Quarterly Report (10-q)

Date : 11/07/2019 @ 9:14PM
Source : Edgar (US Regulatory)
Stock : NovaBay Pharmaceuticals Inc New (NBY)
Quote : 0.5682  0.0051 (0.91%) @ 5:00AM

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 September 30, 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

 

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 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 November 5, 2019, there were 27,901,850 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: September 30, 2019 (unaudited) and December 31, 2018

1

       

 

2.

Consolidated Statements of Operations and Comprehensive Loss (unaudited): Three and nine months ended September 30, 2019 and 2018

2

 

 

 

 

 

3.

Consolidated Statements of Cash Flows (unaudited): Nine months ended September 30, 2019 and 2018

3

       
 

4.

Consolidated Statements of Stockholders’ Equity (unaudited): Three and nine months ended September 30, 2019 and 2018

4

 

 

 

 

 

5.

Notes to Consolidated Financial Statements (unaudited)

6

 

 

 

 

Item 2.

 

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

38

 

 

 

 

Item 3.

 

Quantitative and Qualitative Disclosures About Market Risk

48

 

 

 

 

Item 4.

 

Controls and Procedures

48

 

 

 

 

PART II

OTHER INFORMATION

 

 

 

 

Item 1.

 

Legal Proceedings

49

       

Item 1A.

 

Risk Factors

49

  

  

  

 

Item 6.

 

Exhibits

62

 

 

 

 

SIGNATURES  

65

  

 

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®, NeutroPhase®, CelleRx®, intelli-Case™, AgaNase®, Aganocide®, AgaDerm®, Neutrox® and Going Beyond Antibiotics® 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)

 

 

   

September 30,

   

December 31,

 
   

2019

   

2018

 
   

(Unaudited)

         

ASSETS

               

Current assets:

               

Cash and cash equivalents

  $ 9,020     $ 3,183  

Accounts receivable, net of allowance for doubtful accounts ($24 and $10 at September 30, 2019 and December 31, 2018, respectively)

    1,505       3,385  

Inventory, net of allowance for excess and obsolete inventory and lower of cost or estimated net realizable value adjustments ($135 and $104 at September 30, 2019 and December 31, 2018, respectively)

    838       280  

Prepaid expenses and other current assets

    1,135       1,760  

Total current assets

    12,498       8,608  

Operating lease right-of-use assets

    1,435        

Property and equipment, net

    128       201  

Other assets

    542       552  

TOTAL ASSETS

  $ 14,603     $ 9,361  
                 

LIABILITIES AND STOCKHOLDERS' EQUITY

               

Liabilities:

               

Current liabilities:

               

Accounts payable

  $ 503     $ 551  

Accrued liabilities

    1,642       3,255  

Deferred revenue

          41  

Operating lease liabilities

    1,058        

Notes payable, related party

    1,155        

Convertible note

    1,890        

Embedded derivative liability

    4        

Total current liabilities

    6,252       3,847  

Operating lease liabilities-non-current

    627        

Deferred rent

          184  

Warrant liability

    3,902       178  

Other liabilities

    315       198  

Total liabilities

    11,096       4,407  
                 

Series A non-voting convertible preferred stock, $0.01 par value; 2,700 shares authorized; 2,700 and 0 shares issued and outstanding at September 30, 2019 and December 31, 2018, respectively

    584        

Stockholders' equity :

               

Common stock, $0.01 par value; 50,000 shares authorized; 25,202 and 17,089 shares issued and outstanding at September 30, 2019 and December 31, 2018, respectively

    252       171  

Additional paid-in capital

    125,009       119,764  

Accumulated deficit

    (122,338 )     (114,981 )

Total stockholders' equity

    2,923       4,954  

TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY

  $ 14,603     $ 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 September 30,

   

Nine Months Ended September 30,

 
   

2019

   

2018

   

2019

   

2018

 

Sales:

                               

Product revenue, net

  $ 1,615     $ 3,142     $ 4,854     $ 8,870  

Other revenue

    -       -       41       13  

Total sales, net

    1,615       3,142       4,895       8,883  
                                 

Product cost of goods sold

    401       332       1,145       1,062  

Gross profit

    1,214       2,810       3,750       7,821  
                                 

Research and development

    49       45       166       152  

Sales and marketing

    1,544       3,230       6,610       9,603  

General and administrative

    1,333       1,344       4,136       4,326  

Total operating expenses

    2,926       4,619       10,912       14,081  

Operating loss

    (1,712 )     (1,809 )     (7,162 )     (6,260 )
                                 

Non-cash gain on changes in fair value of warrant liability

    1,480       267       936       971  

Non-cash gain on changes in fair value of embedded derivative liability

    669       -       423       -  

Other (expense) income, net

    (719 )     4       (1,166 )     13  
                                 

Loss before provision for income taxes

    (282 )     (1,538 )     (6,969 )     (5,276 )

Provision for income tax

    -       -       (3 )     (1 )

Net loss and comprehensive loss

  $ (282 )   $ (1,538 )   $ (6,972 )   $ (5,277 )
                                 

Net loss per share attributable to common stockholders (basic)

  $ (0.01 )   $ (0.09 )   $ (0.36 )   $ (0.31 )

Net loss per share attributable to common stockholders (diluted)

  $ (0.02 )   $ (0.11 )   $ (0.36 )   $ (0.37 )

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

    23,096       17,089       19,623       16,864  

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

    23,213       17,148       19,623       17,056  

 

 

As the Company adopted the requirements of 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)

  

   

Nine Months Ended
September 30,

 
   

2019

   

2018

 
                 

Operating activities:

               

Net loss

  $ (6,972 )   $ (5,277 )

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

               

Depreciation and amortization

    50       219  

Loss on disposal of property and equipment

    32       1  

Impairment of operating lease right-of-use assets

    125       -  

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

    270       413  

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

    28       18  

Stock option modification expense

    45       77  

Issuance of RSUs to employees

    228       -  

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

    (936 )     (971 )

Non-cash gain on embedded derivative liability

    (423 )     -  

Interest expense related to amortization of debt issuance and debt discount

    498       -  

Interest expense related to amortization of debt issuance related to related party notes payable

    16       -  

Issuance of warrants for service

    59       -  

Changes in operating assets and liabilities:

               

Accounts receivable

    1,880       1,546  

Inventory

    (558 )     89  

Prepaid expenses and other assets

    573       379  

Operating lease right-of-use assets

    679       -  

Other assets long-term

    10       48  

Accounts payable and accrued liabilities

    (1,551 )     (56 )

Operating lease liabilities

    (788 )     -  

Deferred rent

    -       (48 )

Deferred revenue

    (41 )     (13 )

Related party notes payable

    159       -  

Long-term obligations

    117       -  

Net cash (used) in operating activities

    (6,500 )     (3,575 )
                 

Investing activities:

               

Purchases of property and equipment

    (19 )     (13 )

Net cash (used) by investing activities

    (19 )     (13 )
                 

Financing activities:

               

Proceeds from preferred stock issuances, net

    2,598        

Proceeds from common stock issuances, net

    6,700       5,585  

Proceeds from issuance of notes payable, related party

    1,000        

Proceeds from exercise of options, net

    189       11  

Proceeds from stock options & RSUs sold to cover taxes

    4       1  

Proceeds from exercise of warrants

    67        

Proceeds from convertible notes, net of discount

    2,000        

Debt issuance cost

    (202 )      

Net cash provided by investing activities

    12,356       5,597  

Net increase in cash, cash equivalents, and restricted cash

    5,837       2,009  

Cash, cash equivalents and restricted cash, beginning of period

    3,658       3,673  

Cash, cash equivalents and restricted cash, end of period

  $ 9,495     $ 5,682  

 

   

Nine Months Ended September 30,

 
   

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

  $ 10     $ 7  

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

  $     $ 1  

Warrant liability transferred to equity

  $ 553     $  

Fair value of warrants issued in connection with financings

  $ 5,269     $  

 

 

As the Company adopted the requirements of 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

 

 

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

(Unaudited)

(in thousands)

 

                                   

Additional

            Total  
   

Preferred Stock

   

Common Stock

    Paid-     Accumulated     Stockholders'  

2019

 

Shares

   

Amount

   

Shares

   

Amount

    In Capital     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 convertible note – beneficial conversion feature

    -       -       -       -       184       -       184  

Balance at March 31, 2019

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

Net loss

    -       -       -       -       -       (2,501 )     (2,501 )

Down round feature adjustment related to warrants

    -       -       -       -       29       (29 )     -  

Issuance of common stock in connection with offering, net of offering costs

    -       -       3,269       33       2,434       -       2,467  

Issuance of common stock in connection with exercise of warrants

    -       -       286       3       443       -       446  

Issuance of common stock for option exercises

    -       -       83       -       189       -       189  

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

    -       -       -       -       95       -       95  

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

    -       -       -       -       7       -       7  

Stock option modification

    -       -       -       -       21       -       21  

Debt discount associated with convertible note – beneficial conversion feature

    -       -       -       -       (184 )     -       (184 )

Balance at June 30, 2019

    -     $ -       20,733     $ 207     $ 123,518     $ (122,056 )   $ 1,669  

Net loss

    -       -       -       -       -       (282 )     (282 )

Issuance of Series A Preferred Stock and common stock warrants, net of offering costs

    2,700       584       -       -       -       -       -  

Issuance of common stock in connection with offering, net of offering costs

    -       -       4,198       42       994       -       1,036  

Issuance of common stock in connection with exercise of warrants

    -       -       103       1       173       -       174  

Issuance of RSUs related to employee separation agreement

    -       -       168       2       218       -       220  

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

    -       -       -       -       68       -       68  

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

    -       -       -       -       14       -       14  

Stock option modification

    -       -       -       -       24       -       24  

Balance at September 30, 2019

    2,700     $ 584       25,202     $ 252     $ 125,009     $ (122,338 )   $ 2,923  

 

4

 

 

                                   

Additional

            Total  
   

Preferred Stock

   

Common Stock

    Paid-     Accumulated     Stockholders'  

2018

 

Shares

   

Amount

   

Shares

   

Amount

    In Capital     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  

Net loss

    -       -       -       -       -       (1,589 )     (1,589 )

Offering costs

    -       -       -       -       (6 )     -       (6 )

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

    -       -       -       -       148       -       148  

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

    -       -       -       -       6       -       6  

Balance at June 30, 2018

    -     $ -       17,089     $ 171     $ 119,433     $ (112,175 )   $ 7,429  

Net loss

    -       -       -     $ -     $ -       (1,538 )     (1,538 )

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

    -       -       -       -       163       -       163  

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

    -       -       -       -       5       -       5  

Balance at September 30, 2018

    -     $ -       17,089     $ 171     $ 119,601     $ (113,713 )   $ 6,059  

 

5

 

 

 

 NOTE 1. ORGANIZATION

  

NovaBay Pharmaceuticals, Inc. (the “Company”) 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 the wound care market, and CELLERX® for the aesthetic dermatology market. The Aganocide compounds have target applications in the dermatology and urology markets but are still in a clinical phase and not yet commercially available.

 

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 was 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. In April 2016, the Company dissolved DermaBay, a wholly-owned U.S. subsidiary that was formed to explore dermatological opportunities. Historically, the Company operated as four business segments. At the direction of its Board of Directors, the Company is now focused primarily on commercializing 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 September 30, 2019, the Company believes these resources will be sufficient to fund its operations into the second quarter of 2020. 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; and (2) raising additional capital through debt and equity financings or from other sources. The Company may issue securities, including common stock, preferred 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.

 

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.

 

6

 

 

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 September 30, 2019, the Company’s cash and cash equivalents were held in one highly-rated, major financial institution in the United States. As of 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 Standards Update (“ASU”) 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 and nine months ended September 30, 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:

 

   

September 30,

   

December 31,

 
   

2019

   

2018

 

Cash and cash equivalents

  $ 9,020     $ 3,183  

Restricted cash included in Other assets

    475       475  

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

  $ 9,495     $ 3,658  

 

The restricted cash amount included in other assets on the consolidated balance sheet represents amounts held as certificates 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 one highly-rated, major financial institution in the United States.

  

Deposits in this bank 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 institution in which the deposits are held.

 

During the nine months ended September 30, 2019 and 2018, revenues were derived primarily from sales of Avenova directly to doctors through the Company’s webstore, directly to consumers through Amazon.com, and to pharmacies via three major distribution partners.

 

During the nine months ended September 30, 2019 and 2018, revenues from our major distribution or collaboration partners greater than 10% were as follows:

 

   

Three Months Ended September 30,

   

Nine Months Ended September 30,

 

Major distribution or collaboration partner

 

2019

   

2018

   

2019

   

2018

 

Distributer A

    15

%

    25

%

    17

%

    22

%

Distributer B

    13

%

    24

%

    17

%

    25

%

Distributer C

    19

%

    25

%

    16

%

    25

%

 

7

 

 

As of September 30, 2019 and December 31, 2018, accounts receivable from our major distribution or collaboration partners greater than 10% were as follows:

 

   

September 30,

   

December 31,

 

Major distribution or collaboration partner

 

2019

   

2018

 

Distributer A

    29 %     32 %

Distributer B

    20 %     23 %

Distributer C

    16 %     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. There is a risk however that 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, a 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. Additionally, the derivative liability related to certain embedded features contained within the Convertible Note is carried at fair value. The warrant liability is also 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 or identifies amounts due that are in dispute and believes such amounts are unlikely to be collected. As of September 30, 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.

 

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 September 30, 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 $135 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.

 

8

 

 

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 amortized 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

 

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. During the third quarter of 2019, the Company recorded an impairment charge of $32 thousand related to previously capitalized software. There was no impairment charge during the three and nine months ended September 30, 2018.

 

Leases

 

In February 2016, the Financial Accounting Standards Board (the “FASB”) issued ASU 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, at an amount equal to the lease payments in a similar economic environment. Certain adjustments to the right-of-use assets 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 and Amazon.com. 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 distributor on a “sell-in” basis.

 

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 the Company fulfills its obligations under its agreements, it 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.

 

9

 

 

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 ASU 2014-09, Revenue from Contracts with Customers (Topic 606) (“ASU 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 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 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 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).

 

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.

 

10

 

 

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 (“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, “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

 

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. 

 

11

 

 

Common Stock Warrant Liability

 

The Company accounts for the issuance of common stock purchase warrants issued in connection with the equity offerings in accordance with the provisions of ASC 815, Derivatives and Hedging. The Company classifies as equity any contracts that (i) require physical settlement or net-share settlement or (ii) give the Company a choice of net-cash settlement or settlement in its own shares (physical settlement or net-share settlement). The Company classifies as assets or liabilities any contracts that (i) require net-cash settlement (including a requirement to net-cash settle the contract if an event occurs and if that event is outside the control of the Company) or (ii) give the counterparty a choice of net-cash settlement or settlement in shares (physical settlement or net-share settlement). For warrants that are classified as liabilities, the Company records the fair value of the warrants 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 Black-Scholes valuation method or the Binomial Lattice (“Lattice”) valuation model where deemed appropriate. These values are subject to a significant degree of the Company’s 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 reclassifying warrant liabilities related to outstanding warrants that have a down round feature to additional paid in capital on its March 31, 2019 consolidated balance sheet, 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, “Warrant Liability”).

 

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 earnings per share is computed using the weighted average number of common shares and, if dilutive, potential common shares outstanding during the period. Potential common shares consist of the incremental common shares issuable upon the exercise of stock options (using the treasury stock method) and the conversion of the Company’s Series A Non-Voting Convertible Preferred Stock (the “Series A Preferred Stock”) if the contingency is resolved and warrants (using the if-converted method). Diluted loss per share excludes the shares issuable upon the conversion of the Series A Preferred Stock and the exercise of stock options and warrants from the calculation of net loss per share if their effect would be antidilutive.

 

During the three months ended September 30, 2019 and 2018, the basic EPS was a net loss of $0.01 and $0.09, per share, respectively, and the diluted EPS was a net loss of $0.02 and $0.11, per share, respectively, due to the gain on changes in fair value of warrant liability. During the nine months ended September 30, 2019, both basic and diluted EPS was a net loss of $0.36 per share. During the nine months ended September 30, 2018, the basic EPS was a net loss of $0.31 per share and the diluted EPS was a net loss of $0.37 per share due to the gain on changes in fair value of warrant liability.

 

12

 

 

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

 

   

Three Months Ended September 30,

   

Nine Months Ended September 30,

 

Numerator

 

2019

   

2018

   

2019

   

2018

 

Net loss

  $ (282 )   $ (1,538 )   $ (6,972 )   $ (5,277 )

Less retained earning reduction related to round down feature triggered

    -       -       (29 )     -  

Net loss, basic

    (282 )     (1,538 )     (7,001 )     (5,277 )

Less gain on changes in fair value of warrant liability

    (75 )     (267 )     -       (971 )

Net loss, diluted

  $ (357 )   $ (1,805 )   $ (7,001 )   $ (6,248 )
                                 

Denominator

                               

Weighted average shares outstanding, basic

    23,096       17,089       19,623       16,864  

Net loss per share, basic

  $ (0.01 )   $ (0.09 )   $ (0.36 )   $ (0.31 )
                                 

Weighted average shares outstanding, basic

    23,096       17,089       19,623       16,864  

Effect of dilutive warrants

    117       59       -       192  

Weighted average shares outstanding, diluted

    23,213       17,148       19,623       17,056  

Net loss per share, diluted

  $ (0.02 )   $ (0.11 )   $ (0.36 )   $ (0.37 )

 

The following outstanding stock options, stock warrants and Series A Preferred Stock were excluded from the diluted net loss per share computation for the three and nine months ended September 30, 2019. The stock options to purchase common stock were excluded as their effect would have been anti-dilutive, the common stock warrants were excluded as they were out-of-the-money, and the Series A Preferred Stock was excluded as such preferred stock was only convertible upon shareholder approval, which occurred on October 9, 2019, subsequent to the period ended September 30, 2019. The following outstanding stock options, stock warrants and convertible preferred stock were excluded from the diluted net loss per share computation for the three and nine months ended September 30, 2019 and 2018:

 

   

Three Months Ended September 30,

   

Nine Months Ended September 30,

 

(in thousands)

 

2019

   

2018

   

2019

   

2018

 

Period end stock options to purchase common stock

    2,240       3,180       2,240       3,180  

Period end common stock warrants

    8,438       -       8,588       -  

Period end Series A Preferred Stock

    2,700       -       2,700       -  
      13,378       3,180       13,528       3,180  

 

Preferred Stock

 

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

 

The Company’s Series A Preferred Stock was classified as mezzanine equity in the Company’s consolidated balance sheet as the conversion trigger was dependent upon shareholder approval (which did not occur until after the quarter end), which is considered to be outside the control of the Company. The Company applied the fair value allocation methodology for allocating the proceeds of $2.7 million received from the Series A financing. The Company first allocated $2.0 million based on the fair value of the warrants issued in connection with the Series A financing as of the issuance date, with residual amount being allocated to the Series A Preferred Stock. Additionally, the issuance cost allocated to Series A Preferred Stock was recorded against Series A Preferred Stock in the Company’s consolidated balance sheet. See Note 12, “Stockholders’ Equity” for further discussion of the allocation of the proceeds and the issuance cost.

 

13

 

 

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 standard implemented in 2019 is the inclusion of the shareholders’ equity reconciliation to display quarter-to-quarter details.

 

Leases

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842), which replaced the prior 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 not reassessing: (1) the lease classification for any expired or existing leases, (2) the treatment of initial direct costs as they relate to existing leases, and (3) whether expired or existing contracts are or contain leases. The Company also elected the practical expedient not to separate lease and non-lease components of its operating leases in which it is the lessee.

 

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 June 2016, the FASB issued ASU 2016-13, Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. The amendments in ASU 2016-13 require a financial asset (or a group of financial assets) measured at amortized cost basis to be presented at the net amount expected to be collected. ASU 2016-13 is effective for the Company for annual and interim reporting periods beginning January 1, 2020. The Company is currently evaluating the impact ASU 2016-13 will have on its consolidated financial statements.

 

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 480, Distinguishing Liabilities from Equity (“ASC 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 reclassifying 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, “Warrant Liability”).

 

14

 

 

In June 2018, the FASB issued ASU 2018-07, Compensation—Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting. This 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.

 

As of September 30, 2019, the Company’s warrants consist of warrants to purchase the Company’s common stock issued in July 2011, March 2015, October 2015, June 2019 and August 2019, out of which the warrants issued in July 2011, October 2015 and August 2019 are classified as liabilities. 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 Black-Scholes valuation method or the Lattice valuation model where deemed appropriate. 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.

 

15

 

 

The following table presents the Company’s assets and liabilities measured at fair value on a recurring basis as of September 30, 2019:

  

           

Fair Value Measurements Using

 

(in thousands)

 

Balance at

   

Quoted Prices in

   

Significant

   

Significant

 
   

September 30,

   

Active Markets

   

Other

   

Unobservable

 
   

2019

   

for Identical

   

Observable

   

Inputs

 
           

Items

   

Inputs

   

(Level 3)

 
           

(Level 1)

   

(Level 2)

         

Assets

                               

Cash equivalents

  $     $     $     $  

Restricted cash held as a certificate of deposit

    324       324              

Deposit held as a certificate of deposit

    151       151              

Total assets

  $ 475     $ 475     $     $  
                                 

Liabilities

                               

Warrant liability

  $ 3,902     $     $     $ 3,902  

Embedded derivative liability

    4                   4  

Total liabilities

  $ 3,906     $     $     $ 3,906  

 

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 effective January 1, 2019, 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, resulting in $56 thousand of the fair value of the warrant liabilities being reclassified to stockholders’ equity. 334,109 warrants continued to be classified as a liability as of January 1, 2019, out of which 158,400 warrants were exercised in the second quarter of 2019 and 102,602 warrants were exercised in the third quarter of 2019.

 

During the three months ended September 30, 2019, the net change in fair value associated with the July 2011 and October 2015 warrants was a decrease of $228 thousand, of which $75 thousand is reported in the Company’s consolidated statement of operations as a gain from the change in fair value of warrant liabilities and approximately $153 thousand as a reclassification of the fair value of the warrant liabilities to stockholders’ equity in connection with the exercise of the warrants. During the nine months ended September 30, 2019, the net change in fair value associated with these warrants was a decrease of $84 thousand, of which $469 thousand is reported in the Company’s consolidated statement of operations as a loss from the change in fair value of warrant liabilities and approximately $553 thousand as a reclassification of the fair value of the warrant liabilities to stockholders’ equity in connection with the exercise of the warrants. In August 2019, the Company issued a total of 7,066,508 warrants to purchase 7,066,508 shares of the Company’s common stock in two security offerings. The Company recorded $5.3 million of warranty liabilities upon issuance of these warrants. During the three months and nine months ended September 30, 2019, the net change in fair value associated with these warrants resulted in a gain of $1.4 million. See Note 11, “Warranty Liability” for further discussion of the calculation of the fair value of the warrant liability.

 

16

 

 

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 and nine months ended September 30, 2019:

 

(in thousands)

 

Level 3

 
   

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 July 2011 and October 2015 warrant liability at March 31, 2019

    57  

Derivative liability embedded in Convertible Note issued in March 31, 2019

    427  

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

  $ 606  

Fair value of July 2011 and October 2015 warrants transferred to equity upon exercise

    (400 )

Increase in fair value of July 2011 and October 2015 warrant liability at June 30, 2019

    487  

Increase in fair value of embedded derivative liability at June 30, 2019

    246  

Fair value of warrant liability and embedded derivative liability at June 30, 2019

  $ 939  

Issuance of Domestic, Foreign and Ladenburg warrants

    5,269  

Decrease in fair value of July 2011 and October 2015 warrant liability at September 30, 2019

    (75 )

Decrease in fair value of Domestic, Foreign and Ladenburg warrant liability at September 30, 2019

    (1,405 )

Fair value of October 2015 warrants transferred to equity upon exercise

    (153 )

Decrease in fair value of embedded derivative liability at Sepember 30, 2019

    (669 )

Fair value of warrant liability and embedded derivative liability at September 30, 2019

  $ 3,906  

 

  

 

NOTE 4. PREPAID EXPENSES AND OTHER CURRENT ASSETS

 

Prepaid expenses and other current assets consisted of the following:

 

(in thousands)

 

September 30,

   

December 31,

 
   

2019

   

2018

 

Prepaid sales rebates

  $ 550     $ 925  

Rent receivable

    83       108  

Prepaid rent

    -       130  

Prepaid employees’ benefits

    6       113  

Prepaid dues and subscription

    42       130  

Prepaid Insurance

    175       57  

Other

    279       297  

Total prepaid expenses and other current assets

  $ 1,135     $ 1,760  

 

17

 

 

 

NOTE 5. INVENTORY   

 

Inventory consisted of the following:

 

(in thousands)

 

September 30,

   

December 31,

 
   

2019

   

2018

 

Raw materials and supplies

  $ 176     $ 217  

Finished goods

    797       167  

Less: Reserve for excess and obsolete inventory

    (135 )     (104 )

Total inventory, net

  $ 838     $ 280  

 

 

NOTE 6. PROPERTY AND EQUIPMENT

 

Property and equipment consisted of the following:

 

 

 

September 30,

   

December 31,

 
(in thousands)  

2019

   

2018

 

Office and laboratory equipment

  $ 24     $ 24  

Furniture and fixtures

    157       157  

Computer equipment and software

    362       385  

Production equipment

    65       65  

Leasehold improvements

    79       79  

Total property and equipment, at cost

    687       710  

Less: accumulated depreciation and amortization

    (559 )     (509 )

Total property and equipment, net

  $ 128     $ 201  

 

18

 

 

Depreciation and amortization expense was $17 thousand and $92 thousand for the three months ended September 30, 2019 and 2018, respectively, and $50 thousand and $219 thousand for the nine months ended September 30, 2019 and 2018, respectively. During the three months and nine months ended September 30, 2019, the Company recorded an impairment charge of $32 thousand related to previously capitalized software. There was no impairment charge during the three and nine months ended September 30, 2018.

 

 

 

NOTE 7. ACCRUED LIABILITIES

 

Accrued liabilities consisted of the following:

 

(in thousands)

 

September 30,

   

December 31,

 
   

2019

   

2018

 

Employee payroll and benefits

  $ 552     $ 708  

Avenova contract liabilities

    983       2,282  

Deferred rent

    -       101  

Other

    107       164  

Total accrued liabilities

  $ 1,642     $ 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 September 30, 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 the 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 September 30, 2019.

 

19

 

 

Legal Matters

 

From time to time, the Company may be involved in various legal proceedings arising in the ordinary course of business. On July 29, 2019, Mr. John McGovern, the Company’s former Interim President & Chief Executive Officer and Chief Financial Officer, submitted a demand for arbitration seeking severance in the amount of $370,000 as well as additional damages in connection with his separation from service with the Company. The Company does not believe the claims asserted by Mr. McGovern have any merit, and the Company intends to defend against all such claims. As of September 30, 2019, there are no other matters 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, California (“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, California (“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 had an operating lease for 2 copiers which expired 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 assets 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 assets and lease liability, but are reflected as an expense in the period incurred.

 

The components of lease expense for the three and nine months ended September 30, 2019 were as follows (in thousands except lease term and discount rate):

 

Lease Costs

 

Three months ended

    Nine months ended  
    September 30, 2019    

September 30, 2019

 

Operating lease cost

  $ 273     $ 861  

Sublease income

    (158 )     (474 )

Net lease cost

  $ 115     $ 387  
                 

Other information

               

Operational cash flow used for operating leases

  $ 322     $ 970  

 

   

September 30, 2019

 

Weighted-average remaining lease term (in years)

    1.8  

Weighted-average discount rate

    12 %

   

20

 

 

Future lease payments under non-cancelable leases as of September 30, 2019 were as follows (in thousands):

 

Remaining in 2019

  $ 323  

2020

    1,045  

2021

    438  

2022

    75  

Thereafter

     

Total future minimum lease payments

    1,881  

Less imputed interest

    (196 )

Total

  $ 1,685  
         

Reported as:

       

Operating lease liability

  $ 1,058  

Operating lease liability- non-current

    627  

Total

  $ 1,685  

 

 

Future lease payments to be received under non-cancelable leases as of September 30, 2019 were as follows (in thousands):

 

Remaining in 2019

  $ 192  

2020

    577  

2021

     

2022

     

Thereafter

     

Total future minimum lease payments

  $ 769  

 

 

 

NOTE 9. RELATED PARTY NOTES PAYABLE

 

On February 27, 2019, the Company issued a $1.0 million promissory note payable to Pioneer Pharma (Hong Kong) Company Ltd. (“Pioneer Hong Kong”), which was amended on June 25, 2019 (the “Promissory Note”). The Promissory Note currently bears an interest payment of $300 thousand (initially $150 thousand) and is payable in full upon the Company's next financing with Pioneer Hong Kong and in no event after July 1, 2020 (an extension per the June amendment from the initial maturity date of 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 paid China Kington a 2% fee for brokering the transaction and has entered into a consulting agreement with China Kington for a 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 such 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 1, 2020. The Company determined that the changes in the terms of Promissory Note per the June amendment are accounted for as troubled debt restructurings in accordance with ASC 470, Debt. However, as future undiscounted cash flow is greater than the net carrying value of the original Promissory Note, no gain was recognized. The Company established a new effective interest rate based on the carrying value of the original debt and the revised cash flows.

 

The interest expense recognized, including amortization of the issuance costs, was $45 thousand and $175 thousand during the three and nine months ended September 30, 2019, respectively.

 

21

 

 

The Promissory Note is presented as follows as of September 30, 2019:

 

(in thousands)

       

Principal amount

  $ 1,000  

Unamortized debt issuance costs

    (4 )

Accrued interst

    159  

Total debt

    1,155  

Less: short-term

    1,155  

Long-term

  $  

 

 

 

NOTE 10. CONVERTIBLE NOTE

 

On March 26, 2019 (the “Closing Date”), the Company entered into a Securities 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 an additional $182 thousand of debt issuance costs associated with the issuance of the Convertible Note.

 

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 first 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 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 model. The key assumptions used to value the combined embedded derivative upon issuance at 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  

 

22

 

 

The key assumptions used to value the combined embedded derivative as of September 30, 2019 were as follows:

 

   

As of

 

Assumption

 

September 30, 2019

 

Stock price

  $ 0.61  

Equity volatility

    179.1

%

Risk-free interest rate

    1.75

%

Remaining term

    0.99  

 

The fair value of the combined embedded derivative was $4 thousand as of September 30, 2019. During the three months and nine months ended September 30, 2019, the Company recorded a gain of $669 thousand and $423 thousand, respectively, in the consolidated statements of operations and comprehensive loss.

 

The aggregate $627 thousand discount, including the original issue discount, and the aggregate $197 thousand of debt issuance costs, including the Company’s issuance costs and payment for the Lender’s transaction fees, were recorded at issuance, and were classified as an offset to the Convertible Note on the consolidated balance sheet. The Convertible Note is presented as follows as of September 30, 2019:

 

(in thousands)

       

Principal amount

  $ 2,215  

Unamortized discount

    (248 )

Unamortized debt issuance costs

    (77 )

Total debt

    1,890  

Less: short-term

    1,890  

Long-term

  $  

 

 

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 and nine months ended September 30, 2019, the effective interest rate on the Convertible Note was 52% and 53%, respectively. Interest expense recognized, including amortization of the issuance costs and debt discount, was $293 thousand and $615 thousand during the three and nine months ended September 30, 2019, respectively.

 

On August 8, 2019, the Company entered into a securities purchase agreement for the sale and issuance of 4,198,566 shares of common stock at an offering price of $1.00 per share. The securities purchase agreement prohibits the Company from redeeming in common stock or common stock equivalents in satisfaction of the Promissory Note with Iliad Research & Trading, L.P. and may only issue common stock in satisfaction of the Promissory Note if the stock price equals or exceeds $2.00. See Note 10, “Convertible Note”, for detailed information related to the convertible note. See Note 12, “Stockholders’ Equity” for further discussion of the terms of the purchase agreement.

 

The Lender redeemed $200 thousand of the Convertible Note on September 27, 2019 and October 7, 2019, which the Company chose to pay in cash pursuant to the terms of the Securities Purchase Agreement entered into by the Company, dated August 8, 2019. The payments were made on October 1, 2019 and October 11, 2019 respectively. As of September 30, 2019, the Company's contractual maturity of the principal balance of the Convertible Note was as follows:

 

(in thousands)

       

Remainder of 2019

  $ 800  

2020

    1,415  

2021 and thereafter

     

Total

  $ 2,215  

 

23

 
 

 

 

NOTE 11. 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, 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.

 

In October 2015, the holders of all warrants issued pursuant to the Company’s securities purchase agreement, dated March 3, 2015, 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 defined 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 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 Warrants, March 2015 Warrants 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. 

 

In May 2019, the strike price of the July 2011 Warrants, March 2015 Warrants and October 2015 Warrants was further reduced to $0.2061 per share, pursuant to the price protection provisions in such warrants, because the Company sold common stock to Triton Funds LP at that price.

 

The key assumptions used to value the July 2011 Warrants as of September 30, 2019 and December 31, 2018 were as follows:

 

   

As of

 
   

September 30,

   

December 31,

 

Assumption

 

2019

   

2018

 

Expected price volatility

    234

%

    77

%

Expected term (in years)

    0.43       1.18  

Risk-free interest rate

    1.84

%

    2.60

%

Dividend yield

    0.00

%

    0.00

%

Weighted-average fair value of warrants

  $ 0.53     $ 0.29  

 

24

 

 

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 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.

 

As described in Note 2, “Summary of Significant Account Policies,” upon adoption of ASU 2017-11, the Company determined that excluding the consideration of the down round provision, the Long-Term and the Short-Term Warrants are considered to be indexed to the Company’s stock and should be classified in equity. The Company reclassified warrant liabilities related to the Long-Term Warrants 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.

  

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 September 30, 2019 and December 31, 2018 were as follows:

 

   

As of

 
   

September 30,

   

December 31,

 

Assumption

 

2019

   

2018

 

Expected price volatility

    178

%

    73

%

Expected term (in years)

    1.08       1.83  

Risk-free interest rate

    1.74

%

    2.51

%

Dividend yield

    0.00

%

    0.00

%

Weighted-average fair value of warrants

  $ 0.52     $ 0.38  

 

25

 

 

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 warrants issued in October 2015, November 2015 and December 2015 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 Short-Term Warrants 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.

 

During the second quarter of 2019, a total of 158,400 warrants to purchase 158,400 shares of common stock were exercised related to the July 2011 Warrants and October 2015 Warrants resulting in gross proceeds of $33 thousand. Upon exercise, the warrant liability associated with these warrants was adjusted to its fair value as of the date of exercise of $0.4 million, with any change in fair value recorded in the consolidated statement of operations and comprehensive loss. The $0.4 million fair value was subsequently transferred to equity as of the date of their exercise.

 

During the third quarter of 2019, a total of 102,602 warrants to purchase 102,602 shares of common stock were exercised related to the October 2015 Warrants resulting in gross proceeds of $21 thousand. Upon exercise, the warrant liability associated with these warrants was adjusted to its fair value as of the date of exercise of $0.2 million, with any change in fair value recorded in the consolidated statement of operations and comprehensive loss. The $0.2 million fair value was subsequently transferred to equity as of the date of their exercise.

 

In August 2019, the Company issued: (1) warrants to purchase up to 4,198,566 shares of Company common stock to certain domestic investors in connection with its registered direct offering of 4,198,566 shares of common stock (the “2019 Domestic Warrants”); (2) warrants to purchase up to 2,700,000 shares of Company common stock to certain foreign investors in connection with a private placement of the Series A Preferred Stock (the “2019 Foreign Warrants”); and (3) warrants to purchase up to 167,942 shares of Company common stock to Ladenburg Thalmann & Co., Inc. for its services as placement agent in the registered direct offering (the “2019 Ladenburg Warrants”). See Note 12, “Stockholders’ Equity” for further discussion of the terms of the financing transactions in August 2019.

 

The 2019 Domestic Warrants are exercisable six months after the date of issuance and will expire on February 13, 2025, with an exercise price of $1.15. The terms of the 2019 Domestic 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. The 2019 Domestic 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 the 2019 Domestic Warrants be classified as liabilities. The fair values of these warrants have been determined using the Black-Scholes 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 2019 Domestic Warrants at issuance on August 13, 2019 was $3.1 million. 

 

26

 

 

The key assumptions used to value the 2019 Domestic Warrants as of August 13, 2019 were as follows:

 

   

As of

 
   

August 13,

 

Assumption

 

2019

 

Expected price volatility

    149.29

%

Expected term (in years)

    5.50  

Risk-free interest rate

    1.58

%

Dividend yield

    0.00

%

Weighted-average fair value of warrants

  $ 0.75  

 

The key assumptions used to value the 2019 Domestic Warrants as of September 30, 2019 were as follows:

 

   

As of

 
   

September 30,

 

Assumption

 

2019

 

Expected price volatility

    151.33

%

Expected term (in years)

    5.38  

Risk-free interest rate

    1.56

%

Dividend yield

    0.00

%

Weighted-average fair value of warrants

  $ 0.55  

 

The 2019 Ladenburg Warrants were exercisable immediately upon issuance and will expire on August 8, 2024, with an exercise price of $1.25. The terms of the 2019 Ladenburg Warrants are consistent with the 2019 Domestic Warrants, and therefore were classified as liabilities in accordance with ASC 480. The fair values of these warrants have been determined using the Black-Scholes 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 2019 Ladenburg Warrants at issuance on August 13, 2019 was $124 thousand. 

 

The key assumptions used to value the 2019 Ladenburg Warrants as of August 13, 2019 were as follows:

 

   

As of

 
   

August 13,

 

Assumption

 

2019

 

Expected price volatility

    155.19

%

Expected term (in years)

    5.00  

Risk-free interest rate

    1.57

%

Dividend yield

    0.00

%

Weighted-average fair value of warrants

  $ 0.74  

 

The key assumptions used to value the 2019 Ladenburg Warrants as of September 30, 2019 were as follows:

 

   

As of

 
   

September 30,

 

Assumption

 

2019

 

Expected price volatility

    156.63

%

Expected term (in years)

    4.86  

Risk-free interest rate

    1.55

%

Dividend yield

    0.00

%

Weighted-average fair value of warrants

  $ 0.54  

 

The 2019 Foreign Warrants were exercisable upon shareholders’ approval, which was received on October 9, 2019, and will expire on February 13, 2025, with an exercise price of $1.15. The terms of the warrants are consistent with the 2019 Domestic Warrants, and therefore were classified as liabilities in accordance with ASC 480. The fair values of these warrants have been determined using the Black-Scholes 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 2019 Foreign Warrants at issuance on August 13, 2019 was $2.0 million. 

 

27

 

 

 The key assumptions used to value the 2019 Foreign Warrants as of August 13, 2019 were as follows:

 

   

As of

 
   

August 13,

 

Assumption

 

2019

 

Expected price volatility

    149.29

%

Expected term (in years)

    5.50  

Risk-free interest rate

    1.58

%

Dividend yield

    0.00

%

Weighted-average fair value of warrants

  $ 0.75  

 

The key assumptions used to value the 2019 Foreign Warrants as of September 30, 2019 were as follows:

 

   

As of

 
   

September 30,

 

Assumption

 

2019

 

Expected price volatility

    151.33

%

Expected term (in years)

    5.38  

Risk-free interest rate

    1.56

%

Dividend yield

    0.00

%

Weighted-average fair value of warrants

  $ 0.55  

 

The details of the outstanding warrant liability as of September 30, 2019, were as follows:

 

 

 

 

   

Warrant

 
Shares and dollars in thousands   Shares    

Liability

 

July 2011 Warrants

    35     $ 18  

October 2015 Warrants

    38       20  

2019 Domestic Warrants

    4,199       2,296  

2019 Foreign Warrants

    2,700       1,477  

2019 Ladenburg Warrants

    168       91