Quarterly Report (10-q)

Date : 05/15/2019 @ 8:06PM
Source : Edgar (US Regulatory)
Stock : NovaBay Pharmaceuticals Inc New (NBY)
Quote : 0.66  0.0 (0.00%) @ 10:15AM

Quarterly Report (10-q)

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended March 31, 2019

  

OR

 

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: 001-33678

 

NOVABAY PHARMACEUTICALS, INC.

(Exact name of registrant as specified in its charter)

 

Delaware

68-0454536

(State or other jurisdiction of incorporation or organization)

(I.R.S. Employer Identification No.)

 

2000 Powell Street, Suite 1150, Emeryville, CA 94608

(Address of principal executive offices) (Zip Code)

 

Registrant’s Telephone Number, Including Area Code: (510) 899-8800

 

Securities Registered Pursuant to Section 12(b) of the Act:

Title of Each Class

Trading Symbol(s)

Name of Each Exchange On Which Registered

Common Stock, par value $0.01 per share

NBY

NYSE American

 

 

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 ☒    No ☐

 

Indicate by check mark whether the registrant has submitted electronically 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 such files).

Yes ☒    No ☐

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer 

Accelerated filer 

Emerging growth company

Non-accelerated filer 

Smaller reporting company 

  

  

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes ☐ No ☒

 

As of May 13, 2019, there were 18,992,116 shares of the registrant’s common stock outstanding. 

 

 

 
 

 

NOVABAY PHARMACEUTICALS, INC.

 

TABLE OF CONTENTS

 

  

PART I

FINANCIAL INFORMATION

 

 

 

 

Item 1.

 

Financial Statements

1

 

 

 

 

 

1.

Consolidated Balance Sheets: March 31, 2019 (unaudited) and December 31, 2018

1

       

 

2.

Consolidated Statements of Operations and Comprehensive Loss (unaudited): Three months ended March 31, 2019 and 2018

2

 

 

 

 

 

3.

Consolidated Statements of Cash Flows (unaudited): Three months ended March 31, 2019 and 2018

3

 

 

 

 

 

4.

Consolidated Statements of Stockholders’ Equity (unaudited): Three months ended March 31, 2019 and 2018

4
       

 

5.

Notes to Consolidated Financial Statements (unaudited)

5

 

 

 

 

Item 2.

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

30

 

 

 

 

Item 3.

 

Quantitative and Qualitative Disclosures About Market Risk

37

 

 

 

 

Item 4.

 

Controls and Procedures

37

 

 

 

 

PART II

OTHER INFORMATION

 

 

 

 

Item 1A.

 

Risk Factors

39

  

  

  

 

Item 6.

 

Exhibits

52

 

 

 

 

SIGNATURES   

55

 

 

EXHIBIT INDEX

52

  

Unless the context requires otherwise, all references in this report to “we,” “our,” “us,” the “Company” and “NovaBay” refer to NovaBay Pharmaceuticals, Inc.

 

NovaBay ® , NovaBay Pharma ® , Avenova TM , NeutroPhase ® , CelleRx ® , intelli-Case™, AgaNase ® , Aganocide ® , AgaDerm ® , Neutrox and Going Beyond Antibiotics TM are trademarks of NovaBay Pharmaceuticals, Inc. All other trademarks and trade names are the property of their respective owners.

 

 

 

 

PART I

FINANCIAL INFORMATION

 

ITEM 1.

FINANCIAL STATEMENTS

 

  

NOVABAY PHARMACEUTICALS, INC.

CONSOLIDATED BALANCE SHEETS

(In thousands, except par value amounts)

 

   

March 31,

   

December 31,

 
   

2019

   

2018

 
   

(Unaudited)

         

ASSETS

               

Current assets:

               

Cash and cash equivalents

  $ 2,932     $ 3,183  

Accounts receivable, net of allowance for doubtful accounts ($24 and $10 at March 31, 2019 and December 31, 2018, respectively)

    2,430       3,385  

Inventory, net of allowance for excess and obsolete inventory and lower of cost or estimated net realizable value adjustments ($110 and $104 at March 31, 2019 and December 31, 2018, respectively)

    302       280  

Prepaid expenses and other current assets

    1,451       1,760  

Total current assets

    7,115       8,608  

Operating lease right-of-use assets

    1,870        

Property and equipment, net

    193       201  

Other assets

    542       552  

TOTAL ASSETS

  $ 9,720     $ 9,361  
                 

LIABILITIES AND STOCKHOLDERS' EQUITY

               

Liabilities:

               

Current liabilities:

               

Accounts payable

  $ 462     $ 551  

Accrued liabilities

    2,860       3,255  

Deferred revenue

          41  

Operating lease liabilities

    1,073        

Notes payable, related party

    1,019        

Total current liabilities

    5,414       3,847  

Operating lease liabilities-non-current

    1,143        

Deferred rent

          184  

Warrant liability

    179       178  

Convertible note

    1,227        

Embedded derivative liability associated with the convertible note

    427        

Other liabilities

    201       198  

Total liabilities

    8,591       4,407  
                 

Stockholders' equity:

               

Preferred stock: 5,000 shares authorized; none outstanding at March 31, 2019 and December 31, 2018

           

Common stock, $0.01 par value; 50,000 shares authorized; 17,095 and 17,089 shares issued and outstanding at March 31, 2019 and December 31, 2018, respectively

    171       171  

Additional paid-in capital

    120,484       119,764  

Accumulated deficit

    (119,526

)

    (114,981

)

Total stockholders' equity

    1,129       4,954  

TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY

  $ 9,720     $ 9,361  

 

As the Company adopted the requirements of Accounting Standards Update (ASU) 2016-02, Leases (Topic 842) , as of January 1, 2019, using the modified retrospective method, there is a lack of comparability to the prior periods presented. See Note 2.

 

The accompanying notes are an integral part of these consolidated financial statements. 

 

1

 
 

 

NOVABAY PHARMACEUTICALS, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS

(Unaudited)

(In thousands, except per share data)

 

 

   

Three Months Ended March 31,

 
   

2019

   

2018

 

Sales:

               

Product revenue, net

  $ 1,450     $ 2,934  

Other revenue

    41       13  

Total sales, net

    1,491       2,947  
                 

Product cost of goods sold

    341       251  

Gross profit

    1,150       2,696  
                 

Research and development

    85       46  

Sales and marketing

    3,531       3,396  

General and administrative

    1,605       1,622  

Total operating expenses

    5,221       5,064  

Operating loss

    (4,071 )     (2,368 )
                 

Non cash (loss) gain on changes in fair value of warrant liability

    (57 )     214  

Other (expense) income, net

    (60 )     4  
                 

Loss before provision for income taxes

    (4,188 )     (2,150 )

Provision for income tax

    (1 )      

Net loss and comprehensive loss

  $ (4,189 )   $ (2,150 )
                 

Net loss per share attributable to common stockholders (basic)

  $ (0.25 )   $ (0.13 )

Net loss per share attributable to common stockholders (diluted)

  $ (0.25 )   $ (0.14 )

Weighted-average shares of common stock outstanding used in computing net loss per share of common stock (basic)

    17,093       16,406  

Weighted-average shares of common stock outstanding used in computing net loss per share of common stock (diluted)

    17,093       16,670  

 

As the Company adopted the requirements of Accounting Standards Update (ASU) 2016-02, Leases (Topic 842) , as of January 1, 2019, using the modified retrospective method, there is a lack of comparability to the prior periods presented. See Note 2.

 

The accompanying notes are an integral part of these consolidated financial statements.

 

2

 
 

 

NOVABAY PHARMACEUTICALS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)  

(In thousands)

 

   

Three Months Ended
March 31,

 
   

2019

   

2018

 
                 

Operating activities:

               

Net loss

  $ (4,189 )   $ (2,150 )

Adjustments to reconcile net loss to net cash used in operating activities:

               

Depreciation and amortization

    17       41  

Impairment of operating lease right-of-use assets

    125        

Stock-based compensation expense for options and stock issued to employees and directors

    107       102  

Stock-based compensation expense for options and stock issued to non-employees

    7       7  

Stock option modification expense

          77  
Issuance of RSUs to employees     10        

Non-cash loss (gain) on change in fair value of warrant liability

    57       (214 )

Amortization of debt issuance and debt discount

    20        

Amortization of debt issuance related to related party notes payable

    5        

Changes in operating assets and liabilities:

               

Accounts receivable

    954       1,934  

Inventory

    (21 )      

Prepaid expenses and other assets

    214       (88 )

Operating lease right-of-use assets

    244        

Other assets long-term

    10       17  

Accounts payable and accrued liabilities

    (521 )     (161 )

Operating lease liabilities

    (256 )      

Deferred rent

          (16 )

Deferred revenue

    (41 )     (13 )

Related party notes payable

    34        

Long-term obligations

    3        

Net cash (used) in operating activities

    (3,221 )     (464 )
                 

Investing activities:

               

Purchases of property and equipment

    (14 )     (2 )

Net cash (used) by investing activities

    (14 )     (2 )
                 

Financing activities:

               

Proceeds from common stock issuances, net

          5,591  

Proceeds from issuance of notes payable, related party, net of issuance cost

    980        

Proceeds from exercise of options, net

          11  

Proceeds from stock options & RSUs sold to cover taxes

    4       1  

Proceeds from convertible notes, net of discount

    2,000        

Net cash provided by investing activities

    2,984       5,603  

Net (decrease) increase in cash, cash equivalents, and restricted cash

    (251 )     5,137  

Cash, cash equivalents and restricted cash, beginning of period

    3,658       3,673  

Cash, cash equivalents and restricted cash, end of period

  $ 3,407     $ 8,810  

 

 

 

   

Three Months Ended March 31,

 
   

2019

   

2018

 

Supplemental disclosure of non cash information:

               

Cumulative effect of adoption of ASU 606

  $     $ 2,638  

Cumulative effect of adoption of ASU 2017-11

  $ 56     $  

Addition of operating lease, right-of-use asset

  $ 2,473     $  

Fixed asset purchases, included in accounts payable and accrued liabilities

  $ (5 )   $ 3  

Proceeds from stock options and restricted stock for taxes, in accounts payable and accrued liabilities

  $     $ 1  

 

As the Company adopted the requirements of Accounting Standards Update (ASU) 2016-02, Leases (Topic 842) , as of January 1, 2019, using the modified retrospective method, there is a lack of comparability to the prior periods presented. See Note 2.

 

The accompanying notes are an integral part of these consolidated financial statements.

 

3

 
 

 

NOVABAY PHARMACEUTICALS, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

(Unaudited)

(in thousands)

 

   

Common Stock

   

Additional

Paid-In

    Accumulated Other Comprehensive     Accumulated     Total Stockholders'  

2019

 

Shares

   

Amount

    Capital     Loss     Deficit     Equity  

Balance at December 31, 2018

    17,089     $ 171     $ 119,764     $     $ (114,981 )   $ 4,954  

Net loss

                                    (4,189 )     (4,189 )

Reclassification of Warrant Liability to Equity – see note 2

                412             (356 )     56  

Vesting of employee restricted stock awards

    6             10                   10  

Stock-based compensation expense related to employee and director stock options

                107                   107  

Stock-based compensation expense related to non-employee and director stock options

                7                   7  
Debt discount associated with the convertible note – beneficial conversion feature                 184                   184  

Balance at March 31, 2019

    17,095     $ 171     $ 120,484     $     $ (119,526 )   $ 1,129  

 

 

 

 

 

                   

Additional

    Accumulated Other           Total  
   

Common Stock

    Paid-In     Comprehensive     Accumulated     Stockholders'  

2018

 

Shares

   

Amount

    Capital     Loss     Deficit     Equity  

Balance at December 31, 2017

    15,385     $ 154     $ 113,514     $     $ (111,074 )   $ 2,594  

Net loss

                            (2,150 )     (2,150 )

Issuance of common stock in connection with offering

    1,700       17       5,967                   5,984  

Offering costs

                (393 )                 (393 )

Issuance of stock for option exercises

    4             11                   11  

Adoption of ASC 606

                            2,638       2,638  

Stock-based compensation expense related to employee and director stock options

                102                   102  

Stock-based compensation expense related to non-employee and director stock options

                7                   7  

Stock option modification

                77                   77  

Balance at March 31, 2018

    17,089     $ 171     $ 119,285     $     $ (110,586 )   $ 8,870  

 

As the Company adopted the requirements of Accounting Standards Update (ASU) 2016-02, Leases (Topic 842) , as of January 1, 2019, using the modified retrospective method, there is a lack of comparability to the prior periods presented. See Note 2.

 

The accompanying notes are an integral part of these consolidated financial statements.

 

4

 

 

 

NOTE 1. ORGANIZATION

  

NovaBay Pharmaceuticals, Inc. is a biopharmaceutical company focusing on commercializing and developing its non-antibiotic anti-infective products to address the unmet therapeutic needs of the global, topical anti-infective market with its two distinct product categories: the NEUTROX ® family of products and the AGANOCIDE ® compounds. The Neutrox family of products includes AVENOVA ® for the eye care market, NEUTROPHASE ® for wound care market, and CELLERX ® for the aesthetic dermatology market. The Aganocide compounds, still under development, have target applications in the dermatology and urology markets.

 

The Company was incorporated under the laws of the State of California on January 19, 2000, as NovaCal Pharmaceuticals, Inc. It had no operations until July 1, 2002, on which date it acquired all of the operating assets of NovaCal Pharmaceuticals, LLC, a California limited liability company. In February 2007, it changed its name from NovaCal Pharmaceuticals, Inc. to NovaBay Pharmaceuticals, Inc. In June 2010, the Company changed the state in which it is incorporated (the “Reincorporation”) and is now incorporated under the laws of the State of Delaware. All references to “the Company” herein refer to the California corporation prior to the date of the Reincorporation and to the Delaware corporation on and after the date of the Reincorporation. Historically, the Company operated as four business segments. In April 2016, the Company dissolved DermaBay, a wholly-owned U.S. subsidiary that was formed to explore dermatological opportunities. At the direction of its Board of Directors, the Company is now focused primarily on commercializing prescription Avenova for managing hygiene of the eyelids and lashes in the United States and is managed as a single segment.  

 

Effective December 18, 2015, the Company effected a 1-for-25 reverse split of its outstanding common stock (the “Reverse Stock Split”). The accompanying financial statements and related notes give retroactive effect to the Reverse Stock Split.

  

  Liquidity

 

Based primarily on the funds available at March 31, 2019, the Company believes these resources will be sufficient to fund its operations through the second quarter of 2019. The Company has sustained operating losses for the majority of its corporate history and expects that its 2019 expenses will exceed its 2019 revenues, as the Company continues to re-invest in its Avenova commercialization efforts. The Company expects to continue incurring operating losses and negative cash flows until revenues reach a level sufficient to support ongoing growth and operations. Accordingly, the Company's planned operations raise substantial doubt about its ability to continue as a going concern. The Company's liquidity needs will be largely determined by the success of operations in regard to the commercialization of Avenova. The Company also may consider other plans to fund operations including: (1) out-licensing rights to certain of its products or product candidates, pursuant to which the Company would receive cash milestones or an upfront fee; (2) raising additional capital through debt and equity financings or from other sources; (3) reducing expenditures on one or more of its sales and marketing programs; and/or (4) restructuring operations to change its overhead structure. The Company may issue securities, including common stock and warrants, through private placement transactions or registered public offerings, which would require the filing of a Form S-1 or Form S-3 registration statement with the Securities and Exchange Commission (the “SEC”). In the absence of the Company's completion of one or more of such transactions, there will be substantial doubt about the Company's ability to continue as a going concern within one year after the date these financial statements are issued, and the Company will be required to scale back or terminate operations and/or seek protection under applicable bankruptcy laws. The accompanying financial statements have been prepared assuming the Company will continue to operate as a going concern, which contemplates the realization of assets and the settlement of liabilities in the normal course of business. The consolidated financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts of liabilities that may result from uncertainty related to its ability to continue as a going concern.

 

 

 

NOTE 2.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

Basis of Presentation

 

The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”) and are expressed in U.S. dollars.

 

5

 

 

Use of Estimates

 

The preparation of financial statements in accordance with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. These estimates include useful lives for property and equipment and related depreciation calculations, estimated amortization periods for payments received from product development and license agreements as they relate to revenue recognition, assumptions for valuing options and warrants, and income taxes. Actual results could differ from those estimates.

 

Unaudited Interim Financial Information

 

The accompanying interim condensed consolidated financial statements and related disclosures are unaudited, have been prepared on the same basis as the annual consolidated financial statements and, in the opinion of management, reflect all adjustments, which include only normal recurring adjustments, necessary for a fair statement of the results of operations for the periods presented.

 

The year-end condensed consolidated balance sheet data was derived from audited financial statements but does not include all disclosures required by U.S. GAAP. The condensed consolidated results of operations for any interim period are not necessarily indicative of the results to be expected for the full year or for any other future year or interim period. 

 

Cash , Cash Equivalents , and Restricted Cash

 

The Company considers all highly-liquid instruments with a stated maturity of three months or less at the date of purchase to be cash equivalents. Cash and cash equivalents are stated at cost, which approximates fair value. As of March 31, 2019 and December 31, 2018, the Company’s cash and cash equivalents were held in two highly-rated, major financial institutions in the United States.

 

Beginning fiscal 2018, the Company adopted Accounting Standard Update ASU No. 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash , which requires the statement of cash flows to explain the change during the period relating to total cash, cash equivalents, and restricted cash. Net cash flows for the three months ended March 31, 2019 and 2018 did not change as a result of including restricted cash with cash and cash equivalents when reconciling the beginning-of-period and end-of-period amounts presented on the statements of cash flows.

 

The following table provides a reconciliation of the cash, cash equivalents, and restricted cash reported in the consolidated balance sheet that sum to the total of the same reported in the consolidated statement of cash flows: 

 

(in thousands)

 

March 31,

   

December 31,

 
   

2019

   

2018

 

Cash and cash equivalents

  $ 2,932     $ 3,183  

Restricted cash included in Other assets

    475       475  

Total cash, cash equivalents, and restricted cash in the statement of cash flows

  $ 3,407     $ 3,658  

 

The restricted cash amount included in Other assets on the consolidated balance sheet represents amounts held as certificate of deposit for long-term financing and lease arrangements as contractually required by our financial institution and landlord.

 

 

Concentrations of Credit Risk and Major Partners

 

Financial instruments that potentially subject us to significant concentrations of credit risk consist primarily of cash and cash equivalents. The Company maintains deposits of cash and cash equivalents with two highly-rated, major financial institutions in the United States.

 

Deposits in these banks may exceed the amount of federal insurance provided on such deposits. The Company does not believe it is exposed to significant credit risk due to the financial position of the financial institutions in which these deposits are held.

 

During the three months ended March 31, 2019 and 2018, revenues were derived primarily from sales of Avenova directly to doctors through the Company’s webstore, three major distribution partners and partner pharmacies.

 

6

 

 

During the three months ended March 31, 2019 and 2018, revenues from our major distribution or collaboration partners greater than 10% were as follows:

 

   

Three Months Ended March 31,

 

Major distribution or collaboration partner

 

2019

   

2018

 

Distributer A

    26

%

    21

%

Distributer B

    14

%

    27

%

Distributer C

    17

%

    25

%

 

As of March 31, 2019 and December 31, 2018, accounts receivable from our major distribution partners greater than 10% were as follows:

 

   

March 31,

   

December 31,

 

Major distribution or collaboration partner

 

2019

   

2018

 

Distributer A

    41 %     32 %

Distributer B

    33 %     23 %

Distributer C

    13 %     31 %

 

The Company relies on two contract sole source manufacturers to produce its finished goods. The Company does not have any manufacturing facilities and intends to continue to rely on third parties for the supply of finished goods. Third party manufacturers may not be able to meet the Company’s needs with respect to timing, quantity or quality.

  

Fair Value of Financial Assets and Liabilities

 

The Company’s financial instruments include cash and cash equivalents, accounts receivable, accounts payable and accrued liabilities, related party notes payable, convertible note, and warrants. The fair value of cash and cash equivalents, accounts receivable, accounts payable and accrued liabilities, and related party notes payable is carried at cost, which management believes approximates fair value due to the short-term nature of these instruments.

 

The convertible note issued in March 2019 (the “Convertible Note”) is carried at cost, which management believes approximates fair value. The warrant liability is carried at fair value. Additionally, the derivate liability related to certain embedded features contained within the Convertible Note is carried at fair value.

 

The Company follows Accounting Standards Codification (“ASC”) 820, Fair Value Measurements and Disclosures , with respect to assets and liabilities that are measured at fair value on a recurring basis and nonrecurring basis. Under this standard, fair value is defined as the exit price, or the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants as of the measurement date. The standard also establishes a hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used when available. Observable inputs are inputs market participants would use in valuing the asset or liability developed based on market data obtained from sources independent of the Company. Unobservable inputs are inputs that reflect the Company’s assumptions about the factors market participants would use in valuing the asset or liability developed based upon the best information available in the circumstances. There are 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; and

Level 3 – inputs that are unobservable (for example, cash flow modeling inputs based on assumptions).

 

Categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement.

 

Allowance for Doubtful Accounts

 

The Company charges bad debt expense and records an allowance for doubtful accounts when management believes it to be unlikely that specific invoices will be collected. Management identifies amounts due that are in dispute and it believes are unlikely to be collected. As of March 31, 2019 and December 31, 2018, management reserved $24 thousand and $10 thousand, respectively, primarily based on specific amounts that were in dispute or were over 120 days past due.

 

7

 

 

Inventory

 

Inventory is comprised of (1) raw materials and supplies, such as bottles, packaging materials, labels, boxes and pumps; (2) goods in progress, which are normally unlabeled bottles; and (3) finished goods. We utilize contract manufacturers to produce our products and the cost associated with manufacturing is included in inventory. At March 31, 2019 and December 31, 2018, management had recorded an allowance for excess and obsolete inventory and lower of cost or estimated net realizable value adjustments of $110 thousand and $104 thousand, respectively.

 

Inventory is stated at the lower of cost or estimated net realizable value determined by the first-in, first-out method.

 

Property and Equipment

 

Property and equipment are stated at cost, less accumulated depreciation and amortization. Depreciation is calculated using the straight-line method over the estimated useful lives of the related assets of five to seven years for office and laboratory equipment, three years for computer equipment and software and seven years for furniture and fixtures. Leasehold improvements are depreciated over the shorter of seven years or the lease term.

 

The costs of normal maintenance, repairs, and minor replacements are charged to operations when incurred. 

 

Impairment of Long-Lived Assets and Operating Lease Right-of-Use Assets

 

The Company accounts for long-lived assets and operating lease right-of-use assets in accordance with ASC 360, Property, Plant and Equipment , which requires that companies consider whether events or changes in facts and circumstances, both internally and externally, may indicate that an impairment of long-lived assets held for use or right-of-use assets are present. Management periodically evaluates the carrying value of long-lived assets and right-of-use assets. Determination of recoverability is based on an estimate of undiscounted future cash flows resulting from the use of the asset and its eventual disposition. In the event that such cash flows are not expected to be sufficient to recover the carrying amount of the asset, the assets are written down to their estimated fair values and the loss is recognized in the statements of operations. During the first quarter of 2019, in connection with the restructuring of its U.S. sales force, the Company reviewed its fleet leases for impairment and recorded an impairment charge of $125 thousand. See Note 8, “Commitments and Contingencies” for further information regarding the impairment. There was no impairment charge during the three months ended March 31, 2018.

 

Leases

 

In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842) , to enhance the transparency and comparability of financial reporting related to leasing arrangements. The Company adopted the standard effective January 1, 2019. Using the optional transition method, prior period financial statements have not been recast to reflect the new lease standard.

 

At the inception of an arrangement, the Company determines whether the arrangement is or contains a lease based on the unique facts and circumstances present. Operating lease liabilities and their corresponding right-of-use assets are recorded based on the present value of lease payments over the expected lease term. The interest rate implicit in lease contracts is typically not readily determinable. As such, the Company utilizes its incremental borrowing rate, which is the rate incurred to borrow on a collateralized basis over a similar term an amount equal to the lease payments in a similar economic environment. Certain adjustments to the right-of-use asset may be required for items such as initial direct costs paid or incentives received.

 

The Company has elected to combine lease and non-lease components as a single component for all leases in which it is a lessee or a lessor. The lease expense is recognized over the expected term on a straight-line basis. Operating leases are recognized on the balance sheet as right-of-use assets, operating lease liabilities current and operating lease liabilities non-current. As a result, as of the effective date, the Company no longer recognizes deferred rent on the balance sheet.

 

Comprehensive Income (Loss)

 

ASC 220 , Comprehensive Income , requires that an entity’s change in equity or net assets during a period from transactions and other events from non-owner sources be reported. The Company reports unrealized gains and losses on its available-for-sale securities as other comprehensive income (loss).

 

Revenue Recognition

 

The Company generates product revenue through product sales to its major distribution partners, a limited number of distributors and via its webstore. Product supply is the only performance obligation contained in these arrangements, and the Company recognizes product revenue upon transfer of control to its major distribution partners at the amount of consideration that the Company expects to be entitled to, generally upon shipment to the distributer on a “sell-in” basis.

 

8

 

 

Other revenue is primarily generated through commercial partner agreements with strategic partners for the development and commercialization of the Company’s product candidates. The terms of the agreements typically include more than one performance obligation and generally contain non-refundable upfront fees, payments based upon achievement of certain milestones and royalties on net product sales.

 

In determining the appropriate amount of revenue to be recognized as it fulfills its obligations under its agreements, the Company performs the following steps: (i) identification of the promised goods or services in the contract; (ii) determination of whether the promised goods or services are performance obligations including whether they are distinct in the context of the contract; (iii) measurement of the transaction price, including the constraint on variable consideration; (iv) allocation of the transaction price to the performance obligations based on estimated selling prices; and (v) recognition of revenue when (or as) the Company satisfies each performance obligation.

 

Performance Obligations

 

A performance obligation is a promise in a contract to transfer a distinct good or service to the customer and is the unit of account in ASC Topic 606. The Company’s performance obligations include:

 

 

Product supply

 

Exclusive distribution rights in the product territory

 

Regulatory submission and approval services

 

Development services

 

Sample supply, free of charge

 

Incremental discounts and product supply prepayments considered material rights to the customer

 

The Company has optional additional items in contracts, which are considered marketing offers and are accounted for as separate contracts when the customer elects such options. Arrangements that include a promise for future commercial product supply and optional research and development services at the customer’s or the Company’s discretion are generally considered as options. The Company assesses if these options provide a material right to the licensee and if so, such material rights are accounted for as separate performance obligations.

 

Transaction Price

 

The Company has both fixed and variable consideration. Under the Company’s license arrangements, non-refundable upfront fees and product supply selling prices are considered fixed, while milestone payments are identified as variable consideration when determining the transaction price. Funding of research and development activities is considered variable until such costs are reimbursed at which point they are considered fixed. The Company allocates the total transaction price to each performance obligation based on the relative estimated standalone selling prices of the promised goods or services for each performance obligation.

 

For product supply under the Company’s distribution arrangements, contract liabilities are recorded for invoiced amounts that are subject to significant reversal, including product revenue allowances for cash consideration paid to customers for services, discounts, rebate programs, chargebacks, and product returns. Because the Company does not have sufficient historical data to compute its own return rate, the return rate used to estimate the constraint on variable consideration for product returns is based on an average of peer and competitor company historical return rates. The Company updates the return rate assumption quarterly and applies it to the inventory balance that is held at the distributer and has not yet been sold through to the end customer. Payment for product supply is typically due 30 days after control transfers to the customer. At any point in time there is generally one month of inventory in the sales channel, therefore uncertainty surrounding constraints on variable consideration is generally resolved one month from when control is transferred.

 

At the inception of each arrangement that includes milestone payments, the Company evaluates whether the milestones are considered probable of being achieved and estimates the amount to be included in the transaction price using the most likely amount method. If it is probable that a significant revenue reversal would not occur, the value of the associated milestone (such as a regulatory submission by the Company) is included in the transaction price. Milestone payments that are not within the control of the Company, such as approvals from regulators, are not considered probable of being achieved until those approvals are received.

 

For arrangements that include sales-based royalties and the license is deemed to be the predominant item to which the royalties relate, the Company recognizes revenue at the later of (a) when the related sales occur, or (b) when the performance obligation to which some or all of the royalty has been allocated has been satisfied (or partially satisfied).

 

9

 

 

Allocation of Consideration

 

As part of the accounting for arrangements that contain multiple performance obligations, the Company must develop assumptions that require judgment to determine the stand-alone selling price of each performance obligation identified in the contract. When a contract contains more than one performance obligation, the Company uses key assumptions to determine the stand-alone selling price of each performance obligation. The estimated stand-alone selling prices for distribution rights and material rights for incremental discounts on product supply are calculated using an income approach discounted cash flow model and can include the following key assumptions: forecasted commercial partner sales, product life cycle estimates, costs of product sales, commercialization expenses, annual growth rates and margins, discount rates and probabilities of technical and regulatory success. For all other performance obligations, the Company uses a cost-plus margin approach. The Company allocates the total transaction price to each performance obligation based on the estimated relative stand-alone selling prices of the promised goods or services underlying each performance obligation.

 

Timing of Recognition

 

Significant management judgment is required to determine the level of effort required under an arrangement and the period over which the Company expects to complete its performance obligations under the arrangement. If the Company cannot reasonably estimate when its performance obligations either are completed or become inconsequential, then revenue recognition is deferred until the Company can reasonably make such estimates. Revenue is then recognized over the remaining estimated period of performance using the cumulative catch-up method. Revenue is recognized for products at a point in time and for licenses of functional intellectual property at the point in time the customer can use and benefit from the license. For performance obligations that are services, revenue is recognized over time proportionate to the costs that the Company has incurred to perform the services using the cost-to-cost input method.

 

The Company’s intellectual property in the form of distribution rights are determined to be distinct from the other performance obligations identified in the arrangements and considered “right to use” licenses which the customer can benefit from at a point in time. The Company recognizes revenues from non-refundable, up-front fees allocated to the license when the license is transferred to the customer, and the customer can use and benefit from the license. 

 

Cost of Goods Sold

 

Cost of goods sold includes third party manufacturing costs, shipping costs, and other costs of goods sold. Cost of goods sold also includes any necessary allowance for excess and obsolete inventory along with lower of cost and estimated net realizable value.

  

Research and Development Costs

 

The Company charges research and development costs to expense as incurred. These costs include salaries and benefits for research and development personnel, costs associated with clinical trials managed by contract research organizations, and other costs associated with research, development and regulatory activities. Research and development costs may vary depending on the type of item or service incurred, location of performance or production, level of availability of the item or service, and specificity required in production for certain compounds. The Company uses external service providers to conduct clinical trials, to manufacture supplies of product candidates and to provide various other research and development-related products and services. The Company’s research, clinical and development activities are often performed under agreements it enters into with external service providers. The Company estimates and accrues the costs incurred under these agreements based on factors such as milestones achieved, patient enrollment, estimates of work performed, and historical data for similar arrangements. As actual costs are incurred, the Company adjusts its accruals. Historically, the Company’s accruals have been consistent with management’s estimates and no material adjustments to research and development expenses have been recognized. Subsequent changes in estimates may result in a material change in the Company’s expenses, which could also materially affect its results of operations. 

 

Patent Costs

 

Patent costs, including legal expenses, are expensed in the period in which they are incurred. Patent expenses are included in general and administrative expenses in the consolidated statements of operations and comprehensive loss.

 

Stock-Based Compensation

 

The Company’s stock-based compensation includes grants of stock options and restricted stock units, or RSUs, to employees, consultants and non-employee directors. The expense associated with these programs is recognized in the Company’s consolidated statements of stockholders’ equity based on their fair values as they are earned under the applicable vesting terms or the length of an offering period. For stock options granted, the fair value of the stock options is estimated using a Black-Scholes-Merton option pricing model. See Note 13 for further information regarding stock-based compensation expense and the assumptions used in estimating that expense. The Company accounts for restricted stock unit awards issued to employees and non-employees (consultants and advisory board members) based on the fair market value of the Company’s common stock as of the date of issuance.

 

Income Taxes

 

The Company accounts for income taxes under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance is recognized if it is more likely than not that some portion or the entire deferred tax asset will not be recognized. 

 

10

 

 

Common Stock Warrant Liability

 

For warrants that are newly issued or modified and there is a deemed possibility that the Company may have to settle them in cash, the Company records the fair value of the issued or modified warrants as a liability at each balance sheet date and records changes in the estimated fair value as a non-cash gain or loss in the consolidated statements of operations and comprehensive loss. The fair values of these warrants have been determined using the Binomial Lattice (“Lattice”) valuation model. The Lattice valuation model provides for assumptions regarding volatility, call and put features and risk-free interest rates within the total period to maturity. These values are subject to a significant degree of our judgment.

 

On January 1, 2019, the Company adopted ASU 2017-11, “ Earnings Per Share (Topic 260), Distinguishing Liabilities from Equity (Topic 480) and Derivatives and Hedging (Topic 815): I. Accounting for Certain Financial Instruments with Down Round Features; II. Replacement of the Indefinite Deferral for Mandatorily Redeemable Financial Instruments of Certain Nonpublic Entities and Certain Mandatorily Redeemable Noncontrolling Interests with a Scope Exception ” on a modified retrospective basis. ASU 2017-11 changes the classification analysis of certain equity-linked financial instruments with down round features. When determining whether certain financial instruments should be classified as liabilities or equity instruments, securities with anti-dilution features no longer preclude equity classification when assessing whether the instrument is indexed to an entity’s own stock. As a result, freestanding equity-linked financial instruments (or embedded conversion features) would no longer be accounted for as liabilities at fair value because of the existence of an anti-dilution feature. Upon adoption of ASU 2017-11, the Company changed its method of accounting for warrants by reclassing warrant liabilities related to outstanding warrants that have a down round feature to additional paid in capital on its March 31, 2019 consolidated balance sheets, which increased additional paid-in capital by $56 thousand and decreased warrant liability by $56 thousand. In addition, because of the modified retrospective adoption, the Company recorded a cumulative-effect adjustment of $356 thousand to the Company’s beginning accumulated deficit as of January 1, 2019, with an offset that increased additional paid-in capital by $356 thousand (see Note 11).

 

Net (Loss) per Share

 

The Company computes net (loss) per share by presenting both basic and diluted (loss) per share (“EPS”).

 

Basic EPS is computed by dividing net (loss) available to common shareholders by the weighted average number of common shares outstanding during the period. Diluted EPS gives effect to all dilutive potential common shares outstanding during the period, including stock options and warrants, using the treasury stock method, using the if-converted method. In computing diluted EPS, the average stock price for the period is used in determining the number of shares assumed to be purchased from the exercise of stock options or warrants. Potentially dilutive common share equivalents are excluded from the diluted EPS computation in net loss periods since their effect would be anti-dilutive.

 

During the three months ended March 31, 2019, there was no difference between basic and diluted EPS due to the Company’s net loss. During the three months ended March 31, 2018, the basic EPS was a net loss of $0.13 per share and the diluted EPS was a net loss of $0.14 per share due to the gain on changes in fair value of warrant liability.

 

11

 

 

The following table sets forth the calculation of basic EPS and diluted EPS:  

 

(in thousands except per share)

 

 

Three Months Ended March 31,

 

Numerator

 

2019

   

2018

 

Net loss

  $ (4,189 )   $ (2,150 )

Less gain on changes in fair value of warrant liability

          (214 )

Net loss, diluted

  $ (4,189 )   $ (2,364 )
                 

Denominator

               

Weighted average shares outstanding, basic

    17,093       16,406  

Net loss per share, basic

  $ (0.25 )   $ (0.13 )
                 

Weighted average shares outstanding, basic

    17,093       16,406  

Effect of dilutive warrants

          264  

Weighted average shares outstanding, diluted

    17,093       16,670  

Net loss per share, diluted

  $ (0.25 )   $ (0.14 )

 

The following outstanding stock options and stock warrants were excluded from the diluted net loss per share computation, as their effect would have been anti-dilutive:   

 

   

As of March 31,

 

(in thousands)

 

2019

   

2018

 

Period end stock options to purchase common stock

    2,389       2,433  

Period end common stock warrants

    544        
      2,933       2,433  

 

Recent Accounting Pronouncements

 

SEC Disclosure Regulation Simplifications

During the fourth quarter of 2018, the SEC published Final Rule Release No. 33-10532, “Disclosure Update and Simplification.” This standard, effective for quarterly and annual reports submitted after November 5, 2018, streamlines disclosure requirements by removing certain redundant topics. For the Company, the most notable simplification implemented in 2019 is the expansion of the shareholders’ equity reconciliation to display quarter-to-quarter details.

 

Leases

In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842) , which replaces the existing guidance for leases. The new standard establishes a right-of-use (ROU) model that requires a lessee to record a ROU asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Disclosure requirements have been enhanced with the objective of enabling financial statement users to assess the amount, timing, and uncertainty of cash flows arising from leases. ASU 2016-02 became effective for the Company beginning in the first quarter of 2019. The Company has implemented the standard using an optional transition method that allows the Company to initially apply the new leases standard as of the adoption date and recognize a cumulative-effect adjustment to the opening balance of accumulated deficit, if applicable, in the period of adoption. In connection with the adoption, the Company has elected to utilize the package of practical expedients, including: (1) not reassess the lease classification for any expired or existing leases, (2) not reassess the treatment of initial direct costs as they related to existing leases, and (3) not reassess whether expired or existing contracts are or contain leases. The Company also elected the practical expedient to not separate lease and non-lease components of its operating leases in which it is the lessee.

 

12

 

 

The adoption of the new leases standard resulted in the following adjustments to the consolidated balance sheet as of January 1, 2019 (in thousands):

 

Prepaid expenses and other current assets (a)

  $ (49 )

Operating lease right-of-use assets

    2,239  

Other assets (b)

    (2 )

Other accrued liabilities (c)

    (101 )

Operating lease liability

    1,063  

Deferred rent

    (184 )

Operating lease liability - non-current

    1,410  

 

 

(a)

Represents current portion of prepaid fleet leasing costs reclassified to Operating lease right-of-use assets .

 

(b)

Represents noncurrent portion of prepaid fleet leasing costs reclassified to Operating lease right-of-use assets.

 

(c)

Represents current portion of deferred rent and lease incentive liability reclassified to Operating lease liability.

 

The adoption of the new leases standard did not impact previously reported financial results because the Company applied the optional transition method and therefore all adjustments were reflected as of January 1, 2019, the date of adoption.

 

In July 2017, the FASB issued ASU 2017-11, Earnings Per Share (Topic 260 ), Distinguishing Liabilities from Equity (Topic 480 ), Derivatives and Hedging (Topic 815 ): I. Accounting for Certain Financial Instruments with Down Round Features and II. Replacement of the Indefinite Deferral for Mandatorily Redeemable Financial Instruments of Certain Nonpublic Entities and Certain Mandatorily Redeemable Noncontrolling Interests with a Scope Exception. Part I applies to entities that issue financial instruments such as warrants, convertible debt or convertible preferred stock that contain down round features. Part II simply replaces the indefinite deferral for certain mandatorily redeemable noncontrolling interests and mandatorily redeemable financial instruments of nonpublic entities contained within ASC Topic 480 with a scope exception and does not impact the accounting for these mandatorily redeemable instruments. This ASU is effective for public companies for the annual reporting periods beginning after December 15, 2018, and interim periods within those annual periods. The Company adopted ASU 2017-11 on a modified retrospective basis effective January 1, 2019. Upon adoption of ASU 2017-11, the Company changed its method of accounting for warrants by reclassing warrant liabilities related to outstanding warrants that have a down round feature to additional paid in capital on its March 31, 2019 consolidated balance sheets, and recorded a cumulative-effect adjustment to the Company’s beginning accumulated deficit as of January 1, 2019 (see Note 11).

 

In June 2018, the FASB issued ASU 2018-07,  Compensation—Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting . The ASU aligns the measurement and classification guidance for share-based payments to nonemployees with the guidance for share-based payments to employees, with certain exceptions. Under the new standard, equity-classified share-based payment awards issued to nonemployees will be measured on the grant date, instead of the current requirement to remeasure the awards through the performance completion date. The Company adopted ASU 2018-07 effective January 1, 2019, and this guidance had an approximately $2 thousand impact on the Company’s financial statements.

 

In August 2018, the FASB issued ASU 2018-13,  Fair Value Measurement (Topic 820): Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement . This amendment modifies the disclosure requirements on fair value measurements. The guidance is effective for fiscal years ending after December 15, 2019, and interim periods within those fiscal years. Early adoption is permitted. The Company does not expect the adoption to have a material impact on the Company's financial position, results of operations or cash flows.

 

 

 

NOTE 3. FAIR VALUE MEASUREMENTS

 

The Company follows ASC 820, Fair Value Measurements and Disclosures , with respect to assets and liabilities that are measured at fair value on a recurring basis and nonrecurring basis. Under this standard, fair value is defined as the exit price, or the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants as of the measurement date. 

 

The Company's cash equivalents and investments are classified within Level 1 or Level 2 of the fair value hierarchy because they are valued using quoted market prices in active markets, broker or dealer quotations, or alternative pricing sources with reasonable levels of price transparency. The types of investments that are generally classified within Level 1 of the fair value hierarchy include money market securities and certificates of deposit. The types of investments that are generally classified within Level 2 of the fair value hierarchy include corporate securities and U.S. government securities.

 

13

 

 

The Company's warrant liability is classified within Level 3 of the fair value hierarchy because the value is calculated using significant judgment based on the Company’s own assumptions in the valuation of this liability. The Company determined the fair value of the warrant liability using the Lattice valuation model. See Note 11, “Warrant Liability” for further discussion of the calculation of the fair value of the warrant liability.

 

As a result of the call option and the put feature within the Convertible Note entered into in March 2019, the Company recorded a derivative liability on its consolidated balance sheet with a corresponding debt discount which is netted against the face value of the Convertible Note. The fair value of embedded derivative liability is classified within Level 3 of the fair value hierarchy because the value is calculated using significant judgment based on the Company’s own assumptions in the valuation of this liability. The Company determined the fair value of the embedded derivative liability using the Monte Carlo simulation model. See Note 10, “Convertible Note” for further discussion of the calculation of the fair value of the embedded derivative liability.

 

The following table presents the Company’s assets and liabilities measured at fair value on a recurring basis as of March 31, 2019:

 

           

Fair Value Measurements Using

 
(in thousands)  

Balance at

March 31,

2019

   

Quoted

Prices in 

Active

Markets 

for Identical 

Items 

(Level 1)

   

Significant

Other

Observable

Inputs

(Level 2)

   

Significant Unobservable Inputs

(Level 3)

 

Assets

                               

Cash equivalents

  $ 103     $ 103     $     $  

Restricted cash held as a certificate of deposit

    324       324              

Deposit held as a certificate of deposit

    151       151              

Total assets

  $ 578     $ 578     $     $  
                                 

Liabilities

                               

Warrant liability

  $ 179     $     $     $ 179  

Derivative liability

    427                   427  

Total liabilities

  $ 606     $     $     $ 606  

 

14

 

 

The following table presents the Company’s assets and liabilities measured at fair value on a recurring basis as of December 31, 2018:

 

           

Fair Value Measurements Using

 
(in thousands)  

Balance at December 31,

2018

   

Quoted

Prices in

Active

Markets

for Identical

Items

(Level 1)

   

Significant

Other

Observable

Inputs

(Level 2)

   

Significant Unobservable Inputs

(Level 3)

 

Assets

                               

Cash equivalents

  $ 103     $ 103     $     $  

Restricted cash held as a certificate of deposit

    324       324              

Deposit held as a certificate of deposit

    151       151              

Total assets

  $ 578     $ 578     $     $  
                                 

Liabilities

                               

Warrant liability

  $ 178     $     $     $ 178  

Total liabilities

  $ 178     $     $     $ 178  

 

Upon adoption of ASU 2017-11, the Company reclassified 210,586 warrants from warrant liabilities to equity and is no longer required to record the change in fair values for these instruments. 334,109 warrants continued to be classified as a liability, for which the Company recorded a non-cash loss of $57 thousand for the three-month period ended March 31, 2019, on a decrease in the fair value of the warrants. See Note 11, “Warranty Liability” for further discussion of the calculation of the fair value of the warrant liability.

 

 

The following is a reconciliation of the beginning and ending balances for the liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) during the three months ended March 31, 2019:

 

   

Level 3

 
(in thousands)  

liabilities

 

Balance at December 31, 2018

  $ 178  

Fair value of warrant liability reclass to equity-Adoption of ASU 2017-11

    (56 )

Increase in fair value of warrant liability at March 31, 2019

    57  
Embedded derivative liability associated with the convertible note     427  

Fair value of warrant liability and embedded derivative liability at March 31, 2019

  $ 606  

 

15

 

 

 

 

NOTE 4. PREPAID EXPENSES AND OTHER CURRENT ASSETS

 

Prepaid expenses and other current assets consisted of the following:

 

 

 

March 31,

   

December 31,

 
(in thousands)  

2019

   

2018

 

Prepaid sales rebates

  $ 803     $ 925  

Rent receivable

    80       108  

Prepaid rent

          130  

Prepaid employees’ benefits

    8       113  

Prepaid dues and subscription

    129       130  

Inventory deposits

    83        

Other

    348       354  

Total prepaid expenses and other current assets

  $ 1,451     $ 1,760  

 

 

N OTE 5. INVENTORY    

 

Inventory consisted of the following:

 

   

March 31,

   

December 31,

 
(in thousands)  

2019

   

2018

 

Raw materials and supplies

  $ 188     $ 217  

Finished goods

    224       167  

Less: Reserve for excess and obsolete inventory

    (110 )     (104 )

Total inventory, net

  $ 302     $ 280  

 

16

 
 

 

 

NOTE 6. PROPERTY AND EQUIPMENT

 

Property and equipment consisted of the following:

 

   

March 31,

   

December 31,

 
(in thousands)  

2019

   

2018

 

Office and laboratory equipment

  $ 24     $ 24  

Furniture and fixtures

    157       157  

Computer equipment and software

    394       385  

Production equipment

    65       65  

Leasehold improvements

    79       79  

Total property and equipment, at cost

    719       710  

Less: accumulated depreciation and amortization

    (526 )     (509 )

Total property and equipment, net

  $ 193     $ 201  

 

Depreciation and amortization expense was $17 thousand and $41 thousand for the three months ended March 31, 2019 and 2018, respectively.

 

 

 

NOTE 7. ACCRUED LIABILITIES

 

Accrued liabilities consisted of the following:

 

   

March 31,

   

December 31,

 
(in thousands)  

2019

   

2018

 

Employee payroll and benefits

  $ 630     $ 708  

Severance

    124        

Avenova contract liabilities

    1,816       2,282  

Deferred rent

          101  

Other

    290       164  

Total accrued liabilities

  $ 2,860     $ 3,255  

 

 

 

NOTE 8 . COMMITMENTS AND CONTINGENCIES  

 

Directors and Officers Indemnification

 

As permitted under Delaware law and in accordance with its bylaws, the Company indemnifies its officers and directors for certain events or occurrences while the officer or director is or was serving at the Company’s request in such capacity. The term of the indemnification period is for the officer’s or director’s lifetime. The maximum amount of potential future indemnification is unlimited; however, the Company has a director and officer insurance policy that limits its exposure and may enable it to recover a portion of any future payments. The Company believes the fair value of these indemnification agreements is minimal. Accordingly, it has not recorded any liabilities for these agreements as of March 31, 2019. 

 

In the normal course of business, the Company provides indemnification of varying scope under its agreements with other companies, typically its clinical research organizations, investigators, clinical sites, suppliers and others. Pursuant to these agreements, it generally indemnifies, holds harmless, and agrees to reimburse the indemnified parties for losses suffered or incurred by the indemnified parties in connection with use or testing of its products or product candidates or with any U.S. patent or any copyright or other intellectual property infringement claims by any third party with respect to its products. The term of these indemnification agreements is generally perpetual. The potential future payments the Company could be required to make under these indemnification agreements is unlimited. Historically, costs related to these indemnification provisions have been immaterial. The Company also maintains various liability insurance policies that limit its exposure. As a result, it believes the fair value of these indemnification agreements is minimal. Accordingly, the Company has not recorded any liabilities for these agreements as of March 31, 2019.

   

17

 

 

Legal Matters

 

From time to time, the Company may be involved in various legal proceedings arising in the ordinary course of business. There are no matters as of March 31, 2019, that, in the opinion of management, would ultimately result in liability that would have a material adverse effect on the Company’s financial position, results of operations or cash flows.

 

Leases

 

The Company leases office space for its corporate headquarters, located in Emeryville, CA (“Office Lease”). The initial lease term is through February 28, 2022. The Company has the option to extend the term of the lease for one five (5)-year period upon written notice to the landlord. The Company intends to exercise the renewal option for this lease. The Company also has a lease commitment for laboratory facilities and office space at EmeryStation North in Emeryville, CA (“EmeryStation”) under an operating lease that will expire on October 31, 2020. There are no stated renewal terms. Per the terms of the agreements, the Company does not have any residual value guarantees.

 

In July 2016, the Company subleased all rentable square feet of real property at EmeryStation (“Sublease Agreement”). The Sublease Agreement commenced September 8, 2016. The Sublease Agreement will terminate on October 21, 2020 and there are no stated renewal terms. Per the terms of the agreement, the sublessee does not have any residual value guarantees.

 

In addition to the facility leases, the Company has leased 54 vehicles under a master fleet lease agreement. Each lease is for a period of 36 months, which commenced upon the delivery of the vehicle during the first quarter of 2017. During the first quarter of 2019, in connection with the restructuring of its U.S. sales force, the Company reviewed its fleet leases for impairment. The Company estimated fair value based on the lowest level of identifiable estimated future cash flows and recorded an impairment charge of $125 thousand, which is included in the Sales and Marketing expenses line item within the Operating Expenses in the Consolidated Statements of Operations and Comprehensive Loss.

 

Additionally, the Company has an operating lease for 2 copiers which will expire in August 2019. The monthly lease payment for the copiers is not material.

 

In calculating the present value of the lease payments, the Company has elected to utilize its incremental borrowing rate based on the original lease term and not the remaining lease term. The Company has elected to account for each lease component and its associated non-lease components as a single lease component, and has allocated all of the contract consideration across lease components only. This will potentially result in the initial and subsequent measurement of the balances of the right-of-use asset and lease liability for leases being greater than if the policy election was not applied. The leases include variable components (i.e. common area maintenance, excess mileage charges, etc.) that are paid separately from the monthly base payment based on actual costs incurred and therefore were not included in the right-of-use asset and liability, but are reflected as an expense in the period incurred.

 

The components of lease expense for the three months ended March 31, 2019 were as follows (in thousands except lease term and discount rate):

 

Lease Costs

       
         

Operating lease cost

  $ 312  

Sublease income

    (158 )

Net lease cost

  $ 154  
         

Other information

       

Operational cash flow used for operating leases

  $ 324  

Weighted-average remaining lease term (in years)

    2.2  

Weighted-average discount rate

    12 %

 

18

 

 

Future lease payments under non-cancelable leases as of March 31, 2019 were as follows (in thousands):

 

Remaining in 2019

  $ 970  

2020

    1,046  

2021

    438  

2022

    75  

Thereafter

     

Total future minimum lease payments

    2,529  

Less imputed interest

    (313 )

Total

  $ 2,216  
         

Reported as:

       

Operating lease liability

  $ 1,073  

Operating lease liability- non-current

    1,143  

Total

  $ 2,216  

 

Future lease payments to be received under non-cancelable leases as of March 31, 2019 were as follows (in thousands):

 

Remaining in 2019

  $ 566  

2020

    577  

2021

     

2022

     

Thereafter

     

Total future minimum lease payments

  $ 1,143  

 

 

 

NOTE 9. RELATED PARTY NOTES PAYABLE

 

On February 27, 2019, the Company issued a $1.0 million promissory note (the “Promissory Note”) payable to Pioneer Pharma (Hong Kong) Company Ltd. (“Pioneer Hong Kong”). The Note bears an interest payment of $150 thousand and is payable in full upon the Company's next financing with Pioneer Hong Kong and in no event after July 27, 2019. The transaction was facilitated by China Kington Asset Management Co. Ltd. (“China Kington”) which has a perfected security interest in all tangible and intangible assets of the Company. In connection with the Promissory Note, the Company must pay China Kington a 2% fee for brokering the transaction and enter into a consulting agreement with China Kington for the term of one year. Bob Wu, acting in a dual role as a member of the Company’s Board of Directors and as principal of China Kington, will be paid $100 thousand pursuant to this consulting agreement. Debt issuance costs associated with the issuance of the Promissory Note of $20 thousand is recognized and recorded as an offset to the related party notes payable in the Consolidated Balance Sheet. The debt issuance cost is being amortized to interest expense using the effective interest rate method over the term of the Promissory Note, assuming that the Promissory Note will be fully paid on July 27, 2019. The interest expense recognized, including amortization of the issuance costs, was $39 thousand during the three months ended March 31, 2019.

 

19

 

 

The Promissory Note is presented as follows as of March 31, 2019:

 

(in thousands)

       

Principle amount

  $ 1,000  

Unamortized debt issuance costs

    (15 )

Accrued interst

    34  

Total debt

    1,019  

Less: short-term

    (1,019 )

Long-term

  $  

 

 

NOTE 10. CONVERTIBLE NOTE

 

On March 26, 2019 (the “Closing Date”), the Company entered into a Securities Purchase Agreement (the “Purchase Agreement”) with Iliad Research and Trading, L.P. (the “Lender”), pursuant to which the Company issued a Secured Convertible Promissory Note (the “Convertible Note”) to the Lender dated as of the Closing Date. The Convertible Note has an original principal amount of $2,215,000, bears interest at a rate of 10% per annum and will mature on September 26, 2020, unless earlier paid, redeemed or converted in accordance with its terms. The Company received net proceeds of $2.0 million after deducting an original issue discount of $200 thousand and debt issuance cost of Lender’s transaction fees of $15 thousand. The Company recognized additional $182 thousand of debt issuance costs associated with the issuance of the Convertible Note, which had not been paid as of March 31, 2019.

 

The Convertible Note provides the Lender with the right to convert, at any time, all or any part of the outstanding principal and accrued but unpaid interest into unregistered shares of the Company’s common stock at a conversion price of $1.65 per share. Beginning on September 26, 2019, the Convertible Note also provides the Lender with the right to redeem all or any portion of the Convertible Note (“Redemption Amount”) up to $200 thousand per calendar month. The payments of each Redemption Amount may be made, at the option of the Company, in cash, by converting such Redemption Amount into unregistered shares of Common Stock (“Redemption Conversion Shares”), or a combination thereof. The number of Redemption Conversion Shares equals the portion of the applicable Redemption Amount being converted divided by the lesser of $1.65 or the Market Price. The Market Price is defined as 85% of the lowest closing bid price during the 20 Trading Days immediately preceding the applicable measurement date. In addition, the Company may redeem the Convertible Note at its option at any time at a redemption price equal to 115% of the aggregate outstanding balance of principal and interest.

 

The Company has reserved 3,200,000 shares of its authorized and unissued common stock to provide for all issuances of common stock under the Convertible Note.

 

Pursuant to a Security Agreement between the Company and the Lender, repayment of the Convertible Note is secured by all of the assets of the Company. The assets covered by the Security Agreement are currently encumbered by that certain lien of up to $1.0 million, plus accrued and unpaid interest and fees, in favor of Pioneer Hong Kong described above.

 

The Convertible Note contains events of default upon the occurrence and during the continuance of which all obligations may be declared immediately due and payable. Under certain events of default, the outstanding balance of principal and interest shall be automatically due and payable in cash. Upon other events of default, the Lender, at its option, can elect to increase the outstanding balance by up to 15%, depending on the magnitude of the default, without accelerating the outstanding balance.

 

The Company’s prepayment terms represent an embedded call option, the Lender’s share redemption terms represent an embedded put option and certain events of default also represent embedded derivatives, each of which require bifurcation. A single derivative comprising all bifurcatable features was measured at fair value using a Monte Carlo simulation. The key assumptions used to value the combined embedded derivative as of March 26, 2019 were as follows:

 

 

   

As of

 

Assumption

 

March 26, 2019

 

Stock price (latest bid price)

  $ 1.28  

Equity volatility

    93.8

%

Risk-free interest rate

    2.34

%

Remaining term

    1.5  

 

The fair value of the combined embedded derivative was $427 thousand as of March 26, 2019 and is subject to remeasurement each reporting period, with changes recorded to other (expense) income, net in the Consolidated Statements of Operations and Comprehensive Loss. The Company believed that the change in the fair value of the combined embedded derivative was immaterial due to the short duration between the issuance date of March 26, 2019 and the quarter ended March 31, 2019.

 

The effective conversion rate of the debt, taking into consideration the original issue discount and the value of the combined embedded derivative, was lower than the fair value of the Company’s common stock as of the Closing Date, resulting in a beneficial conversion feature (“BCF”). The Company recorded the intrinsic value of the BCF of $184 thousand as a further discount to the Convertible Note and to Additional paid-in-capital on the Consolidated Balance Sheet.

 

20

 

 

The aggregate $811 thousand discount, including the original issue discount, embedded derivative and BCF, and the aggregate $197 thousand of debt issuance costs, including the Company’s issuance costs and payment for the Lender’s transaction fees, are classified as an offset to the Convertible Note on the Consolidated Balance Sheet. The Convertible Note is presented as follows as of March 31, 2019:

 

(in thousands)

       

Principle amount

  $ 2,215  

Unamortized discount

    (795 )

Unamortized debt issuance costs

    (193 )

Total debt

    1,227  

Less: short-term

     

Long-term

  $ 1,227  

 

The Convertible Note is classified as long-term based on the Company intent and ability to issue shares of its common stock upon early redemption by the Lender.

 

The discount and debt issuance costs are being amortized to interest expense using the effective interest rate method over the term of the Convertible Note, assuming that the Convertible Note will be redeemed at the maximum $200 thousand per month beginning in September 2019. During the three months ended March 31, 2019, the effective interest rate on the Convertible Note was 64% and interest expense recognized, including amortization of the debt discount and issuance costs, was $24 thousand.

 

As of March 31, 2019, the Company's contractual maturity of the principle balance of the Convertible Note was as follows:

 

(in thousands)

       

Remainder of 2019

  $  

2020

    2,215  

2021 and thereafter

     

Total

  $ 2,215  

 

 

 

NOTE 1 1 . WARRANT LIABILITY  

 

In July 2011, the Company sold common stock and warrants in a registered direct financing. As part of this transaction, 139,520 warrants were issued with an exercise price of $33.25 and were exercisable from January 1, 2012 to July 5, 2016. The terms of the warrants require registered shares to be delivered upon each warrant’s exercise and also require possible cash payments to the warrant holders (in lieu of the warrant’s exercise) upon specified fundamental transactions involving the Company’s common stock, such as an acquisition of the Company. Under ASC 480, Distinguishing Liabilities from Equity , the Company’s ability to deliver registered shares upon an exercise of the warrants and the Company’s potential obligation to cash-settle the warrants if specified fundamental transactions occur are deemed to be beyond the Company’s control. The warrants contain a provision according to which the warrant holder would have the option to receive cash, equal to the Black Scholes fair value of the remaining unexercised portion of the warrant, as cash settlement in the event that there is a fundamental transaction (contractually defined to include various merger, acquisition or stock transfer activities). Due to this provision, ASC 480 requires that these warrants be classified as liabilities. The fair values of these warrants have been determined using the Lattice valuation model, and the changes in the fair value are recorded in the consolidated statement of operations and comprehensive loss. The Lattice valuation model provides for assumptions regarding volatility and risk-free interest rates within the total period to maturity. In addition, after January 5, 2012, and if the closing bid price per share of the common stock in the principal market equals or exceeds $66.50 for any ten trading days (which do not have to be consecutive) in a period of fifteen consecutive trading days, the Company has the right to require the exercise of one-third of the warrants then held by the warrant holders.

 

21

 

 

In October 2015, the holders of all warrants issued pursuant to the Company’s securities purchase agreement dated March 3, 2015 (the “2015 Securities Purchase Agreement”) agreed to reduce the length of notice required to such investors prior to the Company’s issuance of new securities from twenty business days to two business days, for the remainder of such investors’ pre-emptive right period (which expired March 3, 2016). The Company entered into these agreements to enable it to expeditiously raise capital in the October 2015 Offering (as described below) and future offerings. As consideration for these agreements, the Company amended certain provisions of both the warrants with a 15-month term (the “Short-Term Warrants”) and warrants with a five-year term (the “Long-Term Warrants”) issued pursuant to the 2015 Securities Purchase Agreement (together, the “March 2015 Warrants”) and the warrants issued pursuant to the placement agent agreement dated June 29, 2011 (the “July 2011 Warrants”). Specifically, the amendments decreased the exercise price for both the March 2015 Warrants and the July 2011 Warrants to $5.00 per share. In addition, the amendments extended the exercise expiration date for the Short-Term Warrants and the July 2011 Warrants to March 6, 2020. A price protection provision also was added to both the July 2011 Warrants and March 2015 Warrants, such that if the Company subsequently sells or otherwise disposes of Company common stock at a lower price per share than $5.00 or any securities exchangeable for common stock with a lower exercise price than $5.00, the exercise price of such warrants will be reduced to that lower price.

 

In October 2015, the Company also entered into an underwriting agreement with Roth Capital Partners, LLC, relating to the public offering and sale of up to (i) 492,000 shares of the Company’s common stock; and (ii) warrants to purchase up to 442,802 shares of the Company’s common stock (the “October 2015 Warrants”) with an exercise price of $5.00 per share (the “October 2015 Offering”). The shares of common stock and warrants were issued separately. Each warrant was exercisable immediately upon issuance and will expire 60 months from the date of issuance. The price to the public in the October 2015 Offering was $5.00 per share of common stock and related warrant. The net proceeds to the Company were approximately $2.1 million after deducting underwriting discounts and commissions and offering expenses.

 

In February 2016, the strike price of the July 2011, March 2015 and October 2015 warrants was reduced to $1.81 per share, pursuant to the price protection provisions in such warrants, because the Company sold common stock to Mr. Jian Ping Fu at that price. 

 

The key assumptions used to value the July 2011 Warrants as of March 31, 2019 and December 31, 2018 were as follows:

 

   

As of

 
   

March 31,

   

December 31,

 

Assumption

 

2019

   

2018

 

Expected price volatility

    104

%

    77

%

Expected term (in years)

    0.93       1.18  

Risk-free interest rate

    2.41

%

    2.60

%

Dividend yield

    0.00

%

    0.00

%

Weighted-average fair value of warrants

  $ 0.45     $ 0.29  

 

In March 2015, the Company issued both the Short-Term Warrants ($15.00 per share exercise price) and the Long-Term Warrants ($16.25 per share exercise price). At that time, the Company determined that these warrants qualified for equity accounting and did not contain embedded derivatives that required bifurcation. After the Company’s agreement to modify the terms of the March 2015 Warrants and July 2011 Warrants in October 2015, the Company evaluated the change in terms of the March 2015 Warrants and noted that the change in terms resulted in liability classification of both the Short-Term and Long-Term Warrants. The March 2015 Warrants were re-issued and valued as of October 27, 2015 at a total of $1.8 million with the new terms, and a modification expense was recorded as the difference between the fair value of the warrants on their new terms after modification as of October 27, 2015 and the fair value of the warrants on their original terms prior to modification as of October 27, 2015. The fair values of these warrants were determined using the Lattice valuation model, and the changes in the fair value were recorded in the consolidated statement of operations and comprehensive loss.

 

As described in Note 2, upon adoption of ASU 2017-11, the Company determined that excluding the consideration of the down round provision, the Long-Term and Short-Term Warrants are considered to be indexed to the Company’s stock and should be classified in equity. The Company reclassed warrant liabilities related to the Long-Term and Short-Term warrants to additional paid in capital on its March 31, 2019 consolidated balance sheets, which increased additional paid-in capital by $56 thousand and decreased warrant liability by $56 thousand. In addition, because of the modified retrospective adoption, the Company recorded a cumulative-effect adjustment of $356 thousand to the Company's beginning accumulated deficit as of January 1, 2019, with an offset that increased additional paid-in capital by $356 thousand.

 

22

 

 

The key assumptions used to value the Short-Term Warrants as of December 31, 2018 were as follows:

 

   

As of

 
   

December 31,

 

Assumption

 

2018

 

Expected price volatility

    77

%

Expected term (in years)

    1.18  

Risk-free interest rate

    2.60

%

Dividend yield

    0.00

%

Weighted-average fair value of warrants

  $ 0.24  

 

The key assumptions used to value the Long-Term Warrants as of December 31, 2018 were as follows:

 

   

As of

 
   

December 31,

 

Assumption

 

2018

 

Expected price volatility

    77

%

Expected term (in years)

    1.18  

Risk-free interest rate

    2.60

%

Dividend yield

    0.00

%

Weighted-average fair value of warrants

  $ 0.29  

 

As noted above, the Company issued warrants in connection with the October 2015 Offering. The Company evaluated the terms of the October 2015 Warrants and noted that under ASC 480, the Company’s potential obligation to cash-settle the warrants if specified fundamental transactions occur are deemed to be beyond the Company’s control. Due to this provision, ASC 480 requires that these warrants be classified as liabilities. The fair values of these warrants have been determined using the Lattice valuation model, and the changes in the fair value are recorded in the consolidated statement of operations and comprehensive loss. The fair value of the warrants at issuance on October 27, 2015 was $1.3 million. 

 

The key assumptions used to value the October 2015 warrants as of March 31, 2019 and December 31, 2018 were as follows:

 

   

As of

 
   

March 31,

   

December 31,

 

Assumption

 

2019

   

2018

 

Expected price volatility

    93

%

    73

%

Expected term (in years)

    1.58       1.83  

Risk-free interest rate

    2.33

%

    2.51

%

Dividend yield

    0.00

%

    0.00

%

Weighted-average fair value of warrants

  $ 0.55     $ 0.38  

 

During the third quarter of 2016, a total of 3,613,284 warrants to purchase 3,613,284 shares of common stock were exercised related to warrants issued during July 2011, March 2015 and October 2015, resulting in gross proceeds of $6.9 million. Upon exercise, the warrant liability associated with these warrants was adjusted to its fair value as of the date of exercise of $1.6 million, with any change in fair value recorded in the consolidated statement of operations and comprehensive loss. The $1.6 million fair value was subsequently transferred to equity as of the date of exercise.

  

During the fourth quarter of 2016, a total of 363,523 warrants to purchase 363,523 shares of common stock were exercised related to the October 2011, November 2015 and December 2015 warrants resulting in gross proceeds of $0.9 million. Upon exercise, the warrant liability associated with these warrants was adjusted to its fair value as of the date of exercise of $0.5 million, with any change in fair value recorded in the consolidated income statement and comprehensive loss. The $0.5 million fair value was subsequently transferred to equity as of the date of exercise.

 

During the second quarter of 2017, a total of 21,000 warrants to purchase 21,000 shares of common stock were exercised related to the March 2015 Short-Term and Long-Term warrants resulting in gross proceeds of $38 thousand. Upon exercise, the warrant liability associated with these warrants was adjusted to its fair value as of the date of exercise of $58 thousand, with any change in fair value recorded in the consolidated income statement and comprehensive loss. The $58 thousand fair value was subsequently transferred to equity as of the date of exercise.

   

23

 

 

The details of the outstanding warrant liability as of March 31, 2019, were as follows:

 

           

Warrant

 
Shares and dollars in thousands   Shares    

Liability

 

July 2011 Warrants

    49     $ 23  

October 2015 Warrants

    284       156  
      333     $ 179  

 

 

NOTE 1 2 . STOCKHOLDERS’ EQUITY

 

Preferred Stock

 

Under the Company’s amended articles of incorporation, the Company is authorized to issue up to 5,000,000 shares of preferred stock in such series and with such rights and preferences as may be approved by the Board of Directors. As of March 31, 2019 and December 31, 2018, there were no shares of Company preferred stock outstanding. 

 

Common Stock

 

During the first quarter of 2018, the Company entered into a share purchase agreement with OP Financial Investments Limited for the sale of an aggregate of 1,700,000 shares of the Company’s common stock, par value $0.01 per share, for an aggregate purchase price of $5,984,000 (the “OP Private Placement”). The OP Private Placement closed on February 8, 2018. OP Financial Investments Limited is an investment firm based in Hong Kong focused on cross-border investment opportunities and listed on the Hong Kong Stock Exchange. China Kington served as placement agent in exchange for a commission equal to six percent (6%) of the gross proceeds, totaling $359,040. The Company also paid $34 thousand to NYSE American for the listing of the additional shares.

 

On March 29, 2019, the Company entered into a Common Stock Purchase Agreement with Triton Funds LP, a Delaware limited partnership (the “Investor”), pursuant to which the Company has the right to sell up to $3,000,000 of shares of common stock of the Company at a purchase price equal to 90% of the lowest trading price of the common stock of the Company for the five business days prior to the applicable closing date. The Company also entered into a Registration Rights Agreement on March 29, 2019 with the Investor, pursuant to which the Company registered such shares for resale by the Investor on a registration statement on Form S-3 filed with the SEC on April 1, 2019 and declared effective on April 12, 2019. In connection with the transaction with Triton Funds LP, the Company entered into a Letter Agreement with Triton Funds LLC, an affiliate of the Investor, pursuant to which the Company issued 150,000 shares of common stock to Triton Funds LLC.

 

Stock Warrants

 

In February 2016, the strike prices of the July 2011, March 2015 Short-Term and Long-Term, and October 2015 warrants were reduced to $1.81 per share, pursuant to the price protection provisions in such warrants, because the Company sold common stock to Mr. Jian Ping Fu at that price. 

 

As more fully described in Note 3, the Company reclassified 210,586 warrants from warrant liabilities to equity upon adoption of ASU 2017-11, resulting in an increase to paid-in capital by $56 thousand and a decrease to warrant liability by $56 thousand. In addition, because of the modified retrospective adoption, the Company recorded a cumulative-effect adjustment of $356 thousand to the Company’s beginning accumulated deficit as of January 1, 2019.

 

The details of all outstanding warrants as of March 31, 2019, were as follows:

 

           

Weighted-

 
           

Average

 
           

Exercise

 
(in thousands)   Warrants    

Price

 

Outstanding at December 31, 2018

    544     $ 1.81  

Warrants granted

        $  

Warrants exercised

        $  

Warrants expired

        $  

Outstanding at March 31, 2019

    544     $ 1.81  

 

24

 
 

 

 

NOTE 1 3 . EQUITY-BASED COMPENSATION

 

Equity Compensation Plans  

 

In October 2007, the Company adopted the 2007 Omnibus Incentive Plan (the “2007 Plan”) to provide for the granting of equity awards, such as stock options, unrestricted and restricted common stock, stock units, dividend equivalent rights, and stock appreciation rights to employees, directors and outside consultants, as determined by the Board of Directors. At the inception of the 2007 Plan, 40,000 shares were reserved for awards under the 2007 Plan.

 

For the years from 2009 to 2012, the number of shares of common stock authorized for awards under the 2007 Plan increased annually in an amount equal to the lesser of (a) 40,000 shares; (b) 4% of the number of shares of the Company’s common stock outstanding on the last day of the preceding year; or (c) such lesser number as determined by the Board. Accordingly, an additional 40,000, 37,427, and 37,207 shares of common stock were authorized for awards under the 2007 Plan in January 2012, 2011 and 2010, respectively. Beginning in 2013, the shareholders voted to remove the 40,000-share cap and the 2007 Plan’s shares authorized for awards increased annually by 4% of the number of shares of the Company’s common stock outstanding on the last day of the preceding year. Accordingly, an additional 32,646 and 59,157 shares of common stock were authorized for awards under the 2007 Plan in January 2014 and 2013, respectively. On March 30, 2015, the Company filed a registration statement to add an additional 82,461 shares to the 2007 Plan’s shares authorized for awards. In January 2016, the Company added 139,449 shares to the 2007 Plan’s shares authorized for awards, per the 2007 Plan’s evergreen provision. On May 26, 2016, the stockholders of the Company approved an amendment to the 2007 Plan to increase the number of shares of Company common stock authorized for awards thereunder by 1,124,826 shares. In January 2017, the Company added 610,774 shares to the 2007 Plan’s shares authorized for awards, per the 2007 Plan’s evergreen provision. As a result of the foregoing, the aggregate number of shares authorized for awards under the 2007 Plan was 2,318,486 shares, prior to its expiration on March 15, 2017 (after taking into account prior awards under the 2007 Plan).

 

Upon expiration of the 2007 Plan, new awards cannot be issued pursuant to the 2007 Plan, but awards outstanding as of its March 15, 2017 plan expiration date will continue to be governed by its terms. Under the terms of the 2007 Plan, the exercise price of incentive stock options may not be less than 100% of the fair market value of the common stock on the date of grant and, if granted to an owner of more than 10% of the Company’s stock, then not less than 110% of the fair market value of the common stock on the date of grant. Stock options granted under the 2007 Plan expire no later than ten years from the date of grant. Stock options granted to employees generally vest over four years, while options granted to directors and consultants typically vest over a shorter period, subject to continued service.

 

In March 2017, the Company adopted the 2017 Omnibus Incentive Plan (the “2017 Plan”), which was approved by shareholders on June 2, 2017, to provide for the granting of equity awards, such as nonqualified stock options (“NQSOs”), incentive stock options (“ISOs”), restricted stock, performance shares, stock appreciation rights (“SARs”), restricted stock units (“RSUs”) and other share-based awards to employees, directors, and consultants, as determined by the Board of Directors. The new 2017 Plan will not affect awards previously granted under the 2007 Plan. The 2017 Plan allows for awards of up to 2,318,486 shares of the Company’s common stock, plus an automatic annual increase in the number of shares authorized for awards on the first day of each of the Company’s fiscal years beginning January 1, 2018 through January 1, 2027 equal to (i) four percent of the number of shares of Common Stock outstanding on the last day of the immediately preceding fiscal year or (ii) such lesser number of shares of Common Stock than provided for in Section 4(a)(i) of the 2017 Plan as determined by the Board. As of March 31, 2019, there were 1,932,623 shares available for future awards under the 2017 Plan.

 

Under the terms of the 2017 Plan, the exercise price of NQSOs, ISOs and SARs may not be less than 100% of the fair market value of the common stock on the date of grant and, if ISOs are granted to an owner of more than 10% of the Company’s stock, then not less than 110% of the fair market value of the common stock on the date of grant. The term of awards will not be longer than ten years, or in the case of ISOs, not longer than five years with respect to holders of more than ten percent of the Company’s stock. Stock options granted to employees generally vest over four years, while options granted to directors and consultants typically vest over a shorter period, subject to continued service. The Company issues new shares to satisfy option exercises under the 2007 and 2017 plans.

 

25

 

 

Stock Option Summary  

 

The following table summarizes information about the Company’s stock options outstanding at March 31, 2019, and activity during the three-month period then ended:

 

(in thousands, except years and per share data)

 

Options

   

Weighted-Average Exercise Price

   

Weighted-Average Remaining Contractual Life (years)

   

Aggregate Intrinsic Value

 

Outstanding at December 31, 2018

    3,374     $ 4.13       8.2     $ 8  

Restricted stock units vested

    (6 )   $                  

Options forfeited/cancelled

    (978 )   $ 2.66                  

Restricted stock units cancelled

    (1 )   $                  

Outstanding at March 31, 2019

    2,389     $ 4.75       7.7     $ 6  
                                 

Vested and expected to vest at March 31, 2019

    2,355     $ 4.78       7.7     $ 5  
                                 

Vested at March 31, 2019

    1,725     $ 5.71       7.3     $  
                                 

Exercisable at March 31, 2019

    1,725     $ 5.71       7.3     $  

 

For options that have a quoted market price in excess of the exercise price (“in-the-money options”), the aggregate intrinsic value is calculated as the difference between the exercise price of the underlying stock option awards and the closing market price of the Company’s common stock as quoted on the NYSE American as of March 31, 2019. There were no stock option awards exercised during the three months ended March 31, 2019. The Company received no cash payments for the exercise of stock options during the three months ended March 31, 2019. There were 4 thousand stock option awards exercised during the three months ended March 31, 2018 for which the Company received cash payments of $11 thousand. The aggregate intrinsic value of stock option awards exercised was $5 thousand for the three months ended March 31, 2018.

 

As of March 31, 2019, total unrecognized compensation cost related to unvested stock options and restricted stock units was approximately $823 thousand. This amount is expected to be recognized as stock-based compensation expense in the Company’s consolidated statements of operations and comprehensive loss over the remaining weighted average vesting period of 2.79 years.

 

Stock Option Awards to Employees and Directors

 

The Company grants options to purchase common stock to its employees and directors at prices equal to or greater than the market value of the stock on the dates the options are granted. The Company has estimated the value of stock option awards as of the date of grant by applying the Black-Scholes-Merton option pricing model using the single-option valuation approach. The application of this valuation model involves assumptions that are judgmental and subjective in nature. See Note 2, “Summary of Significant Accounting Policies” for a description of the accounting policies that the Company applies to value its stock-based awards.

  

During the three months ended March 31, 2019 and March 31, 2018, the Company did not grant options to purchase common stock to employees and directors.

 

When the Company grants stock options, the stock options are recorded at their fair value on the grant date and recognized over the respective service or vesting period. The fair value of the stock options that are granted is calculated using the Black-Scholes-Merton option pricing model using the following assumptions:

 

Expected Price Volatility —This is a measure of the amount by which the stock price has fluctuated or is expected to fluctuate. The computation of expected volatility was based on the historical volatility of our own stock.

   

Expected Term —This is the period of time over which the options granted are expected to remain outstanding. The expected life assumption is based on the Company’s historical data.

 

Risk-Free Interest Rate —This is the U.S. Treasury rate for the week of the grant having a term approximating the expected life of the option.

 

Dividend Yield —We have not made any dividend payments nor do we have plans to pay dividends in the foreseeable future.

 

Forfeitures are estimated at the time of grant and reduce compensation expense ratably over the vesting period. This estimate is adjusted periodically based on the extent to which actual forfeitures differ, or are expected to differ, from the previous estimate.

 

In addition, during the three months ended March 31, 2019 and 2018, the Company did not grant restricted stock to employees. 

 

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For the three months ended March 31, 2019 and 2018, the Company recognized stock-based compensation expense of $107 thousand and $179 thousand, respectively, for stock-based awards to employees and directors.  

 

In March 2018, the Company modified stock options held by Mr. Liu, who resigned as a director of the Company, effective March 21, 2018. The option exercise period for Mr. Liu was extended from three months to three years, calculated from his date of resignation. In connection with the stock option modification, the Company recognized stock-based compensation expense of $26 thousand.

 

 

Stock-Based Awards to Non-Employees for Advising and Consulting Services

 

During the three months ended March 31, 2019 and March 31, 2018, the Company did not grant options to purchase shares of common stock to non-employees.

  

When the Company grants stock options, the stock options are recorded at their fair value on the grant date and recognized over the respective service or vesting period. The fair value of the stock options that are granted is calculated using the Black-Scholes-Merton option pricing model as discussed above.

 

In addition, during the three months ended March 31, 2019 and 2018, the Company did not grant restricted stock to non-employees.

 

For the three months ended March 31, 2019 and 2018, the Company recognized stock-based compensation expense of $7 thousand, related to non-employee stock and option grants. 

 

  

Summary of Stock-Based Compensation Expense

 

A summary of stock-based compensation expense included in results of operations for the option and stock awards discussed above is as follows: 

 

   

Three Months Ended March 31,

 

(in thousands)

 

2019

   

2018

 

Research and development

  $ 11     $ 7  

Sales and Marketing

    19       34  

General and administrative

    84       145  

Total stock-based compensation expense

  $ 114     $ 186  

 

Since the Company has operating losses and net operating loss carryforwards, there are no tax benefits associated with stock-based compensation expense.

 

 

NOTE 14. LICENSE, COLLABORATION AND DISTRIBUTION AGREEMENTS

 

Transactions under the Company's major distribution agreements are recognized upon transfer of control to its major distribution partners at the amount of consideration that the Company expects to be entitled to. The Company records contract liabilities for the invoiced amounts that are estimated to be subject to significant reversal, including product revenue allowances for cash consideration paid to customers for services, discounts, rebate programs, chargebacks, and product returns.

 

Milestone payments are included in the estimated transaction price when they are considered probable of being achieved. For license and collaboration revenue, the transaction price under license and collaboration arrangements, including upfront fees and milestone payments, are allocated differently to each performance obligation and may be recognized at earlier points in time or with a different pattern of performance over time. 

 

The following table presents changes in the Company's contract assets and liabilities for the three months ended March 31, 2019:  

 

   

Balance at Beginning of the Period

   

Additions

   

Deductions

   

Balance at

the end of the Period

 
   

(in thousands)

 

Contract Liabilities: Deferred Revenue

  $ 41     $     $ (41 )   $  

Contract Liabilities: Accrued Liabilities

    1,432       2,664       (3,029 )     1,067  

Total

  $ 1,473     $ 2,664     $ (3,070 )   $ 1,067  

 

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During the three months ended March 31, 2019 and 2018, the Company recognized the following revenue (in thousands):

 

   

Three Months Ended March 31,

 
   

2019

   

2018

 

Revenue recognized in the period from:

               

Amounts included in contract liabilities at the beginning of the period:

               

Performance obligations satisfied

  $ 1,444     $ 1,439  

New activities in the period:

               

Performance obligations satisfied

    47       1,508  
                 
    $ 1,491     $ 2,947  

 

License , Collaboration and Distribution Agreements

 

In January 2012, the Company entered into a distribution agreement with China Pioneer, a Shanghai-based company that markets high-end pharmaceutical products into China and an affiliate of Pioneer Singapore, for the commercialization of NeutroPhase in this territory. Under the terms of the agreement, NovaBay received an upfront payment of $312,500. NovaBay also received $312,500 in January 2013, related to the submission of the first marketing approval for the product to the Chinese Food and Drug Administration (the “CFDA”). The deferred revenue was recognized as the purchase discounts were earned, with the remaining deferred revenue recognized ratably over the product distribution period. During the year ended December 31, 2014, NovaBay received $625,000 upon receipt of a marketing approval of the product from the CFDA.

 

In September 2012, the Company entered into two agreements with China Pioneer: (1) an international distribution agreement (“Distribution Agreement”) and (2) a unit purchase agreement (“Purchase Agreement”). These agreements were combined and accounted for as one arrangement with one unit of accounting for revenue recognition purposes.

 

Pursuant to the terms of the Distribution Agreement, China Pioneer has the right to distribute NeutroPhase, upon a marketing approval from a Regulatory Authority, in certain territories in Asia (other than China). Upon execution of the Distribution Agreement, the Company received an upfront payment, which was recorded as deferred revenue. China Pioneer is also obligated to make certain additional payments to the Company upon receipt of the marketing approval. The Distribution Agreement further provides that China Pioneer is entitled to a cumulative purchase discount not to exceed $500,000 upon the purchase of NeutroPhase product, payable in NovaBay unregistered restricted common stock.

 

Pursuant to the Purchase Agreement, we also received $2.5 million from China Pioneer for the purchase of restricted units (comprising one share of common stock and a warrant for the purchase of one share of common stock). The unit purchase was completed in two tranches: (1) 800,000 units in September 2012; and (2) 1,200,000 units in October 2012, with both tranches at a purchase price of $1.25 per unit. The fair value of the total units sold was $3.5 million, based upon the trading price of our common stock on the dates the units were purchased and the fair value of the warrants based on the Black-Scholes Merton option pricing model. Because the aggregate fair value of the units on the dates of purchase exceeded the $2.5 million in proceeds received from the unit purchase by approximately $1.0 million, we reallocated $600,000 from deferred revenue to stockholders’ equity as consideration for the purchase of the units.

 

In December 2013, the Company announced it had expanded its NeutroPhase commercial partnership agreement with China Pioneer. The expanded agreement includes licensing rights to Avenova and CelleRx, which were developed internally by NovaBay. The expanded partnership agreement covers the commercialization and distribution of these products in China and 11 countries in Southeast Asia.

 

On February 7, 2012, the Company entered into a distribution agreement with Integrated Healing Technologies, LLC, (“IHT”) to distribute NeutroPhase. NovaBay received an upfront payment of $750,000.

 

In April 2013, the Company entered into a collaboration and license agreement with Virbac. Under this agreement, Virbac acquired exclusive worldwide rights to develop the Company’s proprietary compound, auriclosene (NVC-422), for global veterinary markets for companion animals. The Company received an upfront payment of $250,000.

 

On June 1, 2013, the Company entered into a distribution agreement with Principal Business Enterprise Inc., (“PBE”) to distribute NeutroPhase. NovaBay received an upfront payment of $200,000.

 

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During the three months ended March 31, 2019, the Company earned $41 thousand in revenue due to the Company being relieved of contract liability as a result of changes in contract terms associated with the distribution agreement with PBE. During the three months ended March 31, 2018, the Company earned $13 thousand in revenue as a result of satisfied performance obligations of sample supply due to Pioneer China and PBE. The Company had $0 and $41 thousand deferred revenue at March 31, 2019 and December 31, 2018, respectively.

 

Avenova Distribution Agreements

 

In November 2014, the Company signed a nationwide distribution agreement for its Avenova product with McKesson Corporation (“McKesson”) as part of the Company’s commercialization strategy. McKesson makes Avenova widely available in local pharmacies and major retail chains across the U.S., such as Wal-Mart, Costco, CVS and Target. In January 2015, the Company signed a nationwide distribution agreement with Cardinal Health. In April 2015, the Company also signed a distribution agreement with AmerisourceBergen to distribute Avenova nationwide. 

 

During the three months ended March 31, 2019 and 2018, the Company earned $1.2 million and $2.6 million,   respectively, in product revenue under the Avenova distribution agreements.

 

Under the Avenova product distribution arrangements, the Company had a contract liability balance of $1.1 million and $1.4 million at March 31, 2019 and December 31, 2018, respectively. The contract liability is included in accrued liabilities in the consolidated balance sheet. The contract liability as of March 31, 2019 and December 31, 2018 included a prepayment of $0.8 million and $0.9 million rebate, respectively, that is recorded in the prepaid expenses and other current assets in the consolidated balance sheet (see Note 4).  

 

 

 

NOTE 1 5 . EMPLOYEE BENEFIT PLAN

 

The Company has a 401(k) plan covering all eligible employees. The Company is not required to contribute to the plan and made no contributions during the three months ended March 31, 2019 and 2018. 

 

 

 

NOTE 1 6 . RELATED PARTY TRANSACTIONS       

 

Related Party Financing

 

See Note 9, “Related Party Notes Payable” for a description of the Promissory Note issued on February 27, 2019.

 

Related Party Revenue 

 

The Company recognized related party revenues from product sales and license and collaboration fees of $41 thousand and $13 thousand for the three months ended March 31, 2019 and 2018, respectively. In fulfillment of the performance obligations under this contract, the company supplied product samples with a cost of $0 and $219 thousand for the three months ended March 31, 2019 and 2018. Related party accounts receivable was $6 thousand and $39 thousand as of March 31, 2019 and December 31, 2018, respectively. See Note 14, “License, Collaboration and Distribution Agreements” for additional information regarding the Company's distribution agreements with China Pioneer, which is an affiliate of Pioneer Singapore, the Company's second largest stockholder.

 

Related Party Expenses  

 

The Company paid related party fees of $70 thousand and $359 thousand for the three months ended March 31, 2019 and 2018, respectively. The fee of $20 thousand paid to China Kington during the three months ended March 31, 2019 represented the broker fee for the issuance of the Promissory Note to Pioneer Pharma (Hong Kong) Company Ltd., and was recorded as an offset to the related party notes payable in the Consolidated Balance Sheet. For the three months ended March 31, 2019, $4 thousand was recorded to interest expense using the effective interest rate method over the term of the Promissory Note. The fee of $50 thousand paid to Director Bob Wu represented the consulting fees pursuant to that certain Consulting Agreement, between the Company and China Kington, dated March 11, 2019. It was included in the prepaid expenses and other current assets in the Consolidated Balance Sheet and will be amortized over the service period pursuant to the Consulting Agreement. $8 thousand expense was recorded for the three months ended March 31, 2019. See Note 9, “Related Party Notes Payable” for additional information regarding such fees. The fees paid to China Kington during the three months ended March 31, 2018 represented the commission on its sale of the Company’s common stock. See Note 12, “Stockholders’ Equity (Deficit)” – “Common Stock” for additional information regarding such commissions.

 

 

 

NOTE 17. SUBSEQUENT EVENTS

 

On March 29, 2019, the Company entered into a Common Stock Purchase Agreement with Triton Funds LP, a Delaware limited partnership (the “Investor”), pursuant to which the Company has the right to sell up to $3,000,000 of shares of common stock of the Company at a purchase price equal to 90% of the lowest trading price of the common stock of the Company for the five business days prior to the applicable closing date. The Company also entered into a Registration Rights Agreement on March 29, 2019 with the Investor, pursuant to which the Company registered such shares for resale by the Investor on a registration statement on Form S-3 filed with the SEC on April 1, 2019 and declared effective on April 12, 2019. In connection with the transaction with Triton Funds LP, the Company entered into a Letter Agreement with Triton Funds LLC, an affiliate of the Investor, pursuant to which the Company issued 150,000 shares of common stock to Triton Funds LLC.

 

Pursuant to the Common Stock Purchase Agreement, on April 22, 2019, the Company issued a purchase notice to the Investor requiring the Investor purchase 1,747,312 shares of common stock, the maximum amount the Company could demand the Investor purchase as of April 22, 2019 pursuant to the Investor’s ownership limitation of 9.99% as described in the Common Stock Purchase Agreement.

 

Separately, on April 12, 2019, the Company was notified by the NYSE American LLC that the Company is not in compliance with Section 1003(a)(iii) of the NYSE American Company Guide (requiring stockholders’ equity of $6.0 million or more if it has reported losses from continuing operations and/or net losses in its five most recent fiscal years). Therefore, the Company has become subject to the procedures and requirements of Section 1009 of the NYSE American Company Guide and must submit a plan of compliance by May 12, 2019 addressing how it intends to regain compliance with Section 1003(a)(iii) of the NYSE American Company Guide by October 12, 2020. The Company intends to submit a plan to regain compliance with NYSE American listing standards.

 

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ITEM 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

The following discussion of our financial condition and results of operations should be read together with our consolidated financial statements and related notes included in Part I, Item 1 of this report, and with our consolidated financial statements and related notes, and Management’s Discussion and Analysis of Financial Condition and Results of Operations, included in our Annual Report on Form 10-K for the year ended December 31, 201 8 , as amended, which was filed with the Securities and Exchange Commission (the “SEC”) on March 2 9 , 201 9 . This discussion contains forward-looking statements that involve risks and uncertainties. Words such as “expects,” “anticipated,” “will,” “may,” “goals,” “plans,” “believes,” “estimates,” variations of these words, and similar expressions are intended to identify these forward-looking statements.   As a result of many factors, such as those set forth under the section entitled “Risk Factors” in Part II, Item 1A and elsewhere in this report, our actual results may differ materially from those anticipated in these forward-looking statements. Readers are cautioned that these forward-looking statements are only predictions based upon assumptions made that we believed to be reasonable at the time, and are subject to risks and uncertainties. Therefore, actual results may differ materially and adversely from those expressed in any forward-looking statements. Except as required by law, we undertake no obligation to revise or update publicly any forward-looking statements.   

 

Overview 

 

We are a medical device company predominantly focused on eye care. We are currently focused primarily on commercializing Avenova ® , a prescription product sold in the United States for cleansing and removing foreign material including microorganisms and debris from skin around the eye, including the eyelid.

 

Avenova is an eye care product formulated with our proprietary, stable and pure form of hypochlorous acid. Avenova has proven in laboratory testing to have broad antimicrobial properties as a preservative in solution as it removes foreign material including microorganisms and debris from the skin on the eyelids and lashes without burning or stinging.

 

Our overall business strategy remains the same since November 2015, when we restructured our business to focus our resources on growing sales of Avenova in the United States. However, the Company recently announced a refocus to strategically shift its commercialization strategy to focus on high performing territories and territories identified as having significant prescription volume potential along with favorable health plan coverage while continuing to focus on contracting with additional specialty pharmacies as channel partners. Our current three-part business strategy is comprised of: (1) focusing our resources on growing the U.S. commercial sales of Avenova, including implementation of a new sales and marketing strategy intended to maintain current product margin and target profitability; (2) maintaining low expenses and continuing to optimize sales force efficiency, including strategic geographical reach; and (3) seeking additional sources of revenue through partnering, divesting and/or other means of monetizing non-core assets in urology, dermatology, and wound care.

 

Pursuant to our business strategy, we have developed additional products containing our proprietary, stable and pure form of hypochlorous acid, including NeutroPhase ®  for the wound care market and CelleRx ®  for the dermatology market. Since the launch of NeutroPhase in 2013, we have established a U.S. distribution partner and an international distribution partner in China. We currently do not sell or distribute CelleRx.

 

Avenova, NeutroPhase, and CelleRx are medical devices cleared by the FDA under the Food and Drug Administration Act Section 510(k). The products are intended for use under the supervision of healthcare professionals for the cleansing and removal of foreign material, including microorganisms and debris. For wound treatment, NeutroPhase ®  is also intended for use under the supervision of healthcare professionals for moistening absorbent wound dressings and cleansing minor cuts, minor burns, superficial abrasions and minor irritations of the skin. It is also intended for moistening and debriding acute and chronic dermal lesions.

 

Critical Accounting Policies and Estimates

 

Our consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States. The preparation of these consolidated financial statements requires us to make estimates, assumptions and judgments that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported revenues and expenses during the reporting periods. In preparing these consolidated financial statements, management has made its best estimates and judgments of certain amounts, giving due consideration to materiality. On an ongoing basis, we evaluate our estimates and judgments related to revenue recognition, research and development costs, patent costs, stock-based compensation, income taxes and other contingencies. We base our estimates on historical experience and on various other factors that we believe are reasonable under the circumstances. Actual results may differ from these estimates.  

 

While our significant accounting policies are more fully described in Note 2 of the Notes to Consolidated Financial Statements (Summary of Significant Accounting Policies), included in Part II, Item 8 of this report, we believe that the following accounting policies are most critical to fully understanding and evaluating our reported financial results.

 

Allowance for Doubtful Accounts

 

We charge “Bad Debt” expense and set up an “Allowance for Doubtful Accounts” when management identifies amounts due that are in dispute and believes it unlikely a specific invoice will be collected. At March 31, 2019 and December 31, 2018, management had reserved $24 thousand and $10 thousand, respectively, primarily based on specific amounts that were in dispute or were over 120 days past due as of those dates.

 

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Inventory

 

Inventory is comprised of (1) raw materials and supplies, such as bottles, packaging materials, labels, boxes and pumps; (2) goods in progress, which are normally unlabeled bottles; and (3) finished goods. We utilize contract manufacturers to produce our products and the cost associated with manufacturing is included in inventory. At March 31, 2019 and December 31, 2018, management had recorded an allowance for excess and obsolete inventory and lower of cost or estimated net realizable value adjustments of $110 thousand and $104 thousand, respectively.

 

Inventory is stated at the lower of cost or estimated net realizable value determined by the first-in, first-out method.

 

Leases

 

In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842) , to enhance the transparency and comparability of financial reporting related to leasing arrangements. The Company adopted the standard effective January 1, 2019. Using the optional transition method, prior period financial statements have not been recast to reflect the new lease standard.

 

At the inception of an arrangement, the Company determines whether the arrangement is or contains a lease based on the unique facts and circumstances present. Operating lease liabilities and their corresponding right-of-use assets are recorded based on the present value of lease payments over the expected lease term. The interest rate implicit in lease contracts is typically not readily determinable. As such, the Company utilizes its incremental borrowing rate, which is the rate incurred to borrow on a collateralized basis over a similar term an amount equal to the lease payments in a similar economic environment. Certain adjustments to the right-of-use asset may be required for items such as initial direct costs paid or incentives received.

 

The Company has elected to combine lease and non-lease components as a single component for all leases in which it is a lessee or a lessor. The lease expense is recognized over the expected term on a straight-line basis. Operating leases are recognized on the balance sheet as right-of-use assets, operating lease liabilities current and operating lease liabilities non-current. As a result, as of the effective date, the Company no longer recognizes deferred rent on the balance sheet.

 

 

Revenue Recognition

 

We generate product revenue through product sales to our major distribution partners, a limited number of distributors and via our webstore. Product supply is the only performance obligation contained in these arrangements, and we recognize product revenue upon transfer of control to our major distribution partners at the amount of consideration that we expect to be entitled to, generally upon shipment to the distributor on a “sell-in” basis.

 

Other revenue is primarily generated through commercial partner agreements with strategic partners for the development and commercialization of our product candidates. The terms of the agreements typically include more than one performance obligation and generally contain non-refundable upfront fees, payments based upon achievement of certain milestones and royalties on net product sales.

 

In determining the appropriate amount of revenue to be recognized as we fulfill our obligations under these agreements, we perform the following steps: (i) identification of the promised goods or services in the contract; (ii) determination of whether the promised goods or services are performance obligations including whether they are distinct in the context of the contract; (iii) measurement of the transaction price, including the constraint on variable consideration; (iv) allocation of the transaction price to the performance obligations based on estimated selling prices; and (v) recognition of revenue when (or as) we satisfy each performance obligation.

 

Performance Obligations

 

A performance obligation is a promise in a contract to transfer a distinct good or service to the customer and is the unit of account in Topic 606. Our performance obligations include:

 

 

Product supply

 

Exclusive distribution rights in the product territory

 

Regulatory submission and approval services

 

Development services

 

Sample supply

 

Incremental discounts and product supply prepayments considered material rights to the customer

 

We have optional additional items in our contracts, which are considered marketing offers and are accounted for as separate contracts when the customer elects such options. Arrangements that include a promise for future commercial product supply and optional research and development services at the customer's or our discretion are generally considered options. We assess if these options provide a material right to the licensee and if so, such material rights are accounted for as separate performance obligations.

 

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Transaction Price

 

We have both fixed and variable consideration. Under our license arrangements, non-refundable upfront fees are considered fixed, while milestone payments are identified as variable consideration when determining the transaction price. Product supply selling prices are identified as variable consideration subject to the constraint on variable consideration for estimated discounts, rebates, chargebacks and product returns. Funding of research and development activities are considered variable payments until such costs are reimbursed at which point they are considered fixed. We allocate the total transaction price to each performance obligation based on the relative estimated standalone selling prices of the promised goods or services for each performance obligation.

 

For product supply under our distribution arrangements, contract liabilities are recorded for invoiced amounts that are subject to significant reversal, including product revenue allowances for cash consideration paid to customers for services, discounts, rebate programs, chargebacks, and product returns. Because we do not have sufficient historical data to compute our own return rate, the return rate used to estimate the constraint on variable consideration for product returns is based on an average of peer and competitor company historical return rates. We update the return rate assumption quarterly and apply it to the inventory balance that is held at the distributor and has not yet been sold through to the end customer. Payment for product supply is typically due 30 days after control transfers to the customer. At any point in time there is generally one month of inventory in the sales channel, therefore uncertainty surrounding constraints on variable consideration is generally resolved after one month from when control is transferred.

 

The following table summarizes the activity in the accounts related to product revenue allowances (in thousands) during the three months ended March 31, 2019:

 

   

Wholesaler/

Pharmacy

fees

   

Cash

discounts

    Rebate     Returns     Total  

Balance at December 31, 2018

  $ (600 )   $ (61 )   $ (329 )   $ (442 )   $ (1,432 )

Current provision related to sales made during current period

    (438 )     (72 )     (2,085 )     (69 )     (2,664 )

Payments

    632       93       2,225       79       3,029  

Balance at March 31, 2019

  $ (406 )   $ (40 )   $ (189 )   $ (432 )   $ (1,067 )

 

At the inception of each arrangement that includes milestone payments, we evaluate whether the milestones are considered probable of being achieved and estimate the amount to be included in the transaction price using the most likely amount method. If it is probable that a significant revenue reversal would not occur, and achievement is in our control (such as a regulatory submission by us), the value of the associated milestone is included in the transaction price. Milestone payments that are not within our control, such as approvals from regulators, are not considered probable of being achieved until those approvals are received.

 

For arrangements that include sales-based royalties and the license is deemed to be the predominant item to which the royalties relate, we recognize revenue at the later of (a) when the related sales occur, or (b) when the performance obligation to which some or all of the royalty has been allocated has been satisfied (or partially satisfied).

 

Allocation of Consideration

 

As part of the accounting for arrangements that contain multiple performance obligations, we must develop assumptions that require judgment to determine the stand-alone selling price of each performance obligation identified in the contract. When a contract contains more than one performance obligation, we use key assumptions to determine the stand-alone selling price of each performance obligation. The estimated stand-alone selling prices for distribution rights and material rights for incremental discounts on product supply are calculated using an income approach discounted cash flow model and can include the following key assumptions: forecasted commercial partner sales, product life cycle estimates, costs of product sales, commercialization expenses, annual growth rates and margins, discount rates and probabilities of technical and regulatory success. For all other performance obligations, we use a cost-plus margin approach. We allocate the total transaction price to each performance obligation based on the estimated relative stand-alone selling prices of the promised goods or service underlying each performance obligation.

 

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Timing of Recognition

 

Significant management judgment is required to determine the level of effort required under an arrangement and the period over which we expect to complete our performance obligations under each arrangement. If we cannot reasonably estimate when performance obligations either are completed or become inconsequential, then revenue recognition is deferred until we can reasonably make such estimates. Revenue is then recognized over the remaining estimated period of performance using the cumulative catch-up method. Revenue is recognized for products at a point in time and for licenses of functional intellectual property at the point in time the customer can use and benefit from the license. For performance obligations that are services, revenue is recognized over time proportionate to the costs that we have incurred to perform the services using the cost-to-cost input method.

 

Our intellectual property in the form of distribution rights is determined to be distinct from the other performance obligations identified in the arrangements and considered “right to use” licenses which the customer can benefit from at a point in time. We recognize revenues from non-refundable, up-front fees allocated to the license when the license is transferred to the customer, and the customer can use and benefit from the license.

 

Cost of Goods Sold

 

Cost of goods sold includes third party manufacturing costs, shipping costs, and other costs of goods sold. Cost of goods sold also includes any necessary allowances for excess and obsolete inventory, along with the lower of cost or estimate net realizable value.

  

Research and Development Costs

 

We charge research and development costs to expense as incurred. These costs include salaries and benefits for research and development personnel, costs associated with clinical trials managed by contract research organizations, and other costs associated with research, development and regulatory activities. Research and development costs may vary depending on the type of item or service incurred, location of performance or production, or lack of availability of the item or service, and specificity required in production for certain compounds. We use external service providers to conduct clinical trials, to manufacture supplies of product candidates and to provide various other research and development-related products and services. Our research, clinical and development activities are often performed under agreements we enter into with external service providers.  We estimate and accrue the costs incurred under these agreements based on factors such as milestones achieved, patient enrollment, estimates of work performed, and historical data for similar arrangements.  As actual costs are incurred, we adjust our accruals.  Historically, our actual costs have been consistent with management's estimates, and no material adjustments to research and development expenses have been recognized.  Subsequent changes in estimates may result in a material change in our expenses, which could also materially affect our results of operations.

 

Stock-Based Compensation

 

The Company’s stock-based compensation includes grants of stock options and restricted stock units, or RSUs, to employees, consultants and non-employee directors. The expense associated with these programs is recognized in the Company’s consolidated statements of stockholders’ equity based on their fair values as they are earned under the applicable vesting terms or the length of an offering period. For stock options granted, the fair value of the stock options is estimated using a Black-Scholes-Merton option pricing model. See Note 13 of the Notes to Consolidated Financial Statements (Equity-Based Compensation) for further information regarding stock-based compensation expense and the assumptions used in estimating that expense. The Company accounts for restricted stock unit awards issued to employees and non-employees (consultants and advisory board members) based on the fair market value of the Company’s common stock as of the date of issuance.

 

Income Taxes

 

We account for income taxes under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance is recognized if it is more likely than not that some portion or the entire deferred tax asset will not be recognized.

 

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Common Stock Warrant Liabilities

 

For warrants that are newly issued or modified and there is a deemed possibility that the Company may have to settle them in cash, the Company records the fair value of the issued or modified warrants as a liability at each balance sheet date and records changes in the estimated fair value as a non-cash gain or loss in the consolidated statements of operations and comprehensive loss. The fair values of these warrants have been determined using the Binomial Lattice (“Lattice”) valuation model. The Lattice model provides for assumptions regarding volatility, call and put features and risk-free interest rates within the total period to maturity. These values are subject to a significant degree of our judgment.

 

On January 1, 2019, the Company adopted ASU 2017-11 and changed its method of accounting for certain warrants that were initially recorded as liabilities due to their down round features on a modified retrospective basis. ASU 2017-11 allows companies to exclude a down round feature when determining whether a financial instrument (or embedded conversion feature) is considered indexed to the entity’s own stock. As a result, financial instrument (or embedded conversion feature) with down round features may no longer be required to be accounted for as liabilities. We will recognize the value of a down round feature only when it is triggered and the strike price has been adjusted downward. For warrants classified as equity, we will treat the value of the effect of the down round as a dividend and a reduction of income available to common shareholders in computing basic earnings per share.

 

 

Recent Accounting Pronouncements

 

See Note 2 of the Notes to Consolidated Financial Statements (Summary of Significant Accounting Policies) included in Part II, Item 8 of this report for information on recent accounting pronouncements.

 

 

 

Results of Operations

 

Comparison of the Three Months Ended March 31 , 201 9 and 201 8

 

   

Three Months Ended

                 

(in thousands)

 

March 31,

   

Dollar

   

Percent

 
   

2019

   

2018

   

Change

   

Change

 

Statement of Operations

                               

Sales:

                               

Product revenue, net

  $ 1,450     $ 2,934     $ (1,484 )     -51 %

Other revenue

    41       13       28       215 %

Total sales, net

    1,491       2,947       (1,456 )     -49 %
                                 

Product cost of goods sold

    341       251       90       36 %

Gross profit

    1,150       2,696       (1,546 )     -57 %
                                 

Research and development

    85       46       39       85 %

Sales and marketing

    3,531       3,396       135       4 %

General and administrative

    1,605       1,622       (17 )     -1 %

Total operating expenses

    5,221       5,064       157       3 %

Operating loss

    (4,071 )     (2,368 )     (1,703 )     72 %
                                 

Non cash (loss) gain on changes in fair value of warrant liability

    (57 )     214       (271 )     -127 %

Other (expense) income, net

    (60 )     4       (64 )     -1600 %
                                 

Loss before provision for income taxes

    (4,188 )     (2,150 )     (2,038 )     95 %

Provision for income tax

    (1 )           (1 )     -100 %

Net loss and comprehensive loss

  $ (4,189 )   $ (2,150 )   $ (2,039 )     95 %

 

Sales, Product Cost of Goods Sold and Gross Profit

 

Product revenue, net, decreased by $1.5 million, or 51%, to $1.4 million for the three months ended March 31, 2019 from $2.9 million for the three months ended March 31, 2018. The change in product revenue, net, is the result of a decrease in the number of Avenova units sold as well as a decrease in the net sales price of Avenova products. The decrease in the net selling price as well as the decrease in the number of units sold of Avenova was largely due to a decrease in insurance coverage of the product by national payors. Due to the decrease in insurance coverage and restructuring of its U.S. sales force during the first quarter of 2019, the Company expects revenue to decrease compared with comparable periods in 2018.

 

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Other revenue increased by $28 thousand for the three months ended March 31, 2019, or 215%, to $41 thousand from $13 thousand for the three months ended March 31, 2018.

 

Product cost of goods sold increased by $90 thousand, or 36%, to $341 thousand for the three months ended March 31, 2019, from $251 thousand for the three months ended March 31, 2018. The increase in product cost of goods sold was primarily the result of the product mix.

 

Gross profit decreased by $1.5 million, or 57%, to $1.2 million for the three months ended March 31, 2019 from $2.7 million for the three months ended March 31, 2018. The decrease in gross profit was primarily the result of decreased product revenue, net, and product mix.

 

Research and Development

 

Research and development expenses increased by $39 thousand, or 85%, to $85 thousand for the three months ended March 31, 2019, from $46 thousand for the three months ended March 31, 2018. The increase is primarily due to higher usage of consultants to support our patient registry and post marketing clinical efforts.

   

Sales and marketing

 

Sales and marketing expenses increased by $0.1 million, or 4%, to $3.5 million for the three months ended March 31, 2019, from $3.4 million for the three months ended March 31, 2018. The increase was primarily due to the increase in sales headcount and employees related costs, as well as an impairment charge related to the fleet lease. This is partly offset by lower sample production. As a result of the restructuring of its U.S. sales force during the first quarter of 2019, the Company expects sales and marketing expenses to decrease in future quarters.

 

General and administrative

  

General and administrative expenses was $1.6 million for the three months ended March 31, 2019 and 2018.

  

Non-cash ( los s) gain on changes in fair value of warrant liability

 

The adjustments to the fair value of warrants resulted in a loss of $57 thousand for the three months ended March 31, 2019, compared to a gain of $214 thousand for the three months ended March 31, 2018.

 

During the three months ended March 31, 2019, the Company incurred a non-cash loss resulting from the increase in the price of the Company’s common stock price during that period. During the three months ended March 31, 2018, the Company incurred a non-cash gain resulting from the reduction in the price of the Company’s common stock price during that period.

 

Other (expense) income, net

 

Other (expense) income, net, changed to an expense of $60 thousand for the three months ended March 31, 2019, as compared to an income of $4 thousand for the three months ended March 31, 2018. The expense was due to the interest due on the Promissory Note issued in February 2019 and the amortization of discount and issuance cost related to the Convertible Note issued in March 2019. For additional information regarding the Promissory Note, please see Note 9 in the Notes to Consolidated Financial Statements (Related Party Notes Payable) in Part I, Item 1 of this report.  For additional information regarding the Convertible Note, please see Note 10 in the Notes to Consolidated Financial Statements (Convertible Note) in Part I, Item 1 of this report. 

 

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Financial Condition, Liquidity and Capital Resources

 

As of March 31, 2019, our cash and cash equivalents were $2.9 million, compared to $3.2 million as of December 31, 2018. Based primarily on the funds available at March 31, 2019, the Company believes these resources will be sufficient to fund its operations through the second quarter of 2019. The Company has sustained operating losses for the majority of its corporate history and expects that its 2019 expenses will exceed its 2019 revenues, as the Company continues to re-invest in its Avenova commercialization efforts. The Company expects to continue incurring operating losses and negative cash flows until revenues reach a level sufficient to support ongoing growth and operations. Accordingly, the Company's planned operations raise substantial doubt about its ability to continue as a going concern. The Company's liquidity needs will be largely determined by the success of operations in regard to the commercialization of Avenova. The Company also may consider other plans to fund operations including: (1) out-licensing rights to certain of its products or product candidates, pursuant to which the Company would receive cash milestones or an upfront fee; (2) raising additional capital through debt and equity financings or from other sources; (3) reducing expenditures on one or more of its sales and marketing programs; and/or (4) restructuring operations to change its overhead structure. The Company may issue securities, including common stock and warrants, through private placement transactions or registered public offerings, which would require the filing of a Form S-1 or Form S-3 registration statement with the Securities and Exchange Commission (the “SEC”). In the absence of the Company's completion of one or more of such transactions, there will be substantial doubt about the Company's ability to continue as a going concern within one year after the date these financial statements are issued, and the Company will be required to scale back or terminate operations and/or seek protection under applicable bankruptcy laws. The accompanying financial statements have been prepared assuming the Company will continue to operate as a going concern, which contemplates the realization of assets and the settlement of liabilities in the normal course of business. The consolidated financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts of liabilities that may result from uncertainty related to its ability to continue as a going concern.

 

Net Cash Used In Operating Activities

 

For the three months ended March 31, 2019, net cash used in operating activities was $3.2 million, compared to $0.5 million for the three months ended March 31, 2018. The increase was primarily due to the increase of net loss by $2.0 million and unfavorable changes in working capital of $1.1 million, partially offset by the impairment of right-of-use assets of $0.1 million, and the decrease of the loss on change of the warrant liability fair value by $0.3 million.

 

Net Cash Used In Investing Activities

 

For the three months ended March 31, 2019, net cash used in investing activities for the purchase of property and equipment was $14 thousand, compared to $2 thousand for the three months ended March 31, 2018.

 

Net Cash Provided By Financing Activities

 

Net cash provided by financing activities was $3.0 million for the three months ended March 31, 2019, which was mainly attributable to the net proceeds from the issuance of the Promissory Note to Pioneer Pharma (Hong Kong) Company Ltd. and issuance of the Convertible Note to Iliad Research and Trading L.P. Net cash provided by financing activities was $5.6 million for the three months ended March 31, 2018, which was mainly attributable to the net proceeds from issuance of common stock related to the share purchase agreement with OP Financial Investments Limited.

  

Net Operating Losses and Tax Credit Carryforwards

 

As of December 31, 2018, we had net operating loss carryforwards for federal and state income tax purposes of $100 million and $84.1 million, respectively. The federal net operating loss carryforwards consist of $94.9 million generated before January 1, 2018, which will begin to expire in 2024 and $5.2 million that will carryforward indefinitely but are subject to the 80% taxable income limitation. The state net operating loss carryforwards will begin to expire in 2028. As of December 31, 2018, we also had tax credit carryforwards for federal income tax purposes of $1.3 million and $0.3 million for state tax purposes. If not utilized, the federal tax credits will begin expiring in 2026. The state tax credits have an indefinite carryover period.

 

Current federal and California tax laws include substantial restrictions on the utilization of net operating loss carryforwards in the event of an ownership change of a corporation. Accordingly, our ability to utilize net operating loss carryforwards may be limited as a result of such ownership changes. Such a limitation could result in the expiration of carryforwards before they are utilized.

 

Inflation

 

We do not believe that inflation has had a material impact on our business and operating results during the periods presented, and we do not expect it to have a material impact in the near future, although there can be no assurances that our business will not be affected by inflation in the future.

 

Off-Balance Sheet Arrangements

 

We had no off-balance sheet arrangements as of March 31, 2019.

 

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Seasonality

 

Consistent with our peers in the United States pharmaceutical industry, our business experiences seasonality with the first quarter of each year typically being the lowest revenue quarter. This annual phenomenon is due to consumers facing the need to satisfy health insurance deductibles and changes to copays as each new insurance year begins.

 

Contractual Obligations

 

Our contractual cash commitments as of March 31, 2019 were as follows (in thousands):

 

Contractual Obligations

 

Less than 1

year

   

1-3 years

   

3-5 years

   

More than 5

years

   

Total

 
                                         

Facility leases

  $ 838     $ 1,464     $ 75     $     $ 2,377  

Vehicle leases

    123       20                   143  

Equipment leases

    9                         9  

Total

  $ 970     $ 1,484     $ 75     $     $ 2,529  

 

Our commitments as of March 31, 2019 consist of two operating facility leases, 54 operating vehicle leases and 2 copiers.

 

The total commitment for the Office Lease as of March 31, 2019 was $1.3 million due over the lease term, compared to $1.4 million as of December 31, 2018.

 

The total commitment of the Emery Station lease as of March 31, 2019 was $1.1 million due over such lease term, compared to $1.3 million as of December 31, 2018. On July 11, 2016, we entered into a Sublease Agreement to sublease our former corporate headquarters. Sublease rental reimbursement is not deducted from the above table. We anticipate collecting $566 thousand and $577 thousand in the years ending December 31, 2019 and 2020, respectively, under the Sublease for the lease of Emery Station.

 

We have operating leases for a fleet of 54 vehicles, which commenced upon the delivery of the vehicles during the first quarter 2017. The total commitment for these leases as of March 31, 2019 was $143 thousand due over the lease terms, compared to $176 thousand as of December 31, 2018.

 

We have operating leases for 2 copiers, which will expire in August 2019. The total commitment for the lease as of March 31, 2019 was $9 thousand due over the lease term, compared to $14 thousand as of December 31, 2018.

 

See Note 8 in the Notes to Consolidated Financial Statements (Commitments and Contingencies) in Part I, Item 1 of this report for further information regarding these leases.

 

Recent Events

 

On March 29, 2019, the Company entered into a Common Stock Purchase Agreement with Triton Funds LP, a Delaware limited partnership (the “Investor”), pursuant to which the Company has the right to sell up to $3,000,000 of shares of common stock of the Company at a purchase price equal to 90% of the lowest trading price of the common stock of the Company for the five business days prior to the applicable closing date. The Company also entered into a Registration Rights Agreement on March 29, 2019 with the Investor, pursuant to which the Company registered such shares for resale by the Investor on a registration statement on Form S-3 filed with the SEC on April 1, 2019 and declared effective on April 12, 2019. In connection with the transaction with Triton Funds LP, the Company entered into a Letter Agreement with Triton Funds LLC, an affiliate of the Investor, pursuant to which the Company issued 150,000 shares of common stock to Triton Funds LLC.

 

Pursuant to the Common Stock Purchase Agreement, on April 22, 2019, the Company issued a purchase notice to the Investor requiring the Investor purchase 1,747,312 shares of common stock, the maximum amount the Company could demand the Investor purchase as of April 22, 2019 pursuant to the Investor’s ownership limitation of 9.99% as described in the Common Stock Purchase Agreement.

 

Separately, on April 12, 2019, the Company was notified by the NYSE American LLC that the Company is not in compliance with Section 1003(a)(iii) of the NYSE American Company Guide (requiring stockholders’ equity of $6.0 million or more if it has reported losses from continuing operations and/or net losses in its five most recent fiscal years). Therefore, the Company has become subject to the procedures and requirements of Section 1009 of the NYSE American Company Guide and must submit a plan of compliance by May 12, 2019 addressing how it intends to regain compliance with Section 1003(a)(iii) of the NYSE American Company Guide by October 12, 2020. The Company intends to submit a plan to regain compliance with NYSE American listing standards.

 

 

ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Our market risk consists principally of interest rate risk on our cash and cash equivalents.  

 

With most of our focus on Avenova in the domestic U.S. market, we do not have any material exposure to foreign currency rate fluctuations.

 

ITEM 4.  CONTROLS AND PROCEDURES

 

As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures pursuant to Rule 13a-15 and 15d-15 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”).

 

A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Assessing the costs and benefits of such controls and procedures necessarily involves the exercise of judgment by management. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, have been detected.

 

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Based upon that evaluation, our Chief Executive Officer and our Chief Financial Officer concluded that, as of the end of the period covered by this report, our disclosure controls and procedures were effective at the reasonable assurance level to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and were effective in ensuring that information required to be disclosed by us in the reports that we file or submit under the Exchange Act was accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

 

Changes in Internal Control Over Financial Reporting

 

There was no change in our internal control over financial reporting during the quarter ended March 31, 2019, that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

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PART II. OTHER INFORMATION

 

ITEM 1A. RISK FACTORS

 

Our business is subject to a number of risks, the most important of which are discussed below. You should consider carefully the following risks in addition to the other information contained in this report and our other filings with the SEC before deciding to buy, sell or hold our common stock. If any of the following risks actually occur, our business, financial condition or results of operations could be materially adversely affected, the value of our common stock could decline and you may lose all or part of your investment. The risks and uncertainties described below are not the only ones facing our Company. Additional risks and uncertainties not presently known to us or that we currently believe are immaterial may also impair our business operations.

 

Risks Relating to Our Liquidity

 

There is uncertainty about our ability to continue as a going concern.

 

We have sustained operating losses for the majority of our corporate history and expect that our 2019 expenses will exceed our 2019 revenues, as we continue to invest in our Avenova commercialization efforts. Our operating cash flow is not sufficient to support our ongoing operations, and we expect to continue incurring operating losses and negative cash flows until revenues reach a level sufficient to support ongoing growth and operations. Any additional financing that we are able to secure in the near-term will be limited and will only provide working capital sufficient through the second quarter of 2019. As such, additional funding will be needed in both the short- and long-term in order to pursue our business plan, which includes maintaining a small salesforce in the U.S. for Avenova, increasing market penetration for our existing commercial products, research and development for additional product offerings, seeking regulatory approval for these product candidates, and pursuing their commercialization in the United States, Asia, and other markets. These circumstances raise doubt about our ability to continue as a going concern, which depends on our ability to raise capital to fund our current operations.

 

We have a history of losses and we may   never achieve or maintain sustained profitability.  

 

We have historically incurred net losses, and we may never achieve or maintain sustained profitability. In addition, at this time:

 

 

we have recently suffered and will continue to suffer, from a decline in product revenue due to the decrease in insurance coverage of Avenova by national payors;

 

 

we expect to incur substantial marketing and sales expenses as we continue to attempt to increase sales of our Avenova product;

 

 

our results of operations may fluctuate significantly;

 

 

we may be unable to develop and commercialize our product candidates; and

 

 

it may be difficult to forecast accurately our key operating and performance metrics because of our limited operating history.

 

We will need to generate significant revenues to achieve and maintain profitability. If we cannot successfully market and sell Avenova, either independently or with partners, we will not be able to generate sufficient revenues to achieve or maintain profitability in the future. Our failure to achieve and subsequently maintain profitability could have a material adverse impact on the market price of our common stock. 

 

Risks Relating to Owning Our Common Stock

 

If our stockholders' equity does not meet the minimum standards of the NYSE American, we may be subject to delisting procedures.

  

On April 12, 2019, we received a letter from the NYSE American notifying us that our stockholders’ equity as of December 31, 2018 was below the minimum requirements of Section 1003(a)(iii) of the NYSE American Company Guide (the “Company Guide”) (requiring stockholders’ equity of $6.0 million or more if a company has reported losses from continuing operations and/or net losses in its five most recent fiscal years). Therefore, the Company has become subject to the procedures and requirements of Section 1009 of the NYSE American Company Guide and must submit a plan of compliance by May 12, 2019 addressing how it intends to regain compliance with Section 1003(a)(iii) of the NYSE American Company Guide by October 12, 2020. The Company intends to submit a plan to regain compliance with NYSE American listing standards. If the Company does not regain compliance with those standards, or does not make progress consistent with the plan, the NYSE American staff may commence delisting proceedings.

 

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In 2017 and prior years, we have periodically been notified by the NYSE American that we did not comply with the exchange's minimum stockholders' equity requirements. Although we were able to regain compliance in the past, we cannot guarantee that we will be able to do so again, and therefore our common stock could be subject to delisting. If our common stock is delisted, this could, among other things, substantially impair our ability to raise additional funds; result in a loss of institutional investor interest and fewer financing opportunities for us; and/or result in potential breaches of representations or covenants of our warrants, subscription agreements or other agreements pursuant to which we made representations or covenants relating to our compliance with applicable listing requirements. Claims related to any such breaches, with or without merit, could result in costly litigation, significant liabilities and diversion of our management's time and attention and could have a material adverse effect on our financial condition, business and results of operations.

 

If we conduct offerings in the future, the price at which we offer our securities may trigger a price protection provision included in warrants originally issued in July 2011, March 2015 and October 2015 , reducing the probability and magnitude of any future share price appreciation.

 

As part of our October 2015 offering, we agreed to provide certain price protections affecting currently outstanding warrants exercisable for an aggregate of 544,695 shares of our common stock, of which the warrants exercisable for 260,093 shares will expire on March 6, 2020, and the warrants exercisable for 284,602 shares will expire on October 27, 2020 (the “Warrants”). Specifically, in the event that we undertake a third-party equity financing of either: (1) common stock at a sale price of less than $5.00 per share; or (2) convertible securities with an exercise or conversion price of less than $5.00 per share, we have agreed to reduce the exercise price of all Warrants to such lower price. The exercise price of the Warrants is currently set at $1.81 as a result of our February 2016 private placement offering. The further reduction of the exercise price for the Warrants would limit the probability and magnitude of future share price appreciation, if any, by placing downward pressure on our stock price if it exceeds such offering sale price. All of the Warrants are currently exercisable and will remain so after any exercise price adjustment. In the past, we have extended the expiration dates or adjusted other terms of the Warrants as consideration for certain offering conditions, and we cannot assure you that we will not do so in the future. Any such modifications would reduce the probability and magnitude of any share price appreciation during the period of the extension. We cannot guarantee that you will receive a return on your investment when you do sell your shares or that you will not lose the ent