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

The accompanying consolidated financial statements include the accounts of Opexa and its wholly owned subsidiary, Opexa Hong Kong Limited (“Opexa Hong Kong”). All intercompany balances and transactions have been eliminated in the consolidation.

 During the nine months ended September 30, 2014, the Company has elected to early adopt Accounting Standards Update No. 2014-10, Development Stage Entities (Topic 915): Elimination of Certain Financial Reporting Requirements. The adoption of this ASU allows the Company to remove the inception to date information and all references to development stage.

Revenue Recognition.  Opexa recognizes revenue in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 605, “Revenue Recognition.” ASC 605 requires that four basic criteria must be met before revenue can be recognized: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred or services rendered; (3) consideration is fixed or determinable; and (4) collectability is reasonably assured.

On February 4, 2013, Opexa entered into an Option and License Agreement (the “Merck Agreement”) with Ares Trading SA (“Merck”), a wholly owned subsidiary of Merck Serono S.A.  Pursuant to the terms, Merck has an option to acquire an exclusive, worldwide (excluding Japan) license of the Company’s Tcelna® program for the treatment of multiple sclerosis (“MS”).  Tcelna is currently in a Phase IIb clinical trial in patients with Secondary Progressive MS (“SPMS”). The option may be exercised by Merck prior to or upon the Company’s completion of the Phase IIb Trial.

Opexa received an upfront payment of $5 million for granting the option. If the option is exercised, Merck would pay the Company an upfront license fee of $25 million unless Merck is unable to advance directly into a Phase III clinical trial of Tcelna for SPMS without a further Phase II clinical trial (as determined by Merck), in which event the upfront license fee would be $15 million. After exercising the option, Merck would be solely responsible for funding development, regulatory and commercialization activities for Tcelna in MS, although the Company would retain an option to co-fund certain development in exchange for increased royalty rates.  The Company would also retain rights to Tcelna in Japan, certain rights with respect to the manufacture of Tcelna, and rights outside of MS.

Opexa evaluated the Merck Agreement and determined that the $5 million upfront payment from Merck has “stand-alone value.” Opexa’s continuing performance obligations, in connection with the $5 million payment, include the execution and completion of the Phase IIb clinical trial in SPMS using commercially reasonable efforts at the Company’s own costs.  As a “stand-alone value” term in the Merck Agreement, the $5 million upfront payment is determined to be a single unit of accounting, and is recognized as revenue on a straight-line basis over the exclusive option period based on the expected completion term of the Phase IIb clinical trial in SPMS.  Opexa includes the unrecognized portion of the $5 million as deferred revenue on the consolidated balance sheets. During the second quarter of 2014, Opexa adjusted the number of months over which it was recognizing the deferred revenue from 43 to 47 months.  This extension will align the period for recognition of the revenue to the present projection for expiration of the Merck Agreement.

Cash and Cash Equivalents.  Opexa considers all highly liquid investments with an original maturity of three months or less, when purchased, to be cash equivalents. Investments with maturities in excess of three months but less than one year are classified as short-term investments and are stated at fair market value.

Opexa primarily maintains cash balances on deposit in accounts at a U.S.-based financial institution.  The aggregate cash balance on deposit in these accounts is insured by the Federal Deposit Insurance Corporation up to $250,000.  Opexa’s cash balances on deposit in these accounts may, at times, exceed the federally insured limits.  Opexa has not experienced any losses in such accounts.

At September 30, 2014, Opexa has approximately $12.3 million in a savings account.  For the nine months ended September 30, 2014, the savings account recognized an average market yield of 0.10%.  Interest income of $12,940 was recognized for the nine months ended September 30, 2014 in the consolidated statements of operations.

Other current assets consisted of the following at September 30, 2014 and December 31, 2013:

Prepaid expenses at September 30, 2014 and December 31, 2013 include advance payments totaling $0 and $21,982, respectively, made to vendors and consultants for the conduct of the Phase IIb clinical trial in SPMS.

Prepaid expenses at September 30, 2014 and December 31, 2013 also include costs incurred from third parties in connection with the Merck Agreement (see Note 2).  As of September 30, 2014 and December 31, 2013, the remaining costs of $38,938 in connection with the Merck Agreement that are expected to be amortized over the upcoming 12-month period are capitalized and included in other current assets in the consolidated balance sheets.  The remaining costs of $48,674 in connection with the Merck Agreement that are expected to be amortized beyond the upcoming 12-month period are capitalized and included in other long term assets in the consolidated balance sheets (see Note 4).

Supplies inventory at September 30, 2014 and December 31, 2013 includes reagents and supplies that will be used to manufacture Tcelna and placebo product in Opexa’s Phase IIb clinical study.  Opexa expects to amortize these prepaid reagents and supplies to research and development costs in the consolidated statements of operations over the period that these supplies are expected to be used which is in the next three months.

Deferred offering costs at September 30, 2014 and December 31, 2013 include costs incurred from third parties in connection with the implementation of a $1.5 million Purchase Agreement in November 2012 pursuant to which Opexa has the right to sell to Lincoln Park Capital Fund, LLC (“Lincoln Park”) up to $1.5 million in shares of its common stock, subject to certain conditions and limitations.  As of September 30, 2014 and December 31, 2013, the remaining costs of $134,518 in connection with the implementation of the $1.5 million Purchase Agreement remained capitalized and are included in other current assets in the consolidated balance sheets.  Upon the sales of shares of common stock under the $1.5 million Purchase Agreement, the remaining capitalized costs are offset against the proceeds of such sales of shares of common stock.

Deferred offering costs at September 30, 2014 also include costs incurred from third parties in connection with the implementation of an at-the-market program (“ATM Agreement”) in March 2014 pursuant to which Opexa may sell shares of its common stock from time to time depending upon market demand through a sales agent in transactions deemed to be an “at-the-market” offering as defined in Rule 415 of the Securities Act of 1933.  As of September 30, 2014, the remaining costs of $21,835 in connection with the implementation of the ATM Agreement remained capitalized and are included in other current assets in the consolidated balance sheets. Upon the sales of shares of common stock under the ATM Agreement, the remaining capitalized costs are offset against the proceeds of such sales of shares of common stock.

Deferred offering costs at September 30, 2014 include deferred offering costs of $103,636 which were incurred from third parties in connection with the implementation of a $15.0 million Purchase Agreement in November 2012 pursuant to which Opexa has the right to sell to Lincoln Park up to $15.0 million in shares of its common stock, subject to certain conditions and limitations. The termination date of this right to sell shares is within 12 months, therefore, the Company has reclassified this deferred offering cost from long term to current within the third quarter of 2014. (see Note 4)

Other long-term assets at September 30, 2014 and December 31, 2013 also include costs incurred from third parties in connection with the Merck Agreement (see Note 2) amount to $48,674 that are expected to be amortized beyond the upcoming 12-month period.

Other long term assets at December 31, 2013 include deferred offering costs of $103,636 which were incurred from third parties in connection with the implementation of a $15.0 million Purchase Agreement in November 2012 pursuant to which Opexa has the right to sell to Lincoln Park up to $15.0 million in shares of its common stock, subject to certain conditions and limitations. Because the termination date of this right to sell shares is within 12 months, the Company has reclassified this deferred offering cost from long term to current within the third quarter of 2014. (see Note 3)

For the nine months ended September 30, 2014, equity related transactions were as follows:

Stock Options

The 2010 Stock Incentive Plan (the “2010 Plan”) provides for the grant of equity incentive awards to employees, directors and consultants of Opexa in the form of incentive stock options or nonqualified stock options, as well as restricted stock, stock appreciation rights, restricted stock units and performance awards that may be settled in cash, stock or other property.  The 2010 Plan is the successor to and continuation of Opexa’s June 2004 Compensatory Stock Option Plan (the “2004 Plan”). A total of 625,000 shares of common stock are authorized to be issued for awards made under the 2010 Plan through September 2020, plus (i) the number of shares subject to stock options outstanding under the 2004 Plan that are forfeited or terminate prior to exercise and would otherwise be returned to the share reserves under the 2004 Plan and (ii) any reserved shares under the 2004 Plan that were not issued or subject to outstanding grants.  In addition, shares subject to awards granted under the 2010 Plan that terminate or expire before being exercised or settled will become available for grant under the 2010 Plan. As of September 30, 2014, options to purchase an aggregate of 2,411,607 shares were issued and outstanding.

Opexa accounts for share-based compensation, including options and nonvested shares, according to the provisions of FASB ASC 718, “Share Based Payment.” During the nine months ended September 30, 2014, Opexa recognized option expense of $840,303. Unamortized stock compensation expense as of September 30, 2014 amounted to $1,470,092.

Stock Option Activity

         A summary of stock option activity for the nine months ended September 30, 2014 is presented below:

Employee Options:

Option awards are granted with an exercise price equal to the market price of Opexa’s stock at the date of issuance, generally have a ten-year life, and have various vesting dates that range from no vesting or partial vesting upon date of grant to full vesting on a specified date. Opexa estimates the fair value of stock options using the Black-Scholes option-pricing model and records the compensation expense ratably over the service period.

During the nine months ended September 30, 2014, performance-based options to purchase an aggregate of 510,125 shares at an exercise price of $1.82 were granted to senior management. These options have a term of ten years and vest 100% upon the earlier of achievement of a performance-based, strategic milestone objective or termination of employment without cause following a change of control. Fair value of $918,554 was calculated using the Black-Scholes option-pricing model.  Variables used in the Black-Scholes option-pricing model for these options include (1) discount rate of 2.65%, (2) expected term of 10 years, (3) expected volatility of 172% and (4) zero expected dividends.

During the nine months ended September 30, 2014, time-based options to purchase an aggregate of 721,375 shares at exercise prices ranging from $1.44 to $1.82 were granted to employees.  These options have a term of ten years and have a vesting schedule of the earlier of four years or termination of employment without cause following a change of control. Fair value of $1,277,548 was calculated using the Black-Scholes option-pricing model.  Variables used in the Black-Scholes option-pricing model for these options include (1) discount rate range of 2.63% and 2.79%, (2) expected term of 6.25 years, (3) expected volatility range of 179%-186% and (4) zero expected dividends.

During the nine months ended September 30, 2014, options to purchase 102,782 shares were forfeited and cancelled.

Non-Employee Options:

During the nine months ended September 30, 2014, options to purchase an aggregate of 120,440 shares at exercise prices ranging from $1.82 to $2.00 were granted to non-employee directors for service on Opexa’s Board.  Options to purchase an aggregate of 78,858 shares will expire on the earlier of 10 years or a change in control of the Company, with 50% of the shares vesting immediately and 50% vesting on December 31, 2014.  Options to purchase an aggregate of 26,288 shares have terms of 10 years, with 50% of the shares vesting immediately and 50% vesting on February 28, 2015.  An option to purchase 8,844 shares will expire on the earlier of 10 years or a change in control of the Company, with vesting in quarterly increments beginning on March 31, 2014.  An option to purchase 6,450 shares will expire on the earlier of 10 years or a change in control of the Company, with vesting in three quarterly increments beginning June 30, 2014.  Fair value of $211,097 was calculated using the Black-Scholes option-pricing model.  Variables used in the Black-Scholes option-pricing model for these options include (1) discount rate range of 2.65% and 2.77%, (2) expected term of 5.25 years, (3) expected volatility range of 155% and 157% and (4) zero expected dividends.

Restricted Stock

See Note 5 for a description of restricted stock awards made to employees and non-employee directors under the 2010 Plan during the nine months ended September 30, 2014.

Warrant Activity

A summary of warrant activity for the nine months ended September 30, 2014 is presented below:

Opexa recognizes revenue in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 605, “Revenue Recognition.” ASC 605 requires that four basic criteria must be met before revenue can be recognized: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred or services rendered; (3) consideration is fixed or determinable; and (4) collectability is reasonably assured.

On February 4, 2013, Opexa entered into an Option and License Agreement (the “Merck Agreement”) with Ares Trading SA (“Merck”), a wholly owned subsidiary of Merck Serono S.A.  Pursuant to the terms, Merck has an option to acquire an exclusive, worldwide (excluding Japan) license of the Company’s Tcelna® program for the treatment of multiple sclerosis (“MS”).  Tcelna is currently in a Phase IIb clinical trial in patients with Secondary Progressive MS (“SPMS”). The option may be exercised by Merck prior to or upon the Company’s completion of the Phase IIb Trial.

Opexa received an upfront payment of $5 million for granting the option. If the option is exercised, Merck would pay the Company an upfront license fee of $25 million unless Merck is unable to advance directly into a Phase III clinical trial of Tcelna for SPMS without a further Phase II clinical trial (as determined by Merck), in which event the upfront license fee would be $15 million. After exercising the option, Merck would be solely responsible for funding development, regulatory and commercialization activities for Tcelna in MS, although the Company would retain an option to co-fund certain development in exchange for increased royalty rates.  The Company would also retain rights to Tcelna in Japan, certain rights with respect to the manufacture of Tcelna, and rights outside of MS.

Opexa evaluated the Merck Agreement and determined that the $5 million upfront payment from Merck has “stand-alone value.” Opexa’s continuing performance obligations, in connection with the $5 million payment, include the execution and completion of the Phase IIb clinical trial in SPMS using commercially reasonable efforts at the Company’s own costs.  As a “stand-alone value” term in the Merck Agreement, the $5 million upfront payment is determined to be a single unit of accounting, and is recognized as revenue on a straight-line basis over the exclusive option period based on the expected completion term of the Phase IIb clinical trial in SPMS.  Opexa includes the unrecognized portion of the $5 million as deferred revenue on the consolidated balance sheets. During the second quarter of 2014, Opexa adjusted the number of months over which it was recognizing the deferred revenue from 43 to 47 months.  This extension will align the period for recognition of the revenue to the present projection for expiration of the Merck Agreement.

Opexa considers all highly liquid investments with an original maturity of three months or less, when purchased, to be cash equivalents. Investments with maturities in excess of three months but less than one year are classified as short-term investments and are stated at fair market value.

Opexa primarily maintains cash balances on deposit in accounts at a U.S.-based financial institution.  The aggregate cash balance on deposit in these accounts is insured by the Federal Deposit Insurance Corporation up to $250,000.  Opexa’s cash balances on deposit in these accounts may, at times, exceed the federally insured limits.  Opexa has not experienced any losses in such accounts.

At September 30, 2014, Opexa has approximately $12.3 million in a savings account.  For the nine months ended September 30, 2014, the savings account recognized an average market yield of 0.10%.  Interest income of $12,940 was recognized for the nine months ended September 30, 2014 in the consolidated statements of operations.