RXII Rxi Pharmaceuticals Corp. (MM)

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1. Nature of Operations

RXi Pharmaceuticals Corporation (“ RXi ,” “ we ,” “ our ” or the “ Company ”) is a biotechnology company developing the next generation of immuno-oncology therapeutics based on its self-delivering RNAi (“ sd-rxRNA ^® ”) therapeutic platform. The Company’s sd-rxRNA compounds do not require a delivery vehicle to penetrate the cell and are designed to “silence,” or down-regulate, the expression of a specific gene that may be over-expressed in a disease condition. We believe that this provides RXi with a distinct advantage in adoptive cell transfer therapy, the Company’s initial focus and approach to immuno-oncology.

Prior to RXi’s acquisition of MirImmune Inc. in January 2017, the Company’s principal activities consisted of the preclinical and clinical development of the Company’s sd-rxRNA compounds and topical immunotherapy agent in the areas of dermatology and ophthalmology. In January 2018, after a thorough review of its business operations, development programs and financial resources, the Company made a strategic decision to focus solely on immuno-oncology to accelerate growth and support a potential return on investment for its stockholders. The Company’s business strategy focuses on the development of immuno-oncology therapeutics utilizing our proprietary sd-rxRNA technology. The Company intends to seek a partner and/or out-licensee for each of its dermatology and ophthalmology franchises, including RXI-109 and Samcyprone™, to continue their development. The goal of any such transaction would be to allow the Company to monetize these preclinical and clinical assets to further fund ongoing and future development work in our immuno-oncology programs and extend our financial runway.

On January 3, 2018, the Board of Directors of the Company approved a 1-for-10 reverse stock split of the Company’s outstanding common stock, which was effected on January 8, 2018. All share and per share amounts in the financial statements have been retroactively adjusted for all periods presented to give effect to the reverse stock split, including reclassifying an amount equal to the reduction in par value to additional paid-in capital.

2. Liquidity and Going Concern

The Company has limited cash resources and has expended substantial funds on the research and development of the Company’s product candidates and funding general operations. As a result, the Company has reported recurring losses from operations since inception and expects that the Company will continue to have negative cash flows from its operations for the foreseeable future. Historically, the Company’s primary source of financing has been the sale of its securities. The Company’s ability to continue to fund its operations is dependent on the amount of cash on hand and its ability to raise additional capital through, but not limited to, equity or debt offerings or strategic opportunities. This is dependent on a number of factors, including the market demand or liquidity of the Company’s common stock. There can be no assurance that the Company will be successful in accomplishing these plans.

The funds available under the Company’s purchase agreement with Lincoln Park Capital Fund, LLC (“ LPC ”) should provide the Company with sufficient cash to fund operations for at least the next twelve months. However, certain ownership limitations under the terms of the purchase agreement preclude the Company from relying on the full available funds for going concern purposes. As a result, the Company has concluded that there is substantial doubt regarding its ability to continue as a going concern for at least the next twelve months. If the Company fails to obtain additional funding when needed, the Company would be forced to scale back or terminate its operations or to seek to merge with or to be acquired by another company. These financial statements do not include any adjustments to, or classification of, recorded asset amounts and classification of liabilities that might be necessary should the Company be unable to continue as a going concern.

3. Significant Accounting Policies

Basis of Presentation

The accompanying condensed consolidated financial statements are unaudited and have been prepared in accordance with accounting principles generally accepted in the United States of America (“ GAAP ”). Certain information and footnote disclosures included in the Company’s annual financial statements have been condensed or omitted. The year-end condensed balance sheet data was derived from audited financial statements, but does not include all disclosures required by GAAP. In the opinion of management, all adjustments (including normal recurring accruals) considered necessary for a fair presentation of the condensed consolidated financial statements have been included. Interim results are not necessarily indicative of results for a full year.

Principles of Consolidation

The consolidated financial statements include the accounts of RXi Pharmaceuticals Corporation and its wholly-owned subsidiary, MirImmune, LLC. All material intercompany accounts have been eliminated in consolidation.

Uses of Estimates in Preparation of Financial Statements

The preparation of financial statements in accordance with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ materially from these estimates.

Cash Equivalents and Restricted Cash

The Company considers all highly liquid instruments with an original maturity of three months or less to be cash equivalents. Cash equivalents consist primarily of amounts invested in certificates of deposit.

Restricted cash consists of certificates of deposit held by financial institutions as collateral for the Company’s corporate credit cards.

Fair Value of Financial Instruments

The carrying amounts reported in the balance sheet for cash equivalents, restricted cash, accounts payable and accrued expenses approximate their fair values due to their short-term nature.

Research and Development Expenses

Research and development costs relate to salaries, employee benefits, facility-related expenses, supplies, stock-based compensation related to employees and non-employees involved in the Company’s research and development, external services, other operating costs and overhead related to its research and development departments, costs to acquire technology licenses and expenses associated with preclinical activities and its clinical trials. Research and development expenses are charged to expense as incurred. Payments made by the Company in advance for research and development services not yet provided and/or for materials not yet received are recorded as prepaid expenses and expensed when the service has been performed or when the goods have been received. Accrued liabilities are recorded related to those expenses for which vendors have not yet billed the Company with respect to services provided and/or materials that it has received.

Preclinical and clinical trial expenses relate to estimates of costs incurred and fees connected with clinical trial sites, third-party clinical research organizations and other preclinical and clinical related activities and include such items as subject-related fees, laboratory work, investigator fees and analysis costs. Costs associated with these expenses are generally payable on the passage of time or when certain milestones are achieved. Expense is recorded during the period incurred or in the period in which a milestone is achieved. In order to ensure that the Company has adequately provided for preclinical and clinical expenses during the proper period, the Company maintains an accrual to cover these expenses. These accruals are assessed on a quarterly basis and are based on such assumptions as expected total cost, the length of the study, timing of certain milestones and other information available to us. Actual results may differ from these estimates and could have a material impact on the Company’s reported results. The Company’s historical accrual estimates have not been materially different from its actual costs.

Stock-based Compensation

The Company follows the provisions of the Financial Accounting Standards Board (“ FASB ”) Accounting Standards Codification (“ ASC ”) Topic 718, “ Compensation — Stock Compensation ” (“ ASC 718 ”), which requires the measurement and recognition of compensation expense for all stock-based payment awards made to employees, officers, non-employee directors, and non-employees, including stock options. Stock compensation expense based on the grant date fair value estimated in accordance with the provisions of ASC 718 is recognized as an expense over the requisite service period.

Income Taxes

The Company recognizes assets or liabilities for the deferred tax consequences of temporary differences between the tax basis of assets or liabilities and their reported amounts in the financial statements in accordance with the FASB ASC Topic 740,  “Accounting for Income Taxes”. On December 22, 2017, the President of the United States signed into law the Tax Cuts and Jobs Act tax reform legislation. This legislation makes significant changes in U.S. tax law including a reduction in the corporate tax rates, changes to net operating loss carryforwards and carrybacks, and a repeal of the corporate alternative minimum tax. There has been no impact to the Company’s income tax expense as a result of the Tax Cuts and Jobs Act. The Company is still assessing the impact of the Tax Cuts and Jobs Act and does not expect the other provisions to have a material impact on the Company’s financial statements.

Comprehensive Loss

The Company’s comprehensive loss is equal to its net loss for all periods presented.

Net Loss per Share

The Company accounts for and discloses net loss per share in accordance with the FASB ASC Topic 260, “ Earnings per Share”. Basic and diluted net loss per share is computed by dividing net loss by the weighted average number of common shares outstanding. Diluted earnings per share is computed by dividing the Company’s net earnings by the weighted average number of common shares outstanding and the impact of all dilutive potential common shares.

4. Recent Accounting Pronouncements

In May 2014, the FASB issued Accounting Standards Update (“ ASU ”) 2014-09, “ Revenue from Contracts with Customers (Topic 606) ”. ASU 2014-09 states that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. On July 9, 2015, the FASB voted to delay the effective date of the new revenue standard by one year but to permit entities to choose to adopt the standard as of the original effective date. In March 2016, the FASB issued ASU 2016-08, “ Revenue from Contracts with Customers (Topic 606) – Principal Versus Agent Considerations,”  which improves the operability and understandability of the implementation guidance on principal versus agent considerations. In April 2016, the FASB issued ASU 2016-10, “ Revenue from Contracts with Customers (Topic 606) – Identifying Performance Obligations and Licensing ,” which clarifies two aspects of the guidance on accounting for revenue contracts with customers: identifying performance obligations and the licensing implementation guidance. In May 2016, the FASB issued ASU 2016-12, “ Revenue from Contracts with Customers (Topic 606) – Narrow Scope Improvements and Practical Expedient s,” which addresses collectability assessment, presentation of sales taxes, noncash consideration and completed contracts and contract modifications at transition. The amendments in these ASUs do not change the core principles for those areas. This standard became effective for annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period. Early adoption is not permitted. The Company adopted this ASU in the first quarter of 2018. Since the Company has no significant revenue, this ASU had no immediate impact on its consolidated financial statements.

In February 2016, the FASB issued ASU 2016-02, “ Leases (Topic 842) ,” which requires companies that are lessees to recognize a right-of-use asset and lease liability for most leases that do not meet the definition of a short-term lease. For income statement purposes, leases will continue to be classified as either operating or financing. Classification will be based on criteria that are largely similar to those applied in current lease accounting. This standard will result in extensive qualitative and quantitative disclosure changes. This standard will be effective for annual reporting periods beginning after December 15, 2018, including interim periods within that reporting period. The Company is currently evaluating the impact of this ASU on its consolidated financial statements.

In June 2018, the FASB issued ASU 2018-07, “ Compensation – Stock Compensation (Topic 718) – Improvements to Nonemployee Share-Based Payment Accounting ,” which expands the scope of Topic 718 to include share-based payment transactions for acquiring goods and services from non-employees. The amendment specifies that Topic 718 applies to all share-based payment transactions in which a grantor acquires goods or services to be used or consumed in a grantor’s own operations by issuing share-based payment awards. This standard will be effective for annual reporting periods beginning after December 15, 2018, including interim periods within that reporting period. Early adoption is permitted, but no earlier than an entity’s adoption date of Topic 606. The Company early adopted this ASU in the second quarter of 2018. The ASU had no material impact on the Company’s consolidated financial statements.

5. Stockholders’ Equity

Lincoln Park Capital Fund, LLC – On August 8, 2017, the Company entered into a purchase agreement (the “ LPC Purchase Agreement ”) and a registration rights agreement with LPC, pursuant to which the Company has the right to sell to LPC shares of the Company’s common stock, subject to certain limitations and conditions set forth in the LPC Purchase Agreement.

During the three months ended June 30, 2018, the Company sold 150,000 shares of common stock to LPC for net proceeds of approximately $359,000. During the six months ended June 30, 2018, the Company sold 420,000 shares of common stock to LPC for net proceeds of approximately $1,291,000.

April 2018 Registered Direct Offering and Private Placement – On April 11, 2018, the Company closed a registered direct offering of 1,510,604 shares of the Company’s common stock at a purchase price of $3.15 per share (the “ Offering ”) pursuant to the Securities Purchase Agreement dated as of April 9, 2018, by and among the Company and each purchaser identified on the signature pages thereto. In a concurrent private placement, the Company sold warrants (the “ Warrants ”) to purchase a total of 1,132,953 shares of common stock at a purchase price of $0.125 per underlying warrant share and with an exercise price of $3.15 per share (the “ Private Placement ”). In connection with the Offering and Private Placement, the Company issued warrants to purchase a total of 75,530 shares of common stock with an exercise price of $4.0546 per share to the placement agent, H.C. Wainwright & Co., LLC (the “ Placement Agent Warrants ”). Assuming the Warrants and Placement Agent Warrants are not exercised, net proceeds to the Company from the Offering and Private Placement were $4,210,000 after deducting placement agent fees and offering expenses paid by the Company.

The Company assessed the Warrants and Placement Agent Warrants under the FASB ASC Topic 480, “ Distinguishing Liabilities from Equity ” (“ ASC 480 ”) and determined that the Warrants and Placement Agent Warrants were outside the scope of ASC 480. The Company next assessed the Warrants and Placement Agent Warrants under the FASB ASC Topic 815, “ Derivatives and Hedging ” (“ ASC 815 ”). Under the related guidance, a reporting entity shall not consider a contract to be a derivative instrument if the contract is both (1) indexed to the entity’s own stock and (2) classified in stockholders’ equity. The Company determined that the Warrants and Placement Agent Warrants were indexed to the Company’s stock, as the agreements do not contain any exercise contingencies and the settlement amount equals the difference between the fair value of the Company’s common stock price and the strike price. The Company also assessed the classification in stockholders’ equity and determined the Warrants and Placement Agent Warrants met all of the criteria for classification as equity under ASC 815. Based on this analysis, the Company determined that the Warrants and Placement Agent Warrants would be classified in stockholders’ equity.

Warrants — The following table summarizes the Company’s outstanding equity-classified warrants at June 30, 2018:

6. Net Loss per Share

The following table sets forth the potential common shares excluded from the calculation of net loss per share because their inclusion would be anti-dilutive:

7. Stock-based Compensation

The Company uses the Black-Scholes option-pricing model to determine the fair value of all its option grants. For valuing options granted during the three and six months ended June 30, 2018 and 2017, the following assumptions were used:

The weighted average fair value of options granted during the three months ended June 30, 2018 and 2017 was $1.72 and $4.70, respectively. The weighted average fair value of options granted during the six months ended June 30, 2018 and 2017 was $2.80 and $4.90, respectively.

The risk-free interest rate used for each grant is based upon the yield on zero-coupon U.S. Treasury securities with a term similar to the expected life of the related option. The Company’s expected stock price volatility assumption is based upon the Company’s own implied volatility. The expected life assumption for option grants is based upon the simplified method provided for under ASC 718. The dividend yield assumption is based upon the fact that the Company has never paid cash dividends and presently has no intention of paying cash dividends.

The following table summarizes the activity of Company’s stock option plan for the six months ended June 30, 2018:

The Company recorded stock-based compensation expense in the condensed consolidated statement of operations for the three and six months ended June 30, 2018 and 2017 as follows, in thousands: