HILS Hillstream BioPharma Inc

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

Note 1 – Description of Business and Liquidity

Nature of Operations

Hillstream BioPharma, Inc. (“HBI”) was incorporated on March 28, 2017, as a Delaware C-corporation. At September 30, 2022, Hillstream BioPharma, Inc. had two wholly-owned subsidiaries: HB Pharma Corp. (“HB”) and Farrington Therapeutics LLC (“Farrington” and together with HBI and HB, the “Company”).

The Company is a pre-clinical biotechnology company developing novel therapeutic candidates targeting ferroptosis, an emerging new anti-cancer mechanism resulting in iron mediated cell death (“IMCD”) for treatment resistant cancers. The Company’s most advanced product candidate is HSB-1216, an IMCD modulator, targeting a variety of solid tumors. The active drug in HSB-1216 was found to reduce tumor burden in a clinical pilot study in Germany in treatment resistant cancers, including triple negative breast cancer and epithelial carcinomas. The Company’s goal is to file an investigational new drug application (“IND”) with the U.S. Food and Drug Administration (“FDA”) in 2023 and start a clinical study with HSB-1216 in 2023; however, no assurance can be provided that the Company’s IND will be accepted by the FDA in 2023, if at all. If the IND is accepted by the FDA, the HSB-1216 clinical study will focus on expanding upon the clinical pilot study conducted in Germany. If the Company is able to start the clinical study with HSB-1216 in 2023, the Company anticipates that initial data from such trial will be released either at the end of 2023 or early 2024. The Company uses Quatramer™, the proprietary tumor targeting platform, to enhance the uptake of HSB-1216 in the tumor microenvironment with an extended duration of action and minimal off-target toxicity. The discovery of regulated cell death processes, such as apoptosis and autophagy, has enabled novel target discovery for drug development. Ferroptosis, a form of IMCD, is an emerging regulated cell death process which decreases intracellular iron or the Labile Iron Pool (“LIP”). Cancer cells increase the LIP leading to unregulated cell growth and metabolism. Decreasing the LIP, induces iron-led reactive oxygen species production and lipid peroxidation, two key hallmarks of ferroptosis/IMCD. HSB-1216 binds iron in the cytoplasm of cancer cells and decreases the LIP, thereby inducing ferroptosis/IMCD, leading to regulated cell death. Areas of interest for the development of HSB-1216 are as a treatment of solid tumors, including small cell lung cancer, metastatic castration resistant prostate cancer, triple negative breast cancer, uveal melanoma, glioblastoma multiforme, head and neck squamous cell carcinoma, and other treatment resistant cancers with high unmet need.

Liquidity

The accompanying condensed consolidated financial statements have been prepared on the basis that the Company is a going concern, which contemplates, among other things, the realization of assets and satisfaction of liabilities in the normal course of business. For the nine months ended September 30, 2022, the Company incurred operating losses in the amount of approximately $5.1 million, expended approximately $5.5 million in cash in operating activities, and had an accumulated deficit of approximately $13.6 million as of September 30, 2022. The Company financed its working capital requirements through September 30, 2022 primarily through the issuance of common stock in its initial public offering (“IPO”). Net proceeds to the Company from the IPO were approximately $13.0 million. See Note 5 to the condensed consolidated financial statements for details regarding the IPO. The shares of the Company’s common stock began trading on The Nasdaq Capital Market on January 12, 2022 under the ticker symbol “HILS”.

The Company believes its cash on hand as of September 30, 2022 is sufficient to meet its operating obligations and capital requirements for at least 12 months from the filing date of this Quarterly Report on Form 10-Q. Thereafter, the Company may need to raise further capital through the sale of additional equity or debt securities or other debt instruments, strategic relationships or grants or other arrangements to support its future operations. If such funding is not available, or not available on terms acceptable to the Company, the Company’s current development plan may be curtailed.

Other Risks and Uncertainties

There can be no assurance that the Company’s products, if approved, will be accepted in the marketplace, nor can there be any assurance that any future products can be developed or manufactured at an acceptable cost and with appropriate performance characteristics, or that such products will be successfully marketed, if at all. The Company is subject to risks common to biopharmaceutical companies including, but not limited to, the development of new technological innovations, dependence on key personnel, protection of proprietary technology, compliance with government regulations, product liability, uncertainty of market acceptance of products and the need to obtain additional financing. The Company is dependent on third party suppliers. The Company’s products require approval or clearance from the FDA prior to commencing commercial sales in the United States. Approvals or clearances are also required in foreign jurisdictions in which the Company may license or sell its products. There can be no assurance that the Company’s products will receive all of the required approvals or clearances.

COVID-19 Considerations

On March 11, 2020, the World Health Organization characterized the outbreak of a novel strain of coronavirus (“COVID-19”) as a pandemic, prompting many national, regional, and local governments to implement preventative or protective measures, such as travel and business restrictions, temporary store closures and capacity limitations, and wide-sweeping quarantines and stay-at-home orders. As a result, COVID-19 and the related restrictive measures have had a significant adverse impact upon many sectors of the economy.

As a result of the COVID-19 pandemic, the Company had to delay the start of its IND enabling studies for over a year. As the COVID-19 situation continues to evolve, the Company intends to closely monitor the impact of the COVID-19 pandemic on all aspects of its business, including, but not limited to, impacts on third-party contractors, suppliers, vendors and employees. The Company believes that the ultimate impact of the COVID-19 pandemic on operating results, cash flows, and financial condition is likely to be determined by factors which are uncertain, unpredictable, and outside of the Company’s control. The situation surrounding COVID-19 remains fluid, and if disruptions arise, they could have a material adverse impact on the Company’s business.

Note 2 – Summary of Significant Accounting Policies

Basis of Presentation

The accompanying unaudited condensed consolidated interim financial statements have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”) for interim financial reporting. These financial statements are unaudited and, in the opinion of management, include all adjustments (consisting of normal recurring adjustments and accruals) necessary for a fair statement of the balance sheet, operating results, and cash flows for the periods presented in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”). Operating results for the three and nine months ended September 30, 2022 are not necessarily indicative of the results that may be expected for the fiscal year ending December 31, 2022 or any other future period. Certain information and footnote disclosure normally included in the annual financial statements prepared in accordance with U.S. GAAP have been omitted in accordance with the SEC’s rules and regulations for interim reporting. The Company’s financial position, results of operations, and cash flows are presented in U.S. Dollars. These financial statements and related notes should be read in conjunction with the audited financial statements and related notes thereto for the year ended December 31, 2021 included in the Company’s Annual Report on Form 10-K filed with the SEC on April 1, 2022. The Company operates in one segment.

Principles of Consolidation

The condensed consolidated financial statements include the accounts of HBI and its wholly-owned subsidiaries, HB and Farrington. All significant intercompany balances and transactions have been eliminated in consolidation.

Use of Estimates

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities as of the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Management bases its estimates on historical experience and on assumptions believed to be reasonable under the circumstances. The estimation process often may yield a range of potentially reasonable estimates of the ultimate future outcomes, and management must select an amount that falls within that range of reasonable estimates. Estimates are used in the following areas, among others: research and development expense recognition, valuation of common shares and stock options, allowances of deferred tax assets, valuation of debt related instruments, accrued expenses and liabilities, and cash flow assumptions regarding going concern considerations. Given the situation surrounding the COVID-19 pandemic, many estimates and assumptions have required increased judgment and are subject to a higher degree of variability and volatility. Although management believes the estimates that have been used are reasonable, as events continue to evolve and additional information becomes available, actual results could vary from the estimates that were used.

Concentration of Credit Risk

The Company maintains cash balances with various financial institutions. Account balances at these institutions are insured by the Federal Deposit Insurance Corporation up to $250,000 per depositor. At various times during the year, bank account balances may have been in excess of federally insured limits. The Company has not experienced losses in such accounts. The Company believes that it is not subject to unusual credit risk beyond the normal credit risk associated with commercial banking relationships.

Research and Development

Research and development costs are expensed as incurred. Research and development expenses include personnel costs associated with research and development activities, including third party contractors to perform research, conduct clinical trials, and manufacture drug supplies and materials. The Company accrues for costs incurred by external service providers, including contract research organizations and clinical investigators, based on its estimates of service performed and costs incurred. These estimates include the level of services performed by third parties, patient enrollment in clinical trials, administrative costs incurred by third parties, and other indicators of the services completed. Approximately $61,000 of prepaid expenses at September 30, 2022 and December 31, 2021 relate to a manufacturing services agreement.

Stock Based Compensation

The Company recognizes compensation costs resulting from the issuance of stock-based awards to employees, non-employees and directors as an expense in the condensed consolidated statements of operations over the requisite service period based on a measurement of fair value for each stock-based award. The fair value of each option grant to employees, non-employees and directors is estimated as of the date of grant using the Black-Scholes option-pricing model, net of actual forfeitures. The fair value is amortized as compensation cost on a straight-line basis over the requisite service period of the awards, which is generally the vesting period.

The fair value of each stock option grant is estimated on the date of grant using the Black-Scholes option-pricing model. Prior to January 12, 2022, the Company was a private company and the Company’s common stock has been publicly traded since that date. As a result, the Company has lacked company-specific historical and implied volatility information. Therefore, it has estimated its expected stock volatility based on the historical data regarding the volatility of a publicly traded set of peer companies. The expected term of stock options granted was between five and seven years. The risk-free interest rate was determined by reference to the U.S. Treasury yield curve in effect at the time of grant of the award for time periods approximately equal to the expected term of the award.

Common Stock Valuations

Prior to the IPO, the Company was required to periodically estimate the fair value of common stock with the assistance of an independent third-party valuation expert when issuing stock options and computing its estimated stock based compensation expense and value of shares issued in acquiring product candidates. The assumptions underlying these valuations represented management’s best estimates, which involved inherent uncertainties and the application of significant levels of management judgment. In order to determine the fair value, the Company considered, among other things, contemporaneous valuations of the Company’s common stock; the Company’s business, financial condition and results of operations, including related industry trends affecting its operations; the likelihood of achieving various liquidity events; the lack of marketability of the Company’s common stock; the market performance of comparable publicly traded companies; and U.S. and global economic and capital market conditions. After the closing of the Company’s IPO on January 14, 2022, the fair value of common stock is determined by using the closing price of the Company’s common stock on The Nasdaq Capital Market.

Treasury Stock

The Company’s board of directors has authorized the repurchase of up to $1 million of shares of the Company’s common stock, from time to time, in the open market or through privately-negotiated transactions, at such times and at such prices as the Company’s management may decide. Treasury stock purchases are accounted for under the cost method whereby the entire cost of the acquired common stock is recorded as treasury stock.

Debt Discount and Derivative Instruments

The initial fair value of the redemption feature relating to the convertible debt instruments was treated as a debt discount and was amortized over the term of the related debt using the straight-line method, which approximates the interest method. Amortization of debt discount is recorded as a component of interest expense. If a loan is paid in full, any unamortized debt discounts will be removed from the related accounts and charged to operations. As the convertible debt was converted into common stock at the date of the IPO, the unamortized debt discount was charged to interest expense. In accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Update (“ASU”) 2015-03, Interest - Imputation of Interest, the unamortized debt discount at December 31, 2021 was presented in the accompanying condensed consolidated balance sheet as a direct deduction from the carrying amount of the related debt.

The Company accounts for derivative instruments in accordance with FASB Accounting Standards Codification (“ASC”) 815, Derivative and Hedging, which establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other financial instruments or contracts and requires recognition of all derivatives on the balance sheet at fair value. The Company’s derivative financial instrument consisted of an embedded feature contained in the Company’s convertible debt that was bifurcated and accounted for separately. See Note 3 to the condensed consolidated financial statements for further details.

Fair Value Measurements

The Company applies FASB ASC 820, Fair Value Measurement (“ASC 820”), which establishes a framework for measuring fair value and clarifies the definition of fair value within that framework. ASC 820 defines fair value as an exit price, which is the price that would be received for an asset or paid to transfer a liability in the Company’s principal or most advantageous market in an orderly transaction between market participants on the measurement date. The fair value hierarchy established in ASC 820 generally requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. Observable inputs reflect the assumptions that market participants would use in pricing the asset or liability and are developed based on market data obtained from sources independent of the reporting entity. Unobservable inputs reflect the entity’s own assumptions based on market data and the entity’s judgments about the assumptions that market participants would use in pricing the asset or liability and are to be developed based on the best information available in the circumstances.

The carrying value of the Company’s prepaid expenses, accounts payable, and accrued expenses approximate fair value because of the short-term maturity of these financial instruments. The redemption feature of the debt instruments is recorded at fair value. See Note 4 to the condensed consolidated financial statements for further details.

The valuation hierarchy is composed of three levels. The classification within the valuation hierarchy is based on the lowest level of input that is significant to the fair value measurement. The levels within the valuation hierarchy are described below:

Level 1 Inputs: Observable inputs such as quoted prices (unadjusted) in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities.

Level 2 Inputs: Inputs other than quoted prices that are observable for the asset or liability, either directly or indirectly. These include quoted prices for assets or liabilities recently traded in active markets, with similar underlying terms, as well as direct or indirect observable inputs, such as interest rates and yield curves that are observable at commonly quoted intervals, as well as quoted prices for identical or similar assets or liabilities in markets that are not active.

Level 3 Inputs: Unobservable inputs, such as estimates, assumptions, and valuation techniques when little or no market data exists for the assets or liabilities, that reflect the reporting entity’s own assumptions.

Deferred Offering Costs

Deferred offering costs consisted of legal, accounting, printing, and filing fees that the Company capitalized which were offset against the proceeds from the IPO.

Income Taxes

The Company accounts for income taxes using the asset-and-liability method in accordance with FASB ASC 740, Income Taxes (“ASC 740”). 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 income taxes are recognized for the tax effect of temporary differences between the financial statement carrying amount of assets and liabilities and the amounts used for income tax purposes and for certain changes in valuation allowances. Valuation allowances are recorded to reduce certain deferred tax assets when, in management’s estimation, it is more-likely-than-not that a tax benefit will not be realized. A valuation allowance has been recognized for all periods since it is more-likely-than-not that some portion or all of the deferred tax assets will not be realized in future periods.

The Company follows the guidance in FASB ASC Topic 740-10 in assessing uncertain tax positions. The standard applies to all tax positions and clarifies the recognition of tax benefits in the financial statements by providing for a two-step approach of recognition and measurement. The first step involves assessing whether the tax position is more-likely-than-not to be sustained upon examination based upon its technical merits. The second step involves measurement of the amount to be recognized. Tax positions that meet the more-likely-than-not threshold are measured at the largest amount of tax benefit that is greater than 50% likely of being realized upon ultimate finalization with the taxing authority. The Company recognizes the impact of an uncertain income tax position in the financial statements if it believes that the position is more likely than not to be sustained by the relevant taxing authority. The Company will recognize interest and penalties related to tax positions in income tax expense. At September 30, 2022 and December 31, 2021, the Company had no unrecognized uncertain income tax positions, and therefore no amounts have been recognized in the condensed consolidated financial statements.

Net Loss per Share

The Company reports loss per share in accordance with FASB ASC 260-10, Earnings Per Share, which provides for calculation of basic and diluted earnings per share. Basic earnings per share includes no dilution and is computed by dividing net income or loss available to common stockholders by the weighted average common shares outstanding for the period. Diluted earnings per share reflect the potential dilution of securities that could share in the earnings of an entity. The calculation of diluted net earnings (loss) per share gives effect to common stock equivalents; however, potential common shares are excluded if their effect is anti-dilutive.

Potentially dilutive securities not included in the computation of loss per share for the three and nine months ended September 30, 2022 and 2021 included options to purchase 1,628,813 and 903,468 shares of common stock, respectively. All common share amounts as of September 30, 2022 and December 31, 2021 and per share amounts for the three and nine months ended September 30, 2022 and 2021 have been adjusted to reflect a 1-for-26.4 reverse stock split of the Company’s common stock effectuated on September 16, 2021. Other potentially dilutive securities also not included in the computation of loss per share for the three and nine months ended September 30, 2022 included warrants to purchase 187,500 shares of the Company’s common stock.

Recently Adopted Accounting Pronouncements

The Company has evaluated all recent accounting pronouncements and believes that none of them will have a material effect on the Company’s financial position, results of operations, or cash flows, except as described below.

Earnings per Share

In May 2021, the FASB issued ASU 2021-04, Earnings Per Share (Topic 260), Debt-Modifications and Extinguishments (Subtopic 470-50), Compensation-Stock Compensation (Topic 718), and Derivatives and Hedging-Contracts in Entity’s Own Equity (Subtopic 815-40). This ASU addresses an issuer’s accounting for certain modifications or exchanges of freestanding equity-classified written call options. This amendment is effective for fiscal years beginning after December 15, 2021, including interim periods within those fiscal years, and was effective for the Company beginning January 1, 2022. This ASU did not have a material impact on the Company’s consolidated financial statement presentation.

Recent Accounting Pronouncements Not Yet Adopted

Debt with Conversion and Other Options and Derivatives and Hedging

The FASB recently issued ASU 2020-06, Debt - Debt with Conversion and Other Options (Subtopic 470- 20) and Derivatives and Hedging - Contracts in Entity’s Own Equity (Subtopic 815-40): Accounting for Convertible Instruments and Contracts in an Entity’s Own Equity (“ASU 2020-06”), to reduce complexity in applying U.S. GAAP to certain financial instruments with characteristics of liabilities and equity. The guidance in ASU 2020-06 simplifies the accounting for convertible debt instruments and convertible preferred stock by removing the existing guidance that requires entities to account for beneficial conversion features and cash conversion features in equity, separately from the host convertible debt or preferred stock. The guidance in FASB ASC Subtopic 470-20 applies to convertible instruments for which the embedded conversion features are not required to be bifurcated from the host contract and accounted for as derivatives. In addition, the amendments revise the scope exception from derivative accounting in FASB ASC Subtopic 815-40 for freestanding financial instruments and embedded features that are both indexed to the issuer’s own stock and classified in stockholders’ equity, by removing certain criteria required for equity classification. These amendments are expected to result in more freestanding financial instruments qualifying for equity classification (and, therefore, not accounted for as derivatives), as well as fewer embedded features requiring separate accounting from the host contract. The amendments in ASU 2020-06 further revise the guidance in FASB ASC 260, Earnings Per Share, to require entities to calculate diluted earnings per share (“EPS”) for convertible instruments by using the if-converted method. In addition, entities must presume share settlement for purposes of calculating diluted EPS when an instrument may be settled in cash or shares. The amendments in ASU 2020-06 are effective for public entities that meet the definition of an SEC filer, excluding smaller reporting companies as defined by the SEC for fiscal years beginning after December 15, 2021. For all other entities, including the Company, the amendments are effective for fiscal years beginning after December 15, 2023. Early adoption is permitted. The Company is currently evaluating the impact this standard will have on its consolidated financial statements.

Codification Improvements

In October 2020, the FASB issued ASU 2020-10, Codification Improvements. The guidance contains improvements to the codification by ensuring that all guidance that requires or provides an option for an entity to provide information in the notes to financial statements is codified in the disclosure section of the codification. The guidance also contains codifications that are varied in nature and may affect the application of the guidance in cases in which the original guidance may have been unclear. This ASU is effective for fiscal years beginning after December 15, 2021, and interim periods within annual periods beginning after December 15, 2022. The Company does not expect the adoption of ASU 2020-10 to have a material impact on its consolidated financial statements.

Note 3 – Convertible Notes - Related Parties

Commencing in May 2017, the Company entered into Subordinated Convertible Promissory Note Agreements (the “Agreements”) with certain lenders (together, the “Holders” or individually, the “Holder”), pursuant to which the Company issued Subordinated Convertible Promissory Notes (individually the “Note” or together, the “Notes”) to the Holders, principally all to the Chief Executive Officer (“CEO”) and founder of the Company, a member of the Company’s board of directors and third parties that are family members of the founder and CEO. Interest on the unpaid principal balance accrued at a rate of 5% per annum, computed on the basis of the actual number of days elapsed and a year of 365 days. Unless earlier converted into shares of the Company’s common stock or preferred stock (collectively, the “Equity Securities”), the principal and accrued interest was to be due and payable by the Company on demand by the Holders at any time after the earlier of (i) the Maturity Date (as defined in each Agreement) and (ii) the closing of the Next Equity Financing. “Next Equity Financing” means the next sale, or series of related sales, by the Company of its Equity Securities pursuant to which the Company received gross proceeds of not less than $5.0 million for Notes issued in 2017 and through November 2020 and $7.5 million for Notes issued after November 2020 (including the aggregate amount of debt securities converted into Equity Securities upon conversion or cancellation of the Notes). The Company’s IPO qualified as a Next Equity Financing.

In general, the stated maturity date was two years from the date of issuance, except for the Notes issued in December 2020 and thereafter (in the aggregate principal amount of approximately $2.1 million) which had a stated maturity date of three years. For Notes issued in 2017 and through September 2018, the default interest rate of 20% was added to the Notes for the period after the stated maturity date.

The Notes were to automatically convert into the type of Equity Securities issued in the Next Equity Financing upon closing. The number of shares of such Equity Securities to be issued was equal to the quotient obtained by dividing the outstanding principal and unpaid accrued interest due on the Note on the date of conversion by the lesser of (i) 80% of the price paid per share for Equity Securities by the investors in the Next Equity Financing, or (ii) an equity valuation of $25 million ($50 million for Notes issued after December 2020). On January 14, 2022, all outstanding Notes and accrued interest were converted into an aggregate of 1,225,384 shares of the Company’s common stock as the IPO qualified as a Next Equity Financing.

Certain embedded features contained in the Notes in the aggregate were embedded derivative instruments, which were recorded as a debt discount and derivative liability at the issuance date at their estimated fair value for all Notes of approximately $2.4 million. Amortization of debt discount for the Notes recorded as interest expense was approximately $1.6 million for the nine months ended September 30, 2022, and approximately $192,000 and approximately $455,000 for the three and nine months ended September 30, 2021, respectively. The amount for the nine months ended September 30, 2022 contains amortization charged to interest expense of approximately $34,000 up to the date of the IPO and the full amount of the unamortized debt discount of approximately $1.5 million charged to interest expense on the date of the IPO.

Accrued interest expense associated with the Notes at December 31, 2021 was approximately $180,000. Accrued interest at the date of the IPO was approximately $187,000 and was converted into common stock as the IPO qualified as a Next Equity Financing. Total interest expense, including accrued interest and amortization of the debt discount, amounted to approximately $1.6 million for the nine months ended September 30, 2022, and $236,000 and $573,000 for the three and nine months ended September 30, 2021, respectively.

The carrying value of the outstanding related-party convertible notes at December 31, 2021 was as follows:

Roll-over Notes

Effective October 1, 2020, all Notes which matured, and were not repaid or converted, were rolled over, including the default interest rate of 20% as disclosed above. Approximately $805,000 of such Notes were rolled over through December 31, 2021, of which approximately $166,000 occurred prior to December 31, 2020 and approximately $639,000 occurred between January 1, 2021 and December 31, 2021. Since the terms of the new notes were not substantially different from the Notes, this was not accounted for as a debt modification or debt extinguishment.

Note 4 – Redemption Liability

The fair value of the redemption liability is calculated under Level 3 of the fair value hierarchy, determined based upon a probability-weighted expected returns method (“PWERM”). This PWERM was determined to be the most appropriate method of estimating the value of possible redemption or conversion outcomes over time, since the Company had not entered into a priced equity round through December 31, 2021. The significant assumptions utilized in these calculations are the possible exit scenarios (either a conversion of the principal and accrued interest of the Notes in the event of a Next Equity Financing (see Note 3 to the condensed consolidated financial statements), a repayment of the Notes and accrued interest in the event of a corporate transaction (as defined in the Notes) or a repayment of the Notes and accrued interest at maturity), the pre-money valuation of the Company’s common stock, the probabilities of such exit events occurring, and discounts/premiums available to the Holders at such measurement dates. The calculation of the redemption liability at December 31, 2021 was based upon the actual incremental value derived by the Holders at the IPO date. The fair value of the redemption liability is re-measured at each period and is summarized as of December 31, 2021 as follows:

The change in fair value of a loss of approximately $76,000 and approximately $980,000 for the three and nine months ended September 30, 2021, respectively, was recorded as a component of other expense in the accompanying condensed consolidated statements of operations. The balance of approximately $980,000 as of December 31, 2021 and as of the date of the IPO was converted into common stock in connection with the related-party convertible debt to which it related.

Note 5 – Common Stock

Pursuant to an amendment to the Company’s Certificate of Incorporation filed in April 2019, the Company increased the number of authorized shares of common stock to 250,000,000 shares. See the Net Loss Per Share section of Note 2 to the condensed consolidated financial statements for a discussion of the reverse stock split effectuated on September 16, 2021.

On January 14, 2022, the Company closed the IPO pursuant to which it issued 3,750,000 shares of its common stock at a public offering price of $4.00 per share. The gross proceeds to the Company from the IPO were $15.0 million, prior to deducting underwriting discounts of approximately $1.1 million and commissions and other offering expenses of approximately $1.0 million. Other offering expenses include deferred offering costs of approximately $547,000 that were capitalized prior to December 31, 2021 and additional costs incurred prior to the date of the IPO. The net proceeds to the Company from the IPO were approximately $13.0 million. The Company granted the underwriters a 45-day option to purchase up to an additional 562,500 shares of common stock at the public offering price less discounts and commissions, to cover over-allotments; however, this option expired unexercised. Additionally, and as a result of the completion of the IPO, all of the Company’s convertible debt and accrued interest was converted into an aggregate of 1,225,384 shares of the Company’s common stock pursuant to the terms of the Notes. Outstanding principal of approximately $3.7 million, accrued interest of approximately $187,000, and a redemption liability of approximately $980,000 were converted to common stock as the IPO qualified as a Next Equity Financing. In addition, the Company issued warrants in connection with the IPO. See Note 6 to the condensed consolidated financial statements for a discussion of the warrants issued.

On February 16, 2022, the Company entered into an agreement for marketing and investor related consulting services. Pursuant to the agreement, compensation includes a monthly fee and an upfront issuance of shares of the Company’s common stock. On the effective date of February 16, 2022, the Company issued 31,746 shares of common stock with a per share value of $3.15 and a total value of $100,000 as compensation expense.

On June 9, 2022, the Company’s Board of Directors authorized the repurchase of up to $1.0 million of shares of the Company’s common stock until December 31, 2022. On June 10, 2022, the Company entered into a Repurchase Agreement (the “Repurchase Agreement”) with a financial institution pursuant to which such financial institution may purchase shares of the Company’s common stock upon the terms and conditions set forth in such agreement, including in accordance with the guidelines specified in Rules 10b5-1 and 10b-8 under the Securities Exchange Act of 1934, as amended. Shares of the Company’s common stock may be repurchased in open market or through privately-negotiated transactions. Pursuant to the Repurchase Agreement, the financial institution shall cease purchasing shares of the Company’s common stock upon the earlier of (i) the close of trading on December 31, 2022, (ii) the completion of repurchases up to the approved amount and (iii) the date upon which the Company gives notice of termination of the Repurchase Agreement to the financial institution. The Company will determine the timing and amount of any repurchases based upon its evaluation of market conditions, applicable SEC guidelines and regulations, and other factors.

During the three and nine months ended September 30, 2022, the Company purchased 45,109 and 75,109 shares of its common stock, respectively, for a total purchase cost of approximately $37,000 and $62,000, respectively.

Note 6 – Stock Based Compensation

Incentive Plans and Options

Under the Company’s 2017 Stock Incentive Plan (the “2017 Stock Incentive Plan”) the Company may grant incentive stock options, non-statutory stock options, rights to purchase common stock, stock appreciation rights, restricted stock, performance shares, and performance units to employees, directors, and consultants of the Company and its affiliates. Up to 94,696 shares of the Company’s common stock may be issued pursuant to the 2017 Stock Incentive Plan.

The Company has granted options to acquire 92,801 shares of common stock at $13.20 per share under the 2017 Stock Incentive Plan, and 1,895 shares remain available for issuance. At both September 30, 2022 and December 31, 2021, there were options outstanding to acquire 92,801 shares of common stock. As of both September 30, 2022 and December 31, 2021, all such options were fully vested, and the weighted average remaining contractual life for such options was approximately 5.4 and 6.2 years, respectively.

In July 2019, the Company authorized a new plan (the “2019 Stock Incentive Plan”). The Company initially reserved 284,090 shares of its common stock for issuance pursuant to the 2019 Stock Incentive Plan in the form of incentive stock options, non-statutory stock options, rights to purchase common stock, stock appreciation rights, restricted stock, performance shares, and performance units to employees, directors, and consultants of the Company and its affiliates. On August 30, 2019, the Company approved an increase in the number of shares authorized for issuance under the 2019 Stock Incentive Plan by 2,575,757 shares. In January 2021, the Company approved an increase in the number of shares reserved for issuance under the 2019 Stock Incentive Plan by 574,494 shares. On May 31, 2021, the Company approved an increase in the number of shares reserved for issuance under the 2019 Stock Incentive Plan by 467,171 shares. At both September 30, 2022 and December 31, 2021, a total of 3,901,512 shares were authorized for issuance under the 2019 Stock Incentive Plan.

The Company has granted options to acquire 3,386,385 and 2,420,514 shares of common stock under the 2019 Stock Incentive Plan, and 515,127 and 1,480,998 shares of common stock remain available for issuance under the 2019 Stock Incentive Plan at September 30, 2022 and December 31, 2021, respectively. There are stock options outstanding to acquire 1,536,012 and 810,667 shares of common stock with weighted average exercise prices of $3.80 and $3.25 and weighted average contractual terms of 8.7 years and 8.0 years at September 30, 2022 and December 31, 2021, respectively.

The following table summarizes stock-based activities under the 2017 Stock Incentive Plan and 2019 Stock Incentive Plans:

The fair value of stock option awards is estimated at the date of grant using the Black-Scholes option-pricing model. The estimated fair value of each stock option is then expensed over the requisite service period, which is generally the vesting period (ranging between immediate vesting and four years). The determination of fair value using the Black-Scholes model is affected by the Company’s share price as well as assumptions regarding a number of complex and subjective variables, including expected price volatility, expected life, risk-free interest rate and forfeitures.

Stock options granted during the three and nine months ended September 30, 2022 and 2021 were valued using the Black-Scholes option-pricing model with the following weighted average assumptions:

The weighted average grant date fair value of stock options granted during the three months ended September 30, 2022 was approximately $0.78. The weighted average grant date fair value of stock options granted during the nine months ended September 30, 2022 and 2021 was approximately $2.70 and $5.47, respectively. The weighted average fair value of stock options vested during the three and nine months ended September 30, 2022 was approximately $1.60 and $1.10, respectively, and during the three and nine months ended September 30, 2021 was approximately $0.53 and $5.46, respectively.

Included in the above table are stock options granted in 2019 to purchase 231,058 shares of the Company’s common stock at an exercise price of $0.08 per share, which vest upon a specified performance condition. These stock options vested at the date of the Company’s IPO, which was the specified performance condition.

Total stock based compensation expense included in the accompanying condensed consolidated statements of operations was as follows:

At September 30, 2022, the total unrecognized compensation expense related to non-vested options was approximately $2.1 million and is expected to be recognized over the remaining weighted average service period of approximately 2.9 years.

In March 2021, the Company modified the stock option exercise price for stock options granted during 2020, increasing the exercise price of such stock options (after adjusting for the 1-for-26.4 reverse stock split) from $0.18 or $2.60 to $0.31 or $3.82 per share, respectively. The increase in the stock option exercise price was accounted for as a modification of the stock grant in 2021; however, the impact on the Company’s condensed consolidated statements of operations was immaterial.

Warrants

In connection with the IPO, the Company issued warrants to purchase such number of shares of the Company’s common stock equal to 5% of the total shares of common stock issued in the IPO. The warrants are exercisable at $5.00 per share, were not exercisable within the first six months after issuance, and may, under certain circumstances, be exercised on a cashless basis. The exercise price of the warrants is subject to standard antidilutive provision adjustments for stock splits, stock combinations, or similar events affecting the Company’s common stock. The Company has determined that these warrants should be classified as equity instruments since they do not require the Company to repurchase the underlying common stock and do not require the Company to issue a variable amount of common stock. In addition, these warrants are indexed to common stock and do not have any unusual antidilution rights. Terms of the warrants outstanding at September 30, 2022 are as follows:

Note 7 – Related-party Transactions

As described in Note 3 to the condensed consolidated financial statements, the Company entered into the Notes with the Holders commencing in May 2017. The Holders of substantially all of the Notes were the Company’s founder and CEO, a member of the Company’s board of directors, and third parties that are family members of the founder and CEO. The Notes were converted into shares of the Company’s common stock on January 14, 2022 in connection with the closing of the IPO.

In addition to the above Notes, the Company had amounts due to the founder and CEO that totaled $200,000 at December 31, 2021 for accrued compensation. See Note 8 to the condensed consolidated financial statements. On April 1, 2022, the founder and CEO received the full amount of $200,000.

On January 4, 2022 and January 6, 2022, the Company issued unsecured promissory notes in the aggregate principal amount of approximately $139,000 (including an original issuance discount of an aggregate of approximately $14,000) to three related-party investors. The notes were to accrue interest at a rate of 12% per annum and mature upon the earlier of (i) June 30, 2022, and (ii) the closing of a subsequent equity financing. “Subsequent Equity Financing” means the next sale (or series of related sales) by the Company of its equity securities following the date of the notes pursuant to which the Company receives gross proceeds of not less than $5.0 million. The notes were repaid in full on January 21, 2022 following the Company’s IPO on January 14, 2022 as the IPO was considered a Subsequent Equity Financing.

Additionally, on April 18, 2022, the founder and CEO exercised options to purchase up to 240,526 shares of the Company’s common stock at a weighted average exercise price of $0.10 per share for a total of approximately $24,000.

Note 8 – Commitments and Contingencies

Small Molecule Analogues

On December 30, 2019, the Company acquired a series of small molecule analogues pursuant to an Asset Purchase Agreement (“APA”). Pursuant to the APA, the Company is required to make a payment of $50,000 upon raising of at least $2.0 million in funding, and up to $1.75 million based upon successfully meeting clinical and sales milestones. As of September 30, 2022 and December 31, 2021, such fund-raising requirement was not met and no payments were made pursuant to the APA. The Company included, in accounts payable at both September 30, 2022 and December 31, 2021, the $50,000 required initial payment. Milestone based payments, if any, will be expensed as incurred.

Employment Agreement

In January 2019, the Company entered into a three-year employment agreement with its CEO which provides a specified base salary and bonus. The employment agreement also provides the CEO with certain benefits while employed and if employment ceases. The Company accrued $200,000 in 2019 related to the CEO’s base salary as per the employment agreement, which was included in due to founder as of December 31, 2021, which was paid in full on April 1, 2022. No bonus was approved by the board of directors of the Company for any period through September 30, 2022.

In January 2020, the Company amended the employment agreement pursuant to which, in lieu of a cash base salary, the CEO was to be compensated with stock options to purchase 7,575 shares of the Company’s common stock per month (at an exercise price based upon the Company’s most recent 409A valuation at the date of the grant) effective January 1, 2020 until the Company received a minimum of $3.0 million of gross proceeds from the sale of its securities, after which time, cash compensation, pursuant to the employment agreement, would be paid.

Effective January 1, 2021, the Company amended the employment agreement with its CEO to provide a revised base salary pre-funding (as defined in the employment agreement). In lieu of cash base salary, the CEO was to be compensated with stock options to purchase 18,939 shares of the Company’s common stock per month at an exercise price of $7.82 per share effective January 1, 2021 until funding meets or exceeds $5.0 million, after which time, cash compensation, pursuant to his employment agreement, would be paid. The amended employment agreement also provides for a future base salary for the CEO after the Company receives funding greater than $5.0 million or completes an initial public offering or similar transaction as set forth in the employment agreement. In addition, if the CEO acts as the “finder” of an investor who purchases more than $5.0 million of the Company’s equity, he will receive a grant of stock options to acquire 757,575 shares of common stock of the Company at an exercise price equal to the most recent fair value of the Company’s common stock at the time of grant.

On June 1, 2021, the Company entered into an Amended and Restated Employment Agreement, as amended on September 24, 2021 (the “Amended and Restated Employment Agreement”) with the Company’s CEO. The term of the Amended and Restated Employment Agreement commenced upon the closing of the Company’s IPO and continues for a period of five years and automatically renews for successive one-year periods at the end of each term unless either party provides written notice of their intent not to renew at least 60 days prior to the expiration of the then effective term. Pursuant to the Amended and Restated Employment Agreement, the CEO will receive an annual base salary of $485,000, which may be increased from time to time, and shall be eligible to receive an annual cash bonus equal to 55% of his then base salary based upon the achievement of Company and individual performance targets established by the Company’s board of directors. In addition, in the first year in which the Company’s market capitalization (as defined in the Amended and Restated Employment Agreement) equals or exceeds (i) $250 million, the CEO shall receive a cash payment of $150,000; (ii) $500 million, the CEO shall receive a cash payment of $350,000; and (iii) $1.0 billion, the CEO shall receive a cash payment of $750,000. Furthermore, following the date of the Company’s IPO, the CEO was issued an option to purchase 757,575 shares of the Company’s common stock at an exercise price of $4.00 per share, which options shall vest over a 48-month period commencing 12 months after the date of grant. This shall be in addition to any additional equity-based compensation awards the Company may grant the CEO from time to time.