in thousands).
 
   
Number of Shares Issued
and Outstanding
             
   
December 31, 2013
   
December 31, 2012
   
Par Value
   
Conversion Ratio
 
Series "A"
    -       -     $ 0.0001       N/A  
Series "B"
    1       1       0.0001    
1:1
 
Series "C"
    1       -       0.0001    
1:1
 
Series “D"
    1,227,582       -       0.0001    
10:1
 
Series “D-1"
    59,265       -       0.0001    
10:1
 
Series “E”
    -       -       0.0001    
1:1
 
Series “F"
    -       -       0.0001    
1:1
 
Series “F-1"
    156,250       -       0.0001    
1:1
 
Series “H"
    459,043       -       0.0001    
10:1
 
Series “I”
    119,760       -       0.0001    
20:1
 
 
Series A Preferred Stock

The Company’s board of directors has designated 500,000 shares of its preferred stock as Series A Participating Preferred Stock (“Series A Preferred Stock”).

On January 1, 2013, the Company adopted a stockholder rights plan in which rights to purchase shares of Series A Preferred Stock were distributed as a dividend at the rate of one right for each share of common stock.  The rights are designed to guard against partial tender offers and other abusive and coercive tactics that might be used in an attempt to gain control of Spherix or to deprive its stockholders of their interest in the long-term value of Spherix.  These rights seek to achieve these goals by forcing a potential acquirer to negotiate with the board of directors (or go to court to try to force the Board of Directors to redeem the rights), because only the Board of Directors can redeem the rights and allow the potential acquirer to acquire the Company’s shares without suffering very significant dilution.  However, these rights also could deter or prevent transactions that stockholders deem to be in their interests, and could reduce the price that investors or an acquirer might be willing to pay in the future for shares of the Company’s common stock.

Each right entitles the registered holder to purchase one one-hundredth of a share (a “Unit”) of the Company’s Series A Preferred Stock.  Each Unit of Series A Preferred Stock will be entitled to an aggregate dividend of 100 times the dividend declared per share of common stock.  In the event of liquidation, the holders of the Units of Series A Preferred Stock will be entitled to an aggregate payment of 100 times the payment made per share of common stock.  Each Unit of Series A Preferred Stock will have 100 votes, voting together with the common stock.  Finally, in the event of any merger, consolidation or other transaction in which shares of common stock are exchanged, each Unit of Series A Preferred Stock will be entitled to receive 100 times the amount received per share of common stock.  These rights are protected by customary anti-dilution provisions.

 
F-22

 

The rights will be exercisable only if a person or group acquires ten percent (10%) or more of the Company’s common stock (subject to certain exceptions stated in the plan) or announces a tender offer the consummation of which would result in ownership by a person or group of ten percent (10%) or more of the Company’s common stock.  The board of directors may redeem the rights at a price of $0.001 per right.  The rights will expire at the close of business on December 31, 2017 unless the expiration date is extended or unless the rights are earlier redeemed or exchanged by the Company. 
 
Series B Convertible Preferred Stock

In connection with an offering of securities, which the Company closed in October 2010, the Company created a Series B Convertible Preferred Stock.  All shares of Series B Convertible Preferred Stock issued in the offering have been converted to common stock except for one (1) outstanding share of Series B Convertible Preferred Stock as of December 31, 2013 and 2012.
 
The Series B Convertible Preferred Stock is convertible at the option of the holder at any time into shares of the Company’s common stock at a conversion ratio determined by dividing the stated value of the convertible preferred stock, or $1,000, by a conversion price of $250 per share.  The conversion price is subject to adjustment in the case of stock splits, stock dividends, combination of shares and similar recapitalization transactions.  The conversion price may also be subject to adjustment if the Company issue rights, options or warrants to all holders of its common stock entitling them to subscribe for or purchase shares of its common stock at a price per share less than the daily volume weighted average price of its common stock, if the Company distribute evidences of its indebtedness or assets or rights or warrants to subscribe for or purchase any security to all holders of its common stock, or if the Company consummate a fundamental corporate transaction such as a merger or consolidation, sale or other disposition of all or substantially all of its assets, or an exchange or tender offer accepted by the holders of 50% or more of the Company’s outstanding common stock.  Subject to limited exceptions, a holder of shares of Series B Convertible Preferred Stock will not have the right to convert any portion of its Series B Convertible Preferred Stock if the holder, together with its affiliates, would beneficially own in excess of 4.99% of the number of shares of the Company’s common stock outstanding immediately after giving effect to its conversion.

The Series B Convertible Preferred Stock is entitled to receive dividends (on an “as converted to common stock” basis) to and in the same form as dividends actually paid on shares of the Company’s common stock.

Except as required by law, holders of the Series B Convertible Preferred Stock are generally not entitled to voting rights.

Series C Convertible Preferred Stock

As disclosed in Note 5, on March 6, 2013, the Company and certain investors that participated in the November 2012 private placement transaction, entered into separate Warrant Exchange Agreements pursuant to which the investors exchanged common stock purchase warrants acquired in the private placement transaction for 229,337 shares of the Company’s Series C Convertible Preferred Stock.  Each share of Series C Convertible Preferred Stock is convertible into one (1) share of common stock at the option of the holder.  The Series C Convertible Preferred Stock was established on March 5, 2013 by the filing in the State of Delaware of a Certificate of Designation of references, Rights and Limitations of Series C Convertible Preferred Stock.  During the year ended December 31, 2013, 229,336 shares of Series C Convertible Preferred Stock were converted into 229,336 shares of common stock and as a result, as of December 31, 2013, one share of Series C Convertible Preferred Stock was outstanding.

Series D Convertible Preferred Stock
 
At the closing of the Merger, the Company issued 1,379,685 shares of its newly designated Series D Convertible Preferred Stock to the stockholders of North South.

 
F-23

 

Each share of Series D Preferred Stock has a stated value of $0.0001 per share and is convertible into ten (10) shares of common stock. Upon the liquidation, dissolution or winding up of the Company’s business, each holder of Series D Preferred Stock shall be entitled to receive, for each share of Series D Preferred Stock held, a preferential amount in cash equal to the greater of (i) the Stated Value or (ii) the amount the holder would receive as a holder of the Company’s common stock on an “as converted” basis.  Each holder of Series D Preferred Stock shall be entitled to vote on all matters submitted to its stockholders and shall be entitled to such number of votes equal to the number of shares of common stock such shares of Series D Preferred are convertible into at such time, taking into account the beneficial ownership limitations set forth in the governing Certificate of Designation and the Conversion Limit limitations described below.  At no time may shares of Series D Preferred Stock be converted if such conversion would cause the holder to hold in excess of 4.99% of the Company’s issued and outstanding common stock, subject to an increase in such limitation up to 9.99% of the issued and outstanding common stock on 61 days’ written notice to the Company.  The conversion ratio of the Series D Preferred Stock is subject to adjustment in the event of stock dividends, splits and fundamental transactions.

Additionally, subject to the beneficial ownership limitations described above, holders of Series D Preferred Stock may not convert such shares in excess of the “Conversion Limit”.  The “Conversion Limit” is defined as that number of shares of common stock as shall equal 15% (the “Volume Percentage”) of the greater of (i) the trading volume of the Company’s common stock on such conversion date or (ii) the average trading volume of the Company’s common stock for ten trading days immediately prior to such conversion date.  If the Company common stock trades at a price of at least $12.00 per share on the conversion date, then the Volume Percentage for purposes of the foregoing calculation shall equal 20%.  Notwithstanding the foregoing, holders of the Series D Preferred Stock may convert such shares without regard to the aforementioned conversion limit if the Company’s common stock trades at a minimum price of $15.00 per share on the conversion date.
 
During the year ended December 31, 2013, (a) 16,588 shares of Series D Convertible Preferred Stock were converted into 165,880 shares of common stock and (b) 135,515 shares of Series D Convertible Preferred Stock were exchanged for Series D-1 Convertible Preferred Stock (see below).  As of December 31, 2013, 1,227,582 shares of Series D Convertible Preferred Stock were issued and outstanding.

Series D-1 Convertible Preferred Stock
 
The Company’s Series D-1 Convertible Preferred Stock (“Series D-1 Preferred Stock”) was established on November 22, 2013.  Each share of Series D-1 Preferred Stock has a stated value of $0.0001 per share and is convertible into ten (10) shares of common stock. Upon the liquidation, dissolution or winding up of the Company’s business, each holder of Series D-1 Preferred Stock shall be entitled to receive, for each share of Series D-1 Preferred Stock held, a preferential amount in cash equal to the greater of (i) the stated value or (ii) the amount the holder would receive as a holder of the Company’s common stock on an “as converted” basis.  Each holder of Series D-1 Preferred Stock shall be entitled to vote on all matters submitted to the Company’s stockholders and shall be entitled to such number of votes equal to the number of shares of common stock such shares of Series D-1 Preferred are convertible into at such time, taking into account the beneficial ownership limitations set forth in the governing Certificate of Designation.  At no time may shares of Series D-1 Preferred Stock be converted if such conversion would cause the holder to hold in excess of 9.99% of the Company’s issued and outstanding common stock.  The conversion ratio of the Series D Preferred Stock is subject to adjustment in the event of stock dividends, splits and fundamental transactions.  The Company commenced an exchange with holders of Series D Convertible Preferred Stock pursuant to which the holders of the Company’s outstanding shares of Series D Preferred Stock acquired in the Merger could exchange such shares for shares of the Company’s Series D-1 Preferred Stock on a one-for-one basis.   During the year ended December 31, 2013, 76,250 share of Series D-1 Preferred were converted into 762,500 shares of common stock, and as a result, as of December 31, 2013, 59,265 shares of Series D-1 Convertible Preferred Stock were issued and outstanding.

 
F-24

 

On January 27, 2014, Spherix Incorporated (the “Company”) entered into a lockup agreement with certain holders of an aggregate of 1,508,148 shares of the Company’s common stock, $0.0001 par value per share (the “Common Stock”) and shares of Common Stock issuable upon conversion of shares of Series D-1 Convertible Preferred Stock, which are included in the Company’s Registration Statement on Form S-1 (File No.333-192737) (the “Lockup Agreement” and such 1,508,148 shares, the “Locked Up Shares”).  The holders of the Locked Up Shares have agreed, for so long as such holders own such shares, not to sell any Locked Up Shares unless either (i) if such sale price is at least $6.00 per share, the cumulative amount sold by such holder (including the anticipated sale) does not exceed such holder's pro rata portion of 60% of the composite aggregate trading volume of the Common Stock during the period beginning on the date that the Registration Statement is declared effective and ending on the date of sale (the “Lockup Measuring Period) or (ii), if the sale price is less than $6.00 per share, the cumulative amount sold by such holder does not exceed such holder's pro rata portion of 20% of the composite aggregate trading volume during the Lockup Measuring Period.

Series E Convertible Preferred Stock
 
The Company’s Series E Preferred Stock was established on June 25, 2013.  Each share of Series E Preferred Stock is convertible, at the option of the holder at any time, into one (1) share of common stock and has a stated value of $0.0001.  Such conversion ratio is subject to adjustment in the case of stock splits, stock dividends, combination of shares and similar recapitalization transactions.  The Company is prohibited from effecting the conversion of the Series E Preferred Stock to the extent that, as a result of such conversion, the holder will beneficially own more than 4.99% (or, if such limitation is waived by the holder upon no less than 61 days prior notice, 9.99%) in the aggregate of the issued and outstanding shares of the Company’s common stock calculated immediately after giving effect to the issuance of shares of common stock upon the conversion of the Series E Preferred Stock. 

On June 25, 2013, the Company sold 100,000 shares of its newly designated Series E Convertible Preferred Stock to North South for a purchase price of $5.00 per share with gross proceeds to the Company of $500,000 pursuant to a subscription agreement. These securities were sold pursuant to an exemption from registration under Section 4(2) and Regulation D (Rule 506) under the Securities Act and corresponding provisions of the securities laws. As a result of the Merger, all outstanding shares of the Company’s Series E Preferred Stock were held by North South and retired in full on September 30, 2013.
 
Series F Convertible Preferred Stock

The Company’s Series F Convertible Preferred Stock was established on November 1, 2013.  Each share of Series F Convertible Preferred Stock is convertible, at the option of the holder at any time, into one (1) share of common stock and has a stated value of $0.0001.  Such conversion ratio is subject to adjustment in the case of stock splits, stock dividends, combination of shares and similar recapitalization transactions.   Each share of Series F Convertible Preferred Stock is entitled to one vote per share (subject to beneficial ownership limitation) and shall vote together with holders of the Company’s common stock.  The Company is prohibited from effecting the conversion of the Series F Convertible Preferred Stock to the extent that, as a result of such conversion, the holder will beneficially own more than 9.99% in the aggregate of the issued and outstanding shares of the Company’s common stock calculated immediately after giving effect to the issuance of shares of common stock upon the conversion of the Series F Convertible Preferred Stock.

On November 6, 2013, the Company sold an aggregate of 304,250 shares of its newly designated Series F Convertible Preferred Stock and 48,438 shares of common stock to five accredited investors for gross proceeds to the Company of $2,235,000 pursuant to subscription agreements. The purchase price per share of Common Stock was $6.40 for $1,310,000 of such investment and $6.25 for $925,000 of such investment. No broker was utilized in connection with the sale.

On November 26, 2013, the Company entered into separate Amendment and Exchange Agreements (each, a “Series F Exchange Agreement”) with the holders of the Company’s outstanding shares of Series F Convertible Preferred Stock (the “Series F Preferred Stock” and each holder, a “Series F Holder”) pursuant to which the Series F Holders agreed to return their shares of Series F Preferred Stock to the Company for cancellation in consideration for which the Company issued such Series F Holder an equal number of shares of Series F-1 Convertible Preferred Stock, $0.0001 par value per share (the “Series F-1 Preferred Stock” and the transaction, the “Series F Exchange”).  During the year ended December 31, 2013, all 304,250 shares of the Series F Convertible Preferred Stock were converted into Series F-1 Convertible Preferred Stock.

 
F-25

 
 
Series F-1 Convertible Preferred Stock

The Company’s Series F-1 Convertible Preferred Stock (“Series F-1 Preferred Stock”) was established on November 22, 2013. Each share of Series F-1 Preferred Stock is convertible, at the option of the holder at any time, into one (1) share of common stock and has a stated value of $0.0001.  Such conversion ratio is subject to adjustment in the case of stock splits, stock dividends, combination of shares and similar recapitalization transactions.   Each share of Series F-1 Preferred Stock is entitled to 91% of one vote per share (subject to beneficial ownership limitation) and shall vote together with holders of the Company’s common Stock.  The Company is prohibited from effecting the conversion of the Series F-1 Preferred Stock to the extent that, as a result of such conversion, the holder will beneficially own more than 9.99% in the aggregate of the issued and outstanding shares of the Company’s common stock calculated immediately after giving effect to the issuance of shares of common stock upon the conversion of the Series F-1 Preferred Stock.  During the year ended December 31, 2013, 148,000 shares of Series F-1 Preferred Stock were converted into 148,000 shares of common stock, and as a result, as of December 31, 2013, 156,250 shares of Series F-1 Preferred Stock are outstanding.
 
Series H Convertible Preferred Stock
 
On December 31, 2013, the Company designated 459,043 shares of preferred stock as Series H Convertible Preferred Stock (“Series H Preferred Stock”).  On December 31, 2013, the Company issued approximately $38.3 million of Series H Preferred Stock (or 459,043 shares) to Rockstar.  Each share of Series H Preferred Stock is convertible into ten (10) shares of common stock and has a stated value of $83.50. The conversion ratio is subject to adjustment in the event of stock splits, stock dividends, combination of shares and similar recapitalization transactions. The Company is prohibited from effecting the conversion of the Series H Preferred Stock to the extent that, as a result of such conversion, the holder beneficially owns more than 4.99% (which may be increased to 9.99% and subsequently to 19.99%, each upon 61 days’ written notice), in the aggregate, of the Company’s issued and outstanding shares of common stock calculated immediately after giving effect to the issuance of shares of common stock upon the conversion of the Series H Preferred Stock. Holders of the Series H Preferred Stock shall be entitled to vote on all matters submitted to the Company’s stockholders and shall be entitled to the number of votes equal to the number of shares of common stock into which the shares of Series H Preferred Stock are convertible, subject to applicable beneficial ownership limitations.  The Series H Preferred Stock provides a liquidation preference of $83.50 per share.
 
Holders of 50.1% of the outstanding common stock of the Company entered into voting agreements to vote in favor of approving the issuance as the Company was required to obtain stockholder approval pursuant to NASDAQ Listing Rule 5635.  As of December 31, 2013, 459,043 shares of Series H Preferred Stock were outstanding.
 
Series I Preferred Convertible Stock
 
On December 31, 2013, the Company designated 119,760 shares of preferred stock as Series I Convertible Preferred Stock (“Series I Preferred Stock”). On December 31, 2013, the Company issued approximately $20 million (or 119,760 shares) of Series I Preferred Stock to Rockstar.  Each share of Series I Preferred Stock is convertible into twenty (20) shares of the Company’s common stock and has a stated value of $167. The conversion ratio is subject to adjustment in the event of stock splits, stock dividends, combination of shares and similar recapitalization transactions.  The holder is prohibited from converting the Series I Preferred Stock to the extent that, as a result of such conversion, the holder beneficially owns more than 4.99% (which may be increased to 9.99% and subsequently to 19.99%, each upon 61 days’ written notice), in the aggregate, of the Company’s issued and outstanding shares of common stock calculated immediately after giving effect to the issuance of shares of common stock upon the conversion of the Series I Preferred Stock.  Holders of the Series I Preferred Stock shall be entitled to vote on all matters submitted to its stockholders and shall be entitled to the number of votes equal to the number of shares of common stock into which the shares of Series I Preferred Stock are convertible, subject to applicable beneficial ownership limitations.  The Series I Preferred stock provides for a liquidation preference of $167 per share.

 
F-26

 

The Series I Preferred Stock contains a mandatory redemption date of December 31, 2015 as to 100% of the Series I Preferred Stock then outstanding, requiring a minimum of 25% of the total number of shares of Series I Preferred Stock issued to be redeemed (less the amount of any conversions occurring prior thereto) on or prior to each of June 30, 2014, December 31, 2014, June 30, 2015 and December 31, 2015 (each, a “Partial Redemption Date” and each payment, a “Redemption Payment”).  On each Partial Redemption Date, the Company is required to pay Rockstar a Redemption Payment equal to the lesser of (i) such number of shares of Series I Preferred Stock as have a stated value of $5.0 million; or (ii) such number of shares of Series I Preferred Stock as shall, together with all voluntary and mandatory redemptions and conversions to common stock occurring prior to the applicable Partial Redemption Date, have a stated value of $5.0 million; or (iii) the remaining shares of Series I Preferred Stock issued and outstanding if such shares have a stated value of less than $5.0 million, in an amount of cash equal to its stated value plus all accrued but unpaid dividends, distributions and interest thereon, unless Rockstar, in its sole discretion, elects to waive such Redemption Payment or convert such shares (or a portion thereof) into common stock.  No interest or dividends are payable on the Series I Preferred Stock unless the Company fails to make the first $5.0 million Partial Redemption Payment due June 30, 2014, then interest shall accrue on the outstanding stated value of all outstanding shares of Series I Preferred Stock at a rate of fifteen (15%) per annum from January 1, 2014.  The Company’s obligations to pay the Redemption Payments and any interest payments in connection therewith are secured pursuant to the terms of a Security Agreement under which the Rockstar Patents serve as collateral security.  No action can be taken under the Security Agreement unless the Company has failed to make a second redemption payment of $5.0 million due December 31, 2014.  The Security Agreement contains additional usual and customary “Events of Default” (as such term is defined in the Intellectual Property Security Agreement) under which Rockstar can take action, including a sale to a third party or reduction of secured amounts via transfer of the Rockstar Patents to Rockstar.
 
Additionally, in the event the Company consummates a Fundamental Transaction (as defined in the Certificate of Designation of Preferences, Rights and Limitations of Series I Convertible Preferred Stock), the Company shall be required to redeem such portion of the outstanding shares of Series I Preferred Stock as shall equal (i) 50% of the net proceeds of the Fundamental Transaction after deduction of the amount of net proceeds required to leave the Company with cash and cash equivalents on hand of $5.0 million and up until the net proceeds leave the Company with cash and cash equivalents on hand of $7.5 million and (ii) 100% of the net proceeds of the Fundamental Transaction thereafter.
 
Holders of 50.1% of the outstanding common stock of the Company entered into voting agreements to vote in favor of approving the issuance as the Company was required to obtain stockholder approval pursuant to NASDAQ Listing Rule 5635.  As of December 31, 2013, 119,760 shares of Series I Preferred Stock were outstanding.
 
The shares of Series I Preferred Stock are not immediately convertible and do not possess any voting rights until such time as the Company has obtained stockholder approval of the issuance, pursuant to NASDAQ Listing Rule 5635.  The Company has agreed to use the Company’s reasonable best efforts to obtain such stockholder approval on or prior to March 31, 2014.  In connection with the foregoing, the Company entered into separate Voting and Support Agreements with various stockholders holding in excess of 50.1% of the Company’s voting capital pursuant to which the stockholder agreed to vote in favor of the Purchase Agreement and the transactions contemplated thereunder (including the issuances of securities in consideration for the acquisition of assets, pursuant to NASDAQ Listing Rule 5635) at a meeting called therefor or by written consent. As of December 31, 2013, 119,760 shares of Series I Preferred Stock were outstanding.

Common Stock

The Company authorized capital stock consists of 50,000,000 shares of common stock, $0.0001 par value. The authorized and unissued shares of common stock and the authorized and undesignated shares of preferred stock are available for issuance without further action by the Company’s stockholders, unless such action is required by applicable law or the rules of any stock exchange or automated quotation system on which the Company’s securities may be listed or traded. If the approval of the Company’s stockholders is not so required, the board of directors may determine not to seek stockholder approval.

 
F-27

 

On February 2, 2012, the Company sold an aggregate of 53,240 shares of its common stock and warrants to purchase up to an additional 10,648 shares of its common stock to certain accredited investors for gross proceeds of approximately $1.15 million.  The common stock and warrants were sold in units, with each unit consisting of one share of common stock and a warrant to purchase 0.2 of a share of common stock.  The purchase price per unit was $21.60.  Subject to certain ownership limitations, the warrants are exercisable for a five-year period at an exercise price of $28.00 per share.  The net proceeds to the Company from the registered direct offering, after deducting placement agent fees and the Company’s offering expenses, and excluding the proceeds, if any, from the exercise of the warrants issued in the offering, were approximately $1.1 million.   In connection with the closing of our February 2012 offering, the Company issued to Rodman & Renshaw, LLC, as partial consideration for its services as placement agent, warrants with a term of two years to purchase up to 1,597 shares of our common stock at an exercise price of $27.00 per share.  The estimated fair value of the warrants at the date of grant was $19,000.  
 
On September 17, 2013 the Company entered into an investor relations agreement with RedChip Companies Inc. (“RedChip”).  The initial term of the agreement expired on March 17, 2014.  As consideration for the services performed by RedChip, the Company agreed to (a) issue RedChip 15,000 shares of common stock in connection with execution of the agreement, and (b) pay $20,000 per in cash.  The Company has determined that the fair value of common stock was more readily determinable than the fair value of the services rendered.  During the year ended December 31, 2013, the Company recorded a stock-based compensation expense associated with the issuance of the shares of $120,000, which is included in other selling, general and administrative expenses on the consolidated statement of operations.
 
Warrants

A summary of warrant activity for the years ended December 31, 2013 and 2012 is presented below:
   
Warrants
   
Weighted Average Exercise Price
   
Total Intrinsic Value
 
Outstanding as of January 1, 2012
    54,762     $ 178.79     $ -  
Issued
    495,902       7.06          
Exercised
    -       -          
Cancelled
    -       -          
Outstanding as of December 31, 2012
    550,664       24.14       145  
Issued
    -       -          
Converted
    (474,266 )     6.53          
Exercised
    (9,391 )     6.53          
Cancelled
    (1,744 )     105.10          
Outstanding as of December 31, 2013
    65,263     $ 5.83     $ -  
 
Stock Options

2012 Plan

In late 2012, the Company adopted the 2012 Equity Incentive Plan (the “Plan”) which permits issuance of incentive stock options, non-qualified stock options and restricted stock. The Plan replaced a prior incentive stock plan. During 2012, the Company granted 5,487 options to the Company’s Board of Directors and officers under the previous plan. Options issued to employees typically vest over a four-year period and options issued to non-employee directors vested immediately upon being granted. At December 31, 2012, there were 6,789 options under the previous plan that were fully vested.

2013 Plan

In April 2013, the Company’s board of directors adopted the Spherix Incorporated 2013 Equity Incentive Plan (the “2013 Plan”), an omnibus equity incentive plan pursuant to which the Company may grant equity and cash and equity-linked awards to certain management, directors, consultants and others.  The plan was approved by the Company’s shareholders in August 2013.
 
F-28

 

The 2013 Plan authorized approximately 15% of the Company’s fully-diluted Common Stock at the time approved (not to exceed 2,800,000 shares) be reserved for issuance under the Plan, after giving effect to the shares of the Company’s capital stock issuable under the Merger.  On April 4, 2013, with the approval of the Board of Directors, the Company granted 2,005,500 option shares to executives of the Company and certain outside consultants under the 2013 Plan.  The total fair value of the options on the date of grant was approximately $15.9 million under the Black-Scholes and other lattice models of valuing options.  The stock options were granted to various employees, directors and consultants at a contractual price of $7.08 per share, which was equal to the fair market value of the Company’s common stock on the date that the terms of those awards were agreed to by the Company and optionees.

Awards with service conditions only were granted as follows:
 
·
750,000 stock options to the Company’s former interim Chief Executive Officer which vest in four equal installments of 187,500 options each on October 4, 2013, April 4, 2014, October 4, 2014 and April 4, 2015, subject to a time based service condition only;
 
·
250,000 stock options to the former Chief Executive Officer of North South, who became the Company’s Chief Executive Officer upon the completion of the acquisition of North South on September 10, 2013, which vest in four equal installments of 62,500 options each on October 4, 2013, April 4, 2014, October 4, 2014 and April 4, 2015, subject to a time based service condition only;
 
·
An aggregate of 225,000 options to three directors that fully vested on October 4, 2013, subject to each of these directors’ continued service to the Company through that date; and
 
·
An aggregate of 30,000 options to two consultants and one employee that fully vested on August 16, 2013 upon shareholder approval of the plan.

    Awards with combined market and service conditions were granted as follows:

·
250,000 stock options to the former interim Chief Executive Officer for which (i) the exercisability of the options is subject to the volume weighted average price of the Company’s stock attaining at least $12 per share for at least 30 days during any consecutive 90 day period through December 31, 2014, and (ii) the continued employment/directorship of the interim Chief Executive Officer over a period of time that permits vesting at the rate of 62,500 options each on October 4, 2013, April 4, 2014, October 4, 2014 and April 4, 2015, subject to a time based service condition only; and
 
·
500,000 stock options to the former Chief Executive Officer of North South, who became the Company’s Chief Executive Officer upon the completion of the acquisition of North South on September 10, 2013 for which (i) (i) the exercisability of the options is subject to the volume weighted average price of the Company’s stock attaining at least $12 per share for at least 30 days during any consecutive 90 day period through December 31, 2014, and (ii) achieving performance conditions as follows:

o
100,000 options subject to the delivery of a business plan acceptable to the board of directors of the Company by no later than June 30, 2013;
o
70,000 options subject to the closing of a financing transaction as set forth in the business plan;
o
70,000 options for two successful patent monetization’s;
o
70,000 options upon the completion of an additional purchase of a patent portfolio;
o
70,000 options upon the initiation of litigation upon at least four defendants in infringement cases;
o
70,000 options upon the presentation of at least two additional monetization opportunities acceptable to the board of directors; and
o
50,000 options for attending at least 20 investor relations meetings.
 
 
F-29

 

The fair value of the stock options issued with combined market and service conditions only was calculated on the date that the final approval by the stockholders was obtained using the same assumptions as the awards that contain service conditions only; however, the fair value was adjusted for the risk associated with attaining the volume weighted average pricing target that must be met in order for the award to become exercisable. The Company determined that the unit fair value of each award amounted to $4.90 based on a 70% probability of attaining the aforementioned price target, which was determined using a Monte Carlo Simulation of the probability of attaining the target.  The aggregate fair value of the 250,000 stock options that feature the combined market and service condition amounted to $1.2 million on the date of grant. The fair value of these awards is being amortized over an explicit service period in which the award vests at the rate of 62,500 options each on October 4, 2013, April 4, 2014, October 4, 2014 and April 4, 2015 as noted above. Compensation expense recognized for this award amounted to $0.4 million as of December 31, 2013. Unamortized compensation cost for this award amounts to $0.8 million and will be amortized over the remaining explicit service of 18 months.

The aggregate fair value of the 500,000 stock option that features the combined market and performance condition amounted to $2.5 million on the date of grant. All these criteria were met as of December 31, 2013.

The 2013 stock option plan was approved by the Company’s stockholders on August 16, 2013, which resulted in the ratification of the awards approved by the Company’s board of directors on April 4, 2013.

In addition to the above, on October 28, 2013, the Company, with the approval of the board of directors, granted 1,214 options to a board member at a contractual price of $8.24 per share, which was equal to the fair market value of the Company’s common stock on the date that the terms of those awards were agreed to by the Company and optionee.  The options had a grant date fair value of approximately $6,000, vested immediately, and expire in 5 years.

The fair value of the Company’s common stock was based upon the publicly quoted price on the date that the final approval of the awards was obtained. The Company does not expect to pay dividends in the foreseeable future so therefore the dividend yield is 0%. The expected term for stock options granted with service conditions represents the average period the stock options are expected to remain outstanding and is based on the expected term calculated using the approach prescribed by the Securities and Exchange Commission's Staff Accounting Bulletin No. 110 for “plain vanilla” options.  The expected term for stock options granted with performance and/or market conditions represents the estimated period estimated by management by which the performance conditions and market conditions will be met. The Company obtained the risk free interest rate from publicly available data published by the Federal Reserve. The volatility rate was computed based on a comparison of average volatility rates of similar companies.  The fair value of options granted in 2013 was estimated using the following assumptions:

   
For the Years Ended
December 31,
 
Stock option plans
 
2013
   
2012
 
Exercise price
  $ 7.08 - $8.24     $ 9.80 - $228.00  
Expected stock price volatility
    78.9% - 86.4 %     91.3% - 122.7 %
Risk-free rate of interest
    0.36% - 2.84 %     0.62% - 0.74 %
Expected Term (years)
    1.0 - 10.0       5.0  
 
Compensation expense recognized for the above noted awards amounted to approximately $9.0 million for the year ended December 31, 2013. Unamortized compensation cost for these awards amounted to $6.8 million and will be amortized over a weighted average vesting period of 1.3 years.

 
F-30

 

A summary of option activity under the Company’s employee stock option plan for the years ended December 31, 2012 and 2013, is presented below:
  
   
Number of Shares
   
Weighted Average Exercise Price
   
Total Intrinsic Value
   
Weighted Average Remaining Contractual Life (in years)
 
Outstanding as of January 1, 2012
    2,426     $ 53.60     $ -       4.8  
Employee Options granted
    5,487       10.93               4.7  
Employee Options exercised
    -                          
Employee Options cancelled
    (750 )     40.00                  
Outstanding as of December 31, 2012
    7,163       22.35       -       4.4  
Employee Options granted
    1,976,714       7.08               9.3  
Employee Options exercised
    -                          
Employee Options cancelled
    -                          
Outstanding as of December 31, 2013
    1,983,877       7.14       1,935,990       9.2  
                                 
Options vested and expected to vest
    1,983,877       7.14       1,825,166       9.2  
Options vested and exercisable
    733,626     $ 7.22