EX-99.2 3 exh_992.htm EXHIBIT 99.2 exh_992.htm
Exhibit 99.2
 

 
 
Condensed unaudited interim consolidated financial statements of
 
Intellipharmaceutics
International Inc.
 
May 31, 2013
 
 
 
 
 
 
 

 
Intellipharmaceutics International Inc.
May 31, 2013

Table of contents

 
Condensed unaudited interim consolidated balance sheets
2
   
Condensed unaudited interim consolidated statements of operations and comprehensive loss
3
   
Condensed unaudited interim consolidated statements of shareholders’ deficiency
4
   
Condensed unaudited interim consolidated statements of cash flows
5
   
Notes to the condensed unaudited interim consolidated financial statements
6-18
 
 
 

 
Intellipharmaceutics International Inc.
           
Condensed unaudited interim consolidated balance sheets
           
As at
           
(Stated in U.S. dollars)
           
   
May 31,
   
November 30,
 
   
2013
   
2012
 
    $       $  
               
Assets              
Current
             
Cash and cash equivalents (Note 12)
    1,576,704       497,016  
Accounts receivable
    2,662       2,778  
Investment tax credits
    449,961       301,932  
Prepaid expenses, sundry and other assets
    136,978       137,449  
      2,166,305       939,175  
                 
                 
Property and equipment, net
    1,441,565       1,535,703  
      3,607,870       2,474,878  
                 
Liabilities
               
Current
               
Accounts payable
    934,393       512,360  
Accrued liabilities
    372,517       224,797  
Employee costs payable (Note 5)
    706,656       663,222  
Current portion of capital lease obligations
    53,103       51,524  
Due to related parties (Note 4)
    755,845       783,717  
      2,822,514       2,235,620  
                 
Convertible debenture (Note 4)
    1,360,756       -  
Capital lease obligations
    16,799       46,242  
Warrant liability (Note 9)
    1,183,516       1,960,893  
      5,383,585       4,242,755  
                 
Shareholders' deficiency
               
Capital stock (Notes 6 and 7)
               
Authorized
               
Unlimited common shares without par value
               
Unlimited preference shares
               
Issued and outstanding
19,721,936 common shares
    147,152       147,152  
(2012 - 17,906,937)
               
Additional paid-in capital
    31,249,525       28,409,665  
Accumulated other comprehensive income (loss)
    34,086       (240,010 )
Accumulated deficit
    (33,206,478 )     (30,084,684 )
      (1,775,715 )     (1,767,877 )
Contingencies (Note 11)
               
      3,607,870       2,474,878  
 
 
See accompanying notes to condensed unaudited interim consolidated financial statements
 
Page 2

 
Intellipharmaceutics International Inc.
 
Condensed unaudited interim consolidated statements of operations and comprehensive loss
             
                         
                         
(Stated in U.S. dollars)
                       
   
Three months ended
   
Six months ended
 
   
May 31, 2013
   
May 31, 2012
   
May 31, 2013
   
May 31, 2012
 
                         
   
$
   
$
   
$
   
$
 
                         
                         
Revenue
                       
Research and development
    -       -       -       107,091  
      -       -       -       107,091  
                                 
Expenses
                               
Research and development
    934,068       1,098,421       2,271,822       3,101,848  
Selling, general and administrative
    752,431       823,054       1,585,888       1,972,810  
Depreciation
    100,013       76,065       193,086       137,435  
      1,786,512       1,997,540       4,050,796       5,212,093  
                                 
Loss from operations
    (1,786,512 )     (1,997,540 )     (4,050,796 )     (5,105,002 )
Fair value adjustment of derivative liabilities (Notes 4 & 9)
    174,917       846,467       1,407,074       1,814,648  
Financing expense (Note 6)
    (56,826 )     -       (56,826 )     -  
Net foreign exchange (loss) gain
    (26,539 )     (199,792 )     (269,156 )     10,815  
Interest income
    78       8,913       88       17,542  
Interest expense
    (86,780 )     (15,891 )     (152,178 )     (32,366 )
Loss     (1,781,662 )     (1,357,843 )     (3,121,794 )     (3,294,363 )
Other comprehensive income (loss)
                               
Foreign exchange translation adjustment
    31,842       77,728       274,096       (117,204 )
Comprehensive loss
    (1,749,820 )     (1,280,115 )     (2,847,698 )     (3,411,567 )
                                 
Loss per common share, basic and diluted
    (0.09 )     (0.08 )     (0.17 )     (0.20 )
                                 
Weighted average number of common shares outstanding, basic and diluted
    19,287,915       17,455,183       18,605,014       16,696,422  
 
 
See accompanying notes to condensed unaudited interim consolidated financial statements
 
Page 3

 
Intellipharmaceutics International Inc.
 
Condensed unaudited interim consolidated statements of shareholders' deficiency
                   
for the six months ended May 31, 2013 and 2012
       
                                     
(Stated in U.S. dollars)
                                   
                     
Accumulated
             
               
Additional
   
other
         
Total
 
 Special voting shares
 
Common stock
   
paid-in
   
comprehensive
   
Accumulated
   
shareholders'
 
 Amount
 
Number
   
Amount
   
capital
   
(loss) income
   
deficit
   
deficiency
 
$
 
   
$
   
$
   
$
   
$
   
$
 
                                     
Balance, November 30, 2011
    15,908,444       147,152       20,822,672       (115,035 )     (23,947,819 )     (3,093,030 )
Issuance of common shares (Note 6)
    1,818,182               5,000,000       -               5,000,000  
Share issuance cost (Note 6)
    -       -       (779,271 )     -               (779,271 )
Stock options to employees
    -       -       1,791,495       -       -       1,791,495  
Stock options to non-management board members
    -       36,482       -       -       36,482  
DSU's to non-management board members (Note 8)
    -       16,008       -       -       16,008  
Issuance of shares on exercise of warrants (Note 9)
    -       93,828       -       -       93,828  
Other comprehensive loss (net of tax - $Nil)
    -       -       -       (117,204 )     -       (117,204 )
Net loss
    -       -       -       -       (3,294,363 )     (3,294,363 )
Balance, May 31, 2012
    17,751,626       147,152       26,981,214       (232,239 )     (27,242,182 )     (346,055 )
                                                 
                                                 
                                                 
Balance, November 30, 2012
    17,906,937       147,152       28,409,665       (240,010 )     (30,084,684 )     (1,767,877 )
Issuance of common shares (Note 6)
    1,815,000       -       2,714,242       -       -       2,714,242  
Share issuance cost (Note 6)
    -       -       (378,449 )     -       -       (378,449 )
Stock options to employees
    -       -       405,655       -       -       405,655  
Stock options to non-management board members
    -       79,196       -       -       79,196  
DSU's to non-management board members
    -       -       19,216       -       -       19,216  
Other comprehensive loss (net of tax - $Nil)
    -       -       -       274,096       -       274,096  
Loss
    -       -       -       -       (3,121,794 )     (3,121,794 )
Cancellation on shares exchanged
    (1 )     -       -       -       -       -  
Balance, May 31, 2013
    19,721,936       147,152       31,249,525       34,086       (33,206,478 )     (1,775,715 )
 
 
See accompanying notes to condensed unaudited interim consolidated financial statements
 
Page 4

 
Intellipharmaceutics International Inc.
 
Condensed unaudited interim consolidated statements of cash flows
       
                         
(Stated in U.S. dollars)
                       
   
Three months ended
   
Six months ended
 
   
May 31, 2013
   
May 31, 2012
   
May 31, 2013
   
May 31, 2012
 
   
$
   
$
   
$
   
$
 
                         
Net loss
    (1,781,662 )     (1,357,843 )     (3,121,794 )     (3,294,363 )
Items not affecting cash
                               
Depreciation
    100,013       76,065       193,086       137,435  
Stock-based compensation (Note 7)
    281,978       238,134       484,851       1,827,977  
Deferred shared units (Note 8)
    9,404       9,439       19,216       16,008  
Interest accrual (Note 4)
    11,072       11,110       21,883       22,411  
Fair value adjustment of derivative liabilities
    (174,917 )     (846,467 )     (1,407,074 )     (1,814,648 )
Unrealized foreign exchange loss
    110,059       207,012       372,327       9,591  
Change in non-cash operating assets & liabilities
                               
Accounts receivable
    8,303       11,459       116       977  
Investment tax credits
    (65,129 )     (65,946 )     (164,986 )     (163,235 )
Prepaid expenses, sundry assets and other assets
    16,959       (77,911 )     (6,554 )     (144,687 )
Accounts payable and accrued liabilities
    (271,002 )     (38,717 )     425,126       (521,440 )
Deferred revenue
    -       -       -       (107,091 )
Cash flows used in operating activities
    (1,754,922 )     (1,833,665 )     (3,183,803 )     (4,031,065 )
                                 
Financing activities
                               
Repayment of capital lease obligations
    (12,368 )     (10,637 )     (24,439 )     (21,222 )
Proceeds from convertible debenture (Note 4)
    -       -       1,500,000       -  
Proceeds from issuance of shares on exercise of warrants (Note 9)
    -       -       -       62,500  
Proceeds from issuance of shares and warrants (Note 6)
    3,121,800       5,000,000       3,121,800       5,000,000  
Share issuance cost
    (222,308 )     (510,421 )     (222,308 )     (510,421 )
Cash flows from financing activities
    2,887,124       4,478,942       4,375,053       4,530,857  
                                 
Investing activity
                               
Purchase of property and equipment
    (64,123 )     (323,823 )     (101,187 )     (376,577 )
Cash flows used in investing activities
    (64,123 )     (323,823 )     (101,187 )     (376,577 )
                                 
Effect of foreign exchange loss on cash held in foreign currency
    (7,215 )     (19,046 )     (10,375 )     (5,358 )
                                 
Increase in cash
    1,060,864       2,302,408       1,079,688       117,857  
Cash and cash equivalents, beginning of period
    515,840       2,632,537       497,016       4,817,088  
                                 
Cash and cash equivalents, end of period
    1,576,704       4,934,945       1,576,704       4,934,945  
                                 
Supplemental cash flow information
                               
Interest paid
    62,383       -       86,531       113,940  
Taxes paid
    -       -       -       -  
 
 
See accompanying notes to condensed unaudited interim consolidated financial statements
 
Page 5

 
Intellipharmaceutics International Inc.
Notes to the condensed unaudited interim consolidated financial statements
For the three and six months ended May 31, 2013 and 2012
(Stated in U.S. dollars)
 
1.
Nature of operations
 
Intellipharmaceutics International Inc. (“IPC” or the “Company”) is a pharmaceutical company specializing in the research, development and manufacture of novel and generic controlled-release and targeted-release oral solid dosage drugs.
 
On October 22, 2009, IntelliPharmaCeutics Ltd. (“IPC Ltd. “) and Vasogen Inc. (“Vasogen”) completed a plan of arrangement and merger (the “IPC Arrangement Agreement”), resulting in a publicly-traded company, Intellipharmaceutics International Inc., which is incorporated under the laws of Canada and whose shares are traded on the Toronto Stock Exchange and NASDAQ.
 
The Company earns revenues from development contracts which provide upfront fees, milestone payments, reimbursement of certain expenditures and royalty income upon commercialization of its products. The Company has incurred losses from operations since inception, and has an accumulated deficit of $33,206,478 as at May 31, 2013 (November 30, 2012 $30,084,684). Previously, the Company funded its research and development activities through the issuance of capital stock, loans from related parties, funds from the IPC Arrangement Agreement and funds received under development agreements. On January 10, 2013, the Company completed a private placement financing of an unsecured convertible debenture (the “Debenture”) in the principal amount of $1.5 million, which will mature January 1, 2015.  The Debenture bears interest at a rate of 12% per annum, payable monthly, is pre-payable at any time at the option of the Company, and is convertible at any time into 500,000 common shares at a conversion price of $3.00 per common share at the option of the holder. In March 2013, the Company completed a registered direct unit offering and received net proceeds of approximately $2.7 million, as described in Note 6.  There is no certainty that any funding will be available going forward.
 
The condensed unaudited interim consolidated financial statements are prepared on a going concern basis and substantial doubt exists on the appropriateness of this.  In order for the Company to continue operations at existing levels, the Company expects that for at least the next twelve months the Company will require significant additional capital.  While the Company expects to satisfy its operating cash requirements over the next twelve months from cash on hand, collection of anticipated revenues resulting from future commercialization activities, development agreements or marketing license agreements, through managing operating expense levels, funds from senior management through the convertible debenture described elsewhere herein, equity and/or debt financings, and/or new strategic partnership agreements funding some or all costs of development, there can be no assurance that the Company will be able to obtain any such capital on terms or in amounts sufficient to meet its needs or at all.  The availability of equity or debt financing will be affected by, among other things, the results of the Company’s research and development, its ability to obtain regulatory approvals, the market acceptance of its products, the state of the capital markets generally, strategic alliance agreements, and other relevant commercial considerations.  In addition, if the Company raises additional funds by issuing equity securities, its then existing security holders will likely experience dilution, and the incurring of indebtedness would result in increased debt service obligations and could require the Company to agree to operating and financial covenants that would restrict its operations.  In the event that the Company does not obtain additional capital over the next twelve months, there may be substantial doubt about its ability to continue as a going concern and realize its assets and pay its liabilities as they become due.  Any failure by the Company to raise additional funds on terms favorable to the Company, or at all, may require the Company to significantly change or curtail its current or planned operations in order to conserve cash until such time, if ever, that sufficient proceeds from operations are generated, and could result in its not taking advantage of business opportunities, in the termination or delay of clinical trials for one or more of its product candidates, in curtailment of its product development programs designed to identify new product candidates, in the sale or assignment of rights to its technologies, products or product candidates, and/or its inability to file abbreviated new drug applications (“ANDAs”) or New Drug Applications (“NDAs”) at all or in time to competitively market its products or product candidates.
 
The condensed unaudited interim consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.
 
Page 6

 
Intellipharmaceutics International Inc.
Notes to the condensed unaudited interim consolidated financial statements
For the three and six months ended May 31, 2013 and 2012
(Stated in U.S. dollars)
 
2.
Basis of presentation
 
 
(a)
Basis of consolidation
 
These condensed unaudited interim consolidated financial statements include the accounts of the Company and its wholly owned operating subsidiaries, IPC Ltd., Intellipharmaceutics Corp. (“IPC Corp”), and Vasogen Corp.
 
These condensed unaudited interim consolidated financial statements have been prepared using the same accounting policies, and methods as those used by the Company in the annual audited consolidated financial statements for the year ended November 30, 2012, and accordingly, these condensed unaudited interim consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto for the year ended November 30, 2012. The condensed unaudited interim consolidated financial statements reflect all adjustments necessary for the fair presentation of the Company’s financial position and results of operation for the interim periods presented.  All such adjustments are normal and recurring in nature.
 
All inter-company accounts and transactions have been eliminated on consolidation.
 
 
(b)
Use of estimates
 
The preparation of the consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the year. Actual results could differ from those estimates.
 
Areas where significant judgment is involved in making estimates are: the determination of estimated useful lives of property and equipment; the fair values of financial assets and liabilities; the expected term of the Company's continued involvement in the research and development of each contract; the fair value of stock options and the determination of performance criteria for expensing share-based payments; the fair value of warrants; the fair value of conversion option embedded derivative; evaluation of income tax positions; the determination of valuation allowances; the determination of investment tax credits; accrued liabilities; forecasting future cash flows for assessing whether there are any impairments of long-lived assets; and the going concern assumption.

3.
Significant accounting policies

(a)  
Convertible Debenture
 
The Company issued a convertible debenture as described in Note 4.  The conversion option is bifurcated from its host contract and the fair value of the conversion option characterized as an embedded derivative upon issuance as it meets the criteria of Accounting Standard Codification (“ASC”) topic ASC815-15-25-1 Embedded Derivatives. Subsequent changes in the fair value of the embedded derivative are recorded in the consolidated statements of operations and comprehensive loss.
 
(b)  
 Recently adopted Accounting pronouncements
 
In February 2013, the FASB provided amendments to Accounting Standards Update (“ASU”) 2013-02 “Comprehensive Income (Topic 220): Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income”. The amendments are effective prospectively for reporting periods beginning after December 15, 2012. Early adoption is permitted. The Company adopted the amendments on March 1, 2013. The adoption did not have an impact on the Company’s financial position, results of operations or cash flow.
 
Page 7

 
Intellipharmaceutics International Inc.
Notes to the condensed unaudited interim consolidated financial statements
For the three and six months ended May 31, 2013 and 2012
(Stated in U.S. dollars)
 
3.
Significant accounting policies (continued)

(c)  
Future Accounting pronouncements

In March 2013, the FASB provided amendments to Accounting Standards Update No. 2013-05 “Foreign Currency Matters (Topic 830): Parent’s Accounting for the Cumulative Translation Adjustment upon Derecognition of Certain Subsidiaries or Groups of Assets within a Foreign Entity or of an Investment in a Foreign Entity (a consensus of the FASB Emerging Issues Task Force)”. The amendments are effective prospectively for reporting periods beginning after December 15, 2013. The Company does not expect the adoption of the amendments to have a material impact on IPC’s financial position, results of operations or cash flow.
 
4.
Due to related parties
 
Amounts due to the related parties are payable to entities controlled by two shareholders who are also officers and directors of the Company.
     
May 31
   
November 30,
 
     
2013
   
2012
 
     
$
   
$
 
                   
 
Promissory note payable to two directors and officers of the Company, unsecured 6% annual interest rate on the outstanding loan balance (i)
(May 31, 2013 - C$755,493 ; November 30, 2012 - C$750,534)
     728,678       755,368  
 
Note payable to an entity controlled by shareholders, officers and directors of the Company, unsecured, non-interest bearing with no fixed repayment terms. 
(May 31, 2013 - C$28,167; November 30,2012 - C$28,167)
    27,167       28,349  
        755,845       783,717  
                   
 
Convertible debenture payable to two directors and officers of the Company, unsecured 12% annual interest rate payable monthly (ii)
    1,360,756       -  
 
(i)         Promissory note payable

The promissory note dated September 10, 2004 issued by IPC Corp to Dr. Isa Odidi and Dr. Amina Odidi (the “Promissory Note”), principal shareholders, directors and executive officers of the Company was amended effective October 22, 2009 (“effective date”),  to provide that the principal amount thereof shall be payable when payment is required solely out of (i) revenues earned by IPC Corp following the effective date, and/or proceeds received by any IPC Company from any offering of its securities following the effective date, other than the securities offerings completed in February 2011, March 2012 and March 2013 (Note 6) and/or amounts received by IPC Corp for the scientific research tax credits received after the effective date for research expenses of IPC Corp incurred before the effective date and (ii) up to C$800,000 from the Net Cash (as defined in the IPC Arrangement Agreement).

Interest expense on the promissory note payable to related parties for the three and six months ended May 31, 2013 is $11,072 and $21,883 (three and six months ended May 31, 2012 - $11,110 and $22,411) and has been included in the consolidated statements of operations and comprehensive loss.

(ii)         
Convertible debenture

On January 10, 2013, the Company completed a private placement financing (the "Financing") of an unsecured convertible debenture in the principal amount of $1.5 million (the "Debenture"), which will mature January 1, 2015.
 
Page 8

 
Intellipharmaceutics International Inc.
Notes to the condensed unaudited interim consolidated financial statements
For the three and six months ended May 31, 2013 and 2012
(Stated in U.S. dollars)
 
4.
Due to related parties (continued)
 
The Debenture bears interest at a rate of 12% per annum, payable monthly, is pre-payable at any time at the option of the Company, and is convertible at any time into 500,000 common shares at a conversion price of $3.00 per common share at the option of the holder. Dr. Isa Odidi and Dr. Amina Odidi, principal shareholders, directors and executive officers of the Company purchased the debenture and provided the Company with the $1.5 million of the proceeds for the Debenture.

The conversion price of the Debenture is in U.S. dollars and IPC’s functional currency is Canadian dollars. Under U.S. GAAP where the conversion price of the Debenture is denominated in a currency other than an entity's functional currency, the conversion option meets the definition of an embedded derivative. The conversion option is bifurcated from its host contract and the fair value of the conversion option characterized as an embedded derivative upon issuance.
 
The embedded derivative is presented on a combined basis with the host contract. The derivative is re-measured at the end of every reporting period with the change in value reported in the statement of operations and comprehensive loss.
 
The initial proceeds received from the Debenture less the initial amount allocated to the embedded derivative is allocated to the liability and accreted over the life of the Debenture using the imputed rate of interest.
 
The fair value of the conversion option at January 10, 2013 using the Black-Scholes Option Pricing Model was initially estimated to be $220,100, using volatility of 46.6%, risk-free interest rate of 0.26%, expected life of two years, and dividend yield of Nil. The fair value of the conversion option at May 31, 2013 using the Black-Scholes Option Pricing Model was estimated to be $29,060, using volatility of 36.1%, risk-free interest rate of 0.12%, expected life of 1.6 years, and dividend yield of Nil.  This amount has been recorded in the convertible debenture line on the condensed unaudited interim consolidated balance sheet. The change in fair value of the conversion option from the previously recorded amount to the three and six months ended May 31, 2013 is a gain of $35,335 and $195,412, respectively, and has been recorded as a fair value adjustment of derivative liabilities in the condensed unaudited interim consolidated statement of operations and comprehensive loss.
 
The initial proceeds of $1.5 million less the initial fair value of the conversion option embedded derivative of $220,100, amounts to $1,279,900 and is accreted at an annual imputed interest rate of 8%, over the life of the Debenture. Accreted interest expense during the three and six months ended May 31, 2013 is $26,154 and $51,796, respectively, and has been included in the consolidated statement of operations and comprehensive loss. In addition, the coupon interest on the Debenture for the three and six months ended May 31, 2013 is $45,339 and $69,487, respectively, and has also been included in the condensed unaudited interim consolidated statement of operations and comprehensive loss.

As described in Note 5, the Company had salaries payable to the two principal shareholders.
 
 
5.
Employee costs payable
 
As at May 31, 2013, the Company had $472,619 (November 30, 2012 - $472,619) salaries payable to Dr. Isa Odidi and Dr. Amina Odidi, principal shareholders, directors and executive officers of the Company and $234,037 (November 30, 2012 - $190,603) for other amounts payable to certain employees.  These balances are due on demand and therefore presented as current in nature.
 
Page 9

 
Intellipharmaceutics International Inc.
Notes to the condensed unaudited interim consolidated financial statements
For the three and six months ended May 31, 2013 and 2012
(Stated in U.S. dollars)

6.
Capital stock
 
 
Authorized, issued and outstanding
 
(a)  
The Company is authorized to issue an unlimited number of common shares, all without nominal or par value and an unlimited number of preference shares. As at May 31, 2013, the Company has 19,721,936 (November 30, 2012 – 17,906,937) common shares issued and outstanding, and no preference shares issued and outstanding.
 
(b)  
In March 2012, the Company completed a registered direct common share offering for gross proceeds of $5,000,000. The Company sold an aggregate of 1,818,182 shares to U.S. institutional investors at a price of $2.75 per share. Professional, regulatory and other costs in the amount of $779,271 directly attributable to the common share offering have been recorded as share issuance costs in shareholders’ deficiency.
 
(c)  
In March 2013, the Company completed a registered direct unit offering for gross proceeds of approximately $3,100,000 at a price of $1.72 per unit. The Company sold units comprised of an aggregate of 1,815,000 common shares and warrants to purchase an additional 453,750 common shares. The warrants are exercisable for a term of five years and an exercise price of $2.10 per common share. After placement agent fees and estimated offering expenses, the Company received net proceeds from the offering of approximately $2.7 million. The Company determined the fair value of the warrant liability at issuance to be $407,558 using the Black-Scholes Option Pricing Model (Note 9). The direct costs related to the issuance of the common shares were recorded as an offset against shareholders’ deficiency and the direct costs related to the issuance of the warrants were recorded in the consolidated statements of operations and comprehensive loss.
 
 
7.
Options
 
All grants of options to employees after October 22, 2009 are made from the Employee Stock Option Plan (the “Employee Stock Option Plan”). The maximum number of common shares issuable under the Employee Stock Option Plan is limited to 10% of the issued and outstanding common shares of the Company from time to time, or 1,972,194 based on the number of issued and outstanding common shares as at May 31, 2013. As at May 31, 2013, 1,716,632 options are outstanding and there were 255,562 options available for grant under the Employee Stock Option Plan. Each option granted allows the holder to purchase one common share at an exercise price not less than the closing price of the Company's common shares on the Toronto Stock Exchange on the last trading day prior to the grant of the option. Options granted under these plans generally have a maximum term of 10 years and generally vest over a period of up to three years.
 
In August 2004, the Board of Directors of IPC Ltd. approved a grant of 2,763,940 performance-based stock options, to two executives who were also the principal shareholders of IPC Ltd. The vesting of these options is contingent upon the achievement of certain performance milestones. A total of 1,381,970 performance-based stock options have been vested as of May 31, 2013. These options were still outstanding as at May 31, 2013 and will expire in 2014.
 
In the three and six months ended May 31, 2013, 391,000 (three and six months ended May 31, 2012 – Nil and 955,000) stock options to management, directors and employees were granted.
 
The fair value of each option grant is estimated on the date of grant using the Black-Scholes Option Pricing Model, consistent with the provisions of Accounting Standards Codification topic ASC 718.

Option pricing models require the use of subjective assumptions, changes in these assumptions can materially affect the fair value of the options.
 
Page 10

 
Intellipharmaceutics International Inc.
Notes to the condensed unaudited interim consolidated financial statements
For the three and six months ended May 31, 2013 and 2012
(Stated in U.S. dollars)
 
7.
Options (continued)
 
The Company calculates expected volatility based on historical volatility of the Company’s peer group that is publicly traded for options that have an expected life that is more than three years. For options that have an expected life of less than three years the Company uses its own volatility.

The expected term, which represents the period of time that options granted are expected to be outstanding, is estimated based on an average of the term of the options.

The risk free rate assumed in valuing the options is based on the U.S. Treasury yield curve in effect at the time of grant for the expected term of the option. The expected dividend yield percentage at the date of grant is Nil as the Company is not expected to pay dividends in the foreseeable future.
 
Details of stock option transactions are as follows:
 
    May 31, 2013       May 31, 2012  
           
Weighted
               
Weighted
       
           
average
   
Weighted
         
average
   
Weighted
 
           
exercise
   
average
         
exercise
   
average
 
     
Number of
   
price per
   
grant date
   
Number of
   
price per
   
grant date
 
     
options
   
share
   
fair value
   
options
   
share
   
fair value
 
                             
$
   
$
 
                                       
                                       
 
Outstanding, beginning of fiscal year
    4,139,059       4.86       2.76       3,216,954       5.33       2.82  
 
Granted
    391,000       1.81       1.06       955,000       3.27       2.51  
 
Exercised
    -       -       -       -       -       -  
 
Expired
    (4,487 )     654.48       403.93       -       -       -  
 
Forfeited
    (45,000 )     -       -       (31,195 )     -       -  
 
Balance at end of period
    4,480,572       3.95       2.21       4,140,759       4.86       2.76  
                                                   
 
Options exercisable, end of period
    2,482,936       4.36       2.58       2,227,732       6.02       3.59  
 
Total unrecognized compensation cost relating to the unvested performance-based stock options at May 31, 2013 is approximately $2,214,000 (May 31, 2012 - $2,214,000). For the three and six months ended May 31, 2013, no compensation cost has been recognized for the remaining unvested performance-based options (three and six months ended May 31, 2012 - $Nil).

No options were exercised in the three and six months ended May 31, 2013 or in the three and six months ended May 31, 2012.
 
The following table summarizes the components of stock-based compensation expense, including DSU’s.
 
 
Stock-based compensation
 
Three months ended
   
Six months ended
 
 
related to:
 
May 31, 2013
   
May 31, 2012
   
May 31, 2013
   
May 31, 2012
 
     
$
   
$
   
$
   
$
 
                           
 
Research and development
    154,822       145,887       283,920       1,200,538  
 
Selling, general and administrative
    136,561       101,686       220,147       643,447  
        291,383       247,573       504,067       1,843,985  

The Company has estimated its stock option forfeitures to be $Nil for the three and six months ended May 31, 2013 (three and six months ended May 31, 2012 - $Nil).
 
Page 11

 
Intellipharmaceutics International Inc.
Notes to the condensed unaudited interim consolidated financial statements
For the three and six months ended May 31, 2013 and 2012
(Stated in U.S. dollars)
 
8.
Deferred share units
 
During the three and six months ended May 31, 2013, one non-management board member elected to receive director fees in the form of DSUs under the Company’s DSU Plan. As at May 31, 2013, 32,190 DSUs are outstanding.

     
Three months ended
   
Six months ended
 
     
May 31, 2013
   
May 31, 2012
   
May 31, 2013
   
May 31, 2012
 
      $    
shares
    $    
shares
    $    
shares
    $    
shares
 
                                                           
 
Additional paid in capital
    9,404       5,131       9,439       3,195       19,217       9,741       16,008       5,245  
 
Accrued liability
    10,368       5,821       10,408       3,533       10,368       5,821       10,408       3,533  
 
9.
Warrants
 
The warrants are denominated in U.S. dollars and IPC’s functional currency is Canadian dollars. Under U.S. GAAP, where the strike price of warrants is denominated in a currency other than an entity's functional currency  the warrants would not be considered indexed to the entity’s own stock and would consequently be considered to be a derivative liability.
 
In connection with the February 1, 2011 private offering, the Company issued 4,800,000 five year Series A common shares purchase warrants to purchase one half of a share of common stock at an exercise price of $2.50 per whole share and 4,800,000 two year Series B common shares purchase warrants to purchase one half of a share of common stock at an exercise price of $2.50 per whole share. The Company also issued to the placement agents 96,000 warrants to purchase a share of common stock at an exercise price of $3.125 per share.
 
The  fair value of the Series A warrants of $7,214,366 and Series B warrants of $5,441,216 have been initially estimated at February 1, 2011 using the Black-Scholes Option Pricing Model, using volatilities of 70% and 59%, risk free interest rates of 0.99% and 0.29%, expected lives of 5 and 2 years, and dividend yields in each case of Nil, respectively. The fair value of the placement agents’ warrants was initially estimated at February 1, 2011 as $229,005 using the Black-Scholes Option Pricing Model, using volatility of 67%, a risk free interest rate of 0.99%, an expected life of 3 years, and a dividend yield of Nil. These placement agent warrants were expensed and are included in financing expense.

The holders of Series A common share purchase warrants and placement agents warrants are entitled to a cashless exercise under which the number of shares to be issued will be based on the number of shares for which warrants are exercised times the difference between market price of common share and the exercise price divided by the market price. Also under U.S. GAAP, warrants with the cashless exercise option satisfying the explicit net settlement criteria are considered a derivative liability.
 
In the registered direct unit offering completed in March 2013, gross proceeds of $3,121,800 were received through the sale of the Company’s units comprised of common stock and warrants. The offering was the sale of 1,815,000 units at a price of $1.72 per unit, each unit consisting of one share of common stock and a five year warrant to purchase 0.25 of a share of common stock at an exercise price of $2.10 per share (“March 2013 Warrants”).
 
The  fair value of the March 2013 Warrants of $407,558 have been initially estimated at closing using the Black-Scholes Option Pricing Model, using volatilities of 63%, risk free interest rates of 0.40%, expected life of 5 years, and dividend yield of Nil.
 
Page 12

 

Intellipharmaceutics International Inc.
Notes to the condensed unaudited interim consolidated financial statements
For the three and six months ended May 31, 2013 and 2012
(Stated in U.S. dollars)
 
9.
Warrants (continued)
 
The following table provides information on the 5,631,000 warrants outstanding and exercisable as of May 31, 2013:
 
           
Number
     
Shares issuable
 
 
Warrant
 
Exercise price
   
outstanding
 
 Expiry
 
upon exercise
 
                       
 
Placement Agent Warrants
    3.125       96,000  
March 30, 2014
    96,000  
 
Series A Warrants
    2.50       3,720,000  
February 1, 2016
    1,860,000  
 
March 2013 Warrants
    2.10       1,815,000  
March 22, 2018
    453,750  
                5,631,000         2,409,750  

During the six months ended May 31, 2013, there were no exercises of warrants.  During the six months ended May 31, 2012, there were exercises in respect of 50,000 warrants resulting in the issuance of 25,000 common shares. During the six months ended May 31, 2013, 3,470,000 Series B Warrants issued under the February 1, 2011 private placement offering expired.

Details of warrant transactions are as follows:

                             
May 31, 2013
 
     
Series A
   
Series B
   
Placement
   
March 2013
       
     
Warrants
   
Warrants
   
Agent Warrants
   
Warrants
   
Total
 
                                 
 
Outstanding, December 1, 2012
    3,720,000       3,470,000       96,000       -       7,286,000  
 
Issued
    -       -       -       1,815,000       1,815,000  
 
Exercised
    -       -       -       -       -  
 
Expired
    -       - 3,470,000       -       -       3,470,000  
 
Outstanding, end of period
    3,720,000       -       96,000       1,815,000       5,631,000  

U.S. GAAP requires the fair value of these liabilities be re-measured at the end of every reporting period with the change in value reported in the statement of operations and comprehensive loss.
 
Accordingly, the fair value of the Series A Warrants at May 31, 2013 using the Black-Scholes Option Pricing Model was estimated to be $809,472 (November 30, 2012 - $1,659,492), the fair value of the Placement Agent Warrants was estimated to be $2,649 (November 30, 2012- $25,363), and the March 2013 warrants was estimated to be $371,395, using the following assumptions as of May 31, 2013:
 
     
Number
         
Risk-free
   
Expected
 
 
Warrant
 
outstanding
   
Volatility
   
rate
   
life
 
           
%
   
%
   
years
 
 
Placement Agent Warrants
    96,000       27.60       0.12 %     0.8  
 
Series A Warrants
    3,720,000       43.50       0.12 %     2.8  
 
March 2013 Warrants
    1,815,000       63.30       0.34 %     4.8  

The change in the fair value of the Series A, Series B, Placement Agent and the March 2013 Warrants from the previously recorded amount to the three and six months ended May 31, 2013 is a gain of $139,582 and $1,211,662 respectively, (three and six months ended May 31, 2012 amounted to a gain of $846,467 and $1,814,648 respectively) has been recorded as a fair value adjustment of derivative liabilities in the statement of operations and comprehensive loss.
 
Page 13

 
Intellipharmaceutics International Inc.
Notes to the condensed unaudited interim consolidated financial statements
For the three and six months ended May 31, 2013 and 2012
(Stated in U.S. dollars)
 
10.
Income taxes
 
The Company has had no taxable income under the Federal and Provincial tax laws of Canada for the six months ended May 31, 2013 and May 31, 2012. The Company has non-capital loss carry-forwards at May 31, 2013, totaling $26,583,686 in Canada and $75,053 in United States federal income tax losses that must be offset against future taxable income. If not utilized, the loss carry-forwards will expire between 2014 - 2032.

For the six months ended May 31, 2013, the Company has a cumulative carry-forward pool of Scientific Research & Experimental Development (“SR&ED”) expenditures in the amount of $7,980,961 Federal, which can be carried forward indefinitely.

At May 31, 2013, the Company had approximately $440,246 of Ontario harmonization credits, which will expire in the November 30, 2017 taxation year. These credits are subject to a full valuation allowance as they are not more likely than not to be realized.

At May 31, 2013, the Company had approximately $2,410,029 of unclaimed Canadian investment tax credits which expire from 2024 to 2032.

These losses and credits are subject to a full valuation allowance as they are not more likely than not to be realized.
 
11.
Contingencies
 
From time to time the Company may be exposed to claims and legal actions in the normal course of business, which may be initiated by the Company.  There were no pending or threatened litigation claims outstanding other than the ones described in the following paragraphs.

Pursuant to an arrangement agreement between Vasogen and Cervus LP (“Cervus”) dated August 14, 2009 (the "Cervus Agreement"), Vasogen and a Vasogen subsidiary (“New Vasogen”) entered into an indemnity agreement (the "Indemnity Agreement"), which became an obligation of the Company as of October 22, 2009. The Indemnity Agreement is designed to provide Cervus with indemnification for claims relating to Vasogen's and New Vasogen's business that are brought against Cervus in the future, subject to certain conditions and limitations. The Company's obligations under the Indemnity Agreement relating to the Tax pools defined in the Indemnity Agreement are limited to an aggregate of C$1,455,000 with a threshold amount of C$50,000 before there is an obligation to make a compensation payment. The Company does not presently expect to have to pay any amount under this indemnity agreement.

In February 2012, the Company filed an amendment to the ANDA for generic Focalin to include the 40 mg strength of dexmethylphenidate hydrochloride extended-release capsules.  Celgene Corporation, Novartis Pharmaceuticals Corporation, and Novartis Pharma AG, filed a Complaint against Intellipharmaceutics Corp. for alleged patent infringement in the United States District Court for the District of New Jersey. In addition, Alkermes Pharma Ireland Limited (successor in title to Elan Pharma International Limited) filed a Complaint against Intellipharmaceutics Corp. and Intellipharmaceutics Ltd. for alleged patent infringement in the United States District Court for the District of Delaware. Both Complaints were in relation to Intellipharmaceutics’ generic version of 40 mg Focalin XR®.  Both of these actions were settled on April 2, 2013 by the agreement of all parties. In April, 2013, the parties stipulated to a full and final dismissal of the pending patent litigation in the states of New Jersey and Delaware, and the cases were dismissed on May 21, 2013. The terms of the settlements are confidential. These settlements are in addition to earlier announced settlements concerning the 5, 10, 15, 20 and 30 mg strengths of generic versions of Focalin XR®.
 
Page 14

 
Intellipharmaceutics International Inc.
Notes to the condensed unaudited interim consolidated financial statements
For the three and six months ended May 31, 2013 and 2012
(Stated in U.S. dollars)
 
12.         Financial instruments
 
 
(a)
Fair values
 
The Company follows ASC topic 820, “Fair Value Measurements and Disclosures” which defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. The provisions of ASC 820 apply to other accounting pronouncements that require or permit fair value measurements. ASC 820 defines fair value as 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 at the measurement date; and establishes a three level hierarchy for fair value measurements based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date.
 
Inputs refers broadly to the assumptions that market participants would use in pricing the asset or liability, including assumptions about risk. To increase consistency and comparability in fair value measurements and related disclosures, the fair value hierarchy prioritizes the inputs to valuation techniques used to measure fair value into three broad levels. The three levels of the hierarchy are defined as follows:
 
Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities.
 
Level 2 inputs are inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly for substantially the full term of the financial instrument.
 
Level 3 inputs are unobservable inputs for asset or liabilities.  There were no transfers in or out of level 3 instruments during the three and six month period ended May 31, 2013.
 
The categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement.
 
The following table presents for each of the fair value hierarchies, the assets and liabilities that are measured at fair value on a recurring basis as of May 31, 2013 and November 30, 2012:
 
                    May 31, 2013  
     
Fair value
liability
   
Level 1
   
Level 2
   
Level 3
 
     
$
   
$
   
$
   
$
 
                           
 
(a)   Conversion option1
    29,060       -       -       29,060  
 
(b)   Warrant liability2
    1,183,516       -       -       1,183,516  
        1,212,576       -       -       1,212,576  
                                   
                          November 30, 2012  
     
Fair value
(liability)
   
Level 1
   
Level 2
   
Level 3
 
        $       $       $     $  
 
(a)   Warrant liability2
    1,960,893       -       -       1,960,893  
 
(1)   Conversion options are included in convertible debenture on the condensed unaudited interim consolidated balance sheet.
 
(2)   Warrant liabilities are included on the condensed unaudited interim consolidated balance sheet.
 
Page 15

 
Intellipharmaceutics International Inc.
Notes to the condensed unaudited interim consolidated financial statements
For the three and six months ended May 31, 2013 and 2012
(Stated in U.S. dollars)
 
12.
Financial instruments (continued)
 
 
(a)
Fair values (continued)
 
The key unobservable inputs as well as the change in fair value related to  valuing the conversion option and warrant liability are as follows:
 
 
Quantitative Information about Level 3 Fair Value Measurements
 
     
Fair Value at
 
Valuation
       
     
May 31, 2013
 
Techniques
Unobservable Input
 
Range
 
     
$
           
 
Conversion Option
    29,060  
Black-Scholes
Discount Rate
    0.12 %
             
Volatility
    36 %
                       
 
Warrant Liability
    1,183,516  
Black-Scholes
Discount Rate
    0.10 %
             
Comparable Annualized Volatility (i)
    48% - 63 %
                       

(i)  
The Company calculates expected volatility based on historical volatility of the Company’s peer group that is publicly traded for options that have an expected life that is more than three years.
 
An increase/decrease in the volatility and/or an increase/decrease in the discount rate would result in an increase/decrease in the fair value of the conversion options and warrant liability.
 
The change in fair value of the conversion option and the warrant liability has been recorded as a fair value adjustment of derivative liabilities in the statement of operations and comprehensive loss.
 
The carrying values of accounts receivable, accounts payable, accrued liabilities, employee costs payable, capital lease obligations and due to related parties approximates their fair values because of the short-term nature of these instruments.
 
 
(b)
Interest rate and credit risk
 
Interest rate risk is the risk that the value of a financial instrument might be adversely affected by a change in interest rates. The Company does not believe that the results of operations or cash flows would be affected to any significant degree by a sudden change in market interest rates, relative to interest rates on cash and cash equivalents, due to related parties and capital lease obligations due to the short-term nature of these balances.
 
Trade accounts receivable potentially subjects the Company to credit risk. The Company provides an allowance for doubtful accounts equal to the estimated losses expected to be incurred in the collection of accounts receivable.
 
The following table sets forth details of the aged accounts receivable that are not overdue as well as an analysis of overdue amounts and the related allowance for doubtful accounts:
 
     
May 31,
   
November 30,
 
     
2013
   
2012
 
     
$
   
$
 
               
 
Total accounts receivable
    2,662       2,778  
 
Less allowance for doubtful accounts
    -       -  
 
Total accounts receivable, net
    2,662       2,778  
                   
 
Not past due
    2,662       2,778  
 
Less allowance for doubtful accounts
    -       -  
 
Total accounts receivable, net
    2,662       2,778  
 
Page 16

 
Intellipharmaceutics International Inc.
Notes to the condensed unaudited interim consolidated financial statements
For the three and six months ended May 31, 2013 and 2012
(Stated in U.S. dollars)
 
12.
Financial instruments (continued)
 
 
(b)
Interest rate and credit risk (continued)
 
The following table sets forth details of the cash and cash equivalents:
 
 
 
 
May 31,
   
November 30,
 
     
2013
   
2012
 
     
$
   
$
 
               
 
Cash
    1,576,704       447,016  
 
Bankers acceptance (30 days maturity, interest 0.10%)
    -       50,000  
 
Total cash and cash equivalents
    1,576,704       497,016  
 
Financial instruments that potentially subject the Company to concentration of credit risk consist principally of uncollateralized accounts receivable. The Company’s maximum exposure to credit risk is equal to the potential amount of financial assets. For the three and six months ended May 31, 2013, one customer accounted for 100% of accounts receivable of the Company.
 
For the three and six months ended May 31, 2012, one customer accounted for 100% of net revenue of the Company and the same customer accounted for 100% of accounts receivable of the Company.
 
The Company is also exposed to credit risk at period end from the carrying value of its cash. The Company manages this risk by maintaining bank accounts with a Canadian Chartered Bank. The Company’s cash is not subject to any external restrictions.
 
 
(c)
Foreign exchange risk
 
The Company has balances in U.S. dollars that give rise to exposure to foreign exchange (“FX”) risk relating to the impact of translating certain non-Canadian dollar balance sheet accounts as the Company’s functional currency is Canadian dollars. A strengthening U.S. dollar will lead to a FX loss while a weakening U.S. dollar will lead to a FX gain. For each U.S dollar balance of $1.0 million a +/- 10% movement in the U.S currency held by the Company versus the Canadian dollar would affect the Company’s loss and other comprehensive loss by $0.1 million.
 
 
(d)  Liquidity risk
 
Liquidity risk is the risk that the Company will encounter difficulty raising liquid funds to meet commitments as they fall due. In meeting its liquidity requirements, the Company closely monitors its forecast cash requirements with expected cash drawdown.
 
Page 17

 
 
Intellipharmaceutics International Inc.
Notes to the condensed unaudited interim consolidated financial statements
For the three and six months ended May 31, 2013 and 2012
(Stated in U.S. dollars)
 
12.
Financial instruments (continued)
 
 
(d)  Liquidity risk (continued)
 
The following are the contractual maturities of the undiscounted cash flows of financial liabilities as at:
 
                                May 31, 2013  
     
Less than
   
3 to 6
   
6 to 9
   
9 months
   
Greater than
       
     
3 months
   
months
   
months
   
1 year
   
1 year
   
Total
 
     
$
   
$
   
$
   
$
   
$
   
$
 
 
Third parties
                                   
 
Accounts payable
    934,393       -       -       -       -       934,393  
 
Accrued liabilities
    372,516       -       -       -       -       372,516  
 
Related parties
                                               
 
Employee costs payable (Note 5)
    706,656       -       -       -       -       706,656  
 
Due to related parties (Note 4)
    755,845       -       -       -       -       755,845  
 
Convertible debenture (Note 4)
    45,339       44,486       45,339       45,339       1,605,954       1,786,457  
        2,814,749       44,486       45,339       45,339       1,605,954       4,555,867  
 
                                May 31, 2012  
     
Less than
   
3 to 6
   
6 to 9
   
9 months
   
Greater than
       
     
3 months
   
months
   
months
   
to 1 year
   
1 year
   
Total
 
     
$
   
$
   
$
   
$
   
$
       
 
Third parties
                                   
 
Accounts payable
    644,376       -       -       -       -       644,376  
 
Accrued liabilities
    378,471       -       -       -       -       378,471  
 
Related parties
                                               
 
Employee cost payable
    576,452       11,305       11,723       12,157       70,166       681,803  
 
Due to related parties
    769,827       -       -       -       -       769,827  
        2,369,126       11,305       11,723       12,157       70,166       2,474,477  
 
13.
Segmented information
 
The Company's operations comprise a single reporting segment engaged in the research, development and manufacture of novel and generic controlled-release and targeted-release oral solid dosage drugs. As the operations comprise a single reporting segment, amounts disclosed in the financial statements for revenue, loss, depreciation and total assets also represent segmented amounts. In addition, all of the Company's long-lived assets are in Canada.
 
         Three months ended      Six months ended  
     
May 31,
   
May 31,
   
May 31,
   
May 31,
 
     
2013
   
2012
   
2013
   
2012
 
     
$
   
$
   
$
   
$
 
                           
 
Revenue
                       
 
Canada
    -       -       -       107,091  
 
United States
    -       -       -       -  
        -       -       -       107,091  
                                   
                     
May 31,
   
November 30,
 
                        2013       2012  
                        $       $  
 
Total assets
                               
 
Canada
                    3,607,870       2,474,878  
                                   
 
Total property and equipment
                               
 
Canada
                    1,441,565       1,535,703  
 
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